What Drives Investment Decisions?

What drives investment decisions? Is it hard core data about actual operating conditions or perceptions? It would be logical for perceptions to be based on facts and data. But a just-released index ranking states as investment destinations - the National Council of Applied Economic Research (NCAER) State Investment Potential Index (N-SIPI) - gives a different picture.

The index rests on five pillars, four of them objective and data driven (labour, infrastructure, economic conditions, political stability and governance) and one subjective (perceptions based on a survey of industry covering current business climate, availability of land, labour, infrastructure and other hurdles companies face in individual states). Of the 21 states this index is applied to, the top five investment destinations are Gujarat, Delhi, Tamil Nadu, Andhra Pradesh and Maharashtra.

But when the states are ranked on only the four data-driven parameters, Delhi and Gujarat trade places, Tamil Nadu and Maharashtra retain the third and fifth positions respectively and Goa pushes Andhra Pradesh to seventh place. (Goa doesn’t figure in the first index since the perception surveys were not carried out in six north-eastern states, Sikkim, Goa and Jammu and Kashmir).

States that move up on the perceptions-based index are Andhra Pradesh, Chhattisgarh, Rajasthan, Madhya Pradesh and Assam. Those that slip are Kerala, West Bengal, Punjab and Odisha.

It isn’t just overall rankings. The same discrepancy also comes through in the 51 sub-indicators making up the five pillars. Industry’s perception was that Gujarat, West Bengal, Rajasthan, Uttarakhand and Chhattisgarh top in the availability of skilled labour. But secondary data shows that the top five states are Kerala, Maharashtra, Himachal Pradesh, Tamil Nadu and Punjab.

The bottom five states in perceptions on this category are Karnataka, Telengana, Andhra Pradesh, Punjab and Jharkhand. Going purely by data, however, the bottom five are Bihar, Jharkhand, Uttar Pradesh, Rajasthan and Assam.

In fact, Gujarat tops quite a few parameters based on perception – rail connectivity, road quality, availability of power, access to finance, political stability. But when judged only by facts and data, barring a couple of areas, it is dislodged from that position by other states, though it does manage to hold on to second position in some.

Some of the discrepancy can be explained, says Shekhar Shah, NCAER director, could be due to lack of communication (or perhaps better communication) and some because government policies or initiatives have not got transmitted to the ground.

The perception survey unsettles several long-held assumptions that shape discourse on economic reforms. The continued noise over labour laws and labour relations could just be a lot of barking up the wrong tree, because less than 50 per cent of the surveyed companies listed these as key constraints. Corruption is the top concern, with 79.4 per cent of the respondents listing that as a concern. This was followed by getting approvals before starting a business (72.1 per cent) and getting environmental clearances (66.7 per cent).

But since the N-SIPI is about both perceptions and data, let’s look at how things stack up.

On the first parameter of labour (covering labour availability, quality, labour climate and labour competitiveness), Kerala, Tamil Nadu and Karnataka are the top three. On infrastructure (connectivity, competition, access and growth potential), Delhi, Punjab and Gujarat emerge as the top three.

Delhi, Andhra Pradesh and Maharashtra top the economic climate (micro-economic fundamentals, resource endowments, market-led demand and government) indicator while Gujarat, Tamil Nadu and Madhya Pradesh do so in the case of governance and political stability (crime, law and order, political equity, government efficiency and corruption).

When it comes to perceptions (on labour related issues, political stability and governance related issues, business expectations, infrastructure related issues and land related issues), Gujarat, Rajasthan and Chhattisgarh top.

How relevant are such indices to investment decisions by companies? Various speakers at a seminar where the N-SIPI was unveiled said companies don’t go by indexes alone, but often look for a lot of intangible factors.

Indexes also miss out on some granularities. Dilip Chenoy, former head of the Society for Indian Automobile Manufacturers and chairman of the National Skill Development Corporation, pointed out that Haryana may well show the least number of mandays lost due to strikes at an overall level, but could top in terms of mandays lost in the automobile industry. This could influence the decision of an automobile or component manufacturer on where to locate a new plant.

But what this index is most certain to do is set off a competition among states to improve attractiveness for industry. And that can only be good for the economy and the country.