Introduction

Foreign investment in India is regulated by the Foreign Exchange Management Act, 1999, rules and regulations framed under the act and government policies on foreign investment. The policy on foreign investment for 2015 is set out in the Consolidated Policy Circular of 2015 ('FDI Policy')(1) and the subsequent press notes issued by the Department of Industrial Policy and Promotion and the Ministry of Commerce and Industry.(2)

As per the act and FDI Policy, foreign investment in India can be made under either the automatic route (ie, without prior approval from the Reserve Bank of India (RBI) – which regulates foreign exchange transactions – or the government) or the approval route (ie, with prior approval from the RBI or the government). The FDI Policy has been progressively liberalised in order to permit foreign investment in most sectors under the automatic route and remove limits on foreign investment in various sectors.

Sectoral caps

The FDI Policy permits foreign investment to be made under different routes – in particular:

  • foreign direct investment (FDI);
  • foreign portfolio investment (FPI) (which also encompasses foreign institutional investment);
  • non-resident Indian investment;
  • foreign venture capital investment;
  • qualified foreign institutional investment;
  • limited liability partnerships investment; and
  • depository receipts.

Different conditions apply to each route. A distinct feature of India's foreign investment policy is the limits prescribed on total foreign investment for different sectors (so-called 'sectoral caps') and the use of separate sub-limits within the sectoral caps for different routes of foreign investment. While 100% foreign investment is now permitted in most sectors, sectoral caps are still implemented in some sectors.

Where sectoral caps are prescribed, the total foreign investment in the relevant sector cannot exceed the cap. If, in addition to a cap, sub-limits for different routes of foreign investment are provided, foreign investment under the relevant route cannot exceed the sub-limits, even if the sectoral cap for the sector is higher. For instance, while the sectoral cap for the commodity exchange sector is 49%, foreign investment under the FDI and FPI routes is capped at 26% and 23%, respectively.

While the rationale behind sectoral caps was to restrict foreign ownership at different levels in different sectors, the reason for the sub-limits was not specifically articulated. In fact, these limits made the foreign investment regulatory regime more complex. As a result, unnecessary bottlenecks were created for foreign investment in India.

Composite caps

In order to simplify the complex regulatory regime and make it more attractive to foreign investors, the Department of Industrial Policy and Promotion issued a press note on July 30 2015 introducing composite caps for foreign investment in India. The press note removes the sub-limits for different routes of foreign investment and eliminates the distinction between foreign investment under different routes for the purpose of calculating sectoral caps. In other words, foreign investment can be made under any route up to the sectoral cap prescribed for the relevant sector without being constrained by a separate, lower sub-limit. In addition, in order to compute foreign investment in any Indian company, investment made under different routes will be considered on an equal footing, regardless of how the investment is categorised. For instance, taking the example discussed above, foreign investment in the commodity exchange sector can now be made up to 49%, using any foreign investment route, including FDI and FPI.

Scope of press note

Sectors in which 100% foreign investment is permitted under the automatic route without any conditions will not be affected by the introduction of composite caps. Further, the press note will not affect foreign investment already made in accordance with the FDI Policy and hence is prospective in nature.

The defence and private banking sectors have been excluded from the composite caps regime. The defence sector's 24% sub-limit for investment made under the foreign institutional investment, FPI, qualified foreign institutional investment, non-resident Indian investment and foreign venture capital investment routes will remain. Likewise, while the sectoral cap in the private banking sector is 74%, investments made under the foreign institutional investment, FPI and qualified foreign institutional investment routes will continue to be capped at 24%.

Foreign currency convertible bonds and depository receipts with underlying instruments have been kept outside the purview of foreign investment, as they are considered to be in the nature of debt. However, the press note has clarified that any equity holding of a person resident outside India resulting from the conversion of any foreign debt instrument under any arrangement will be considered foreign investment under the relevant cap.

In addition to bringing much-needed clarity to the foreign investment regime, the press note has created more room for foreign investment in sectors which were subject to sub-limits that are lower than the sectoral caps. This may help to increase foreign investment in India.

Existing sectoral caps

The introduction of composite caps does not change the sectoral caps prescribed under the FDI Policy. Therefore, direct or indirect foreign investment in an Indian entity cannot exceed the prescribed sectoral caps.

The press note also clarifies that no changes will be made to the conditions and other requirements prescribed under the FDI Policy and press notes issued by the Department of Industrial Policy and Promotion, and foreign investment must comply with these conditions and requirements.

Transfer of ownership or control of Indian entities

Foreign investment in sectors under the approval route that results in the transfer of ownership or control of Indian entities from resident Indian citizens to non-resident entities requires government or RBI approval. Further, foreign investment in sectors under the automatic route (subject to certain conditions) that results in the transfer of ownership or control of Indian entities from resident Indian citizens to non-resident entities must comply with the prescribed conditions.

The press note has permitted FPI up to 49% or the prescribed sectoral cap (whichever is lower) without the need to obtain government approval or comply with the sectoral conditions applicable to foreign investment generally, as long as the foreign investment does not result in the transfer of ownership or control of Indian entities from resident Indian citizens to non-resident entities. This new policy has significantly eased the foreign investment requirements under the FPI route.

Comment

The elimination of sub-limits and introduction of composite caps for foreign investment are welcome initiatives. Simplification of the complex regulatory framework will make it easier to do business in India. The government expects that the revised regulatory framework will boost investor confidence and increase foreign investment in India.

While the composite caps are expected to bring positive results, certain fallouts may occur. Foreign investment under the FPI route is generally characterised as 'quick money' and is relatively easy to repatriate compared to foreign investment under the other routes. Accordingly, increased foreign investment under the FPI route may render share prices of Indian entities more vulnerable to global developments.

For further information on this topic please contact Abhishek Saxena at Phoenix Legal by telephone (+91 11 4983 0000) or email (abhishek.saxena@phoenixlegal.in). The Phoenix Legal website can be accessed at www.phoenixlegal.in.

Endnotes

(1) Dated May 12 2015.

(2) Available at www.dipp.nic.in.

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