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Direct investment rider for 74% FDI in telecom

Surajeet Das Gupta

The government is planning to make it mandatory that foreign companies invest directly in the operating company when picking up equity in the domestic telecom sector, while allowing them to increase stake to 74 per cent from the current cap of 49 per cent.

A government note has already been prepared in this regard and sources say this will go a long way in plugging the loophole used by foreign telecom companies to skirt the sectoral cap limit.

At present, telecom multinationals tend to bypass the sectoral cap limit by investing indirectly in the operating company, picking up equity in an investment company which in turn holds equity in the former.

As the government considers an investment company Indian as long as up to 51 per cent is held by domestic promoters, most multinationals use this route to gain indirect majority control of the telecom businesses, which they owned.

Meanwhile, the move to bypass the sectoral cap limit has raised concern in the home ministry, which has suggested that the rules be changed in lines with that of foreign direct investment in the insurance sector.

The note has also suggested another alternative which is that the government continue with the existing sectoral cap policy and in fact make it more stringent by including "preference shares, whether carrying conversion option or not, within the sectoral FDI cap. This would need the approval of the Cabinet." At the moment, preference shares issued to a foreign company which are not convertible are not included while calculating the total sectoral cap for telecom services-yet another route through which foreign telecom companies are bypassing the sectoral cap limit.

The Telecom Commission, which met on July 13 to discuss the note decided to defer a decision on the crucial issue to the next meeting.

The need for a change in the FDI policy has emanated due to questions being raised by various sections of the government on whether the sectoral cap policy was being manipulated by foreign telecom companies, who have already taken majority control indirectly. Secondly, telecom companies, especially Bharti Enterprises as well as the Cellular Operators Association of India, have been pushing to exclude foreign institutional investment (who can invest up to 40 per cent in one company) from the sectoral cap.

The home ministry, in a letter to the department of telecommunications, has expressed concern that the basis of the sectoral cap policy which entails that management control remain with the Indian shareholders is under threat. The letter says that on the question of management control to be vested with Indians, "there are some grey areas with foreign equity participation."

The letter takes into cognizance the request made by Bharti Enterprises, which has pointed out that FIIs are purely financial investors and their exclusion would "undermine the rationale for a sectoral cap." The Bharti representation also points out that there is already a precedent like this in the insurance sector where investment by FIIs is not considered as part of the sectoral cap of 26 per cent.

The note however questions the Bharti argument and points out that "the points raised are somewhat misleading as in the case of the insurance sector, foreign equity cap is 26 per cent. Even if FIIs' investment up to 40 per cent is permitted, the balance 34 per cent remains with the Indian shareholders who will have a higher stake than the 26 per cent FDI permitted. Therefore, controlling stake remains with the Indian shareholders. In the case of the Bharti request, the Indian equity in the company may fall to 11 per cent thereby amounting to transferring management control to foreign hands."

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