Are Conditionalities Choking India’s FDI Policy?

The government’s ‘radical liberalisation’ cheer of its foreign direct investment (FDI) policy suggests foreign investors should join the chorus too. Experts say, maybe not. And that’s because of the many conditions that come with the policy. This week on The Fineprint lawyers and policy experts weigh in on the question:

Are Conditionalities Killing India’s FDI Policy?

Defence: Devil Is In The Details

In June this year, the government allowed 100 percent foreign direct investment in the defence sector, under the government approval route. Concomitantly, it also relaxed the condition for government approval in the case of foreign investment up to 49 percent, that is, 49 percent FDI is now under the automatic approval route. But that may be only on paper – because this policy change comes with its own set of conditions. One of these says that an up to 49 percent investor will need government approval if its infusion of fresh funds results in either change or transfer of ownership.

Shishir Vayttaden, lawyer and partner at Cyril Amarchand Mangaldas says this condition defeats the purpose of the automatic route.

He adds, “It’s very clear that there must have been departments within the government that were never in favour of placing defence under the automatic route. Presumably, some other ministries, like the ministry of finance, have an interest in liberalising the regime. And the compromise they have struck is that across the defence space, there will be one occasion or another when the government will get a look-in on the transaction. So, if it’s a greenfield project, then the government gets to look in at the time of granting the industrial licence. And if it’s a brownfield investment, then the government gets to look at it in reliance of this condition – any foreign investment is bound to trip up that condition.”

Shishir says one way to address this is that the government could prescribe a lock-in requirement and permit automatic approval after that. But that may help industry, not assuage the government’s concerns.

Real Estate: Policy Reality

While a lock-in may work for defence, a similar condition is proving to be an impediment in the real estate sector. The 2016 FDI policy, continues to permit 100 percent FDI in built-up infrastructure under the automatic approval route, but the conditionalities have changed. A new condition imposes a lock-in of three years on FDI in all under-construction projects, and the lock-in is to be calculated with reference to each tranche of foreign investment.

Srini Sriniwasan, CEO, Kotak Realty & Special Opportunities Fund is interpreting it to mean that every time the foreign investor makes an additional investment in the same project, the lock-in evergreens itself.

The policy suggests that if the foreign investor invests Rs 100 in a ready built-up infrastructure project, on day zero, and some time later, say after one year, invests another Rs 50, the two tranches be counted separately and not as one foreign investment or two.

Srini says the last ‘in’ date becomes the reference date for the purpose of calculating the three year lock-in.

When asked for a solution, Srini explains that some investors are taking the view that each tranche can be tranched-out separately, as different series of instruments, and the tranche that came in first can go out first.

Pharmaceuticals: Policy Pain Points

While creative thinking may work for real estate, a condition applicable to the pharmaceutical sector may force deal-makers to change deal structures. The 2016 FDI policy allows 74 percent investment in existing pharmaceutical companies, commonly referred to as brownfield, under the automatic approval route; any foreign investment above 74 percent needs government approval. The policy disallows non-compete clauses in pharmaceutical deals and insists that for up to 5 years after the investment or acquisition, the production of essential or NLEM (National List of Essential Medicines) drugs and research and development (R&D) expenditure be maintained at the highest level achieved in the three years prior to the acquisition.

It’s both the conditions together that is creating structuring difficulties in transactions, says Shishir. He explains that this typically hurts a pharmaceutical company engaged in different related activities.

Shishir adds that such a condition may compel foreign investors to acquire a business or vertical, rather than invest in the parent pharmaceutical company, and that has its own set of tax and other costs.

Because if, after such an investment, say the foreign investor wants to hive-off a division, because globally it’s not permitted to be invested in that space, the policy makes no provision for it. Such a hive-off will then result in a reduction in the manufacture of NLEM drugs and amount to a breach of the policy. Unless the foreign investor seeks specific approval from the FIPB (Foreign Investment Promotion Board), thus making what should be an automatic route investment one that requires government approval.

Single Brand Retail: Manufacturers’ Dilemma

Much has been said about the government’s stance, approach and policy in the retail sector. The 2016 FDI policy eased local sourcing norms for foreign brands that qualify as ‘state-of-the-art’ and with ‘cutting edge’ technology. The policy allows up to 49 percent investment via the automatic route and an investment exceeding 49 percent requires government approval.

To qualify as a single brand manufacturer-cum-retailer and owner of a brand, at least 70 percent of the products should be manufactured in house and at least 30 percent sourcing should be from Indian manufacturers. Such an Indian brand, says the policy, should be owned and controlled by resident Indian citizens or companies owned by resident Indian citizens.

He added that many Indian-owned-and-controlled manufacturers, desirous of raising foreign equity capital would not be able to because then they could cease to be Indian-owned-and-controlled. As a result, manufacturers would have to seek government approval to raise such foreign investment, thus bringing what was under the automatic route to the approval route.

Besides new conditions that are plaguing the defence, pharmaceutical, retail and real estate sectors, some old conditions are adversely affecting new sectors – for instance, the ‘Indian owned and controlled’ test that impacted the banking and insurance sectors at one point is now hurting asset management companies. The 2009 FDI policy defines control as,

This definition implied that Indian companies with a diversified but majority foreign ownership, such as ICICI Bank and HDFC, are foreign-owned and controlled. Caveats were written in to rectify this for the banking industry and the insurance regulator came up with its own fix. But Srini points out that now funds set up by the likes of HDFC and ICICI Bank are being classified as ‘foreign’ funds, even if they raise money from domestic investors. And that classification is accompanied by a host of policy restrictions.

Experts say the fineprint in India’s FDI policy begs the question – does the government want a truly liberalised FDI policy or simply be seen as having one?