Economy

A ‘negative list’ for a positive change: How to rev up India’s FDI environment

Updated : May 02, 2019 09:18 AM IST

India still has multiple layers of regulations that deter a higher level of foreign investment.

Some sectors will necessarily be defined as strategically significant and foreign investment limitations will remain.

For most of the last five years, the Modi government has steadily improved India’s investment environment for foreign investors. But despite government pronouncements that ‘India is one of the world’s most-open investment destinations,’ more still needs to be done for India to start attracting the levels of foreign direct investment that China and other markets enjoyed at their peak. The next government should move quickly to lift foreign investment caps in non-security sectors, relax onerous regulations in other sectors, and shift to a ‘negative list’ approach to encourage investment in emerging sectors.

The Modi government has been uniquely proactive among Indian leaders in encouraging foreign direct investment (FDI) inflows. In addition to his personal courtship of potential investors, his government made over 40 positive changes to India’s FDI limitations in sectors ranging from construction (relaxing minimum size), insurance, pension fund management, defence, and some forms of retail trade. The impact came quickly. In the first four full fiscal years in office, the government has averaged over $55 billion in annual FDI inflows. This is considerably higher than FDI inflows under the United Progressive Alliance in its first term ($23 billion) or second ($38 billion), and leagues above the annual FDI inflow during the Vajpayee government ($4.9 billion).

India has also made two other fundamental changes to how foreign firms invest in India. First, the country has amended its bilateral tax treaty with Mauritius (and, by default, its tax treaty with Singapore), ending a provision that allowed for tax-free repatriation of capital gains. This provision had made Mauritius, with population of 1.3 million, the preferred destination for foreign firms to establish a shell company through which they handled financial transactions with India. Due to this fact, Mauritius has accounted for 32 percent of all FDI into India from April 2000 through December 2018. Removing these tax incentives has increased tax liabilities of foreign investors, but also given more reliability — these tax provisions were being regularly challenged already, most notably in the Vodafone tax case.

Despite these helpful changes, India still has multiple layers of regulations that deter a higher level of foreign investment. These include foreign equity limitations, uneven treatment of foreign-invested firms in some sectors, and other crucial domestic regulations that have an outsized impact on foreign firms such as data flow restrictions.

Sectors with foreign ownership restrictions

FDI banned -- eight sectors: Real estate (where no development occurs), law firms, tobacco, farm house construction, business-to-consumer e-commerce (inventory), gambling, nuclear power, accredited higher education.
26 percent FDI allowed -- one sector: News publishing
49 percent FDI allowed, seven sectors: Insurance, pension fund management, defence, TV and radio terrestrial broadcasting, airlines, securities infrastructure (stock exchanges), power exchange.
51 percent FDI allowed, one sector: Brick and mortar retail
74 percent FDI allowed, two sectors: Private security agencies, banking.

Sectors with limiting regulations only applicable to firms with foreign investment:

Single brand retail: If a firm has above 51 percent FDI, must source 30 percent locally.
Multi-brand retail: Apart from the 51 percent FDI cap noted above, harsh regulations placed on foreign firms such as sourcing, minimum investment criteria, and geographical criteria.
Insurance: Apart from the 49 percent FDI cap noted above, there are new rules mandating local control of the venture.
Marketplace e-commerce: Caps on a range of business actions, such as sales from a specific vender, barring the marketplace firm from offering discounts, and more.
Construction: A series of rules such as a three-year lock-in period.

Domestic regulations that have outsized impact on foreign firms:

Data flows: Any restrictions on data flows, such as the 2018 Reserve Bank of India requirement to hold data on local transactions locally, will have an outsize impact on foreign firms.
Bilateral investment treaties: India’s decision to trigger the end clauses to its existing investment treaties and force nations to comply with India’s lackluster new model would curtail investment in sectors where the government of India is a partner, such as infrastructure.
Taxation policies: Some domestic tax policies can target foreign invested firms, such as when they look at linking taxes to global activities that are sometimes unfairly attributed to India, creating double taxation scenarios.

Separately, India should strongly consider shifting to a ‘negative list’, where emerging sectors not included in the FDI schedule are considered open to investment. New sectors are created with regularity, and if they do not fit into this schedule, it can cause investors to withhold potentially meaningful investments.

Some sectors will necessarily be defined as strategically significant, and foreign investment limitations will remain. Ownership of nuclear power plants is one such likely example. But the new Indian government should strongly consider a dual approach — first, issuing a press note once in office, lifting FDI caps in most remaining sector to 100 percent, and removing damaging regulations targeting foreign investments. And second, shifting to a ‘negative list’ that outlines the specific sectors where foreign investment is limited.

Richard M. Rossow is Senior Adviser and Wadhwani Chair in US-India Policy Studies at the Center for Strategic and International Studies in Washington.

Breaking Down Elections 2019 is a series of articles by experts of Center For Strategic and International Studies that will go beyond the headlines to provide a deeper look into what the 2019 Lok Sabha Elections means for the Indian polity and electorate.

A ‘negative list’ for a positive change: How to rev up India’s FDI environment

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