Continuing with its practice of engaging in public consultation before announcing changes to the FDI policy, the Department of Industrial Policy and Promotion (DIPP) has issued a discussion paper on “FDI Policy-Rationale and Relevance of Caps”. The discussion paper introduces the possibility of abolishing all sectoral caps for foreign equity shareholding below 49%.
Before dealing with the rationale of discussion paper, it would be necessary to identify the various rights available to shareholders at the different equity caps that currently operate under the FDI policy (which are identified in the discussion paper itself).
26% - ability to block special resolutions;
49% - shareholding falling short of control;
51% - availability of control rights (i.e. ability to appoint and remove directors); and
74% - inability to pass special resolutions (as remaining shareholders collectively hold the right to block).
The discussion paper provides a number of reasons for the move to abolish caps up to 49%. These require further consideration:
First, the paper relies on aspects of interpretation of the FDI policy. Specific reference is made to Press Notes 2, 3 and 4 of 2009 (discussed here and here) which permit Indian companies with ownership and control remaining with Indian hands to make downstream investments. In other words, an Indian company with 49% foreign investment can make downstream investments without restrictions on further equity holding. The current discussion paper adopts the stance that if foreign investment is indirectly permitted up to 49% in the holding company (where control remains with Indian hands), there is no reason to restrict direct holding in Indian companies to the extent of 49%. If something is permitted indirectly, there is no reason why it should not be permitted directly. The logic of this approach is that with a 49% cap on foreign shareholder, there is no “control” available to foreign investors under company law.
The above reasoning arises from an interpretation of previous policy established in 2009, rather than by way of any independent analysis. It flows from the viability or otherwise of previous policy. From a conceptual standpoint, the reason for limiting the analysis to 49% and below is not clear. The discussion paper seems to proceed on the basis that any shareholding up to 49% would provide same rights in respect of the company (i.e. the lack of control). If that logic were to be accepted, there is no merit in retaining separate caps and 51% and 74%, because the control rights at both those levels too are the same – namely that ordinary resolutions may be passed, but not special resolutions. It remains to be seen whether such differentiation in shareholding above 49% will be considered.
Second, the discussion paper seeks to reduce the effect of sectoral caps as they “also provide an opportunity for arbitrage to unscrupulous Indian partners, which certainly has a cost for the consumer and comes in the way of the country deriving optimal benefit of the FDI”. Interestingly, reliance in placed on a couple of newspaper editorials which make a case for removal of caps as they provide the Indian shareholders with distinct advantages.
Even here, the limitation of the discussion to caps up to 49% is not clear. In fact, the issue of sleeping partners deriving undue advantage will have greater play when the foreign shareholder has a higher stake than 50% and therefore is in control. Minority Indian partners in that scenario only make passive investments without participation in the management.
Third, the partial removal of equity caps is linked to ebbing FDI flows into India in the year 2010. Among several countries in a study cited by the discussion paper, India “is the only major country in South Asia where FDI inflows have fallen during 2010”. This concern has been significant in policy making even in liberalizing other aspects of the FDI policy.Overall, the partial removal of sectoral caps will result in streamlining the FDI policy. Other areas where the discussion paper seeks to remove ambiguities relate to the requirement for foreign investors to offload equity within a stipulated period and in addressing the question as to whether the caps should (or should not) include investments by foreign institutional investors (FII).