Foreign Investment in India and its Regulatory Framework

Amit Shekhar

May 26, 2023

Foreign Investment in India and its Regulatory Framework

Foreign Direct Investment (“FDI”) refers to the investment made by an individual, company, or entity from one country into another country, with the objective of establishing a lasting interest and control in a business enterprise located in the host country. It involves the direct ownership or control of assets in the foreign country, typically in the form of equity capital, reinvested earnings, or intra-company loans.

Foreign investment plays a crucial role in promoting economic growth, technological advancements, and job creation in India. With a rapidly expanding market and a favorable business environment, India has attracted significant foreign direct investment in various sectors in the recent past.

India has lately been a hub for overseas investment despite the hindrances posed by COVID-19. According to the data from the Ministry of Commerce and Industry, India has received foreign direct investment inflows of USD 82.274 billion in the financial year 2021-22 and USD 54.934 billion in the first 3 (three) quarters of the financial year 2022-23. Further India's ongoing economic reforms and initiatives like the ‘Make in India’ program have also helped to boost foreign investment significantly. This article explores the concept of foreign direct investment, provides an overview of the regulatory framework governing foreign investments in India, and highlights recent developments in this area.

ROUTES OF INVESTMENT: The Indian government has been making efforts to liberalize FDI norms and reduce regulatory complexities to attract more foreign investment. As part of these efforts, the FDI policy is periodically reviewed and updated to encourage investments and promote ease of doing business in India. Foreign investment in India can be made through various routes, including automatic routes and government routes.

Automatic Route: Foreign investment in most sectors is allowed without prior approval from the Indian government. The FDI policy specifies the sectors in which foreign investment is allowed under the automatic route along with the conditions and limits for such investment. For instance, foreign investment in sectors including but not limited to agriculture and animal husbandry, plantation, mining, petroleum and natural gas, airports, construction, manufacturing, industrial parks, e-commerce activities, railway infrastructure, asset construction companies, credit information companies, and pharmaceuticals are allowed under the automatic route.

The FDI policy also specifies the sectors in which foreign investment is allowed under the automatic route along with the conditions and limits for such investment. The FDI policy also specifies the maximum percentage of foreign investment allowed in a particular sector under the automatic route. For example, the power exchange sector under the automatic route has been capped at 49%. Further, sectors like pensions, insurance companies, and infrastructure companies in the securities market, have also been capped at 49%. The private security agencies and banking under the private sector have been capped at 49% under the automatic route, however investment above 49% and up to 74% under the aforesaid sectors is allowed through the government route for which appropriate approval is required to be sought.

Government Route: Also known as the approval route in FDI, the government route is where foreign direct investments require the prior approval of the government or the Reserve Bank of India (“RBI”). This ensures that the sectors where the involvement of foreign parties is critical are properly regulated.

The government routes foreign investment in certain sectors and requires prior approval from the Indian government. The FDI policy specifies the sectors in which foreign investment is allowed under the government route and the conditions for such investment. For instance, foreign investment in sectors such as mining, defense, broadcasting, print media/digital media, civil aviation, satellites, telecommunications, and private security agencies requires prior approval from the Indian government as per the rules, regulations and procedures prescribed under FEMA (defined hereinafter) and by RBI.

Prohibited Sectors: Certain sectors in India are prohibited or have restrictions on foreign direct investment (FDI) due to reasons such as national security, strategic importance, or protection of domestic industries. These prohibited sectors include lottery business, gambling, and betting, chit funds, Nidhi company, trading in transferable development rights, real estate business, manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes, activities/sectors not open to private sector investment e.g. atomic energy and railway operations. These restrictions are in place to safeguard national interests, preserve domestic capabilities, and maintain strategic control over critical sectors.

LAW AND REGULATORY FRAMEWORK: All transactions in India involving foreign exchange are primarily governed by the Foreign Exchange Management Act, 1999 (“FEMA”), which ensures compliance with the rules and regulations of the Reserve Bank of India which is the central bank of India established on April 1, 1935, in accordance with the provisions of the Reserve Bank of India Act, 1934. Other regulatory authorities include the Ministry of Commerce and Industry, the Securities and Exchange Board of India (“SEBI”), and the Department for Promotion of Industry and Internal Trade.

Foreign investment proposals under the government route were earlier considered by the Foreign Investment Promotion Board (“FIPB”), which was the apex body responsible for regulating and promoting foreign investments in India. However, the FIPB was abolished in 2017, and the Department for Promotion of Industry and Internal Trade (“DPIIT”) now handles all foreign investment proposals and formulates policies related to foreign investment in India. The foreign investment proposals are now considered by the Foreign Investment Facilitation Portal (“FIFP”), managed by DPIIT. The FIFP is an online platform that facilitates and streamlines the process of foreign direct investment in India and serves as a one-stop digital interface for investors to obtain information, apply for approvals, and access various services, including FDI consulting services, related to foreign investment.

FDI consulting services is one of the key services which involves market analysis and research. These services help companies identify and evaluate potential investment destinations by analyzing factors such as market size, growth potential, regulatory frameworks, political stability, and competitive landscapes. FDI consulting services also play a vital role in securing investment incentives and negotiating favorable terms for businesses. Consultants providing such services assist companies in accessing various incentives offered by host countries, such as tax breaks, grants, or subsidies, which can significantly enhance the attractiveness of an investment. They also provide guidance in negotiating agreements with local stakeholders, ensuring that businesses secure advantageous terms that align with their objectives and minimize potential risks.

The FDI regulatory framework plays a significant role in formulating policies, issuing guidelines, granting approvals, and ensuring compliance with regulations as may be applicable from time to time. With a focus on attracting foreign capital, the Indian government has implemented reforms to simplify procedures, increase sectoral caps, and streamline the approval process. The regulatory framework strikes a balance between protecting national interests and promoting a conducive environment for foreign investors thereby fostering growth of the Indian economy in a regulated manner.

CONCLUSION: Foreign investment continues to be a key driver of economic growth in India. The regulatory framework governing foreign investment has undergone significant reforms to promote ease of doing business and attract more foreign capital. The Indian government's initiatives to liberalize FDI norms, increase sectoral caps, and streamline the approval process demonstrate its commitment to creating a conducive environment for foreign investors. By striking a balance between promoting investment and safeguarding national interests, the regulatory bodies contribute to creating a conducive and secure environment for foreign investors, fostering economic development, and forging stronger ties between nations. With ongoing reforms and initiatives, the regulatory landscape for FDI continues to evolve, aiming to attract more foreign capital, encourage technological transfer, and deepen international partnerships for shared prosperity. As India further opens up its economy, foreign investors can expect increased opportunities and a more investor-friendly ecosystem.

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