Now the doubts

Govt seems to be waking up rather late in the day to the implications of its decision to allow indirect FDI, even in sectors where it's not allowed

The government seems to be waking up rather late in the day to the implications of its decision to allow indirect foreign direct investment (FDI), even in sectors where FDI is not allowed, or is limited by sectoral caps (typically 26 per cent). The Cabinet approved this in February, so that indirect foreign holdings in a retail operation could (through corporate pyramiding) reach 90 per cent and more, even if the policy says no FDI is allowed in retailing. The proposal was pushed through by the industry ministry at a time when the Prime Minister was out of commission, on account of medical reasons. Now, somewhat belatedly, the finance ministry and Reserve Bank of India seem to have woken up to what has happened, and are asking questions. If news reports are to be believed, the industry ministry is scrabbling around for convincing answers.

 

This newspaper has argued earlier that the new policy had little to recommend it. It created artificial differences between foreign investment that would not be treated as such, and other foreign investment that would. It involved grey areas like defining corporate control (and did so inadequately, indeed poorly). And it invited companies to get into complex holding structures that would be non-transparent at the best of times—indeed, one or two companies have started creating such structures, in order to take advantage of the new policy regime.

Why any of this was needed is not clear, except if it was as a round-about way of circumventing the existing rules on FDI. If so, such “reform” (if that is the appropriate word) by stealth has little to recommend it. If the government believes that FDI in retailing and other barred sectors is a good thing, and if it believes that the existing limits on FDI in sectors like the media are too low, then the right and logical thing to do is to open up the front door, not engineer back-door entry.

The confusion created by the new policy comes at a time when, by the government’s own estimate, the outlook for FDI inflows into India remains bright. The official assessment seems to be that FDI inflows during the new financial year (2009-10) will touch $40 billion, marginally higher than the figure for last year. Also, about $30 billion out of this will be fresh money coming into the country. It is hard to tell whether this assessment is correct, since money is scarce globally and most companies are cutting back on fresh investments. To be sure, some of them will decide that getting into China and India has become all the more important as these remain growing economies in even the worst recession of the last 70 years. Whatever the case, investors would welcome the opportunity to invest directly and get a degree of control that has some relationship with the level of their investment. The policy passed a couple of months ago would actually discourage FDI because 49 per cent investment, done through pyramiding and holding structures, would give the overseas investor less control, not more. Since overseas investors are not fools, this is an open invitation for side arrangements on corporate control that may or may not be disclosed. In other words, if the finance ministry and RBI are raising questions because they have doubts, it may be a good idea to review the Cabinet decision.