Stepping Up Fdi

The control of babus has to go if India is to even remotely approach China's success, writes T Thomas

A question that has haunted successive Prime Ministers and policy makers over the last decade is: "Why is India unable to attract even 20 per cent of the foreign direct investment (FDI) that China is able to attract year after year?"

This in spite of our being a more open and democratic society, with a well established legal system and courts, a thriving private sector, world class managerial talent and widespread command of the English language. Successive governments have liberalised economic and investment policy step by step over the last decade. Yet there is no dramatic improvement in the flow of FDI. Why?

This analysis is based on my association with investments in India by more than one multinational and also my more recent experience as a venture capitalist who has been investing offshore funds in India over the last 10 years. The basic problem with India as a destination for foreign investment is with implementation of policy at the official, bureaucratic level, rather than with the formulation of policy at the (Prime) ministerial level. So the Prime Minister may do well to think of some simple reforms in the administration of policies, which don't need to go to Parliament.

The first hurdle that any foreign investor has to pass is the Foreign Investment Promotion Board (FIPB). When government policies for foreign investment were ambiguous and had a large element of discretion, a body like FIPB was probably relevant.

Now that the government has spelt out clearly the areas in which foreign companies can invest and the level of shareholding that they can have, what is the purpose in making investors go through this time consuming and frustrating exercise? Why not let the foreign investor get his advice on investment guidelines from recognised firms of chartered accountants, merchant bankers or legal firms and make his investment? If he deviates from the guidelines, the risk is for him as at any stage the relevant authority can question such deviation. Why block and frustrate an investor at the starting line?

India needs foreign investment more than a European country or the US. Yet in none of these places is there such a pre-investment approval process. Certain restrictions are clearly spelt out by governments, as indeed our government has done. For instance, in the US, there are restrictions on foreign investment in defence industries, air transportation, etc. These are so clearly spelt out that it is not necessary for a foreign company wanting to invest in an American IT, textile or chemical company to seek any prior approval. The onus is on the investor.

The RBI can instruct all commercial banks that when foreign investors bring in funds, they have the obligation as bankers to the investor to point out government guidelines and to ensure that the rules are observed. If the bankers give them inaccurate advice, investors have their own way of claiming compensation from their advisors.

The primary purpose of a central bank is to serve as the monetary authority of the country. But the Reserve Bank of India has been assigned over the last few decades the additional function of administering FERA, which regulated the inflow and outflow of foreign investments, dividends, etc.

FDI was not seen as a desirable input, so instead of increasing foreign exchange reserves through exports and inflow of long-term investment, the effort was to preserve foreign exchange, As a result, RBI's officialdom has been bred, nurtured and immersed in the culture of regulating all foreign exchange transactions, including investment.

Today FERA restrictions on investment have been virtually abolished; yet RBI's babus still work diligently to regulate and control FDI, causing unnecessary delays and frustration. To take an example, an NRI investor had acquired shares in a listed Indian company by swapping his shares held in a foreign company for corresponding shares in the Indian company, which had acquired the foreign company "�"� all done with the approval of the FIPB and the RBI. After some time the NRI investor wanted to sell his holdings in the Indian company and repatriate the sale proceeds. His enquiries with the RBI revealed that one more RBI approval was necessary. The earlier approval was considered incomplete by the RBI as it was only to "issue and allot shares".

Another permission was required to "hold the shares on repatriable basis" although it is common sense that when an NRI invests in an Indian company he does so in foreign exchange and has the right to repatriate the sale proceeds. It took three months to get the additional (redundant) approval from RBI and, in the meantime, the share prices of the Indian company fell by more than half and the investor suffered a significant loss! Most NRIs even today are put off by the RBI's bureaucracy, rigidity, timidity and uncommercial behaviour.

Sometimes, officials get carried away by their sense of power without realising the consequences for investment. Let me cite two examples:

The panic among foreign institutional investors and the consequent collapse of the Indian stock market in April this year can be attributed to the over-enthusiastic misinterpretation of the Indo-Mauritius tax treaty by some income tax officials in Mumbai, and the inability of their superiors to clarify the position. Billions of dollars have flown into India in the last decade as FDI through the Mauritius route, based on a tax treaty which was considered sacrosanct.

Suddenly a novel interpretation was given and tax exemption denied to major investors. The flight of capital was arrested only after the finance minister realised the consequences and categorically assured foreign investors and NRIs that the tax concessions were indeed valid.

Another example is the statements attributed to the chairmen of leading Indian financial institutions, which are either owned or controlled by government. They raise money in India and abroad to support investments in India and abroad. When a foreign company invests in India it usually brings in its own equity and expects to fund the borrowings of the acquired company through corresponding loans from local institutions.

This is necessary for the investor to minimise the exchange risks that are endemic in a country like India. Most lenders wish to increase their lending to reputable foreign companies. Yet, of late, there have been press reports that Indian financial institutions are under pressure to not lend to Indian companies in which foreign investors acquire majority shareholding. Such discrimination will be contrary to the objective of attracting FDI. Paradoxically the same Indian financial institutions are themselves seeking to raise equity and bonds overseas!

There are other issues, like the crude atmosphere and behaviour that greet visitors at the immigration entry points; the deplorable state of the roads to our international airports and of the arrival and departure halls; and the lack of basic amenities like assured electricity and fault-free telephone lines even in major cities like Bangalore and Delhi.

If the Prime Minister can bring about changes on these few fronts, he will not have to plead specifically for FDI when he goes to the US; FDI will flow in without any such plea. On the other hand, if he does not carry out these basic changes, even several visits by him will not carry much conviction with overseas investors. Like water, investment flows where there is a welcoming gradient. Obstacles in the way of the flow end up diverting the water, irrespective of government wishes and encouragement. Investment will bypass India and go to other destinations, like China.