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Recent disagreements have emerged within the Indian government, particularly between the Reserve Bank of India (RBI), the Ministry of Finance, and the Ministry of Commerce regarding the implications of Press Notes 2, 3, and 4 issued in February 2009. These press notes significantly relax the existing guidelines on foreign direct investment (FDI), which has created a rift among key economic bodies.
The current alignment seems to position the RBI and the Department of Economic Affairs (DEA) as opponents to the Department of Industrial Policy and Promotion (DIPP), which operates under the Ministry of Commerce and is responsible for FDI matters. This division highlights the need for clarification on several issues stemming from the new guidelines.
On March 20, 2023, the RBI formally requested the DEA to reassess the regulations related to FDI as detailed in press notes 2, 3, and 4, expressing concern that these changes might effectively lead to full capital account convertibility. For these new norms to gain legal standing, they must be ratified under the Foreign Exchange Management Act (FEMA) by the RBI.
Potential issues were raised by the DEA upon receiving the RBI’s communication, leading the DEA to seek clarifications from the DIPP, despite the latter's involvement in drafting the initial press notes. Officials close to the matter indicate that while the DIPP does not see the feasibility of a comprehensive review of the new norms, it remains open to issuing clarifications. These could include minor adjustments rather than a complete reversal of the established guidelines.
Capital account convertibility allows investors to freely exchange local currency for foreign currency. India maintains limited capital account convertibility to shield its economy from potential shocks and to stabilize exchange rates. This is achieved by imposing sectoral norms that enforce lock-in periods for foreign investments.
The recent press notes aimed to simplify FDI calculations suggest that as long as Indian promoters retain a majority equity (over 51%) in any operational and investing company, they may attract an FDI of up to 49.9%. Such entities would be classified as Indian companies and can enter into joint ventures with others in sectors where FDI quotas exist. This has allowed companies, such as Pantaloon and UTV, to restructure their businesses to secure FDI through step-down joint ventures, despite FDI being prohibited in multi-brand retail and limited to 26% for media-related industries.
In its correspondence, the RBI challenged the proposed definitions of Indian ownership and control outlined in Press Note 2. It contended that ownership does not strictly correlate to formal equity stakes or the right to appoint a majority of directors in investment-receiving companies.
The RBI's letter elaborated that control could also stem from various mechanisms, such as funding through preference shares, loan agreements, or contractual rights in minority shareholder agreements. The central bank emphasized the necessity to refine the control definition rather than solely depending on the majority director appointments.
Echoing RBI’s concerns, the DEA indicated that a company with 49% foreign investment could theoretically invest in sectors where FDI is restricted or breach existing sectoral limits. This suggests that sectoral caps could become ineffective for companies qualifying as Indian-owned and controlled but with less than 50% foreign investment.
According to the DEA's letter, companies with foreign investment falling below 50% could apply for licenses in various sectors, such as cable operations (capped at 49%), FM broadcasting (20%), licensed defense manufacturing (26%), and newspaper printing (26%). The ambiguities surrounding whether this represents an intentional change or an unintended liberalization remain unresolved.
The RBI echoed similar sentiments, warning that such developments could result in the creation of Indian shell companies primarily established to facilitate downstream investment in sectors restricted to FDI. This scenario could undermine the effectiveness of existing FDI policies, rendering them ineffective, as stated in RBI’s communication to the DEA.
The ongoing debate between the RBI, DEA, and DIPP illustrates the complexity of the FDI landscape in India. As the government navigates these evolving guidelines, clarity and coherence will be essential to maintain a balanced approach to FDI while safeguarding India's economic interests.