By Krishna Kumar Sinha
The government recently carried out an amendment in the foreign direct investment policy to stop opportunistic acquisitions of Indian companies by foreign firms taking advantage of the low valuations in the market. The amendment makes prior government approval mandatory for all investment from countries that share border with India. This restriction was earlier in place for investments from Bangladesh and Pakistan. Though India shares land borders with seven countries, China is the only neighbour among these whose companies have the financial capacity to take over Indian companies. It is quite clear that Press Note No. 3 (2020 Series) issued by the department for promotion of industry and internal trade (DPIIT) is targeted at Chinese firms.
In another development, the government has asked market regulator SEBI to furnish details on portfolio investments. The regulator has asked banks to disclose the ultimate beneficial owners (UBOs) of foreign portfolio investments based in countries not considered friendly with India. What triggered this pre-emptive action was the disclosure about the People’s Bank of China raising its stake in HDFC beyond 1% and the suspicion that Chinese companies could possibly take over Indian companies during this time of pandemic. As far as Pakistan, Bangladesh, Nepal or Bhutan are concerned, even earlier FEMA had a specific policy for inward investment owing to historical and other reasons. But, for the first time, an exception in policy has been made for a large economy and a potential investor.
Over the past three decades, India has liberalised the FDI policy and has put in place a regime that not only encourages, but also protects overseas investors through instruments like bilateral investment treaties (BITs). Such agreements are also under review since some sections in the Indian establishment argue that BIT text adopted so far is too investor-centric. In the last few years, however, there have been signs that countries are re-evaluating their approach towards foreign investment. As a result, calibrated protectionism is on the rise, with the screening of inward M&A becoming more frequent under the guise of national security.
India is not alone in taking such moves. Australia and several European countries have already put in place measures to stop opportunistic acquisitions. Takeovers by foreign companies whose valuations have been hit by the coronavirus outbreak have become a global issue. Australia has temporarily tightened its rules on foreign takeovers. As per the revised rules announced in March-end, all foreign takeovers and investment proposals would be scrutinized by the foreign investment review board. Previously, only proposals valued more than A$1.1 billion were reviewed by the board. Large European economies such as the UK, France, and Germany have also brought in more stringent measures based on equity share or market share limits under their FDI screening system to stop Chinese investors from acquiring control in sensitive sectors.
Why China is viewed with suspicion
What is interesting, however, is the fact that India is only concerned about possible takeovers by China-based investors, and not from Europe or the US. Why are Chinese investors viewed with suspicion across the world? The patterns of Chinese investment in Africa give us a clue. It is the sectors targeted by Chinese investors in African countries that have given rise to such suspicions. Experts believe that the objectives are not just economic dominance such as establishing a long-term source of raw materials to feed China’s industry, or to grab the market in emerging economies in Africa, but it extends to enhance China’s global political clout.
What prompts this thinking is the Chinese investment in strategic and sensitive sectors by enterprises, some of them state-owned, with strong links with the People’s Liberation Army. The recent buzz around Huawei’s participation in 5G trials is an example as pieces of evidence point towards Huawei’s active participation in military technology development and intelligence work for PLA.
The western response
Concerns of western nations regarding strategic mergers and takeovers by Chinese companies do not have its origin in the present health crisis and resulting economic slowdown. European nations and Australia which have received record levels of Chinese investment in the past, resulting out of a friendly foreign investment policy followed by these nations, began revisiting their policies around 2015 as concerns began to be aired by experts that these takeovers are aimed at making China globally dominant in key areas. Some of the Chinese policies that helped strengthen these beliefs are:
- Targeted takeover of companies with a view of gaining technological, and defensive advantage. The purchase of robot-maker Kuka AG by Midea Group in 2016 and the halted takeover in July of German semiconductor maker Aixtron SE are examples.
- China continues to impose restrictions on inward FDI. Chinese antitrust authorities blocked a move by Coca-Cola to take over Huiyuan Juice Group, valued at $2.4 billion.
- China’s ambitious One Belt One Road initiative intends to expand Chinese investment worldwide. With an estimated investment of up to $8 trillion and participation of 37 countries, the project has acquired global dimensions.
- The Made in China 2025 10-year plan, an industrial policy to make China globally dominant in high-tech manufacturing. Under the plan, Chinese companies have been encouraged to invest in foreign companies to gain access to advanced technology. The value of Chinese acquisitions in the United States peaked in 2016 at over $45 billion.
- The influence of the Chinese Communist Party over private firms in Chia is always a concern.
The response of EU nations to the preponderate policy of China could be seen in the agreed scope of the EU-China Comprehensive Agreement on Investment (CAI), currently under negotiation. The EU is also looking for a pie of China’s growing domestic market, a significant business opportunity for European companies. However, China’s market is much less open than the EU’s. Many sectors are either restricted or prohibited for foreign investors. There is also a lack of transparency and fair competition as compared to the European market. Thus, through the agreement, the EU aims to significantly improve EU investors’ access to the Chinese market by eliminating quantitative restrictions, equity caps or joint venture requirements.
Here is a wish list of EU under the EU-China Comprehensive Agreement on Investment
- To improve market access conditions beyond China’s existing commitments under the WTO.
- Non-discriminatory treatment, prohibition of performance requirements.
- Transparency, predictability and legal certainty of the investment environment.
- High level of investment protection.
- Provisions for dispute settlement (state-to-state) and an institutional framework to monitor its implementation.
- Disciplining the behaviour of state-owned enterprises and increasing transparency of subsidies.
- Commitments regarding labour and the environment.
The objectives outlined by the EU appear too ambitious given the track record of China’s external economic engagement strategy so far. Nevertheless, it would be interesting to watch the progress of the negotiations, and outcomes would be useful in preparing a roadmap for India’s future engagements with China.
Options and opportunities
India has responded to the critics of the policy change, described by Chinese media as discriminatory, asserting that it doesn’t prohibit investment from any country with which India shares its border, it is only about a procedure change. To assuage their hurt feelings, a fast track approval process has also been suggested. However, what could be bothering the Chinese investors is not the time taken in the approval process, but the criterion for evaluating the proposals. While China would like to wait and watch, the lockdown has given time to Indian policy makers to delve further into the issue and to draw strategy for dealing with Chinese investment proposals.
India’s security interest and safety of sensitive infrastructure installations have to be in no-compromise zone, however, the anti-China sentiments prevailing globally today may provide India the elusive bargaining power to get access to expertise for building up local supply chain capacity for boosting manufacturing in India. The disruption in China’s supply chain due to Covid-19 has no doubt impacted the manufacturing supply chains across the world, and countries are now looking at alternative locations for their manufacturing units. However, expecting any large exodus of investors from China may be premature at this stage. Thus, India needs to be cautious, but realistic too when engaging with China.
Another question being debated is whether placing all proposals under government approval route was the only option available to negate predatory move by opportunistic investors. We all agree that an opportunistic investor may not be allowed to take advantage of dipped market prices. But, what about a greenfield investment? A greenfield investment proposal in a non-strategic sector could have been permitted under the automatic route without any such fears. But, does the extant FDI policy specifically lists strategic or sensitive sectors? There is, however, one precedence. In the year 2009, alarmed by the high-profile takeover of generic pharma producer Ranbaxy by the Japanese MNC Daiichi, an expert committee had warned that M&A by foreign companies of Indian generic producers may neutralize its cost competitiveness.
Indian policymakers sought to check such a takeover bid by placing a foreign investment in the brownfield pharma sector under the government approval route (DIPP Press note no 3 of 2011) while investment in greenfield pharma sector remained under the automatic route. This was, however, relaxed to permit up to 74% FDI under automatic route in brownfield pharma units also in the year 2016 after a review.
India-China economic engagement
Turning back to the trade and economic relationship between India and China, it has seen rapid growth from $3 billion in 2000 to $51.8 billion in 2008 and thereafter reaching an all-time high of $95.54 billion in 2018, making China India’s largest trading partner. According to the ministry of commerce of China, cumulative Chinese investments in India till the end of September 2019 amounted to $5.08 billion. However, as per DPIIT, cumulative FDI from China stood at $2.34 billion up to December 2019. Besides, Chinese venture capital investors have become very active and invested in Indian start-ups. Chinese investments in India’s start-up ecosystem were also reported to have risen to $3.9 billion in 2019, up from around $2 billion in the previous year. To name a few, Alibaba Group, Tencent, Didi Chuxing, China Lodging Group, Ant Financial, Shunwei Capital are shareholders in Indian leading start-ups.
Despite considerable growth in bilateral investment relations, the perception was that increase in bilateral investment has not kept pace with the expansion in trading volumes between the two countries and mutual investment flows are yet to catch up. China was treated as one of the potential investors that remain largely untapped. Suddenly, post-COVID, the new reality is it is in India’s best interest to review all investment proposals from China.
The bottom line
We are living in an increasingly globalised economy, resulting in more and more capital mobility. The long-term gains of FDI in an economy are well established. However, an emerging economy needs to weigh the pros and cons of FDI inflows continuously. The challenges vary from country to country. FDI does bring about positive change in the economy. In the case of M&As, foreign investment is not just a shift of ownership from domestic to foreign investors. It also involves transfer of management control to foreign investors that may not always be in the best interests of the host country.
This is a time of crisis for both humanity and the global economy. During crises, unusual policy changes amounting to protectionism are expected as short-term measure. However, the country needs FDI in large amounts to attain a double-digit GDP growth trajectory. Despite India’s impressive jump in the ranking of ease of doing business, annual FDI inflows are hovering around $60 billion for the last 3 years.
A quantum jump in FDI is essential to accelerate manufacturing growth and job creation for an estimated 1 million Indians entering the workforce every month. India’s share in China’s annual outward investment of $60 billion is minuscule. It ranks 18th in the list of top investor nations. Thus, the bilateral engagement on investment front calls for qualitative change. Caution is indeed needed, however, not at the cost of losing the tag of an open economy. Engaging constructively and cautiously rather than distancing is the answer.
(Krishna Kumar Sinha is an industrial policy expert based in New Delhi. He retired from Indian Engineering Services in 2017. His last assignment with the government was as an Industrial adviser in the Department of Industrial Policy and Promotion, DIPP, currently known as DPIIT.)