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Reforms That Reflect A More Long-term Agenda Than Short

The latest FDI relaxations announced by the centre are expected to have limited, but positive impact on the Indian economic growth

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In line with its continued policy initiatives towards liberalising foreign investment in the economy, the NDA has once again announced further liberalisation in sectors such as single-brand retailing, aviation, construction development and financial markets. The relaxations are less big-bang reforms, as have been seen in the past, and more like tweaks to existing policy provisions. Nevertheless, they are likely to have marginal positive impact in terms of improved foreign direct investment (FDI) inflows, employment creation and adding to the centre’s capital receipts. The ‘Make in India’ programme, however, might take a hit in the short term as domestic producers face competition from foreign single-brand retailers. Plus, given the limited nature of the policy changes, there will be almost no immediate impact on growth, thus doing little towards providing political leverage to the ruling NDA government, which goes into polls next year.

FDI Inflows To Benefit
India saw FDI inflows of over $33 billion during the first half of 2017-18, an increase of 16.3 per cent over the corresponding period in the previous year. Even without the FDI push, a continuation of the trends from the first half of the current fiscal could have resulted in higher FDI inflows than those in 2016-17, at $60 billion. But with further FDI relaxation, the government has nudged the probability slightly higher. The latest figures could well be the third consecutive year of breaching previous records of highest amounts of gross FDI inflows. It can also be a significant achievement for the NDA government from the economic perspective, as it sees record FDI inflows for three in four years of its governance.

It needs to be noted that some of the areas addressed under the latest policy changes, are included in major beneficiaries of FDI inflows. For instance, between April 2000 and September 2017, almost 17.5 per cent of the total FDI equity inflows have been in the services sector, which includes finance, banking, insurance, etc. Almost 7 per cent FDI equity inflows have been received in the construction development segment, while relatively limited amounts have been received by sectors such as aviation and retail. However, the policy changes comprise only very specific segments within these larger sectors, thus allowing for limited improvements only.

Ease Of Doing Business To Improve
The relaxations will also allow India to be seen as a better environment in terms of ease of doing business, which has been an important focus area for the government at the centre. India’s ranking in the World Bank assessments have been on the rise. It ranked among the top 100, at the 100th spot, for the first time in 2017, a jump of 30 places since the year before. While a number of criteria used to assess the ease of doing business pertain to local conditions that impact small and medium size firms, the bank does point to a positive correlation between FDI inflows and better rankings as well.

Easing regulations in single-brand retail, in the present case, is particularly likely to feed into greater ease of doing business. FDI in single-brand retail was already at 100 per cent, but the latest reform allows for it to come entirely under the automatic route. Previously, only 49 per cent was allowed under the automatic route. The fine print also has promising relaxations. Earlier, single-brand retailers were mandated to source at least 30 per cent of goods from India, but now they need not source from India for up to five years of operation. That clause on sourcing was seen as one of the key reasons why foreign retailers found it hard to make an entry into India.

Further, ease of doing business could also receive some boost from the clarification that real estate broking services are allowed 100 per cent FDI under the automatic route, since they are not a real estate business. Similarly, allowing foreign portfolio investors and foreign institutional investors to invest in the primary markets for power exchanges, whereas earlier they were allowed only through the secondary markets, also boosts doing business.

Letting Go Off Aviation Deadweight
Easing FDI policy pertaining to Air India is also a welcome step, given the airline was making losses even after it received a bailout to the tune of Rs 30 billion in 2012. The centre has been looking to sell it off for a while, but couldn’t manage to, given the large debt overhang on Air India. A relaxation in the FDI policy is probably a measure to find more takers. While 49 per cent FDI through the approval route is at present allowed in Indian airlines, the same was not allowed for Air India so far.
If a stake sale of Air India comes through during the course of 2017-18, it will add to the possibility of the government achieving its disinvestment target for the current fiscal year. The budget estimates for disinvestments, which is sum of disinvestment of the government’s equity holdings and strategic disinvestment, stands at Rs 615 billion. For the period up to November 2017, 57 per cent of this target has been met. To the extent that the Air India sale can add to the disinvestment target, the fiscal gap has also narrowed, even if by a very small margin. So far, the centre’s fiscal situation is looking stretched. The fiscal deficit has ballooned to 112 per cent of its budget estimates up to November 2017, up from 86 per cent during the corresponding period last year.

Job Creation Benefits
The provisions for more foreign investments could also lend a helping hand to India’s fast growing labour surplus. The centre has faced criticism for not having been able to create enough jobs, which was a part of its poll promises. Sectors such as retail and aviation are potential job creators for the future.

‘Make In India’ To Be Hit
There is, however, a downside to the announcements as well. Relaxing of the clause for 30 per cent sourcing from Indian producers for single-brand retailers, can hit the ‘Make in India’ programme. Allowing easier foreign entry into the retail market creates greater competition for domestic producers in any case, but the removal of sourcing clause hits them even harder in the short term. That said, it can be argued that over the longer term, as the foreign single-brand retailers ease into the Indian market, the sourcing clause will come into play, which will make the market bigger for Indian producers.

Limited Growth Impact
Given the nature of the latest relaxations, there is unlikely to be any significant impact on the Indian economic growth. The Central Statistics Office (CSO) estimates India’s gross value added growth will be 6.1 per cent in 2017-18, an accelerated slowing down for the past two years and a come off of 1.8 percentage points from 2015-16 alone. Some pickup in foreign investments, could though, prove to be a token substitute for the lagging domestic investment cycle. Gross fixed capital formation has picked up pace since last year, but still remains subdued with a 4.5 per cent growth expectation as per the CSO’s advance estimates.

Political Gains Unlikely

There will also be very limited political gains for the NDA government from the latest initiative, given the limited nature of the policy changes. This is particularly so, since the government is going into a general election in 2019, and the effects of the latest changes could well take longer to come into play. It does, however, suggest that the government has a long-term agenda in mind. With the BJP gaining more power across states over the past few years, it is likely that the party expects to come into power, despite the fact that the growth cycle is in an unfavourable place.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

Manika Premsingh

Economist and Founder, Orbis Economics

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