Investment professionals in India believe that tightening the country’s foreign direct investment (FDI) policy is the right way to protect vulnerable companies from foreign companies looking for value. However, Indian startups looking for funding may need to look for alternative routes for funding as a result. Additionally, it is unclear what the Indian government’s approach will vis-a-vis approving deals.
Directed primarily at China, India has introduced approval requirements for investment from any entity of a country it shares a land border with, including China, Bangladesh, Pakistan, Bhutan, Nepal, Myanmar and Afghanistan.
Before the change, FDI was allowed for certain sectors such as manufacturing and construction under the automatic route. For some sectors such as media and aviation, FDI continues allowed up to certain thresholds without restrictions.
According to Indian think tank Gateway House, from 2015 to 2020, Chinese tech investors invested $4 billion in Indian startups, with 18 out of 30 Indian unicorns now Chinese-funded.
“While valuations globally have almost hit the bottom, the pandemic presents cash rich investors with a fantastic opportunity to do bottom fishing and value-buying of fundamentally promising companies," said Avijit Banerjee, CEO and managing director at Argon Capital Advisors.
"The stake increase in one of India's premier financial institution, HDFC, from 0.8% to 1.1%, by the People’s Bank of China amid the ongoing pandemic triggered the government move to amend its FDI policy.”
“This is a very timely and proactive move to prevent acquisitions and inroads by Chinese companies looking to take advantage of attractive valuations, other countries should follow suit,” said Nirmal Jain, chairmain at India Infoline Group.
Meenal Maheshwari, lead counsel of global transactions at Essar, said: “What came as a surprise is the Indian government’s approach of directly targeting China instead of going about it in a round-about way, like in Europe where more rules on non-EU investments have been applied."
Maheshwari is not surprised that the hardened rules are sector agnostic and don’t apply to sensitive sectors alone. The loss of Indian data to China through various businesses such as payments could be a concern for the government.
After the news of the People’s Bank of China's stake increase broke on April 13, it created a panic that abysmally low valuations might make strategically important Indian companies vulnerable and attractive takeover targets.
“The amended FDI policy will also apply to acquiring entities where beneficial ownership include citizens from any of the countries bordering India, even if such acquiring entities are not incorporated and/or operating from any of those countries," said Banerjee "This has been done to ensure non-circumvention of such investment restrictions by routing investments through any other countries where this ban does not apply.”
“In my experience, it takes anywhere between two to three months to get an approval,” said Essar's Maheshwari. “With this change, the volume of applications under approval route will go up considerably and it may take even longer to do so. So one is looking at substantially increased timeline for transactions.”
It is unclear whether approvals will apply for direct and indirect FDI from Hong Kong SAR, or to transactions where the direct or indirect beneficial ownership of the investment is from Hong Kong SAR, given that city state is a part of China but also a special administrative region.
Another challenge is regulatory uncertainty. It is unclear what the Indian government’s approach will be in giving out approvals, whether it will determine this sector by sector or if it will depend on whether the nature of the investment is strategic, controlling or non-controlling.
“To my mind it may be a valuation game,” said Maheshwari. “As long as Chinese investors are coming at a good premium in non-sensitive sectors, the approvals should be forthcoming subject to conditions on sharing data with China.”
Banerjee agrees and said: “While the new FDI policy may likely impact Chinese investments, that may still not stop good fundamental start-up companies in India from accessing equity capital from Chinese investors, now with the only additional step of seeking approval from the Indian government.”
He continued: “The timeframe to consummate a transaction will go up due to the additional process of government approval, but that still should not more than offset – as a mood killer – a good investment opportunity.”
However, Indian startups looking for funding may need to consider alternatives.
“While the Indian government has taken a proactive step, it will come with significant challenges for the startups in India,” said startup fundraiser and advisor Rahul Saria. “For larger corporates this is a good move but there should have been exceptions for startups with some thresholds, since the whole idea and concept of cheap valuations and takeover is applicable only for established companies and not new age futuristic ideas.”
This FDI policy change would unnecessarily delay the process of getting government approvals for startup investments, and in these challenging times will only make life tougher and survival more unlikely.
Saria continued: “It is expected that the amendment would be prospective and should not impact the approval of the allotted shares however, ongoing deals may take a toll since investors may be wary of the fact and start reworking on the stretched timelines.”
India is not the only country that has tightened its FDI policy since Covid-19 broke out. Australia, Germany, Italy and Spain have also put in stricter approval measures for foreign investments. It won’t be a surprise if many more countries follow.