In recognition of the important role of foreign direct investment (FDI) in driving economic growth, the Government of India initiated numerous economic and financial reforms in 1991, transforming the nature of the Indian economy from a restrictive regime to a liberalized one.
The government has introduced greater transparency and has simplified the regulatory and tax regimes, bringing them into line with best international practices. India is a more attractive investment destination as a result.
Entry strategies for foreign companies investing in India have also been simplified.
Investors can now establish their presence through a liaison or representative office, project office, 100% wholly owned subsidiary or a joint venture company after obtaining requisite approval from the Reserve Bank of India (RBI) or Foreign Investment Promotion Board (FIPB).
By and large, FDI is now permitted in almost all sectors in India via the “automatic route” save for some exceptional cases such as defence and print media (commonly referred to as negative list).
Automatic route requirements
While there is no need to obtain the prior approval of the RBI under the automatic route, within 30 days of receipt of consideration from a foreign investor, the Indian company is required to file a report with the RBI giving certain details and within 30 days from the date of issue of shares to the foreign investor, is required to file another declaration in the prescribed form.
However, if the investment is not in accordance with prescribed guidelines or if the activity falls under the negative list, approval has to be obtained from the FIPB.
For some of the following categories, government approval for FDI through the FIPB is necessary:
- Manufacturing of cigars, cigarettes, tobacco and tobacco substitutes.
- Manufacturing of electronic, aerospace and defence equipment (all types).
- Manufacturing of items exclusively reserved for small scale sector with more than 24% FDI.
- Proposals in which the foreign collaborator has a previous venture or tie-up in India in the same field.
- Proposals falling outside notified sectoral policy/caps.
FDI is not permitted in the following prohibited sectors:
- Gambling and betting
- Lottery business
- Atomic energy
- Retail trading (except for single brand retailing)
India’s principal sources of FDI between 1991 and 2007 have been Mauritius, the US, the UK, the Netherlands, Japan, Germany and Singapore.
The principal sectors attracting FDI during this period have been electrical equipment, services, telecommunications, transportation, fuels, chemicals and construction.
The government has embarked on a series of ambitious economic reforms in these sectors. These reforms include the following changes:
- The government has divested some of its own powers to approve foreign investments that it exercised through the FIPB and has handed them over to the general permission route under the RBI.
- The FDI cap in the telecommunications sector has been increased to 74% from 49%.
- An investment commission has been set up to garner investments in a number of sectors including infrastructure.
- The government has approved partial opening of retail markets to foreign investors. It will now allow 51% FDI in single brand products in the retail sector.
- In some sectors such as power trading, processing and warehousing of coffee and rubber, foreign investment of 100% is now allowed.
- The FDI limit has been raised to 100% under the automatic route in mining of diamonds and precious stones, development of new airports, cash and carry wholesale trading and export trading, laying of natural gas pipelines, petroleum infrastructure and captive mining of coal and lignite.
- Indian investors are now allowed to transfer shares in an existing company to foreign investors. For their part, foreign funds are allowed to own up to a 26% stake in entities that are set up by state-owned banks, mutual funds and other financial institutions to manage pension funds.
These initiatives are likely to be the beginning. With more and more sectors opening up and with enhancements to the sectoral caps, the Indian market continues to progress towards a globalized economy. It is now evident that India is in the reckoning.
Gautam Khaitan is a partner at OP Khaitan & Co. He works mainly on corporate and commercial matters and has considerable experience over a wide range of corporate and commercial transactions.
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