Reading ‘ease of doing business’ rankings : Business Line July 13 2018

While they encourage States to improve governance systems, a high rank doesn’t guarantee higher investments

The ranking of States on the basis of ‘ease of doing business’ on a regular basis is a good exercise as it helps to evaluate the best practices in governance. By formally putting down the States on a scale, benchmarking becomes easier and they can work towards improving their position.

The new dimension added this time is the feedback from users. The process hence is twofold where the first step involves complying with a series of reforms in terms of changes in systems, which is easier to implement. But more important is how the stakeholders feel about the same. By giving a weighted score, both the issues are addressed.

Newer States better placed

Quite interestingly while States like Telangana and Jharkhand score 100 for ‘reform evidence’, the corresponding score on feedback was 83.95 and 81.67, respectively. In fact, the State with the top score in ‘feedback’ was AP with 86.5. Quite clearly, tick-marking a reform is easier to do as against getting it right in terms of implementation. It is not surprising that there have been indications made that in future the feedback criteria would be the more important one.

How is one to read into these numbers? Sates which are new and relatively small would be better placed to score well as those starting off would find it easier to bring in the best practices as adaptation would be easier. The larger State economies will have legacy issues and have to comply with the book gradually.

A simple thing like making applications for construction or extension of a building as a factory would have an established system that has to be disbanded before creating a new one, which will take time as old records and staffing, among other things, have to be addressed. At times bidding processes have to be invoked to choose vendors which can be time-consuming. Therefore, there would be time lags. Often a lower score here would not be because of ideological differences but operational issues.

Some surprises

A surprise element is Maharashtra, which is probably the most industrialised State and also lodging the financial hub of Mumbai, having a rank of 13. Tamil Nadu comes even lower at 15. These two are considered to be the more advanced States along with Gujarat and Karnataka. It does appear that State rankings on ‘ease of doing business’ are not a necessary condition for drawing investment.

Investment decisions are driven by factors such as: availability of power, intrinsic strengths such as being a mineral base, roads, access to ports, links with ancillary industries, availability of skilled and unskilled labour, availability of land or rentals, and access to finance. This would be on the supply side.

Also, on the demand side, linkages need to be strong and hence investment decisions are not taken solely based on ‘ease of doing business’. Large IT hubs in Bengaluru would attract all retail participants irrespective of the EODB. It would probably only be at the margin when an entrepreneur has to choose between two States other things being the same that the ranking could become decisive.

In this context, the ranking of States on these criteria of doing business can be juxtaposed with those related to IEMs filed, as this reflects investment intentions. The linkage between the two is clear as the hypothesis is that a higher rank in EODB should ideally increase investment intentions which are captured by the IEMs that are filed.

The top 10 States in terms of value of IEMs filed for 2016 and 2017 have been juxtaposed with the ‘ease of doing business’ rank to validate this hypothesis (see Table).

 

It shows that the EODB rank is not necessary to draw in large investments. Maharashtra, Odisha, Tamil Nadu, Uttar Pradesh and West Bengal have ranks in double digits. Yet, they score well in terms of investment intentions. Investors come in where there is opportunity and would probably increase their exposures when the environment is congenial. But they would not stop their investment in case it is tough to do business.

Therefore, some States with good rank are able to get the additional ‘delta’ on this score. A State like Bihar which has a low rank of 18 in EODB did well in terms of investment in 2016 with a rank of 10. When a State is rich in minerals, investment would come irrespective of whether or not the EODB is congenial. This cost of doing business would be higher and get reflected in final prices.

An analogy can be provided with the national-level EODB, where India was a preferred destination even when the World Bank rank was in the 130s. Improving the rank does bring in some additional FDI which was visible when the score improved in the last two years. But the opportunity has to be there. At a different level, the country’s credit rating at just about investment grade does not deter FPI and FDI as India has been revealed to be a preferred market for investments.

Valuable signposts

Therefore, not much should be read into the State ranking for EODB as being the be all and end all for future investment. These are valuable signposts on what should be done for better governance systems. These are absolutely essential and there can be no argument on this score.

This kind of benchmarking will encourage States to at least comply with the rules to ensure that they score well on ‘reform evidence’. But having these essentials in place does not guarantee investment and governments need to work on the other prerequisites too, such as creating infrastructure to multiply these flows.

It is, therefore, one parameter on which to judge State economies and definitely not the overriding one. This is the spirit in which the ranking must be viewed.