1. Dear foreign investor, we love your money, not you!

Dear foreign investor, we love your money, not you!

The caveats of the policy on increasing the FDI cap for the insurance sector make this apparent

By: | Published: December 12, 2014 12:11 AM

After almost a decade of political wrangling, India seems set to enhance the foreign investment limit in insurance from 26% to 49%. If it happens, and the chances look good it will, the Narendra Modi-led government will undoubtedly count this among its early victories. But is it really a victory? Does this limit enhancement represent the new government’s economic approach, i.e. a more liberal foreign investment policy, simpler investment rules, more investment and more competition?

Maybe not! Because the hike in the FDI limit could likely be accompanied by two caveats. The first is endemic to our foreign investment policies, that ‘ownership and control’ should be vested with Indians. That means 51% of the business should be owned by Indians and that Indians should have the right to appoint a majority of directors or control the management or policy decisions. On the face of it, there is nothing wrong in stipulating that insurance businesses must be controlled by Indians. But this restriction contradicts the rationale for enhancing the FDI limit. In its representations to the Select Parliamentary Committee, the finance ministry argued in favour of raising the FDI limit by saying India needs large amounts of capital, technology and knowhow in the sector.

‘The Dept of Financial Services further explained that the rationale behind increasing the FDI limit to 49% is that insurance companies are regulated by stringent solvency norms and continuously require additional capital for growth, which partly get invested in key sectors like infrastructure. IRDA has estimated that the additional capital requirement of insurance sector would be R55,000 crore (R44,500 crore for the life sector and R10,500 crore for the non-life sector) over the next five years, which may not be taken care of by the limited domestic sources. Further, it was stated that the foreign equity potentially enables transfer of technical knowhow and better customer service through improved practices and competitive pressure. The FDI allowed in insurance sector in other countries, the sectoral FDI limits existing in the country for other sectors and the key provisions proposed in the Bill for safeguarding the interests of the policy-holders were also highlighted. Giving specific instances of quantum of FDI in different countries, the department submitted that it was 100% in Japan, South Korea, Hong Kong; 80% in Indonesia and 50% in China.’

Report of the Select Committee on the Insurance Laws (Amendment) Bill, 2014

So we want their money, their technology and their expertise … but we won’t give them control? Why would a foreign investor put in half the capital and not expect equal control? If he doesn’t get it directly, he’s going find ways to exercise it indirectly, leading to all kinds of complicated structures and ‘front’ investors. Telecom is an appropriate example of how FDI limits were rendered virtually meaningless because the foreign telecom company funded a few individuals to hold stake on its behalf. The FDI limits and circumstances maybe different, but the underlying principle is the same.

It isn’t the first time I have asked this question of foreign investment policy. The bureaucratic response often is—‘But India is too important a market for them to ignore!’ I suppose we believe that no matter how unreasonable we are, foreign investors will come. Well, Indian insurance businessmen, who do business with these foreign investors, think otherwise.

‘The representatives of private sector insurance companies referring to the advantages of increase in the FDI limit pointed out that insurance being a capital-intensive and low-return business, it is a better option to expose foreign capital to a low-return industry, in place of scarce Indian capital. Foreign companies would bring in latest technology and provide access to global re-insurance market besides boosting infrastructure sector as foreign capital would be invested in government securities and sectors as per IRDA guidelines…

The private sector representatives also stated that there may be hindrances to the amount of FDI coming in, if the full management control lies with the Indian shareholders as per the provisions of the Bill. It was suggested that while the FDI limit may be increased to 49%, there should be no provision for control and instead it should be left to the shareholders to sort out amongst themselves, based on their shareholdings.’
Report of the Select Committee on the Insurance Laws (Amendment) Bill, 2014

The report includes dissent notes by some MPs and they cite the global financial crisis, foreign insurance companies’ investments in complex derivatives and AIG’s bailout by the US government as instances why foreign insurance players should not be trusted. But can’t those fears be mitigated by stringent regulation? Two of our leading private banks are majority owned by foreign investors. Yet we think of them as Indian banks and trust RBI to regulate them effectively. Can we not trust IRDA to do the same, effectively regulate Indian insurance companies, irrespective of the colour of money funding them? Maybe therein lies the trouble. It is not the foreign investors we don’t trust, it is the lack of confidence in our own regulatory structures?

Worse still, the 49% limit includes FDI and FPI (earlier known as FII). This makes an IPO tough because, in an insurance company that already has a foreign partner—assuming the foreign partner wants to own 49% or thereabouts—the headroom for foreign portfolio investment will be zero or severely restricted. And foreign portfolio investors are an essential segment of our equity markets. Oddly enough, the Select Committee acknowledges this but doesn’t resolve it.

‘The Committee also notes the views expressed by secretary, Dept of Financial Services, that there is a requirement of huge amount of capital as defined by the regulator for stipulated solvency levels to maintain the trust level of stakeholders in life insurance companies through solvency under all circumstances. This enhanced foreign equity will not only help in expansion of insurance coverage, comprehensive and better portfolio management, and enable growth of pension sector, but also potentially enable transfer of technical knowhow and other better consumer services through improved practices and competitive pressures. The Committee observed that IPOs may not be the best route for raising capital in the insurance sector as FIIs face constraints due to sectoral foreign equity caps.’
Report of the Select Committee on the Insurance Laws (Amendment) Bill, 2014

The second caveat? The Select Committee wants the hike in the FDI limit to be accompanied by fresh capital.

‘The Committee is also of the view that incremental equity should ideally be used for expansion of capital base so as to actually strengthen the insurance sector.’

Report of the Select Committee on the Insurance Laws (Amendment) Bill, 2014

Again, the intention is noble—insurance needs more capital and, hence, the guiding policy should enable the inflow of fresh capital. Therefore, the emphasis on primary issuance of shares and a bar on secondary transactions (stake sales). But why should a law prescribe the nature of the investment transaction? Can we not leave this up to the two consenting adults to determine?

It is well known that, over the last decade, Indian insurance businesses often sought capital from their foreign partners. But since foreign ownership was limited to 26%, many foreign partners indirectly funded the business by funding the Indian promoter, in the hope that when the FDI limit is raised, the money will convert to equity. This happened for a host of reasons. Indian promoters didn’t have the money to invest in a growing, capital-hungry business, or they didn’t have the risk appetite, or they were getting the foreign funds cheap. Whatever the reason, these structures and side-letters (granting the foreign investor certain rights including conversion) were riding on the hope of a hike in the FDI limit.

If the Committee’s caveat persists, many of these structures will have to be restructured. That could put the foreign investor at a disadvantage.
Conversely, it may even hurt the Indian partner’s ability to exit (partially), discharge the foreign debt or invest his money elsewhere. Unless, of course, the Indian partner had no intention of honouring the debt or side-letters.

But even if all these silly structural complications are surmounted by lawyers and their hefty fees—and still more structures—the message this policy sends out to foreign investors is not flattering to India. The message is: We want your money, your technology, your expertise, but we don’t trust your intentions and we will prescribe to you the exact manner in which you can invest. But we want your money.

A Committee member I spoke to explained that the only way to achieve political consensus in favour of raising the FDI limit in insurance was to explain to the legislators the urgent need for additional capital in the insurance business. That pitch, he said, is justified only if the policy ensures new capital comes in. Hence the proposed bar on secondary transactions.

I wonder, if the BJP had a majority in the Rajya Sabha as well, would the Committee have dropped this clause?

The other argument in favour of this restriction is that, in a secondary transaction (Indian promoter selling stake to foreign investor), only Indian promoter stands to gain, and that is unacceptable.

Committee member Naresh Gujral admitted as much in his comment to CNBC TV18 when he said, “The idea is to strengthen the companies and not give windfall gains to a few select individuals in this country. You recall that this is exactly what happened during 2G. There were a few individuals that gained. So we want money to go into the companies and not into the pocket of a few rich individuals.”

This grouse finds mention in the Committee Report as well. MP Derek O’Brien, in his dissent note, states, “The Bill in its current form creates no impetus for increased foreign investments in the insurance sector to be channelled towards improving insurance coverage or social security for the poor. It is quite possible that a higher FDI cap will only result in Indian entities liquidating their stake, at several times their original investment, without any fresh investments coming in.”

Well, if the Committee’s recommendation makes it to the final form of the law, O’Brien has one less thing to complain about.
Let me add here that I am not suggesting that the Committee’s recommendations will definitely make it as law. They might if that’s the only way to get political consensus. Or they may not. Several lobbies are at work. This is merely a contemplation of our approach to foreign investment and an examination of how our legislators think.

In summation, we want foreign investment, foreign technology and foreign expertise. But we won’t trust the foreigners with control, nor trust our regulators to regulate them effectively. But then we don’t want Indian businessmen to profit either. Definitely not making any ‘windfall gains’.
My grumbling aside, hopefully, none of this will hurt India’s insurance sector. It is a big market and its return potential will draw foreign money. But that’s not the point. It is about how we choose to craft our investment policies. If even a historic majority and a right-wing government can’t fix that, then nothing will.

The author is executive editor at CNBC TV18. Views are personal

(Equal & Opposite is a column that explores business practices prompted by legal & regulatory action and vice-versa)

  1. J
    Jamil Ahmad
    Dec 19, 2014 at 10:56 am
    Out flow of black or unaccounted money from India is more than what is coming in India as FDI. We are diluting the laws to attract the FDI but we are practically doing nothing to stop the outflow. India must strengthen the infrastructure to effectively tackle the outflow of our precious resource. A bird in the hand is better than two in the bush.

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