FDI POLICY

 

FDI policy: Opening the floodgates

In a quiet move that constitutes one more step in its long-term effort to dismantle regulation of foreign direct investment in the country, the government has advanced the process of liberalisation quite significantly. It has decided to drop the condition inadequately defined in its Press Release as the need for “prior approval in case of existing joint ventures/technical collaborations in the ‘same field’”.

This opaque statement needs clarification. Prior to the recently issued Circular 1 of 2011 from the Department of Industrial Policy and Promotion of the Ministry of Industry, any foreign investor who had entered into a joint venture, technology transfer or trademark agreement with an Indian partner prior to January 12, 2005, had to obtain special approval from the government before undertaking any new independent investment or entering into a new technology transfer or trademark agreement with a different partner in the same field. When doing so, the foreign investor and/or the existing partner had to establish that the new proposal “would not jeopardize the existing joint venture or technology transfer/trademark partner”.

The importance of this clause needs to be emphasised. When in the early post-Independence years the government pressured foreign firms into entering into collaboration with Indian partners rather than setting up wholly owned subsidiaries or affiliate firms, there were two important factors, among others, that motivated it. The first was the need to strengthen the still young and inadequately experienced industrialist class in India, by mediating the relationship between domestic players and the foreign firms on whom the former were dependent for technology and foreign finance. The second was to provide some basis for technological learning, since domestic managers and technologists would in joint venture enterprises play a role in transferring technology, adapting it if necessary and operating it under local conditions. Subsequently, this requirement of partnership was strengthened by making it necessary under the Foreign Exchange Regulation Act for foreign firms to hold only 40 per cent or less of equity in most industries, if the foreign invested firm had to be eligible for national treatment. This was aimed at eroding foreign influence over their local joint ventures.

In practice, of course, most foreign firms used their control over technology to sabotage this effort. Since the use of patented technology by the domestic joint venture had to be licensed, foreign firms wrote into technology transfer agreements clauses that limited the ability of domestic partners to unbundle and adapt the technology, let alone seek to improve upon it through investment in Research and Development (R&D).

The net result was that though there was some development of indigenous technological capability, that process was slow because of restrictions on the nature of technology use. Moreover, domestic firms needing the implicit or explicit link with known foreign brands as tools in the competitive battle with rivals were unwilling to break away from their foreign partners and use the knowledge they had acquired to strike out on their own. Hence, every time technology was upgraded and/or modernised as part of the competitive effort, a new technology agreement had to be signed with the foreign partner, which was at all times far ahead of the domestic subsidiary in technological terms.

The foreign partner, on the other hand, benefited from the domestic partnership, inasmuch as it allowed it to use the skills of major Indian firms when it came to dealing with an interventionist government and local labour, for example, and especially when it came to accessing the domestic market for credit. Large firms were built with small infusion of foreign capital, allowing significant repatriation of profits and royalties on the basis of a limited amount of investment and substantial borrowing.

Matters changed after liberalisation, which substantially diluted regulations with regard to foreign equity caps and technology transfer, and relaxed the prerequisites for national treatment. Now, foreign firms are permitted to claim and repatriate a larger share of domestic profits based on a larger share in equity ownership. They can also ensure complete protection of frontline technology through direct control, rather than through patents and licensing agreements. With foreign equity caps relaxed and flexibility increased, foreign firms increasingly wanted to opt out of the collaborations they had entered into earlier. There were clearly two routes. One was to buy out Indian shareholders or partners. The other, when this was not possible, was to set up a wholly new venture to which technology of more recent date and/or relating to new products was transferred.

Given the obstacles that were set to technological learning by domestic partners and their resulting dependence on the foreign partner for technologies of more recent date, the former were in no position to compete on equal terms with their erstwhile collaborators. The pressure on them to sell-out was high. Where there were attempts to resist, as in the case of Dabur and Hero, for example, the foreign collaborator attempted to set up a wholly new venture.

It was in circumstances like this that the “prior approval” clause served a purpose. It allowed the government to rule in favour of domestic partners who had served their collaborators well, but who on account of path dependence were not in a position to compete with them. It was a way of continuing with the protection afforded to weaker domestic players, without discriminating against the foreign partner.

By doing away with the approval clause the government is overturning this whole edifice and paving the way for two potential developments. The first is one where domestic industrialists choose to sell out convinced that it would be too difficult for them to face the competition. The second is one where they refuse to sell, and foreign partners, with their newly granted freedoms, choose to set up their own sole control subsidiaries or majority ventures with pliant partners to outcompete their erstwhile collaborator. Both of these trends would alter the industrial landscape with a far greater presence of foreign firms than earlier, and a smaller presence of India industrialists in high technology areas. It would also mean that technological capabilities acquired in the past are now rendered useless and little technological capacity acquisition would take place in the future. India would merely be the location for transnational production seeking to cater to its large domestic markets and a supplier of skilled labour to enhance the control over technology of transnational firms.

The argument being given for this shift with its adverse implications for industrial self-reliance and indigenous technological capability generation is that India needs to stall the decline in foreign direct inflows into the country. Such flows are privileged over portfolio flows since FDI flows are seen as reflecting a long-term interest of the foreign investor in domestic productive activity.

It is indeed true (see Chart) that India is experiencing a decline in FDI inflows when compared to the FDI surge over the 2007-08 to 2009-10 period. But these figures are misleading. Over the liberalisation period as a whole portfolio inflows have been far more important than FDI flows. And even in the period of high FDI inflows, the figures reflect a definitional discrepancy. In the early 1990s India moved to a definition of foreign direct investment where the acquisition of a stake of 10 per cent in a company by a single non-resident investor is adequate for it to be characterised as a firm with foreign direct investment control. In actual fact, many portfolio investors are in the wake of liberalisation acquiring stakes of 10 per cent or more in domestic firms, exploiting the lax regulatory framework. As a result a substantial chunk of portfolio investment geared to garnering capital gains through speculative investment gets registered as foreign direct investment. That it is not. And India does not need this capital for balance of payments reasons either.

To use this argument to undermine the hard won, even if limited, advances on the technological front is therefore completely unj

Relaxing the rules for foreign direct investment (FDI) in the country, the government on Thursday decided to permit the issuance of equity to overseas firms against imported capital goods and machinery.
Crucial changes have also been made to norms regarding convertible instruments and downstream investments
under the extant policy, investments into most sectors fall under the automatic route. Such investments require no prior permission of the government or any regulator and the Indian company receiving the foreign investment is only required to intimate the RBI of any such investment.  But some sectors still require prior government approval and most sectors that require government approval fall within the ‘sensitive’ category. 

• Curbs on expat PF end up hurting local cos
• A government diktat in late November, barring expats from withdrawing
  their provident fund balance till the age of 58, was seen as India’s
  tough response to developed countries like the UK and the US. ‘Tit for
  tat’ was the message for these nations that virtually forfeit Indian
  workers’ social security funds on completion of their foreign
  assignments.
• But as India Inc is discovering, the levers of economic diplomacy can often
  be double-edged. Thanks to the new norms, companies would have to shell
  out at least a quarter more for foreign workers’ skill sets.
• International workers were brought under the mandatory PF contribution net in 2008,
  as part of efforts to repatriate billions of dollars contributed by
  Indian workers to foreign countries’ social security funds. Expats’ PF
  contributions were pegged at 24% of their total pay, instead of basic
  pay as is applicable for Indian workers.
• International workers were, however, allowed to withdraw their PF account balance at
  the end of their Indian stint, irrespective of the tenure. But under the
  new rules, such employees would be unable to withdraw 24% of their
  Indian salary that is paid into the PF – until they are 58.
• To offset these changes, employers would have to contribute additional
  money to meet the regulatory requirements over and above expats’
  negotiated salary.
• While complying with the PF law, firms gave workers an equivalent amount in
  the form of a bridge loan. At the end of their stint, workers would
  repay the bridge loan, recouping that amount from the PF account. This
  ingenuity would no longer work.  The reason - an employer can’t keep a
  loan on his books till the expat turns 58 as most foreign workers are in
  the age group of 30-45 years.  Even when the expat turns 58, he won’t
  be with the same company and the balance would only be paid to him, not
  to the employer. So it’s a write-off for companies.

Sector Specific Foreign Direct Investment in India

Latest Updates FDI in Small Scale Sector in India Further Liberalized India Further Opens Up Key Sectors to Foreign Investment

 

Hotel & Tourism: FDI in Hotel & Tourism sector in India

100% FDI is permissible in the sector on the automatic route.
The term hotels include restaurants, beach resorts, and other tourist complexes providing accommodation and/or catering and food facilities to tourists. Tourism related industry include travel agencies, tour operating agencies and tourist transport operating agencies, units providing facilities for cultural, adventure and wild life experience to tourists, surface, air and water transport facilities to tourists, leisure, entertainment, amusement, sports, and health units for tourists and Convention/Seminar units and organizations.
For foreign technology agreements, automatic approval is granted if

1. up to 3% of the capital cost of the project is proposed to be paid for technical and consultancy services including fees for architects, design, supervision, etc.
2. up to 3% of  net turnover is payable for franchising and marketing/publicity support fee, and up to 10% of gross operating profit is payable for management fee, including incentive fee.

 

Private Sector Banking:

Non-Banking Financial Companies (NBFC)

49% FDI is allowed from all sources on the automatic route subject to guidelines issued from RBI from time to time.

1. FDI/NRI/OCB investments allowed in the following 19 NBFC activities shall be as per levels indicated below:

1. Merchant banking
2. Underwriting
3. Portfolio Management Services
4. Investment Advisory Services
5. Financial Consultancy
6. Stock Broking
7. Asset Management
8. Venture Capital
9. Custodial Services
10. Factoring
11. Credit Reference Agencies
12. Credit rating Agencies
13. Leasing & Finance
14. Housing Finance
15. Foreign Exchange Brokering
16. Credit card business
17. Money changing Business
18. Micro Credit
19. Rural Credit

2. Minimum Capitalization Norms for fund based NBFCs:

i) For FDI up to 51% - US$ 0.5 million to be brought upfront

ii) For FDI above 51% and up to 75% - US $ 5 million to be brought upfront

iii) For FDI above 75% and up to 100% - US $ 50 million out of which US $ 7.5 million to be brought upfront and the balance in 24 months

3. Minimum capitalization norms for non-fund based activities:

Minimum capitalization norm of US $ 0.5 million is applicable in respect of all permitted non-fund based NBFCs with foreign investment.
    d.   Foreign investors can set up 100% operating subsidiaries without the condition to disinvest a minimum of 25% of its equity to Indian entities, subject to bringing in US$ 50 million as at b) (iii) above (without any restriction on number of operating subsidiaries without bringing in additional capital)
    e.  Joint Venture operating NBFC's that have 75% or less than 75% foreign investment will also be allowed to set up subsidiaries for undertaking other NBFC activities, subject to the subsidiaries also complying with the applicable minimum capital inflow i.e. (b)(i) and (b)(ii) above.
   f.   FDI in the NBFC sector is put on automatic route subject to compliance with guidelines of the Reserve Bank of India.  RBI would issue appropriate guidelines in this regard.

Insurance Sector: FDI in Insurance sector in India

FDI up to 26% in the Insurance sector is allowed on the automatic route subject to obtaining licence from Insurance Regulatory & Development Authority (IRDA)
 

Telecommunication: FDI in Telecommunication sector

1. In basic, cellular, value added services and global mobile personal communications by satellite, FDI is limited to 49% subject to  licensing and security requirements and adherence by the companies  (who are investing and the companies in which investment is being made) to the license conditions for foreign equity cap and lock- in period for transfer and addition of equity and other license provisions.
2. ISPs with gateways, radio-paging and end-to-end bandwidth, FDI is permitted up to 74% with FDI, beyond 49% requiring Government approval. These services would be subject to licensing and security requirements.
3. No equity cap is applicable to manufacturing activities.
4. FDI up to 100% is allowed for the following activities in the telecom sector :
1. ISPs not providing gateways (both for satellite and submarine cables);
2. Infrastructure Providers providing dark fiber (IP Category 1);
3. Electronic Mail; and
4. Voice Mail

The above would be subject to the following conditions:

5. FDI up to 100% is allowed subject to the condition that such companies would divest 26% of their equity in favor of Indian public in 5 years, if these companies are listed in other parts of the world.
6. The above services would be subject to licensing and security requirements, wherever required.

Proposals for FDI beyond 49% shall be considered by FIPB on case to case basis.
 

Trading: FDI in Trading Companies in India

Trading is permitted under automatic route with FDI up to 51% provided it is primarily export activities, and the undertaking is an export house/trading house/super trading house/star trading house. However, under the FIPB route:-

9. 100% FDI is permitted in case of trading companies for the following activities:

• exports;
• bulk imports with ex-port/ex-bonded warehouse sales;
• cash and carry wholesale trading;
• other import of goods or services provided at least 75% is for procurement and sale of goods and services among the companies of the same group and not for third party use or onward transfer/distribution/sales.

ii. The following kinds of trading are also permitted, subject to provisions of EXIM Policy:

1. Companies for providing after sales services (that is not trading per se)
2. Domestic trading of products of JVs is permitted at the wholesale level for such trading companies who wish to market manufactured products on behalf of their joint ventures in which they have equity participation in India.
3. Trading of hi-tech items/items requiring specialized after sales service
4. Trading of items for social sector
5. Trading of hi-tech, medical and diagnostic items.
6. Trading of items sourced from the small scale sector under which, based on technology provided and laid down quality specifications, a company can market that item under its brand name.
7. Domestic sourcing of products for exports.
8. Test marketing of such items for which a company has approval for manufacture provided such test marketing facility will be for a period of two years, and investment in setting up manufacturing facilities commences simultaneously with test marketing.

FDI up to 100% permitted for e-commerce activities subject to the condition that such companies would divest 26% of their equity in favor of the Indian public in five years, if these companies are listed in other parts of the world. Such companies would engage only in business to business (B2B) e-commerce and not in retail trading.
 

Power: FDI In Power Sector in India

Up to 100% FDI allowed in respect of projects relating to electricity generation, transmission and distribution, other than atomic reactor power plants. There is no limit on the project cost and quantum of foreign direct investment.

 

Drugs & Pharmaceuticals 

FDI up to 100% is permitted on the automatic route for manufacture of drugs and pharmaceutical, provided the activity does not attract compulsory licensing or involve use of recombinant DNA technology, and specific cell / tissue targeted formulations.
FDI proposals for the manufacture of licensable drugs and pharmaceuticals and bulk drugs produced by recombinant DNA technology, and specific cell / tissue targeted formulations will require prior Government approval.

 

Roads, Highways, Ports and Harbors

FDI up to 100% under automatic route is permitted in projects for construction and maintenance of roads, highways, vehicular bridges, toll roads, vehicular tunnels, ports and harbors.

 

Pollution Control and Management

FDI up to 100% in both manufacture of pollution control equipment and consultancy for integration of pollution control systems is permitted on the automatic route.


 

Call Centers in India / Call Centres in India

FDI up to 100% is allowed subject to certain conditions. 
 

 

Business Process Outsourcing BPO in India

FDI up to 100% is allowed subject to certain conditions. 


 

Special Facilities and Rules for NRI's and OCB's

NRI's and OCB's  are allowed the following special facilities:

1. Direct investment in industry, trade, infrastructure etc.
2. Up to 100% equity with full repatriation facility for capital and dividends in the following sectors:
    
   1. 34 High Priority Industry Groups
   2. Export Trading Companies
   3. Hotels and Tourism-related Projects
   4. Hospitals, Diagnostic Centers
   5. Shipping
   6. Deep Sea Fishing
   7. Oil Exploration
   8. Power
   9. Housing and Real Estate Development
   10. Highways, Bridges and Ports
   11. Sick Industrial Units
   12. Industries Requiring Compulsory Licensing
   13. Industries Reserved for Small Scale Sector
        
3. Up to 40% Equity with full repatriation: New Issues of Existing Companies raising Capital through Public Issue up to 40% of the new Capital Issue.
4. On non-repatriation basis: Up to 100% Equity in any Proprietary or Partnership engaged in Industrial, Commercial or Trading Activity.
5. Portfolio Investment on repatriation basis: Up to 1% of the Paid up Value of the equity Capital or Convertible Debentures of the Company by each NRI. Investment in Government Securities, Units of UTI, National Plan/Saving Certificates.
6. On Non-Repatriation Basis: Acquisition of shares of an Indian Company, through a General Body Resolution, up to 24% of the Paid Up Value of the Company.
7. Other Facilities: Income Tax is at a Flat Rate of 20% on Income arising from Shares or Debentures of an Indian Company.

Certain terms and conditions do apply. 

See also Opening Branch in India | Formation of Subsidiary in India | Starting a Business in India | Opening Branch in India | Incorporating company in India | Procedure for Formation of Company in India

Joint Ventures in India | Joint Venture Agreements | Outsourcing Agreements | Outsourcing to India | Formation of Subsidiary in India |  Starting a Business in India | Opening Branch in India | Incorporating company in India | Procedure for Formation of Company in India

See also  Government Approvals for Investing in India  |  Entry Strategies in India for Foreign Investors
 

Foreign Direct Investment in Small Scale Industries (SSI's) in India

Recently, India has allowed Foreign Direct Investment up to 100% in many manufacturing industries which were designated as Small Scale Industries.
India further ended in February 2008 the monopoly of small-scale units on 79 items, leaving just 35 on the reserved list that once had as many as 873 items.

While industrial policy reforms began with the new industrial policy statement of 1991, India remained wary of intruding on the politically sensitive issue of reservation for small-scale industry till the end of the 1990s.

Thus, while at the turn of the millennium the number of items reserved for SSI units had come down from its peak of 873 in 1984, well over 800 items remained on the list.

Since 2002, the scenario has changed dramatically. In these last seven years, around 790 items - including things like farm equipment, toothpaste, ice cream, footwear, detergents and even garments - have been knocked off the list.

Thus, for the first time in over 40 years, there are today as few as 35 items reserved for SSI units. When the policy of reservation was first introduced in 1967, there were just 47 items reserved for small-scale manufacturers.

However, what was till then an administrative decision was given legal backing by an amendment enacted in 1984 to the Industries (Development and Regulation) Act, 1951. That year also saw the number of items reserved reaching a peak of 873.

Reservation means that units producing the reserved items cannot go beyond a stipulated cap on investment in plant and machinery.  Moreover, FDI was allowed on a limited basis in SSI's.

In the old days, therefore, it was standard practice for mass consumption items covered by the reserved list to be farmed out by large marketing companies to dozens of small units, thereby negating economies of scale.

What it also meant was that some companies resorted to manufacturing completely new class of products. So, if ice cream was reserved for small scale units, a large player could always produce, say, 'frozen desserts'.

Apart from the steady trickle of de-reservation over the last decade, one of the measures taken to get over this problem without confronting the political problems involved was to allow foreign investment even in reserved items with the caveat that such units would have to fulfill an export obligation.

For players who were already manufacturing items that were suddenly reserved in 1967, the government came up with what was carry-on-business license which capped their capacity, and fixed the location of the plant and the goods produced.

The latest de-reservation means that pastries, hard boiled sugar candy and tooth powder can be manufactured by large units too. Similarly, buckets, paper bags, paper cups, envelopes, letter pads, paper napkins might not be manufactured only in small units but also in specialized factories.

The same for sesame and rapeseed oil, which are not solvent extracted, a host of chemicals and dyes paints be it distempers.

Electrical goods, which include geysers, hot air blowers and toasters, too are out of the reserved list, as are ballpoint and fountain pens.
The remaining 35 items that would be produced by the SSI sector are food and allied items, wood, wood products, paper, paper products, plastic products, organic chemicals, drugs, drug intermediates, other chemicals, chemical products, glass, ceramics, mechanical engineering and electrical machines, appliances and apparatus.
In a nutshell, only 35 items remain reserved for the small scale industries sector. For foreign investors, it means that in those 35 reserved sectors foreign investment is allowed on a limited basis, except where certain conditions are met.
Contact us for further information

India Further Opens Up Key Sectors for Foreign Investment

India has liberalized foreign investment regulations in key sectors, opening up commodity exchanges, credit information services and aircraft maintenance operations. The foreign investment limit in Public Sector Units (PSU) refineries has been raised from 26% to 49%. An additional sweetener is that the mandatory disinvestment clause within five years has been done away with.

FDI in Civil aviation up to 74% will now be allowed through the automatic route for non-scheduled and cargo airlines, as also for ground handling activities.

100% FDI in aircraft maintenance and repair operations has also been allowed. But the big one, allowing foreign airlines to pick up a stake in domestic carriers has been given a miss again.

India has decided to allow 26% FDI and 23% FII investments in commodity exchanges, subject to the proviso that no single entity will hold more than 5% of the stake.

Sectors like credit information companies, industrial parks and construction and development projects have also been opened up to more foreign investment.

Also keeping India's civilian nuclear ambitions in mind, India has also allowed 100% FDI in mining of titanium, a mineral which is abundant in India.

Sources say the government wants to send out a signal that it is not done with reforms yet. At the same time, critics say contentious issues like FDI and multi-brand retail are out of the policy radar because of political compulsions. (Jan 2008)
Contact us for further information