The Ministry of Finance recently published on its website a report of the Working Group on Foreign Investment in India. The report seeks to address the complexity and overlaps in the existing regime on foreign investment in India and to propose a more streamlined framework. It focuses largely on foreign portfolio investment and less on foreign direct investment, although some of the recommendations do impact the latter as well. This report follows recent efforts to simplify the foreign investment regime, and comes in the wake of the Consolidated FDI Circular that became effective on April 1, 2010.
Before examining the key recommendations, it may help to set out the context. With the onset of the economic liberalization policy followed by the Indian Government in 1991, various modes of investment were made available to foreigners. These include the foreign direct investment (FDI), foreign institutional investment (FII), non-resident Indian (NRI) investment, overseas corporate body (OCB) investments and later the foreign venture capital investments (FVCI). Initially, these different investor classes were subject to varying regulations, and they served distinct purposes. However, in the last decade or so, continuing regulatory changes began diluting, and sometimes even obliterating, the distinctions between various investor classes. Overlaps crept into the regulatory regime. The availability of multiple classes caused uncertainties to foreign investors when it came to opting for the appropriate investment route to adopt in order to invest in India. It is in this background that the Working Group reviewed the entire policy on portfolio investments and issued its recommendations.
The key recommendations are as follows:
1. Qualified Foreign Investor (QFI) Scheme: The Working Group recommends that all portfolio investments be brought in through a common scheme. To that extent, the current NRI, FII and FVCI regimes are being collapsed into the QFI scheme.
2. Percentage Limits: Investment into unlisted or listed securities of an Indian company would be considered as portfolio investment up to 10% shares in each company. If the shareholding is in excess of 10%, then it will be considered as FDI and hence governed under the appropriate policy. While the creation of a single portfolio investor regime is desirable, the use of a 10% limit for determination of whether an investment is under the portfolio route or FDI route may be fraught with some difficulties. To the extent that this report focuses on portfolio investments (i.e. less than 10%) and leaves excess investments to the FDI policy, it remains to be seen whether appropriate changes are to be effected to the FDI policy as well.
3. Participatory Notes: The Working Group recommends that “SEBI should have the final right to demand details about the end investor in cases of needed investigations”. Moreover, it is expected that a streamlined QFI framework will encourage investors to participate directly in the Indian markets rather than through indirect offshore instruments (such as participatory notes).
4. Debt Instruments: The QFI model is to be extended to debt investments as well in the Indian markets.
5. Legal Process: The Working Group lays emphasis on the importance of legal processes in foreign investment. Its recommendations on this count include: (i) the creation of a financial sector appellate tribunal to hear appeals on capital flows management regulations; (ii) institution of processes of public consultation before issuance of law or policy; (iii) creation of “user-friendly access to the law through public information systems”.
Although the Working Group recommendations constitute a concerted effort towards simplifying the policy on portfolio investments, the extent to which these proposals would be translated into action is not clear, and doubts are already being expressed.