A long-delayed law

But insurance Bill should make fresh equity mandatory

The Union Cabinet has cleared the long-expected Bill to open up the insurance sector to more foreign investment. The approval of the Insurance Laws (Amendment) Bill of 2008 means that the end is in sight of a years-long journey, in which first one political party and then another competed to oppose the proposed increase in the foreign investment limit for the sector. Finally, thanks to the work of a select committee of Parliament, a cooperative Congress party and a government willing to incorporate the Opposition's desired changes, it appears that the Bill will finally become law. If all goes well, the impact of the law could be considerable. It could lead to the inflow of thousands of crores, an infusion of cash that could not just rejuvenate the insurance sector in particular but - crucially - add in general to the pool of long-term finance in the country that is much needed for investment in long-gestation infrastructure projects. The central proposition is that the cap for foreign equity will be raised from 26 per cent of an insurance company to 49 per cent. Control will continue to be vested domestically; and the cap will be "composite", meaning that all forms of foreign investment will count towards it.

The Bill is far from perfect, however. In particular, the positive effects on the sector and the economy will depend on one crucial aspect: that the companies issue fresh equity for the foreign capital. The select committee of Parliament recognised that reality by recommending the issue of fresh equity; sadly, however, this will not be made mandatory. This is a problem. The door has been left open to arbitrage for domestic promoters - they could simply sell their equity up to the 49 per cent cap to foreigners. This means no fresh money will flow into the company as such - it will just be a windfall for the existing promoters, plain and simple. This, clearly, would not be a reformist or market-friendly eventuality. It would not help the insurance sector acquire more capital or modernise. The point of raising the cap is that it should facilitate the growth of the insurance business; it will be unfortunate if it is reduced to being an opportunity for the existing domestic promoters to cash out.

Many opportunities now open up for insurance companies, and they have choices to make. They may decide to list on the stock markets; they may opt for foreign direct investment, or foreign institutional investment. They may choose an initial public offering, or IPO. These decisions, presumably, will be made once the fine print of the law is known - not to mention its associated rules, which too often reduce the operative aspect of reformist laws. Questions of the exact definition of "control" of "ownership", whether approval will be automatic or discretionary, and whether senior management can be foreign or must be Indian are still to be answered. However, it is important to note that one major step on the road to reform has been taken. For years, the insurance Bill has been a necessary first step in financial and real structural change; it is almost a bellwether for the health of a reformist political economy. The new government has done well to take it to this last stage. Parliament should pass it forthwith, hopefully after addressing the concerns over the absence of the condition on mandatory fresh capital issue. Few things will as quickly provide a fillip to the India story.