When Finance Minister Arun Jaitley rises in Parliament on July 10 to present his first budget, it will not only be India paying attention. Investors, diplomats, premiers and rating agencies across the world will be scanning through the proposals to spot changes in India’s business environment.
Prime Minister Narendra Modi has promised that his government—which swept to power in the recent general elections with an absolute majority—will revive India’s economic diplomacy with its immediate neighbours, strategic partners and other countries. He also reportedly said that India’s foreign policy should be viewed through the prism of economics. Jaitley’s budget speech is expected to provide just the lens for such a roadmap.
The government’s thrust on economic diplomacy will be crystallised predominantly through its policies on foreign direct investment (FDI). India needs FDI across a wide sweep of industries, primarily to kick-start shrinking manufacturing activity. The Index of Industrial Production contracted by 0.1% during 2013-14 over the previous year. [1]
While the government’s overall FDI policy will be keenly watched, FDI in defence manufacturing has got special attention, given that India is the world’s largest arms importer. [2] This government has indicated that it wants to open up FDI in defence production—leading to a string of visits to New Delhi by ministers and senators from France, UK and the U.S. But it has not yet clarified how far it is willing to go with the current FDI ceiling of 26%. The budget this week is expected to spell it out.
The Indian budget has long ceased to be a dry account of the government’s income and expenditure trends; it has instead morphed into an economic policy document which spells out the government’s policy stance for the months ahead, and this could include limits on FDI. In the past, the government has used the budget exercise to announce changes in FDI limits in certain sectors.
It is evident by now that the 26% foreign investment limit in defence production has been a deterrent for foreign investors. Although foreign investors are likely to be interested only if the limit for foreign holdings is above 50%, the government has to contemplate three levels of holdings—49%, 74% or 100%—depending on pressure from various stakeholders.
However, it is the government’s stand on technology transfer which can become the deal-maker or deal-breaker. Conversely, foreign manufacturers will be willing to share technology only if they are allowed to have a higher stake in the Indian manufacturing facility.
Therefore, Jaitley—who is in charge of both the finance and defence portfolios—will have to come up with a combination that pleases both foreign investors (who want a higher stake in India-based defence manufacturing facilities) as well as Indian sceptics (who fear that a higher FDI limit compromises the country’s security).
Apart from these doubters, Indian companies with an interest in defence production are also opposed to 100% FDI in defence. Their logic: domestic companies must get reciprocal access to foreign markets. Resistance may also emanate from another source: a shadowy pack of facilitators and deal-makers, weaned on India’s large defence imports over the years, is likely to oppose any move to increase FDI in defence production. Higher domestic production directly impacts their business model. The current government will have to navigate the budget’s passage through these tricky shoals.
India’s energy security will also depend, to a large extent, on economic diplomacy. There are two ways of going about it. One is to allow greater foreign participation in the exploration and production (E&P) of oil and gas. India must promote investments to economically exploit its natural resources and, given the capital constraints, FDI can be a way forward. But foreign investment will flow in only if two pre-conditions are met: easier investment approval norms (including clearances from the ministries of defence and environment) and a stable gas pricing regime in the country.
In the past, a lack of policy clarity and long delays in clearances have frustrated investors. Some—such as BHP Billiton (from Australia), ENI (from Italy), Santos (from Brazil) and BG (from UK)—even withdrew from India. [3] & [4] This will require the government to clarify taxes (such as applicability of tax holidays for the production of natural gas) and align shale gas E&P norms with the extant oil and gas E&P rules.
Investments in exploration and production will commence only when there is certainty about the gas pricing regime in the domestic market. Digging oil or gas wells is an inexact science fraught with risks, which requires huge investments. Multinationals will want clarity about the price at which they will have to sell their end-product in the Indian market before making such large investments.
The second method of ensuring energy security is through investments in key oil and gas properties across the world. While both public and private sector companies have been investing in major oil and gas projects across the globe—including in Mozambique, Russia, and the U.S.’s shale properties—global majors feel Indian companies must be more proactive. Long delays and lengthy approval processes (especially at public sector companies) make Indian investments pale in the face of Chinese alacrity, not just in the terms of absolute investments made but also in the nature of the strategic intent displayed and executed. Jaitley will also have to place all tax incentives and concessions for outward and inward investments in the oil and gas sector on an equal footing.
The budget has its limitations in fixing many of these problems. But it can surely make a policy statement and enhance allocations to the relevant ministries (such as the Ministry of Petroleum and Natural Gas) for recapitalising public sector companies in that sector. In addition, once the budget proclaims its intentions, India must revitalise its old ties with allies and friendly nations to further its goal of energy security.
This budget will hopefully be a starting point and more, by setting forth the government’s stand on increasing FDI, boosting manufacturing, ensuring energy and food security, enhancing trade, tamping down on inflation, promoting financial savings, and streamlining tax policies. Economic diplomacy will play a part in each of these objectives.
Rajrishi Singhal is Senior Geoeconomics Fellow, Gateway House. He has been a senior business journalist, and Executive Editor, The Economic Times, and served as Head, Policy and Research, at a private sector bank, before shifting to consultancy and policy analysis.
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References:
[1] Ministry of Statistics and Programme Implementation, Government of India, Quick estimates of Industrial Production and Use-based Index for the month of April 2014 <http://mospi.nic.in/Mospi_New/upload/iip_pressrelease12jun14c.pdf>, p.1.
[2] Wezeman, Siemon T. and Pieter D. Wezeman, ‘Trends in International Arms Transfers, 2013’, SIPRI Fact Sheet, <http://books.sipri.org/files/FS/SIPRIFS1403.pdf>, p.5.
[3] Kebede , Rebekah, Prashant Mehra and Nidhi Verma, ‘BHP gives up nine oil & gas exploration blocks in India’, Reuters, <http://in.reuters.com/article/2013/10/21/bhp-india-idINDEE99K05E20131021>
[4] Saikia, Siddhartha P., ‘Four oil companies walk out, give up 7-times Reliance Industries’ KG area’, The Indian Express, <http://indianexpress.com/article/business/companies/four-oil-companies-walk-out-give-up-7-times-reliance-industries-kg-area/>