New round of liberalization follows annual policy recap

By Shinoj Koshy and Neha Sinha, Luthra & Luthra

On 24 June, merely two weeks after the issue of the annual consolidated foreign direct investment (FDI) policy, the government issued a press note (PN 5) introducing amendments that include several relaxations to the FDI policy. The changes to FDI caps and conditions introduced by PN 5 in four key sectors that have seen significant interest from overseas investors in the past two to three years are summarized below.

Shinoj Koshy, Partner, Luthra & Luthra
Shinoj Koshy
Luthra & Luthra

Defence sector: Prior to PN 5, FDI beyond 49% was permitted under the government approval route wherever such investment was likely to secure access to “modern and ‘state of the art’ technology”. PN 5 has replaced the rather ambiguous term “modern and ‘state of the art’ technology” with “modern technology”, and the Foreign Investment Promotion Board (FIPB) has been empowered to permit FDI beyond 49%, irrespective of whether such investment leads to access to modern technology, provided the reasons for making such an exception are recorded.

The introduction of the objective criterion of “modern technology” and greater discretion to the FIPB should provide the much required impetus to foreign defence companies to consider direct investments or to enter into joint ventures with Indian partners, and consequently reduce India’s import dependence for military hardware.

Aviation sector: In order to provide a boost to India’s ailing aviation sector, the government has set out ambitious plans to revive 50 underserved airports and airstrips in the next three years. To meet these targets and promote greater capital flow into aviation infrastructure, the FDI cap in the brownfield airport sector has been increased from 74% to 100% under the automatic route.

Additionally, the FDI cap in scheduled air transport service/domestic scheduled passenger airlines and regional air transport service has been increased from 49% to 100%, subject to government approval for investments beyond 49%. However, the 49% cap on investments by foreign airlines continues to apply.

Neha Sinha, Managing associate, Luthra & Luthra
Neha Sinha
Managing associate
Luthra & Luthra

Single-brand retail trading: FDI conditions for investment in all segments of single-brand retail include mandatory sourcing of 30% of the value of goods purchased from medium and small-scale industries, village and cottage industries. This condition was imposed with the aim of ensuring a trickle-down effect on local industries but it became a significant roadblock, especially for high-end and luxury brands. Time and again foreign brands, most prominently Apple, approached the FIPB to relax sourcing conditions. While the FIPB rejected these requests, the Department of Industrial Policy and Promotion recognized the hurdle and has relaxed the conditions via PN 5. Sourcing norms now will not be applicable for up to three years for single-brand retail trading of products with “state-of-art” and “cutting edge” technology and where local sourcing is not possible. Foreign brands will have to make a strong case for their products to benefit from this relaxation.

Pharmaceutical sector: FDI in brownfield projects in the pharmaceutical sector, which was under the approval route for up to 100% FDI, has been liberalized to allow FDI up to 74% under the automatic route, and beyond 74% under the approval route. This relaxation will be welcome as the sector has seen large inflows of FDI and heightened M&A activity in past four to five years.

However, FDI in the brownfield pharmaceutical sector (under both routes) has been made subject to the following conditions: (i) production and supply in the domestic market of products on the National List of Essential Medicines should be maintained for five years from when FDI is brought in, at an absolute quantitative level based on the highest production level in the preceding three years; (ii) R&D spending is to be maintained in value terms for five years from when FDI is brought in, at an absolute quantitative level based on the maximum R&D spending in the preceding three years; and (iii) the relevant ministry should be provided information relating to any transfer of technology at the time of infusion of foreign capital.

In conclusion, PN 5 is yet another attempt by the government to give a fillip to foreign investment, and if speculation is to be believed, was intended to stem the negative impact on the capital market from RBI Governor Raghuram Rajan’s announcement that he would not stay for another term. Whatever be the reasons for the timing of the announcement, PN 5 seems to have done a good job at allaying the investors’ concerns.

Luthra & Luthra is a full-service law firm with a pan-India presence. Shinoj Koshy is a partner and Neha Sinha is a managing associate. The views expressed here are personal. They are intended for general information purposes and are not a substitute for legal advice.

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