f o r    m a n a g i n g    t o m o r r o w
FEB. 25, 2007
 Cover Story
 BT Special
 Back of the Book
Business Today,  February 11, 2007
The centre is looking at removing the distinction between FDI and FII investments. This will impact sectors like asset reconstruction, real estate and aviation, where separate ceilings apply to FDI and FII investment. However, allowing FDI through the FII route in the realty sector could result in prices shooting through the roof. The Asian financial crisis of the '90s is still fresh in mind, and a method should be devised to moderate possible volatility in key sectors.

The long-held perception is that-FDI in principle is expenditure on physical investment by a foreign partner that brings with it a modern technology and experience. While, FIIs provide liquidity in the market. FIIs are free to buy and sell shares on Indian stock exchanges and can freely remit funds into and outside India for purposes of such transactions. On the other hand, non-FII foreign investment, including investment from non-resident Indians (NRIs), is treated as FDI.

Having said this, would it really impact the Indian industry once the distinction is gone? Well, as a matter of fact, it won't. The Tata Steel's take over of Corus, to become world's fifth largest steel maker is a case in point. To clinch the deal Tata Steel didn't have to bring in a foreign partner in its board. Even the more recent buyout-Hindalco acquiring Atlanta-based aluminum manufacturer, Novelis was not through any joint venture with a foreign company.

Even Airtel and Reliance didn't consider giving equities to a foreign telecom company in their respective while launching their telecom services. So to launch and run a business successfully one does not require bringing a foreign partner in shape of FDI.

So it is for the shareholders and the board of the members to decide whether they require a foreign institutional investor's money or FDI. The fear that FIIs are good weather friends who would exit the country at the first sign of trouble is also unfounded. The Indian economy in 2007 is a matured one. Over the last few years, portfolio investments in the Indian stock markets have continued to increase. The private equity firms invested $7.9 billion (Rs 35,550 crore) in several companies and start-ups in India in 2006.

The government, however, is opposed to FDI in real estate through the FII route. Tough norms on foreign investment are encouraging companies to put foreign investments into realty in the garb of FII funds. The norms on foreign direct investment are tough, leading to many instances of ineligibility, while they are comparatively easier for FIIs. Moreover, a majority of the projects of any real-estate company does not comply with FDI norms. FIIs are currently allowed to invest in real estate companies through the secondary market but they cannot invest in pre-IPOs or IPOs or follow on public offers (FPO).

Also the RBI has been cautioning the government against large-scale FDI flows into the realty sector which is showing clear signs of excessive speculation and has led to an asset-bubble, as indicated by prices shooting through the roof.

Government's fear is that any move to scrap FFI and FDI distinction in this sector will see a surge of foreign money pouring into the real estate. This will lead to serious problems for the middle-class people, shattering their dreams to acquire a house for themselves in cities. High land prices have a negative impact for a broad cross-section of the economy because land is not a reproducible asset.

However, one should not forget that land is immovable property. Any individual holding vast tracts of land will eventually have to sell it in the country. If the prices are too high it will scare away the genuine buyers from the market. Though it will affect many people, but such escalated prices of land will be a temporary phenomenon. The market pressures-demand and supply will help determine the correct prices.

In fact the RBI has already started taking steps to control prices in the real estate. The recent hike in repo rate to 7.5 per cent will have an affect on the home loan rates in the country. Some of the leading financial institutions have already announced a hike in their floating and fixed rates. Other may follow suit soon. Though it would affect the middle class, in the long-run price of real estate will fall.

So any policy measure that seeks to promote integration of the Indian market is welcome-as for a foreign investor bringing funds will become easier than before once the distinction is scrapped. The requirement to get approval from the Foreign Investment Promotion Board (FIPB) would not be necessary unless the funding is beyond 70-74 per cent.

The new policy, which will require changes in the Foreign Exchange Management Act regulations, will look at foreign investments in a company as a whole, instead of treating FIIs as a separate entity. Treating all foreign investments, irrespective of FDI or FII, as the same when it comes to investment limits and conditions is seen as a more realistic approach.