As someone who has constantly written about further liberalising the Foreign Direct Investment (FDI) regime in India, my wait for the bi-annual consolidated FDI policy (Policy) is akin to the eagerness with which Harry Potter fans waited for the next novel from the Rowling stable. As a legal practitioner, one often notes that a lot of proposed FDI investments are put on hold in anticipation of the changes the new Policy may introduce. This could in part explain the sharp decline in FDI into India in recent months. One hopes that the new Policy, effective April 1, 2011, will help boost FDI, with some of the major changes being the removal of the condition of prior approval in case of existing joint ventures, the pricing of convertible instruments, clarity on the guidelines relating to downstream investments, the inclusion of fresh items for issue of shares against non-cash considerations and, finally, permission for FDI in the development and production of seeds and planting material. Let’s understand the implications of the primary changes in the new Policy in some detail.
Until the new Policy, foreign companies, which had a venture existing in India dating prior to 2005, were required to obtain a no-objection from their local partner before they could set up a fresh business in the same field. Originally intended to safeguard local industry, this rule was grossly misused by domestic companies to extract their pound of flesh from foreign partners. This finds support in the fact that in 2009, 16% of the proposals reviewed by FIPB related to existing venture/tie-up conditions. In response to a discussion paper issued by the Department of Industrial Policy and Promotion (DIPP) on this subject, I had advocated the need to completely abolish this requirement. Hence, this much-awaited change marks a significant decision.
In keeping with government expectations, one hopes that this change will “promote the competitiveness of India as an investment destination and be instrumental in attracting higher levels of FDI and technology inflows into the country”.
At present, Indian companies can issue equity shares or fully, compulsorily and mandatorily convertible debentures and/or preference shares, all of which are included in the definition of capital. Until the current Policy, the pricing of capital instruments (including convertibles) were required to be determined upfront, like at the time of issuance of the instrument. Practically, this defeated the whole purpose of convertibles. I had previously voiced the opinion that this matter required the immediate attention of the DIPP. The new Policy proposes that instead of specifying the price of convertible instruments upfront, companies will now have the option of prescribing a conversion formula at the time of issue of the instruments. It further clarifies that the price at the time of conversion should not be lower than the fair value worked out at the time of issuance of such instruments, in accordance with the extant FEMA or Sebi guidelines on pricing. Fixing the issue price on the date of the issue itself takes away some of the risks for private equity and financial investors who like investing through convertibles. As the press release relating to the new Policy notes, this would also help recipient companies obtain a better valuation based on their performance. Additionally, this change will help startups, where the potential lies in the future, attract greater FDI.
The issue of ownership and/or control, both by foreign investors and by Indian residents, where such Indian residents further have non-resident investments, has been a complicated matter and one of constant concern. This issue assumes even greater importance when the above-mentioned investors make downstream investments in sectors with caps on FDI. The fact that this matter required clarity was also something I have previously written about. And while the new Policy doesn’t completely clear the air regarding the subject, it does away with the earlier categorisation of investing companies, operating companies and investing-cum-operating companies. In its attempt to simplify and rationalise the guidelines in relation to ownership and control, companies under the new Policy are now classified into only two categories: “companies owned or controlled by foreign investors” and “companies owned and controlled by Indian residents”. Foreign investment through an investing Indian company would not be considered for calculation of the indirect foreign investment in the case of Indian companies that are owned and controlled by resident Indian citizens. But where the investing company is owned or controlled by non-resident entities, then the entire investment by the investing company into the Indian company would be considered as indirect foreign investment. In the latter case, investments by the intermediate companies would have to comply with the sectoral caps and other regulatory conditions.
Barring a few exceptions, the issue of shares to a foreign investor for consideration other than cash requires government approval, which is difficult to obtain. The new Policy now permits the issue of equity under the government route and subject to specific conditions even for the import of capital goods/machinery/equipment (including second-hand equipment) and for pre-operative/pre-incorporation expenses. This change will help Indian companies, who cannot afford upfront payments, to pay through their shares and makes the foreign supplier an equal risk-taker with the Indian company.
There is little doubt that all of the changes proposed are intended to promote FDI through a policy framework that is transparent and simple, and that attempts to reduce the regulatory burden. Clear efforts are also being made to make the Policy investor-friendly. And unlike the fantasy wizarding world where much can be achieved with the wave of a wand, in real life, and especially given coalition politics, changes to policy require careful deliberation and feedback from various constituents. Hence, for the next six months I once again assume the eagerness of a Harry Potter fan, hoping that in its next revision the government will open up multi-brand retail to foreign investment, increase the sectoral cap in the insurance sector, increase FDI limits in defence and permit FDI in limited liability partnerships. Like in the battle against the Dark Forces, let’s hope that the evil of regulatory restrictions is eventually vanquished and, more importantly, wish that nothing jinxes our hopes.
First Published in the Financial Express on April 12, 2011