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Since independence in 1947 until 1991, India’s policy towards foreign direct investment (FDI) was ad hoc, and lacked consistent direction and proper institutions (Sahoo 2006; Sahoo et al. 2013). As a result, FDI inflows into India were negligible. However, following the balance-of-payments crisis in 1991, the comprehensive structural economic reforms included steps to attract FDI to supplement domestic resources without adding to the national debt. These included raising foreign equity caps in most sectors, diluting provisions of the Foreign Exchange Regulation Act[1] (FERA), and allowing automatic approval of FDI. To improve the overall business environment for investors, Indian reforms also included the dismantling of controls in the areas of industrial policy, taxation, export-import policy, dividend balancing[2], easing of competition controls, deregulating interest rates, opening up capital markets, and implementing trade reforms. The result has been significantly positive. While only 29 countries invested in India in 1991, today India has more than 130 FDI source countries.

After the National Democratic Alliance (NDA) government led by Prime Minister Modi came into power in 2014, FDI reforms accelerated. In the first year itself, the FDI cap was raised to 49 per cent in defence, e-commerce, insurance, and health insurance. The government also scrapped retrospective taxes to attract FDI and boost manufacturing-led growth for job creation. In 2015, India moved ahead of the US and China to become the top destination for FDI worldwide from the fifth position in 2014. This underscores India’s efforts to boost investment through a number of reforms. As other emerging economies, including China, are experiencing a slowdown, India is now the bright spot in the world economy today. It is experiencing the highest growth among emerging economies, and is the best market to put money in. This has largely been due to the efforts of the Modi-led NDA government, which has assured investors of a congenial environment for FDI to facilitate the government’s ‘Make in India’ programme.

To boost the prevailing investment climate further and help India realise its FDI potential, the government increased in July 2016 the FDI equity cap to 100 per cent in several sectors (defence, civil aviation, pharma, single-brand retailing, and animal husbandry). A few of the implications of FDI, especially in the areas of defence, civil aviation, and pharma, are detailed below. The recently announced FDI reforms offer foreign investors, including European firms, huge opportunities to make India their major investment destination in Asia.

Defence

India aims to strengthen its strategic presence worldwide and become a member of the Nuclear Suppliers Group and the UN Security Council, but it imports nearly 70 per cent of its defence equipment and depends on imports for critical defence technologies. To meet its aims of self-reliance, therefore, the country needs top-end technologies and a vibrant defence manufacturing base. Of course, India has been spending an increasing amount of resources on defence. With the FDI equity in defence hiked to 100 per cent, the Indian defence industry is all set for a massive change. Earlier, increasing the FDI limit to merely 49 per cent in 2014 had been largely ineffective in achieving India’s objective of technology enhancement, and foreign vendors had hesitated to transfer technologies without ownership and management control of the Indian venture. Though FDI ceiling in defence in graded steps to 74 per cent and 100 per cent was allowed in case of technology sharing and state-of-the-art technology transfer, the July 2016 announcement of 100 per cent FDI in defence with modern technology transfers through government route is a big step for foreign investors, particularly original equipment manufacturers. Foreign investors would like this full liberalisation of the defence sector, as retaining control of a firm assumes importance, especially in the light of transfer of special technology. This would help India in setting up joint ventures to leverage critical technologies to shore up domestic capability in the Indian defence industry and, thereby, create jobs in the country.

India’s cap on FDI was stunting the process of the modernisation of the armed forces. The success of a liberal FDI policy depends critically on how it is managed for the benefit of the domestic private sector defence industry. Sometimes, the fear of national security being compromised was over-hyped, as a manufacturing facility within the country would have been governed by Indian laws and, therefore, a much better option than importing. Certainly, raising the equity cap in defence to 100 per cent will not only reduce India’s dependence on imports but also provide the private sector a level playing field. The public sector defence companies in India are overburdened, and the responsibility of making the Indian defence industry self-sufficient lies with the private sector.

India is one of the largest spenders and buyers of defence equipment. Though Russia has been the closest partner for India’s defence equipment, collaboration in the defence sector with the US and Europe has been increasing. France has been leading the European countries when it comes to defence trade with India. With the opening up of the defence sector to the private sector and the allowing of 100 per cent FDI, India offers European defence firms a big opportunity to enter Indian markets through fully owned subsidiaries and also start production and development jointly with India private firms. As state-owned Indian defence firms are looking for resources and technology, European firms can find it easier to access India’s huge defence sector. In a short span of time, several collaborations between European firms and Indian firms have taken place, and such collaboration is expected to increase in the near future.

Pharmaceuticals

India is the largest provider of generic medicines worldwide. The Indian pharmaceutical industry constitutes nearly 20 per cent of the global generic drugs exports in terms of volume. One of the fastest growing industries worldwide, it is poised to expand exponentially. According to the India Brand Equity Foundation, with 70 per cent of market share (in terms of revenues), generic drugs form the largest segment of the Indian pharmaceutical sector. Over-the-counter medicines and patented drugs constitute 21 per cent and 9 per cent, respectively, of total market revenues of US$ 20 billion (IBEF, 2016).

Against the above backdrop, the Government’s decision to allow up to 74 per cent FDI in the pharma sector under the automatic route for brownfield investment, and 100 per cent under greenfield investment, is a welcome move, and would further boost the sector. The investment in the brownfield sector can also be 100 per cent, but through the government approval route. This will ensure that new drugs and medicines are made available to Indian patients and also increase employment in the sector. The increased FDI would also enable enhanced investment (in the form of merger and acquisition (M&A) activity) from multinational corporations (MNC), which believe in the growth potential of the domestic industry.

With a population of 1.25 billion and increasing per capita income, India offers foreign investors one of the largest markets in the pharmaceuticals sector. The sector has been growing at an average of 17 per cent for the past decade (IBEF, 2016).. A highly educated workforce at internationally lower wage rate and other cost advantages make India the potential hub of pharmaceutical research and development (R&D). European pharmaceutical companies are already working closely with Indian partners, and members of the European Federation of Pharmaceutical Industries and Associations  have increased their investment in India in recent years. The present hike in FDI ceiling to 100 per cent certainly offers further opportunity.

However, FDI in brownfield investment has been a contentious issue, as concerns have been raised over some M&As of Indian pharma companies by foreign firms. It is believed that these M&As had impacted the accessibility and growth of the generic drugs industry in India. As per estimates, 96 per cent of the total FDI in the sector between April 2012 and April 2013 has been brownfield.

Civil aviation

India’s first-ever National Civil Aviation Policy (NCAP), formulated by the NDA in 2016, targets to increase domestic passengers traffic from 70 million s in 2014-15 to 300 million by 2022 by ensuring affordable civil aviation to the middle class. To realise this objective, the government has been focusing on the civil aviation sector for regional connectivity and modernisation. In fact, the sector has been provided $1.16 billion in the budget for 2016-17 for the development of airports through public-private-partnerships in all Tier 2[3] and Tier 3[4] cities. With a view to release the NCAP 2016, the government allowed 100 per cent FDI in aviation sector under the automatic route in greenfield projects and 74 per cent FDI in brownfield projects under automatic route. At present, foreign investment up to 49 per cent is allowed under automatic route in scheduled air transport and passenger airlines, which has been raised to 100 per cent.

India’s aviation industry is largely untapped with huge growth opportunities, considering that air transport is still expensive for nearly 40 per cent of the upwardly mobile middle class. FDI would be very useful in the civil aviation sector, which is short of capital, and a few airlines are incurring losses and struggling for capital. More investment and competition as a result of 100 per cent FDI equity into the sector would help improve regional connectivity and boost technology upgradation and management practices. It is a good step for civil aviation, along with earlier policies like curtailed customs duty on aircraft parts and allowing import of aviation turbine fuel. This policy certainly complements the NCAP that caps domestic fares and allows domestic airlines fly international routes without any time barriers, etc. Overall, these big reforms announced will contribute to India’s ‘Make in India’ programme.

The hike in FDI ceiling in civil aviation to 100 per cent adds to the already ongoing EU-India civil aviation project. In fact, India’s civil aviation minister met senior executives of major European companies like Airbus, Textron, Thales, Bombardier, Dassault, and SAFRAN, and briefed them about various opportunities in the Indian aviation sector.

Single-Brand Retailing

Though 100 per cent FDI was allowed earlier in single-brand retailing, the biggest change in the recently announced policy in 100 per cent FDI in single-brand retailing is the three-year waiver on 30 per cent local sourcing. However, in the next five years, MNCs must source 30 per cent of their products on average locally, particularly if these products use state-of-the-art, cutting-edge technology. Though the decision is contrary to the demand of MNCs for a complete waiver, the policy is flexible, and gives single-brand MNCs time to establish their brand in India before local outsourcing. MNCs can open their stores immediately and sell their products in the Indian market without sourcing or manufacturing locally for the first three years. The 100 per cent FDI in single brands offers huge opportunity for well established, luxury European brands in jewellery, apparel, time wear, accessories, etc. Though the luxury brands segment in India is small and at an initial stage, the potential is huge, given an aspirational society with increasing per capita income. Urbanisation, exposure to luxury brands, and the opening of mega super-markets/malls, etc., do indicate a huge market potential for European firms in single-brand retailing.

The latest changes in FDI norms in India have made entry and control of foreign investors in a lot of sectors easier. Overall,the change in FDI policy will certainly boost FDI inflows and increase the ease of doing business in India. In addition, increasing FDI ceiling in these crucial sectors offers foreign investors a huge opportunity and opens up the huge Indian market to well established European MNCs.

Footnotes:
[1] FERA includes stringent regulations on foreign exchange management and transactions in foreign currency affecting FDI.
[2]The cumulative outflow of foreign exchange on accourt of payement of dividende over a period of seven years from the date of commencement of commercial production to investors outside India shall not exceed the cumulative amount of export earning of the company during those years.
[3]Tier 2 cities are those with a population of above 1 million, and are usually regional hubs such as state capitals or industrialised centres.
[4]Tier 3 cities have a population of less than 1 million and are beginning to develop.

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Notes:

  • This article appeared originally at Bruegel.
  • The post gives the views of the author, not the position of LSE Business Review or the London School of Economics.
  • Before commenting, please read our Comment Policy.

pravakar-sahooPravakar Sahoo was a Visiting Fellow at Bruegel in 2016. He is a tenured associate professor with the Institute of Economic Growth (IEG), Delhi. Prior to that, he worked as senior fellow in Indian Council for Research on International Economic Relations (ICRIER). He has published more than 60 research papers in refereed international and national journals on issues related to macroeconomics, international trade & investment, regional cooperation and infrastructure. Pravakar has wide international exposure and served as a consultant/researcher to organizations such as Ministry of Finance and Commerce, GoI, Indo-Sastri Canadian institute, IDRC, Korea Institute for International Economic Relations (KIEP), East West Center, USA, South Asian Bureau of Economic Research (SABER), ANU, Australia;  The South Asia Network of Economic research Institutes (SANEI), Institute of Developing Economies, IDE-JETRO, Japan,  and Heritage Foundation, USA. He has work experience on India, South Asia, Japan, Korea, China, USA, France and other Asian Countries.