Irrational Caps on FDI

Time and again, government treats it as a very serious policy matter as to how much FDI is allowed in a particular sector which seems completely senseless except in some sensitive sectors like defence, and that too, for a very very limited purpose. When India can buy weapons from foreign suppliers with 100% foreign equity, why can’t it allow a foreign company to set up factory in India with 100% equity? With the latter, India still benefits from local value addition, technological upgradation in the industry, higher GDP, higher exports and so on.

Yesterday’s decision to allow 100% FDI in certain sectors where the previous limit was 74% is supposedly a smart move to attract foreign capital into India. Yes, permitting 100% FDI is smart but limiting it to 74% or 49% was downright dumb and counter-productive to India’s interests.  With 74% foreign holding, management of a company is naturally completely in the hands of foreigners and for all practical purposes, the remaining 26% Indian holding cannot be in the hands of a joint venture partner who could exercise any restraints on such management. In all probability, the remaining 26% Indian holding is held by a number of retail investors, mutual funds etc who are only interested in dividends and capital appreciation, and would hardly attend any AGMs to pose even theoretical restraint on management determined to pass a special resolution. What the government has achieved in this situation is a mandatory providing of 26% capital to such foreigner who never asked for it and was willing to bring 100% of is own, and thus, government has reduced the flow of foreign capital into India, while at the same time, reducing the capital availability to another Indian entrepreneur who wished to raise capital from the capital markets. The FDI cap has thus, hit India twice.

Likewise, 49% cap on FDI is equally counter-productive for the same reason.

Now, let us consider a situation where the Indian company is a joint venture between a foreigner and an Indian entrepreneur who could participate in management or prevent the foreigner from exercising complete control on management due to his inability to pass a special resolution without the support of this Indian JV partner. In this situation also, the government is assuming that Indian JV partner would be more complaint with letter and spirit of Indian laws completely ignoring the ground realities that MNCs have a far superior record of compliance with letter and spirit of laws, and we Indians, be it companies or even our own governments, have completely discarded the concept of spirit of law and are only concerned with letter of law to the extent it is impossible to escape.

The caps on FDI are hurting Indian capital markets and retail investors even more when we look at recent reports of MNCs vastly increasing their royalty payments to their foreign holding companies (consequent upon government’s scrapping of caps on royalty payments). Even old Indian MNCs like Maruti, and Hindustan Lever are prominent names in the dubious list of such companies hiking royalty remittances widely seen by income tax department as tax evasion schemes. Large number of retail investors in India, holdings 26% or 51% held in such companies, have not been able to exercise any control on such management against these large unjustified royalty payments. This phenomena exposes the weakness in the idea behind forcing MNCs to dilute their holdings to minority investors in India.

Therefore, the government needs to be more realistic and smart, and be advised to scrap such caps on FDI. Let foreigners bring 100% equity if they wish, and let the Indian investors money be available to whosoever needs such capital on terms attractive to such retail investors.