Economic Highlights

New Delhi, 24 June 2008

Sustaining High Growth

FDI Better OPTION Than FII

By Dr.Vinod Mehta

(Former Director, Research, ICSSR)

The high rate of economic growth, which we have been enjoying for the past few years appears to be under strain, given the soaring prices of petroleum products and rate of inflation rising to 11.5 per cent last week. 

Economists have already forecast that the growth rate will come down from nine to eight per cent. Besides, with the Government’s concentrating on controlling inflation, the rate may further go below seven per cent. And, in all likelihood the Reserve Bank may go in for tight monetary policy, which will make borrowing for investment purposes costlier.

The economy was on the upswing not because of computer software sector but the traditional manufacturing sector such as steel, cement etc. However, these sectors are now facing a slowdown in their demand. Therefore, the Government must make all efforts to ensure that the growth rate of the manufacturing sector is not allowed to slip very sharply.

Economic reforms of the past one and a half decade have already created a positive climate for the economy to grow fast and we should build on it. The Indian industry by and large has become competitive in the international market.  With foreign exchange regulations being relaxed in a phased manner, it is acquiring manufacturing units abroad, while others have started acquiring new technologies to stay competitive.  For instance, the Indian motor parts manufacturers were initially opposed to the inclusion of their product in the FTA (free trade area) between India and Thailand. However, they are now scouting for new processes and technologies in South East Asia and other countries.

At the moment, both India and China are enjoying relatively high growth rates.  This has particularly attracted the attention of foreign investors, who wish to set up manufacturing bases in India or invest in the service sector. Thus, it is time that we have a clear-cut foreign direct investment (FDI) policy, which covers all the sectors of the economy except those where States feels that there shouldn’t be foreign investment as in the case of atomic power.

In fact, FDI in manufacturing, infrastructure and other sectors is far better than commercial borrowing or investment in scrips by foreign institutional investors FIIs). The investment by FIIs could be considered as hot money, which can be withdrawn by them at any time depending upon their judgment of the economic scene.  The recent sharp dip in the stock market can be attributed to the FIIs’ perception that India will not be able to handle inflation because of its flawed petroleum pricing policy and its waiver on farm loans.

But as opposed to FII, the FDI in manufacturing, infrastructure etc. leads to the creation of assets, which will remain within the territorial boundaries of the country even if the foreign investor wishes to withdraw from the company.

At the moment, there is no single policy on FDI, instead some sort of ad hocism. The cap on FDI varies from sector to sector: in insurance business it is 26 per cent, in banking sector it’s 74 per cent and in  some cases even 100 per cent foreign equity is allowed., whereas there is an automatic approval in other cases, where foreign equity participation is up to 51 per cent. In certain areas such as real estate no FDI is allowed.

Moreover, foreign companies are not as yet allowed to take over sick companies.  There are a number of these in the textile, bicycle manufacturing sectors or there are individual PSUs like pharmaceuticals and photo films which could be taken over by foreign companies with salutary effect, if allowed. This will not only bring in new technology and management system, but can turn them into profitable units!

Some time ago, the Department of Industrial Policy and Promotion (DIPP) is reported to have made a proposal to allow a maximum of 76 per cent stake in the form of FDI across all sectors, including real estate. This would be as good as 100 per cent FDI, as it will allow full management control to the foreign firm, but it would be obliged to disclose its financial results, which at present the 100 per cent owned foreign companies are not expected to make.

Another aspect of the DIPP proposal is that the balance of 24 per cent equity would have to be sold to the Indian public, which means the Indian investor will share the prosperity of the foreign firm.  Actually it turns out to be much more –the 24 per cent equity to Indian public means that the liquid stock (shares that are regularly bought and sold) will grow, which is not only good for stock exchanges but for widening of the share market too. It is likely to have a positive impact on mutual funds and the proposed pension funds as well.

If we can have such a policy as proposed by the DIPP with suitable modifications, one can expect a large inflow of FDI into India.  The timing is very important; and it is now. The economy has finally come out of the Hindu Growth Rate (about 3 per cent) and FDI can provide the necessary push.

It may be mentioned that not only the developing countries but also the developed countries are looking for opportunities to increase inflow of FDI.  A study by FICCI three years ago stated that countries such as  Germany and France still allow investment allowance or accelerated depreciation to foreign direct investors. China grants 10-year tax incentive to promote firms engaged in infrastructure, energy sector and knowledge industry. South Korea provides special incentives for capital investments. Others like Netherlands, Denmark, Belgium, Spain, Switzerland, Luxembourg provide tax incentives; they follow the concept of group taxation.

If India encourages FDI it won’t be unusual or against its own interest. In the current context, FDI would mean creation of assets, more jobs and a competitive economy; it is also likely to contribute significantly to the exchequer in the form of direct and indirect taxes. Therefore, the Left parties as well as the Opposition must have a realistic approach to FDI and should welcome it in almost all the sectors, including real estate and retail, barring sensitive areas such as atomic power. A good monsoon coupled with realistic FDI policy can sustain the now floundering high growth rate, which we were able to achieve with much difficulty in these past few years. ---INFA

 (Copyright, India News and Feature Alliance)