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October 05, 2016

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FDI and Investment Climate In India


- Smruti Shah, Partner [ Cyril Amarchand Mangaldas ]
- Saloni Shroff, Associate [ Cyril Amarchand Mangaldas ]

smrutishah_salonishroff

Despite multiple hurdles, India continues to be a bright spot for foreign investors; it has replaced China as the top destination for FDI by capital investment and has surpassed the United States

The Indian government, under the leadership of Prime Minister Narendra Modi, has been making a constant effort to make India a more attractive investment destination. Prime Minister Modi has given Amitabh Kant, CEO of Niti Aayog, a government institution which catalyses economic development in India, a mandate to bring India up in the ranks in Ease of Doing Business Index by the World Bank. After its ranking at 134 last year, India now ranks 130 out of 189 countries in the Ease of Doing Business Index. Prime Minister Modi has been engaged in an exceptionally busy and a highly personalised style of diplomacy with an aim to recalibrate India’s external engagements that saw an improvement of ties with major powers like the United States, China, France and Japan.

The Government has made many policy changes to bring in foreign investment and economic reforms. Soon after his election, Modi liberalised many sectors including defence, railways, civil aviation, broadcasting, pharmaceuticals, and many more and helped cut red tape. Many of these sectors such as defence and railways have traditionally been controlled by the government. Additionally, the changing course of economic liberalisation, generational shift among leaders and eroding strength of national parties in states has transformed the structure of federalism in India and re-written equations between the States and the Centre, with the States getting more fiscal freedom and state-oriented private investment to implement their own course of development. States have realised the importance of investment from large and multi-national companies, and hence, have been vying for investment with each other. They are conducting investment summits and road shows to create more visibility of their state to investors and making policy changes to attract more investment.

In terms of cross-border mergers and acquisitions (“M&A”) deal activity, for inbound activity during the first six months of 2016, there were 82 deals struck, worth USD 8.9 billion. This is an increase of 21.9% in value from the first half of 2015, which saw deals worth USD 7.3 billion. As a whole including both cross-border and domestic M&A activity, India recorded 162 M&A transactions worth USD 17.5 billion in the first six months of 2016. There is a lot more domestic M&A deal activity taking place in India with the sale of distressed assets.

FDI

FDI Policy

In furtherance of the Indian Government’s continuing endeavour to liberalise India’s FDI framework (under the Consolidated FDI Policy (“FDI Policy”) for foreign investors, it has made many changes to the FDI regime. In Press Note 5 (2016 Series) (“Press Note”), the Indian Government has reviewed the FDI policy in various sectors. We hope that this will provide a major impetus to employment and job creation, incentivise industrialisation and attract greater influx of FDI into India. There have been many changes, which can be clubbed into three categories: 1) increase in sectoral caps; 2) sectors brought under the automatic route, and hence do not need government approval; and 3) liberalisation of sectoral conditions.

Pharmaceutical

The FDI Policy permitted 100% FDI under the automatic route (i.e., without prior government approval) in a ‘Greenfield’ pharmaceutical entity and 100% FDI under the Government route (i.e., with prior government approval) in a ‘Brownfield’ pharmaceutical entity. This policy has now been relaxed and FDI investment in a Brownfield pharmaceutical entity is now permitted up to 74% under the automatic route. Investment above 74% in a Brownfield pharmaceutical entity would continue to be under the government route. Furthermore, a non-compete clause would not be permitted in the automatic or government approval route except in special circumstances with the approval of the Foreign Investment Promotion Board (“FIPB’).

Defence

FDI in the defence sector up to 49% was permitted under the automatic route; and any investment above 49% was permitted under the government route, on a case-to-case basis, depending on whether such FDI investment was likely to result in India getting access to modern and ‘stateof- the-art’ technology. While there has been no change to sectoral caps as provided in the erstwhile FDI Policy, there is now a key change which has been made by deleting the requirement of ‘state-of-the-art’ technology and permitting approval under the government route, for FDI beyond 49%. The approval will be granted under the government route, provided there is access to modern technology or for ‘other reasons’ to be recorded in writing.

Another key change is the extension of existing FDI limits to allow foreign entities to enter manufacturing of small arms and ammunitions under the Arms Act, 1959, which was until recently reserved exclusively for Government of India agencies. It may be noted that ‘small arms’ would include revolvers, self-loading pistols, rifles, carbines, submachine guns, assault rifles, light machine guns, certain caliber of shotguns and sporting rifles, as well as their parts, components and ammunition.

Single-Brand Retail Trading

Under the erstwhile FDI Policy, FDI above 49% in single brand product retail trading (“SBPRT”) was permitted under the government route. Additionally, where such FDI exceeded 51%, certain additional conditions were imposed, including restrictions on sourcing of materials. This specific condition on sourcing mandated that 30% of the value of goods would have to be sourced from within India, preferably from micro, small and medium enterprises, cottage industries and artisans/craftsmen (“Domestic Sourcing”). There were additional stipulations on the operation and compliance of the Domestic Sourcing norms. The Press Note has sought to relax the Domestic Sourcing norms and accordingly, for SBPRT entities whose products possess state-of-the-art and cutting-edge technology, there will be relaxed Domestic Sourcing norms for up to 3 years. Foreign investment in SBPRT is aimed at attracting investments in production and marketing, improving the availability of such goods for the consumer, encouraging increased sourcing of goods from India, and enhancing competitiveness of Indian enterprises through access to global designs, technologies, and management practices.

Civil Aviation and Private Security Agencies

The sectoral caps have also increased for the airport sector, civil aviation, and private security agencies. 100% FDI is permitted under the automatic route for FDI in existing and Greenfield airport projects. 100% FDI is now permitted for scheduled air transport services/domestic scheduled passenger airline and regional air transport services with up to 49% being under the automatic route and above 49% being under the government route. It may be noted that the limit of up to 49% under the government route and other conditionalities for foreign airlines investing in the capital of Indian companies operating scheduled and nonscheduled air transport services, continue to apply. For private security agencies, 74% FDI is permitted with up to Associate, Cyril Amarchand Mangaldas 49% being under the automatic route and beyond 49% and up to 74% being under the government route.

The Government has now also eased establishing of Branch Office, Liaison Office and Project Office. Establishment of Branch/Liaison/Project Offices in India was regulated in terms of Section 6(6) of Foreign Exchange Management Act, 1999 (“FEMA”) read with Notification No. FEMA 22/2000- RB dated May 3, 2000 (“Former Law”). Under the Former Law, a foreign entity (including a firm or other association of individuals) can open a Branch Office or a Liaison Office in India only with the prior approval of the Reserve Bank of India (“RBI”). However, for Branch Office or a Liaison Office where principal business of the foreign entity falls under the sectors where 100% FDI is not permitted under the automatic route and foreign non-governmental organizations, non-profit organizations and foreign government bodies and departments desirous of opening a Branch Office or a Liaison Office or a Project Office, the applications will be considered by the RBI in consultation with the Ministry of Finance.

In order to avoid duplication of the approval process, the Press Note now provides that a foreign entity seeking to establish a Branch Office or a Liaison Office or a Project Office where the principal business of the applicant is in the defence, telecom, private security or information and broadcasting sectors and where the approval by the FIPB or license/permission by the concerned ministry or regulator has been granted, then an approval from the RBI would not be required.

Drawbacks: Issues Yet to Be Sorted

In 2014, foreign investors were banking on Prime Minister Modi and were ready to pour in a cumulative of up to USD 60 billion, which amounts to over 100% increase in foreign investment inflows. However, not much has materialised compared to what was expected. The Government needs to focus on improving on the policies and processes for land acquisition, electricity, and availability of funds.

For new investors, dealing with the framework consisting of multiple regulators including the RBI, Department of Industrial Policy and Promotion, and FIPB can be challenging. Sectoral regulators may also be required to be approached in certain cases (Home-Pension Fund Regulatory and Development Authority in case of pension sector or Telecom Regulatory Authority of India for telecom sector or Insurance Regulatory and Development Authority for insurance sector). The challenges faced by investors include access to all information/data analysis to investors across all sectors, bottlenecks with respect to follow up on information/approvals from all departments/agencies of Government on behalf of the investor and the investing community, absence of framework for handholding the investor from the point of arrival to the point of departure, and absence of framework for interacting with all States in a Hub & Spoke Model and feeding the investors with State policies relating to land/labour/capital and investment. In order to eliminate the above challenges, a dedicated ‘Investor Facilitation Cell’ has been set up by the Government of India to act as primary support for all investment queries and for providing handholding and liaising services to investors.

Availability of funds is rather difficult as credit is difficult and expensive to get. The traditional form of funding has been difficult to obtain, given the apprehensions to accept the risk of lending to companies. India’s answer to address availability of funds is Masala Bonds. Masala Bonds are rupee-denominated bonds issued overseas to offshore investors. The International Finance Corporation, the investment arm of the World Bank, in November 2014, issued a INR 1,000 crore bond to fund infrastructure projects in India. These bonds were listed on the London Stock Exchange.

Land Acquisition in India was governed by the Land Acquisition Act of 1894. However, this Act was deemed to be very outdated and therefore, the Indian Parliament passed the Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013 (“LARR”). The LARR came into force on January 01, 2014. There are still many issues concerning Land Acquisition in India. Briefly, these include: 1) availability of contiguous land to contain project cost escalation and project timelines as landowners are often wary of selling, given the potential future price appreciation and nontransparent price benchmarks; 2) time-consuming process where the average time taken to acquire land is 14 months; 3) multiple department approvals which incur high costs and transaction fees; 4) issue of eminent domain which often results in clashes between sovereign and business houses; 5) uncertainty due to unsecured land titles and many other reasons.

As the Indian Government is focussed on making India attractive for foreign investment and has been proactive on pushing for economic reforms, there are many laws which need to be aligned with this vision. There are still many compliances under environmental laws which investors will have to be wary of. Indian laws still don’t grant protection for intellectual property registered outside India. Additionally, the investor must bear in mind issues relating to contract labour and labour/trade unions.

Nonetheless, even with all of the abovementioned hurdles which investors may find tricky to overcome, India continues to be a bright spot for foreign investors. Looking at the global market, India remains as a promising destination. It replaces China as the top destination for FDI by capital investment, and has surpassed the United States. The States of Gujarat and Maharashtra remain as strong performers in terms of attracting investment. While Prime Minister Modi has been aggressive on making India a manufacturing hub with his Make in India campaign, India is emerging as a key destination for renewable energy projects, aided by a wider government policy of incentives, infrastructure, and programmes.

Disclaimer – The views expressed in this article are the personal views of the author and are purely informative in nature.

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