Want more FDI? Relax those caps
Source: By Sobhomoy Bhattacharjee: The Financial Express
Around the excitement created by the easing of FDI rules by the Cabinet, it is a good test check to measure those against the actual inflows. It would tell us if the government is easing up on the right sectors and whether this would lead to the expected bulge in foreign exchange flows. A revealing analysis of company-wise inflow of foreign investment made by RBI recently makes for some startling observations, however.
It shows, for instance, that an overwhelming percentage of foreign collaborations into Indian companies were through the foreign subsidiaries. Of the 832 companies surveyed, this is 80.4%.
If foreign investment is flowing in through subsidiaries and mostly through wholly-owned ones, it is clear that serious money comes into a sector only when the overseas investor is convinced that he can exercise effective control.
This would imply that sectors where the government has kept the caps at 49% or less should not expect any big time money to come in. The only sector where this rule was countered was the insurance sector. Companies put in serious money into Indian ventures, expecting the caps to be relaxed quickly. Yet, each year the government fails to act on this promise, it hurts the investment story, which is increasingly becoming less plausible to the larger body of investors.
The RBI analysis is based on two sample surveys on foreign fund inflows for the periods 1994 to 2001 and then from 2007 to 2010. Since the second one captures the impact of the global meltdown too, it is a cogent line of argument.
Obviously, there is no surprise that foreign investment is rising rapidly in the services sector than in manufacturing. Between 2000-01 and 2007-10, the share of the services sector in foreign technical collaboration has risen from 7.5% to 25.6%. And within the manufacturing sector, there has been a transformation. From nowhere, the pharmaceutical sector has leapt to become the second largest area of interest for technical tie-ups behind machinery and equipments. But in the present round of FDI relaxation, the cap on brownfield investments in pharma has not moved beyond 49%.
The Foreign Investment Promotion Board (FIPB) is forced to take an unconventional approach of clearing the investments on a case-by-case basis while the government keeps up the red light switched on for the industry. The bias towards services and the interest among overseas investors in taking the subsidiary route also displays the reasons why the bitter battle in FDI policy is happening in insurance, retail and telecom services.
The foreign investor is following some obvious trends in the Indian market. India is not a manufacturing story except for pharma and auto. The interest is, therefore, on the action available in services.
Within services, the overseas investor wants to set up shop with his own management control. So, no amount of relaxation in manufacturing will move foreign investment significantly and caps less than 50% make no sense in any sector, least of all services. The data from the past 15 years including the Congress and the BJP years provide the same spectacle.
Instead, by preferring to maintain an ostrich-like attitude, we are risking something else. From 1994 till now the percentage of foreign collaborations that involved transfer of know-how has come down fast. It accounted for 72% of the agreements signed in the seventh round of the RBI survey. It is now only 38% in the eighth round of the survey.
In the absence of effective management control, companies abroad have cut down on technology transfer to their Indian ventures. The nature of agreements has shifted to tap the markets instead. This is evident from another table in the same study. The intensity of research and development (R&D) in the companies with foreign collaboration has come down. For the entire manufacturing sector, the percentage of R&D by Indian firms with foreign tie-ups has slipped from a healthy 1.56% of total production in 2007-08 to 1.01% in three years. The only sector where it has bucked the trend is pharmaceutical.
A related set of numbers also bear this out. The earlier vintage of foreign investments insisted on export restrictions. This applied even for the services FDI. But as technical collaborations dipped, this restriction has lost salience and has come down sharply. The advantage is that exports have gained from the inflows.
So, the Cassandras of the socialist vintage railing against foreign investment have ended up doing exactly the opposite of what they thought the restrictions would do to Indian industry. Limiting the exposure to foreign capital has cut the gains an inflow would have made to the economy. This could be instructive in the context of stiff opposition the defence ministry has mounted on raising cap for production in the sector. The Indian arm of the proposed foreign tie-ups risk becoming shops to sell the foreign production than provide any serious value-added service.
What about the employment numbers? For the set of companies that took foreign investment, employment has risen by almost 15% in just three years. It will be a serious challenge to any of the swadeshi apologists to discover any sector of the Indian economy where such a transformational rise in employment has happened, even in two decades.
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