India and Japan have historically shared deep cultural and economic relationships. Over time, both countries have undertaken efforts to sustain and strengthen their economic ties. Japan is currently one of the largest investors in India, having made cumulative investment of USD38.13 billion as of September 2022, with a total of about 1,455 Japanese companies operating across the country.
This article presents a brief guide for Japanese investors looking for investment opportunities in India, while focusing on current developments strengthening the Indo-Japan relationship.
MECHANISMS FOR INVESTMENT
Foreign direct investment (FDI) in India is regulated by the Foreign Exchange Management Act, 1999 (along with associated rules and regulations), and the Consolidated FDI Policy, 2020, which provide sectoral caps, pricing guidelines, reporting requirements and other conditionalities for investment.
Up to 100% of FDI is permitted in most sectors under the automatic route. However, very few highly regulated and sensitive sectors such as pharmaceuticals, banking and insurance require government approval if the investment is beyond prescribed limits. The acquisition of a substantial stake or “control” may trigger additional obligations under other Indian laws, such as antitrust and securities laws. Preferred structures for FDI include:
- Joint ventures. Under this structure, two or more companies come together to undertake a specific project or business activity. Due consideration should be paid to management and governance rights (such as adequate board representation, veto rights, the right of transferability of shares and exit rights), and commercial concerns (such as alignment of business plans, roles and responsibilities, non-compete and non-solicit obligations of the concerned parties and intended objectives). These should be agreed upfront under the joint venture agreement.
- M&A. Foreign investors can opt to invest in India by way of cross-border mergers, or partial or full acquisition of an Indian company. This mechanism offers various market advantages to investors in terms of market consolidation, minimal entry barriers and efficient technology transfer. Protective harbours in the form of deferred consideration or a share swap can be opted for by investors while negotiating terms concerning price adjustment and closing structures. Such structures are generally preferred as they offer favourable tax benefits, among others.
- Limited liability partnerships. These may be a useful vehicle for investing as they offer characteristics of both partnership and company. However, large investors usually prefer to adopt a company structure as it offers flexibilities of ownership and a management structure suitable to the business’s specific needs, making it easier to raise capital.
- Foreign portfolio investment (FPI). This allows for portfolio diversification and access to markets with different risk-return characteristics. Investments through FPI may be undertaken by registered investors with the Securities and Exchange Board of India (SEBI) via: investments of up to an individual limit of 10% equity share capital; debentures; share warrants in a listed company or proposed listed company; units of domestic mutual funds; category III alternative investment funds (AIFs) or offshore funds subject to certain conditionalities; or units of real estate and infrastructure investment trusts subject to the conditions specified by the SEBI, among others. The aggregate limit of all FPIs put together by an Indian company shall not exceed the sectoral cap specified under the above-mentioned FDI policy as applicable. The aggregate limit of FPI in an Indian company in a sector where FDI is prohibited is 24%.
- Foreign venture capital investment (FVCI). This permits investors to subscribe to securities of unlisted companies engaged in specified sectors (such as nanotechnology, infrastructure and biotechnology), or units of venture capital funds and category I AIFs and equity, or debt instruments issued by startups, irrespective of the sector in which the startup is involved. FVCI in equity instruments must comply with sectoral limits and attendant conditionalities prescribed under FDI policy.
Foreign investors can also invest in entities through forms of optionally or partially convertible or non-convertible debt, treated as external commercial borrowings (ECBs), which can be raised under the automatic or approval route. ECBs can be converted into equity shares after a minimum average maturity period. Any call and put options available to the investor cannot be exercised before the completion of the minimum average maturity period, which is typically three years, although it varies in certain categories of ECB. The conversion of ECB to equity is also subject to conditions such as pricing guidelines, reporting requirements, lenders’ consent and applicable sectoral norms.
Foreign investors can also purchase convertible notes issued by an Indian startup company of USD30,000 or more in a single tranche. Such investments, including conversion into equity, are subject to entry routes, sectoral caps, pricing guidelines and other attendant conditions prescribed under FDI policy.
AVAILABLE POLICY INITIATIVES
Japan is the first country with dedicated industrial townships in India. State-of-the-art infrastructure has been developed by the government for Japanese companies to set up their business in these Japanese Industrial Townships (JITs). Investment incentives for companies in JITs are at par with special economic zones and national investment and manufacturing zones.
A cluster of incentives in subsidies and reimbursements related to financial investment, land-related charges, taxes, duties and employment generation are provided to Japanese companies if they set up operations in these townships.
For instance, a JIT at Neemrana Industrial Park, Rajasthan, offers a capital subsidy of 25% of the investment made on plant and machinery, up to USD70,000. Notable Japanese companies such as Isuzu, Yamaha Music and Daikin have set up manufacturing units in these townships.
Japan Plus is another strategic bilateral initiative between India and Japan to promote, facilitate and retain Japanese investment in India. Through Japan Plus, investors are provided strategic business advisory, policy guidance, location assessment, issue redressal and expansion support. This initiative also aims to facilitate and fast-track investment proposals from Japan, and offers a one-stop location for prompt resolution to any problems faced by Japanese investors.
SECTORS OF SELECT INTEREST
There is a range of industry sectors Japanese companies can focus on in India, namely automobiles and electric vehicles (EVs), renewable energy, electronics and semiconductors.
With the EV revolution looming large, the government is currently boosting demand through consumer subsidies such as the Faster Adoption and Manufacturing of Hybrid and Electric Vehicles (FAME II) Scheme, which is extended up to 31 March 2024.
The government has also introduced multiple measures such as the Vehicle Scrappage Policy, 2021, and the Battery Waste Management Rules, 2022, to ensure a transition to EVs. With Japanese giants such as Toyota, Suzuki and Honda operating in India, the EV industry is bound to flourish.
In renewable energy, the government recently launched a production linked incentive (PLI) scheme to manufacture photovoltaic cells used in solar panels with an outlay of about USD2.38 billion. The government also aims to make India a global hub for green hydrogen production by implementing the National Green Hydrogen Mission with an outlay of about USD2.41 billion.
The mission will follow a phased approach, initially focusing on increasing the domestic manufacture of electrolysers. The latter stage will focus on exploring the industrial use of green hydrogen across different sectors of the economy, slowly moving towards decarbonisation.
With many Japanese companies having committed to net-zero emissions, India has become an important investment destination. Japan’s MUFG Bank has recently extended a sustainable finance facility of USD55 million to Tata Power for establishing solar projects. Mitsui has also invested in renewable energy projects, including ReNew Power’s renewable energy project.
In the electronics sector, the government is offering incentives such as production linked incentive schemes, manufacturing cluster schemes for shared infrastructure and exemption from customs duty.
The Gujarat state government recently announced the Gujarat Electronics Policy, 2022, which provides for capital assistance of up to 20%, reimbursement of stamp duty and registration fees, logistics subsidy, speedy regulatory approvals and relaxation from compliances.
In semiconductors, the government has launched a comprehensive programme for the development of semiconductors and a display manufacturing ecosystem in India, with an outlay of USD9.3 billion. The programme contains various schemes offering prominent benefits such as fiscal support of 50% of the project cost, or capital expenditure to eligible investors having the technology and capacity to execute such highly capital and resource-intensive projects. Various states, such as Tamil Nadu and Gujarat, have also launched state policies for semiconductors, offering incentives such as capital assistance, subsidies on land procurement, exemptions from stamp duties and electricity costs.
In addition to the above-mentioned sectors, Japanese investors have shown interest in sectors like: food processing (Kagome, Ise Foods); textiles (Uniqlo); and medical devices (Nipro), considering the initiatives undertaken by the government to develop friendly infrastructure in these sectors.
Investments from Japan form a big part of foreign investment received by India. However, the investment potential of Indian industries is still not completely explored.
Favourable and Japan-specific investment developments are changing the trend, and investments have started pouring into non-conventional sectors such as renewable energy, healthcare and digital technologies.
A comprehensive evaluation of entry alternatives – while keeping in mind important influencing variables such as social, political and economic factors – will further assist Japanese investors in establishing a robust foundation in India.