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Foreign Direct Investment

Apart from being a critical driver of economic growth, foreign direct investment (FDI) is a major source of non-debt financial resource for the economic development of India. Foreign companies invest in India to take advantage of relatively lower wages, special investment privileges such as tax exemptions, etc. For a country where foreign investments are being made, it also means achieving technical know-how and generating employment.

Foreign investment in India is primarily governed by the FDI policy formulated by the secretariat for industrial assistance (SIA), the Department of Industrial policy and promotion (DIPP), the foreign investment promotion board (FIPB) and foreign exchange regulations, which are governed by the RBI. 

Under the present policies and regulations, foreign investment in India is possible through the following avenues:

A. As FDI;

D. By qualified foreign investors, via the PIs; and

B. By FIIs, directly, via the Portfolio investment scheme(PIS);

E. By foreign venture capital investors (FVCIs)

C. By NRIs/persons of Indian origin (PIO), directly and indirectly, via the PIS;

What is FDI ?

In the wake of liberalisation in 1980s and the introduction of the new industrial policy of 1991, substantial policy changes were made to pull down administrative barriers to allow for the free flow of foreign capital and international trade. The FDI regime has been progressively liberalised, largely by removing restrictions on foreign investment and simplifying procedures. As a result, among the emerging economies, India has one of the most liberal and transparent foreign investment regimes.

The Indian government’s favourable policy regime and robust business environment have ensured that foreign capital keeps flowing into the country. The government has taken many initiatives in recent years such as relaxing FDI norms across sectors such as defence, PSU oil refineries, telecom, power exchanges, and stock exchanges, among others.

Foreign persons who can invest in India under the FDI regime

  • A non-resident entity (other than a citizen of Pakistan or Bangladesh or an entity incorporated in Pakistan or Bangladesh) can invest in India subject to compliance with the extent FDI regulations.

  • A person who is a citizen of Bangladesh or Pakistan or an entity incorporated in Bangladesh or Pakistan can invest in India under the FDI provisions, subject to receiving the prior approval of the FIPB.

FDI Policy

The government of India releases a compendium of FDI policy every six months. Foreign investment in India can be made either through the automatic route or the approval route.

Prohibited Sectors

  • Gambling and Betting
  • Lottery business (including government/ private lottery, online lotteries etc)
  • Activities /sectors not open to private sector investment (eg, atomic energy /railways)
  • Retails trading (expect single-brand product retailing)
  • Business of chit fund
  • Nidhi company
  • Real estate business or construction of farm houses
  • Trading in transferable development rights (TDRs)
  • Manufacturing of tobacco, cigars, cheroots , cigarallos, cigarettes and other tobacco substitutes
  • Agriculture (excluding floriculture, horticulture, apiculture and cultivation of vegetables and mushrooms under controlled conditions, the development and production of seeds & planting materials, animals husbandry including the breeding of dogs, viniculture & aquaculture under controlled conditions and services related to the agro and allied sector)

Automatic Route

Under the automatic route, no prior regulatory approval is required from either the RBI or FIPB. Under this route, investors are required to notify the concerned regional office of the RBI within 30 days of receiving investment money in India and to file the required documents and details of the shares allotted, with the same regional office, within 30 days of issuing such shares to the respective foreign investors.

Approval/ Govt Route

FDI in business sectors not covered under the automatic route requires prior approval from the Government of India. Applications for foreign investments that need prior governmental approval are required to be submitted to the FIPB.

Conclusion

Investing into another country’s economy, buying into a foreign company or otherwise expanding your business abroad can be extremely financially rewarding and might provide you with the boost needed to jump to a new level of success. However, foreign direct investment also carries risks, and it is highly important for you to evaluate the economic climate thoroughly before doing it. Also, it is essential to hire a financial expert who is accustomed to working internationally, as he can give you a clear view of the prevailing economic landscape in your target country. He can even help you monitor market stability and predict future growth.

Remember that we live in an increasingly globalised economy, so foreign direct investment will become a more accessible option for you when it comes to business. However, you should weigh down its advantages and disadvantages first to know if it is the best road to take.

Types of instruments available for making FDI

  • Indian companies can issue equity shares, fully compulsorily & mandatorily convertible debentures and fully compulsorily & mandatorily convertible preference shares, subject to the following:
  • Compliance with pricing guidance’s and valuation norms prescribed under the FEMA;
  • Determination of the price/conversation formula for convertible instruments upfront at the time of the issue; and
  • The price of convertible instruments at the time of conversation cannot be less than the fair value determined as per the FEMA guidance at the time of issue.
  • The RBI has recently specified amendments with respects to put and call options. It has clarified that shares or convertible debentures containing an optionality clause but without an option to exit at an assured price shall be eligible instruments.
  • The instruments should be subject to a minimum lock in of 1 year or as prescribed, whichever is higher.
  • Exit in the case of a listed company is at the market price determined on the recognised stock exchange.
  • In case of equity shares of unlisted companies exit is at a price not exceeding that arrived at on the basis of returns on equity as per last audited balance sheet.
  • In case of preference shares or debentures, exit is at a price worked out as per any internationally accepted pricing methodology at the time of exit, duly certified by a chartered accountant or SEBI registered merchant banker
  • An Indian company can also raise funds from abroad through the issue of foreign currency convertible bond (FCCBs) and depository receipts in accordance with the relevant regulations and guidelines issued by the government of India.
  • Other type of instruments such as non-convertible or optionally convertible preference shares are treated as debt and therefore have to follow the ECBs regulations issued by the RBI.

Prior approval of FIPB

  • Prior approval of the FIPB is also required in the following cases:
  • Foreign investment exceeding 24 percent of the equity capital of an industry undertaking that is not a micro or small scale enterprise (MSE) but manufactures items reserved exclusively for the MSE sectors.
  • Foreign investment in an Indian company engaged only in the activity of investing in the capital of other Indian companies, regardless of the amount or extend of the foreign investment; and
  • Infusion of foreign investment in an Indian company that does not have any operations or any downstream investments, regardless of the amount or extend of the infusion.
  • An application for investment under the approval route should be made to the FIPB/Ministry of Finance.
  • This application can be made on plain paper or online by either the investment company or by the foreign investor. It will however, be necessary to provide the full details of the proposal to the FIPB.
  • Recommendation of the FIPB in respect of proposal falling in the non- automatic route and involving an investment of Rs 12,000 million are submitted by the FIPB to the cabinet committee on Economic Affairs for further approval.
  • Application for the approval of FDI proposals, along with the FIPB, can also be submitted to the Department of Economic Affairs (DEA) and the ministry of finance. However, in the case of NRI investments, Export oriented units (EOUs) and retail trading (single branded products), the applications are supposed to be submitted to the SIA of DIPP. Application can also be submitted to Indian mission abroad, which in turn, will forward them to the DEA for further processing. Approval is granted by the FIPB on an individual basis, after examining the proposal for investment. Prescribed fillings are then required to be carried out under the prior approval route.
Market Size of FDI

According to the Department for Promotion of Industry and Internal Trade (DPIIT), FDI equity inflows in India stood at US$ 456.79 billion during April 2000 to December 2019, indicating that government's effort to improve ease of doing business and relaxation in FDI norms is yielding results.

FDI equity inflows in India stood at US$ 36.79 billion during April-December 2019. Data for 2019-20 indicates that the service sector attracted the highest FDI equity inflow of US$ 6.52 billion, followed by computer software and hardware – US$ 6.34 billion, telecommunications sector - US$ 4.29 billion and trading – US$ 3.52 billion.

During 2019-20, India received the maximum FDI equity inflows from Singapore (US$ 11.65 billion), followed by Mauritius (US$ 7.45 billion), Netherlands (US$ 3.53 billion), Japan (US$ 2.80 billion) and USA (US$ 2.79 billion).

 FDI in partnership firms/proprietary concern

NRIs and PIOs can invest in the capital of the partnership firm or proprietary concern in India, on a non- repatriation basis, in accordance with the following conditions:

The firm or proprietary concern is not engaged in any agriculture/plantation, real estate or print media business.

Any amount so invested is brought in by inward remittances or out of an NRE/ FCNR (B)/ NRO account maintained with an authorised dealer (AD) or other authorised banks.

Any amount so invested cannot be remitted outside India.

NRIs and PIOs may, however, seek the prior approval of the RBI for investment in partnership firms or proprietary concern with an option to repatriate funds out of India and the RBI, in consultation with the, government will decide on each application based upon the merits of the specific case.

A non- resident other than an NRI or a PIO can apply and seek the approval of the RBI to invest in the capital of partnership firms/proprietary concerns and the RBI, in consultation with the government will decide on each application based upon the merits of the specific case.

Investments/ developments done by FDI in India.

Some of the recent significant FDI announcements are as follows:

  • In January 2020, Amazon India announced investment of US$ 1 billion for digitising small and medium businesses and creating one million jobs by 2025.
  • In January 2020, Mastercard announced its plans to invest up to US$ 1 billion in India over next five years to double-up its research and development efforts for the Indian market.
  • In October 2019, French oil and gas giant Total S.A. have acquired a 37.4 per cent stake in Adani Gas Ltd for Rs 5,662 crore (US$ 810 million) making it the largest Foreign Direct Investment (FDI) in India’s city gas distribution (CGD) sector.
  • In October 2018, VMware, a leading software innovating enterprise of US has announced investment of US$ 2 billion in India between by 2023.
  • In June 2018, Idea’s appeal for 100 per cent FDI was approved by Department of Telecommunication (DoT) followed by its Indian merger with Vodafone making Vodafone Idea the largest telecom operator in India
  • In August 2019, Reliance Industries (RIL) announced one of India's biggest FDI deals, as Saudi Aramco will buy a 20 per cent stake in Reliance's oil-to-chemicals (OTC) business at an enterprise value of US$ 75 billion.
  • In August 2018, Bharti Airtel received approval of the Government of India for sale of 20 per cent stake in its DTH arm to an America based private equity firm, Warburg Pincus, for around $350 million.
  • In May 2018, Walmart acquired a 77 per cent stake in Flipkart for a consideration of US$ 16 billion.

Road Ahead for FDI

India has become the most attractive emerging market for global partners (GP) investment for the coming 12 months, as per a recent market attractiveness survey conducted by Emerging Market Private Equity Association (EMPEA).

Annual FDI inflows in the country are expected to rise to US$ 75 billion over the next five years, as per a report by UBS.

The Government of India is aiming to achieve US$ 100 billion worth of FDI inflows in the next two years.

FDI in limited liability partnerships (LLPs)

Under the government/approval route, FDI is permitted in LLPs operating in business sector in which 100 percent FDI is allowed under the automatic route, subject to the condition that there are no FDI linked performance conditions.

LLPs with FDI are not permitted to operate agriculture/plantation activity and a real estate or print media business.

An Indian company with FDI is permitted to make further downstream investments in an LLP if both the company and the LLP are operating in business sector in which 100 percent FDI is allowed under the automatic route, subject to the condition that there are no FDI linked performance conditions. However, LLPs with FDI are not permitted to make further downstream investment.

Foreign investment in LLPs are permitted only as cash consideration received by inward remittances, through normal banking channels or by debit to NRE/FCNR accounts maintained by an ad or authorised bank, expect in the case of conversation of an existing company into an LLPs.

FVCIs and FIIs are not allowed to invest in LLPs, and LLPs are not permitted to avail of external commercial borrowing (ECBs)

Conversation of a company with FDI into a LLPs is allowed only if the above conditions are met and with prior approval of the FIPB.

FDI options available in following sectors:

FDI in various sectors is governed by conditions laid down by the DIPP. These include, among others, minimum capitalisation in the case of non-banking finance companies, minimum projects size & capitalisation for real estate companies.

Discussed below are certain sectors in which FDI is permitted under the Automatic route/Approval Route subject to certain conditions/ restrictions.

i. FDI in single-brand retail trading

  • The government has now allowed FDI of up to 100 percent in the retail trade of single brand products, subjects to the prior approval of the FIPB and the compliance with the following conditions:
  • The products to be sold are of a single brand.
  • The products are sold under the same brand in India, and every other country in which the product is sold.
  • Single brand product retailing only covers products that are branded during the manufacturing process.
  • The foreign investor should own the brand or one non-resident entity, whether owner of the brand or otherwise, and shall be permitted to undertake single brand product retail trading for the specific brand through a legally tenable agreement, with the brand owner for the specific brand for which approval is being sought.
  • If the proposal for FDI exceeds 51 percent of the total capital of the company, at least 30 percent of the products sold have to mandatorily be sourced from Indian small industries (where the total investment in plant and machinery does not exceed US$ 2 million at the time of installation), village and cottage industries, artisans and craftsmen.
  • Retail trading in any form by mean of e-commerce is not permitted
  • The policy requires investors to submit an application to SIA seeking permission from the government for the intended FDI in the retail trade of a single brand product. The application should specifically indicate the product/products categories that are proposed to be sold under a single brand. Any addiction to the product/product categories to be sold under the single brand will requires fresh approval from the government.

ii. Investment in multi-brand retail trading

  • Foreign investment in multi-brand retail trading has been permitted up to 51 percent under the approval route in states favouring multi brand retail trading.
  • The investment would be subject to certain conditions. Some of these conditions are as follows:
  • Minimum US$ 100 million to be brought in as FDI;
  • 50 percent of the total FDI brought in the first tranche of US$ 100 million to be invested in back end infrastructure; and
  • At least 30 percent of the value of the procurement of manufactured/processed products to be sourced from Indian micro, small and medium industries.
  • Retail sales outlets only in cities with a population of more than 1 million as per the 2011 census.
  • E-commerce not permitted for multi brand retail trading.

iii. FDI in township, housing, built-up infrastructure and construction development projects

  • FDI has been allowed in township, housing, built-up infrastructure and construction development projects (including, inter alia, housing, commercial premises, hotels, resorts, hospitals, educational institutional, recreational facilities, and city and regional level infrastructure). The government has allowed to FDI of up to 100 percent under the automatic route in this sector, subject to the following condition:
  • Minimum area to be developed under each projects should be as under:
    • Land area of 10 hectares for serviced housing plots;
    • Built-up area of 50,000 sq. mt. for construction development projects; and
    • For projects that are combination of serviced housing and construction development, the satisfaction of any one of the aforementioned minimum areas condition is sufficient.
  • Wholly owned subsidiaries should have a minimum capitalisation of US$10 million and JV's with Indian partner should have a minimum capitalisation US$5 million. The funds are required to be brought in within six months from the date that the business commences.
  • The original investment i.e., the entire initial FDI cannot be repatriated for a period of three years from the date that minimum capitalisation condition is achieved. If the initial investment is brought in instalment/tranches, the three year lock-in period will be applied from the date of receipt of each instalment/ tranche or the date that the minimum capitalisation condition achieved, whichever is later. The foreign investor can however exit earlier than the required three year lock-in period by seeking the prior approval of the government through the FIPB for such an exit.
  • At least 50 percent of the project must be developed within five year from the date of all of the statutory clearances being obtained. The investor is not to be permitted to sell undeveloped plots, i.e., plots where road, water supply, street lighting, drainage, sewerage and other conveniences, as per the prescribed regulation have not been made available.
  • The condition listed above would not apply to hotels and tourism, hospitals, special economic zones, the education sector, old age homes and investment by NRIs.

iv. FDI in the telecom sector

  • FDI in telecom services is allowed up to 49 percent under the automatic route and up to 100 percent with the prior approval of the FIPB. Telecom services for this purpose includes basic, cellular, and unfired access services, national/international long distance, V-sat, public mobile radio trunked services, global mobile personal communication services and other value added services.
  • The total composite foreign holding would include investments by FIIs, NRIs, FCCBs, American depository receipt shares and proportionate foreign investment in Indian promoters/investment companies, including their holding companies.
  • While approving investments proposals, the FIPB normally takes note that investment is not coming from countries of concern/unfriendly entities. Certain other restrictions on the transfer of accounting information, user information and details of infrastructure/network diagram have been prescribed that are to be followed by the FIPB while considering the proposals

v. Investment in asset-reconstruction companies

  • Asset reconstruction company (ARC) means a company registered with the RBI under section 3 of the Securitisation and Reconstruction of Finance Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act).
  • A person resident outside India can invest in the equity capital of ARCs registered with the RBI under the government route.
  • Such investments have to strictly be in the nature of FDI. FIIs registered with the SEBI can invest in the security receipt SR's issued by ARCs registered with the RBI. FIIs can acquire up to 74 percent of each tranche of SR's issued, subject to the condition that no single FII investment exceeds 10 percent of the total issue of each tranche of SR's.

vi. Investment in infrastructure companies in the stock markets

Foreign investment of up to 49 percent of the paid up capital is permitted in infrastructure companies in the securities markets, namely stock exchanges, depositories and clearing corporations, in compliance with SEBI regulations.

Within the permitted limit of 49 percent, the FII component cannot exceed 23 percent and the FDI component cannot exceed 26 percent. FDI in such companies is only permitted under the government/approval route. Furthermore, FII investment is permitted only through purchase from the secondary market.

vii. Investment in credit information companies (CICs)

Foreign investment in CICs is permitted subject to compliance with the Credit Information Companies (Regulation) Act, 2005, and regulatory clearance from the RBI. The aggregate foreign investment in such companies is permitted only up to 49 percent of the paid up the capital (including both FDI FII limits). Investment by SEBI registered FIIs is permitted up to 24 percent (within the overall 49 percent permitted limit) only in CICs listed on the stock exchanges. However, no FII can individually hold, directly or indirectly, more than 10 percent of the equity of the CIC.

viii. Investment in commodity exchanges

A composite ceiling of 49 percent for foreign investment in commodity exchange is only permitted under the government/approval route, whereas FII purchases are restricted to purchases made via secondary markets. Foreign investment in commodity exchanges is subject to compliance with the requirement that no non-resident investor/entity, including persons acting in concert with them, hold more than 5 percent of the total equity in such a company.

ix. Investment in public sector banks

FDI and FII investment in nationalised banks are subject to overall statutory limits of 20 percent. The investment is subject to banking companies (acquisition & transfer of undertaking) Acts, 1970/80. The same ceiling also applies to investments in the state bank of India and its associate bank.

x. Investment in print media, dealing with news and current affairs

  • FDI under the government /approval route is allowed up to 100 percent in the publication of the facsimile edition of foreign newspapers by the owner of the original foreign newspaper, subject to compliance with the guidelines issued by the ministry of information and broadcasting. Publication can be undertaken only by an entity incorporated or registered in India under the provisions of the Companies Act.
  • Under the government/approval route and subject to compliance with the guidelines issued by the minister of information and broadcasting, FDI and investment by NRIs/PIOs/FII in the publication of India editions of foreign magazines dealing with news and current affairs and newspapers and periodicals dealing with news and current affairs is allowed up to 26 percent.

Advantages of FDI

FDI can be Greenfield, wherein an organisation creates a subsidiary concern in another country and builds its business operations there from the ground up. Greenfield investments provide the highest degree of control to the organisation. It can construct the production plant as per its specifications, employ and train human resources as per company standards, as well as design and monitor its operational processes. 

Alternatively, FDI can be brownfield - wherein an organisation expands by way of cross-border mergers, acquisitions and joint ventures - by either leasing or purchasing existing facilities for its production. The clear advantage of brownfield investments is the savings in cost and time for starting up, as well as engaging in construction activities. Addition of equipment to an existing facility also qualifies as brownfield investment.

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1. Increased Employment and Economic Growth

Creation of jobs is the most obvious advantage of FDI. It is also one of the most important reasons why a nation, especially a developing one, looks to attract FDI. Increased FDI boosts the manufacturing as well as the services sector. This in turn creates jobs, and helps reduce unemployment among the educated youth - as well as skilled and unskilled labour - in the country. Increased employment translates to increased incomes, and equips the population with enhanced buying power. This boosts the economy of the country.

2. Human Resource Development

This is one of the less obvious advantages of FDI. Hence, it is often understated. Human Capital refers to the knowledge and competence of the workforce. Skills gained and enhanced through training and experience boost the education and human capital quotient of the country. Once developed, human capital is mobile. It can train human resources in other companies, thereby creating a ripple effect. 

3. Development of Backward Areas

This is one of the most crucial benefits of FDI for a developing country. FDI enables the transformation of backward areas in a country into industrial centres. This in turn provides a boost to the social economy of the area. The Hyundai unit at Sriperumbudur, Tamil Nadu in India exemplifies this process. 

5. Increase in Exports

Not all goods produced through FDI are meant for domestic consumption. Many of these products have global markets. The creation of 100% Export Oriented Units and Economic Zones have further assisted FDI investors in boosting their exports from other countries.

7. Stimulation of Economic Development

This is another very important advantage of FDI. FDI is a source of external capital and higher revenues for a country. When factories are constructed, at least some local labour, materials and equipment are utilised. Once the construction is complete, the factory will employ some local employees and further use local materials and services. The people who are employed by such factories thus have more money to spend. This creates more jobs. 


These factories will also create additional tax revenue for the Government, that can be infused into creating and improving physical and financial infrastructure. 

4. Provision of Finance & Technology

Recipient businesses get access to latest financing tools, technologies and operational practices from across the world. Over time, the introduction of newer, enhanced technologies and processes results in their diffusion into the local economy, resulting in enhanced efficiency and effectiveness of the industry.

6. Exchange Rate Stability

The constant flow of FDI into a country translates into a continuous flow of foreign exchange. This helps the country’s Central Bank maintain a comfortable reserve of foreign exchange. This in turn ensures stable exchange rates.

8. Improved Capital Flow

Inflow of capital is particularly beneficial for countries with limited domestic resources, as well as for nations with restricted opportunities to raise funds in global capital markets.

9. Creation of a Competitive Market

By facilitating the entry of foreign organisations into the domestic marketplace, FDI helps create a competitive environment, as well as break domestic monopolies. A healthy competitive environment pushes firms to continuously enhance their processes and product offerings, thereby fostering innovation. Consumers also gain access to a wider range of competitively priced products.