Cyril Shroff On India’s BQ: Evolution Of FDI And The Ease Of Doing Business
This is a series of articles by leaders on how India can raise its Business Quotient.
From being a protectionist regime to complete liberalisation, India’s foreign investment laws have changed dramatically since the start of liberalisation in 1990. Looking at the turmoil in the global market, India remains an attractive destination for foreign investors. Last year, India replaced China as the top destination for foreign direct investment (FDI) by capital investment and has surpassed even the United States. Today, almost 90 percent of sectors are now fully open for FDI such that foreign investments do not require any prior governmental approval. Considering the approval route of foreign direct investment only comprises of 10 percent or so of the FDI inflow, the decision to abolish the Foreign Investment Promotion Board (FIPB) seems logical.
As India turned 70 this year, it is appropriate to examine the evolution of the FDI regime in India, before delving into whether the abolishing of the FIPB will further ease doing business in India.
Prior to liberalisation in 1991, the government adopted an extremely cautious approach towards FDI with the objective of encouraging self-reliance, sheltering domestic industries, permitting import of only select technologies and promoting export. This protectionist approach is evidenced by the conservative investment ceiling of 40 percent which was prescribed for foreign-held equity prior to 1991. Economic liberalisation commenced in India in 1991 as a response to a crisis involving a steep fall in foreign exchange reserves, a sharp downgrade of India’s credit rating, reduced foreign lending coupled with high inflation, large fiscal and current account deficits, and a growing burden of domestic and foreign debt. The FIPB was set up under the Prime Minister’s Office in the wake of the 1991 wave of economic reforms. In 1996, this task was delegated to the Department of Industrial Policy and Promotion (DIPP) and, later in 2003, the FIPB was reconstituted and placed in the Department of Economic Affairs (DEA) under the Ministry of Finance.
The government took important measures to encourage FDI such as introducing the dual route - the automatic route governed by the Reserve Bank of India (RBI) and the approval route governed by FIPB, permitting non-resident Indians and overseas corporate bodies to invest up to 100 percent investment in high priority sectors and removing all restrictions on FDI in low technology areas, easing regulations for import of technology and increasing foreign equity participation limit to 51 percent for existing companies and liberalising the use of foreign brand names. The enactment of the Foreign Exchange Management Act in 1999 gave further impetus to the movement, aided by several subsequent Press Notes issued by the DIPP, which significantly transformed the landscape of FDI in India.
India’s approach towards FDI remained relatively conservative, and sectors open to foreign investments remained highly regulated. FDI in certain sensitive sectors was still subject to prior approval from the FIPB. Procedural delays in obtaining approvals from the government posed a further challenge at the stage of implementation leading to increasing costs and impacting the competitive advantage of the Indian market, thereby making an otherwise reasonably liberal policy less competitive and economically unviable.
An additional hurdle to the inflow of FDI in India was the lack of decision-making authority with the state governments, unlike other countries wherein regional governments played an active role in pushing reforms and encouraging local FDI.
The requirement to obtain multiple approvals from various government agencies when setting up companies and facilities in India made it difficult for foreign investors to take timely decisions.
Ever since Prime Minister Modi was elected in 2014, the government has made sweeping changes to the FDI framework, under the Consolidated FDI Policy. The FDI policy was revised to liberalise many regulated sectors such as defence, railways, civil aviation, broadcasting, and pharmaceuticals. With the evolving economic environment, new laws, and successive liberalisation in the FDI policy, the role of the FIPB was diminishing.
The government through its press release dated May 24, 2017, has approved the proposal of phasing out of the FIPB, pursuant to which the Department of Economic Affairs has issued an office memorandum dated June 5, 2017, providing a framework for carrying out the same. As provided in the press release and the office memorandum, going forward, approval of FDI under the approval route shall be handled by the concerned ministries or departments in consultation with the DIPP. The office memorandum provides for the list of notified sectors and activities, and the concerned administrative ministry or department responsible for approvals of the FDI proposals under the approval route.
With the increase in the number of liberalised sectors, implementation of e-filing and online processing of FDI applications, the FDI regime is ready for the FIPB to be phased out.
Also, as stated above, the process of approval through the FIPB was prolonged and drawn out as apart from the FIPB, approvals were also required from the administrative ministry and the regulator or the licensor concerned, which grants the operating license or approval. It is believed that scraping of the FIPB will also result in cutting the red tape in the government and facilitate ease of doing business, thereby boosting FDI inflows into the country and making India a more investor-friendly destination.
Even though entrusting the responsibility of the FIPB to the ministries may simplify the present procedure of seeking clearance on FDI proposals, the real concern is whether the ministries are equipped and versed with the nuances of the FDI policy, Foreign Exchange Management Act, 1999 and the regulations issued thereunder, to ensure speedy approvals or disposals of applications for foreign investment.
Further, in terms of evaluation of a proposal, the competence of a department or ministry to evaluate such proposals based on their effect on the entire economy rather than addressing specific concerns of the department or ministry will be a vital concern. As envisaged in the office memorandum, concerned departments and ministries will follow the process laid down by the DIPP in the standard operating procedure (SOP), for processing of approvals for FDI.
However, considering the distinct nature of the sectors and the activities that fall under the purview of the approval route under the FDI policy, it may be a challenge for DIPP to lay down the SOP which ensures consistency and uniformity in the approval process, across all prohibited and partially prohibited sectors.
The extinguishing of the FIPB is a welcome step in improving the ease of doing business in India and increasing investor confidence. However, a great deal will depend on the implementation of the steps envisaged in the office memorandum in the days to come. While this is progress for the nation in terms of making India an attractive destination for foreign investment, the other roadblocks still need to be cleared to fulfill the government’s vision for India.
Cyril Shroff is the Managing Partner at Cyril Amarchand Mangaldas.
The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.