FDI reforms give embattled economy a shot in the arm

By Vaibhav Kakkar and Sahil Arora, L&L Partners
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Government data show that economic growth has slipped to 5% for the April-June 2019 quarter, a six-year low. With stock markets tumbling and automobile manufacturers grumbling, the government has gone on a reform spree. It has, by way of Press Note No. 4 of 2019, liberalized foreign direct investment (FDI) policy in coal mining, contract manufacturing, single brand retail trading (SBRT) and digital media. This article analyzes the key points of such liberalization and their impact on the economy.

SBRT norms

FDI
Vaibhav Kakkar
Partner
L&L Partners

While FDI up to 100% under the automatic route was previously permitted, single brand retailers with FDI in excess of 51% were required to procure 30% of the value of goods domestically. Despite past liberalizations, the sector has not achieved the desired traction, as local sourcing (LS) has remained an issue for international retailers, especially for those in tech-heavy sectors. They have struggled to meet these conditions because domestic suppliers have been unable to meet demand. With the changes in LS, these strict conditions have been done away with.

The government now allows SBRT entities to meet LS by procuring goods domestically for export and local operations, thus giving substantial impetus to exports. Previously, LS only included goods procured for local operations and exports to the extent they exceeded past procurement after an entity had set up a presence locally. That was for an initial period of only five years. An SBRT entity can now also procure from third parties, with the government recognizing commercial arrangements such as those that exist between Apple and Foxconn.

SBRT entities may also now undertake online retail operations immediately without first having to open physical stores, provided that they open physical stores within two years. The previous restrictions had affected retailers such as Ikea and Apple.

Contract manufacturing

FDI
Sahil Arora
Senior associate
L&L Partners

A manufacturing entity is permitted to receive 100% FDI under automatic route, and can undertake wholesale as well as retail trade, including e-commerce, without the applicability of retail trading conditions. However, with the government having taken the view previously that contract manufacturing should not enjoy benefits of the manufacturing sector, entities engaged in this area were required to comply with retail conditionalities, which brought in several restrictions. In what could be a game-changer, the government has now permitted FDI up to 100% under automatic route in contract manufacturing, which would allow an Indian entity to undertake manufacturing either directly or through a third party, with the freedom after to sell by wholesale, retail or online.

The government’s move is welcome, as it allows effective and optimal utilization of local manufacturing infrastructure, with greater employment opportunities.

Digital media

While on the face of it, it may be seen as liberalization, the government’s decision to permit FDI in digital media up to 26% under the government route is anything but that. The FDI policy regarding digital media was ambiguous; the online nature of the sector prompted an argument that there should be 100% FDI allowed under the automatic route as the sector is not regulated.

Against a backdrop of false reporting, and apprehension that a number of online-only news outlets were funded by foreign entities (especially from China), the government has equated digital media with the publication of newspapers. This appears in furtherance of the erstwhile Foreign Investment Promotion Board’s observations in the case of News Laundry.

The new policy is controversial, given the lack of clarity on its applicability to news aggregators as opposed to content developers, which have many aggregators worried that they already have FDI well in excess of the 26% cap. The policy changes will also be a challenge to new age media houses backed by foreign capital.

Where to from here?

The changes will be effective once notified under the Foreign Exchange Management Act, which one expects will happen soon. The government should also consider liberalizing the multi-brand retailing of products such as electronics and apparel manufactured or produced domestically, in the same way that it opened up the food processing sector.

The opening up of the sectors is timely. However, the government must focus on making business easier. Much like an open door does not necessarily make a place hospitable, FDI reforms do not by themselves spur investment and economic activity, which require ease of doing business to be implemented at the ground level.

Vaibhav Kakkar is a partner and Sahil Arora is a senior associate at L&L Partners. The views of the authors are personal.

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