Redefining The Contours Of FDI

In furtherance of the recommendations made by the Mayaram Committee (formed to characterize ‘foreign investment’ based on international practice), the Reserve Bank of India had in November, 2017 issued the Foreign Exchange Management (Transfer and Issue of Security by a Person Resident Outside India) Regulations, 2017 (New FEMA 20) to replace inter alia the Foreign Exchange Management (Transfer and Issue of Security by a Person Resident Outside India) Regulations, 2000 (Old FEMA 20). The New FEMA 20 introduces for the very first time a definition of ‘foreign investment’ and categorizes it into ‘foreign direct investment’ and ‘foreign portfolio investment’. This categorization fundamentally changes the foreign exchange regime of India by making it an ‘investment-specific’ regime, as compared to an ‘investor-specific’ regime under the Old FEMA 20. By virtue of these amendments, a new route has also been made available for foreign investment by person resident outside India in a listed Indian company up to a limit of 10%.

Under the Old FEMA 20, the percentage of holding was never a determining factor to categorize foreign investment into India as a foreign direct investment or foreign portfolio investment. The reasoning behind this was in the theme on which the Old FEMA 20 was promulgated. It was based on an ‘investor-specific’ regime whereunder the percentage of holding held by a person resident outside India (depending on the amount of investment made by it under Schedule I (i.e., the ‘foreign direct investment scheme’) of the Old FEMA 20) had no bearing on its classification (i.e., whether it is foreign direct investment or foreign portfolio investment). All of this now stands changed as the New FEMA 20 is based on an ‘investment-specific’ regime as discussed below.  

The genesis for this radical change in approach can be traced to the Union Budget for 2013 – 2014, wherein the then Finance Minister had, while taking note of the ambiguity surrounding what is considered as foreign direct investment and what is considered as foreign institutional investment, laid down a broad principle that an investment resulting in a stake of 10% or less in a company needs to be treated as foreign institutional investment and where such investment results in a stake of more than 10% needs to be treated as foreign direct investment. Such categorization, as per the then Finance Minister, was modelled on the international practice of categorizing ‘foreign investment’ on the basis of the percentage of holding which such investment will result into and not on the nature of the investor. This categorization based on the percentage of holding held by a person resident outside India is the cornerstone of an ‘investment-specific’ regime. 

To apply this principle, a committee headed by Dr. Arvind Mayaram, Secretary, Department of Economic Affairs, Ministry of Finance (Mayaram Committee) was formed to re-look at the definitions of foreign direct investment and foreign portfolio investment and rationalize them. The Mayaram Committee after undertaking a detailed review of the literature available on the subject, laid down the conceptual framework relating to foreign direct investment and foreign portfolio investment based on their respective characteristics and eventually adopted such framework to frame the recommendations forming the basis for the New FEMA 20. As per the Mayaram Committee, ‘foreign direct investment’ is characterized by a lasting interest (i.e., the existence of a long-term relationship and a significant degree of influence). Normally, ownership of 10% or more of the ordinary shares or voting power signifies this relationship. On the other hand, ‘foreign portfolio investment’, as per the Mayaram Committee, is distinctive because of the nature of the funds raised and the largely anonymous relationship between the issuers and holders. Further, the degree of trading and liquidity in the instruments purchased under foreign portfolio investments were also drastically different from foreign direct investment. Based on the said distinctive characteristics of foreign direct investment and foreign portfolio investment, the Mayaram Committee through its report (submitted in June 2014) made its recommendations, as discussed below. 

The Mayaram Committee recommended that foreign investment in an unlisted Indian company irrespective of any threshold limit would be treated as foreign direct investment. Additionally, it recommended that foreign investment of 10% or more made in an Indian listed company (through eligible instruments) would also be treated as foreign direct investment. At the same time, is also clarified that all existing foreign investment below 10% would continue to be treated as foreign direct investment. As regards the foreign portfolio investment, the Mayaram Committee recommended that any investment (either by way of equity shares or by way of compulsorily convertible preference shares/debentures) resulting in less than 10% of the post-issue paid-up equity capital or of the post-issue paid-up value of each series of convertible debentures of a listed Indian company would be treated as foreign portfolio investment. 

Accordingly, the definition of foreign investment under the New FEMA 20 segregates foreign investments made in unlisted and listed Indian companies. All foreign investments made in unlisted Indian companies irrespective of any threshold limit will be considered as foreign direct investment. Any foreign investment of 10% or more of a listed Indian company will also qualify as foreign direct investment. However, any foreign investment of less than 10% of the post issue paid-up share capital of a listed Indian company on a fully diluted basis or of less than 10% of the paid-up value of each series of capital instruments of a listed Indian company will now be considered as foreign portfolio investment and not foreign direct investment. Rationalization brought in through these new definitions have also opened a new route for non-residents to invest in a listed Indian company up to a limit of 10%.