FOREIGN DIRECT INVESTMENT IN INDIA

By. S.R. Rajagopal, Advocate, Madras

**** Basically International Law is a system composed solely of rules governing the relations between nations.

The American Law Institutes Revised Statement of the Foreign Relations Law of the United States (1986) defines International Law as that law concerned with the conduct of states and of international organizations, and with their relations inter se, as well as some of their relations with persons, whether natural or personal.

Series

of

developments

like

establishment

of

permanent

international institutions and organizations viz., United Nations, World Health Organization, movements sponsored by them,

Bilateral Investment Treaties {BIT}, customs, Judicial decisions of International Court of Justice {ICJ} etc, have given rise to new rules of International Law and in shaping principles of International Law.

Developing countries, increasingly see foreign direct investment (FDI) as a source of economic development, modernization and employment generation, and have liberalised their FDI regimes to attract investment. Given the appropriate host-country policies and a basic level of development, a preponderance of studies show that FDI triggers technology spillovers, assists human capital formation, contributes to international trade integration, helps create a more competitive business environment and enhances enterprise

2 development. All these contribute to higher economic growth. Existence of real business opportunities is one of the key factors in attracting FDI.

FDI influences growth by increasing total factor productivity and, more generally, the efficiency of resource use in the recipient economy. Technology transfers through FDI generate positive externalities in the host country. In order to reap the maximum benefits from FDI, there is a need to establish a transparent, broad and effective enabling policy environment for investment and to put in place appropriate framework for their implementation. FDI contributes to export growth, productivity growth and finance for balance of payments, it supports increase in national income. FDI increases employment and contributes to economic growth. FDI has increased manifold over the past 2 decades. FDI brings private overseas funds into the country for investments. FDI IN INDIA GROWTH AND POLICIES India, among the foreign investors, is believed to be a good investment despite political uncertainty, bureaucratic hassles,

shortages of power and infrastructural deficiencies. India presents a vast potential for foreign investment and is actively encouraging the entrance of foreign players into the market. Foreign investors cannot ignore India, which is expected to become one of the top three emerging economies.

India is the fifth largest economy in the world and has the third largest GDP in the entire continent of Asia. It is also the second largest among emerging nations. India is also one of the few

3 markets in the world which offers high prospects for growth and earning potential in practically all areas of business. Yet, despite the practically unlimited possibilities in India for overseas businesses, the world's most populous democracy has, until fairly recently, failed to get the kind of enthusiastic attention generated by other emerging economies such as China.

Indian Government has permitted access to FDI through automatic route, except for a small negative list. Time to time there has been revision in liberalization of the FDI.

Recently the Government of India has liberalized their policies in certain sectors, like i. Increase in the FDI limits in "Air Transport Services (Domestic Airlines)" up to 49 per cent through automatic route and up to 100 per cent by non-resident Indians (NRIs) through automatic routes. (No direct or indirect equity participation by foreign airlines is allowed) ii. Prior approval of the Government would be required only in cases where the foreign investor has an existing joint venture for technology transfer/trade mark agreement in the 'same' field. iii. Even in the above mentioned cases, the approval of the Government would not be required in respect of the following: i. Investments to be made by venture capital funds

registered with SEBI; or ii. Where the existing joint venture investments by either of the parties is less than 3 per cent; or

4 iii. Where the existing venture/collaboration is defunct or sick. In so far as joint ventures to be entered after the date of Press Note dated January 12, 2005 are concerned, the joint venture agreement may embody a 'conflict of interest' clause to safeguard the interest of joint venture partners in the event of one of the partners desiring to set up another joint venture or a wholly owned subsidiary in the 'same' field of economic activity.

iv.

Foreign investment in the banking sector has been further liberalised by raising FDI limit in private sector banks to 74 per cent under the automatic route including investment by FIIs. The aggregate foreign investment in a private bank from all sources will be a maximum of 74 per cent of the paid up capital of the bank and at all times, at least 26 per cent of the paid up capital held by residents except in regard to a wholly owned subsidiary of a private bank. Further, the foreign banks will be permitted to either have branches or subsidiaries, not both. Foreign banks

regulated by a banking supervisory authority in the home country and meeting Reserve Bank's licence criteria will be allowed to hold 100 per cent paid up capital to enable them to set up wholly-owned subsidiary in India. FDI ceiling in telecom sector in certain services (such as basic, public mobile radio trunked services (PMRTS), global mobile personal communication service (GMPCS) and other value added services), has been increased from 49 per cent to 74 percent, in February 2005. The total composite foreign holding including but not limited to investment by

5 FIIs, NRI/OCB, FCCB, ADRs, GDRs, convertible preference shares, proportionate foreign investment in Indian

promoters/investment companies including their holding companies etc., will not exceed 74 per cent. v. In January 2004, guidelines on equity cap on FDI, including investment by NRIs and Overseas Corporate Bodies (OCBs) were revised as under: - FDI up to 100 per cent is permitted in printing scientific and technical magazines, periodicals and journals subject to compliance with legal framework and with the prior approval of the Government. i) FDI up to 100 per cent is permitted through automatic route for petroleum product marketing, subject to existing sectoral policy and regulatory framework. ii) FDI up to 100 per cent is permitted through automatic route in oil exploration in both small and medium sized fields subject to and under the policy of the Government on private participation in exploration of oil fields and the discovered fields of national oil companies. iii) FDI up to 100 per cent is permitted through automatic route for petroleum products pipelines subject to and under the Government policy and regulations thereof.

6 iv) FDI up to 100 per cent is permitted for Natural Gas/LNG approval. * {Source Information by Ministry of Finance, Government of India} A news report from World Bank "Doing Business in 2005; Removing Obstacles to Growth" has shown that India has made the highest progress among South Asian nations in improving its investment climate. India was rated among top ten reformers in the world. Further, a recent confidence survey by global consultancy AT Kearney rated India as the third most favoured FDI destination, next only to China and United States. According to the World Investment Report, 2004 of United Nations Conference on Trade and Development (UNCTAD), Global FDI Inflows have declined significantly from the peak of US$ 1.4 trillion in 2000 to US$ 560 billion in 2003. FDI inflow to India, on the contrary, has shown a rise, particularly in 2003, to reach US$ 4.27 billion Country-wise, FDI inflows to India are dominated by Mauritius (34.49 percent), followed by the United States (17.08 percent) and Japan (7.33 percent). Formulation of policy for Indian Direct Investment for setting up Joint Ventures (JV) and Wholly Owned Subsidiaries (WOS) abroad, pipelines with prior Government

promotion of Indian investment abroad and Bilateral Investment Promotion and Protection Agreement {BIPA} are the major functions of IC Section of the Government of India, Ministry of Finance, Department of Economic Affairs Investment Division. Indian investment abroad is governed by the Foreign Exchange Management (Transfer or issue of any foreign security) Regulations, 2000 notified by RBI from time to time.

7 As part of the Economic Reforms Programme initiated in 1991, the foreign investment policy of the Government of India was liberalised and negotiations undertaken with a number of countries to enter into Bilateral Investment Promotion & Protection Agreement (BIPAs) in order to promote and protect on reciprocal basis investment of the investors. Government of India have, so far, signed BIPAs with 57

countries out of which 47 BIPAs have already come into force and the remaining agreements are in the process of being enforced. In addition, agreements have also been finalised and/ or being negotiated with a number of other countries. The important features of BIPA are : National Treatment for foreign investment; MFN treatment for foreign investment and investors; free repatriation/ transfer of returns on investment; recourse to domestic disputes resolution and international arbitration for investor-State and State-State disputes; nationalization / expropriation only in public interest on a non-discriminatory basis and against compensation etc. Status of Bilateral Investment Promotion and Protection Agreements ratified by India (as on 01.04.2005) (ranked in alphabetical order)

Sl. No. 1. 2. 3. 4.

Country Argentina Australia Austria Belarus

Date of ratification/ enforcement 12th August 2002 4th May 2000 1st March 2001 23rd November 2003

8 Belgium Bulgaria Croatia

5. 6. 7.

8th January 2001 23rd September 1999 19th January 2002

8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20.

Cyprus

12th January, 2004

Czech Republic 6th February 1998 Denmark Egypt Finland France Germany Indonesia Israel Italy Kazakhstan Kuwait Kyrgyz Republic 28th August 1996 22nd November 2000 9th April 2003 17th May 2000 13th July 1998

22nd January,2004 18th February 1997 26th March 1998 26th July 2001 28th June 2003 12th May 2000

9 Lao PDR Malaysia Mauritius Mongolia Morocco Netherlands Oman Philippines

21. 22. 23. 24. 25. 26. 27. 28.

5th January 2003 12th April 1997 20th June 2000 29th April 2002 22nd February 2001 1st December 1996 13th October 2000 29th January 2001

29. 30. 31. 32. 33. 34. 35. 36.

Poland Portugal Qatar Romania Russian Federation South Korea Spain Sri Lanka

31st December 1997 19th July 2002 15th December 1999 9th December 1999 5th August 1996 7th May 1996 16th October 1998 13th February 1998

10 Sweden Switzerland Taiwan # Tajikistan Thailand Ukraine United Kingdom USA * Uzbekistan Vietnam Yemen

37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47.

1st April 2001 16th February 2000 28th November 2002 14th November .2003 13th July 2001 12th August 2003 6th January 1995 16th April 1998 28th July 2000 1st December 1999 10th February 2004

* Investment Incentive Agreement # An Unilateral Declaration issued by GOI to give effect to the

Agreement signed between India-Taipei Association, Taipei and Taipei Economic & Cultural Center , N.Delhi. {Source Information by Ministry of Finance, Government of India}

11 List of countries with whom india has signed Double Taxation Avoidance Agreement(DTAA) 1. Australia 2. Austria 3. Bangladesh 4. Belgium 5. Belarus 6. Brazil 7. Bulgaria 8. Canada 9. China 10. Cyprus 11. Czech Republic 12. Denmark 13. Egypt 14. Finland 15. France 16. Germany 17. Greece 18. Hungary 19. Indonesia 20. Ireland 21. Israel 22. Italy 23. Japan 24. Jordan 25. Kazakhstan 26. Kenya 27. Kyrgyz Republic 28. Libya 29. Malaysia 30. Malta 31. Mauritius 32. Mongolia 33. Morocco 34. Namibia 35. Nepal 36. The Netherlands 37. New Zealand 38. Norway 39. Oman 40. Philippines 41. Poland

12 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. Portugal Qatar Romania Russian Federation Singapore South Africa South Korea Spain Sri Lanka Sweden Switzerland Syria Tanzania Thailand Trinidad & Tobago Turkey Turkmenistan Ukraine UAE United Kingdom USA Uzbekistan Vietnam Zambia

List of countries with whom india has signed Limited DTA 1. Afghanistan 2. Ethiopia 3. Iran 4. Kuwait 5. Lebanon 6. Pakistan 7. P.D.R. Yemen 8. Saudi Arabia 9. Yemen Arab Republic

13 India - U.A.E. BIPA Text of BIPA between India and UAE was finalized in June 1998 and Cabinet approval for signing and subsequent ratification of the Agreement was obtained on 10-4-1999. However, signing of the BIPA has been held up on account of two amendments proposed by the UAE in the agreed text of the Agreement which are to be negotiated. Foreign Investment Policy: The Ministry of Industry has expanded the list of industries eligible for automatic approval of foreign investments and, in certain cases, raised the upper level of foreign ownership from 51 percent to 74 percent and further in certain cases to 100 percent. In January 1998, the RBI announced simplified procedures for automatic FDI approvals. The announcement further provided that Indian companies will no longer require prior clearances from the RBI for inward remittances of foreign exchange or for the issuance of shares to foreign investors. Facilitating foreign investment: In the recent budget, the GOI has announced its commitment to a 90day period for approving all foreign investments. Government officers are assigned to larger foreign investment proposals and to facilitate Central and State clearances in a time-bound manner. Unlisted companies with a good 3 year track record, have been permitted to raise funds in international markets through the issue of Global Depository Receipts (GDRs) and American Depository Receipts (ADRs). A number of recent policy changes have reduced the discriminatory bias against foreign firms. The government has amended exchange control regulations previously applicable to companies with significant foreign participation. The ban against using foreign brand

names/trademarks has been lifted. The FY 1994/95 budget reduced

14 the corporate tax rate for foreign companies from 65 percent to 55 percent. The tax rate for domestic companies was lowered to 40 percent. The long-term capital gains rate for foreign companies was lowered to 20 percent; a 30 percent rate applies to domestic companies. The Indian Income Tax Act exempts export earnings from corporate income tax for both Indian and foreign firms. Other policy changes have been introduced to encourage foreign direct and foreign institutional investment. The Securities and Exchange Board of India (SEBI) has recently formulated guidelines to facilitate the operations of foreign brokers in India on behalf of registered Foreign Institutional Investors (FII's). These brokers can now open foreign currency-denominated or rupee accounts for crediting inward remittances, commissions and brokerage fees. The condition of dividend balancing (offsetting the outflow of foreign exchange for dividend payments against export earnings) has been eliminated for all but 22 consumer goods industries. A 5-year tax holiday is extended to enterprises engaged in development of infrastructural facilities. Even without a registered office in India, foreign companies are allowed to start multimodal transport services in India. The Reserve Bank of India (RBI) now permits 100 percent foreign investment in the construction of roads/bridges. The peak custom duty rate was reduced to 50 percent from 65 percent in the March 1995 budget. Import regime changes included enhancement of the scope of Special Import License (SIL) programs, and the expansion of freely importable items on the Open General License (OGL) list to include some consumer goods.

15 Currently, there are no investment disputes over expropriation or nationalization. A committee has been named to study the

longstanding disputes in pharmaceutical sector, but the failure of Government to produce a swift and transparent resolution has led to a virtual standstill in foreign investment in India's pharmaceutical sector. Indian Courts and constitution of Intellectual Property Rights Tribunal provide adequate safeguards for the enforcement of property and contractual rights. Foreign Direct Investment (FDI) in India is permitted under the following forms of investments.

Through financial collaborations. Through joint ventures and technical collaborations. Through capital markets via Euro issues. Through private placements or preferential allotments.

FDI is not permitted in the following industrial sectors:

Arms and ammunition. Atomic Energy. Railway Transport. Coal and lignite. Mining of iron, manganese, chrome, gypsum, sulphur, gold, diamonds, copper, zinc.

16 Foreign Investment through GDRs (Euro Issues) Foreign Investment through GDRs is treated as Foreign Direct Investment. Indian companies are allowed to raise equity capital in the international market through the issue of Global Depository Receipt (GDRs). GDRs are designated in dollars and are not subject to any ceilings on investment. floating of GDR issue. There is no restriction on the number of Euro-issue to be floated by a company or a group of companies in the financial year . A company engaged in the manufacture of items covered under Annex-III of the New Industrial Policy whose direct foreign investment after a proposed Euro issue is likely to exceed 51% or which is implementing a project not contained in Annex-III, would need to obtain prior FIPB clearance before seeking final approval from Ministry of Finance. In India, Department of Industrial Policy and Promotion (DIPP) is the nodal agency constituted by Ministry of Commerce & Industry. Foreign Investment Implementation Authority (FILA) has been set up by Government of India to facilitate quick translation of FDI approvals into implementation and to help foreign investors to obtain necessary approvals, sort out operational problems and find solutions to Foreign Investors problems. Fast track Committee for each sector has been The Government of India has approved

constituted to assist FILA. CONCLUSION : The Indian middle class is large and growing; wages are low; many workers are well educated and speak English; investors are optimistic and local stocks are up; despite political turmoil, the country presses on with economic reforms. The rapid economic growth of the last few

17 years has put heavy stress on India's infrastructural facilities. The projections of further expansion in key areas could snap the already strained lines of transportation unless massive programs of expansion and modernization are put in place. Problems include power demand shortfall, port traffic capacity mismatch, poor road conditions (only half of the country's roads are surfaced), low telephone penetration (1.4% of population). Although the Indian government is well aware of the need for reform and is pushing ahead in this area, business still has to deal with an inefficient and sometimes still slow-moving bureaucracy. The Indian market is widely diverse. The country has 17 official languages, 6 major religions, and ethnic diversity as wide as all of Europe. Thus, tastes and preferences differ greatly among sections of consumers. The general economic direction in India is toward liberalization and globalization. There is always a constant fear for the investor of the frequent changes in environmental legislations and policies in India. Long term environment policies could be drawn up. India is not a member of the International Center for the Settlement of Investment Disputes, nor of the New York Convention of 1958. Commercial arbitration or other alternative dispute resolution (ADR) methods are not yet popular ways of commercial dispute settlement in India. The recent introduction in Parliament of a new Arbitration Bill signals the importance now accorded to this matter by the GOI. However, India still has a heavy regulation burden among other countries, e.g the time taken to start business or to register a property is higher in India. Similarly, indirect taxes, entry-exit barriers and import duties have been a major detriment to investment climate in India.

18 All these issues are required to be addressed or at least partically avoided for having higher FDI in India.

Though India is not a signatory to the Convention on Settlement of Investment Disputes between States and nationals of other States, many Bilateral Investment Agreements entered by India include an ICSID Arbitration clause for settlement of disputes. legislative and institutional reform is a barrier to FDI. Though there are several set backs and deficiencies, the existence of economic opportunities would not dissuade FDI in India. The lack of

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