Until the time it is clarified that sectoral caps in individual sectors will continue to apply, there is little doubt the new policy makes a mockery of the existing restrictions.
It is true that India needs to attract more foreign direct investment (FDI). It is also true that many Indian companies in industries like the media are struggling to raise equity capital. The new FDI policy may have the effect of raising some foreign capital — however, even for this objective, at this belated stage of the global economic meltdown, this FDI policy may turn out to be too little, too late.
One of the notoriously famous things about FDI sectoral caps in India is that, ever since they came to being in the early 1990s, they have been successfully bypassed, circumvented, and compromised by smart Indian entrepreneurs and foreign investors. A wink-wink enforcement philosophy by various governments helped, aided of course by smart Indian lawyers with very interesting interpretations about sectoral caps.
I saw this in the telecom sector all the way from the very start in the ’90s until recent times, when foreign companies effectively controlled and ran telecom companies despite the sectoral caps and the classification of telecom as a ‘sensitive sector’! There was no attempt to enforce the spirit of the sectoral cap for the most part of the decade.
The recent FDI norms can be viewed in two ways. One is that it cleans up and establishes a clear framework for raising capital for Indian companies and increasing FDI flows into India. The other is that it creates big, wide loopholes for foreign companies — loopholes that our policymakers love, because of the wide administrative authority it gives them and, of course, a wide canvas of subjective decisions to make as well.
While the first is true and is important, the consequence is clearly going to be the latter. It is clear that unless the follow-on issue of enforcement of domestic control is unambiguous and clear, this new policy is definitely going to be abused. The government’s track record in the enforcement of FDI caps is pathetically dismal. Take the example of Hutchison in telecom or of several other insurance companies where, despite ‘Indian boards’, the companies were so obviously being managed by foreign investors and partners.
The whole issue of FDI in ‘sensitive sectors’ must be either black or white — given that the most important justification used for sectoral caps is that these sectors are ‘sensitive’. Either the country takes a clear decision to permit foreign control openly in sensitive sectors or it does not. There cannot be a grey area that depends on bureaucratic (read political) administration for enforcement. Permitting foreign control openly also permits the right foreign companies — those who respect the law and don’t operate in the twilight zone of legal ambiguity — to come into the country. If our FDI and sectoral cap regimes are ambiguous and attract those foreign companies who are here because of their confidence in managing the administrative and political structure, then they are clearly the wrong kind of foreign companies — considering we have many Indian ones who do that anyway!
If the government wishes not to make the issue of sectoral caps a joke, then there must be significant disincentive against abuse. Severe legal provisions that punish companies, investors and those who aid/abet the circumvention of sectoral caps are required to accompany this kind of relaxation of FDI norms.
The question is not one of circumvention of sectoral caps for FDI, it is of restricting the ability of Indian-owned and -controlled companies from accessing scarce capital from overseas. Indirect foreign investment has been embroiled in a controversy for the last few years. The Foreign Investment Promotion Board is flooded with applications for downstream investment permissions, both in permitted or restricted sectors, from Indian companies with foreign investments ranging from 1 per cent to more than 50 per cent. Questions are also raised on the ability of Indian companies with just 1 per cent foreign investment to make downstream investment in restricted sectors, be it retail, defence or even real estate.
To compound the confusion, there was no clarity on what constituted foreign investment. Different sectoral policies defined foreign investment differently — some included FII and NRIs, while others excluded it. The telecom policy stipulated pro-rata determination of indirect foreign equity. Other sectoral policies stipulated Indian management control in addition to equity caps.
The current policy dispensation, enunciated in Press Notes 2 and 3, makes a paradigm shift and brings a welcome breath of clarity to the entire confusion. It is now clear that Indian control is paramount!
Any downstream investment by an Indian-owned (greater than 50 per cent) and -controlled company shall be considered as 100 per cent Indian investment while computing the FDI. It is now clear that all forms of foreign investment in the investing company whether FII, NRI portfolio, or ADR/GDR, shall be considered to be foreign investment.
The changes to the FDI policy should be looked at from the point of view of facilitating the much-needed foreign capital to Indian-owned and -controlled companies for making investments in all sectors without restrictions — it can not and should not be viewed as a way of circumventing the sectoral caps. If a foreign investor is willing to invest capital without getting corresponding control, why should Indian companies be denied this opportunity?
As far as specific sectors are concerned, the law, regulation or licensing conditions of those sectors would in fact determine as to whether the indirect foreign investment would be permitted or not. Here are some examples:
On the other hand, the converse is also true — where pro-rata foreign shareholding was considered earlier or FII/NRI investment was not considered, the downstream investment by an Indian company where foreigners own more than 50 per cent will result in breaching the sectoral cap and no further investments by such companies in restricted sectors will now be possible.
