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Foreign Direct Investmentin India

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Luthra & Luthra Law Offices 2

Phases of Indian Economy

1947-1980

Command and Control Economy

Allocation of resources by the Government(budgetary grants)

Government took active part in setting prioritiesfor the economy

Self-Reliance was the buzz word Nationalisation of Banks

Limited scope for private participation

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1991-2000 Liberalization and Globalization of Indian

Economy

Increased emphasis on private sector

participation

Limited extent of FDI participation

Gradual improvement in the enablingenvironment

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post 2000 Political Coalitions have started providing

stable governments

Government to get out of owning and

managing businesses: Disinvestment Policy

Gradual relaxation in the FDI Policy

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Progressive LiberalisationPre-1991 FDI was allowed selectively up to 40% under FERA

This period was dominated by the Congress party

1991 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

1997 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 reforms.

2000 All sectors placed on the Automatic Route for FDI except for a small negative list

BJP coalition government:(coalition of Left and Right wing parties) was

traditionally seen as opposed to FDI, but continued with economic reforms.

Post 2000 M

any 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.

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Consensus on Economic Liberalisation

Change in perception

Indian Business Houses

Government Legal Framework: shift from a Positive List to a

Negative List(FERA FEMA)

Gradually all sectors moving to Choice

andCompetition (Multiple Player Model)

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Present Picture

India: Fourth largest economy in terms of Purchasing Power Parity

Tenth most industrialized economy

GDP growth rate of 8.1% - Second highest in theworld.

Considerable improvement in FDI inflows

FII inflows:

For the period, July 2003 Jan 2004 FII inflow hasexceeded USD 7 bn, which is more than the cumulativeFII inflow in the last five years.

Still a big gap between India and China

Current economic situation in india

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Foreign Direct Investment

Foreign direct investment (FDI) is defined as "investmentmade to acquire lasting interest in enterprises operating inthe host economy of the investor.

The FDI relationship, consists of a parent enterprise and a

foreign affiliate which together form a transnationalcorporation (TNC).

In order to qualify as FDI the investment must afford theparent enterprise controlover its foreign affiliate.

The UN defines control in this case as owning 10% or more ofthe ordinary shares or voting power of an incorporated firmor its equivalent for an unincorporated firm; lowerownership shares are known as portfolio investment.

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The 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 byforeign venture capital investors, earnings data

of indirectly held FDI enterprises and control

premium, non-competition fee, and so on.

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FDI definition in India is restricted mainly to hardcash unlike other countries which include non-

cash 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.

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Entry Process & Entry

Strategies

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The Industrial Policy

Industrial Licensing

All Industrial undertakings exempt from obtaining an

industrial license to manufacture, except for: Industries reserved for the Public Sector

Industries retained undercompulsory licensing

Items of manufacture reserved for the Small Scale

Sector If the proposal attracts locational restriction

Industrial Entrepreneur Memorandum

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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 types

Industrial explosives including detonating fuses, safety fuses,

gun powder, nitrocellulose and matches

Certain hazardous chemicals

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Locational Policy

Industrial undertakings are free to select the location

Location to be 25 km away from any city with amillion strong population

Exceptions:

When located in an area designated as anIndustrial Area before the 25th July, 1991.

Electronics, Computer Software and Printing (andany other industry which may be notified in futureas non polluting industry).

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SmallScale 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 byany industrial undertaking either foreign or domestic

Upon such equity exceeding 24% the SSI status is lost.

Carry-on-Business (COB) Licence required.

Various items reserved exclusively for SSIs.

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The Entry Process.

Automatic Route Prior Permission

Investing in India

General rule

Inform RBI within 30 days of

inflow/issue of shares

Pricing: FEMA RegulationsUnlisted CCI (Comp Comm of India)

Listed SEBI

Cap of Rs. 600 Crore

By 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 ofexisting shares in

an existing Indian Company by a foreign investor.

All proposals falling outside notified sectoral policy/

caps or under sectors 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

Published Transparent Guidelines vs.Earlier Case by Case Approach

Downstream Investment

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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 ofTakeover Code formalities

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Foreign Technology Collaboration

Foreign technology collaborations are permittedeither through the automatic route or by theGovernment.

Policy for Automatic Approval

To all industries for foreign technology collaborationagreements, irrespective of the extent of foreign equity in the

shareholding, subject to: The lump sum payments not exceeding US $ 2 Million;

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Policy for Automatic approval(contd.)

Royalty payable being limited to 5 per cent for

domestic sales and 8 per cent for exports, subject toa 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.

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Policy for Automatic approval(contd.)

Payment of royalty up to 2% for exports and 1% for

domestic sales is allowed under automatic route onuse of trademarks and brand name of the foreign

collaboratorwithout 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 Office

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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 doesnot require any 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 Structuresfacilitating FDI

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Facilitating FDI in India

Emergence of Independent Regulators:Electricity, Telecom, Insurance, Capital

Market and Competition Law

Ensuring level playing field vis--visGovernment Corporations and inter se private

players

Expertise in the subject matter involved Expeditious resolution of dispute

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Emergence ofIndependent Regulators (Contd.)

Regulators under consideration: Petroleum,Railways, Information and Broadcasting

Regulator to curb Anti-Competitive Practices

Government Directives

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Labour laws a more contractual approach. Move towards: hire and fire

Progressive use ofdiscretionary 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 certainlabour laws

Amendment to Industrial Disputes Act under consideration 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 termcapital gains in certain cases

Import duty rates have been reduced for varioustelecom equipment

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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 ofInformation Technology

The Information Technology Act, 2000 was

passed to tackle cyber crimes and facilitate e-commerce

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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.

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Incentives for Investment in Power Sector

Other investment incentives:

New Power Projects eligible for 100% tax holiday in anyblock of ten years, within first fifteen years of operation.

The Deadline for income tax exemption for new powerprojects 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 investboth in Debt and Equity

FDI cap in private sector banks raised to74%

10% cap on voting rights

The Mutual Fund market is also open now

to foreign players. Equity issue pricing is 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 trackrecord.

Minimum area of development: 100 acres as per local bylaws/rules. In absenceof such by laws/rules, minimum of 2000 dwelling houses for about 10,000population to be 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 other touristcomplexes providing accommodation and/or Catering

Tourism related industries includes travel agencies, touroperating agencies, units providing facilities for cultural,adventure and wild life experience to tourists; surface, airand water transport facilities to tourists; leisure,

entertainment, amusement, sports and health units fortourists and Convention/ Seminar units and organizations.

Automatic approval for Technical, Consultancy, Marketing,Publicity, Managerial services subject to specified limits.

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Conclusion

Economics occupies centre stage in various

elections

Rising expectations; rising prosperity

Legal regime: more stable and predictable

Bureaucracy: changing with the times

The Future beckons

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FDI IN INDIA: FACTS AND FIGURES

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LOCATIONAL DETERMINANTS OF

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FDI

A firm becomes multinational mainly for threereasons.

-Ownership advantages,

-Location-specific advantages-Internalization.

Large market size, proximity to home market, low-

cost labor and favorable tax treatment in the hostcountry are all considered as location advantages

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LOCATIONAL DETERMINANTS OF FDI

Location-specific advantages are further classifiedby three types of motives of FDI.

First, market-seeking investment is undertaken to

sustain existing markets or to exploit newmarkets.

For example, due to tariffs and other forms of

barriers, the firm has to relocate production tothe host country where it had previously servedby exporting

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FDI

Second, when firms invest abroad to acquire

resources not available in the home country, 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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The Model

FDI = f (MS, OE/FT, I, DMA, EE, IE)

Where FDI = Foreign direct Investment,

MS = Size 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.

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The Model

The economic theory suggests that a positive relationship

between FDI and size of domestic market, openness of the

economy to foreign trade, and infrastructure of the

country.

While a negative relationship between FDI and External

economic stability, internal economic stability.

The larger the market size, the more demand for the products

or services to be provided by the FDI.

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Share of Five Top States Attracting FDI Approvals

(January 1991 to March 2004)

Rank Name of the State

No. of FDI Approvals Amount of FDI

% FDI

Approv

alTotal Technical Financial Rs. In Crores

US $ in

Bill

ion

1 Maharashtra 4,816 1,308 3,508 51,114.68 13.18 17.48

2 Delhi 2,638 304 2,334 35,250.74 9.78 12.06

3 Tamil Nadu 2,607 613 1,994 25,071.77 6.52 8.58

4 Karnataka 2,467 494 1,973 24,138.44 6.15 8.26

5 Gujarat 1,204 556 648 18,837.30 4.81 6.44

Source: Economic Survey-2003-04

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FDI

Four states namely Karnataka, Maharashtra, Tamilnadu andGujarat accounted for over one-third of total FDIapprovals.

The shares of these individual states were, respectively,7.6%, 13.7%, 6.7% and 5.3%. The shares of other majorstates were considerably lower: West Bengal (3.7%),Andhra Pradesh (4.2%), Madhya Pradesh (4.5%) andOrissa (3.8 %).

The shares of Kerala, Haryana, Punjab and Rajasthan werecomparatively smaller whereas the flow of FDI intopopulous states such as Bihar and Uttar Pradesh has beenvirtually negligible.

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ConclusionAs far as the economic interpretation of the

model is concerned, the size of the domesticmarket is positively related to foreign directinvestment.

The greater the market, the more customers andthe more opportunities to invest.

Since FDI is mostly in the form of physicalinvestment, investors would prefer the marketswith better infrastructure.