Foreign direct investment in railways: Does national security matter?

9 Feb

This post has been written by Mr. Pratik Datta.

Background

Present Indian laws ’prohibit’ foreign direct investment (FDI) in railways (other than mass rapid transport system). Of late there has been growing expectation that the Indian Government might allow 100% FDI in construction and maintenance of railway projects (but not in operations). Suddenly the optimism seems to have yielded to apprehensions of ’national security’ concerns (link). These concerns reportedly stem out of potential Chinese investment in Indian railways. India and China have long standing border disputes. The deep penetration of the Indian railways into some remote border areas seem to be bothering the Government. But is this apprehension justified? Do other countries restrict foreign investment based on ’national security’ concerns? Is there no other option but to prohibit foreign investment in railways? These are some of the questions that I will try to answer in this post.

Do other jurisdictions restrict foreign investment on grounds of “national security”?

Yes.

Let’s take the example of US. Since World War II, US has traditionally been an ardent advocate of reduced restrictions on foreign investments. However, at different points of time, specific concerns over national security have shaped US policies on foreign investment. For instance, in 1970s, the US Congress had growing concerns about the increasing foreign investment into US from OPEC countries. This led to the establishment of the Committee on Foreign Investment in the US (CFIUS) in 1975 to oversee the national security implications of foreign investment. In 1988, amidst concerns over acquisition of some US companies by Japanese firms, the Congress approved the Exon-Florio provision that granted the President the power to block cross-border mergers with, or acquisition and takeovers of, certain US companies that might threaten national security.

Subsequently, the 9/11 attacks led to the passage of the Patriot Act, 2001 which declared certain sectors as ’critical infrastructure’ (including transportation) necessary for ’national defense, continuity of government, economic prosperity, and quality of life in the United States ’. The following year, the power to identify ’critical infrastructures’ was transferred to the Department of Homeland Security under the Homeland Security Act, 2002. In 2006, the proposed purchase of the US port operations of British-owned Peninsular and Oriental Steam Navigation Company by Dubai Port World fuelled much discontent among US policymakers. This culminated in the enactment of the Foreign Investment and National Security Act, 2007 that changed the way foreign direct investments are reviewed. First, it included ’critical infrastructures’ and ’homeland security’ as areas of concern comparable with ’national security’ under Exon-Florio provision. Second, it requires CFIUS to investigate all foreign investments involving foreign entities owned or controlled by a foreign government regardless of the nature of business. Therefore, it can safely be concluded that ’national security’ concerns may restrict the free flow of foreign investment into US.

Is US an exception?

No.

An OECD study across 39 jurisdictions found that transportation is the most targeted sector all the jurisdictions have discriminatory foreign investment policy in this sector. The discrimination usually takes three forms: blanket restrictions, sector-specific licensing provisions or contracting, and trans-sectoral measures. The study however concludes that discriminatory investment rules serve as a policy of last resort if all other mechanisms fail, investment policy can be used to prevent investments by foreign entities that may pose risks.

Can it be argued that there is a legitimate national security reason to prevent FDI in Indian railways?

No.

Railways and airways are both modes of transportation. Yet under the present Indian laws, FDI in railways is prohibited while it is allowed in ’air transport service’. In ’scheduled air transport service’ 49% FDI is allowed under automatic route and in ’non-scheduled air transport service’ 74% FDI is allowed – 49% under automatic route and beyond it through approval. Moreover, in ’helicopter services/seaplane services requiring DGCA approval’, 100% FDI is allowed under automatic route. If FDI is not prohibited for air transport on grounds of ’national security’, it is difficult to see why railways should be treated differently.

The prohibition of FDI in railways can be traced back to the Industrial Policy Resolution (IPR), 1948. Railways along with atomic energy, arms and ammunitions were reserved only for state monopolies. The position was reiterated in Schedule A of IPR 1956, which expanded the list of industries (to include air transport also) the ’future development of which would be the exclusive responsibility of the state’. The reason for including ’public utilities services’ within Schedule A was for ’planned and rapid development’ and to provide ’investment on a scale which only the State’ could provide. Evidently, national security never motivated the policy makers to include railways as a state monopoly in the first place. So, it is hard to justify the current blanket ’prohibition’ of FDI in railways on grounds of ’national security’.

If FDI in Indian railways is allowed, would it compromise ’national security’ concerns?

No.

Under the present regime, FDI can come in automatically (automatic route) or through Government approval (approval route). If FDI in railways is allowed under approval route, ’national security’ concerns can be looked into by Foreign Investment Promotion Board (FIPB). If it thinks the concerns are valid, it can reject the FDI proposal. If there is no such valid concern, FDI will be allowed. Subsequent to the FIPB approval, if any genuine ’national security’ concern arises, the foreign investment itself will not be protected under bilateral investment treaties (BITs). For example, Art. 14 of the India-China BIT provides for the ’exception’ clause which excludes from the scope of the treaty any action under domestic laws for protection of ’essential security interests’ by a Contracting Party. The ICSID held in CMS Gas Transmission Company v. Argentine Republic (link) (in paragraph 360) that ’essential security interests’ include ’national security’. Therefore, India can take appropriate actions under domestic law (even expropriate the foreign investment) if there are valid ’national security’ concerns.

To conclude, national security is certainly a crucial issue for foreign investment into any country including India. However, apprehension in itself should not be a ground to prohibit foreign investment. The current legal regime gives enough room to India to address these concerns within the rule of law framework. Imposing a blanket prohibition on foreign investment in Indian railways because of vague national security concerns is neither necessary nor justified.

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3 Responses to “Foreign direct investment in railways: Does national security matter?”

  1. DC February 10, 2014 at 6:42 pm #

    Determination of essential security interests can be quite problematic – because while the exception exists, whether exercised validly or not by a Host State is often subject to determination by a tribunal (again). So it doesn’t really solve the problem, even more so if ‘Full Protection & Security’ is being offered to the investment as a right under the treaty (which it usually is).

    Ideally, you don’t want to submit to tribunals (in any situation and even more so for security issues), so to determine whether you have validly exercised your right or not as a Host State, if you have to go back to a tribunal – then the point of the exception is lost.

    • Pratik Datta (author) February 10, 2014 at 8:02 pm #

      You are right. The ‘exception’ clause is not a self-judging clause. The State’s actions under the aegis of the ‘exception’ clause can be reviewed by the Tribunal. This will ensure that the State does not interpret every random event to be a ‘national security’ concern. Because once the clause is triggered, none of the protections under the treaty apply – even an expropriation is possible. So the host country should think it through before it opts to call an act of an investor a ‘national security’ concern. This is because, in all probability, there will be other domestic laws (other than investment related laws) that will be triggered if the investor was doing something which has national security implications. Like sabotaging the railways! The Indian management can be hauled up under various provisions of IPC and laws on railways. So invoking the treaty exception should be the last resort, under very, very pressing circumstances only. Most countries use foreign investment laws as a last resort to handle ‘national security’ concerns as highlighted by OECD. So when the host country ends up before the Tribunal, either it has a really good case or else the ‘national security’ concern isn’t as serious as it wants others to believe.

      • DC February 11, 2014 at 3:45 pm #

        While I agree with the larger points made, it must be noted that the tribunals in CMS and Enron reached similar conclusions against Argentina, LG&E partially permitted Argentina’s reliance on the exception. Given this scenario of conflicting decisions by investment arbitration tribunals, in the same factual circumstances (Argentine Peso crisis) and while interpreting the same BIT (US-Argentina), we should tread very cautiously around the issue of expropriation and the validity of expropriation of an Investment on this basis.

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