By Bhumesh Verma, Managing Partner, Corp Comm Legal.
Foreign Direct Investment or FDI, as it is called in common parlance, has become the fuel which is essential to sustain and develop any country’s economy. Developing countries such as India, require significant and consistent infusion of foreign investments in their economy in order to maintain a high GDP rate. The demands of the ever-growing consumerist culture are also satiated by the influx of FDI. Sectors such as infrastructure, retail, aviation, pharmaceuticals, etc. require continuous cash flow for their sustenance. A liberal FDI regime allows companies existing within such sectors to look for financial assistance outside the country. This ensures that the country’s economic development does not suffer due to lack of financial resources within the country. The authors explain the essentials of the FDI regime in India through this article.
What is FDI?
Foreign Direct Investment is an investment by an entity or person, who is resident outside India, in the capital of an Indian company. An Indian company for the purposes of FDI would be a company incorporated in India under the applicable Companies Act. The term ‘capital’ here includes primarily equity shares (shares which entitle its holder to vote), fully, compulsorily and mandatorily convertible debentures (instruments issued against loans) and fully, compulsorily and mandatorily convertible preference shares (shares which do not give voting rights).
In simple words, FDI translates into a prospect for a foreign investor to explore the financial avenues and markets offered by a country and for a country, the prospect to attract foreign investment in diversified fields/sectors.
History of Foreign Direct Investment in India:
Post-independence, India was an inward-looking economy with a socialist bent and was not very open to foreign investment. The weak financial position of India on the international front and the gaping international trade payment defaults contributed to the articulation of the New Economic Policy. It was in July, 1991 that India opened its gates to foreign investment through the New Economic Policy. Liberalization, Privatization, Disinvestment and Globalization were the key dimensions of the New Economic Policy. The policy played a pivotal role in enabling foreign entities to invest in India. India, since 1991 has witnessed further liberalization of the FDI regime leading to a plethora of foreign investors being attracted to the Indian markets.
Forms of Entry
There are various ways in which foreign investors may invest in India. Some of the forms through which FDI enters the country are:
- Investment in an existing Indian entity: In consonance with various sectoral caps, a foreign entity or person may invest in an existing Indian company.
- Setting up a fresh entity: Foreign entities may set up a fresh entity in India through:
- wholly owned subsidiaries (100% stake of foreign entities)
- joint ventures (collaboration between Indian and foreign entities) or;
- by setting up liaison offices (acting as a communication channel between the place of business and the head office), branch offices (acting as the buying or selling agent of the foreign entity in India and for other specified activities) or project offices (place of business which represents the interests of a foreign entity in respect of a specific project) in India.
Categories of FDI based on investors’ target and motive:
Greenfield Investment: Foreign direct investment (FDI) under which a parent company builds its operations in a foreign country from scratch is termed as Greenfield Investment.
Cross Border Merger and Acquisition: This includes either a merger of a domestic entity with a foreign entity wherein the former is completely dissolved, or an acquisition, typically of equity shares by a foreign investor in a domestic entity.
Horizontal FDI: Horizontal FDI means any investment by a foreign investor (involved in a particular line of business) in any foreign entity (which is engaged in the same line of business as the investing entity).
Vertical FDI: Vertical FDI means any investment of a foreign investor (involved in a particular line of business) in any foreign entity (which is engaged in the different line of business to that of investing entity).
Resource seeking FDI: Foreign investment in a country with the main motive of accessing that country’s resources such as cheap labour, raw materials etc. is a resource seeking FDI.
Market seeking FDI: Foreign investors invest in countries which have the potential of turning into huge markets for their products. This motive too propels the infusion of FDI especially in countries like India which has a huge untapped market.
Efficiency seeking FDI: Certain companies make investments in foreign entities purely with the motive of enhancing the efficiency of its services.
Strategic asset seeking FDI: Certain companies make investments in foreign entities with an intent to acquire strategic assets such as brands, human capital, etc. which would enable them to gain a competitive advantage.
Why is FDI important for the economic development of any nation?
- A fresh infusion of capital in a country with talent abundance is just the right impetus needed for economic growth.
- FDI also leads to creation of new employment opportunities. A consumerist culture which is the by-product of FDI has led to coming up of malls, luxury stores, etc. thereby creating new job avenues.
- No country in today’s world will be able to survive on its own and sustain the economic development with its own financial and revenue generating assets, without the assistance of and collaboration with other countries.
- FDI plays a vital role in ensuring that no country will face acute shortage of financial resources to run the economy of the nation.
To be precise, a nation’s economic development prospect is dependent on the combination of well organized utilization of internal financial reserves and revenue generating assets, and articulating foreign investor-friendly policies encouraging them to endow investments in that country.
Advantages of FDI to the host nations:
- FDI will ensure that no nation will fall short of finance and will further help any such nation to transform its reserves into more productive material by bridging the gap amid reserves’ accessibility and finance necessity.
- Every nation has natural resources of its own depending upon its geographical landscape; FDI will aid the nation in untapping the potential of such natural resources by exploring them.
- FDI in diversified public and private sectors and key revenue generating sectors will aid the nation in developing and building strong infrastructure from rural to urban corners of the nation.
- FDI plays a key role in generating more job prospects for the unemployed, by contributing to the development of key revenue and job generating sectors.
- FDI will assist nations in embracing new technologies into their landscape, thus enhancing the communication network of the nation(s), by helping in connecting people belonging to all walks of life.
- FDI will enable a nation to build strong economic zones with the objective to develop and manufacture products heightening the magnitude of the exports sector of that nation.
- The outstanding advantage of FDI is that it will facilitate the nation to develop areas that have remained backward over centuries, by building robust infrastructure, conferring basic facilities such as electricity, education, medicine and transportation.
- Financial services play a vital role in maintaining the balance amid inflow and outflow of cash to bring stability to a nation’s economy. Such financial services backed up by FDI will ensure that the financial system of the nation is in balance and possesses the knack to sustain any financial crisis.
- FDI will certainly enhance the living standards of the people by uplifting the lifestyle pattern of people to a new high by turning a product which was once a luxury, into today’s necessity, and create easy accessibility of such product, to all categories of people.
Advantages of FDI to Investors (Entity/Person):
- FDI affords the route to channelize the finances of investor to different financial sources of a foreign country, for the greater good of a nation and the investor himself.
- FDI opens the gateway for investors to enter into foreign soil to invest and conduct business on such foreign soil.
- Investors will have the opportunity to access the manpower, material, natural resources and certain other miscellaneous things at much cheaper rates in the foreign island when compared to the cost of expenses of the same in the investor motherland.
- FDI is one of the best ways to expand the business of the investor to other nations and aids the investor in sustaining his business and compete with his contemporaries in his line of business, with the right spirit.
- FDI enhances the prospect of the investor to enter into a new line of business and alliances– which is otherwise improbable in the investor motherland due to the prevailing circumstances (i.e., government policies, geographic limitations, high amount of investment involved, labor problems etc.).
FDI is the key driving force that contributes to the economic development of any nation. It is the bridge that connects nations, requiring flow of investments from foreign territories and investors, looking for options to enter into foreign capital markets to invest funds and conduct business on foreign soil. It is essential to have a liberalized FDI regime in order to attract more foreign investment. FDI is, therefore, very crucial for the overall development of any nation.
About the Author:
One of the leading Indian senior corporate practitioners, his expertise is in advising domestic and foreign clients on inbound and outbound mergers and acquisitions (M&A) transactions, private equity, venture capital, joint ventures, technical collaborations, external commercial borrowings, corporate structuring, strategic advice, regulatory approvals, corporate advisory, due diligence for share/asset acquisition, corporate-commercial agreements. With over 23 years of practice behind him, he is also involved with research, opinions and presentations on the above subjects.
He started his career at Ajay Bahl & Co. (now part of AZB & Partners) and went on to become partner at some of the leading Indian law firms in India. While in London as a Chevening scholar, he was a visiting lawyer with Ashursts’ London office.
He has been writing consistently in-house journals of many international law firms on Indian laws and related business issues. These articles are followed very keenly, particularly on LinkedIn. Bhumesh is a guest faculty with law colleges and online legal education portals. He also conducts workshops for students and professionals on corporate laws and drafting skills. He has authored a book on Drafting of Commercial Agreements.
Bhumesh is consistently ranked in the ‘A List’ of the Top 100 Indian Lawyers by India Business Law Journal.