Thursday, February 2, 2012

FDI Needs a Strategy

India needs to maximise public interest from FDI in sectoral investments

Shyam Ponappa / Feb 02, 2012

The logic of strategic investment, stumbled upon for airlines after years of confusion, should drive policy on foreign direct investment (FDI). What a relief that FDI in airlines was cleared, somehow, at 49 per cent. This is undoubtedly positive for India’s aviation sector and consumers, i.e., in the public interest. Musing on the latter, there are aspects of FDI that point to the need for a nuanced strategy because of the economic and technological effects on domestic stakeholders.

FDI can be beneficial overall in many sectors as a source of capital, technology, systems and processes, and experienced human resources and organisation. A strategic approach could, however, lead to better outcomes for Indian stakeholders, through building local capacity and profiting from it.

Imagine if the airlines decision had happened 11 years ago. Arguably, Air India could have, once again, become a leading global airline in alliance with Singapore Airlines and the Tata group. Of course, it would have needed much more than just the investment decision to succeed.

Hundred per cent FDI: benefits and detriments

It is not a simple matter of the percentage of foreign holding. At one extreme are 100 per cent foreign-owned companies. There are several such entities in India, in sectors as diverse as pharmaceuticals, automobiles, chemicals and construction materials — or financial, IT and industrial services. Among these, Texas Instruments (TI) was a pioneer among technology companies. TI set up a subsidiary over 25 years ago in Bangalore, employing local recruits in research and design, with considerable success. This model has been replicated by Motorola, GE, Intel, Samsung, Microsoft and so on.

In terms of local benefits, these companies bring technology and access to markets, systems and execution capability and, most important, access to capital. The pioneers were initially stand-alone entities, with little effect on the local environment, other than excellent employment opportunities for qualified local talent. Over time, accretion led to critical mass as well as the emergence of local ecosystems around these enterprises, spawning new companies built on similar principles and culture. These were developed by talented people from the original enterprises, and others who were attracted to this environment of knowledge-based innovation. This makes Bangalore what it is, despite its inadequate infrastructure.

Similar effects are visible among automobile manufacturing clusters, e.g., around Chennai and in the National Capital Region. Suzuki’s joint venture with Maruti created an ecosystem of component suppliers near Delhi. Hyundai and Ford brought along their ecosystem of suppliers and set up in the vicinity of Chennai. Similar developments occurred elsewhere, as in the automotive cluster in Western India, with Tata Motors, Mahindra, Mercedes, and more recently, Volkswagen.

Consumers benefited immensely, as these enterprises extended the range of available products and services, and raised quality. They also provided challenging and remunerative employment to qualified local recruits.
Similar benefits show in areas like technology and R&D. Companies like GE address a broad range of technologies and products in India, such as wind turbines or materials research. The scope of activities is vast compared with the kind of product and material innovation prior to their entry. Subsidiaries of IBM, Microsoft and Ericsson are doing equally remarkable work in IT.

Some local benefits clearly accrue from the quality and range of innovation arising from the employment of high-calibre talent, a mix of external human resources together with opportunities for local recruits, backed by the corporate strengths of technology, capital, systems and market access. The quality of work content, therefore, is another local benefit from the entry of these companies.

However, a startling innovation is Huawei’s setting up of telecommunications Network Operating Centres (NOCs) in India. Huawei first set up an NOC in Gurgaon near Delhi in 2009 to cater to the Indian market. Another centre set up in Bangalore in 2011 now offers managed services to global networks. This is an example of leveraging local resources in a way Indian companies cannot, despite pioneering managed services from offshore — because they do not have Huawei’s combination of technology, manufacturing and financial capacity (with state backing).

The negatives are that local companies are often at a disadvantage when competing with well-known, well-funded multinationals for market share and for talent. Dominant multinationals can smother nascent local manufacturers and service providers who do not have their capital, technology, design, or human resource strengths. However, multinationals have greatly improved quality as evidenced by automobiles and consumer goods. In all these cases, did India have a strategy, or was it happenstance?

Listed foreign investments

Another type of foreign-owned company is listed on domestic stock exchanges and actively traded, with a broad retail ownership, such as Hindustan Unilever, Nestle, or the Procter & Gamble subsidiaries. The benefit to Indian stakeholders is that they get to share in the profits of these enterprises while sharing the risks, in contrast to the fully-owned subsidiaries in the automobile, pharmaceutical, or banking sectors. It is clearly in the local interest to require companies with strong prospects to allow participation in their profits (though WTO considerations might determine the idea’s feasibility). In other words, WTO permitting, fully-owned subsidiaries in booming sectors that profit from local markets or resources should be required to have listed public shares. Likewise, local participation in profits is lost if multinationals delist or increase their holdings.

Extended to profitable Indian companies, the implication is that profit participation is desirable for local stakeholders. From this perspective, there’s little reason for permitting dilution of local shareholdings, or an increase in foreign ownership to 74-100 per cent.

By the same token, the “deadweight loss” to social welfare (i.e., the public interest) through high taxes/fees on inputs and services needs to be reduced, as in the case of petroleum products, or radio frequency spectrum charges.

To conclude, a strategic approach to foreign investments should be applied to areas with high potential, such as aviation and telecommunications. Specifically, efforts should be made to emulate focused, convergent initiatives – as in Huawei’s development – through consistent long-term support for a manufacturing ecosystem integrated with R&D and managed services. Otherwise, India’s imports in these sectors will dwarf its current energy and defence imports. Opportunities for local participation through listing are desirable for a share of profits to be retained.

                                                                     shyamponappa at gmail dot com