India outbound FDI trends and recent developments

By Gautam Khaitan and Nidhi Mathur, OP Khaitan & Co
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In today’s global environment, emerging market economies are playing a significant role in foreign investment around the world. Outward foreign direct investment (OFDI) is also a key aspect in the globalization of the Indian economy.

Gautam Khaitan
Gautam Khaitan

Indian companies such as Tata, Birla, Mittal Steel, Reliance, Bharti Airtel, Suzlon Energy, Bharat Forge, Asian Paints, Sundaram Fasteners and Infosys are on a globalization drive and are creating a global footprint. They are going abroad not only to obtain new product mix or acquire new products but also to acquire an international image and vision and promote their brand equity.

Both private-sector companies and public-sector undertakings such as NTPC, GAIL, ONGC and NALCO have made significant overseas greenfield investments as India’s demand for energy rises. Recent big discoveries in Mozambique and increasing opportunities in Tanzania and Kenya are seen as having a huge potential for long-term opportunities in these markets. ONGC is expected to invest up to US$8.8 billion to acquire overseas assets in the next five years.

The main target countries have been the US, UK, Europe, Singapore and Australia, with Africa becoming an increasingly popular destination.

Regulatory environment

With growing foreign reserves, the government of India has introduced new measures and proactive policies aimed at encouraging OFDI.

Any Indian party can now make an overseas direct investment in any bona fide activity except certain real estate and banking business that is specifically prohibited.

Nidhi Mathur
Nidhi Mathur

Under the automatic route, an Indian party does not require any prior approval from the Reserve Bank of India (RBI) to invest in a joint venture or wholly owned subsidiary (JV/WOS) abroad, subject to certain conditions. Proposals not covered by the conditions under the automatic route require the prior approval of the RBI, for which a prescribed application is required to be made through an authorized dealer category-I bank.

Factors considered under the approval route include the prima facie viability of the JV/WOS; likely contribution to external trade and other benefits that may accrue to India; financial position and business track record of the Indian party and the foreign entity, and experience and expertise of the Indian party in the same or a related line of business.

Emerging issues

OFDI from India is expected to increase exponentially. However, many issues need to be addressed in the current market scenario. These include: (1) the need for transparency to prevent the abuse of multi-layered structures (also called “treaty shopping”, “tax planning” or “tax avoidance”); (2) the need to closely monitor capital outflows from India as unlimited OFDI could have significant implications for the sustainability of the country’s current account deficit and external debt profile; (3) the need to examine the impact on the domestic environment as even though both domestic capital formation and OFDI have increased concomitantly in recent years, a rising trend in OFDI has potential implications for domestic investment, growth and employment, which need to be weighed against the benefits that domestic companies derive elsewhere in terms of expanded market base, vertical integration and cheap skilled labour; (4) the need to consider contingent liabilities, given the uncertain global environment, as exposure in the form of guarantees issued by Indian companies for JVs/WOS has been rising in recent years (the RBI has prescribed that in case of issuance of guarantees or letters of comfort, if the investment structure requires a non-operating holding company, there should not be more than two tiers in the structure); (5) the need to take into account the potential impact of economic downturn of foreign economies as a sudden downward trend as experienced during the recent global financial crisis and the eurozone sovereign debt crisis may adversely impact Indian companies also.

Conclusion

As Indian companies become increasingly competitive and explore various global opportunities, a more investor friendly regulatory environment becomes all the more imperative. The government has taken various steps in this regard such as removing the cap of 1% on the ceiling for resident individuals to acquire qualification shares and linking the ceiling to the monetary ceiling under the liberalized remittance scheme; and permitting the acquisition of shares offered through an employee stock ownership plan globally, on a uniform basis, in a foreign company which has an equity stake, directly or indirectly, in an Indian company.

However, the approach to multi-layered structuring has to be examined, along with whether limited liability partnerships should be permitted to invest in JVs/WOS abroad and issues relating to allowing individuals to set up JVs/WOS abroad. The country’s OFDI policy has progressively evolved and with Indian companies becoming more competitive, further opening in various sectors would help India realize its true potential and help in its future growth plan.

OP Khaitan & Co is a 40-lawyer law firm, based in New Delhi. Gautam Khaitan is the firm’s managing partner and Nidhi Mathur is a junior partner.

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