This article is written by Sreeja Krishna S., pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.
This article has been published by Abanti Bose.
India is one of the world’s fastest-growing economies. It is a land blessed with natural resources and immense wealth, since time immemorial. Unfortunately, the foreign colonizers attacked, looted and conquered India multiple times. Even after 74 years of independence, India remains a struggling developing economy. What may be the cause? Has anyone analyzed it? The evil seeds of corruption sowed by various political parties hindered its economic growth. But, yes, things are changing slowly.
By 2030, India and China are poised to become the world’s largest manufacturing hubs. The historical significance of these countries in maritime trade is starting to become significant again. As such, the International North-South Transport Corridor (INSTC) will be the connecting link between Central Asia and Europe. So, in the next five years, India will continue to grow as an economic influence in the Asia-Pacific region.
India’s geographical position as a peninsula has contributed to its foreign trade via sea route. The Arabian Sea in the West, the Indian Ocean in the South and the Bay of Bengal in the East helped in flourishing its foreign trade all over the world.
But what about the countries sharing land borders with India? Why is the government insisting on its approval regarding these foreign investments? Are there any particular reasons? Let us find out.
Countries that share land borders with India (in alphabetical order) are Afghanistan, Bangladesh, Bhutan, China, Myanmar, Nepal and Pakistan.
During the COVID-19 pandemic, in April of 2020, the Indian Government had made it mandatory for foreign investments from countries from the above-mentioned list, i.e., the countries that share a land border with India, to obtain its approval beforehand. This step was necessary so as to prevent opportunistic takeovers. This implies that Foreign Direct Investment (FDI) proposals from these countries need the approval of the Government of India, for any sector, be it electronics and IT or in heavy industries or internal trade.
The trending sectors coming under these FDI proposals include the following industries:
- Manufacturing of light engineering,
- Electrical Industry,
- Computer software and hardware,
- Automobile and related Industries,
- Manufacturing of heavy machinery.
What is meant by foreign investment?
Foreign investment is said to be an investment that is made by a person residing outside India on a repatriable basis in equity instruments of an Indian company or to the capital of an LLP. The equity instruments shall include:
- Equity shares,
- Fully Compulsorily Convertible Preference Shares,
- Fully Compulsorily Convertible Debentures,
- Share warrants,
- NCRPS/ OCPS – regarded as ECB.
There are four different types of foreign investment. These are:
- Foreign Direct Investment [FDI],
- Foreign Portfolio Investment [FPI],
- Official flows and,
- Commercial loans.
What are the reasons for foreign investment?
Foreign investors prefer to invest in Indian companies for various reasons. One explanation is that India has a growing consumer base and foreign capital is expected to witness greater growth. Compared to saturated western markets, the emerging Indian market has more potential. Some of the reasons are:
- A foreign investor might be capable of investing more compared to an Indian source, which can help the startup expand faster. It is a reality that risk capital, which is a name given to the capital available to startups, is in short supply in India. As a result of foreign investment in the form of FDI, valuation drastically improves as a result of increased competition amongst investors themselves.
- A foreign financial investor may let the Indian business enjoy more autonomy to operate after the investment compared to an Indian investor.
- A foreign strategic investor who wants to acquire an Indian business may offer a great synergy and may allow the Indian product to integrate with a foreign offering and expand to global markets.
- In various sectors, technical expertise is necessary, which local businesses in India may not be able to provide without an experienced foreign partner. For e.g., modernized airports, metro rails etc. are being built by Indian companies in collaboration with experienced foreign JV partners. Many automobile manufacturers also operate on a joint venture basis – e.g. Maruti Suzuki, Mahindra Renault etc.
- FDI often provides exit options to existing shareholders and promoters.
- The FDI route is a major mechanism used by foreign businesses to establish a presence in India – for example, companies such as Google, Microsoft and Amazon create their subsidiaries in India. An example of a joint venture is between Bajaj of India and Allianz of Germany.
What are the available roadmaps for a foreign investor?
In India, foreign direct investments can be made through two routes:
- Automatic Route (government permission not required), or
- Government- Approval Route (government permission taken).
In the first route, the automatic route simply implies that permission to invest is not required for an investor to continue their investments in India. However, in the second route, the investor is required to obtain all the necessary permissions from the Government.
Until 2017, Foreign Investment Promotion Board (FIPB) was a nodal agency that had existed for 25 years to process FDI applications for the second route (the Government approval route). In May 2017, a memorandum was issued concerning the abolishing of FIPB and also gave the authority to the concerned bureau. Any decision taken by the concerned department now had to be in sync with the Department of Industrial Policy and Promotion (DIPP).
For any foreign investment worth more than Rs. 5000 crores, the expert authority should present the proposal to the Cabinet Committee in Economic Affairs (CCEA) for consideration. Proposals for consideration can also be referred to the CCEA. If a proposal is found lacking, the subsequent rejection would be done by a competent authority in consultation with DIPP.
Within 2 days, DIPP also has to forward the given proposal to the following authorities, other than the competent authority:
|Time Period||Name of Authority||Purpose||Significance|
|Four weeks||RBI||For comments from the FEMA perspective||Mandatory to send comments|
|Four weeks||Ministry of External Affairs||For information||May or may not send any comments|
|Four weeks||Department of Revenue||For information||May or may not send any comments|
|Six weeks||Ministry of Home Affairs||For security clearance, if any||Mandatory to send comments|
For the cases given below, security clearance is required from the Ministry of Home Affairs:
- Investment in Private Security Agencies, Defense, Civil Aviation;
- Investments in Mining and its processes, mineral separation of titanium bearing minerals and ores, its value addition and integrated activities;
- Investments in Broadcasting and related services, Telecommunication, Satellites – establishment and operation;
- Investments from Pakistan and Bangladesh.
The expected time period for processing a proposal is 8 weeks (it may extend up to 10 weeks if security clearance is required).
What are the initiatives taken by the government?
For increasing FDI flow, the Government of India has amended the policy by raising the upper limit from 26% to 49% in the insurance sector in 2014.
The ‘Make in India’ initiative launched in September 2014 liberalized the FDI policy for 25 sectors.
In May 2020, the government increased FDI in defense manufacturing under the automatic route from 49% to 74%.
In March 2020, the government permitted NRIs to acquire up to 100% stake in Air India.
In April 2020, the government amended the existing consolidated policy for restricting opportunistic takeovers or acquisition of Indian companies from neighbouring nations.
The Department for Promotion of Industry and Internal Trade and Invest India has developed the India Investment Grid [IIG] which provides a pan-India database of projects from Indian promoters for promoting and facilitating foreign investments.
The coronavirus pandemic effect
During the pandemic, the Government of India decided that it was important to regulate FDIs from countries bordering India. Thus, an order was passed to the same effect on 18 April 2020, and the consolidated changes were released on 28 October 2020.
During the financial years 2014-16, most of India’s FDI came from the Netherlands, Mauritius, Japan, Singapore and the US. As we all know, the ‘Make in India’ initiative was launched on 25 September 2014, which provided relaxed norms for 25 sectors. Selected sectors affected by this initiative are mentioned below.
Almost 10% of India’s total Gross Domestic Product (GDP) is based on construction activity. The Indian government has invested $ 1 trillion in infrastructure from 2012-2017. 40% of this $ 1 trillion had to be funded by the private sector. Under the automatic route, 100% FDI is permitted in the construction sector for cities and townships.
Electronic system design and manufacturing
The ESDM sector in India is rapidly growing and India is poised to become a global electronics manufacturing hub in the future with targeted exports of 180 billion USD within 2025.
FDI in the automotive sector increased by 89%. Globally, India is the 7th largest producer of vehicles, with nearly 25.5 million vehicles being produced annually. Automobiles share 7% of India’s GDP. 100% FDI is permitted in the sector via the first route (automatic route).
The FDI sector in the IT domain is one of the biggest in India. Lots of global companies have their R&D offices in India. Bangalore and Hyderabad are considered to be global hubs.
In terms of the global market, the Indian pharmaceuticals market is one of the 3rd largest in terms of volume and 13th largest in terms of the value it produces. The Indian pharmaceuticals industry is expected to grow by 20% in the coming years. 74% of FDI is permitted in this sector.
FDI in the service sector increased by 46% in 2015, which had a value of US $1.88 billion in 2017. This sector includes R&D, courier, banking, insurance, and technology testing. The FDI limit in Insurance has been further increased to 74% in 2021.
100% FDI is allowed under automatic route on most railways. Foreign investments worth Rs. 90,000 crores [US$ 12 billion] are expected in different developmental projects.
The Indian chemical industry had a revenue of $155 to 160 billion in 2013. 100% FDI is allowed under automatic route. From 2013, with a share of 2.3% in the global market, it is expected to go up to 7% in 10 years.
One of the major contributors to India’s export is Textile [ 11%]. 100% FDI is allowed under automatic route. 91% FDI permitted. Revenues of the Indian textile industry reach up to $141 billion in 2021.
FDI permitted upto 100% for a scheduled or regional air transport service or domestic scheduled passenger airline.
Indian aerospace manufacturing is also growing rapidly and has attracted huge investments. The industry is projected to reach USD 70 billion in 2030.
India’s global position
The UN Conference on Trade and Development (UNCTAD) presented the World Investment Report 2020, which stated that in 2019, India was the 9th largest recipient of FDI, with an inflow of $51 billion, an improvement FDI received in the previous year, which was $42 billion.
According to the Financial Times in 2015, India overtook China and the United States as the top destination for the FDI.
The service sector had the highest FDI equity inflow of US$ 7.85 billion, followed by Computer software and hardware at US$ 7.67 billion, then the telecommunications sector at US$ 4.44 billion, and trading at US$ 4.57 billion.
The Department for Promotion of Industry and Internal Trade reported that India received FDI from China worth $2.34 billion [Rs. 14.846 crores] between April 2000 and December 2019. This rose by about $900 million due to the ‘Make in India’ initiative. During the same period, other neighbouring countries, such as Bangladesh, invested Rs. 48 lakhs. Nepal invested Rs. 18.18 crores. Other countries that had an interest in Indian investments were Myanmar, Rs. 35.78 crores and Afghanistan with Rs. 16.42 crores respectively.
Though new rules and ordinances were passed to curb opportunistic takeovers, Chinese portfolio investments in startup companies such as Snapdeal, Ola, Swiggy and Paytm amount to $6 billion now, which is only 1.3% of the cumulative FDI.
Some examples of distressed sales are that of Britain’s Jaguar Land Rover and South Korea’s SsangYong sales to Tata Motors and Mahindra. Though it might not have been pleasant for the companies, there was little they could do under economic duress.
However, this law confuses the case of greenfield (FDI in the brand new company) and brownfield (FDI in the existing company) companies, as it does not distinguish between the two. One can argue for both sides of these investments, but it is an irrefutable fact that a foreign party influences both of them. A similar predicament is faced by companies listed and unlisted on the stock market. As seen earlier, 100% FDI was permitted in selected sectors such as the infrastructure sector and the railway sector, it can be inferred that these two sectors need as much support as they are the backbone of our country.
To somewhat mitigate the huge trade deficits, Indian prime ministers have been soliciting Chinese investment, albeit with a mandatory security clearance.
This is beneficial to India as these types of investors are ready to invest in Indian startups. This is illustrated by the fact that Chinese investors have wisely financed Indian startups like Flipkart, Paytm and Zomato, and pushed them to vast appraisals.
Any company established and registered in India, is required to conform to Indian laws and policies, as the entity is seen as an Indian corporate citizen, irrespective of the nationality of the shareholders. Therefore, FDI should be done based on its usefulness in contributing to the growth of the Indian economy.
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