The Hindu Business Line : Why FDI caps must go

The government wants the private sector to invest in telecommunication, insurance, finance, banking, retail trade and real estate. But the Indian investor may not have the financial strength to make the large investments these sectors demand. Which is why India needs FDI. The US President, Mr George Bush, urged India to lift the cap on foreign investments, make rules transparent, continue reducing its tariffs and open the market for American agricultural products. This is the way to go.

The US President, Mr George W. Bush's is exuberant about firmer ties with India. Thus, he went ahead against all odds, even taking on the Congress and overruling the Non-Proliferation Treaty (NPT) rules, to push forward the nuclear deal with India. This is the harbinger of a new era of faith and trust in India. Mr Bush's overwhelming thrust on outsourcing as one of the key areas of focus for the US' relation with India should be a lesson for those setting the FDI (Foreign Direct Investment) policy in India; he urged them to raise the FDI cap on sectors in the negative list.

Driving India's growth

The US is the biggest investor in India and the largest trade partner as well, accounting for one-fifth of India's exports — especially in Information Technology. The US accounts for close to 60 per cent share of India's IT exports.

The US propelled FDI growth in India, which was sluggish for long due to the changes in the government and the restrictive policies. With the domestic consumption increasing because of the gross domestic product (GDP) growth, the FDI also increased in early 2000.

About 48 per cent of the total FDI inflows since 1991 came in just four years, during 2000-04. American multinational companies (MNCs) were the main engines for this growth in FDI. They invested both directly from the US — 13 per cent of the total FDI during this period — and indirectly, via Mauritius. American Foreign Institutional Investors have also given a boost to the Indian stock market.

India needs substantial FDI to achieve the target of 8 per cent GDP growth during the Eleventh Plan. The fact that this growth target could be a reality is one good reason to applaud the Finance Minister, Mr P. Chidambaram's Budget. The rate of investment (gross capital formation to GDP) in India is 30 per cent, which is considered a good platform for such high growth, and is backed by robust domestic savings of 29 per cent of GDP. China too gets big support from domestic savings — nearly 40 per cent of GDP. Yet, it depends much on FDI to sustain its high manufacturing growth.

From an annual average of 1.9 per cent between 1985 and 1995, the share of FDI in India's gross capital formation increased to 3.4 per cent in 2004. Simultaneously, FDI stock in GDP increased from 0.5 per cent in 1990 to 5.9 per cent in 2004.

Non-manufacturing sectors

The US MNCs invested mainly in non-manufacturing sectors such as services (financial and non-financial), computer software and consultancy.

Together these sectors accounted for 50 per cent of the total US FDI during 2000-04. During this period, India opened up its non-manufacturing sector, but moderately. It opened sectors such as insurance, real-estate, retail, telecommunications and banking.

But they are all outside the purview of the automatic approval system and are subject to higher cap restrictions. Now, with its sights set on fiscal prudence, the government wants the private sector to invest in these sectors. But the Indian investor may not have the financial strength to make large investments that these sectors demand. Hence, India needs investment back-up by the MNCs and the major the investors are mainly from the US.

But why would the MNCs risk making big investments if they cannot have majority stake — as in the insurance sector — or are subject to multiple procedures which delay projects — as in telecommunications. India needs US platform to spur its external economy.

Huge potential lies in the global growth of IT spend. According to a Nasscom (National Association of Software and Services Companies) report, the global IT services market would be worth about $1,200 billion by 2009.

The Americas will remain the largest business service market, accounting for a little less than 60 per cent of the global spend. Currently, India is the biggest IT service provider to the US. Outsourcing of IT services in the US is estimated to grow at 15 per cent till 2010. Approximately $98 billion worth of these services will be outsourced by 2010.

Terms of new relationship

But a major cause for concern is the unemployment in the US, because of IT service imports. Over 20 American States have proposed Bills to restrict outsourcing. However, Mr Bush has always defended outsourcing as an important link for stronger relations with India. Before his India visit, he said, "The area of America's relationship with India that seems to receive most attention is outsourcing." He is well aware of India's ability to provide IT services cheap. A US firm saves up to 67 per cent by outsourcing services to India. At the same time, he added: "India's growth is creating new opportunities for American businesses, farmers and workers." He urged New Delhi to lift the cap on foreign investment, make rules transparent, continue reducing its tariffs and open the market for American agricultural products.

The policy-makers should heed the US President's prescription for raising the FDI cap in the services sector. This sector accounts for 55 per cent of GDP. Insurance, banking, and telecommunication are the key links to bringing rural and urban sectors closer. Only 10 per cent of the country's population is covered by insurance. Banks have limited penetration in the rural areas. Telecommunication still remains a distance call for the rural people. Huge FDI is required to supplement the domestic investment to develop these sectors.

Since 1999 when the New Telecom Policy was introduced, FDI worth $1.5 billion came into the sector. This accounted for less than 49 per cent of all investments in the sector, mainly due to the FDI cap of 49 per cent. Had the Government raised the ceiling earlier, there would have been a better FDI flow.

This would have spurred the growth of the sector and made it possible to achieve the target of "telephone on demand" by 2007.

(The author is a Senior Researcher with a Japanese MNC in New Delhi.)

More Stories on : Foreign Direct Investment | Economy

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Towards a partnership

The Pascal pressure

A case of seizure logic that suffered serious seizures

Taxpayers' nightmare

Conflict between `heads'

Have IDRs arrived?

Why FDI caps must go

Oily skid is just dangerously around the corner