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PM Modi’s FDI reform is as big as it comes, nothing to do with Raghuram Rajan

The opening up of foreign direct investment (FDI) through the automatic approval route in the range of 74-100 percent in several sectors, including defence, aviation, brownfield airports, food retailing, broadcast carriage, pharmaceuticals and private security agencies, is as big a reform as they come. India was the largest FDI destination in the world last year, and these relaxations will help India consolidate its position this year and in the future.

There are two reasons for this: Rexit and Fixit.

The uncharitable explanation for the flurry of changes is the government’s need to mute the deafening roar over Raghuram Rajan's impending exit from the Reserve Bank of India (Rexit), but this only explains ‎the timing of the announcements, not its rationale.

 PM Modi’s FDI reform is as big as it comes, nothing to do with Raghuram Rajan


When faced with the prospect of a loss of external confidence in India’s growth story, governments tend to become reformist: this happened in 1991, it happened in the Vajpayee’s government after the dotcom bust and US sanctions post-Pokharan 2, and it is happening now. External triggers help focus governments on the need for change.

However, the more important reason is revival of growth or Fixit - fixing the broken investment engine. FDI is the one investment engine available to revive the growth cycle, which has been ruined by the UPA that gave crony loans and saddled banks with impossible burdens of bad loans. With both India Inc and banks reeling under the pressure of bad loans, FDI is the obvious pick-me-up.

Of the four engines available to push up growth – government spending, private consumption, private investment and exports – only two are firing (the first two). Corporate investment is comatose, and exports are in steep decline as the external environment is weak.

FDI liberalisation will come as a booster dose to basic push being given by government spending to revive the investment cycle.

But don’t believe all this is about Rexit. Foreign investment has been the theme song of Narendra Modi’s government so far, which has been focused on strong external diplomacy, and on opening up India to foreign investment. The first major laws to pass were about FDI in insurance and pension funds. Then came the Japanese investment in the bullet train. The Gulf nations are also game – especially in aviation and refining. China would also have been willing, but is hampered by concerns over its antagonistic postures on security issues towards India. Its efforts to block our entry into the Nuclear Suppliers’ Group is one such roadblock to higher Chinese investment in India.

In 2015, India was the largest beneficiary of FDI (around $63 billion) in terms of investments announced, and this money should start flowing this year and the next. The current flurry of FDI relaxations are intended to ensure that this positive sentiment continues despite the exit of Rajan. The link between Mission Investment Fixit and Rexit is short-term.

Let’s take a quick look at what the various FDI relaxations will mean for India and growth.

FDI in aviation: The new policy allows 49 percent FDI through the automatic route, and 100 percent through the approval route. This has major implications. Since aviation is a low-margin business, only those with financial staying power and the right business model can survive. The recent return to profits by Jet, SpiceJet, GoAir and even Air India is mainly the result of lower oil prices. Only IndiGo has been consistently profitable since birth, thanks to its superior business model. The aviation business is steadily shifting towards two nodes – cash-rich Gulf airlines (Etihad, Emirates, Qatar, etc), and the East Asian airlines, which have superior service and often good business models. The chances are Indian civil aviation will increasingly be owned by foreign principals. Air India is a goner in this scenario – unless it is privatised quickly.

FDI in brownfield airports: India’s aviation is metro-oriented and many smaller airports are starved of investment, including state capitals in remote areas. The new aviation policy announced last week tries to address this problem by capping fares at Rs 2,500 for non-commercial routes below one hour’s flying distance, with viability gap funding available from the Centre and state. The 100 percent FDI now allowed in brownfield airports through the automatic route will enable regional and distant airports to operate as no-frills landing strips with foreign investment. India’s low-cost carriers will finally find low-cost airports to match their claims. Earlier, we had low-fare airlines, and not low-cost ones.

100 percent FDI in defence: This will be only through the approval route, not surprisingly, since it involves national security. This is the one area where Make in India has the best possibility of success, since defence production is typically driven not by competition, but technology and cost-plus strategies on products and equipment vital for defence. India currently imports so many defence items, that this ought to be the logical place to start to promote Make in India. Given the size of purchases, the government also has leverage in defence that it does not have in other industries.

Food retailing: 100 percent FDI in food will happen only through the approval route, but is potentially a game-changing idea. It could interest the Wal-Marts to enter into domestic sourcing of food items and help the farmer obtain a better price. The various online grocers can also find fresh funding, since food e-commerce is now open. Online grocers like Big Basket will need big investments and viable business models to succeed when the 800-pound gorillas of global commerce enter the picture. Amazon also seems to be interested in food retailing, and may invest in backend infrastructure. One can expect big bucks in this space.

Relaxation in pharma: 74 percent FDI will be allowed in brownfield pharma units through the automatic route, and 100 percent through the approval route. India has huge competitive advantages in generics, and also R&D. The relaxation of FDI rules will enable more medium-sized generics companies to be acquired by foreign MNCs, and also allow private equity players to fund pharma expansion projects. This is another big boost for Make in India beyond defence. Big pharma can buy into Indian generics companies to fend off competition from the likes of Sun Pharma, Dr Reddy’s, Cipla, Lupin and others.

Broadcast carriage: With 100 percent FDI allowed through the automatic route, major investments can be expected in cable networks, direct-to-home services, and mobile TV businesses, among others. This relaxation will complement the government’s Digital India strategy by increasing investments in broadband infrastructure and communications. Expansion of entertainment, education and ecommerce services will also increase demand for spectrum and optical fibre.

Single brand retail: Local sourcing norms have been waived for three years, with the possibility of extending this by another five years, enabling the likes of Apple to set up their stores in India. The idea is that at some point they will start local sourcing to keep some costs down.

The big takeout from this FDI policy is simple: India is finally abandoning its swadeshi mindset. One wonders why the government has not already abolished the Foreign Investment Promotion Board. It serves very little useful purpose now that FDI will be largely through the automatic route, and only those on the negative list will need government approvals.

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Updated Date: Jun 21, 2016 13:59:29 IST

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