FOREIGN INVESTMENT ROUTES IN INDIA
India, being a developing nation cannot fulfil its total capital requirements by internal resources alone. Thus, the foreign investments act a crucial factor when it comes to supplying capital to the country. Both foreign and domestic investments can drive the Indian stock market and are impacted by the political and economic status of the nation.
The two most popular ways of supplying capital to the country are foreign direct investments (FDI) and foreign portfolio investments (FPI)
Foreign Direct Investment (“FDI”)
The Government of India regulates foreign direct investment (“FDI”) into India. FDI means investment by way of subscription and/or purchase of securities of an Indian company by a non-resident investor
| AUTOMATIC ROUTE | GOVERNMENT ROUTE |
| FDI is allowed without prior approval either of the government or the RBI in sectors specified in the FDI policy. These are, typically, strategic long-term investments. | FDI in activities not covered under the automatic route requires the prior approval of the government, which is considered by the Foreign Investment Promotion Board (FIPB), Department of Economic Affairs and Ministry of Finance. |
Foreign Portfolio Investment (“FPI”)
A designated depository participant shall consider an application for grant of certificate of registration as a foreign portfolio investor if the applicant satisfies the following conditions namely :
- the applicant is not a resident Indian;
- the applicant is not a non-resident Indian or an overseas citizen of India;
- non-resident Indians or overseas citizens of India or resident Indian individuals can be constituents of the applicant provided they meet conditions specified by the Board from time to time;
- the applicant is a resident of the country whose securities market regulator is a signatory to the International Organization of Securities Commission’s Multilateral Memorandum of Understanding (Appendix A Signatories) or a signatory to the bilateral Memorandum of Understanding with the Board: Provided that an applicant being Government or Government related investor shall be considered as eligible for registration, if such applicant is a resident in the country as may be approved by the Government of India;
- the applicant being a bank is a resident of a country whose central bank is a member of Bank for International Settlements, provided that a central bank applicant need not be a member of Bank for International Settlements;
- the applicant or its underlying investors contributing twenty-five percent or more in the corpus of the applicant or identified on the basis of control, shall not be the person(s) mentioned in the Sanctions List notified from time to time by the United Nations Security Council and is not a resident in the country identified in the public statement of Financial Action Task Force as
- a jurisdiction having a strategic Anti-Money Laundering or Combating the Financing of Terrorism deficiencies to which counter measures apply; or
- a jurisdiction that has not made sufficient progress in addressing the deficiencies or has not committed to an action plan developed with the Financial Action Task Force to address the deficiencies;
- the applicant is a fit and proper person based on the criteria specified in Schedule II of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008;
- any other criteria specified by the Board from time to time, provided that clause (1), (4) and (5) shall not apply to an applicant incorporated or established in an International Financial Services Centre.
Difference between FDI and FPI
FDI implies that foreign investors are directly investing in the productive assets of another nation.
On the other hand, there is no difference between FPI and FII. Foreign institutional investors (FII) are a single investor of a group of investors that brings in foreign portfolio investments. Hence, they are one in the same. They involve investing in financial assets like the bonds and stocks of another country.
| Criteria | Foreign Direct Investment (“FDI”) | Foreign Portfolio Investment (“FPI”) |
| Type of Asset | Investment is focussed in productive assets like machinery and plant for their business and the value of these assets increases with time | Foreign institutional investments put their money into financial assets like the bonds, mutual funds, and stocks of the nation and the value of these financial assets may increase, or decrease with time depending upon the company in charge, economic, and political consensus |
| Investment Tenure | Foreign director investors tend to take a longer-term approach to their FDI investments. It can take anywhere between 6 months to a couple of years to advance from the planning stage to the project implementation stage. | Investors for these types of foreign investments have a much shorter investment horizon. FIIs may be invested for the long haul however, the investment horizon continues to remain small, especially when one’s local economy is turbulent. |
| Liquidity | Due to the length of the investment horizon, FDI investors also cannot depart as easily from their investments. FDI assets can even be considered larger and definitely less liquid. Lack of liquidity reduces the buying power of an investor and increases the risk. This is why investors prepare for long periods before investing in FDI assets. | FII portfolio investments are both widely traded and highly liquid. An FPI investor has the luxury of exiting their investment with a few clicks of their mouse. Hence, these types of investments do not require as much planning and may also be considered more volatile due to being highly liquid. The liquidity of an asset is a factor of how widely traded it is and also how volatile it is. |
| Degree of control in the management of the business | Investors who look into FDI can usually exercise a higher degree of control. In general, FDI investors are actively involved in the management of their investments. FDI investors take controlling positions in two ways: either through joint ventures or in domestic firms. | FII investors tend to take on more passive positions in their investments. FIIs are considered passive investors and aren’t involved in the day-to-day functioning and operation as well as strategic planning required by any domestic companies. |
| Investment Limit | Under the prevailing FDI regime, foreign investment in most sectors, other than certain restricted sectors, is permitted up to 100% of the paid-up capital of an Indian company. The ‘restricted sectors’ include certain sectors such as insurance, banking, real estate, multi-brand retailing and defence related industries where either no foreign investment is permitted or foreign investment is capped. | The purchase of equity shares of each company by a single foreign portfolio investor including its investor group shall be below ten percent of the total paid-up equity capital on a fully diluted basis of the company |
Foreign Investment in Alternative Investment Funds (AIFs)
Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“NDI Rules”) continues to allow a person resident outside India or an entity incorporated outside India to invest in units of AIF except from Pakistan and Bangladesh.
The conditions set forth in Schedule 8 of the NDI Rules are as follows:
- The funding for the units of an Investment Vehicle acquired by a person resident or registered/ incorporated outside India shall be made by inward remittance through the normal banking channel or by debit to the NRE or FCNR account. The NDI Rules defines a ‘Unit’ to mean beneficial interest of an investor in the ‘Investment Vehicle’.
- A person resident outside India who has acquired or purchased units in accordance with the Schedule 8 of the FEMA Regulations may sell or transfer in any manner or exit from the units as per regulations framed by SEBI or directions issued by RBI.
- An AIF may issue its units to a person resident outside India against swap of capital instruments of a Special Purpose Vehicle (SPV) proposed to be acquired by such Investment Vehicle.
- Investment made by an AIF into an Indian entity shall be reckoned as indirect foreign investment for the investee Indian entity if the sponsor or the Manager or the Investment Manager
a) is not owned and not controlled by resident Indian citizens or
b) is owned and controlled by persons resident outside India - ‘Downstream Investment’ by an AIF shall be regarded as indirect foreign investment if either the sponsor or the investment manager is not Indian ‘owned and controlled’ as per the provisions of FEMA.
- ‘Control’ of the AIF should be in the hands of ‘sponsors’ and ‘managers/investment managers’, with the general exclusion to others. In case the ‘sponsors’ and ‘managers/investment managers’ of the AIF are individuals, for the treatment of downstream investment by such AIFs as domestic, the ‘sponsors’ and ‘managers/investment managers’ should be resident Indian citizens. For sponsors or managers / investment managers organized in a form other than companies or LLPs, SEBI shall determine whether the sponsor or manager or investment manager is foreign owned and controlled.
- A Category III AIF which has received any foreign investment shall make portfolio investment in only those securities or instruments in which an FPI is allowed to invest under the SEBI Act, rules or regulations made thereunder.
AIFs receiving foreign investment shall be required to make such report and in such format to RBI or to SEBI as may be prescribed by them from time to time.
Further, by way of operating guidelines dated 5 November 2019, SEBI has stipulated that an FPI shall not hold more than 25% in a Category III AIF.
Additionally, as per schedule IV of the NDI Rules, a non-resident Indian (NRI) or an Overseas Citizen of India (OCI), including a company, a trust and a partnership firm incorporated outside India and owned and controlled by NRIs or OCIs, may purchase/ contribute, as the case may be, on non-repatriation basis to the Units issued by an ‘Investment Vehicle’ without any limit, either on the stock exchange or outside it. The investment made under schedule IV will be deemed to be domestic investment at par with the investment made by residents.
Other Forms of Investments
Foreign Venture Capital Investors
A Foreign venture capital investor (FVCI) is the one who is incorporated or established outside India, and can invest either in a domestic venture capital fund or a venture capital undertaking (domestic unlisted company).
FVCIs have to seek a separate registration from SEBI and have to invest at least 66.67% of the investible funds in unlisted equity shares or equity linked instruments of an Indian venture capital undertaking.
Other Investments
NRIS and FIIs can also invest in government securities, treasury bills, listed nonconvertible debentures, bonds, commercial papers issued by Indian companies, and units of domestic mutual funds, subject to certain restrictions laid out by the RBI. (Like NRI, PIO, QFI, FII)
Non-Repatriable Investments
An NRI or PIO can purchase shares in rupees through an NRO savings bank account. In case of investment on non-repatriation basis, the sale proceeds are credited to the NRO account. The amount invested under the scheme and the capital appreciation is not allowed to be repatriated abroad.
Suitable route for Foreign Investment
Choosing a suitable route to bring in Foreign Investment into India is dependent on various factors including but not limited to :
- Quantum of the investment
- Sector into which the investment is proposed to be done
- Nature and Structure of the foreign Investor
- Tax Rates / Exchange Rates / Interest Rates
