<b>Bhargavi Zaveri & Radhika Pandey:</b> Why India needs a new FDI regime

A new law that would govern all aspects of foreign direct investment and end the licence raj prevalent in the FDI regulatory system will improve the country's investment climate


Bhargavi ZaveriRadhika Pandey
Dismantling the Foreign Investment Promotion Board (or FIPB) is the first step in a long road to a rationalised foreign direct investment (or FDI) regime. However, in a country where the legal framework governing FDI is generally ambiguous, this step does not count for much. True structural reform would require the government to formulate a simple law on foreign direct investment in India.

Contrary to popular perception, the FIPB performs four distinct functions. First, it considers applications for proposals for foreign direct investment in sectors where government approval is required (popularly referred to as the approval route). Second, it considers applications for proposals which are not clearly addressed under the law. For example, if an Indian company proposes to issue warrants to a non-resident, the FDI policy and the Foreign Exchange Management Act are silent on the conditions for such issuance. In such cases, the application for approval will require to be made to the FIPB. Third, it acts as a feedback loop for the Department of Industrial Policy and Promotion (DIPP), which is the nodal body in charge of designing India's policy on foreign direct investment.

Fourth, it considers applications for ad hoc exemptions from the FDI policy. For example, in the aftermath of the global financial crisis, several foreign firms claimed exemption from minimum capitalisation norms applicable to foreign direct investment in some sectors. The FIPB considered these applications, allowed some and rejected a few. Similarly, a foreign investor that wants to acquire an existing pharmaceutical Indian company and wishes to contractually impose a non-compete obligation on the Indian shareholder must apply to the FIPB for approval.

Except for the first, all the other functions assigned to the FIPB emerge from the generally ambiguous and ad hoc nature of the FDI policy. As with any ambiguity in law, this vests the central government (acting through the FIPB) with extensive and unguided discretion in dealing with proposals for foreign direct investment. If the proposal, therefore, is to substitute the FIPB with sectoral regulators, it merely transfers this discretion from the FIPB to the sectoral regulator.

The solution to fixing the FDI regulatory regime lies in enacting a simple law that will govern all foreign direct investment into India. What will be the features of such a FDI law? First, it must abolish the approval route, except for proposals involving national security considerations (such as ownership of critical infrastructure or critical technology). The sector-driven approval route was arguably necessary at a time when India was in the nascent stages of capital account liberalisation. Now, the primary law itself can codify the considerations involved in sectors under the approval route.

For example, FDI in tea plantations is allowed to the extent of 100 per cent under the approval route. Now, it is possible to codify in a clean FDI law what conditions must be satisfied by an entity that wishes to invest in a tea plantation in India. Putting this under the approval route means that the decision may be driven by the attributes of the foreign investor, as opposed to the considerations, if any, involved in investing in Indian tea plantations.

Abolition of the approval route will ensure that we get rid of the licence raj that is currently prevalent in the FDI regulatory regime. If a non-resident satisfies the codified conditions, she may make the investment. If she does not, she cannot. This will reduce the discretion involved in granting or rejecting applications for approval under the approval route.

Second, the FDI law should only concern itself with sectoral caps and conditions. All other forms of artificial controls must be dispensed with. For example, restrictions on the structure and form of investee entities, artificial distinctions between investment routes such as the FVCI (foreign venture capital investors) and FDI routes, artificial distinctions between instruments through which investments may be made, special dispensations such as dispensations to NRIs, find no place in a mature law governing FDI. Firstly, artificial restrictions of this kind do not have any economic substance. Secondly, they add to the complexity of the framework, create scope for arbitrage and increase the administrative burden without commensurate benefits to the country.

Third, such a law would eliminate the need for having multiple legal instruments such as circulars, consolidated policy and regulations that make the current framework unduly complex. A case in point is the South Korean law on foreign direct investment called the Foreign Investment Promotion Act. All aspects governing FDI in South Korea, including procedural requirements, are codified in the aforementioned law.

A clean FDI law is agnostic to the roadmap towards full capital account convertibility. Even if we choose to retain partial capital account convertibility, a simple FDI law will go a long way in improving the investment climate in the country. Dispensing with the FIPB alone and transferring its discretionary powers to sectoral regulators will not be enough.

The writers are with the National Institute of Public Finance and Policy
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper

First Published: Jun 04 2016 | 9:50 PM IST

Explore News