How Will India’s Revised FDI Policy Impact Future Chinese Investment?
UPDATE: India has approved 80 foreign direct investment (FDI) proposals involving Chinese entities, reported The Economic Times, based on data accessed from a Right to Information (RTI) request. While there have been 382 applications from Chinese entities (as on June 29, 2022), it is not clear how many applications have been rejected by the Indian government. From the second half of 2021, India has been considering FDI requests linked to Chinese entities on a case-by-case basis. India’s approvals will likely benefit FDI proposals that do not change the controlling stakes in the targeted firm/business or are directed at capital-intensive sectors like manufacturing (instead of financial services or online platforms).
Under the revised foreign direct investment (FDI) policy, India’s bordering countries will require mandatory government approval for investing in any sector. This policy change is only applicable for FDI; other routes of foreign investments, such as foreign portfolio investment (FPI), remain unchanged. However, media reports indicate the government also intends to scrutinize FPIs in the future. Experts assume the government will approve new FDI proposals in non-sensitive sectors, such as manufacturing and technology in 8 to 10 weeks – which is the prevailing case under the government approval route.
India’s official trade and investment regulator, the Department of Promotion for Industry and Internal Trade (DPIIT) notified changes to the country’s foreign direct investment (FDI) policy – making government approval mandatory for FDI inflows from India’s neighboring countries through Press Note No. 3(2020 Series), dated April 17, 2020.
In the notification issued by DPIIT – transfer of ownership of any existing entity or future FDI in an entity in India, directly or indirectly, resulting in beneficial ownership falling within this restriction will require mandatory government approval.
Basically, this means that investors from India’s neighboring countries – Afghanistan, Bangladesh, Bhutan, China, Myanmar, Nepal and Pakistan – will need to seek the Indian government’s approval before taking forward their FDI investment – for the foreseeable future.
The revised FDI policy will impact Chinese investment the most – as investors and firms from China have invested in various sectors in India.
For instance, China has heavily invested in the technology sector, including, start-ups, mobile apps, and smartphone manufacturing as well as in sectors such as automobile, manufacturing, renewable energy, power, and industrial machinery. There is also a considerable investment by Chinese firms in India’s digital ecosystem, especially in-e-commerce, online payments, and healthcare.
Here we answer the most common questions on this topic.
Does the FDI policy change apply to other forms of foreign investment?
No, the notification issued by DPIIT under Press Note No. 3(2020 Series) is only applicable for FDI.
However, media reports in recent months seem to indicate that India is also working on tighter scrutiny of Foreign Portfolio Investors (FPIs). The FPI mechanism merges two modes of investment – Foreign Institutional Investor (FII) and Qualified Foreign Investor (QFI) – and there are three categories of FPI. FPI includes securities and financial assets held by foreign investors, and do not result in their ownership of the corporate entity. FPI holdings include stocks, bonds, mutual funds, ADRs (American Depository Receipts), and exchange-traded funds.
One reason given for the Indian government’s attention to the FPI route is the worry that investors from China and Hong Kong ‘could increase their purchase of company securities like equities to gain control’. As reported by Reuters in late May, Indian government sources stated that a draft proposal made in consultation with the trade ministry and the capital market regulator, the Securities and Exchange Board of India (SEBI), is currently under review by the Union finance ministry. The clearest implication, if such a proposal were to be approved, will be an extra layer of security clearance.
China has 16 FPIs registered in India – 15 are in Category I, which is for government and government related foreign investors, such as Central Banks and Sovereign Wealth Funds. Category I have easier compliance, lower taxation, and disclosure requirements. One FPI from China is registered under Category II, which typically comprises of hedge funds.
Through FPI, People’s Bank of China held a 1.01 percent stake in HDFC, an Indian banking and financial services company, until end-March. (However, as of end-June, PBoC has dropped off the list of investors holding at least one percent stake in HDFC.) Other examples include CIFM Asia Pacific Fund, a joint venture with JPMorgan Asset Management Co., which holds 13.5 percent stake in Indian banks and infrastructure firms, among others.
There are 111 registered FPIs from Hong Kong; it is understood that a substantial amount of Chinese investment is routed through Hong Kong.
FPI registration is permanent in nature and FPI investors pay the prescribed fees every three years to their designated depository participant (DDP). Foreign portfolio investors are crucial to India’s financial markets; net FPI inflows in 2019 stood at US$18 billion.
According to reporting by the Indian Express: the market value of all FPI investments from China stood at INR 7.74 billion (US$103.32 million) at the end of December 2019, but jumped sharply to INR 32.57 billion (US$434.79 million) by March 2020.
India has formalized the changes to its FDI policy introduced in April 2020, in its Consolidated FDI Policy 2020, which it announced on October 28, 2020. FDI applications involving investments from an entity of a country sharing a ‘land border with India’ or where the ‘beneficial owner of an investment into India’ is based in or is a citizen of any such country, will need mandatory government approval. Again, it is clarified that such investment is not banned, only subject to greater scrutiny. The latest FDI policy (see official document here) has retrospective effect from October 15, 2020.
Additionally, a 26 percent cap on FDI is introduced in the segment that covers digital news (uploading or streaming of news and current affairs through digital platforms).
The latest FDI policy also makes it mandatory for e-commerce entities with foreign investment to obtain and maintain a statutory audit report by September 30 every year for the preceding financial year, which indicates their compliance with India’s laws.
The previous Consolidated FDI Policy was released in 2017 and was effective from August 28, 2017. The latest FDI policy consolidates the changes introduced in the past three years.
How will the policy change impact existing Chinese investment in India?
Existing investment from China will not be impacted as it has already been processed by the DPIIT / government authorities.
However, industry experts are of the understanding that in certain cases of investment, investors may have to seek government approval. For example, if there is further capital infusion in the company by a Chinese investor – either to maintain their stake in the company or to increase their FDI stake – then the Chinese investors will have to seek India’s regulatory approval.
Even global transactions by Chinese investors can be impacted in certain cases. For instance, a European target company, which has an India subsidiary, proposed to be acquired by a Chinese investor, will now require prior approval in India – in addition to the applicable approval process for investment from Europe. This is because the beneficial ownership of the Indian entity will be deemed to have been transferred to the Chinese investor.
In terms of FDI inflows, FDI from Hong Kong jumped from US$1.2 billion until March 2014 to US$4.4 billion by end-March 2020; FDI from China amounted to US$404 million till March 2014 and jumped to US$2.378 billion by the end of March 2020.
Startups in India who have counted marquee investors Alibaba and Tencent among their backers include Zomato, Paytm, Byjus, Ola Cabs, BigBasket, etc. In fact, of 30 unicorn startups in India worth at least US$1 billion, more than half reported major investments from Chinese firms.
However, just last month, in July, it was reported that the food delivery aggregator Zomato had been facing difficulty in receiving the second tranche of US$100 million in equity capital from Ant Financial – an affiliate of the Chinese internet technology giant Alibaba.
The situation is in stark contrast with earlier in the year, when 13 out of 15 deals, which saw Chinese investment pour into Indian startups, were signed until April. This included Alibaba’s injection worth US$150 million into Zomato in January and Tencent’s investment of nearly US$20 million as part of food delivery platform Swiggy’s US$150 million round in February.
How does the policy impact Indian entities where Chinese investors hold a major stake?
In case of entities where Chinese investors are a major stakeholder, or in case of a wholly owned subsidiary of a Chinese firm, the revised policy may not affect anything – as there will be no change in the ownership of the company. It is important to note that the purpose of these changes in the FDI policy is to prevent hostile takeovers of Indian firms by foreign investors from India’s neighbors, including China.
But if a Chinese investor wants to increase their stake in the company – despite being a shareholder – they will likely have to seek approval from the government. However, the approval process time may be shorter in such cases.
On the other hand, the Indian government has taken issue where the existing Chinese presence is considered to be ‘a security and privacy threat’. This has been the explanation behind India’s recent ban on 59 Chinese developed apps from use in the domestic market, including popular products, such as short video platform TikTok, owned by the Chinese internet technology giant ByteDance Ltd., messaging platform WeChat, and apps developed by Xiaomi and Alibaba.
India had over 200 million users on TikTok before the June 29 ban and is the company’s largest market outside China. The latest development in this segment appears to be that ByteDance may be in talks with India’s Reliance Industries Limited since last month for backing the technology company’s business in India. The deal is reported to be valued at US$5 billion. (Reliance and Bytedance have both denied any information on the reported deal.) Separately, ByteDance is in discussions with Microsoft Corp. to sell part of its overseas operations; US President Donald Trump has given ByteDance until September 15 before a ban could come in effect in the American market. Interestingly, Trump has demanded a cut of any sale, which has complicated prospects for a deal.
What is the expected timeline for the government’s approval process?
While the government is yet to announce the processing time, it is expected that it would range between eight to 10 weeks for non-sensitive sectors, such as assembly and manufacturing. It may take longer for sensitive sectors, such as defense and technology.
Investment from China may also be subjected to security clearance from the Ministry of Home Affairs, which may take additional one or two weeks.
Since all FDI inflow from India’s neighboring countries will be scrutinized by the government, the overall approval time may increase. However, it is expected that the government will clear proposals swiftly as it does not want foreign investment to India to slow down.
What clarifications are needed from the government?
The notification does not clarify the status of investments from Hong Kong, which is treated as a special administrative region. DPIIT tracks investment data from Hong Kong and China separately, so it is unclear if this revised policy is applicable to investment from Hong Kong or if the beneficial owners are based in Hong Kong.
Clarity is also needed on how the beneficial ownership test will be applied in cases where the entity seeking to invest in India under the FDI route is a private equity fund. Chinese investors should seek expert advice from foreign investment professionals as they plan their investments into India under the revised FDI policy.
What is India’s position on bidding for government projects, tenders?
On July 23, the Indian government amended its public financing rules, erecting barriers for companies from bordering countries to bid on government tenders and projects. Such companies would now have to register with a committee set up by the DPIIT where their eligibility will be assessed. Political and security clearance from the Ministry of External Affairs (MEA) and Ministry of Home Affairs (MHA) will also be mandatory.
According to the press release by the Union finance ministry:
“…Any bidder from such countries sharing a land border with India will be eligible to bid in any procurement whether of goods, services (including consultancy services and non-consultancy services) or works (including turnkey projects) only if the bidder is registered with the Competent Authority.
“The Order takes into its ambit public sector banks and financial institutions, Autonomous Bodies, Central Public Sector Enterprises (CPSEs) and Public Private Partnership projects receiving financial support from the Government or its undertakings”
Bordering countries to whom India currently offers lines of credit or to countries with which the Indian government has established a joint development project, such as Bangladesh and Nepal, will be exempted from the need to register with the DPIIT or seek security clearance. That shortens the list of affected countries.
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(Editor’s Note: This article was originally published on April 30, 2020. It was last updated on October 28, 2020.)
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