360 Analysis of Inbound and Outbound Foreign Direct Investment

author Soumyashree Meesaraganda

calender November 22, 2023

360 Analysis of Inbound and Outbound Foreign Direct Investment

Foreign direct investment (‘FDI’) is a crucial and important aspect of globalisation and mobilisation of markets and is a useful tool in the development of an economy. FDI is a type of international or cross-border transaction where an investment from a member of a foreign country lays the foundation for a substantial foothold in an entity of an economy other than that of the investor. Many developing countries like India have liberalised their FDI policies across several sectors so as to encourage foreign investment by easing the rules for the inflow of such investments. FDI may be considered one of the most substantial sources of financing for developing countries.[1]

The United Nations Conference on Trade and Development defines FDI as “an investment reflecting a lasting interest and control by a foreign direct investor, resident in one economy, in an enterprise resident in another economy (foreign affiliate)”[2]. As per the Organisation for Economic Co-operation and Development (OECD), one of the key indications to identify such an association is the ownership of 10% or more of voting power in an entity by the foreign investor[3]. Hence, one of the distinctive characteristics of FDI may be the aspect of control by foreign investors over the policy and management of the entity to which the investment is routed.

There are several advantages of FDI for the receiving country and some of them are listed here. Firstly, FDI promotes the creation of employment which is very advantageous for a developing economy such as India. The influx of FDI bolsters various sectors such as the manufacturing and services sector which in turn creates opportunities for skilled as well as unskilled labour. An increase in employment opportunities also provides a welcome boost to the economy of the receiving country. Secondly, FDI provides access to technology transfer opportunities in developing economies. This allows the recipient country to gain access to superior technology available in the foreign economy and utilize such technology in its processes. Thirdly, FDI allows for an increase in exports and international trade. Fourthly, FDI promotes a competitive market and ensures that domestic enterprises enhance their offerings thereby automatically encouraging innovation.

There are primarily two types of FDI, i.e., inbound foreign direct investment and outbound foreign direct investment. In general, inbound and outbound investments mean investments that come into a country and investments that go outside the same country, respectively.

Inbound Foreign Direct Investment

One of the types of FDI is inbound foreign direct investment or inward foreign direct investment which is the investment that is made in a country by investors from other countries and economies. Inbound foreign direct investment allows foreign individuals or entities to infuse non-debt capital into the economic stream of the recipient country. Inbound foreign direct investments may be done in different ways by a foreign investor such as by setting up a liaison or branch office of the foreign entity or a subsidiary, through a joint venture, by acquiring an interest in a local entity, or through mergers and acquisitions. The governments of various developing nations have started to ease their regulations to promote the influx of inbound foreign direct investment. Inbound foreign direct investment allows domestic entities to grow while also encouraging integration with the international markets. Some advantages of inbound foreign direct investment range from the creation of employment opportunities, technology transfer, market integration, inflow of foreign currency, development of infrastructure, along with overall economic development. Each country has its laws, regulations, and compliances pertaining to the receipt of inbound foreign direct investment which have to be considered by foreign investors before entering any market.

Outbound Foreign Direct Investment

Outbound foreign direct investment or outward foreign direct investment is the investment that is made by a domestic entity in a foreign country. Outward foreign direct investment is often used as a strategy to expand the operations of a business into a foreign economy. Similar to inbound foreign direct investment, outbound foreign direct investment may also be achieved in different ways including, establishing a subsidiary in the foreign country, or mergers and acquisitions with foreign entities, joint ventures, or other similar ways. Each country also has its own rules, regulations, and compliances dealing with outbound foreign direct investment. Outbound foreign direct investment is often chosen where foreign markets offer more profitable opportunities than the domestic markets.

Regulations for Inbound/Outbound Foreign Direct Investment in India

In the past few years, the Government of India has made comprehensive changes to the FDI policies pertaining to inbound and outbound investments. After launching its ‘Make In India’ campaign, the Government liberalised its policies to increase the inflow of foreign investment into India allowing as much as 100% (One Hundred Percent) FDI in various sectors[4]. FDI in India is primarily regulated and governed by the Foreign Exchange Management Act, 1999 along with the rules and regulations thereunder, in particular the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 as amended from time to time.

The Department for Promotion of Industry and Internal Trade (DPIIT) under the aegis of the Ministry of Commerce and Industry, Government of India was established in 1995 and is the nodal branch responsible for formulating the policy on inbound foreign direct investment. It acts as a single point of contact between the Government of India and foreign investors who are seeking government approval where required. The DPIIT issues FDI Policy through circulars, press notes, press releases, and the same is notified by the Department of Economic Affairs of the Ministry of Finance. These are notified as amendments to the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 under the Foreign Exchange Management Act, 1999. Further, rules pertaining to inward investments and reporting requirements are provided under the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019 issued by the Reserve Bank of India (RBI). Any inward FDI in the capital markets is also regulated by Securities and Exchange Board of India.

The FDI Policy issued by the DPIIT from time to time provides detailed rules pertaining to inward foreign direct investment. The FDI Policy provides an exhaustive list of eligible investors and investees. FDI in India may be permitted through two routes, Automatic Route or Government Route. The automatic route allows a foreign investor to invest without the need for any approval from the Government of India. Some examples of categories/sectors that fall under the automatic route are sectors pertaining to auto components, automobiles, chemicals, E-commerce activities, renewable energy, textiles, and garments. Government route, however, requires prior approval from the Government of India, and any proposal for FDI under the Government Route is dealt with by the respective ministry or department. Some examples of sectors that require government route for investment are food product retail trading, print media, multi-brand retail trading, broadcasting and content services. There are also some sectors where FDI is permitted through the automatic route plus the government route, such as defence, healthcare, pharmaceuticals. The FDI Policy also lays down the sectors where FDI is completely prohibited. These sectors include the lottery business, gambling and betting, chit funds, manufacturing of cigars, etc. Government approval where required may be sought via the online Foreign Investment Facilitation Portal after which the internal procedures would be completed prior to issuing an approval[5].

The outbound foreign direct investment was previously governed by the FEMA (Transfer or Issue of Foreign Security) Regulations, 2004 and the FEMA (Acquisition and Transfer of immovable property outside India) Regulations, 2015. In the year 2022, in furtherance of liberalisation, the Government of India notified the Foreign Exchange Management (Overseas Investment) Rules, 2022. RBI then notified the Foreign Exchange Management (Overseas Investment) Regulations, 2022 and Foreign Exchange Management (Overseas Investment) Directions, 2022. Hence, the outbound FDI in India is now governed by the Foreign Exchange Management Act, 1999 along with the Overseas Investment Regulations, Rules, and Directions mentioned above. The new regime brings in clarity regarding certain aspects of outbound foreign direct investments. It provides a definition of overseas direct investments, foreign entity, and control which were not provided in the previous rules and regulations. The new regime also provides rules regarding the restrictions on outbound investments in certain sectors and has also updated the reporting procedures and approval requirements for such investments.

Though the regime regarding inbound and outbound investments has been extensively liberalised by the Government of India, investors are required to be well-versed with the rules and regulations pertaining to such transactions.

Conclusion

As per the World Investment Report 2023 published by the United Nations Conference on Trade and Development, though the global FDI fell by 12% (Twelve Percent) in 2022, developing economies have seen a 4% (Four Percent) increase in FDI[6]. As per the same report, India attracted inbound FDI of US$49,355 million in the year 2022 and outbound FDI from India was reported to be US$14543 million[7]. It is well-established that FDI plays an important role in the development of an economy and is a driving factor in the upliftment of developing countries. Investment in India and across various sectors has been encouraged by the Government by liberalising and simplifying the procedures and practices surrounding such investments. As a result of the government’s liberalisation policies, investment in India across various sectors has become a potential channel for economic growth for foreign investors.  

 

 



[1] https://documents1.worldbank.org/curated/en/956231593150550672/pdf/Foreign-Direct-Investment-and-Employment-Outcomes-in-Developing-Countries-A-Literature-Review-of-the-Effects-of-FDI-on-Job-Creation-and-Wages.pdf

[2] https://unctad.org/system/files/official-document/tdstat47_FS09_en.pdf

[3] https://www.oecd-ilibrary.org/finance-and-investment/foreign-direct-investment-fdi/indicator-group/english_9a523b18-en

[4] https://investmentpolicy.unctad.org/investment-policy-monitor/measures/2909/india-india-liberalized-fdi-rules-in-various-sectors#:~:text=On%2024%20June%202016%2C%20India,of%20conditionalities%20for%20foreign%20investment

[5] https://www.investindia.gov.in/foreign-direct-investment

[6] https://unctad.org/publication/world-investment-report-2023

[7] Id.

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