Every FDI (foreign direct investment) comes embedded with a significant FDO (foreign direct outflow). Promoting FDI without assessing the FDO is an incomplete picture and can be potentially harmful.
Finance Minister P. Chidambaram, while presenting the Budget this year called attention to the Current Account Deficit, caused by the fact that India imports far more than it exports thereby putting a strain on foreign exchange reserves.
The Finance Minister has been making a case for foreign direct investment (FDI) into India in this context at many forums. What is missing in this line of thought is that it only looks at what can potentially come into the country. It is not balanced with an assessment of what could flow out as a result of the FDI. In other words, foreign direct outflow or FDO.
Investment means Returns
Any foreign company putting money into India does so with the intent of earning a decent return, which is perfectly legitimate. Ideally, from the multinationals’ point of view, such returns should be copious, continuous and predictable, with minimum risks. The returns earned are either retained in India (adding to the company’s reserves) or repatriated in foreign currency to the parent.
Public companies report their foreign currency outflows and inflows, on account of their operations, in their annual reports. An analysis of this reveals that the multinational companies in India take out money from India under four streams. While we can debate the fairness of some of these outflows, it should be stated that these are all perfectly legal.
Royalty payments: This is paid out as a percentage of sales and justified as the cost of technology, for use of brand name and simply for management services.
Dividend payments: This is the share of the after-tax earnings of the company that is paid to the foreign investor proportionate to shareholding.
Information Technology payments: This is the money paid out for IT services by some companies to their parent.
Cif (cost, insurance, freight) value of imports: These are by far the largest amounts paid out. It is the cost/insurance/freight for goods imported by the Indian subsidiary mostly to sell in India. These could be finished goods or components and parts or CKD kits which are finished and sold in India. Importantly, these amounts are paid mostly to associated entities abroad at “transfer prices”, which are not transparent. (Transfer pricing is a global issue that countries struggle with when it comes to corporate taxation.)
Multinational companies have foreign exchange inflows as well, mostly on account of sales and service from India.
The Royalty bonanza
Prior to April 2010, royalty remittances by Indian resident firms to foreign companies, in case of technology transfer, were capped at a lumpsum payment of $2 million plus 5 per cent on annual domestic sales or 8 per cent on exports sales without prior regulatory approvals. If there was no technology transfer, royalty payments were permitted up to 2 per cent on exports and 1 per cent on domestic sales (Department of Industrial Policy & Promotion Press Note No 8 (2009 series) dated 16/12/2009).
The Ministry of Commerce and Industry removed all such caps on royalty payments to overseas parents in April 2010 with retrospective effect from December 2009, for the benefit of the foreign investors. This has led to a predictable rush of enhanced royalty payments by multinational companies — a foreign direct outflow of earnings from India.
Quantum of FDO
We tallied the foreign direct outflow of 28 companies from their annual reports for the year ended December 2011 or March 2012. This is not a special or purposive sample. Nor is it a tally of all multinationals with a foreign direct outflow. It is simply a compilation from companies for which such data were available. See the accompanying table for a summary of the analysis.
The companies represent a cross-section drawn from various industries — automotive, consumer goods, engineering, pharma, appliances, and others. The list of companies includes many that have been in operation in India for decades, and some that are relatively new. The share capital invested in these companies is taken as the foreign direct investment made. (In reality, this number should be reduced because many of these companies have an Indian component of shareholding as well.) Reserves are excluded from FDI as these are retained from earnings within India.
The net foreign direct outflow works out to 14 per cent of the annual sales of these companies. Since a major component of the outflow relates to cif imports, the more the sales, the more forex outflow these companies could cause. As a measure of return on share capital, just the dividends and royalty payment of Rs 4,065 crore of these 28 companies adds up to more than 2x the share capital of Rs 1,954 crore invested. The Rs 15,638 crore of net forex outflow from these companies is 8x the share capital invested. Significantly, while the forex outflows are annual, the investment in capital is mostly a one-time affair (although there could be additional investments from time to time). Given the thousands of multinationals operating in India, this analysis is only the proverbial tip of the iceberg.
See the whole picture
As stated earlier, these foreign direct outflows are not improper. It is how business is done. However, talks of FDI as a panacea to the current account deficit, without taking into account the direct outflows that will occur, are misleading. To put this in perspective, FDI inflows into India in 2011-12 was $46.5 billion or approx. Rs 227,000 crore. Just the 28 companies for which we could compile data are responsible for net foreign direct outflows of Rs 15,638 crore or 7 per cent of the year’s FDI. What is the total annual FDO on account of FDI, and what is the trend in this? This information should be made public by the government for a balanced view on this matter.
Retail FDI, a big hole
The Government pushed for FDI in retail arguing that it will bring foreign exchange which is badly needed. In reality, the foreign retailers with their international sourcing will cause major annual outflow of foreign currency due to cif imports of consumption products. The Finance Minister is right in identifying the current account deficit problem. The FDI solution proposed is a bucket with a big hole.
Part II of this article further examines trends in FDO in FDI, and at possible solutions.
(The author is Group CEO, R. K. SWAMY HANSA and Visiting Faculty, Northwestern University, US. The views are personal.)
(To be concluded)