Pushing reforms to attract foreign funds

At this juncture, when the country is witnessing a decline in inflow of Foreign Direct Investment (FDI) — one of the key factors fueling growth momentum of the economy — the government’s decision to further liberalise policy regime governing foreign investments in various spectrum of economic activities is, no doubt, a timely step in the right direction.

Though the government has not done any major radical changes in the FDI policy regime as the existing cap on limit of FDI in sensitive segments like insurance and telecom continue to remain, the policy initiatives to allow more flexibility to foreign firms to carry out their business operations are being considered as significant.

For instance, with a twin objective to attract fresh inflow of state-of-the art overseas technology and investment in the country, the government through its latest Consolidated FDI Policy Circular – a comprehensive reference guidebook on foreign investment-related regulations – now allows foreign investors to bring in more funds without obtaining prior approval from their existing domestic partners.

Now the foreign company will not have to seek a No Objection Certificate (NOC) from the Indian partner for investing in the sector where joint venture operates. The government as well as FDI experts overwhelmingly feel this will increase FDI inflows.

“There is a need to attract fresh investment and technology inflows into the country as also to reduce the levels of state intervention in the commercial sphere… It is expected that this measure will promote the competitiveness of India as an investment destination and be instrumental in attracting higher levels of FDI and technology inflows into the country,” says the Department of Industrial Policy and Promotion Secretary R P Singh.

Initially when the government first kicked off the liberalisation policy way back in 1991, it had technically not put any such restriction on foreign firms. But under pressure from the domestic industry, which nursed apprehension that multinationals would take them over, the government in 1998 issued a Press Note 18 stipulating that a foreign investor intending in the same or allied area needed to get a NOC from his Indian partner.

After issuance this Press Note it was noticed that several Indian promoters started using this restrictive provision to block investment plans of foreign partners to set up new business or expand present operations in India.  At some point of time, this led to souring of relations between foreign firms and their Indian partners. This, naturally, discouraged FDI into the country. “Removal of this restrictive condition will now give more confidence to foreign investors, who were retrained by their Indian partners, to bring in more investment. This relaxation can be viewed as a milestone in the formulation of FDI policy,” PricewaterhouseCoopers Executive Director Akash Gupta says.

Leading FDI expert, Deloitte Financial Advisory National Leader Avinash Gupta feels, “The government’s decision to give more flexibility to foreign firms to expand their business operations is a timely and positive move given the fact that there is some decline in current inflow of FDI.”

Besides, it will inject more competitiveness among Indian firms to project themselves as efficient strategic partners so that their foreign counterparts cannot afford to ignore them, he said. In fact, Indian industry, which, more than a decade ago, lobbied for such restrictive clause, now welcomes its removal. As Ficci Director General Rajiv Kumar says, “There is no need for such restrictions as time has changed. There is now a definite need for a liberal FDI policy regime to promote inflow of FDI.”

Echoing similar views, CII says, “industry has now reached a stage of commercial and economic maturity and can negotiate with foreign counterparts on an equal footing without compromising its interest .”

Easing fund raising

Another significant feature of liberalisation of FDI policy regime relates to injecting more flexibility to Indian companies to source foreign capital. Indian firms will now be allowed to directly source FDI through issuance of equity to overseas firms against imported capital goods and machinery.

The facility of conversion of capital goods import into equity was earlier available for companies raising external commercial borrowings (ECBs). This measure, which liberalises the conditions for conversion of non-cash items into equity, is expected to significantly boost the prospects for foreign companies doing business in India, Department of Industrial Policy and Promotion (DIPP) Secretary R P Singh says.

As Avinash Gupta says, “This is more of a symbolic move to encourage prospective foreign investors to look at India as an attractive destination for investment by rotating their funds through equity route in Indian ventures.”

The other measure that is widely being viewed as an incentive for prospective foreign investors to look at India as an attractive destination for investment relates to relaxation of norms for calculating convertible instruments.

As per the new FDI circular, companies would now be free to prescribe a formula for transforming convertible instruments (like debentures, partly paid shares and preferential shares) into equity in accordance with the guidelines of Fema and Sebi. Currently the pricing of capital instruments issued to foreign investors is supposed to be decided upfront, at the time of issuance. Investors feel this deprives them of a better valuation in case company performs better than expected.

Now, under the liberalised norms, companies will have a choice between specifying the price of convertible instruments upfront or prescribing a conversion formulae so that the investors can get a higher premium if the company does well.

As DIPP officials explain this decision will help the recipient companies in obtaining a better valuation based upon their performance. “The overall stance of current round of liberalisation of FDI regime is primarily to boost up business confidence  of foreign investors,” feels Gupta.

Need of the hour

In the face of decline in FDI inflow, the government is desperate to woo prospective foreign investors to bring in their capital investment into the country. As per the latest data during the 11-month April-February period of 2010-11 FDI inflows into India declined by 25 per cent to $18.3 billion.

Ever since the process of globalisation began, there has been growing competition among emerging economies like China, India, Brazil, Mexico and South Africa to get bigger chunk of FDI. Besides, FDI is increasingly becoming an integral part of development strategies of almost all countries globally in view of its positive impact on productivity and employment.

Most countries welcome FDI more in comparison to inflow of funds trough Foreign Institutional Investors (FII). FII fund is primarily volatile in nature and cannot be relied upon. Where as funds coming through FDI route are meant for long-term investment, which contributes to growth of the economy as well as creation of jobs. This is the reason why the RBI has been stressing the need to alter the composition of capital inflows towards FDI. This in turn has prompted government to further relax the FDI policy regime.

However, analysts point out though India’s FDI policy is more liberal compared to some of the other competing emerging economies the country is not receiving the desire level of FDI inflow.  Experts say that a major negative factor is that transaction cost is one of the highest in India. To make India more attractive  efforts must be made to drastically to bring down the transaction costs.