Need to Rationalise FDI Approvals Under Press Note 3 : Daily Current Affairs

Relevance: GS-2: Government policies and interventions for development in various sectors and issues arising out of their design and implementation.

Key Phrases: Press Note 3, Foreign entities, Foreign Direct Investment, Government approval route, Opportunistic takeovers, Pooled funds, Restricted entities, Beneficial ownership, Transparency, Department for Promotion of Industry and Internal Trade, Manufacturing sectors.

Why in News?

Press Note 3, aimed at curbing predatory takeovers by foreign entities, needs to be reviewed in the current economic situation.

Context:

As companies across the globe battled the uncertainty that the pandemic brought on in 2020, several economies began to raise concerns about opportunistic takeovers of entities stressed by pandemic in their country.
These countries imposed restrictions on foreign investments which could be ‘predatory’ in nature and to ensure that assets in sensitive sectors do not end up in foreign hands, jeopardising national security.
Against this backdrop, India introduced Press Note 3 (PN3) in 2020, which required all foreign direct investment (FDI) proposals from an entity based in a country that shares a land border with India were brought under the government approval route.

What is Foreign Direct Investment (FDI)?

Any investment from an individual or firm that is located in a foreign country into a country is called Foreign Direct Investment (FDI)
With FDI, foreign companies are directly involved with day-to-day operations in the other country.
This means they aren’t just bringing money with them, but also knowledge, skills and technology.
Generally, FDI takes place when an investor establishes foreign business operations or acquires foreign business assets, including establishing ownership or controlling interest in a foreign company.
It is different from foreign portfolio investment where the foreign entity merely buys equity shares of a company.
FDI generally takes place in an economy which has the prospect of growth and also a skilled workforce.
FDI is a major driver of economic growth and an important source of non-debt finance for the economic development of India. A robust and easily accessible FDI regime, thus, should be ensured.

Understanding Press Note 3 (PN3) 2020

Press Note 3 (2020 series) was brought during the initial days of the pandemic in April 2020 – and as an immediate reaction to the concerns of Indian companies being vulnerable to opportunistic takeovers during the pandemic.
Press-note 3 requires that all investments from entities, which are based in a land-bordering country, or when the beneficial owner of the investment is based in a land-bordering country, will have to be made under the ‘approval route’ and will require security-clearance.
The challenging part for the implementation of press-note 3 was that it did not define the threshold for identifying the beneficial owner.
The Press Note changes the FDI Policy in two fundamental respects:
- First, it expands the list of countries whose investors are no longer eligible to invest in India under the automatic route.
- Second, an investment in India – that would otherwise fall under the automatic route – now falls under the government route if it is from an entity whose "beneficial owner" is from such Bordering Country. These changes have far-reaching implications on the overall FDI regime.

Current Issues on Press Note 3 (PN3):

However, there has been a series of important developments since the issuance of PN3, resulting in a need to update and rationalise it. During this period, the government also introduced several bold reform measures like
- opening up of travel and tourism
- scrapping the controversial retrospective tax imposed in 2012 on transfer of Indian assets
- ending vexatious litigations with 17 companies including Cairn and Vodafone
- infusing a new life into the earlier moribund telecom sector.
The present healthy trends may potentially ward off any attempts of ‘opportunistic takeovers’ as feared earlier.
On the global front, there have been radical changes in the geopolitical situation after the Russia-Ukraine war, which has severely impacted the global economy and created potentially huge inflationary pressures, forcing countries to review their policies.
In this situation, there is a need to review PN3 to boost legitimate investments, particularly from sources like ‘pooled funds’. These are investment vehicles that pool money from multiple investors and are managed by fund managers who independently and professionally drive the investment strategy for delivering returns for their investors.

Areas needed to be reform:

There are some additional areas for simplifying PN3 which could also be considered:

Exemption of low hanging fruits:
- Effectively, investments from restricted entities constituting less than 10 per cent (or even 5 per cent) of the economic interests of an Indian company, in non-strategic sectors, regardless of investment route, could be exempted from the prior approval requirement.
- The rationale would be that such minority shareholding of ‘restricted entities’ may not be able to influence control/direction of the entities.
Clarification on scope and ambit of ‘beneficial ownership’:
- As the ambit and extent of “beneficial ownership” has not been elaborated under PN3, considerable discussion has taken place on acceptable threshold of ‘beneficial ownership’.
Cue from several other regulations
- There could be a mechanism involving relaxation for investors where the ultimate beneficial ownership or control is less than 25 per cent.
- This could also include companies listed on overseas stock exchanges wherein restricted shareholders hold less than 25 per cent of listed stock
Further investments into Indian companies where restricted entities are existing shareholders:
- It is well known that a number of start-up sectors (e-commerce, technology, social media, etc) in India have substantial amounts of Chinese investments.
- Considering the curbs placed on fresh investments under PN3, incoming and existing investors looking to participate in fund-raising rounds by such start-ups might hesitate.
As the intention behind PN3 has been to prevent opportunistic takeovers, screening future rounds of funding or acquisitions by restricted entities in companies already owned and controlled by such restricted entities may be relaxed since the question of an opportunistic takeover may not arise.
Need for greater transparency and expediency in the approval process: Another challenge in the context of PN3 has been the time taken for security clearance of the proposals. According to recent reports, since 2020 nearly 347 proposals have been received under PN3, of which, only 66 have been granted approval so far.

Do you know?

India attracted total foreign direct investments (FDI) inflow of $83.57 billion in the financial year 2021-22, up by 1.95 per cent on-year, according to data released by the Department for Promotion of Industry and Internal Trade (DPIIT).
India has attracted highest ever total FDI inflow of US$ 81.72 billion during the financial year 2020-21 and it is 10% higher as compared to the last financial year 2019-20 (US$ 74.39 billion).
Singapore is the top investing country with 27 per cent of the equity inflows.
This is followed by the US with inflows at 21 per cent and Mauritius that continued to remain one of the top sources of FDI for India at 16 per cent inflows in FY22..
Karnataka is the top recipient State for yet another year with 38 per cent share of the total FDI equity inflows, followed by Maharashtra at 26 per cent and Delhi at 14 per cent.
Majority of equity inflow of Karnataka has been reported in the sectors — computer software and hardware, with a share of 35 per cent of the total FDI equity inflow. For the automobile industry it was 20 per cent and 12 per cent in case of education during FY22.
FDI equity inflow in manufacturing sectors has increased by 76 per cent in FY2021-22 ($21.34 billion) compared to previous FY2020-21 ($12.09 billion).

Way forward:

While the security risk posed by Chinese entities persists, there an urgent need for Indian entities to raise funds, particularly in the current geopolitical situation and more so in strategic sectors.
The Indian economy has exhibited great resilience and upswing during and after the Covid pandemic, as evidenced by reassuring FDI inflows and growth of a record number of unicorns, which has just crossed 100 during the period. Now when the economy is accelerating, there is a need to ensure greater facilitation, transparency and time-bound decision-making.

Source: The Hindu BL

Mains Question:

Q. Discuss the relevance of Foreign Direct Investment for development of a country like India.