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Recent changes to indian foreign direct investment rules

Recent changes to indian foreign direct investment rules

Introduction

Diminished economic growth, attributed in a large part to “policy paralysis” of the Indian Government, led to sudden and swift action by the Indian Government in late September. Setting aside the shackles of political expediency, the Indian Government decided to introduce changes to the Indian Foreign Direct Investment (FDI) Policy to facilitate foreign investment in the civil aviation sector and the controversial “retail” sector.

Civil Aviation Sector

Under the erstwhile FDI Policy, foreign airlines were not permitted to invest in Indian airlines. Considering the deepening crisis in the debt-laden Indian aviation sector, the Indian Government decided to remove this prohibition and allow foreign airlines to hold up to 49% in Indian airlines (other than Air India), subject to the approval of the nodal Foreign Investment Promotion Board (FIPB), provided:

1 .the investee company has its principal place of business within India;
2. the Chairman of the investee company and at least two-thirds of its directors are Indian citizens;
3. the substantial ownership and effective control of the investee company lies with Indian nationals;
4. all foreign nationals likely to be associated with the investee company, as a result of investment, are approved by the Indian Government from a security standpoint;
5. all technical equipment that might be imported into India as a result of investment must be approved by the relevant authority of the Ministry of Civil Aviation;
6. other applicable regulations are complied with.

The 49% cap subsumes investment under the FDI route and the foreign institutional investment route. Therefore, a company with foreign institutional investment can only get FDI investment up to the difference between 49% and the percentage of foreign institutional investment.

Recent newspaper reports suggest that following this change in the FDI Policy, two private carriers, Jet Airways and SpiceJet, are considering foreign investment from foreign airlines. This has led to a spike in their market value.

Retail

The other major change in the FDI Policy was the amendment to the rules on FDI in the “retail” sector. Prior to September, FDI was only allowed for single-brand retail up to 100% of the capital of the Indian company, subject to the prior approval of the Indian Government and certain other conditions. FDI in any other form of retail was prohibited. The amended FDI Policy has removed the prohibition on FDI in “retail”, modified the conditions applicable to FDI in single-brand retail and permitted up to 51% FDI in multi-brand retail, subject to various conditions. By this move, the Indian Government has really bitten the bullet of sensitive foreign investment reforms since multi-brand retail was perceived as an “untouchable sector” owing to its political sensitivity.

Single-brand retail involves the sale of products under a recognized brand owned or licensed to the foreign investor as opposed to multi-brand retail which involves the sale of products under a number of brands, not necessarily owned by the foreign investor. Multi-brand retail is commonly understood as a supermarket format as opposed to an exclusive outlet format, which is single-brand retail. With the fast pace of economic growth in India, consumerism is on the rise, making the “retail” sector an attractive investment opportunity. Add to this the fact that “organized” retail (supermarket chains as opposed to “mom and pop” stores) constitutes only a small percentage of the overall “retail” market, which is expected to treble in the next decade and the growth potential of this sector becomes apparent.

After the amendment, FDI in single-brand retail is now permitted up to 100% of the capital of the Indian company, subject to prior approval of the Indian Government (both the Department of Industrial Policy and Promotion (DIPP) and FIPB must approve the proposal unlike other sectors where only FIPB approval is necessary), provided:

1 . products are sold under a single brand;
2. products are branded during manufacture;
3. products are sold under the same brand in one or more countries outside India;
4. the brand is owned or licensed to the foreign investor;
5. for FDI above 51%, 30% of the products purchased by the Indian company are sourced from India, preferably from micro, small or medium enterprises (MSMEs), village and cottage industries or artisans and craftsmen. This sourcing requirement is a five year average in the first instance after FDI is received and an annual requirement thereafter. Further, this requirement must be self certified by the Indian company and audited by its statutory auditors.

Following the amended rules, Pavers England appears to be the first foreign investor who has been permitted to operate single-brand retail in India through a wholly owned subsidiary. IKEA’s massive proposed investment of nearly US$1.5 billion for single-brand retail through a wholly owned subsidiary has been approved by DIPP and is awaiting FIPB approval.

FDI in multi-brand retail is now permitted up to 51% of the capital of the Indian company, subject to prior approval of the Indian Government (similar to single-brand retail), provided:

1. the relevant State or Union Territory in which the operations are to be introduced has permitted FDI in multi-brand retail. Currently, 9 (out of 28) States (Andhra Pradesh, Assam, Delhi, Haryana, Jammu & Kashmir, Maharashtra, Manipur, Rajasthan and Uttarakhand) and 2 Union Territories (Daman & Diu and Dadra & Nagar Haveli) permit FDI in multi-brand retail
2. at least US$ 100 million is invested by the foreign investor;
3. 50% of the FDI amount is invested in back-end infrastructure (the supply chain), excluding the cost of front end-units, land and rentals;
4. 30% of products purchased by the Indian company are sourced from Indian “small industries” (total investment in plant and machinery does not exceed US$ 1 million). The compliance parameters are the same as single-brand retail;
5. the population of the cities where retail operations are set up exceeds 1 million as per the 2011 census or a city(ies) of choice for States without cities that meet the population threshold or is within 10 kms of the municipal limits of such cities.

Fresh agricultural produce need not be branded for multi-brand retail but the Government would have the first right of procurement over agricultural products.

Considering the conditions for FDI in multi-brand retail, the offtake is unlikely to be swift since (i) a large minimum investment is required; (ii) a local partner willing to making a substantial investment is required; (iii) the States and Union Territories, which permit such investment are few diminishing the possibility of returns; and (iv) the reputational risk to the foreign investor, considering the divided public opinion and political sensitivity of this issue. In the circumstances, only large foreign supermarket chains like Tesco, Carrefour, etc. are likely to consider investments. Political controversy also continues on this issue with the opposition parties seeking a vote in Parliament on the Government’s decision. The efficacy of such a vote is unclear since the Government is entitled to take executive action on this issue without Parliamentary sanction.

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