In this blog post, Mamta Ramaswamy, a student pursuing her Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, describes FDI and provides an overview of the approval route in FDI. This article is written only for educational purposes and does not constitute a legal advice.

Introduction

Overseas investments in joint ventures and wholly owned subsidiaries have been recognised as important avenues for promoting global business by Indian entrepreneurs. Joint Ventures are perceived as a medium of economic and business co-operation between India and other countries. Transfer of technology and skill, sharing of results of research & development, access to the wider global market, promotion of brand image, generation of employment and utilisation of raw materials available in India and in the host country are other significant benefits arising out of such overseas investments (or financial commitment). They are also important drivers of foreign trade through increased exports of plant and machinery and goods and services from India and also a source of foreign exchange earnings by way of dividend earnings, royalty, technical know-how fee and other entitlements on such investments (or financial commitment). The FEMA 120/FB – 2004 notification issued by RBI on 7^th July 2004 (notification) seeks to regulate acquisition and transfer of a foreign security by a resident in India, i.e., investment (or financial commitment) by Indian entities in overseas joint ventures and wholly owned subsidiaries as also investment by a person resident in India in shares and securities issued outside India. Overseas Investment (or financial commitment) can be made under two routes viz. (i) Automatic Route and (ii) Approved Route[1].

Direct investment outside India means investment by way of contribution to the capital or subscription to the Memorandum of Association of a foreign entity or by way of purchase of existing shares of a foreign entity either by market purchase or private placement or through stock exchange, but does not include portfolio investment[2]. Portfolio investment means investment in securities that is intended for financial gain only and does not create a lasting interest in or effective management control over an enterprise[3].

By regulating direct investment, the RBI is regulating investments where the investor has the real interest in the foreign company and not just financial interest.

Indian Parties i.e., a company incorporated in India or a body created under an Act of Parliament or a partnership firm registered under the Indian Partnership Act, 1932 or a Limited Liability Partnership, registered under the Limited Liability Partnership Act, 2008, making investment in joint ventures or wholly owned subsidiaries abroad and includes any other entity in India as may be notified by RBI[4] are prohibited from making investment (or financial commitment) in foreign entity engaged in real estate (meaning buying and selling of real estate or trading in Transferable Development Rights (TDRs) but does not include development of townships, construction of residential/commercial premises, roads or bridges) or banking business, without the prior approval of the Reserve Bank[5].

Approval route in FDI

With effect from July 03, 2014, it has been decided that any financial commitment exceeding USD 1 (one) billion (or its equivalent) in a financial year would require prior approval of the RBI even when the total financial commitment of the Indian Party is within the eligible limit under the automatic route (i.e., within 400% of the net worth as per the last audited balance sheet)[6]. Indian software exporters are permitted to receive 25 percent of the value of their exports to an overseas software start-up company in the form of shares without entering into Joint Venture Agreements, with prior approval of the Reserve Bank[7].

Listed Indian companies are permitted to invest up to 50 percent of their net worth as on the date of the last audited balance sheet in (i) shares and (ii) bonds / fixed income securities, rated not below investment grade by accredited / registered credit rating agencies, issued by listed overseas companies[8]. Therefore, any investment by the listed Indian companies over and above 50 per cent of their net worth as on last audited balance sheet shall require approval from the RBI.

Indian mutual funds registered with the Securities and Exchange Board of India (SEBI) investing more than USD 7 billion in the following shall require approval from the RBI:

1. ADRs / GDRs of the Indian and foreign companies;
2. equity of overseas companies listed on recognised stock exchanges overseas
3. initial and follow-on public offerings for listing at recognised stock exchanges overseas;
4. foreign debt securities in the countries with fully convertible currencies, short- term as well as long-term debt instruments with rating not below investment grade by accredited/registered credit agencies;
5. money market instruments rated not below investment grade;
6. repos in the form of investment, where the counterparty is rated not below investment grade. The reports should not, however, involve any borrowing of funds by mutual funds;
7. government securities where the countries are rated not below investment grade;
8. derivatives traded on recognised stock exchanges overseas only for hedging and portfolio balancing with underlying as securities;
9. short-term deposits with banks overseas where the issuer is rated not below investment grade; and
10. units / securities issued by overseas Mutual Funds or Unit Trusts registered with overseas regulators and investing in (a) aforesaid securities, (b) Real Estate Investment Trusts (REIT) listed on recognised stock exchanges overseas, or (c) unlisted.

Apart from the investment values mentioned above and in the sections B.1 to B.7 of the Master Direction, all the other investment amounts need prior approval of the RBI, including the following:

1. investment in energy and natural resource sectors in excess of the prescribed limit of financial commitment[9].
2. A joint venture/ wholly owned subsidiary set up by the Indian Party as per the Regulations may diversify its activities / set up step down subsidiary / alter the shareholding pattern in the overseas entity. The Indian Party should report to the Reserve Bank through the AD Category – I bank, the details of such decisions within 30 days of the approval of those decisions by the competent authority of the JV / WOS concerned in terms of local laws of the host country and include the same in the Annual Performance Report (APR – Part III of Form ODI) required to be forwarded to the AD Category-I bank.[10]
3. Unlisted companies are permitted to write off capital and other receivables up to 25 per cent of the equity investment in the JV /WOS under the Approval Route[11].

References: 

[1] RBI/FED/2015-16/10 FED Master Direction No. 15/2015-16

[2] Paragraph A.3 (e) of RBI/FED/2015-16/10 FED Master Direction No. 15/2015-16

[3] http://www.businessdictionary.com/definition/portfolio-investment.html

[4] Paragraph A.3 (k) of RBI/FED/2015-16/10 FED Master Direction No. 15/2015-16

[5] Paragraph A.4 (a) of RBI/FED/2015-16/10 FED Master Direction No. 15/2015-16

[6] Paragraph B.1 of RBI/FED/2015-16/10 FED Master Direction No. 15/2015-16

[7] Paragraph B.5 (2) of RBI/FED/2015-16/10 FED Master Direction No. 15/2015-16

[8] Paragraph B.7(1) of RBI/FED/2015-16/10 FED Master Direction No. 15/2015-16

[9]Paragraph B.9 of RBI/FED/2015-16/10 FED Master Direction No. 15/2015-16

[10] Paragraph B.11 of RBI/FED/2015-16/10 FED Master Direction No. 15/2015-16

[11] Paragraph B.12(ii) of RBI/FED/2015-16/10 FED Master Direction No. 15/2015-16