Following the announcement in the Union Budget 2013-14 (Para 95), a Committee has been constituted to rationalise the definition of FDI and FII in India. This conveys an impression that there is a definitional ambiguity on FDI and FII in India vis-a-vis international best practices.

However, a perusal of the IMF Balance of Payment Manual Version 6 and the RBI’s Balance of Payment Manual 2010 reveals that India adheres to the international best practice while defining both FDI and FII. As the RBI Manual itself points out, “With regard to FDI, while as per the international definition, for an investment to qualify as FDI the foreign investor needs to have a 10 per cent or higher stake in a given company, in India this has not been strictly adhered to.”

On the contrary, the treatment towards FII has been relatively strict and rightly so, given the volatility of such flows with their repercussions on the balance of payments. Thus, the problem is not one of conceptual or definitional ambiguity, but rather one of a compliance mismatch.

Against the above backdrop, it is pertinent to examine the role of the proposed Committee. The Committee surely cannot reinvent the wheel! Contextually, the following questions assume critical importance:

What is international best practice, regarding the definition of FDI and FII?

How does India compare with international norms?

What could be the terms of reference of this Committee?

What would be the implications of the proposed rationalisation for financing CAD?

GLOBAL PRACTICE AND INDIA

The definition of direct investment followed by India is the same as the internationally accepted norm. The latter defines a ‘Direct Investment Relationship’ as one where the investor immediately or indirectly owns 10 per cent or more of the equity (and hence voting power) in an enterprise, while all cross-border transactions and positions involving debt or equity securities other than those included in the direct investment or reserve assets fall under the purview of ‘Portfolio Investment’.

Operationally however, as has been stated in the RBI Manual, this definition has not been strictly adhered to. All acquisition of shares in a company other than by way of acquisition from the stock market (the secondary route) by non-residents has been treated as FDI so far. Thus, irrespective of the quantum of shares acquired , so long as such shares have been acquired by way of IPOs, preferential allotment or through private placements, they have been subsumed under FDI.

Non-adherence to the strict technical definition in all these years could have been to facilitate flexibility in FDI flows into India, given the historically cautious and selective approach in line with the objective of ‘self reliance’ and to protect and nurture domestic industries. Even with the adoption of a more liberal approach post-1991, the emphasis till date has been primarily on liberalising the sectoral caps, rather than on equity participation norms.

TERMS OF REFERENCE (TOR)

In the above context, an indicative Terms of Reference (not suggested so far by the Government) for the new proposed Committee should comprise the following:

Identify origin of mismatch : The TOR needs to focus on the origin of this mismatch vis-à-vis global standards, viz., whether through the automatic route or the approval route.

Identify quantum of mismatch : The Committee will need to bring greater data transparency in the number of companies falling short of the minimum 10 per cent mandated as per international, as also Indian, norms. This can be undertaken sector-wise as well. A list of the existing companies investing in India under the current FDI policy should be made available in the public domain.

Specify time-frame for compliance : The Committee would need to specify an appropriate time–frame within which existing companies may be permitted to increase their investments to match the international norms of 10 per cent and above.

FINANCING CAD

Such a rationalisation, within an appropriate time-frame, has favourable implications for financing the Current Account Deficit (CAD), which touched an alarming level of 6.7 per cent of the GDP in Q3 of 2012-13. With companies having to follow the 10 per cent and above norm for FDI in India, we can expect higher capital inflows through the FDI route, thus easing the pressure on CAD.

Such a policy stance may not be a day late, given that followed by other emerging economies, especially China. The latter’s FDI policy, though more stringent in terms of a higher equity participation requirement norm of 25 per cent, manages to attract greater FDI on account of its greater tax incentives, better infrastructure, lower bureaucratic delays and red-tapism. To conclude, the ‘so-called ambiguity’ with regard to the definition of FDI is more a problem of mismatch with international norms than an ambiguity in definition.

The operational weakness that India has exhibited in adhering to international norms needs to be corrected immediately, to address CAD problems. While liberalisation of sectoral caps is a welcome move, the mantra should be compliance with the ‘10 per cent and above’ international FDI norms.

(The authors are Professors at the S P Jain Institute of Management & Research, Mumbai.)