In our July update, we reviewed the Narendra Modi government’s progress in completing a list of 30 important domestic reforms pending since May 2014. The government started fast, completing six reforms in its first year but only three more in the subsequent two years. This month we look at the Modi government’s progress in liberalizing India’s foreign investment regime. Since coming to office, the Modi government has executed 37 reforms easing India’s restrictive foreign direct investment (FDI) rules. The majority of changes to the FDI regime came in the second year of the Modi government, with relatively few reforms in years one or three.
Changes in India’s foreign investment rules are notified in two different ways:
Press Notes: For the vast majority of sectors, FDI regulatory changes are notified through a Press Note issued by the Department of Industrial Policy and Promotion (DIPP). These Press Notes can also alter other types of regulations on centrally regulated sectors, such as extending the validity of industrial licenses. Some of these Press Notes, such as Press Note 12, 2015 and Press Note 5, 2016 liberalize multiple sectors simultaneously.
Legislative Change: A small minority of FDI changes are the result of legislative action. This avenue really only applies to the insurance and pension FDI caps, which are set by legislation, and to the coal sector, where recent legislative changes allow private firms—including foreign-owned firms—to establish merchant coal operations.
Looking at its entire tenure in office, the Modi government is liberalizing India’s FDI regime faster than any of its recent predecessors. This point is particularly notable since, after 25 years of adopting pro-market policies, India’s foreign investment regime is already much more open than it was in the early 1990s. The Atal Vajpayee government made 29 changes to India’s foreign investment regime during its six years in office. During Manmohan Singh’s first term his government made 19 changes and 18 in its second term. The Modi government has made 37 sector reforms in just over three years—a historic pace.
The Modi government’s openness to foreign investment, in addition to domestic reforms and other external factors, has resulted in a foreign investment boom in India. During the first year of the Modi government, India attracted $33.8 billion in fresh foreign equity investments. This jumped to $40.7 billion in year two and $44.5 billion in year three. Foreign portfolio investment (FPI) has been choppier. India attracted $28 billion in FPI during Modi’s first 12 months in office. In year two, FPI saw net outflows to the tune of $2.7 billion. In year three, FPI rebounded somewhat to $9.2 billion. And early in year four, the pace has quickened again, with around $12.5 billion in inflows in May–July 2017.
However, the pace of FDI reform has been uneven. Of the Modi government’s 37 reforms, 6 came in his first year in office, 22 in his second year, and 9 in his third year. Some of these were quite modest, such as incremental changes to the rules governing foreign investment in defense and single brand retail. Others are more significant, such as opening the railways sector to 100 percent foreign investment and relaxing onerous rules around foreign investment in construction projects.
There are rumors of new foreign investment reforms on the anvil. These could include opening India’s legal services market to foreign firms and lawyers; further liberalization of the insurance and defense sector regulations; and expanding the scope for foreign investment in the retail sector. There is even chatter about deregulating India’s tightly controlled betting market, with potential scope for foreign investment in this forbidden sector. New FDI reforms would certainly be welcomed. The pace of such reforms has demonstrably slowed. On the backs of a major domestic reform like the Goods and Services Tax, the time is ripe to dust off the welcome mat.
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