FDI policy change may dry up access to Chinese investments in post-covid world

The industry department on Saturday notified changes in its foreign direct investment (FDI) policy by mandating government clearance for all FDI inflows from countries with whom it shares land borders.

The move comes amid reports of China trying to acquire distressed assets in strategic sectors globally, with companies seeing a substantial fall in their valuations because of the containment measures to rein in the pandemic. In fact, Australia and the European Union have also taken measures to counter the Chinese move.

However, India’s decision may come in the way of home-grown unicorns and startups that aim to expand their businesses. At least 18 of the 23 Indian unicorns, including Paytm, Snapdeal, OYO Rooms, Ola, Swiggy, Zomato, and BigBasket, are backed by Chinese investors such as Alibaba, Tencent and Ant Financial.

The new FDI norms may force these investors to postpone or even stop these funds from topping up their investments or respecting the agreed term sheets.

Therefore, the unicorns, which depend on their largest investors to keep the cash flowing, may now have to start looking for new anchor investors. Growth-stage startups may also see investments drying up.

The change in FDI rule is too drastic a move and could potentially end the growth of the booming startup ecosystem in India, said Mahendra Swarup, chairman, Startup India Association.

“It’s a double whammy. The pool of capital coming from US and Europe will dry out because their own economies are taking a beating. At such a time, the government is turning off the tap from China, which had the ability to invest. It could have set some rules about Chinese investments in strategic assets and protecting investments into startups. There will be growing distrust between the Chinese investors and Indian regulators. The government should at least allow Category I and II Alternative Investment Funds to raise money from China to support the startups here, as they are not after management control. We hope when the Foreign Exchange Management Act notification comes, such things will be clarified," he said.

The government has not banned foreign investment from China. It has only put a filter to have an oversight to examine the implications of the investment, alarmed by the People’s Bank of China raising its stake in the country’s largest mortgage lender, HDFC Ltd, from 0.8% to 1.01% through open-market purchases in the March quarter. The move led to concerns that India’s most valued companies could be susceptible to hostile takeovers as their market values have taken a severe hit because of covid-19-related uncertainties.

India is now talking about legal vetting of not just direct ownership but also beneficial ownership. For example, if a Chinese national has put money in an international fund or is a limited liability partner in the fund, that fund’s investment process in India will also be delayed, even if its an American fund. “We can expect the compliance process to take time on many investments in internet startups and many more legal disclosures to be made by the investors," said an internet industry analyst, requesting anonymity.

The government should lay out a clear roadmap for the approval process for investments from Chinese companies, said Devraj Singh, associate tax partner, EY India. “It should ensure that proposals are considered in a time-bound manner and restrictions should not have any adverse impact on bonafide investments in these challenging times, wherein Indian companies are in need of funds," Singh said.

This is not the first time that India has resisted possible Chinese aggression in trade. It had refused to join the China-led Belt and Road Initiative despite much persuasion, citing security reasons. It also allowed Huawei to participate in the 5G trial after much deliberation.

Madhurima Nandy, Utpal Bhaskar, Prasid Banerjee, Nandita Mathur, Abhijit Ahaskar, Malyaban Ghosh and Leroy Leo contributed to this story.