Despite the progressive opening up of the Indian economy to foreign investment in 1991, there has been tight control over the entry and exit prices for foreign investors into and from investments in Indian companies through the foreign direct investment route (FDI). While the initial approach was to benchmark the transaction prices to the erstwhile formula prescribed by the Controller of Capital Issues (CCI), more lately (since 2010) the benchmark was altered to the discounted cash flow (DCF) valuation. While unlisted company investments were subject to these benchmarks, listed companies were entitled to the benefit of market efficiency and prevailing stock exchange prices that provided proxies for company valuation. Further relaxations were made more recently in January this year.
Latest reports and analyses (here and here) have alerted us to the possibility that the Reserve Bank of India (RBI) is set to further rationalize the pricing of entry and exit of foreign investment into Indian companies. This is based on a statement in the First Bi-monthly Monetary Policy Statement, 2014-15 by Dr. Raghuram Rajan, Governor of the RBI, as follows:
As regards foreign direct investment (FDI), it has been decided to withdraw all the existing guidelines relating to valuation in case of any acquisition/sale of shares and accordingly, such transactions will henceforth be based on acceptable market practices. Operating guidelines will be notified separately.
This potential change represents an important development in FDI structuring. Hitherto, investors have been hamstrung by unduly stringent pricing norms that have adversely affected the commercials of investment transactions. While entry-pricing norms for FDI have imposed floor prices on foreign investors thereby disabling them from investing at low prices (that may be necessary for specific types such as early-stage investments), the exit pricing norms have imposed caps that disallow foreign investors from exiting their Indian investments at commercially attractive prices. The policy rationale for the pricing norms is understandable – as it is a measure of regulating the inflow and outflow of foreign exchange. However, the rigidity in its implementation acts as a disincentive to foreign investments and not only curbs foreign investors from investing into India but also limits the availability of foreign capital to Indian companies.
The regulatory progression in the recent years coupled with the latest announcement seems to rationalize the policy in a manner that favours foreign investment. It is certainly not the case that FDI pricing must be free from any regulation whatsoever so as to permit the parties to contractually determine any manner of pricing conditions. That might move matters away from the policy goal of regulating foreign exchange, a role that the RBI has discharged quite effectively over the years. However, the pricing norms must be in tune with reality and must provide the necessary flexibility to promote ordinary commercial transactions without imposing unnecessary hindrances.
At the same time, what we currently have is only a broad policy pronouncement. It is necessary to await the details in the form of “operating guidelines” before their efficacy or impact can be judged more specifically.