Both India and China have been important players in terms of foreign direct investment (FDI) flows since the early 2000s. Between 2000 and 2008, FDI inflows to both countries combined were about 8% of world inflows, which represented about 4.5% of their combined gross output. The post global financial crisis phase, however, has seen a sharp slowdown in FDI to India, while China continued to attract a significant share of world FDI inflows, with the proportion of FDI as a share of their combined output dipping to about 2.5% between 2009 and 2013 (figure 1). China received nearly twice the amount of FDI that India did in 2008—$110 billion compared to India’s $48 billion. By 2013, FDI had climbed up to $124 billion in China while India’s world FDI inflows fell sharply to $28 billion.
Beyond these numbers, however, India has a much larger share of mergers and acquisitions (M&As) than China (figure 2). While this could be because of the comparatively more well-developed financial markets in India, it could also well highlight the investors’ concerns in establishing new (greenfield) investment facilities in India.
Why does the distinction between M&A versus greenfield matter from a policy perspective?
Analytically, the macroeconomic implications of M&A are quite distinct from greenfield. While most policies start with the premise that FDI is a preferred and stable source of financing, one has to differentiate between greenfield and M&A at a very basic level. Ignoring secondary effects on productivity or income growth and, therefore, tax revenue growth, etc, for simplicity, analytically, the basic balance of payments identity tells us that current account (CA) plus financial account (FA) must equal zero; from national income accounting, we know that CA equals national savings (NS) minus investment (I).
When, say, FDI worth $10 enters in the form of greenfield, assuming everything else to be zero for simplicity, the FA goes up by $10. The CA, therefore, should be minus $10. How? In the case of greenfield, the investor sets up a new company and ‘I’ goes up. So, for a given NS, ‘I’ rises, causing the CA to become minus $10. In the case of M&A, it is not so straightforward. FDI in the form of M&A comes in and so the FA shows a balance of plus $10. But there has been no new actual investment that has been undertaken. How does this affect savings, ‘I’ and CA? There are various possibilities but not as clear cut as greenfield.
For illustration, hypothetically, if Daiichi Sankyo buys Ranbaxy, then one possibility is that Ranbaxy could make a conscious decision to reinvest those funds in India, which raises ‘I’. That is like greenfield but a conscious decision that Ranbaxy has taken to actually reinvest the funds. Or Ranbaxy might place the proceeds in the bank or elsewhere in the domestic financial system which gets re-channelled into the economy, resulting in the lowering of cost of funds due to increased supply of funds which eventually increases ‘I’.
The other possibility would be when Ranbaxy owners decide to consume all the money that they get out of the deal, in which case domestic consumption goes up. Since NS is defined as that part of income that is not consumed, income has not gone up because income is about value added; the M&A is just a transfer payment. So, income remains the same, consumption goes up and, therefore, NS goes down. So, with M&As, while the FA of plus $10 is matched by a CA of minus $10, unlike in the case of greenfield, the CA balance of minus $10 is not because ‘I’ has gone up but because the country’s NS rates have come down.
The third possibility would be when the Ranbaxy owners take their proceedings and invest abroad as they do not find lucrative investment opportunities in India. When the funds are transferred overseas, there is no change in NS, no change in ‘I’, no change in CA and hence no change in the FA balance. What happens is that the $10 coming into the country in the form of M&A goes out as gross capital outflows minus $10. So, while FDI in the form of M&As may not lead to increased domestic investments, they may not even be a net source of external financing. It really depends on how the money is used. This shows that all FDI are not the same and one has to appreciate that point when prescribing policies.
In the Indian policy context, the type of FDI assumes significance especially with the DIPP suggesting that it is acceptable to allow 100% greenfield in sectors like pharmaceuticals but only 49% for M&A. Such a piecemeal approach to restrictions on ownership per se may not be desirable. Indeed, with the exception of some sensitive sectors like defence, FDI should be attracted to promote the government’s newly launched initiatives such as Make in India where location of production matters more than ownership. The concern with FDI in the form of M&A is that it may not necessarily lead to new net production and in some cases domestic capacity may actually be reduced depending on the objectives of foreign investors. There are also valid concerns that in areas such as banking and public health, the objectives of foreign investors may not always be consistent with more development-oriented objectives of countries like India, which underlines the need for appropriate regulation.
While the WTO rules have, no doubt, constrained policy space significantly, the coverage of its rules is uneven and does not completely preclude use of any incentives or imposition of obligations on foreign investment where deemed appropriate. Thus, Indian policy-makers should try to be more innovative in how they formulate and implement investment policies to facilitate domestic development and overall economic objectives while still ensuring that the stricter WTO rules are not avoided to minimise the possibility of adverse legal implications.
By Ramkishen S Rajan & Sasidaran Gopalan
Ramkishen S Rajan is an adjunct fellow at Research and Information Systems for Developing Countries, New Delhi. Sasidaran Gopalan is a post-doctoral research fellow at the Institute for Emerging Market Studies and Institute of Advanced Study at Hong Kong University of Science and Technology