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Will increasing FDI caps improve rupee value?
The Indian government has increased the caps on Foreign Direct Investment (FDI) in the telecommunications and defence industries as well as credit information companies, among others, and has mentioned that more FDI reforms will be announced shortly.
By increasing FDI caps, the Indian government hopes to bring in more capital to finance its huge current account deficit (CAD), which currently stands at 4.8 percent of the GDP.
The government has increased the FDI limit for the telecom industry from 74 percent to 100 percent and raised the FDI limit for credit information companies from 49 percent to 74 percent.
There are two routes that a foreign company can take when it is planning to invest in India – the automatic route and the Foreign Investment Promotion Board (FIPB) route.
In the automatic route, the Indian government’s permission is not required if the investment of the foreign company falls within the stipulated cap. In such a scenario, the company has to complete certain formalities with the Reserve Bank of India (RBI) within 30 days of receipt of remittances and issuance of shares.
However, in the FIPB route, which companies take when their investments exceed the cap stipulated by the government, an organisation requires the permission of the government and it takes 4-6 weeks for the entire process before a decision is reached. So, by increasing the cap on FDIs, the Indian government is encouraging foreign firms to invest more in India and it is eliminating barriers to entry.
The value of a country’s currency increases when there is a positive balance of payments (BoP). BoP refers to the difference between the inflow and outflow of money. If India sells more goods and services in other countries than what it purchases from these countries, there will be trade surplus.
In such a situation, there is more foreign currency coming into the country, which in turn strengthens the local currency. So, based on the principles of macroeconomics, in order to enhance the value of rupee, India has to increase the inflow of foreign currency, which is the same as increasing FDI. So, by increasing the cap of FDIs, we can surely improve the rupee value.
In order to increase the value of rupee, the government has to undertake a number of measures apart from increasing FDIs; the government should also increase the value and volume of exports, which is possible when more companies set up manufacturing plants in India.
By the end of the second quarter of 2013, Indian exports declined by 1.4 percent as compared to the corresponding period last year. In 2012-2013, exports reduced by 1.76 percent year on year.
The Indian government has a lot on its plate this year – it has to boost exports, reduce the country’s current account deficit and enhance the value of rupee. All these objectives will be fulfilled with the government’s current plan on increasing caps on FDIs.
On July 16, 2013, telecom stocks rose on reports that the Indian government will increase caps on FDIs. Idea Cellular gained 2.63 percent, with an increase from Rs 157.95 to Rs 158.70, which is the highest in the last 52 weeks.
Bharti Airtel gained 2 percent and Tata Teleservices, Maharashtra, went up by 2.89 percent. An increase in stock prices is a clear indication on the positive sentiment among investors with regards to the telecom industry.
Similarly, experts expect stock prices to increase in other industries for which the government is planning to increase the cap on FDIs. So, given the positive outcome of the government’s latest regulation, we can safely conclude that by increasing FDI caps, the value of rupee will increase.