20 Jun 11 End of Press Note 1 (and 18): Boost to foreign direct investment (FDI) in India
India has a reputation for its complex policies, despite a professed liberal attitude. The best example of this has been the protectionist clauses espoused by Press Note 18 (of 1998) and Press Note 1 (2005).
These press notes are not laws passed in Parliament, but merely guidelines. However, they are treated as laws for all practical purposes, and effectively restricted foreign investors from starting new ventures in India if they already had an Indian partner.
Press Note 18, issued in 1998, required foreign investors (including technology and trademark collaborators) to get FIPB (Foreign Investment Promotion Board) permission if they had a prior partnership. In order to get approval, the investor had to prove the new investment would not damage the existing venture or get a no objection certificate (NOC) from its earlier partner. This was later diluted to exclude IT companies, and then multilateral financial institutions (ADB, IFC, etc.). In 2005, Press Note 1 was issued which said the rule applied only to joint ventures signed prior to 2005. Press Note 1 also exempted venture capitalists, as well as situations where stakes held were under 3%.
Fast forward to 2011 – faced with declining foreign direct investment (FDI) in FY2011, the government has decided to scrap this retrograde provision. Why retrograde? How did it hurt FDI?
Consider a few examples.
In 1993, Disney set up a JV with Modi Enterprises (controlled by Lalit Modi, of IPL fame!) to market Disney merchandise. Another JV was set up to license Disney shows to TV channels. But in 2001, when Disney wanted to set up its own channels (and without Lalit Modi), they could not get the required NOC. Rumour has it that it cost several million dollars for Disney to disengage. Worse, Disney lost out to others like Turner’s Cartoon Network and Pogo, who got a significant head-start.
In 2007, the Wadia group objected to its partner Danone (which held a stake in Britannia) investing in Avesthagen, a Bangalore based nutraceutical company. Japan’s Takata Corp was similarly constrained by partner Abhishek Auto Industries, when it wanted to go it alone. The TVS group kept denying the elusive no objection certificate to Suzuki, even after the TVS-Suzuki JV had ended. V.K. Modi of Gujarat Guardian tried to block the Guardian Group (2006) and L&T used the same tactics to stall its former German partner Ralf Schneider in 2008. Telcon (incidentally a JV between Hitachi and Tata Motors ) tried to stop John Deere (its JV partner) from allying with Ashok Leyland.
These are just a few isolated examples, but between 15-20% of cases registered with the FIPB related to objections covered by Press Note 1. Incidentally, the FIPB was remarkably fair in its rulings – in 103 of the 107 cases since 2008, the ruling went against the Indian partner (Source: Sridhar Gorthi, Partner, Trilegal, quoted on moneycontrol.com).
But, even though FIPB has mostly ruled in favour of the foreign party, this has meant huge delays and legal costs. Obviously, the press notes facilitated significant scope for obstruction and rent-seeking by Indian joint venture partners. The need for FIPB approval (even in sectors where no FIPB approval was required for new investments) was no small irritant. Arguably, Honda might have got a better deal from Hero or Disney might not have lost three precious years.
I don’t doubt that in future, many multinationals will ditch their Indian partners, once they get a handle on what it takes to succeed in India. But so what?
This simply means that the Indian partner has stopped providing value. If not, the foreign partner would not want to get rid of them. In any partnership, if one party outlives its usefulness, shouldn’t the other be allowed an alternative course of action? Press Note 1 clearly provided an unfair bargaining tool to Indian partners, as they could not be dislodged even if they were destroying value.
But will this affect FDI inflows?
I believe it will have a significant impact. In several sectors (most, actually), an Indian partner enables quick access, an ability to “manage” the environment, and knowledge of local conditions and markets. Even when 100% FDI is allowed, international players may prefer a lower cost entry to test the waters or to ramp up market share quickly. Such local expertise is valued across the world, otherwise we wouldn’t have any JVs!
Going forward, the decision on whether to have a local partner or not will be made for business reasons, and if a JV is the best option, so be it. The risk of a failed relationship will not be such a big deterrent as it is today.
In the Press Note 1 era, foreign companies had a Hobson’s choice – go it alone, or get stuck with a partner you may not gel with. There are many sectors where JVs make a lot of sense, and typically these tend to be capital intensive and highly regulated sectors. Examples include a variety of capital goods, oil and gas, petrochemicals, infrastructure, automobiles, pharmaceuticals, etc.