Foreign Investment

The investments that are made by Foreign Corporates, Foreign Nationals, as well as Non-Resident
of the nation would fall into the category of Foreign Investment. Any investment that is made in
India with the source of funding that is from outside of India is a foreign investment.

Types of Foreign Investments

Funds from foreign country could be invested in shares, properties, ownership / management or
collaboration. Based on this, Foreign Investments are classified as below.

 Foreign Direct Investment (FDI)

 Foreign Portfolio Investment (FPI)
 Foreign Institutional Investment (FII)

Details on each of the foreign investment type can be found below:

Foreign Direct Investment (FDI)

FDI is an investment made by a company or individual who us an entity in one country, in the
form of controlling ownership in business interests in another country. FDI could be in the form
of either establishing business operations or by entering into joint ventures by mergers and
acquisitions, building new facilities etc.

Foreign Portfolio Investment (FPI)

Foreign Portfolio Investment (FPI) is an investment by foreign entities and non-residents in Indian
securities including shares, government bonds, corporate bonds, convertible securities,
infrastructure securities etc. The intention is to ensure a controlling interest in India at an
investment that is lower than FDI, with flexibility for entry and exit.

Foreign Institutional Investment (FII)

Foreign Portfolio Investment (FPI) is an investment by foreign entities in securities, real
property and other investment assets. Investors include mutual fund companies, hedge fund
companies etc. The intention is not to take controlling interest, but to diversify portfolio ensuring
hedging and to gain high returns with quick entry and exit.

1) FOREIGN DIRECT INVESTMENT (FDI)

Foreign direct investment (FDI) is when a foreign company or individual makes an investment in
India that involves either

(i) Establishing new business operations (known as green-field FDI) or

(ii) Acquiring business assets, including controlling interests, in an already existing Indian
company. (Known as brown-field FDI)

FDI is distinguished from FII in the sense it establishes a long-term relationship and involves
substantial control over the decision making of the company.

 Inward FDI is when foreign companies or individuals invest in India.

 Outward FDI is when Indian companies or individuals invest in foreign countries

As per the Companies Act 2013, if a foreign investor owns more than 10 % shares in a listed
company, it will be treated as FDI. The rationale behind the rule is that the higher equity
ownership will result in substantial control over the decision-making of the company.

Types of FDI

1. Horizontal FDI arises when a firm duplicates its home country-based activities at the same
value chain stage in a host country through FDI.
2. Platform FDI Foreign direct investment from a source country into a destination country
for the purpose of exporting to a third country.
3. Vertical FDI takes place when a firm through FDI moves upstream or downstream in
different value chains i.e., when firms perform value-adding activities stage by stage in a
vertical fashion in a host country.
Methods

The foreign direct investor may acquire voting power of an enterprise in an economy through
any of the following methods:

 by incorporating a wholly owned subsidiary or company anywhere

 by acquiring shares in an associated enterprise
 through a merger or an acquisition of an unrelated enterprise
 participating in an equity joint venture with another investor or enterprise[7]

2) FOREIGN INSTITUTIONAL INVESTMENT (FII)

FII is when foreign institutional investors invest in the shares of an Indian company, or in bonds
offered by an Indian company. So, if a foreign investor buys shares in Reliance, it is an FII.

Only institutional investors like Investment companies, Insurance funds etc. are allowed to
invest in Indian stock market directly. Hence the term foreign institutional investor. These
investors have to get a license from SEBI.

However, if foreign individuals want to invest in India’s markets, they have to get themselves
registered as a sub-account of an FII. The FII will buy shares/ bonds from the India markets on
their behalf.

India allows only wealthy foreign individuals or high net worth individuals (HNIs) who have a
minimum net worth of $50 million to be registered as a sub-account of a foreign institutional
investor (FII).

FII’s are mostly adapting High Frequency Trading. It is a computational trading system that uses
powerful super computers to place buy/sell orders in fraction of seconds. These super
computers analyze gigabytes of data across various sectors and timeframe to arrive at the best
possible trading decision. A pre-defined trading algorithm(s) needs to be fed into these
computers before making it live. Some HFT systems also have artificial intelligence capabilities
to learn and optimize the trading algorithms. Speed is a key factor for the success of HFT
systems. Typically, the traders with the fastest execution speeds will be more profitable than
traders with slower execution speeds.

High Frequency Trading Strategies

Although there are no pre-defined rules to select strategies for HFT, but there are few popular
strategies which are more popular than others and used by most of the HFT trading firms.
Below High frequency trading strategies are complied from various sources:

 Statistical Arbitrage: This strategy exploits the temporary deviations of various

statistical parameters among various securities. Statistical arbitrage at high
frequencies is actively used in all liquid securities, including equities, bonds, futures,
foreign exchange, etc. Even classical Arbitrage can be used by examining the price
parity of securities in different exchanges or spot and future market. The TABB Group
estimates that annual aggregate profits of high-frequency arbitrage strategies
exceeded US$21 billion in 2009.
 Option pricing disparity: Generally, it takes some time for the price of an option to
follow a stock and vice versa. Modern HFT systems are capable to precisely model
these differences to arrive at a favorable trade. Read about options pricing and Black-
Scholes model to understand this better.
 News based HFT systems: Company news in electronic text format is available from
many sources including commercial providers like Bloomberg, public news websites,
and Twitter feeds. Automated systems can identify company names, keywords and
sometimes semantics to trade news before human traders can process it.
 Momentum Ignition: This strategy aims to cause a spike in the price of a stock by
using a series of trades with the motive of attracting other algorithm traders to also
trade that stock. The instigator of the whole process knows that after the somewhat
“artificially created” rapid price movement, the price reverts to normal and thus the
trader profits by taking a position early on and eventually trading out before it fizzles
out.
  Pair Trading: Pair Trading is a market neutral strategy where two highly co-related
instruments are bought and sold together when there is a certain degree of deviation
in their co-relation. Usually the stock or commodities selected for Pair Trading are
from the same sector and moves together during most of the market events. Pair
trading in intraday timeframe through HFT systems have given impressive results.
Read more about pair trading he

Foreign institutional investors are also known as ‘hot money’ because it is not stable in nature.
The FIIs can pull out money from a country’s stock market/ bond market overnight.

3) QUALIFIED FOREIGN INVESTMENT (QFI)

As we know, foreign individuals cannot invest directly in India’s markets without sub-accounts
with an FII.

As an alternative, QFI was introduced in the year 2002. A Qualified Foreign Investor can invest in
India without sub-account.

However, they have to open a Demat account and Trade account with a depository participant
in India.

 The Qualified foreign investor (QFI) can be an individual, group or an association.

 The QFI should be resident in a foreign country that is compliant with the standards of
Financial Action Task Force (FATF).
 In addition, the QFI must be a signatory to International Organization of Securities
Commission’s Multilateral Memorandum of Understanding. (MMOU).

4) FOREIGN PORTFOLIO INVESTMENT (FPI)

In the Indian context, FIIs (along with sub-accounts with FIIs) and QFIs can be collectively
classified as Foreign Portfolio Investment (FPI).

Factors That Influence a Company’s Decision to Invest

Let’s look at why and how companies choose to invest in foreign markets. Simply purchasing
goods and services or deciding to invest in a local market depends on a business’s needs and
overall strategy. Direct investment in a country occurs when a company chooses to set up
facilities to produce or market their products; or seeks to partner with, invest in, or purchase a
local company for control and access to the local market, production, or resources. Many
considerations influence its decisions:

 Cost. Is it cheaper to produce in the local market than elsewhere?

 Logistics. Is it cheaper to produce locally if the transportation costs are significant?
 Market. Has the company identified a significant local market?
 Natural resources. Is the company interested in obtaining access to local resources or
commodities?
 Know-how. Does the company want access to local technology or business process
knowledge?
 Customers and competitors. Does the company’s clients or competitors operate in the
country?
 Policy. Are there local incentives (cash and noncash) for investing in one country versus
another?
 Ease. Is it relatively straightforward to invest and/or set up operations in the country, or
is there another country in which setup might be easier?
 Culture. Is the workforce or labor pool already skilled for the company’s needs or will
extensive training be required?
 Impact. How will this investment impact the company’s revenue and profitability?
 Expatriation of funds. Can the company easily take profits out of the country, or are there
local restrictions?
 Exit. Can the company easily and orderly exit from a local investment, or are local laws
and regulations cumbersome and expensive?

How Governments Encourage FDI

Governments seek to promote FDI when they are eager to expand their domestic economy and
attract new technologies, business know-how, and capital to their country. In these instances,
many governments still try to manage and control the type, quantity, and even the nationality of
the FDI to achieve their domestic, economic, political, and social goals.

 Financial incentives. Host countries offer businesses a combination of tax incentives and
loans to invest. Home-country governments may also offer a combination of insurance,
loans, and tax breaks in an effort to promote their companies’ overseas investments. The
opening case on China in Africa illustrated these types of incentives.
 Infrastructure. Host governments improve or enhance local infrastructure—in energy,
transportation, and communications—to encourage specific industries to invest. This also
serves to improve the local conditions for domestic firms.
 Administrative processes and regulatory environment. Host-country governments
streamline the process of establishing offices or production in their countries. By reducing
bureaucracy and regulatory environments, these countries appear more attractive to
foreign firms.
 Invest in education. Countries seek to improve their workforce through education and
job training. An educated and skilled workforce is an important investment criterion for
many global businesses.
 Political, economic, and legal stability. Host-country governments seek to reassure
businesses that the local operating conditions are stable, transparent (i.e., policies are
clearly stated and in the public domain), and unlikely to change.

Foreign Direct Investment Overview

The Indian Government is keen on increasing foreign investment in India and has taken various
policy decisions to encourage FDI. The FDI Policy in India is regulated by the Department of
Industrial Policy and Promotions (DIPP), Ministry of Commerce and Industry. A consolidated
circular issued by the DIPP services as an important policy note on FDI and the latest FDI
Circular was issued 17-4-2014.

As per regulations, FDI means investment by non-resident entity/person resident outside India
and includes all types of foreign investment in India including investment by FIIs, investment by
NRI, investment by foreigners or foreign entities, etc.,

FDI in Private Limited Company

FDI in Private Limited Company is allowed for non-resident entities, subject to the FDI Policy and
sectoral caps. FDI in a Private Limited Company falls under two categories, automatic route or
approval route. FDI is permitted upto 100% in most of the sectors other than those sectors which
are capped or restricted. In cases where automatic approval is not allowed, prior approval from
the Foreign Investment Promotion Board (FIPB) of the Government of India must be obtained
prior to the investment. Further, citizens or entities of Bangladesh or Pakistan can invest in India,
only under the approval route.

FDI in a Private Limited company can be through various equity instruments. Indian companies
can issue equity shares, preference shares and convertible debentures, subject to the norms and
guidelines. The equity shares of a private limited company issued under FDI must as at fair value.
However, in case of a newly incorporated entity or subscription to the Memorandum of
Association during Company Incorporation by a NRI or Foreigner, the shares can be issued at
face value.
Illustration of FDI in Private Limited Company
FDI Prohibited Sectors

FDI in the following sectors is prohibited completely:

 Atomic Energy
 Lottery business including government lottery and online lottery (even foreign
collaboration, franchise, trademark, brand name, management contract is prohibited)
 Gambling and betting including casino (even foreign collaboration, franchise, trademark,
brand name, management contract is prohibited)
 Business of chit funds
 Nidhi Company
 Trading in transferable development rights
  Real estate business or construction of farm house (except development of townships,
roads or bridges, city and regional infrastructure, etc.,)
 Manufacturing of cigars, cheroots, cigarillos and cigarettes of tobacco or of tobacco
substitutes
 Activity / sector not opened to private sector investment [e.g. Atomic energy and Railway
Transport (other than Mass Rapid Transport Systems)].

FDI under Approval Route

FDI in Private Limited Company under the automatic route is not permitted for the following
sectors. Hence, prior approval of the FIPB is required.

 Petroleum sector (except for private sector oil refining), Natural gas/LNG Pipelines
 Investing companies in Infrastructure & Service Sector
 Defense and strategic industries
 Atomic minerals
 Print media
 Broadcasting
 Postal services
 Courier services
 Establishment or operation of satellite
 Development of integrated township
 Tea sector
 Asset Reconstruction Company

FDI under Automatic Route

In case the activity proposed to be undertaken by the foreign or non-resident entity in India,
doesn’t fall under the FDI prohibited or approval category, FDI under the automatic route is
permissible. Under automatic route, an application for FDI in the Private Limited Company is not
required, if the investment is within the FDI cap. Download sector wise FDI cap in India.
Under the automatic route, no prior permission of the FIPB or RBI is required for FDI in a Private
Limited Company. The Company must only file certain filings relating to the FDI with the Reserve
Bank of India after receipt of the share subscription money from the foreign or non-resident
investor and issuance of shares. Further, under the automatic route, the investment cannot be
made in a company which required an industrial license under the Industries Act, 1951 or for
acquisition of another Indian companies existing shares or for financing an expansion.

It is important to note that, majority of the sectors in India are eligible for 100% FDI under the
automatic route, wherein a FDI report has to be filed only after issuance of shares for the foreign
or non-resident entity. Therefore, the process for starting a business in India for Foreign Nationals
and Non-Resident Indians is very smooth and easy.

About FDI in India

Introduction
Apart from being a critical driver of economic growth, foreign direct investment (FDI) is a major
source of non-debt financial resource for the economic development of India. Foreign companies
invest in India to take advantage of relatively lower wages, special investment privileges such as
tax exemptions, etc. For a country where foreign investments are being made, it also means
achieving technical know-how and generating employment.
The Indian government’s favourable policy regime and robust business environment have
ensured that foreign capital keeps flowing into the country. The government has taken many
initiatives in recent years such as relaxing FDI norms across sectors such as defence, PSU oil
refineries, telecom, power exchanges, and stock exchanges, among others.
Market size
According to Department of Industrial Policy and Promotion (DIPP), the total FDI investments in
India April-June 2018 stood at US$ 12.75 billion, indicating that government's effort to improve
ease of doing business and relaxation in FDI norms is yielding results.
Data for April-June 2018 indicates that the services sector attracted the highest FDI equity inflow
of US$ 2.43 billion, followed by trading – US$ 1.63 billion, telecommunications – US$ 1.59 billion
and computer software and hardware – US$ 1.41 billion. Most recently, the total FDI equity
inflows for the month of June 2018 touched US$ 2.89 billion.
During April-June 2018, India received the maximum FDI equity inflows from Singapore (US$ 6.52
billion), followed by Mauritius (US$ 1.49 billion), Japan (US$ 0.87 billion), Netherlands (US$ 0.84
billion), and United Kingdom (US$ 0.65 billion).
Investments/ developments
India emerged as the top recipient of greenfield FDI Inflows from the Commonwealth, as per a
trade review released by The Commonwealth in 2018.
Some of the recent significant FDI announcements are as follows:

 In August 2018, Bharti Airtel received approval of the Government of India for sale of 20
per cent stake in its DTH arm to an America based private equity firm, Warburg Pincus,
for around $350 million.
 In June 2018, Idea’s appeal for 100 per cent FDI was approved by Department of
Telecommunication (DoT) followed by its Indian merger with Vodafone making Vodafone
Idea the largest telecom operator in India
 In May 2018, Walmart acquired a 77 per cent stake in Flipkart for a consideration of US$
16 billion.
 In February 2018, Ikea announced its plans to invest up to Rs 4,000 crore (US$ 612 million)
in the state of Maharashtra to set up multi-format stores and experience centres.
 In November 2017, 39 MoUs were signed for investment of Rs 4,000-5,000 crore (US$
612-765 million) in the state of North-East region of India.
 In December 2017, the Department of Industrial Policy and Promotion (DIPP) approved
FDI proposals of Damro Furniture and Supr Infotech Solutions in retail sector, while
Department of Economic Affairs, Ministry of Finance approved two FDI proposals worth
Rs 532 crore (US$ 81.4 million).
 The Department of Economic Affairs, Government of India, closed three foreign direct
investment (FDI) proposals leading to a total foreign investment worth Rs 24.56 crore
(US$ 3.80 million) in October 2017.
  Kathmandu based conglomerate, CG Group is looking to invest Rs 1,000 crore (US$ 155.97
million) in India by 2020 in its food and beverage business, stated Mr Varun Choudhary,
Executive Director, CG Corp Global.
 International Finance Corporation (IFC), the investment arm of the World Bank Group, is
planning to invest about US$ 6 billion through 2022 in several sustainable and renewable
energy programmes in India.

Government Initiatives
Government of India is planning to consider 100 per cent FDI in Insurance intermediaries in India
to give a boost to the sector and attracting more funds.
In January 2018, Government of India allowed foreign airlines to invest in Air India up to 49 per
cent with government approval. The investment cannot exceed 49 per cent directly or indirectly.
No government approval will be required for FDI up to an extent of 100 per cent in Real Estate
Broking Services.
In September 2017, the Government of India asked the states to focus on strengthening single
window clearance system for fast-tracking approval processes, in order to increase Japanese
investments in India.
The Ministry of Commerce and Industry, Government of India has eased the approval mechanism
for foreign direct investment (FDI) proposals by doing away with the approval of Department of
Revenue and mandating clearance of all proposals requiring approval within 10 weeks after the
receipt of application.
The Government of India is in talks with stakeholders to further ease foreign direct investment
(FDI) in defence under the automatic route to 51 per cent from the current 49 per cent, in order
to give a boost to the Make in India initiative and to generate employment.
In January 2018, Government of India allowed 100 per cent FDI in single brand retail through
automatic route.
Road ahead
India has become the most attractive emerging market for global partners (GP) investment for
the coming 12 months, as per a recent market attractiveness survey conducted by Emerging
Market Private Equity Association (EMPEA).
Annual FDI inflows in the country are expected to rise to US$ 75 billion over the next five years,
as per a report by UBS.
The World Bank has stated that private investments in India is expected to grow by 8.8 per cent
in FY 2018-19 to overtake private consumption growth of 7.4 per cent, and thereby drive the
growth in India's gross domestic product (GDP) in FY 2018-19.

Impact /Role of foreign investment on the developing economics

In fact, foreign investment has served as a model for policies diffusing into the wider society. This
is apparent in the economic system in innumerable ways, including in the reform of the banking
system; the break-up of the monopolies of state-owned import–export companies, with respect
to cross border trading rights; the opening and the reform of stock markets creating a culture of
stock ownership; and the expansion of private housing. Domestic private equity and venture
capital investments are also developing. Private Foreign Investment has therefore played a
significant role in the major changes experienced in these sectors.

Corporate social responsibility

With respect to social consciousness, foreign investment has inspired a rise in awareness of and
commitment to corporate social responsibility. Foreign investment has also inspired the
formation of business interest groups such as those with a mission of social betterment, such as
the Chamber of Commerce, Export Promotion Council, Export Processing Zones Authority where
majority of businesses are owned by foreign investors. Foreign business interests have also been
approaching these organizations to ask them to take a prominent role in proposing changes to
legislative issues of common concern that would foster a friendly economic environment to
invest.

Fostering the development of society

n addition to continuing to grow, albeit in newer and often more sophisticated forms than FDI,
foreign investment is responsible for fostering the development of society. Foreign Direct
Investment into Kenya has brought with it several international private firm to invest in Kenya.
Most of these business firms stand for better quality life of their employees and the community
around the business. Kenya native business management have taken the same course and are
advocating for better working conditions of their employees, investing heavily on Corporate
Social Responsibility projects etc. Companies like Safaricom Ltd, Kenya Commercial Bank, Equity
Bank Ltd are giving quite an amount of resources to support such projects as clean water,
scholarships for financially needy students. Firms with their parent companies overseas like
Biersdolf East Africa, Colgate and Palmolive, Nestle were able to attract the best experience and
qualified personnel due to packages and opportunities they offered their employees and the
community around them. Kenyan firms have slowly followed suit.

Technology transfer and Progress

FDI increases the rate of technological progress in the host country through a contagion effect
from the more advanced technology and management practices used by the foreign firms
(Findlay, 1978). This is through either copying the technology used by the foreign firms or
accessing the latest technology. Such technology transfers may take place as a result of
demonstration effects. Local firms may adopt technologies introduced by foreign firms through
imitation or reverse engineering; as a result of labour turnover whereby workers trained by
foreign firms transfer technological knowledge to local firms or they start their own firms; and
through demand linkages whereby foreign firms provide services or inputs to local firms.
Technology transferred from foreign investment projects improves the efficiency of local firms
as well.

Integrate domestic markets into the global economic system

PFI can serve to integrate domestic markets into the global economic system far more effectively
than could have been achieved only by traditional trade flows. The benefits from Private Foreign
Investment will be enhanced in an open investment environment with a democratic trade and
investment regime, active competition policies, macroeconomic stability and privatization and
deregulation. Under such conditions, FDI can play a key role in improving the capacity of a country
to correspond to global economic integration and future national developmental strategies. In
practice, the greater the openness and freedom toward FDI, the more economic reforms and
potential benefits that receiving countries will reap. The country is generally perceived as the
Eastern and central Africa's hub for Financial, Communication and Transportation services due
to continued stability, foreign investment incentives offered by the Kenyan Government like the
EPZ.

Growth and development

Besides the addition to macroeconomic resources in developing countries like Kenya, PFI is
believed to make other important contributions to growth and development. First, it can raise
tax revenues, create employment, and open new markets for exports. In practice, though,
performance in these areas does not always meet expectations. Poor and developing countries
often compete to offer tax holidays as a way to attract investment. Employment may actually be
lost, if foreigners buy and re-structure inefficient existing enterprises, often previously owned by
the state. For instance, the government sold a large stake in Telkom Kenya to Orange, a UK
telecommunication Firm. A sizebale number of employees were retrenched in order to get back
Telkom Kenya on the profit path. PFI however has been know to create more jobs and increase
incomes of the poor. In turn, this generates the revenues that governments need to expand
access to health, education and infrastructure services and so help improve productivity. The
Kenya annual budget for 2012/2013 will hit one trillion Kenya Shillings the highest ever in the
Eastern Africa. This budget will highly be supported PFI projects in Kenya.

Bridge investment thresholds

FDI and FPI can help breach investment thresholds. In poor countries especially, where
government revenues are small or the domestic financial system is shallow, foreign companies
may be the only ones to invest in projects with a high minimum financing threshold, such as
infrastructure or natural resource extraction. For instance Oil Exploration in Northern part of
Kenya, Titanium mining at the Kenyan coast and coal mining in Eastern Province. All these
projects are being handle by Private Foreign Investors. PFI can also help start an investment and
growth dynamic that attracts further domestic and foreign investment.

Lift productivity and competitiveness

FDI and FPI can lift productivity and competitiveness by adding to the stock of capital equipment
in the economy, introducing new technology in production and new organizational structures
and management methods in companies, and training employees. Orange (UK) management
took over Telkom Kenya and introduced some of the best technology in telecommunication
industry in voice, data and mobile money transactions.

Tend to concentrate on one or few areas

FDI tends to reinforce existing patterns of economic structure. It concentrates in one or a few
sectors, often in industries with few linkages to the rest of the economy, such as natural
resources or light manufacturing (behind protective tariffs) for the domestic market. FDI also
concentrates in regions which already have the best infrastructure and human capital. The
agricultural sector and rural areas are particularly neglected. This results in neglect of rural areas
where the efforts are concentrated on investment areas like the urban centres. This has been the
case for a couple of decades but the country management is opening up the rural areas by
building roads and expanding electricity to tap into the rich agricultural production in the area.

Putting non-used resources to work

FDI also boosts investment in other industries "by putting nonused resources to work, by
encouraging local suppliers to act as suppliers and distributors for foreign corporations, and by
helping disseminate efficient foreign product techniques and management styles to local
businesses" (John M. Rothgeb, Jr. 1989, pp. 82-3). Non-used deposits of coal in Eastern Province
and Titanium in Kwale county are some of the resources that were lying idle. The resources will
be put into productive activities therefore benefiting the community and the country. FDI and
FPI directed at heavy intermediate or capital goods industries are more likely to facilitate
additional investment than FDI directed at specific consumer goods industries.
Supplements domestic savings
Foreign investment supplement domestic savings and harnesses them to secure a rapid rate of
growth. It serves as a stimulant to additional domestic investment in the recipient country. By
increasing the rate of capital formation in the country, it goes a long way in removing the capital
deficiency which is the main hurdle in the economic growth.

Improves the balance of payments

FDI improves the balance of payments and current account substantially if it is
directed towards the production for exports or import replacement (Peter Hess and
Clark Ross, 1997, p.496). The government budget balance also improves through
high tax revenue from corporate profits, salaries of employees, and Value Added Tax (VAT) on
finished goods and services. Nestle are large exporters of manufactured and processed foods.
Foreign investors are now on centrating on the service industry in Kenya like the tourism and
hotel industry. This attracts foreign earnings that are much needed to improve the balance of
payments.