The Institute for Studies in Industrial Development (ISID) is a national-level policy research organisation affiliated to the Indian Council of Social Science Research (ICSSR). Having joined the Corporate Studies Group (Indian Institute of Public Administration), the predecessor of ISID, in 1980, professor KS Chalapati Rao has over three-and-a-half decades of experience in studying various aspects of India’s industrial policy and corporate sector. His research contributions have been in the form of project reports, articles and working papers. In one of the institute’s reports on the manufacturing sector titled FDI into India’s Manufacturing Sector via M&As: Trends and Composition, Rao and his colleagues have pointed out that India’s FDI policy and the resultant M&As have failed to spur the manufacturing sector, the prime focus of the 1991 policy shift. In an interaction with Outlook Business, Rao talks about what went wrong and how
What was the nature of the study that led to the creation of the working report?
The study is a part of a two-year research project on India’s inward FDI experience in the post-liberalisation period, with emphasis on the manufacturing sector. The basic premise is that the current level of understanding of foreign direct investment (FDI) is grossly inadequate and misleading. FDI being based only on 10% foreign ownership and devoid of the essential elements associated with FDI contributed to this state of affairs. Besides an in-depth understanding of India’s reported FDI inflows (type of investor, mode of entry, role of tax havens), the study intends to analyse global cross-border greenfield investments, foreign PE and VC investments, related-party transactions and pattern of transactions in foreign exchange by major manufacturing FDI companies operating in India. The study should be completed by mid-2015.
The idea behind FDI in 1991 was to create more manufacturing jobs. So, where did India falter? Have we watered down the policy?
India started off with the assumption that an unfettered FDI would deliver. It gave up many performance requirements voluntarily even before some of them could be outlawed under the WTO. India even categorically stated that technology need not accompany investments. Notwithstanding the expectation that FDI could provide access to external markets and, thereby, promote exports, India sought to attract FDI on the strength of the domestic market represented by a large middle class population. The dividend-balancing condition specified in the early period was soon watered down and allowed to lapse. Instead of leveraging the domestic market, India expected the benefits to follow automatically. In the process, it ignored the experience of Japan and South Korea.
In the process, the basic understanding that technology licensing and FDI are substitutes and not complementary seems to have been ignored. Given the fact that India was also subjected to conditionalities by multilateral institutions, it would be difficult to distinguish the influence of external pressure and the preferences of policy makers and their advisers. It is, however, relevant to note that in 2008, the group appointed by the then prime minister Manmohan Singh to suggest measures for ensuring sustained growth of the Indian manufacturing sector raised some critical points. (see: What they observed) It is evident that the MNC-dependent strategy endorsed by most of the international scholars did not deliver the expected benefits to India.
Why have MNCs used FDI for M&As instead of greenfield strategies as the report states? And why is it that Indian manufacturing entrepreneurs were more than willing to sell their businesses (of course, apart from the fact that they were being offered very good multiples)?
Indian entrepreneurs had set up world-class enterprises that international companies could integrate into their operations. Not many of the taken-over companies were sick. In fact, even while giving a backhanded compliment to Indian industry, the Indian policy-makers thought that FDI would be a disciplining factor that would provide competition and make Indian entrepreneurs a better lot. The budget speech of 1991-92 said, “[FDI] would expose our industrial sector to competition from abroad in a phased manner. Cost, efficiency, and quality would begin to receive the attention they deserve.”
India also dismantled the developmental financial institutions and expected corporate financing to be market-based, ignoring the limitation that stock market financing cannot be universal. A number of taken-over companies were associated with private equity financing, for which M&A is a major exit option. The PE route also has the disadvantage that net inflows would be far lower than what the aggregates would suggest. For instance, of the total inflow of $887 million recorded in case of Paras Pharma and its subsequent acquisition by Reckitt Benckiser, as much as $507 million went out straight away. The PEs made a killing in the process by gaining 3-4 times in just five years. In case of Mylan’s takeover of Matrix labs, too, bulk of the proceeds were on account of foreign financial investors. The selling Indian promoters got far less.
A number of the taken-over companies were promising start-ups that either depended upon foreign financial investors or were unable to scale up their operations globally. In the freer regime, foreign companies were also reluctant to transfer technology, thereby making it more difficult for Indian companies to catch up. A stricter IPR regime turned out to be an additional constraining factor. On the other hand, Indian companies’ investment in R&D remained low.
Lack of support from development financial institutions, dependence on foreign PE and VC investors and low risk-taking ability appear to be some of the important contributing factors to the sell-offs.
Why have Indian domestic companies failed to create capacity and instead opt for imports from China and overseas?
This is where India’s eagerness to get into trade liberalisation and entering into FTAs without preparation hurt its interests. For instance, the information technology agreement virtually robbed India of its electronics industry. No wonder, then, that both Samsung and Micromax are heavily import dependent. Following the FTA with Thailand, Sony had in fact abandoned all manufacturing in India. Voltas also engages in substantial imports of finished goods. Out of its imports of nearly $530 million from FY12 to FY14, finished goods accounted for as much as 72%, with 26% going to stores and spares. With a 0.2% share, capital goods imports are virtually absent. This story holds true with many other consumer goods, including some leading Indian brands. The situation is best summed up by the data released by the RBI on the operations of foreign manufacturing subsidiaries for FY13. Except for pharmaceuticals, food products and machinery and equipment, all other branches of manufacturing exhibit a negative trade balance, the aggregate being $20 billion for the year. (see: Lopsided) The positive trade balance in the case of pharmaceuticals could be due to the takeover of heavily export-oriented Indian companies such as Ranbaxy and Matrix labs. Direct imports to purchases ratio was high in most branches, the highest being 79% in case of computer, electronic and optical products. With such hard evidence, it would be difficult to expect Indian companies to invest in large capacities.
Are we barking up the wrong tree when we pin the blame on the bureaucracy and archaic regulations for the failure of India’s manufacturing sector to thrive?
It is a fact that Indian industry and the government have been heavily dependent for advice on foreign consultancy firms, which have far greater dependence on their global clientele. While India has opened the manufacturing sector to FDI and also liberalised the trade and technology imports regime, its failure to attract a large amount of manufacturing FDI has to be explained without going against the global received wisdom. The investment climate thus came in handy as an explanation. Successive governments have emphasised the need for monitoring large projects but the results are hardly visible.
Opening up is greeted as an act of reform but underlying assumptions are never looked into deeply. For instance, caps on FDI in certain sectors are almost a farce. The reality is different from the expectations from the caps. Is it so difficult for DIPP, FIPB, RBI, MCA and CSO to come together to bring out objective and policy-relevant data instead of the data routinely dished out by them? Thanks to the exemption available to private companies, data on the operations of large FDI firms in India is also becoming difficult to get. The absence of reliable and relevant data also takes attention away from the problems with India’s trade policy, which seems to be the culprit.
Could you talk about overseas acquisitions by Indian firms? Did India Inc go on a global M&A binge to derisk its domestic business, or is there something amiss?
No single objective can explain India’s outward FDI (OFDI). However, India’s overseas M&As are acquiring troubled assets. Some companies have the objective of acquiring technology that they were unable to get in the liberalised domestic FDI policy regime while some consider energy security. Then there are those whose objectives aren’t honourable. Use of holding companies and tax havens obscure the end-use of funds, thus raising doubts about their real intentions. But what is difficult to digest is how a country seemingly short of investments can promote outward investments with no clear-cut strategy. While citing a host of benefits, including foreign exchange earnings through dividend earnings and royalty, RBI says that integration of the Indian economy with the rest of the world with all its attendant benefits is achieved through overseas investment. Not only is India encouraging companies to invest abroad by permitting up to four times their net worth, it is allowing mutual funds to invest in overseas stock markets and has provision for foreign companies to raise funds from India through IDRs. With loans constituting a large portion of India’s OFDI figures, much of the risk is borne by Indian financial institutions. In a way, the country is reluctant to look at empirical evidence for fear of failing to justify the course suggested by the dominant paradigm.
Does India have a shot at becoming a manufacturing hub? What needs to be done?
The first step would be to review all FTAs, investment agreements and tariffs. India has little leeway where further opening up of the manufacturing sector is concerned. Technically, defence industries are also open for 100% FDI. Globally, cross-border FDI flows from developed countries have been falling and greenfield investments haven’t really materialised. The difference with China narrows when one moves from the aggregate inflows (3.96X) in 2003-2011 to greenfield investments (2.24X) and to M&As (1.54X).
The issue of manufacturing should be tackled from the ground level. States should be made aware that any incentives offered by them should be related to certain agreed monitorable performance requirements. Domestic enterprises should be taken into confidence. Development financial institutions with a mandate to promote Indian enterprises should be revived.
Does that require a shift in mindset, too?
The mindset of being on the right side of foreign investors to benefit from them needs to change. Policy-makers should start believing that with concerted efforts, domestic winners could emerge. This is a lesson that India should have learnt from China’s experience, where the latter is ready to challenge Microsoft, Google and Amazon.
What They Said
In his preface to the report India’s Economic Reforms, July 1993, Dr Manmohan Singh, the then finance minister, explained that he had invited the two “outstanding and internationally recognised academicians [Jagdish Bhagwati and TN Srinivasan] to study the reforms underway and to make recommendations for future action.”
What Was Observed
Excerpts from the National Manufacturing Competitiveness Council report from Sept ‘08
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