The Government, in a bid to attract foreign investment into the country, has introduced composite caps in foreign direct investment. This replaces individual limits placed on different foreign investors such as FDIs, FPIs and NRIs. But a closer examination of the policy change makes us feel that it will not materially influence foreign investments in India. The FDI Policy covers 27 sectors out of which eight are prohibited sectors and 19 are restricted sectors. Of the 19 restricted sectors, banking and defence have been kept out of the purview of the composite caps. From the remaining 17 sectors only two sectors — financial services and power exchanges — had sub-limits for FIIs/FPIs. Besides these 27 sectors, FDI is freely permitted up to 100 per cent in all other sectors.

The Government has permitted portfolio investment of up to 49 per cent or sectoral/statutory caps, whichever is lower, without any approval or compliance of sectoral conditions. This is permitted if the investment does not result in transfer of ownership and/or control of Indian entities from resident Indian citizens to non-resident entities.

No approvals While the new rule may seem like a simplification, it may not be of much benefit. Why so? Because, of the 17 restricted sectors, most are either under the 100 per cent or 49 per cent automatic route.

After the rule change, there are a few sectors that will no longer require Government approval for investment by an FII/FPI. These include tea plantation; mining and mineral separation of titanium bearing minerals and ores, its value addition and integrated activities; broadcasting content services; print media; establishment and operation of satellites; private security agencies; multi-brand retail trading; insurance; and brownfield pharmaceuticals.

Nor is this change likely to attract substantial foreign investment interest. Sample this. As per the Fact Sheet on FDI, published by the Department of Industrial Policy and Promotion (DIPP), most of these sectors have only attracted 2 to 5 per cent of the cumulative FDI received from April 2000 to May 2015. So, unless substantive reforms (read as labour law, GST, efficient and enforceable dispute resolution mechanism) are implemented, expectations of higher foreign investment may remain as wishful thinking.

Other limits It is also pertinent to note other restrictions that may come into play. For example, FIIs/FPIs are permitted to invest in an Indian investee company under the portfolio investment scheme. The individual limit for this investment is below 10 per cent of the capital of an Indian company and the aggregate limit is 24 per cent of the capital of the Indian investee company (which can be increased to the sectoral cap or statutory ceiling as applicable, subject to certain compliances being met). Therefore, a single FII/FPI cannot invest 10 per cent or more in any sector.

So, what if an FPI/FII wants to invest over 10 per cent? Though an Indian company can have FPI investments of up to 49 per cent or sectoral cap, whichever is lower, multiple FIIs/FPIs will be required to make investments of 10 per cent or more.

One risk to consider when substantial investment comes through the portfolio investment route is that it may expose the Indian company to stock market volatility, especially in situations of multiple sell transactions by FIIs/FPIs.

FDI under Annexure I of the Foreign Exchange Management (Transfer or Issue of Security By a Person Resident Outside India) Regulations, is not impacted and the same continues to be governed under the previous FDI Policy requiring compliance with pricing guidelines, sectoral caps and conditionalities.

Therefore, the composite caps are unlikely to contribute to FDI under the FDI Scheme except perhaps in the two sectors viz. financial services and power exchanges which had sub-limits for FII/FPI which would now become available for FDI under the FDI Scheme.

In conclusion, the policy change is not likely to have a ubiquitous impact in attracting foreign investment. It may attract foreign investors in certain sectors such as multi-brand retail trading, power exchanges, brownfield pharmaceuticals, print media and commodity exchanges and listed companies in these sectors such as Future Retail, PTC India and MCX.

If the Government wants to come up with a more meaningful reform to increase foreign investment activity, it needs to do a few things. One, it must consider taking another look at the foreign investment laws holistically. Two, it must keep in view that the majority of Indian businesses are mid to small size and most companies in India are unlisted. Three, the Government must understand that the demand for long-term capital is immense.

The writer is Partner, BMR Legal. With inputs from Ami Parikh

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