How Investment Policies were Introduced in the Indian Market:
Investment Policies were not a part of the legal framework around national trade and commerce prior to the early 1990s. Countries simply followed implicit practices and norms which were general in nature, within an express framework being developed. But, by the end of the Cold War era, most countries understood the need for definitive strategies and thus adopted detailed policies[1]. These were formulated with the understanding that globalization is a fast growing trend, especially in international trade markets. Further, in the 1990s, nations pooled a majority of resources towards developing better trade relations with neighboring States for which multiple trade agreements which were targeted at tariff, trade taxes and economic concessions were entered into[2]. To govern these agreements, particularly with foreign investors, investment policies were developed and laws such as FEMA, 2000 were implemented to regulate the foreign direct investment policy of India.
These policies then became an essential part of their regulations that govern and enhance investments on capital goods like new technologies, military developments, etc. and were a necessary element of economic revolutions arising in most countries post 1990s. For many countries investments laws are now a core policy tool to promote and regulate investment, and become necessary frameworks dealing with cross-border expenditure derived from International Investment Agreements[3].
In India, the government under British rule solely survived on foreign trade, and this continued until the 1950s when independent India had made poor progress in development of its resources domestically. This meant that the State had a struggling supply of technology and machinery for production, the education and skills for large scale manual labour in specialized sectors, and the mental fervor for innovation and advancement by regional businesses. This made the economy severely dependent on foreign investors, mainly from Europe[4], who was guaranteed concessions, better profitability and equitable compensation schemes in cases of acquisition.
Following this era, the government developed a five year plan[5] which centered on developing a closed economy, focusing on the use of capital goods developed domestically, including power plants and steel factories being established. This restricted the extent of FDI permitted so that the economy could become more self-sufficient. Later, in 1973, inspired by this revolution, FERA[6] was created and had a provision which limited the maximum amount of equity owned in regional companies by foreign investors to 40%. As a result, several foreign investors who had thrived under the previous regime were now restricted, and this environment became unfeasible, forcing them to leave by the end of the 1970s[7].
In the 1980s, international practice moved towards globalization and international trade relations became a priority for most governments. India, too, realized the need for this, and changed its laws to allow for more liberal trade policies to create more encouraging conditions for foreign businesses to invest in India. This also led to a boom in transnational corporations[8] with the limit of 40% being eased as the law allowed for exceptional cases where this was increased.
By the 1990s, this practice became large scale in an attempt to enhance economic integration in the global scenario and new policies were enforced which provided for easier approvals given to foreign investors in certain essential sectors, subject to regulation by the RBI[9]. This was done based on three categories of ownership, namely maximum of 50%, maximum of 51% and maximum of 74%[10]. In the following decades, these ceilings were eased and some sectors were even permitted up to 100% of foreign investment under these laws.
Further, in 1991, the FIPB[11] was created to further govern these policies and FEMA[12] was enforced as a replacement for FERA. Under this policy, transnational companies no longer had any limits on the amount of shareholding permitted, the rules governing the import and licensing of foreign technology were liberalized to increase the access to imported machinery and products[13], and the laws dealing with investments by Indian companies into other countries were eased.
Thus, these national investment policies underwent several changes from the 1950s to the 1990s, along with supporting agreements such as bilateral investment treaties[14] (BITs) which meant that foreign investors found the financial environment more inviting and regulated. The policies now provide detailed explanations of existing taxation frameworks, incentives and business schemes, the processes of approval and establishment in various sectors, the laws protecting their investments, extent of natural resources available, and the kinds of financial institutions existing. Under the newly developed structure of investment policies, India has had decent success since the 1970s which has helped the GDP grow.
Investment Policy Practices in India through Economic Reforms:
Around the 1990s, India recognized the need for changes in the economic condition by liberalizing the market, and this led to the enforcement of the NEP[15] which introduced large scale amendments to the regulations governing industrial policies, trade agreements and the investment policy[16], especially in regards to FDI which had become an essential part of the globalized trade system practiced by most countries at the time.
This change was a response to the fact that India was facing massive debts which made the economy unstable. By 1991, the Indian Government was forced to seek assistance from the IMF Compensatory and Contingency Financing Facility and had to borrow loans to pay off its debts. Following this, to bring about a short-term recovery of its own economy, India followed the guidelines provided by the World Bank which included reduction in imports and devaluation of the currency, followed by changes to the financial structure under the NEP[17]. The changes were also done to solve issues with restrictive trade practices that were prevalent in the 1980s and the inability of public sector industries to increase domestic output[18].
With this new measure to liberalize trade, an implied result was that the attitude of the government towards flow of capital from foreign investors into the market and the scope of restrictions were eased. However, the policy didn’t address restrictions on outward FDI[19]. Thus, under the investment policy of 2001, certain conditions were imposed on Indian companies such as[20]:
- Companies can’t invest more than 25% of the average export earnings it receives per year in the three years preceding the present year,
- The company can use up to 100% of funds raised through GDR for overseas investments or up to 15 million dollars from its EEFC[21] Account.
Further, under the policy, outward FDI is automatically approved if the capital amount is repatriated[22] within 5 years, in the form of royalty or dividends[23] and such approval can only be given once every three years for a single investment undertaking. To further liberalize investment laws, the ceiling for capital invested for outward FDI was raised from 15 million to 50 million dollars and the limit for number of times automatic approval could be given was changed from once every 3 years to once every year[24].
However, under the policy, any investment above 50 million dollars could only be approved in cases where the investor proves to have a stable past record of trade and commercial exports and the particular investment opportunity could lead to exceptional benefits[25]. The main purpose of this restrictive policy, especially in the case of outward FDI is to protect Indian companies from severe loss if they decide to aggressively invest in a foreign market with an objective of earning profits in short time periods.
Under this policy, inward FDI are permitted in most sectors, both public and private, but are explicitly not permitted in the defence sector, agricultural industry and in media broadcasting. The policy also specifies that foreign investments of up to 49% of paid-up capital could be permitted in telecommunication sectors[26]. For this, the policy has categorized sectors into 3 types[27]:
- Industries where FDI is not permitted under any circumstances,
- Industries in which FDI is allowed up till a limited amount of foreign equity, and
- Industries where FDI up to 100% foreign equity is permitted.
Based on the criteria for approval of FDI, the third kind is divided into two subcategories which are the industries where approval for FDI is automatically given and those where prior approval by FIPB[28] is necessary. In case of automatically approved investments, there are 34 specific types of industries that fall under this category provided they invest only up to 51% of paid up capital[29], which thus increased the limit of control for foreign investors in these industries.
Based on this, there are specific kinds of investments that are subject to automatic approval by the RBI and the foreign company can make the investment before filing for this approval, provided that the department is informed about the undertaking within a month. Under the policy, the kinds of investment proposals where such automatic approval is not given are[30]:
- Where the investment is made in a sector that statutorily needs mandatory licensing[31] including the manufacture of defence equipment, alcoholic beverages and cigarettes, pharmaceuticals and drugs,
- Where an investment of at least 24% is made in small scale manufacturing industries,
- Where the foreign company had previously established a subsidiary company in India, and
- Where the foreign company is acquiring the shares of an Indian company already existing.
If an investment proposal doesn’t lie in any of the categories of automatic approval, the company has to put the proposal before the FIPB for review. During this review, the FIPB will seek the advice and observations of the relevant ministry or government authority regulating the sector of investment[32]. Thus, if the investment is made in the petrochemical industry, the Petroleum Ministry would have to provide its opinion, following which certain guidelines are followed to check whether the foreign company has a pre-existing subsidiary or joint-venture in India or whether the company has plans of acquiring shares in a company existing in India. If this case arises, the foreign company must obtain a NOC from the Indian company or a resolution from its shareholders adopted during the Annual General Meeting[33]. Once the respective ministry provides its comments and the Indian company approves of the investment proposal by the foreign investor, the FIPB makes a decision. Finally, under the investment policy, if the amount is less than 130 million dollars, the Ministry of Industry can directly allow the investment to be made, and if it is more than the stipulated amount, this has to be finally approved by the CCFI[34].
Once the approval has been given, the company will be allowed to establish a representative office or subsidiary company in India, subject to certain conditions on entry. Once the establishment is completed, the investor must register the subsidiary company with the Registrar of Companies[35].
Issues with Existing Practices of Governance of Investment Policies:
While there are several factors that must be considered when drafting and enforcing investment policies, most policies still fail to attract more FDI because of issues with effective governance within existing frameworks. This usually means that the laws in force or the rules laid out in the policy are not effectively implemented, especially in developing nations[36]. The governance of a policy includes:
- The language of the laws in force, and rules and guidelines in place under the policy to regulate investments,
- The efficient functioning of financial institutions and other regulatory authorities to oversee the enforcement of these rules and guidelines,
For governance, the policy must assign responsibility for the execution of the terms and the regular overview of the results of this enforcement, and must provide a structured and organized system to review each step of the investment undertaking. Further, in cases of large jurisdictions, there may the need to appoint financial institutions as external consultants and the monitoring of the discharge of their functions also falls within the purview of policy governance[37]. Finally, as market conditions change during the course of a project, the provisions must deal with allocation of capital assets based on the kind of investment made and the sector.
A necessary step for effective governance would be to set up independent regulatory bodies, especially to overlook the agricultural and real estate sectors where FDI received in most countries is high[38]. This becomes necessary because an implicit factor in foreign investments is that the company receives a percent of ownership and control over the asset and once the policy has secured an investment, it fails to oversee how this control is being exercised. Certain studies also criticize MNCs on the grounds that when they invest in the agricultural sector, an objective is to improve the opportunities for employment and enhance existing facilities of machinery or infrastructure. But, most MNCs fail to meet this promise of generating employment opportunities for local populations and other promised improvements. MNCs also tend to neglect rules around the environment and the relevant laws are expected to monitor these activities that fall under the purview of FDI[39].
While the investment policy cannot be expected to encompass rules governing such issues, the creation of independent committees under the policy will ensure that the regulation isn’t just for monetary transactions, but is also to deal with ownership and control, and the terms arising out of such investments. The governance will also include measures within the policy to ensure that all relevant laws and rules of the country, especially dealing with investments in the foreign sector, and including small scale companies and not just MNCs, their enforcement and implementation are done effectively, in a transparent manner and with complete accountability[40]. This is an important step in the process of enforcing a structured policy framework nationally since most of the issues arise from the lack of such transparency, which then discourages future investment proposals. Investment opportunities carry practical consequences due to the rules and terms laid out in the policy, and when the governance Is carried out effectively, investors are made well aware of the conditions, the procedures for review, and the processes of appeal in case of any dispute once the investment is made. This will help institutionalize the undertaking and make foreign investments in public sectors subject to public scrutiny, where necessary[41]. Thus, effective governance by such regulatory authorities will ensure that these companies are made well aware of the concerned laws and will act as a guarantee to the company that these laws will not prospectively be amended to the detriment of the company after the undertaking begins.
In order to ensure this, most investment policies globally are drafted with a clause of stabilization[42] which provides an inherent security to foreign investors against any possible changes in the laws and rules in force by the legislation. Governance through this clause guarantees protection in regards to specific laws that would affect the rights of the investor, including custom duty regulations. The clause usually means that amendments to these laws will not have any retroactive consequences on the project, as was reiterated in the case of IDBI Trusteeship Services Ltd vs Hubtown Ltd[43]. In certain countries, the clause states that once the investment is active, the company shall only benefit from the rights acquired under the federal laws in force for the duration of the undertaking[44].
Thus, this function of policy governance is also to ensure that when a policy rule is to be amended or added, this is done with consultation from the foreign investor and other concerned stakeholders in such projects so that these rules do not create unintended consequences for the investor[45]. Thus, the policy rules and processes will take effect in a way that the objectives in its preamble are met, while capital costs on investors are minimized in the long run. This solves the issue that when governance is left to the judiciary or other administrative bodies, bureaucracy adds additional burdens of cost from delays, especially for small-scale companies[46].
Other basic steps of governance that have been adopted in developing countries such as Tanzania include the codification of rules of enforcement, a strict interpretation of these rules in case of disputes, effectively managing records of any proposed changes in the conditions, and to regularly review all activities in terms of ownership and exercise of control under the policy[47]. Further, the information on steps taken in this governance which could impact the terms of the investment made must be made accessible to the company as well, especially with regards to ownership and limits of control, taxation, incentives and concessions, and CSR norms.
An example of a universally accepted structure of policy governance is seen in the UK Pension Protection Fund[48] where the Statement of Investment Principles provides detailed rules for the structure of governance including the duties and roles assigned under the policy to an investment committee, the allocation of assets and liabilities by the committee, and the responsibilities and authority vested in external advisors and financial custodians.
Conclusion:
Effective governance becomes necessary so that the credibility of financial institutions within the country can be strengthened and policy responses can suit existing economic conditions[49]. This also arises due to poor enforcement of existing legislations, primarily dealing with the system of taxation in the country and the poor functioning of courts of law and the judiciary. This could also be affected by the extent of political control which delays processes due to severe red tape[50].
While understanding the changes made to the investment policy of India in 2020, it is clear that India has taken an aggressive interpretation of protecting national interests at the cost of a discriminatory provision. But, the reason for this is evident and well-explained against international standards. To prevent exploitation of financially affected industries during times of economic distress, the government has to adopt provisions that regulate international approval. But, apart from this, it is clear that while India’s investment policy has provisions that create an encouraging environment for foreign investors, but fails to keep constant checks on the quality of FDI especially in carrying out the objective of national and economic development. With the policy reviews and recommendations put forth by global bodies like the UNCTAD which deal with extensive coverage, better independent regulatory authorities, and the more stringent enforcement of rules and regulations in these policies, especially in developing countries like India. An important objective of most national policies in transitioning economies is to prioritize certain sectors where most development would be needed such that focus can be placed on local and domestic private industries through foreign investors, primarily transnational corporations. But, while inviting such companies, the regulatory authorities have to ensure that their business models have policies that focus on legal compliance with social and environmental laws[51].
[1] UNCTAD, “The Universe of the Largest Transnational Corporations”, 2007, Geneva: United Nations
[2] McCobb, Derrick, “Having a Strong Investment Policy”, April 2014
[3] UNCTAD study, “Laws that Cover the Basic Legal Framework for Investment”, Special Issue, 2016
[4] UNCTAD, “The Financial Crisis in Asia and Foreign Direct Investment: An Assessment”, 1998, p 101
[5] The Second Five-Year Economic Plan of 1956-1961
[6] Foreign Exchange Regulation Act
[7] Eden, Lorraine and Maureen Appel Molot, “Insiders, Outsiders and Host Country Bargains”, 2002, Journal of International Management, 8th edn, p 359
[8] UNCTAD, “World Investment Report 1993: Transnational Corporations and Integrated International Production”. 1993, New York: United Nations
[9] ibid
[10] Chaminade, Cristina, Davide Castellani, and Monica Plechero, “The Emergence of China and India as New Innovation Power House – Threat or Opportunity?”, 2014, Globalisereings forum Rapport, 6th edn
[11] Foreign Investment Promotion Board
[12] Foreign Exchange Management Act
[13] Chaminade, Cristina, Ed, “Technology-Driven FDI by Emerging Multinationals”, 2015, Project Report and Global Challenges Project, Lund University
[14] BIT is defined as an trade agreement between two countries to specify the conditions for investments into each other’s private sectors – icsid.worldbank.org
[15] National Economic Policy, 1991
[16] Bhaduri, Amit and Nayyar, Deepak, “The Intelligent Person’s Guide to Liberalization”, Penguin Books, New Delhi, 1996, p 48
[17] Bhaduri, Amit and Nayyar, Deepak, “The Intelligent Person’s Guide to Liberalization”, Penguin Books, New Delhi, 1996, p 53
[18] S. Chaudhuri, “Debates on Industrialization: The Indian Economy and Major Debates Since Independence”, TJ Byrnes Edn, Oxford University Press, 1979
[19] “Outward FDI is the flow of capital from a domestic company which carries out expansion of its operations into a foreign country through an acquisition or merger” – As defined by FDI India, Foreign Investment Facilitators
[20] The Economic Times, July 1, 2003 – “Guidelines under the Investment Policy”
[21] Export Earners Foreign Currency
[22] It is the process of converting foreign assets, usually currency into local currency, especially during international trade and foreign investments – https://www.investopedia.com/terms/r/repatriation.asp
[23] Bhattacharya.B and Palaha, Satinder, “Policy Impediments to Trade and FDI in India”, Indian Institute of Foreign Trade, 1996
[24] RBI Press Notification, no. 2000-2001/1225, March 2, 2001
[25] RBI Annual Report, 1999-2000
[26] Kumar, Nagesh, “Globalization and the Quality of Foreign Direct Investment”, 2002, Oxford University Press
[27] Report of the Steering Group on Foreign Direct Investment, Planning Commission, Government of India, New Delhi, 2002
[28] Foreign Investment Promotion Board, 1991
[29] Annex III of Statement on Industrial Policy, 1991
[30] Annexure to the Manual on Industrial Policy and Procedures in India, Secretariat of Industrial Assistance, Government of India, August 2001, www.nic.in/indmin
[31] Annex II of Statement on Industrial Policy, 2001
[32] ibid
[33] Report of the Steering Group on Foreign Direct Investment, Planning Commission, Government of India, New Delhi, August 2002
[34] Cabinet Committee on Foreign Investment
[35] Manual on Industrial Policy and Procedures, Secretariat of Industrial Assistance, Ministry of Industry, Government of India, 2001, www.nic.in/indmin
[36] World Bank, “A Better Investment Climate for Everyone”, 2005, World Development Report, New York and Oxford University Press
[37] CFA Institute, “Elements of an Investment Policy for Investors”, 2010
[38] Gestrin, Michael and Ana Novik, “Multinational enterprises and the Shifting Global Business Landscape”, 2015, The E15 Initiative Second Task Force Workshop on Investment Policy
[39] Criscuolo, Paola and Rajneesh Narula, “Using Multi-hub Structures for International R&D: Organizational Inertia and the Challenges of Implementation”, 2007, Management International Review, edn 47, p 639
[40] UNCTAD, “Promoting Investment and Trade: Practices and Issues”, 2009, Investment Advisory Series, vol 4, Geneva
[41] Foreign Investment Advisory Service, “Transforming the Tanzania Investment Center into a Service-Oriented Investment Promotion Agency”, 1998, unpublished report
[42] UNCTAD Investment Policy Monitor, “A Widespread Tool for the Promotion and Regulation of Foreign Investments”, Special Issue, 2016
[43] Civil Appeal No. 10860 of 2016
[44] Côte d’Ivoire National Investment Policy
[45] UNCTAD, “World Investment Report: Trends and Determinants”, 1998, Geneva, United Nations publication No. E 98
[46] ibid
[47] Services Group, “Tanzania Investor Roadmap: Final Report”, 1999, Virginia, PriceWaterhouse Coopers
[48] Governance Section of the Pension Protection Fund, 2020, UK
[49] Eden, Lorraine, Stefanie Lenway, and Douglas Schuler, “From the Obsolescing Bargain to the Political Bargaining Model”, 2005, Ed. Robert Grosse, Cambridge University Press
[50] Dunning, John H, “Governments and multinational enterprises: from confrontation to cooperation?”, 1993, Multinationals in the Global Political Economy, Macmillan, London, p. 82
[51] The Economist, 2011, “International Investments – The Commercial and Philanthropic Perspective”
YLCC would like to thank Dylan Sharma for his valuable insights in this article.
