On Tuesday, the Union government announced several policy changes that seek to attract more foreign direct investment (FDI) into the country. These are welcome moves, but will not work in isolation. It is interesting that two large industrial projects were shelved soon after the policy changes were announced: South Korean steel giant Posco gave up its plans to build a $5 billion steel plant in Karnataka while ArcelorMittal pulled the plug on plans to build a steel plant in Orissa.
The reason why the changes in FDI rules were pushed through is well known: India needs stable capital inflows to finance its massive current account deficit. However, the bigger reason why any country should seek investment from global companies is that they add to industrial capacity, transfer knowledge and help build supply chains. India is too focused on the former at present, and it is no surprise that some of the biggest foreign investment deals in recent years have been in existing operations rather than in greenfield projects. Consider the recent bid by Unilever to increase its stake in its local unit or the earlier investment by BP in the gas fields operated by Reliance Industries.
The root problem is that such policy changes are made at moments of panic rather than with a broader strategic vision. The measures taken on Tuesday reveal this clearly.
Broadly, the changes fall in two classes. The bulk involves changes in the route by which FDI is allowed in the country. Instead of the usual route of seeking approvals from the Foreign Investment Promotion Board (FIPB), automatic approvals—which do not require cumbersome presentation and approval from FIPB—have been granted in the case of petroleum and natural gas and refining; commodity exchanges, stock exchanges; and power exchanges. In these cases, the sectoral caps remain constant at 49%. So, essentially, these are steps just to ease the red tape that foreign investors face in getting their proposals through. There’s nothing earth-shattering here.
It balked at freeing more promising sectors or where it did take the right steps, they are unlikely to translate into any greenfield investments. In the case of insurance, the government raised the sectoral cap from 26% to 49% but the step is subject to parliamentary approval. Until the Insurance Bill is cleared, the increase in the limit is illusory. Similarly, in the case of defence production, the cap has been raised from 26% to potentially 100%. India is one of the world’s largest defence equipment buyers. Hundred per cent FDI in this sector could lead not only to substantial national security gains but given its capital-intensive nature, huge inflows are possible. But any investment beyond 26% will require approval by the cabinet committee on security, a hurdle even more difficult to surmount than FIPB. This is unlikely to click. Similarly, the raising of investment limit to 100% in the case of basic and cellular services (from the existing 74%) will only make it easy for existing companies such as Vodafone to buttress their existing investments. The same is true for single-brand retail where 100% investment has now been permitted via the FIPB route.
One clue to why these steps will not work lies in India’s experience with multi-brand retail. Announced with much fanfare last year, the step is yet to yield results. The Swedish giant Ikea’s experience—or rather nightmare—in getting approvals for inconsequential things as selling food in its stores is instructive. After announcing big changes, the government nitpicks on minutiae. This unnecessary needling sends a signal to investors that what India does on paper and what it really means are two different things. These examples can be multiplied. The travails of the Jet-Etihad deal are too well-known to be recounted here. This is sufficient to deter even the hardiest India optimist abroad.
Then there is the question of timing. The right time to attract FDI is when the country’s growth is on an upswing. A fast-growing economy is a far more attractive proposition than one that is growing modestly. If the investment regime is liberalized during troubled times, any foreign investor will be cautious before committing money. If anything, the desperation evident in Tuesday’s measures will actually prompt a wait and watch attitude on the part of investors.
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