Review of Foreign Direct Investment (FDI) policy

Review of Foreign Direct Investment (FDI) policy

Legal & Compliance

Shruti Sodhi

Shruti Sodhi

29 Apr 2020, 16:23 — 6 min read

In these uncertain times, it is heartening to see that the Indian government has been proactive in its efforts to contain the spread of the Covid-19 virus, as well as offer various relaxations in order to enable corporate India to cope with this pandemic. That said, in an unexpected move, the Department for Promotion of Industry and Internal Trade (DIPP), which lies under the Ministry of Commerce and Industry has released Press Note 3 (2020 Series) (“Press Note 3”) controlling foreign direct investment (FDI) in India.

According to Press Note 3, prior government approval is required where investment is to be received from an entity from or citizen of a country which shares its land border with India (“Specified Country”). This restriction also applies to investments made where the beneficial owner of such investment is an entity from or citizen of such a Specified Country. In addition to this, prior government approval is also required where transfer of securities of an Indian entity results in a direct or indirect change in the beneficial ownership of an entity from or citizen of a Specified Country in such Indian entity.

The proposal for obtaining such government approval can be filed online on the Foreign Investment Facilitation Portal in the format available along with the requisite supporting documents. Once the proposal is filed online, DIPP will identify the concerned Administrative Ministry/Department and e-transfer the proposal to the concerned Administrative Ministry/Department. Depending upon the complexity of the proposal, it may take approximately 8 to 12 weeks to approve the proposal, excluding the time taken by the applicant in removing deficiencies in the proposal or supplying additional information, as may be required.

In our view, a key reason for the issue of Press Note 3 is for the government to control the extent of Chinese investment in India and to prevent opportunistic or hostile acquisitions and takeovers of Indian companies in the wake of the Covid-19 pandemic. While such control is, in our view, justifiable, Press Note 3 does pose some concerns and challenges for Indian companies, which are as follows:

Beneficial ownership: FDI in India is governed by the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“Non Debt Rules”) issued by the Reserve Bank of India (RBI), who is the exchange control regulator in India. The term “beneficial ownership” has not been defined under the Non Debt Rules. Other statutes such as the Prevention of Money-laundering (Maintenance of Records) Rules, 2005 and the Companies (Significant Beneficial Owners) Rules, 2018 provide percentage thresholds for calculation of beneficial ownership and consequent reporting requirements. The absence of such a threshold under the Non Debt Rules, requires Indian companies with pre-existing investment from entities from or citizens of a Specified Country to seek prior government approval for any change in shareholding.

Investments from Hong Kong: Hong Kong is a Special Administrative Region of the People’s Republic of China. Press Note 3 is silent on whether Hong Kong will fall within its ambit, and given its special status, this remains unclear. In our view, Press Note 3 will apply to Indian investments by Hong Kong entities or citizens, as it is a part of China. This will have a significant impact on foreign investment in India, as Hong Kong is one of the financial hubs in Asia, from where several investments are routed into India.

FPI Investments: Investments by registered foreign pooling vehicles, being foreign portfolio investors (FPIs) in unlisted Indian companies will also be impacted by Press Note 3. With lack of clarity on how “beneficial ownership” is to be considered under the Non Debt Rules, it can be argued that investments in Indian entities by FPIs that have received investments from entities or citizens of a Specified Country will require prior government approval.

Impact: Press Note 3 is a step in the right direction aimed to safeguard Indian interests and national security during these uncertain times. We hope that this is a stop-gap arrangement in light of the ongoing global crisis, as any prolonged restriction will be counter-intuitive to the Government’s ongoing effort to improve India’s ease of doing business standing worldwide. Further, such a long-term FDI restriction may also have a negative impact on inflow of FDI in India. Given that the Indian economy is already reeling from the heat of the financial sector distress, a long term restriction may worsen the capital crunch that is already being faced by corporate India.

The RBI has on 22 April 2020 amended the Non Debt Rules to give effect to Press Note 3.

Image source: shutterstock.com

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Shruti Dvivedi Sodhi

Shruti is a Partner based in the Delhi office of Khaitan Legal Associates. With over 25 years of experience across leading law firms, multinational organizations and a niche...

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