NOVEMBER 21, 2015

Playing with Foreign Investment Policy

The new policy on foreign investment is only concerned with augmenting inflows.

he recent amendments to Indias foreign direct investment (FDI) policy seek to increase the scope for foreign
investment through multiple ways: raising the sectoral
caps, withdrawing the sub-limits within the overall composite
caps and minimising the requirement of government approvals.
The amendments cover several key sectors: defence, broadcasting, private sector banks, non-scheduled air transport service,
ground handling services, plantations, single brand retail trade,
construction, and credit information companies.
The process of attracting investment to create jobs by amending the FDI policy, also underlined in the Union Budget for 201516,
was initiated by the National Democratic Alliance government
in August 2014. The first major step was to raise the cap on foreign
investment in defence sector enterprises from 26% to 49%. This
was followed by permitting FDI in rail infrastructure, relaxing
the conditions relating to construction development sector,
clarifying the policy towards FDI in medical devices, raising the
cap for the insurance sector, pension funds, etc.
Due to the progressive liberalisation of Indias FDI regime, caps
on the share of FDI in an individual companys equity are hitherto
applicable to only a few service sectors like retail trade, banking,
insurance, broadcasting and print media, besides defence. This
implies that barring a few exceptions, the entire manufacturing
sector and a large number of service sectors are not constrained by
restrictions on foreign ownership. Since the scope for further opening up is quite limited, the focus has turned to the existing caps.
While the FDI policy tries to distinguish between various types
of foreign investors, FDI per se is merely being seen as a source
of funds. This was clearly implied in Union Finance Minister
Arun Jaitleys budget speech last February: To further simplify
the procedures for Indian Companies to attract foreign investments,
I propose to do away with the distinction between different
types of foreign investments, especially between foreign portfolio
investments and foreign direct investments, and replace them
with composite caps. This was the view even earlier; a 2011
discussion paper of the Department of Industrial Policy and
Promotion (DIPP), FDI Policy-Rationale and Relevance of Caps,
bears testimony to this approach. The paper clarified that the
methodology for calculating aggregate foreign investment
introduced earlier in 2009 implicitly recognises that foreign
equity, up to 49%, is purely a source of funding, as long as control
Economic & Political Weekly

EPW

NOVEMBER 21, 2015

vol l nos 46 & 47

is not yielded to non-resident investors/entities. This interpretation seemed to have been accepted when the government
rewrote the FDI norms for the defence sector in 2014. The guidelines state that the applicant company seeking permission of the
Government for FDI up to 49% should be an Indian company
owned and controlled by resident Indian citizens.
A major and relevant question in this regard is whether serious
foreign investors who contribute almost half of the risk capital
can accept the position of sleeping partners. Further, it would be
unrealistic to expect foreign investors not to be interested in securing their technologies and reputation besides maximising their
overall returns on their investments. On the other hand, the Indian
partners are likely to seek FDI to get access to critical intangibles,
namely, technologies, goodwill, etc, apart from a stable source of
risk capital. Under such circumstances, foreign investors are more
likely to seek control of the operations of the joint venture (JV).
Since what distinguishes FDI from foreign portfolio investment
is influence/control and the intangibles, companies with 49%
foreign investment but with no foreign control would actually
be having portfolio investments. The way indirect FDI has been
defined has given rise to a piquant situation. For instance, FDI
is not allowed in inventory-based e-commerce operations. A
leading US-based e-commerce company circumvented this
restriction by forging a JV with an obliging Indian investor
and using the JVs subsidiary to sell through its website, thus
effectively following the inventory model.
Since the distinction between FDI and the other forms of foreign
investment is being done away with, Indias FDI policy is
progressively turning into a generic foreign investment policy.
The government is rapidly rendering irrelevant the notion of
sectoral caps. It must be noted however that foreign investment
caps provide domestic entrepreneurs the opportunity to form JVs
and to meaningfully contribute to the running of such enterprises.
The government can ill-afford to ignore the significant benefit that
can be derived through the promotion of true JVs, namely,
opportunities for Indian entrepreneurship to develop.
In the name of FDI policy reforms, India is merely easing the
procedures and enhancing the scope for foreign equity participation. There cannot be a stand-alone FDI policy with the main
objective of maximising inflows. What it actually should do is to
constantly review the requirements of various sectors, assess the
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EDITORIALS

contribution of different constituents, create conditions which

force foreign investors to contribute positively to the national
economy and devise ways to enhance the bargaining power and
capabilities of domestic entrepreneurs. Thus, instead of giving the
concept of foreign investment caps a quiet burial, the government
needs to carefully review Indias experience with FDI over the
past two decades and proceed further to maximise the net

benefits within the freedom allowed by its international

commitments. In his budget speech, the finance minister stated
that the measures relating to FDI in defence, insurance and railway
infrastructure, construction and medical devices sectors were
taken to create jobs. It may therefore be worthwhile to look at
the past experiences with FDI in job creation, in order to ensure
that such expectations are being realised.

NOVEMBER 21, 2015

vol l nos 46 & 47

EPW

Economic & Political Weekly