Daily Current Affairs – 1st July, 2016

Daily Current Affairs – 1st July, 2016

Is FDI really a gift horse?

Government of India recently announced another new set of “radical changes” in foreign direct investment (FDI) policies

Just in November 2015, the government had introduced changes in 15 major sectors, and now, the latest announcement covers nine sectors

Comparison between the changes adopted by the earlier and latest FDI policy reforms:

November 2016 FDI policy changes

Last year’s announcement stated that the policy changes were intended

  • to “ease, rationalise and simplify the process of foreign investments in the country and
  • to put more and more FDI proposals on automatic route instead of Government route where time and energy of the investors is wasted

Latest FDI policy changes

The recent amendments to FDI policy seek to

  • further simplify the regulations governing FDI in the country and
  • make India an attractive destination for foreign investors”
  • to attract and promote FDI in order to supplement domestic capital, technology and skills, for accelerated economic growth

However, the thrust/vision of the two sets of policy changes remains the same – “to ease entry of foreign investors in India”

With these successive changes in FDI policy, India has become “the most open economy in the world for FDI” but can the country expect to benefit from this form of investment?

 

Can the country expect to benefit from this form of investment?

In order to answer the above question, it is important to understand the following –

  1. Are India’s FDI true in its character i.e. long-term inflows?
  • FDI, as distinguished from portfolio investment, has the connotation of establishing a ‘lasting interest’ in an enterprise that is resident in an economy other than that of the investor.
  • Therefore, it is important to understand whether FDI has retained its character of being long-term inflows of investible capital in an age when global capital markets are being ruled by investors having short-term targets.
  1. Understanding the proper definition of FDI
  • Economists have always treated FDI as that component of foreign investment in an enterprise that confers “control” to the foreign investor over the enterprise.
  • All other foreign investment was defined as portfolio investment, and this component was considered “footloose”.
  • As regards the threshold for identifying whether an enterprise was foreign-controlled or otherwise, most countries adopted their own definitions.
  1. Improper/poor definition of FDI – do not allow us to make the distinction between long-term investments and portfolio investments
  • In the past, the RBI followed the practice of identifying “foreign-controlled rupee companies”, which were companies having foreign shareholding of 25 per cent or more of total equity or where 40 per cent share is held by investors from a single country.
  • In recent decades, the Organisation for Economic Cooperation and Development (OECD) and International Monetary Fund (IMF) have pushed for a globally acceptable definition of FDI, according to which 10 per cent or more of foreign equity constitutes the “controlling share” in an enterprise. But not all countries have adopted the OECD-IMF definition.
  • For instance, in India all investments other than those through the stock market are reported as FDI. India, therefore, does not make any distinction between the “controlling share” and the others as far as FDI is concerned.
  • This implies that data on FDI for India do not allow us to make the distinction between long-term investments and portfolio investments.
  1. Lack of access to the state-of-the-art technologies
  • Foreign investors consider “controlling share” to be vital for bringing in state-of-the-art technologies.
  • However, given the fact that developing countries have been struggling to get access to proprietary technologies despite steep increases in FDI inflows over time, there seems to be the proverbial slip between access to technology and FDI inflows.
  1. Increasing reinvested earnings
  • The OECD-IMF duo introduced some other components in the definition of FDI, the most significant of these being the inclusion of reinvested earnings.
  • While it may be justified for balance of payments purposes, the fact is that retained earnings increase the host country’s liabilities without actually transferring resources from abroad.
  • Retained earnings are a part of the profits earned by foreign companies in their host countries, which are in domestic currencies. Once capitalised and absorbed in the equity stock, retained earnings become conduits for larger dividend remittances in future.
  • Further, if such earnings are used to take over domestic companies or to buy back shares from the public, then they would not add to the existing capacities.
  • Data provided by the UN Conference on Trade and Development (UNCTAD) show that the share of reinvested earnings has increased progressively during the recent past and by 2013 they constituted two-thirds of the FDI outflows from the developed countries.
  • In fact, more money was flowing into the developed countries as dividend income than that was flowing out as direct investment. Thus actual cross-border equity flows that meet the conventional definition of FDI are only a fraction of the reported global FDI flows.
  1. Inflows and outflows

According to official statistics, India has seen a steep increase in FDI inflows totalling over $55 billion in 2015-16. However, in the world of high finance, FDI is not a gift horse —there are at least two sets of costs that host countries have to bear.

  • The first is the direct cost stemming from outflows on account of operation of foreign companies.

The RBI has reported that between 2009-10 and 2014-15, outflows due to repatriations, dividends and payments for technology have together constituted a major foreign exchange drain — nearly one-half of the equity inflows during this period!

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