Dig Deeper To Boost Foreign Investments

It is no secret that the macro-economic situation in India is worsening. The external value of the rupee is at its lowest point, the Current Account Deficit is only widening, and manufacturing activity (as represented by HSBC PMI data compiled by Markit Economics) falling to its 4-year low for the month of May. One of the ways to sort out these problems is to increase the inflow of foreign money.

In a move to attract more Foreign Direct Investment (FDI), the government is considering the prospect of increasing the direct investment limits in various sectors. In a recent report submitted to the Finance Minister by the Economic Affairs Secretary Arvind Mayaram has recommended increasing the FDI limits in various sectors. In the Defence sector, the report proposes to increase the limit from the current 26%. Multi-brand retail and telecom are the other sectors in which it has been proposed to increase FDI limits to 100% from the current caps of 51% and 74% respectively.

According to a circular by the Department of Industrial Policy and Promotion (DIPP), there are around 14 major sectors where FDI is capped below 100%. These include banking, insurance, aviation and terrestrial broadcasting FM. Final decisions on the actual increase in limit will be taken only next month, once the individual ministries meet and vote on the issue.

The government’s desperation to attract more FDI should also be viewed against the backdrop of the free fall of the rupee in the last one month or so and the huge drop in FDI inflows (more than the one third on a yearly basis). Telecom, pharmaceutical, construction and power were the sectors that witnessed the sharpest fall in FDI funds. Only the services and hotels & tourism saw a rise in FDI flows in FY13 (on a yearly basis).

Of course, even if the government ups the FDI limit after discussion with the individual ministries, this does not necessarily mean that FDIs will start pouring in. This is well illustrated in the case of multi-brand retail, where we are still to see any investment which uses the enhanced (51%) FDI limit that the government brought in after acrimonious debates with the opposition.

Even hiking the FII investment limit in Indian debt (government as well as corporate) seems to have backfired, as the current outflow of foreign money has been triggered in the debt market. This exposes the pitfalls of taking short-term measures like hiking of FII in debt instruments to handle the long-term issue of widening CAD. We believe that the government should take bolder measures to discourage investments in non-productive assets such as gold and should strive much harder to reduce the subsidy burden.