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What Does India’s Foreign Direct Investment Policy Mean For Businesses?

By News Creatives Authors , in Small Business , at August 6, 2021

Managing Partner, BTG Legal (India) | Lawyer specializing in investigation support and dispute management | Read Prashant’s full profile.

In 2020, the Indian government amended its foreign direct investment policy and made it mandatory for companies based in countries sharing a border with India to acquire government approval prior to investing in India-based businesses. According to Reuters, this move was meant to “deter ‘opportunistic’ takeovers and acquisitions during the pandemic,” and there is no “sunset clause” for the policy.

As the managing partner of a law firm based in India, this is a change I’ve been paying close attention to. Below are some of the impacts I’ve observed, along with what I believe it could mean for business leaders.

What are the effects of this change?

From my perspective, this policy change had immediate ramifications. A few months after the policy was established, the Indian government banned 59 Chinese applications operating in India, according to Quartz India. And it reserves the right to review any future Chinese investments in the Indian market. Foreign investment in India also faces a higher level of scrutiny to monitor instances of tax avoidance and anti-money laundering. This shows me the government has prioritized ensuring the protection of national security and national interests by strictly regulating key sectors such as defense, e-commerce (inventory models), key infrastructure, digital news, telecommunications, etc.

Although I find the Indian investment regime is inclined toward liberalization, the FDI policy is complex and takes into account the nature of the specific sector and the impact of allowing foreign investment. Although there is no centralized and overarching legislation like the Committee on Foreign Investment in the United States, the way the policy is structured enables frequent revisions and further sectoral blocks. Combined with the restrictions on investment forms and instruments, I believe it is safe to conclude that it is not the easiest to navigate and provides the government with sufficient leeway to block investments that it does not consider to be in the national interest.

While the overall objective — national security or national interest — is a common enough ground for governments to want to retain oversight and veto over investments, I believe the issue is exacerbated due to the lack of predictability (and, to a certain extent, transparency in the criteria used) in the decision-making process. This extends to gray areas such as news, online gaming and e-commerce. In addition, the involvement of multiple agencies in the decision-making process can add to an ad hoc approach.

Is a regulatory body needed?

In recent months, there has been a call for the establishment of an FDI regulatory body, similar to the Committee on Foreign Investment in the United States. Although CFIUS has certain advantages, there are concerns that a similar agency would not necessarily mean a solution to the existing challenges. My view is that it would add a layer to those challenges while severely discouraging foreign investment.

From my perspective, the Indian government recognizes the importance of foreign direct investments, especially in the current global economic downturn. But it cannot afford to treat certain routes of money flow as pariah jurisdictions. For instance, between 2019 and 2020, FDI from the Cayman Islands increased “three-fold” compared to the previous year. At the same time, the government appears to be keen to retain oversight over investments, which seems to be inevitable given the contraction of globalization in many other parts of the world.

The need of the hour is probably not another regulator but a certain amount of predictability and certainty in the manner in which foreign investments will be scrutinized. Ever since the infamous Vodafone decision, I believe regular flip-flopping on how investments will be treated could have shaken foreign investors. The latest telecom AGR rulings and the challenges facing e-commerce and defense companies don’t help this perception. I believe the government should streamline the FDI policy and also provide clear guidance on all allied areas that are relevant from a sectoral perspective. This would, in my opinion, go a long way in improving the confidence of foreign investors in India as a stable market for investments.

What does this mean for business leaders?

In terms of the impact of these policy changes on investors in India, it is notable that these FDI restrictions already applied to Pakistan and Bangladesh. Since investments in India from other neighboring countries is negligible, it is evident to me that these actions appear to be directed toward China, as a reaction to changing relationships between the two countries. (It’s worth noting the Times of India reported in February the government was beginning to clear FDI proposals from China “on a ‘case-by-case’ basis, ending the freeze on such clearances that lasted around nine months.”)

The new rules apply to existing and planned investments by foreign firms, which will significantly impact startups, many of which receive funding from Chinese investors. The effects of the increased regulations already became evident in the latter half of 2020, where companies have found difficulty in receiving additional tranches of equity capital originating in countries that share a land border with India.

These rules are also likely to impact global transactions where target companies being acquired by investors from India’s neighboring countries have a subsidiary based in India. However, I believe the revised policy is unlikely to really impact companies in India that already have such investors as major stakeholders or companies that are wholly owned subsidiaries, wherein any further transactions will not lead to a change in ownership.

In the long term, perhaps these regulations could lead to loss of investments and a halt in plans for expansion by business owners. However, India is not alone in this endeavor: The European Commission, for example, also issued guidelines meant to protect critical assets during the pandemic, and similarly tightened laws have also been seen in Australia.

Based on recent developments, it is clear the Indian government continues to prioritize increased foreign investment and is likely to deal with approval requests swiftly. Business leaders may have to prepare for increased processing windows for their investments, but from my perspective, the decision is unlikely to have any greater implications on their ability to invest.

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