India in 2020: Easing restrictions on foreign investment

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This article is one of four in an annual Vantage Point series where in-house counsel identify key risks and opportunities in the year ahead

Foreign direct investment (FDI) is a major monetary source for India’s economic development. Foreign companies invest directly in fast-growing private businesses to take benefits from cheaper wages and the fast-changing business environment.

One route for FDI is the automatic route, where FDI is allowed without prior approval from the government or the Reserve Bank of India (RBI). The other is the government route, where prior approval from the government is required.

The government from time to time amends the FDI policy to increase FDI inflow. In 2014, it increased the upper limit for foreign investment from 26% to 49% in the insurance sector. It also launched the “Make in India” initiative in September 2014, under which FDI policy was liberalized for a further 25 sectors. As of April 2015, FDI inflow in India increased by 48% since the launch of this initiative, which is laudable.

Sweeping reforms needed

FDI
Reema Thakker

In a further commendable effort to ease the flow of foreign funds into legitimate business activities, the government may soon ease FDI restrictions by joint ventures (JVs) or wholly-owned subsidiaries (WOS) of an Indian company without categorizing such investments as “suspect” or involving the “round tripping” of funds.

The existing legal framework under the Foreign Exchange Management Act, 1999 (FEMA), does not permit FDI by an overseas JV, or a WOS of an Indian party, without the prior approval of the RBI. Similarly, there are restrictions on Indian entities undertaking overseas direct investment (ODI) in a foreign entity that already has existing FDI investment structures in India.

It is understood that changes will soon be made in existing ODI regulations to ease the restrictions and put such investments (FDI and ODI) under the automatic route, i.e., without prior approval of the RBI.

These changes have become important in light of the slowing Indian economy and lack of investment from the corporate sector. The stringent view adopted by the RBI under the objective of preventing round tripping of funds has impacted the abilities of certain Indian companies, which have made ODI outside India, to attract FDI in India even for their group entities, and even for legitimate and bona fide business purposes.

The High-Level Advisory Group (HLAG), chaired by economist Surjit Bhalla and established with the aim to increase India’s exports, in its report also suggested sweeping changes in FDI regulations, along with a way to attract funds for building businesses in the country.

Expected changes

It is understood that the Department for Promotion of Industry and Internal Trade (DPIIT) is also studying the report for finalizing changes in the Press Note pertaining to FDI by either JV or WOS of an Indian company. Although the changes would give free access to FDI by an Indian entity through its own JV or WOS, it would need to be established that such flow of funds is only for bona fide business interests, and such funds are invested as FDI in India through proper banking channels.

Accordingly, it is likely that investment by a foreign entity (in which ODI is being made) whose total value of existing FDI does not exceed 25% of its consolidated net worth, will not be considered as round tripping, or in violation of ODI regulations.

Net worth of the overseas entity in this case should be at least US$10 million. Moreover, any additional FDI may be allowed, provided such funds are not directly or indirectly from India. The HLAG, in its report, also recommended exemptions to overseas listed companies, i.e., companies that are listed overseas in Financial Action Task Force (FATF) jurisdictions (with market capitalization of certain specified thresholds) should also be allowed to invest in India, irrespective of its shareholding being held by persons resident in India.

ODIs include investments done outside of India by an Indian by the way of subscription to the memorandum of a foreign entity, or purchase of existing shares of a foreign entity either by market purchase or private placement or through stock exchanges, signifying a long-term interest in the foreign entity.

If liberalization in FDI either by JV or WOS is implemented, international trade will become easier and the surge in FDI will result in a boost for employment and the economy.

Reema Thakker is the deputy general manager – legal at Suvidhaa.com.

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