Seize the Crisis

Between January and March this year, the People’s Bank of China (PBoC), the Chinese central bank, quietly bought 17,492,909 shares in HDFC, India’s top non-banking mortgage company. With this, the shareholding of the Chinese entity in the Indian firm crossed 1 per cent, the threshold after which the investment had to be disclosed legally. When that happened last week, alarm bells rang in New Delhi. The script was familiar: from Europe to Asia, state-backed Chinese entities were stepping in to buy assets even as prices fell in the wake of the unprecedented Covid-19 pandemic.

Within no time, the Union Government tweaked its Foreign Direct Investment (FDI) norms even as it made plans to woo potential investors ‘fleeing’ from China. On April 17th, it issued fresh guidelines specifying that ‘…an entity of a country, which shares land border with India or where the beneficial owner of an investment into India is situated in or is a citizen of such country, can invest only under the Government route.’ Shorn of bureaucratese, the meaning was clear: Chinese investments will now require permission from the Union Government. Earlier, these restrictions were imposed only on entities from Pakistan and Bangladesh.

As expected, China was quick to respond. The spokesperson of its Embassy in India, Ji Rong, said on April 20th: “The additional barriers set by the Indian side for investors from specific countries violate World Trade Organization’s (WTO) principle of non-discrimination, and go against the general trend of liberalization and facilitation of trade and investment…We hope India would revise relevant discriminatory practices, treat investments from different countries equally, and foster an open, fair and equitable business environment.”

This was an over-reaction. Government sources told Open that China’s allegations of discriminatory practices have no basis: “Seen from a multilateral trading perspective, India’s actions don’t fall foul of any trade agreements. Our actions don’t violate TRIMS (Agreement on Trade Related Investment Measures) as it is just a change in process of investment and did not ban investments.”

“India’s changes in its FDI policy do not affect trade in goods and neither is it a market access or national treatment restriction. As such, the changes do not involve any World Trade Organization (WTO) issue,” the official said, adding: “There is no question of Bilateral Investment Treaty (BITs) violation as these BITs (between India and China and India and Nepal) have been terminated. No retrospective action has been taken to negate existing investments after the change in FDI policy.”

In contrast to India merely changing its procedure for FDI from China, Beijing has inflicted serious damage on the prospects of Indian and other investors in its territory. The list of China’s obstructive behaviour is far more extensive than what can be described here. But some examples are noteworthy.

The growth of Indian technology companies in China that have operated there for a decade has been limited, if not crippled, beyond a point by market access restrictions and non-tariff barriers. Here, the contrast between the behaviour of the Indian Government and the manner in which the Chinese government reacts to interests of private companies is instructive. What has happened to Indian companies is well-known to the Government. China, on the other hand, has thrown the full-force of its official machinery in backing Huawei in its efforts to push 5G technology to unwilling countries. Most democracies are unwilling to let in Huawei’s technology for security concerns and the close links between the company and the Chinese state. This is now considered by many observers as a key faultline
between democracies and authoritarian states.

If that were not enough, China relies on a ‘nationwide negative list’ to control market access restrictions for foreign investors in many sectors. Financial services, media, telecom, automobiles and transport equipment remain out of bounds for many foreign investors.

India’s reaction was along expected lines as the country seeks to protect its companies from unwelcome acquisitions by China at a time when the India and the world are busy fighting a viral pandemic. This has been noticed widely. “I think Modi is a hero. I think Modi has stood up [to China]. I want this done in the US and this has to be done in Europe,” former White House Chief Strategist Stephen Bannon told a TV channel in response to a question on changes in India’s FDI policy. Bannon compared China’s “predatory capitalism” to the behaviour of the East India Company.

Since the opening of the world economy more than three decades ago, China has gained immensely from the system of open markets and free trade. For much of this time, the world had been more than happy to gain from cheap goods produced in China and supply lines shifted there over time. This continued until about a month ago when the coronavirus crisis fanned out. By then, it had become clear that ‘globalisation with Chinese characteristics’—China’s mercantilist outlook and cornering of vital medical resources during the crisis—was broken. In Europe, there are calls for increased scrutiny of Chinese investments. Japan is devoting $2 billion to shift production lines of its companies from China back to its territory. India, a late-mover as always, is also ‘exploring’ options to woo companies that want to leave China for other countries.

India is not behind in following these changes. The changes in FDI policy are the immediate response of the Centre. At the level of state governments, notably Uttar Pradesh, efforts are on to craft a special package to attract companies that want to explore alternative options to China. Gujarat is another state that is trying to seize this opportunity. The state government has written to the Japan External Trade Organization, the US-India Business Council and the US-India Strategic Partnership Forum, inviting companies to Gujarat from these countries. What works in favour of Gujarat as compared to many other states is its much better developed industrial infrastructure.

The trouble is that India never manages to exploit these opportunities that are at best fleeting and need to be grasped very fast. A year ago, many companies left Chinese shores by droves. But instead of coming to India—the country widely speculated at that time to be a possible beneficiary—these investments landed in countries like Vietnam and Mexico. Not only was there no red tape in these countries but their governments cleared all roadblocks in the path of investments.

“I think countries that were better able to support the establishment of new production facilities with land, infrastructure, etcetera, were more successful in bringing in capital. Vietnam has been praised for its agility, perhaps deservedly,” Pravin Krishna, professor of international economics and business at Johns Hopkins University, US, told Open. Krishna, however, cautioned against overt comparisons between India and Vietnam as the latter enjoys other advantages. “One should be cautious in comparing India’s exports with Vietnam and Bangladesh though, as these countries have duty-free access to the EU market through the Everything but Arms agreement, and India does not.”

There are recent reports that close to 300 foreign companies are in ‘active engagement’ with the Indian Government to explore India as an investment destination.

On paper, FDI flows in India have accelerated greatly in the last five to six years when compared with the situation two decades ago. In the last four years for which data is available (from 2015-16 to 2018-19), FDI equity inflows—a better measure than the aggregate inflows, which are even higher—showed that India routinely received flows in excess of $40 billion per year. Compared to China, these are peanuts but by India’s historical standards, these appear to be decent sums. And yet, the picture is deceptive. In key sectors where inflows can make a difference—power, automobiles, chemicals, drugs and pharmaceuticals among others—they were, in percentage terms, in low single digits. In contrast, services and computer software and hardware garnered a much higher share.

This is reflective of India’s services-dominated economy. But it is also a product of policy missteps and measures getting lost in red tape. The big-ticket investments where a single project can ‘move’ an entire sector are missing.

Last year, in her Budget speech, Finance Minister Nirmala Sitharaman proposed 100 per cent FDI for insurance intermediaries. These intermediaries—third-party administrators, assessors, insurance repositories, insurance brokers and surveyors—are essential for any insurance market to work. Allowing FDI in this area will lead to importing of best practices, technologies and ideas. Earlier, the investment limit was capped at 49 per cent. So, on paper, this was a great move that would have led to the modernisation of the area. Instead, even the notification of the move was stalled for nearly seven months and was finally moved in late February, just weeks before the coronavirus pandemic hit India. That was not all: there were conditions attached to the move to bring in FDI, including ‘Indianisation’ of the top management of a company receiving FDI in this area. The point is moot now: in a very uncertain world, this ‘liberalising’ move will in all likelihood remain a dead letter. Even here, the area where money can come—insurance companies proper—remains out of bounds for foreign equity. The cap on FDI in insurance companies remains at 49 per cent. Indian companies remain shielded from competition that can make them efficient.

Even in totally liberalised sectors, the policy is designed in a way that no foreign investor will put his money in India unreservedly. A good example is single-brand retail. The FDI policy allows 100 per cent FDI. But this comes with such riders that an investor has to run a steeplechase before he can do anything. Investment up to 49 per cent is ‘automatic’. Beyond that, the investor has to seek government approval. Once, investment crosses 51 per cent, the investor had to compulsorily source 30 per cent of the value of goods purchased from India, ‘preferably from MSMEs (micro, small and medium enterprises), village and cottage industries, artisans and craftsmen, in all sectors.’ Those guarding the gates of FDI inflows appear not to have thought about what would happen if the goods needed by the investor were not available from ‘village and cottage industries’ and craftsmen.

Ultimately, it took some heavy political lifting to change these sourcing norms if the policy was going to be of any use. The result is that not even a handful of global brands are present in India’s single-brand retail market. The only ‘success story’ is that of Swedish giant IKEA. The chances of global multi-brand retailers ever cracking the Indian market can be safely reckoned to be low. These stories can be multiplied several times over and in different sectors.

Can India do something at this stage to woo investors wanting to exit China?

The reasons for hope lie in the experience of Prime Minister Narendra Modi in wooing investments in his previous avatar as the Chief Minister of Gujarat. His clearing of hurdles to attract major investments for automobiles in the Sanand area have not been forgotten. Even if India manages to wangle two or three big-ticket investments at this time, it will help the economy in a big way.

The crisis India faces is not just in the case of large investment by big companies but also in the far more vulnerable Micro Small and Medium Enterprises (MSMEs). These companies are almost existing crisis-to-crisis. Even two decades ago, specialised development finance institutions catered to these. Those institutions are now gone and venture capital funds are simply not interested in funding MSMEs. This is one sector the Government needs to provide succour to once the worst of the coronavirus crisis is behind us.

The challenge for India will begin after the lockdown ends and when the speeding up of the economy will be necessary. This is especially true for sectors that are ‘customer-facing’.

So far, the Government has proceeded cautiously and its macroeconomic management has been sound. It has resisted calls for a large fiscal stimulus to be imparted at one go. This is based on the possibility of potential risks in future that might necessitate further spending then. It is a foregone conclusion that more spending will be necessary. The approach of the Government at the moment is to keep its powder dry even as it seeks to bring in as much foreign capital as possible.

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