Regulatory Scenario of Foreign Direct Investment in India

14th September, 2012 is historic in a sense. After the watershed year of 1991, India has not seen such a ‘reformation bonanza!’ Amongst widespread protest, UPA II government has nodded 51% FDI in multi-brand retailing, 49% in aviation & 74% in DTH. India is now a preferred destination for investment for its political stability, natural resources, and a large number of English speaking populations, well-regulated financial markets, tested legal systems and above all an investor-friendly attitude of the government. Some statistics might help in understanding the same. Cumulative amount of foreign direct investment (“FDI”) inflows into India from 2000-2012 is US$ 243,055 [Source: Fact Sheet on FDI, Aug. 1991 – Jan 2012 of Department of Industrial Policy & Promotion (“DIPP”)] Investors are attracted towards India because it has the largest democracy in the world along with skilled & competitive labour market & liberalised foreign investment regime. Coupled with large domestic market & highest return on investment, it has become the second largest emerging market of the world. Countries like the USA, the UK, the Netherlands, Japan, Germany, Singapore, Mauritius, France and others did not waste much time to grab the opportunity to tap the potential market in India. As there were (are) several sectoral caps in FDI, most of the initial investment was in the form of Joint Ventures (“JV”).With regular changes in FDI norms, the nature of investment too has witnessed a change. There are some advantages as well as disadvantages of FDI. Infrastructure & technology transfer, increased productive efficiency due to competition from MNC subsidiaries, faster growth of output & employment, threefold consumer benefits (price, quality, and varieties), increasing export, investments & savings are some of the advantages. On the other hand the disadvantages are dominance of industrial sector in domestic market, dependence on foreign technology sources, disturbances of domestic economic plans in favour of FDI-directed activities, cultural change by means of ‘ethnocentric staffing’ (infusion of foreign culture & business practices). Foreign investments in India can be made through five channels, namely: i) Foreign Direct Investment ii) Foreign Portfolio Investment iii) Foreign Venture Capital Investment iv) Other Investments (G-SEC, NCDs etc.) v) Investments on non- repatriable basis Different modes, through which FDI in India can be made, are • By direction (Inward & Outward) • By target( M&A, Horizontal FDI, Backward & Forward Vertical FDI) • By motive (resource-seeking, strategic asset-seeking, market-seeking & efficiency-seeking) India has its own distinct policy for promoting foreign investment in the country. As on date, there are some regulatory hurdles for insurance & multi brand retail segments, as there is no consensus of allowing FDI in these sectors. This seems to have given a wrong message to investors from USA, as American President Barack Obama had commented on 15th July, 2012, “They (US business community) tell us it is still too hard to invest in India. In too many sectors, such as retail, India limits or prohibits the foreign investment that is necessary to create jobs in both our countries… there appears to be a growing consensus in India that the time may be right for another wave of economic reforms…” Indian Commerce Minister, Anand Sharma has reassured that the ‘foreign investment environment is conducive. As a result of assurance, FDI in Multi brand retail has been approved by CCEA on 14th September, Friday, 2012. So far, it could not be implemented due to wide political protests, although the Government has allowed it up to 51% under approval route ('Circular 2 of 2011- Consolidated FDI Policy', dated 30.09.2011, issued by the DIPP) almost a year ago. There is immense fear among the small traders & farmers, that once these giants with ‘big discounts’ flooded Indian market, they would lose their livelihood & most of the political parties, both national & regional are supporting their concerns. India has already revised its earlier stand on single brand retail trading. By issuing press note PN- 1/2012 (10th January, 2012), the Government of India has reviewed the extant policy on FDI and decided that up to 100% FDI, under the government approval route, would be permitted in Single-Brand Product Retail Trading, subject to specified conditions. IKEA, world’s largest furniture manufacturer is coming to India with a promise of investments worth 1.5 billion Euros (R10, 500 crore) in two stages via its Indian subsidiary. The company will invest 600 million Euros (around R4, 200 crore) in the first stage and an additional estimated FDI of up to 900 million Euros (around R6, 300 crore). These conditions are as follows: FDI in Single Brand product retail trading would be subject to the following conditions as prescribed in the Master Circular of April, 2012: (a) Products to be sold should be of a ‘Single Brand’ only (b) Products should be sold under the same brand across the world (c) ‘Single Brand’ product-retail trading would cover only products which are branded during manufacturing. (d) The foreign investor should be the owner of the brand (e) In respect of proposals involving FDI beyond 51%, mandatory sourcing of at least 30% of the value of products sold would have to be done from Indian small industries/ village and cottage industries, artisans and craftsmen. This 30% clause, however, has been opposed by several foreign retailers. The government is also considering allowing the foreign companies to undertake local sourcing through a separate entity from that of the retailing venture. As per the present government norms, both the activities have to be undertaken by the same entity. As soon as notification has been made by the Central Government in single brand retail trade, IKEA didn’t waste any time to investment. Now, IKEA has demanded certain ‘favours’ from the Indian government: • It wants India to tweak a clause that will require it to source 30% of the value of goods sold in India from domestic small industries whose investment do not exceed Rs 5.5 crore. • Local firms, which will supply its inventory, should continue to qualify as small industries even if their investments exceed Rs 5.5 crore after their association with the Swedish giant. • It also wants the compliance of the mandatory 30% sourcing condition to be calculated over a cumulative period of 10 years and not annually. • The export value of materials sourced from Indian MSMEs should be included. In simpler terms, this means IKEA can source raw materials from domestic MSMEs but export it to other markets. However, as of now no changes in the single-brand retail policy has been implemented. DIPP has referred the IKEA demands before FIPB. The DIPP will take a decision on any change only after receiving the views of the FIPB. Very recently, the Commerce Minister of India has said that, the process of reconstructing the definition of small and medium enterprises is underway, in order to help the foreign retailers meet the MSME criteria. After much deliberation, IKEA has agreed to comply with India's local sourcing conditions by the seventh year of its operations and has said that it is willing to sell food items under the eponymous brand at its stores. However, there are some issues between the Swedish company's plans and the current government policy, which need to be sorted out before the final nod from the government. However, not all foreign investments meet with such regulatory hurdles. For instance, the Reliance Industries Ltd. - British Petroleum joint venture, which is the biggest FDI in India ever. But on the other hand, the Cairn-Vedanta deal had a long story of facing various legal barriers before it commenced business in India. RIL-BP Deal A 50:50 joint venture formed by the RIL-BP for sourcing and marketing gas in India, taking the overall investment in the partnership to $20 billion or Rs 90,000 crore. BP is taking a 30% stake in 23 RIL-operated PSCs in India, including the offshore producing KG D6 block. This is the single-largest FDI flow into India ever and a multi-year commitment. Valuation was justified with analysts having valued RIL’s upstream business at around $30 billion implying $9 billion for a 30% stake. Cairn-Vedanta Deal Vedanta Resources wanted to buy a 51% controlling stake in Cairn India for $9.6 billion. Vedanta Resources was in talks with Cairn Energy, which had a 62.4% stake in Cairn India, to buy a controlling stake in the unit in August, 2010. The deal was done in 2010 but got stuck due to ONGC and Government of India. ONGC and Cairn India had started oil drilling operation in Rajasthan under a Joint Venture. Cairn owned 70% and ONGC 30%. So Cairn had sought an NOC (No objection certificate) from ONGC for this deal with Vedanta, which was denied by ONGC by using the Right of First Refusal or Preemptive Rights as per Companies Act, 1956.But, ONGC did not provide that at the first go citing the issue of royalty for Rajasthan Block, which was supported by government of India, as ONGC wanted to buy the controlling stake. In 2011, the petroleum ministry gave “in-principle” approval for Vedanta Resources’ $9.6 billion acquisition of Cairn India with a set of 11 preconditions. Despite Cairn India's reservations, its current and future promoters -- Cairn Energy and Vedanta, respectively -- accepted the government conditions, following which ONGC waived its preemption rights over the deal. Vedanta Group now holds 60 per cent in Cairn India, while Cairn Energy retains about 22 per cent. The Supreme Court in July, 2012 said, it will be difficult to reverse the deal. Both the deals are valuable examples of the legal issues one might face while doing business in India and an in-depth look at the cases brings to light a substantial number of nitty-gritty’s existing in the current business environment. Both Cairn-Vedanta and RIL-BP are equity-based partnerships. Unlike RIL-BP deal, Vedanta-Cairn stake sale faced a number of regulatory hurdles as the issue of controlling stake was involved. Because of this very issue of controlling stake, the issue of national interest had been raised by the parties as well. According to the SSPA (Share Sale & Purchasing Agreement), an acquisition in this case does not need any approval per se. The acquired entity maintains its individuality. But, once a company wants to buy out more than 50% of the equity stake in the target company, it involves a change in the management and control of the company. In the Cairn-Vedanta case, this was exactly the situation. Vedanta wanted 51% controlling stake in Cairn India where the change of management would be inevitable. Initially Cairn had claimed that its deal with Vedanta was a corporate transaction and not a transfer of stake and hence did not require the permission of the GOI. Subsequently it agreed, albeit reluctantly to the government clauses. Analysts are of the view that the two deals (RIL-BP and Cairn-Vedanta) were completely different. In the RIL deal, the Indian company was selling a significant minority stake; Reliance would remain in charge of operations and retain a majority stake. On the other hand, the Cairn-Vedanta deal involved a transfer of ownership. Besides, the Cairn-Vedanta US$ 9.6 bn deal was a transaction between two London-listed companies and the money would not come into India. The RIL-BP deal, in contrast, is the single-largest FDI in India. Also, the non-existence of a party like ONGC in the deal is another positive sign for the RIL-BP stake transfer. Foreign companies come to India as an incorporated entity by floating a company under the Companies Act, 1956 through JVs or Wholly Owned Subsidiaries. According to the existing norms, more than 49% investment by a foreign company needs prior approval of FIPB. But RIL-BP deal does not need any clearance as only 30% stake is being sold to BP and hence no change in management is expected. Aviation too was a highly debated sector regarding the inflow of foreign money. India allowed 49% FDI by foreign investors i.e. foreign airlines can buy stake in local carriers. Till September 13, 2012 foreign airlines are barred from buying stakes in domestic carriers. Why FDI is so important? FDI refers to capital inflows from abroad that are invested by the foreign entities in a domestic economy to enhance the production capacity of the economy. Presently there are two entry routes to invest in India. Those are:- • Automatic Route • Approval Route/Government Route There are four slabs of FDI ranging from 100% to a complete bar in certain sectors. The slabs are 100%, 74%, 51% & 49%. Some sectors are there where no FDI is allowed. Automatic Route Under automatic route, to invest in India, does not require any prior approval either by the Government or RBI. The only requirement is to notify the Regional office of RBI within 30 days of receipt of inward remittance and file the required documents with the office concerned within 30 days of issue of shares to foreign investors. The conditions are, • The company has complied with the procedure for the issue of shares as laid down under the FDI scheme as indicated in the Notification No. FEMA 20/2000-RB or its subsequent amendments • The proposal is within the sectoral cap Approval Route In many cases, foreign investors need consent from Government of India prior to investments. It is known as approval route. The FDI, which doesn’t come under the automatic route, requires following this step. Such proposals are considered by the FIPB. Government approval is required in the following cases: • In sectors with caps, including inter-alia defence production, air transport services, ground handling services, asset reconstruction companies, private sector banking, broadcasting, commodity exchanges, credit information companies, insurance, print media, telecommunications and satellites, Government approval / FIPB approval would be required in all cases where: • When an Indian company is being established with foreign investment and is owned or/and controlled by a non-resident entity or • When the control or ownership of an existing Indian company, currently owned or controlled by resident Indian citizens and Indian companies, is being transferred to a non-resident entity as a consequence of transfer of shares and/or fresh issue of shares. Other than automatic & approval routes, the foreign investments can also come to India in various other ways, like: i) Acquisition of shares route (since 1996) Under the Foreign Direct Investments (FDI) Scheme, investments can be made in shares, mandatorily and fully convertible debentures and mandatorily and fully convertible preference shares of an Indian company by non-residents through Automatic & Approval routes. ii) RBI’s non-resident Indian (NRI’s) scheme There are several schemes for the NRIs to invest in India. NRI and erstwhile OCBs may transfer by way of sale or gift the shares or convertible debentures held by him or it to another NRI. A person resident outside India can transfer any security to a person resident in India by way of gift. Person resident outside India can transfer shares / convertible debentures, by way of sale under private arrangement to a person resident in India. A person resident in India can transfer by way of sale, shares of an Indian company in sectors other than financial service sector (Banks, NBFC, Insurance, ARC,) under private arrangement to a person resident outside India iii) External Commercial Borrowings (ADR/GDR) route Indian companies have been granted general permission for conversion of External Commercial Borrowings (ECB) into shares / convertible debentures, subject to the following conditions and reporting requirements: (RBI Master Circular). Indian companies can issue equity shares, fully, compulsorily and mandatorily convertible debentures and fully, compulsorily and mandatorily convertible preference shares subject to pricing guidelines/valuation norms prescribed under FEMA Regulations. In this regard, a limited two-way Fungibility scheme has been put in place by the Government of India for ADRs / GDRs. Under this Scheme, a stock broker in India, registered with SEBI, can purchase shares of an Indian company from the market for conversion into ADRs/GDRs. Two-way fungibility implies that an investor who holds ADRs/GDRs can cancel them with the depository and sell the underlying shares in the market. The company can then issue fresh ADRs to the extent of shares cancelled. An Indian company can also sponsor an issue of ADR / GDR. The relationship between FII and FDI is intertwined. Number of reforms was initiated in the end of 1990s to attract FDI. FDI is also allowed through FII’s by way of private equity, preferential allotment, joint ventures and capital market operations. However, there are some sectors where FDI is completely prohibited both via automatic route or approval route, primarily from the perspective of national Security concerns & Consumer/industry interests. (a) Lottery Business including Government /private lottery, online lotteries, etc. (b) Gambling and Betting including casinos etc. (c) Chit funds (d) Nidhi company (e) Trading in Transferable Development Rights (TDRs) (f) Real Estate Business or Construction of Farm Houses (g) Manufacturing of Cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes (h) Activities / sectors not open to private sector investment e.g. Atomic Energy and Railway Transport (other than Mass Rapid Transport Systems). (i) Foreign technology collaboration in any form including licensing for franchise, trademark, brand name, management contract is also prohibited for Lottery Business and Gambling and Betting activities. Though there are some complaints against India’s FDI policy, the government has been continuously trying to make it more flexible and investment-friendly. By relaxing certain policies, India has successfully attracted foreign investments in 2011-12, as compared to the previous year. It is believed that the recent decline was temporary. Courtesy: • The Economic Times • The Hindu Business Line • The Business Standard • The Mint • Website of DIPP (Consolidate FDI Policy, 2012, Press Notes, FDI sector wise chart) • Website of RBI • Website of RIL • Website of BP • Website of Cairn India • Website of Vedanta Resource • Website of ONGC • Website of IKEA • Slideshare • http://www.unctad-docs.org/files/UNCTAD-WIR2012-Full-en.pdf • http://www3.weforum.org/docs/WEF_GCR_Report_2011-12.pdf