Introduction to Foreign Direct Investment (FDI)
On April 18, 2020, the Central government amended the consolidated FDI Policy of 2017 with the stated view of curbing ‘opportunistic takeovers/acquisitions of Indian companies’ due to the COVID-19 pandemic.
In a major change to its Foreign Direct Investment(FDI) policy, the government over the weekend has mandated that all the investments from neighboring countries including China would now require government approval. This effectively closes the automatic route for these nations investing in India. In this article, we will analyze the reason behind this new policy change, and what would this mean for the Indian economy and for its trait.
Restrictions & Modifications
Press Note No. 3 of 2020, issued by the Department of Promotion of Industry and Internal Trade (DPIIT) amends paragraph 3.1.1 of the FDI Policy to introduce the following two new restrictions while leaving prior restrictions intact.
An entity of a country that shares a land border with India or where the beneficial owner of investment into India is situated in or is a citizen of any such country can invest only under the Government route.
Government approval will also be required by subsequent changes in beneficial ownership whether by way of direct or indirect transfers of any existing or future FDI would result in such beneficial ownership falling within the purview of the first restriction.
The revised policy and the amendments made in the FDI policy of 2017 has now brought Chinese companies under the govt route-filter. However, earlier, the policy limited only Bangladesh and Pakistan to go through the government route of go-ahead.
Impacts of FDI
One of the major questions that come in mind is whether the action taken by the government with respect to tightening the curbs of FDI is a timely move or not?
At a time like this, we’re not only susceptible to fear of acquisitions from countries that share a border but all over that the government should have specified on not just certain countries but maybe made the spectrum a little broader?
Well, it is clear that the move is more aimed at our neighbors because right since the inception, the FDI Policy of 2017 had restricted the investments coming in from Bangladesh where it was already a part of the prior government approval and the same was also true of Pakistan, so all that has been clarified is that it should extend to every country where a common border has been shared.
What needs to be understood here is that the approval doesn’t mean the prohibition of investments. There are already may sectors where this approval has been required. And countries like Italy, Germany, Australia, and Spain are also tightening their foreign investment policies.
Thus, India is not the only country that is erecting barriers for cross-border investments being made from China. The European Union is considering a plan through which it can empower the states to block the unfair competition being originated from enterprises, which are backed up by the governments. This plan is aimed at China too. The main motive is to prevent any hostile takeovers by overseas investors amid the COVID-19 pandemic.
Curbing opportunistic takeovers
The government has revised its FDI policy to curb the opportunistic takeovers or acquisitions of Indian companies. This means that companies of the 7 nations i.e. Bangladesh, China, Pakistan, Nepal, Myanmar, Bhutan, and Afghanistan will have to approach the government for a go-ahead for investing in India, rather than going via the automatic route.
The amended policy is applicable in cases of large shareholdings of 10% and above. Sectors including defense, pharmaceuticals, and telecom, etc will need prior government approval if any company from abroad sharing boundaries with India, wants to invest beyond the specified percentage.
The Centre’s concern was that Chinese firms including mammoth state-run companies might take over Indian companies at a time when their financial strenth and valuations have taken a massive hit due to the economical recession caused by the COVID-19 pandemic.
The move has been warranted especially during this time when India Inc. has to recover and stand on its feet as soon as possible. The FDI being subjected to government approval will help in monitoring India’s FDI in cases where the acquisitions and takeovers of the Indian entities are done at low valuations.
How will this affect the Indian economy
India is already vulnerable in areas like pharmaceutical industries as the Chinese competitors have manipulated the domestic manufacturing of key pharma ingredients and chemicals. A transfer for ownership in an FDI deal that benefits any country that shares a border with India will need prior approval from the government.
The move has been aimed to stop overseas countries and investors from exploiting the domestic markets of our country using cheap-valuations amid the economic depression conditions in the country. It will act as a safeguard against the investors which are fishing for the distressed entities in need of cash due to the lockdown and post– COVID-19 scenarios.
Impact of F.D.I. policy amendments on startups
There has been a sudden upsurge of China’s investments in India, in the last five years. Currently, there are 23 unicorns in India. The term ‘unicorn’ is used for startups with more than $1 billion in value. And out of these 23 unicorns, 18 of them have some investments from China. Some of these startups are OYO, BYJU’s, Paytm, Swiggy, etc.
The Chinese capital and investments in the tech- startups have helped India to increase the use of digital payments across the country. So, now that the wall has been raised, it must be kept in mind that the approvals in the tech start-up space should be quick in cases where the investors are tapped for a ‘top-up investment’ and ‘cash burn’ is high.
Investors and startup founders have highly criticised the Centre’s move pointing out the capital deficiency already faced by them in the country. It is an undisputed fact that there isn’t enough domestic capital for these startups to sustain, and this move will not hurt the investors but the economy of India.
Thus, the amendment will surely impact the startups as their biggest backers will be going through prior governmental approval as per the new FDI policy. As of now, the startup ecosystem is waiting for detailed notification and further clarifications as per the FEMA(Foreign Exchange Management Act) and the RBI.
How has China responded to FDI’s policy revision?
On 20th April, China asked India to revise the amendments made in the Foreign Direct Investment regulations and called the changes to be ‘discriminatory’, aimed at preventing opportunistic takeovers of Indian firms amid the COVID-19 crisis. The revised policy is not applicable to the recent 1.01% sale by mortgage lender HDFC, to the People’s Bank of China (PBC), as the deal was less than the strategic 10%.
“We hope India would revise relevant discriminatory practices, treat investments from different countries equally, and foster an open, fair and equitable business environment. These additional barriers set by India for investors from specific countries violate WTO’s principle of non-discrimination and go against the general trend of liberalization and facilitation of trade and investment.”The official statement of Ji Rong, who is the spokesperson of the Chinese embassy
Chinese cumulative investment in India is more than $8 Billion, which is a lot more than the total investments made in India, by other neighboring countries. This amendment will act as a barrier for companies sharing land borders with India, to invest in the country.
It has also been contended that these changes do not conform to the consensus of G20 leaders and trade ministers to have a free, fair, non-discriminatory, transparent, predictable environment of trading and investments, and to keep the markets open.
Although there hasn’t been any official response to the statements of Ji Rong, the people who are aware of the matter are of the view that the Centre can’t allow any vulnerabilities created by the COVID-19 pandemic to be further exploited by any country, including China.
Are these changes violation of the WTO principals?
The move is said to be a pre-emptive action that was needed to protect the assets of India from any hostile takeovers, especially in case of startups that have limited financial resources. In an unofficial statement and on the condition of anonymity, it has been said that the move was felt to be necessary not just by India, but many other powerful countries who are a part of the G20 nations. These countries have also expressed their serious concerns about Chinese designs.
China has itself put restrictions for entry of firms including from India in an effort to protect its own interest. Similarly, the FDI policy change made by India is aimed at deterring foreign investors, like China from distressing the Indian businesses or the investments in enterprises that are facing financial crunch due to the pandemic.
The need to protect domestic interests has been highlighted saying that due to the actions of Chinese investors, and such actions being backed from the China government are not fair business as usual. The Indian government is not entirely closing the doors to Chinese FDI, as is pronounced in cases of tech-startups. However, prior to govt. approval is mandatory even if its a minuscule amount of transaction.
A nuanced understanding of the announcements made by the Central government will show that the step has been taken in an effort of prioritizing national security. The vulnerabilities faced by the country need a recalculation based on a perceptible change that has been made in China’s strategic policies.
What else could have been done?
At a time of a global pandemic, and unforeseeable crisis due to COVID-19, it is a time when countries need to come together and create a favorable investment environment. Which will help in the redemption of losses being faced by the production, supply chain, and other industrial sectors of the country? Does a question arise that this erection of firewall against China might hurt India and thus resulting in a backfire?
There is no doubt that India is in a dire and desperate need for additional investments from every possible source. These, panic restrictions might appear as a defense in the short run but can be ridiculous in the longer run. We must not forget that India owed its transition to a miracle economy in the 2000s to the increased inflow of FDI’s and FPI’s (Foreign Portfolio investments). Back then, the valuations of Indian companies were done at a far cheaper rate than today, still, the economy had a growth rate of 8 percent annually.
Also, the ‘opportunistic takeovers’ which the government is trying to curb, can be doubtful due to the fact that no one knows when falling stocks become bargains. As the stock market saying goes ‘Never catch an old knife’, it is important for the Centre to carefully analyze the implications of the FDI policy amendments.
Almost every fortune 500 company now has some of the other operations in India,
for e.g. Microsoft, Amazon, Ford, Suzuki, Nestle, GE, etc. They have successfully dominated the production and other sectors of the market, but have not threatened India’s security not made it a puppet.
Thus, a nuanced approach to Chinese investments using automatic routes only may have been a better solution. Also, India may seek favor from all foreign investors, including China, and still, have a strategy for boundaries preventing hostile takeovers.
A very successful way of doing this could be by keeping Greenfield investments out of the purview of this policy change. The reason being that such investments don’t impose any major threat of takeovers of the existing business or companies. Rather it eventually helps in creating new opportunities and building capacities of the business sector of the country.
A major factor that determines the amount of investment and the operation of industries is the economic policies, business environment. And other fundamentals like international relations of the country (in this case, India). It is true that the development of Indian industries such as that in the telecom sector, aviation sector, infrastructure, and the automobile sector, etc is influenced and driven by the investors of China and other neighboring countries of India.
But, India has compelling reasons to take such actions. It’s not only because of the unresolved border issues with China, or the country’s support to Pakistan undermining India’s fight against cross-border terrorism. But also because of the disquiet about the role that China played in releasing warnings to other countries in a time-bound manner. And containing the further spread of this highly contagious virus.
There are still many unanswered questions like what will happen to investments that come through the market route? How will they be regulated? Also, what about the FDI’s that come via countries not sharing boundaries with India. But trace their beneficiary ownership to China or any other neighboring country?
Another major unanswered question is that the PN3 uses the terms “beneficial owners” and “beneficial ownership”. However, the same has not been defined anywhere. As per the Companies Act, 2013, or the RBI’s Master Direction- KYC, 2016. These terms have very different meanings, creating difficulty in determining the ambit of restrictions.
Thus, we can say that this move to end the automatic entry of the neighboring country’s investments in India. It is a prudent step ensuring the existence of the domestic industries of our country. Otherwise, the foreign investments can be used as a vehicle for political takeovers, and the history could repeat itself like in the case of the East India Company.
However, a more nuanced approach is required and clarifications need to be made in the implementation. And of the ambit of the restrictions being made via the FDI policy revisions.
This Article is written by Akarsh Tripathi, student of 1st year at Symbiosis Law School, Noida. Read More by him: COVID-19 and Biomedical Waste – By Akarsh Tripathi
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