Saturday, 18 July 2015

Composite Cap for Foreign Investments | Mayaram Panel

Why in news?
The Cabinet in July 2015 approved the implementation of ‘composite cap’ for foreign direct investments, essentially doing away with the distinction between various foreign investments by FIIs, NRIs and others FDIs.
Historical perspective:

  • Earlier, a government-appointed panel under the chairmanship of former finance secretary Arvind Mayaram had suggested moving to the system of composite cap.
  • For well over a decade, several official committees have addressed the issue of boosting foreign investment: 
    • in 2002, the then Planning Commission member  N K Singh headed an inter-ministerial steering group on FDI; 
    • Ashok Lahiri Committee in 2003-04; 
    • U K Sinha Committee in 2010 and, finally, 
    • Arvind Mayaram Committee which submitted its report in 2014.
What does the 'composite cap' mean?
  • Current distinctions between FDI, FPI and other categories of foreign investors have been abolished.
  • It will benefit sectors including commodity and power exchange where 
    • FDI sub-limit is 26% 
    • FII sub-limit is 23% 
    • Sectoral cap is 49%
      • Similarly, while for credit information companies sectoral cap is 74 per cent, FII and FPI limit is 24 per cent. These companies can increase foreign investments through FII up to the sectoral cap.
  • Foreign Currency Convertible Bonds (FCCBs) and depository receipts  would not be treated as foreign investment unless the debt is converted into equity. 
  • The Cabinet’s decision would apply on all the sectors except for banking and defence because these are sensitive sectors, strategically important to the country. 
    • We don’t want hot money of portfolio investment to come in these sectors beyond a limit
  • Banking:
    • Currently, foreign investment of up to 74% of the paid-up capital is allowed in the banking sector while the permissible limits through FIIs, FPIs and NRIs is 24% which can go up to 49% through a special resolution by bank.
  • Defence:
    • FDI limit of a composite 49% is allowed in the defence sector but the portfolio investment by FPIs/FIIs/NRIs/QFIs and investments by FVCIs together can not exceed 24% of the total equity of the investee.
Why this move?

  • This rationalisation is eminently sensible, given that the distinctions between various categories of foreign investments were based on the flawed logic that FPIs represent “fickle” investment as opposed to more “solid” FDI in plant, machinery and technology. 
  • The experience of the last two decades shows that foreign institutional investors have rarely undertaken equity sell-offs or exited in hordes. 
    • On the contrary, they have stayed invested in India, the proof of which is in their cumulative investment of over $227 billion since November 1992, the bulk of it ($169 billion) in equity. 
    • Even the run on the rupee in July-August 2013 had to do with FIIs selling in the debt rather than equity markets. 
  • The alleged “fickleness” of investments, if such a thing can be posited at all, is more about debt versus equity as opposed to FDI versus FPI.

Benefits of the move?
  • expected to boost FDI investment
  • help in simplifying foreign investment norms.
  • flexibility to issuers of capital, 
  • simplification of rules and 
  • greater transparency.
  • may lower the overall cost of raising capital for local firms.
  • helps remove uncertainty for both investor and investee companies
  • Greater clarity and legal certainty, 
  • eliminates inconsistencies, 
  • lowers transaction overheads, and 
  • does away with the costs of complying with multiple sets of rules and dealing with multiple regulators and authorities. 
  • It should boost overall investment flows, especially in sectors with multiple caps or ceilings such as commodity, power and stock exchanges, besides credit information companies. 
    • Foreign investors such as the Government of Singapore, which has a few investment arms in India, may not have to worry now about breaching limits while buying into companies as FDI or FII.
  • In line with  global best practices
Concerns?
  • Hot money and related concerns
  • Concerns in the defence sector relate to national security, and in the banking sector to ‘hot money’ flows — or the threat of volatile capital — and to the potential risk of a group of investors joining hands, especially through the portfolio route, to take control of banks. 
    • The RBI had flagged the latter concern in the case of a few old private banks — therefore, even now any investment of 5% or more in the banking sector has to be approved by the central bank. 
  • There are also worries about laundered money or terror funds coming into certain sectors, apart from attempts to ‘round-trip’ money back into the country.

What next?
  • What the government needs to do next is to look at greater easing of sectoral limits on foreign investment, including in defence or multi-brand retail. Most of these caps are based on old fears about multinationals taking over, while the evidence suggests that they stimulate domestic investment through creation of forward and backward linkages. 
  • Policy should now focus only on due diligence and ascertaining credentials of investors in the form of KYC.
  • Simultaneously, there is a need to be more mindful of debt flows, even while leaving it to Indian companies (and foreign investors) to choose the form of equity capital they wish to access (or invest in) and manage any risks arising from that.
[Sources: The Hindu, Indian Express]

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