The Hindu Business Line : FDI: An agenda for action

THE importance of foreign direct investment for development has increased dramatically in recent years. It is now considered an instrument which integrates economies by bringing with it a package, including technology and managerial capability. In the recent past, India, if not completely hostile, was not very receptive to foreign private capital. The situation, however, has changed, and the Government is trying ever-harder to attract FDI now.

On paper, the current policies on FDI in India can be argued to be very liberal. For instance, after entry foreign firms are generally provided national treatment while differential treatment is limited to a few entry rules spelling out the proportion of equity that a foreign firm can hold in an Indian registered company or business. A few sectors such as lotteries and gaming and legal services are banned and some sectors have limits on foreign equity proportion. However, over the years, sectoral caps on foreign equity participation have been relaxed. The procedures are now simpler and non-discriminatory. There exist sector-specific incentives, but they are also available to domestic investors and to a large extent, incentives have been made transparent and rule-based.

However, FDI inflows to India (as a share of GDP) have been modest compared to many other developing countries. Of late, though India has done well in attracting FDI flows, the general opinion of the stakeholders (that is, foreign and domestic investors and civil society) is that given the size, there is significant scope for increasing FDI flows.

The dissatisfactory investment climate in India is reflected primarily in the substantial difference between the approved and actual FDI inflows, with the latter constituting only about 50 per cent of the former. Delays, complexities, obfuscation, overlapping jurisdictions and endless requests for more information frustrate the foreign investor. Hence, the regime does not work the way it is supposed to despite being liberal on paper. To be specific, out of the three stages of a project — general approval, clearance and implementation — the delays faced by foreign investors are not at the stage of FDI approval per se, but vis-à-vis clearance and at the State level — as projects reach the crucial implementation stage. One of the main reasons for the absence of a visible impact of FDI in India is the exit of many foreign investors mid-way in the project implementation stage as a result of excessive or bad governance.

For investors bureaucracy and red-tapism are biggest negatives. Further, the federal structure with many of the clearances vested in State-level authorities, leads to procedural delays. Environmental and legal clearances take up too much time. More important, the limited credibility of regulatory systems, and multiple and conflicting roles of agencies and government affect foreign investors more than their domestic counterparts because the latter know how the system works.

For developing strategies to raise FDI flows, the Government constituted a Steering Group on FDI under the chairmanship of Mr N. K. Singh. The group, which came out with its report in 2002, recommended a range of policy and regulatory measures for the Central and State governments. It advocated a change of strategy towards FDI, more vigorous marketing of the country as an investment destination, and reforms in specific sectors.

In the light of growing importance of FDI in India, the National Council of Applied Economic Research (NCAER) in collaboration with CUTS Centre for Competition, Investment and Economic Regulation Jaipur undertook a study recently to analyse the investment regime in India and build capacity of civil society on these issues. Part of a larger analysis of the investment regimes in seven developing/transition economies undertaken by CUTS, this study made recommendations for improving the pace of FDI inflows, and set for the government this agenda:

Create an enabling environment

The Government can enhance the benefits of FDI through a policy framework that creates development incentives for firms. It can improve the domestic investment environment by adopting several steps, such as reducing business cost in India, reorienting the policy framework in terms of transparency, simplifying bureaucratic procedures, establishing a regulatory mechanism for healthy development and monitoring of projects, and establishing an institutional base for attracting and regulating investments.

Further, competition policy and taxation policies, among others, are likely to increase the benefits of FDI. A Foreign Investment Promotion Law (FIPL), incorporating and integrating aspects relevant to promotion of FDI, needs to be created. The bankruptcy laws should be strengthened. Further, the database of FDI should be improved.

Emphasise on infrastructure sector

The infrastructure sector should get special attention in the Government's efforts to attract FDI as it is the basic underlying framework of facilities, which can help enhance the flows of FDI into the country. The States should also be encouraged to endorse special investment laws on infrastructure for the purpose of expediting investment in this sector. Domestic policy reforms are required in the power sector, urban infrastructure and real estate.

A good legal framework is a prime condition for attracting FDI in infrastructure because of the investments being huge and involving long gestation periods. At the same time, the Government should also establish a transparent regulatory framework to facilitate timely monitoring of projects to ensure the long-term continuity of policies.

Further, there is the need to expedite de-control/de-licensing to promote both domestic and foreign private investments. Policies focussing on building domestic capabilities through education and training are also extremely important for encouraging technological upgrading and entrepreneurship to improve the social infrastructure in the country.

Concentrate on sectoral FDI

The approach should be one of targeting specific companies in specific sectors instead of a broad one. Sectoral FDI caps should be reduced to the minimum and entry barriers eliminated. Reservations for the small-scale industry (SSI) should be removed. The existing SEZs (special economic zones) should be developed as destinations for export-related global FDI by simplifying laws, rules and administrative procedures as also cutting down on red-tape.

Work closely with civil society

There is a need for civil society to work closely with the Government and make direct and indirect policy intervention wherever possible. Civil society can play an important role in reducing the levels of bureaucratic hassles and interference and the discretionary power of the government to make India an attractive FDI destination.

Build awareness and stimulate debate on investment

There is also a need to raise awareness, stimulate national debate and build capacity of the civil society on investment issues. Also, there needs to be a way out to resolve the conflicting views within the civil society. On the one hand, civil society wants a more liberal policy regime and, on the other, it wants to impose restrictions on foreign investors in job creation, technology/skill transfer, export commitments and so on.

As the above policy recommendations suggest, the Government has to play a pro-active role by taking appropriate steps to attract increased FDI flows into the country. However, as the CUTS study suggests, there is an equally important role to be played by the civil society.

(The author is Principal Economist, National Council of Applied Economic Research, New Delhi.)

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