THE NEW FIPB GUIDELINES
On January 17, 1997, the Government of India announced the long awaited guidelines for the consideration of foreign direct investment ("FDI") proposals by the FIPB. A summary and explanation of these new guidelines are stated below.
The FIPB must bear in mind the sectoral requirements and the sectoral policies for each proposal.
Each proposal has to be considered in its totality (that is, whether it includes a proposal for a technical collaboration or an industrial license) so that the FIPB can grant a composite approval for the entire proposal. But, the FIPB's approval would relate only to the foreign financial and technical collaboration and the foreign investor would need to take the other prescribed clearances separately. For instance, if any approval is needed from the Pollution Control Board of any State Government, such approval would have to be taken separately.
If an activity requires an industrial license, the consideration governing the grant of such industrial license must be reviewed.
If a proposal involves technical collaboration, the source and nature of the technology sought to be transferred and the terms of payment have to be reviewed.
100% subsidiaries will not be allowed to pay royalties to their holding companies.
If the proposal involves a mandatory requirement for exports, the FIPB will require the applicant to undertake an obligation to make such exports. For example, foreign investment in the small scale sector is permitted only up to 24%. Under a directive dated August 30, 1994, if the proposal involves an investment exceeding this ceiling, the applicant will be required to export 75% of the production of the unit within a maximum period of three years and must further obtain an industrial license for the manufacturer of the items. Likewise, if the activity is located in a 100% export oriented unit ("EOU") or in an export processing zone ("EPZ"), the FIPB will require the applicant to export 100% of its production subject to a sale of up to 25% of its production to a destination in the domestic tariff areas ("DTA").
The FIPB will consider the export projections made in the application and the items of export and the export destinations of those items.
If the proposal involves the import of machinery and equipment on payment of a concessional customs duty subject to an export obligation, the FIPB will insist on the compliance with such export obligations.
If the activity concerns an Export Oriented Unit ("EOU"), the FIPB will require full compliance with the minimum value additions norms and the minimum turnover of exports.
The FIPB will also consider any possible relaxation of the locational restrictions for industrial units stipulated in the industrial licensing policy.
If the proposal has any strategic or defence related considerations, the FIPB will give due weightage to those considerations.
The following items are given greater weightage while considering the proposals for foreign investment: items which do not fall within Annex 3 of the Policy that is those that do not qualify for automatic approval; items falling in the infrastructure sector; items which have an export potential; items which have large scale employment potential, especially for rural people; items which have a direct or backward linkage with the agro-business or farm sector; items which have greater social relevance, such as hospitals, human resource development, life saving drugs and equipment and proposals which result in the induction of technology or infusion of capital.
The following matters have to be given special consideration during the scrutiny and consideration of proposals by the FIPB:
the extent of the foreign equity proposed to be held and especially whether it exceeds the ceilings prescribed for certain sectors of industry - 24% for small scale industrial ("SSI") units - 40% for air taxes and airline operators and 49% in basic telephone networking and in the cellular or paging sectors of the telecom industry;
the composition of the group of foreign investors such as non-resident Indians ("NRI"), overseas corporate bodies predominantly owned by NRIs and resident Indians;
the extent of the equity in the target company that is, whether the latter would be a holding company or a wholly owned subsidiary with dominant foreign investment of 76% or more;
the nature of the investment - new project (joint venture or otherwise) - enlargement of existing foreign or NRI equity - fresh induction of foreign or NRI equity in an existing Indian company;
if it is a case of a new induction of foreign or NRI equity or the enlargement of foreign or NRI equity in an existing Indian Company, the board of directors of the company should support the investment and the shareholders should enter into an agreement concerning such investment and in such a case the reason for the new investment should be examined together with the method employed to investment the new equity or to increase the existing equity - increase in capital - transfer of shares (hostile or otherwise) - rights issue;
whether the issue or transfer price of the shares is in accordance with the valuation guidelines established by the Reserve Bank of India or by the Securities and Exchange Board of India ("SEBI");
whether the activity is an industrial or a service activity or a combination of both;
whether the item to be manufactured is reserved for the small scale sector ("SSI");
whether the sector in which the investment is to be made is one where foreign investment is restricted - for example, foreign investment in real estate is forbidden whereas it is permitted for NRIs and OCBs;
if the activity is exclusively devoted to trading, whether it involves export, or both export and import, or whether it also includes domestic trading and if so whether it also includes retail trading;
whether the proposal involves the import of items which are either hazardous or banned or which are detrimental to the environment; for example, imports of plastic scrap or recycled plastic materials.
If the item is included in Annex 3 to the Policy, where automatic approved by the Reserve Bank of India is accorded up to 50%, 51%, or 74%, the FIPB may consider recommending higher levels of foreign equity in respect of such items keeping in view the special requirements and merits of each case. It should be noted that this particular guideline brings back the old and highly criticized case by case approval procedure that the FIPB used to adopt. Only, now it will be exercised in investment proposals that exceed 74% of the total equity of the target company.
If the item is not listed in Annex 3, the FIPB is directed to consider a foreign equity investment of up to 51% on the examination of each individual proposal.
If the item is not listed in Annex 3 and if the proposal involves an investment of up to 74%, the FIPB is required to consider matters such as the extent of the capital needed for the project, the nature and quality of the technology, the requirements of marketing and management skills and the commitment for exports.
The FIPB must consider the following criteria when reviewing proposals for investments in 100% subsidiary or holding companies:
(a) If the target company is going to be exclusively a holding company, all subsequent or downstream investments by that company must also require the prior approval of the Government;
(b) If proprietary technology is sought to be protected or if sophisticated technology is proposed to be transferred;
(c) If at least 50% of the production is proposed to be exported;
(d) If it is a consultancy activity; and
(e) If it is a proposal for 100% investment in the infrastructure sector-power, roads, ports and industrial model towns, industrial parks or estates.
In special cases, where the foreign investor is unable initially to identify an Indian Joint venture partner, the FIPB may permit him to set up a 100% subsidiary on a temporary basis on the conditions that he should divest to Indian residents (individuals, joint venture partners or the general public or some or all of them) at least 26% of the capital of the company within a period of between 3 and 5 years.
Similarly, in the case of a joint venture, where the Indian partner is unable to raise resources for expansion or technological upgradation of the existing industrial activity, the FIPB may permit an increase in the foreign equity participation in that company up to 100%.
The following criteria are applicable in respect of trading companies where there is a proposal to set up a 100% foreign owned subsidiary:
(b) bulk imports with export or expanded warehouse sale;
(c) cash and carry wholesale trading;
(d) other imports of goods or services provided that at least 75% is intended for procurement and sale of goods and services among the companies of the same group.
If the Government has prescribed a foreign investment ceiling in the capital of an enterprise in the infrastructure or services sector, it is now clarified that only the direct foreign investment will be considered. If an Indian company is an investor in the target company and if there is a foreign equity investment in that company, such investment will not be included in the ceiling provided that the total direct foreign investment in such investing company does not exceed 49% and provided further that the management of the investing company is with the Indian owners. It is to be noted that this clarification was informally applied when proposals were being considered for foreign investment in the telecom sector where there is a cap of 49% and where the Indian joint venture partner itself was unable to subscribed the large amounts of capital needed for the remaining 51%. It was informally acceptable to the FIPB to have foreign investment in the capital of the joint venture company up to a limit of 49% provided that such joint venture investor company was managed by its Indian owners.
It is now clarified that if once the FIPB imposes a specific condition in the letter of approval, such condition would not be changed nor would any additional condition be imposed afterwards. This would not, however, prohibit changes in general policies and regulations applicable to the industrial sector. It should be noted that this clarification is particularly welcome because instances have been known where the Secretariat for Industrial Assistance ("SIA"), formerly the Secretariat for Industrial Approvals has imposed further conditions in respect of the foreign investment after the original approval was issued.
If a foreign investment proposal in an Indian company, other than one in a 100% subsidiary of the foreign investor, has been approved up to a designated percentage of foreign equity in the joint venture company, the Government will not reduce such percentage while permitting the investment of additional capital at a later stage. Likewise, if the proposed activities in the target company have been approved, and if there is a proposal to bring in additional capital at a subsequent stage for the same approved activities, the new investment will be approved on an automatic basis.
If the foreign investment proposal concerns an investment in the private banking sector, the application will not be entertained by the FIPB unless the foreign investor has obtained the approval in principle of the Reserve Bank of India.
The list of guidelines ends with a caveat that those guidelines are meant to assist the FIPB to consider proposals in an objective and transparent manner. But, they would not in any way restrict the flexibility of the FIPB or prevent it from considering the proposals in their totality or from making recommendations based on other criteria or special circumstances which it considers relevant. Moreover, these are supposed to be in the nature of administrative guidelines and would not be in way be legally binding in respect of any recommendations to be made by the FIPB or the decisions to be taken by the Government in cases involving foreign direct investment. The guidelines have been issued without prejudice to the Government's right to issue fresh guidelines or to change the legal provisions and policies whenever considered necessary. It is suspected that this caveat has been inserted on legal advise to prevent the application of the doctrine of promissory and to protect the Government if there is litigation or if there are legal disputes.
Sector Specific Ceilings on FDI
As stated elsewhere in this paper, the FIPB had been imposing unpublished ceiling on foreign investment in certain sectors, for example, the minimum capital adequacy norm of US$ 5,000,000 for an investment therein between 51% and 75% and US$ 50,000,000 for an investment in that sector above 75%. The January 1997 Guidelines have for the first time put together and specified the different ceilings on FDI in certain sectors. This, again, is a welcome development and will improve the confidence of the foreign investors in the procedures that are being followed to approve FDI. These are reproduced below:
No. Sector Guidelines
1. Banking Foreign investment of up to 20% and NRI investment of up to 40% are permitted
2. Non-banking financial Services I. Up to 51% foreign equity, no special conditions are attached except those requiring approval of the SEBI/RBI etc.
II. For foreign equity beyond 51% but up to 75%, it is necessary that foreign investment should be minimum US$ 5,000,000 million and that it should come in one lot.
III. For foreign investment beyond 75% minimum foreign investment should be US$ 50 million.
3. Domestic Air-Taxi Operations and Airlines (i) Foreign equity up to 40% can be permitted on a case by case basis
(ii) 100% by NRIs
4. Power Foreign investment in the power sector can either be in the form of a joint venture with an Indian partner or as a fully owned operation with 100% foreign equity.
5. Telecommunications (Basic, Value Added) In basic, Cellular, Mobile and paging services, foreign investments are limited to 49% subject to grant of license from DoT. (Department of Telecommunications)
6. Drugs and Pharmaceutical industry Foreign investment up to 51% in the case of bulk drugs, their intermediates and formulations thereof (except those produced by the use of recombinant DNA technology) are granted automatic approval by the RBI. Other purposes are considered on merit on a case by case basis by the Government Manufacturing activity essential for FDI above 51% as per the Drug Policy.
7. Petroleum Foreign companies can invest up to 100% of the equity in any venture in the petroleum sector.
8. Real Estate No foreign investment in this sector is permitted, NRIs/OCBs are allowed.
9. Roads and Highways Private sector including foreign equity participation up to 100% in highways is envisaged on the Build Operate and Transfer (BOT) concept. Investors in identified highway projects would be permitted to recover their investment by way of collection of tolls for specified periods. At the end of the agreed concession period, the facilities will revert to the Government. Construction of bypasses, bridges and widening of high density corridors, of National Highways have been identified for four-laning through the BOT route. The Government has, in the Budget Session of 1995, passed the necessary legislation for collection of toll tax. The rates of toll charges a well as the period of concession will be on the basis of competition/bids and the land requirement for the construction and operation of the facilities would be provided by the Government free from encumbrances Private parties would be allowed to develop service and rest areas along the roads entrusted to them.
10. Ports Indian ports offer significant potential to foreign investors in major operational and infrastructural areas. The following areas have been identified for participation or investment by the private sector.
(i) Leasing out existing assets of the Port
(ii) Construction or creation of additional assets, such as
(a) Construction and operation of container terminals.
(b) Construction and operation of bulk bread, bulk multipurpose an specialized cargo berths.
(c) Warehousing, Container Freight Stations, storage facilities and tank farms.
(d) Cranage/Handling Equipment
(e) setting up of captive power plants.
(f) Dry docking and ship repair facilities.
(iii) Leasing of equipment for port handling and leasing of floating crafts from the private sector.
(iv) Captive facilities for Port based industries.
These areas are indicative in nature. Further details regarding participation by the foreign investors are available with individual port authorities and the Ministry of Surface Transport, Government of India.
11. Tourism This is a sector with immense possibilities for foreign investment. 100% foreign equity is permissible in the sector and automatic approvals are also granted by the Reserve Bank of India for foreign equity up to 51% and subject to specified parameters.
12. Mining I. Foreign equity participation of up to 50% in the mining sector would be automatic except for gold, silver, diamonds and precious stones.
II. For gold, silver, diamonds and precious stones, approvals would be given keeping in view inter alia, the following parameters.
(a) The size of the project
(b) Commitment of external resources for funding project costs.
(c) Track record of the company in the mining sector.
(d) The level of technology sought to be employed in the project.
(e) Financial strength of the company
(f) Level of the Indian equity in the joint venture at the mining stage for the JV partner/Indian partner.
For companies which seek to set up 100 per cent wholly owned subsidiaries, permission may be given subject to the condition that in case the company wishes to enter into a joint venture for investment in mining where a foreign equity holding in excess of 50 per cent is envisaged, the prior approval of the FIPB would be taken.
13. Coal While this has been reserved for the public sector, private and foreign investment is permitted in coal for captive consumption only (generation of power) and for washeries, etc.
14. Venture Capital Fund An offshore venture capital company may contribute 100 per cent of the capital of a domestic venture capital fund and may also set up a domestic asset management company to manage the fund.
VCFs and VCCs are permitted up to 40% of the paid up corpus of the domestic VCF/VCCs.
More specific guidelines have been published for the development for the development of activities and for investment in each of these sectors; but for purposes of brevity, it is not proposed to describe them in detail in this paper.
The list of 18 industries that had been specified in Annex II to the New Industrial Policy for which industrial licensing will continue to be compulsory has since been pruned to only 15. Some of the important deletions include motor cars, white goods, raw hides and skins.
The requirement of the New Industrial Policy to match dividends against export earnings has been abolished except in the case of 18 specified consumer industries. The condition of dividend balancing also does not apply to investments by approved international financial organizations.
By an announcement in Press Note 5 of 1992 dated April 22, 1992, the electronics software industry was declared to be a high priority industry falling under Annex III to the New Industrial Policy.
Hotels and Tourism
Although hotels and tourism are included in Annex III to the New Industrial Policy, it has been clarified that "Hotels" include "Restaurants, beach resorts and other tourist complexes providing accommodation or catering and food facilities to tourists." The expression "Tourism related industry" has been defined to include
(i) travel agencies, tour operating agencies and tourist transport operating services; (ii) units providing facilities for cultural, adventure and wild life experience to tourists; (iii) surface, air and water transport facilities to tourists; (iv) leisure, entertainment, amusement, sports, and health units for tourists and (v) convention and seminar units and organizations.
In the case of foreign technology agreements for the hotels and tourism related industry, it has been clarified that the automatic approval of the Reserve Bank of India will be granted subject to the following parameters: (i) technical and consultancy services: lump sum fee not exceeding US$ 200,000; (ii) Franchise, marketing and publicity support fee: up to 3% of the gross room sales; (iii) management fees: up to 10% of the foreign exchange earnings provided that the foreign party puts in 25% of the equity. This will also cover payment for marketing and publicity support.
Foreign direct investment - some statistics
The story of the implementation of the New Industrial Policy would not be complete without a brief mention of the impressive gains recorded in the area of foreign direct investment ("FDI"). Between July 1991 and October 1996, the Government of India (either through the Foreign Investment Approval Board or the Reserve Bank of India) had approved 10077 foreign collaboration proposals of which 5470 involved foreign direct investment ("FDI") in the capital of Indian companies. The total amount of FDI involved was Rs 88,290,000.
Small Scale Sector
One of the major modifications in the area of FDI is that relating to foreign investment in the small sector ("SSI"). Investment by industrial undertakings in SSI companies are restricted to 24% of the equity capital. If the foreign investment in an SSI exceeds 24%, the applicant may give up its SSI status and apply for and obtain either an industrial license or file an Industrial Entrepreneurs Memorandum ("IEM"). If the item of manufacture is exclusively restricted to SSIs, a higher equity participation than 24% would be considered only if the proposal is accompanied with a commitment to export 75% of the production.
The "unlevel playing field"
The transition from a strictly regulated foreign investment policy into one which is more or less without substantial restrictions coupled with the implementation of the Government's declared policy of removing the protections which Indian industries were enjoying and thus exposing them to competition from outside and inside the country has evoked a mild protest from certain sectors of Indian industry which have complained to the Government and to the media that they are made to play with foreign competitors in an unlevel playing field. They suggest, for example, that foreign companies pay a very low rate of interest on their borrowings, that the rates of taxation in their own countries are lower than those prevailing in India and that they have the ability to reduce their labor force at will, a facility which is denied to Indian companies. For example, a foreign investor needs only one clearance - Reserve Bank of India or Foreign Investment Promotion Board - to make his investment in an Indian company. An Indian company may need several clearances including the formidable one under section 372 of the Companies Act 1956. Some Indian industrialists have even asked the Government to constitute an "Indian Investment Promotion Board" to provide a single window clearance for all the approvals which an Indian company requires under Indian law to make investment in other companies. The liberalization of the economy has now brought into sharp focus the effect of the action of market forces which have compelled Indian companies to pay special attention to the quality and prices of their products and the terms and condition of delivery. This has greatly benefited the Indian consumer who has acquired, and exercises, the ability to choose between Indian and foreign products.
Are the reforms irreversible?
Almost every foreign investor who looks at India as an investment opportunity asks this question. During the five years that have followed the announcement of the New Industrial Policy, politicians both in the government and in the opposition have repeatedly reaffirmed their conviction that the process of reforms will neither be withdrawn nor diverted. Everyone in a position of power realizes that it is too late to back track on the path of the liberalization of the economy. The only directions available are forward, upward and outward.
Within a short period of about 66 months, most of the old irksome obstructions and delays that used to hinder the orderly development of Indian industry have been removed or greatly reduced. The way is clear for India to march forward and take her place among the leading nations of the world. With hard work, redoubled energy and continuing support from the Government and from foreign investors this should not be difficult to achieve.