Foreign direct investment (FDI) is a category of cross-border investment in which an investor resident in one economy establishes a lasting interest in and a significant degree of influence over an enterprise resident in another economy. Ownership of 10 percent or more of the voting power in an enterprise in one economy by an investor in another economy is evidence of such a relationship. FDI is a key element in international economic integration because it creates stable and long-lasting links between economies. FDI is an important channel for the transfer of technology between countries, promotes international trade through access to foreign markets, and can be an important vehicle for economic development. The indicators covered in this group are inward and outward values for stocks, flows and income, by partner country and by industry and FDI restrictiveness.
Basic principles of FDI into India
India’s business sectors may be divided into three for the purposes of FDI inflow:
- prohibited sectors – prohibited from receiving FDI. Includes atomic energy, real estate business, lottery business, manufacturing tobacco products, gambling and betting;
- automatic route – no prior approval required from the government for receiving FDI. Includes airports, construction, industrial parks, mining, manufacturing and IT; and
- government approval route – prior approval required from the government for receiving FDI. Includes air transport services, satellites, print media and public sector banks.
The FDI Policy further imposes sector-specific FDI thresholds based on the sensitivity of the sector, regardless of whether the sector falls under the automatic route or the government approval route. These are, generally:
- up to 100% FDI allowed (includes manufacturing, construction and IT);
- up to 74% FDI allowed (includes pharmaceuticals and defence);
- up to 49% FDI allowed (includes air transport services and private sector banking); and
- up to 26% FDI allowed (print media).
If the NDI Rules and FDI Policy do not specifically prescribe any conditions for any sector, 100% FDI under the automatic route is allowed for that sector.
Where an Indian entity is neither ‘owned’ nor ‘controlled’ by resident Indian citizens, any investment made by that entity in another Indian entity will be considered downstream foreign investment, and governed by the NDI Rules and FDI Policy. For the purposes of the NDI Rules, ‘owned’ refers to a beneficial holding of more than 50% of the equity instruments of a company, and ‘controlled’ refers to the right to appoint a majority of directors or to control the company’s management or policy decisions.
Under the NDI Rules, FDI includes any investments made by a person resident outside India in equity instruments of Indian companies. For listed entities, investments of at least 10% or more of the post issue paid-up capital is treated as FDI.
The NDI Rules permit investment into:
- equity shares (including partly paid equity shares, provided that at least 25% of the consideration is received upfront and they are fully called-up within 12 months of issuance);
- convertible debentures which are fully and mandatorily convertible, and fully paid;
- preference shares which are fully and mandatorily convertible, and fully paid; and
- share warrants, for which at least 25% of the consideration is to be received upfront and the balance is to be received within 18 months of issuance.
While FDI is only permitted in these equity instruments, a recent exception applies to start-ups, as discussed below.
Recent amendments to India’s FDI regime
On 17 April 2020, the Indian government amended the FDI Policy making it mandatory to obtain government approval for FDI received from countries that “share a land border” with India, which include China, Bangladesh, Pakistan, Bhutan, Nepal, Myanmar and Afghanistan. While the move was ostensibly intended to “curb opportunistic takeovers / acquisitions”, the intention has been widely held to have stemmed from the need to limit the inflow of Chinese investments since FDI from Pakistan and Bangladesh was already subject to similar restrictions. As a result of this amendment, FDI inflow from these countries has been restricted, with only 80 of 388 proposals received as of July 2022 granted approval,
However, other than this protective limitation, India has been on the path of liberalisation since 1991. Even as recently as 2021, and going against the tide of the prevailing protectionist trends, India has brought about relaxations in several key sectors, including:
- insurance – the FDI limit in the insurance sector was raised from 49% to 74% under the automatic route.
- defence – the FDI limit in the defence sector was significantly liberalised by raising the FDI limit for investment under the automatic route from 49% to 74%.
- telecoms – as a much-needed boost to the telecoms sector in India, the government increased the FDI limit into the sector from 49% to 100% under the automatic route.
- oil and gas – while the overall cap for FDI into the oil and gas sector continues to remain at 49% under the automatic route, a window has been created for 100% FDI in oil and gas public sector undertakings (PSU) that have obtained ‘in-principle approval’ from the government for strategic disinvestment.
Further, and in line with government policy to create an ever-burgeoning start-up ecosystem in India, the ‘Start-up India Initiative’ has introduced two further changes targeted at start-up investment.
While FDI is generally permitted only through equity instruments, eligible start-ups have the benefit of issuing convertible notes (CN): instruments evidencing receipt of money initially as a debt, and which are either repayable at the option of the holder or convertible into such number of equity shares of the company upon occurrence of specified events and as per the other terms and conditions agreed to and indicated in the instrument. For start-ups to be eligible to issue CNs, the minimum amount of investment required from a single investor is INR 25 lakhs (roughly US$ 30,000) in a single tranche. The maximum tenor of conversion or repayment of a CN is 10 years.
Eligible start-ups can also benefit from the ‘angel tax’ exemption under Income Tax Act if their aggregate paid-up share capital and share premium after the issue or proposed issue of shares do not exceed INR 25 crores (roughly US$3 million). The angel tax exemption comes with end use restrictions of investments on specified assets. If the investment consists of a capital contribution made to any other entity, shares and securities, bullion, archaeological collections, or any work of art, the angel tax exemption will not apply.
Who files
There are two routes governing FDI into India: (i) the automatic route and (ii) the government approval route. Whether an investor proceeds via one route or the other would depend largely on the sector in which the investee entity falls as well as the quantum value of the investment.
Under the automatic route, FDI is allowed without the need to obtain any approval or license from the government. The amount of investment permitted would depend on the sector in which the investee operates. For example, some sectors, such as the manufacturing, telecom and financial services sectors, allow foreign investors to invest up to 100 percent of an Indian entity.
Certain other sectors fall under the government approval route, and require the prior approval of the government, the Reserve Bank of India, or both. Key sectors that require government approval include the multi-brand retail trading sector (where FDI of up to 51 percent is permissible assuming certain regulatory conditions are met) and the brownfield pharmaceutical sector (where any FDI above 74 percent must obtain government approval).
Some sectors, such as lottery businesses and the manufacture of tobacco or tobacco substitutes, are prohibited sectors where FDI is not permitted.
No application is required for transactions that fall within the automatic route. For transactions that fall under the government approval route, the foreign investor will have to file its FDI proposal under the Foreign Investment Facilitation Portal (FPIP) managed by the DPIIT. The proposal will then be sent by the DPIIT to relevant stakeholders, such as the RBI and the Ministry of External Affairs.
Scope of the review
If a transaction falls under the government approval route, then the foreign investor must submit an FDI proposal to the DPIIT using the FPIP platform.
Documents that an FDI proposal must annex include the following: (i) charter documents of the foreign investor and investee entity; (ii) audited financial statements and tax returns of both the foreign investor and investee entity; (iii) diagrammatic representation of the flow of funds from the foreign investor to the investee entity; and (iv) a summary of the FDI proposal by the foreign investor.
Foreign investment into certain sectors may require prior security clearance from the Ministry of Home Affairs. These sectors include broadcasting, telecommunication, private security agencies and civil aviation. For these sectors, the FDI proposal will also be sent to the Ministry of Home Affairs for its review.
The Indian government has broad discretion whether to grant or reject a proposal. The DPIIT and competent authorities would consider, among other things, the reputation of the foreign investor, its history of owning and operating similar investments, national security and the overall impact of the proposed investment on the national interest.
FAQs
What are the Different Routes for Foreign Investment in India?
Foreign investment in India can be made through the automatic route or the approval route, depending on the sector. Under the automatic route, no prior approval is required, while the approval route requires clearance from relevant authorities.
What is the Automatic Route for Foreign Investment?
The automatic route allows foreign investors to invest in certain sectors without prior approval. The investor needs to comply with reporting requirements after the investment.
Which Authority Approves Foreign Direct Investment (FDI) in India?
The Department for Promotion of Industry and Internal Trade (DPIIT), under the Ministry of Commerce and Industry, is the primary authority for approving FDI in India.
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