In a quiet move that constitutes one more step in its long-term effort to dismantle regulation of foreign direct investment in the country, the government has advanced the process of liberalisation quite significantly. It has decided to drop the condition inadequately defined in its Press Release as the need for “prior approval in case of existing joint ventures/technical collaborations in the ‘same field’”.

This opaque statement needs clarification. Prior to the recently issued Circular 1 of 2011 from the Department of Industrial Policy and Promotion of the Ministry of Industry, any foreign investor who had entered into a joint venture, technology transfer or trademark agreement with an Indian partner prior to January 12, 2005, had to obtain special approval from the government before undertaking any new independent investment or entering into a new technology transfer or trademark agreement with a different partner in the same field. When doing so, the foreign investor and/or the existing partner had to establish that the new proposal “would not jeopardize the existing joint venture or technology transfer/trademark partner”.

The importance of this clause needs to be emphasised. When in the early post-Independence years the government pressured foreign firms into entering into collaboration with Indian partners rather than setting up wholly owned subsidiaries or affiliate firms, there were two important factors, among others, that motivated it. The first was the need to strengthen the still young and inadequately experienced industrialist class in India, by mediating the relationship between domestic players and the foreign firms on whom the former were dependent for technology and foreign finance. The second was to provide some basis for technological learning, since domestic managers and technologists would in joint venture enterprises play a role in transferring technology, adapting it if necessary and operating it under local conditions. Subsequently, this requirement of partnership was strengthened by making it necessary under the Foreign Exchange Regulation Act for foreign firms to hold only 40 per cent or less of equity in most industries, if the foreign invested firm had to be eligible for national treatment. This was aimed at eroding foreign influence over their local joint ventures.

In practice, of course, most foreign firms used their control over technology to sabotage this effort. Since the use of patented technology by the domestic joint venture had to be licensed, foreign firms wrote into technology transfer agreements clauses that limited the ability of domestic partners to unbundle and adapt the technology, let alone seek to improve upon it through investment in Research and Development (R&D).

The net result was that though there was some development of indigenous technological capability, that process was slow because of restrictions on the nature of technology use. Moreover, domestic firms needing the implicit or explicit link with known foreign brands as tools in the competitive battle with rivals were unwilling to break away from their foreign partners and use the knowledge they had acquired to strike out on their own. Hence, every time technology was upgraded and/or modernised as part of the competitive effort, a new technology agreement had to be signed with the foreign partner, which was at all times far ahead of the domestic subsidiary in technological terms.

The foreign partner, on the other hand, benefited from the domestic partnership, inasmuch as it allowed it to use the skills of major Indian firms when it came to dealing with an interventionist government and local labour, for example, and especially when it came to accessing the domestic market for credit. Large firms were built with small infusion of foreign capital, allowing significant repatriation of profits and royalties on the basis of a limited amount of investment and substantial borrowing.

Matters changed after liberalisation, which substantially diluted regulations with regard to foreign equity caps and technology transfer, and relaxed the prerequisites for national treatment. Now, foreign firms are permitted to claim and repatriate a larger share of domestic profits based on a larger share in equity ownership. They can also ensure complete protection of frontline technology through direct control, rather than through patents and licensing agreements. With foreign equity caps relaxed and flexibility increased, foreign firms increasingly wanted to opt out of the collaborations they had entered into earlier. There were clearly two routes. One was to buy out Indian shareholders or partners. The other, when this was not possible, was to set up a wholly new venture to which technology of more recent date and/or relating to new products was transferred.

Given the obstacles that were set to technological learning by domestic partners and their resulting dependence on the foreign partner for technologies of more recent date, the former were in no position to compete on equal terms with their erstwhile collaborators. The pressure on them to sell-out was high. Where there were attempts to resist, as in the case of Dabur and Hero, for example, the foreign collaborator attempted to set up a wholly new venture.

It was in circumstances like this that the “prior approval” clause served a purpose. It allowed the government to rule in favour of domestic partners who had served their collaborators well, but who on account of path dependence were not in a position to compete with them. It was a way of continuing with the protection afforded to weaker domestic players, without discriminating against the foreign partner.

By doing away with the approval clause the government is overturning this whole edifice and paving the way for two potential developments. The first is one where domestic industrialists choose to sell out convinced that it would be too difficult for them to face the competition. The second is one where they refuse to sell, and foreign partners, with their newly granted freedoms, choose to set up their own sole control subsidiaries or majority ventures with pliant partners to outcompete their erstwhile collaborator. Both of these trends would alter the industrial landscape with a far greater presence of foreign firms than earlier, and a smaller presence of India industrialists in high technology areas. It would also mean that technological capabilities acquired in the past are now rendered useless and little technological capacity acquisition would take place in the future. India would merely be the location for transnational production seeking to cater to its large domestic markets and a supplier of skilled labour to enhance the control over technology of transnational firms.

The argument being given for this shift with its adverse implications for industrial self-reliance and indigenous technological capability generation is that India needs to stall the decline in foreign direct inflows into the country. Such flows are privileged over portfolio flows since FDI flows are seen as reflecting a long-term interest of the foreign investor in domestic productive activity.

It is indeed true (see Chart) that India is experiencing a decline in FDI inflows when compared to the FDI surge over the 2007-08 to 2009-10 period. But these figures are misleading. Over the liberalisation period as a whole portfolio inflows have been far more important than FDI flows. And even in the period of high FDI inflows, the figures reflect a definitional discrepancy. In the early 1990s India moved to a definition of foreign direct investment where the acquisition of a stake of 10 per cent in a company by a single non-resident investor is adequate for it to be characterised as a firm with foreign direct investment control. In actual fact, many portfolio investors are in the wake of liberalisation acquiring stakes of 10 per cent or more in domestic firms, exploiting the lax regulatory framework. As a result a substantial chunk of portfolio investment geared to garnering capital gains through speculative investment gets registered as foreign direct investment. That it is not. And India does not need this capital for balance of payments reasons either.

To use this argument to undermine the hard won, even if limited, advances on the technological front is therefore completely unjustifiable.