Insights into Editorial: FDI liberalization is one part of the puzzle

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Insights into Editorial: FDI liberalization is one part of the puzzle

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22 June 2016

The government has unveiled another round of economic policy reforms by liberalising the foreign direct investment norms in nine key sectors ranging from defence to aviation, pharmaceuticals to retail trade. This is the second such easing of norms since November.

  • The new measures are expected to pave the way to attracting more foreign investment since they target sectors which have been relative laggards in attracting FDI.

Highlights:

  • In defence, foreign investment beyond 49% (and upto 100%) has been permitted through the government approval route, in cases resulting in access to modern technology in the country. The condition of access to ‘state-of-art’ technology in the country has been done away with, as many foreign investors had complained about the ambiguity regarding that term. FDI limit also has been made applicable to Manufacturing of Small Arms and Ammunitions covered under Arms Act, 1959.
  • 100% FDI has been permitted under government approval route for trading, including through e-commerce, in respect of food products manufactured or produced in India, bringing into effect the proposal made in the Budget 2016-17.
  • To promote the development of pharmaceutical sector, the government has permitted up to 74% FDI under automatic route in existing pharmaceutical ventures. The government approval route will continue beyond 74% FDI and upto 100% in such brown-field pharma.
  • 100% FDI has been permitted in India-based airlines. However, a foreign carrier can only own upto 49% stake in the venture, and the rest can come from a private investors including those based overseas. This is expected to bring in more funds into domestic airlines. To boost airport development and modernisation, 100% FDI in existing airport projects has been allowed without government permission, from 74% permitted so far.
  • Entities undertaking single brand retail trading have been relaxed from local sourcing norms up to 3 years. Entities engaged in of single brand retail trading of products having ‘state-of-art’ and ‘cutting edge’ technology have been relaxed from local sourcing norms up to 5 years.

What’s good about this move?

  • The policy changes are promising. A 100% FDI allowance for trading, including e-commerce in food products that are made in India, can be expected to enthuse the major players in this sector.
  • Relaxation in FDI in aviation is likely to go well with the recently unveiled civil aviation policy. Foreign carriers would no longer have to look for an Indian partner to set up a domestic airline and could join hands with private investors abroad. Though equity holding of foreign airlines is still limited to 49%, a foreign airline can join hands with its sovereign fund or private investors and set up a 100 per cent foreign-owned airline in India.
  • Defence, a sector which has yet to receive FDI, is also likely to benefit. The government decision to liberalise conditions allowing 100% FDI in the defence sector may result in at least some foreign entities setting up subsidiaries in India.
  • New policy will be a significant step forward in ensuring that OEM [original equipment manufacturer] subsidiary-driven manufacturing plans take off. It will result in greater comfort for OEMs to establish high-technology manufacturing-driven subsidiaries.  

Why this would make a little difference?

  • The sectors targeted in the latest round account for just 11% of the total FDI received by India. Compare that to the top five sectors — services, construction, computer software and hardware, telecom and automobiles — that account for a 45% FDI share.
  • These measures are more incremental than game-changing. In defence, for instance, existing policies already allow for FDI up to 49% under the automatic route and above that contingent on government approval on a case-by-case basis. The change, now, is the removal of the “access to state-of-the-art technology” clause for the latter.
  • Other major sectors like pharmaceuticals and broadcasting have seen similar changes revolving around tilting the balance in favour of investment under the automatic route.
  • The notable exception is the significant hike in the FDI cap in domestic airlines from 49% to 100%. But this is balanced by retaining the prior cap as far as foreign airlines are concerned.
  • Also, investment by foreign airlines is still capped at 49% — so it remains to be seen whether other investors such as private equities and the like would have the risk appetite to make such investments.

What else is needed?

For both measures and message to be truly effective, a number of structural issues must be addressed. Take defence, for instance. It is a massively capital-intensive sector, one where project gestation periods can extend to decades. The investment risk level is commensurately high with no guaranteed pay-off at the end of it. In such circumstances, liberalizing FDI is not enough if risk levels for foreign investors remain unsustainably high. The centre must have a clear, long-term defence acquisition road map, allowing private sector companies to plan ahead and manage risk effectively.

Look at pharmaceuticals. Over the past few years, expanding price control has been the department of pharmaceuticals’ signal achievement. This is counterproductive for both domestic players and their potential foreign investors, particularly given the high costs and, again, long cycles of research and development projects. This is not to say that the sector can or should be entirely unregulated—low-priced Indian generics are essential both domestically and globally—but there are other means such as bulk government purchases that would serve better.

Way ahead:

Apart from focusing on the unexplored sectors, the government should be complimented for aggressively bringing in more and more activities under the automatic route, which reduces bureaucratic discretion and promises policy certainty.

Conclusion:

It is true that given the series of changes under the current regime, there is now just a small negative list where FDI is not allowed. However, opening the door to investments is just the first step. It is more a statement of intent, an invitation for investors and companies around the world. To truly achieve its aim of opening up — to increase employment and create jobs for the millions streaming into the labour force every year — the government will have to do more. India continues to enjoy a lowly rank in the ease of doing business. Retaining the investments that come in as a result of these measures will be the key challenge.