India Law Journal

Legal Articles

FDI in the Pharma Sector: - Capitalizing India’s Growth Potential or Disaster for a Booming Economy

With the sector booming, in the last few years there have been increased mergers and acquisition of indigenous companies by foreign players. Karan Kumar Kamra tries to explore the sanctity of the threats of foreign domination raised by some quarters urging a cap on foreign direct

investments (FDI) and focuses on both the key challenges and solutions to the problem of regulation of FDI in the pharma sector.

An Overview of the pharmaceutical industry

The global pharmaceutical market is currently amidst a dramatic transformation. A large number of forthcoming patent expiries, a dry pipeline of new drugs to replace the same, declining R&D Productivity, regulatory challenges and stringent pricing restrictions have led to an economic slowdown in prominent global pharmaceutical markets such as North America, Europe and Japan. A study of the recent trends in the Pharma Sector reveals that the multinationals are looking at new markets for growth opportunities to boost drug discovery potential, reduce time to market and squeeze costs along the value chain. IMS Health and other sources suggest that emerging markets like China, India, Brazil, Russia, Turkey, Mexico and South Korea will play a vital in addressing these concerns and are expected to contribute to over 40% of the incremental growth in the global pharmaceutical industry over the next decade.

India is currently poised for exciting times and is pitted to be a global pharma leader by 2020. As per a Pricewaterhouse Cooper report, the domestic market will grow to US $49 billion by 2020 – at a compounded annual growth rate (CAGR) of 15%, with the potential to reach US$74 billion – a CAGR of 20%, if aggressive growth drivers kick in. The anticipated growth rate is the product of the stable macro economic conditions facilitating a favorable climate for the industry to thrive. With traditional dominance and possessing considerable expertise in manufacturing of generics and vaccines, India is well positioned to don non-traditional robes providing significant assistance in the area of contractual research and development coupled with extensive manufacturing services. India has the world’s second biggest pool of English

Restricting Foreign Direct Investment in India: - A Step Back?

The recent slew of acquisitions, buyouts and takeovers of Indian drug companies by foreign drug makers had triggered fears in the domestic pharma, their regulatory counterparts and health groups that the multinationals were poised to dominate the local industry which in turn would result in destruction of competition, upward pressure on prices and scarcity of essential drugs. Intense rounds of debates were held within the government ministries as to whether the FDI in pharma sector should be capped upto 49 per cent or alternatively whether to continue FDI upto 100 per cent but put safeguards in place in the FDI process to exercise supervision over the investments made in the sector.

Settling the debate the Government of India issued Press Note 3 of 2011 dated November 8, 2011 amending the Consolidated FDI policy. As per the press note:

"FDI upto 100 per cent in greenfield projects was to remain under the automatic route. FDI upto 100 per cent in brownfield investment (i.e. investments in existing companies), was permitted though through Government approval route This meant scrutiny and approval by the Foreign Investment Promotion Board (FIPB) initially for six months and in future was to be taken over by the Competition Commission of India (CCI). During this period, necessary enabling regulations were to be put in place by the CCI for effective oversight on mergers and acquisitions to ensure that there is a balance between public health concerns and attracting FDI in the pharma sector."

It is rather unfortunate that despite the expiry of the six-month deadline, the government is still grappling to formulate guidelines for regulating mergers and acquisitions. There is still a looming uncertainty as to which agency will be the gatekeeper vetting pharma acquisitions as clearly the CCI; the fair watchdog is in no position to regulate FDI. Though a legal amendment could be done to empower CCI, the corporate affairs ministry wants an overhaul of the Competition Act at one go that is expected to take several months. To make matters worse, the health ministry and even the Indian Pharmaceutical Alliance are favouring the Foreign Investment Promotion Board (FIPB) as the regulator over the CCI as it is better equipped in their opinion to watch such transactions, especially from the public health point of view. The lack of proper regulatory guidelines is adversely impacting future foreign brownfield investment with the FIPB deferring four such proposals on the ground that specific conditions for considering cases of brownfield foreign investment in the pharma sector were under formulation.

India's attempts to check foreign investment in pharma and expand drug pricing control could force multinationals to exit the country. It's the attractiveness of the domestic business that attracts investment. All global companies have their options open. One does not put money where the opportunity is less, and India may not be considered has having the right ecosystem for investments. Restricting FDI in the sector would send a wrong signal to the world and may backfire if other economies decide to retaliate in the same manner with Indian companies making investments in overseas jurisdictions.

Many believe that a promising industry may be nipped in the bud restricting India’s growth prospects but to be fair to the Government one estimate says in the last 10 years less than 10% of the FDI in pharma has been in Greenfield activities. The opposing side believes that it is actually time for the domestic drug industry to turn more protective if it wants to withstand the increasing onslaught of giant multinationals, which accentuates the need for a cap on foreign inroads. The argument is that multinationals could come in and swallow some of the top names in the Indian drugs industry and we could then lose our industry to foreigners.

The devil always lies in the details and thereby we should delve into the finer aspects to conclude decisively as to whether FDI in Pharma is really as big a demon to fear?

The Indian Pharma in a Jeopardy: -Exaggerated fears and misplaced anxiety

FDI is often seen as a catalyst for the host country’s development and economic growth. Reasons for the importance of FDI are not only because the foreign investor finances the “ hardware” like new plants and equipment, but FDI can be a major transfer of technology, knowledge and capital for the host industries. With FDI comes financial and managerial resources, access to larger markets, technical assistance and strategic assets, for instance; brand name, which can give the host firms, domestic and international, comparative advantage. Spillover effects may take place when the entry or presence of foreign firms leads to productivity and efficiency benefits in the host country’s local firms. Five transmission channels, through which positive intra- industry spillover effects might occur, are (i) competition (ii) availability of drugs and price rise (iii) demonstration and imitation effects (iv) transfer of technology and R&D (v) human capital and labour turnover (vi) industrial management.

(i) Competition: - The business environment in the Indian pharmaceutical market is today highly competitive with a large number of players. Features such as costs, research orientation, product portfolio, production capability and marketing and distribution network are important factors for a firm to succeed and be able to compete effectively in the pharmaceutical industry. The MNCs in India are characterized by advantage in many of these factors, while their domestic competitors have an advantage in production capacities and costs. Since the foreign firms do not have cost advantage in production, they invest large sums in marketing and fieldwork to promote drugs. Global pharma majors probably preferred acquisition of domestic companies as an easy entry point in India for reasons such as equipped infrastructure, licenses, manufacturing base and settled available skilled labour force over brownfield projects. Setting up a green-field project would always have its lead time and derail the business plans. The domestic firms are more are forced to try to keep up with the MNCs and their marketing expertise and their increasing market share is a testimony to their doing well.

With the introduction of the product patent regime in 2005, more research- based pharmaceutical companies are expected to establish their presence India. Many of the domestic firms are strong enough to face increased competition in the new setting, however as a spill over from competition inefficient unproductive firms will be swept off the market which in the long run could pave the way for better allocation of resources.

Acquisition of only generic companies with the wherewithal to manufacture variants could have adverse implications for availability of off patent drugs especially with 90 billion U.S.$ are going off patent in the near future. It could create perpetuation of extension of patents in the absence of competition. The acute therapy segment consists of treatments like antibiotics and painkillers for short-term ailments such as cough and cold. In this competitive environment, multinational companies are looking at expanding their Indian operations very aggressively through competitive pricing below Indian companies. While this has not significantly dented market share, it is a precursor to the competitive intensity in future.

(ii) Availability of Drugs and Price Rise: - There is a general belief that MNCs will cause prices of medicines to go up and will reduce availability of generics in the market, a part of the concerted strategy by foreign companies to dominate the Indian drug market diverting its capacity towards Western markets. The attractiveness of the local market is growing substantially with increased social and economic progress coupled increase in public expenditure on health. India is also seen as an attractive base for manufacturing of generics for exports both by multinational and Indian Companies. Acquisitions of other companies already established in the market are a universal business strategy in all industries and in all countries, to save time and also ensure more surety of success. Therefore the recent acquisitions of Indian pharma companies by MNCs could as well be an expression, as some evidence suggests, of these foreign companies to grow their business by investing more India to produce and sell more in India itself. This could be in India’s favour bringing increased investments and technology into the pharma sector. The Indian market is too competitive and fragmented for a single foreign company to dominate the Indian market. If the multinationals take over the generic goods, the present indigenous pharma industry of India is well equipped to come up with more generic drugs. The Government can moreover try alternative policies such as public procurement of drugs from the indigenous companies to ensure the availability of these goods. The need to maintain low prices for essential medicines has been addressed in the government's draft National Pharmaceutical Pricing Policy (NPPP), released in 2011. The major change is a move from the principle of cost-based pricing to a market-based pricing model. The Department of Pharmaceuticals argues that market-based pricing would result in more transparent and fair pricing, as well as increasing competition in the marketplace. Price regulation will encompass all drugs listed in the NLEM, as well as formulations containing combinations of drugs listed in the NLEM; this will include combinations comprising listed drugs and unlisted drugs. If the NPPP is implemented, around 60% of the drugs currently available in India will come under price control. It must also be recognized that monopolistic situations and unreasonable upward pressure on prices, can also result from strategies of acquisitions, cartelization, and unfair trade practices of domestic players within the Indian market even if there were no foreign companies.

(iii) Imitation and Demonstration effects: - Imitation of already existing products has led to know- how adoption and technological development for the local Indian companies. The Indian pharmaceutical industry would not have been able to develop as fast if firms were not allowed to make copies of already existing molecules and drugs. The average cost of developing a new drug for the international market is high and large investments are required for the process. It is much cheaper and less time- consuming to develop new processes and produce already existing products and for India, with limited resources, the industry could develop because of the production of generic drugs. The making of increased sales, creation of strong brand names in India and the low costs have offset the loss of knowledge by the MNC’s.

(iv) Technology and Transfer of R&D: - Technology in the pharmaceutical industry is often very complex and the need for up- grading the technology is large due to the rapid pace of new drug discovery and strict requirements of safety and efficiency. Foreign pharmaceutical affiliates in India receive up to date technology from their parent firm, both in managerial practices and in manufacturing facilities, which could stimulate spillover effects. It is possible that under the new patent laws, MNCs will start to outsource even patented drugs in India; consequently there will be larger scope for technology transfer spillovers in the future. With the new patent regime and enhanced work pool of skilled labour, it is very likely that MNCs will begin innovative research in India in the future. R&D activity is very competitive, which can benefit the domestic industry in terms of increased focus on innovation and improvement, increased competition among drug players not to mention the knowledge gap between the firms will decrease.

(v) Labour training and human capital: - Training and development of employees across all levels is a key investment area for many of the MNCs. The aim of investment in training is to make each employee highly productive. Thus, there seem to be spillover effects generated in terms human capital in the Indian pharmaceutical industry.

(vi) Industrial management: - The local industry can benefit from FDI through the superior industrial management skills that MNCs possess. Because of the threat of market loss, foreign companies can raise managerial incentives in host- country enterprises. A well functioning industrial management is key to the firm’s growth and development increasing its productivity significantly. The lack of marketing skills forces Indian firms to produce for the domestic market instead of expanding into the global market. It can therefore be argued that spillover effects in terms of marketing infrastructure are especially important for firms that want to expand internationally.

FDI in Pharma: - Of Dangers and Genuine Concerns

Questions are being raised as to the need of FDI in Pharma sector, whether brownfield or green- field projects. The industry has been doing well and if at all investment is needed, it ought to be based on the technologies and medicines necessitated by India's disease patterns. The choice ought to be in our hands as to where we source investments. That way, we can avoid technologies with little or no evidence base or relevance to India coming under the guise of new technologies. Not only 100 per cent FDI, even a controlling share in any local pharma major by an MNC means it ceases to be an Indian company for all practical purposes. A foreign pharma company is much less accountable to the local needs and to the national government; and having deeper pockets, their ability to influence our government and bring upon cross-sectoral pressures from Western governments is very high.

During the last decade, Indian pharma companies have become the chief source of low-priced quality generics (that is drugs out of patent). For instance, more than 60 per cent of UNICEF's international medicine procurement is from India while India is the major supplier of medicines for HIV in Africa. A “good” pharma MNC with strategic grasp would lobby for tougher IP regimes, lobby against inconvenient measures like Section 3d of India's Patents Act, canvass in international fora for a slew of measures that make things difficult for India's pharma exports. These would include border measures like ACTA that legitimise seizing goods in transit, the whole exercise to call India-made generics “counterfeit.’ Within the nation, they would oppose any kind of price regulation or essential medicines policy and cite them as inconvenient factors to operate in the market. Government panics and withdraws strict regulation on prices resulting in spiraling prices rule Government wants to impose compulsory license but there will be no takers, owing to few or no Indian generic companies left to pick up the gauntlet. Slowly, because of such dominance, or abuse of dominance, higher entry barriers for new companies will be set causing a deterrent for new entrants. This could lead to a monopoly of big multinational pharma companies with no motivation to service local needs, or no compulsion to comply with local government interests. This denouement, if anything, highlights the need for maintaining the current plurality of Indian generic companies with intelligent use of price regulation, compulsory license provisions and TRIPS flexibilities.

The Maira Committee Report believes that the MNC’s will co-operate without hesitation should the Government require it to manufacture under a compulsory license, as a public commitment of its intention to make affordable medicines in the public interest”; and that the pharma industry would respond to exhortation to “voluntarily become a role model of a new paradigm of business responsibility” — reveals a deliberate naiveté on the part of the Maira Committee or a poor reading of pharma history world over.

The FIPB and the CCI Debate

A well-equipped institutional mechanism is required to deal with the issue of FDI in pharmaceutical industry. This system must be sensitive to public interest, evidence based, supported by strong processes and consistent in its assessment processes and judgments over time. The two possible mechanisms that are readily available for the purpose are the Foreign Investment Promotion Board (FIPPB) and the Competition Commission of India (CCI). Under the new rules, for any merger or acquisition, the overseas investor will have to seek permission from FIPB. After six months, it will be the monopoly watchdog CCI, which will vet such details. Though the government and the Maira Committee has reposed confidence in the CCI, they are clearly untested waters. As of now there are several factors, which are operating both in favour and against the CCI as the gatekeeper of mergers and acquisitions.

Factors favoring CCI: -

The procedure of the FIPB is opaque and there is an impression of arbitrariness of government decisions. There is no certainty as to the time period required for FIPB to clear an acquisition. It may hold it indefinitely without specifying the reasons for doing so. In the field of mergers and acquisitions, delaying the procedure of clearance of an acquisition is as good as denying it, as it will result in the concerned companies incurring huge losses. The CCI is more transparent and accepted by the free economies all over, as the right approach to regulate the activities of the players without distorting the market structure. It operates within a well-defined structure, providing legal certainty and transparency to the parties, who have full opportunity to exercise their rights and strong legal protection against any arbitrary decision, with clearly defined appellate processes.

In its inquiry into cases of mergers and acquisitions, it takes into account the entire gamut of relevant issues, including those relating to the specific market, interests of consumer, likely impact on prices and availability of relevant products/ substitutes, innovation, competitiveness, contribution to economic development etc., and the likely effect of the proposed M &A(Mergers and Acquisitions) on competition market. The Competition Act 2002 empowers the Commission to evaluate all aspect of the proposed deal such as reduction of capacities for production or R&D and market distorting issues related to ownership of IPR.

It can reject a proposal or approve it with modifications in its final reasoned order, which is to be delivered within time limits prescribed in the Act/Regulation (30 days for prima facie determination, and 180 days, in- case further investigation is required). In prescribing the modifications in its order, the Commission can require the parties to make structural changes in either of, or both the acquiring and the acquired entities. Further Commission’s behavioral/ conduct remedies also regarding capacities, IPR issues etc.

The Competition Commission of India has already designed internal processes for specifically consulting and obtaining requisite data and expert advice from appropriate sources, including the concerned ministries/ departments of the government and the sectoral regulators, in line with the provisions of the Competition Act, 2002 which duly enable and empower CCI for this purpose. This structure has in-built systems for consultation with designated persons/ cells in these organizations.

Factors not favoring CCI:

The Competition laws may be intelligently drafted but the ultimate test of their efficacy lies in the implementation. No empirical evidence is available which would be a testimony of the institution’s worth with respect to public interest issues. The generic drugs, which have become a necessity for the poor class of India is not of primary concern for the CCI. The Competition commission of India only looks at sustaining the competition that was prevalent before the advent of foreign companies. A product-mix oriented to the developed market, brought by the acquiring companies could adversely impact the production quality and supply of low priced generics. This would make health care and life saving medicines out of reach of large sections of the population around the world, as India is the largest supplier of generic drugs in the world. Overpricing of medicines and unethical marketing practices of pharma companies, are not seen as a failure of competition or abuse of dominance due to CCI’s restricted interpretation of the term’ competition.’ Public interest would entail ensuring addition of manufacturing capacities by FDI, enhancing R&D for tropical diseases and ensuring the availability of capacity to work a compulsory license in case of an epidemic or public health emergency. The CCI is perhaps already seen as helpless against, if not oblivious to, the real problems consumers have with pharma companies.

The issue of threshold in the Competition Act is critical. Most pharmaceutical companies in India, which are targets of acquisitions at present, have turnovers below the thresholds introduced for target companies. Any merger or acquisition, which exceeds the limits mentioned in Section 5 of the Competition Act 2002, requires an approval from CCI. However the majority of the pharmaceutical companies fall within these limits. Further only, those cases of combinations are required to be notified to CCI where the size of the acquired enterprise in India (the target company) based on turnover is beyond Rs. 750 crore and assets are beyond Rs 250 crore. It may be noted that the most of the major acquisitions of Indian pharmaceutical companies made so far (Ranbaxy, Wockhardt, Piramal, Vetrex Animal Health) would have required clearances from the CCI, had the provisions relating to combination in the Competition Act 2002 been made operative when those acquisitions were made. However today, very few companies fall within the amended threshold of the Competition Act 2002. This limits the jurisdiction of Competition Commission of India. The high level committee head by Mr. Arun Maira constituted by Planning Commission of India has recommended that in the case of pharmaceutical sector, the notification can be revisited to bring more combinations under the purview of merger review, as per the provisions the Competition Act 2012, in order to achieve the objective of better scrutiny of the drug industry. However the Central government is empowered to enhance the threshold only on the basis of the wholesale price index or fluctuations in exchange rate of rupee of foreign currencies. Therefore the remedy is practically not workable. There have even been suggestions of the pharma Sector being exempted from the operation of these notifications given the importance of this sector for Indian Healthcare requirements. With the banking sector already in the way of seeking exemption from the CCI’s purview of its mergers and acquisitions , the shipping sector is also following suit. Concerns are being raised that all sectors may seek exemption, as no sector would like to file with the CCI.

The Road Ahead

After analyzing the pros and cons of the FDI in the Indian Pharmaceutical Industry, it is established that India needs adequate FDI and its spillovers for the growth of the industry The Government of India has taken a very optimistic decision to allow CCI to be the watchdog of all the mergers acquisitions in the pharma industry, but it must ensure that it brings about necessary amendments to the Competition Act 2002 to widen the scope of the commission strengthening it as an institution. A Standing Advisory Committee may be formed consisting of pharma experts to assist CCI. The Government must look at the option of alternative public policies like public procurement of generic drugs and the domestic industry should be encouraged to produce cheap medicines. Emphasis must also be laid on increased R&D and transfer of technology to indigenous companies.

As per a report in the leading daily ‘ Indian Express’ dated 14th July 2012, the government is likely to announce fresh norms for the FDI in pharma sector by next week as the inter – ministerial group(IMG) has finalized its recommendations. The IMG was set up to resolve issues raised by the sparring departments of pharma, health, industrial policy and promotion and economic affairs over imposition of specific conditions on foreign investors. The report suggests that the IMG has addressed concerns of the health ministry and recommended stiff riders defining the quantity of generic drugs that foreign companies manufacture in India. Further, it has prescribed norms for higher investment in research and development activities by such companies. It has also suggested doing away with the mandatory clause of technology transfer by the foreign company by the foreign company in brown- field investment.

The recommendations are expected to bring an end to the inter-ministerial feud that had stalled clearance of FDI proposals in the pharma sector. The FIPB in its meeting scheduled for July 20, 2012 will be considering numerous proposals. These include a fresh proposal by Fresenius Kabi (Singapore) to increase public holding in its Indian venture — Fresenius Kabi Oncology along with reconsideration of three deferred proposals- Arch Pharma Labs Ltd to get foreign investment for manufacture and sale of active pharmaceutical ingredients and contract research and manufacturing services; B Braun Singapore to acquire of shares of a company engaged in the business of life-saving intravenous fluids and ophthalmic products and ultimately Pfizer’s induction of foreign equity in an operating-cum-investing company to carry out business in pharma sector.

Onerous restrictions on foreign buyouts will hurt global investment confidence threatening the health of the entire Indian Pharmaceutical Sector which is burgeoning at a rapid pace as a Pharma Super-power. Tortuous vetting, uncertainty and plain policy discouragement of the stake sales would thoroughly restrict cross-border investment and expertise. It is far too presumptuous to see a sinister design in the investment behaviour of pharma majors to hijack the domestic markets and to enhance the price of drugs locally. The increased anxiety seems misplaced as it is a standard norm that all drug companies, without bias on ownership, must operate subject to domestic laws. India has a very strong price control authority, the National Pharmaceutical Pricing Authority (NPPA) which closely controls and monitors the prices of every single drug, effectively acting as a deterrent on any runaway pricing. The bogey of possible cartelization by the MNCs in the pharma sector is just not true, as the Competition Commission is empowered to check the activities of market dominance and unfair trade practices.

Undoubtedly India’s approach should be one best described as ‘protectionist proactive’ wherein alongside reasonable safeguards to foreign direct investment in the Sector, there is increased focus creating talent and otherwise facilitating research and development and ethical drug trials. By restricting Foreign Investment in the pharma sector, all the government would achieve is to discourage value creation and realization by Indian entrepreneurs. Finally both domestic and foreign pharmaceutical companies must realize the importance of public health and the need for affordable and accessible medicines to all consumers in a country like India and must rearrange their business models to serve the larger purpose if they truly want to emerge as a future leader of this industry.

KARAN KUMAR KAMRA is a final year law student pursing his LLB from Campus Law Centre, University of Delhi.

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