Allowing FDI not enough; new government needs to deal with operational inefficiencies

Sectoral Hurdles

India attracted inflows of $28 billion in 2013, a growth of 17% over 2012, according to the United Nations Conference on Trade and Development. The figure is the second lowest, after South Africa’s, among the BRICS (Brazil, Russia, India, China, South Africa) economies (see FDI Inflows...), though South Africa registered the highest growth among them, of 126% on a low base, to $10 billion in 2013.

Rashesh Shah, chairman and CEO, Edelweiss group, admits that raising FDI limits in insurance and defence will have a big positive psychological impact on investors. “But it is only the first of measures that should be taken to encourage investors. After FDI, we have to ensure all the approvals for a project or a venture are given quickly,” he adds. According to the Reserve Bank of India (RBI), half of the infrastructure projects worth Rs 150 crore or more each and awarded by the central government are stuck due to regulatory hurdles and sector-specific problems.

Some RBI statistics in an August 2013 report are startling. Less than a third of 576 special economic zones approved so far are operational; just over a fifth of the targeted 50,621 km of road projects have been awarded in the 2008-13 period; just four of the planned 16 ultra mega power projects (of 4,000 MW and above) have been awarded; and under the New Exploration and Licensing Policy for exploration of crude oil and natural gas, under half of the 251 blocks allotted have reported discoveries but only six are operational. Foreign investors can pick up 100% in these sectors, save some exceptions, so FDI limits are clearly not the problem here.

Fixing the Infra Mess

“You haven’t really seen the [FDI] floodgates opening in what is being billed as the world’s biggest PPP [public-private partnership] opportunity,” says Vinayak Chatterjee, chairman and managing director of Feedback Infra, a consultancy. India plans to spend about Rs 50 lakh crore on infrastructure in the 12th Five-Year Plan (2012-17), with about half of it coming from the private sector, up from over a third in the previous plan. Mukherjea says the key issues to be tackled in infrastructure are “coal shortage, the finances of state electricity boards [SEBs] and bailing out independent power producers who have signed long-term power-purchase agreements at sub-optimal tariffs”. Demand for coal has been growing at twice the rate as the growth of domestic production and Coal India, which accounts for four-fifths of the coal produced here, has struggled to meet its targets, which has made India the third largest importer of coal.

This has increased the cost of power producers, which have been demanding a hike in tariffs to make their projects viable. SEBs are worse off, with the government having to intervene in 2012 to clear a recast of their Rs 1.9 lakh crore debt. Indian banks’ woes have been increasing, too, with gross non-performing assets (NPAs) growing every year since 2008. In 2012, their gross NPAs grew at nearly three times the rate of growth in advances.

If foreign investors are turned away by the inefficiency of Indian regulators and stateowned companies, the sheer venality of government bodies coupled with India Inc’s disregard for rules is not making them any keener on India.

Irregularities in the allocation of 2G spectrum and coal blocks, the losses to the government from which have been pegged at tens of thousands of crores, have led to CEOs, politicians and bureaucrats coming under scrutiny, with some like former telecom minister A Raja, Unitech and DB Realty chiefs, Sanjay Chandra and Shahid Balwa, even spending time in jail.

The increased scrutiny of the Comptroller and Auditor General, the judiciary and activists have made bureaucrats and ministers wary of signing off on contentious projects, adding them to a worrying backlog of files.

The other scary bogeyman for foreign companies has been the taxman. British telecom company Vodafone group has been embroiled in a dispute with the Indian government over the latter’s demand of Rs 20,000 crore in retroactive taxes, interest and penalties in relation to Vodafone’s acquisition of a majority stake in what is now its Indian arm in 2007.

But this did not stop the company from buying Piramal Enterprises’ 11% stake in Vodafone India for Rs 8,900 crore on Thursday, to fully control the Indian unit. Even Nokia and Royal Dutch Shell are battling tax demands by the government.

Time for Haste

While it is a no-brainer that these problems need to be sorted out forthwith, any delays in passing the Insurance Amendment Bill in parliament to hike the FDI limit in insurance from 26% to 49%, which will then be followed in the pension sector, too, could dampen investor sentiment at a time when the International Monetary Fund has projected India’s GDP growth to improve from 4.6% in 2013-14 to 5.4% in 2014-15 and 6.4% the year after.

Vighnesh Shahane, chief executive of IDBI Federal Life Insurance, believes hiking the FDI limit in insurance is the most logical route to increasing insurance penetration in the country. Life insurance penetration, a ratio of the premium underwritten in a year to the GDP, has been falling since 2009 and was 3.17 in 2012.

“The insurance industry is in need of long-term capital to expand. It’s not as profitable as it used to be,” says Shahane. IDBI Federal is a three-way joint venture between IDBI Bank, Federal Bank and Belgian insurer Ageas.

“While banking, which is a more strategic sector, has 74% FDI, I don’t understand why we have had only 26% FDI in insurance,” adds Janmejaya Sinha, chairman, Asia Pacific, Boston Consulting Group. Defence production, where the government allowed FDI of more than 26% on a case-to-case basis last year, is another sector ripe for foreign investment.

Since the sector was opened up to the private sector in 2001, progress has been painfully slow. MV Kotwal, president, heavy engineering at Larsen & Toubro, says FDI in defence cannot be viewed only in commercial terms given the sensitive nature of the sector.

“FDI in defence should be increased to 49% on a selective basis provided the right level and type of technology comes along with it.” L&T’s joint venture with Airbus Defence and Space, inked in 2009, is expected to be commercially operational in a year.

Other private players in the defence sector include Mahindra & Mahindra, Tata group and Ashok Leyland. While foreign institutional investors (FII), hopeful of a Narendra Modi-led government in May, have pumped in over $4.5 billion in Indian equities in 2014, pushing the Sensex to record highs, Sinha believes short-term FII flows should be substituted by long-term FDI, which is a better indicator of the health of the economy.

But for that to happen, the next government should do a lot more than just increase FDI limits.