SINCE 1991, foreign investors automatically qualify for a 51 per cent equity stake in new investments in 34 priority industries. The government now proposes to increase the automaticity to 75 per cent, and increase the list of industries. It is doing so largely because the Foreign Investment Promotion Board, handling all non-automatic cases, finds itself overburdened with hundreds of applications, and wants to cut its work load.
There is a more logical way to change foreign investment policy. If the aim is to get more foreign exchange, then surely we need to ask for 100 per cent foreign equity. In many foreign investments in China, not only the equity but even the debt component comes entirely from abroad. By contrast, General Motors’ proposed car project in India has an estimated cost of Rs 800 crores but General Motors’ dollar equity may be barely one-tenth of that, with the remaining equity and debt coming from Indian sources. The Chinese approach can yield ten times as much foreign exchange for the same project. Why should we not adopt the same approach?
FOREIGN INVESTMENT: At one time, all foreign investment was considered a loot of the country, and so discouraged. Some economists complained out that foreign-controlled companies generally imported more than they exported. However, as I showed in a study last year, the ratio of imports to exports is lowest for foreign investors, higher among Indian private sector companies, and highest of all for public sector companies. It is appropriate for Third World industries to be net importers, using aid and foreign capital to plug the trade gap.
It is now acknowledged worldwide the foreign investment brings extra investment, new technology and access to global markets, and so is wooed. So is there any reason not to encourage 100 per cent foreign equity ?
HIGH TARIFFS: Yes, there is. India has high tariff barriers, and even after the Chelliah Committee reforms import duties will range up to 30 per cent. These barriers keep imports out, and this protection gives a windfall gain to all producers in India, including foreign investors. Domestic companies keep their windfall in India, but foreign investors can remit theirs abroad. By insisting on some Indian shareholding, we ensure that enough profits stay in India, mitigating or even completely offsetting the windfall repatriated abroad. There is no such windfall for foreign investors producing in India for export. So there is little reason to ask them to dilute their equity.
Note that a new venture typically takes four or five years to build its factory, stabilise production and earn enough profits to declare a dividend. So why restrict the equity stake of foreign investors in their initial years ? We should say foreigners are welcome to have 100 per cent equity to start with, but should dilute their stake within ten years. That will make India look attractive to foreigners, yet limit the outgo of dividends when the flow really becomes large.
GRADED NORMS: We need graded norms for foreign equity dilution to get the best results. For instance, if a multinational exports one-third or more of its output, it is a global player whose export earnings will far exceed dividends, and should be allowed to foreign equity. A company whose net export earnings (exports minus imports) are twice as high as its dividends should be allowed to keep 80 per cent equity even after 10 years. Any other company that is a net foreign exchange earner after dividend payments should be able to keep 66 per cent equity. And companies which are not net not foreign exchange earners should be obliged to dilute their stake to 51 per cent after 10 years. We should not ask for dilution below 51 per cent, since investors prize majority control.
LAUNCHING PAD: This graded set of incentives will encourage foreign investors to use India as a launching pad for global sales. It will reward multinationals that are the most outward-looking, and ensure that companies which concentrate on the domestic market will have to leave almost half their profits in India.
Will foreign investors be put off by such restrictions? Very unlikely. Indonesia already has rules that oblige foreign investors to dilute their stake to 49 per cent over two decades, and still money is pouring into that country. China’s rules provide that foreigners cannot own land and must lease it for limited periods (often 20 years), so the venture formally closes at the end of the lease period and needs renegotiation. Privately, foreign investors say they expect the rules in China and Indonesia to be changed long before the two decades are over. Be that as it may, formal restrictions of this sort do not discourage foreign investors provided the underlying spirit is positive.
In India too we need a positive spirit. Once that is demonstrated, we can, with impunity, demand future dilution. But we must avoid rules which insist on dilution at the outset. Don’t squeeze an orange that is not yet in your grasp.