Kanika Datta: Guideline to uncertainty

SWOT

Over the past decade, India has been positioning itself as a competitive destination for foreign direct investment (FDI). Steady liberalisation of the regulatory and competitive environment has put the country on the radar screens of global corporations, especially over the past year and a half.

Given this, it is difficult to understand why little change can be expected on Press Note 18 ahead of next week's Budget "" despite several discussions within government over the past year.

This is a five-year-old guideline "" not a law "" that denies the automatic approval route for foreign investors who have or had previous joint ventures or technical and trade mark agreements in the same or allied field from setting up wholly-owned subsidiaries. Foreign investors in such categories have to apply to the Foreign Investment Promotion Board (FIPB) for approval.

Press Note 18 is unique to India and is ostensibly designed to protect the interests of Indian promoters and minority shareholders. The guidelines do not stipulate it, but foreign investors are almost always required to acquire no-objection certificates (NOC) from their Indian partners before they submit their proposals. Not surprisingly, Press Note 18 evokes strong reactions from supporters and detractors and in one case ended up in the Delhi High Court last month.

If the government is to be believed, foreign investors have nothing to fear. Since January 2003, sources point out, no FDI proposal has been turned down as a result of this December 1998 guideline.

It is true that the FIPB has been liberal in interpreting the guideline. For instance, the requirement was waived for the Saudi Arabian company Amiantit, which had had a tie-up with Graphite India. The Indian partner refused Amiantit an NOC on the grounds that it already had a tie-up with it. But further enquiry by the FIPB showed that the tie-up had been inoperative since 1997 and the Saudi company had only a 1 per cent stake in Graphite. Consumer Electronics Company TCL acquired a similar waiver from acquiring an NOC from Baron Electronics.

More recently, US company Kennametal obtained a waiver of the NOC requirement to raise its stake through an open offer in tool-maker Widia, a joint venture with the Birlas, following a global acquisition that gave it a majority stake in the Indian joint venture.

As of now, only two or three multinationals find their plans stalled as a result of Press Note 18 stipulations. So what is the big deal, ministry sources say, pointing to India's improved rankings on the Global Competitive Index as a sign that the guideline is no real FDI deterrent.

Yet, despite clear signals that the government is willing to be flexible in its interpretation of Press Note 18, foreign investors consider it a major irritant and point to the sharp reduction in joint ventures as evidence.

True, obtaining an NOC may not be an issue where relations between joint venture partners are cordial. The amicable settlements between the Hero group and Honda, TVS and Suzuki and the RPG group and Swatch are cases in point. But where relations are less than cordial, Press Note 18 can become a source of rent.

As a recent Ernst & Young study on FDI points out, "Press Note 18 creates a potential risk where exit valuations demanded by the existing Indian partner may be unrealistic/opportunistic as a trade-off against the NOC ...".

Equally, Press Note 18 can be punitive for multinationals that had to dilute their stakes in Indian subsidiaries and induct Indian partners, as, say, Philip Morris did, once the Foreign Exchange Regulation Act came into effect in 1973. This is one of the corporations whose proposal for a wholly owned subsidiary stalled for lack of an NOC from its Indian partner.

Indeed, in this case, it is hard to see how local promoter or shareholder interests have been protected, since Philip Morris now imports and sells Marlboro, its best-selling global brand, through a branch office in India.

Consultants also complain that the term "same or allied field" creates additional confusion because the official classification code is structured in such a way as to cover a wide variety of products.

Thus, there have been instances where the Indian partner has taken the foreign investor to court for setting up a new venture, despite FIPB clearance having been obtained on the grounds that the new venture (for truck tyres) is not in conflict with the old venture (for car brakes).

It is clear, however, that in the prevailing quasi-protectionist climate it will not be politically expedient to scrap Press Note 18. But as a starting point, some modifications could allay foreign investor reservations far more than FIPB's case-by-case approach, fair though it might be.

For one, lobbyists suggest that Press Note 18 should be made inoperative for publicly listed companies because Sebi already provides for the transparent mechanism of the open offer to protect shareholder interest.

Unlisted joint ventures should be strictly governed by the terms of the agreement. The government could even suggest a valuation methodology should it feel optimum valuations are not being achieved.

As for technical collaborations, Hero-Honda and TVS-Suzuki showed the way by providing for a "cooling off" period after agreements expire.

Either way, it seems illogical for the government to allow a mere guideline to vitiate the spirit of liberalisation.