FDI in India demystified: Interrupted Horses for the Courses

One of the remarkable and spectacular highlights of progress in our times is one of China, creating mobility that took half a billion people out of poverty and deprivation. India could be the next one and both these countries are examples of how to excel in drawing investments, which includes FDI.

Foreign Direct Investment runs a strong correlation with GDP and broad indicators of trade as shown in this report ; but when measures become a target it ceases to be a good measure is what Goodhart’s Law reminds us. The statistical regularity in the data that leads to a regression would be lost if control measures were instituted putting additional pressures on the data; either way FDI must increase to make India grow.

The Indian Prime Minister Modi’s biggest tagline, “Make in India” is directed towards attracting FDI, which has some mix of success and failures, but the report by NDTV that almost shocked everyone with the headline, “India pips China & U.S. to emerge as favorite foreign investment destination”, is one that raised a million eye balls.

The jury is still out on whether FDI is a cause or an effect. Cause of an effect or the effect of a cause that accelerates FDI in India, either way, is the least worry, as long it propels India to the next trajectory of growth. Reinhart and Rogoff’s book, “This Time is different”, had identified 1) governance 2) vibrant institutions and 3) levels of corruption as the three basic factors influencing investments into a country; perhaps a responsible polity could be the fourth, at least so it seems in India.

The spate of comparisons with countries, China in particular, has donned the limelight around FDI for years. The devil is in the details as one would compare the stock ofChinese FDI over Indian FDI in the last five years. One would also notice that the stock as a percentage of the GDP is actually moving down in China, while it is moving up in India as in this data. The question then if India has to grow at more than 8%, it cannot do so without manufacturing and therefore it is all the more important to attract FDI into India to be able to do what the domestic industry could be incapable of doing, whether be it in products or processes. More of the same, in areas, where the domestic industry could be already in surplus, may not be the right areas where FDI could really help the cause. So there is a fine line.

But first let me unravel FDI in India in some novel ways. Let me start with the good news that overall FDI into India grew by 27 per cent year-on-year to USD 30.93 billion in 2014-15 as one would see in this data. In the year 2015, the run rate of FDI seems to project close to $40 Billion flowing into India. 

The Central Bank in India, The RBI, defines FDI with all its associated facets in its official website. By definition FDI has got to include equity as part of partnerships, not mere investments. Obviously every sector in the economy is not allowed and there are some areas where restrictions are imposed, like Atomic Energy, etc. The two routes through which FDI could be channelized on the other hand looks rather simple:

“Under the Foreign Direct Investments (NYSE:FDI) Scheme, investments can be made in shares, mandatorily and fully convertible debentures and mandatorily and fully convertible preference shares of an Indian company by non-residents through two routes:

Automatic Route: Under the Automatic Route, the foreign investor or the Indian company does not require any approval from the Reserve Bank or Government of India for the investment.

Government Route: Under the Government Route, the foreign investor or the Indian company should obtain prior approval of the Government of India (Foreign Investment Promotion Board (FIPB), Department of Economic Affairs (NYSE:DEA), Ministry of Finance or Department of Industrial Policy & Promotion, as the case may be) for the investment.”

The “Make in India” campaign uses a website which also details out the sectors barred (as it is only to be expected that some strategic sectors should be) and the list is surely very small. The sectors that are prohibited do not include Railways Infrastructure. A range of areas have been opened up for FDI in Indian Railways that includes “construction, operation and maintenance in following areas of the railway sector – suburban corridor projects through PPP; high-speed trains; dedicated freight lines; rolling stock including train sets and locomotives and coaches and their manufacturing and maintenance facilities; railway electrification; signaling systems; freight and passenger terminals; infrastructure in industrial parks pertaining to railway lines and sidings including electrified railway lines and connectivity to main railway lines; and mass rapid transport systems.” This is the most visible shift in the whole articulation around FDI.

If FDI happens in Railways in so many areas, this would be a game changer and one must congratulate the government for being so bold. That would also mean equity participation in Railways, something that the domestic players are yet to initiate. The massive scale of funding on the other hand needed to make Railways suitable for mass transportation and efficient for freight movement would benefit largely from the equity participation, whether through FDI or through domestic equity. Given that India’s logistics cost is the highest in the World at 14% of the GDP this provides a very solid direction in which costs would be brought down through investments that would make movements far more efficient. Ultimately it is the poor who would derive the maximum benefit if the logistics cost actually comes down as essential commodities all have to take the brunt of the sky-high logistics cost.

If one studies the FDI data in India for the last several years, the sources of FDI has not changed much. The surprise entry of Mauritius (20% of all FDI into India is from this tiny country) being the harbinger of FDI movements into India clearly needs a change. FDI cannot and should not be a way of avoiding double taxation through round tripping (as Mauritius for example has a tax treaty with India that makes this legal) as it happened quite rampantly between Hong Kong and Mainland China.

Foreign entities operating out of India in a number of areas like services, telecommunication, construction activities and computer software and hardware have been the key sources of FDI and it seems that new entrants have been cautious in putting up Greenfield facilities, other than in automotive; Cairns UK Holding was a rare exception. However Posco’s ordeal is one that cannot be ignored. And it is not that land acquisition was the biggest deterrent for them to move out of the huge $10 Billion of FDI into India, it was the recent scheme of auctioning of Mines that put them off as the cost of the ore would have doubled through this scheme.

Let me explore two of these most stated concerns, land acquisition and cost of ore post the spate of auctions that have happened, both being the potential deterrents for foreign investments to enter India.

On the first one, Land acquisition, the polity is taking stock and it is only time that the wisdom is settling for a more concerted attempt to solve India’s biggest problem, which is land acquisition for industrial purpose. A Joint Parliamentary Committee has been set up for further deliberations; it will submit its report in the Parliament’s winter session.But I believe that now land ordinance may not progress as a central ordinance, but rather in the states, whether or not NDA (National Democratic Alliance, which is in power at the Centre) is in power, land laws might be changed to pave way for projects in the states.

LARR (Land Acquisition, Rehabilitation and Resettlement) Ordinance would eventually have to be passed in both the Houses to become an Act. So the wisdom of the opposition to act to the interests of India would eventually over-ride the narrow interests of temporarily benefitting from the status quo.

On the issue of auctioning of all ore and natural resources of the country, the initial round of auctions did reveal that the cost of the ore rose above the prevailing rates at which the ore traded in the market. This is an area where the government must reconsider their much avowed position of auctioning all natural resources in the country, which in some ways do not benefit the poor as the essential commodities like coal if priced higher (due to higher cost) would only impact them adversely.

There is little doubt that price of ore and logistics would play a key role to create further Greenfield projects in India, whether be it through the FDI route or even otherwise. It is only the duty of the government to see that these issues are sorted out to pave way for investments to double in the next five years. At least by allowing FDI in infrastructure, that includes Railways, the government has set its agenda very rightly.