Some Of The FDI Caps Have Lost Relevance.

Only a few sectors now have FDI caps, key being, defence, insurance, print media, single-brand product retailing, broadcasting and telecom. Proponents of FDI caps have various arguments in favour ranging from sensitive nature of certain sectors, security and national interest concerns, systemic risk to the Indian economy, the negative impact on local businesses, the interest of Indian consumers, etc.

Some of these are indeed valid concerns. As the 2008 global financial crisis has shown, India was left un-hurt primarily because of the cautious regulatory approach. There are genuine security concerns in certain sectors like defence, print media, telecom, etc. Insurance involves management of public monies and can be left only in the hand of credible hands. An offshore bankruptcy could substantially impact Indian operations and pose systemic risk to the Indian economy as well as impact Indian consumers and households.

Having said that in a developing economy like India, huge capital is required to fund certain activities. Domestic capital sources are often insufficient to meet the ever increasing capital needs. Also, the presence of foreign players brings innovation to India and enables to leverage on the expertise gained in countries around the globe. For e.g., the FDI caps in defence sector have led to underdeveloped R&D and production base in India leading to low quality of defence machinery and higher thrust on expensive imports. A balance needs to be achieved between the two seemingly conflicting objectives and in India, till date, this has largely been achieved by FDI caps. However, over a period of time, some of the FDI caps have lost relevance/reasoning.

I would like to point out a few such instances. Firstly, under the Indian company law, a 26% cap gives the shareholders a right to block a special resolution. The same rights continue until the investor reaches 49% and it is only after the investor crosses 50% that he gets majority control. It would be more reasonable to have a 49% cap in say, insurance and defence, and allow more capital at the same time ensuring that the purpose of the cap is achieved. Similar is the case for sector like single brand product retailing where 51% is allowed. It can be easily increased to 74% without any incremental rights.

Secondly, in 2009, the government allowed downstream investments by Indian owned and controlled operating entities without any restrictions as long as the operating activity in the holding company was FDI compliant. This has effectively opened the doors for a 49% FDI in any restricted / capped sector. Even in insurance, many companies have direct and indirect foreign ownership far exceeding the 26% cap.

Thirdly, the FDI caps have given room for Indian partners to come-in and act as passive partners / shareholders at a fee / exit gain. This effectively negates the relevance of a FDI cap as the foreign player effectively continues to control the Indian entity.

Given the above, while FDI cap can continue for certain sectors, the following seems to be a better approach: (i) Increase 26% caps and 51% caps to 49% and 74%, respectively as an immediate measure(ii) Incorporate checks and balances in the respective regulations instead of expecting the FDI cap to serve the required purpose (e.g. For the banking industry, RBI has followed this approach allowing a phased entry to foreign banks in India); (iii) Introduce minimum capitalisation and compulsory inflow of technology in sectors where FDI is being liberalised (e.g. A similar approach has been followed in financial services sector in India); and (iv) Where possible, allow 100% subsidiaries with a condition to divest / list in the future. The above approach would go a long way in balancing the dual purposes of the FDI caps and accelerating the growth / technology and innovation in these sectors.


Source : financialexpress.com