The Cabinet committee on economic affairs approved some new rules for foreign investment last week. Since then, the detailed guidelines have been issued. These establish that the initial questions and doubts were justified, because there are several problems with the new rules. If the reports on there having been opposition to the new rules from ministries like finance and information and broadcasting are to be believed, there was good reason for such opposition.
Two specific problems can easily be identified. Both lie in the new provision that any company which has an Indian majority shareholding and Indian control will be treated as an Indian company. Therefore, its entire shareholding in a downstream venture will be treated as being Indian shareholding -- which therefore would open up to indirect foreign investment all sectors that have been closed to such investment so far.
The first problem here is with the definition of control, which is limited to the question of whether the Indian shareholder has the right to appoint the majority on the board. What is crucially left out is another element in the definition of control, which has been there in the past -- namely the identity of the chief executive.
If the CEO can be appointed by the foreign shareholder, and all directors are non-executive (and we now know what non-executive directors are about), then control is certainly not in Indian hands. The ceding of de facto control to the foreign shareholder can be further ensured by legitimate shareholder agreements that provide for a specified majority to approve key issues; that would mean foreign control over key issues as well as of the chief executive.
If this is indeed what the new rules allow, while calling it Indian control, then the rules are a bad joke and will become a laughing stock.
The second problem lies with that old issue of pyramiding of holdings, which is now permitted ad infinitum. Technically speaking, therefore, a company with 49 per cent foreign shareholding can have a subsidiary which too has 49 per cent foreign shareholding, and so on for two more such steps, at which point the extent of beneficial ownership in foreign hands goes up to more than 90 per cent. And yet, all the companies on this ladder will be considered Indian companies!
If anyone believes that a 90 per cent beneficiary owner overseas will allow a 10 per cent Indian beneficiary owner to have control of operations, then he must be day-dreaming. Other arrangements will have been worked out for control to move into foreign hands, to which the new rules will be blind.
It is easy to see that these rules have been framed under pressure from cash-strapped Indian promoters who want to access foreign capital without losing control of their companies. While there is nothing wrong with wanting this (and the objective could easily be served by allowing non-voting shares, or special category shares with limited voting rights), the manner in which the government has framed the rules leaves several loopholes wide open for misuse.
There are other issues too, of the difficulties involved in administering such a policy, the complications that will arise when the investment limits are crossed because of independent upstream actions by more than one party, and so on. All of this makes it abundantly clear that the government should quickly re-examine the whole issue, and keep the new guidelines on hold till the review is over and a properly thought-out policy is framed.