Deceleration in FDI is no surprise

Foreign direct investment (FDI) inflows into India in 2010 are said to have decelerated by 31% in 2010, according to a report by the United Nations Conference on Trade and Development (UNCTAD), which is based on data from the Reserve Bank of India (RBI). China, Hong Kong, Malaysia, Singapore, Indonesia and Thailand, are reported to be beneficiaries of higher FDI inflows during the year.

This should not come as a surprise at all. Systematically, the regulatory framework governing FDI has become increasingly ambiguous. FDI policy, through the past two years, has taken on a pretentious air of becoming "smart" and ostensibly "plugging loopholes" even without pointing out the rationale for the policy and the intended state of affairs.

This column has repeatedly pointed out such issues through the past year. Examples of newfound ambiguity in FDI policy in the past twelve to eighteen months abound. For instance, the FDI policy says "what cannot be done directly should not be done indirectly" - a seemingly rational proposition, which creates hopeless ambiguity in the context of considering whether a single dollar of foreign shareholding in a company that has an indirect small interest in a regulated sector, is at all kosher.

The entire framework of determining how to treat Indian companies on the basis of whether they are owned and controlled by foreigners is another such example. Without corresponding clarity from the Reserve Bank of India (RBI), which is the regulator of exchange controls, bizarre and unthinkable propositions on how an Indian company should conduct itself the moment majority ownership moves to foreign hands, abound. Would banking companies like ICICI Bank and HDFC Bank have to be treated as foreign entities because they are majority-owned by foreigners? Long-standing companies that have been in such ownership patterns even prior to the policy changing would continue to brave the ambiguity and fight it, but new capital can never come in without full clarity. Undoubtedly, FDI inflows have to slow down.

Out of the blue, warrants that are convertible into shares have been held to be instruments that are not recognized as valid forms of FDI investment into India. No empirical study on how many companies had issued warrants, whether the warrants at all posed any incurable mischief to the intended policy, and how to deal with companies that had already issued warrants to foreign investors, was considered. If such issues were ever considered, the world has not been told about it, because there is no articulation at all on why the sudden change of policy was warranted.

With other convertible instruments, the RBI has contributed its own share of ambiguity. It recently sent out letters to various issuers of convertible debt, asking them to confirm the precise number of shares that would be allotted upon conversion of the instruments, simply ignoring the very logic behind issuance of convertible instruments — of rewarding Indian issuers with a higher valuation if they in fact performed to the level they promised their investors, when taking their money. Worse, the law governing pricing for cross-border transfer of listed shares has been mindlessly linked to price regulations framed by the Securities and Exchange Board of India in a completely different context with a different policy objective.

The Foreign Investment Promotion Board, a motley group of ministries that was cobbled together to get FDI going when India opened up her doors to FDI in 1991, has become anachronistic. The surprising absence of a dialogue between the draftsmen of FDI policy in the Government of India, and the draftsmen of exchange control policy in the RBI, is also remarkably surprising. Each is taken by surprise by the other. Worse, even the ministry handling FDI policy (commerce ministry) is different from the ministry that administers matters relating to the RBI (finance ministry).

Either exchange controls should be taken away from the RBI, or more conveniently, FDI policy may be taken away from the commerce ministry. Each has a role to play, but the ambiguity they give rise to, without talking the same language, makes a strong case for merging the two arms, or doing away with one of them.

Meanwhile, if Indian corporate groups prefer to inv-est abroad, and if non-Ind-ian corporates give India a go-by, one should not be too surprised.

(The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.)

Email: somasekhar@jsalaw.com