Screening of Foreign Direct Investment: A Shield against Opportunistic Takeovers or a Knee-Jerk Reaction?
– Vishal Singh
Amid the Covid-19 pandemic, the Department of Industrial Policy and Promotion (DIPP), on 17th April 2020, issued an amendment to the Consolidated FDI Policy, 2017, acting on the fear that China-backed investment may unsheathe the elbow room created during this economic turmoil. The tweaked policy obligates certain investment to go through the government screening and is seen as a shield against opportunistic takeovers.
Under Para 3.1.1 of the 2017 FDI policy, any non-resident entity was permitted to invest in India in sectors which are not prohibited. However, investment by citizens of Bangladesh and Pakistan was only permitted under the government approval route. Be that as it may, the tweaked policy prescribes that government approval is required if,
- the investment is by an entity of a country, which shares land borders with India, or
- the ‘beneficial owner’ of an investment is situated or citizen of any such country.
BACKGROUND
World Health Organization (WHO), on 11 March 2020, declared the Covid-19 outbreak a pandemic, the highest level of health emergency. This global crisis has disturbed the economic front with declining trade, falling stock market, rising unemployment etc. As per the OECD estimate, the global GDP could reduce at an annualized rate of 24%, a decline which has not been seen since the Great Depression. As per WTO, due to the disruption in normal economic activity, world trade is expected to fall between 13% to 32% in 2020. This has led to frequent decline and higher volatility in the stock market. Amid the movement of Foreign Portfolio Investors (FPIs) from the Indian market to a dollar-backed asset, the Indian financial market index, SENSEX, has seen a sharp decline from an all-time high of 42059 points (on 20th January 2020). Taking into consideration the current scenario, countries have been rigidifying foreign investment policies to make their economy less susceptible to outside takeover. The decision is considered as an outcome of Chinese investment in distressed assets globally amid this pandemic. European Union was the first to stiffen the foreign investment which has been followed by Germany, Italy, Spain etc.
Recently, the Housing Development Finance Corporation (HDFC) has intimated the stock exchange that shareholding of People’s Bank of China (PBoC) has hit the 1% (=1.01%) mark in the company. Thereafter, the Government of India revised Para 3.1.1 of Consolidated FDI Policy 2017, which mandates investment from certain countries to be subject to government approval. The revision is considered as a great wall against China.
ANALYSING THROUGH THE ECONOMIC LENS
Until recently, China was India Inc’s largest trading partner. In 2018, the bilateral trade between these two neighbouring nations reached USD 95.7 billion, an increase of 13.34% from the previous year. As per the DIPP’s statistics, the FDI inflow from China, in between April 2000 and December 2019, stands at USD 2342.03 million (or USD 2.3 billion). However, Ministry of Commerce (MOFCOM) in Beijing estimates that the Chinese entities have invested around USD 8 billion as FDI in India. It is believed by some experts, given the trade relationship between these two neighbouring nations, that this revision might have an adverse impact on our industries, due to decreasing demand in the market, especially automobile and real estate sector. Besides, there exists a trade imbalance of over $ 50 billion, hence, the current rules are surrounded by risks.
As of March 2020, 18 of the 30 Indian unicorns are now Chinese funded, with an estimated investment of $ 4 billion. The blanket FDI acts as a stumbling block in the process of external financing from China. Now, entities will have to go through government offices and bureaucratic obstacles while raising external finance, hence, prolonging the ‘fundraise’ timeline. Also, there exists a trade imbalance of over $ 50 billion and investments are one way to bridge the wedge.
The revised FDI Policy makes every investment from China subject to government approval, irrespective of the investment sector, investment size, etc. It also fails to distinguish between investment in listed and unlisted entities. Making an investment in unlisted entities subject to approval will only lead to lower valuation (due to fewer investors) and delay in fundraising. Besides, the note failed to distinguish on the basis of investment size and post-investment holdings. This move will deter small investors as the process has become time-consuming. Further, failure to distinguish between greenfield and brownfield investment is only going to hurt the Indian economy, as greenfield investments create employment opportunities in the host country. The Brookings India Paper outlines,
“In greenfield investments and capital invested in acquiring or expanding existing facilities in India, Chinese companies have invested at least $4.4 billion. Chinese companies have also invested in acquiring stakes in Indian companies, mostly in the pharmaceutical and technology sectors, and participated in numerous funding rounds of Indian start-ups in the tech space. Another $15 billion approximately is pledged by Chinese companies in investment plans or in bids for major infrastructure projects that are as yet unapproved.”
Therefore, this restriction is going to thwart the greenfield investment by putting up unwanted screenings. Further, this move on the part of Centre, is going to largely hurt the Indian Start-up sector. Gateway India claims that over 75 domestic companies (Start-ups) have Chinese investments which are estimated to be about $ 4 billion. Therefore, Chinese entities play a key role in the Indian Start-up ecosystem and placing restrictions on Chinese funding is likely to impact additional investments.
Be that as it may, a paper, published by Brookings India, claims that the total (current plus planned) investment by Beijing in India stands at $ 26 billion. Chinese FDI in India is currently valued at $6.2 billion, however, this value does not present the real penetration that China has done in India’s tech industry. Therefore, this move may be completely unfounded.
BENEFICIAL OWNERSHIP: Lacks Clarity
The presents, “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 para 3.1.1(a), such subsequent change in beneficial ownership will also require Government approval.”
Here, the note does not define the term ‘beneficial ownership’, which raises concerns as to tracing the source of investment. S. 90 of the Companies Act, 2013 defines ‘Significant Beneficial Ownership’, however, the same applies to ‘Individuals’ only. Additionally, the term has been defined under S. 2(fa) of ‘Prevention of Money Laundering Act, 2002’. Therefore, it isn’t clear as to how broad the term ‘beneficial ownership’ will be interpreted while implementing the revised scheme and whether the criteria will be objective or subjective. In this regard, investors, as well as an investee, would need clarity for better implementation.
CONCLUSION
Even though the objective of the note seems to be novel, the implementation lacks details. The government has adopted ‘One-Size fits all’ approach, however, a balanced approach is required. This can be achieved by excluding the non-sensitive sectors and greenfield investments from the ambit of press note 3. In this regard, the government needs to come up with a modus operandi in the form of screening guidelines, approval timeline, etc. Further, at present, the term ‘beneficial ownership’ lacks definition. Without any numeric limit or clear definition, it is not clear how to decide a beneficial interest for an entity set-up in other countries (not sharing land borders with India). It is very conceivable that such entities may have Chinese investors as beneficiaries with very insignificant stake. Therefore, in this regard, it is submitted that the authorities should clarify the issue for the better implementation of the policy.
This article is authored by Vishal Singh. He is a student of law at Dr RML National Law University, Lucknow.