Column : Does the FII route make sense?

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SummaryBy allowing FIIs to invest 23% instead of raising FDI cap to 49% compromises economic interests of all foreign insurers.

The new proposal emerging from a political deal (reported by FE) for increasing foreign equity in Indian private insurance JVs—by allowing FIIs to invest 23% with new equity instead of simply raising the FDI cap to 49%—should be viewed with deep concern for several reasons.

To begin with, it compromises the economic interests of all foreign insurers that have entered the Indian insurance industry; especially those who did so after 2004. Their joint-ventures have yet to reach break-even and generate positive cash surpluses and accumulate reserves sufficient to meet future long-term policy payout obligations.

It also risks introducing new third parties (i.e. FIIs) with no experience of the insurance industry as major shareholders in insurance JVs at the wrong time and at the wrong value. FIIs stand to make windfall gains in a short period of time when IPOs are launched. Yet they will have taken none of risks, nor borne the heavy costs that foreign insurers have borne for the last 6-7 years, in the face of regulatory U-turns, a sharp economic downturn, and acute policy uncertainty. All have affected the insurance industry adversely in terms of risks, revenues and profits. That introduces an element of unfairness and discrimination against the interests of long-term players with commitment to India.

The proposal favours insurers that already have related FIIs in India—through their in-house asset management operations—versus those that do not. The former can align interests through sweet-heart deals with affiliated FIIs while the latter cannot.

The proposal will create major valuation problems at entry for FIIs and for foreign insurers with a 26% equity stake in the majority of JVs that are still loss-making. It will create complications that will overtax the MoF and IRDA (and possibly the Indian courts) with undue administrative burdens.

If FIIs now entered into the shareholding of Indian insurance JVs at book value then in most JVs (especially the 17 late entrants in life insurance, 15 in general insurance and 4 in health insurance) they would be buying shares at 25-40% of par to reflect the sustained losses that long-term foreign shareholders have taken. These losses have been exacerbated by JV agreements that require foreign insurers to provide guaranteed returns of 12-24% to their domestic partners on the domestic share of the equity in these JVs. If FIIs entered into the share-holdings of the handful of pre-2003 JVs that are now in profit, they would paying 2.5 to 3

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