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Not an open-and-shut case

Whether the claim that India is the most welcoming country when it comes to FDI is true or not is besides the point. India has been getting progressively more open in welcoming FDI.

twitter-logo Prosenjit Datta        Last Updated: January 23, 2017  | 14:31 IST

Business Today Editor Prosenjit Datta
On Monday, Prime Minister Narendra Modi tweeted that India had become the most open country in the world as far as FDI was concerned. By evening, there was a press conference announcing new FDI policy relaxations in a host of areas - defence, single brand retail, food, animal husbandry, pharmaceuticals and a few others.

Whether the claim that India is the most welcoming country when it comes to FDI is true or not is besides the point. India has been getting progressively more open in welcoming FDI. It started in 1991, when the then Prime Minister P.V. Narasimha Rao and his finance minister Manmohan Singh started reforming the Indian economy, and opening it to global investors. Since then, practically every government has tried to woo investments from abroad in a host of sectors.

Some governments have done more, while others have done less. The UPA I and UPA II governments tried to open up the country to more FDI but it was strongly opposed, ironically, by Narendra Modi and his party. The BJP contention then was that India was selling out to the West. Since coming to power, the BJP and Prime Minister Modi have changed their stance where FDI is concerned. And while there are accusations of a U Turn, it makes eminent sense for anyone running the country to try and attract as much capital as it can - whether domestic or foreign. We have plenty of labour but we are perpetually short of capital. In two years, Modi's government has managed to attract a lot of foreign capital and that is to his credit, no matter what people in the RSS say or what the Congress is saying now that it is out of power.

At the press conference, the government also said that the FDI which will flow in will give a boost to manufacturing and create a large number of jobs. It is a good claim to make but it is also untrue. Data of the past 10 years show that there is not a huge correlation between FDI flows in a particular year and the GDP growth. Even if one were to assume that the FDI's effect on the GDP will show up only after a lag, the evidence seems weak if one looks at the data (see chart).

There is a rational explanation for that. One, the way FDI is counted does not distinguish between money coming in for investment into equity markets (or bond markets for that matter) and money coming in for business activities. Even when the segregated data is available, it needs to be further segregated between money that goes into buying assets - that is Brownfield investments - and money that goes into a new project, or what is called a Greenfield investment. In the former, an asset already present in the ground changes hands. And its employees might see a change in the employer but that necessarily does not create a large number of jobs unless the foreign company buying the Indian asset plans to very rapidly scale up operations. Money coming into a greenfield project on the other hand does create a lot of new jobs and has a spin-off effect on other industries.

While all capital is generally welcome, some are more welcome than others. How does a government ensure that it is more welcoming to capital that will ensure productive activity instead of just financial investment into equity markets? Essentially I think there are two ways to do that. One, foreign investors think of setting up a manufacturing plant or a service company in the country only if they think there is a big market for the product or service. That is why sectors such as hospitality, telecom, and automobiles have attracted a lot of FDI. Typically, the government opening up the market in a sector is a prelude to attracting FDI in big numbers.

The second way to attract the more productive FDI would be to give incentives that make it more attractive for a global player in the segment to invest in the country rather than a pure financial investor. Unfortunately, governments often try to do the reverse because of some thoughts of critical industries being dominated by foreign industries. So they often put caps on what an existing business can invest in as opposed to a financial investor. The aviation industry is a good example.

A foreign airline can now own 49 per cent of a domestic airline. It can own 100 per cent provided it gets some pure financial investors to co-invest in the rest of the shares. In my mind, such distinctions do not serve much purpose. A 49 per cent shareholder can still exert control by holding other shares through proxy. So the purpose of keeping control in the hands of an Indian promoter is not served. Nor is the airline industry particularly strategic. A few foreign investors with control over the airlines they invest in would not create any major harm.

Airlines is just one example. There are others. Any government that is trying to attract FDI should first be clear why it is trying to attract that FDI. And then make the regulations accordingly.


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