Protectionism in the COVID-19 era: A step back for the global economy?

December 8, 2020 3:04 PM

Foreign direct investments in Indian companies from border sharing countries now require prior approval of the Indian government.

Fofandi said that demand from major markets of US and EU is improving slowly, but exporters are concerned because of the delay in announcing the new export incentive scheme.Fofandi said that demand from major markets of US and EU is improving slowly, but exporters are concerned because of the delay in announcing the new export incentive scheme.

Rukshad Davar

The COVID-19 pandemic has caused widespread economic uncertainty globally, and coupled with the US-China trade war, has caused countries to adopt protectionist measures. While the regulations introduced by India, the US, the UK and the European Union have taken different forms, the underlying concern is uniform – save homegrown companies, especially in strategic sectors, from being acquired by state-backed investors from other countries.

Protectionist measures adopted by India

India has introduced protectionist measures in two ways. One, the Indian government has launched the “Atmanirbhar Bharat” policy, which translates to “self-reliant India,” to promote local industry and reach self-sufficiency in the near future.

Second, foreign direct investments in Indian companies from border sharing countries now require prior approval of the Indian government. This requirement is applicable for direct investments, as well as investments which are beneficially held by entities or citizens of neighbouring countries. This rule is primarily aimed at regulating investments from China and may also cover investments from entities based in Hong Kong and Taiwan. Further, the Indian government has not provided a de minimis threshold for beneficial ownership of, or indirect investment by, an entity or a citizen of a border sharing country. This ambiguity has led to significant uncertainty specifically in case of acquisitions and greenfield ventures by foreign listed corporations and investment funds, whose beneficial ownership may at times not be traceable easily.

Reports also suggest that applications made to the Indian government under this new rule have not been cleared as yet, more so in light of the border tussle between India and China.

Measures adopted by other countries

That said, the US, the European Union and the UK already have or are looking to introduce similar protectionist measures.

Measures in the US:

In February 2020, the Foreign Investment Risk Review Modernization Act came into force in the US. It empowers the Committee on Foreign Investment in the United States (CFIUS) to address national security concerns regarding foreign exploitation of certain investment structures, which have traditionally remained outside the jurisdiction of the CFIUS.

Consequently, certain additional transactions have to be notified to CFIUS, such as:

  • those involving the purchase or lease of real estate near sensitive government installations,
  • those which provide a foreign person with control over an entity, or
  • those which provide a foreign person access to material non-public technical information available with the
  • business, membership on the board of directors or decision-making rights (other than by voting rights acquired through the ownership of shares).

In addition, acquisition of minority interests in certain specified sectors, such as telecom, power, oil and gas, defence and finance, also have to be notified to the CFIUS. The expanded scope of transactions being subjected to CFIUS review means that pending transactions can be blocked or completed transactions may have to be unwound if the CFIUS finds a national security interest emanating from the transaction.

Measures in the European Union

Similarly, the European Union has also encouraged member states to adopt screening mechanisms for foreign investments which are likely to affect security or public order. The European Union regulations suggest that to determine whether an investment is likely to affect security or public order, member states must consider whether the investment:

  • has an impact on critical infrastructure (such as water, energy, transport, health and communications);
  • has an impact on critical technologies (such as artificial intelligence, cybersecurity, defence and energy storage);
  • results in access to sensitive information, including, personal data;
  • is being made by an entity which is, directly or indirectly, controlled by the government of a third country; or
  • is being made by an investor which has already been involved in activities affecting security or public order in another member state.

Currently, among other members of the European Union, France, Italy, Germany and Spain have adopted national mechanisms to screen foreign investments.

Measures in the UK

More recently, the National Security and Investment Bill has been introduced in the UK Parliament, which seeks to empower the Secretary of State to investigate certain acquisitions if it is apprehended that the acquisition could be a risk to national security. This bill proposes to capture not only acquisitions of entities, but also acquisitions of assets, intellectual property and minority shareholding. In order to determine whether an acquisition creates a risk to national security, the bill requires the Secretary of State to consider:

  • the target risk, which includes assessing the nature of the target and the sector in which it operates;
  • the trigger event risk, which includes assessing the nature and degree of control; and
  • the acquirer risk, which includes assessing the risk posed by the acquirer to national security.

The bill also proposes to introduce a mandatory notification requirement under which certain acquisitions (which are yet to be prescribed) must be mandatorily notified to the Secretary of State.

Impact on the Indian economy

Based on the foregoing, it is clear that India is not alone in imposing measures to protect national interests from opportunist acquisitions. However, the implications for India, as a developing economy, may be far-reaching as compared to the developed countries. As the Indian economy recovers from the pandemic, it is important to recognize that foreign investment, including investment from neighbouring countries, represents a key mechanism for supporting domestic industries and rebuilding India’s economic capacity. After all, India received almost INR6.1 billion (approx. US$820 million) in direct equity inflows from China and Hong Kong in the financial year ended on March 31, 2020 alone.

The liberalization of the Indian economy at the turn of the century represented a key moment in its economic development. Over the past two decades, India has gradually continued on the path of liberalization and opened up more sections of its market to foreign investment. Consequently, India has reaped the benefits of globalization, including, an increase in employment opportunities and exports, development of infrastructure and technological capabilities, and availability of a better quality of goods and services. Given this, it is important for India to strike a balance between protecting national interests and attracting foreign investment and to continue to be a part of the global economy.

Rukshad Davar is Partner at Majmudar & Partners. Views expressed are the author’s personal. 

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