It’s ironical. In 1991, Manmohan Singh, the architect of economic liberalisation and the then finance minister, became the darling of foreign investors after he opened the floodgates of foreign investment in various sectors, but after nearly 20 years, with the same stalwart now Prime Minister, foreign investors are wary of investing in the country.
The hard facts say it all. The declining trend in foreign direct investment inflows intensified further in October 2010, with funds coming into the country through this route falling 40% to $1.39 billion compared to $2.33 billion a year ago. Cumulatively, for April-October 2010, the decline is of the order of over 25% to $14.91 billion, compared to $19.95 billion in the corresponding period last year.
While a slowdown in investment by multinational companies due to problems in their home markets is one reason, government officials say there were other factors too. “A lot of companies that were hoping to get into the retail business or increase their stake in insurance ventures are still awaiting the required policy changes. But nothing has moved in the past few months, and the falling graph may continue for a while,” says a commerce and industry ministry official.
The fall in foreign direct investment (FDI) inflows comes at a time when foreign institutional investors are pouring money into Indian shares and bonds. As per Sebi data, despite the recent share sale, so far in 2010, FIIs have pumped in $28.7 billion into India, compared to $17.5 billion last year.
The rise in portfolio investment has put pressure on the Indian rupee, which has gained against the US dollar and reduced the competitiveness of Indian exports.
Analysts feel one of the biggest weaknesses affecting India?s economic liberalisation is the way industrial policies are made. ?Changes affecting industries that range from telecoms and banks to aviation and retail stem far more from the pressures of vested interests and lobbies than from reasoned analysis and debate,? says Ravi Mini, partner MK Kini, a Mumbai-based law firm that handles FDI-related legal work of its foreign clients.
Foreign or domestic companies push for changes, which are then resisted by rivals, and supported, if opposition to foreign investment is involved, by Leftist parties that often reflect vested interests. Ministers and bureaucrats are persuaded to tilt one way or another, sometimes nudged by various inducements and sometimes by legal action. Eventually, someone wins and reforms are introduced, or aren?t.
This has been glaringly evident since the government announced on February 11 that it was introducing major changes to its rules on FDI and other forms of foreign equity. There was little open discussion (apart from a series of confusing newspaper leaks) before the announcement, and the changes are still complicated and confusing. These very ambiguities are seen as the main cause for prospective foreign investors staying away.
?Even policy makers are unsure about the policy implications and what will happen in sectors where foreign investment is capped or banned. Multi-brand retail, lottery, agriculture and atomic energy are some sectors where FDI is disallowed. And, there is a cap on FDI in sectors such as aviation, telecom, media and defence, among others,? says the commerce and industry ministry official.
The announcement of the change in the FDI policy in 2009 first came as a press release and statement after a Cabinet meeting. That was followed by an unclear statement from commerce and industry minister Kamal Nath. Then came two ‘press notes’, one of three pages and one of seven pages, that are indecipherable to non-professionals, and further explanations. (Curiously, the government has issued FDI policy change since 1991 as ‘press notes’, not official regulations).
There are more questions. Will currently banned investments creep in? For example, could foreign companies owning 49% in an Indian holding company take a large stake in the operating subsidiary of an airline, newspaper or supermarket chain?
There are also problems for companies that are already foreign owned when FDI and FII investments are assessed together. For example, two Indian banks?ICICI and HDFC?come into this category and are looking for ways to remain Indian.
The government has sought to further simplify FDI rules, allowing foreign investment well beyond the current sectoral limits. Henceforth, foreign investment coming into a holding company majority owned by Indians will not count as FDI when invested in a downstream subsidiary. This will enable Indian promoters in sectors such as telecom, insurance, civil aviation, etc, to get more foreign investment into their companies without being constrained by current FDI limits. So companies in these sectors can legitimately breach the FDI limits by getting foreign funds through separate holding companies. While welcoming more foreign investments in various sectors, given that global capital is not so easy to come by, industry experts, however, strongly feel the government must become more transparent about its policy framework.
For instance, if the government wants foreign investment limit to go up to 100% in some sectors like telecom or civil aviation, it must say so upfront and raise the limit to 100%. Pro-liberation wings have always held that the government must open up all sectors to 100% FDI, except in a select few that it considers highly sensitive, such as defence, nuclear energy and media.
?Such a convoluted framework is totally avoidable. It is much better to fully permit foreign investment in all sectors, except the really strategic ones, from the national interest standpoint. Once this is done, the other issue of whether the FII portfolio investment must be clubbed with FDI under a single limit also becomes redundant,? says Balbir Singh Mastan, partner, DSP Legal, a law firm.
The entire exercise seems to have been guided by the short-term need for cash felt by sections of industry, rather than any deep commitment to liberalisation, he adds. Mastan also feels that the government must bring uniformity in clearance of FDI proposals. ?In the same sector, I have seen two diverse approvals for two identical cases. This happens when there is no set precedence,? he explains.
A deeper take on the FDI policy will lead you to believe that the revised guidelines allow foreign investment irrespective of the sectoral caps. And, if that was the intent, it could have been done in a more simpler manner rather than making it onerous in terms of creating multiple holding companies and for financial investors creating the whole issue on exits from holding companies.
?Also, clubbing of FII, FCCB, ADR, GDR and NRIs under FDI is in contravention of previous policies, as it will lead to entities in retail or banking sector that were operating under the older guidelines to violate the revised guidelines,? says Saroj Jha, a partner with Delhi-based law firm SRGR.
Further, the press note prescribes that in case of companies with sectoral caps, FIPB approval would be required for transfer of ownership from Indian residents to a non-resident entity, and theoretically this can encompasses even a usual trade of equity share on stock exchange where the buyer is non-resident. Furthermore, the guidelines are not clearly applicable in case of 50:50 JVs where both partners enjoy equal board seats.
?Mandatory permission from FIPB for FII investments would act as a deterrent as it can shoo away potential investors.
FIIs need no entry restrictions, as unlike FDI investors FIIs are invested in companies for shorter duration and they mainly buy stocks from the secondary market. Moreover, FIIs do not have representation on the board of directors of a company whereas FDI does have that motive,? Jha explains.
One significant outcome of the new PNs has been that several foreign investment compliant Indian companies may now be in breach of sectoral caps, especially in sectors such as banking and telecommunication. This is so because the PNs have replaced the conventional proportionate method of computing foreign indirect equity by the parameter of beneficial ownership and control of the entities at each stage of investment. It appears many such companies will now have to seek clarifications from the FIPB on their foreign equity holding, and some may have to divest such holding.
?The country has benefited from large foreign investment flows, and the government has admitted that FDI needs to be encouraged through appropriate policy regime. As a first step, the government must quickly issue adequate clarification to the Press Note 2/3/4 of 2009 to remove ambiguities in their interpretation. All pending proposals for further opening up of sectors to FDI, without the need for legislative changes, must be quickly carried through,? says Akash Gupt, executive director, PwC.
Restrictions on FDI should be placed only in sectors where there are genuine national security implications. The government would also do well to take a re-look at other attendant conditions that make investments in India unattractive. Global capital has become scarce and the new government has to become much more proactive in attracting FDI.