New FDI policy may hurt India's start-up dream

'As much as $4 billion in India's start-up companies has come from Chinese funds.'
'Government policy must not remain indifferent to the problems India's start-up ventures are likely to face after the change in FDI rules,' says A K Bhattacharya.

A few days ago, the Union government took two important economic policy decisions in the wake of the COVID-19 outbreak.

A closer look at both the decisions showed that their common target was foreign investment in India.

One decision could have a long-term bearing on India’s foreign investment space, while the other would have a temporary implication, but its impact on foreign investors in certain sectors would be no less significant.

The first decision was an amendment to an order of April 15 that, among other things, allowed e-commerce companies to resume supplies of non-essential goods from April 20 as part of the phased withdrawal of the national lockdown.

But four days later, on April 19, the government clarified that the relaxation was withdrawn.

The Confederation of All India Traders, which represents the physical retail sector, thanked the government and welcomed the decision.

What did the government achieve by the rollback?

If the purpose of the earlier order was to gradually withdraw the lockdown, allowing e-commerce companies to resume supplies of goods was a sensible move.

But what perhaps came in the way was the fact that most of these e-commerce companies were subsidiaries of foreign companies and CAIT was deeply upset that while physical stores would remain shut, the foreign-owned e-commerce companies would resume supplies.

The sequence of events has left the e-commerce giants in no doubt that they have a hostile policy environment to deal with while doing business in India.

There is also no denying the adverse impact such decisions will have on India's foreign direct investment policy environment.

The second decision, taken on April 18, mandated that all FDI from countries with which India had a land border would be subjected to specific and prior approval from the government.

The notification explained that it was aimed at 'curbing opportunistic takeovers/acquisitions of Indian companies due to the current COVID-19 pandemic'.

Remember that already foreign investment proposals from Pakistan and Bangladesh were subject to specific approvals of the Indian government.

Thus, the new order essentially impacted investment flows from Bhutan, Nepal, Afghanistan, Myanmar and China.

But cumulative FDI flows from all these countries, except China, were negligible in the last two decades -- none from Bhutan, $80,000 from Bangladesh, $2.44 million from Afghanistan, $3.25 million from Nepal and $8.97 million from Myanmar.

For China, the amount of FDI inflows in this period was about $2.34 billion, accounting for just half a per cent of India's total cumulative foreign investments of about $457 billion.

So, what was the concern over FDI from a country that was so little in the last 20 years?

There are two possible reasons.

One, it was a decision prompted by strategic considerations.

Already, Australia, Germany, Italy and Spain had taken steps to subject Chinese investments in their countries to greater scrutiny.

India also wanted to take similar steps against China.

Two, the official FDI flows from China may look very small, but there are reports that huge amount of FDI come into India from countries other than China, but whose beneficial ownership resides with Chinese nationals or in China.

Hence, the industry ministry notification clarified that all foreign investments whose beneficial ownership was in China would also be subjected to specific approvals.

According to one estimate, an investment of as much as $4 billion in India's start-up companies has come from Chinese funds, which are present in as many as 18 of the 30 unicorns (a start-up venture with a valuation of over $ 1 billion) in India.

If foreign fund flows to these start-up companies slow down because of the new procedural tightening, the government's grand Start-up India initiative to encourage innovation and entrepreneurship is likely to suffer.

While strategic interests are of paramount importance for the government, no less critical should be the financial needs of the start-up sector that had just begun flowering in this country.

Government policy, therefore, must not remain indifferent to the problems that India's start-up ventures are likely to face in the wake of a change in FDI rules.

A fast-track mechanism should be created within the government system for considering and expeditiously clearing all FDI proposals coming in from China for all ventures, in particular the start-up companies, provided these are not aimed at acquiring or taking over existing companies.

It can be nobody's case that India does not need foreign capital, particularly for ventures that help create jobs in the country.

If there are concerns over investments from China from a strategic perspective, these should be addressed.

But the government should simultaneously take steps to minimise any sudden disruptive impact on existing start-up companies, in particular, which are critically dependent on the next tranche of foreign investment, at least till such time they can find alternative sources of funds.

After many years of gradual and slow reforms in India's FDI policy, discretion is once again trying to reclaim its space in decision making, using the excuse of the threats arising out of the COVID-19 outbreak and China's growing dominance.

This is a trend that needs to be closely monitored and reversed.