IASbaba’s Daily Current Affairs – 1st July, 2016

IASbaba's Daily Current Affairs Analysis, IASbaba's Daily Current Affairs July 2016, UPSC

IASbaba’s Daily Current Affairs – 1st July, 2016

ECONOMICS

TOPIC: General Studies 3

Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

Effects of liberalization on the economy, changes in FDI policy and their effects on economic growth.

Investment models

Is FDI really a gift horse?

Government of India recently announced another new set of “radical changes” in foreign direct investment (FDI) policies

Just in November 2015, the government had introduced changes in 15 major sectors, and now, the latest announcement covers nine sectors

Comparison between the changes adopted by the earlier and latest FDI policy reforms:

November 2016 FDI policy changes

Last year’s announcement stated that the policy changes were intended

to “ease, rationalise and simplify the process of foreign investments in the country and
to put more and more FDI proposals on automatic route instead of Government route where time and energy of the investors is wasted

Latest FDI policy changes

The recent amendments to FDI policy seek to

further simplify the regulations governing FDI in the country and
make India an attractive destination for foreign investors”
to attract and promote FDI in order to supplement domestic capital, technology and skills, for accelerated economic growth

However, the thrust/vision of the two sets of policy changes remains the same – “to ease entry of foreign investors in India”

With these successive changes in FDI policy, India has become “the most open economy in the world for FDI” but can the country expect to benefit from this form of investment?

Can the country expect to benefit from this form of investment?

In order to answer the above question, it is important to understand the following –

Are India’s FDI true in its character i.e. long-term inflows?

FDI, as distinguished from portfolio investment, has the connotation of establishing a ‘lasting interest’ in an enterprise that is resident in an economy other than that of the investor.
Therefore, it is important to understand whether FDI has retained its character of being long-term inflows of investible capital in an age when global capital markets are being ruled by investors having short-term targets.

Understanding the proper definition of FDI

Economists have always treated FDI as that component of foreign investment in an enterprise that confers “control” to the foreign investor over the enterprise.
All other foreign investment was defined as portfolio investment, and this component was considered “footloose”.
As regards the threshold for identifying whether an enterprise was foreign-controlled or otherwise, most countries adopted their own definitions.

Improper/poor definition of FDI – do not allow us to make the distinction between long-term investments and portfolio investments

In the past, the RBI followed the practice of identifying “foreign-controlled rupee companies”, which were companies having foreign shareholding of 25 per cent or more of total equity or where 40 per cent share is held by investors from a single country.
In recent decades, the Organisation for Economic Cooperation and Development (OECD) and International Monetary Fund (IMF) have pushed for a globally acceptable definition of FDI, according to which 10 per cent or more of foreign equity constitutes the “controlling share” in an enterprise. But not all countries have adopted the OECD-IMF definition.
For instance, in India all investments other than those through the stock market are reported as FDI. India, therefore, does not make any distinction between the “controlling share” and the others as far as FDI is concerned.
This implies that data on FDI for India do not allow us to make the distinction between long-term investments and portfolio investments.

Lack of access to the state-of-the-art technologies

Foreign investors consider “controlling share” to be vital for bringing in state-of-the-art technologies.
However, given the fact that developing countries have been struggling to get access to proprietary technologies despite steep increases in FDI inflows over time, there seems to be the proverbial slip between access to technology and FDI inflows.

Increasing reinvested earnings

The OECD-IMF duo introduced some other components in the definition of FDI, the most significant of these being the inclusion of reinvested earnings.
While it may be justified for balance of payments purposes, the fact is that retained earnings increase the host country’s liabilities without actually transferring resources from abroad.
Retained earnings are a part of the profits earned by foreign companies in their host countries, which are in domestic currencies. Once capitalised and absorbed in the equity stock, retained earnings become conduits for larger dividend remittances in future.
Further, if such earnings are used to take over domestic companies or to buy back shares from the public, then they would not add to the existing capacities.
Data provided by the UN Conference on Trade and Development (UNCTAD) show that the share of reinvested earnings has increased progressively during the recent past and by 2013 they constituted two-thirds of the FDI outflows from the developed countries.
In fact, more money was flowing into the developed countries as dividend income than that was flowing out as direct investment. Thus actual cross-border equity flows that meet the conventional definition of FDI are only a fraction of the reported global FDI flows.

Inflows and outflows

According to official statistics, India has seen a steep increase in FDI inflows totalling over $55 billion in 2015-16. However, in the world of high finance, FDI is not a gift horse —there are at least two sets of costs that host countries have to bear.

The first is the direct cost stemming from outflows on account of operation of foreign companies.

The RBI has reported that between 2009-10 and 2014-15, outflows due to repatriations, dividends and payments for technology have together constituted a major foreign exchange drain — nearly one-half of the equity inflows during this period!

The RBI also tells us that during the same period, subsidiaries of foreign companies operating in India ran negative trade balances in almost all manufacturing sub-sectors.

But, together with remittances and other payments, foreign subsidiaries in most sectors regularly drew out surpluses which look quite large when compared with the capital that the foreign companies were bringing in.

Apart from the direct costs, foreign investors are able to extract indirect benefits from their host economies by using bilateral investment promotion and protection agreements (BIPA).

In recent years, India has faced a number of disputes with foreign investors, which arose because the latter was able to invoke the investor-state dispute settlement (ISDS) mechanism included in the BIPAs that allows disputes to be taken to private international arbitration panels. Most of the cases have arisen as the foreign investors have challenged the tax liabilities imposed by the government.

The government has amended the model BIPA ostensibly to blunt the ISDS mechanism. The new model BIPA includes a strong stricture to foreign investors to make timely payment of their tax liabilities in accordance with India’s laws. It will be well worth watching as to how this instrument gels with the investor-friendly regime that has now been put in place.

(Note: Crux of the whole article can be concluded as below)

IASbaba’s views on: India has become “the most open economy in the world for FDI” but can the country expect to benefit from this form of (FDI) investment?

From the above article, we can conclude that India gets benefitted from FDI if –

India’s FDI inflows retains its character of being long-term inflows (rather than short term inflows or portfolio investments)
Definition of FDI adopted by India provides data that allow us to make the distinction between long-term investments and portfolio investments
India succeeds in its true interest of obtaining access to state-of-the-art technologies and proprietary technologies from the FDI
Its retained earnings are less, as the retained earnings increase the host country’s liabilities without actually transferring resources from abroad
Effective policies and laws are implemented to restrict or reduce the share of reinvested earnings and also to keep a check on inflows and outflows

India should also be aware of the two sets of costs that it has to bear:

Direct cost stemming from outflows on account of operation of foreign companies; and
Indirect benefits, that the foreign investors are able to extract from their host economies by using bilateral investment promotion and protection agreements (BIPA)

Connecting the dots:

India has become “the most open economy in the world for FDI” but can the country expect to benefit from this form of investment? Critically comment.

ENVIRONMENT

TOPIC: General studies 3

Conservation, environmental pollution and degradation

Let us get smarter about Water

India has sizeable water resources, but the country faces huge challenges in the water sector as the distribution of water varies widely by season and region owing to the growing scarcity; increasing pollution; enhanced competition, conflicts and trans-boundary water sharing issues; that have dominated the national discourse in current times.
Although industry is the largest contributor to India’s GDP, agriculture accounts for nearly 90% of water use. Two-thirds of India’s irrigation needs and 80% of domestic water needs are met using groundwater, contributing to the significant groundwater depletion rate. Although India has one of the world’s largest irrigation systems, it is characterised by high levels of inefficient water use
The country is also facing the potent threat of climate change, which may have complex implications on the pattern of availability of water resources including changes in pattern and intensity of rainfall and glacial melt resulting in altered river flows, changes in ground water recharge, more intense floods, severe droughts in many parts of the country, salt water intrusion in coastal aquifers, and a number of water quality issues.

For India— Improving water security is essential for India’s development

With total water demand in India expected to rise by over 70% by 2025, a huge demand-supply gap is expected in the coming years and will act as a potentially significant constraint on economic growth
The alarming rate of groundwater depletion
Declining water tables means increased cost of pumping, salty irrigation water as a result of over-abstraction leading to crop and revenue losses for farmers, and long-term consequences for water availability.
Poor water quality and lack of adequate access to sanitation are also major causes of disease and poor health

Innovative Ways: Ensuring access to water sustainably

Comprehensive assessment of water resources:

The last time a comprehensive assessment of water resources for the entire country was done was in 1999-2000
Weakness: absence of data on the sources and volume of water supply
Planning:
- Need for a complete assessment on water availability (use and future demand) updated in real time on the size and sustainable levels of exploitation
- Build a data infrastructure around the multiple sources of water in the city:
  - Creation of a flexible, responsive water management system
  - Utilization of Data: To integrate surface and groundwater sources more wisely.

Community-based modelling of Water Usage

Better understanding of its groundwater reserves and ensuring adequate recharge; groundwater being a common pool resource—consensus must be built to get users to bear the true ecological and social cost of using that water privately
Building local capacity of both citizen groups and government, allows cities to have a reliable, cost-efficient system. If the city also gets real-time data, partly with crowd-sourced, citizen-led information, the system can become more sustainable over time
Models of decentralized groundwater governance— Installation of a wastewater treatment plant—public reporting on the volume and quality of water they treat and release, then communities residing there could do more to ensure the health of water bodies around them (influence innovation and new policy alike).
Water-use efficiency would increase multi-fold:
- By the adoption of low-cost technologies
- Better demand management
- Effective recycling and reuse

Efficient Regulation Mechanism:

By a statutory regulatory authority; Water pricing should be shifted away from the shadows of politics and be assigned to a statutory regulatory authority

Determining water tariff for cost recovery allowing for reasonable costs
Hear all stakeholders and formulate a standard mechanism for pricing
No alteration be allowed from government
Government should be allowed to introduce a subsidy which can be paid directly to the targeted consumers after making necessary provision in the budget—making the pricing of water transparent, and help begin the transition to a system of public debate on the importance of cost recovery and scrutiny of cost elements.

Connecting the Dots: