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”. 

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

5 comments

  • 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

  • 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?

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