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Simplifying investment rules

Simplifying investment rules
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First Published: Tue, Mar 10 2009. 10 04 PM IST

Illustration: Jayachandran / Mint
Illustration: Jayachandran / Mint
Updated: Tue, Mar 10 2009. 10 04 PM IST
In rapid succession, the Indian government has issued three new foreign direct investment (FDI) guidelines since last month, amending policy on downstream investment by foreign companies. In a matter of weeks, India has drastically changed its foreign investment policy. But the actual changes show that it’s taken two steps forward and one step backward.
Illustration: Jayachandran / Mint
Previously, the government’s position on downstream investments in Indian companies had been ambiguous, and was subject to severe criticism from industry and foreign investors. This was compounded by a position taken by the Foreign Investment Promotion Board (FIPB), India’s regulator for foreign investment, that domestic investments made by Indian companies possessing foreign equity required government approval. This resulted in an unduly restrictive situation. All companies listed in India would have some level of foreign equity; the previous rule led to an unreasonable position that all domestic investment made by them would require government approval.
The first of the new guidelines—set out in press note 2 that was released on 13 February—state that any investment made by an Indian company into another Indian company will not be counted as foreign investment if the Indian company making the investment is owned and controlled by resident Indians. Press note 3, released at the same time, clarified “ownership” and “control”.
Under press notes 2 and 3, the concept of ownership and control revolves around majority ownership of the shares of the company and the ability of shareholders to appoint the majority of directors. While these concepts are not new, press note 3 clarified that a company with more than 50% shares held or controlled by resident Indians is considered “owned” by them. Similarly, if resident Indians or Indian companies controlled by them have the power to appoint the majority of the directors, the company would be considered “controlled” by them. Consequently, any investment made by an Indian company that is “owned and controlled” by resident Indians or companies controlled by them will be a “domestic investment”, even if the investing Indian company has substantial foreign investment (but 50% or less). Such investments thus do not need prior government approval. This is a much-improved position from the one FIPB took previously.
The change in the government’s stance through press notes 2 and 3 is a positive development for Indian companies in these difficult economic times, allowing them easier access to foreign capital. This is particularly true for companies in the retail and real estate sectors that have been scrambling for funds. India’s previous foreign investment laws prohibited or restricted FDI in retail and real estate sectors. However, with the changes in press note 2, foreign companies were allowed to indirectly invest in these companies through other Indian companies that are owned and controlled by Indians.
Another change is that other forms of capital inflows, such as American and global depository receipts, investments by non-resident Indians and convertible debentures issued by an Indian company, will now all be considered as foreign investment. FDI policies now apply to foreign institutional investors (FII), or portfolio investment. This unifies, and simplifies, the government’s approach to foreign capital.
However, as is typical, the government took some contradictory steps with the issuance of press note 4 on 25 February. The position has again changed drastically, this time backwards. According to this press note, any downstream investment by companies owned or controlled by non-Indians would have to follow the same norms as required for direct foreign investment. The rationale behind this: What cannot be done directly should not be allowed to be done indirectly. Hence, any downstream investment by an operating or operating-cum-investing company would have to comply with the foreign investment guidelines applicable to the sector. This undoes the work of press note 2, and doesn’t really help FDI.
It appears the government has realized that India will not be able to maintain the recent level of economic growth without foreign capital. At a time when attracting fresh investment is becoming difficult, the recent changes, particularly in press notes 2 and 3, were very welcome. However, the retraction in press note 4 shows the government is still cautious and does not want to be seen as liberalizing too quickly.
Despite the confusion and restrictions press note 4 bring in, these recent changes taken in aggregate are more helpful than harmful. Overall, they allow Indian firms to raise money via equity more easily. Press note 4 at least allows companies in an automatic sector to seek downstream foreign investment without approval. This is a considerable relaxation from the earlier position where FIPB considered all downstream investment as requiring government approval.
These changes are welcome because, on the whole, they make the Indian government’s mechanism of approving FDI far simpler and more streamlined.
Rohit Kumar is an associate at Freehills, an Australia-based international law firm. He has advised clients on investing in India. The views expressed here are personal. Comments are welcome at theirview@livemint.com
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First Published: Tue, Mar 10 2009. 10 04 PM IST