Ill fitting caps
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Government must not prescribe royalty caps for foreign subsidiaries. The market is a better judge
Commerce Minister Anand Sharma has written to finance minister P. Chidambaram on the "excessive" royalty payments made by Indian subsidiaries of foreign companies to their parent firms, suggesting that restrictions be reintroduced to curtail the "excess". In 2009, restrictions on royalty payments — which are paid in lieu of technology transfers, marketing rights, brand equity etc — had been lifted. The payment of royalties as a proportion of total FDI inflows has increased from 7.9 per cent in 2009-10 to 19.1 per cent in 2012-13. But it is also true that 2012-13 was a particularly bad year for FDI inflows, which declined by 21 per cent from the previous year and were $885 million less than in 2009-10. Moreover, the ministry does not take into account the earnings that foreign companies reinvest in India as a part of FDI. If this were done, royalty payments as a percentage of FDI would be much smaller.
If companies are not allowed to realise returns, or if the rate of return is to be arbitrarily decided by government, then why would a foreign entity take the risk to invest in India? The market is a much better judge of when royalty payments are "excessive". For instance, the commerce ministry is probably upset that, starting from February 2013, Hindustan Unilever Ltd plans to increase royalty payments to its parent company, Unilever, from 1.4 to 3.15 per cent of turnover by 2018. However, the fact that Unilever was unable to meet its open offer buyback target to acquire 22.52 per cent of HUL — it was only able to reach approximately 15 per cent, resulting in an FDI injection of $3.2 billion — indicates the market's confidence in the company and its distribution network despite its royalty commitments.