India in 2020: Easing restrictions on foreign investment

This article is one of four in an annual Vantage Point series where in-house counsel identify key risks and opportunities in the year ahead

Foreign direct investment (FDI) is a major monetary source for India’s economic development. Foreign companies invest directly in fast-growing private businesses to take benefits from cheaper wages and the fast-changing business environment.

One route for FDI is the automatic route, where FDI is allowed without prior approval from the government or the Reserve Bank of India (RBI). The other is the government route, where prior approval from the government is required.

The government from time to time amends the FDI policy to increase FDI inflow. In 2014, it increased the upper limit for foreign investment from 26% to 49% in the insurance sector. It also launched the “Make in India” initiative in September 2014, under which FDI policy was liberalized for a further 25 sectors. As of April 2015, FDI inflow in India increased by 48% since the launch of this initiative, which is laudable.

Sweeping reforms needed

In a further commendable effort to ease the flow of foreign funds into legitimate business activities, the government may soon ease FDI restrictions by joint ventures (JVs) or wholly-owned subsidiaries (WOS) of an Indian company without categorizing such investments as “suspect” or involving the “round tripping” of funds.

The existing legal framework under the Foreign Exchange Management Act, 1999 (FEMA), does not permit FDI by an overseas JV, or a WOS of an Indian party, without the prior approval of the RBI. Similarly, there are restrictions on Indian entities undertaking overseas direct investment (ODI) in a foreign entity that already has existing FDI investment structures in India.

It is understood that changes will soon be made in existing ODI regulations to ease the restrictions and put such investments (FDI and ODI) under the automatic route, i.e., without prior approval of the RBI.