The Reserve Bank of India has toned down objections to FDI instruments with alleged debt nature and agreed to allow them subject to certain conditions.
According to sources, during the discussions for the bi-annual FDI policy review, the government and the RBI have come to agree that a blanket ban on these instruments may not be a good idea. Given the difficult global economic situation, the policy focus should be on encouraging long-term capital inflows, the two have concurred.
These instruments ? with underlying put/call options that allow the foreign investor to exit and ward off risk ? are allegedly being used to circumvent the curbs on external commercial borrowings in certain sectors like real estate.
The new regime will, however, be marked by certain safeguards. The Indian promoters will not be allowed to buy back shares from foreign investor who came in through instruments with alleged debt character for a period of three years. That apart, the FDI policy will specify a separate format for the reporting and monitoring of these inflows and subsequent transactions. Sources said the RBI and the government have also agreed to consider these capital flows under the head of ?other capital? instead of FDI or portfolio capital for the purpose of balance of payment (BoP) calculation. These changes will be part of the revised FDI policy to be announced on March 31.
?I think the minimum lock-in period being planned will apply to foreign investments through these instruments in real estate sector. There is no rationale for having such a lock-in in other sectors,? said PwC’s Akash Gupt.
Compulsorily convertible debentures and compulsorily convertible preference shares are among the instruments through which foreigners invest in Indian firms.
Although these are required to be converted into equity within a specified period of time, at the time of conversion, Indian promoters often use put options, letting foreign investors exit. This undermines the equity nature of the investments as the foreign investors practically don’t take any significant risk.
Up to $5 billion worth of private equity investments in India’s real estate sector over the last five to six years were to be affected by the RBI’s refusal to prevent their exit. If the policy change materialises, these investments can be bought back by Indian promoters and the foreigners can exit.
Six out of every 10 private equity deals in the real estate sector have put and call options built into them.
The policy imbroglio was owing to a department of industrial policy & promotion (DIPP) circular in October last year that accommodated RBI’s concerns. It said: ?Equity instruments issued/transferred to non-residents having built-in options or supported by options sold by third parties would lose their equity character and such instruments would have to comply with the extant ECB guidelines.? But after a huge amount of negative feedback on the subject, DIPP later deleted the clause. The RBI, however, continued to question deals that had in-built options, saying such investments will be considered debt. With the latest change in the central bank’s stance, companies across sectors will benefit, but it will especially come handy for those in sectors that need foreign funds but can’t access external commercial borrowing.
Another clarification likely as part of the bi-annual FDI policy revision is that downstream investments by Indian private banks in certain areas like debt restructuring, strategic investments and other para-banking activities will not be computed for calculating FDI and ascertaining whether the FDI cap is breached. Banking companies will be given an exemption for their normal business operations from the consolidated FDI policy circular on downstream investment by Indian companies.
Indian private banks, including HDFC and ICICI, will benefit from the move. The same principle will apply for new banks in the banking sector, for which the government is still in the process of formalising FDI rules in consultation with the central bank.