U.S.-India Insight: Hope and Reality: India’s Recent History of FDI Reforms
January 16, 2019The Modi government’s early courtship of foreign firms has been seriously damaged with a range of anti-business steps in recent months. While disappointing, such a populist course correction is fatefully natural in a democracy. Hope for new foreign investment-related reforms are shifting to the other side of the election, expected in April 2019. Yet such hopes may be misplaced. Looking back at the three governments before Modi, there are usually more foreign direct investment (FDI) reforms during the last year of an administration, as opposed to the first year.
Prime Minister Modi has aggressively pursued foreign investment since taking office in May 2014. His government moved fast in liberalizing foreign equity restrictions and focused efforts on moving up the World Bank’s “Doing Business” ranking. Prime Minister Modi himself has personally courted investors, regularly engaging executives to win investments.
In recent months, however, India has taken a range of steps that are eroding the confidence of international business executives. Most notoriously, the Indian government has dramatically increased customs duties in a wide range of sectors. The government has expanded local content mandates into new sectors like automobiles, as well as expanded price controls in key sectors such as medical devices. Recent decisions, such as the revision in foreign investment rules for the e-commerce sector and the Reserve Bank of India’s rules forcing data localization of financial transactions, have raised alarm bells.
Other populist steps by the Indian government are being closely watched, such as the dramatic expansion of subsidies and the degradation of the independence of the Reserve Bank of India. While these issues may not impact foreign firms immediately or directly, they grind down the significance of Mr. Modi’s “less government, more governance” mantra.
Despite the perception that India’s elections interfere with economic reforms, recent governments do have a surprisingly good track record of making new foreign investment reforms ahead of elections, as we noted over two years ago. Put another way—how does the government’s ability to move reforms late in their term compare with the ability to push for early reforms? Are foreign firms correct in presuming an FDI reform “floodgate” usually opens just after an election?
Highlighted below is the number of sectors the last four governments (including Modi) liberalized FDI rules in each of the five years of their respective administrations. Clearly, the second year in office is the “sweet spot” for FDI reforms, accounting for 36 of the 97 total sector liberalizations over this period, including the Modi administration.
On the one hand this makes sense, as a new government may need time to prepare its reform agenda. However, it is notable that the only true second-term government in recent years—the United Progressive Alliance-2 (UPA-2) led by Dr. Manmohan Singh—did not manage a single positive FDI reform in the first year of its second term. The “rookie government” excuse, therefore, does not pass muster.
Apart from the Modi government, which has yet to complete its first term, India’s recent leaders have done more to open the nation to FDI in their last year in office than their first year. There were 20 sectoral foreign investment liberalizations collectively in their last year in office versus a total of only 6 such liberalizations in their first year in office.
India has made little progress in further liberalizing India’s FDI regime over the last two years. Barring some last-minute FDI moves in sectors like insurance brokerages, it appears the Modi government may break this “late reform” trend. But perhaps the window is not yet closed. The Vajpayee government relaxed foreign investment rules on a range of sectors such as scientific journals, gas pipelines, and petroleum marketing, then further eased FDI rules in banking just a few months before the 2004 election. The Singh government relaxed FDI rules in the sensitive news media sector just a few months ahead of the 2009 election. Going by the recent past, the last year of a government’s tenure is a better bet for liberalization than its first year.