FDI in Indian economy

Recent amendments to FDI policy – a boon or a bane?

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Routes of FDI, External commercial borrowing etc.

Mains level : Paper 3- What are the factors responsible for declining FDI in India? Discuss the changes made in FDI policy amid covid pandemic.

This article deals with the recent changes made by the government in the FDI policy. The major change was that the government approval route was made mandatory for investment coming from certain countries. There are certain ambiguities and issues with the latest changes.These are discussed here.

What changes were made in the FDI policy?

  • Government approval route for investment: Investment is permitted through government route only in the following cases-
  • 1) An entity situated in a country which shares a land border with India.
  • 2) Where the owner of investment into India is situated in or is a citizen of any such country.
  • Further, any transfer of ownership of any existing or future foreign direct investment (FDI) in an entity in India (indirectly or indirectly) resulting in the beneficial ownership falling within the purview of the above restrictions, would require the government’s approval.

Ambiguities arising due to press note

  • There appear to be certain ambiguities arising from the press note and the amendments to the Rules.
  • The usage of the term “FDI” in the press note and the relevant amendments to Rule 6(a) of the Rules, seem to suggest that the restrictions are on investments that are structured as FDI.
  • FDI is defined under the Rules to mean investment through equity instruments by a person resident outside India in an unlisted Indian company, or in 10% or more of the post issue paid-up equity capital on a fully diluted basis of a listed Indian company
  • The restriction doesn’t seem to be on investments by an FPI registered with SEBI.
  • FPI is permitted to invest in listed or to be listed Indian companies’ securities, in the manner set out in Schedule II of the Rules.
  • Also not on investments under the FVCI route.
  • Investment through FVCI is an investment in the securities of Indian companies operating in certain specific sectors, in the manner set out in Schedule VII of the Rules.
  • It is also unclear if “foreign investments” in LLPs, not being FDI, would also be subject to these restrictions.
  • This ambiguity is further amplified by the subject line of the press note, which reads “curbing opportunistic takeovers/acquisitions of Indian companies”, without making any reference to LLPs.
  • And the amendments to Rule 6(a) of the Rules, which only pertain to investments in equity instruments of an Indian company under Schedule I of the Rules.

The points mentioned here add to our understanding of FDI and issues with it. A question based on the issue can be asked, for ex-“What are the reasons for a steady decline in FDI in India? To what extent FDI poilcy is responsible for this?”

Difficulties in seeking government approval

  • The requirement of seeking government approval may also pose operational difficulties for many entities.
  • For instance, the approval requirement seems to be applicable in all cases of further investments irrespective of the threshold.
  • It applies whether or not such investments are in the form of rights issue (where all or almost all existing shareholders also participate) or preferential allotments.
  • Which results in causing some amount of hardship for entities to raise further capital, especially where entities already have existing investments from investors situated in countries like China.
  • The amendments to the Rules also do not attempt to clarify the applicability of the approval requirements where there is no change in the shareholding percentage of the investor pursuant to a follow-on investment.
  • Another aspect which is important, is the usage of the terms “directly or indirectly” in the context of transfer/ divestment of beneficial ownership of existing FDI, to entities in/ citizens of a country which shares a land border with India.
  • This may require global acquisitions of entities in other jurisdictions which have subsidiaries/ investee companies in India, by a person in one of India’s neighbouring countries, to be subject to the approval requirements, thereby impacting timelines for closing.

No restrictions on external commercial borrowings (ECB)

  • There are presently no such commensurate restrictions under the ECB regulations.
  • Therefore, an eligible borrower could avail ECB from a recognised lender.
  • That includes a foreign equity holder in one of India’s neighbouring countries which are FATF compliant for any immediate funding requirements.
  • Any conversion of the ECB or any part thereof, into shares of the Indian company, would be subject to the restrictions and approval requirements under the FDI policy and the Rules.

Conclusion

The government/RBI should provide necessary clarifications on these issues and ambiguities at the earliest. With there being no sunset clause presently contemplated on the applicability of these restrictions, only time will tell if the amendments to the Rules are a boon to the economy and a step in the right direction, or otherwise.


Back2Basics: What is ‘Rights issue’

  • Cash-strapped companies can turn to rights issues to raise money when they really need it.
  • In these rights offerings, companies grant shareholders the right, but not the obligation, to buy new shares at a discount to the current trading price.
  • A rights issue is an invitation to existing shareholders to purchase additional new shares in the company.
  • This type of issue gives existing shareholders securities called rights.
  • With the rights, the shareholder can purchase new shares at a discount to the market price on a stated future date.
  • The company is giving shareholders a chance to increase their exposure to the stock at a discount price.
  • Until the date at which the new shares can be purchased, shareholders may trade the rights on the market the same way that they would trade ordinary shares.
  • The rights issued to a shareholder have value, thus compensating current shareholders for the future dilution of their existing shares’ value.
  • Dilution occurs because a rights offering spreads a company’s net profit over a larger number of shares.
  • Thus, the company’s earnings per share, or EPS, decreases as the allocated earnings result in share dilution.

What is the Limited Liability Partnership (LLP)?

  • LLPs are a flexible legal and tax entity that allows partners to benefit from economies of scale by working together while also reducing their liability for the actions of other partners.
  • In a general partnership, all partners share liability for any issue that may arise.
  • The LLP is a formal structure that requires a written partnership agreement and usually comes with annual reporting requirements depending on your legal jurisdiction.

What is the FVCI route of investment?

  • Foreign Venture Capital Investor’ (FVCI) means an investor incorporated and established outside India and registered with Securities and Exchange Board of India under Securities and Exchange Board of India (Foreign Venture Capital Investors) Regulations, 2000.
  • The amount of consideration for all investment by an FVCI has to be received/made through inward remittance from abroad through banking channels or out of funds held in a foreign currency account and/ or a Special Non-Resident Rupee (SNRR) account maintained by the FVCI with an AD bank in India.
  • The foreign currency account and SNRR account shall be used only and exclusively for transactions under the relevant Schedule.
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