Rukshad Davar at Majmudar & Partners analyses the recent FDI reforms and their implications for foreign investors
Recent policy moves have relaxed the sectoral caps and the conditions for foreign investment in certain sectors. The effects will be primarily felt in the retail sector, but investors in several other sectors will also benefit.
Multi-brand retail
Previous reforms in the multi-brand retail sector failed to attract even a single application from a foreign investor. This has been blamed largely on ambiguity over the conditions stipulated for such investments. The government’s recent amendments aim to address this.
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An earlier norm for foreign investment in the multi-brand retail sector required that at least 30% of the value of manufactured or processed products was to be sourced from small industries in India with an investment in plant and machinery not exceeding US$1 million. This rule raised concerns, especially with respect to quality control. In response, the government has now clarified that at least 30% of the value of manufactured or processed products can be sourced from micro, small and medium enterprises (as opposed to only small enterprises). Medium scale enterprises can have a total investment in plant and machinery up to US$2 million in certain cases. The government has also clarified that the micro, small and medium scale industry status will continue to apply in respect of the foreign investment even if in future such enterprises exceed their limits of total investment in plant and machinery.
Furthermore, previously at least 50% of the total foreign investment was required to be invested in back-end infrastructure within three years of the first tranche of investment. Now, at least 50% of the total foreign investment brought in the first tranche of US$100 million (i.e. US$50 million) must be invested in back-end infrastructure within three years. This modification offers some relief to foreign investors. However, they may be concerned about the requirement to invest US$100 million in the first tranche.
The government has also clarified that the investment is required to be made in greenfield back-end infrastructure operations, and that any investment in existing back-end infrastructure operations will not be counted towards the investment limit. This stipulation will be detrimental to Indian entities that had established world-class back-end infrastructure operations with a view to selling their stakes to foreign investors, and will also prove cumbersome for foreign investors which will now have to set up entire back-end infrastructure, which will delay front-end operations. Front-end multi-brand stores must also be greenfield operations, so foreign investment in existing front-end stores or operations will not be permitted. This will also prove detrimental to Indian entities which had been looking at divesting their stake in front-end stores or operations to foreign investors.
State governments can now decide whether to allow multi-brand retailers to set up in any city and not just cities with a population of more than 1 million, as earlier stipulated.
Although these measures could improve foreign investor sentiment, an issue that yet remains unaddressed is the minimum foreign investment requirement of US$100 million, which many investors view as prohibitively high. Another concern relates to the upcoming general elections and the possibility of a roll-back of policy decisions should the opposition party come to power.
Single-brand retail
In single-brand retail, foreign investment of up to 49% will now be permitted without prior approval from the Foreign Investment Promotion Board (FIPB). Further, the earlier stipulation that only one non-resident entity can invest in a single-brand retail operation has been liberalized so that more than one non-resident entity can invest, irrespective of whether they are owners of the brand or licensees.
Other sectors
Foreign investment in other sectors such as basic and cellular services, stock exchanges, depositories, asset reconstruction companies, credit information companies, commodity exchanges, petroleum, natural gas and refining, power exchanges and courier services have also been liberalized.
Foreign investment in the defence sector may be permitted in excess of the existing sectoral cap of 26% for proposals which are likely to result in access to “modern and state-of-the-art technology” in India. In order to attract the desired level of foreign investment in this sector, the government must lay down clear guidelines to define “modern and state-of-the-art technology”.
Despite many shortcomings, the liberalization measures are a welcome move. However, they may not be enough to push the Indian economy out of the present slowdown as infrastructure setbacks and macroeconomic issues faced by the Indian economy yet need to be resolved.
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Rukshad Davar is a Mumbai-based partner at Majmudar & Partners. He handles corporate, M&A and real estate matters. He can be contacted at rdavar@majmudarindia.com.
