Sectoral Caps Under Lens in FDI Reforms.

NEW DELHI: Stung by a sharp fall in capital inflows, the government has set the ball rolling on policy reforms to attract more foreign direct investment.

The department of industrial policy and promotion, or DIPP, has invited suggestions on reforms in the FDI policy, with focus on the relevance of sectoral caps. Stakeholders must give their views on the discussion paper - FDI policy rationale and relevance of caps - by July 15.

Finance Minister Pranab Mukherjee had said earlier this month that the government was thinking of further liberalising the FDI policy, after inflows in 2010-11 dropped 28% from a year ago, bucking the uptrend in other emerging economies. Experts, however, say a more comprehensive reform is needed.

"There is no reason to believe that removal of sectoral caps will lead to increase in FDI flows," said Nagesh Kumar, chief economist of the United Nations Economic and Social Commission for Asia and Pacific, Bangkok .

"Just before the crisis, there was a jump in FDI flows," he added. Biswajit Dhar, director-general of think tank RIS said, "There is a big gap between what we want and our policies. We want FDI that ensures increased production, makes technology available, and brings managerial skills. Where do we see that?"

India currently allows 100% foreign investment is many sectors but has set a cap for many sectors such as 74% for telecom and banks and 26% for insurance. While claiming that these are not the government's views, the discussion paper has questioned the relevance of sectoral caps, particularly below 49%, after the revamped 2009 policy put in place new rules of what constituted foreign investments.

The policy made a distinction between ownership and control and said a company in which more than 50% beneficial equity and the right to appoint the majority of the board of directors was with resident Indians was to be considered Indian. More importantly, all downstream investments of such a company would be considered Indian even if the parent company had as much as 49% FDI.

"Therefore, there is a clear case of abolishing all caps below 49%" the paper says. The paper admits that the current sectoral limits can be breached through layers of subsidiaries and 'the caps also provide an opportunity for arbitrage to unscrupulous Indian partners'.

The paper says policy should be more concerned with 'control' and not beneficial ownership and that only sensitive sectors should have sectoral regulations. For sector such as defence manufacturing, telecommunication services and private security, the paper says sectoral conditions could be imposed.

"Such an approach would directly and explicitly secure an objective in a much better manner than caps," it notes. In cases where caps are seen as necessary, it suggests that the option of asking the multinational companies to list on Indian stock exchanges within a stipulated period could be considered. The decline in FDI has come at a time when the current account deficit is likely to have widened to 2.5% of GDP in 2010-11.

The robust portfolio flows have allowed India to bridge this deficit, but reliance of such hot money to fund current account deficit can cause problems in the event of a sudden outflow. "...rising reliance on hot money flows inevitably leaves the economy and, of course, the INR increasingly exposed to swings in global risk appetite," wrote Richard Iley and Mole Hau of BNP PARIBAS in a note. FDI by its long-term orientation is considered more stable, but experts say India's policy is not tuned to encourage investments.

"Globally, investors would still rank India as one of the top-10 destinations for FDI but the quantum does not reflect the confidence," said Sunil Sinha, senior economist, Crisil. The paper has also sought clarity on whether the caps are in respect of FDI alone or include both FDI and foreign institutional investment.

Source : economictimes.indiatimes.com