(July 15: I have made some minor amendments in italics below following comments sent by a member of a Delhi law firm)
India’s foreign direct investment (FDI) rules are in a muddle that no one in the government currently seems able, or willing, to try to solve. No minister or bureaucrat has publicly acknowledged this, though it was indirectly confirmed on Monday when finance minister Pranab Mukherjee failed even to utter the words “foreign direct investment” or the acronym FDI in his budget speech – surely the first time this has happened since the main thrust of economic reforms began in 1991.
The muddle stems from complex and bewildering changes that were announced in three “press notes” by the industry ministry in February, just before the recent general election campaign began.
The story illustrates the murky interface between government and big business in a country which still has the trappings of a semi-controlled – and business-manipulated – economy, 18 years after 1991.
Opposed by many in the finance ministry – including former finance minister Palaniappan Chidambaram – and by the Reserve Bank of India (RBI), the changes were pushed through by Kamal Nath, then the minister for commerce and industry, and were endorsed by Mukherjee when he became finance minister in December. Nath’s aim may have been partly to honour personal commitments he had made on relaxing FDI bans and limits in areas such as retail, which he had not been able to implement because of opposition.
Since then the changes have been neither formally clarified by the industry ministry, nor notified by the RBI under the Foreign Exchange Management Act (FEMA). Yet they are supposed to have become effective from the announcement dates, which is inevitably causing problems for would-be foreign investors – and worry about whether the changes would ever be enforceable in law.
“Ownership and control”
The changes shift the focus of FDI limits from straight foreign equity percentages to an assessment of whether or not an Indian company has both “ownership and control” – a concept introduced for the first time in Indian regulations by the second of the press notes.
The intention is to allow a foreign-invested Indian company – providing it is both Indian majority-owned (in terms of equity holdings) and Indian controlled (in terms of board membership) – to invest in downstream subsidiaries or associate businesses without the original FDI foreign stake counting against the new company’s FDI limit.
In FDI jargon, this legitimises cascading investments which have been used to bring foreign capital into sectors such as telecoms that need heavy investment. FDI limits here are bypassed by progressively adding foreign investment through tiers of subsidiary joint ventures so that, though official limits are exceeded overall, the rules are not technically broken.
Officially, the aim of the changes is to boost the inflow of FDI, which rose 85% to $46.5bn last year according to a recent UNCTAD study, and to make it easier for Indian companies to raise private equity and other foreign capital.
Officials and friends tell me the aim was also to end uneven application of rules in different sectors such as insurance (where there is officially a 26% FDI limit), telecoms (74%) and media (various). This included, according to some experts, clearing up lingering doubts (despite official approval) about whether Vodafone Essar has exceeded its limits with controversial holdings by two small minority shareholders, as well as indirect FDI allowed by insurance legislation, (even though insurance is formally excluded from press note two).
The timing of the changes was curious, coming at the fag end of the government’s five-year term in office when there was little chance of the new rules having much effect on FDI decisions before the election. The changes were not only complex – their presentation in three departmental “press notes” was bewildering. Wouldn’t it have been better to have put the idea in the Congress Party manifesto and announced it now?
Nath made his usual swashbuckling remarks that, probably intentionally, added little to understanding. Since the election, no one has tried to clear the air. Anand Sharma, the new commerce and industry minister, has indicated that he does not intend to review the policy changes, and Mukherjee has backed them since he became finance minister last December.
Who is the government favouring?
Inevitably, the timing of the announcement, and the conflicting views within the administration, have led to wild rumours of why the changes were done – wild, but widely believed. As I reported on this blog in February, The Economic Times dubbed the policy “irrational” and asked, “for whom is the government doing this?”. A friend, who has long watched companies bend government policies, emailed me that “this is meant to recycle politicians’ and bureaucrats’ money (and) fund elections”.
Finance ministry and RBI officials have opposed the changes mainly because they believe they will bust existing equity limits. Supporters of the policy however say that this does not matter providing the company involved stays within Indian control. If it does remain Indian, they say, what is the harm of extra FDI?
“Foreign money is only foreign money if it’s owned and controlled by foreigners – otherwise it is not,” said one contact, trying, and failing, with such tautology to persuade me that the policy is sound. Surely, I replied it would be easy to dress up a semblance of Indian control in a foreign-run business, as has been done in some insurance joint ventures.
The government has said in various statements that areas where FDI is totally banned such as nuclear, multi-brand retail, lottery and betting, and foreign airlines in Indian carriers will not be affected, but this has not been formally spelt out. So what is to stop companies like, for example, Bharti Enterprises and Wal-Mart setting up an Indian controlled joint venture for their wholesale business and then forming a subsidiary for currently banned multi-brand retailing and dressing it up as Indian owned and controlled?
The same could surely be done by, say, EADS and Larsen & Toubro with their recent joint venture in defence where there is a 26% FDI limit, or by Vijay Mallya with a foreign carrier for his cash-starved Kingfisher airline and, or Mukesh Ambani for some of his Reliance Retail joint ventures.
It is not clear what happens in joint ventures where the equity or the board membership is split 50-50, nor whether FDI in both an Indian controlled company and its offshoot are counted if the offshoot is foreign-controlled.
The finance ministry has already mounted some challenges through the FDI regulatory body, the FIPB. It objects especially to the new policy being applicable retrospectively, which in effect would give an amnesty to past rule infringements. Bharti and Tata telecom companies have for example, according to media reports, been refused waivers for fines levied earlier for breaches of FDI rules. Bharti might also have problems clearing its proposed merger/takeover of South Africa’s MTN because of high FDI equity levels in its existing operations
The finance ministry is also objecting to a request from India Rizing Fund, an Indian controlled defence sector private equity fund with foreign money, that its investments should be exempted from the 26% rule under the new policy.
Basically, the changes smell. Maybe I’m being unfair but, given the mishandling and noting some those involved, it’s an inevitable conclusion – and will remain so till someone says something understandable to a layman, and not just to consultants who make money inventing and then applying policy quirks for their clients.