Compulsory CSR and inward FDI in India: a positive step forward or a misguided reform?

By Alessandra Silva

1 Introduction

Homo homini lupus. Men are wolves for other men. With this aphorism, Plautus warned his contemporaries that human beings, dominated by egoism, are intrinsically predisposed to fight each other and to take advantage of one another. Two thousand years later, this maxim seems appropriate to describe the reality of the business and financial sectors, where men appear –at least, prima facie- to act led by their self-interest and greed. Nevertheless, the current panorama in these areas is not as harsh as one may think, as exemplified by the relatively modern practice of Corporate Social Responsibility (hereafter, CSR). This concept can be defined as a business approach that aims to contribute to sustainable development by focusing not only on the creation of economic benefits, but also on social and environmental ones. In 2014, India became the first country in the world to mandate CSR activities. As it is clearly stated in Section 135 of the Indian Companies Act, 2013 (hereinafter, ICA), certain companies in this State are now legally obliged to invest 2% of their net profits in CSR-related projects. Most of these investments have been undertaken in the field of health, education and environment.

According to the OECD, India is –and will remain- one of the fastest growing G20 economies, with a projected annual growth of 7.5% in 2017-2018. A fundamental role in the country growth and economy is played by inward foreign direct investments (FDI). Although a univocal definition of this concept does not exist, foreign direct investments can be described as a ‘form of long-term international capital movement, made for the purpose of productive activity and accompanied by the intention of managerial control or participation in the management of a foreign firm’. More simply put, FDI are investments undertaken by a foreign investor in the business of certain country. Generally speaking, these transactions have the potential to bring several benefits to the recipient State, such as the creation of high-quality jobs and the introduction of efficient production and management practices. Inward FDI play a particularly important role in the Indian economy: being a developing country, this State requires foreign capital for several reasons. First of all, domestic capital is inadequate to sustain the economic growth of the State. Furthermore, together with their financial assets investors bring to the country technical know-how and business experiences, hence further contributing to India’s economic development. At present, India is one of the main recipient of FDI in the world. With an inflow of $44 billion, the country scored a fourth position as the “largest recipient of FDI in developing Asia and the tenth largest in the world”.

But what effect could the rule on mandated CSR have on inward FDI, and shall it be considered as a positive provision or rather as a misguided reform? In this paper, an answer to this query will be sought. First of all, a clear explanation of the ambiguous term ‘Corporate Social Responsibility’ will be provided, together with its origins. A brief overview of India’s past and present FDI regulation will then be provided, together with a description of the Government’s strives to reduce barriers to FDI. Particular attention will be devoted to the FDI Consolidated Policy of 2016. An in-depth analysis of Section 135 of the ICA will then be conducted, so to shed clarity on the mandated CSR provision. The controversies and difficulties surrounding this legal obligation will be discussed, together with its (negative) effect on FDI and the social reasons behind this reform. On the basis of the information presented, the following conclusion will finally be reached: even though the provision mandating the investment of 2% of a company net profit has the potential to discourage the incoming flow of FDI, this provisions should still be welcomed, as it will provide substantial private financing to ameliorate the social welfare in India. Nevertheless, it will be suggested that some modifications to the current regime are needed. The adoption of enforcement measures and penalties in case of non-compliance with the 2% obligation, combined with strict governmental supervision, will be recommended, in order to ensure that CSR investments will effectively lead to the creation of long-term benefits for the local communities.

II Corporate social responsibility: origins and meaning
Despite the fact that the modern concept of CSR has gained attention only in the last few years, the main ideas behind it are well-rooted in the past. Already in the pre-Christian era, Different philosophers in the West as well as in the East were preaching for the adoption of ethical principles and conduct while doing business. The idea of improving one’s surroundings by helping the disadvantaged, which is the very basis of the concept of CSR, was also promoted by different religious law, such as the Muslim Zakaat (i.e. mandatory donations from one’s profit to the poors), the Hindus’ principle of Dhramada and the Sikhs’ Daashant. On the global scene, the CSR concept started to get its current shape and meaning towards the end of the 18th century. Identified under the name of social philanthropy, until 1990’s it mainly consisted in voluntarily contributions by business leaders to the establishment of trusts that promoted, among the others, educations and women’s welfare.

The modern concept of CSR is fundamentally different from the traditional one of social philanthropy, as developed both in the East and in the West.
Although a univocal definition does not exist, it can be described as follows:
‘Companies have an impact on society and the environment through their operations, products or services and through their interaction with key stakeholders such as employees, customers, investors, local communities, suppliers and others. Corporate responsibility means understanding such impacts and managing business processes to add social, environmental
and economic value in order to produce a positive sustainable impact for both society and the business’.
There are three main principles which are commonly accepted as underling CSR, namely:
CSR is a business imperative. Independently from the reason why CSR policies are pursued (i.e. are they being voluntarily implemented, or are they mandated by law?), they will be able to achieve their objectives solely if businesses will truly understand that CSR is advantageous for them as well.
CSR is a link to sustainable development. Businesses are learning to appreciate the benefits of integrating environmental, social and economic concerns in their operations. As Niall FitzGerald, Former CEO of Unilever, argued, ‘corporate social responsibility is a hard-edged business decision. Not because it is a nice thing to do or because people are forcing us to do it… because it is good for our business’.
CSR is a way to manage business. It is not a vague, nebulous concept which can be neglected by companies: contrarily, it has become a full-fledge business strategy. It plays a fundamental role in today business life, where making profit is equally important to how such results are achieved and with what non-financial costs. Nowadays, corporate profit will be analysed in conjunction with social prosperity, and strong consideration will be given to issues like sustainable development and ethical business.
CSR acknowledges the corporations’ debt owed to the communities within which they operate, and communities themselves are considered as equal stakeholders. It also defines the ‘business corporation’s partnership with social action groups in providing financial resources’ in order to promote and support development plans, especially concerning disadvantaged communities.

To sum up, it may be said that CSR is basically a new business strategy, which aims at reducing investment risks and maximising profit by taking all the key stake-holders into account. These actors include consumers, employees, affected communities as well as shareholders, all of whom have an interest in knowing about corporations, their business and their impact. As a consequence, a shift from companies’ accountability to shareholders to accountability to stake-holder has occurred: under the concept of CSR, an enterprise (at least, ideally) will have to answer for its actions in front of the whole society.

III India and FDI: regulation and policy evolution
From 1991 until 2012: waves of liberalization
It would be very difficult to understand the characteristics of India’s inward FDI current policy and regulations without looking at their past reforms and changes. Therefore, a brief historical excursus on the matter will now be provided.

India’s economy was profoundly transformed by waives of economic liberalisation in 1991, which constituted a response to the balance of payments crisis that afflicted the country. In the following years, the Foreign Investment Promotion Board was set up and the Foreign Exchange Management Act, 1999 (hereinafter, FEMA) was enacted. These innovations clearly demonstrated a shift in the governmental investment policy, fuelled by a desire to attract foreign direct investments into the country. At the time, FDIs were governed by the FEMA, as well as by the regulations adopted under that Act and by the clarifications delivered by the Department of Industrial Policy & Promotion (hereafter, DIPP). In order to further encourage the inflow of FDI, a transparent policy framework was adopted, with a view to simply the existing regulatory situation. On the 31st March 2010, the DIPP published its first consolidated policy. Regularly updated since then, this legal instrument provides a single document substituting all the previous press notes, releases, and clarifications. It constitutes a transparent, coherent and straightforward source of information on Indian FDI regulation and treatment. In 2012, another wave of liberalisation further shaped the economy of the country: norms were introduced to liberalise FDI in multi-brand retail, single-brand retail, aviation, broad-casting and power exchanges. All these reforms demonstrated a clear desire of the Indian Government to boost the incoming flow of FDI.

Latest developments: the 2016 FDI Consolidated Policy
As evidenced by the FDI Consolidated Policy of 2016, the Indian Government has strived to open new sectors to inward FDI, to increase the existing sectoral limits and more generally to simplify the conditions imposed on these investments. But what steps exactly does a foreign investor need to undertake in order to invest in India? There are two main paths that an investor can (or rather, has to) follow: either the Automatic or Governmental route. While in the former no governmental approval is required; in the latter an investor would have to submit his application to the Foreign Investment Promotion Board and to receive official approval. Furthermore, there are sector-specific conditions for FDI. As an example, in the area of gambling and betting no foreign investment is permitted, while in others a sectoral cap (i.e. a maximum amount of capital which can be invested) is imposed. Admittedly, despite the substantial efforts of the Indian Government, foreign investors still face several difficulties when investing in the country. Nevertheless, the regulatory framework has been in constant evolution in the past years and substantial improvements have been achieved. For instance, in the insurance and pension sector foreign investments are now permitted up to 49% under the Automatic route; while the cap of investments made in the defence sector (which fall under the category of Manufacturing of Small Arms and Ammunitions covered under the Arms Act 1959) has increased to 100%, 49% of which can now be entered via the automatic route.

IV Section 135 of the Indian Companies Act (2013)
The content of the clause
It was mentioned in the Introduction to this paper that India has been the first country in the world to mandate CSR activities. This may surprise the reader, since it does not seem coherent with the State’s liberalisation policy. In order to ensure a complete understanding of this relatively new duty imposed on businesses, it is useful to provide a detailed account of the content of Section 135 of the ICA. Effective as of 1st of April 2014, the main innovation introduced by this provision is the obligation to spend ‘in every financial year, at least two per cent of the average net profits of the company made during the three immediately preceding financial year’ pursuing CSR activities. What constitutes a ‘CSR activity’ is exemplified in the non-exhaustive list of Section VII of the Act: this includes initiatives to combat extreme hunger and poverty, to promote education and to ensure environmental sustainability. The addressees of the spending duty are qualified under the same Section, namely companies incorporated in India which have either (i) net worth of at least Rs. 5 billion, (ii) a turnover of at least Rs. 10 billion or (iii) a net profit of at least Rs. 50 million during any financial year. In order to achieve the aims of the provision, these companies are required to establish a CSR Committee of the Board, responsible for the formulation and monitoring of the enterprise CSR policy. One of the crucial tasks of the Committee is to ensure the implementation of such policy by the company, as well as the compliance with the 2% spending requirement. In case this obligation would not be respected, the Committee would be responsible to specify the reason of such failure in their annual report. Finally, a geographical limit for the implementation of CSR activities is also imposed, although under the Proposed Draft Corporate Social Responsibility Rules: only projects undertaken in India will be taken into consideration for the purposes of the 2% obligation.

The application of the clause in practice
But how many companies are covered by this provision in practice? India’s Minister for Corporate Affairs, Sachin Pilot, has estimated that around 9.000-10.000 companies fall under the scope of this clause, their annual spending for CSR activities amounting to Rs. 120 billion. In reality, this prediction seems to be far too optimistic. In 2015, Futurescape and the Indian Institute of Management Udaipur studied 200 of the main Indian companies employing governance, disclosure, CSR stakeholders and sustainability as parameters. The results were quite startling: only 18% of the examined enterprises complied with their 2% spending obligation, with the majority of businesses investing only 1.28% of their average net profit in CSR activities. Of course, these findings do not hold true for each and every company. As an example, among the top-performing Indian companies it is possible to find the Mahindra Group, who invested more than the required 2% in initiatives supporting girl children, youth as well as farmers in the fields of education, public health and environment education.

V The CSR rule, its effects on inward FDI and social considerations: a controversy
The reactions to the CSR reform and four main challenges to CSR activities in India
Different reactions have accompanied the enactment of Section 135 ICA. On the one hand, several actors of the civil society have welcome the introduction of this provision, enthusiastic of the idea of having giant corporate legal persons contributing towards the general social welfare. On the other end, the most sceptics have highlighted that CSR activities were already part of Indian businesses’ practices before the introduction of ‘mandated philanthropy’. An illustrative example is IBM’s work in 2013 with the Tribal Development Department of Gujarat, which aimed at improving the living condition of tribes in the Sasan area of Gir forests; or Tata Group’s projects in the fields of health services and family planning. These considerations led some companies to argue that the rule is unnecessary, in addition to being impractical. Furthermore, Section 135 has been accused to possess several loopholes. Among these, the complete lack of any enforcement measure or penalty in cases of non-compliance with the provision is seen as one of the main drawbacks of the reform. Finally, it has been argued that mandating CSR has the potential to lead to corruption and to the masking of data, in order to avoid having to comply with the obligation.

Generally speaking, four can be recognised as the main challenges which are posed to CSR activities in India. First of all, there is a lack of community participation in CSR activities. Very often, the social groups which are intended to be the beneficiaries of these plans show little interest in participating and contributing towards the achievements of their objectives. Furthermore, generally speaking no relevant effort has been made to spread knowledge about CSR in local communities and instil confidence in them. Secondly, a need to improve the capacities of local non-governmental organisations has been highlighted. Several NGOs do not possess an adequate training which could enable them to operate more efficiently and effectively, therefore negatively affecting the actions undertaken by corporations under they CSR initiatives. A third issue concern the exist lack of transparency, i.e. the perceived secrecy surrounding these plans. Often NGOs are perceived as non-disclosing fundamental information on their implementing programs, as well as utilisation of funds. This has in turn a negative impact on the process of trust-building between companies and local, affected community, relationship which is fundamental for the accomplishment of every CSR activity. Finally, a fourth issue entails the lack of consensus among local agencies concerning CSR projects needs and priorities. This often leads to several, different activities of corporate actors in the same areas, and to a spirit of unhealthy competitiveness between the different local implementing agencies. This factor severally limits the ‘organization’s abilities to undertake impact assessment of their initiatives from time to time’, as well as endangers the achievement of the established CSR policy aims.

The effects on FDI and the social reasons behind the CSR clause
It is now the turn to consider a fundamental question: what are (and will be) the effects of this rule on inward FDI? It is still not possible to provide a certain answer, supported by reliable data and studies. Nevertheless, some hypothesis can be formulated on the basis of the previously presented information. Despite the Indian Government’s great strives to simplify the existing FDI regulation and to reduce barriers to their entry, the legislative framework concerning these investments is still quite complicated. This has been evidenced in the 2017 World Bank study on the ease of Doing Business, where the country was ranked 130 on 179 States. The enactment of a mandated CSR duty, requesting the creation of specifics organisms within a business and being regulated by a controversial provision, does not seem likely to encourage foreign investors to bring their capital to India. Rather, it seems likely that it will exercise a deterrent effect. As it was highlighted by the OECD, in order to boost inward FDI a country should remove ‘specific regulatory obstacles’ to their entrance, and ‘under certain circumstances, it may also be appropriate to provide specific incentives to potential foreign investors’.

Despite all these economical and financial considerations pointing to a negative connotation of Section 135 INCA, social factors should be taken under consideration as well before expressing a final opinion of the CSR clause. As emphasized by the OECD, FDI policies and incentives ‘should not become a substitute for policies aimed at improving the business environment more generally’. In a country like India, where more than 20% of the population lives with less than US$2 per day, a third is illiterate and two-thirds do not have access to proper sanitation, the introduction of a mandatory-CSR rule could still be welcomed as a positive step. Big businesses will now share responsibility with the Government for improving social welfare and develop sustainable business environments, contributing with their own profits to the achievement of these aims. Therefore, whether the mandated-CSR obligation contained in Section 135 should be considered as a positive reform or not will depend on the outcome of a balancing exercise between its effects on the economy (i.e. to discourage inward FDI) and its social benefits (i.e. the investment of private funds in projects ameliorating the social welfare of the country).

VI Conclusion
The importance of inward FDI for every State is undeniable. This is especially true for developing countries, such as India, where often domestic funds are not sufficient to provide for the resources needed to sustain the economic growth of the State. In this paper, after having explained the meaning and origins of the concept of Corporate Social Responsibility, the attention shifted to India and the role played in the country by FDIs. It was explained than since 1991 liberalization has characterised the Indian Government policy concerning FDI. Several reforms have been introduced in order to simplify the existing regulatory framework and a more transparent approach has been adopted. Nevertheless, as it was found when analysing the FDI Consolidated Policy of 2016, some hindrances still exist: the need to request the Government approval before investing in certain sectors, as well as the existing sectoral caps, might still discourage potential foreign investors. An in-depth analysis of the Section 135 ICA was then provided. After having outlined the exact content of the 2% obligation, its practical effects and the debate concerning the mandated CSR were considered. It was highlighted that, especially because of its loopholes, the CSR provision could constitute a hindrance for foreign investors. The rule represents a further difficulty with which businesses would have to deal with, and they could therefore be discouraged from investing their capital in India. Nevertheless, special social conditions existing in this country should be taken into account as well. Although India’s economy has been growing in the past (and present) years, the same cannot be said about the quality of life of its citizens. It was mentioned in the previous chapter that serious social issues, such as poverty, severely affect large parts of the population. Therefore, despite the fact that it may discourage the inflow of FDI, the rule mandating certain business to invest 2% of their net profits in CSR-related activities should still be considered as a positive reform. In fact, thanks to this provision substantial private funding will be invested in projects aiming at the improvement of the Indian social welfare. Nevertheless, the Indian Government should ensure that big businesses actually comply with this obligation: as it was shown in Chapter IV (B) of this paper, this is not so at the moment. In particular, the lack of enforcement measures and sanctions in case of non-compliance with the 2% spending duty seems to provide an incentive for companies to depart from the rule. The enactment of strict enforcement measures, together with close supervision and monitoring from the Government through one of its agencies, could perhaps be suitable tools to address this issue and to ensure that businesses CSR investments will effectively lead to the creation of long-term benefits for the local communities. In this way, even the more sceptics could be convinced that the introduction of a compulsory CSR duty constitutes a positive step forward, rather than a misguided reform.

VI Bibliography

Primary sources

Legislation

Draft Corporate Social Responsibility Rules under Section 135 of the Companies Act, 2013

Foreign Exchange Management Act, 1999

The Companies Act, 2013

Consolidated Policies

Consolidated FDI Policy (31 March, 2010), Department of Industrial Policy and Promotion
Ministry of Commerce and Industry

Consolidated FDI Policy (07 June, 2016), Department of Industrial Policy and Promotion
Ministry of Commerce and Industry

Secondary sources

Book

Plautus T, Asinaria (1st edn, Brepols Publishers 2010)

Chapters in Edited Books

Donovan L and Shukla A, ‘Issues in Implementing CSR: an Indian Perspective’, Implementing Corporate Social Responsibility – Indian Perspectives (Springer India 2014)

Gupta A, ‘Implementing Corporate Social Responsibility In India: Issues And The Beyond’, Implementing Corporate Social Responsibility – Indian Perspectives (Springer India 2014)

Handbook

Confederation of Indian Industry, ‘Handbook On Corporate Social Responsibility In India’ (Pricewaterhouse Coopers Private Limited 2013)

Journal Articles

Ali H and others, ‘India’ (2013) 47 International Lawyer

‘Developments In Individual OECD And Selected Non-Member Countries’ (2017) 26 OECD Economic outlook

Dodh P, Singh R and Singh S, ‘Corporate Social Responsibility And Sustainable Development In India’ (2013) 3 Global Journal of Management and Business Studies

Ibrahim S and Muthusamy A, ‘Role Of Foreign Direct Investment (Fdi) In India’s Economic Development-An Analysis’ (2014) 2 Journal of International Relations and Foreign Policy

Kiran R and Sharma A, ‘Corporate Social Responsibility Initiatives Of Major Companies Of India With Focus On Health, Education And Environment’ (2015) 4 African Journal of Basic & Applied Sciences

Moura‐Leite R and Padgett R, ‘Historical Background Of Corporate Social Responsibility’ (2011) 7 Social Responsibility Journal

Nagaraj R, ‘What Has Happened Since 1991? Assessment Of India’s Economic Reforms’ (1997) 32 Economic and Political Weekly

Prathima D, ‘The 10 Companies With Best CSR Reputations’ [2015] Proceedings of the Second European Academic Research Conference on Global Business, Economics, Finance and Banking
Rakesh V, ‘Corporate Social Responsibility Under Companies Act 2013: An Overview’ [2015] Law Mantra Online Journal

Policy Brief

OECD, ‘India Policy Brief -Encouraging Greater International Investment In India’ (2014)

OECD, ‘Policy Brief – The Social Impact Of Foreign Direct Investment’ (2008)

Reports

Futurescape and Indian Institute of Management Udaipur, India’s Top Companies For Sustainability And CSR 2015 (2015)

Global Reporting Initiative, Mumbai Declaration on Sustainability Reporting for Sustainable Development (2014)

UNCTAD, World Investment Report (United Nation Publication 2016)

World Bank Group, Doing business. Economy Profile – India (International Bank for Reconstruction and Development / The World Bank 2017)

World Bank Group, Purchasing Power Parities And The Real Size Of World Economies (International Bank for Reconstruction and Development / The World Bank 2015).

White Paper

KPMG and ASSOCHAM, Corporate Social Responsibility – Towards A Sustainable Future: A White Paper (KPMG In INDIA 2008)

Websites

Balch O, ‘Indian Law Requires Companies To Give 2% Of Profits To Charity. Is It Working?’ (the Guardian, 2016)

Ghuliani C, ‘India Companies Act 2013: Five Key Points About India’S “CSR Mandate” (BSR, 2013)

Dawan A, ‘Companies Bill 2012: How Can India Inc Make CSR A Game-Changer?’ (The Economic Times, 2013)

‘Foreign Direct Investments’ (Make in India, 2017)

Majmudar U, Rana N and Sanan N, ‘Mahindra & Mahindra Tops CSR List In India Even As Companies Scale Up Operations’ (The Economic Times, 2017)

”Memorable Quotes On Ethics, CSR And Sustainability’ (The CSR Company International, 2017) accessed 22 June 2017

Pilot Estimates CSR Spend Of Companies At Rs 15,000-20,000 Cr A Year’ (The Hindu Business Line, 2013)
Incoming or inflowing FDI??

‘Zakaat (Alms To Charity) Talimul-Haq Part 12’ (Inter-islam.org, 2017)

***                                                                   

Essay written by Alessandra Silva

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s