Tackling the FDI headache

Coca-Cola: its expansion in India has been hampered by divestment rules

Singh's group produced a report in September that the government is set to act on in the run-up to February's budget. It says that if India is to raise the annual GDP growth rate to 8%, it must attract $8 billion in FDI each year, more than twice 2001's $3.9 billion. India's share of the total $225 billion FDI invested in developing countries in 2001 was just 1.7%, and FDI constitutes under 1% of its GDP, compared with just under 4% in China and Malaysia.

India, says the steering group, has one of the most liberal and transparent FDI regimes among developing countries, and often it is in fact domestic policy - applying to all companies, foreign or Indian - that foreign investors find irksome. Curiously then, the group suggests that limits on foreign ownership must be raised and that India should have a foreign investment promotion law comparable to those in Korea and Malaysia.

Foreign investors find that limits on foreign investment, and changes in investment policy, can put them in difficulties. Three years ago, Shell got Foreign Investment Promotion Board (FIPB) approval to trade in petrochemicals products on condition that it divest 26% of its company to local investors.

Last June Shell went back to the FIPB seeking a waiver because the rules now allow foreign companies to own 100% in the petrochemicals trading sector, but it was turned down in October. A plea by Coca-Cola for a waiver of the 26% divestment condition has also been rejected. Both Shell and Coca-Cola are privately held companies in India, and would rather not be listed there. They are, say corporate lawyers, likely to sell small stakes privately to suppliers or their Indian employees to get past the rule.

Foreign private-equity investors find that the restrictions on foreign ownership prove obstructive at the time of exit. Foreign ownership in telecoms companies is capped at 49%. So when Bharti Televentures, in which Warburg Pincus is a large investor, went public this year, foreign portfolio investors could buy few shares since foreign ownership was already at around 40%.

Donald Peck, who heads CDC Capital Partners in India, says that if foreign portfolio investors cannot buy their shares, private-equity investors often have to settle for a lower exit price. CDC and American Insurance Group are investors in BPL, another unlisted telecoms company.

CDC had invested in Satyam Infoway, an internet access start-up, some years back. At the peak of the internet boom, Satyam Infoway could not get listed in India because listing rules required that a company must make profits for three years before it goes public. So the company listed on Nasdaq, but CDC could not sell its shares because the Indian rules then barred conversion of Indian shares into American depositary receipts. The rules have since changed but the boom had gone bust by then.

Not all foreign investors are put off by Indian rules; some have found ways around them. Foreign companies that are minority partners in Indian telecom and insurance joint ventures know that restrictions on foreign ownership will be eased in time. Prudential, Standard Life and ING own 26%, the maximum allowed under law, in Indian insurance joint ventures. So they have invested in other group companies of their Indian partners to secure their investment in the insurance venture. Dutch bank ING, for instance, gained control of Vysya Bank, its partner in an Indian insurance venture, soon after regulations were eased early this year, allowing foreign ownership in private banks up to 49%. Bart Hellemans, managing director, ING Vysya, says the group will raise its stake when regulations allow.

Lawyers have also helped design joint ventures in telecoms to get around the 49% foreign ownership limit. The foreign firm owns 49% in the telecoms joint venture but can own another 49% in the special purpose vehicle that owns the other 51%. Foreign companies effectively control up to 74% of telecoms joint ventures, says a lawyer.

The curbs on FDI make investing in India tedious. The FDI panel report has suggested that caps on FDI be raised from 49% to 74% in telecoms, 26% to 49% in insurance, 40% to 49% in civil aviation, 20% to 49% in direct-to-home satellite broadcasting. It has also suggested opening up investment in housing, real estate, off limits to foreigners so far, removal of existing limits on investment in private banks (49% to 100%) and oil and gas pipelines (51% to 100%).

Singh's group, however, endorses a ban on foreign investment in the retail trade; possibly because of concern about small shopkeepers being put out of business. About six months back, more than seven years after the internet and foreign TV news channels entered India, foreign investment in print media was finally allowed. Old ways die hard.