India's thorny FDI rule under
scrutiny By Indrajit Basu
KOLKATA - He is just four days into his job as
finance minister in Prime Minister Manmohan Singh's
brand new Congress-led government, but it appears that
Palaniappan Chidambaram, known as the "radical reformer"
- a name that he acquired during his previous stint as
finance minister in 1997-98 - has already started
cracking the whip in earnest.
Reports emanating
from the finance ministry suggest that Chidambaram is
addressing reforms in foreign direct investment (FDI)
first, by diluting a controversial clause called Press
Note 18 that was initiated by the Foreign Investment
Promotion Board (FIPB), responsible for regulating
foreign investment in the country.
According to
senior government officials in the finance ministry,
"The new finance minister has sought a policy proposal
from the ministry officials on sectoral caps and other
matters relating to foreign investment. The proposals,
which would be placed to the cabinet of ministers at the
earliest opportunity, should include complications such
as applicability of Press Note 18."
Indeed,
perhaps Press Note 18 is the most contentious of the
country's FDI rules, and even as some sections of Indian
industry feel that it acts as a "gatekeeper" to their
interests in all joint ventures with foreign investors,
the fact remains that Press Note 18 has often been a
hurdle and deterrent to foreign investors. The dilution
of Press Note 18, therefore, according to Asia Law &
Practice, a Euromoney Publication, "could have
far-reaching implications in making India one of the
most attractive FDI destinations in Asia".
Under
the provisions of Press Note 18, a government
notification which came into effect on December 14,
1998, foreign companies which previously or currently
have joint ventures, technology collaborations or
trademark license agreements in India are prohibited
from "automatically" making new foreign direct
investment in India in the "same or allied field". All
such foreign investors must apply for approval of new
investment to the FIPB. Procedurally, the FIPB requires
that a "no objection letter" accompany each application
from the prior or existing Indian joint venture partner,
technology collaborator or trademark licensee.
The FIPB says that the objective in issuing
Press Note 18 was to protect the interests of local
shareholders, owners and Indian financial institutions,
and prevent a dominant foreign investor from abandoning
existing joint ventures.
In practice, however,
it has been frequently used as leverage over foreign
investors, and Indian business owners have often refused
to issue a "no objection letter" on the thinnest of
grounds. "An Indian partner uses it mercilessly to
extract greater exit value or challenge termination
which is otherwise legally and contractually valid,"
says Pallavi Shrof, a partner in the Mumbai-based
international legal advisory firm Amarchand Mangaldas.
"Press Note 18 clearly restricts a foreign investor's
right to do business and denies it the equal footing and
treatment that it ought to be assured by the
government."
The most recent case of the misuse
of Press Note 18 is the instance of the Chinese consumer
electronics company TCL Electronics, which, after its
"fleeting few-months-old" failed venture with India's
now-sick Baron International, wanted to set up a 100
percent subsidiary in India. But TCL was stymied for
months owing to Baron's refusal to grant the "no
objection" and although the FIPB finally overruled the
objections raised by Baron and granted TCL permission at
the end of last year, that did not take place until TCL
proved that the joint venture with Baron had not been
functional for two years.
Like the TCL-Baron
skirmish, the country's joint venture arena is strewn
with Press Note 18-related spats; for instance the
Kennametal Inc-Widia India-Yash Birla group spat, and
the Marley-Paharpur Cooling Towers squabble. However,
the most juicy joint venture bust-up in the Indian
corporate landscape is that of the United Kingdom's
British American Tobacco (BAT) Plc and India's bluechip
ITC Ltd, a tobacco-to-hotels-to-agricultural products
major, which has been using the rationale of Press Note
18 to restrict BAT for almost a decade from acquiring a
majority stake in ITC.
Clearly then, Press Note
18 costs India dear in many FDI-related inflows. Besides
creating significant delays, it often hinders the
country from getting much-needed new foreign investment
in certain sectors of the Indian economy. It has also -
in a couple of cases - led to a hurried and harmful
retreat of crucial FDI proposals. Walt Disney, for
instance, one of the world's largest entertainment
companies, which had proposed major investments in India
to start a television channel and to set up
entertainment parks, dumped its proposal after it failed
to get a "no objection" from its Indian partner, the K K
Modi group, with which it had signed a joint venture
agreement. The K K Modi group, which also owns Godfrey
Phillips India, a joint venture with the world's largest
cigarette company Phillip Morris, had also blocked a
proposal by FTR International, a Phillip Morris arm,
which had proposed to make investments in tobacco leaf
processing. The company had major export plans from
India.
Still, Press Note 18 remains because it
has the backing of a few powerful business groups in the
country. One such influential group supporting it is the
powerful industry lobby Federation of Indian Chamber of
Commerce and Industry (FICCI). Although FICCI admits
that it had "at times" vitiated an investment-friendly
environment, shareholders and owners of the old venture
also need to be considered, it says.
"Press Note
18 corrected a serious policy anomaly that could have
ruined the future of many small shareholders, weakened
some major financial institutions and brought disaster
to hundreds of Indian business owners," says Amit Mitra,
secretary general of FICCI. "The simple issue is, if a
foreign direct investor or technology collaborator had
formed a joint venture with an Indian partner under
whose leadership a great brand name was created,
shareholders garnered and financial institutional loans
generated, can the multinational simply walk away and
form a 100 percent equity company of its own through the
new policy of the 'automatic FDI route', leaving the
Indian company in the lurch?"
Admittedly, going
by Mitra's logic, allowing foreign investors to walk out
of Indian joint ventures at will could be lethal. As
Mitra says, "Suppose Honda [Motors Ltd, which along with
India's Hero Cycles promoted India's largest two-wheeler
maker Hero-Honda Ltd] were to walk away from Hero
overnight and stop the supply of technology while
creating its solely-owned Honda, what would happen to
the shareholders of the Hero Honda brand? What would
happen to the loans from Indian financial institutions?
And what would happen to the owners of Hero in the
future?"
Similarly, imagine Suzuki walking away
from TVS-Suzuki overnight because 100 percent equity has
been allowed in that sector. "Many such success stories
of joint ventures would be ruined in a jiffy," he adds.
All that Press Note 18 requires, say its
supporters, is furnishing of details to the FIPB on the
circumstances under which a foreign investor would like
to part the Indian company and start a new joint
venture, a wholly owned company or form a new
partnership for technology transfer, including
trademarks.
Nevertheless, according to Joshi of
legal advisory firm Amarchand Mangaldas, "Press Note 18
contradicts the Indian government's promise to create a
foreign investment friendly environment in India and is
clearly archaic in the present economic scenario. It is
in the government's best interest to repeal it."
Which is why perhaps, cutting across ideologies
and policies, India's top political parties have been
trying to repeal the controversial clause for some time
now. The erstwhile Bharatiya Janata Party-led National
Democratic Alliance government - which advocated
aggressive reforms - tried it first, by initiating a
process about a year back, and now, according to finance
ministry officials, even Chidambaram - whose government
follows a softer stand on reforms - is keen on pushing
that effort of repealing Press Note 18 forward.
Meanwhile, the FICCI appears to be softening its
stand. Although Mitra was not available for comment on
the new finance minister's moves, a spokesperson of the
industry lobby admitted that with foreign direct
investment in almost all sectors having been put under
the automatic route and sectoral caps removed,
provisions of Press Note 18 did not seem valid in the
present circumstances.
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