Themes > Current Issues
26.04.2003
The FDI Policy
C.
Rammanohar Reddy
Deep
in the April issue of the Reserve Bank of India's Bulletin are a couple
of statistics that policy-makers could use. In 2000-01, exports as a
proportion of sales among a sample of 400-odd foreign direct investment
(FDI)-controlled firms in India was just 11.6 per cent. And of the funds
utilised by these FDI companies, 40 per cent went into acquisition of
gross fixed assets such as plant and machinery. Compare this with the
corresponding ratios in a similar RBI survey of nearly 2,000 public
limited Indian companies. In 2000-01, exports as a proportion of sales
was higher at 12.6 per cent and a much larger proportion of funds, 48.9
per cent, was used for the acquisition of gross fixed assets. In other
words, Indian companies are showing a greater export focus than foreign
firms and they are also investing more in plant and machinery. This was
not unique to 2000-01. The gap, if anything, was larger in 1999-2000 and
this was probably the case right through the 1990s.
To put it simply, two of the fundamental reasons for the wooing of FDI are not borne out by the experience of the 1990s. It is more than a decade since India dismantled one of the most restrictive FDI regimes in the world and replaced it with one of the most open and relaxed national policies towards foreign investment among the developing countries. Yet, even now the debate is about how much more open India should be towards FDI. Earlier this week, the Union Cabinet could not take a decision on the proposal to raise the existing limits on FDI in a number of sectors such as telecom, petroleum refining and marketing. Caught between the xenophobes and unthinking liberalisers, the policy on FDI has been lurching in the wrong direction. It has been obsessed with what can only be called the dollar and China syndrome: why is India still receiving less than $ 4 billion of FDI every year and why is it attracting a far smaller amount of FDI dollars than China?
The most visible impact of FDI in the manufacturing sector has been in expanding the range of products available to the consumers. This is so in cars, two-wheelers, consumer durables, food products and apparel. In services as well, a more open FDI regime has seen the entry of more banks, new insurance companies, while global management consultancies and accountancy firms have virtually taken over the Indian market. But do we know what FDI has done for fixed investment, exports, and technological modernisation? Unfortunately not, because the Government does not seem to be bothered about the original rationale for FDI. A good example of the warped contours of the Government discourse on FDI is to be found in the Planning Commission (N. K. Singh) committee on FDI whose recommendations seem to have currently set the parameters for national policy in this area and were the subject of debate in the Union Cabinet earlier this week. Here was an opportunity to evaluate FDI policy over the past decade and suggest measures that would encourage investment that the economy could do with. Instead, all that the committee did was focus on what it thought the Government should do to meet a (presumed) savings-investment gap during the Tenth Plan of around $ 8.8 billion a year. That explains why all the core proposals of the Planning Commission committee were about a sweeping removal of sectoral caps in infrastructure, manufacturing and financial services and the removal of existing prohibitions in agriculture (plantation) and real estate.
There was no discussion of why FDI has been showing less interest in greenfield investment (the establishment of new industrial and service units) than in using the merger and acquisition (M and A) route to establish or increase its presence in the Indian market.
There was no discussion of why much of the roughly $ 30 billion FDI that has come into the country since 1991 has been more interested in "tariff-jumping" into the Indian market than in contributing to exports. There was no discussion of what one can learn from the largest case of FDI since 1991, which also turned out to be the biggest fiasco — Enron. And there was no discussion of why there has been such a limited ripple effect of the technology that the FDI is supposed to have brought in across the larger economy.
The case for the sweeping relaxation of the remaining sectoral caps in FDI also rests on very flimsy grounds. The Planning Commission committee argued that removal of the remaining entry restrictions will remove "irritants that are sometimes blown out of proportion by interested parties to the detriment of national interest" (p39). The report also refers (p84) to an un-named study which suggested that the cap in telecom should be raised to 74 per cent, investment in petroleum retailing should not be linked to refining and FDI should be allowed in retail, real estate and commercial construction. It does not take much to infer where such recommendations and un-named studies come from. Besides holding discussions with chambers of commerce and a few State Government officials, the N.K. Singh group interacted with multinational consultancies that have set up shop in India. It does not mean that India's policy must be tailored to suit these interests. The Planning Commission group's own comparative analysis shows that India has a more liberal FDI regime than Malaysia or China. Yet, the two East Asian countries attract considerably more investment than India in spite of the Governments there following a hands-on approach and having in place a positive rather than a negative list (as in India) of sectors where FDI is allowed. As far as the volume of FDI is concerned, it is clearly not the presence or absence of FDI caps in each sector that matter as much as the environment for investment. If a liberal FDI policy is all that was important then the sub-Saharan African countries, which by and large now have the most open policy towards foreign investors in the developing world, should be attracting huge volumes of FDI.
The fundamental problem with FDI in India today is that while before 1991 all of it went into greenfield investment, it now appears to be increasingly concentrated in the M and A route. A 2000 study by Nagesh Kumar of RIS, Delhi, concluded that between 1997 and 1999, approximately 40 per cent of FDI was using the M and A route to take over Indian companies, increase control in existing subsidiaries by issuing shares at low cost or buy back shares and de-list from the stock exchanges.
In a new study of FDI in India, R. Nagaraj of the Indira Gandhi Institute for Development Research has argued that the problem is that our policy towards foreign investors does not have a focus. In comparison with the Chinese approach, the Indian FDI regime suffers because it is passive (open to all, without any targeting) and not strategic as in China. In the opinion of this economist, India's FDI policy should aim at encouraging investment in manufacturing for acquisition of technology and for the establishment of international trading channels to facilitate labour-intensive exports.
It cannot be that most of the FDI that has come into the country has made no contribution to the economy. A notable example of large-volume FDI that has had many positive externalities is Hyundai Motors, which has created substantial new investment, contributed to modernisation of the auto ancillary industry and exported volumes which are not insignificant. But Hyundai and a few others are only notable exceptions. The problem is that in dismantling the pre-1991 regulation of FDI, India has not just swung to the other extreme.
The Government has set about creating a policy regime that has neither coherence nor macro-economic purpose, the only objective being to create what it thinks is a set of incentives that will bring in large volumes of FDI.
To put it simply, two of the fundamental reasons for the wooing of FDI are not borne out by the experience of the 1990s. It is more than a decade since India dismantled one of the most restrictive FDI regimes in the world and replaced it with one of the most open and relaxed national policies towards foreign investment among the developing countries. Yet, even now the debate is about how much more open India should be towards FDI. Earlier this week, the Union Cabinet could not take a decision on the proposal to raise the existing limits on FDI in a number of sectors such as telecom, petroleum refining and marketing. Caught between the xenophobes and unthinking liberalisers, the policy on FDI has been lurching in the wrong direction. It has been obsessed with what can only be called the dollar and China syndrome: why is India still receiving less than $ 4 billion of FDI every year and why is it attracting a far smaller amount of FDI dollars than China?
The most visible impact of FDI in the manufacturing sector has been in expanding the range of products available to the consumers. This is so in cars, two-wheelers, consumer durables, food products and apparel. In services as well, a more open FDI regime has seen the entry of more banks, new insurance companies, while global management consultancies and accountancy firms have virtually taken over the Indian market. But do we know what FDI has done for fixed investment, exports, and technological modernisation? Unfortunately not, because the Government does not seem to be bothered about the original rationale for FDI. A good example of the warped contours of the Government discourse on FDI is to be found in the Planning Commission (N. K. Singh) committee on FDI whose recommendations seem to have currently set the parameters for national policy in this area and were the subject of debate in the Union Cabinet earlier this week. Here was an opportunity to evaluate FDI policy over the past decade and suggest measures that would encourage investment that the economy could do with. Instead, all that the committee did was focus on what it thought the Government should do to meet a (presumed) savings-investment gap during the Tenth Plan of around $ 8.8 billion a year. That explains why all the core proposals of the Planning Commission committee were about a sweeping removal of sectoral caps in infrastructure, manufacturing and financial services and the removal of existing prohibitions in agriculture (plantation) and real estate.
There was no discussion of why FDI has been showing less interest in greenfield investment (the establishment of new industrial and service units) than in using the merger and acquisition (M and A) route to establish or increase its presence in the Indian market.
There was no discussion of why much of the roughly $ 30 billion FDI that has come into the country since 1991 has been more interested in "tariff-jumping" into the Indian market than in contributing to exports. There was no discussion of what one can learn from the largest case of FDI since 1991, which also turned out to be the biggest fiasco — Enron. And there was no discussion of why there has been such a limited ripple effect of the technology that the FDI is supposed to have brought in across the larger economy.
The case for the sweeping relaxation of the remaining sectoral caps in FDI also rests on very flimsy grounds. The Planning Commission committee argued that removal of the remaining entry restrictions will remove "irritants that are sometimes blown out of proportion by interested parties to the detriment of national interest" (p39). The report also refers (p84) to an un-named study which suggested that the cap in telecom should be raised to 74 per cent, investment in petroleum retailing should not be linked to refining and FDI should be allowed in retail, real estate and commercial construction. It does not take much to infer where such recommendations and un-named studies come from. Besides holding discussions with chambers of commerce and a few State Government officials, the N.K. Singh group interacted with multinational consultancies that have set up shop in India. It does not mean that India's policy must be tailored to suit these interests. The Planning Commission group's own comparative analysis shows that India has a more liberal FDI regime than Malaysia or China. Yet, the two East Asian countries attract considerably more investment than India in spite of the Governments there following a hands-on approach and having in place a positive rather than a negative list (as in India) of sectors where FDI is allowed. As far as the volume of FDI is concerned, it is clearly not the presence or absence of FDI caps in each sector that matter as much as the environment for investment. If a liberal FDI policy is all that was important then the sub-Saharan African countries, which by and large now have the most open policy towards foreign investors in the developing world, should be attracting huge volumes of FDI.
The fundamental problem with FDI in India today is that while before 1991 all of it went into greenfield investment, it now appears to be increasingly concentrated in the M and A route. A 2000 study by Nagesh Kumar of RIS, Delhi, concluded that between 1997 and 1999, approximately 40 per cent of FDI was using the M and A route to take over Indian companies, increase control in existing subsidiaries by issuing shares at low cost or buy back shares and de-list from the stock exchanges.
In a new study of FDI in India, R. Nagaraj of the Indira Gandhi Institute for Development Research has argued that the problem is that our policy towards foreign investors does not have a focus. In comparison with the Chinese approach, the Indian FDI regime suffers because it is passive (open to all, without any targeting) and not strategic as in China. In the opinion of this economist, India's FDI policy should aim at encouraging investment in manufacturing for acquisition of technology and for the establishment of international trading channels to facilitate labour-intensive exports.
It cannot be that most of the FDI that has come into the country has made no contribution to the economy. A notable example of large-volume FDI that has had many positive externalities is Hyundai Motors, which has created substantial new investment, contributed to modernisation of the auto ancillary industry and exported volumes which are not insignificant. But Hyundai and a few others are only notable exceptions. The problem is that in dismantling the pre-1991 regulation of FDI, India has not just swung to the other extreme.
The Government has set about creating a policy regime that has neither coherence nor macro-economic purpose, the only objective being to create what it thinks is a set of incentives that will bring in large volumes of FDI.
© MACROSCAN 2003