Easing FDI: Will it revive India's slowing economy?

Trust the government to introduce economic reforms under duress and only after the economy has been pushed into a corner.

Earlier this week, various media reports said the rules on foreign direct investment (FDI) in multi-brand retail and aviation are likely to be eased very soon.

It’s been a long, long wait, especially for the retail industry. The cabinet is expected to consider a note from the commerce and industry ministry next week on allowing 51 percent FDI in multi-brand retail and increasing the limit on single-brand retail to 100 percent from 51 percent.

[caption id=“attachment_134358” align=“alignleft” width=“380” caption=“Currently, foreign retailers selling different brands are only allowed wholesale outlets and cannot sell directly to retail buyers. Reuters”]  [/caption]

In the case of aviation, reports said the aviation ministry is proposing to allow 24 percent FDI in the sector. India currently allows FDI up to 49 percent in the aviation sector, but foreign airlines are not allowed to invest in local airlines. That looks set to change: foreign airlines may soon be allowed to invest up to 24 percent.

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Both proposals are expected to be considered by the cabinet in the next two weeks.

Both are intended to increase overall capital inflows, which have dwindled in the past few months, into the country.

A much-needed step

The government’s plan to ease FDI rules is a step in the right direction.Foreign direct investments are more stable and permanent compared with investments in capital markets, which can be pulled out in a matter of days.

At the moment, the dire state of the economy is struggling to attract investors.Industrial activity is slowing down, corporate earnings are sliding, foreign investors are moving out of relatively riskier emerging-market assets and into safe havens, like the US dollar, and the rupee is crashing.

Meanwhile, inflation remains at elevated levels, posing a threat of stagflation - stagnating growth and inflation.

What can the government do? Not much, at least on its own.

With the government’s finances spinning out of control- the fiscal deficit (the gap between government revenues and government expenditure) is already equivalent to 70 percent of what was estimated for the year ending March 2012)- it’s in no position to jumpstart the economy through a fresh bout of spending.

The next bet is attracting foreign investments. While foreign investments in capital markets have fallen sharply this year, surprisingly, FDI has actually held up in the first half of the current financial year (April to September), with investments equaling the entire FDI for the year ending March 2011, according to Mint.

However, in September, inflows slowed down compared with a year ago. The government needs to do something now to ensure this source of funds does not evaporate as well.

No option but to reform

That “something” has to be big-bang economic reforms. The most controversial measure, of course, involves liberalising the lucrative retail sector, which is $450 billion currently.With India tipped to become one of the top markets for retail growth over the next few years, international giants from Wal-Mart to Carrefour have been salivating over the prospects of this market.

Currently, foreign retailers selling different brands are only allowed wholesale outlets and cannot sell directly to retail buyers. Only single-brand companies like Levi’s are allowed to do that.

One advantage of allowing more foreign investments is the possibility that food inflation -still hovering in double-digits - could ease over time, because investors will most likely be required to invest at least 50 percent in “back-end infrastructure”.

Such investments will help improve agricultural supply chains that are badly in need of upgrades. According to one estimate, up to 40 percent of India’s fruits and vegetables rot before they can be sold because of a lack of cold-storage facilities and poor transport infrastructure.

Of course, expect political opposition to all foreign investment proposals, especially retail, to be extremely vocal.But given the situation the economy is in, the government might just decide to take a deep breath and brush aside those concerns.

It will take a lot of courage, but given that the government is running out of options, there’s no turning back now.