Much ado about FDI

It is time the euphoria over the recent government announcement to liberalise its policy on foreign direct investment, or FDI, in about a dozen sectors was suitably qualified and placed in its appropriate context. Three caveats need to be introduced for a better understanding of last week's policy blitz at a meeting convened by none other than Prime Minister Manmohan Singh.

One, the decisions taken at that meeting are yet to receive the final go-ahead, in the sense that the Cabinet's approval is still awaited - and, more importantly, the necessary notifications to bring them into effect are yet to be issued. This may be a minor point, but given the many slips between the cup and the lip this government has experienced (remember the fiasco over allowing FDI in multi-brand retail and then rolling it back in 2011), it is not inappropriate to nurse some doubt on this front.
 

Two, most of the changes are procedural since they only place the FDI proposals on the automatic route for clearances instead of subjecting them to the mandatory approval required by the Foreign Investment Promotion Board, or FIPB. Of the 12 sectors covered under last week's review, as many as seven have seen no increase in the FDI cap; it's only that the FIPB clearance has been made optional for them. But ask anyone in Indian industry, and he will tell you that this is no big deal. The political and bureaucratic environment is so complex and uncertain in India that even when FDI in a sector is on the automatic approvals route, applicants feel more secure and assured with an FIPB clearance.

Of the remaining five sectors, telecom and asset reconstruction saw an increase in the FDI cap from 74 per cent and 49 per cent, respectively, to 100 per cent. For tea and other plantations, the mandatory requirement for diluting foreign equity from the approved 100 per cent to 74 per cent in favour of Indian shareholders in five years was removed. The FDI cap for defence production was raised from 26 per cent; but any change must now be cleared by the Cabinet Committee on Security, making the relaxation subject to discretionary control by the political establishment. And for insurance, last week's meeting only expressed the hope that the legislative Bill to raise FDI from 26 per cent to 49 per cent would be cleared in the forthcoming monsoon session of Parliament, a hope even the government's die-hard supporters would not nurture in the current politically volatile environment. So why celebrate the FDI policy changes in a big way?

Three, the FDI policy changes announced last week are no reforms. At best, these are a procedural streamlining of existing policy that should in any case have happened long ago. These are being hailed now by a government that finds such steps direly needed to shore up foreign exchange inflows so that the rupee does not fall further as a result of the yawning current account gap. To describe them as reforms is to misunderstand and, in the process, devalue what true reforms are expected to be. How can anyone equate allowing automatic clearances to FDI proposals in a few sectors with, for instance, the government's plan to introduce a goods and services tax in the entire country?

There is yet another problem with the way the government went about launching its FDI policy liberalisation drive. Note that of the dozen sectors impacted by the changes, only two - petroleum refining and defence production - are in the manufacturing sector; one is in the plantations industry; and the remaining nine belong to the services sector. It would appear that there is a clear bias in favour of relaxing FDI rules for the services sector.

Note that the largest chunk of FDI has come for the services sector so far. In the 13 years since 2000, FDI in the services sector has accounted for almost 30 per cent of the total cumulative investment of about $1.96 trillion. At a time when the share of the manufacturing sector in the economy is shrinking to around 15 per cent, and the target is to raise it to 25 per cent in the next seven years, it is a bit odd that the FDI policy shows no concern for the need to make it more attractive for industries across the globe to invest in the manufacturing sector.

It could be argued that nothing more needs to be liberalised in the manufacturing sector in terms of the FDI policy, as most of the investment caps have already been relaxed up to 100 per cent. But there is always scope for making the foreign investment policy more attractive for the manufacturing sector, whose growth will have several positive spin-off effects for other areas of the economy. Also, there are clear advantages of creating more jobs in industries and the consequent growth achieved through such investment is believed to be more inclusive than what can be secured through increased investment in the services sector.

The FDI policy needs to be liberalised, but not through the kind of tokenism and misplaced emphasis that was largely on display in last week's policy announcement.