Indias Experience with fdI: Role of a Game Changer

JAnuAry 2012

The Associated Chambers of Commerce and Industry of India

ASSOCHAM Corporate Office: 1, Community Centre, Zamrudpur, Kailash Colony, New Delhi-110048 Tel: 011 46550555 (Hunting Line) | Fax: 011 46536481/82, 46536498

Email: assocham@nic.in | Website: www.assocham.org

Contents
I. II. Indias FDI Overall View ....................................................................4 Assessment of Global FDI ..............................................................10

III. Indias Sectoral Analysis ................................................................12 IV. relevance of FDI in India ................................................................24 V. Potential FDI Sectors ......................................................................27

VI. ASSOCHAMs Suggestions ............................................................40

Executive Summary
The study examines the Role of FDI in India ASSOCHAM has attempted to estimate possible foreign investment flows if Pension Funds and Civil Aviation are opened up for FDI Impact of FDI on Indian economy is assessed by analyzing the performance of three sectors where FDI has been permitted. These sectors were: Telecommunications Automobiles IT/ITES Some of the benefits of liberalization of Telecom Sector were: Increase Penetration Growth in Subscriber Base Reduction of Call Rates Some of the benefits of liberalization of Automobiles Sector were: Increase in Production, Domestic Sales and Exports Development of a healthy Auto Components Industry Greater Choice for the Consumer Some of the benefits of liberalization of IT/ITES Sector were: High Growth Rates India becoming one of the leading exporters of software services The study further tries to assess the impact of opening up of FDI in other sectors. Two sectors that have been considered for this purpose are: FDI in Pension Funds FDI in Civil Aviation

Indias Experience with FDI: Role of a Game Changer

 The study of FDI in Pension Funds observed: The 12th Draft approach paper of the Planning Commission suggests the total infrastructure investment requirement would be US $ 1 trillion. Pension Fund investments into infrastructure seem to be a befitting alternative given the match of interests for both the sectors. 1 percent of the total pension funds held by pension fund companies would increase Indias Pension fund assets to GDP ratio from the current level of 5 percent to close to 17 percent. 2.1 percent allocation of total pension fund assets to India would increase its reserves to US $ 342 billion the level of pension assets estimated in Brazil in 2010. CAGR of 16.5 percent would give an equity allocation of US$ 344.95 billion at the end of 2017. If 30 percent of the equity allocation goes into Infrastructure Sector it would mean an investment of US $ 103.49 billion which shall be one tenth of the infrastructure investment. The study of FDI in Civil Aviation observed: Huge amounts of additional investments required to realize the vision of the Civil Aviation industry as suggested in Working Groups report. Airport Infrastructure would require an investment of about Rs.67,500 crore during the 12th Plan of which around Rs 50,000 crore is likely to be contributed by the private sector. Airlines in India are expected to add around 370 aircrafts worth Rs.150,000 crore. Decade 2000-2010 witnessed a profitless growth. The Airline Industry in India suffers from huge debt burden close to US $ 20 billion (Estimated 2011-12).

Indias Experience with FDI: Role of a Game Changer

 Allowing foreign airlines to pick up stake in three major Indian Airlines (Kingfisher, Jet Airways and Spice Jet) would result in capital infusion to the tunes of : Promoters off loading 26% of their Equity Stake can raise approximately upto Rs. 1341 crore. Figure goes approximately upto Rs.2530 crore in case 49 per cent FDI is allowed. Equity valuation at 26% of all issued shares (promoter and nonpromoter) approximately comes out to be Rs.2835 crore. Estimates at 49% goes approximately upto Rs.5341 crore. The amount raised can be used to address working capital requirements of the airlines.

Indias Experience with FDI: Role of a Game Changer

I. Indias FDI Overall View

he early nineties was a period when the Indian economy faced a severe Balance of Payment crisis. Exports began to experience serious difficulties. The crippling external debts were putting pressure on the economy. In view of all these developments there was a serious threat of the economy defaulting in respect of external payments liability. It was in the light of such adverse situations that the policy makers decided to adopt a more liberal and global approach thereby, opening its door to FDI inflows in order to restore the confidence of foreign investors.FDI provides a situation wherein both the host and the home nations derive some benefit. The home countries want to take the advantage of the vast markets opened by industrial growth. Whereas the host countries get to acquire resources ranging from financial, capital, entrepreneurship, technological know-how and managerial skills which assist it in supplementing its domestic savings and foreign exchange.

The contribution or impact of FDI has been well acknowledged in various discussion papers and studies amongst these in one of the recent study done on Indias FDI inflows trends and concepts1 it is mentioned that, The Economic Survey 2008-09 reiterated that: FDI is considered to be the most attractive type of capital flow for emerging economies as it is expected to bring latest technology and enhance production capabilities of the economy. And the National Manufacturing Competitiveness Council specified that: Foreign investments mean both foreign portfolio investments and foreign direct investments (FDI). FDI brings better technology and management, access to marketing networks and offers competition, the latter helping Indian companies improve, quite apart from being good for consumers. This efficiency contribution of FDI is much more important. The evolution of Indian FDI can broadly be divided into three phases classified on the premises of the initiatives taken to induce foreign investments into the Indian economy: (a) The first phase, between 1969 and 1991, was marked by the coming into force of the Monopolies and Restrictive Trade Practices Commission (MRTP) in 1969, which imposed restrictions on the size of operations, pricing of products and services of foreign companies. The Foreign Exchange Regulation Act (FERA), enacted in 1973, limited the extent of foreign equity to 40%, though this limit could be raised to 74%

K.S. Chalapati Rao & Biswajit Dhar INDIAS FDI INFLOWS Trends & Concepts by Institute for Studies in Industrial Development Working Paper No: 2011/01

Indias Experience with FDI: Role of a Game Changer

for technology-intensive, export-intensive, and core-sector industries. A selective licensing regime was instituted for technology transfer and royalty payments and applicants were subjected to export obligations. (b) The second phase, between 1991 and 2000, witnessed the liberalisation of the FDI policy, as part of the Governments economic reforms program. In 1991 as per the Statement on Industrial Policy, FDI was allowed on the automatic route, up to 51%, in 35 high priority industries. Foreign technical collaboration was also placed under the automatic route, subject to specified limits. In 1996, the automatic approval route for FDI was expanded, from 35 to 111 industries, under four distinct categories (Part Aup to 50%, Part Bup to 51%, Part Cup to 74%, and Part D-up to 100%). A Foreign Investment Promotion Board (FIPB) was constituted to consider cases under the government route. (c) The third phase, between 2000 till date, has reflected the increasing globalisation of the Indian economy. In the year 2000, a paradigm shift occurred, wherein, except for a negative list, all the remaining activities were placed under the automatic route. Caps were gradually raised in a number of sectors/activities. Some of the initiatives that were taken during this period were that the insurance and defence sectors were opened up to a cap of 26%, the cap for telecom services was increased from 49% to 74% , FDI was allowed up to 51% in single brand retail. The year 2010 saw the continuation of the rationalisation process and all existing regulations on FDI were consolidated into a single document for ease of reference. The evolution of the FDI policy, towards more rationalisation and liberalisation, has narrowed down the instruments regulating FDI policy broadly to three2: (i) Equity caps: restricting foreign ownership of equity capital

(ii) Entry route: requiring prior Government oversight, including screening and approval (iii) Conditionalities: comprising of operational restrictions/licencing conditions, such as nationality criteria, minimum-capitalisation and lock-in period etc.

http://dipp.nic.in/English/Discuss_paper/DiscussionPaper_relevance_23June2011.pdf

Indias Experience with FDI: Role of a Game Changer

A. FDI InFLOWS Trends: 1991-2011

The data on FDI inflows into the country shows that foreign investors have shown a keen interest in the Indian economy ever since it has been liberalized. An increasing trend of flows can be observed since 1991 with the peak of FDI flows being reached in 2008-09. (Chart 1) Therefore the trend gives support to the fact that as and when the government has taken initiatives to open up and liberalize the economy further, the investors have welcomed the initiative and reciprocated by infusing investments into India. There are various reasons which work in favour of India and increase the level of interest shown in by foreign organizations some of them being its demographics with a young population there is a huge consumer base that is to be tapped, the growing middle class, increased urbanization and awareness, rising disposable incomes. Chart 1: Trends of FDI Inflows

Source: DIPP

B. FDI Inflow by Components:

There has been a change in the method of estimation of FDI inflows since 2000-01, prior to this only equity inflows was taken as the FDI inflow figure however post 2000-01 the RBI has started following the international practice and taken into account other components of FDI inflows namely re-invested earnings and other capital. A look at the contribution of various components of FDI reveals that the share of re-invested earnings was rising from 2000 onwards uptil 2005-06 after which it has constantly been declining. The share of equity inflows has risen sharply since 2000-01 when it stood at 59.6 per cent to 74.3 per cent in 2010-11. (Chart 2)

Indias Experience with FDI: Role of a Game Changer

Chart 2: Share of FDI Components

Source: DIPP

C. Ways of receiving Foreign Direct Investment by an Indian company3

i. Automatic route
FDI up to 100 per cent is allowed under the automatic route in all activities/sectors except where the provisions of the consolidated FDI Policy, paragraph on Entry routes for Investment issued by the Government of India from time to time, are attracted. FDI in sectors /activities to the extent permitted under the automatic route does not require any prior approval either of the Government or the Reserve Bank of India.

ii. Government route

FDI in activities not covered under the automatic route requires prior approval of the Government which are considered by the Foreign Investment Promotion Board (FIPB), Department of Economic Affairs, Ministry of Finance. Indian companies having foreign investment approval through FIPB route do not require any further clearance from the Reserve Bank of India for receiving inward remittance and for the issue of shares to the non-resident investors. As can be seen that since 2005-06 there has been a significant difference in the amount of FDI inflows through the two routes a possible explanation for which could be that with the investment climate in India improving and healthy competition among states to
3

http://www.rbi.org.in/scripts/FAQView.aspx?Id=26

Indias Experience with FDI: Role of a Game Changer

attract FDI, the government eased foreign investment regulations leading to a spurt in FDI coming through the RBI route, which is a positive sign. As per the data available there is an increase in share of inflows through the RBIs automatic route, a decrease in the shares of inflows through the SIA/FIPB. (Chart 3) Chart 3: Trend of Equity inflow through FIPB and Automatic route

Source: RBI

D. Sectoral FDI Flow: Changing Dynamics of Investment:

Overall FDI into almost all the sectors had declined in the year 2010-11, a reason for which could be the global situation that prevailed during that time frame. Although services sector remain the sector attracting the highest FDI inflows since 2006-07 its share has been constantly declining. The FDI flows into computer hardware and software has been downward ever since 2005-06. It has drastically gone down from 24.8 per cent in 2005-06 to 4.0% in 2010-11. Housing & Real Estate have shown an upward trend in terms of their share in FDI inflows. Investments in chemicals and metallurgical industries have been erratic as no clear trend could be observed for the time period 2005-06 to 2010-11.

Indias Experience with FDI: Role of a Game Changer

Table Sectors Attracting Highest FDI Equity Inflows (uS $ Million) Sector Services Sector Computer Software & Hardware Telecommunications Housing & Real Estate Construction Activites Automobile Industry Power Metallurgical Industries Petroleum & Natural Gas Chemicals Total FDI Source: DIPP 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 543 4664 6615 6138 4353 3403 (9.8) (37.3) (26.9) (22.5) (16.8) (17.5) 1375 2614 1410 1677 919 784 (24.8) (20.9) (5.7) (6.1) (3.6) (4.0) 624 478 1261 2558 2554 1665 (11.3) (3.8) (5.1) (9.4) (9.9) (5.8) 171 467 2179 2801 2844 1127 (3.1) (3.7) (8.9) (10.2) (11.0) (5.8) 151 985 1743 2028 2862 1125 (2.7) (7.9) (7.1) (7.4) (11.1) (5.8) 143 276 675 1152 1208 1331 (2.6) (2.2) (2.7) (4.2) (4.7) (6.9) 87 157 967 985 1437 1252 (1.6) (1.3) (3.9) (3.6) (5.6) (6.4) 147 173 1177 961 407 1105 (2.7) (1.4) (4.8) (3.5) (1.6) (5.7) 14 (0.3) 390 (7.0) 5540 89 (0.7) 205 (1.6) 12492 1427 (5.8) 229 (0.9) 24575 412 (1.5) 749 (2.7) 27330 272 (1.1) 362 (1.4) 25834 578 (3.0) 398 (2.0) 19427

Indias Experience with FDI: Role of a Game Changer

II. Assessment of Global FDI4

UNCTADs recent world investment report 2011 has some interesting insights into the FDI pattern during 2010. Certain key highlights of the report are: Global foreign direct investment (FDI) flows rose moderately to $1.24 trillion in 2010, but were still 15 per cent below their pre-crisis average. For the first time, developing and transition economies together attracted more than half of global FDI flows. Outward FDI from those economies also reached record highs, with most of their investment directed towards other countries in the South. In contrast, FDI inflows to developed countries continued to decline.

Emerging economies are the new FDI powerhouses

Developing economies increased further in importance in 2010, both as recipients of FDI and as outward investors. As international production and, recently, international consumption shift to developing and transition economies, TNCs are increasingly investing in both efficiency- and market-seeking projects in those countries. For the first time, they absorbed more than half of global FDI inflows in 2010. FDI outflows from developing and transition economies also increased strongly, by 21 per cent.

Services FDI subdued

Sectoral patterns. FDI in services, which accounted for the bulk of the decline in FDI flows due to the crisis, continued on its downward path in 2010. All the main service industries (business services, finance, transport and communications and utilities) fell, although at different speeds. FDI flows in the financial industry experienced one of the sharpest declines.

FDI policies interact increasingly with industrial policies, nationally and internationally
The challenge is to manage this interaction so that the two policies work together for development. Striking a balance between building stronger domestic productive capacity on the one hand and avoiding investment and trade protectionism on the other is key, as is enhancing international coordination and cooperation.

http://www.unctad-docs.org/files/UNCTAD-WIR2011-Full-en.pdf

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Indias Experience with FDI: Role of a Game Changer

FDI trends in various EMEs (Emerging Market Economies) in uS $ Millions

Source: UNCTAD

As can be seen from the figures China is way ahead of other emerging economies in terms of FDI flows. Mexico has been witnessing a steady flow of foreign funds through the years. India alongwith Russia has witnessed increase in FDI flows in recent years. South Africa is the one that has been lagging behind other EMEs in terms of foreign investments.

Indias Experience with FDI: Role of a Game Changer

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III. Indias Sectoral Analysis

A. Telecommunications

he growth in certain key industries is indicative of the economic development taking place in an economy. Increased efficiency and reach provided by the telecom sector has been instrumental in improving the operations of various sectors such as IT, banking, or Media & Advertisement industry. The liberalization process that took place and the subsequent policy initiatives has paved the way for influx of private players. (Fig 1) The regulatory body overseeing the functioning of the sector is The Telecom Regulatory Authority of India (TRAI) and its main objective is to ensure a level playing field that encourages greater but fair competition so as to provide the consumers a better ambit of services at an affordable price. The Indian government has relaxed the limits on FDI into the sector considerably. (Table 1), which has lead to an increase of foreign capital into the sector. (Table 2) FDI helps in attracting large amount of funds, advanced technology and market competition which results in better services for the customer. Figure 1: Evolution of Telecom in India

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Indias Experience with FDI: Role of a Game Changer

Table 1: Investment caps and other conditions for specified services are given below:5 Telecom services (a) ISP with gateways (b) ISPs not providing gateways i.e. without gate-ways (both for satellite and marine cables) (c) Radio paging (d) End-to-End bandwidth (a) Infrastructure provider providing dark fibre, right of way, duct space, tower (IP Category I) (b)Electronic Mail (c) Voice Mail note: Investment in all the above activities is subject to the conditions that such companies will divest 26% of their equity in favour of Indian public in 5 years, if these companies are listed in other parts of the world. Table 2: Telecom Sector FDI Equity Inflows (uS $ Million) Sector 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 (upto Sep. 2011) 1901 74% Automatic upto 49% Government route beyond Automatic upto 49% Government route beyond 49% and up to 74%

74%

100% Automatic upto 49% Government route

beyond 49%

Telecom
Source: DIPP

624

478

1261

2558

2554

1665

Sector Performance: India with its favourable demographics and growing economy provides telecom players from world over an exciting and profitable opportunity. (Table 3) Rising demand for a wide range of telecom equipment, particularly in the area of mobile telecommunication which comprises of products like cell phones, chipsets, DSL and cable
5

http://dipp.gov.in/Fdi_Circular/FDI_Circular_012011_31March2011.pdf

Indias Experience with FDI: Role of a Game Changer

13

modems and networking devices,, has provided excellent opportunities to domestic and foreign investors in the manufacturing sector. The mobile phone has been transformed from being a luxury to being an essential device required by almost everyone. Such a change has been possible due to various reasons either at the policy level or at the operators or manufacturers end. Low priced handsets and tariffs alongwith increased connectivity has helped in the progress of various other sectors as well. Table 3: Sectors Performance

There is a huge difference in terms of the PSU and private sector networks, thereby suggesting that it is the private players which actually are responsible for the significant growth of telecom in the economy.

14

Indias Experience with FDI: Role of a Game Changer

Indias Experience with FDI: Role of a Game Changer

15

Outcomes of the FDI policy:

Some of the benefits Industry Consumers Provided private players to tap the More Choices in terms of service existing potential in the sector. provider Assisted the industry in upgrading its Prices of products and services have technology quotient by being exposed come down substantially to international standards. A lot more products to choose from in Opening up international markets for the terms of handsets telecom equipment manufacturers Greater connectivity assists customers Provided the sector with the much from all walks of life, be it the trader, needed financial assistance to set up farmer, entrepreneurs the infrastructure required to distribute Increased usage of internet has meant the benefits of the telecom revolution. new models of imparting education can be adopted in the form of e-learning

B. Automobiles
Although the delicensing of the passenger car sector was initiated in 1993 the quantitative restrictions still prevailed. Therefore most of the foreign firms had to enter into joint ventures during the 1990s. (Fig 2) However since 2002 when the equity caps for foreign

16

Indias Experience with FDI: Role of a Game Changer

investors had been lifted the automobile industry has witnessed a healthy growth in the inflow of foreign funds. As reported in the data the FDI flow in 2005-06 was approximately 143million US$ which in 2010-11 became 1331million US$. (Table 4) Fig 2: Evolution of Automobile FDI Policy

Table 4: Automobiles Sector FDI Equity Inflows (uS $ Million) Sector Automobile Industry
Source: DIPP

2005-06 143

2006-07 276

2007-08 675

2008-09 1152

2009-10 1208

2010-11 1331

Sector Performance: India is considered to be one of the fastest growing auto markets in the world owing to its huge market size, expanding middle class, availability of finance options and a high percentage of young aspirational population. Apart from these from the viewpoint of a manufacturer India provides auto companies with low cost production facility, a growing talent pool of technical personnel, and a growing and competent auto components market. A look at some of the key parameters of the industry shows that the sector has been growing continuously thereby benefitting both the manufacturers as well as the consumers. A look at the production, sales and exports figures suggest that all the three indicators have shown an upward trend alongwith the rise in FDI flows into the sector. The growth of the automobile sector has assisted India in developing a healthy auto component industry, with its turnover and investments rising almost every year since 2005-06. (Table 5) An indicator of increase in the competitiveness of the Indian auto components market can be judged by the fact that a major share of the exports of these products is to Tier 1 OEMs.

Indias Experience with FDI: Role of a Game Changer

17

Table 5: Sectors Performance

18

Indias Experience with FDI: Role of a Game Changer

Indias Experience with FDI: Role of a Game Changer

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Indias Experience with FDI: Role of a Game Changer

Outcomes of the FDI policy:

Some of the benefits Industry Consumers Has increased the competitiveness of Consumer choices have increased by domestic players. many folds both in terms of product range within a price range as well as The growth in the sector assisted the across price range. development of the auto component industry which not only produces The Indian consumer today has access products of global standards but has to global brands also resulted in increased employment. The quality of products in terms of The productivity levels within the customer experience as well as other sector have improved as a result of parameters such as safety, accessories following globally recognized models of have improved tremendously. manufacturing. Over the years there have been new The technological capability of Indian product categories that have been firms has also seen improvements over created keeping in mind the change the years. in customer preferences. The recent surge in demand for luxury and high FDI bought the required capital into the end automobiles has been noticed by sector which assisted players in scaling various international brands which have up their supply thereby assisting their now started looking at India as a future overall efficiency and growth. growth driver.

C. IT/ITES
100% FDI is permitted in the Electronic hardware sector and the Software development sector under the automatic approval route. Industrial Licensing has been virtually abolished in the Electronics and Information Technology sector except for manufacturing electronic aerospace and defence equipment. In order to promote domestic investment, foreign direct investment, transfer of technology / process know-how, technical collaboration, joint venture etc in India and export IT software products and services from India to the global market, both Government of India and State Governments in India have been offering a series of policy packages including tax breaks, import duty concessions etc. The rapid growth in the sector is a consequence of highly skilled human resource, low wage structure, quality of work and the various policy initiatives as discussed earlier. The

Indias Experience with FDI: Role of a Game Changer

21

recent fall in FDI flow to the sector could be due to the turmoil prevailing in most of the developed nations which are a big market for the Indian IT industry. (Table 6) Table 6: Computer Software & Hardware Sector FDI Equity Inflows (uS $ Million) Sector Computer Software & Hardware
Source: DIPP

2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 1375 2614 1410 1677 919 784

Sector Performance: The Information Technology (IT) sector in India is one of the sunshine sectors of the Indian economy and amongst the fastest growing in the country. The demand for IT services has been fuelled by subsequent growth in allied sectors such as telecom, banking, insurance, retail, healthcare and automobiles. Abundant investment opportunities exist in the following thrust areas in India. Hence IT sector is attracting considerable interest not only as a vast market but also as potential production base by international companies. The trend over the last few years indicates a healthy rate of growth both in terms of production and exports. (Table 7). Table 7: Sectors Performance

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Indias Experience with FDI: Role of a Game Changer

Indias Experience with FDI: Role of a Game Changer

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IV. relevance of FDI in India

he 12th Plans draft approach paper of the Planning Commission mentions that Thus the average investment rate needed during the Twelfth Plan period is estimated to be 38.5 per cent of GDP for the 9.0 per cent growth scenario with 4.55.0 average inflation. It would have to rise as much as 41.4 per cent of GDP for the 9.5 per cent growth scenario with 5.05.5 rate of inflation and in terms of investment in infrastructure the same document suggests that The total investment in infrastructure would have to be over Rs.45 lakh crore or $ 1 trillion during the 12th Plan period. Financing this level of investment will require larger outlays from the public sector, but this has to be coupled with a more than proportional rise in private investment. It is seen that every nation world over is the race of attracting more FDI inflows to accelerate the pace of economic progress Indias case is no different as in order to achieve and sustain a healthy rate of growth India would require huge investments which cannot be financed locally therefore the government needs to look at alternate avenues of building up investments, FDI in this context is a very useful mechanism. Recent reports have also suggested that greater FDI inflows must be encouraged to meet capital requirements.6 Aside from using FDIs as investment channel and a method to reduce operating costs, many companies and organizations are now looking at FDI as a way to internationalize. FDI should be looked upon as a means of industrialisation and development. The Benefits of FDI Inflows can be broadly identified as:7 Bridging the financial gap between the quantum of funds needed to sustain a level of growth and the domestic availability of funds Technology transfer coupled with knowledge diffusion that leads to improvement in productivity. It can, thus, fasten the rate of technological progress through a contagion effect that permeates domestic firms The transfer of better organisational and management practices through the linkages between the investing foreign company and local companies.

6 7

http://www.financialexpress.com/news/more-fdi-must-for-fund-requirements/754904/0 http://dipp.gov.in/oecd_backpaper/FDI%20AND%20INFRASTRUCTURE.pdf

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Indias Experience with FDI: Role of a Game Changer

Some of these benefits have been seen in the cases of automobile and the telecom industry as discussed in the study earlier. Moreover it can be seen that a promotion and growth in one industry simultaneously fuels the growth in its interconnected sectors as well. It is well accepted that Indias rising growth would require a simultaneous expansion of its infrastructure facilities to support it. The Government of India has been frequently taking initiatives to liberalize and incentivize its foreign direct investment policies to attract investments however the recent decision to suspend FDI in retail as well as hold all other FDI decisions could dampen the international investors confidence, as the initial announcement and then the rollback of the initiative might be interpreted as a sign of political instability in taking key policy decisions. In todays global scenario when investors might be looking at alternate avenues, to invest their money there are only a few nations across the world that provide opportunities to foreign companies, with a highly potential market and a low cost manufacturing opportunity and India is one of them. FDI in retail would have been an opportunity to attract inflow of funds which would have resulted in major benefits for the Indian economy: 1. Agriculture: Organized retailing would have led to a complete overhauling of the existing agricultural supply chain. It would have led to bypassing of various intermediaries thereby reducing costs. Investments made by them would have helped in creating back end infrastructure like warehousing and distribution centres, transport and cold storage facilities. It would have created both direct as well as indirect employment at various levels. All these would have resulted in enhanced farmers realizations, improved quality of products and reduction in consumer price. Growth in allied industries: The inflow of funds into retailing would have simultaneously led to the growth of allied industries as happened in the case of automobiles, which led to the growth of auto components sector. Likewise FDI in retail would assist growth in supplier industries such as food-processing and textiles moreover, growing demand for retail space, construction of real estate would have also taken place. Increase in Employment: As mentioned in the previous point the growth in a number of allied industries would also result in the growth of employment opportunities across sectors. Both direct and indirect labour would be required to support the industrial and operational machinery that would have been formed as a result of opening up of the sector.

2.

3.

Indias Experience with FDI: Role of a Game Changer

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4.

Improvement of Government revenues: Another significant advantage of organized retailing is its contribution to government revenues. Organized retailers, by virtue of their being corporate entities need to file tax returns periodically whereas in the unorganized sectors there have been leakages in the collection of central and state taxes.

Recent Development
Farmers have reiterated their support for Cabinets decision to allow FDI in Multi-Brand Retail. In a meeting with the Minister of Commerce, Industry and Textiles Shri Anand Sharma, Secretary General of Consortium of Indian Farmers Associations (CIFA), Shri P Chengal Reddy conveyed the desire of various farmers body to implement the . decision as soon as possible. FDI in retail will free farmers from the middleman and will get the remunerative price for the produce to the farmer said Shri Reddy after the meeting. Shri Reddy also informed about the CIFAs efforts to engage state governments on the issue of FDI in retail. Many states are reconsidering their opinion as we have explained to them various details because of which FDI will help the small farmers in the long run as it builds competitiveness informed Shri Reddy.
Source: PIBs Website

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Indias Experience with FDI: Role of a Game Changer

V. Potential FDI Sectors

A. FDI in Pension Funds
As per the 12th Draft Approach paper of the Planning Commission The total investment in infrastructure would have to be over rs. 45 lakh crore or $ 1 trillion during the 12th Plan period. The year wise requirement of infrastructure investments is given in the table below: Table: Projected Investment in Infrastructure during the Twelfth Five year Plan
(Rs crore at 2006-07 prices) year GDP at market prices (Rs crore) Rate of growth of GDP (%) Infrastructure investment as % of GDP Infrastructure investment (Rs crore) Infrastructure investment (US$ billion) @ Rs 40/$ Base year (2011-12) 63,14,265 2012-13 2013-14 2014-15 2015-16 2016-17 Total 12th Plan 4,11,90,064

68,82,549

75,01,978

81,77,156

89,13,100

97,15,280

9.00

9.00

9.00

9.00

9.00

9.00

9.00

8.37

9.00

9.50

9.90

10.30

10.70

9.95

5,28,316

6,19,429

7,12,688

8,09,538

9,18,049

10,39,535

40,99,240

132.08

154.86

178.17

202.38

229.51

259.88

1,024.81

Source: Mid-Term Appraisal of the Eleventh Five Year Plan

Such high level of investments cannot be financed by traditional sources of public finance alone. Moreover, with increased globalization, provisions will have to be made to counter any global risks that might be prevailing as is the case with Euro zone crises currently. In the light of such events therefore the Central Government might have to pursue an even more cautious approach while incurring expenditures. This could lead to a significant

Indias Experience with FDI: Role of a Game Changer

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infrastructure gap and therefore there is need to recognize the importance of private sectors role in developing the infrastructure requirements of the nation. The share of private sector investments in infrastructure has been marginally on a rise. Please refer to the figure below: Figure: Share in Total Investment

Source: Mid-Term Appraisal of the Eleventh Five Year Plan

However amidst a slowing economy and a fall in corporate performance there might be a situation wherein even the private sector might have monetary constraints to fund huge infrastructure projects.

To fill this Infrastructure Gap

Pension Fund investments into infrastructure seem to be a befitting alternative given the match of interests for both the sectors. FDI in pension funds would further increase the volume of assets that can be invested into infrastructure and help in realizing the infrastructure needs of the country.

Characteristics of infrastructure projects that assist in attracting investments from pension funds: Long term income streams Stability

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Indias Experience with FDI: Role of a Game Changer

Predictable cash flows Low default rates Diversification of projects The project stands to benefit the society at large

Given the large infrastructure financing requirements, all potential resources must be tapped into by channeling available domestic and international funds into project finance. However, long-term investors, such as pension and insurance funds, have had a limited presence in the Indian market due to regulatory restrictions. The contribution of Pension and Insurance companies to infrastructure financing has been relatively small as indicated by their percentage share as sources of debt during the Eleventh Five Year Plan. Please refer to table below: Table: Likely Sources of Debt Financing for Infrastructure (rs crore 2006-07 price) 2007-08 2008-09 2009-10 2010-11 2011-12 Total Eleventh Plan 55414 122263

Pension/Insurance Companies External Commercial Borrowing (ECB) Estimated Requirement of Debt % Share of Pension/Insurance in Estimated requirement of Fund % Share of ECBs in Estimated Requirement of Fund

9077 19593

9984 21768

10983 24184

12081 26868

13289 29851

131718 6.9

155704 6.4

187333 5.9

229571 5.3

283709 4.7

988035 5.6

14.9

14.0

12.9

11.7

10.5

12.4

Source: Eleventh Five Year Plan

Therefore it is imperative that financial sector reforms continue in order to offer products and services to meet financing and risk management of the needs infrastructure projects.

Indias Experience with FDI: Role of a Game Changer

29

Size of Pension Funds Market

As per an OECD report8 According to the OECD calculations, the funded pensions market (both occupational and work related) has a size of US$ 24.6tr worldwide. Of this, US$ 16.2tr is held by pension funds. According to another report9 The OECD (Organization for Economic Cooperation and Development) countries account for more than 90 percent of the worlds private pension assets and the US account for nearly half of the total assets of private pension assets. Pension fund assets in BrIC countries are relatively low in relation to their GDP (17 percent in Brazil, 2 percent in russia, 5 percent in India, and one percent in China). The total pension assets in 13 markets at the end of 201010 are given in the table below: Table: Pension Fund Assets Country Australia Brazil Canada France Germany Hong Kong Ireland Japan Netherlands South Africa Switzerland UK US Total Plan 1261 342 1140 133 471 87 100 3471 1032 256 661 2279 15265 26496 % GDP 103 17 73 5 14 38 49 64 134 72 126 101 104 76

Source: Global Pension Asset Study 2011 Towers Watson

Georg Inderst Pension Fund Investment in published by OECD, Working Papers on Insurance and Private Pensions No. 32 9 Global Pension Funds : Overview FT Knowledge Management Company Limited Vol 1I No. 32I October 25, 2010 10 Global Pension Asset Study 2011 Towers Watson
8

30

Indias Experience with FDI: Role of a Game Changer

As per the Global Pension Asset Study 2011 the trend observed in the allocation of pension assets at a world level are: Table: Asset Allocation in 2010 Asset Allocation Equity Bonds Other Cash
Source: Global Pension Asset Study 2011 Towers Watson

Percentage Allocated 47 33 19 1

Pension Fund Assets in India

Table: Current Status rs. Crores Indias GDP at (constant price 2004-05) in 2010-11 Pension Fund Assets Fund Allocation Equity Bonds Other Cash
ASSOCHAMs Calculations

uSD Billion 97556 Exchange Rate taken as 1 US$ = 50 Indian Rupees As stated earlier pension fund asset in India is 5 per cent of the GDP Assuming that allocation is done as per the world trend indicated in the earlier table

4877842

48.78

22.93 16.10 9.27 0.49

Allowing FDI in Pension funds would give access to global pension fund companies to the vast untapped Indian market and assuming that opening up of FDI in Pension Funds shall help India in attracting slightly more than 1 percent of the total pension funds held by pension fund companies (size of pension fund holdings assumed to be uS $ 16.2 trillion as given in an OECD report).

11

Global Pension Funds : Overview FT Knowledge Management Company Limited Vol 1I No. 32I October 25, 2010

Indias Experience with FDI: Role of a Game Changer

31

India would be able to raise the share of Pension fund assets to GDP from the current level of 5 percent to close to 17 percent which would be similar to that of another emerging economy Brazils level in 2010.

Moreover a 2.1 percent allocation of total pension fund assets to India would increase its reserves to US $ 342 billion the level of pension assets that were there in Brazil in 2010. If Pension Funds reach 17 per cent of Indias GDP then this would result in assets worth US$ 165.85 Billion Moreover if India is able to reach the levels witnessed in Brazil in 2010 then going by the world trends the Equity allocation of these alone could be as high as US$ 160 Billion A CAGR of 16.5 percent as witnessed by Brazil would result in total pension assets of US$ 733.93 Billion, of which equity would be US$ 344.95 Billion.

Of this even if 30 per cent goes into Infrastructure Sector then it would mean an investment of uS $ 103.49 billion which is close to one tenth of the infrastructure investment requirement of the 12th Plan. Table: Potential Scenario Asset Allocation Percentage Allocated Pension Fund Assets at 5 per cent of GDP (current status) 48.78 47 33 19 1 22.93 16.10 9.27 0.49 Pension Fund Assets at 17 per cent of GDP Pension Fund Assets at Brazils Current Level Pension Fund Assets at the end of 2017 (starting at uS $ 342 billion in 2012) if CAGr is 16.5 percent*

Total Available Assets (uSD Billion) Equity Bonds Other Cash

165.85 77.95 54.73 31.51 1.66

342.00 160.74 112.86 64.98 3.42

733.93 344.95 242.20 139.45 7.34

ASSOCHAMs Calculations *CAGR is taken as 16.5 per cent as this has been the rate achieved by Brazil in the period 31/12/2000 to 31/12/2010 as per Global Pension Asset Study 2011 Towers Watson

32

Indias Experience with FDI: Role of a Game Changer

Other Benefits
A vast majority of Indias population is not covered by any formal old age income scheme and is dependent on their earnings and transfer from family members. The unorganized sector has no access to formal channels of old age economic support. As indicated in remarks made on the pension system in India12: Only about 12 per cent of the working population in India is covered by some form of retirement benefit scheme. The total pension liability on account of the Central Government employees has increased at a compound annual growth rate of more than 21% during the 1990s, the comparable rate for the State Government was 27% per annum. The implications of demographic dynamics for pension planning in India becomes more evident when one takes into account the fact that average life expectancy at age 60, which is currently 17 years, is likely to rise to more than 20 years in the next three decades and that the population over 60 years of age will approach 200 million in 2030.

Therefore large scale reforms are required to ease the pressure on the treasury, to provide for a social security net for growing numbers of senior citizens as well as a growing workforce.

12

Pension Reform in India A Social Security Need ( D. Swarup, Chairman, PFRDA)

Indias Experience with FDI: Role of a Game Changer

33

B. FDI in Civil Aviation

I. Importance
The aviation industry is critical for any nation to gain from participation in the global economy. Civil Aviation in its role of a key infrastructure sector facilitates: Growth of other industries Trade - by offering a reliable and faster mode of transport services to move products and personnel across long distances Tourism Generates both direct and indirect employment opportunities

The vision for the Indian civil aviation industry for the 12th Plan period is:
To propel India among the top five civil aviation markets in the world by providing access to safe, secure and affordable air services to everyone through an appropriate regulatory framework and by developing world class infrastructure facilities

II. Potential
A growing middle class supplemented with rise in disposable incomes, change in lifestyles, a globalized economy all act as drivers that project a huge potential for the industry. Another way of looking at the potential of the sector is by comparing the domestic tariff of another emerging economy China. Domestic traffic in China is believed to be five times the size of Indias despite having a population just 10% larger. Forecast of air traffic carried out for 12th plan13 period suggests: Domestic passenger throughout would grow at an average annual rate of around 12%. Domestic passenger throughout is expected to touch around 209 million by FY-17 from 106 million in FY-11. International passenger throughout is estimated to grow at an average annual rate of 8% during the 12th Plan period International Passengers to reach 60 million passengers by FY-17 from 38 million in FY-11.

13

Report of Working Group on Civil Aviation for formulation of Twelfth Five Year Plan (2012-17)

34

Indias Experience with FDI: Role of a Game Changer

III. Investment required

Huge amounts of additional investments will have to be made into the sector to develop more airports, increase the existing capacities as well as improve and create additional support infrastructure if India intends to harness the existing potential efficiently. Broad Investment requirements: Expense On Airport Fleet Expansion Total Amount (rs. Crores) 67,500 147,600 2,15,100

Estimates given in the Report of Working Group on Civil Aviation suggest the investments requirement would be:

a) Airport Infrastructure
Estimates received from AAI and the industry indicate that the Indian airports would require an investment of about rs 67,500 crores during the 12th Plan of which around Rs 50,000 crores is likely to be contributed by the private sector. Please refer to the Table below: Table: Expected investments in airports during 12th Plan Investor AAI Private Investments Investment Category Airport projects By Airport Operator By Others (Concessionaires, Third Party, etc.) Subtotal TOTAL Inr (Crores) 17500 40,000 10,000 50,000 67,500

Source: Report of Working Group on Civil Aviation for formulation of Twelfth Five Year Plan (2012-17)

b) Airlines
Airlines in India are expected to add around 370 aircrafts worth Rs 150,000 crores to their fleet by FY-17. Fleet expansion at this scale would require airlines to explore multiple

Indias Experience with FDI: Role of a Game Changer

35

funding options including capital markets, long-term borrowings and leasing etc. Please refer to table below: Table: Expected fleet expansion by Indian carriers Airline Air India Go Air Jet Airways JetLite Kingfisher Spicejet Indigo TOTAL number of aircrafts expected to be added by 2017 40 22 79 20 78 68 69 376 Estimate value of aircrafts to be added (rs. crores) 18,000 8,100 32,000 7,600 29,700 26,100 26,100 147,600

Source: Report of Working Group on Civil Aviation for formulation of Twelfth Five Year Plan (2012-17)

realization of the civil aviation industrys vision would require huge amounts of funds to be invested. However, looking at the existing financial status of the industry the achievement of set objective seems to be ambitious14. The decade 2000-2010 witnessed a profitless growth phase of the air lines industry. During the three year period between 1 Apr 2007 and 31 Mar 2010, Indian carriers incurred an accumulated operational loss in excess of Rs 26,000 crores. As per certain estimates the Airline Industry in India suffers from huge debt burden close to US $ 20 billion (estimated for 2011-12). Half of this debt is aircraft related and the rest for working capital loans, payments to airport operators and fuel companies. High costs of operation and competitive pricing mechanism followed has adversely dented the financials of the airline sector.

14

Report of Working Group on Civil Aviation for formulation of Twelfth Five Year Plan (2012-17)

36

Indias Experience with FDI: Role of a Game Changer

IV. Foreign Airlines Equity Participation

Raising huge amounts of investments would require the government to adopt more progressive and positive fiscal regime as well as develop a collaborative approach with the industry. Civil Aviation industry would require not only large but continuous flow of funds if the next phase of growth needs to take place. For this to happen the government must relook at its FDI policy which disallows foreign airlines from purchasing equity of domestic airlines. Direct investment by foreign airlines would: Provide managerial and technical expertise needed to improve productivity. Raise much-needed capital for the private-sector players Improve operating standards and services

An estimation of the amount of capital that can be raised by three prominent Indian Private Airlines shows: (foreign non- airline investors equity has not been considered in estimation). The promoters by off loading 26 % of their Equity Stake can raise upto Rs. 1341.45 crores. This figure goes up to Rs. 2528.3 crores in case 49 per cent FDI is allowed. Combined equity valuation (promoter and non-promoter) at 26 % comes out to be rs. 2834.27crores. The valuation at 49 % goes upto Rs. 5341.52 crores.

The capital raised from equity sale can be used to address the working capital requirements of the airlines.

Estimates:
Table: Estimates of capital that can be raised Condition (a) Promoters off load their stakes (b) total available equity(promoter and non-promoter) is diluted
ASSOCHAMs Calculation

Amount of Capital raised (rs. Crores) At 26 per cent At 49 per cent 1341.54 2834.27 2528.29 5341.51

Indias Experience with FDI: Role of a Game Changer

37

A. Investment flow through FDI

Promoters share is diluted Airline Kingfisher Jet Airways Spice Jet Total
ASSOCHAMs Calculation

no of shares 263085543 10183 156528305

% Share 56.08 0.06 38.61

Total Value (rs Crores) 4268.56 .57 890.65

Amount of Capital raised (rs. Crores) if FDI 26% FDI 49% 1109.82 .15 231.57 1341.54 2091.59 .28 436.42 2528.29

Overall (promoter and non-promoters) share is diluted Airline Kingfisher Jet Airways Spice Jet Total
ASSOCHAMs Calculation

no of shares 469107140 17275436 405378065

Total Value (rs Crores) 7611.26 983.17 2306.6

Amount of Capital raised (rs. Crores) if FDI 26% FDI 49% 1978.92 255.62 599.72 2834.27 3729.51 481.75 1130.23 5341.51

B. Individual Airlines
Kingfisher Category Promoter Non Promoter Total no of shares 263,085,543 206,021,597 469,107,140 % Share 56.08 43.92 100 Total Value (rs Crores) 4268.56 3343.11 7611.26 Amount of Capital raised (rs. Crores) if FDI 26% FDI 49% 1109.82 869.20 1978.92 2091.59 1638.12 3729.51

ASSOCHAMs Calculation

note: Rs 162.27 that is the average of highest share price and lowest share price in the last four years has been used to calculate the valuation.

38

Indias Experience with FDI: Role of a Game Changer

Jet Airways Category Promoter Non Promoter Total no of shares 10,183 17,265,253 17,275,436 % Share 0.06 99.94 100 Total Value (rs Crores) .57 982.60 983.17 Amount of Capital raised (rs. Crores) if FDI 26% FDI 49% .15 255.47 255.62 .28 481.47 481.75

ASSOCHAMs Calculation

note: Rs 569.13 that is the average of highest share price and lowest share price in the last four years has been used to calculate the valuation. Spice Jet Category Promoter no of shares 156,528,305 % share 39.68 60.32 100 Total Value (rs Crores) 890.65 1415.96 2306.60 Amount of Capital raised (rs. Crores) if FDI 26% FDI 49% 231.57 368.15 599.72 436.42 693.82 1130.23

Non Promoter 248,849,760 Total 405,378,065

ASSOCHAMs Calculation

note: Rs 56.9 that is the average of highest share price and lowest share price in the last four years has been used to calculate the valuation.

Indias Experience with FDI: Role of a Game Changer

39

VI. ASSOCHAMs Suggestions

DI since 1991 has proved to be game changer for wide segments of Indian industry. FDI has change quality, productivity, and production in areas where it has been allowed. FDI has led to the creation of new activities such as IT-BPO, which was initiated

by select foreign companies. India needs huge investment in the 12th Plan period, it is calling for investments to the tune of $1 trillion in the infrastructure sector alone. We need among many other infrastructure facilities infrastructure in retail as well as those for food & perishable products. Opening of FDI in retail would have led to the creation of such farm infrastructure. This apart mining and manufacturing sectors also require huge investments and FDI can supplement domestic efforts significantly. There is also an urgent need for India to augment the investment absorption capacity. Moreover it has to be understood that India is competing for foreign investments with other emerging economies and so far a comparative analysis suggest that India has not been a large recipient of FDI. It is in this context that ASSOCHAM studied the role of FDI in Indian economy and particularly in select sectors. While ASSOCHAM feels that FDI liberalization should be pursued we also recommend some immediate ground level reforms for increasing the ease of doing business in India. Therefore we would like to propose a few suggestions to the policymakers for their consideration: Bureaucratic delays and various governmental approvals and clearances involving different ministries need to be fastened so as to increase the absorption rate of FDI into the country. Restrictions on sector caps and entry route to sectors other than those of national importance need to be liberalized further and constant reviewing of policies must be done. Government must ensure consistency of policy so as to improve the business and investor confidence.

40

Indias Experience with FDI: Role of a Game Changer

It is in the interest of the industry at large if a mechanism could be developed which facilitates a consultation between Centre and State governments before a policy rollout so that once the decision is taken its implementation does not get affected. Government must recognise that good regulations and efficient processes are key catalysts for FDI. Accessible and reliable information and efficient and predictable actions by public institutions help create a business environment conducive to investment. Time bound, non-discretionary, simplified and less number of procedures and approvals would also help in uplifting the international investors confidence and help foster more investment into India.
HHH

Indias Experience with FDI: Role of a Game Changer

41

About ASSOCHAM
ASSOCHAM acknowledged as Knowledge Chamber of India has emerged as a forceful, pro-active, effective and forward looking institution playing its role as a catalyst between the Government and Industry. ASSOCHAM established in 1920 and has been successful in influencing the Government in shaping Indias economic, trade, fiscal and social policies which will be of benefit to the trade and industry. ASSOCHAM renders its services to over 3,50,000 members which includes multinational companies, Indias top corporates, medium and small scale units and Associations representing all the sectors of Industry. ASSOCHAM is also known as a Chamber of Chambers representing the interest of more than 350 Chambers & Trade Associations from all over India encompassing all sectors. ASSOCHAM has over 100 National Committees covering the entire gamut of economic activities in India. It has been especially acknowledged as a significant voice of Indian industry in the field of Corporate Social Responsibility, Environment & Safety, Corporate Governance, Information Technology, Agriculture, Nanotechnology, Biotechnology, Pharmaceuticals, Telecom, Banking & Finance, Company Law, Corporate Finance, Economic and International Affairs, Tourism, Civil Aviation, Infrastructure, Energy & Power, Education, Legal Reforms, Real Estate, Rural Development etc. The Chamber has its international offices in China, Sharjah, Moscow, UK and USA. ASSOCHAM has also signed MoU partnership with Business Chambers in more than 45 countries. The Associated Chambers of Commerce and Industry of India

ASSOCHAM Corporate Office 1, Community Centre, Zamrudpur, Kailash Colony, New Delhi-110048 Tel: 011 46550555 (Hunting Line) | Fax: 011 46536481/82, 46536498 Email: assocham@nic.in | Website: www.assocham.org

NOTES

NOTES