The government’s well-intentioned flurry of reforms to ease restrictions in a dozen sectors have so far been nothing more than a damp squib. There is a simple explanation: the unexpected flashflood of reforms is unlikely to result in a sudden rush of foreign capital into the Indian economy anytime soon.
The loosening of restrictions signal’s the government’s progressive change in attitude to foreign investors. But the market reaction has been largely skeptical. The reforms aimed at drawing foreign investments needed to turn around India’s slowing economy, record current account deficit and crumbling rupee, barely lifted markets on Wednesday due to doubts whether long-term inflows would actually materialise.
Finance Minister P Chidambaram was in Washington last week for meetings to drum up investment from the likes of Microsoft Corp, Wal-Mart, Lockheed Martin, Boeing and other potential investors. They all thought he was silver-tongued and bubbling with pro-business ideas compared to his predecessor Pranab Mukherji. They were even more heartened by Tuesday’s decision taken by Prime Minister Manmohan Singh and senior cabinet ministers to lower barriers to foreign direct investments (FDI) in sectors such as telecommunication, defense, stock exchanges and power exchanges.
Still, US investors with deep pockets are wrestling with one moot question: Is it worth investing in India as it heads to the polls in May 2014?
“Although these moves are designed to generate capital flows to help bolster the weak rupee and lagging economic growth, they are unlikely either to spur major new investment or have more than a very limited short-term economic effect,” New York-based Eurasia Group, which monitors political risk, said in a research note to clients.
It added that the government appears to have loosened restrictions selectively in sectors where it may not have to deal with strident political opposition. But, unfortunately for the government, the note added that none of these sectors offer “particularly compelling opportunities for foreign investors.”
Eurasia noted the sectors most attractive to foreign investors, such as civil aviation, media, airports, pharmaceuticals and multi-brand retail, were not included in the government’s reforms.
The Eurasia Group may have a point, but the relaxation of foreign investment rules in the telecommunication sector may be the sole bright spot. The limit on foreign holdings in mobile telephone operations, at present 74 percent, will be scrapped. Tuesday’s move could nudge some foreign companies with minority domestic partners, including Britain’s Vodafone and Norway’s Telenor, to take 100 percent control of their Indian operations.
“It may also help bring about a widely anticipated period of consolidation, helping larger operators buy smaller players or allowing struggling companies, such as billionaire Anil Ambani’s Reliance Communications, to attract new foreign investors,” said the Financial Times.
Analysts have also pointed out that many of the measures are cosmetic. In defense production, foreign investors with “state-of-the art” technologies will be able to exceed the current 26 percent limit with the approval of the Cabinet Security Committee (CSC). One can imagine the sea of confusion as foreign defense firms and the CSC wrestle over what is state-of-the-art? After all, most defense companies can be forgiven for believing that they have “state-of-the-art” technology.
“It all sounds good, but we will wait and watch,” said a senior executive in a US insurance firm who didn’t want to be named.
“With elections less than a year away, I am sure the opposition Bharatiya Janata Party (BJP) will be in no mood to let the UPA-government build its reform credentials,” he added.
Lack of political consensus on previous FDI decisions has scared some investors, who fear a change of guard in New Delhi could lead to a reversal in some of the decisions taken by the Manmohan Singh government, imperiling their investments.
The long-pending move to increase the FDI cap in insurance from 26 to 49 percent, for example, still needs approval from parliament, where a bill has been stuck for months. Under that proposal, investments over 26 percent would have only been permitted after FIPB approval. However Tuesday’s announcement did away with the requirement for approval.
Most investors feel Singh’s weak coalition government has struggled to push through reforms and has limited firepower for pushing through big bang reforms as it faces elections by May.
Foreign direct investment slid about 21 percent to $36.9 billion last fiscal year compared with 2011-12. India needs durable FDI inflows which are preferable over short-term capital to fund the current account deficit.
Foreign institutional investors (FIIs) withdrew a net $1.76 billion from Indian stocks last month through June 27 due to the expected pullback in US Federal Reserve stimulus. We saw the rupee hit a record low of 61.21 to the dollar on July 8, as funds flowed out of emerging markets, rendering those with high current account deficits, like India, particularly vulnerable.
Chidambaram has been hoping to revive the economy’s mojo by unveiling a slew of reforms to attract some $20 billion in new investment to fund the deficit without depleting India’s $300 billion in foreign exchange reserves.
