NATIONAL LAW UNIVERSITY, ODISHA

SUBJECT
LAW AND ENTREPRENEURSHIP

TOPIC- “FOREIGN DIRECT INVESTMENT REGULATIONS & RESTRICTIONS”

TENTH SEMESTER B.A. L L.B (January-April 2024, Batch of 2019)

UNDER THE GUIDANCE OF

Dr. Itishree Mishra

(Assistant Professor of Law)

SUBMITTED BY:

Punyashlok Panda (2019/B.A. LL. B/079)

 TABLE OF CONTENTS

TOPIC- “FOREIGN DIRECT INVESTMENT REGULATIONS & RESTRICTIONS”.........1

Table of Contents.......................................................................................................................2

Research Question......................................................................................................................3

Research Methodology...............................................................................................................3

Introduction................................................................................................................................4

Regulatory Framework...............................................................................................................4

Principal Regulators and Authorities.........................................................................................5

types of Foreign Investment.......................................................................................................5

Foreign Direct Investment (FDI)...........................................................................................5

FDI Pathways.........................................................................................................................5

Sectoral Limits...........................................................................................................................6

Sectors Not Permitted for FDI...............................................................................................7

Entities Qualified for FDI Inflows.............................................................................................7

Foreign Venture Capital Investor (FVCI)...................................................................................8

Foreign Portfolio investor (FPI).................................................................................................8

Penalties and rectification measures..........................................................................................9

Conclusion................................................................................................................................10

Bibliography.............................................................................................................................12

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 RESEARCH QUESTION

I. What is the legislative framework to govern foreign investments in India?

II. What are the various modes through which foreign investments are made in India?
III. What are the sectors in which foreign direct investments is permitted/prohibited?

RESEARCH METHODOLOGY

The research methodology employed in this study is predominantly theoretical and analytical.
The research paper incorporates both primary data, exemplified through case studies. Various
sources have been extensively referenced, encompassing books, online articles, blogs,
newspaper publications, research articles, case precedents, and legislative statutes. These
diverse resources were meticulously utilized by the researchers throughout the composition
of this paper.

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 INTRODUCTION

Since 1991, India has pursued economic liberalization by progressively opening up its
foreign investment in business and industrial sectors. The government's efforts have focused
on improving the ease of doing business in India to foster enduring economic ties.

In recent years, India has emerged as a prime destination for foreign investment due to its
favourable demographics and consistent economic growth. “In the fiscal year 2021-2022,
India experienced its highest ever inflow of foreign direct investment (FDI), totalling around
US$83.57 billion.”1 Notably, the rise in Foreign Direct Investment occurred despite
government limitations on FDI originating from nations that share land borders with India, a
topic that will be elaborated on in subsequent sections of this chapter.

The increase in Foreign Direct Investment (FDI) can be credited to multiple factors. Initially,
the Indian government's enactment of diverse policy reforms with the objective of
liberalizing the economy and enhancing the business environment within the nation has
played a significant role. Additionally, alterations in global trade dynamics and geopolitical
shifts have prompted investors to divert their investments from China.2

This chapter offers a summary of the regulations that oversee Foreign Direct Investment
(FDI) in India, alongside a concise description of the processes and rules associated with
engaging in foreign investments within the nation.

REGULATORY FRAMEWORK

Primary legislation overseeing foreign exchange matters in India comprises:

“The Foreign Exchange Management Act of 1999 (FEMA), subject to amendments over time,
alongside its associated rules and regulations, including the Foreign Exchange Management
(Non-Debt Instruments) Rules of 2019 (NDI Rules) and the Foreign Exchange Management
(Mode of Payment and Reporting of Non-Debt Instruments) Regulations of 2019.”

1
Press Release by the Ministry of Commerce and Industry, ‘Press Information Bureau, Delhi’ dated May 20,
2022.
2
Lee Kah Whye, ‘Will India Scoop up more investments at the expense of China in the new year?’ (Livemint, 03
January 2022) <https://www.livemint.com/news/india/will-india-scoop-up-more-investments-at-the-expense-of-
china-in-the-new-year-11641180733027.html> accessed on 13 March 2024.
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The “Consolidated Foreign Direct Investment Policy of 2020”, issued by the “Department of
Promotion of Industry and International Trade (DPIIT)”, which undergoes amendments
through press notes from DPIIT. These combined components are collectively referred to as
the 'FEMA Regime'.

PRINCIPAL REGULATORS AND AUTHORITIES

Principal Regulatory Bodies and Authorities Overseeing foreign investment in India are the
(1) “Department for Promotion of Industry and Internal Trade (DPIIT)”, operating under the
“Ministry of Commerce and Industry” of the Indian government, in coordination with various
other relevant governmental departments and ministries; and (2) the “Reserve Bank of India
(RBI), endowed with the authority to administer the NDI Rules.”

TYPES OF FOREIGN INVESTMENT

Modes of Foreign Investment avenues in India encompass three primary modes: FDI, FVCI,
and FPI, delineated as follows:

FOREIGN DIRECT INVESTMENT (FDI)

FDI stands as the predominant and favoured method of investment in India. The associated
conditions, regulations, and constraints pertaining to investments under the FDI mode are
elaborated below.

As per the FEMA Regime's definition, FDI constitutes “investment through equity
instruments by a non-resident individual or entity in an unlisted Indian company, or 10% or
more of the post-issue paid-up equity capital on a fully diluted basis of a listed company.”3

FDI PATHWAYS

Within the FEMA Regime, FDI inflow into India follows two avenues: “the automatic route
and the government (approval) route.”4 The choice of pathway hinges upon the sector of
operation of the Indian recipient entity and the scale of investment. The automatic route
allows for FDI without necessitating approval from either “the government or the RBI,

3
‘Foreign Direct Investment (FDI) in India’ (Reserve Bank of India, 4 January 2018)
<https://www.rbi.org.in/scripts/bs_viewmasdirections.aspx?id=11200> accessed 12 March 2024.
4
Ibid.
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permitting up to 100 percent investment or any other specified limit allocated for a particular
sector, noteworthy sectors falling within the 100 percent automatic route encompass
manufacturing, telecommunications services, and various financial services.” 5

Moreover, sectors or activities not explicitly listed in the FEMA Regime, and not included in
the list of prohibited sectors, are encompassed by the 100 percent automatic route. Such
sectors face no sectoral cap, yet FDI within them remains subject to relevant regulations and
guidelines.

Prior Approval is required for investments in sectors that are categorised under the
government route, permission can be taken either from the RBI or the government itself, or
both. Any investment undertaken through this route is subjected to conditions mandated by
the government or the RBI, or both, as part of their approval process. “Sectors falling within
the 100 percent government route, where foreign investment is permissible up to 100 percent
with approval, encompass satellite operations, mining and extraction of titanium-bearing
minerals and ores, and financial services (in cases where certain financial services lack
regulation by a financial services regulator).” 6 Additionally, investments deemed to impact
India's national security also fall under the government route, discussed in further detail
below.

It's worth noting that in specific sectors, FDI is allowed to specified thresholds under the
automatic route. Approval is required for investments exceeding this threshold from the
government. For example, in sectors like defence and established pharmaceuticals, FDI is
permitted up to 74 percent under the automatic route, with government approval mandated
for investments surpassing this threshold.

SECTORAL LIMITS

As mentioned previously, the Indian government has significantly liberalized foreign

investment over time, allowing for 100 percent FDI in most sectors. However, for certain
sectors deemed critical from a national security standpoint, the FEMA regulations set limits
beyond which non-residents are barred from making investments, whether through the

5
Hardeep Sachdeva, ‘Snapshot: foreign investment law and policy in India’ (Lexology, 16 January 2024)
<https://www.lexology.com/library/detail.aspx?g=19821821-6ea0-4983-88cf-58018a301604> accessed 13
March 2024.
6
Supra note 3.
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government or automatic route. For example, in the private sector banking industry, foreign
investment is capped at 74 percent of the share capital, with 49 percent falling under the
automatic route. Any investment surpassing 49 percent but up to 74 percent necessitates
approval from the government. Similarly, in the print media sector, organizations involved in
publishing periodicals and newspapers focusing on news and current affairs are permitted to
receive foreign investment of up to 26 percent of the share capital, solely through the
government route.

SECTORS NOT PERMITTED FOR FDI

“FDI is restricted in businesses operating in the following sectors:

 Lottery operations
 Gambling and betting establishments, such as casinos
 Chit funds
 Nidhi companies
 Trading of transferable development rights
 Real estate ventures or the construction of farm residences
 Production of cigars, cheroots, cigarillos, and cigarettes, whether from tobacco or
substitutes
 Activities or industries not open to private sector investment, like atomic energy and
railway operations (except as specifically permitted by the FEMA Regime)
 Collaboration with foreign technology in any form, including licensing for franchises,
trademarks, brand names, and management contracts, is also prohibited for lottery
operations and gambling establishments.”7

ENTITIES QUALIFIED FOR FDI INFLOWS

Initially, an Indian entity was defined as a limited liability partnership (LLP) or an Indian
company, under the FEMA Regime. FDI was permissible in LLPs operating in sectors
allowing 100 percent FDI under the automatic route without any foreign investment-linked
performance conditions.

7
‘Sectors where foreign Direct Investment is Prohibited’ <https://www.indembassybern.gov.in/docs/Make%20in
%20India%20-%20Foreign%20%20Direct%20Investment.doc> accessed 13 March 2024.
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Recently, in March 2022, “DPIIT issued Press Note No. 1 of 2022 Series, dated 14 March
2022, expanding the scope of an Indian company to include: a body corporate established or
constituted by or under a central or state act, which is incorporated in India.” This
modification aimed to introduce the concept of a "corporation" as an Indian entity, facilitating
foreign investment in the “Life Insurance Corporation (LIC) of India.” LIC, being established
as a corporation, now allows “FDI up to 20 percent under the automatic route since April
2022.”8

It's essential to highlight that societies, trusts, and other excluded entities are explicitly stated
under the FEMA Regime not to be considered Indian companies and thus do not qualify as
eligible investee entities under FEMA.

FOREIGN VENTURE CAPITAL INVESTOR (FVCI)

“An FVCI is a foreign venture capital investor incorporated and established outside India,
mandated to obtain registration with SEBI and are authorized to invest in unlisted securities
of Indian companies operating in sectors such as biotechnology, IT (including hardware and
software development), nanotechnology, seed research and development, new chemical
entities in the pharmaceutical sector, dairy and poultry industries, biofuels production, large-
scale hotels and convention centers, and the infrastructure sector.” 9 Additionally, FVCIs has
to ensure compliance with applicable SEBI regulations if they want to invest in listed
securities of an Indian company.

Choosing the FVCI investment route offers several advantages to investors: (1) FVCIs are
not bound by pricing restrictions applicable to FDI investments; and (2) shares held by FVCIs
are exempt from the statutory lock-in period of one-year post-initial public offering, provided
the shares have been held for at least six months from acquisition.

Furthermore, FVCIs registered with SEBI have the option to invest under the FDI mode,
subject to the conditions and regulations governing FDI discussed earlier.

8
Life Insurance Corporation Act, 1956.
9
Radhika Gaggar, Abhishek Kalra ‘India: Foreign Direct Investment Regulations’ (GlobalCompetitonReview, 06
December 2022) < https://globalcompetitionreview.com/guide/foreign-direct-investment-regulation-guide/
second-edition/article/india#footnote-008> accessed 13 March 2024.
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 FOREIGN PORTFOLIO INVESTOR (FPI)

“A person registered under the applicable SEBI laws is referred to as a foreign portfolio
investor (FPI).” FPIs are divided into two categories: Category I consists of investors who are
connected to the government, such as central banks and sovereign wealth funds, and
Category II consists of businesses, nonprofits, and unregulated funds.
Investments by FPIs are permitted in listed Indian companies as well as those aspiring to list.
Foreign portfolio investment is defined by the FEMA Regime as “Any investment made by an
FPI through equity instruments where such investment is less than 10% of the post issue
paid-up share capital on a fully diluted basis of a listed Indian company or less than 10% of
the paid-up value of each series of equity instrument of a listed Indian company.”
If an FPI or its investor group exceeds the designated ten4 percent threshold with their
investment, they have the choice to sell off the excess within five trading days. Otherwise, the
investment will be treated as FDI, barring the FPI or its investor group from making
additional portfolio investments in the respective company. They would then need to adhere
to all FDI regulations, including pricing guidelines and reporting requirements.
Equity instrument pricing for foreign portfolio investments is determined by two main
criteria:
1. In the event of a public offer, the price must not fall below the price offered to Indian
residents.
2. For private placements, pricing must adhere to SEBI guidelines or reflect the fair
value.
If an FPI holds equity shares in an unlisted company and retains them after the company goes
public, the FPI's shares are subject to the same lock-in period as shares held by FDI investors
under comparable circumstances as per prevailing laws.

PENALTIES AND RECTIFICATION MEASURES

In case of any violation of the FEMA Regime or approvals given by the RBI, the offender
could face a penalty up to thrice the amount of the violation after an adjudication process. If
the amount cannot be determined, the penalty may be as high as Rs 2,00,000. Furthermore,
for violations that persist beyond the initial day, an additional penalty of Rs 5,000 per day
may also be imposed on the violator.

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To reduce transaction costs and address violations promptly, individuals or corporations
facing contraventions have the option of compounding instead of going through the
adjudication process. Compounding is a voluntary procedure where the contravener
acknowledges the violation and pays the specified penalty determined by the “RBI's Director
of Enforcement.” Only after completing all required administrative actions can this process
begin., such as obtaining post facto approvals or undoing impermissible transactions, have
been completed. According to the FEMA Regime, this process must be finalized within 180
days of receiving the compounding application. Once a contravention is compounded, it
cannot be re-adjudicated by the RBI in the future.

Regarding violations due to delays in meeting reporting obligations, the offender can choose
to fulfill the necessary filings by paying a late submission fee determined using the
calculation matrix outlined in the FEMA Regime. For all other violations under FEMA, they
must be either compounded or adjudicated as explained earlier.

CONCLUSION

India has a well-formed regulatory structure to cover the prices, sector-specific constraints
and other conditions regarding foreign investments. Through this approach, The Government
is devising policies aimed at reducing foreign investment complexities and create equal
chances for all by allowing 100% investments in most sectors and a centralized portal for
reporting the transactions. To invest successfully in India, investors need to get acquainted
with Indian regulations and the factors that will affect the investment. The main factors
behind the fast growth of Fintech sector are its scalability, surveillance, engagement with
regulators, state-specific incentives, and prior approvals of RBI or the Indian
government. Besides some states such as the single window clearance systems are also
instrumental in foreign investors through the dedicated investment facilitation centers.
The fact that the approval requirement and communication effectiveness among regulators
plays a very important role when it comes to deciding about the transaction timeline and
drafting the documentation is undeniable. As an example, FDI deals having mergers,
demergers or similar structure and also need specific approvals of the NCLT or relevant
authority before obtaining approval under “FEMA” requires an additional approval

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step. Also, similar to the cases of deals needing to be cleared by the Competition Commission
of India, completion of notification process is a must prior to acquisition of FDI approval and
breaking this rule can result in very heavy penalization.
Discretion cannot be overlooked that the FDI approvals are subject to. The specific
information about past approvals or rejections is not available to public view, hence there is a
knowledge deficit and uncertainty that a potential investor needs to consider in his extensive
risk evaluation prior to the investment.
As a result, before direct foreign investment in India, it would be wise to consider learning
the framework and also evaluate the criteria already mentioned.

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 BIBLIOGRAPHY

 Press Release by the Ministry of Commerce and Industry, ‘Press Information Bureau,
Delhi’ dated May 20, 2022.
 Lee Kah Whye, ‘Will India Scoop up more investments at the expense of China in the
new year?’ (Livemint, 03 January 2022) <https://www.livemint.com/news/india/will-
india-scoop-up-more-investments-at-the-expense-of-china-in-the-new-year-
11641180733027.html> accessed on 13 March 2024.
 Hardeep Sachdeva, ‘Snapshot: foreign investment law and policy in India’ (Lexology,
16 January 2024) <https://www.lexology.com/library/detail.aspx?g=19821821-6ea0-
4983-88cf-58018a301604> accessed 13 March 2024.
 Sectors where foreign Direct Investment is Prohibited’
<https://www.indembassybern.gov.in/docs/Make%20in%20India%20-%20Foreign
%20%20Direct%20Investment.doc> accessed 13 March 2024.
 DPIIT Startup Recognition & Tax
Exemption’<https://www.startupindia.gov.in/content/sih/en/startupgov/
startup_recognition_page.html#:~:text=An%20entity%20shall%20be
%20considered,to%20generate%20employment%2F%20create%20wealth.> accessed
13 March 2024.
 Naresh Ajwani, ‘Indirect Foreign Investment and Downstream Investments’ (Rashmin
Sanghvi & Associates, August 2016)
<https://www.rashminsanghvi.com/downloads/foreign_exchange_law/FEMA/Indirect
%20Foreign%20Investment%20and%20Downstream%20investments.html> accessed
13 March 2024.
 Radhika Gaggar, Abhishek Kalra ‘India: Foreign Direct Investment Regulations’
(GlobalCompetitonReview, 06 December 2022) <
https://globalcompetitionreview.com/guide/foreign-direct-investment-regulation-
guide/second-edition/article/india#footnote-008> accessed 13 March 2024.
 Press Note No. 3 (2020), Ministry of Commerce and Industry
<https://dpiit.gov.in/sites/default/files/pn3_2020.pdf.> accessed on 1st March 2024.
 S. 149 (3), Companies Act 2013.
 Indian Insurance Companies (Foreign Investment) Rules, 2015.
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 Foreign Direct Investment (FDI) in India’ (Reserve Bank of India, 4 January 2018)
<https://www.rbi.org.in/scripts/bs_viewmasdirections.aspx?id=11200> accessed 12
March 2024.

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