Credibility is Comprehensive
I was recently in a panel discussion on India’s commitment credibility crisis for cross-border flows. And while that is definitely present, I made a case that a State’s commitment problem cannot be isolated into capital account and labour and retail. All of these are shades of the same underlying problem. The most expensive thing about investing in India is not any particular tax, tariff, or rule. It is the knowledge that whatever the rule is today, it can change tomorrow. The Indian state has rarely committed to treating a market outcome as final. Prices, contracts or even profits that are gained by the market are revisable the moment it becomes politically or fiscally inconvenient. Investors know this and it is priced into the investment decisions. One should not see the retrospective tax as a tax story, the torn-up power contract as an energy story, the cab-fare cap as a gig-economy story, but all shades of the same policy credibility issue. When an investor is thinking about entering India (either FDI or FII), they would make a comprehensive judgement of the nature of the state - whether it allows the market to function or whether it intervenes; whether the state follows rules-based policy making or is it given to whims and discretion. An investor pricing India does not run separate discount rates for tax risk, expropriation risk, and price-control risk. This is why credibility cannot be compartmentalised. The state cannot build a reputation for respecting outcomes in capital markets while overturning them in labour or retail, because it is one sovereign holding every instrument. When a commitment becomes inconvenient, it reaches for whichever tool is nearest, whether it is a legislative amendment, an executive order, a tax notice, a convenient judicial finding.
Some Examples
The evidence is aplenty and I am tempted to write another blog posts with just examples of such behaviour by Indian governments (both at the union and state level). A state government (Tamil Nadu) permits longer factory shifts to attract manufacturing, then reverses under pressure. Foreign retailers commit billions under one set of investment rules, and the rules tighten around their model after the capital is sunk (Amazon’s inventory model). Cab aggregators face bans and fare caps that shift from state to state. Stents and medicines are brought under sudden price control. Foreign investors are handed minimum alternate tax demands for years already past. Start-ups face an “angel tax” applied at an assessing officer’s discretion. Add online gaming, the farm-law reversal, abrupt agricultural export bans, an overnight laptop-import licensing regime, and a crypto policy that has lurched from prohibition to punitive taxation. The list spans ministries, governments, and decades.
Intertemporal vs Dirigisme
These failures come in two flavours worth distinguishing. Some are intertemporal: the state offers terms, capital sinks, and it reneges because its incentives changed once the capital could no longer leave. Others are plain dirigisme: a standing, reserved right to override any outcome the market produces. This is the structural make-up of the state that believes that it ought to intervene in markets to ensure outcomes that it prefers, nevermind Hayek’s famous quote about the curious task of economics.
“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.
Cross-border Flows
This credibility commitment is particularly obvious in cross-border flows. Immobile capital, like a factory, a power plant or even spectrum, is expropriated after the fact (ex-post), once the capital is sunk. The state’s bargaining power increases and can take such actions with seeming impudence. Of course, the next round of investors will not show up. Mobile capital such as FIIs will not wait for the commitment to falter. They flee the country, as FIIs have been leaving India in 2025 and 2026. Underneath all of it sits the fiscal root. An expansive, rarely-reviewed welfare state rests on too narrow a tax base. So the state taxes whatever is elastic enough to reach, and to keep that option open, it must avoid ever binding its own hands. Indian government likes to have the flexibility to break its promises, which is why it will not commit to a fiscal council or have an FRBMA with actual teeth. We have had a fiscal responsibility law with targets but no consequence for breaching them, where the targets function as suggestions, which resets whenever an election or a crisis makes them inconvenient. Successive Finance Commissions and the committee that reviewed the fiscal responsibility framework have recommended an independent fiscal council to monitor the rules. The state has declined, every time.