Riding the Elephant

One of the biggest weaknesses affecting India’s  economic liberalisation is the way that industrial and allied policies are made. Changes affecting industries that range from telecoms and banks to aviation and retail stem far more from the pressures of vested interests and lobbies than from reasoned analysis and debate.

Foreign or domestic companies push for changes, which are then resisted by rivals, supported, if opposition to foreign investment is involved, by leftist parties that often reflect vested interests as well as their own creeds. Ministers and bureaucrats are persuaded to tilt one way or another, sometimes nudged by various inducements and sometimes by legal action. Eventually someone wins and reforms are introduced – or aren’t.

This has been glaringly evident since the government announced on February 11 that it was introducing major changes to its rules on foreign direct investment (FDI) and other forms of foreign equity.

Sectional interests dictate norms

There was little open discussion (apart from a series of confusing newspaper leaks) before the announcement, and the changes are so complicated and confusing that The Economic Times newspaper dubbed the policy “irrational”, adding “don’t let sectional interests dictate norms”. It pointed out that even ardent supporters of FDI are “asking only one question – for whom is the government doing this?”

A friend, who has long watched companies bend policy rules, emailed me last weekend: “First this is meant to recycle politicians’ and bureaucrats’ money. Second, it is to fund elections. Third it is short sighted – rather then curbing the black money [used in FDI] it is only going to bring more unknown money, leading us to a spiralling downward whirlpool”.

The Business Standard last week said, when the announcement was first made, that “critics will …. question the propriety of reforms by sleight of hand” because “definitional loopholes are being used to change foreign investment by executive order” in sectors previously regarded as controversial. It then dismissed “the manner and timing of the decision” as “side issues”, and said it was more important to ask whether the changes were beneficial.

Why do it now – and make it so complicated?

The questions that need to be asked are why the government has suddenly introduced what potentially are the most far-reaching FDI rule changes for several years and why, as several critics have said, do it at the “fag end of the government” – and in such a complex way.

The changes broadly allow an Indian majority-owned and controlled holding company, which is 49% (ie minority) foreign owned, to invest in a “downstream” subsidiary or associate company without the 49% counting against the new company’s FDI limit – which enables more FDI to go in. In FDI jargon, the restriction on cascading investment has been removed. That looks like good sense, but there is a widespread suspicion – illustrated by the comments above – that foreign companies intend to use it as a loophole to exceed permissible holdings.

The other major change is that various forms of foreign investment are to be merged for assessment purposes. This means that funds from foreign financial institutions (FFIs), foreign stock markets (in the form of depository receipts – ADRs and GDRs) and bonds, and non-resident Indians (NRIs), are all counted together with FDI instead of being assessed separately under different headings. That is also sensible, except that it will lead to countless complications, and therefore loopholes, as existing permissions and investments are re-scrambled.

Doubts about the effects

There is doubt about what the net effects will be. It appears that many limits on foreign investment will disappear in various sectors, barring defence where a 26% (but variable) FDI limit will be maintained for some time, and insurance where legalisation is needed to change the 26% FDI cap.

But many government officials seem unsure, or are not admitting that they are sure, what will happen for example to:

– the ban on FDI in multi-brand retailing such as supermarkets,
– the 74% cap on telecom (for years a tortuous rule bender),
– the 26% cap on foreign newspaper companies (though 100% FDI was approved on February 14th for facsimile editions of foreign newspapers in a nice Valentines Day present for the well-connected Wall Street Journal that will soon appear in India).

Will currently banned investments creep in – for example could foreign companies owning 49% in an Indian holding company take a large stake in the operating subsidiary of an airline, newspaper, or supermarket chain?

There are also problems for companies that are already foreign owned when FDI and FII investments are assessed together. Two Indian banks – ICICI and HDFC – for example come into this category and are looking for ways to remain Indian.

There are three possible reasons why the government has created this muddle:

One is genuinely to open up FDI, especially in areas such as retail and the media, now that the government is no longer constrained by the communist-led Leftist parties that blocked such changes until the end of last year.

FDI inflows totalled over $21bn in the nine months of the current financial year to the end of December, but have been declining since that month, so it might be logical for the government to try to revive the inflow. But, in the current world financial crisis, little extra FDI is likely to come in, however far the rules are relaxed, so that is not a very good reason.

In any case, if that is the aim, why not say so and keep the changes simple, instead of issuing (as the Industry Department has done) ten pages of unintelligible officialese in two “press notes” that refer to so many other press notes and laws and regulations that it is impossible to work out what is intended.

The second also laudable but surely misdirected reason, is to enable companies that are strapped for cash in the current economic crisis to bring in equity from abroad. Fair enough, but should industrial policy be permanently changed to meet individual companies’ short-term financial problems?

The third possible reason is to help foreign companies that want to gain bigger FDI stakes than are currently allowed – but that will not happen quickly.

Whatever the reason, it is surely wrong for the government to have allowed such negative media speculation – and party gossip – to grow in the past week.

The announcement first came as a press release and statement after a cabinet meeting. That was followed by a not very clear statement from Kamal Nath, the commerce and industry minister. Then came the two “press notes”, one of three pages and one of seven pages, which are indecipherable to nonprofessionals, and further explanations yesterday. (Curiously, the government has issued FDI policy change since 1991 as “press notes”, not official regulations).

Why I wondered, talking to a contact, was it all made so impenetratable. He replied: “This isn’t for public understanding but is designed as fertile ground for specialists and lobbyists who will know exactly where the loopholes are”.

This post is also on the Financial Times‘ website – http://www.ft.com/cms/s/0/60936f90-fd8e-11dd-932e-000077b07658,dwp_uuid=a6dfcf08-9c79-11da-8762-0000779e2340.html