Foreign Direct Investments (FDI) in India


May 2015
 Ajit Kumar                                                                       Wisdom IAS, New Delhi


An investment made by a company or entity based in one country, into a company or entity based in another country. Foreign direct investments differ substantially from indirect investments such as portfolio flows, wherein overseas institutions invest in equities listed on a nation's stock exchange. Entities making direct investments typically have a significant degree of influence and control over the company into which the investment is made. Open economies with skilled workforces and good growth prospects tend to attract larger amounts of foreign direct investment than closed, highly regulated economies.
The investing company may make its overseas investment in a number of ways - either by setting up a subsidiary or associate company in the foreign country, by acquiring shares of an overseas company, or through a merger or joint venture.
Advantages of FDI
In the context of foreign direct investment, advantages and disadvantages are often a matter of perspective. An FDI may provide some great advantages for the multinational enterprises (MNEs) but not for the foreign country where the investment is made. On the other hand, sometimes the deal can work out better for the foreign country depending upon how the investment pans out. Ideally, there should be numerous advantages for both the MNE and the foreign country, which is often a developing country. We'll examine the advantages and disadvantages from both perspectives, starting with the advantages for MNEs.
(i) Access to markets: FDI can be an effective way for you to enter into a foreign market. Some countries may extremely limit foreign company access to their domestic markets. Acquiring or starting a business in the market is a means for you to gain access.
(ii) Access to resources: FDI is also an effective way for you to acquire important natural resources, such as precious metals and fossil fuels. Oil companies, for example, often make tremendous FDIs to develop oil fields.
(iii) Reduces cost of production: FDI is a means for you to reduce your cost of production if the labor market is cheaper and the regulations are less restrictive in the target foreign market. For example, it's a well-known fact that the shoe and clothing industries have been able to drastically reduce their costs of production by moving operations to developing countries.
FDI also offers some advantages for foreign countries. For starters, FDI offers a source of external capital and increased revenue. It can be a tremendous source of external capital for a developing country, which can lead to economic development.
Procedure for receiving FDI in an Indian company
An Indian company may receive Foreign Direct Investment under the two routes as given under:
Automatic Route: FDI is allowed under the automatic route without prior approval either of the Government or the Reserve Bank of India in all activities/sectors as specified in the consolidated FDI Policy, issued by the Government of India from time to time.
Government Route: FDI in activities not covered under the automatic route requires prior approval of the Government which are considered by the Foreign Investment Promotion Board (FIPB), Department of Economic Affairs, Ministry of Finance.
The Indian company having received FDI either under the Automatic route or the Government route is required to comply with provisions of the FDI policy including reporting the FDI to the Reserve Bank.
Constitution of FIPB The FIPB comprises of the following Secretaries to the Government of India: (i) Secretary to Government, Department of Economic Affairs, Ministry of Finance – Chairperson (ii) Secretary to Government, Department of Industrial Policy & Promotion, Ministry of Commerce & Industry (iii) Secretary to Government, Department of Commerce, Ministry of Commerce & Industry (iv) Secretary to Government, Economic Relations, Ministry of External Affairs (v) Secretary to Government, Ministry of Overseas Indian Affairs.
Strategically FDI comes in three types:
(i) Horizontal: where the company carries out the same activities abroad as at home (for example, Toyota assembling cars in both Japan and the UK. 
(ii)Vertical: when different stages of activities are added abroad. Forward vertical FDI is where the FDI takes the firm nearer to the market (for example, Toyota acquiring a car distributorship in America) and Backward Vertical FDI is where international integration moves back towards raw materials (for example, Toyota acquiring a tyre manufacturer or a rubber plantation). 
(iii) Conglomerate: where an unrelated business is added abroad. This is the most unusual form of FDI as it involves attempting to overcome two barriers simultaneously - entering a foreign country and a new industry.  This leads to the analytical solution that internationalisation and diversification are often alternative strategies, not complements.
Instruments for receiving FDI in an Indian company
Foreign investment is reckoned as FDI only if the investment is made in equity shares, fully and mandatorily convertible preference shares and fully and mandatorily convertible debentures with the pricing being decided upfront as a figure or based on the formula that is decided upfront. Partly paid equity shares and warrants issued by an Indian company in accordance with the provision of the Companies Act, 2013 and the SEBI guidelines, as applicable, shall be treated as eligible FDI instruments subject to compliance with FDI scheme.
Any foreign investment into an instrument issued by an Indian company which: gives an option to the investor to convert or not to convert it into equity or does not involve upfront pricing of the instrument as a date would be reckoned as ECB and would have to comply with the ECB guidelines.
The FDI policy provides that the price/ conversion formula of convertible capital instruments should be determined upfront at the time of issue of the instruments. The price at the time of conversion should not in any case be lower than the fair value worked out, at the time of issuance of such instruments, in accordance with the extant FEMA regulations [valuation as per any internationally accepted pricing methodology on arm’s length basis for the unlisted companies and valuation in terms of SEBI (ICDR) Regulations, for the listed companies] without any assured return.
Modes of payment allowed for receiving FDI
An Indian company issuing shares /convertible debentures under FDI Scheme to a person resident outside India shall receive the amount of consideration required to be paid for such shares /convertible debentures by:
(i) inward remittance through normal banking channels.
(ii) debit to NRE / FCNR account of a person concerned maintained with an AD category I bank.
(iii) conversion of royalty / lump sum / technical know how fee due for payment or conversion of ECB, shall be treated as consideration for issue of shares.
(iv) conversion of import payables / pre incorporation expenses / share swap can be treated as consideration for issue of shares with the approval of FIPB.
(v) debit to non-interest bearing Escrow account in Indian Rupees in India which is opened with the approval from AD Category – I bank and is maintained with the AD Category I bank on behalf of residents and non-residents towards payment of share purchase consideration.
If the shares or convertible debentures are not issued within 180 days from the date of receipt of the inward remittance or date of debit to NRE / FCNR (B) / Escrow account, the amount shall be refunded. Further, Reserve Bank may on an application made to it and for sufficient reasons permit an Indian Company to refund / allot shares for the amount of consideration received towards issue of security if such amount is outstanding beyond the period of 180 days from the date of receipt.
Sectors where FDI is not allowed in India
FDI is prohibited under the Government Route as well as the Automatic Route in the following sectors:
i) Atomic Energy
ii) Lottery Business
iii) Gambling and Betting
iv) Business of Chit Fund
v) Nidhi Company
vi) Agricultural (excluding Floriculture, Horticulture, Development of seeds, Animal Husbandry, Pisciculture and cultivation of vegetables, mushrooms, etc. under controlled conditions and services related to agro and allied sectors) and Plantations activities (other than Tea Plantations).
vii) Housing and Real Estate business (except development of townships, construction of residen­tial/commercial premises, roads or bridges to the extent specified.
viii) Trading in Transferable Development Rights (TDRs).
ix) Manufacture of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes.
Foreign Portfolio Investment (FPI)
A hands-off or passive investment of securities in a portfolio. A portfolio investment is made with the expectation of earning a return on it. This expected return is directly correlated with the investment's expected risk. Portfolio investment is distinct from direct investment, which involves taking a sizeable stake in a target company and possibly being involved with its day-to-day management.
Portfolio investments can span a wide range of asset classes – stocks, government bonds, corporate bonds, Treasury bills, real estate investment trusts, exchange-traded funds, mutual funds, certificates of deposit and so on. Portfolio investments can also include options, warrants and other derivatives such as futures, and physical investments like commodities, real estate, land and timber.
The composition of investments in a portfolio depends on a number of factors, among the most important being the investor’s risk tolerance, investment horizon and amount invested. For a young investor with limited funds, mutual funds or exchange-traded funds may be appropriate portfolio investments. For a high net worth (HNW) individual, portfolio investments may include stocks, bonds, commodities and rental properties.
Portfolio investments for the largest institutional investors such as pension funds and sovereign funds include a significant proportion of infrastructure assets like bridges and toll roads. This is because their portfolio investments need to have very long lives, so the duration of their assets and liabilities match.

Sunday, 10th May 2015, 10:50:21 AM

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