By Persis Khambatta & Samir Nair

 

The Indian government announced a series of economic reforms the week of July 15, raising the limits for foreign direct investment (FDI) in a number of sectors while attempting to shore up investor confidence worldwide.

Amid sluggish growth, declining FDI inflows, a high current account deficit, and an ailing rupee, these measures dovetail with a growing consensus that a fresh impulse to the bilateral economic relationship is needed. The Obama administration welcomed the reforms in advance of Vice President Joe Biden’s four-day trip to India.

A total of thirteen sectors saw FDI increases. Here are a few highlights:

1)     The FDI cap in the insurance sector was raised from 26% to 49%, and is subject to parliamentary approval.

2)     FDI of up to 49% in the insurance, petroleum, power exchange, and single-brand retail sectors has been allowed via an automatic route, which means no prior approval is required from the government’s Foreign Investment Promotion Board (FIPB).

3)     The FDI cap in the telecommunications sector was raised from 74% to 100%, 49% of which is allowed through the automatic route and the rest via the FIPB.

4)     Though the 26% FDI cap in the defense sector technically remains unchanged, investments involving “state-of-the-art technologies” that exceed this limit would be considered on a case-by-case basis by the Cabinet Committee on Security.

The liberalization of India’s telecom sector is a welcome development, as foreign operators will no longer have to partner with Indian entities in order to offer services in the country – a move projected to inject fresh capital into a sector that badly needs it.  But, as many have noted, further improvements in policy and implementation are still needed, especially with regard to spectrum pricing and allocation.

Increasing the investment cap in the insurance sector was also cheered by investors, as the move is expected to help bring product, risk management and distribution expertise to the industry. It is also expected to attract more capital and competition into the industry, and may help drive insurance companies into rural markets, where both health care and insurance are in severely short supply.

The announced reforms came on the heels of a decision by the Prime Minister’s Office to put the controversial Preferential Market Access (PMA) policy on hold – a move particularly well-received by the U.S. business community. Under this policy, investors in the electronics sector would be required to source electronic goods from domestic manufacturers. To do this, they would have to set up factories and train Indian workers to produce such goods in a short period of time – not an easy undertaking for foreign companies operating in India.

Concerns about India’s investment climate are compounded by the country’s rigid labor laws, cumbersome land acquisition process, a problematic intellectual property regime and unreliable access to power and infrastructure. Just last week, South Korean steelmaker Posco withdrew from a $5.3 billion project in the state of Karnataka, citing inordinate delays related to land acquisition. ArcelorMittal soon followed suit, canceling plans for an $8.3 billion steel plant in the eastern state of Orissa for similar reasons. The government, for its part, has moved slowly with respect to streamlining land acquisition procedures. And without serious land reform, India will remain a frustrating destination for companies planning large industrial investments.

Foreign investors reacted to the FDI reforms stoically. They will undoubtedly continue to press the Indian government on other concerns, including important structural reforms which have not been forthcoming. India is currently ranked 132^nd on the World Bank’s Ease of Doing Business list, underlining the common complaint expressed by investors that once they receive clearance from the government, they still struggle to navigate a maze of regulations and unclear guidelines. For these reasons, many eagerly await a proposed Goods and Services Tax (GST), which would create a more unified Indian market, better integrate India into the global supply chain and bring down the cost of transporting goods within the country. Some also hope to see the expeditious conclusion of a Bilateral Investment Treaty (BIT) between the United States and India, something Vice President Joe Biden called attention to during his visit.

Raising limits on FDI is a welcome step in the right direction and sent a positive signal to investors, but it would be a mistake to count on these reform measures alone to boost India’s economic competitiveness. Deeper and more difficult policy decisions are needed to rekindle enthusiasm in India’s economy.

To learn more about some of the areas of untapped potential in India’s economy, please see our recent report The Emerging Indian Economy.

Ms. Persis Khambatta is a Fellow with the Wadhwani Chair in U.S.-India Policy Studies at CSIS. Follow her on twitter at @pkhambat. Mr. Samir Nair is a researcher with the Wadhwani Chair.