FDI policy 2017: Why Narendra Modi government must unleash FDI reforms

Published: October 6, 2017 4:43 AM

The government released the Consolidated FDI Policy for 2017 in late August. Given that this document is usually released between April-June, this year’s delay led many to believe that the FDI Policy would be used to unleash a fresh set of reforms, to underscore the government’s pro-growth and investor-friendly image.

fdi, fdi reforms, fdi 2017, narendra modi economic reformsDespite the anticipated big-bang reforms not quite coming through, the FDI Policy, which is usually just a consolidation of the year’s changes to foreign investment policy, has brought clarity to certain crucial pain points for foreign investors.

By- Vaibhav Kakkar & Sahil Arora

The government released the Consolidated FDI Policy for 2017 in late August. Given that this document is usually released between April-June, this year’s delay led many to believe that the FDI Policy would be used to unleash a fresh set of reforms, to underscore the government’s pro-growth and investor-friendly image.

Despite the anticipated big-bang reforms not quite coming through, the FDI Policy, which is usually just a consolidation of the year’s changes to foreign investment policy, has brought clarity to certain crucial pain points for foreign investors.

Contract manufacturing

The policy has long been that a manufacturing entity is permitted to receive FDI up to 100% under automatic route, and can undertake wholesale and retail trade (including e-commerce) without retail trading conditionalities being applicable. However, concerns had been raised whether this exemption from retail conditionalities should be applicable where an entity has engaged a ‘contract manufacturer’ in India?

Despite the confusion, a number of Indian entities who were using ‘contract manufacturing’ route raised FDI under automatic route, without having had to comply with retail FDI conditions. To curb this practice, the government amended the FDI Policy through Press Note 5 of 2016 to stipulate that an Indian ‘manufacturer’ would be required to manufacture at least 70% of its products in house, and source at most 30% from other Indian manufacturers. If not, they would have to adhere to single brand retail trading (SBRT) conditionalities including local sourcing norms (70-30 Rule). The advent of 70:30 Rule caused much discontent, as many Indian manufacturers who were in breach of 70-30 Rule were either unable to raise FDI (and remained cash-starved) or had already received FDI (and had to considerably alter their business operations).

In a noteworthy liberalisation, the recently introduced 70:30 Rule has been removed. This will ensure effective utilisation of Indian infrastructure for manufacturing activities, which wasn’t being achieved in light of curbs on ‘contract manufacturing’.

SBRT norms

In a move beneficial to international retailers such as Apple, the government had earlier liberalised local sourcing norms for companies bringing in ‘cutting-edge’ and ‘state of art’ technology into India. However, there wasn’t any clarity on the meaning of terms ‘cutting-edge’ and ‘state of art’.

The FDI Policy now contains a mechanism through which technology companies setting up manufacturing facilities can approach a committee headed by the Secretary, DIPP, which would recommend dispensation after determining whether the products have ‘state of art’ and ‘cutting-edge’ technology, where local sourcing is impossible. While defining the scope of these terms may be difficult, the committee should formulate guiding parameters to determine what constitutes ‘state of art’ and ‘cutting-edge’, to ensure predictability for foreign investors and the objectiveness of the committee’s decisions.

While the government’s reforms can hardly be doubted, there are a number of sectors that continue to suffer on account of onerous conditionalities or sectoral caps.

The foremost is multi-brand retail. The government must, in line with the opening up of food processing sector, consider permitting FDI (albeit under approval route) in multi-brand retail of certain classes of products such as electronics and apparel, so long as they are manufactured/produced in India. This would give impetus to manufacturing and enable gradual opening-up of multi-brand retail trading sector, while preserving the interests of kiranas. The move would be in line with promoting ‘Make in India’.

There is also a strong case for insurance intermediaries (agents, brokers, TPAs, surveyors, loss assessors) to not be clubbed with insurance companies with respect to FDI Policy. The sectoral cap of 49% coupled with a differential mode of computation of foreign investment limits funding prospects in insurance intermediaries—insurance companies pose a far greater systemic risk compared to insurance intermediaries, and IRDA regulations as a result are far more liberal for insurance intermediaries. A differential FDI regime for insurance intermediaries would be prudent.

A point of concern is holding companies, where foreign investment requires prior approval. While this is understandable in case underlying investments are in sectors requiring prior approval, there should be no such requirement if underlying investments are in automatic route sectors. Anyway, there is a detailed RBI framework governing holding companies wherein certain classes of companies are regulated and require registration. Further government oversight appears unwarranted.

The case of private security agencies is even more curious. The FDI Policy permits foreign investment up to 49% under automatic route, and up to 74% under approval route. This is, however, rendered moot because the Private Security Agencies Regulation Act, 2005, requires for an Indian citizen to be the majority shareholder. Similarly, 100% foreign investment is permitted in the scheduled/regional air-transport service sector, but substantial ownership and effective control is required to remain in Indian hands under Aircraft Rules.

In brownfield pharma, FDI up to 74% is permitted under automatic route, with FDI beyond 74% requiring approval. The cap should be enhanced to 100% under automatic route and any concerns may be administered through the pharma policy itself. Similarly, raising the FDI cap in the print media sector from 26% under approval route to 49% should be considered. Security concerns can be tackled by ensuring that FDI remains under approval route, and ownership and control with resident Indian citizens.

Though there are notable changes in the FDI Policy, the government must continue to remove bottlenecks and unleash FDI reforms. With the festive season round the corner, and murmurs of economic slowdown becoming louder, the FDI Policy has hopefully set the stage for a Diwali bonanza. As the famous Scorpions’ song goes, “An August summer night… The future’s in the air, I can feel it everywhere, Blowing with the wind of change.”

Vaibhav Kakkar is Partner, Sahil Arora is Associate, Luthra & Luthra Law Offices. Views are personal.

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