Towards a neo-liberal foreign investment policy

The flow of foreign investment in India is closely tied to the sensitivity of the regulators to market fluxes and investor sentiment. If news reports and industry sources are to be believed the government as well as the Reserve Bank of India (RBI) have contemplated certain measures to modify the existing foreign investment policy and regulations to suit the changing reality of India’s economy. In this column, we discuss the two important developments in this regard.

Tie-up condition

Circular 2 of 2010, which consolidated documents on foreign direct investment (FDI) policy, states that a joint venture agreement entered into by a non-resident investor must include a conflict of interest clause. While reflecting policy stipulated in press note 1 of 2005 (PN1 ’05), this safeguards the interests of the joint venture partners in the event that one of them wants to set up another joint venture or a wholly owned subsidiary in the same field of economic activity. Circular 2 of 2010 also specifies that as on 12 January 2005 any proposal by a non-resident investor, who has an existing joint venture, technology transfer, or trademark agreement, to invest in the same field would need approval from the Foreign Investment Promotion Board (FIPB) or the Project Approval Board (Tie-up Condition).

Not partners for life

In the past, the FIPB has cleared proposals by foreign investors despite objections raised by their Indian partners. A noteworthy example is that of the German plastic moulding company Ralf Schneider, who proposed to set up a wholly-owned subsidiary in India in 2008. Ralf Schneider had a tie-up with the engineering giant Larsen and Toubro (L&T) in 1992 for a technical partnership that expired in 2007. L&T invoked PN1 ‘05 and objected to Schneider’s proposal on the basis that if the German entity is permitted entry, it would result in a situation where two producers in the market would be offering the same product using the same technology. Initially, the FIPB agreed with L&T, but later concurred with Schneider’s argument that PN1 ‘05 should not be applicable to the proposal since the tie-up was a technical one (as opposed to a financial one) and it had expired the previous year.

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Changes afoot?

Certain sources have recently suggested that the government is considering if it should dispense with the tie-up condition altogether. The protectionist outlook that it reflects has affected several foreign companies investing in India in the past. Now with FDI during April 2010-January 2011 dipping 25% to US$17 billion from US$22.9 billion in the corresponding period last year, the scrapping of PN1 ’05 should be considered. It would go a long way in signalling that India’s FDI policy is dynamic and responsive to the needs and aspirations of foreign investors.

One-stop rules

The Reserve Bank of India is set to rewrite the Foreign Exchange Management (Transfer or Issue of Security by a person resident outside India) Regulations, 2000 (FEMA 20) to reflect changes made to India’s FDI policies over the last few years. FEMA 20 has been the cornerstone of regulations under the Foreign Exchange Management Act, 1999, and deals primarily with the transfer of securities involving a person residing overseas.

The regulations that will replace FEMA 20 are likely to define control and ownership of an Indian company as it has been defined in press note 2 of 2009. It will also incorporate an explanation to the definition of capital as stated in the consolidated FDI circular 2 of 2010, which excludes instruments like warrants, partly paid shares etc from the purview of capital and makes it clear that such instruments can be issued to persons resident outside India only with government approval. This is a right step in making FEMA the one-stop regulation governing all foreign investment related matters.

Opening up

With a revised FDI circular expected to be issued on 31 March 2011 the government is making the right noises at the right time. At the start of India’s FDI story, the focus of the regulations was on protecting Indian companies. As time has moved on and with foreign investment now playing a predominant role in India’s economy, the government is no longer keen on “babysitting” domestic players at the cost of foreign investors. The recent developments point to slow but sure signs that the government is poised to carry forward and act on the liberalization mantra.

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Sawant Singh is a partner at the Mumbai office of Phoenix Legal. Hemant Krishna V is an associate at the firm’s Mumbai office. They can be reached at sawant.singh@phoenixlegal.in and hemant.krishna@phoenixlegal.in.