Managing foreign flows

There's need to track end-use of funds

Nobody in her right senses can disagree with the Reserve Bank of India’s (RBI’s) advice that the government should consider setting up a mechanism to monitor the end-use of the money brought into the country by way of foreign investment in the hotels and tourism sector. Lest the logic of the move should be misconstrued and dubbed as a veiled attempt at rolling back the government’s liberalised foreign investment regime, the central bank’s concerns in this area should be placed in the right context. The present policy allows hundred per cent foreign investment in the hotels and tourism sector through the automatic route. In other words, any foreign entity can enter the sector entirely on its own and without seeking the mandatory clearance required from the Foreign Investment Promotion Board. All it needs to do is to apply to RBI for remitting the money for the project. Permission to bring in money comes almost routinely as long as the stated purpose for which the remittance is taking place fulfils the criteria set out in the government’s foreign investment policy. However, nobody in the government or RBI tracks the trail of the money once it enters the country through the automatic route. The concern is that some of this money may find its way into other, more lucrative sectors, including the real estate or precious metals, and contribute to the creation of avoidable and unhealthy asset bubbles.

That said, it must be conceded that the extent of the problem may not be that serious at present. The latest data available for foreign investment flows into the country in the first eight months of 2010 show that only about $410 million came in by way of investment in the hotels and tourism sector, compared to about $1 billion in the housing and real estate sector. Such investments account for tiny portions of the total foreign direct investment estimated at $13.9 billion for this period. What, therefore, may have triggered the RBI advice is not any surge in the flow of foreign money into the hotels and tourism sector, but the potential damage that any diversion to the real estate sector can cause by creating speculative price pressures in other related areas. An efficient and effective monitoring mechanism to monitor the end-use of all types of foreign flows can go a long way in alerting the government to any sharp and unnatural increase in investments in certain areas so that, if necessary, it can take steps to prevent the formation of asset bubbles.

One of the options the government may well consider is to place curbs on repatriation of profits by way of dividends, with the introduction of a lock-in clause for investments in the hotels and tourism sector. Until last year, such a lock-in clause was in force for foreign investment in the real estate as well as hotels and tourism sectors. Early this year, the government had exempted the hotels and tourism sector from the lock-in provision with a view to encouraging more investment flows so that the huge gap between the demand and availability of hotel rooms could be met. The RBI advice to consider re-imposing the lock-in clause is worth a close look, since the dangers of an asset bubble in the real estate sector, it fears, should be tackled well in time, before they become too unmanageable.