Decoding Foreign Direct Investment (FDI)

Foreign Direct Investment, or FDI, is typically defined as an investment made by an individual or a firm from a foreign country into a country.

• FDI usually involves a foreign entity acquiring ownership or a controlling stake in a company's shares in another country, or setting up businesses there.
• This is distinct from foreign portfolio investment where the foreign entity only purchases equity shares of a company.
• In the case of FDI, the foreign entity has a say in the daily operations of the company.
• FDI is not merely about money inflow; it also involves the inflow of technology, knowledge, skills, and expertise.
• It is a major source of non-debt financial resources for a country's economic development.
• FDI generally occurs in an economy that shows growth potential and has a skilled workforce.
• FDI has evolved significantly over the years, becoming a major form of international capital transfer.
• The benefits of FDI are not uniformly distributed. It largely depends on the host country’s systems and infrastructure.
• Several factors determine FDI in host countries, such as:
  • Policy framework
  • Rules regarding entry and operations (mergers/acquisitions and competition)
  • Political, economic, and social stability
  • Standards of treatment for foreign affiliates
  • International agreements
  • Trade policy (tariff and non-tariff barriers)
  • Privatisation policy

Recent Updates on Foreign Direct Investment (FDI) in India

1. From April to August 2020, India received a total Foreign Direct Investment inflow of USD 35.73 billion. This is the highest ever for the first five months of a financial year. Interestingly, the FDI inflow increased despite the contraction of Gross Domestic Product (GDP) growth by 23.9% in the first quarter (April-June 2020).
2. The FDI received in the first five months of 2020-21 (USD 35.73 billion) is 13% higher compared to the first five months of 2019-20 (USD 31.60 billion).

FDI in India: An Overview

Since the government liberalised the economy and initiated the LPG strategies in 1991, the investment climate in India has improved significantly.

• This improvement is largely attributed to the relaxation of FDI norms.
• Since the economic liberalisation of the country, many sectors have partially or wholly opened up for foreign investment.
• Currently, India ranks among the top 100 countries in terms of ease of doing business .
• In 2019, India was among the top ten recipients of FDI, with a total of $49 billion inflows , according to a UN report. This marked a 16% increase from 2018.
• In February 2020, the DPIIT announced a policy to allow 100% FDI in insurance intermediaries.
• In April 2020, the DPIIT  introduced a new rule stating that any entity of a company sharing a land border with India or where the beneficial owner of investment into India is situated in or is a citizen of such a country can invest only under the Government route. In other words, such entities can only invest with the approval of the Government of India.
• In early 2020, the government decided to sell a 100% stake in the national airline’s Air India.

Understanding FDI Routes in India

In India, FDI flows through three primary routes. They are described in the following table:

Automatic Route FDI

Under the automatic route , the foreign entity does not require the prior approval of the government or the RBI .

Examples:

• Medical devices: up to 100%
• Thermal power: up to 100%
• Services under Civil Aviation Services such as Maintenance & Repair Organizations
• Insurance: up to 49%
• Infrastructure company in the securities market: up to 49%
• Ports and shipping
• Railway infrastructure
• Pension: up to 49%
• Power exchanges: up to 49%
• Petroleum Refining (By PSUs): up to 49%

Government Route FDI

In the government route , the foreign entity must obtain the approval of the government. It must file an application through the Foreign Investment Facilitation Portal, which facilitates single-window clearance. This application is then forwarded to the respective ministry or department, which then approves or rejects the application after consultation with the DPIIT .

Examples:

• Broadcasting Content Services: 49%
• Banking & Public sector: 20%
• Food Products Retail Trading: 100%
• Core Investment Company: 100%
• Multi-Brand Retail Trading: 51%
• Mining & Minerals separations of titanium bearing minerals and ores: 100%
• Print Media (publications/printing of scientific and technical magazines/speciality journals/periodicals and a facsimile edition of foreign newspapers): 100%
• Satellite (Establishment and operations): 100%
• Print Media (publishing of newspaper, periodicals and Indian editions of foreign magazines dealing with news & current affairs): 26%

Sectors where FDI is prohibited

Certain sectors are completely off-limits for any FDI. They are:

• Agricultural or Plantation Activities (although there are many exceptions like horticulture, fisheries, tea plantations, Pisciculture, animal husbandry, etc.)
• Atomic Energy Generation
• Nidhi Company
• Lotteries (online, private, government, etc.)
• Investment in Chit Funds
• Trading in TDR’s
• Any Gambling or Betting businesses
• Cigars, Cigarettes, or any related tobacco industry
• Housing and Real Estate (except townships, commercial projects, etc.)

Revisions in FDI Policy

According to the revised FDI policy, an entity of a country, which shares a land border with India or where the beneficial owner of investment into India is situated in or is a citizen of any such country, can invest only under the Government route.

A transfer of ownership in an FDI deal that benefits any country that shares a border with India will also need government approval.

Investors from countries not covered by the new policy only have to inform the RBI after a transaction rather than asking for prior permission from the relevant government department.

The earlier FDI policy was limited to allowing only Bangladesh and Pakistan via the government route in all sectors. The revised rule has now brought companies from China under the government route filter.

Advantages of FDI

FDI brings in numerous benefits to a country. Some of them are:

1. It provides financial resources for economic development.
2. It introduces new technologies, skills, knowledge, etc.
3. It creates more employment opportunities for the population.
4. It fosters a more competitive business environment in the country.
5. It enhances the quality of products and services in various sectors.

Drawbacks of FDI

Despite its advantages, FDI also has certain disadvantages. Some of them include:

1. It can negatively impact domestic investment and domestic companies.
2. Small companies in a country may not be able to withstand the competition from MNCs in their sector. This can lead to many domestic firms shutting down as a result of increased FDI.
3. FDI may also adversely affect a country's exchange rates.

Government Initiatives to Boost FDI in India

1. Government schemes like the production-linked incentive (PLI) scheme in 2020 for electronics manufacturing, have been notified to attract foreign investments.
2. In 2019, the amendment of FDI Policy 2017 by the government, to permit 100% FDI under automatic route in coal mining activities enhanced FDI inflow.
3. FDI in manufacturing was already under the 100% automatic route, however, in 2019, the government clarified that investments in Indian entities engaged in contract manufacturing is also permitted under the 100% automatic route provided it is undertaken through a legitimate contract.
4. Further, the government permitted 26% FDI in digital sectors. The sector has particularly high return capabilities in India as favourable demographics, substantial mobile and internet penetration, massive consumption along technology uptake provides great market opportunity for a foreign investor.
5. Foreign Investment Facilitation Portal (FIFP) is the online single point interface of the Government of India with investors to facilitate FDI. It is administered by the Department for Promotion of Industry and Internal Trade, Ministry of Commerce and Industry.
6. FDI inflow is further expected to increase –
   • as foreign investors have shown interest in the government’s moves to allow private train operations and bid out airports.
   • Valuable sectors such as defence manufacturing where the government enhanced the FDI limit under the automatic route from 49% to 74% in May 2020, is also expected to attract large investments going forward.

Regulatory Framework for FDI in India

In India, FDI inflows are regulated by several laws. They include:

• Companies Act
• Securities and Exchange Board of India Act, 1992 and SEBI Regulations
• Foreign Exchange Management Act (FEMA)
• Foreign Trade (Development and Regulation) Act, 1992
• Civil Procedure Code, 1908
• Indian Contract Act, 1872
• Arbitration and Conciliation Act, 1996
• Competition Act, 2002
• Income Tax Act, 1961
• Foreign Direct Investment Policy (FDI Policy)

Important Government Authorities in India concerning FDI

• Foreign Investment Promotion Board (FIPB)
• Department for Promotion of Industry and Internal Trade (DPIIT)
• Reserve Bank of India (RBI)
• Directorate General of Foreign Trade (DGFT)
• Ministry of Corporate Affairs, Government of India
• Securities and Exchange Board of India (SEBI)
• Income Tax Department
• Several Ministries of the GOI such as Power, Information & Communication, Energy, etc.

Looking Ahead: The Future of FDI

1. FDI is a major driver of economic growth and an important source of non-debt finance for the economic development of India. A robust and easily accessible FDI regime, thus, should be ensured.
2. Economic growth in the post-pandemic period and India’s large market shall continue to attract market-seeking investments to the country.