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Why Foreign Direct Investment is Crucial for Economic Growth?

by | Feb 16, 2024

FDI

Meaning of FDI:

FDI is a procedure whereby the citizen of one nation buys the right to manage the production and other operations of an organization in another (host country).

Regarding FDI

Foreign Direct Investment (FDI) is the word used to describe the transfer of money in the kind of long-term investments from one nation to another. It takes place when an investor creates a long-term position in a foreign company by purchasing a controlling interest or starting a new venture. Developing nations like India rely on FDI to expand and flourish because it delivers not only finance but also technology, managerial know-how, and access to new markets.

For instance, the USA will make investments in the Indian company while India serves as the home country. Therefore, FDI refers to an American company investing in an Indian business.

Kinds of FDI
  • Horizontal FDI: In this type of FDI, money is invested internationally in the same sector. In other words, a business may invest in a foreign firm that manufactures comparable goods. For example, a US board company, Nike, might buy Puma, a firm with headquarters in Germany.
  • Vertical FDI: an organization invests in a foreign company that it might sell to or supply as part of a supply chain, rather than immediately in the same industry.
  • Conglomerate FDI: With this sort of FDI, a purchase is undertaken in a completely unrelated sector of the economy. It has no immediate connection to the investor’s company. For example, a US store might buy stock in the German automaker BMW. 

 

How can an Indian company receive foreign investment?

For FDI to enter India, there are two entrance points: the Automatic Route and the Government Route.

  1. Automatic method: Under this method, investments in shares of equity, entirely and obligatory converted bonds, or completely and obligatory converted preferred stock of an Indian company do not need the government of India’s consent.
  2. Governmental Route: Foreign investments in particular industries and endeavors must receive prior government authorization in India. The relevant Administrative Ministry/Department evaluates proposals. If an Indian firm with foreign investment has been founded and isn’t controlled or owned by a local entity, government authorization is required. 

b. By fusion, merger, demerger, or acquisition, control of an existing Indian firm that is controlled or owned by resident Indian people or Indian companies is being given to a non-resident entity. 

c. The ownership of an existing Indian company, owned or controlled by resident Indian citizens or Indian companies, is being transferred to a non-resident entity through amalgamation, merger, demerger, or acquisition.

The entities which can invite FDI in India:

  1. Indian Companies: They can issue capital against FDI.
  2. Partnership Firms/Proprietary Concerns: NRIs can invest under certain conditions, while other non-residents need prior approval from the Reserve Bank. Certain restrictions apply to investments in agricultural, plantation, real estate, and print media businesses.
  3. Trusts: FDI is not permitted, except in Venture Capital Funds (VCF) regulated by SEBI and ‘Investment vehicles’.
  4. Limited Liability Partnerships (LLPs): Foreign investment is allowed under specific conditions and compliance with the LLP Act, 2008.
  5. Investment Vehicles: Entities regulated by SEBI or other designated authorities, including REITs, InvITs, and AIFs, are permitted to receive foreign investment subject to specific terms and conditions.
  6. Startup Companies: Startups can issue equity, equity-linked instruments, debt instruments, or convertible notes to foreign investors, subject to certain conditions and regulations.

Prohibited Sectors for FDI in India

While the Indian government has liberalized its FDI to encourage foreign investment in most sectors, there are certain areas where investments by non-residents are prohibited. These include:

  1. Lottery businesses, including government/private lottery and online lotteries.
  2. Gambling and betting activities, such as casinos.
  3. Cheque money.
  4. Nidhi businesses.
  5. Transferable development rights (TDRs) trading.
  6. Farmhouse construction or real estate businesses. This restriction does not apply to the development of townships, the building of homes or businesses, the building of roads or bridges, or the creation of Real Estate Investment Trusts (REITs) that are registered and subject to regulation by the SEBI (REITs) Regulations, 2014.
  7. Manufacturing tobacco goods, such as cigars, pipes, cheroots, cigarillos, and nicotine replacement products.
  8. Sectors or activities that are off-limits to investments from the private sector, such as the railway industry and atomic energy.
  9. Any type of foreign technological partnership, including franchising, trademark, brand name, or management contract licensing in connection with lotteries, gaming, or betting operations.

Documents required for FDI approval in India:

  • Certificate of incorporation
  • Memorandum of Association(MOA)
  • Board Resolution
  • Audited financial statement of last financial year
  • Article of association

Importance of FDI in India

  1. Economic growth: FDI is a vital source of capital for India’s economic growth. It supplements domestic capital, enables infrastructure development, and fuels industrialization.
  2. Employment generation: FDI helps create job opportunities by establishing new businesses, expanding existing ones, and increasing production capacities.
  3. Technological advancement: FDI brings state-of-the-art technology and expertise, promoting innovation and competitiveness in the Indian market.
  4. Access to global markets: FDI allows Indian businesses to integrate with global supply chains, fostering the export of goods and services.
  5. Balance of payments: FDI inflows help improve India’s balance of payments, strengthening the country’s foreign exchange reserves.

 

FDI policy 2020:

As of April 2020, the government has received over 120 FDI proposals worth Rs. 12000 crore from China. India received the highest-ever total FDI inflow of $ 81.72 billion during the financial year 2020-2021 and it is 10% higher as compared to the last financial year 2019-2020 worth US$ 74.39 billion.

Holding and subsidiary company:

Holding company:-A company that purchases 51% of shares that company is known as a holding company (host country)

The subsidiary company:-A company that sales its shares as its shares are purchased by another company is called the subsidiary company

Two ways of FDI:

  1. Foreign companies purchase shares or debentures of the Indian company and invest in the Indian company
  2. The foreign company comes to India and establishes its own company in India

Examples of FDI in India:

  • Google picked up 7.73% of Reliance’s JIO platform for USD 4.5 Billion it is one of the biggest deals in India’s corporate fundraising session.
  • General Atlantic, one of New York’s most equity USD 900 million for a picket in reliance’s JIO platform in JUNE 2020.

 

The following rules apply to the issuing and exchange of shares under the FDI policy:

  1. Capital instruments must be issued 60 days after the inward remittance is received. The money shall be returned within 15 days following the 60-day period if they are not issued within that time limit. Non-compliance results in a violation of FEMA, which is punishable.
  2. The issue price for shares should follow certain rules:

a. SEBI’s rules for listed businesses 

b. A fair valuation for unlisted companies by a Chartered Accountant or Merchant Banker registered with SEBI. 

c. The Reserve Bank of India pricing rules for preferred allocation

3. Following RBI regulations, Indian enterprises that are permitted to distribute shares to outsiders may keep the subscription money in an overseas bank account.

4. Shares and convertible debt transfers:

  • General approval is provided for the transfer of shares, subject to particular criteria and requirements, and non-resident investors may invest in Indian enterprises by purchasing/acquiring existing shares, according to the FDI sectoral policy.
  • The AD Category-I Bank must receive Form FC-TRS following sixty days of the date of the transfer of funds or receipt/remittance of monies, whichever comes first.
  • Sale consideration must undergo a KYC check by the remittance receiving AD Category-I bank.
  • Non-resident investors, including NRIs, who hold control by SEBI regulations, can acquire shares of a listed Indian company on the stock exchange.
  • Escrow accounts can be opened and maintained by AD Category-I banks without prior RBI approval, subject to terms and conditions.
  • Deferred payment for share transfer between resident and non-resident is allowed up to 25% of total consideration, not exceeding 18 months from the transfer agreement date. Escrow arrangements or indemnity provisions can be made within these limits. The total consideration must comply with applicable pricing guidelines.

Remittance and restoration of sales profits guidelines:

  • Remittance of sale proceeds, remittance upon winding up, and company liquidation:
  • Are governed by FEMA’s 2000 Foreign Exchange Management (Remittance of Assets) Regulations.
  • Provided the security has been held on a repatriation basis, the sale complies with established rules, and a NOC/tax clearance certificate from the Income Tax Department is produced, AD Category-I banks may permit the transfer of sale proceeds to sellers who reside outside of India.
  • Remittance on winding up/liquidation of companies is allowed by AD Category-I banks, subject to payment of applicable taxes and submission of required documents, including a tax clearance certificate, auditor’s certificates, and confirmation of no pending legal proceedings.
  1. Dividend repatriation is allowed without restriction (net of any appropriate tax deductions made at the source or payment of dividend taxes).
  2. Interest repatriation is unrestricted (net of any applicable taxes) for completely, mandatorily, and compulsorily convertible debentures.

 

Reporting Requirements:

All the necessary reporting must be completed using the Single Master Form (SMF) accessible on the Foreign Investment Reporting and Management System (FIRMS) platform at https://firms.rbi.org.in. The guide for reporting can be found at https://firms.rbi.org.in/firms/faces/pages/login.xhtml.

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