FDI in India- Luring World to Investment

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Published: 21st January 2008
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FDI in India- Luring World to Investment

An Article by Rajiv Tuli, Advocate*

I. Introduction

Foreign direct investment, in the common parlance, is defined as a company from one country making a physical investment into building of its business in another country. Foreign direct investment (FDI) has assumed a crucial role in the internationalisation of economic activities and plays an extraordinary and ever increasing growing part in global business. For the country receiving the investment, it provides source of capital, new technologies, processes, products, organizational techniques and management skills, and as such can provide a strong impetus to economic development. For the business entity making foreign investment, it provides new business opportunities through expanded market and marketing channels. Given the appropriate host-country policies and a basic level of development, a prevalence of studies show that FDI triggers technology spillovers, assists human capital formation, contributes to international trade integration, helps create a more competitive business environment and enhances enterprise development. All these contribute to higher economic growth. Existence of real business opportunities is one of the key factors in attracting FDI. FDI influences growth by increasing total factor productivity and, more generally, the efficiency of resource use in the recipient economy. Technology transfers through FDI generate positive externalities in the host country.

Reacting to changes in technology, growing liberalization of the national regulatory framework governing investment in enterprises, and changes in capital markets profound changes have occurred in the size, scope and methods of FDI. FDI has increased manifold over the past 2 decades. Developing countries, increasingly see foreign direct investment as a source of economic development, modernization and employment generation, and have liberalised their FDI regimes to attract investment. In order to reap the maximum benefits from FDI, there is a need to establish a transparent, broad and effective enabling policy environment for investment and to put in place appropriate framework for their implementation.

• The Author is managing partner, MARS & Partners, International Legal Consultants

II. Trend of Foreign direct Investment in India –

Since liberalization of Indian economic policies in 1991, India has experienced acceleration in the inflows of FDI into the country. According to the World Bank, India cornered a major portion of US$ 40.1 billion net capital inflows to South Asia in 2006. In fact, India has overtaken the erstwhile East Asian Tigers — Thailand, Malaysia, Indonesia, the Philippines, Taiwan and South Korea — in terms of FDI flow. Year wise data of FDI inflow in India from Aug. 1991 to March 2006 is as under -
Year (April-March) FDI inflows (In US$ million)
1991-1992 (Aug-March) 167
1992-1993 393
1993-1994 654
1994-1995 1,374
1995-1996 2,141
1996-1997 2,770
1997-1998 3,682
1998-1999 3,083
1999-2000 2,439
2000-2001 2,908
2001-2002 4,222
2002-2003 3,134
2003-2004 2,634
2004-2005 3,755
2005-2006 5,549
2006-2007 15,700 (Appox.)
2007-2008 30,000 (Target)

This table clearly shows the growth that India has made in these 15 yrs in terms of FDI inflow has been at the tremendous pace. Equally important is the analysis of growth rate in last 2 years. India’s FDI inflows have almost tripled in a year from US$ 5.5 billion in 2005-06 to US$ 15.7 billion in 2006-07 and double of that, i. e. US$ 30 billion has been set a target for 2007-08 by the Government of India.

III. FDI in India – Modes and Policies

a) Modes –

Foreign Direct Investments in India can be made either: -

• Under the Automatic Route, or;
• With the specific prior approval of Foreign Investment Promotion Board (FIPB)

1. Automatic Route - FDI up to 100% is allowed under the automatic route in all activities / sectors except the following, which require prior approval of the Government:

I. Where provisions of Press Note 1 (2005 Series) issued by the Government of India are attracted.
II. Where more than 24% foreign equity is proposed to be inducted for manufacture of items reserved for the Small Scale sector.

FDI in sectors/activities to the extent permitted under Automatic Route does not require any prior approval either by the Government or the Reserve Bank of India but permission from the competent authority may be required. For e.g. in case of industrial licence for a particular manufacturing activity the permission of the competent authority may be required. The investors are only required to notify the Regional Office concerned of the Reserve Bank of India within 30 days of receipt of inward remittances and file the required documents along with form FC-GPR with that Office within 30 days of issue of shares to the non-resident investors.

2. Government Route – FDI in activities not covered under the automatic route requires prior Government approval and are considered by the Foreign Investment Promotion Board (FIPB), Ministry of Finance. Application can be made in Form FC-IL. Indian companies having foreign investment approval through FIPB route do not require any further clearance from the Reserve Bank of India for receiving inward remittance and issue of shares to the non-resident investors. The companies are required to notify the concerned Regional Office of the Reserve Bank of India of receipt of inward remittances within 30 days of such receipt and submit form FC-GPR within 30 days of issue of shares to the non-resident investors.

b) Activities where no FDI is allowed –

FDI in any form is prohibited under Government as well as Automatic Route for the following sectors -

I. Retail Trading (except single brand product retailing)
II. Atomic Energy
III. Lottery Business
IV. Gambling and Betting
V. Business of Chit Fund
VI. Nidhi Company
VII. Agriculture or Agricultural / plantation activities except Floriculture, Horticulture, Development of seeds, Animal Husbandry, Pisiculture and Cultivation of vegetables, mushrooms etc. under controlled conditions and services related to agro and allied sectors) and Plantations (Other than Tea plantations)
VIII. Real estate business or construction of farm houses (except development of townships, construction of residential / commercial premises, roads or bridges to the extent specified in Notification No. FEMA 136/2005-RB dated July 19, 2005)
IX. Trading in Transferable Development Rights (TDRs)

IV. FDI in India by a Foreign Company

A foreign company can set up business in India in following ways:

1) As an incorporated entity by incorporating a company under the Companies Act, 1956 through –

 Joint Ventures
 Wholly Owned Subsidiaries

2) As an office of a foreign entity through

 Liaison Office / Representative Office – Liaison office acts as a channel of communication between the head office or principal place of business and entities in India. Liaison office cannot undertake any commercial activity directly or indirectly and cannot, therefore, earn any income in India. Its role is limited to collecting information about possible market opportunities and providing information about the company and its products to prospective Indian customers. It can promote export/import from/to India and also facilitate technical/financial collaboration between parent company and companies in India. Approval for establishing a liaison office in India is granted by Reserve Bank of India (RBI)

 Project Office – Foreign Companies planning to execute specific projects in India can set up temporary project/site offices in India. RBI has now granted general permission to foreign entities to establish Project Offices subject to specified conditions. However, such offices cannot undertake or carry on any activity other than those relating and incidental to execution of the project. Project Offices may remit outside India the surplus of the project on its completion, general permission for which has been granted by the RBI.

 Branch Office: Permission for setting up branch offices is granted by the Reserve Bank of India (RBI). Foreign companies engaged in manufacturing and trading activities abroad, are allowed to set up Branch Offices in India for the following purposes:

I. Export/Import of goods;
II. Rendering professional or consultancy services;
III. Carrying out research work, in which the parent company is engaged;
IV. Promoting technical or financial collaborations between Indian companies and parent or overseas group company;
V. Representing the parent company in India and acting as buying/selling agents in India;
VI. Rendering services in Information Technology and development of software in India;
VII. Rendering technical support to the products supplied by the parent/ group companies;
VIII. Foreign Airline/shipping Company

Further, a branch office is not allowed to carry out manufacturing activities on its own but is permitted to subcontract these to an Indian manufacturer. Branch Offices established with the approval of RBI may remit outside India profit of the branch, net of applicable Indian taxes and subject to RBI guidelines.

Such offices can undertake activities permitted under the Foreign Exchange Management (Establishment in India of Branch Office or other place of business) Regulations, 2000. Further, such Companies are also required to register themselves with Registrar of Companies (ROC) within 30 days of setting up a place of business in India.

V. FDI - Sector wise Policy Framework

1. Telecom Sector:

The partial opening of telecom sector for foreign investment was done long back in 1991 with the permission for FDI in the telecom-manufacturing segment. Today, riding on expectations of overall high economic growth and consequent rising income levels, telecom market offers an unprecedented opportunity for foreign investment. A combination of factors, promising rich returns on investments is driving growth in the sector. Same gets also reflected in the year wise data of actual FDI Inflow from August 1991 to January 2007 in the Telecom Sector which is as follows -

(Rs. in Crore) Year FDI INFLOW
(Rs. in Crore)
Till 1993 2.06 2000 288.58
1994 14.02 2001 3,970.90
1995 206.74 2002 1,081.50
1996 764.83 2003 301.40
1997 1,245.19 2004 454.85
1998 1,775.64 2005 94.31
1999 212.67 2006 1404.48
2007 (Till January) 0.74
TOTAL 11817.78

Present Policy status

Business Activities FDI allowed (In %)
In Basic, Cellular Mobile, National Long Distance, International Long Distance, Value Added Services and Global Mobile Personal Communications by Satellite 49
1. Internet Service (with gateways)
2. Infrastructure Providers (Category II)
3. Radio Paging Service 74
1. ISPs not providing gateways (Both for satellite and submarine cables)
2. Infrastructure Providers providing dark fibre (IP Category I)
3. Electronic Mail
4. Voice Mail 100

The above given FDI limits are subject to the following conditions:

1) FDI up to 100% is allowed subject to the condition that such companies would divest 26 per cent of their equity in favour of Indian public within 5 years, if these companies are listed in other parts of the world.

2) The above services would be subject to licensing and security requirements, wherever required.

3) Foreign Investment Promotion Board (FIPB) shall consider proposals for FDI beyond 49 per cent on a case-to-case basis.

4) In manufacturing activities relating to telecom sector, FDI upto 100% is allowed under the automatic route.

2. Insurance Sector:

The insurance sector in India has taken a full round from being an open competitive market to nationalisation and back to a liberalised market again. Tracing the developments in the Indian insurance sector reveals the 360 degree turn witnessed over a period of almost two centuries. For long, the insurance sector in India was operated through public sector companies only and thus was kept away even from the private players, forget of any foreign investment. Reforms in the Indian insurance sector commenced with the enactment of the Insurance Regulatory and Development Authority (IRDA) Act 1999, which facilitated the entry of private insurance companies into the Indian market. Thereafter only, the major international players like AIG, Aviva, MetLife, New York Life, Prudential, Allianz, Sun Life, Standard Life and Lombard etc. could come into the picture and set-up joint ventures with Indian companies for both Life and Non-life segments.

The business of insurance started in India in the year 1818 with the establishment of the “Oriental Life Insurance Company” in Calcutta. Presently, only 10% of the market share has been tapped by Life Insurance Corporation and General Insurance Corporation and the balance 90% of the market still remains untapped. In the private sector, only 12 life insurance and 6 general insurance companies have been registered with the IRDA. Hence, To serve the population of more than 100 crore Indians, Indian insurance market offers tremendous opportunities to private insurers. This vast Potential of the Indian insurance market offers great scope of investment to the foreign players.

Present Policy status

FDI up to 26% in the Insurance sector is allowed on the automatic route subject to obtaining license from Insurance Regulatory & Development Authority (IRDA).

Procedure to obtain License from IRDA: -

1. An applicant desiring to carry on insurance business in India shall make a requisition for registration application in Form IRDA/R1.

2. Every requisition for registration application where the applicant is a company and incorporated under Companies Act, 1956 shall be accompanied by------

a) a certified copy of the memorandum of association and articles of association;
b) the name, address and the occupation of the directors and principal officer;
c) a statement of the class of insurance business proposed to be carried on;
d) a statement indicating the sources that will contribute the share capital required

3. An applicant, whose requisition for registration application has been accepted by the Authority, shall make an application in Form IRDA/R2 for grant of a certificate of registration.

4. The fee of Rs. 50,000/- for each class of business for registration shall be remitted by a bank draft issued by any scheduled bank in favour of the IRDA.

5. An applicant granted a certificate of registration under the Regulations shall commence insurance business for which he has been authorised within 12 months of the date of registration.

No Growth Data

3. Advertising Sector:

Initially up to 74% FDI was allowed in advertising sector but limit was increased in 2003 present day FDI in advertising sector is allowed up to 100% on the automatic route.

No trade history details and No Growth Data

4. Film Sector:

The Indian film industry has experienced advancements on all fronts including technology used, themes of the movies, finance, exhibition and marketing. The movie making business has got strong impetus from the growth of multiplex culture. The Indian film industry is getting corporatized and has started looking overseas for co -production. India has the world's biggest movie industry and produces around 1000 movies each year. Today, the Indian film industry stands at approx. INR 85 billion and is projected to reach around INR 175 billion by 2011. The major reason for this high growth rate is that the industry is increasingly getting more corporatised, highlighted by public issues of several film production, distribution and exhibition companies, long term contracts between film production companies and directors/ actors and the fact that more than half of 2006’s releases were by corporates rather than individual banners

Before 2002-03, upto 100% FDI was permitted in film industry (i.e. film financing, production, distribution, exhibition, marketing and associated activities relating to film industry) under the automatic route, subject to the following conditions:

 Companies with an established track record in films, TV, music, finance, and insurance would be permitted;
 The company should have a minimum paid up capital of US$ 10 million if it is the single largest equity shareholder and at least US$ 5 million in other cases;
 Minimum level of foreign equity investment would be US$ 2.5 million for the single largest equity shareholder and US$ 1 million in other cases;
 Debt equity ratio of not more than 1:1, i.e., domestic borrowings shall not exceed equity.

Present FDI Policy:

FDI under the automatic Route up to 100% is available for film sector and will not to subject to any conditions about debt equity ratio, minimum level of equity investment.

No Growth Data

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