Understanding the Importance of Investment Screening measures for Financial and Economic Security of India

Introduction

The interdependence of economic policies and progress and national security always remains intertwined; financial and economic strength of India underpins its military capabilities, diplomatic influence, and internal stability.

The Indian economy is likely to continue growth-rate of 7% in next few years. The Indian economy is growing with such robustness that now experts are predicting India to become the third-largest economy by 2027-2028, overtaking both Japan and Germany.[1] India is currently marching towards economic prosperity and global leadership.

Per contra, such growth comes with its own set of challenges, including income inequality, unemployment, inflation, and fiscal deficits.[2] Moreover, the global economic environment, marked by trade wars, fluctuating oil prices, and geopolitical tensions, adds layers of complexity to India’s economic and financial security strategy.[3] The COVID-19 pandemic has further underscored the importance of economic resilience and the need for robust financial systems that can withstand global shocks.[4] It highlighted vulnerabilities in global supply chains, the digital divide, and the critical importance of sectors like healthcare and agriculture to national security.[5] In response, India needs a strategic, multifaceted approach to safeguard and enhance its financial and economic growth with stability and security – a daunting goal. For small economies, this could be relatively easy but a giant economy with largest population, this indeed is a most difficult challenge.

Let me just outline first priority areas crucial for financial and security and role of investment screening. These areas hold strategic importance to India's overall development goals, their impact on national security, and their role in ensuring sustainable growth and stability.

My purpose is to outline a brief roadmap for policymakers, stakeholders, and industry leaders and to initiate an institutionalised dialogue in India on integrating financial and economic policies with national security strategies.

Whether India will be able to navigate the complexities of the modern global economy, mitigate risks, and seize opportunities to enhance its stature on the world stage is as much as an economic issue as national security issue. We all are aware that the path to financial and economic security is iterative and requires adaptive strategies that respond to evolving global trends and domestic needs. Is it correct at this stage to state that Indian financial and economic stakeholders have been shying away from systematically discussing the importance of investment screening?

I would like to state that transplanting OECD model to India as far as financial and economic security through investment screening is a double-edged sword. The debate has to be placed in a larger geopolitical and political economy context. It would be too risky to be advised by simply economists and financial risk analysts and therefore a fair amount of alignment of larger and long-term political goals and objectives between India and OECD will inevitably be required to prevail over financial and economic considerations.

 

Economic Security: A global perspective

There are various levels and geopolitical of analysis – one global, one largely European, one largely OECD and US and an Indian. Although China is the second largest economy and holds key importance for the entire global economy, I am excluding the same from my discussion. As per USA perspective, the concept of economic security majorly revolves around four components, namely: aspects of trade and investment, economic and policy instruments, projection of global capacity or power, and the fear of global economic, social and ecological instability.[6] A Japanese perspective of economic security relate the concept of “economic security” to independence, survival and prosperity from an economic perspective.[7] Economic security in Japan is synonymous with “strategic autonomy” and “strategic indispensability”.[8]  EU postulates the following three priorities: (1) promoting its own competitiveness; (2) protecting itself from economic security risks; and (3) partnering with the broadest possible range of countries who share its concerns or interests on economic security.[9] Further the EU delineates the pivotal economic security risks which need to be protected:

• Risks to the resilience of supply chains, including energy security
• Risks to the physical and cyber-security of critical infrastructure
• Risks related to technology security and technology leakage
• Risk of weaponization of economic dependencies or economic coercion

 

Financial and Economic Security of India: Priority Areas

To fortify financial and economic security of India, the importance of investment screening is far more important than one can imagine.

Economic Growth and Stability: India needs to focus on macroeconomic policies that stimulate growth while keeping inflation and fiscal deficits in check. Enhancing productivity across sectors, implementing tax reforms, and improving the ease of doing business are crucial steps in this direction.

Supply Chain security:

• • Energy Security: Ensuring a reliable, affordable, and sustainable energy supply is vital for economic stability. Diversifying energy sources to reduce dependence on imports and investing in renewable energy technologies are strategic imperatives. This not only addresses the issue of energy security but also aligns with global sustainability goals. Restrictive versus liberal investment screening can hold back India’s energy security.
  • Food Security: Food security involves increasing agricultural productivity, reducing wastage, and improving supply chain efficiencies. Innovations in biotechnology, irrigation, and farming practices can play a pivotal role in achieving food security. Agriculture, being a sensitive economic sector, India needs to tread very carefully and resist global especially European pressures.
  • Cybersecurity for Financial Systems: As financial transactions become increasingly digitized, protecting financial data and infrastructure from cyber threats is critical. Strengthening cybersecurity measures, developing robust regulatory frameworks, and fostering international cooperation to combat cyber threats are essential for safeguarding India's financial sector. As Indian economy grows and capital markets expand, there is tendency for foreign capital to move into lucrative sectors, however, this needs to remain a closely guarded area. Instead of screening, close coordination and cooperation with advanced economies and democracies is a key.

Foreign Direct Investment (FDI) and Trade Policies: Balancing the need for open markets with the protection of domestic industries is a delicate task. Encouraging FDI through favourable policies, while negotiating fair trade agreements, can boost economic growth and provide access to new markets and technologies. However, this is the area where OECD economies adopting protectionist measures without due regard to international law and interpreting globally accepted norms for their political and geostrategic interests need to practice principles of fairness, transparent and equity which in the last few years have been undermined by them. WTO case-law and several international arbitral awards are evidence of this trend.

Financial Inclusion and Accessibility: Expanding access to financial services for the unbanked and underbanked populations is crucial for inclusive growth for India. Digital banking, mobile wallets, and microfinance initiatives are key to increasing financial inclusion and reducing economic disparities. These are the areas where protectionist OECD economies and their financial and banking sectors like to have a big pie of the cake from exponential growth in India. 46% of the global real-time payment transactions is happening in India. Indian FinTech industry’s market size is $584 Bn in 2022 and is estimated at $1.5 Tn by 2025 with 17 fintech unicorn (more than 1 billion USD value), 34 USD billion fintech funding. Opening up and expansion and deepening financial growth to support various social and economic development measures for Indian population across all Indian states remain the prime goal. Various financial regulators, the Reserve Bank of India, the Securities and Exchange Board of India, Pension Fund Regulatory and Development Authority, Insurance Regulatory and Development Authority, Insolvency and Bankruptcy Board, are initiating and implementing quantum jump innovative measures. In my view, one of the prime goals of the India-European Free Trade Association Trade and Economic Partnership Agreement signed on 10 March 2024 between Iceland, Liechtenstein, Norway and Switzerland and India has lot to offer in this regard. Yet at the same time, the very success of this agreement requires that these four EFTA states have to carve out niche from the other narrow protectionist economies of EFTA as far as investment screening measures are concerned for mutual benefit in the long-run.

Strategic Alliance Security: Collaborative efforts and policies between India and OECD economies to enhance mutual security interests involve sharing intelligence, military support, and technology to address common threats and maintain global stability. I am sure I can find unanimous support in this hall on this front as this is the strongest common interest and no OECD economy or industry can afford to play unequal level-playing field vis-à-vis India. India pursues legitimate aspirations for its population, its size and stature and therefore it will be detrimental to the long-term interests of OECD economies if they try to box India in anyway.

It shall be appreciated that addressing these priority areas through comprehensive and integrated strategies will contribute significantly to financial and economic security. Investment screening constitutes an important part of these strategies.

Fundamental difference between OECD economies and few allies and India is while OECD economies to a great extent are technology-exporting countries, India is and its growth depends on technology-import. Hence, technology transfer and relations between India and OECD economies is one of the biggest challenges. Health care, education, agriculture, transportation and waste management are non-critical but these are key drivers of Indian economy and these sectors suffer from major problems that can be solved by technology. As these sectors are non-critical, seamless flow of technology from OECD economies is imperative and while OECD economies may have challenges of technology-theft, there can be no reason for worry as far as India is concerned. In fact, technology transfers from OECD economies will power the internal capabilities and hence OECD economies look forward for trained and skilled manpower to meet challenges of dwindling and aging population, there is clear win-win for OECD economies and India.

India faces a big challenge from OECD economies namely how to overcome enhanced investment screening and export controls imposed or enacted by OECD economies.

 

Technology control and investment screening

India has to do technology-shopping against all the odds of technology restrictions. It is imperative that India will opt for relationships with those countries which are tech-friendly to India. In fact, tech-transfers shall be the most important security clause in any trade and business agreements between government to government and business to business. India, unlike other countries, need tech-quantum-jump, OECD economies are advised to realise this necessity of India. Investment controls from these countries will directly impact upon innovation systems and programs of India which would have long-term impact on supply of goods and services to these countries. Thus, it is advisable to have genuine re-examination of the controls for the long-term benefits. Populist governments and forces will invariably like to triumph especially in election years. Besides civilian innovation systems, it also has direct impacts on civil-military innovation and processes.

On its part, India has been opening up its tech-sensitive sectors. Few months back, India has liberalized FDI regulations in technology-sensitive sectors. For instance, up to 74% FDI is now permitted under the automatic route for satellite manufacturing and operations, and up to 49% for launch vehicles and related systems. Additionally, 100% FDI is allowed under the automatic route for manufacturing components and systems for satellites and related ground segments. These changes signal a positive trend towards further liberalization, even in sensitive sectors, which could have a significant impact on the IT industry. To be fair in analysis, regulatory landscape, sectoral caps, sourcing norms, security clearances are some areas which India legitimately uses for level-playing field in the negotiations.

While it is legitimate to have strong linkage between national security and export controls, as part of international trade regulations, it is imperative that these are used for only those who abuse the technology transfer by way of technology-theft, etc. We often read that OECD countries are having excessive restrictive controls that actually limit market access for businesses and hinder technological advancement for countries like India.

We often read how entry of foreign labour in sensitive sectors have eroded the confidence of certain countries, it is safely assumed that such concerns are absent in case of India. It is desirable that under capacity building component of strategic partnerships with OECD countries, infusion of sustainable foreign scientists and engineers in Indian industry will actually contribute to local capacity building of Indian talents. Several Indian conglomerates have CEOs of foreign countries and it is desired that technical leadership level too, infusion of talent is actively acquired. Innovation in flexible labour regime in critical industry is one of the ways to promote better collaboration. It is also desired that same flexibility is accorded by foreign tech-strategic industry as far as Indian talent is concerned.

 

Capital controls

It is likely that countries like India will continue to use capital controls to address national security concerns associated with financial stability, economic vulnerability, and technological dependency. India needs to safeguard financial stability by mitigating the risks of speculative capital flows, currency volatility, and potential systemic crises. Sudden outflows of capital during economic stress are possible and therefore to ensure stable and resilient financial system, the government is required to impose certain limits. One can think that, as of now, the concern behind capital control is to prevent investment in strategic industries from hostile actors and undue foreign influence. However, on the other hand, as Indian outbound FDI grows significantly and as Indian industry look for strategic collaboration including the sensitive industry, it is important that concerns are mutually sorted out. India has started implementing legal framework that enables the country to help in capital control and it includes among others amended regulations on cross-border capital flows, especially land-border, FDI restrictions and extensive monitoring of financial transactions.

India faces several challenges with regard to implementation of capital controls. First, how to balance between both, inward and outbound investments and national security concerns. On one hand, India with OECD countries is developing long-term strategic partnerships including critical technologies, however, whether those countries are willing to accept outbound investment from Indian conglomerates is a question that needs specific research. One hardly fails to notice that India has liberalised capital movements from friendly-foreign countries. Reduction in capital controls have helped decreasing regulatory burdens and also reduced compliance costs for businesses and contributed to global competitiveness. This has helped India to be immune from tax evasion and has fostered more formal economic structures and prevented illicit financial activities. In fact, the three new criminal laws of India which came into effect from July 2024, takes care of such concerns.

 

Investment controls

Investment controls have become an ideal lawfare tool for nations who are seeking to protect their critical assets and technologies from foreign influence and have indeed been useful to safeguard national security interests. In context of India, investment controls are needed for regulating cross-border investments, especially land-borders and mergers and acquisitions that have implications for national security. As India gives huge push to start-ups and innovations in defense industry, investment control will remain a double-edged sword for any government. One can appreciate that intellectual property theft, access to sensitive information and deep adversarial impacts on key sectors, practice by hostile actors and nations are genuine practical concerns.

A list of legislations and regulations concerning investment controls would be very useful to see how outbound investments of India are negatively affected. Case-studies to be collected.

While national security concerns are legitimate, we are also reminded how stricter controls increase compliance costs for business. Due diligence, stricter risk assessments requirements and incorporating changes suggested by regulatory bodies, in context of India, SEBI, RBI, for example, can work both as negative and positive catalyst for incoming and outbound investments. As of now, there are no significant reports suggesting that outbound investments from India in critical industry of OECD is a real issue nor the other-way around situation is a cause of concern now. However, as OECD become increasingly internal looking and enacts stricter legal frameworks and regulations, Indian outbound investment, including that from government sectors, will have a fair share of challenges.

National Security and Investment Act 2021 of UK allows UK authorities to review and potentially block or impose conditions on foreign investments in 17 critical sectors, including defense, artificial intelligence, nuclear technology, and advanced materials. These are some of the most important areas where India is looking mutually beneficial partnership but to what extent discriminatory treatments are meted out under the garb of NSIA is a key area of research. EU too has coordinated investment controls across member States to safeguard strategic industries and technologies. In fact, current stalemate in FTAs with the EU as a whole and UK largely depend on the outcome of the negotiations in these areas. In this regard, Trade and Economic Partnership Agreement between India and European Free Trade Association (Iceland, Liechtenstein, Norway and Switzerland) will give impetus to “Make in India” and Atmanirbhar Bharat by encouraging domestic manufacturing in sectors such as Infrastructure and Connectivity, Manufacturing, Machinery, Pharmaceuticals, Chemicals, Food Processing, Transport and Logistics, Banking and Financial Services and Insurance. Investment regimes emerging subsequent to the agreement in these sectors, non-sensitive and non-strategic, will allow us to see how capital controls and investment controls will work out in day-to-day realities.

There are certain pointers which I consider difficult ones for the audience but we can hardly wish them away. First, weaponisation of trade links has affected negatively India as well as OECD countries. Financial and economic security has started traction now in India and in fact there are no significant scholarships or publicly-available papers like OECD to learn about India’s issues, challenges and approaches on financial and economic security. India, as one of the largest economies of the world has to walk a tight-rope, on one hand, it needs to coordinate more closely with like-minded nations and at the same time, be vary about long-term implications if the currently like-minded OECD countries will turn hostile to India’s success story and will use the tools to adversely impact India’s rising growth.

India like several OECD countries have been affected by the Covid pandemics and also ongoing conflicts in the middle-East and Russia-Ukraine, although the constant growth trajectory shows that the country has remained relatively immune because of its resilience nature and internal consumption markets. OECD countries have reasons to be endorsing reluctantly India’s march ahead as it pursues path of economic independence even against the calls of aligning with countries who are favouring unilateral sanctions against a particular country. India, a democratic, populous, military and economically growing power, has to see which of the models can help it achieving financial and economic security – Chinese, American or Japanese or European, as each of these countries or a block of countries have swiftly moved towards insulating their economies from adversarial forces. Each initiative taken by these countries with whom Indian economy is closely intertwined poses a new set of issues and challenges and adaptation by India.

 

Trade controls

OECD countries have started using significant trade policy intervention, industrial policies and other measures to justify economic security. As economic security becomes a new strategy for OECD countries, it is enigmatic whether these are meant for economic outcomes or beyond economic but also political and strategic outcomes. Undoubtedly, all these are having significant legal implications and are shaping new legal order. What is clear is that OECD countries are using economic policy tools more robustly and at times at the verge of being called discriminatory to the world order of fair trade for national security goals. The use of security exception clause by US in world trade now is being used in different avatar by OECD countries and as much as WTO rejected use of security exception clause in several cases by US, as other OECD countries started following US model and measures, WTO will undoubtedly have new jurisprudence which will be opposed by many WTO member states. OECD countries are rushing to prevent, reduce and control economic shocks in the short-term, both foreign and domestic. However, the long-term implications of such measures will make world economic and financial order more uncertain, more unstable and more unpredictable. A question may arise is OECD pushing global economy to a zone of zero-sum game under the rubric of economic security.

 

Supply control

Supply chain resilience has become one of the most important pillars of economic security which are against hostile foreign interventions and influences. US approach to economic security is largely based on economic prosperity but if we look at Chinese model than it is aligning with the goal of self-sufficiency which is also the key objective of India. However, there are nuances and subtle differences between the self-sufficiency models followed by these countries.

It would be interesting to map dependency of India on other countries and to analyse context-specific situations. Having a huge internal market, it is known that India, despite being one of the largest economies, is less dependent on trade than similarly situated countries like China, Japan and EU. However, it is noteworthy that Indian economy is significantly dependent on external supply chains in particular sectors such as energy. In this regard, it is imperative to identify India’s dependence on product both across all sectors, strategic and defense sectors. China is a key provider to India for many dependency products like other EU, Japan, South Korea and US economies. It can be said that India is dependent on China, US, EU on a relatively high number of strategic and defense products and India is not a dominant in world exports, except very few, such as pharmaceuticals, textiles and chemicals.

Like US, India is linking economic security with economic prosperity of its vast population which was largely missing till now. Various welfare schemes implemented by the current government since 2014 are aiming precisely for economic prosperity of every Indian. India needs to identify those sectors which are fundamental to sustain its ongoing economic growth and are also national security important and then to justify various policies, including trade and large public investments (which it is doing). Infrastructure, transportation, climate and energy, and cybersecurity are key infrastructural pillars of India’s growth and it is actually these sectors which will face fierce competition and threats from economic security measures implemented by OECD countries.

Current US interest for India can be considered a friendshoring strategy of US which enables it to secure supply chains of critical products, measures outside of traditional free trade agreements. A closer look at this strategy can show that India will be losing out on the traditional reciprocal market access concessions bargain under these new measures.

India needs to enact more robust mechanisms to criminalize the use of foreign government-sponsored capital to gain control over economic activities, production chains, natural resources, technology, or companies within India. One can suggest that three criminal laws implementation will allow classification of any transaction involving foreign capital as an offense against the financial and economic order if it poses a risk to security or public order of India. It would indeed be useful for India to establish an inter-ministerial or inter-departmental taskforce which would resist foreign countries’ growing economic coercion against governments, corporate houses, businesses, organisations and individuals, including friendly-foreign countries of India.

It is imperative that India establishes a formal screening mechanism for outward direct investment that allows India to actively facilitate outward investment into critical sectors of foreign governments under bilateral strategic partnerships.

 

Legal instruments – latest measures

Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) of US, Chinese National Security Law of 2015, Japanese Economic Security Promotion Act 2022, South Korean national security regulations 2022, Internal Market Emergency and Resilience Act of EU, along with the Artificial Intelligence Act, Net-Zero Industry Act (NZIA), the Critical Raw Materials Act (CRM Act), Anti-Coercion Instrument of 2023 and the EU’s electricity market reform, are some of the glaring examples how OECD and non-OECD countries have integrated the concept of investment screening in the economic security acts.

In order to achieve financial and economic security, India shall keep ensuring growth rate of close to 10%, its robust economic performance is indispensable. With more economic performance comes, dissuasive power of the anti-coercion instruments and less vulnerability to retaliation from other economies. India shall identify its indispensability in particular goods and services. This will insulate her against economic coercion. Targeted industrial policy to support general economic and business environment is must. Indian stakeholders need to identify, asses, monitor and take actively measures as investment screening measures against India can pose threats to economic security. One way would be to prepare case-studies and various data-sets which gives comprehensive understanding of exposures.

Regardless of the precise configuration, partnering with, and developing trust between OECD and India is a critical component of attempts to build alternative supply chains in critical areas.

[1] ‘India — towards Becoming the Third Largest Economy in the World’ <https://www.ey.com/en_in/tax/economy-watch/india-towards-becoming-the-third-largest-economy-in-the-world> accessed 6 February 2024.

[2] ‘GDP at Record High but Unemployment Continues to Rise’ (India Today) <https://www.indiatoday.in/business/story/unemployment-rate-jumps-cmie-data-record-gdp-growth-1848426-2021-09-02> accessed 6 February 2024.

[3] Anuttama Banerji, ‘The Impact of the War in Ukraine on the Indian Economy’ (South Asian Voices, 2 June 2022) <https://southasianvoices.org/the-impact-of-the-war-in-ukraine-on-the-indian-economy/> accessed 8 February 2024; ‘Why Is India Edgy about Israel’s War? The Threats That Loom over India - The Economic Times’ <https://economictimes.indiatimes.com/news/economy/foreign-trade/why-is-india-edgy-about-israels-war-the-threats-that-loom-over-india/articleshow/104436341.cms?from=mdr> accessed 8 February 2024.

[4] ‘WDR 2022 Chapter 1. Introduction’ (World Bank) <https://www.worldbank.org/en/publication/wdr2022/brief/chapter-1-introduction-the-economic-impacts-of-the-covid-19-crisis> accessed 8 February 2024.

[5] Maria Nicola and others, ‘The Socio-Economic Implications of the Coronavirus Pandemic (COVID-19): A Review’ (2020) 78 International Journal of Surgery (London, England) 185 <https://www.ncbi.nlm.nih.gov/pmc/articles/PMC7162753/> accessed 14 February 2024.

[6] ibid at pp. 306-307.

[7] Kitamura Shigeru, 'Economic Security Perspective' (2022) 29(3) Asia-Pacific Review 56-77 https://doi.org/10.1080/13439006.2022.2152620/.

[8] ibid at 67.

[9] ibid.