Foreign Direct Investment (FDI) norms in India

Please Share with maximum friends to support the Initiative.





Context: Recently, India has revised its FDI rules amid the COVID-19 pandemic. Under the revised norms, the automatic route is now closed to investors from India’s land neighbors, with special reference to China. This new regulation is based on the fear that China may take advantage of the rock-bottom valuations of the firms of national importance in the backdrop of the lockdown.

Relevance:
Prelims: Current events of national and international importance.
Mains: GS III-

  • Indian Economy and issues relating to planning, mobilization of resources, growth, development, and employment. Inclusive growth and issues arising from it.

FOREIGN INVESTMENT
  • Foreign investment involves capital flows from one country to another, granting extensive ownership stakes in domestic companies and assets.
    • Types of Foreign Investment:
      • Foreign Direct Investment (FDI)
      • Foreign Institutional Investment (FII)
      • Qualified foreign investment (QFI)
      • Foreign Portfolio Investment (FPI)
Details on each of the foreign investment type can be found below:
1. FDI:
  • Foreign direct investment (FDI) is when a foreign company or the individual establishes new business operations or acquiring the business assets, including controlling interests, in an already existing Indian company
2. FII:
  • FII is when foreign institutional investors invest in the shares of An Indian company, or in bonds offered by an Indian company.
  • Only institutional investors like Investment companies, Insurance funds, etc. are allowed to invest in the Indian stock market directly.
  • However, if foreign individuals want to invest in India’s markets, they have to get themselves registered as a sub-account of an FII.
3. QFI:
  • QFI was introduced in 2002. A Qualified Foreign Investor can invest in India without sub-account.
  • The Qualified foreign investor (QFI) can be an individual, group or association.
  • The QFI should be a resident in a foreign country that is compliant with the standards of the Financial Action Task Force (FATF).
4. FPI:
  • In the Indian context, FIIs (along with sub-accounts with FIIs) and QFIs can be collectively classified as Foreign Portfolio Investment (FPI).

 

DIFFERENCE BETWEEN FDI AND FPI
FDI  FPI
  1. Investment in productive assets (whose value increase overtime) like plant and machinery for a business,
  2. The investment gives investors ownership right as well as the management right
  3. Engage in decision making of a firm
  4. Investors enter a country with a longterm approach
  5. So investors cannot depart from the country easily
  6. Investment is greater than 10%
  1. Investment in financial assets like stocks, bonds, mutual funds, etc.
  2. The investment gives investors only ownership right and not management right
  3. Not involved in the decision making
  4. Investors can plan for long but often have short-term plans
  5. Investors can easily depart from the country
  6. Investment is less than 10%

 

What is Foreign Direct Investment?
  • A Foreign Direct Investment (FDI) is an investment made by a firm or individual in one country into business interests located in another country.
  • It is different from when companies simply put their money into assets in other countries, which is called portfolio investment.
  • With FDI, foreign companies are directly involved with day-to-day operations in another country.
  • FDIs are commonly made in open economies that offer a skilled workforce and above-average growth prospects for the investor, as opposed to tightly regulated economies.
  • FDIs, apart from being involved in capital investment, also include the provisions of management or technology.
  • The key feature of FDI is that it establishes either effective control of or at least a substantial influence over the decision-making of the foreign business.
  • The FDI can be made in various ways, including the opening of a subsidiary or associate company in a foreign country or ensuring a merger or joint venture with a foreign company.
What are the types of FDI?
  • FDI can be categorized into horizontal, vertical or conglomerate.
    • Horizontal:
      • A horizontal direct investment happens when an investor sets up the same type of business operation in a foreign country as it operates in its home country.
    • Vertical:
      • A vertical investment is one in which different, but related business activities from the investor’s main business is established or acquired in a foreign country. For instance, when a manufacturing company acquires an interest in a foreign company that supplies parts or raw materials required for the manufacturing its finished goods, it is called vertical investment.
    • Conglomerate:
      • A conglomerate type of FDI is the one where a company or an individual makes foreign investment in a business that is unrelated to its existing business in its home country.
  • Since this type of investment involves entering a new industry where the investor has no experience, it often takes the form of a joint venture with a foreign company already operating in the country.
What are the methods of FDI?
  • The methods of FDI can be divided into two broad categories:
    • Greenfield investment
    • Brownfield investment
      • Greenfield Investment:
        • When companies are interested in FDI, they build up their own factory in a different country and train people to work in their factor/organization.
        • For instance, McDonald and Starbucks started everything from scratch and trained their employees themselves.
        • This method is called greenfield investments.
      • Brownfield investment:
        • In this method, the foreign companies do not build something from scratch in another country.
        • These companies expand their business by either going for cross-border mergers and acquisitions (M&As).
        • This allows the companies to immediately start their operations without necessary preparations.
FDI in India
  • The investment climate in India has improved tremendously since 1991 when the government opened up the economy and initiated the LPG strategies.
  • The improvement in this regard is commonly attributed to the easing of FDI norms.
  • Many sectors have opened up for foreign investment partially or wholly since the economic liberalization of the country.
  • Currently, India ranks in the list of the top 100 countries in ease of doing business.
  • In 2019, India was among the top ten receivers of FDI, totaling $49 billion inflows, as per a UN report. This is a 16% increase from 2018.
  • In February 2020, the DPIIT notifies policy to allow 100% FDI in insurance intermediaries.
  • In early 2020, the government decided to sell a 100% stake in the national airline's Air India.

India’s FDI policy
  • A foreign direct investment (FDI) is an investment in the form of a controlling ownership in a business in one country by an entity based in another country.
  • India’s FDI policy allows foreign investment in certain sectors under the automatic route. 
  • 100% FDI is permitted under the automatic route in manufacturing, oil and gas, greenfield airports, construction, railway infrastructure, etc. 
  • In other sectors, FDI is allowed under the automatic route up to a certain threshold, say 26% or 49%.
  • Such conditions apply to defense, broadcast and print media, aviation and other sectors. 
  • There is also a list of prohibited sectors, such as lottery, cigarettes, atomic energy where FDI is not permitted.
FDI Routes in India

There are three routes through which FDI flows into India. They are described in the following table:

Category 1  Category 2  Category 3
  • 100% FDI permitted through Automatic Route
  • Up to 100% FDI permitted through Government Route
  • Up to 100%, FDI permitted through Automatic + Government Route Automatic Route FDI
  • Automatic route FDI
    • In the automatic route, the foreign entity does not require the prior approval of the government or the RBI.
      • Examples:
        • Medical devices: up to 100%
        • Thermal power: up to 100%
        • Services under Civil Aviation Services such as Maintenance & Repair Organizations
        • Insurance: up to 49%
        • Infrastructure company in the securities market: up to 49%
        • Ports and shipping
        • Railway infrastructure
        • Pension: up to 49%
        • Power exchanges: up to 49%
        • Petroleum Refining (By PSUs): up to 49%
  • Government Route FDI
    • Under the government route, the foreign entity should compulsorily take the approval of the government.
    • It should file an application through the Foreign Investment Facilitation Portal, which facilitates single-window clearance.
    • This application is then forwarded to the respective ministry or department, which then approves or rejects the application after consultation with the DPIIT.
      • Examples:
        • Broadcasting Content Services: 49%
        • Banking & Public sector: 20%
        • Food Products Retail Trading: 100%
        • Core Investment Company: 100%
        • Multi-Brand Retail Trading: 51%
        • Mining & Minerals separations of titanium bearing minerals and ores: 100%
        • Print Media (publications/printing of scientific and technical magazines/specialty journals/periodicals and a facsimile edition of foreign newspapers): 100%
        • Satellite (Establishment and operations): 100%
        • Print Media (publishing of newspaper, periodicals and Indian editions of foreign magazines dealing with news & current affairs): 26%
Sectors where FDI is prohibited 
  • There are some sectors where any FDI is completely prohibited. They are:
    • Agricultural or Plantation Activities (although there are many exceptions like horticulture, fisheries, tea plantations, Pisciculture, animal husbandry, etc.)
    • Atomic Energy Generation
    • Nidhi Company
    • Lotteries (online, private, government, etc.)
    • Investment in Chit Funds
    • Trading in TDR’s
    • Any Gambling or Betting businesses
    • Cigars, Cigarettes, or any related tobacco industry
    • Housing and Real Estate (except townships, commercial projects, etc.)

What are the factors that affect FDI?
  • Wage rates:
    • One of the major incentives for a company to invest abroad is to outsource labor-intensive production in countries with lower wages.
    • Countries in the Indian subcontinent are one of the major hubs for labor outsourcing.
    • However, the wage rate alone does not determine FDI.
    • It should also be accompanied by other aspects such as infrastructure and transport.
    • In this context, countries that have low transportation costs and have access to sea hold a significant advantage.
    • For instance, a firm may be reluctant to invest in Sub-Saharan Africa because the advantage of the low wage labour force is outweighed by the other drawbacks like high transportation costs and lack of necessary infrastructure.
  • Skilled labor force:
    • Some industries require skilled labour force for its operation. Example: pharmaceuticals and electronics.
    • For instance, India has attracted significant investment in call centers as it has a high percentage of English-speaking population, but wages are low.
    • This makes it an attractive place for outsourcing and therefore attracts investment.
  • Tax rates:
    • Large Multinational Companies like Apple, Google and Microsoft have sought to invest in countries that have lower corporate tax rates.
    • For instance, Ireland has been able to attract high investments from Google and Microsoft due to its low corporate tax rate.
  • Economic growth potential:
    • FDI is often targeted to sell goods directly to the country involved in the investment.
    • Therefore, the size of the population and the economic growth potential plays an important role in attracting investment.
    • For instance, a large country with a huge population that is willing to spend has a large market that allows investors to increase their sales.
    • Small countries, in this context, maybe at a considerable disadvantage as it is not worth investing in a small population.
  • Political stability:
    • FDI is a risky venture.
    • Countries with an uncertain political situation will be a major disincentive.
    • Furthermore, an economic crisis can discourage investment in that country.
    • This is one of the reasons behind many former communist countries from Eastern Europe joined the European Union. EU was seen as a signal of political and economic stability, which encourages foreign investment.
    • Corruption and trust in institutions like judiciary, law, and order also play a crucial role in influencing FDI inflow.
  • Exchange Rates:
    • A weak exchange rate in the host country can attract more FDI as it will be cheaper for companies to purchase assets.
    • However, exchange rate volatility could discourage investment in the country.
  • Free trade:
    • Free trade area, along with low non-tariff barriers attracts huge investments into the country.
    • For instance, UK post-Brexit is likely to be less attractive to FDI due to its restriction on the movement of people and goods.
  • Other Factors:
    • Numerous other factors determine FDI inflow and it is hard to isolate individual factors, as there are many different variables.
    • Some of them include the type of industry, macroeconomic stability, political openness, etc.
Revised FDI Rules 2020

Issues:

  • Recently, India has revised its FDI rules amid the COVID-19 pandemic. Under the revised norms, the automatic route is now closed to investors from India’s land neighbors, with special reference to China.
  • This new regulation is based on the fear that China may take advantage of the rock-bottom valuations of the firms of national importance in the backdrop of the lockdown.
    • For example, recently People’s Bank of China purchased shares of HDFC Bank at a very low price.
  • However, India is facing a dilemma on this front, as the foreign capital remains crucial to the country’s economic success, and will be doubly important as India tries to revive its economy. Thus, India needs to balance its economic needs and combating the neo-imperialist tendencies of China.
  • Companies in any country that shares a border with India will have to approach the government for investing in India and not go via the automatic route.
  • Under the Automatic route, companies only need to inform the authorities after the investment is made Government Approval route. As per the Government route, prior approval is mandatory before investment.
  • In order to restrict Chinese investments, prior government approval has been made mandatory for foreign direct investments (FDI) from countries that share a land border with India.

Key takeaways:

  • Revised FDI policy has stated that entities from countries that share a land border with India will now be permitted to invest only under the approval route. 
  • Previously, only investments from Pakistan and Bangladesh faced such restrictions.
  • The revised FDI policy is aimed at preventing opportunistic takeovers/acquisitions of Indian companies due to the current COVID-19 pandemic. 
  • The rules shall apply to fresh as well as existing FDI. 
  • Transfer of ownership of any existing or future FDI where the direct or indirect beneficiary is from these countries will also require government approval.
  • This restriction will also apply if the beneficial owner of the investment is an entity situated in or a citizen of such countries.

Neo-Imperialism

  • It is the new wave of imperialism reflected by the use of power and economic influence to dominate smaller countries.
  • Modern imperialistic practices like the economic desire for new resources and markets and a “civilizing mission” ethos can be termed as neo-imperialist strategies.

Neo-Imperialist Trade Practices of China

  • The overt objective of revision of this FDI policy is to guard against “opportunistic takeovers and acquisitions” of Indian companies brought about by low valuations amidst the COVID-19 pandemic. However, India is also apprehensive about Chinese investment in the following accounts:
  • China has alleged by both the developing and developed world of its efforts to control infrastructural, industrial and technological assets in these countries. Thereby, seeking to have a strategic advantage through economic interdependence.
  • Ever since China became central to global supply chains, it has used perverse industrial tools to climb the value chain, exacerbate trade imbalances and undermine global competition.
  • For example, cheap imports backed by China's state capitalism have undermined India’s manufacturing sector and led to a massive trade deficit.
  • China has also blocked market access to Indian companies in pharmaceuticals, dairy products, and IT services.
  • This unfavorable balance of trade was one of the main reasons for India to walk out of the RCEP negotiations.

What are the advantages of FDI?
  • Increase in production:
    • Allowing FDI inflow ensures an increase in investment in key areas such as infrastructure development, which may lead to an upsurge in capital goods production.
    • For instance, investment in power generation can generate more electric power, which would enable the growth of more industries.
  • Increase in capital inflow:
    • FDI promotes more capital inflow into the countries, especially in key sectors.
    • It can address the shortage of money and materials, which can rapidly enhance the growth of the country.
  • Increase in employment opportunities:
    • FDIs in developing countries have enhanced the service sectors.
    • This increased the employment opportunities within these countries, leading to an increase in economic growth.
    • Educated unemployment has also been reduced by the FDIs as they can absorb some of the workforces.
  • Strengthening of financial services:
    • FDIs can enhance the financial services of a country by not only entering its banking industry but also by extending other activities like merchant banking, portfolio investment, etc.
    • This, in turn, can result in the promotion of more companies.
    • It has also helped the capital market within the country.
  • Exchange rate stability:
    • RBI has been maintaining the exchange rate in the country through its exchange control measures.
    • However, the constant and continuous supply of foreign exchange is vital for the continuation of exchange rate stability.
    • FDI inflow plays a crucial role in this aspect by helping RBI to have a comfortable foreign exchange reserve position of more than 1 billion dollars.
  • Economic development:
    • FDIs, in the past, have played a crucial role in developing backward areas by starting industries.
    • This resulted in many of these areas becoming industrial centers, with improvement in the standard of living of the people in these areas.
  • Efficient use of natural resources:
    • The natural resources in the country are put to better use by the FDI, which may otherwise have been unutilized.
  • Improved knowledge and technology:
    • One of the crucial benefits received by the host countries through the FDIs is access to new technologies and expertise from foreign companies.
    • This can result in the enhancement of the country’s growth potential.
  • Maintenance of Balance of Payments:
    • FDI growth can help maintain the Balance of Payments.
    • It can also maintain the value of countries’ currencies.
What are the issues that may arise due to FDI?
  • Foreign ownership of strategically important sectors cannot favor the countries.
  • Foreign investors might strip the business of its value.
  • They could sell unprofitable portions of the company to the local, less sophisticated investors.
  • They can use the company’s collaterals to get low-cost, local loans.
  • Instead of reinvesting it, they lend the funds back to the parent company.
  • The MNCs, through FDIs, can get controlling rights within the foreign countries.
  • FDI can also be a convenient way to bypass local environmental laws.
  • Developing countries are tempted to reduce environmental regulations to attract FDI inflows.
  • FDI does not always benefit host countries as it enables foreign multinationals to gain from ownership of raw materials and even exploit labour force by not distributing its wealth to the backward society.
  • MNCs are often criticized for their poor working conditions in foreign countries.
  • The entry of large firms can often displace local businesses and may drive them out, as these small companies cannot compete.
FDI in Retail Background
  • The Indian retail market is said to be worth USD 600 billion. It comes in the top-five retail markets worldwide by economic value.
  • It is also one of the fastest-growing markets with a surging population of more than a billion people. The retail market is expected to grow tremendously.
  • The total consumption expenditure is estimated to reach about USD 3600 billion by 2020. The retail market is expected to reach USD 1.1 trillion by 2020. Online retail sales are also estimated to grow at a rate of more than 30%.
  • In terms of economy, retail is one of the pillars of the Indian economy with the sector contributing to about 10% of the Gross Domestic Product (GDP).
  • In this sector, the organized sector is merely 9% and the unorganized sector dominates.
  • A maximum number of retailers operate out of less than 500 sq. feet of retail space. The unorganized retail sector also absorbs about 7% of the labor force in India.
  • The central government has approved 100% FDI in single-brand retail and 51% FDI in multi-brand retail.

Organised and unorganised retail:

  • Unorganised retail, which forms the bulk of the retail industry in India, is composed of local kirana stores, owner-managed single general stores, beedi/pan shops, convenience stores, hawkers and pavement vendors, etc.
  • Organised sector comprises of corporate-backed retail chains, supermarkets, and department stores that are able to sell only under a license and are liable to huge volumes of sales and taxes.

 

What are the recent initiatives taken by the government to increase FDI inflow?
  • The government has been liberalising policies to include more items in the automatic list rather than the restrictive list.
  • In December 2019, the government had permitted 26% FDI in digital sectors.
  • In August 2019, the government permitted 100% FDI under the automatic route in coal mining for open sale (as well as in developing allied infrastructures like washeries).
  • In the Union Budget 2019-2020, the Indian Government had proposed opening of FDI in aviation, media and insurance sectors in consultation with all stakeholders.
  • In March 2020, the government had permitted non-residential Indians (NRIs) to acquire up to 100% stake in Air India.
  • 100% FDI is also permitted for insurance intermediaries.
  • In February 2019, the government of India released the Draft National E-Commerce Policy, which encourages FDI in the market place model of e-commerce.
  • In September 2018, the government released the National Digital Communications Policy, 2018, which aims to increase FDI inflows in the telecommunications sector to $100 billion by 2022.
  • In January 2018, the government allowed foreign airlines to invest in Air India up to 49% with government approval. The investment cannot exceed 49% directly or indirectly.
  • Government approval is not required for FDI up to an extent of 100% in Real Estate Broking services.
  • The government is planning to continue with the FDI relaxations in more sectors to attract more investors into the country.
  • Foreign companies look into the World Bank’s Ease of Doing Business ranking before investing in a country and India has improved its ranking as it jumped to 63rd position in the latest ranking.
Which are the agencies that monitor FDI trends across the world?
  • Three agencies keep track of FDI statistics. They are as follows:
    • UN Conference on Trade and Development (UNCTAD) publishes Global Investment Trends Monitor to summarise FDI trends across the world.
    • The Organisation for Economic Cooperation and Development (OECD) publishes quarterly FDI statistics for several countries. It reports on both inflows and outflows.
    • The IMF published its first Worldwide Survey of Foreign Direct Investment Positions in the year 2010. This annual survey covers investment positions for 72 countries.
How would the Coronavirus outbreak affect global FDI?
  • The outbreak of COVID-19 is expected to adversely affect the global FDI flows.
  • Those countries that are severely hit by the pandemic will be the most affected, although negative demand shocks and the economic impact of supply chain disruptions will affect the investment prospects of other countries.
  • Many MNEs have issued statements on the impact of COVID-19 on their businesses.
  • Many are slowing down capital expenditures in affected areas.
  • Also, lower profits will translate into lower reinvested earnings (a major component of FDI).
  • On average, major MNEs that account for a significant share of global FDI, have seen downward revisions of 2020 earnings estimates of 9% due to COVID-19.
  • The worst-hit includes the automotive industry, airlines, energy and basic materials industries.
  • MNE profits based in emerging economies are predicted to be more at risk than those of developed country MNEs.
  • Other aspects that will be affected include the on-going greenfield investment projects, announcement of new greenfield projects and mergers and acquisitions (M&As).
  • According to a report by UBS, an investment banking company, multinational companies looking to diversify their supply chains away from China due to trade protectionist measures and rising risks of coronavirus, could look at India as an alternative as it is the top destination for companies moving out of China.
  • For this to happen, India must provide necessary facilities like land and electricity, along with easier clearance procedures and lower tax rates.
Way Forward
  • The Department of Promotion of Industry and Internal trade should work out a clear process and precise regulations to decide what is an acceptable investment.
  • India should welcome investment in enhancing the country’s productive capacity regardless of where it comes from, except, of course, in sectors where control of that production capacity has a bearing on national security.
  • There is a need for India to develop new legal and institutional tools. As the ones employed by US and EU member states such as data protection laws or revised mergers and acquisitions rules, and institutional bodies.
  • Without the appropriate legal and regulatory sanction, India might experience reciprocal measures.
  • In order to protect India’s unicorn, there is a need to devise a scheme of preferential or special shares that a unicorn can issue to the foreign investor.
  • These shares will preserve the decision making by Indian innovators, while also providing them access to foreign capital.
  • At this crucial juncture of economics, where the world is witnessing another economic crisis, India needs to expand its overseas economic engagements, even while remaining sensitive to its overall economic sustainability needs.
Conclusion
  • Currently, some of the top recipients of the FDI inflow like the US and China are reeling under the numerous pressures like trade tensions and coronavirus outbreak.
  • Taking advantage of this situation, India can attract more FDI inflows by addressing the issues of land acquisitions, taxation, etc.



Please Share with maximum friends to support the Initiative.

Enquire now

Give us a call or fill in the form below and we will contact you. We endeavor to answer all inquiries within 24 hours on business days.