The FDI debate

Foreign capital is important, but security safeguards are a must

The government's efforts to refine and liberalise norms for foreign direct investment (FDI) in India are useful and welcome steps in many ways. The central purpose of FDI, to introduce greater discipline to Indian sectors and permit consumers greater choice, is a valid and important goal. In addition, regulations continually need to be tweaked to ensure that the private sector, which is always more dynamic than regulators, does not get too far ahead in terms of exploiting any loopholes that may exist. This is why, for example, there was a need to revisit the definition of "control" of a company. What does it mean to say that a foreign entity has "control" of an India-based company? The current definition, that foreign entities should be able to appoint the majority of a company's directors on its board, could easily be worked around in practice. Justifiably, therefore, the government wants to tweak the definition of control, which is now proposed to be determined by shareholder agreements or lien over voting rights. An expanded definition will allow for better principles-based regulation.

The question, of course, always needs to be asked: why should there be regulations on foreign ownership, anyway - especially between one sector and another? If FDI can galvanise one sector, say retail, why should it be restricted in another? The most coherent answer is to ensure that there are safeguards for reasons of national security. Whatever steps the government takes to liberalise FDI, it should always allow itself the option to intervene on questions of security. Legitimate questions could be asked, for example, as to whether India's entire telecommunications backbone should be built by providers from a single foreign country. This would lead to an unacceptable degree of vulnerability in a crucial component of India's economy, and one that is susceptible to remote attacks, too. These sectoral interventions, however, should be chosen judiciously, and not at random; the default should always be to attract investment that benefits consumers and broadens the market.

For that is the point of FDI: to help consumers of final and intermediate goods as well as services to access a wider variety of options, and to deepen and strengthen the market economy. The point of FDI is not to allow India to finance a current account deficit or to help the owners of Indian companies bury their mistakes in an avalanche of foreign money. Nor is it to allow existing Indian businessmen to leverage their permissions and contacts to make windfall gains. Sadly, it is far from clear that the government has worked out this difference. This is a larger problem with government attitudes to reform in India: reforms should be pro-markets, and not merely pro-business. If business is helped in the process, then all to the good; but designing or introducing reform measures specifically to help business gives rise to cronyism and corruption of the sort that has bedevilled the Indian state in the recent past. More, the distortions that such policy making causes are precisely those that empower poor business models and overambitious market participants, leading to demands for bailouts. Whether the bailout comes from taxpayers' money or from foreign investment that would otherwise flow to some other productive activity in the Indian economy is irrelevant. The government needs to change its entire mindset about reform; and its thinking about FDI would be a good place to start.