The New Consolidated Foreign Direct Investment Policy 2011: Whether Will Prove a Game Changer in Boosting Investor Confidence?

Article for Blog Post Writing Competition 2011 | by Vaibhav Chaudhary and Deeksha Chaudhary


April 8th, 20118:16 pm


Every developing economy today is so called “FDI hungry”.

Beyond all doubts FDI bears a direct relation with sound economy. Considering case of India specifically India in its march towards being a developed one, is in dire need of FDI to establish itself on economic footing. Like every other issue FDI too is governed by legal framework. Foreign investments into India are subject to the industrial policy established by the Department of Industrial Policy and Promotion (DIPP) under the Ministry of Commerce and Industry and the prime legislation governing FDI is Foreign Exchange Management Act, 1999 (FEMA), and side by side regulations made there under and the various press notes, press releases and clarifications etc. issued on the subject over a period of time.

In an attempt to simplify the rules and regulations pertaining to the foreign direct investment (“FDI”) policy, the Department of Industrial Policy and Promotion (“DIPP”) had issued a consolidated FDI policy (the “Circular”) on March 31, 2010. The Circular which became effective from April 1, 2010 consolidated  \all prior press notes / press releases / clarifications issued  and reflected in a coherent manner the current policy framework on FDI.  To the surprise of many , it was not to be a onetime affair  the Government  this time had bigger plans to update the FDI policy bi-annually, by issuing a new circular which would supersede all prior press notes and circulars. Keeping intact the promise, in this chain the government of India has recently released the third edition of the Consolidated FDI Policy Circular on 31 March 2011 which has become effective from April 1, 2011. It is further crucial to note that it is necessary to comply with any changes notified by the Reserve Bank of India after the issuance of this Circular.

Commenting on the new policy, commerce and industry minister Anand Sharma said, “The Circular 1 of 2011 is a part of ongoing efforts of procedure simplification and FDI rationalization which will go a long way in inspiring \investor confidence.”[i]

Why such a trigger over FDI???

Analyzing the statistics as to FDI in India , makes us to arrive at a conclusion that it was only after 2007 FDI has shown a steady increase in India. This time the prime aim of the government is to make sure that policy and legal framework do not become a stumbling block in this pathway. During 2009-2010 FDI in India showed a whopping increase mainly due to grave recession in other parts of the globe but recent decline from April to May really was perturbing. Thus the Indian government has made scores of changes to the FDI policy to attract more foreign direct investment amidst 25% decline in FDI during the eleven month period between April-February 2010-11 to 18.3 billion.[ii]

The main features of the new consolidate FDI Policy Circular

  • Removal of the condition of prior approval in case of existing joint ventures/ technical collaborations in the “same field”:

This has been done through deletion of Clause 4.2.2 of the earlier Circular (No. 2 of 2010) which provided that FDI would be subject to the “Existing Venture/ tie-up conditions” as stated in sub-clauses of Clause 4.2.2 (basically stating that where a non-resident investor has an existing joint venture/ technology transfer/ trademark agreement, as on January 12, 2005, new proposals in the same field for investment/technology transfer/technology collaboration/trademark agreement would have to be under the Government approval route through FIPB/ Project Approval Board). A discussion paper had been released by DIPP last year on the need for review of this condition. Based on stakeholder comments received by the DIPP on its discussion paper, the Government while releasing the FDI Circular 1 of 2011 has in its press release stated that it has decided to abolish this condition. The press release further states that “It is expected that this measure will promote the competitiveness of India as an investment destination and be instrumental in attracting higher levels of FDI and technology inflows into the country“.[iii]

  • Pricing of convertible instrument – greater flexibility introduced:

This has been done through amendment made in Clause 3.2.1 of the Circular  which earlier provided that “The pricing of the capital instruments should be decided/determined upfront at the time of issue of the instruments” Now it has been added that “price / conversion formula” be determined upfront so in effect instead of having to specify the price of convertible instruments upfront, companies will now also have the option of prescribing a conversion formula, subject to the condition that price at the time of conversion should not in any case be lower than the fair value worked out, at the time of issuance of such instruments, in accordance with the prevailing valuation norms . This would help the recipient companies in obtaining a better valuation based upon their performance.[iv]

  • Liberalization of policy for non-cash capital contributions:

This amendment has been brought about through additions in Clause 3.4.6 of the Circular. The existing policy FDI provided for conversion of only ECB/lump-sum fee/Royalty into equity. The Government has now decided to permit issue of equity, with prior approval from FIPB, in the following cases, subject to stipulated conditions:

(a) Import of capital goods/ machinery/ equipment (including second-hand machinery)

(b) Pre-operative/ pre-incorporation expenses (including payments of rent etc.)

This measure, which liberalises conditions for conversion of non-cash items into equity, is expected to significantly ease the conduct of business.

  • Foreign Institutional Investor Investment:

Clause 3.1.4 (i) of the earlier Circular 2 of 2010 provided as under: “An FII may invest in the capital of an Indian company either under the FDI Scheme/Policy or the Portfolio Investment Scheme. 10% individual limit and 24% aggregate limit for FII investment would still be applicable even when FIIs invest under the FDI scheme/policy.”It has now been clarified in Clause 3.1.4 (i) that aggregate FII limit of 24% can be increased to sectoral cap/ statutory ceiling by Board of Directors resolution followed by special resolution in shareholders meeting.[v] While this has always been clear under the FEMA provisions, the earlier FDI Circulars did not specifically mention this and now with this amendment the provisions relating to FII investments are aligned with the FEMA provisions.

  • Hundred Percent FDI in some area of Farm Sector:

The new FDI Policy allow 100 per cent FDI in development and production of seeds and planting material, floriculture, horticulture, and cultivation of vegetables and mushrooms under controlled conditions.   Besides, animal husbandry (including of breeding of dogs), pisciculture, aquaculture under controlled conditions and services related to agro and allied sectors have been brought under the 100 per cent FDI norm. Similarly, the tea sector has also been brought under the 100 per cent FDI norm. The DIPP has imposed certain conditions for companies dealing with development of transgenic seeds and vegetables wanting to take the 100 per cent FDI route. Under the 100 per cent FDI in tea sector, it demands compulsory divestment of 26 per cent equity of the company in favour of an Indian partner/Indian public within a period of five years prior to approval of the State Government concerned in case of any future land use change.[vi]

The new policy can lead to increasing dependency on foreign companies and shut down of small domestic firms not in a position to sustain competition from established foreign players. The revised FDI policy does carry the process of liberalization further and would assist in augmenting FDI into the Country. However, the revised FDI policy has kept at bay significantly expected changes such as permitting FDI in Limited Liability Partnership, Multi-Brand Retail Trading and several other subjects on which draft discussion papers were released earlier for public comments. It is important that these areas are also taken up the Government for liberalisation towards making India one of the most favourable FDI destinations in the world.


[i] Live Mint, Govt. Announces Flexible Norms To Tap Overseas Capital, Available on www.livemint.com ( Last access on 4 April, 2011)

[ii] The Hindu, FDI Norms Fine-Tuned To Attract More Investment, Available on www.thehinduonnet.com ( Last access on 4 April, 2011)

[iii] Press Release on Circular 1 of 2011 Department of Industrial and Policy and Promotion, Ministry of Commerce and Industry Government of India.

[iv] Press Release on Circular 1 of 2011 Department of Industrial and Policy and Promotion, Ministry of Commerce and Industry Government of India.

[v] Press Release on Circular 1 of 2011 Department of Industrial and Policy and Promotion, Ministry of Commerce and Industry Government of India.

[vi] The Hindu, 100 % FDI Allowed In Some Areas Of Farm Sector, Available on www.thehinduonnet.com ( Last access on 4 April, 2011)

 

Article by-

Vaibhav Chaudhary and Deeksha Chaudhary,

IVth Year Students,  B.A., LL.B (Business & Intellectual Property Law Hons.)

Rajiv Gandhi National University of Law, Punjab.

[Submitted as an entry for the MightyLaws.in Blog Post Writing Competition, 2011]

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