In this blog post, Dr Sreekanth Devalraju, Manager at R.R. Health Care Private Limited and currently pursuing a Diploma in Entrepreneurship Administration and Business Laws by NUJS, Kolkata, writes about the evolution of foreign investment in India. 

 

Introduction

Any transfer of capital by a non-resident entity to a host country amounts to what is known as “Foreign Investment”. According to the benchmark definition provided by The Organisation for Economic Co-operation and Development (OECD)¹, the main characteristic feature of foreign investment is the presence of a ‘lasting interest’ in an enterprise, consisting of a ‘long-term relationship’ and a ‘significant degree of influence’, and considers ownership of at least 10% of the voting power to be evidence of such influence. Over the past few decades, India attracted many foreign capital investors by carrying out certain economic reforms in a liberalised mode. The government of India has taken every possible step to simplify the policy framework of foreign investments in India, not only by promoting the interest of investors but also by execution of enacted reforms in a much more significant and transparent manner. This eventually resulted in a greater inflow of foreign investments in the majority of the areas of Indian economy.

 

Evolution of Foreign Investments in India

1948-1969:

Foreign investments in India evolved over a period of time, and it dates back to the period of independence. Post independence period ranging from 1948 – 1969 was observed to be an era of protection and closed economy where a very minor proportion of foreign investors were participating and moving their investment capital cautiously to India (Host country), in view of Swadeshi Movement.

1969-1991:

This era witnessed an initiation and boon to Indian economy as India started adopting Monopolistic And Restrictive Trade Practices Act (MRTP) ^2,3. The act was passed by Parliament of India on 18 December 1969 and approved on December 27, 1969. But it came into force on June 1, 1970. MRTP Act was enacted primarily with an intention to prohibit monopolistic and restrictive trade practices such that monopolies can be controlled and operation of the economic system does not lead to the confinement of economic power in the hands of few. Yet another Act, Foreign Exchange Regulation Act (FERA)³ was passed in the year 1973 and took force from January 1, 1974. This Act applied to all Indian citizens and primarily focused on the regulation of foreign remittances. The Act also imposed control over dealings with foreign exchange and securities and eventually helped in the conservation of foreign exchange for the country.

1991-2000:

During this period Foreign Exchange Regulation Act (FERA) was replaced by Foreign Exchange Management Act (FEMA)⁴ with a revolutionary liberalisation in the procedural aspects followed for foreign investment in India. This change accounted for Foreign Direct Investments (FDI) that hiked up to 51% in 35 of high priority business sectors which gradually increased to 111 industries by the year 1996. Foreign Investment Promotional Board (FIPB) was formed on the other hand to try the cases pertaining to foreign investments. The contrasting feature of FEMA compared to FERA is that FEMA facilitated trade practices while FERA prevented the misuse of the provisions, that is to say, the emphasis was shifted from Control point of view in the case of FERA to Management side in case of FEMA.

2000-2007:

In the Year 2000 BRICS summit played a vital role by in interlinking of the global economy. The high economic growth rate was seen as a result of the investment of foreign capital in various active sectors. This phase is considered to be the phase of global optimism and global boom.

2007-2010:

During this phase, India remained resistant to global economic recession. Growth rate decreased marginally due to poor fund flow. In the year 2010 rationalisation process continued further, and all the Foreign Investment laws were consolidated as a CIRCULAR and maintained by financial & Economic organisations. The government of India eventually approved foreign investors to have 100% owned subsidiary of the companies set up in India.

2011-2015:

Although global economies started recovering from recession during this period, India witnessed slow growth rate which is attributed to a deficit in the current account and capital outflow. Pathetically, currency depreciation, high inflation, depreciating forex reserves, excessive crude oil/ gold import duties are some more reasons for the said scenario.

 

How to Make Foreign Investments in India

Four common ways are identified for making foreign investments in India, and they include –

• Setting up a new subsidiary and/or manufacturing facility in the host country (GREEN FIELD FDI)
• By acquiring existing business in host country following the concept of mergers and acquisitions
• Participating in joint ventures with business entities of host country
• By reinvesting profits in proposed projects in the host country.

 

Merits & Demerits of Foreign Investments in Host Country

It is always true that increased foreign investments are associated with improved economic growth resulting from the huge inflow of capital and increased tax revenues paid to the host country. Often Foreign investments are channelized by the host country into new infrastructure and other economy gaining projects that in turn develop the nation. Moreover, foreign investments also help in the development of soft skills through orientation and training, the creation of job opportunities, availability of sophisticated technologies, Access to research and development resources, etc. Added to this application of foreign investments and policy directives may improve host country’s standards in the areas of corporate governance.

Associated with advantages, there are also some disadvantages and aspects of serious concern that often caution host countries that encourage the inflow of unregulated foreign investments. Major disadvantages include the impact of foreign investments on environment and depletion of natural resources due to their overconsumption in highly commercial projects. unless and until some stringent regulations are enforced in the host country, there is every possibility that host countries lose control over important industries and projects into which foreign investors are allowed to invest. The risk of volatility is also very high in view of liberalisation of domestic industries and increased exposure to international markets. It becomes inevitable for local business firms to suffer from high levels of pressure exerted by multinational companies with competitive outlook.

 

Two routes for investing in India

Indian Law permits foreign entities to invest in host country through two routes⁵.

1. Automatic Route
2. FIPB Route

a) Automatic Route:

Under this route of investment, the NRI / foreign investor can invest in the host country without any prior approval from government or Reserve Bank of India (RBI). This route permits Indian companies to issue shares to foreign investors up to 100% of their paid up capital in Indian firms. Power, construction & development projects, manufacturing, venture capital funds and non-banking finance companies (subjected to certain conditions) are some of the sectors where Government has permitted foreign investments up to 100% or total required capital. Minimum capitalization norms have been prescribed for some sectors such as financial services. Foreign investments are permitted only up to a limited level or permissive levels in case of some specified sectors (SECTORAL CAPS). Excess investment in the sectoral caps is either not permitted or requires prior approval from RBI. For example, Investment in setting up or improvement of Airports is permitted only up to 74% of the capital requirements and anything beyond the level of 74% of the investments require approval from RBI. Under automatic route, the investors are only required to intimate the concerned regional office of RBI and file necessary documents within a span of 30 days of issuing shares and receipt of inward payment. The documentation and details required to be filed with RBI, in this case, include:

• Name of the collaborators/ promoters/ shareholders
• Details of allotment
• Copy of the foreign collaboration agreement
• The original foreign inward remittance certificate from the authorised dealer and
• Any other specified and relevant information

b) FIPB Route:

Foreign investment in certain classes of activities are not covered under automatic route and require prior approval from the government. Such investments are considered for approval by Foreign Investment Promotion Board (FIPB). FIPB decides the approval within 3-6 months of the application for approval. Following are the sectors where FIPB approval becomes the mandatory and automatic route for foreign investment does not apply.

• Banking
• Non-Banking Financial Companies (NBFC) Activities in Financial Services Sector
• Venture Capital Fund and Venture Capital Company,
• Investing Companies in Infrastructure & Service Sector,
• Atomic Energy & Related Projects,
• Defence and Strategic Industries,
• Civil Aviation,
• Petroleum Including Exploration/Refinery/Marketing,
• Housing & Real Estate Development Sector for Investment from Persons other than NRIs/ Overseas Corporate Bodies (OCB).
• Agriculture (Including Plantation),
• Print Media,
• Broadcasting,
• Postal Services.

 

Legal Regimes Enforced in India for Foreign Investments

1. Indian Contract Act, 1872
2. Civil Procedure Code, 1908
3. Companies Act, 1956
4. Income Tax Act, 1961
5. Securities and Exchange Board of India Act, 1992 and Regulations
6. Foreign Trade (Development and Regulation) Act, 1992.
7. Arbitration and Conciliation Act, 1996
8. Foreign Exchange Management Act, 1999 (FEMA) and Regulations
9. Foreign Direct Investment Policy (FDI Policy)
10. Competition Act, 2002

 

 

 

 

 

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References:

1. OECD Benchmark Definition of Foreign Direct Investment, Fourth Edition, http://www.oecd.org/daf/internationalinvestment/investmentstatisticsandanalysis/40193734.pdf