Dynamics of Foreign Direct Investment (FDI): A Comprehensive Guide

Introduction:

Foreign Direct Investment (FDI) plays a pivotal role in the global economy, representing an enduring interest that investors hold in businesses based in foreign lands. Distinguished by lasting involvement, FDI stands apart from Foreign Portfolio Investments, reflecting an active role in shaping the destiny of the invested entity. This article aims to unravel the complexities surrounding FDI, delving into its definition, methods, benefits, types, and a specific examination of FDI in the context of India. Additionally, it sheds light on regulations, FAQs, and the critical aspects that individuals and organizations should consider when venturing into the realm of FDI.

Methods of Foreign Direct Investment:

A foreign direct investment can be made by expanding a business in another country. Foreign direct investments include reinvesting profits from overseas operations as well as intra-company loans to overseas subsidiaries.

There are several ways for a domestic investor to gain voting power in a foreign corporation like:

• Purchasing voting stock in a foreign corporation
• Establishing a foreign subsidiary of a domestic firm
• Combinations and acquisitions
• Collaborations with foreign corporations.

Benefits of Foreign Direct Investment:

Both the investor and the foreign host country benefit from foreign direct investment. These incentives encourage and facilitate FDI for both parties. Some of the advantages are:

• Stimulation of the economy
• Diversification of the market
• Tax advantages
• Reduced labour costs
• Tariff preferential treatment
• Human capital advancement
• Increased employment opportunities with access to management expertise, skills, and technology

While FDI is often favorable, investors should always consider if it benefits companies and the community as a whole.

Types of Foreign Direct Investment:

HORIZONTAL: Here a company expands its domestic operations into a foreign country where it engages in the same activities but in a different country.

VERTICAL: This occurs when a company expands into a new country by moving up the supply chain. In other words, a company may conduct various activities abroad, but these activities must still be related to its main business.

CONGLOMERATE: Here, a company buys an unrelated company in another country. This is unusual because it necessitates overcoming two entry barriers: entering a foreign country and entering a new industry or market.

PLATFORM: A company expands into a foreign country, but the output of those operations is exported to a third country. This is also known as Export-Platform FDI which is mostly common in low-cost locations within free-trade zones.

FDI in India: Regulations:

As per the RBI’s master directions, Foreign Direct Investment (FDI) is the investment through capital instruments by a person resident outside India:

(a) in an unlisted Indian company; or

(b) in 10 percent or more of the post issue paid-up equity capital on a fully diluted basis of a listed Indian company.

For this purpose, “fully diluted basis” means the total number of shares that would be outstanding if all possible sources of conversion are exercised.

Automatic route: The non-resident or foreign company investing in India does not require prior nod of the RBI or Government of India for FDI. These are activities other than those which fall under Approval Route or for which FDI is prohibited.

Approval route: Prior approval of the Government of India, Ministry of Finance, Foreign Investment Promotion Board (FIPB) is required. Below are the list of Activities for which prior approval is mandatory for investment from person resident outside India:

• Petroleum Refining (except for private sector oil refining), Natural Gas / LNG Pipelines
• Investing companies in Infrastructure & Services Sector
• Defense and Strategic Industries
• Atomic Minerals
• Print Media
• Broadcasting
• Postal services
• Courier Services
• Establishment and Operation of satellite
• Development of Integrated Township
• Tea Sector
• Asset Reconstruction Companies

Prohibited activities:  In India, FDI is prohibited under:

• Lottery Business including Government/private lottery, online lotteries, etc.
• Gambling and Betting including casinos etc.
• Chit funds
• Nidhi company
• Trading in Transferable Development Rights (TDRs)
• Real Estate Business or Construction of Farm Houses Which shall not include development of townships, construction of residential /commercial premises, roads or bridges and Real Estate Investment Trusts (REITs) registered and regulated under the SEBI (REITs) Regulations 2014.
• Manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes
• Activities/sectors not open to private sector investment e.g. (I) Atomic Energy and (II) Railway operations.
• Agriculture (excluding Floriculture, Horticulture, Development of seeds, Animal Husbandry, Pisiculture and Cultivation of vegetables, mushrooms etc. under controlled conditions and services related to agro and allied sectors) and Plantations (Other than Tea plantations)
• Foreign technology collaboration in any form including licensing for franchise, trademark, brand name, management contract is also prohibited for Lottery Business, Gambling and Betting activities.

FDI in India: Regulations FAQs:

1. What is the regulatory and governing framework for FDI in India?

• Foreign investment in India is regulated under codified foreign exchange regulations, sector specific policies/regulations, government policies as well as International agreements. Primarily, foreign investment is regulated through the Foreign Exchange Management Act, 1999 (FEMA) as amended from time to time and rules/regulations issued thereunder. The main objective of FEMA is to regulate, consolidate and amend the law relating to foreign exchange to facilitate foreign investment, external trade and payments and promote the orderly development and maintenance of foreign exchange market in India within the broad policy framework on foreign investment issued by the Government from time to time. Presently, the FDI regime in India is primarily governed by the Consolidated Foreign Direct Investment Policy Circular dated 28.08.2017, as amended through various Press Notes issued by the Department for Promotion of Industry and Internal Trade (DPIIT)(FDI Policy), sector specific policies/regulations, Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 dated 17.10.2019 notified by the DEA, Ministry of Finance (FEM Non-Debt Instruments Rules 2019) which superseded the erstwhile Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 Notification No. FEMA 20(R)/2017-RB dated 07.11.2017 (FEMA 20R Regulations).

2. How can a foreign investor set up business operations in India through a company?

• A foreign investor can set up business operations in India by incorporating a company under the Companies Act, 2013 and operating either as a Joint Venture/Wholly Owned Subsidiary/Holding Company in compliance with the entry route/sectoral cap and other conditions under the FDI Policy and FEM (Non-Debt Instruments) Rules 2019.

Numerous individuals and organizations are contemplating or are considering making Foreign Direct Investment in India nowadays. However, it gets extremely difficult to keep track of the various compliances under the Regulations prescribed by the RBI and submission of timely returns and/or information to be filed with the RBI, as per the regulations applicable to the specific FDIs.

Individuals or organisations making FDIs shall adhere to all these specified requirements while making FDIs and in filing of various Reports, returns or information to the RBI in accordance with the relevant regulations, including liaising with the relevant authorities in this regard. Hence, ensuring that they do not suffer from any legal consequences or penalties.

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