Evolution of FDI Policy

The evolution of FDI policy in India has broadly gone through five phases:

The first phase, between 1948 and 1969, was characterised by a cautious welcome to foreign investment, as outlined in the Industrial Policy Statement of 1948, which observed that the ‘participation of foreign capital and enterprise will be of value to the rapid industrialisation of the country.’ It, however, noted that ‘the conditions under which it may participate be carefully regulated in the national interest. As a rule, majority interest in the ownership and effective control should always be in Indian hands.’ During this phase, foreign firms were encouraged to invest in protected industries, such as fertilisers and machine tools and extensive concessions and tax advantages were offered to attract multinational oil companies.

The second phase, between 1969 and 1991, was marked by the coming into force of the Monopolies and Restrictive Trade Practices Commission (MRTP) in 1969, which imposed restrictions on the size of operations, pricing of products and services of foreign companies. The Foreign Exchange Regulation Act (FERA), enacted in 1973, limited the extent of foreign equity to 40%, though this limit could be raised to 74% for technology-intensive, export intensive, and core-sector industries. A selective licensing regime was instituted for technology transfer and royalty payments and applicants were subjected to export obligations. The year 1977 witnessed a reversal of the policy, when Coca Cola was asked to move out of the country.

The third phase, between 1991 and 2000, witnessed the liberalisation of the FDI policy, as part of the Government’s economic reforms program. Under the ‘Statement on Industrial Policy’ (July, 1991), FDI was allowed on the automatic route, up to 51%, in 35 high priority industries. Foreign technical collaboration was also placed under the automatic route, subject to specified limits. A dividend-balancing condition was imposed for all sectors. This was later restricted to 22 notified consumer items (Press Note 12 of 1992). In 1996, the automatic approval route for FDI was expanded, from 35 to 111 industries, under four distinct categories (Part A–up to 50%, Part B–up to 51%, Part C–upto 74%, and Part D-up to 100%). Press Note 18 of 1998 limited the scope of foreign companies starting new joint-ventures, using the same technology as an existing JV. A Foreign Investment Promotion Board (FIPB) was constituted to consider cases under the government route.

The fourth phase of FDI, between 2000 till 2014, has reflected the increasing globalisation of the Indian economy. In the year 2000, a paradigm shift occurred, wherein, except for a negative list, all the remaining activities were placed under the automatic route (Press Note 2 of 2000). The dividend balancing condition was removed (Press Note 7 of 2000). Caps were gradually raised in a number of sectors/activities. The NBFC Sector was placed on the automatic route (Press Note 2 of 2001). The insurance and defence sectors were opened up to a cap of 26% (Press Notes 10 of 2000, 4 of 2001 and 2 of 2002). The cap for telecom services was increased from 49% to 74% (Press Note 5 of 2005). FDI was allowed up to 51% in single brand retail (Press Note 3 of 2006). In the year 2009, the next significant shift took place, with the differentiation between ‘ownership’ and ‘control’, for the purpose of calculating the total foreign investment-direct and indirect-in an Indian company (Press Note 2 of 2009). Indian companies having FDI, owned and controlled by Indian residents were allowed downstream investments without government approval (Press Notes 2 and 4 of 2009). Limits on payment of royalty were removed (Press Note 8 of 2009).

The year 2010 saw the continuation of the rationalisation process. All existing regulations on FDI were consolidated into a single document for ease of reference (Circular 1 of 2010). Downstream investment through internal accruals was specifically permitted (Circular 2 of 2010). Circular 1 of 2011 allowed issue of shares against non-cash considerations (in respect of import of capital goods/ machinery/ equipment and pre-operative/ pre-incorporation expenses) and also provided flexibility in fixing pricing of convertible instruments through a formula, rather than upfront fixation. The requirement of Government approval for establishment of new joint ventures in the ‘same field’ was also done away with. As a result, non-resident companies were allowed to have 100% owned subsidiaries in India. Government has since allowed FDI, in Limited Liability Partnerships (Press Note 1 of 2011).

The evolution of the FDI policy, towards more rationalisation and liberalisation, has narrowed down the instruments regulating FDI policy broadly to three:

• Equity caps: restricting foreign ownership of equity capital
• Entry route: requiring prior Government oversight, including screening and approval
• Conditionalities: comprising of operational restrictions/licencing conditions, such as nationality criteria, minimum-capitalisation and locking period etc.

“Equity caps”, the first three historical phases, adopted a ‘positive listing’ for sectors eligible for FDI, implying that sectors in which FDI was permitted were listed, with the caps/entry routes/related conditionalities being specified. FDI was not permitted in any sector, other than those specified. The ‘positive list’ was gradually expanded, till in the year 2000, a broad approach of ‘negative-listing’ was adopted. This implied that only those sectors, which were restricted to FDI, were listed. FDI, up to 100%, under the automatic route was permitted in all sectors not explicitly mentioned in the list. The present specification of sectors/activities is still largely a ‘negative list’ but it retains some elements of ‘positive listing’ (e.g. FDI in NBFCs is restricted only to eighteen listed activities).

‘Entry route’ essentially relates to whether FDI can be brought in through the ‘automatic route’ or through the ‘Government route’- i.e. whether prior Government approval is required for its induction. The list of activities and investments permitted under the automatic route, have been significant expanded in the fourth phase.

‘Conditionalities’ refer to the sectoral conditions that must be fulfilled. Such conditions are prescribed for sectors like insurance, telecom, NBFC, construction-development etc. In the construction-development sector, for example, the conditionalities prescribed inter-alia include a lock-in period on FDI, minimum investment and minimum built-up area to be developed.

The fifth phase of FDI – the NDA Regime

When the Narendra Modi-led National Democratic Alliance (NDA) government took charge of the country’s destiny four years ago, the Indian economy was still recovering from the mini-crisis of 2013—when the rupee had crashed after India’s twin deficits (current account deficit and fiscal deficit) ballooned out of control. Since then, the government has succeeded in consolidating the steps taken during the fag end of the previous government’s term to control the twin deficits of current account and fiscal, and to bring down inflation.

The pro-reform Modi government has been credited with a host of reforms aimed at attracting Foreign Direct Investment (FDI), improving the ease of doing business, turning the country into a manufacturing hub, create more jobs and achieve a faster economic growth.

The other notable achievement of the Indian economy over the past few years has been the remarkable rise in foreign flows, and in particular, in foreign direct investment (FDI). From being considered to be among the Fragile Five among emerging markets five years ago, the Indian economy has emerged as a top investment destination. The NDA Government’s first four years in office were marked by landmark tax reforms in the form of GST rollout, a demonetization exercise aimed at bringing out unaccounted wealth, introduction of the bankruptcy code to address loan defaults in the banking sector and government subsidy reforms to plug leakage, besides various flagship schemes such as rural electrification, housing for all, digitization.

The total FDI in India increased from US$16,054 million in 2013-14 to US$ 37,366 in 2017-18. Out of total, the highest FDI is recorded from Mauritius i.e. US$ 13,415 million. India had jumped twice in ease of doing business ranks recently. If we compare the sector wise FDI, it can be seen that the highest FDI is from the Communication Services which has seen an upward trend of US$ 1,256 in 2013-14 to US$8,809 in 2017-18.

Net investment inflows of foreign direct investment (FDI) and foreign portfolio investment (FPI) in year 2017-18 together amounting to US$ 52.4 billion and accounting for 57 per cent of net capital inflows, played a large role in external financing. The Government also took various measures for ease of Foreign Investment regime. A notification (No. FEMA 20(R)) dealing with Foreign Direct Investment (FDI), viz., Foreign Exchange Management (Transfer or issue of security by a person resident outside India) Regulations, 2017 was issued on November 7, 2017, subsuming 2 original and 91 amendment notifications while keeping the instructions as principle-based as possible. The highlights of the notification (including subsequent revisions) are as follows:

(i) While simplifying the instructions, the policy on foreign investment was oriented towards facilitating inflow of capital in a move to make the country a favoured destination for foreign investment.

(ii) Foreign investment limits for scheduled air transport service/ domestic scheduled passenger airline and regional air transport service were increased from 49 per cent to 100 per cent with investment over 49 per cent requiring prior government approval. In addition, foreign investment up to 49 percent has been permitted in M/s Air India Ltd., with the condition that substantial ownership and effective control of M/s Air India Ltd., shall continue to be vested in Indian nationals. Foreign investment limit in single brand product retail trading has been increased.

(iii) Conversion of a company with foreign investment into a limited liability partnership and vice versa was permitted under the automatic route subject to certain conditions.

(iv) FDI and FPI have been defined in line with the recommendations of the Committee on Rationalising the FDI/FII Definition (Chairman: Dr. Arvind Mayaram). In addition, the time period for issue of capital instruments has been brought down from 180 days to 60 days to align the same with the Companies Act, 2013.

(v) A concept of late submission fee for reporting delays has been introduced.

(vi) Transfer of shares from non-resident Indians (NRIs)/ overseas citizens of India (OCIs) to persons resident outside India was brought under the automatic route.

(vii) In order to enable listed Indian companies to ensure compliance with various foreign investment limits, the Reserve Bank, in consultation with Securities and Exchange Board of India (SEBI), has put in place a new system for monitoring foreign investment limits. Necessary infrastructure and systems or operationalising the monitoring mechanism would be made available by depositories. Further, following its implementation, all authorised dealer (AD) banks would be required to provide the details of investment made by their respective NRI clients to depositories.