(Bloomberg) -- When Daikin Industries Ltd., the Japanese air conditioning maker, began operating in India 25 years ago, it was importing finished units from Thailand and selling it to local consumers. 

Now, it not only manufactures them locally in India for an AC market that’s become the second-biggest in the world, but also exports the units to consumers in the Middle East and Africa. It operates three factories in India now, and two research and development centers.

Kanwal Jeet Jawa, chief executive officer of Daikin’s India unit, says the company has seen a marked shift in the business environment since 2009, which has made it easier for foreign investors to set up factories in the country. Key among them have been the improvements in transport and electricity infrastructure. He also cites manufacturing incentives that have been a “game changer” for the industry and a government under Prime Minister Narendra Modi that’s been responsive to the needs of foreign investors.

But as Modi prepares for a likely third term in office when India’s mammoth elections end on June 1, global firms say there’s still plenty of work for the new government to do. Challenges are substantial, with often-cited policy-flip flops, bureaucratic delays and a lack of land availability. 

Even with an improvement in business sentiment, there’s been no major boost in actual investment yet. Net foreign direct investment has steadily dropped to below 0.5% of gross domestic product in 2023 from more than 2% in 2020, according to Barclays Plc. That’s despite India benefiting, along with the likes of Vietnam and Mexico, from international firms wanting to diversify their operations from China.

Manufacturing’s share in the economy has actually declined over the years to 13% in 2022, well below Modi’s goal of 25%. 

Here are some of the key policy priorities foreign businesses and economists say are needed in Modi’s likely third term:

Policy Action

Kamal Bali, president and chief executive officer of Volvo AB’s India operation, says there are huge variations across India’s 28 states and not enough policy coordination among them. 

There’s only about 7-10 states that are doing well, with about 20 that “will have to pick up the pace and have to grow and get policies that are conducive,” he said. “That’s a big ask and a big challenge.”

Modi’s Bharatiya Janata Party draws its support mainly from the northern Hindi-speaking belt of the country. In the southern states like Andhra Pradesh, Tamil Nadu, and Karnataka, regional and opposition parties tend to dominate. 

With its relatively better educated and wealthier population than the north, the southern region is also where Apple Inc. and Google are setting up mobile phone factories, and where Goldman Sachs Group Inc. has its global capability center set up.  

Friction between the opposition-controlled states and the BJP-led national government often plays out around issues like farming policies and how central government tax revenue should be shared among the states.

“India doesn’t have regional equity and besides that it needs better bonhomie between the states and center so that each of the policies are implemented at both the levels,” Bali said.

Labor Policies

While the government’s policy intentions are good, there’s still not enough follow-through on the ground, Bali said. 

One area where this shows up is in the labor policy. To simplify labor rules, the Modi government merged 29 labor and industrial laws into four labor codes, which were passed by the parliament in 2019 and 2020. 

Among other things, the laws allow companies with up to 300 workers to lay off workers without the state government’s approval, and make it tough for the labor unions to be recognized, moves which some states see as controversial and anti-worker. Several states are yet to frame rules for some of these codes, delaying implementation. 

“Policy pronouncement and policy implementation gap needs to be bridged,” Bali said. 

Another key challenge is the lack of appropriate skills in the workforce. One of India’s major advantages is its young and growing population of 1.4 billion people, but economists like Raghuram Rajan, India’s former central bank governor, often highlight the poor level of schooling as a drawback. One basic measure is literacy rates, with India at about 76%, lagging far behind Vietnam’s 96% and a world average of 87%.

Bali echoed those concerns, saying “there’s a huge talent-skills mismatch” in the country. “When businesses want to hire they do not get the right skill-set, so they train and re-train and re-train,” he added. 

Land Reform

A law that made it easier for companies to acquire land for projects was withdrawn in 2015 following widespread protests from farmers. The law had exempted certain sectors, such as defense and industrial corridors, from getting mandatory consent of 70% of farmers for acquiring agricultural land. 

Pranjul Bhandari, chief India economist at HSBC Holdings Plc, says there’s been notable progress in the past decade to boost new sectors, such as high tech manufacturing, professional services and exports. The next phase of reforms will need to focus on fixing stickier problems, like land and labor policies, which continue to hold back investment, she said.

“We have become good at sectoral reforms” like production-linked incentive schemes for electronics and mobile phone manufacturing, she said. The next set of reforms needed are “more sector agnostic, in the sense that every sector benefits,” she added.

Trade Measures

Modi’s government is trying to boost its share of global trade and key to that would be reviewing its relatively high tariff structure on imports. Daikin’s Jawa said to lift manufacturing, the government needs to lower duties on raw material imports while curbing the overseas purchases of finished goods.

The government is negotiating trade pacts with several major partners such as the European Union and the UK, and has shown it’s willing to address thorny issues like labor in the trade deals in a bid to shed its protectionist image and attract investment. Even so, India isn’t part of any major Asia-wide trade pact, like the Comprehensive and Progressive Agreement for Trans-Pacific Partnership. 

Daikin’s Jawa also says he wants the Modi government to continue its production-linked incentive schemes and that free-trade agreements should be directed toward goods targeted by those incentives. He also called for a reduction in consumption taxes on air conditioning units.

BJP’s Promises

In its election manifesto, the ruling party pledged to make India a trusted global manufacturing hub by simplifying regulatory processes, and investing in infrastructure and research and development. Modi’s ambition is to make India a major player in sectors such as chip manufacturing, aviation and defense equipment.

Bhandari says the next set of reforms needed in the economy would be more contentious to implement and require more political capital.

“The next decade belongs more to India than the previous decade did, but for that the new government must move fast,” she added.

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