FDI Reforms: a Tale of too much Caution

The GoI has been steadfast in expressing its desire to ease pain for businesses to operate in India. Debates and discussions within the Government have been a plenty to speed up reforms that will unleash the animal spirits in the economy. Also, the Government has been making very visible gestures in inviting mega foreign enterprises to invest in India. However, in spite of the hype surrounding the Government’s business friendly image, Foreign Direct Investment (“FDI”) inflows have not rallied as expected.

Big ticket sectors that have the capacity to absorb multi billion dollars of investments have not really attracted the desired FDI. Illustrative of this are defence and multi-brand retail sectors. One can blame macro-economic factors that impact movement of capital across the globe for the lack of high FDI inflows. But, time and again India has been hailed as the white speck in an otherwise subdued global economy. It is intriguing then that capital inflow into India has not happened commensurate to its “white speck” reputation.

Let us try to understand why foreign investors have been weary of investing in India. India offers great hope for growth; but the growth comes with its own set of risks.

A principal risk associated with investments in India is the lack of a credible redressal mechanism for enforcement of contracts and other remedies, due to an overburdened judicial system. Exacerbating this risk are the multitude of complex, duplicitous and confusing state and central laws. It is a cause of unnecessary and avoidable litigation that chokes up the judicial system. The Government needs to do a lot more to simplify existing laws and ease the process for compliance. A good place to begin would have been the FDI laws in force currently.

The Government’s reluctance to usher ‘game-changing’ reforms in this avenue is puzzling. It is quite understandable that the Government is concerned about unrestricted inflows in real estate and certain other sensitive sectors such as banking, telecom, multi-brand retail etc. But sectors such as NBFCs which are regulated by an efficient sectoral regulator, i.e., the Reserve Bank of India can be exempted from the weight of dual legislation. A similar case for exemption can be made where efficient regulators supervise operations. The entire financial services and securities market is manned by efficient regulators such as SEBI and IRDA, in addition to the RBI. There is a strong case to completely liberalise insurance, NBFCs, pension funds etc. The FDI policy must regulate foreign ownership (sectoral limits) of businesses in sectors that the Government feels are sensitive from a public policy perspective. But, once the Government has permitted foreign ownership in a particular sector, it should allow regulation of the workings of such entities, to the concerned regulators.

Another area where the Government could significantly free up regulation is by allowing FDI in all forms of legal entities, in sectors that already permit FDI. It does not seem to serve any purpose to allow FDI into sectors, while only permitting such businesses to be housed in companies. Investors should be allowed to invest through any legally permissible structure in India such as LLPs, trusts, partnerships or proprietorship firms, with no additional conditions.

Another compliance that creates unnecessary delay in completion of cross border transactions is the form FCTRS. The investee company is prevented from recording a transfer between residents and non-residents unless the concerned AD bank endorses the FCTRS form and provides it to the Company. In effect, you have a situation where a purchaser has paid the consideration to the seller but is left in the lurch without effective title to the purchased shares. This is certainly a regulation that needs to be done away with or simplified. A simple solution would be to allow the resident buyer or seller to file the form with the concerned AD bank at a later date with the relevant valuation details.

One can only hope that the Government would at some point do away with the requirement of mandating a floor price for cross border transactions between residents and non-residents. In any case, the tax department actively scrutinizes deals that do not seem to have justified valuations. The duplicity of the RBI prescribing a floor price only creates challenges in effecting M&A transactions seamlessly. It is an open secret that if the buyer and seller are not in dispute with each other, the desired valuation can quite often be managed easily.

Many of the purported liberalisations by the GoI have been by way of increasing the sectoral caps for foreign investment from their earlier limits, but mandating that ownership beyond 49% requires Government approval. The necessity for obtaining approval from the Government is a stumbling block for smooth flow of FDI. Investors are weary of being caught within the bureaucratic process of the Foreign Investment Promotion Board. The Government would do well by liberalising many other non-sensitive sectors from the Government approval route and provide certain conditions for compliance, only where absolutely necessary.

To sum up; the lack of game changing reforms by a Government that has comfortable majority is quite disheartening. The Government should take a long hard look at the prevailing FDI policy in light of its objective to facilitate FDI in the country. Sweeping changes to the FDI policy are the low hanging fruits that this Government can achieve easily.

(Article has been authored by Corporate Lawyer Ajay Joseph.)

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