Downstream venture route opens sensitive sectors to FDI

The government has virtually opened up sensitive sectors like defence, multi-brand retail and media for FDI by interpreting relevant press notes liberally.

The government has virtually opened up sensitive sectors like defence, multi-brand retail and media for FDI by interpreting relevant press notes liberally. Entities with up to 49% FDI and controlled by Indians can invest in these areas through downstream ventures, a senior government official has said.

Last week, the Department of Industrial Policy and Promotion (DIPP) said in a discussion paper that sectoral caps below 49% be done away with. This allows any investment with an FDI up to this limit to be considered Indian for all practical purposes. If this proposal is implemented, the extant policy outlined in Press Notes 2, 3 and 4, which reckons downstream investments by specified FDI entities as Indian investment, would come to mean that such entities can even invest in sectors where FDI is barred.

Economists are of the view that such a step is in line with improvement in the investment climate in the country resulting in better FDI inflows. ?This is definitely a step in the right direction and would improve the investment climate in the country. However, certain sectors, like defence, should not be opened up for FDI,? said Crisil principal economist DK Joshi.

Under the current norms, a further investment by a joint venture firm with minority foreign equity and majority Indian equity is not considered as FDI. Last week?s DIPP discussion paper clarified that ?this effectively opens all sectors to 49% FDI indirectly, raising a question mark on the relevance of sectoral caps?. ?It is logical to argue that what can be done indirectly should as well be allowed to be done directly. Therefore, there is a clear case of abolishing all caps below 49%,? the DIPP paper said.

Deloitte Haskins & Sells director Anis Chakravarty said: ?When we talk of FDI, it is about capital, management and control. The latest discussion paper talks about controls and management and not capital. Thus, overall, improving the environment in terms of capital inflow and bringing in clarity by focusing on management and control partly addresses the issue of falling FDI. However, the major change will be seen when procedural matters are made conducive.?

The paper also says that ?control, perhaps, can be better exercised by having sectoral regulations in sensitive sectors?, arguing that the limits provide an opportunity for arbitrage to unscrupulous Indian partners at the cost of consumers.

Citing an example that in the case of inverted pyramid structure of downstream investments the level of indirect FDI can practically be even more than 49%, the paper hints that if foreign retailers can get into sensitive sectors also, like multi-brand retail, by forming a joint venture with an Indian company having 51% stake, the downstream investment by such JV would not be counted as FDI but as domestic investment.

The government official said: ?This discussion paper is an invitation to foreign investors to start investing in sectors like defence, multi-brand retail, media and aviation through downstream investment where you (a foreign company) can come with 49% and if you go two-layers down, you can do (invest) even more.?

Giving a legal perspective, Diljeet Titus, senior partner of law firm Titus & Co, said: ?The FDI limits are artificial and often breached through complex web of subsidiaries. We have had enough experience of FDI in the country. Time has come to open up more sectors, specially multi-brand retail and defence.? He added: ?Legally, it doesn?t matter whether the equity holding is 26% or 49%. In both cases, the investor could exercise the same control.?

The paper said sectors like defence manufacturing, telecommunication services and private security services could have different sector-specific conditions, keeping in view the strategic interest of the country.

Stating that sectoral caps do not in all cases prevent foreign companies from picking up stakes in Indian firms, JNU professor and an expert in overseas investments Manoj Pant said these caps are sometimes meaningless and cannot prevent cross-holding.

The DIPP paper admits ?it needs to be considered whether it may be appropriate to lay more emphasis on sectoral regulatory conditions, as against equity caps… Such an approach would directly and explicitly secure an objective in a much better manner than caps?.

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First published on: 28-06-2011 at 03:44 IST