If an economy is to become dependent on foreign capital, there is a clear hierarchy to flows from abroad in terms of how valuable they are, and the dangers that they pose. At the bottom, most dangerous, are short-term debt funds, and, perhaps a little better, institutional equity investors. "Hot money" can flow out at the slightest provocation or a change in sentiment - something made amply clear, if it was not already, by the events in the market last week. At the top is foreign direct investment (FDI), especially in sectors with a long gestation period for returns. This is the most desirable form of foreign money, and it brings with it spillover effects in terms of productivity gains and technology transfer. India, today, is dependent on foreign money to finance an uncomfortably large current account deficit, at 4.8 per cent of gross domestic product, but more and more of that money is "hot". Thus, the government's move to ease the requirements for FDI in a variety of sectors is both understandable and welcome.
Essentially, in a swathe of sectors, a group of Cabinet ministers decided on Wednesday to do away with the need for global investors to gain the assent of the Foreign Investment Promotion Board (FIPB) - which, by an iron law of government nomenclature, tended to deter rather than promote FDI. On the back of a gloomy policy environment domestically and tightening liquidity internationally, FDI inflows in 2012-13 fell 38 per cent over the previous year. Foreign investment in the retail sector, various financial support sectors like stock exchanges, hydrocarbons, and some agriculture-related fields, as well as many others, was freed from the need to get FIPB approval beforehand. In addition, caps were raised in some sectors, such as telecom - where, in particular, some companies have been hoping for infusions of foreign cash.
Overall, these are valuable steps towards making the Indian economy more competitive in the medium to long term. Had they been put into effect some years ago, India would have reaped benefits by now, which would have come in handy. However, there are caveats in terms of their short-term effectiveness. These measures do not, for example, make up for the decline in external stability following the recent problematic measures to shore up the value of the rupee. Nor will anybody be queuing up immediately to invest in India, where the administrative environment continues to be hostile to investment. Ending that fact, as well as that perception, is necessary for these steps to work. And they must work; India needs long-term capital in order to fund its stalled growth, especially in manufacturing and in infrastructure.
The simple fact is that this will not be enough to get pools of long-term funds interested in India again. That will need major changes to the policy environment. But the best way to make it easier even in the short term is to push through reform of insurance and pension legislation. The government signalled intent at this meeting - but the needed Bill is stalled in Parliament. The Bharatiya Janata Party technically supports it. If the government was as serious about foreign investment as it claims to be about food security, it would pass this Bill as an ordinance too, and force Parliament to discuss it. It is as important to India's future.