From a pre-1991 position of rigorous regulation, India's foreign direct investment (FDI) has increased exponentially with gradual liberalisation of the economy post-1991, culminating in a boom post-2000. With the paradigm shift in its foreign investment policy, India has become one of the most attractive FDI destinations in the world, drawing nearly $99 billion in investment from 1991 to 2008.
However, India's FDI story has not been without its twists. Vagueness and multiplicity of methods of calculating foreign investment; ambiguities in relation to approval requirements for downstream investments by companies having foreign investment; and uncertainties on regulatory approval requirements for transfer and issue of shares were amongst the more interesting twists that threatened to leave an indelible mark on Indian investment.
The Government of India had deliberated over various proposals in recent years to resolve the above and make India's foreign investment policy simpler. As an outcome, much-awaited guidelines were issued on February 13 2009 to streamline the existing position. These guidelines relate to: the so-called see through rules or calculation of total foreign investment (direct and indirect) in Indian companies; and the transfer of ownership or control of Indian companies in sectors with caps from resident Indian citizens to non-resident entities.
These guidelines were shortly followed by clarification guidelines on downstream investments by Indian companies on February 25 2009. The salient features of these guidelines are spelt out below.
Foreign investment in all forms (FDI and investment by foreign institutional investors (FII) and non-resident Indians, American Depository Receipt and Global Depository Receipt holders, and holders of foreign currency convertible bonds, convertible preference shares and convertible currency debentures) will be considered for the calculation of caps on investment in different sectors.
Further, downstream investment by Indian companies that are not "owned and controlled" by resident Indian citizens or companies will be considered as indirect foreign investment. However, if the downstream company is a wholly owned subsidiary of the company making the investment, the indirect foreign investment in the downstream company would be taken to be only to the extent of foreign investment in the investing company. This method of calculation is not applicable to sectors such as insurance, which are governed by specific statutes or rules.
Also, where the sectoral cap is less than 49%, the company is required to be owned and controlled by resident Indians who have legally bound themselves to act jointly in managing the company.
In sectors where the prior approval of the Foreign Investment Promotion Board (the FIPB) is required for foreign investment, all shareholders agreements affecting management and control are required to be disclosed to the FIPB.
Prior Government or FIPB approval will be required in sectors with caps for:
(a) the establishment of a company which will be owned or controlled by a non-resident entity; and
(b) the transfer of control or ownership of a company currently owned or controlled by resident Indians to a non-resident entity by a transfer of shares.
Foreign investment into operating companies and operating-cum-holding companies and downstream investments made by operating-cum-holding companies will require no prior FIPB approval, subject to conditions applicable to the relevant sector.
Prior FIPB approval would be required for foreign investment in holding companies and downstream investments by such holding companies would require compliance with conditions applicable to the relevant sector. Prior FIPB approval will be required for foreign investment into companies not having any operations or downstream investments.
"Ownership", as defined by the new regime set out by the recent guidelines, means the beneficial ownership of more than 50% of the equity interest in a company and "control" means the power to appoint a majority of the directors.
Whilst the clarification on downstream investments was overdue and is a welcome and useful change, the guidelines on calculation of foreign investment clear the air slightly but still contain some ambiguities and risky propositions, particularly in relation to concepts like "ownership" and "control", equivalent treatment of FDI and FII investments and whether sector specific caps will be superseded by the new guidelines.
The guidelines relating to transfer of ownership and control, whether warranted or not, increase governmental control in an age when liberalisation and growth is the mantra. Therefore, whilst the changes brought about by the recent guidelines are important and a few very necessary, some other issues, including the requirement to disclose shareholder agreements, could very well dampen investments. The changes brought about by the recent guidelines therefore present a mixed bag of effects, particularly at a time when the global economy is in flux, and only time will tell whether the guidelines are resilient and whether they will give an impetus to the Indian economy.