Changes to FDI Policy – Part V: Sectoral Rules

In this final post in the series, we look at the one change introduced by the Consolidated FDI Policy, Circular No. 1 of 2011 to the sectoral requirements in the agricultural sector, and also briefly touch upon some areas that have been overlooked in the current round of policy review (but yet are under active consideration).

Earlier, FDI under the automatic route up to 100% was available for “floriculture, horticulture, development of seeds, animal husbandry, pisciculture, aquaculture and cultivation of vegetables & mushrooms under controlled conditions and services related to agro and allied sectors” (para. 5.2.1 of the FDI Circular). The relaxation now made is to allow 100% FDI for development and production of seeds and planting material without the requirement to do so “under controlled conditions”. The other stipulations continue to operate, as elaborated in this report.

As far as a few other sectors and types of entities are concerned, although some movement has been made in relation to the following matters, there is no definitive policy pronouncement forthcoming from the Government:

- multi-brand retail trading, which is a hot-button issue, where Government has been holding consultations after having issued a discussion paper;

- FDI in limited liability partnerships (LLP), in whose case too there is already a discussion paper (although the LLP as an entity appears to be undergoing some turmoil lately due to imposition of minimum-alternate tax in Budget 2011, as discussed here); and

- enhancement of FDI limit in the insurance sector from 26% to 49%.

Investors keen on taking a stake in these sectors will have to await further policy pronouncements.

Regulating use of Internet can stifle

SEBI’s move to regulate the usage of e-mail, internet and electronic means of communication by employees of market intermediaries, and to make the compliance officer liable, was commented upon recently by Umakanth here.

However, well-intentioned, SEBI’s move is not implementable, poses serious issues for the office of the compliance officer, and can have the unintended consequence of stifling sharing of knowledge. For example, if this blog-post is received in the inbox of any employee of the market intermediary, he would be committing an illegal act, if he were to forward that e-mail without getting his compliance officer to verify what I have said.

In a recent column, I have commented on issues posed by this development here.

Changes to FDI Policy – Part IV: Downstream Investments

Indirect foreign investment into Indian companies had been a subject matter of ambiguity in the FDI policy. For instance, if an Indian company (that has foreign investors) makes investments into another Indian company, would that downstream investment be treated as domestic investment or foreign investment? While rules govern such investment?

In order to streamline the policy, the Government had issued Press Notes 2, 3 and 4 of 2009 to clear the confusion on downstream investments. However, the policy continued to operate in a complex manner, particularly because there were differences based on the type of intermediate company: (i) operating company; (ii) operating-cum-investing company; and (iii) investing company.

To simplify the process further, the new Consolidated FDI Policy, Circular No. 1 of 2011 eliminates the differences regarding the type of intermediate company, and applies a common set of principles to so long as the Indian intermediate company is owned and/or controlled by non-resident entities. Investments by such an intermediate company would be considered a foreign investment for the purpose of sectoral caps and other conditionalities. The relevant part of the policy reads:

4.6.4.1 Downstream investment by an Indian company, which is owned and/ or controlled by non-resident entity/ies, into another Indian company, would be in accordance/compliance with the relevant sectoral conditions on entry route, conditionalities and caps, with regard to the sectors in which the Indian company into which the downstream investment is being made, is operating.

However, some distinctions have been maintained to the policy regarding foreign investment into the intermediate company itself depending on its nature. For example, if that is an investing company, then foreign investment is allowed into it only under the approval route. The relevant policy states:

4.6.3.1 Foreign investment into an Indian company, engaged only in the activity of investing in the capital of other Indian company/ies, will require prior Government/FIPB approval, regardless of the amount or extent of foreign investment. Foreign investment into Non-Banking Finance Companies (NBFCs), carrying on activities approved for FDI, will be subject to the conditions specified in paragraph 5.2.18 of this Circular. Those companies, which are Core Investment Companies (CICs), will have to additionally follow RBI’s Regulatory Framework for CICs.

Furthermore, if the intermediate company does not have any operations or investments yet (such as a blank check company), then again foreign investment in it is permissible only under the approval route.

While this set of changes regarding downstream investments simplifies the FDI guidelines in this otherwise complex area, it does not appear to make any substantive changes to the policy itself. 

Changes to FDI Policy – Part III: Previous Venture

A significant condition in the FDI policy, first included in Press Note 18 of 1998 operated to restrict foreign investments. It required foreign investors to obtain prior Government approval to invest where they had a previous joint venture in India. In such cases, the automatic route was not available. This became an obstacle because FIPB, in considering applications, required a no-objection letter from the previous joint venture partner, thereby providing a great amount negotiating leverage to the Indian partner.

Despite significant opposition to this condition, there was insufficient political will to remove it from the policy. Adopting a halfway-house approach, the Government began chipping away at the scope of the condition. For example, several exceptions were built into the condition, both in terms of the sectors in which it became inapplicable (e.g. the information technology industry) and specific investors who were not bound by it (e.g. multilateral institutions). The next major round of dilution came in 2005 in the form of a cut-off date which provided that the condition henceforth applied only to “existing ventures” as of January 12, 2005 (the date of the policy revision) and that it was not applicable to ventures that were established thereafter.

Even this diluted form in which the condition was operating was found to be restrictive. There were calls for a total elimination of this requirement. Finally, as the calls for removal became louder, the Government in late 2010 issued a discussion paper considering the total abolition of the condition. The discussion paper took note of the fact that such a restriction does not exist in the foreign investment regulations of other emerging economies such as Brazil and China, and that its abolition would increase the flow of foreign investment.

For these reasons, the condition has been completely abolished in new policy contained in Consolidated FDI Policy, Circular No. 1 of 2011. Foreign investors are no longer required to obtain Government approval even if they had previous ventures in India so long as the new investment otherwise falls within the automatic route. This truly levels the playing field. It is perhaps the most significant and likely impactful change introduced in the new policy.