[Burning Issue] India’s Amended FDI Norms amidst Hostile Takeover Efforts by China

 

 

For India, the problem lies that, trade with China has often been viewed as a positive in a relationship without any positive sentiment.

Post-Doklam, the Wuhan ‘reset’ with China was premised largely on India and China working towards a more robust economic relationship.

Yet, China’s reluctance to adequately address Indian concerns and the challenges posed by sectors like trade and health also emerging as traditional national security threats in the Sino-Indian matrix meant that New Delhi had had to finally bite the bullet.

FDI is an all-season hot topic for both prelims as well as mains. Reading the Burning Issue will make you aware of its scope. We can expect a mains question like –  Recent amendment in the FDI Policy aims for curbing opportunistic takeovers/acquisitions of Indian companies. Elucidate.

Context

  • The Government of India has reviewed the extant Foreign Direct Investment (FDI) policy for curbing opportunistic takeovers/acquisitions of Indian companies due to the current COVID-19.
  • The Indian policy revision is meant for sectors and enterprises other than defence, space, atomic energy and sectors and activities “prohibited for foreign investment”.
  • It was understood that the Indian decision was a response to the news of an incremental purchase of shares in HDFC by the People’s Bank of China.

Background

What is Foreign Direct Investment (FDI)?

An FDI is an investment in the form of a controlling ownership in a business in one country by an entity based in another country. It means where a foreign company, generally an MNC, may invest in a country in any of the following 3 forms:

1) Set up a plant or project to manufacture a commodity- consumer goods, capital goods, automobile, aircraft, ships etc. It may also engage itself in construction activity- highways, roads, bridges, ports, airports, real estate etc.

2) Setup a network for providing services- banking, insurance, shipping, telecom, software, civil aviation etc.

3) Only provide technology by way of Technology Transfer through any company of the country. It can provide technology only or provide technology along with #1 & #2 above

Why Foreign Investors go for FDI?

  • To take advantage of cheaper wages in the country, special investment privileges such as tax exemptions offered by the country as an incentive
  • To gain tariff-free access to the markets of the country
  • To acquire a lasting interest in enterprises operating in the target country

What attracts FDI?

  • The growth rate of the source economy is an important determinant
  • The political and economic stability of the target region
  • How ‘open’ the economy is towards foreign trade (both imports and exports)
  • The policies, rules, regulations and loopholes incidental thereto
  • For example, Mauritius has been the top FDI source for India due to the later (loophole) reasons

FDI in India

  • Foreign investment was introduced in 1991 under Foreign Exchange Management Act (FEMA), driven by then FM Manmohan Singh.
  • There are two routes by which India gets FDI.

1) Automatic route: By this route, FDI is allowed without prior approval by Government or RBI.

2) Government route: Prior approval by the government is needed via this route. The application needs to be made through Foreign Investment Facilitation Portal, which will facilitate the single-window clearance of FDI application under Approval Route.

  • India imposes a cap on equity holding by foreign investors in various sectors, current FDI in aviation and insurance sectors is limited to a maximum of 49%.
  • In 2015 India overtook China and the US as the top destination for the Foreign Direct Investment.

Chinese contribution

  • Almost 18 of India’s 23 unicorns have investments from China.
  • According to a report, China has remarkable investments in the tech sector in India.
  • “TikTok, the video app, has 200 million subscribers and has overtaken YouTube in India.
  • Alibaba, Tencent and ByteDance rival the US penetration of Facebook, Amazon and Google in India.
  • Chinese smartphones like Oppo and Xiaomi lead the Indian market with an estimated 72 per cent share, leaving Samsung and Apple behind.

What is the recent amendment all about?

  • The govt. has amended para 3.1.1 of extant FDI policy as contained in Consolidated FDI Policy, 2017.
  • In the event of the transfer of ownership of any existing or future FDI in an entity in India, directly or indirectly, resulting in the beneficial ownership, such subsequent change in beneficial ownership will also require Government approval.

The present position and revised position in the matters will be as under:

Earlier Position

  • A non-resident entity can invest in India, subject to the FDI Policy except in those sectors/activities which are prohibited.
  • However, a citizen of Bangladesh or an entity incorporated in Bangladesh can invest only under the Government route.
  • Further, a citizen of Pakistan or an entity incorporated in Pakistan can invest, only under the Government route, in sectors/activities other than defence, space, atomic energy and sectors/activities prohibited for foreign investment.

Revised Position

  • A non-resident entity can invest in India, subject to the FDI Policy except in those sectors/activities which are prohibited.

[spot the difference]

  • However, an entity of a country, which shares a land border with India or where the beneficial owner of investment into India is situated in or is a citizen of any such country, can invest only under the Government route.
  • Further, a citizen of Pakistan or an entity incorporated in Pakistan can invest, only under the Government route, in sectors/activities other than defence, space, atomic energy and sectors/activities prohibited for foreign investment.

What do these restrictions mean?

  • FDI from rest of the countries could come in through the automatic route in sectors where it is allowed such as automobiles, auto parts, construction, asset reconstruction, agriculture, single-brand retail, manufacturing, coal, gems & jewellery, and textiles, capital goods, pharmaceuticals, electronic systems and ports and shipping etc.
  • If FDI is made from investors in China and six other neighbouring countries it will need to have prior government approval.
  • Earlier, these restrictions were applicable only on Pakistan and Bangladesh.

What led India to change the FDI norms?

  • Chinese investments sometimes do follow a pattern. At the peak of the debt crisis, there was a massive inflow of Chinese direct investment into the European Union.
  • In 2010, the total stock of Chinese direct investment in the EU was just over €6.1bn, less than what was held by India, Iceland or Nigeria.
  • By the end of 2012, Chinese investment stock had quadrupled, to nearly €27bn. This was partly opportunistic buying because assets were cheap.
  • It was a structural secular shift in Chinese outbound investment, from securing natural resources in developing countries to acquiring brands and technology in developed countries.
  • Chinese firms are quite ready for discount deals, where domestic companies are reeling under an economic crisis spurred on by the coronavirus pandemic.

Impact on investments

  • The amended policy brings every kind of Chinese investors to India within the ambit of government approval reducing the space for private business negotiations.
  • The decision would face difficulties, especially if the government tried to attribute nationality to venture capital funds.
  • China has argued that the barriers set by the Indian side for investors from specific countries violate WTO’s principle of non-discrimination, and go against the general trend of liberalization and facilitation of trade and investment.

China’s objection raises an important question:

Is India’s revision of its FDI policy valid under international investment law?

1) Invoking WTO

  • It is important to note that the entry or regulation of FDI into a country is not governed by the World Trade Organization (WTO).
  • The multilateral WTO Agreements mainly regulate disciplines on trade in goods and services, and intellectual property and not the right to regulate foreign investment per se.

2) Emergency provisions

  • Many international agreements, including WTO Agreements, provide exceptions for extraordinary measures taken in times of emergencies.
  • The WHO has classified the COVID-19 crisis as a public health emergency of international concern.
  • Therefore, any measures that a country considers necessary for the protection of its essential security interests, which are taken in time of war or other emergencies, are not considered to be in contravention of its international commitments.
  • A state’s commitment to trade and investment liberalization certainly does not include forfeiture of its essential security interests.

3) A more bilateral issue (if considered any)

  • Disputes over the regulation of FDI would normally be considered under the dispute settlement mechanisms of a bilateral investment treaty (BIT).
  • However, currently, there are no bilateral investment treaties between India and China.
  • Therefore, China lacks the ability to challenge India’s amendment to its FDI policy under a BIT arbitration mechanism as well.

Conclusion

 

  • India’s revised FDI policy clearly intends to protect an essential security interest and cannot be considered inconsistent with the relevant WTO Agreements.
  • The amendments are not aimed at any one country but at curbing “opportunistic” takeovers of Indian firms, many of which are under strain.
  • The amendments are not prohibiting investments. Only the approval route for these investments has been changed.
  • Before India, the European Union and Australia had initiated similar measures. These, again, were seen as being targeted at Chinese investments.

Way Forward

  • India is unlikely to be bullied as its FDI moves are on an extremely strong legal footing. But it is important to address the larger picture.
  • The financial and strategic exploitation of a pandemic-induced economic slowdown is reprehensible and unquestionably needs urgent attention.
  • Considering the injury caused to China’s status as a responsible stakeholder (being failed at share information of coronavirus), Beijing would be wise to avoid actions that risk a reaffirmation of its bad faith.
  • Particularly at a time when manufacturing companies are exiting its shores and Chinese capital is increasingly becoming unwelcome, India needs to adopt a more conciliatory approach.

Also read:

FDI in Indian economy

 




References

https://www.theweek.in/news/biz-tech/2020/04/23/the-great-wall-against-china-understanding-india-new-foreign-investment-rules.html

https://www.orfonline.org/expert-speak/india-fires-a-salvo-at-china-65011/

https://indianexpress.com/article/explained/why-india-tightened-fdi-rules-and-why-its-china-thats-upset-6374693/

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