Key Impact of the Proposed Reforms to the FDI Policy

[Rishabh Sharma is a IV Year BA.LLB. (Hons.) student at NALSAR University of Law, Hyderabad]

On 28 August 2019, the Union Cabinet approved the proposed changes in foreign direct investment (FDI) norms in four sectors, namely, coal mining, digital media, single brand retail trading (SBRT), and contract manufacturing. The approved reforms in the FDI policy are anticipated to make India an attractive destination for FDI, thereby boosting investments, growth, and employment in the country. While the reforms hold tremendous promise in fulfilling their intended purpose in the concerned sectors, some of the changes will likely have certain concomitant consequences. In this post, I examine the proposed reforms in each sector, and seek to highlight some of the key impacts in all the four sectors, including the ones that require immediate government attention before the proposed reforms are notified. The impacts discussed are not exhaustive or comprehensive, but merely illustrative.

Coal Mining

Proposed Reforms

In the present FDI framework, 100% FDI through the automatic route is permitted for coal and lignite mining for captive consumption by iron and steel and cement units, power projects, and other eligible activities, subject to the applicable regulations and laws. In addition, 100% FDI through the automatic route is allowed for establishing coal processing plants such as washeries, subject to a condition that coal mining, and selling of washed or sized coal processed in the company’s coal plants shall not be permitted, and supply of washed or sized coal shall only be allowed to the suppliers of raw coal which provide coal to the concerned processing plants for washing or sizing.

In the proposed reforms, 100% FDI through the automatic route will be permitted for selling coal, and for coal mining activities along with the ‘associated processing infrastructure’ (coal washery; coal handling; crushing; and separation, magnetic and non-magnetic), subject to the provisions of the Mines and Minerals (Development and Regulation) Act, 1957, the Coal Mines (Special Provisions) Act, 2015, and other relevant laws on the subject in hand.

Key impacts

The Government has taken first steps towards privatization of coal mining after approving 100% FDI through automatic route in coal mining and associated processing infrastructure, with the hope to create an ‘efficient and competitive coal market’ in India. While this may have left Coal India Limited, India’s largest coal player, apprehensive of losing its monopoly over the market, private coal mining still seems to be a long way away yet. This is because, in their attempt to enter the coal market, private investors will be faced with certain entry level obstacles and operational predicaments.

To begin with, coal mines will only be allocated by auctioning. Thereafter, the auction winner will be expected to complete a host of other formalities before being ready to compete in the market. The miner will be responsible for acquiring the requisite land for operations and for procurement of all the licences essential for commencing mining operations, for instance, environment and forest clearances. Although these obstacles may pose considerable challenges to private mining, they are logistical in nature and may be addressed.

The real predicament for private miners will lie in creation of the much anticipated ‘efficient and competitive coal market’. Following the entry in the market, the private miner will be competing for survival against Coal India. The overarching presence of Coal India will be difficult to eclipse. For entering into long-term contracts for selling coal, the prices of Coal India will have to be rivalled, which may prove to be a daunting task for the new player. The short supply of rakes will only make life harder for the private miners. While the move to allow 100% FDI will certainly garner global interest in Indian coal mining, the right kind of policy changes and operational ease for international miners will be required to translate this interest into investments.

Digital Media

Proposed Reforms

Under the existing FDI policy, FDI up to 49% for up-linking of ‘News & Current Affairs’ through television channels is allowed under the approval route. In tune with print media, the Government has decided to permit FDI up to 26% for uploading/streaming of ‘News & Current Affairs’ through digital media under the government approval route.

Key impacts

The proposed reforms are being considered as a welcome step by the digital media associations. For a long time, news aggregators have been directly competing with news publishers, and have had a similar extent of consumer influence, thereby necessitating parity in FDI limits. The proposed Government decision of capping foreign investment in digital media to 26% provides a level playing field to both the news aggregators and new publishers.

However, the proposed reforms have the potential of smothering the growth of India’s emerging digital media startups. As startups, their funding requirements are not merely limited to the purposes of gathering news, but they also require resources for investment in digital infrastructure. Restricting foreign capital will greatly reduce their funding sources outside the country, in effect, forcing them to scour for Indian investors. Further, there is an uncertainty as to what happens in cases of startups where foreign investment already exceeds 26%.

Another great uncertainty that exists is over the ambit of ‘digital media’. It is unclear whether it also includes foreign news websites sans physical presence in India. The term ‘digital media’ has not been supplemented with any additional explanations, causing regulatory uncertainties. In recent times, in light of greater data penetration, several news aggregators as well as content startups have been significantly attracting investor interest. Several high-profile foreign investment deals in this sector are already in pipeline, giving enormous fundraising opportunities to such news aggregators and content startups. However, according to industry experts, these investments and existing capital structures will require significant alterations for bringing them in line with the reforms. The uncertainties in the scope of digital media could even sabotage some of these investment plans. Therefore, in the press note to follow, there is an urgent need for the Government to clear the air on these critical issues.

Single Brand Retail Trading (SBRT)

Proposed Reforms

With an intention to accord greater flexibility and operational ease to the SBRT entity, the Government has decided that, notwithstanding the fact whether the procured goods are sold in India or exported, all procurements made by the SBRT entity from India will be counted towards the local sourcing requirement. In addition, for giving an impetus to exports, the existing time limit of five years for meeting these requirements has been proposed to be removed.

The present FDI policy provides that for the first five years incremental sourcing for the global operations by a foreign SBRT entity, whether directly or through its group company, must also be counted as part of the local sourcing requirement. However, keeping in mind the extant business models, the entire sourcing of goods for global operations from India, whether undertaken directly by the SBRT entity or its group companies, or indirectly through a third party at their behest, will now be considered a part of their local sourcing. 

Under the present FDI policy, only that part of global sourcing which is over and above the previous year’s value must be counted towards the local sourcing requirement. However, considering this has been discriminatory to companies yielding consistently high exports in comparison to those with lower exports in a base year or any subsequent years, the Government has decided to regard the entire sourcing from India for global operations towards the local sourcing requirement. 

The SBRT entity is required to function through a brick and mortar store before commencing retail trading of the particular brand through e-commerce. However, according to the Government, this has been creating an artificial restriction and is not in alignment with the current market practices. For tackling this situation, it has been decided that retail trading via online trade may be undertaken before setting up a brick and mortar store, with a condition that a brick and mortar store will have to be opened within two years from the commencement of online retail trading. The Government is optimistic that such a step will lead to more jobs in digital payments, logistics, training, customer care, and product skilling.

Key impact

The mandatory local sourcing requirement has been a major stumbling block for many international players in entering the Indian market. The relaxations offered by the proposed reforms in this regard will certainly attract foreign investors, as they will now have some transition time for adjusting to the local Indian conditions and making required financial alterations. In addition, both local manufacturing as well as exports will see a significant boost following the operationalization of the proposed reforms as single-brand companies will now be allowed to begin online retailing before even setting up physical stores in India. Until now, the extravagant real estate costs had been impeding many global retailers from entering the Indian retail market.

However, according to FDI experts, home-grown brands are not happy with the decision as they will possibly suffer after the proposed reforms are operationalized. They will risk being cornered in a market cluttered with fierce competition from the foreign brands. Although the reform is in tune with the Digital India programme, it will throttle the growth of local brands which have hitherto been flourishing on account of the Make in India initiative.

A lot of scope for reforms still exists in the single-brand retail trading sector. The Government has been undertaking micromanagement of the retail sector by curbing legitimate competitive practices, and this ought to stop. While restrictions on foreign investors may be justiciable, they must not be imposed at the expense of innovation.

Contract Manufacturing

Proposed Reforms

100% FDI through the automatic route is allowed in the ‘manufacturing’ sector in the present FDI policy. The policy makes no mention for contract manufacturing. For the sake of clarity, the Government has decided to permit 100% FDI through the automatic route in India in contract manufacturing. 

Foreign investment in ‘manufacturing’ is permitted through the automatic route, subject to the FDI policy provisions. Manufacturing activities can be undertaken either by an investee entity or contract manufacturing in India under an enforceable contract, whether on principal-to-agent or principal-to-principal basis.

Key impacts

In the existing legal framework, in lieu of no restrictive provision in any policy, India has already been allowing 100% FDI in this sector through the automatic route. Therefore, the proposed reform is neither removing any existing restrictions, nor bringing any change in the sector. The reform is clarificatory in nature, indicative of a favourable environment in India for FDI in contract manufacturing.

In my opinion, the proposed reforms in contract manufacturing do not follow any perceivable negative corollaries. It will certainly bolster the Government’s attempts to raise the percentage share of manufacturing sector in India’s GDP to 25% by the year 2022, in alignment with the objects of Make in India initiative.

Conclusion

In the June 2019 quarter, the GDP growth of the Indian economy plummeted to a six-year low of 5%. With the proposed reforms, the Government has attempted to make a big push towards growth. At a general level, this is a welcome move as it promises to make India an attractive destination for foreign investment in the concerned sectors. However, barring the suggested changes in contract manufacturing norms, reforms in other three sectors can lead to several unwitting outcomes. These are the larger issues that require addressing by the Government. As yet, the announcement of the proposed reforms does not have any force of law. The reforms will only have a legal effect upon issuance of a press note by the Government, amending the FDI policy.

Rishabh Sharma

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