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Step into tricky reform terrain

New Delhi, Oct. 3: The Union cabinet is likely to take another risky bet on reforms tomorrow by clearing a proposal to raise the foreign investment limit in the insurance sector to 49 per cent from 26 per cent at present.

Top officials in the finance ministry said were two other important proposals on the agenda: a bill seeking to grant statutory powers to the pension regulator and permit foreign investment in pension funds, and a long-awaited amendment to the Companies Act. (See chart)

Sources said a 49 per cent cap had been suggested for foreign investment in pension funds -- just as in the insurance sector. This is higher than the 26 per cent limit that had been worked out earlier in consultation with the BJP.

After cutting fuel subsidy and clearing a contentious proposal to allow foreign direct investment in multi-brand retail, the government is looking to step up the pace by trying to push financial sector reforms.

But there’s a difference here: until now, the tough decisions were taken through executive fiat. The financial sector reforms in the areas of insurance and pension funds will require parliamentary approval. That might be difficult to obtain given the composition of the two Houses and the intense hostility to some of the proposals.

The insurance amendment bill was first moved in December 2008 and referred to a House standing committee of finance. The dissolution of the 14th Lok Sabha meant that the legislation could not be taken up for discussion. After the formation of the 15th Lok Sabha, the legislation was revived and referred to the standing committee in September 2009.

The standing committee on finance submitted its report in December last year. The note, which will come up before the Union cabinet tomorrow, has been framed after considering the recommendations of the House committee.

The insurance bill was kept in cold storage till now because the UPA’s former ally, the Trinamul Congress, had vehemently opposed any move to raise the FDI limit to 49 per cent.

But with Trinamul having withdrawn support, the Manmohan Singh government is no longer squeamish about trying to push through the reform. But it will have to reach out to Mulayam Singh’s Samajwadi Party and Mayawati’s Bahujan Samaj Party to rally support for the contentious bill if it wants to avoid embarrassment in Parliament during the winter session.

The government has a strong justification for raising the foreign investment limit in insurance. The insurance regulator IRDA has estimated that the sector needs a capital infusion of Rs 61,200 crore over the next five years in order to raise the insurance penetration level from 4.61 per cent in the life insurance business and 0.61 per cent in general insurance business. Insurance penetration is calculated by measuring total premium collections as a percentage of GDP.

In its submission to the standing committee on finance headed by Yashwant Sinha, the IRDA had said that Indian promoters of insurance companies had invested Rs 21,000 crore over the past decade and had received no dividends till date. It said it was futile to expect them to pump in another Rs 61,200 crore now. Moreover, 13 of the 42 private insurers have been promoted by banks which are already under pressure to widen their capital base in order to comply with the tough global capital adequacy standards under Basel II.

There are two ways to raise the required capital: float capital issues on the local bourses or raise the foreign investment limit to 49 per cent.

The IRDA argued that in 2009-10, 73 companies had raised Rs 55,055 crore from the market - which was less than the total requirement of the insurance industry over the next five years. It also said that the insurance companies would be steeped in losses over the next five years. In such a situation, it would be hard to create investor appetite for insurance flotations.

The IRDA said that this meant that a hike in the FDI limit was the only realistic option on the table that “will enable the insurance companies to access the resources required to increase insurance penetration”. It also argued that the FDI limit in the other financial sectors like banking and capital markets had already been raised to 74 per cent.

The other big change that the Centre is trying to introduce through the Insurance Laws (Amendment) Bill 2008 is to allow Lloyd's of London to open an insurance trading floor in Mumbai.

At present, Lloyd’s doesn’t qualify to enter India under the current insurance laws. Lloyd’s operates a loose society of underwriters in London and manages the largest reinsurance pool in the world.

The government is proposing to treat Lloyd’s as a “foreign company” so that it can start operations in India through a joint venture with Indian companies. In China, for instance, Lloyd’s operates as a company.

The legislation also seeks to allow foreign reinsurance firms such as Swiss Re and Munich Re to enter India.

Earlier this year, then finance minister Pranab Mukherjee had advocated that the insurance amendment bill should be introduced without the proviso for a hike in the FDI limit in order to appease allies like the Trinamul and opposition parties like the BJP. However, the Prime Minister had then ruled that the bill ought to include the clause raising the FDI limit.

The pension bill seeks to formally sets up a Pension Funds Regulatory Authority, vesting it with specific powers. It will also set limits on foreign investments in pension funds. The government had reintroduced the PFRDA bill, which was first introduced in 2005.

Pension fund subscribers will be able to choose from different combinations of debt and equity instruments while trying to pick their preferred risk-return matrix.

Top industrialists and bankers such as Adi Godrej, Sidharth Birla and Naina Lal Kidwai met the finance minister P. Chidambaram today and also called for a second wave of reforms especially in the financial sector. They also advocated cuts in fertiliser and food subsidies.

Chidambaram urged them to drum up political support for the insurance and pension fund legislation.