The Hindu Business Line : Structural problems of FDI flows

THE COMMERCE Minister announced recently at an FICCI meeting that Foreign Direct Investment in retail would be permitted, and introduced in a manner that would protect the existing players, mostly small. There have been recent announcements about FDI in construction, real-estate, banking and insurance. Over the last few months, there has been a slew of initiatives to encourage the flow of foreign investments into India. Several ministers, and the Prime Minister himself, have, on different occasions, stressed the need for greater FDI inflows, and taken the mutterings of the Left in their stride.

It is interesting that these initiatives to encourage FDI have happened at a time when capital investment is growing and growth in non-food bank credit is touching 20 per cent year-on-year. The reasons adduced are that while FII flows have increased substantially, these are, by nature, rather volatile additions to forex reserves and that short-term funds do not generate investment in fixed capital, and thus do not serve to add to employment.

There has also been continuous pressure from the developed countries to push India to open these sectors, and some of the new initiatives have their origin in the interest that investors from these countries have shown in these sectors. The previous NDA government had announced and attempted to increase FDI in the telecom sector to 74 per cent and in airport development to 49 per cent; there were also attempts to remove limits in private banking and to do away with the 10 per cent cap on voting, irrespective of the equity held. While supporting these initiatives, the UPA Government has gone further in announcing intentions to provide for FDI in retail, construction and real-estate.

The good news is that survey after survey is pointing to India as a great investment destination, that hedge and equity funds are eagerly scouting around for investment opportunities in the corporate sector, and that flows into the markets are greater than ever before. Therefore, it appears to be the best time to provide incentives for investment in India, and to open up new sectors for foreign investment activity.

At the same time, there are areas of concern on almost every front, where policy correctives are called for. First, in the manufacturing sector, even in areas where 100 per cent FDI is permitted there is no evidence of increased activity. The global automobile industry is investing hugely into Thailand, and that capacity is intended for the Indian market. Second, even in the IT sector, new generation investments for 2007 onwards by Texas Instruments, Intel and other giants are happening in China, not India, and many of these companies have decided to level off growth into India.

These are structural problems, which have as much to do with policy, as with implementation, and perhaps moving ahead fast on the policy front would leave the implementation issues far behind. In the insurance sector, for example, there is an urgent need to move up the FDI cap of 26 per cent. The new insurance companies have secured a reasonable foothold, are offering alternative products, and it is time to let them grow. The local partners neither have the muscle nor are unwilling to put in more money. But this issue has been hanging fire for several years now, and it is not clear whether the legislation will go through even during the Budget session. The case with banking reforms is similar. The bottlenecks in FDI caps and voting rights need to be removed, and again there is no clarity whether this will be achieved during this session.

The retail sector is another example. Permitting FDI alone may not be enough to see enhanced investment activity. It is important that a number of attendant legislation be addressed. These would include the Shops and Establishment Act, certain portions of the Essential Commodities Act, and, most important, issues relating to labour laws, movement of goods, warehousing and storage and a host of other Central and State legislation.

It is important to understand that the foreign investor, unlike the local retailer, would seek complete transparency in all the laws and regulations governing this activity and would not be comfortable until all issues including urban zoning laws and local body approval issues are taken care of. It is difficult to identify a Central ministry that would have the mandate or the muscle to achieve this coordination. The issues in real-estate are similar, with a host of different land holding patterns and land rights across States and dissimilar construction approval procedures.

There are issues regarding taxation as well, both in real-estate and in retail. In retail, there would be the contentious issue of transfer pricing, as well as issues regarding value addition, excise, and VAT. In real estate, there would be the issue of dealing with the existing exemptions in the income tax act. It is not clear whether those who advise articulators of policy have analysed all the attendant steps necessary to convert policy into action in these two sectors. Unless these issues are addressed simultaneously, removal of FDI caps might only result in cherry picking, whereby specific projects in some urban areas get the benefit of these, rather than any significance benefits to the community at large. One hopes the Government will be able to convey that policy is prompted by a perception of improved welfare to all sections of the community, and not to a select few. Finally, among all the committees that are being set up, perhaps there is an opportunity for one to look critically at the obstacles that the external investors are facing, in the areas where FDI has opened up, and to make it easier for more companies from more countries to make India their major business base.

Lastly, this entire exercise does not seem to have taken the views of the Left into account. If it is a reflection of the result of mature consultations and consensus, then it is to be welcomed. If, on the other hand, it is an attempt to push through as many as possible, and to back out of those where opposition mounts, then it is poor strategy, for the results would be ad hoc rather than well envisioned.

(The author is a former Union Finance Secretary.)

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