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Foreign Direct Investment in India

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Phases of Indian Economy 1947-1980 Command and Control Economy Allocation of resources by the Government (budgetary grants) Government took active part in setting priorities for the economy Self-Reliance was the buzz word Nationalisation of Banks Limited scope for private participationLuthra & Luthra Law Offices 2

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Phases of Indian Economy 1991-2000 Liberalization and Globalization of Indian Economy Increased emphasis on private sector participation Limited extent of FDI participation Gradual improvement in the enabling environment

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Phases of Indian Economy post 2000 Political Coalitions have started providing stable governments Government to getout of owning and managing businesses: Disinvestment Policy Gradual relaxationin the FDI Policy


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Progressive LiberalisationPre-1991 1991 FDI was allowed selectively up to 40% under FERA This period was dominated by the Congress party 35 high priority industry groups were placed on the Automatic Route for FDI up to 51% Minority Congress government: Initiated economic reforms in a big way Automatic Route expanded to 111 high priority industry groups up to 100%/ 74%/ 51%/50% United Front Government: Inclusive of left parties, was perceived as traditionally opposed to FDI, but continued with the reform

s. All sectors placed on the Automatic Route for FDI except for a small negativelist BJP coalition government:(coalition of Left and Right wing parties) was traditionally seen as opposed to FDI, but continued with economic reforms. Many new sectors opened to FDI; viz., insurance (26%), integrated townships (100%), mass rapid transit systems (100%), defence industry (26%), tea plantations (100%),print media (26%). Sectoral caps in many other sectors relaxed; BJP coalition government: pursued reforms vigorously and initiated second generation reforms. Luthra & Luthra Law Offices 5

1997

2000

Post 2000

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Consensus on Economic Liberalisation Change in perception Indian Business Houses Government Legal Framework: shift from a Positive List toa Negative List (FERA FEMA)

Gradually all sectors moving to Choice and Competition (Multiple Player Model)


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Foreign Direct InvestmentForeign direct investment (FDI) is defined as "investment made to acquire lasting interest in enterprises operating in the host economy of the investor. The FDIrelationship, consists of a parent enterprise and a foreign affiliate which together form a transnational corporation (TNC). In order to qualify as FDI the investment must afford the parent enterprise control over its foreign affiliate. TheUN defines control in this case as owning 10% or more of the ordinary shares or

voting power of an incorporated firm or its equivalent for an unincorporated firm; lower ownership shares are known as portfolio investment.Luthra & Luthra Law Offices 8

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Foreign Direct InvestmentThe IMF definition of FDI includes as many as twelve different elements, namely:equity capital, reinvested earnings of foreign companies, inter-company debt transactions, short-term and long-term loans, financial leasing, trade credits, grants, bonds, non-cash acquisition of equity, investment made by foreign venturecapital investors, earnings data of indirectly held FDI enterprises and controlpremium, non-competition fee, and so on.

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Foreign Direct InvestmentFDI definition in India is restricted mainly to hard cash unlike other countrieswhich include noncash such as technology and machinery in the FDI flows. It also excludes; -reinvested earnings -subordinated debt -overseas commercial borrowings which are included in other country statistics.Luthra & Luthra Law Offices 10

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Entry Process & Entry Strategies


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The Industrial PolicyIndustrial Licensing All Industrial undertakings exempt from obtaining an industrial license to manufacture, except for: Industries reserved for the Public Sector Industries retained under compulsory licensing Items of manufacture reserved for the Small Scale Sector If the proposal attracts locational restriction

Industrial Entrepreneur MemorandumLuthra & Luthra Law Offices 12

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The Industrial Policy Industries reserved for the Public Sector: (1) Atomic Energy and (2) Railway Transport Compulsory licensing needed in the following industries: Distillation and brewing of alcoholic drinks Cigars and cigarettes and manufactured tobacco substitutes Electronic aerospace and defence equipment of all typesIndustrial explosives including detonating fuses, safety fuses, gun powder, nitrocellulose and matches Certain hazardous chemicals


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The Industrial PolicyLocational Policy Industrial undertakings are free to select the location Location to be 25 km away from any city with a million strong population Exceptions: When located in an area designated as an Industrial Area before the 25th July, 1991. Electronics, Computer Software and Printing (and any other industry which maybe notified in future as non polluting industry).


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The Industrial PolicySmall Scale Industries Suitable for Foreign Investment? Cap on Investment in fixed assets (plant and machinery) is Rs. 10 million (approx. SGD 3,70,000)

Not more than 24 per cent of total equity can be held by any industrial undertak

ing either foreign or domestic Upon such equity exceeding 24% the SSI status islost. Carry-on-Business (COB) Licence required.

Various items reserved exclusively for SSIs.


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The Entry ProcessInvesting in India

Automatic RouteGeneral rule Inform RBI within 30 days of inflow/issue of shares Pricing: FEMA Re

gulations Unlisted CCI (Comp Comm of India) Listed SEBI Cap of Rs. 600 Crore

Prior PermissionBy exception Approval of Foreign Investment Promotion Board needed. Decision generally within 4-6 weeks


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The Entry Process: Automatic Route All items/activities for FDI investment up to 100% fall under the Automatic Route except the following: All proposals that require an Industrial Licence. All proposals in which the foreign collaborator has a previous venture/ tie up in India. All proposals relating to acquisition of existing shares in an existing Indian Company by a foreign investor. All proposals falling outside notified sectoral policy/ caps or under s

ectors in which FDI is not permitted.


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The Entry Process: Government Approval

Foreign Investment Promotion Board (FIPB) Approval For all activities, which are not covered under the Automatic Route Composite approvals involving foreign investment/ foreign technical collaboration PublishedTransparent Guidelines vs. Earlier Case by Case Approach Downstream InvestmentLuthra & Luthra Law Offices 18

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Acquisition of shares in a Listed CompanyTakeover Code Acquisition of more than specified equity stakes would entail public offer Pricing: Average of 26 weeks or 2 weeks, whichever is higher No takeover of management before completion of Takeover Code formalities


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Foreign Technology Collaboration Foreign technology collaborations are permitted either through the automatic route or by the Government.Policy for Automatic Approval To all industries for foreign technology collaboration agreements, irrespectiveof the extent of foreign equity in the shareholding, subject to: The lump sum payments not exceeding US $ 2 Million;


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Foreign Technology CollaborationPolicy for Automatic approval (contd.) Royalty payable being limited to 5 per cent for domestic sales and 8 per cent for exports, subject to a total payment of 8 per cent on sales No restriction on the duration of the royalty payments The aforesaid royalty limits are net of taxes and are calculated according to standard conditions.Luthra & Luthra Law Offices 21

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Foreign Technology CollaborationPolicy for Automatic approval (contd.) Payment of royalty up to 2% for exports and 1% for domestic sales is allowed under automatic route on use of trademarks and brand name of the foreign collaborator without technology transfer. Registration of FC Agreement with RBI.


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The Entry Strategy Forms in which Business can be conducted in India Wholly owned subsidiary Joint Venture Company Branch Office Project Office

India Presence: Liaison OfficeLuthra & Luthra Law Offices 23

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Exit Issues Transfer of shares from non-resident to non-resident does not require RBI approval for pricing Transfer of shares from non-resident to resident does not requireany FIPB Approval, though RBI approval is required for pricing Pricing as per FEMA listed and unlisted securities RBI permission not required if sale through Stock Exchange

Mauritius Route: Capital Gain Advantage


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Legal Structures facilitating FDI


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Facilitating FDI in IndiaEmergence of Independent Regulators: Electricity, Telecom, Insurance, Capital Market and Competition Law Ensuring level playing field vis--vis Government Corporations and inter se private players Expertise in the subject matter involved Expeditious resolution of disputeLuthra & Luthra Law Offices 26

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Facilitating FDI in IndiaEmergence of Independent Regulators (Contd.) Regulators under consideration: Petroleum, Railways, Information and Broadcasting Regulator to curb Anti-Competitive Practices Government Directives


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Facilitating FDI in IndiaLabour laws a more contractual approach. Move towards: hire and fire Progressive use of discretionary executive powers Permissions granted for closure of unviable units Inspections only upon workers grievances Voluntary Retirement Schemes EPZs, SEZs etc may be exempted from application of certain labour laws Amendment to Industrial Disputes Act under conside

ration Amendment to Contract Labour (Regulation & Abolition) Act, 1970 under consideration.


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Investment Incentives


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Incentives for investment in Telecom SectorPermission for Inter-Circle & Intra-Circle Mergers Exemplary growth in teledensity, subscriber base etc. Companies commencing operations before 31st March, 2004, would enjoy tax benefits: 100% deduction for first five years 30% deduction for next five years

Exemption from tax on interest income and long term capital gains in certain cas

es Import duty rates have been reduced for various telecom equipmentLuthra & Luthra Law Offices 30

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Investment Incentive for IT Industry Software companies have a ten year tax holiday on their export income In 1998 the Government set up a new Ministry of Information Technology The Information Technology Act, 2000 was passed to tackle cyber crimes and facilitate ecommerceLuthra & Luthra Law Offices 31

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Incentives for Investment in Power Sector New Legal Regime: Electricity Act, 2003 The Act provides for: Multiple Buyer Model, Independent Regulatory Body, Open Access, Power Trading as an independent business, delicensing of generation 100% FDI Automatic Route in: Hydro-electric power plants; Coal/lignite based thermal power plants; Oil/gas based thermal power plants.Luthra & Luthra Law Offices 32

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Incentives for Investment in Power Sector Other investment incentives: New Power Projects eligible for 100% tax holiday in any block of ten years, within first fifteen years of operation. The Deadline for income tax exemption for new power projects extended from 2006 to 2012. Various indirect tax incentives: Concessional rate of import duties Special project import scheme Deemed export benefit for certain categories of power projects.


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Reforms in Financial Sector FIIs allowed in Capital Market, can invest both in Debt and Equity FDI cap in private sector banks raised to 74% 10% cap on voting rights

The Mutual Fund market is also open now to foreign players. Equity issue pricingis market determined


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FDI in Real Estate: Policy & Issues Press Note 4 (2002 Series) 100% FDI under Automatic Route PERMITTED FOR Integrated Townships, subject to following conditions: Foreign company to be registered as Indian company under Companies Act, 1956 Core Business - Integrated Township Development with a successful track record. Minimum area of development: 100 acres as per local bylaws/rules. In absence of suc

h by laws/rules, minimum of 2000 dwelling houses for about 10,000 population tobe developed by the investor. Conditions post acceptance of FDI proposal

Minimum capitalization norms Upfront payment Minimum lock-in period Time bound completion of project


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FDI in Hotel and Tourism:Policy and Issues 100% FDI under Automatic Route Hotel includes Restaurant, beach resorts and othertourist complexes providing accommodation and/or Catering Tourism related industries includes travel agencies, tour operating agencies, units providing facilitiesfor cultural, adventure and wild life experience to tourists; surface, air andwater transport facilities to tourists; leisure, entertainment, amusement, sports and health units for tourists and Convention/ Seminar units and organizations.

Automatic approval for Technical, Consultancy, Marketing, Publicity, Managerialservices subject to specified limits.Luthra & Luthra Law Offices 36

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Conclusion Economics occupies centre stage in various elections Rising expectations; risingprosperity Legal regime: more stable and predictable Bureaucracy: changing withthe times The Future beckons


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FDI IN INDIA: FACTS AND FIGURES


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LOCATIONAL DETERMINANTS OF FDIA firm becomes multinational mainly for three reasons. -Ownership advantages, -Location-specific advantages -Internalization. Large market size, proximity to home market, lowcost labor and favorable tax treatment in the host country are allconsidered as location advantagesLuthra & Luthra Law Offices 41

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LOCATIONAL DETERMINANTS OF FDILocation-specific advantages are further classified by three types of motives ofFDI. First, market-seeking investment is undertaken to sustain existing marketsor to exploit new markets. For example, due to tariffs and other forms of barriers, the firm has to relocate production to the host country where it had previously served by exportingLuthra & Luthra Law Offices 42

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LOCATIONAL DETERMINANTS OF FDISecond, when firms invest abroad to acquire resources not available in the homecountry, the investment is called resource- or asset-seeking. Resources may be natural resources, raw materials, or low-cost inputs such as labor.


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LOCATIONAL DETERMINANTS OF FDIThird, the investment is rationalized or efficiencyseeking when the firm can gain from the common governance of geographically dispersed activities in the presence of economies of scale and scope.


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The ModelFDI = f (MS, OE/FT, I, DMA, EE, IE) Where FDI = Foreign direct Investment, MSize of domestic market, OE/FT = openness of the economy to foreign trade, I = Infrastructure of the host country, DMA = Domestic market Attractiveness, EE = External economic stability, IE = Internal economic stability.Luthra & Luthra Law Offices 45

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The ModelThe economic theory suggests that a positive relationship between FDI and size of domestic market, openness of the economy to foreign trade, and infrastructureof the country. While a negative relationship between FDI and External economicstability, internal economic stability. The larger the market size, the more demand for the products or services to be provided by the FDI.Luthra & Luthra Law Offices 46

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Share of Five Top States Attracting FDI Approvals (January 1991 to March 2004)No. of FDI Approvals Amount of FDI US $ in Bill ion % FDI Approv al

Rank

Name of the State

Total

Technical

Financial

Rs. In Crores

1 2 3 4 5

Maharashtra Delhi Tamil Nadu Karnataka Gujarat

4,816 2,638 2,607 2,467 1,204

1,308 304 613 494 556

3,508 2,334 1,994 1,973 648

51,114.68 13.18 17.48 35,250.74 9.78 25,071.77 6.52 24,138.44 6.15 18,837.30 4.81 12.06 8.58 8.26 6.4447

Source: Economic Survey-2003-04Luthra & Luthra Law Offices

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LOCATIONAL DETERMINANTS OF FDIFour states namely Karnataka, Maharashtra, Tamilnadu and Gujarat accounted for over one-third of total FDI approvals. The shares of these individual states were, respectively, 7.6%, 13.7%, 6.7% and 5.3%. The shares of other major states were considerably lower: West Bengal (3.7%), Andhra Pradesh (4.2%), Madhya Pradesh(4.5%) and Orissa (3.8 %). The shares of Kerala, Haryana, Punjab and Rajasthan were comparatively smaller whereas the flow of FDI into populous states such as B

ihar and Uttar Pradesh has been virtually negligible.Luthra & Luthra Law Offices 48

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Conclusion As far as the economic interpretation of the model is concerned, thesize of the domestic market is positively related to foreign direct investment.The greater the market, the more customers and the more opportunities to invest.Since FDI is mostly in the form of physical investment, investors would preferthe markets with better infrastructure.Luthra & Luthra Law Offices 50

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