It’s the central bank & finance ministry versus commerce over ‘unintended liberalisation’ permitted in February guidelines.

Differences have developed between both the Reserve Bank of India (RBI) and the finance ministry and within the government on the impact of Press Notes 2, 3 and 4 issued in February 2009 that significantly relax the guidelines on foreign direct investment (FDI).

The alignments appear to be RBI and the Department of Economic Affairs (DEA), which comes under the finance ministry, against the Department of Industrial Policy and Promotion (DIPP) under the commerce ministry, the nodal agency for FDI-related matters, to clarify several issues.

On March 20, RBI had asked the DEA to review the new guidelines on FDI issued under press notes 2, 3 and 4 in February 2009, saying they would lead de facto to full capital account convertibility.

The new norms need to be notified under the Foreign Exchange Management Act (Fema) by RBI to give it legal sanctity.

Significantly, the DEA also raised objections to the new FDI norms after receiving RBI’s letter and has asked the DIPP to clarify several issues. (DEA was, however, involved in the process of formulating the new press notes.)

According to government officials close to the developments, DIPP feels a comprehensive review of the new norms is not possible. The department, however, is open to releasing clarifications, which could take the form of “minor tweaking and not complete reversal of the new norms”.

Capital account convertibility means that an investor is allowed to move freely from the local currency to a foreign currency. India has limited capital account convertibility to prevent shocks to the capital account and maintain a stable exchange rate, by stipulating sectoral norms that ensure a lock-in period for investments.

The press notes simplify the method for calculating FDI and broadly state that as long as Indian promoters hold a majority stake (more than 51 per cent) in any operating-cum-investing company, it can bring investment up to 49.9 per cent through FDI. This company would be treated as an Indian company and it can invest through a joint venture in any other company that may be engaged in industries in which FDI has a sectoral limit. Several companies like retailer Pantaloon and media house UTV have restructured their organisations to raise FDI in their businesses through step-down joint ventures — FDI is prohibited in multi-brand retail and is restricted to 26 per cent for media

Questioning the proposed definition of Indian ownership and control, given in Press Note 2, RBI stated that ownership and control by a company may not be related to formal equity holding and the right to appoint a majority of directors on the board of the company in which the investments are being made.

“Control may be maintained through other forms such as funding through preference shares or loans, vesting of executive authority or super minority provisions (like right of first refusal or veto power) in minority shareholders through shareholder agreements,” argued the central bank in its letter. “Therefore, there is a need to fine-tune the definition of control rather than relying on the power to appoint majority directors,” the letter added.

Echoing RBI’s views, the DEA has also stated that an investing company with 49 per cent FDI can go ahead and invest in any FDI-prohibited sectors or exceed the sectoral limits in those industries that have them, sources said.

“In one sweep, therefore, any sectoral cap of 49 per cent and below has become meaningless in so far as downstream investment by a company with foreign investment below 50 per cent and qualifying as an Indian owned and controlled company,” the DEA argued in a letter, sources said.

“Such a company can apply for cable TV operations (49 per cent cap), FM broadcasting license (20 per cent cap), licensed defence items manufacture (26 per cent cap), printing news papers (26 per cent cap) up linking TV news channels (26 per cent cap) etc. Whether this stance has been approved as such or is an unintended liberalisation is not clear,” the DEA letter said..

The central bank expressed a similar view. “Not only will this lead to the formation of Indian companies that are primarily shell companies whose sole intention would be the downstream investment in sectors with FDI restrictions, but it would also lead to the near total circumvention of the extent FDI policy making it ineffective,” RBI said in the letter to the DEA.

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February 2024