India's FDI Liberalization - Is it Enough and In Time?

With just a year left for the existing Indian government to run its course, it seems to have decided to forge ahead and further liberalize the foreign direct investment (FDI) policies despite the reservations of the ruling United Progressive Alliance's Left partners.

The aim is to cash in on the current interest of foreign investors in emerging markets like India rather than let them move on to greener pastures like China and the tiger economies of East Asia.

As it is, FDI inflows have picked up dramatically in the last two years and are now estimated at over $17 billion annually.

The stock market boom has already shown us the economy's potential for luring international funds. If foreign institutional investors can park their money for short-term gains in the Indian bourses, policymakers have realized that long-term investors are also viewing this country's economy in a favorable light.

So this is the time to cash in on this interest, it has rightly been recognized, rather than wait till after the 2009 elections when another government might reap the benefits.

Some of the most important of the latest decisions are the ones to open up the petroleum refining sector and the sensitive area of titanium mining for higher levels of FDI.

Till now, public sector oil refineries have only been allowed up to 26 percent foreign investment in new projects. This ceiling has now been raised to 49 percent. The first exception to this rule was made six months ago when global steel tycoon Lakshmi Mittal was allowed to invest 49 percent in Hindustan Petroleum Corp's Bathinda refinery.

The government really had no option as it had been hunting for a foreign partner for this prestigious project for quite some time but had not been able to bag any of the leading international oil majors. The entry of Mittal was fortuitous and clearly gave the government the courage to go ahead with the latest decision to raise the cap for all public sector units (PSUs) to 49 percent.

This is bound to lure more international oil companies into the downstream oil sector of refining and marketing, an area that is seen as one of the country's strengths.

Though India may not be viewed as highly prospective in terms of oil exploration, it can become an oil refining and exporting hub for petroleum products like petrol, diesel and aviation turbine fuel.

Reliance has already moved in this direction by importing crude and re-exporting products from its Jamnagar refinery in Gujarat. Other PSUs have also been exporting products but not in such large quantities as most of their output is committed to meet domestic needs.

The need to raise investment in the mining sector has also been recognized with the decision to allow 100 percent foreign investment in the mining of titanium-bearing ores.

India has the world's largest reserves of ilmenite, a mineral used to make titanium dioxide, which is primarily used in the aviation and defence industries. It is thus high time the country leveraged the potential of being a major world supplier of this commodity by allowing multinationals to mine the ore.

But a much-needed rider has been added to ensure that local value-addition units are set up along with transfer of technology by the multinationals concerned.

The decision on FDI caps in the area of commodity exchanges, on the other hand, came as a surprise but is clearly a move to restrain the growing strength of FIIs in this sector. The 49 percent FDI cap has been divided into 23 percent for foreign institutional investors (FIIs) and the 26 percent for FDI. But it has also been stipulated that no single investor can command more than five percent investment stake.

This could come as a blow to some commodity exchanges, which already have investments of over five percent by FIIs like Goldman Sachs and Fidelity. The provision limiting them to a five percent equity stake ensures that foreign investors cannot be on the boards of the commodity exchanges nor can they have a major involvement in their operations.

In other words, the aim is to ensure that the Indian stakeholders have the controlling say in the business of commodity exchanges.

One step that is bound to be welcomed by all airlines is the decision to allow up to 100 percent foreign investment in the maintenance, repair and overhauling of aircraft. With the mushrooming of domestic airlines, infrastructure to maintain their assets has lagged far behind. In the process, safety too has taken a back seat.

By allowing the entry of foreign players with experience in maintenance and repair, the government has taken a major step towards building the infrastructure needed to support the growth of civil aviation in the country. In the case of ground handling services, the FDI cap has been retained at 74 percent but it raised to 100 percent for maintenance and repair as well as for technical training institutes and helicopter and sea services.

Guidelines on FDI relating to construction development projects have also been eased allowing easier participation by FIIs while some restrictions on participation of foreign investors in industrial projects have also been lifted.

With these steps, minor irritants in the way of high FDI inflows in the real estate sector as well as in industrial parks have been removed.

What needs to be watched now is whether these decisions to liberalise FDI norms actually translate into higher inflows from abroad. The UPA government is clearly seeking some kind of bonanza from FDI over the next 12 months that could help sustain the current high economic growth path.

Unfortunately, it has had to keep many ambitious economic reform plans on hold owing to expected opposition from the Left parties. It has yet to be seen whether this latest impetus to improve FDI flows will have the desired effect within the short time frame available to the current government before elections are held.

(Sushma Ramachandran is an economic analyst. She can be contacted atsushma.ramachandran@gmail.com


More by :  Sushma Ramachandran

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