Context: The Government of India has reviewed the existing Foreign Direct Investment(FDI) policy in order to curb opportunistic takeovers/acquisitions of Indian companies due to the current COVID-19 pandemic.

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  • With many Indian businesses coming to a halt due to the imposed lockdown, a number of domestic firms may be vulnerable to acquisitions by foreign players.
    • Last week, it was noted that People’s Bank of China now holds a 1.01% stake in the HDFC company through portfolio investment.
  • The Centre has made prior government approval mandatory for FDI from countries which share a land border with India
    • The land  borders of India are shared  with Pakistan, Afghanistan, China, Nepal, Bhutan, Bangladesh and Myanmar.
    • Previously, only investments from Pakistan and Bangladesh faced such restrictions.
    • Such a move is directed at restricting Chinese investments.
  • Investors from countries not covered by the new policy only have to inform the RBI after a transaction rather than asking for prior permission from the relevant government department.
  • DPIIT (Department for Promotion of Industry and Internal trade) has issued a notification regarding the revised position in FDI policy.
  • Globally too, like Italy, Spain, France and Australia have already taken similar action to protect their businesses from foreign investors looking out for distressed entities.

Present Position of FDI Policy

Revised Position of FDI Policy

  • A non-resident entity can invest in India, subject to the FDI Policy barring the prohibited sectors/activities.
    • However, a citizen of Bangladesh or an entity incorporated in Bangladesh can invest only under the Government route.
  • Further, a citizen of Pakistan or an entity incorporated in Pakistan can invest, only under the Government route with the following caveats.
    • FDI is allowed in sectors/activities other than defence, space, atomic energy and prohibited sectors/activities.
  • A non-resident entity can invest in India, subject to the FDI Policy except in those sectors/activities which are prohibited. 
    • However, an entity of a country, which shares a land border with India or where the beneficial owner of an investment into India is situated in or is a citizen of any such country, can invest only under the Government route. 
  • Further, a citizen of Pakistan or an entity incorporated in Pakistan can invest, only under the Government route with the following caveats.
    • FDI is allowed in sectors/activities other than defence, space, atomic energy and prohibited sectors/activities.
  • In the event of the transfer of ownership of any existing or future FDI in an entity in India, directly or indirectly, resulting in the beneficial ownership falling within the restriction/purview of the above provisions will also require Government approval.
    • For example, if a Chinese national has invested in an international fund or is a LLP (Limited Liability Partnership) in the fund, that fund’s investment process in India will be subject to government’s approval , even if it's a German or say Japanese fund. 

Beneficial Ownership

A beneficial owner is a person/persons who enjoys the benefits of ownership even when the title to the property is not in his/her name.

In other words, It is one who ultimately owns or controls a legal entity or arrangement, such as a company, a trust, or a foundation.

Chinese Economic Footprint in India 

  • Chinese investment in India increased from $1.6 billion in 2014 to $8 billion in 2017 as per a report of Brookings India.
    • The investments span a range of sectors to a tune of 42% were in the manufacturing sector, 25% in infrastructure and others in telecom, petrochemicals, software and IT. 
    • The Brookings paper also tracked major investments in energy, where three out of four Indian power plants use Chinese equipment, automobiles, real estate and consumer goods, especially the mobile phone segment, where Chinese brands dominate the smartphone market.
  • The peculiarity of Chinese investment that is not focussed upon is its significant share in Technology start-up space.
    • Chinese venture capitalists have found way to 18 of 23 Unicorn companies such as Paytm, Flipkart, Swiggy, Zomato, Oyo, Ola, BigBasket, Byju's, SnapDeal, Quikr and MakeMyTrip.

Mode of investment 

  • There are primarily two instruments for foreign investment - FDI and FII
  • Foreign direct investment (FDI) is more stable and strategic.
  • The firms bring FDI commits for a long term, unlike foreign portfolio investments (FPIs) that are made in the stock market mostly for financial returns. 
    • The DPIIT under the Ministry of Commerce ministry’s department for promotion of industry and internal trade regulates FDI.
    • The Securities and Exchange Board of India (SEBI) under the finance ministry oversees FPIs.
  • Sixteen Chinese FPIs are registered in India, with $1.1 billion invested in top-tier stocks.
  • Chinese FDI in India is still small, at $6.2 billion.

Significance of Chinese Economic footprint in India

  1. It signifies that China is embedded in Indian society, the economy, and the technology ecosystem that influences it. 
    1. The technology sector holds prominence where definitions of security or strategic implications are rapidly evolving.
    2. Unlike a port or a railway line, these are invisible assets in small sizes rarely over $100 million and made by the private sector, which does not seem of immediate concern.
  2. The sudden rush of investment from China’s private sector poses new challenges for India’s regulators amid warning signs of blurring boundaries between China's state and private sectors.
    1. It raises an important question whether the Chinese private sector can indeed be considered as an entirely distinct entity from the state given their key roles in advancing government initiatives at home, including in running an effective censorship regime.

Implications of reviewed FDI policy on Investors and Startup Ecosystem

  1. The new FDI norms may force the Chinese investors to postpone their investments.
    1. The unicorns, which depend on their largest investors to keep the cash flowing, may now have to start looking for other options.
    2. Growth-stage startups may also see investments drying up.
  2. The change in FDI rule is a drastic move and could potentially hamper the growth of the booming startup ecosystem in India.
    1. The pool of capital coming from the US and Europe will dry out because their own economies are not in a good shape.
    2. At such a time, turning off the investment channel  from China, which had the ability to invest, comes as a double whammy for the Startup Industry.
    3. It will act as a breeding ground for distrust between the Chinese investors and Indian regulators.

China’s response to the changed FDI policy and India’s counter

  • As per the Chinese official, the new FDI policy that puts additional barriers for investors from specific countries violates the principle of Non-discrimination of WTO.
    • It also goes against the general trend of liberalisation and facilitation of trade and investment.
    • Going forward, they do not conform to the consensus of the G20 leaders and Trade Ministers to realise a free, fair, non-discriminatory, transparent, predictable and stable trade and investment environment.
    • China also invoked the principle of free market economy to foster an open, fair and equitable business environment.
  • India has countered the Chinese response by saying that the new Rule doesn't stand for denial of permission, but only an approval process in turn they do not violate any of the WTO’s principles.
    • Indian officials said that the new norms don't directly affect goods, but just an investment measure.
    • The new rules are not related to market access or National treatment restriction. And also it doesn’t automatically result in any equity cap or restriction.

Is India’s approach in the right direction ?

  • Given that earlier too, India has resisted possible Chinese aggression in trade be it China-led Belt and Road or participation of Huawei in the 5G trials, the current move seems to be in sync with India’s policy.
    • Also given the historical confrontations of 1962 war, 2017 Doklam standoff, financial and military aid and engagement with Pakistan calls for treading with caution. 
    • Their Central banks have unlimited resources and their stake purchases can’t be equated to just another entity’s. 
    • The People’s Bank of China taking a stake in HDFC is to be treated differently, as a financial firm has systemic importance for the banking sector.
  • Having said that, India could have gone with a nuanced approach.
    • It could have set some rules about Chinese investments in strategic assets and protecting investments into startups
    • It could have designed restrictions in a manner that should not have any adverse impact on bonafide investments in these challenging times, wherein Indian companies are in dire need of funds.
    • Greenfield investments should have been kept out of the purview as they do not pose a threat of takeover of existing business, rather they create new capacities and businesses in the country. 
    • All in all, scrutiny was the need of the hour, but not an overkill.

Road Ahead

  • Given the new rules are in place, what the Government can do is to fast pace the investment proposals especially in the tech start-up space where cash burn is high.
    • It should also make a distinction as per the class of investors for allowing such investors (Category I and II Alternative Investment Fund) which are not after management control.
    • China has delivered on quality and service and leads in electric and green technologies. India should encourage all that coming into its territory.
  • Apart from FDI, it should also focus on plugging investments from the market route.
  • There should also be deliberations regarding the new flashpoints in India-China relations after such restrictions.
  • Protection of data that is with the Chinese manufacturers of Smartphones, and apps is a concern that should be looked into.
  • Lastly, it needs to clear the air over the concerns of the free market economy and violation of WTO’s principles,if any.

WTO’s Principles of Trading System

Trade without discrimination

  1. Most-favoured-nation (MFN): Treating other people equally  
    1. Under the WTO agreements, countries cannot normally discriminate between their trading partners. If a nation grants someone a special favour (such as a lower customs duty rate for one of their products) then it has to do the same for all other WTO members.
    2. In general, MFN means that every time a country lowers a trade barrier or opens up a market, it has to do so for the same goods or services from all its trading partners, whether rich or poor, weak or strong.
    3. Exceptions to MFN
      1. For example, countries can set up a free trade agreement that applies only to goods traded within the group, discriminating against goods from outside. 
      2. Or they can give developing countries special access to their markets. 
      3. Or a country can raise barriers against products that are considered to be traded unfairly from specific countries. 
      4. And in services, countries are allowed, in limited circumstances, to discriminate. But the agreements only permit these exceptions under strict conditions.
  2. National treatment: Treating foreigners and locals equally  
    1. Imported and locally-produced goods should be treated equally — at least after the foreign goods have entered the market. 
    2. The same should apply to foreign and domestic services, and to foreign and local trademarks, copyrights and patents. 
    3. This principle of National treatment (giving others the same treatment as one’s own nationals) is also found in all the three main WTO agreements viz GATT, GATS and TRIPS.
    4. National treatment only applies once a product, service or item of intellectual property has entered the market
      1. Therefore, charging customs duty on an import is not a violation of national treatment even if locally-produced products are not charged an equivalent tax.