Taking a composite view of foreign investment in India

The Cabinet has approved a ‘composite’ cap for foreign investment in Indian companies, removing sub-ceilings for multiple investor categories. The move is expected to boost overseas investment flows.

Foreign investors and investment in India Foreign investment can take multiple forms, and involve multiple investor classes. An overseas investor can buy directly into a company involved in manufacturing, infrastructure development, banking, insurance, retail, etc. If the investment is 10 per cent or more of a company’s equity, it is classified as Foreign Direct Investment (FDI) as per OECD norms. Foreign Institutional Investors (FIIs) or Foreign Portfolio Investors (FPIs) purchase a company’s stock through the stock markets. Foreign Venture Capital Investors (FVCIs) put money mainly in new or relatively new ventures from which conventional investors stay away, given the risks involved. Then, there are investments by Non-Resident Indians (NRIs). These overseas investments can be in the form of equity capital, Foreign Currency Convertible Bonds or FCCBs (even though these become foreign investment only when the bonds are actually converted into shares), or investment in shares of Indian companies when they are listed in overseas exchanges through the issue of American Depository Receipts (ADRs) or Global Depository Receipts (GDRs). The government’s traditional approach India needs foreign investment especially to finance its current account deficit — a broad measure of trade in goods and services. Its foreign investment policy has long been designed to encourage more of FDI, which is considered to be more enduring because it manifests itself in plant and machinery on the ground, besides helping to develop skills, create jobs, and diffuse technology and global production practices. Policymakers have been less welcoming of FPI, as it is considered relatively ‘fickle’. The facts don’t always bear this out, though. Cumulative net FII investment flows into India since November 1992 (when they were first allowed) have amounted to $ 227 billion — $ 169 billion in equity and the rest ($ 58 billion) in debt. FIIs have generally remained invested in India; the few episodes of selloffs have largely involved debt rather than equity. FIIs have typically sold shares only to reinvest in fresh purchases. There are investment caps or ceilings on specific sectors. While 100% foreign investment is allowed in many sectors from food processing to railway infrastructure to non-banking finance companies, there is a 74% cap in private banks, and 49% in insurance, defence and commodity exchanges, clearing corporations, stock exchanges and depositories. Within the overall cap, there have been sub-ceilings for various categories of foreign investors. So in commodity exchanges, for instance, FDI is capped at 26%, while combined FPI cannot exceed 23%, which applies to even stock and power exchanges or depositories. And even when FIIs are allowed to invest 23% or more in certain sectors, an individual FII or FPI can invest only up to a maximum of 10%. The change in government’s policy now The approval of the so-called ‘composite cap’ has no effect on the - sectoral ceilings. Thus, foreigners cannot own more than 49% in any insurance or defence venture. But the current distinctions between FDI, FPI and other categories of foreign investors have been abolished. The colour of the mice (or cats!) does not matter so long as these are foreign, and so long as they don’t own more than the prescribed limit, if any, in a particular sector. Composite cap applicable to all sectors except two The proposed composite cap will be applicable to all sectors except defence and banking. So for private banks, portfolio or FII investment can go up to a maximum of 49%, and the overall limit will be 74%. For public sector or state-owned banks, nothing changes — as the foreign investment limit was restricted to 20% much earlier. In the defence sector, within the 49% investment ceiling, foreign portfolio limits will continue to be 24%. The change will be reflected more in investments in commodity, stock and power exchanges. Prior to the composite cap, portfolio investment was capped at 23% in these segments — it can now go up to the full sectoral limit of 49% without any distinctions. A potentially significant decision A composite cap helps remove uncertainty for both investor and investee companies. It provides greater clarity and legal certainty, eliminates inconsistencies, lowers transaction overheads, and does away with the costs of complying with multiple sets of rules and dealing with multiple regulators and authorities. It should boost overall investment flows, especially in sectors with multiple caps or ceilings such as commodity, power and stock exchanges, besides credit information companies. Foreign investors such as the Government of Singapore, which has a few investment arms in India, may not have to worry now about breaching limits while buying into companies as FDI or FII. There are some concerns Concerns in the defence sector relate to national security, and in the banking sector to ‘hot money’ flows — or the threat of volatile capital — and to the potential risk of a group of investors joining hands, especially through the portfolio route, to take control of banks. The RBI had flagged the latter concern in the case of a few old private banks — therefore, even now any investment of 5% or more in the banking sector has to be approved by the central bank. There are also worries about laundered money or terror funds coming into certain sectors, apart from attempts to ‘round-trip’ money back into the country. But composite cap isn’t an altogether new idea Finance Minister Arun Jaitley announced the government’s intentions in his Budget speech in February. Earlier in 2013, then Finance Minister P Chidambaram had said that the government would remove the ambiguity over FDI and FII, and follow global best practices. And back in its Budget of 2002-03, the NDA government had said that portfolio investment would not be subject to sectoral limts except in specified sectors. For well over a decade, several official committees have addressed the issue of boosting foreign investment: in 2002, the then Planning Commission member - N K Singh headed an inter-ministerial steering group on FDI; there was the Ashok Lahiri Committee in 2003-04; the U K Sinha Committee in 2010 and, finally, the Arvind Mayaram Committee which submitted its report in 2014. -