The government of India began the process of economic
liberalization and reform in 1991, a process that has continued to
date. This article focuses on legal reform in India during this
period to highlight the fact that India embarked on an ambitious
agenda of legal reform to support its economic reform process. The
article is divided into the following sections:
Entry of foreign capital
Globalization of Indian business
General statutory and regulatory
reform
Sector-specific statutory and regulatory
reform
Conclusion
Entry of foreign capital
To liberalize its economy, permit the entry of foreign capital,
continue the trend of capital account inflows exceeding the current
account deficit and the need for Indian industry to access capital
and technology, the Indian government and regulators adopted a
policy of gradually opening up the Indian economy.
- The foreign direct investment (FDI) regime
Consistent with the gradual liberalization of the sectors in
which FDI would be permitted, the Indian government recently opened
up the defence sector to private participation (subject to
licensing), with 26% FDI being permitted. FDI in the drugs and
pharmaceuticals sector, and in city and regional-level urban
infrastructure facilities such as road and bridges is now permitted
up to 100%. FDI in the information technology sector and B2B
e-commerce is permitted up to 100%, though FDI in B2C e-commerce
requires the approval of the government. Foreign investment in
courier services, the hotel and tourism sector and airports has
been liberalized. FDI in select telecom services like ISPs
providing international gateways, radio paging and end-to-end
bandwidth providers is permitted to the extent of 74%, and 100% is
permitted for ISPs not providing international gateways (though FDI
in excess of 49% requires the prior approval of the government).
Cellular and basic telecom is still restricted to 49% FDI, while
insurance is restricted to 26% FDI.
As a consequence, India now permits foreign participation in
almost all businesses and there are very few areas (such as print
media and the retail trade industry) that are out of bounds to
foreign investment.
Foreign institutional investors
One of the main components of capital inflow into India is by
way of investment by foreign institutional investors (FIIs). FIIs
registered with the Securities and Exchange Board of India
(SEBI)can now make portfolio investments in Indian companies up to
a maximum of 49% (an increase from the earlier 40% limit) of the
capital of the company, subject to shareholders' approval by a
special resolution. Such investments are, however, not permitted in
Indian companies engaged in the print media sector.
Venture capital funds
To encourage nascent business, the government and SEBI have
sought to regulate the venture capital industry through separate
regulations for foreign and domestic venture capital
funds/companies (VCFs). Regulations have been introduced that
prescribe a framework aimed at encouraging a diverse investment
strategy. For example, a foreign VCF cannot invest more than 25% of
the funds committed for investments to India in one portfolio
company, and at least 75% of the funds set aside for India is
required to be invested in unlisted equity/equity-linked
instruments. It is possible for a foreign VCF to own the entire
capital/funds of a domestic VCF. Recent amendments to the income
tax law have clarified that gains realized by a VCF from divestment
of shares held in companies that are primarily listed or to be
listed Indian companies, will continue to be exempt from tax even
after listing.
Globalization of Indian business
Over the last few years, the government and the Reserve Bank of
India have permitted Indian companies to look globally to raise
capital or acquire companies. A number of Indian companies have
raised capital under the GDR/ADR route and have acquired companies
abroad (by way of cash or an ADR/GDR stock swap route).
American depositary receipts (ADRs) and global depositary
receipts (GDRs)
Indian companies have been permitted to issue GDRs/ADRs for a
number of years. Recent changes on the ADR/GDR front with respect
to dual fungibility of ADRs/GDRs, utilization of 100% of the
ADR/GDR proceeds for international acquisitions, and permitting a
secondary sale of shares by existing private Indian shareholders
(and not just the government of India as has been the case until
now) through an issue of ADRs/GDRs) is expected to give a
significant fillip to such transactions.
Cross-border acquisitions
Pursuant to recent amendments, Indian companies can now invest
without any governmental approvals in companies organized outside
India up to $50 million on an annual basis without being subject to
any profitability criteria. Previously, a company could make
overseas investments only if it had a track record of profitability
in the immediately preceding three years. Further, this $50 million
limit was previously applicable to a block of three financial
years. Acquisitions beyond the $50 million limit would require the
prior approval of the Reserve Bank of India (unless permitted
without governmental approvals under another scheme). Partnership
firms, duly registered in India, providing professional services
have also been permitted to make overseas investments.
Special economic zones (SEZs), software technology parks
and electronic hardware technology parks
The Export-Import Policy has introduced a new scheme for the
establishment of SEZs across the country, with a view to providing
an internationally competitive environment for export production.
The units operating in these zones would be deemed to be outside
the country's customs territory and will have full flexibility of
operations. Prior to the SEZs, the government had permitted the
setting up of software technology parks and electronic hardware
technology parks. Significant tax incentives were provided for
business activities conducted in such parks. A number of such
zones/parks have been established.
General statutory and regulatory reform
To permit greater freedom in the nature of corporate
transactions, as well as fulfil the need to lay down a clear policy
and regulatory framework and ensure compliance with international
obligations and to modernize Indian law, there have been
significant changes made to various Indian commercial laws and
regulations.
Exchange control
To prescribe a regulatory framework that moves from the
regulation of exchange control (with penal consequences for
non-compliance) to the management of foreign exchange, the Foreign
Exchange Regulation Act 1973 was replaced with the Foreign Exchange
Management Act 1999. This replacement has led to a clear
distinction between capital account transactions (which are still
subject to significant regulation albeit much less) and current
account transactions (which have been liberalized significantly).
In addition, violations of exchange control regulations result only
in civil penalties and not in criminal prosecution. With this
change, India has put in place the legislative framework for full
convertibility of the Indian rupee on the capital account, as and
when appropriate.
Transfer pricing
Transfer pricing regulations have recently been introduced in
the Income Tax Act 1961, and provide that pricing of international
transactions between two associated enterprises (either or both of
whom are non-Indian residents) should conform with the arm's-length
principle. Exhaustive and extremely wide definitions of
"international transactions", "arm's-length price" and "associated
enterprises" have been provided.
Detailed methods (examples being the resale price method, cost
plus method etc) for calculation of the arm's-length price have
been prescribed. The burden of proof is spread over the taxpayer
and the revenue authorities. The revenue authorities can, only
after giving the taxpayer an opportunity to explain, determine the
price based on the arm's-length principle. A penalty is levied to
the extent of three times the amount of tax sought to be evaded or
avoided in addition to the additional tax determined to be
payable.
Intellectual property
To address the needs of globalization, a new Trade Marks Act
1999 (which is expected to be brought into force in July/August
2001) has been passed adopting the international classification
system with regard to the registration of marks. Consequently, the
new Act provides for the registration of service marks and expands
the classes of goods/services in which registration is permitted.
The period of registration of a trademark has been increased from
seven years to 10 years. The Act also recognizes the concept of
"well-known trade marks" and "collective marks".
The Copyright Act 1957 has been amended in 1994 and 1999. The
effect of the former amendment was to expand the definitions of
certain key phrases such as "literary work" and "computer program".
The prerequisites for the assignment of copyright were clearly
stipulated and clear remedies were provided for insufficient
exercise of assigned right and/or for non-payment of royalties by
the assignee. The latter amendment introduced the concepts of the
exclusive right to sell/rent computer programs in the bundle of
rights available to copyright holders in computer programs, and
expanded the principles of "fair use" in relation to computer
programs.
India has also passed the Geographical Indications of Goods
(Registration and Protection) Act 1999, to comply with TRIPS
obligations. The Act is expected to come into force in the next few
months and seeks to provide for a sound protection in foreign
countries regime for geographical indicators – which would give
India the right to claim protection for its geographical
indications of goods.
Finally, the patents law in India was amended in 1999 to ensure
compliance with obligations under TRIPS, particularly with respect
to exclusive marketing rights and to permit product patents for
medical drugs.
Alternate dispute resolution
The Arbitration and Conciliation Act 1996 (replacing legislation
from 1940) was passed by parliament to bring India in line with
international standards of commercial dispute resolution mechanisms
(both arbitration and conciliation) and to provide for the
enforcement of foreign arbitral awards in India under both the New
York Convention and the Geneva Convention.
Significant changes to securities laws
The Securities and Exchange Board of India (SEBI) was
established in 1991 as India's capital market regulator and its
powers have increased from time to time. Over the last 10 years,
SEBI has prescribed a detailed regulatory framework on a number of
issues, including:
strengthening of disclosures at the time of listing and on a
continuous basis through disclosure and investor protection
guidelines prescribed by SEBI and by amendments to the listing
agreements with the stock exchanges;
a comprehensive takeover code which stipulates that any person
who together with persons acting in concert with it acquires 15% or
more, or acquires control, of a listed Indian company is required
to make a public offer to the shareholders of the said Indian
listed company agreeing to acquire from them an additional 20% (at
least) of the total paid-up capital of the company. SEBI has set up
a committee that is now in the process of amending these
regulations;
Indian listed entities are now required to ensure that they have
independent directors on their boards, an independent audit
committee and make detailed disclosures on a variety of corporate
governance issues; and while India has had stringent regulations
prohibiting insider trading since 1992, the lack of an effective
enforcement mechanism has seriously compromised the effectiveness
of these regulations. Regulatory changes are being made to ensure
that corporate India regulates itself through the appointment of
compliance officers and ensuring that its employees trade within
"trading windows". In addition to insider trading, regulations to
prevent manipulation of the markets through unfair trade practices
have been in place for some time.
Amendments to the Companies Act have been made from time to time
to ensure that the company laws in India keep pace with the needs
of the market. Recent years have seen amendments/regulations
permitting the buy-back of shares by Indian corporates subject to a
maximum of 25% of the total paid-up capital and free reserves of
the company and other conditions, the issue of shares with
differential rights (which were permitted only for private
companies) and the issue of employee stock options. A recent
amendment has empowered the government to make rules applicable to
the offering of Indian depositary receipts. This is an interesting
development, since the introduction of a legal framework would
facilitate several companies from the Asia-Pacific region to list
on Indian stock exchanges.
The most notable development in the secondary market has been
the introduction of derivatives trading (futures contracts, stock
index futures and stock index options) on Indian stock exchanges.
In addition, internet trading has begun, with SEBI prescribing
technical standards to be enforced by Indian stock exchanges for
ensuring the safety and security of transactions over the internet.
Finally, to achieve increased transparency in the functioning of
SEBI, recent amendments have created a Securities Appellate
Tribunal to consider appeals of the decisions of SEBI.
Anticipated statutory changes
It is expected that the government will introduce legislation
(drafts have already been prepared) with respect to insolvency of
companies and competition law, to parliament in the immediate
future. The former is intended to speed up the process of winding
up defaulting companies and the recovery of dues of creditors by
liquidating the assets of defaulters. The latter seeks to establish
an anti-trust authority in India that would be entitled to
intervene in M&A transactions to prevent monopolistic
tendencies. In addition, it is expected that legislation to
regulate financial companies will be placed before parliament in
the near future. There are also proposals to pass a money
laundering statute (a draft of which was circulated two years ago),
new legislation to protect industrial designs, and a special
statute to protect the intellectual property in semiconductors.
Sector-specific statutory and regulatory reform
As the Indian economy grows and India integrates into the global
economy, the need for sector-specific regulatory reform has been
acutely felt for two reasons: inputs from experts given rapid
changes in technology and/or the need to establish independent
regulators.
Electricity
The legal framework for the power sector over the years has
comprised the Indian Electricity Act 1910, which deals with the
transmission, supply and use of electricity, and the Electricity
(Supply) Act 1948, which established three statutory bodies at the
central, regional and state level to govern the generation,
transmission and distribution of electricity. Parliament passed the
Electricity Regulatory Commission Act 1998 recently to establish a
Central Electricity Regulatory Commission and State Electricity
Regulatory Commissions for the rationalization of electricity
tariffs and the promotion of transparent and efficient policies.
Any reform of electricity laws in India would necessarily involve
the state governments, since electricity falls within the
"concurrent list" of the Indian Constitution and therefore both the
central and state governments have power to regulate electricity. A
few states have sought to reform the state electricity boards set
up under the Electricity (Supply) Act 1948 to provide for a State
Electricity Regulatory Commission, and separating the board into
separate companies for generation, transmission and distribution.
To encourage the state governments to reform their electricity
boards, preferential investment and surplus power would be made
available from the central pool, only if they undertake
reforms.
National highways and roads
The National Highways Act 1956 and the National Highways
Authority of India Act 1988, provide the legal framework in
relation to national highways and roads. The former provides the
government with the power to notify any highway as a national
highway. The latter establishes an authority for the development,
maintenance and management of national highways. Private
participation in highways is being permitted by way of rules first
introduced in 1997 under the former legislation.
IT services
India has passed the Information Technology Act 2000 (IT Act) to
grant legal validity to e-commerce transactions. The IT Act
facilitates the electronic filing of documents with government
agencies and has introduced the concept of digital signatures to be
used for authentication of an electronic record. The IT Act
establishes a Controller of Certifying Authorities to regulate the
provisions of the Act particularly with respect to granting a
"certifying authority" licence to persons who seek to issue digital
signatures. The Controller may, with the previous approval of the
government, recognize a foreign certifying authority for the
purposes of the Act. No person has, to date, received a licence to
act as a certifying authority.
Telecommunications
Legislation from the 19th century, the National Telecom Policy
and licences issued by the government with respect to different
telecom value-added services regulate the telecommunications
industry. The development of the industry was hampered due to
conflicts between the erstwhile Department of Telecommunications of
the government and the Telecom Regulatory Authority of India
(TRAI), which was set up to regulate the telecom sector. These
conflicts have been resolved by splitting the TRAI into two bodies,
one with recommendatory and regulatory functions and the other with
adjudicative functions (the Telecom Tribunal). In addition, the
Department of Telecom Services – the department that provided
telecommunication services – was corporatized in October. This has
resulted in a clear separation of policy/licensing functions and
service provision functions.
The Videsh Sanchar Nigam Limited (VSNL) continues to have the
exclusive monopoly to provide international long-distance
telephony, though the government has decided to permit private
participation by 2002. ISPs have, however, been permitted to
establish international gateways. In line with India's WTO
commitments, the government has also liberalized national
long-distance (NLD) telephony, and guidelines for licensing are now
in place. Guidelines for licensing of infrastructure providers have
also been prescribed.
Media and broadcasting laws
The film sector in India has largely been unregulated and has
not been entitled to access funds from the financial and banking
community. Recently the government accorded the status of an
"industry" to the film sector, and consequently the RBI has framed
broad guidelines regarding bank finance for the production of
films. Banks are now permitted to provide finance (where the total
cost of production does not cross Rs100 million) to film producers
(corporate or non-corporate entities) with a good track record in
their relative fields.
The government has permitted the use of Ku band in India for
broadcasting and has thereby opened up the market for
direct-to-home (DTH) services in India. The government has also
liberalized the norms for uplinking to Indian and foreign
satellites (provided such satellite has been coordinated with the
INSAT system) by Indian companies (foreign participation up to 49%
has been permitted).
Insurance
The liberalization of the Indian insurance sector took place
with the passing of the Insurance Regulatory and Development
Authority Act 1999, which established the Insurance Regulatory and
Development Authority, and the passing of amendments to the
Insurance Act 1938. The cumulative effect of these changes has been
the participation of the private sector in insurance and the
breaking of the monopolies of the Life Insurance Corporation of
India and the General Insurance Corporation of India, foreign
participation to the extent of 26%, and empowering the authority to
prescribe regulations for the conduct of insurance business in
India. A number of Indian companies have entered into joint
ventures with foreign insurance players and have begun offering
insurance services in India.
Conclusion
The link between economic reform and legal reform is
particularly interesting given the existence of a well-established
constitutional and democratic system in India, an independent
judiciary, and the need for Indian institutions to act in a manner
that is consistent with the rule of law and transparency in all
aspects of its functioning. India has the longest written
Constitution in the world, with a guarantee of "fundamental rights"
and an elaborate set of economic and social principles for
governance (though these principles are not enforceable in a court
of law).
In the last 10 years, the Indian economy has taken important
steps towards a market economy, which is poised for growth. A
prudent monetary policy and rationalization of the tax regime has
seen growth in India accelerating while inflation has been
declining. Interest rates are down and foreign exchange reserves
are up (to the tune of over $40 million at present). GDP growth in
India has seen a consistent increase on the back of the growth of
the service sector, the depreciation of the rupee against the
dollar, and the growth of the US and European markets. Industrial
growth has steadily grown though there has been a recent
slackening. Consistent with WTO commitments, India has removed
quantitative restrictions on the import of most items, though the
impact of the movement of international oil prices is significant
on India's import bill.
Over the next few years a number of variables will determine the
success of economic reform and, by necessary extension, legal
reform. The success of the privatization of government companies
like VSNL, Air India and CMC Limited would contribute to a positive
Indian sentiment and showcase the commitment of the government to
reform. Political stability/consensus would ensure continuity of
the policies. Water management policies to reduce the dependence on
the monsoons would go a long way towards ensuring the success of
the agricultural sector on which much of India is dependent. Fiscal
responsibility is an important consideration, and recognized
deficit. In addition, it is imperative that economic and legal
reform percolates to all the state governments.
New business opportunities such as the pharmaceutical and
biotechnology sectors should grow in India and will require clarity
on a number of legal issues. Technological developments such as
convergence would require the establishment of a licensing and
regulatory framework for carriage and content in the age of
convergence of telecommunications, broadcasting, multimedia and
other related technologies. This fact has been recognized, as the
government has already made public a draft of proposed convergence
legislation that it hopes to pass in the near future. In
conclusion, the pace of legal reform in India will need to increase
with economic reform.
Legal Reform
Nishith Desai Associates
93-B Mittal
Court
Nariman Point
Mumbai-400 021
India
Tel: 91 22 282 0609
Fax: 91 22 287 5792
220 California Avenue
Suite 201
Palo Alto, CA 94306
US
Tel: 1 650 325 7100
Fax: 1 650 325 7300
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