Doors Wide Open?

On June 20, around 3 pm, a tweet from the Twitter handle of the Prime Minister's Office (PMO) made a big claim - India has become the most open economy in the world for foreign direct investment (FDI). Around the same time, officials of the commerce ministry were organising a hurried press conference to provide the finer details of the tweet. India had just announced its latest round of FDI reforms and the officials, and Commerce Minister Nirmala Sitharaman herself, took pains to elaborate what it would mean for India's economic growth. Incidentally, the annual update brought out by the United Nations Conference on Trade and Development (UNCTAD) on FDI - the World Investment Report 2016 - also being released the same day, put India in the 10th position in terms of global FDI inflow in 2015. It also stated that multinational enterprises perceive India to be the third best country after the US and China in terms of investment attractiveness.

Earlier during the day, Prime Minister Narendra Modi had convened a meeting of some of his Cabinet colleagues and senior officials from the ministries of finance and commerce, and key stakeholders like representatives of government think-tank Niti Aayog, to further liberalise the rules governing FDI inflow. The key sectors were defence, civil aviation, pharmaceuticals, retail, food products, animal husbandry and private security industry. Modi himself had tweeted the decision as "a measure to boost employment, job creation and benefit the economy".

Ever since India decided to take the path of economic liberalisation in 1991, successive Central governments have been easing FDI norms in various sectors. While the previous United Progressive Alliance (UPA) governments have been credited with some reforms, the NDA governments - earlier under Atal Behari Vajpayee and now under Modi - have been more enthusiastic about FDI reforms. Modi, who has visited close to three dozen countries in the past two years, has always considered inbound FDI as part of his agenda. Hence, even if one questions India's claim to be the most FDI-friendly economy in the world, the fact that India has been one of the most attractive FDI destinations globally ever since the Modi government took charge two years ago cannot be ignored. The $55.46-billion inflow in 2015/16 was the highest ever, and the $45.15 billion in 2014/15 was the second highest. True, approximately one-fifth of these inflows during both the years were re-invested earnings of foreign companies operating in India (as India's FDI figure is a combination of all types of foreign investments including remittances from non-resident-Indians), but the trend pretty much remains the same.

The Changes

The reforms in the defence sector were a direct improvement on what the government had announced last November - foreign investments that add up to 49 per cent in defence without a need for government approval (through automatic route) and a higher level of investment with government permission if it results in transfer of 'state-of-the-art' technology. The current revision, however, makes it easier for companies to invest even in mundane technologies. In other words, the prerequisite of 'state-of-the-art' is gone. In addition, the 'small arms and ammunition segment' was also opened up for FDI. Since India has so far attracted just $5.12 million as defence sector FDI, the latest reform could be seen as the government's last-ditch effort to bring in FDI to the defence sector. The problem is, for the reforms to catch the attention of foreign investors, there should also be an assured market for defence products. Either the companies should be able to supply to the sole Indian buyer - the defence sector - or find an economically viable way to export it. And if that happens, the sector will certainly have the potential to create new manufacturing capacities, new jobs and boost the economy.

The second major policy shift is in food products. The government has now allowed 100 per cent FDI, with government approval, in trading, including e-commerce, of food products manufactured in India. While some call it an attempt to allow backdoor entry of multi-brand retail outlets such as Walmart, questions remain over the attractiveness of large-format retail chains that handle exclusively India-made food products. Walmart's India chief Krish Iyer told Business Today that the company is waiting for the policy document before it can make any commitment. "It is not practical. The consumer pattern in India is changing. They want products that are of international standard. It would not make sense for me to not to keep those products," says Vaibhav Singhal, MD & CEO of Savemax, a wholesale and retail chain.

Even if the changes in FDI policy are not to have an impact on the brick-and-mortar retail business, it has the potential to bring in new players in the online food products and perishable business space in future.

Diluting the local sourcing norms for bringing in FDI in single-brand retail companies - yet another decision taken by the government that can have an impact on the entry of global single-brand retail giants like Apple or IKEA - are also awaiting clarity at the moment. "The government has said that the local sourcing norms for products that are cutting-edge and state-of-the art will be applicable only after eight years. But the government is yet to define what is cutting-edge," says a stakeholder who did not wish to be identified. The local sourcing norms for single-brand retail companies, in general, also have a three-year relaxation in the current FDI norm revision. Easing the FDI restrictions on sectors such as animal husbandry and private security industry are also capable of adding jobs, though the FDI inflow may not be significant in value terms.

The Tweaks

Then come a set of reforms that can primarily attract financial investments, but offer very less scope for job creation - pharmaceuticals, for instance. Since the existing policy already allowed 100 per cent FDI through automatic route for greenfield projects, the only change that could have happened was in the case of brownfield assets, where government clearance was needed on a case-by-case basis. The latest amendment relaxed that condition by allowing foreign companies to acquire up to 74 per cent in existing Indian pharmaceutical companies without any government nod. Beyond that, it continues to remain in the approval route.

Since the change only impacts brownfield projects, what can happen will be easy takeover of Indian companies. "A sticky issue for M&A deals has been the non-compete issue, as non-compete proposals were not permitted without approval. The press release (government FDI policy announcement) is silent, but one would hope that every aspect of the deal, including non-compete clauses, should be under the automatic route so long as the investment is 74 per cent or below," says Rajat Mukherjee, Partner, Khaitan & Co. The government's decision to make takeover of domestic drug companies easy has been criticised by civil society groups that depend on India's low-cost generic supply to carry on with their global humanitarian programmes. "By allowing 74 per cent FDI in pharma under the automatic route and by progressively removing the conditions that FDI be linked to technology transfer and local production (greenfield investments), India has undermined a key component that contributed to the development of the generic industry," says Leena Menghaney, Head, South Asia, MSF (Medicines Sans Frontieres) Access Campaign.

In some cases, though, even investments seem unlikely. Take, for instance, the decision to allow 100 per cent FDI through automatic route in sectors such as broadcasting carriage services and civil aviation. These sectors had seen FDI norm relaxation in November 2015 itself and a further tweak in seven months seems to indicate that the earlier efforts did not bring in desired results. "We are unlikely to see investors suddenly rushing to invest in airlines just because the cap of 49 per cent has been removed," says Peeyush Naidu, Partner, Deloitte India. "Also remember that investment by foreign airlines is still capped at 49 per cent."

Global Pressure

UNCTAD's World Investment Report 2016 says that global FDI, which jumped 38 per cent to $1.76 trillion, its highest level since the global economic and financial crisis of 2008-2009, was driven by developing countries of Asia. Three quarters of the total inflows into developing Asia went to Hong Kong (China), China, Singapore and India. With competition rising among countries to attract more FDI, reform is more of a compulsion, it hints. "In 2015, 46 countries and economies adopted 96 policy measures affecting foreign investment. Of these measures, 71 related to liberalisation, promotion and facilitation of investment, while 13 introduced new restrictions or regulations on investment. Nearly half (42 per cent) of all policy measures were undertaken by Asian developing economies," it adds.

UNCTAD reveals that India and China were among the most active emerging economies in Asia to open up various industries. "China allowed foreign companies to set up bank card clearing companies and loosened restrictions on foreign investment in the real estate market. It also allowed full ownership of e-commerce business and designated Beijing for a pilot program for opening up certain service sectors," the report said. China also revised its 'Catalogue for the Guidance of Foreign Investment Industries' to prune the sectors where FDI is prohibited.

It is too early to say whether the latest round of FDI reforms will result in investments that augment existing manufacturing or service capacities of Indian industry. In fact, there is a weak correlation between India's GDP growth and growth in FDI inflow. Hence, the decision may certainly result in acquisitions and takeovers in at least some sectors like pharma. Promoters will gain and, statistically speaking, India will be seen as a country that has successfully attracted more foreign funds. However, FDI reforms, unless followed up with a series of industry-specific reforms, may not attract investments that create jobs. If the government's prime objective in attracting FDI is job creation, a lot more needs to be done.

With inputs from Anilesh S. Mahajan