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Business News/ Opinion / Quick Edit/  No love for thy neighbour: The great FDI wall
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No love for thy neighbour: The great FDI wall

The government’s new restrictions on Chinese foreign investment in India are in line with a global pattern of self-defence
  • While the intent to prevent “opportunistic” investment from Chinese sources in our domestic market, the government’s move has raised more questions than they provide answers for
  • Photo: ReutersPremium
    Photo: Reuters

    A government which had made it its habit to announce big policy reforms to attract foreign investors, on 17 April took what could possibly go down as one of its boldest foreign policy decisions yet. By issuing Press Note 3 of 2020 (Press Note), the Narendra Modi government has made all foreign direct investment (FDI) from countries sharing a “land border" with India subject to prior government approval. Previously, apart from investment in select sectors, the requirement for such prior approval arose only for investments originating from Pakistan and Bangladesh.

    While the intent to prevent “opportunistic" investment from Chinese sources in our domestic market—which has seen asset values fall sharply—is clear, the government’s move has raised more questions than they provide answers for. The Press Note would only become effective once a formal amendment is made to the rules issued under the Foreign Exchange Management Act (FEMA), and the Centre needs to address some crucial aspects.

    What provoked the Government? As a result of the covid-induced nationwide lockdown, there has been mayhem at Indian stock markets, with the BSE Sensex having reported its sharpest ever fall in the previous quarter. Out of 538 stocks from the BSE500 and Nifty 500, 114 have seen their price halve, with 221 stocks having fallen 30% to 50%. In this backdrop, the government appears to have been particularly spooked by the People’s Bank of China raising its stake in India’s largest non-banking mortgage provider HDFC Ltd, amid warning calls to prevent a “shopping spree" by Chinese investors of heavily discounted Indian companies.

    The Indian government is not alone. With valuations the world over being severely hit, and in an attempt to prevent predatory behaviour by Chinese companies, the Australian, Spanish and German governments have all tightened rules around foreign takeovers—though without specifically singling out China—much like has been done by New Delhi.

    What about foreign portfolio investment? The language in the Press Note covers only FDI from Chinese sources and does not impose any restrictions on foreign portfolio investment from China. Once the FEMA notification is issued, investments in unlisted companies and investments in excess of 10% in listed Indian companies would require prior government approval. However, foreign portfolio investments—i.e., of less than 10% in listed Indian companies—are not impacted by the Press Note.

    Given that the antecedents of the government’s concern lie in potential hostile takeovers of listed Indian companies, the Securities and Exchange Board of India (SEBI) would certainly look at this aspect closely, and one could expect either formal restrictions on foreign portfolio investment from Chinese sources, or SEBI adopting a conservative stance in giving a nod to foreign portfolio investors from China.

    In fact, reports suggest that SEBI has asked depository participants for details of offshore funds whose “beneficial ownership" lies in China, Hong Kong and other countries that could have a Chinese link, such as Pakistan, North Korea, Taiwan, Iran and Myanmar.

    Apart from entities registered in China and Chinese citizens, the Press Note covers investment from entities that are “beneficially owned" by Chinese entities or citizens. However, the Note has not clarified the manner in which this “beneficial ownership" would be determined. Given that most large funds may be substantially funded or controlled by Chinese entities or citizens, yet not majority-owned by them, the rules to determine that would be crucial. This assumes special importance, since most Chinese sourced investment reaches India through funds in Singapore and Mauritius.

    China has Special Administrative Regions (SARs) that complicate matters. In the past, when the government prohibited Chinese investors from acquiring immovable property in India without prior approval from Reserve Bank of India, they specifically called out Hong Kong and Macau (separate from China) for such restrictions as well, since they are SARs. However, the Press Note of 17 April placed these restrictions only on China, though all Chinese SARs would have to be painted with the same brush.

    What about existing Chinese investors? The Press Note and the impending FEMA notification would, in all likelihood, be prospective in nature. Accordingly, existing investments from China (such as Alibaba and Tencent’s investment in e-commerce companies) would be grand-fathered and should require no post-facto government approval. However, given that most Indian companies are in need of funds, the government would need to clarify whether a rights issue wherein Chinese investors are only acquiring pro-rata shareholding and thus not increasing their percentage shareholding in the company, would also require prior approval. The requirement of such approval in such cases could significantly impact even bona fide fund-raising by Indian entities, given that any government approval could take months.

    So, what next? While the government could present the move as one of self-defence, one that is in line with a global pattern, it amounts to a pre-emptive economic strike that will impact foreign investment inflows in India. It could also provoke Chinese retribution against Indian companies with investments in China. However, in times of a global pandemic where survival is king, one can hardly cast any doubt on the government’s motive or second guess its intentions. China’s central bank raised its stake in HDFC Ltd only marginally, from 0.8% to 1.01%, and we hope that the government’s decision is backed by empirical evidence and not mere apprehensions.

    As the country braces for the fallout of this bold decision, it is imperative for the move be immediately followed by a comprehensive FEMA notification and SEBI clarification to address the abovementioned concerns.

    Vaibhav Kakkar is a partner, and Sahil Arora is a senior associate at L&L Partners, Delhi (formerly, Luthra and Luthra Law Offices). Views expressed are personal.

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    Published: 20 Apr 2020, 06:44 PM IST
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