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Dear Foreign Investor, We Love Your Money, Not You!

Published on Thu, Dec 11,2014 | 19:29, Updated at Thu, Dec 11 at 19:30Source : 

After almost a decade of political wrangling India seems set to enhance the foreign investment limit in insurance from 26% to 49%. If it happens, and the chances look good it will, Mr. Modi’s government will undoubtedly count this among its early victories. But is it really a victory? Does this limit enhancement represent this new Government’s economic approach ie: a more liberal foreign investment policy, more investment, more competition?

Maybe not. Because the hike in the FDI limit is likely to be accompanied by 2 caveats. The first one is endemic to our foreign investment policies…that ‘ownership and control’ should vest with Indians. That means 51% of the business should be owned by Indians and that Indians should have the right to appoint a majority of the directors or control the management or policy decisions. On the face of it there is nothing wrong in stipulating that insurance businesses must be controlled by Indians. But this restriction is in contradiction to that rationale for enhancing the FDI limit. In its representations to the Select Parliamentary Committee, the Ministry of Finance argued in favour of raising the FDI limit by saying India needs large amounts of capital and technology and know-how in the sector;

‘The Department of Financial Services further explained that the rationale behind increasing the FDI limit to 49% is that the Insurance Companies are regulated by stringent solvency norms and continuously require additional capital for growth, which partly get invested in key sectors like infrastructure. IRDA has estimated that the additional capital requirement of the insurance sector would be Rs. 55,000 crore (Rs.44,500 crores for the life sector and Rs. 10,500 crores for the non-life sector) over the next five years, which may not be taken care of by the limited domestic sources. Further, it was stated that the foreign equity potentially enables transfer of technical knowhow and better customer service through improved practices and competitive pressure. The FDI allowed in Insurance sector in other countries, the sectoral FDI limits existing in the country for other sectors and the key provisions proposed in the Bill for safeguarding the interests of the policy-holders were also highlighted. Giving specific instances of quantum of FDI in different countries, the Department submitted that it was 100 percent in Japan, South Korea, Hong Kong; 80 percent in Indonesia and 50 percent in China.’
- Report of the Select Committee on the Insurance Laws (Amendment) Bill, 2008

So we want their money, their technology and their expertise…but we won’t give them control?

It isn’t the first time I have asked this question of foreign investment policy. The bureaucratic response often is – ‘but India is too important a market for them to ignore!’

I suppose we believe that no matter how unreasonable we are, the foreign investors will come. Well, Indian insurance businessmen, who do business with these foreign investors, think otherwise;

‘The representatives of the Private Sector Insurance Companies referring to the advantages of increase in FDI limit pointed out that insurance being a capital intensive and low return business, it is a better option to expose foreign capital to a low return industry, in place of scarce Indian capital. Foreign companies would also bring in latest technology and also provide access to global re-insurance market besides boosting infrastructure sector as the foreign capital would be invested in Government Securities and sectors as per IRDA guidelines…

The Private Sector representatives also stated that there may be hindrances to the amount of FDI coming in, if the full management control lies with the Indian shareholders as per the provisions of the Bill. It was suggested that while the FDI limit may be increased to 49 percent, there should be no provision for control and instead it should be left to the shareholders to sort out amongst themselves, based on their share holdings.’
- Report of the Select Committee on the Insurance Laws (Amendment) Bill, 2008

The Report includes dissent notes by some MPs and they cite the global financial crisis, investments in complex derivatives and AIG’s bailout by the US Government as instances why foreign insurance should not be trusted. But can’t those fears be mitigated by better regulation? 2 of our leading private banks are majority owned by foreign investors…yet we think of them as Indian banks and trust RBI to regulate them effectively. Can we not trust IRDA to do the same…effectively regulate Indian insurance companies, irrespective of the colour of money funding them? Maybe therein lies the trouble…it’s not the foreign investors we don’t trust…it’s the lack of confidence in our own regulatory structures?

Worst still the 49% limit includes FDI and FPI (earlier known as FII). This makes an IPO tough…because in an insurance company that already has a foreign partner, assuming the partner wants to own 49% or thereabouts , the headroom for portfolio investment will be zero or severely restricted. Oddly enough, the Select Committee acknowledges this but doesn’t resolve it.

‘The Committee also notes the views expressed by Secretary, Department of Financial Services that there is a requirement of huge amount of capital as defined by the regulator for stipulated solvency levels to maintain the trust level of stake holders in life insurance companies through solvency under all circumstances. This enhanced foreign equity will not only help in expansion of insurance coverage, comprehensive and better portfolio management, enable growth of pension sector but also potentially enable transfer of technical knowhow and other better consumer services through improved practices and competitive pressures. The Committee observed that IPOs may not be the best route for raising capital in the insurance sector as FIIs face constraints due to sectoral foreign equity caps.’
- Report of the Select Committee on the Insurance Laws (Amendment) Bill, 2008

As for the second caveat – the Select Committee wants the hike in the FDI limit to be accompanied by fresh capital.

‘The Committee is also of the view that incremental equity should ideally be used for expansion of capital base so as to actually strengthen the insurance sector.’
- Report of the Select Committee on the Insurance Laws (Amendment) Bill, 2008

Again, the intention is noble – insurance needs more capital and hence the guiding policy should enable the inflow of fresh capital. Hence the emphasis on primary issuance of shares and the bar on secondary transactions. But why should a law prescribe the nature of the investment transaction? Can we not leave this up to the 2 consenting adults to determine?

It is well known that over the last decade Indian insurance businesses often sought capital from their foreign partners. But because foreign ownership was limited to 26%, many foreign partners indirectly funded the business by funding the Indian promoter…in the hope that when the FDI limit is raised the money will convert to equity. This happened for a couple of reasons…Indian promoters didn’t have the money to invest in a growing, capital hungry business…or they didn’t have the risk appetite or they were getting the foreign funds cheap. Whatever the reasons, these structures and side letters (granting the foreign investor certain rights including conversion) were riding on the hope of a hike in the FDI limit. If the Committee’s caveat persists, many of these structures will have to be re-structured. That could put the foreign investor at a dis-advantage.

Conversely it may even hurt the Indian partner’s ability to exit (partially), discharge the foreign debt or invest his money elsewhere. Unless ofcourse the Indian partner had no intention of honouring the debt or side letters.

But even if all these silly structural complications are surmounted by lawyers and their hefty fees….and still more structures…the message this policy sends out to foreign investors is not flattering to India. That we want your money, your technology, your expertise, but we don’t trust your intentions and we will prescribe to you the exact manner in which you can invest. But we want your money…

A Committee member I spoke to explained that the only way to achieve political consensus in favour of raising the FDI limit, was to explain to legislators the urgent need for additional capital in the insurance business. That pitch, he said, is justified only if the policy ensures new capital comes in. Hence the proposed bar on secondary transactions.

I wonder…if the BJP had a majority in the Rajya Sabha as well…would the Committee have dropped this clause?

The other argument in favour of this restriction is that, in a secondary transaction (Indian promoter selling stake to foreign investor) only the Indian promoter stands to gain… and that is unacceptable.

Committee member Naresh Gujral admitted as much in his comment to CNBC TV18 when he said “the idea is to strengthen the companies and not give windfall gains to a few select individuals in this country. You recall that this is exactly what happened during 2G. There were a few individuals that gained. So we want money to go into the companies and not into the pocket of a few rich individuals.”

This grouse finds mention in the Committee Report as well. MP Derek O’Brien in his dissent note states “The Bill in its current form creates no impetus for increased foreign investments in the insurance sector to be channeled towards improving insurance coverage or social security for the poor. It is quite possible that a higher FDI cap will only result in Indian entities liquidating their stake, at several times their original investment, without any fresh investments coming in.”

Well, if the Committee’s recommendation makes it to the final law, Mr O’Brien has one less thing to complain about.

In summation – we want foreign investment, foreign technology, foreign expertise….but we won’t trust them with control, nor trust our regulators to regulate them effectively. But then we don’t want Indian businessmen to profit either. Definitely not make any ‘windfall gains’.

My grumblings aside, hopefully none of this will hurt India’s insurance sector. It’s a big market and its return potential will draw foreign money. That’s not the point. It’s about how we chose to craft our investment policies. If even a historic majority and a right wing Government can’t fix that…then nothing will.

PS: I’m not suggesting that the Committee recommendations will definitely make it to the law. They might if that’s the only way to get political consensus. Or they may not. Several lobbies are at work. This is merely a contemplation of our approach to foreign investment and an examination of how our legislators think.


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