U.S. India Insight: FDI Liberalization: More in Store

In his February 1, 2017, Budget Speech, Finance Minister Jaitley stated that “further liberalisation of FDI [foreign direct investment] policy is under consideration and necessary announcements will be made in due course.” The announcement begs the question—which sectors still have policy limitations on FDI? For this month’s Insight, we review the 16 sectors that still have limitations on foreign investment and possible candidates for liberalization this year.

During its first three years in office, the Narendra Modi government has moved quickly to liberalize foreign direct investment rules. In some cases, the reforms were fairly sweeping and comprehensive, such as in railways and merchant coal mining. Other moves were incremental, such as shifting the approval method from the Foreign Investment Promotion Board (FIPB) to the automatic route under the Reserve Bank of India. Some reforms have been rather ambiguous, particularly defense and single brand retail, which allow for higher foreign equity with certain, poorly defined technology characteristics. In other cases, “poison pills” have somewhat eroded the value of the step, such as limiting foreign control while increasing the FDI cap in insurance.

India’s progress in lifting foreign equity restrictions, paired with India’s relatively high growth rates and Prime Minister Modi’s personal courtship of investors, has resulted in a solid spike in FDI. Per the Reserve Bank of India’s data on fresh equity (not counting reinvested earnings), FDI inflows totaled $47.5 billion in 2016, up 18 percent over 2015.

Looking at the 2016 “ Consolidated FDI Policy,” as well as the six “Press Notes” issued in 2016, there are 16 sectors with explicit FDI restrictions (a few more if you count niche sectors like “Chit funds” or “Nidhi” lending firms).

This list could potentially expand, likely in one of two ways. With the Reserve Bank of India focusing on emerging subsectors of the financial services industry, the government may create a new regulatory regime apart from the broad “nonbanking financial corporation.” And in the retail sector, the government has avoided wide-scale liberalization, instead choosing to chop the sector into a multitude of subsectors with different foreign equity rules, a topic we covered in detail in April 2016.

The stated reasons to limit FDI in the sectors noted above vary but generally break down into a few broad categories: National security (defense, nuclear power, news publishing, TV & terrestrial broadcasting); protecting an emerging domestic sector (retail, airlines, tobacco products, security agencies, power exchanges, farm house construction, gambling); or to avoid cross-border transmission of future financial contagions (insurance, pensions, banking, financial infrastructure).

There are a few sectors that seem particularly good candidates for liberalization this year:

  1. Business-to-Consumer (B2C) e-Commerce: India already allows B2C e-commerce in some situations. For example, FDI in the marketplace model of e-commerce is allowed at 100 percent with regulatory provisions. B2C e-commerce is allowed in wholesale trading, single-brand retail, or when the company produces in India what it wants to sell online.
  2. Defense: While 100 percent FDI is already technically allowed, the provisions governing approvals for FDI above 49 percent are not well-defined, and foreign firms appear wary of committing under the current rules.
  3. News Publishing/Terrestrial & Radio Broadcasting: As more consumers get their information online, it becomes more difficult to see FDI controls on print, TV, and radio as effective.
  4. Food Retail: While foreign investment in the retailing of domestically sourced food products is already allowed, no investors have entered the market. There is discussion of allowing foreign firms to also sell a limited range of other consumer goods; with this addition, the sector may see investment.

During the finance speech, Minister Jaitley also announced a plan to abolish the FIPB this year and shift all FDI approvals to the automatic route. Assuming the government carries out this pledge, many sectors requiring FIPB approvals will witness a modest liberalization. Continued FDI restrictions in some sectors like insurance, airlines, and banking seem like a self-imposed chokehold on growth capital, though the barriers to liberalization are steep—changes to the insurance FDI cap requires legislative approval, while domestic concerns about foreign ownership of large banks and airlines are quite strong. Still, if the past is any indication, we should take Finance Minister Jaitley at his word and expect to see further reductions in the limitations placed on foreign investors in India.

* These sectors also have special rules for foreign investment. Most can be found in the 2016 Consolidated FDI Policy of DIPP, http://bit.ly/25M0Dhv. ** Stock exchanges were the subject of the first FDI reform of 2017. Press Note #1 of 2017 removes the previous 5 percent cap on individual shares in a stock exchange.

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