The ambitious bilateral Free Trade Agreement (FTA) between India and European Union (EU) is stalled. The reason is the failure of the Indian government to pass a significant financial legislation -- the Insurance Laws (Amendment) Bill, 2008.
The Bill has been pending with the Rajya Sabha since 2008. It was to be passed in the monsoon session earlier this year. However, if the statement of the finance minister at the close of the monsoon session and recent news reports are anything to go by, then it seems that the Bill will now be placed in the winter session of parliament.
The proposed legislation could be a game changer and could certainly assist the falling rupee and the wide current account deficit. The Bill seeks to liberalise the insurance sector by increasing the foreign direct investment cap from 26 per cent to 49 per cent. This would permit Llyod's of London -- the world's largest insurance market -- to enter the Indian insurance sector, provide flexible capital structures and take away the divestment provision by Indian promoters after a certain time-frame, which is a requirement under the current regime.
This piece discusses some of the above key proposals of the Bill.
The economic reform measure where a foreign investor can hold equity shareholding up to 49 per cent has been resisted by opposition parties. They argue that Indian insurance companies should raised funds domestically. This could be by way of the promoters of Indian companies investing in the joint venture or by taking such companies public.
However, this viewpoint of the opposition parties seems untenable. Firstly, it is quixotic to raise funds from the capital market through the IPO route, especially at a moment when more than 35 private insurance companies require large capital. Secondly, there is an extensive gestation period in the insurance sector, normally ranging from five to 10 years, which makes it tougher to raise domestic capital. Taking the argument further, if insurance companies borrow funds domestically for capital raising would it not increase costs for such companies in respect to debt servicing?
Another pleasant reform is an amendment to the existing law for flexible capital structures. As per the current law, the paid-up capital of an insurance company should consist of only ordinary shares. Accordingly, insurance companies are debarred from issuing preference shares or other kinds of hybrid instruments for capital buildup. With the proposed changes to the capital structure, Indian insurance companies will be able to raise other forms of capital, which would be highly favorable for meeting solvency margin requirements. In an economic environment with insufficient capital, this is a welcome move to sustain the insurance sector in volatile times.
As a masterstroke intended to give incentives to foreign players, the Bill seeks to make an exception by permitting unregistered entities to operate in Special Economic Zones (SEZs). On a careful analysis of certain clauses in the Bill, it may be deduced that foreign insurers would be allowed to freely conduct business in SEZs, sans any regulatory control by the Insurance Development and Regulatory Authority (IRDA). Accordingly, foreign insurers would not be required to file information and annual returns with IRDA. All in all, these reforms allow for smooth functioning of foreign insurers in India.
The critics argue that it may result in a dual regulatory mechanism, and hence there should be uniform standards of compliances for both Indian and foreign companies, especially with respect to capital requirement and distribution of products. However, this does not affect the legality of the proposed reforms, since it is in complete consonance with the SEZ policy, which bestows the power on the government for meting out exceptional treatment to the insurance businesses carried out in SEZs.
The Bill also proposes to dispense with the condition that requires the Indian promoter(s) to reduce their equity to 26 per cent within 10 years.
In a breakthrough step, it is proposed that the Securities Appellate Tribunal (SAT) would be the appellate authority against IRDA decisions, instead of high courts. This would ensure proper and quick justice to industry players as insurance-related matters would now be dealt by SAT members having specialised knowledge in the subject.
As a concluding remark, it seems the prolonged delay and the political impasse in the passing of the Bill has frustrated corporate players and some serious foreign insurers. The government will have to be proactive in pushing these reforms, lest we lose out this capital to other aggressive markets. With India's economic growth being slowest in a decade, we certainly can't afford to drive away investors by deferring important reforms. Let us now hope that the two major political parties take a constructive view and co-operate to ensure the passage of this Bill.
Let's act in a timely manner, before it's too late.