Tightened FDI norms: No love for thy neighbour

April 21, 2020 4:45 AM

Previously, apart from investment in select sectors, the requirement for prior approval arose only for investments originating from Pakistan and Bangladesh.

By issuing Press Note 3 of 2020, the government has made all FDI from countries sharing a ‘land border’ with India subject to prior government approval.By issuing Press Note 3 of 2020, the government has made all FDI from countries sharing a ‘land border’ with India subject to prior government approval.

By Vaibhav Kakkar & Sahil Arora

A government that had made it a habit to announce big-bang reforms to attract foreign investors, on April 17, 2020, took what could possibly go down as its boldest foreign policy decision. By issuing Press Note 3 of 2020, the government has made all FDI from countries sharing a ‘land border’ with India subject to prior government approval.

Previously, apart from investment in select sectors, the requirement for prior approval arose only for investments originating from Pakistan and Bangladesh.

While the intent to prevent ‘opportunistic’ investment from Chinese sources in a domestic market (which has seen a fall like no other) is clear, the move has raised many questions. The Press Note would only become effective once a formal amendment is made to the rules under FEMA, and it’s imperative for the government to address some crucial aspects.

What provoked the government?

Owing to the lockdown, there has been absolute mayhem at the stock market, with the Sensex having reported its sharpest fall in the previous quarter. Of the 538 stocks from BSE 500 and Nifty 500, 114 saw their price halved, with 221 stocks having fallen 30-50%. Against this backdrop, the government appears to have been spooked by the People’s Bank of China raising its stake in India’s largest non-banking mortgage provider HDFC and amid warning calls by MSMEs to prevent a ‘shopping spree’ by Chinese investors of heavily discounted Indian companies.

India is not alone. With valuations the world over being severely hit and in an attempt to prevent predatory behaviour by Chinese companies, Australia, Spain and Germany have tightened rules around foreign takeover, without specifically singling out China.

The language in the Press Note covers only FDI from Chinese sources and doesn’t impose restrictions on FPI from China—i.e. once the FEMA notification is issued, investments in unlisted companies and investments in excess of 10% in listed Indian companies would require prior government approval, but FPI (investment of less than 10% in listed Indian companies) is not impacted by the Press Note.

Question of beneficial ownership

Apart from entities registered in China and Chinese citizens, the Press Note covers investment from entities which are ‘beneficially owned’ by such Chinese entities or citizens. However, it has not clarified the manner in which ‘beneficial ownership’ would be determined. Given that most large funds may be substantially funded by or controlled by Chinese entities or citizens, yet not majority owned by them, the rules to determine ‘beneficial ownership’ would be crucial. This is important since most Chinese-sourced investment reaches India through funds in Singapore and Mauritius.

Special Administrative Regions (SARs) of China

In the past, when the government prohibited Chinese investors from acquiring immovable property in India without prior approval from RBI, they also specifically called out Hong Kong and Macau (separate from China) within such restrictions, owing to them being SARs. However, the Press Note currently places these restrictions only on China, and it remains to be seen whether Chinese SARs will be painted with the same brush.

Worry for existing Chinese investors

The Press Note and the impending FEMA notification would, in all likelihood, be prospective in nature. Accordingly, existing investments from China (such as Alibaba’s and Tencent’s investments in e-commerce companies) would be grandfathered and should require no post facto government approval. However, given that most Indian companies are in need of fund-raising, the government would need to clarify whether a rights issue, wherein Chinese investors only acquire pro-rata shareholding and don’t increase their percentage shareholding in a company, would also require prior approval?

What next?

While the government would term the move as an act of self-defence and one that follows global pattern, this pre-emptive economic strike would impact foreign investment inflows in India and could follow a Chinese retribution against Indian companies with investments in China. However, in times of a global pandemic, one can hardly cast a shadow on the government’s motive. Given that a close examination reveals that the prime motivator appears to be HDFC where the People’s Bank of China raised its stake marginally from 0.8% to 1.01%, it is only hoped the government’s decision is backed by empirical evidence.

As the country braces for the fallout of this decision, it is imperative for the government’s bold move to be immediately followed by a comprehensive FEMA notification and SEBI clarification that addresses the above concerns.

Kakkar is partner and Arora is senior associate, L&L Partners (formerly Luthra & Luthra Law Offices). Views are personal

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