India Ratings and Research (Fitch Group) believes that the relaxation in the foreign direct investment (FDI) norms announced by the Union Cabinet on 28 August 2019 is unlikely to have an immediate effect on India’s economic growth and/or capital flows into the country. The decision to allow 100% FDI under the automatic route in contract manufacturing and coal mining could facilitate significant domestic and foreign investment in these sectors, provided structural demand-side headwinds and regulatory challenges are addressed suitably over the medium term. However, considering the slowdown in global and domestic demand conditions, increasing the FDI limit by itself is unlikely to be sufficient to attract greater long-term FDI flows into the economy. Ind-Ra believes a broad-based economic recovery will be critical for attracting FDI flows over the medium-to-long term.
Regulatory Risks in the Coal Sector Remain Elevated: To attract FDI to the coal mining industry and associated infrastructure, the ease of doing business needs to be enhanced significantly. The rationalisation of regulatory procedures (like a land acquisition) will be imperative in this context to eliminate regulatory uncertainties and challenges. For instance, private sector investment in captive coal mines has been minimal owing to these regulatory challenges and uncertainties. Additionally, the lack of excavation infrastructure has also constrained private sector investment in the sector.
Any new entrant in the industry would have to acquire and develop virgin coal mines. Apart from requiring a large financial outlay, this would increase the time taken to start commercial operations. Nonetheless, given the demand shortfall in the domestic coal market, the Indian coal industry is likely to remain attractive for foreign investors if these challenges are addressed in a timely manner.
100% FDI in Contract Manufacturing: The agency believes that 100% FDI in contract manufacturing will open the gates for global manufacturers of electronic goods and other research and development-intensive products to set up manufacturing facilities in India. The ability to set up their contract manufacturing units will help alleviate intellectual property-related risks for these players. For various products, the import duty on semi-knocked down units is significantly lower than that on completely built-up units. Therefore, the ability to set up contract manufacturing units will enable such players to import SDKs into the country and assemble the product domestically. At the same time, however, such a policy would limit the extent of the value-added domestically and also restrict India’s share in the global value chain for these products.
For generic products such as consumer goods and auto components, revival in domestic demand could stimulate significant investments in contract manufacturing facilities, thereby bolstering capital flows. However, in the absence of a meaningful pickup in domestic consumption, and considering the weakening growth in both industrial and consumer goods, investment in contract manufacturing is unlikely to see a recovery.
However, once the economy witnesses a revival, Ind-Ra believes that the ability to raise to 100% FDI will augment the financial flexibility of new entrants in the contract manufacturing segment. This will also enable large brands to expand their production facilities in India without necessarily setting up large manufacturing facilities.