Saturday, September 15, 2012

A Comment on the New FDI Reforms


The Government has attempted to stem the trend of economic policy paralysis by announcing a slew of measures yesterday with a view to enhancing foreign direct investment (FDI), including in some sensitive sectors which had witnessed political deadlock over the last year or so. The new measures relate to multi-brand retail, single-brand retail, civil aviation, power trading exchanges and broadcasting.
Multi-brand Retail
The most prominent (and even emotive) sector relates to multi-brand retail. After the Government had to call of its proposed opening of the sector to FDI last November, it has sought to resuscitate its policies, this time with some modifications in an apparent effort to cushion its impact and to enhance its acceptability to various stakeholders. However, given this is a political hot-potato, the extent to which it receives acceptances remains to be seen.
The Government’s new proposal is contained in its press release. First, the Government’s balancing act is evident from that fact the states are provided significant powers. Multi-brand FDI can be carried out in specific states only if that is permitted by the relevant state governments. This is driven by both legal and political compulsions. The legal compulsion, which is expressly stated by the Government, is that the retail sector is regulated under the Shop & Establishments Act, which is essentially within the domain of the states. This legislation touches upon governing the working conditions of personnel employed within the sector. From a political standpoint, this involves some tight-rope walking so as to initiate FDI in states which are amenable to this policy, without confronting those that are against. While some states have taken a liberal view on the issues, several states continue to oppose FDI in the sector. The Times of India lists out the approaches adopted by some of the key states on the issue.
Second, the retail outlets must be set up in urban agglomerations with a population of more than 10 lakhs. In states with no such cities, specific dispensations have been made. This is to ensure that the impact of the proposal can be contained to urban areas, without any impact on the rural areas.
Third, a minimum of 50% of the FDI is to be utilised in “backend infrastructure”, which includes “capital expenditure on all activities, excluding that on front-end units; for instance, back-end infrastructure will include investment made towards processing, manufacturing, distribution, design improvement, quality control, packaging, logistics, storage, ware-house, agriculture market produce infrastructure etc.” This is a significant condition as it generally well-accepted that there is a dire need for funding to develop such backend infrastructure in India. The arguments in favour of liberalisation of FDI in the multi-brand sector have been premised on the need for such funding. Specifically, the press release also states that land cost and rentals will not be counted towards that purpose.
In all, while this move is expected to please the markets and demonstrate the Government’s aim to create a more conducive investment environment, a lot will depend on the acceptability of such a policy to the states. To that extent, while the Government’s policy is merely enabling, the ball now lies in the individual states’ court.
Single-brand Retail
The Government’s approach on single-brand retail has been bolder. The effort has been unequivocal in terms of reducing the burden on foreign players in being able to meet with investment conditions. When the Government allowed 100% FDI in single-brand retail earlier this year, it imposed several conditions, including the requirement for local sourcing from micro, small and medium enterprises (MSME). However, this was considered to be restrictive, and many single-brand retailers including Ikea made representations to the Government to ease the process. The Government, in its new proposal, agreed to relax two significant conditions.
The first relaxation pertains to the condition that the foreign investor must be the owner of the brand. It was felt that this does not recognise group holding structures whereby for reasons of commercial exigency the entity that makes the investments into the Indian company may be different from the entity that holds the brand. Therefore, the new condition simply provides that any non-resident entity, “whether owner of the brand or otherwise”, may make the investment. A protective measure, however, has been introduced to state that only one investment will be permitted for a specific brand. This change is understandable, and can at best be said to be procedural rather than any substantial overhaul.
The second relates to the domestic sourcing condition, which was found to be onerous. The previous condition stipulated that where the FDI were to be in excess of 51%, then a mandatory domestic sourcing was required to the extent of 30% of the value of products sold, and such sourcing was to be from small industries (which were defined as industries where investment in plant and machinery did not exceed US$ 1 million). Representations were made to the Government that this was not practicable for high value goods, and that even where industries may have satisfied the requirement as the commencement of supply to the single-brand retailer, they would soon outgrow their “small” industry status. The Government has favourably addressed these concerns by removing the mandatory nature of the local sourcing norms. The new requirement states that single brand retailers may source their needs locally, and “preferably” from MSMEs, village and cottage industries, craftsmen and artisans “where it is feasible”. The only mandatory part relates to geographical element, i.e. the fact that 30% of the sourcing must be done locally, from India. The rest of the requirement seems to be merely a “good faith” effort on the part of the retailers, and there appears to be no immediate attempt to enforce this so as to invite legal consequences upon retailers who may not source from MSMEs or the village or cottage sectors.
Aviation
The liberalisation of FDI in the aviation sector, although not unexpected, is interesting for different reasons. In case of the retail sector, there has been significant pressure from the multinational players to open up the sector. However, in the aviation sector, the trigger appears to have emerged from within, due to the domestic circumstances. Foreign airlines have been seeking a share of the domestic aviation pie for over a decade now. But, the Government has been steadfast in its resolve not to open up the sector for foreign strategic players. However, the recent economic fractures in the domestic aviation industry have necessitated a change in approach. With the domestic industry being competitive, and with several players facing dire financial circumstances, the new FDI measures appear to be a way of preventing further downturn in the domestic sector in the hope that foreign airlines would be interested in infusing the much needed funds into the domestic aviation sector.
Under the new dispensation, foreign airlines will be permitted to invest in “scheduled and non-scheduled air transport services” that were hitherto out of bounds for them. The investment will be allowed under the Government (approval) route up to a maximum of 49%. The investment cap and other related measures are to ensure that control of the domestic company remains in Indian hands. The proposal also addresses some of the security concerns involved in the industry.
Others
In the broadcasting sector, changes have been made to bring the key services within the scope of FDI to the extent of 74%, so as to confer similar treatment as the telecom sector. Separate regimes continue for cable networks and news (and current affairs) broadcasting services. A limit of 49% has been set for FDI in power trading exchanges.
In a related move, the Cabinet has also announced disinvestments in some key public sector undertaking, which may in turn boost the capital markets.

To conclude, these proposals appear to be an attempt to boost the economy and address the concerns of policy paralysis that have afflicted the country more recently. While it will certainly have the effect of altering the perceptions among investors in the markets, it might be too early to determine the impact of these reforms on the ground. The FDI in multi-brand retail is left to be determined by the states, many of whom continue to reject the idea. Moreover, there could also be a political backlash from the opposition and other regional parties to the idea of liberalisation in that sector, the effect of which will be known only in the coming days and weeks. From a technical standpoint, the current decisions have been taken by the Cabinet, but there appears to be no formalisation in terms of changes to the FDI Policy, which might soon follow nevertheless. But, until these formal legal changes are effected, concrete steps towards investment may have to wait. That would be a prudent approach considering the previous experience where the proposal to open up the multi-brand retail sector last November generated great enthusiasm, only to be soon followed by the proverbial “slip between the cup and the lip”. 

5 comments:

vswami said...

Impromptu (unedited):

Without going into the merits or otherwise, of the subject policies or the reforms intended to be brought about, the conclusion rightly and intelligently brings to surface/sharp focus the root causes as to why more often than not such policies and their main objectives fail to even take off the ground; and happen to be thwarted upfront / at the embryo itself.

Experts , barring those (for obvious reasons) who are part and parcel of the government machinery playing a leading/active role, cannot righteously afford to recognise the truth behind the ground reality as summed up therein.

In one's conviction for long, a similar area where because of the wanton confrontation and violent conflict in ideologies of the centre and the states that an intended reform, despite its inherent merits / advantages has thus far remained elusive, - that is, the 'GST'.

Another one that can be readily thought of is the centre's legislation in the offing aimed at regulating the highly and unashamedly unorganised sector - 'THE REALTY'.

It cannot be prudently regarded or be rightly ignored as just a 'slip' of the kind referred to. But, there is much more to it, of a grievous and culpable nature.

For a better appreciation, the concluding portion is reproduced below, attempting at randum to specially mark (bracket) the key words:

Q

To conclude, these proposals (appear to be an attempt to boost the economy and address the concerns of policy paralysis that have afflicted the country more recently). While it will (certainly have the effect of altering the perceptions among investors in the markets, it might be too early to determine the impact of these reforms on the ground.) The FDI in multi-brand retail is (left to be determined by the states, many of whom continue to reject the idea.) Moreover, there could also be a (political backlash from the opposition) and other regional parties to the idea of liberalisation in that sector, the effect of which will be known only in the coming days and weeks. From a technical standpoint, the current decisions have been taken by the Cabinet, but there appears to be (no formalisation in terms of changes to the FDI Policy), which might soon follow nevertheless. But, (until these formal legal changes are effected, concrete steps towards investment )may have to wait. That would be a prudent approach considering the previous experience where the proposal to open up the multi-brand retail sector last November generated great enthusiasm, (only to be soon followed by the proverbial “slip between the cup and the lip”).
UQ

vswami said...

A correction (!)>

"Experts ,....cannot righteously afford NOT to recognise.."

Ashish said...

Yes FDI will bring lots of progress in our economy and their will be more active competition between sellers. Quality too will improve. Good move by the Govt.

SMS said...

After 65 years of independence we are still trying to retain barriers against globalisation and competition. At the same time we want to be known and recognised as a global player. We want to be permanent member of the security council. What dichotomy. In one side we use plethora of MNC products but when it comes to FDI in retail we panic. We use Colgate toothpaste. We drive Suzuki car, We take photos with Nikon and Sony. We travel in Boeing and Airbus planes. We keep accounts in Citi Bank. We drive Honda motorbikes. We use Viagra for our libido. We play cricket. We travel in Volvo buses. Our industrialists own big industrial empires abroad. Look at Laxmi Mittal, the biggest steel producer in the world. He operates freely across the globe.Our food sufficiency is due to Dr. Norman Borlaug. We have no problems then. So what do you want? Should we drive a third class car like Ambassador only and use only Neem datan and go to the maidans for ablution. My country men, wake up. This is 21st century. You have to integrate with the world. Enough of anti development and anti technology rhetoric. Recognise the reality. See what China has done in a short span. Shall we languish at the bottom of the development index?

Samir said...

Mr Anand Sharma, Minister of Commerce, Industry and Textile, Government of India shares his views on the recent economic reforms. Check out the view of Anand Sharma on FDI in multi-brand retail http://www.ibef.org/resources/perspectives.aspx