FOREIGN DIRECT INVESTMENT (FDI)
CURRENT SITUATION ON FDI POLICIES IN INDIA
Apart from being a critical driver of economic growth, Foreign Direct Investment (FDI) has been a major non-debt financial resource for the economic development of India. Foreign companies invest in India to take advantage of relatively lower wages, special investment privileges like tax exemptions, etc. For a country where foreign investment is being made, it also means achieving technical know-how and generating employment.
The Indian Government’s favourable policy regime and robust business environment has ensured that foreign capital keeps flowing into the country. The Government has taken many initiatives in recent years such as relaxing FDI norms across sectors such as defence, PSU oil refineries, telecom, power exchanges, and stock exchanges, among others.
FDI has a huge share and a key motivator of growth in the Indian economy. India opened up to foreign direct investments in the year 1991 and since then the foreign investments have been pouring in the country immensely.
The government of India has been making regulations in the foreign policies in order to make the FDI process liberal and more streamlined in-order to attract more foreign investments in various sectors of India. Prime Minister Narendra Modi does not leave any stone unturned in order to promote India in various global platforms and also bring major reforms in the business environment of India.
The factors that attract foreign investors to India are the low wage rate, skilled human resources, an abundance of natural resources, and liberal policies. India has gradually made its place in the international market and as a key investment destination that provides promising returns. The position of India has also improved in the global club of Ease of Doing Business and tops the Greenfield FDI ranking.
Due to current COVID-19 pandemic, the Government of India has amended the FDI Policy of 2017. This has been done to curb the opportunistic takeovers/acquisition of Indian Companies. On 17th April, 2020, the Department for Promotion of Industry and Internal trade, Government of India issued a Press Note 3 of 2020, puts two new restrictions:
1. An entity of a country, which shares land border with India or where the beneficial owner of an investment into India is situated in or is a citizen of any such country, can invest only under the Government route.
2. Government approval will also be required where subsequent changes in beneficial ownership (by way of direct or indirect transfers) of any existing or future FDI would result in such beneficial ownership falling within the purview of the first restriction.
The affect of the recent amendment is that all FDI proposals from countries sharing land border with India including China has to mandatorily go through the government approval route. This even applies to “beneficial” owners (the investing company) who are not located in a neighbouring country but would still be subject to these conditions if its owner is a citizen or resident of such a country. Also, any transfer of ownership of any existing or future FDI in an entity in India, directly or indirectly, resulting in the beneficial ownership falling in the hands of any such foreign entity will also require Government approval. The companies whose beneficial ownership also lies in such countries will have to undergo government scrutiny for any change in foreign holding.
Prior to amendment, except FDI from Bangladesh and Pakistan which were already subjected to government approval, the Foreign Companies from any other country was given the opportunity to invest through ‘Automatic Route’ in the permitted sectors, where the non-resident investor or the Indian company does not require any approval from Government of India for the investment.
The changes under the Press Note are in the context of foreign direct investment and would not apply to foreign investments in the public securities market (i.e., foreign portfolio investment (FPI)). At present, it is unclear if a similar change would be introduced in the FPI regime, but SEBI has recently issued directions to custodian banks to disclose details of ultimate beneficial owners of foreign portfolio investors based in China and Hong Kong. This is also relevant for non-mainland China and Hong Kong funds where limited partners may be based in China.
The result of this amendment is that, now any kind of investment from China or other neighbouring countries has to go through the Government Route, which means Government permission is required before investing in an Indian entity.
RECENT AMENDMENT TO FDI POLICY AND ITS EFFECT ON NEIGHBOURING
The government has received maximum foreign direct investment (FDI) proposals in three departments — electronics and IT, industry and internal trade, and heavy industries — from countries sharing land border with India.
In the wake of the economic and financial crisis caused by the COVID-19 pandemic, India has revised its foreign direct investment (FDI) policy through Press Note 3 of 2020 (Press Note) imposing stricter norms on foreign investments in Indian companies from an investor based out of bordering countries. The primary objective of the revised FDI policy is to curb any opportunistic takeovers or acquisitions of Indian companies during the COVID-19 pandemic.
On 17th April 2020, the Department for Promotion of Industry and Internal trade, Government of India issued a Press Note 3 of 2020, puts two new restrictions:
An entity of a country, which shares land border with India or where the beneficial owner of an investment into India is situated in or is a citizen of any such country, can invest only under the Government route.
Government approval will also be required where subsequent changes in beneficial ownership (by way of direct or indirect transfers) of any existing or future FDI would result in such beneficial ownership falling within the purview of the first restriction.
The effect of the recent amendment is that all FDI proposals from countries sharing land border with India including China has to mandatorily go through the government approval route. This even applies to “beneficial” owners (the investing company) who are not located in a neighboring country but would still be subject to these conditions if its owner is a citizen or resident of such a country. Also, any transfer of ownership of any existing or future FDI in an entity in India, directly or indirectly, resulting in the beneficial ownership falling in the hands of any such foreign entity will also require Government approval. The companies whose beneficial ownership also lies in such countries will have to undergo government scrutiny for any change in foreign holding.
As per that decision, FDI proposals from these countries need government approval for investments in India in any sector.
The major sectors under which these FDI proposals mainly came included manufacturing of heavy machinery, automobile, auto components; computer software and hardware; trading, ecommerce, and manufacturing of light engineering and electrical.
The result of this amendment is that, now any kind of investment from China or other neighboring countries has to go through the Government Route, which means Government permission is required before investing in an Indian entity.
The department of economic affairs, under the ministry, has already notified these recent changes to FDI policy under the Foreign Exchange Management Act, 1999, which means that these amendments to the FDI Policy are now in force throughout the country.
Ministry of new and renewable energy and department of pharmaceuticals have also received several proposals from these countries.
Further, pending FDI proposals received under this decision up to June 15 this year in the Ministry of Electronics and IT; Department for Promotion of Industry and Internal Trade (DPIIT); and Ministry of Heavy Industries are over 40.
Most of the foreign investment proposals have come from China and Hong Kong. Besides, Nepal, Bhutan and Bangladesh too have submitted certain applications.
In April this year, the Department for Promotion of Industry and Internal Trade (DPIIT) came out with a press note stating that a company or an individual from a country that shares land border with India can invest in any sector here only after getting government approval.
An inter-ministerial committee has been formed by the government to scrutinize these proposals, they said adding most of the investments are for brownfield projects (means in existing Indian companies).
All administrative ministries and departments have been advised to have dedicated FDI cells to process these proposals expeditiously.
India has received USD 17.6 billion worth of FDI during April-June this fiscal.
WHAT IS THE CHANGE?
Under the Indian FDI framework, a non-resident entity is allowed to invest in all sectors except certain prohibited sectors (such as tobacco, lottery and atomic energy). The FDI policy generally allows foreign investors (except for investors based out of Pakistan and Bangladesh who need to obtain prior government approval) to make foreign investment in most sectors under the automatic route (i.e., without government approval) subject to sectoral conditions.
The amended FDI Policy seeks to narrow the scope of eligible investors who are allowed to invest under the automatic route. Under the new rules, any foreign investment by a non-resident based out of a country that shares a land border with India will require the prior approval of the government irrespective of the sector into which the investment is being made. India shares a land border with China, Pakistan, Bangladesh, Nepal, Myanmar, Bhutan and Afghanistan (Restricted Country). This investment approval requirement also extends to: (i) those investments, where the beneficial owner (corporate or individual) is situated in the jurisdiction of a Restricted Country; or (ii) a direct or indirect transfer of ownership of any existing or future investment, which results in the beneficial owner being from a Restricted Country.
TYPES OF FDI
To further understand the nuances of FDI in India, let us have a look at the types of foreign direct investments.
1. Horizontal FDI
In this type of FDI the parent company initiatives the same business model in another country.
The goods and services that are manufactured abroad are mostly similar to the products/services that are manufactured in the home country of the company.
The term horizontal is given to this type of FDI because the similar operations of a company are carried out in another country
2. Vertical FDI
This type of FDI is known as the export platform foreign direct investment in which the exports are sent back to the home market.
The main contributor to this type of FDI is the increase of the trade blocks that have low internal trade barriers but have higher external barriers.
3. Platform FDI
In the case of platform FDI, a business gets expanded to another country but the aim of this expansion is to take the output from the foreign country and export it to the third country.
Methods of FDI
Foreign investors have the opportunity of expanding their business into other countries through the means of foreign direct investment. The following are the various methods of foreign direct investment:
Mergers and acquisitions
Joint Ventures with foreign companies
Starting subsidiary in an abroad country of the domestic company
Getting voting stocks in a foreign company
THERE ARE TWO ROUTES TO ENTER INTO FDI MARKET.
1. Automatic route- in automatic route there is no need to take previous approval from government. There are various businesses where 100% FDI is allowed.
2. Approval route- in approval route, if foreign investor wants to enter into Indian market than before entering into Indian market foreign investors needs to take previous approval from government as per procedure defined in law. There are various businesses, in which investor needs to take government approval.
There is nothing change in this process, from last past years foreign investors invest amount in Indian market in both routes i.e., Automatic route and approval route.
After inserting the latest press note no.3 of 2020, government only change provisions due to co-vid19 that which country share the land boundary if wants to invest in Indian market they must come through approval route. Earlier approval route was for some business investments but now due to co-vid19 land touching boarder countries only need to take previous approval to start investment in India.
At present, the government has not notified the underlying amendments and in the absence of finer details, there are certain key issues which the government needs to clarify soon.
(i) Impact on signed transactions or committed deals – Existing transactions which are finalized, definitive agreements that have been signed but completion has not taken place or transactions which have multiple closings would all be impacted. It is unclear if this prior government approval will be required for (a) completing transactions that were finalized prior to COVID-19 crisis; (b) future investments to be done by existing Restricted Country shareholders in Indian companies in a rights issue; or (c) investments made by a Restricted Country parent company in its Indian subsidiary or how this would play out in the context of downstream investments by Indian companies which have substantial Restricted Country investments. In previous instances of imposition of new regulations, the government has allowed executed transactions to proceed.
(ii) Guidance on beneficial interest – The Press Note does not clarify how the term
‘beneficial interest‘ will be determined and construed for approval purposes in the present context. Investors would need clarity on the manner of computation of beneficial interest and applicable thresholds. Further, many private equity firms have major Chinese financial institutions and investors as limited partners. It is unclear how this condition would affect such private equity firms.
(iii) Broad Approval Review – While the stated objective is to curb opportunistic takeovers or acquisitions of Indian companies, the approach adopted by the government to go for an ‘overall‘ prior review appears to be all encompassing. A more balanced approach of regulating investments in identified ‘sensitive’ sectors such as telecom, banking, insurance or financial and health critical infrastructure would have been prudent. Further the revised FDI policy does not distinguish between (a) majority investment or acquisition of control transactions; and (b) minority or passive investment transactions from a Restricted Country. We anticipate some of these to be exempted or be under a faster approval route.
(iv) Prior government approval an interim measure? While the revised FDI policy is on account of factors arising from COVID-19, the Press Note does not mention if this modification is an interim measure. We would have to examine the legal amendments to see if they provide for sunset conditions to determine till when this prior approval requirement will remain.
(v) Operational modalities/guidelines – We expect that the legal amendments or the government would issue operating guidelines on the approval procedure, expected timelines for granting such an approval or to respond to a potential investor and set out indicative evaluation parameters it would consider in granting such an approval.
INITIATIVES BY THE GOVERNMENT
The following are the recent measures that the Government of India has taken regarding foreign direct investment. According to the survey done by the Emerging Market Private Equity Association (EMPEA), India will be the most attractive emerging market for global partners (GP) investment. The main aim of government initiatives taken for FDI in India is to bring ease of doing business and promote foreign investments in various sectors of the economy. In recent months, the Government has given 100% FDI in multiple industries and talks about giving 100% FDI in more sectors.
The Indian Government aims to achieve US $100 billion worth of FDI in just two years. India has been attracting significant foreign investments even when the world economy is not in good condition due to COVID 19 pandemic.
The following are the recent government initiatives taken for foreign direct investments in India.
In March 2021, the parliament passed a bill to increase foreign direct investment (FDI) in the insurance sector from 49% to 74%.
In March 2021, Mr. Shripad Naik, the Minister of State for Defence, stated that a total of 44 Indian companies, including public sector units, have received approvals related to FDI for joint production of defence items with foreign organizations.
In December 2020, the Uttar Pradesh government agreed to grant special incentives to Samsung Display Noida Private Limited to establish mobile and IT display product manufacturing unit. Samsung will also receive a financial incentive of Rs. 460 crore (US$ 62.61 million) under the Central Government scheme for the promotion of manufacturing electronic components and semiconductors (SPECS). This project would help Uttar Pradesh create a worldwide export hub and attract more foreign direct investment (FDI).
In December 2020, changes in the guidelines for the provision of Direct-to-Home (DTH) services had been approved by the Union Cabinet, enabling 100% FDI in the DTH broadcasting services market. In May 2020, the Government increased FDI in defence manufacturing under the automatic route from 49 percent to 74 percent.
ADV. AKASH TYAGI