India send mixed messages to investors on foreign direct investment

Investors in India who try to build roads or factories have found their feet tied by the arbitrary application of regulations in the past year, which helps explain why foreign direct investment into the country has shrunk.

Last Friday, the Indian government put into effect a new policy on FDI, which liberalizes the legal framework for investment. Take two restrictions it does away with. First, a foreign firm no longer has to ask for bureaucratic approval to invest in a sector where it has an existing joint venture with a domestic firm, a rule that protected the domestic firm from competition.

Second, a foreign investor who bought stake in a company with a convertible instrument now doesn’t have to fix in advance the price or formula at which, say, a preferred share could be converted into common stock. For the last year in fact, regulators forced firms to declare the absolute price of conversion, defeating the ability to alter the conversion price as an incentive for the future performance of the company.

The new policy doesn’t go as far as to remove certain caps that restrict foreigners to, for instance, 74% ownership in telecom. But it does decree 100% FDI in some agricultural areas and, equally important, plugs loopholes and discrepancies that earlier confused even lawyers. This will go some way in making the process of investing in India predictable.

But the sense of predictability New Delhi gives with one hand, it takes with the other. On Wednesday, the government further delayed approval of one of the largest FDIs into India: the $9.6 billion deal between London-listed Vedanta and British-owned Cairn India. Vedanta has been waiting for eight months to acquire Cairn’s oil fields, but has been held up because an Indian state-owned enterprise’s interests are on the line. Vedanta and Cairn have been negotiating with the government as it tried to change the rules of the game.

India’s cabinet was expected to settle the deal on Wednesday, but it has passed the buck to another ministerial panel. So at the very least, New Delhi has disrupted Vedanta and Cairn’s timeline. But it could derail the whole deal: India’s oil minister now says the cabinet is unanimous about helping the state-owned firm get its due, which will surely change Vedanta’s valuation of Cairn’s assets.

With this, India has signalled that an investor in a sector like oil—where "national interests" are at stake—will be meddled with. No surprise that the country found it hard last week to attract bids from global companies for oil exploration.

Which goes to show that, unless New Delhi deregulates as it did last week with its FDI policy, India’s growth prospects will be the victim. India’s politicians tout grand growth targets these days, but they should know that the few sustained growth spells this country has enjoyed since liberalization have come on the back of private investment. If they can’t encourage investors through simple, predictable rules, they won’t get any growth in return.

from Wall Street Journal