India’s foreign direct investment policy changes – a critique

Dec 4, 2015


India stands committed to having a Foreign Direct Investment (“FDI”) regime that is investor friendly and promotes foreign investment for overall economic growth.  Since the Modi government came to power in June 2014, many FDI policy reforms were made in sectors such as defence, rail infrastructure, construction development, insurance, pension, medical devices and others.  In order to further boost the ease of doing business in India and to further promote the “Make in India” and “Start-up India” initiatives, the government issued a Press Note on November 10, 2015 (the “First Press Note”) and Press Note No. 12 (2015 Series) on November 24, 2015 (the “Second Press Note”) (collectively, the “Press Notes”) outlining significant reforms to the FDI policy. We have prepared a critique outlining the salient changes.

“Manufacture” Defined

The Second Press Note has introduced the definition of the term “manufacture” in the FDI Policy.  As per the definition “any change in the physical object resulting in transformation of the object into a distinct article with a different name or bringing a new object into existence with a different chemical composition or integral structure” will qualify as manufacturing.  In our view, the government, although well intentioned, could have done without this definition because definitions are prone to interpretations which can vary and, thereby, cause ambiguity.  Indian manufacturing companies are now up in arms against this definition because they believe that under this definition foreign companies will effect minor modifications to goods and re-label them as “Made in India”, which will make similar Indian goods less competitive.  

Trading Sector

In the single brand retail trading (“SBRT”) sector, if a foreign company wants to invest in an Indian company and own more than 51%, then the Indian company has to fulfill the sourcing requirement (i.e., 30% of the value of goods purchased over a period of five (5) years has to be sourced from India).  Originally, the five (5) year period requirement had to be calculated beginning April 1 of the year in which the first tranche of FDI is received.

Companies like IKEA approached the government for a relaxation of this rule because there was a significant time lag between the date of receipt of FDI and the opening of the first store.  Therefore, under the Press Notes, the government has liberalized this sourcing requirement, and it will now be reckoned from the opening of the first store and not from the date of receipt of FDI.

Additionally, in certain high technology segments, it was not possible for a retail entity to comply with the sourcing norms.  The Press Notes provide that single brand entities bringing into India “state-of-art” and “cutting-edge technology” can apply to the government for a relaxation of the sourcing norms on a case-to-case basis.  This relaxation will help multinational companies like Apple, Rolex and others, who are unable to source hi-tech parts from India.

The current FDI policy reiterates that retail trading through e-commerce will not be permitted, except that an entity which has been granted permission to undertake SBRT and which is operating through brick and mortar stores will be allowed to sell via e-commerce without obtaining any government approval.

The Press Notes also clarify that an Indian manufacturer will be permitted to sell its own branded products in any manner, i.e., through wholesale, retail or e-commerce platforms.  For the purposes of the FDI policy, an Indian manufacturer will be the investee company, which will have to own the Indian brand and will have to manufacture in India at least 70% in value terms of its products in-house, and source, at most 30% from other Indian manufacturers.  Further, the Indian brand will have to be owned and controlled by resident Indian citizens and/or companies that are owned and controlled by resident Indian citizens.  In our view, this addition is confusing, and it is unclear whether it will apply only to Indian manufacturing companies or to foreign companies who also have established Indian manufacturing subsidiary or joint venture companies.  The government may need to clarify this.

As per the extant FDI policy, in wholesale or cash and carry activities, 100% foreign investment is permitted under the automatic route.  The FDI policy in this sector further requires that a wholesale or cash and carry trader cannot open retail shops to sell to the consumers directly. Pursuant to the Press Notes, a single entity can undertake both, SBRT and wholesale or cash and carry activities, provided that the conditions of the FDI Policy applicable to each, wholesale or cash and carry, and SBRT, are complied with.  In addition, the entity will have to maintain two separate books of accounts and get the books statutorily audited.

Further, 100% FDI under the automatic route will now be permitted in duty free shops located in customs bonded areas.

B2C E-commerce

The B2C e-commerce space is still not open for foreign investment.  However, in a recent case filed by the All India Footwear Manufacturers & Retailers Association in the Delhi High Court against B2C marketplaces like Amazon, Flipkart and others, the court has directed the government to file a reply questioning whether the foregoing B2B marketplaces are de facto undertaking B2C e-commerce in violation of the FDI policy.  One will have to wait and watch how this matter unfolds.

Construction Development Sector

The real property sector in India has stagnated over the last couple of years.  Various projects are stuck because of cash flow shortages, slowness in getting approvals, etc. This sector was first opened up for foreign investment in 2005; however, after an initial frenzy of FDI projects, there was a slowdown because foreign investors could not get exits easily due to the policy restrictions.

Under the Press Notes, the minimum area restriction condition (i.e., the minimum floor area of an FDI project having to be 20,000 square metres) and the minimum capitalization requirement (of US$5 million required to be brought in within six (6) months from the commencement of business) have now been removed.   In addition, foreign investors will now be permitted to exit and repatriate foreign investment before the completion of the project under the automatic route subject to completion of a lock-in period of three (3) years calculated with reference to each tranche of foreign investment.  Moreover, the transfer of stake from a non-resident to another non-resident without repatriation of investment will be permitted even before expiry of the lock-in period without any government approval.   Further, if a project is completed before expiry of the lock-in period, the foreign investor can exit.

The Press Notes also clarify that the condition of lock-in period will not apply to hotels and tourist resorts, hospitals, special economic zones, educational institutions and old age homes, as also to investments by a non-resident Indian (“NRI”).

In our view, these are welcome changes and have the potential to give a major boost to the real estate sector.  We expect NRI funds to come, especially as the new FDI norms make entry and exit norms easier. Additionally, the removal of a minimum threshold floor area and investment amount will encourage investment in smaller projects.

Banking Sector

The Press Notes introduce full fungibility of foreign investment in the banking sector, such that foreign investment up to 74% will be allowed from foreign institutional investors (FIIs), foreign portfolio investors (FPIs), qualified financial investors (QFIs) or strategic investors; provided that there is no change in the control and management of the investee company.  In our view, this change will help the existing private sector banks, payments banks and small finance banks to tap overseas markets to enhance their capital base.

Defence Sector

The position regarding FDI in the defence sector was unclear under the previous policy. FDI up to 49% was allowed under the government route, and for FDI above 49% the approval of the Cabinet Committee on Security (“CCS”) had to be obtained on a case-to-case basis.  Portfolio investment and investment by Foreign Venture Capital Investors (“FVCI”) was restricted at 24%.  The position now is that FDI up to 49% will be allowed under the automatic route, and FVCIs can also invest up to 49% under the automatic route.

Proposals for foreign investment in excess of 49% will be considered by the Foreign Investment Promotion Board (the “FIPB”) and not by the CCS.  Further, in case of infusion of fresh foreign investment in an Indian company in this sector not requiring an industrial license, which results in a change in ownership or which results in the transfer of stake by an existing investor to a new foreign investor, FIPB approval will be required.

In our view, these changes will ease investment in the defence sector in India, and have the potential to boost indigenous manufacturing.

Broadcasting Sector

100% FDI (up to 49% under the automatic route and beyond that under the government route) in Teleports, Direct-To-Home (“DTH”), Cable Networks, Mobile Television, Headend-In-The Sky Broadcasting Services and Cable Networks has now been permitted.  The earlier overall limit was 74%.  The sectoral cap for Terrestrial Broadcasting Services and Up-Linking of News and Current Affairs Channels has been increased from 26% to 49% under the government route. A welcome change is permitting foreign investment in Up-Linking of Non-News and Current Affairs Television Channels and Down-Linking of Television Channels up to 100% under the automatic route (this was earlier under the government route).

In our view, these changes were much awaited. International companies that might have kept away from investing in the DTH sector in the past, due to the requirement of a mandatory partnership with an Indian company, will now be encouraged to increase their investments in India.

In January 2015, the government did away with the concept of Person of Indian Origin (“PIO”) by merging this category with the Overseas Citizen of India (“OCI”).  An OCI is defined in Section 7A of the Citizenship Act, 1955, in a manner similar to that of the PIO, but with some restrictions. Given this transition from PIO to OCI, under the Press Note 7 of 2015, for foreign investment purposes, an NRI now means an overseas resident who is either a citizen of India or an OCI cardholder.  In order to increase the inflow of investment in India, the government has permitted NRIs to invest in the construction development (supra.) and the civil aviation sectors.  Further, investments made by NRIs on a non-repatriation basis will be deemed to be domestic investment on par with investments made by residents.  This benefit has also been extended to investments by companies, trusts and partnership firms incorporated outside India, and owned and controlled by NRIs.

Limited Liability Partnerships

 Foreign investments in Limited Liability Partnerships (“LLPs”) will be permitted under the automatic route in sectors where 100% FDI is allowed and where there are no FDI-linked performance conditions.  Further, LLPs having foreign investments will be permitted to make downstream investments in another company or an LLP that are operating in sectors where 100% FDI is allowed and where there are no FDI-linked performance conditions.

The meaning of the terms “ownership” and “control” has been clarified in relation to LLPS.  An LLP will be considered as “owned” by resident Indian citizens if more than 50% of the investment in the LLP is contributed by resident Indian citizens and/or entities which are ultimately owned and controlled by resident Indian citizens, and such resident Indian citizens and entities get a majority of the profit share.  The term “control” will mean the right to appoint a majority of the designated partners, where such designated partners, with specific exclusion to others, have control over all the policies of the LLP.

LLPs have been regarded by investors as an attractive vehicle as compared to companies for undertaking business in India for tax and other reasons.  With the proposed relaxation of FDI norms for investment in an LLP in India, NRIs and foreign nationals will invest under LLPs to conduct business in India, as no prior FIPB approval will be needed.

Increase in the threshold limit for approval by the FIPB

 As per the extant FDI Policy, the FIPB can consider FDI proposals up to INR30 billion (US$45,454,545 approximately).  The threshold limit for FIPB approval has now been increased from INR30 billion to INR50 billion (US$75,757,575 approximately). FDI proposals above INR50 billion will be considered by the Cabinet Committee on Economic Affairs.  This is another step at reducing the time to obtain the necessary government approvals.

Civil Aviation Sector

In addition to Scheduled Air Transport Service or Domestic Scheduled Passenger Airline, Regional Air Transport Services will now be eligible for FDI up to 49% under the automatic route.  Foreign equity caps in Non-Scheduled Air Transport Service and ground handling services have also been increased from 74% to 100% under the automatic route.

Establishment and Transfer of Ownership or Control of Indian Companies and Swap of Shares

As per the extant FDI Policy, FIPB approval is required for establishment and transfer of ownership or control of Indian companies operating in sectors with caps. However, this provision of the FDI policy has been amended such that FIPB approval will be required only if the Indian companies operate in sectors which are under the government approval route (as opposed to sectors which merely have caps on foreign investment).  Further, the FIPB’s approval will not be required in cases of investment by way of swap of shares for investing in Indian companies operating in sectors under the automatic route. Although the government has liberalized the requirement of the FIPB’s approval in case of swap of shares by restricting it to investments falling under the government route, ambiguity continues as to whether “investment” by way of swap of shares includes both, allotment of fresh shares by the Indian company and transfer of shares from an existing shareholder of an Indian company, as the present reporting formalities under Indian exchange control regulations seem to permit swap of shares only by way of allotment of fresh shares by an Indian company.

Other Rationalization Measures 

100% FDI has been allowed in coffee, rubber, cardamom, palm oil and olive oil plantations under the automatic route.  The government has also simplified the conditions applicable to FDI in the agriculture, animal husbandry and mining sectors.  The FDI cap in credit information companies has also been increased from 74% to 100% under the automatic route.


India is one of the fastest growing economies in the world, and these reforms will further ease and rationalize the process of foreign investment in the country contributing to growth of investment, income and employment.

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