Last week, the government announced changes in its norms for foreign direct investment (FDI). After this announcement, it issued two press notes to implement the changes made in calculating total foreign investment in Indian companies. That all this has added to confusion about FDI remains without doubt. More than that, these press notes have introduced a greater degree of bureaucratic control over indirect foreign investment. They also leave many issues unaddressed.
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In the past, it was unclear if government approval was required for downstream investments—investments made by an Indian company that had received FDI. The Foreign Investment Promotion Board (FIPB) contended that its approval was required in all cases for downstream investment. FIPB’s view here was contradicted by others, who thought only a small chunk of downstream investment—by an Indian company majority-owned by foreigners—needed regulatory approval.
Now, the government states that all investing companies will need FIPB approval for downstream investment, giving the regulator greater control (although FIPB has suggested that this issue will be addressed separately).
Last week’s announcement hinged around the definition of “owned and controlled” for Indian companies. Those companies “ultimately” owned and controlled by Indians could invest in another Indian company without violating existing FDI ceilings. The issue over this definition was then raised. The press note that followed the announcement defines “owned and controlled” to mean the beneficial ownership of more than 50% of equity interest in the Indian entity, and the power to appoint a majority of the directors. But now, FIPB also has the power to review definitive agreements to determine the actual “ownership and control” of an Indian entity.
In addition, the regulator would require that details of the company’s ownership and control be furnished at the time of seeking approval, and that shareholder agreements be intimated in cases where regulatory approval is required. The regulator then has the power to consider these various agreements to determine who “owns and controls” a company before approving any such investment. This would suggest that FIPB can go beyond the definition of “owned and controlled” as set by the new press note; but the issue remains unclear.
If the regulator adopts this strict definition of “owned and controlled”, it would allow non-resident entities to take up to 49.99% stake in an Indian company, and then through veto rights effectively control its operations. Through this mechanism, non-resident entities could use their investment in a company to make downstream investment in restricted sectors (as any investment would then be treated as domestic) and oversee the operations of the downstream company by controlling its management and policy decisions at both the board and the shareholder level.
There are also other problems posed. According to these FDI changes, if an Indian company (say, ABC) owned and controlled by a non-resident entity makes downstream investment in another Indian company (say, XYZ), then the total investment made by ABC in XYZ will be considered as the indirect foreign shareholding of XYZ. However, if XYZ is the wholly owned subsidiary of ABC, then the total foreign shareholding in ABC is treated as the indirect foreign shareholding of XYZ. This prompts the question as to how one considers investments in sectors where different capitalization norms are specified for different percentages of shareholding.
To understand this, assume two scenarios in the non-banking financial company (NBFC) sector: Where foreign investment in ABC is 51% and ABC’s investment in XYZ is 80% (A), and another, where its investment is 100% (B). In scenario B, because XYZ is wholly owned, XYZ’s foreign shareholding is assumed to be the same as in ABC—51%. Not so in scenario A, where XYZ’s foreign shareholding automatically becomes 80%, the extent of ABC’s investment. According to the existing guidelines for NBFCs, for scenario A, ABC will need to infuse minimum capital of $50 million (with $7.5 million to be brought upfront) into XYZ; in scenario B, ABC will need to put in a minimum of $5 million only. This is despite the fact that ABC wholly owns and fully controls XYZ.
The language in these press notes is so vague that the regulator could interpret it anyhow, allowing FIPB to scrutinize any proposal for downstream investment and require onerous disclosures from the investing company. This may act as a deterrent for any Indian company with foreign shareholding to make downstream investments, since it makes FIPB approval for indirect foreign investment time-consuming and arduous.
Government figures show that, thanks to the global economic slowdown, FDI in November decreased to $1.08 billion from $5.6 billion in February 2008. In this climate, it is critical to have clear FDI norms. Instead, the government is creating confusion and bureaucratic bottlenecks.
Yashojit Mitra and Devyani Singh are Mumbai-based lawyers with Economic Laws Practice. These are their personal views. Comments are welcome at firstname.lastname@example.org
Graphics by Ahmed Raza Khan / Mint