It is possible that the new foreign direct investment (FDI) rules that have been announced are Part 2 of the reforms that Finance Minister Nirmala Sitharaman had spoken of last week. There is evidently a tearing hurry to get back on the path of reforms to ensure that the economy gets back on track.
The FDI is definitely very important for the economy as at around $45 billion (about Rs 3.15 lakh crore) a year is about 5 percent of the total gross fixed capital formation of the country. And given that there are issues of liquidity in the system as well as ‘willingness to lend’, FDI can be a very useful source of funds.
Let us see what they have put in place. The norms for single-brand retail is probably the most important one as it gives relief on domestic procurement which now includes global operations so that the 30 percent norm is less onerous. Also, they would no longer have to set up a brick and mortar structure before going online.
While this is also positive, going by experience it does not look likely that there would be too many retail brands that would like to experiment without establishing a physical structure. Ikea has already set up a structure before going in for the online business. But for sure, there would be more interest shown by international brands in India.
This will be good for the consumers who get access to more products, though the pricing issue would be the clincher as they tend to be very price sensitive. This can be seen more in terms of the progress being made by the government to attract more investment in the retail segment and can be seen to move towards multi-brand retail too in course of time.
The second relaxation which is also significant is the FDI in contract manufacturing. Given the close links between the contract modes wherein parts are supplied by smaller entities which now can have access to FDI. This is probably an essential requirement as it cements the relations between the main player and the ancillary players, though it would need to be seen as to how the foreign investors respond given the profitability of such activity which may not be very well organised.
The framework also allows 100 percent FDI in all coal activity which is good for the users to the extent that investment flows in which can reduce cost and increase availability. Coal India, the virtual monopolist, would definitely face competition which hitherto was limited to imports. However, it has been seen that FDI normally tends to stay away from heavily regulated structures as regulatory risk tends to be high. This holds more so when it concerns natural resources and hence the impact may be limited.
There is also an interesting relaxation of allowing 26 percent FDI in digital media for streaming of news. This could be interesting as the concept of digital media has not only caught on in a big way but is also considered to be the future for opportunity. There is a lot of interest in having access to this module and one can see several media houses looking at this avenue in a keen manner.
Information dissemination is definitely a primary goal of the media and hence this can see some flow of investment as it is normally assumed that the next step would be 49 percent. It is, however, unlikely that when it comes to media, the government at this stage would be willing to go beyond 49 percent as is the case with manufacturing.
Will this provide a major boost to the flow of FDI in the coming years? While the impact is positive in terms of enhancing the interest of investors with one may expect a bit of caution as investors judge the overall state of the economy and prospects of the sector concerned. As there has already been a lot of interest shown in the retail space it is likely that this would be the sector to watch out for as fresh investment comes in.
However, it is unlikely that it would be more than $1-2 billion to begin with as players normally like to test the field before venturing deep. For every venture, there will be cost-benefit analysis drawn up as there is still the local procurement clause though it has been made easier to comply with.
The government has certainly sent the right signals to the investing community about investing in India. In the past when the same was freed in railways and defence equipment, there has not really been a significant response.
Besides, when foreigners are considering investment overseas they do tend to also weigh options in other countries. In particular, there is now focus on increasing spending on infra in the US and Europe which means that there will be competition for the same set of investible funds. Therefore, the actual flow of funds would be measured.
The present approach to the FDI also signals that the government is keen to open the doors as wide as possible for foreign investors as such funds come with limited cost as it is in equity. Also, it has been seen that these funds are here to stay and hence are permanent in nature with the reinvestments of profit also being fairly high in the country – nearly 38 percent of fresh equity inflows.
But will this help the sagging economy? The answer is not really because investment has to be driven by domestic private sector and has to be more in manufacturing rather than services which seem to be the favorite of FDI. Overseas investment in a private bank or IT firm does not really lead to higher capital formation and hence has its limitations in the broader scheme of things.
(The writer is chief economist, CARE Ratings)
Updated Date: Aug 29, 2019 20:11:56 IST