On August 13, the US President Donald Trump signed into law the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA), which significantly strengthens the Committee on Foreign Investment in the United States (CFIUS), the inter-agency committee under the Department of Treasury responsible for reviewing the national security implications of foreign investments in the country.
CFIUS was established in 1988 to review all foreign investment transactions that were under its jurisdiction (“covered transactions”) and to make an assessment as to whether any particular case of foreign investment in the US undermines the country’s national security. In addition, CFIUS was empowered to investigate whether a foreign entity investing in the US is controlled by a foreign government, or such an investor would be in control of any “critical infrastructure” in the country that could impair its “national security.” A “covered transaction” within the mandate of the CFIUS meant “any merger, acquisition, or takeover … by or with any foreign person which could result in foreign control of any person engaged in interstate commerce in the United States.”
One of the key elements in the regulatory framework of CFIUS is the term “control”, but a formal definition of the term is not provided. The definition is available in the regulations of the Department of Treasury. It is to be noted that “control” is defined not by a numerical threshold; instead, a functional definition of control provided, which considers the leverage of the foreign investors on their invested firms. According to the Treasury Department, “the term control means the power, direct or indirect, whether or not exercised, and whether or not exercised or exercisable through the ownership of a majority or a dominant minority of the total outstanding voting securities of an issuer, or by proxy voting, contractual arrangements or other means, to determine, direct or decide matters affecting an entity”.
The activities of an enterprise with foreign ownership that are under the ambit of the regulations, include all its functional areas, in particular, its expansion into “new business lines or ventures”, besides “appointment or dismissal of officers or senior managers” and “appointment or dismissal of employees with access to sensitive technology or classified U.S. Government information”. The US government has put in place this comprehensive oversight mechanism on foreign investors, while it impresses upon all other countries to follow the policy of laissez faire, especially when dealing with foreign investors.
FIRRMA has expanded the scope of national security, thus strengthening CFIUS. There are some indications of how this could happen in the Sense of the Congress in approving FIRRMA. These include: “foreign investment provides substantial economic benefits to the United States, including the promotion of economic growth, productivity, competitiveness, and job creation, thereby enhancing national security” (emphasis added); and “national security landscape has shifted in recent years, and so has the nature of the investments that pose the greatest potential risk to national security, which warrants an appropriate modernization of the processes and authorities of the Committee on Foreign Investment in the United States and of the United States export control system”.
What does the “Sense of the Congress” signify? It gives a sense as to what national security can be, which is clearly benchmarked on the performance of the foreign firms in terms of enhancing competitiveness and job creation. This could, therefore, imply that failure of the foreign firms to meet these performance requirements could tantamount to abridgement of national security. With President Trump keen to “Make America Great Again”, these performance indicators could be really critical.
The Congress has gone further in specifying the yardsticks that the CFIUS may consider while considering national security risks. These are (i) control of US industries and commercial activity by foreign persons as it affects the capability and capacity of the US to meet the requirements of national security, including the availability of human resources, products, technology, materials and other supplies and services; (ii) foreign investment exposes, either directly or indirectly, personally identifiable information, genetic information, or other sensitive data of US citizens, which is accessed by a foreign government or foreign person that may exploit that information in a manner that threatens national security; and (iii) foreign investment could have the effect of exacerbating or creating new cybersecurity vulnerabilities in the US or is likely to result in a foreign government gaining a significant new capability to engage in malicious cyber-enabled activities against the US. In the digital age, can there be a better articulation about the regulatory regime to protect the data produced by the citizens of any country?
Having thus provided a peek into the regulatory regime that the US has established for foreign investors, it would be instructive to examine the corresponding scenario in India. We have been studying the changing contours of the policy regime for foreign direct investment (FDI) since the initiation of the economic reforms in the country nearly three decades back, and our studies show that India’s regulations are complete antithesis of those in the US. The policy regime in India has been progressively liberalised so as to allow the foreign investors unfettered access to the Indian market. In fact, both Central and the state governments have been highlighting the rising levels of FDI inflows, thus taking credit for their abilities to attract foreign investors.
It is not the case that India’s policymakers have not felt the need to review the performance of foreign investors in the country. One of the recent examples of this is the Discussion Paper of the Department of Industrial Policy and Promotion (DIPP), titled, ‘Industrial Policy: 2017‘, which spoke of the need to review India’s FDI policy, particularly in respect of technology transfer and establishing local linkages. The question is, does the government have the institutional and the data-backup to undertake such a review?
At the dawn of the economic reforms, the then government had established the Foreign Investment Promotion Board (FIPB), which, despite the emphasis on “promotion” of foreign investment, did screening investments to a limited extent. However, successive governments rendered FIPB largely defunct, before the institution was abolished in 2017. Most foreign investors can now just walk-in through the “automatic route”. In India, there never existed a statutory body, like the CFIUS, for comprehensively screening FDI. Whatever limited examination the FIPB did it did not extend to the post-approval stage.
Our contention is that even if the government attempts to review foreign investments despite the institutional limitations, this exercise will be ineffective because databases reporting FDI are deeply flawed. Our recent study, ‘India’s Recent Inward Foreign Direct Investment: An Assessment‘, shows that annual aggregates do not provide adequate guidance regarding year-to-year changes, and sectoral reporting has serious limitations. Data limitations reported in the study are like multi-headed hydra; they include delayed reporting, duplicate reporting, non-reporting, incorrect entries, notional inflows, inappropriate industrial classification and under-representation of acquisitions.
Delayed and duplicate reporting are long-standing problems. Some cases of reported inflows were purely notional; there were no remittances from abroad in these cases. These were generally cases of corporate restructuring, where shares were issued by an acquiring entity to the foreign owner of the transferred entity, in lieu of cash. Since shares were issued to foreign companies, these were recorded as inflows.
The study identified a number of such cases involving prominent companies and large portfolios. The magnitude of the problem can be gauged by the fact that during 2016-17, the year reporting record FDI inflows, in case of large remittances, each at least $50 million, shares issued accounted for only about half of the total of these remittances. Nearly 37% of these were for earlier years, while duplicate entries accounted for 10%. Notional inflows accounted for about 12% of the large remittances during 2016-17.
Such cases distorted the figures for sector-wise inflows. For instance, official data show that the share of manufacturing sector increased substantially during 2016-17; increasing to 33% from 25.4% a year earlier. A close examination of the electrical equipment industry, the top gainer in this sector, show that nearly $1 billion, out of the reported inflows of $2.3 billion, came in the power generation sector instead.
While the increase in equity inflows during 2016-17 was $3,589 million, the increase on account of acquisition of existing shares was as much as $3,228 million. Thus, acquisitions sustained the reported rise in the reported inflows during 2016-17. Further, acquisitions happen in multiple forms, but the data are unable to capture this phenomenon fully. If dominant firms of Indian ownership across industries are acquired by foreign companies, there can be adverse implications for national economic security.
Given that foreign investments are not adequately monitored, there is ample scope for “base erosion and profit shifting”, or simply put, tax evasion.
FDI inflows are seen as a bellwether of the economy. When assessing the impact of policy changes, questionable quality of data can be a serious impediment. Such data can send out incorrect signals to investors and policymakers.
Once again, it is a painful reminder that while the US monitors its inward investments and various associated operational parameters, India seems content in providing minimum (often inaccurate) information on the operations of FDI companies. Even the minimum information collected about the nature of investors is not analysed. It is time that the government adopts the global good practice of establishing an independent agency that performs effective oversight functions relating to FDI in India, and, more importantly, regularly reports to the Parliament about its findings.
Biswajit Dhar is Professor of Economics, JNU. K.S. Chalapati Rao, is Distinguished Fellow, Institute for Studies in Industrial Development, New Delhi.