Title: THE HYPE VS.THE TRUTH: “AN ECLECTIC REVIEW OF FOREIGN DIRECT INVESTMENT POLICY IN INDIA”
Akshay Jyoti Rakhawat
“Difficulty lies not so much in developing new ideas as in escaping from old ones”
- Maynard Keynes
This quote by Maynard Keynes falls exactly in place if we talk about the current position of foreign direct investment in India. Since our independence itself, we have had a tendency of blindly following the so called “reforms” introduced by the western powers for their selfish gains.
The question thus lies is that in the current scenario, where there in an intense “Global Rat Race” for attracting FDI, does FDI actually lead to greater productivity and overall economic growth, or whether these are mere prerequisites for attracting FDI? Whether larger FDI inflow is really a parameter for judging a country’s economic strength or whether it is just a profit making policy of the western economic powers under the garb of a ”reform”??
This paper will seek to chronologically trace the development of FDI policy in India; will lay down the existing FDI policy in India. Further, this paper will critically analyse the hurdles in the path of effective FDI policy implementation along with the suggested reforms and will lift the veil shadowing the truth behind the policy of Foreign Direct Investment.
- BACKGROUND OF FOREIGN DIRECT INVESTMENT IN INDIA
The notion of foreign capital in India was not so happening at its inception. The marks of the footsteps of FDI in India can be traced with the establishment of East India Company of Britain, where the capital of Britain came to India. It was after the Second World War, when Japanese companies entered into Indian market. The issues related to foreign capital and operations of MNCS, gained momentum after the independence, when the policy makers realized the national interests attached to it. By focusing on the same, they framed the FDI policy which endeavor it as a medium for acquiring advanced technology and to muster foreign exchange resource. After various attempts made in 1966 and 1985, the economic reform in India started with economic liberalization, on 24th July 1991. The reforms made in 1991 were proved sustainable as substantial liberalization was declared in the New Industrial Policy.
After so much of hassle, the Foreign Direct Investment (FDI) in India was made regularised by the FDI policy and governed by the provisions of The Foreign Exchange Management Act, 1999.
Even though India had proved itself as most attractive market for retail investment by topped the A.T. Kearney’s annual Global Retail Development Index (GRDI) for third consecutive years, and had registered a growth of 8% in 2007, but on a whole, Indian retail attracted approximately $1.8 billion in foreign direct investment, in between 2000 to 2010, which was a very small 1.5% of total investment flow into India.
Until 2010, the strings of the entire flow in India were in the hands of the intermediaries and middlemen. Due to their dominated involvement, the pricing lacked transparency and the norms were continuously flouted. Removal of legal restrictions on organised retail was recommended to the Government of India repeatedly. Jagdish Bhagwati, suggested the Indian Parliament, to extend economic reforms by breaking the shackles of the retail sector, so that further liberalization of trade in all sectors amounts to positive change which was the need of the hour as such step will accelerate economic growth and make a sustainable difference in the life of India’s poorest.
On January 11, 2012, India permitted and welcomed the increased competition and innovation in single-brand retail. FDI in multi-brand retail was prohibited in India, till 2011, as foreign groups were not allowed to owe supermarkets or any retail outlets and sell products from different brands to Indian consumers directly. It was on 14 September 2012, the Government of India opened the gates for FDI in multi-brand retail (subject to approvals by individual states), however caused many protests in opposition.
On September 20, 2012, the Government of India has formally approved 51% FDI in multi-brand retail and 100% FDI in single brand retail, thereby making it effective under Indian law. In Ernst & Young 2012 India Attractiveness Survey, India is placed on the fourth global ranking for foreign direct investment (FDI) after the United States, China and Britain. India drew FDI of $8.1 billion in March, which was the highest ever monthly inflows, despite of the brouhaha over Rs 11,000 Crore Vodafone tax dispute.
- FDI POLICY IN INDIA
After Independence, the country was not at all in the condition of contemplating the idea of Foreign Capital due to previous exploitation done by the Britishers. The FDI governing framework of India consisted of complex jumble of legislative enactment and policies which was open to the discretion of the government to interpret and apply according to them. Before economic reform, the FDI policy in India went through 4 different phases:
1) The Phase of Cautious and Selective Attitude towards FDI (1948-1967);
2) The Phase of Semi-Liberalization (1980-1990);
3) The Phase of Restrictive Attitude towards FDI (1968-1979);
4) Trends of FDI Inflows during Pre-reform Period: Before 1991.
The overall inflow of FDI during the period of 1980-1990 was fluctuating. The FDI amount in 1980 was US$ 79 million, which reached upto US$ 252 million in 1989. After such growth, thereafter it declined US$ 237 million in 1990. FDI increased three times during the period of 1980-1990 and the CAGR (actual) was19.05% during the same period of time.
After mid 1990, India was in financial crisis due to political disturbances and other economic factors. This resulted in the erosion of the international community’s confidence on our economy. After the sudden outbreak of Gulf war in January 1991, the status of Foreign Exchange of India became so scanty that the country was not able to pay even for one week imports. To overcome this situation, with the support of IMF and the World Bank, Structural Adjustment Programme (SAP) was introduced to bring economic liberalization process. New Industrial Policy (NIP) was brought in 1991, which supported the role of FDI in the process of industrial development in India regarding the efficiency, modernization, technological upgradation and other relevant factors.
The major highlights of NIP 1991 changes are as followings:
- Abolition of industrial licensing system except for 18 industries specified in the Annex-II of the statement.
- Ceiling of 40 percent foreign equity under FERA was done away with.
- Removal of registration under MRTP Act.
- Foreign investment promotion board (FIPB) was established and has been authorized to provide a single window clearance for all project proposals regarded by it.
- Introduction of the dual approval system for FDI proposals viz. (i) through an automatic approval channel for FDI in 35 priority sectors by RBI upto equity participation 51 percent and (ii) through formal government of India channel via FIPB/SIA.
- Existing companies were allowed to hike their foreign equity upto 51 percent in priority sector.
- Dilution of dividend balancing conditions and its related exports obligation except in case of 22 consumer goods industries.
- Removal of restrictions of FDI in low technology sectors.
- Automatic permission for technology agreement in high priority industries.
- Removal of condition for FDI with necessary technology agreements etc.
After these reforms, Foreign Investment Implementation Authority (FIIA) was setup in 1999 in India, which takes care of quick translation of FDI approvals into implementations. FIIA is assisted by Fast Track Committee which has been established in 30 Ministries/Departments of Government of India.
The steering committee on FDI was set up by the planning commission in August 2001 under Chairmanship of N.K. Singh which submitted its report in September 2002 to the Prime Minister. It was recommended that the ban on FDI in retail trade should not be lifted while for other sector such as oil marketing, petroleum exploration, banking and financial services and real estates was raised to limit of 100 percent.
Foreign Investment in India is governed by the FDI policy announced by the Government of India and the provision of the Foreign Exchange Management Act (FEMA) 1999. The Reserve Bank of India in this regard had issued a notification, which contains the Foreign Exchange Management (Transfer or issue of security by a person resident outside India) Regulations, 2000. This notification has been amended from time to time. Department of Industrial Policy and Promotion (DIPP) under the Ministry of Commerce and Industry, Government of India is the nodal agency for monitoring and reviewing the FDI policy on continued basis and changes in sectoral policy/ sectoral equity cap which goes from 26% to 100% at present. The FDI policy is notified through Press Notes/ Policy Circulars by the Secretariat for Industrial Assistance (SIA), Department of Industrial Policy and Promotion (DIPP) Ministry of Commerce & Industry. FDI is allowed under Direct Route and Government.
Changes brought by the Government of India in FDI Policy in September 2012:
According to the United Nations Conference on Trade & Development, the FDI inflows in India decreased 29% in 2012. Thus India finally in September 2012, permitted FDI limit up to 51% on multi-brand retail and 100% on single brand retail.
Prohibition on FDI in India:
Any type of Foreign Investment in a company or a partnership firm or a proprietary concern or any entity, whether incorporated or not, is prohibited, if found engaged or purposes to engage in following activities:
(a) Business of chit fund, or
(b) Nidhi company, or
(c) Agricultural or plantation activities, or
(d) Real estate business, or construction of farm houses, or
(e) Trading in Transferable Development Rights (TDRs).
The FDI is completely prohibited on the specific sectors, namely, Retail Trading (Except Single Brand Product), Atomic Energy, Lottery Business, Nidhi Company, Gambling and Betting, Chit Fund Business, Manufacture of Tobacco, Cigars. The sector of Agriculture and Housing and Real Estate are partially prohibited.
Subjected to the applicable laws or regulations; security and other conditions, the FDI in following sectors is allowed up to the limits prescribed. These sectors fall under the Government Route, unlike other sectors, which fall under the automatic route.
Sectors falling under Government Route
|Percent of FDI permitted||Sectors/Activities|
|Upto 74% (Automatic upto 49%)||
Sectors falling under Automatic Route (exceptions)
Even though the FDI on the sectors falling under Automatic Route is permitted upto 100%, but there are limitations in to this also. There are sectors which fall under Automatic Route but FDI limit is restricted. Like on Scheduled Air Transport Service/ Domestic Scheduled Passenger Airline, the limit granted is 100% for NRIs and 49% for others and in case of Insurance sector, FDI limit of 26% is granted.
- FDI POLICY IMPLEMENTATION IN INDIA
Regional Inequality In FDI in India
The rise in FDI flows to India has been accompanied by strong regional concentration. The top six states, viz., Maharashtra, New Delhi, Karnataka, Gujarat, Tamil Nadu and Andhra Pradesh accounted for over 70 per cent of the FDI equity flows to India between 2008-09 and 2011-12. The top two states, i.e., Maharashtra and Delhi accounted for over 50 per cent of FDI flows during this period. Maharashtra alone accounted for over 30 per cent of FDI flows to India during the same period.
Despite impressive growth rates achieved by most of the Indian states as well as aggressive investment promotion policies pursued by various state governments, the concentration of FDI flows across a few Indian states continues to exist.
|Table 1: FDI Equity Inflows to Indian States|
|(US $ million)||(Per cent to Total)|
|Regions not indicated||4,181||3,148||4,491||12,782||15.3||12.2||23.1||35.0|
|Top 6 States||22,113||21,757||13,444||22,340||80.9||84.2||69.2||61.2|
|Top 2 States||14,299||17,944||8,774||17,536||52.3||69.5||45.2||48.0|
|Source: Department of Industrial Policy and Promotion (DIPP), Ministry of Commerce andIndustry, Government of India.|
Significant regional inequality across the Indian states may be observed in the terms of per capita FDI flows and various geographic and socio-economic indicators:
|Table 2: Regional Inequality among India States|
|States||Per Capita FDI Flows (Rs)||Area (‘000 Sq. Km)||Per Capita NSDP (Rs)||Population Density (Persons per sq.km)||Rail Route Density (Km per 1000 sq. Km)||Literacy Rate (Per cent)||Annual Wages per Worker (Rs)||State’s Own Tax Revenue as per cent to NSDP|
|A & N Island||0.0||8.2||76,883||46||0.0||86.3||65,831||NA|
|Note: NA indicates not available.
Source: The Census of India 2011; the CSO, GoI; the DIPP, GoI; the Reserve Bank of India; the CMIE; and the author’s own calculations.
The presence of strong agglomeration effect indicates that the states already rich in FDI flows tend to receive more of them which make it more difficult for the other states to attract fresh investments. In view of this difficulty, a conscious and coordinated effort at the national and the state government levels would be essential to make the laggard states more attractive to FDI flows. The direct method to achieve this objective may be to design the national FDI policy in such a way that a sizable portion of FDI flows to India move into the laggard states The indirect way is to provide a boost to the overall economy of the less advanced states, with special thrust on the manufacturing, services and the infrastructure sectors so that they themselves become attractive to foreign investors.
- FDI IN RETAIL- “MYTH V. REALITY”
MYTH – “FDI as a Gateway to sustenance in ever changing dynamic global business environment??”
The supporters of FDI in retail in India often rely on the shortcoming of the current retail scenario for advocating the cause of opening the gateways for foreign investors in retail.
1) Lack of range and choice to customer: Indian shoppers have to reply upon local kirana stores and do not get a chance to pick or examine a good of their choice from the shelf. Thus the access to the shelf or the product storage area is limited.
2) Highly priced products: The long distribution channel in Indian retailing leads to high priced products.
3) Lack of Infrastructure: Lack of storage facilities like cold storages, warehouses, and transportation facilities cause heavy loses in cases of agricultural products in terms of wastage in quantity and quality. Though the FDI is permitted in cold-chain to the extent of 100%, through the automatics route, in the absence of FDI in retailing, FDI flow to the sector has not been significant.
4) No sales service facilities to the consumers: The unorganised retail shops typically offer no after sales service or facility to the consumers.
5) Employment: Organised retail will need workers and so it would generate employment.
6) Improvement in standard of quality of the merchandise: It would lead to improvement in quality of merchandise due to the intense competition which would also lead to wider consumer choice.
7) Increased income to farmers: FDI in retail would lead to increased sourcing by the companies and better infrastructural facilities for farmers to mitigate their post harvest loss.
REALITY – “FDI merely a debt inflow/liability flow exchange”
We have got a tendency to accept anything done, said or followed by western economic powers as a “economic reform”, ignoring the fact that every change introduced is not a reform. The possibility of those western economic powers, intentionally suggesting a counter reform cannot be overlooked.
FDI is a debt inflow or liability foreign exchange. Why? Simple, because the profits or returns it generates will have to be repatriated in foreign exchange. Secondly, all the men, material and merchandise imported in the years to come will have to be paid in foreign exchange. Finally, at the time of winding up/selling off, the proceeds will flow out of the country in foreign exchange. And, it is noteworthy here; all this will end up in the outflow of foreign exchange, many times more than the initial inflow. Thus heavily relying on FDI for economic development and allowing foreigners to reap benefits from Indian markets would not help us in long run.
The following points must be looked into before further liberalising FDI policy in India, and for evaluating the effectiveness of the current policy of government of India with respect to FDI in retail sector:-
1) Job structure In India: FDI in retail has been advocated by arguing that international retailers add on to employment. This is not true. The job structure in India is such that 51% of employable Indians are self employed. Four crores Indians are employed in retail trade. Retail trade impacts twenty crore Indians in terms of population. Only 18 percent of Indians have a structured employment and 30 percent are either unemployed or under-employed.
2) Impact on manufacturing sector: The manufacturing sector will suffer the most due to FDI in retail. As the agricultural sector is not yielding much, it is obvious that a shift has to bring about by laying emphasis on the manufacturing sector. Thus we need manufacturing sector reforms. Without taking manufacturing reforms, the FDI in retail would hit the manufacturing sector. In the USA, when structured retail replaced unorganized retail, more than 40 percent jobs in manufacturing sector were lost in the past 30 years. In 1979, the US employed 19.5 million Americans in manufacturing. Despite being the most powerful economy in 2009, this figure has come down to 11.8 million – loss of 7.7 million jobs.
3) China’s experience misconceived: The advocates of FDI in retails argue that FDI in retail has been successful in China. But China and India cannot be equated when it comes to FDI in retail. Most of the products in such stores in China are usually Chinese goods itself. Thus the international chains have immensely benefited China. That is not the case with India.
4) Displacement of retail jobs: The division of the same market between the organised structured retail and the unorganised retail would lead to the mass scale loss and displacement of retail jobs. The closure of small shops would lead to a mass scale displacement of retails shops. Also, the low employment principle followed by the Multi Brand stores can be proved by the fact that Walmart employs merely 15 lakh people internationally for its global operations.
- SUGGESTED REFORMS FOR FORMULATING FDI POLICY IN INDIA EEFECTIVELY
1) Regional Inequality in Foreign Direct Investment Flows to India must be catered to.
The liberalised FDI regime has failed to benefit all the states of India equally. Strong regional concentration and regional inequality continue to exist. The lion’s share of FDI flows are mostly attracted by the economically powerful states. 70% of the total FDI equity flows into India from April 2000 to June 2012 have been only in the sic states of Maharashtra, Delhi, Karnataka, Tamil Nadu, Gujarat and Andhra Pradesh, clearly reflecting FDI concentration in specific states. FDI mainly flows to the states which are rich in natural resources, have good physical and institutional infrastructure, and have skilled workforce and states which are technologically advanced. Thus the crucial concern must be rapidly developing infrastructure and promoting good governance in these states to attract FDI.
2) Decision of FDI in retail should not be left to the states.
The states and Union Territories that have agreed to open FDI in the multi-brand retail include Assam, Haryana, Jammu & Kashmir, Himachal Pradesh Andhra Pradesh, Maharashtra, Uttarakhand, Daman & Diu, Manipur, and Dadra and Nagar Haveli. FDI is a central subject and it is not mentioned anywhere in the state list. Thus in the first instance itself, decision of FDI in retail must not be left to the states.
Also, India has bilateral investment treaties with 82 countries. Each of such arrangement has the following clause:-
“ Each Contracting Party shall accord to investments of investors of the other Contracting Party, including their operation, management, maintenance, use, enjoyment of disposal by such investors, treatment which shall not be less favourable that that accorded either to investments to its own investors or to investors of any third State”
The essence of any bilateral agreement thus rests of the assumption that the investor can invest in any part of the other contracting state. The investor cannot be restricted from investing in any particular state. This would breed regional inequalities with respect to the FDI flows in different parts of the country due to divergent political atmosphere in different states.
3) Need to uplift the FDI cap in important sectors
Although the Government, on 16th July 2013, approved the various recommendations of Arvind Mayaram Committee to increase the FDI limits in most of the sectors, but still some of the vital sectors are still untouched. Government increased the FDI limits in 12 sectors out of 20 proposed sectors. There is a need to change the limits on sectors like civil aviation, airport, media, multi-brand retail and Brownfield pharmaceuticals. For Example, in the last ten years, according to data released by Department of Industrial Policy and Promotion (DIPP), India’s aviation market has secured foreign direct investment (FDI) worth $456.84 million. The necessary changes were made in case of defence and telecom, but it is expected from the Government to take essential steps towards the other important sectors also because it will not only attract Foreign Investment in India but will also provide growth opportunities to Indian Companies who can collaborate with Foreign Companies to start business in various new sectors.
4) Loopholes in the existing FDI rules governing e-commerce must be catered to
Retail trading, in any form by e-commerce, is not permissible by companies with FDI, engaged in activity of multi brand retailing trading. In a nutshell it can be stated that existing FDI norms prevent brands from sell directly online through their own company Web sites. Still, electronic brands like, Canon, Dell, Nokia, Lenovo, Amazon have found a loophole to get around the FDI norms on e-retailing. They have found Indian distributors who are selling their wares through special websites created only for this purpose. Even though this arrangement is legal, but it raises a question on the existing FDI rules.
5) Clandestine flow of foreign funds into tobacco sector must be prevented.
International companies plan to enter tobacco sector in India by circumventing FDI norms. Under the guise of brand building and marketing activities, foreign funds may clandestinely flow into the tobacco sector. The RBI has already sent a letter to the finance ministry, expressing its concerns on the same issue. This must be prevented by including this clause as suggested by the central bank:-
“”Foreign fund investment received by an Indian company in any form, including that in the guise of current account transactions for the purpose of creating band awareness, brand building, promotion and management contract, is also completely prohibited for cigars, cheroots, cigarillos and cigarettes of tobacco or of tobacco substitutes.”
“A nation is not defined by its borders or the boundaries of its land mass. Rather, a nation is defined by adverse people who have unified by a cause and a value system and who are committed to a vision for the type of society they wish to live in and give to the future generations”
It is the people in a democracy to determine the path of development which the nation would take. It is the citizens who are the pillars of any democratic setup anywhere in the world. Often, the will of the majority is not reflected in the political will, which speaks a language of its own, driven by ulterior motives. The need of too much focus on attracting FDI can be two: a) When domestic direct investment is inadequate b) When foreign exchange is required. The is no dearth of DDI in a nation like India where the domestic savings rate, is one of the highest in the world, market capitalisation, constantly on the rise, makes available investible funds. Thus domestically is there no dearth of funds for investment. Now talking about foreign exchange, FDI is a debt inflow or liability foreign exchange. The profits generated by it have to be repatriated in foreign exchange. Secondly, all the men, material and merchandise imported in the years to come will have to be paid in foreign exchange. Finally, at the time of winding up/selling off, the proceeds will flow out of the country in foreign exchange. And, it is noteworthy here; all this will end up in the outflow of foreign exchange, many times more than the initial inflow!
No nation can develop by relying heavily on foreign capital by way of FDI. We are not in a position to compare ourselves with countries like U.K., U.S.A, and China in terms of FDI as we are not at their level of development. Relying on FDI and allowing foreigners to reap the profits generated in our own nation won’t take us anywhere. Instead of allowing foreigners to set up their shops here, we should focus on boosting our own domestic market. In the industrial revolutions of various nations, the crucial factors that have been instrumental are (1) indigenous mobilisation of resources, (2) domestic technological development and application (3) strategic management and (4) support from the governments in preventing external pressure.
They say, had FDI not come in, our automobile, telecommunication, aviation, banking and many other industries would not have reached global standards. I would say that instead of allowing foreign capital to set up shop here, the country should have used foreign exchange to just import technology, if needed; and set up the same industries with domestic capital. No liability foreign exchange; no profits going out of the country; domestic consumers getting the same products; and the fruits of exports being reaped by domestic firms and not foreign — all the way a win-win situation for us.
Thus before formulating our FDI policy further, we have to keep in mind that foreign exchange is both a boon and bane, to determine which each of its inflow needs to be individually assessed for its costs and benefits, before allowing it.
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 Under Government Route, FDI in activities not covered under the automatic route requires prior approval of the Government which is considered by the FIPB, Department of Economic Affairs, and Ministry of Finance. Indian companies having foreign investment approval through FIPB route do not require any further clearance from the RBI for receiving inward remittance and for the issue of shares to the nonresident investors.
 Under Automatic Route, FDI up to 100 per cent is allowed under the automatic route in all activities/sectors except where the provisions of the consolidated FDI Policy on ‘Entry Routes for Investment’ are attracted. FDI in sectors /activities to the extent permitted under the automatic route does not require any prior approval either of the Government or the Reserve Bank of India.
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