In this blog post, Mithun Pillai, a Management Trainee at a Textile Company in Mumbai and a student pursuing his Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, describes the different categories of FDI in Indian Companies.
“India has already marked its presence as one of the fastest growing economies in the world. It has been ranked among the top 3 attractive destinations for inbound investments. Since 1991, the regulatory environment in terms of foreign investment has been consistently eased to make it investor-friendly.”
-Make in India (Summary) [1]
In 2015, India emerged as the leading global destination for foreign investments, but the seeds were sown in the disillusionment, and subsequent breakdown of the then Prime Minister Chandrashekhar led government. Although the following PM P.V. Narasimha Rao-led government was hailed for pioneering the liberation of Indian economy through the nineties, one may be forgiven for thinking that was an exercise of choice. Because when the IMF agreed to lend India the emergency loan of USD 2.2 billion[4] against a security of our 67 tonnes of gold bullion, it was contingent on the condition that India opened up her economy to the global market forces that were.
In 2014, Prime Minister Narendra Modi launched the “Make in India” initiative with the objective to increase the skill level of workers/employees and job opportunities for the burgeoning youth population. Although the call to manufacture in India was partly to entice domestic entrepreneurs, it is more focussed on attracting foreign money and technology to expand the manufacturing sphere.
So what is FDI? Broadly and simplistically speaking Foreign Direct Investment is funnelling money/knowledge from a foreign economy/country into a domestic economy in exchange for controlling shares and long-term management objectives. It is primarily regulated by the Central bank of the economy and the government. This is in contrast to Foreign Portfolio investment which although dealing in shares has short-term profit motives and is regulated by the securities and bourse regulators.
Different Categories of FDI
Although there are no strictly defined classes of FDI, the below-mentioned are the popular ones based on different parameters for theoretical purposes. I shall explain them in some detail with practical examples in the Indian economic context:-
FDI based on requirement of approval
- Automatic route:-
FDI in sectors where approval from Foreign Investment Promotion Board (FIBP) is not required comes under the automatic route. Barring any special conditions to be fulfilled, RBI gives automatic approval within two weeks. Most sectors (especially the ones which have 100% investment is permitted) come under this route. These are high growth sectors like manufacturing, petroleum biotechnology, etc.
Eg:- Cairn India(Cain Energy + Vedanta PLC)
- Approval of government route:-
FDI in sectors which don’t come under automatic route (or automatic route is allowed only up to a limit above which approval is required) comes under this category. The approval is processed by FIBP and other sectoral regulators and normally takes around four to six weeks. Sectoral regulators include Telecom Regulatory Authority of India (TRAI) for the telecom sector, Insurance Regulatory Authority(IRDA) for insurance sector et al.
Eg:- Bajaj Allianz(Bajaj Finserv Limited + Allianz SE)
FDI based on entry structures
- Incorporation of a company:
FDI in companies (private and public) is most popular. Other corporate structures have to undergo a lot of scrutiny before being incorporated.
The foreign investor can register as the following types of company under the 2013 Companies Act:
- Wholly Owned Subsidiary (WOS): A 100% ownership company by the foreign entity in India. Eg:- Facebook India Online Services Pvt Ltd
- Subsidiary: A majority stake owned by the foreign investor. Eg:-Hindustan Unilever Ltd.
- Joint Venture (JV): Collaboration with an Indian corporate entity in the minimum ratio 51:49 with the Indian entity having the majority share. The JV should be preferably a company although LLP/partnership is possible. Eg:- Arvind OG Pvt. Ltd.(Arvind Ltd. + OG Corporation)
- Associate company: A minority stake owned by the foreign investor. Thus, a JV incorporated as a company will be an associate company. Eg:- Arvind OG Pvt. Ltd.(Arvind Ltd. + OG Corporation(Japan);74:26)
- Incorporation as an LLP:
Although LLP has less compliance requirement than companies, FDI in LLP has more regulations for FDI than a company. 100% FDI is permitted in LLP.
- Extension of the foreign entity:
- Liaison office:- It acts as a connecting link between the foreign corporate office and the domestic body corporate. It’s not allowed to generate income. It can only gather data and help disseminate technical knowledge.
- Branch office:- It is suited for foreign entities involved in manufacturing/trading. It is ideally involved in research, consultancy, aiding in technical help et al.
- Project office:- It is like branch office except much more specific in function and time bound. It is set up to execute certain projects and after execution of the objective is usually wound up.
- Trust:-…..[5] Only venture capital funds registered with SEBI are permitted for FDI as trusts. They usually require approval and have a lot of regulations. They are also subject to provisions of ‘Foreign Contribution Regulation Act.’
FDI based on investors target [2]
- Greenfield Investment:-
Here, FDI is made in new/nascent/upcoming facilities. They are the main area of interest for the host nation as it boosts expansion, economy, jobs and technological advances. A common criticism is the positive effects happen at the peril of local small industries losing market share as they have to compete against cheap products in bulk due to technology.
Eg:- Walmart opening retail stores in India.
- Merger and Acquisition:-
This is the most common type of FDI where the domestic company merges with the foreign body corporate to become a new corporate entity, usually a company. This across-the-border merger does not have long duration benefits of helping the domestic economy because the payment for owners of a domestic entity is made in stocks rather than cash.
Eg:-Vodafone-Hutchison-Essar
- Horizontal FDI:-
FDI in the same horizontal or business as the one in which the foreign investor operates back in its own country.
- Vertical FDI:-
FDI in the vertical segment of the business as the one in which foreign investor operates back in its own country. This is of two types based on the position of the domestic production of foreign entity in the vertical:
- Forward vertical FDI:- FDI into a body corporate which distributes foreign entity’s business product back in its home country.
- Backwards vertical FDI:- FDI into a body corporate which provides the raw material for foreign entity’s business back in its home.
Based on investors motive [2][3]
- Resource seeking FDI:-
Such an FDI is made where primary concerns are abundance/availability of a particular mineral and natural resources (oil, coal, etc.) or cheap labour. Such efficiencies of resource and scale in production is not found in the home country of a foreign entity which makes them seek business opportunities in countries having them in abundance (usually Middle East, Africa, South East Asia). The business here is generally involved in export of its products. Eg:- IT companies are investing in companies in India for its cheap wages/income.
- Market-seeking FDI:-
As the name suggests this FDI seeks entities in countries which have a sizeable target market for its products. It’s usually supplying companies which indulge in such investment to cater to overseas market(existing and/or upcoming). It’s generally seen that such FDI is usually done out of fear of losing markets than exploring new ones. Eg:- Amazon India
- Efficiency-seeking FDI:-
As the name suggests such an FDI seeks entities in countries which can help increase/integrate its already existing business back home and thus, taken over a common geographic area, help achieves increase efficiency and economy on a wider scale than before. Eg:- Samsung, manufacturing individual components in China/Taiwan and setting shop in India to easily import the components, assemble them and sell the smartphones as value added digital products.
- Strategic asset seeking FDI:-
When tactical market capture to sustain/defend their business and avoid loss of asset/market/resource to a competitor is the long term objective, then such an investment is said to be strategic in nature. Eg:- Builder/developers are buying a large plot of land as reserves even though there is no immediate plan to construct.
Thus, the motive or objective for investment must be clear to a foreign investor, or else they face risking precious money and time on wasteful expenditure. The Indian government has as of 2016 very generously opened up our economy for FDI which is evident by the global interest in our markets. Let’s hope it continues to remain as long as it can.
