The FDI Conundrum

Gyanendra Kumar Kashyap

It was on June 27, 2012 that the government criticized for its inability to push through reform measures decided to ‘reverse the climate of pessimism and revive the animal spirit in the country’s economy.’ Cabinet reshuffle and the so called ‘BigBang’ reform measures announced on September 14, 2012 which allowed for opening  the doors for greater flow of FDI are attempts to bolster economic growth and make India a more attractive destination for foreign investment. Despite the debate and logjam in political circles, India Inc. is upbeat and is hopeful that the measures announced would start showing positive results in the next 18-24 months. Questions on the impact of FDI in the context of productivity, economic growth, employee-employer relations, talent deficit, and infrastructural bottlenecks are being raised as well as addressed. Thus, it becomes all the more important to have a conversation on FDI & what it means for sectors that will probably benefit from it. 

The Indian landscape is not new to FDI.  Automobile, Telecom and IT/ITeS serve as excellent examples of what capital and technology infusion can have. Be it in term of employment generation, contribution towards GDP, providing more choice to consumers and of course raising the productivity of these sectors and making them globally competitive; the impact of FDI is for all to see. Dr. Varun Agarwal and Mohd Aamir Khan in their study, “Impact of FDI on GDP-A comparative study of China and India”, International Journal of Business & Management, October 2011, conclude that their study “confirms FDI promotes economic growth, and further provides an estimate that 1% increase in FDI would result in 0.07% increase in GDP of China and 0.02% increase in GDP of India.”

Perhaps, these served as the background for the recent decision to allow FDI in some sectors (aviation, pension etc.) and increase the cap on others (retail and insurance). In essence FDI will provide for both capital and technology. Capital on its part will help build up the productive capacity in the economy, and providing advanced technology and organizational know-how will help increase the efficiency or productivity of investment. For instance, a general observation is that India has low productivity of food grains and an inefficient distribution system. Increasing the scale of investment in organized retail will enable increase in productivity and distribution efficiency. For the insurance sector, this could provide the private insurers the necessary financial wherewithal to reach out to untapped markets. FDI in aviation will give the much needed breathing space for players.  Apart from these, a higher share of FDI is expected to increase market competition thereby raising competitiveness in terms of products and service offerings.

Retail:

As far as the retail sector is concerned, there is a need to compress the market chain and reduce the ‘distance’ between the farmer and the consumer; build a modern, integrated logistical chain involving grading, transport and storage; and add value to perishable commodities to reduce volatility and create wealth and jobs. All these things need investment, infrastructure, technology, management practices and deep pockets. Capital infusion in the form of FDI is one possible answer. An important aspect is the governments move to move to make it mandatory for multi-brand retailers to invest $100 million with at least half the money being compulsorily spent on back-end infrastructure, in the first three year of operations. While foreign players have expressed their apprehension on this, the proponents feel that the move will improve back-end infrastructure. It is to be noted that though India allows 100 percent FDI in cold storage, this has not evoked much of a response in the absence of FDI in multi-brand retailing. A better infrastructure is expected to increase productivity and distribution efficiency by minimizing the role of intermediaries and link the farmers directly to consumers. It will strengthen rural-urban linkages, encourage agro-processing and check post-harvest losses.

Retail (organized and unorganized) provides employment to about 40 million people in India. The government claims that FDI in the retail sector is likely to create as many as 10 million jobs in a span of 10 years, making it the largest sector in organized employment.  For instance, entry level jobs profiles - sales, supply chain executives, security personnel, attendants, in-shop supervisors, floor managers and warehouse supervisors are likely to see significant increase in demand. The present guidelines ensure that FDI in multi-brand retail must domestically outsource 30 percent of the finished products sold in the market. This will help build domestic capacities in manufacturing, create jobs and help build quality human resource. Given the skill/talent deficit, this implies that the new set of retailers will have to invest in training and skilling the manpower – quality controller, standardizer, certification agency, processor, packaging consultants etc.

Insurance /Pension:

The capital intensive insurance sector, which allows for 26 percent FDI, is crunched for money. It is expected that of the announcement to increase the cap to 49 percent can muster the support of the parliament then it will usher in capital infusion to the tune of Rs. 30,000 crores over the next five years. Besides providing capital to the bleeding insurers, the decision will also pave way for new players. The biggest advantage of increasing FDI limit will be to grow the industry by increasing customer penetration with a range of products that are focused on today’s uninsured.  Given the lack of legislative action, many a private players are not very upbeat about the decision, pointing that other avenues such as listing are available to raise capital.

According to Department of Financial Services, just 12 percent of India’s active workforce has a formal pension or social-security plan. The intention behind the pension bill – and allowing greater foreign investment in the pension sector – is ultimately to entice more Indians to open retirement-savings plans.  Given the current structure of India’s pension sector, whereby the majority of such assets are managed by a government agency, the Employees’ Provident Fund Organization, foreign players would not be very interested. Add to this the risk averseness and preference to put money into gold and property or in bank deposit. Yet analysts believe that foreign money managers will invest in India anyway, betting on the growth potential of the sector. Perhaps it is too early to figure out whether or not foreign investors will make a real impact on increasing India’s pension assets.

Aviation:

FDI in aviation is expected to bring in much-needed long-term financial and strategic capital and expertise. However, the real question that seeks attention is that why would foreign investors sink money in order to revive Indian carriers with losses running into thousands of crores? Take for instance, in the last reported financial year (2011-12), Jet Airways, India’s largest carrier by market value, reported a loss of Rs 1,236 crores. The Kingfisher’s losses stood at Rs 2,328 crores while Spicejet posted a loss of Rs 605 crores. On top of it, Jet, Kingfisher and Spicejet’s balance sheets are highly leveraged with debt of Rs 13,500 crore, Rs 7,057 crore, Rs 860 crore respectively.  If foreign investors decide to invest, it is the bakers who have lent money to the sector will be happy. What further renders a grim look to the whole sector is the restrictive and retarding environment in which airlines have to operate. Even International Air Transport Association (IATA) has expressed its reservation stating that unless issues of high taxes and infrastructure costs are addressed, sector may struggle to take-off despite allowing FDI. Domestic carriers like Indigo and Jet who have made the most of the fall of Kingfisher and Air India believe that the FDI decision will hamper growth of the airlines.

On the positive side, if foreign investors post their assessment decide to put their money it would help the domestic players to acquire more aircrafts, add more to its existing route, invest in employing & training pilots, technical staff and crew members.  And of course a few domestic carriers would be in a better financial health to pay salaries (pending for months) to employees. New routes provided the government sorts out the policy and infrastructure reforms, besides providing better connectivity would spur economic activity and new businesses.

A few concerns

Focus on human capital development: While FDI inflows create a potential for spillovers of knowledge to the local labor force, the host country’s level of human capital determines at the same time, how much FDI it can attract and the extent to which the local firms can absorb the spillover techniques. FDI is complementary with human capital, that is, human capital needs to be above a certain threshold for FDI to be more productive than domestic investment. Though FDI may bring with it advanced technology and techniques, India needs to have sufficient absorptive capacity, in terms of qualified people, to benefit fully from it. Without a sufficient level of human capital, the country will not have the absorptive capacity to take full advantage of FDI. Given the skill deficit, it makes for a case that India should create a supportive environment of innovation and skill upgrading. Companies on their part need to invest in training and education and put greater stress on skill building.

 Labor laws: Labor laws fall under the jurisprudence of state governments in India.  Thus, states may use labor laws as instruments to attract (or deter) foreign direct investment.  Depending on the political nature of the government in power, states pass amendments to labor laws that are either more pro-worker or more pro-employer. This may affect outcomes of collective bargaining, disputes, and strikes. Given costs of locating in India (exit barriers, lack of adequate infrastructure, and other factors), it is likely that foreign firms will veer away from states that have high incidences of labor conflict, particularly as measured by the number of man-days lost due to work stoppages translating into higher production costs, low productivity, and thus, reduced profits. Nidhiya Menon and Paroma Sanyal in their work, “Labor Conflict and Foreign Investments: An Analysis of FDI in India” conclude that since FDI brings significant positive benefits, from a purely economic perspective, it may be prudent for state governments to try and reduce the incidence of labor disputes.

FDI, though welcome, is certainly not a panacea; it is important to have in place measures that address infrastructural hurdles and business –unfriendly environment.