Foreign direct investment in industries: policy since 1991

1. Before 1991: restriction

The Industrial Policy Resolutions of 1948 and 1956 reserved key sectors for the State and treated foreign capital with caution. Foreign collaboration was permitted case by case, usually as technical collaboration with minority foreign equity, through approvals of the Foreign Investment Board and the Secretariat for Industrial Approvals, with limits on royalty and duration. The Foreign Exchange Regulation Act, 1973 required most foreign-controlled companies to reduce foreign equity to 40 per cent; some, such as Coca-Cola and IBM, left India in 1977–78. Industrial licensing under the Industries (Development and Regulation) Act, 1951 applied to almost all large investment.

2. The 1991 liberalisation

After the balance of payments crisis of 1991, the Statement on Industrial Policy of 24 July 1991 changed the approach:

• Industrial licensing was abolished except for a short list of industries.
• Automatic approval by the RBI was given for foreign equity up to 51 per cent in a list of high-priority industries (Annex III), subject to conditions on dividend balancing and foreign exchange for capital goods.
• Automatic permission for foreign technology agreements in the high-priority industries, within limits on lump-sum payments and royalty.
• A special board, the Foreign Investment Promotion Board (FIPB), was set up to negotiate with large international firms and approve proposals outside the automatic route.
• FERA was amended in 1993, removing the 40 per cent rule, and replaced by FEMA in 1999.
• Foreign institutional investors were allowed into the stock markets from 1992.

Over the next three decades sector after sector was opened, caps were raised and more sectors placed under the automatic route. In 2017 the FIPB was abolished; proposals under the government route now go through the Foreign Investment Facilitation Portal to the administrative ministry concerned, under a standard procedure of the Department for Promotion of Industry and Internal Trade (DPIIT).

3. The present framework

The legal basis is section 6 of FEMA and the Foreign Exchange Management (Non-debt Instruments) Rules, 2019; the policy statement is the Consolidated FDI Policy issued by DPIIT (the current consolidation effective from 15 October 2020), amended by Press Notes. Where the two differ, the Rules prevail.

Who may invest

A person resident outside India, other than an individual citizen of, or an entity incorporated in, Pakistan or Bangladesh, which need government approval (and in the case of Pakistan, not in defence, space, atomic energy and other sectors), may invest. Non-resident Indians and Overseas Citizens of India have special schemes.

In what

FDI is made through equity instruments: equity shares, fully, compulsorily and mandatorily convertible debentures and preference shares, and share warrants, issued by an Indian company; also capital of LLPs (in sectors allowing 100 per cent automatic FDI) and units of investment vehicles such as REITs and InvITs. Optionally convertible instruments are treated as debt (external commercial borrowings).

By which route

• Automatic route: no prior approval of the Government or RBI; the investee reports to the RBI after the event. Most sectors are now fully or partly under this route, for example manufacturing (100 per cent), single-brand retail trading (100 per cent), telecom services (100 per cent), and defence (up to 74 per cent).
• Government route: prior approval of the administrative ministry, for example multi-brand retail (up to 51 per cent), print media dealing with news and current affairs (26 per cent), defence above 74 per cent, and brownfield pharmaceuticals above 74 per cent.

Prohibited sectors

FDI is prohibited in: lottery business (including government, private and online lotteries); gambling and betting, including casinos; chit funds; Nidhi companies; trading in transferable development rights; real estate business or construction of farm houses (but not townships, construction development or REITs); manufacture of cigars, cheroots, cigarillos and cigarettes of tobacco or its substitutes; and activities not open to private investment, such as atomic energy and railway operations (other than those permitted).

Press Note 3 (2020)

Issued in April 2020, during the pandemic, to prevent opportunistic takeovers of Indian companies: an entity of a country which shares a land border with India, or where the beneficial owner of an investment is situated in or is a citizen of such a country, may invest only under the government route, whatever the sector. Transfers of existing holdings that result in such beneficial ownership also need approval. Its main effect has been on investment from China.

Conditions

• Sectoral caps and conditions (Schedule I of the Rules), including minimum capitalisation, lock-in, security clearance, and local sourcing norms in single-brand retail above 51 per cent.
• Pricing guidelines: issue or transfer of shares to non-residents at not less than fair value, and from non-residents to residents at not more than fair value, to prevent capital flight.
• Reporting to the RBI through the Single Master Form (FC-GPR for fresh issue, FC-TRS for transfers).
• Downstream investment by an Indian company owned or controlled by non-residents counts as indirect foreign investment and must comply with the same caps and conditions.
• Other laws: competition approval for large combinations, sectoral regulators (RBI for banks, IRDAI for insurance, TRAI for telecom), and security clearance in sensitive sectors.

4. Foreign collaboration

“Foreign collaboration” in the Indian policy vocabulary covers both financial collaboration (foreign equity in an Indian company, usually a joint venture) and technical collaboration (licensing of technology, brands and know-how for royalty or fees). Before 1991, both needed approval. Today financial collaboration follows the FDI rules above, and technical collaboration payments are current account transactions freely permitted since 2009–2010 (see the note on technology transfer). A joint venture agreement typically governs shareholding, board composition and reserved matters, transfer restrictions (rights of first refusal, tag-along and drag-along), non-compete clauses, deadlock and exit, and dispute resolution by arbitration. Exit options must respect the FEMA pricing rules: a non-resident cannot be guaranteed an assured return.

How this is examined

For the August 2024 essays: the three periods (restriction, liberalisation, present framework), then the legal basis (FEMA section 6 and the 2019 Rules), the two routes with examples, prohibited sectors, Press Note 3, and the conditions. For “foreign collaboration of investment”: distinguish financial and technical collaboration and explain the joint venture agreement. For the FDI short note: definition (10 per cent threshold), routes, prohibited sectors and Press Note 3.