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Analysis on Types of Foreign Investment in India: FPI, FDI and FI

Varun Hariharan

| Updated: May 02, 2020 | Category: Finance Business, Foreign Investment

types of foreign investment

Overview of Investment in India

The government of India has brought out various modes of foreign investment through which an individual or a company can invest in. These types of foreign investment would have specific requirements related to compliance with the laws of the land. Apart from this, various authorities also have control over the amount of foreign investment that comes into a country. Ever since the liberalization of markets in 1991, the amount of foreign investment in India improved at a rapid pace. In 1991, the Controller of Capital issues (CIC) was repealed. After this move, the markets opened up to foreign investments from foreign institutional investors and Non-Resident Indians. This move was the major eye-opener for the markets to develop.

Foreign companies established their footprints in India either by setting up branch offices and representative offices. These moves by foreign companies increased the gross domestic product of the country. It also promoted healthy competition amongst domestic companies and international companies. All the types of foreign investment in India have contributed to the development of foreign exchange reserves in the country. Over the years, the types of foreign investment have grown into different forms of capital contribution to the economy.

According to the International Monetary Fund (IMF), the Gross Domestic Product of India has risen to 7%. Sources say that this percentage is supposed to remain constant.  In the year 2017-18, the GDP of India was steady at 7.4% and 2018-19; the GDP reduced to 7.3%. The effect of COVID-19 has drastically reduced the amount of economic activity in India. The government of India has brought out stringent changes in the Foreign Direct Investment Route in India due to the lockdown.

Neighbouring countries that share borders with India are supposed to take approval under the government route before investing in particular sectors. This was a radical change due to the increased ownership percentage in HDFC by Peoples Bank of China[1]. Sources say that the gross domestic product was supposed to be more than 7%. However, the effect of COVID-19 has significantly reduced this chance of reaching the minimum average GDP.

However, the Government of India has taken different measures to improve GDP. Some of the actions taken are the implementation of Goods and Services Tax (GST). Apart from this, another step taken by the Government of India is the introduction of Insolvency and Bankruptcy Code (IBC), which has been of vital significance to the case progression of bankruptcy cases. These measures have improved the amount of GDP in the country. Added to this is the amount of foreign exchange that is brought into the country. Through these measures, the Government of India can keep the GDP at a stable rate.

Since the liberalization of the markets in India, there has been a significant outflow of funds from India. Because of this, foreign reserves have reduced in India and only increased the importing patterns of the country. However, this has changed over the years. India is one of the attractive destinations for foreign investment. There are a vast amount of options and alternatives given to foreign investors to invest in India. The types of foreign investment in India are the following:

Types of Foreign Investment

  • Foreign Direct Investment (FDI) – This is the primary mode of foreign investment in the country. Foreign Institutional investors/Non-resident Indians and foreign partnerships can invest through this mode. This is considered as the basic form of inward remittance into the country.  Apart from organizations, this form of investment is used in Private Equity and Venture capital transactions in the country.
  • Foreign Portfolio Investment (FPI) – Foreign Portfolio Investment is a form of investment that represents a portfolio. A portfolio is considered as a combination of different amount of securities. Foreign Portfolio Investment is, therefore, an investment in the amount of securities which has some form of regulation.
  • Foreign Investment (FI) – Foreign Investment is different from FDI and FPI. This form of investment is done by an individual resident outside India in the capital instruments of an Indian Company or the capital instruments of a limited liability partnership. The investment is made on a repatriable basis. This means foreign investment can be shifted back to the home country.
  • External Commercial Borrowings (ECB) – External Commercial Borrowings are commercial loans raised by Indian corporate and public sector undertakings. These companies prefer ECB as the mode of investment as these offer varied advantages compared to the loans offered by domestic banks. The amount of interest charged on an ECB is low and has a maturity period according to the end-use of an ECB. ECB can be used for various purposes. Foreign investment can be raised through an ECB.
  • Investments which are made by Non-Resident Indians- Non-residents can invest in India. This is something similar to the FPI. Non-resident Indians can invest in the portfolio of securities in India.

The above types of foreign investment help India to improve the amount of foreign exchange reserves. However, the types of foreign investment in India keep developing at a rapid pace. The government of India has taken initiatives to make more alternatives in the types of foreign investment which are allowed for a foreign investor in India.

Foreign Portfolio Investment (FPI) – Types of Foreign Investment

A foreign portfolio investment is a foreign investment which is done in a pool of securities. These securities would be regulated under the Companies’ Act 2013, Foreign Exchange Management Act 1999, and the Reserve Bank of India. This form of investment is made through foreign investors in securities that are listed in the stock exchange. Apart from this, investments can be made in other securities. This framework is considered as the FPI framework. This framework is regulated by the securities exchange board of India (SEBI). SEBI is the primary authority for controlling the securities market in India. Therefore Foreign Portfolio Investment (FPI) would come under the purview of SEBI.

According to the Securities Exchange Board of India (Foreign Portfolio Investment) Regulations, 2014, the license for FPI registration can be obtained through the following procedure:

An investor to invest in Foreign Portfolio Investment has to make an application to the concerned authority. This application has to be made in the format as required. The applicant has to also submit the prescribed documents to the authority. This method is necessary to obtain the FPI Licence.

After this step, the Designated Depository Party (DDP) acts as a local custodian of the SEBI would scrutinize the application for being registered as an FPI. After examining the application, the DDP would grant a license to the applicant to be a registered FPI.

The application is made in a particular format. Based on the background of risk that is taken by the investor, the following would be the categories which the investor can consider for the investment:

  • Category I- Here the type of agencies includes government institutions, sovereign wealth funds, international and central banks.
  • Category II- Here, the kind of institutions or agencies include asset management companies, investment funds,  managers who maintain portfolio, banks, pension funds, and other funds which are regulated.
  • Category III- Investors who are not covered either in category I and Category II would come under this category. It would include HNI, individual investors, bonds which are held by families and corporate would be included in this category.

Compliances which have to be followed by an FPI- Types of Foreign Investment in India

There are compliances with all types of foreign investment in India. Like the types of foreign investment in India, an FPI also has to comply with the laws laid down by authorities. When an applicant or an entity wants to invest in foreign portfolio investment, then the applicant must obtain the necessary license and registration.

Apart from this, the FPI applicant has to open bank accounts in its name. It also has to open a bank account for depository purposes. For this, the FPI applicant would need to provide the necessary documentation (FPI form and other documents) to the bank to carry out the process of opening a bank account.

The investors who come from Category II and Category III require information on the executives of the company. A natural person’s information would be provided for identifying the individual as the Beneficial Owner (BO) of the FPI.  The information regarding the BO must be provided to the local custodian.

An FPI can invest in securities that can be transferred, such as equity, preference shares, bonds, derivatives of mutual funds. However, these securities have to be registered in the Indian Capital Markets. As long as compliances are followed, an investment in the above securities can be made. There are restrictions applicable to all types of foreign investment in India. Before applying or investing in types of foreign investment in India, the investor has to be compliant with the regulations.

When it comes to equity securities, an FPI is only permitted to invest in listed equities. Investment, which is made by a pool of FPI, should not exceed 10%. This means that a foreign portfolio investor should not invest more than 10% in a listed entity. The investment should not be more than 10% of the paid-up capital of the listed entity.

For a private sector bank, the amount of percentage is limited to 5%. If such control would go more than 10%, then the foreign portfolio investment would be converted to foreign direct investment, and it would come under the authority and regime of the RBI. Hence different types of foreign investment have certain compliances to be followed.

When these forms of investments are made in debt securities, then a different approach is taken.  The RBI governs investment by an FPI in debt security. In 2018 the RBI brought out an amendment that affected the investment by an FPI in debt security. Due to this, the amount of investment in debt securities has drastically reduced by an FPI.

A bank account has to be opened by FPI. This bank account is a normal account which is used by resident Indians. The account has to be opened with the authorized dealer/authorized bank. All the investments made either inbound or outbound are made through the authorized dealer/authorized bank.

Proceeds of the sale, which are made in India and outside India, can only be realized once the tax has been paid. Borrowing funds in India is not allowed for an FPI. An FPI cannot earn interest. When it comes to taxation of a Foreign Portfolio Investor, then every FPI is required to obtain Tax Identification. They also have to submit annual returns.

Voluntary Retention Route- Types of Foreign Investment

In a commentary and white paper which was issued by the RBI, the following points were observed:

  • To improve the ease of access to FPIs, the government has taken the effort to relax regulation.
  • With the introduction of the VRR, the FPI would get the benefits of easily entering into the securities and capital markets of India.
  • Apart from this, an FPI would have to retain the investment for a particular period.
  • The minimum period of retention for FPI investment in corporate bonds is three years.
  • During the period of retention, 67% of the investment would be a mandatory investment which has to be maintained.
  • The VRR would be applicable for Foreign Portfolio Investors who want to invest in the corporate or bond market.

Though there are many types of foreign investment in India, the FPI would be considered as a beneficial investment route for foreign investors who target securities in the market. With other types of foreign investment, the government has taken relevant considerations to improve the amount of FPIs in India.

Foreign Direct Investment (FDI) – Types of Foreign Investment

Apart from FPI, Foreign direct investment (FDI) is another investment option which foreign investors use. This option is used extensively by foreign private equity and venture capitalists. The RBI has issued guidelines for foreign direct investment in India. Any form of investment which is done through capital instruments in:

  • An unlisted company; and
  • Or the investment amount is more than 10% in the paid-up capital of the company, which is made on a fully diluted basis.

Fully diluted shares are the shares, which are outstanding shares. These shares would be allowed to be traded in the market after they are converted. Capital instruments are shares, bonds, preference shares and debentures. These instruments have to be compliant with the laws related to Foreign Exchange Management Act 1999.

Routes for FDI- Types of Foreign Investment

  • Automatic Route: There is no requirement for any form of permission under the automatic route. Companies and Partnerships can make foreign investment in the automatic route. This investment can be up to 100%. However, there are certain restrictions for investments that are made in the automatic route. Some restrictions would be related to the percentage of investment considered for the particular route. If an investment is not allowed through the automatic route, then it would be allowed under the approval/ government route.
  • Government Route/ Approval Route- This route is also called the approval route. Under the approval route, prior permission is required from the government for investing in capital instruments. The DIPP (Department of Industrial Policy and Promotion) recently has amended a circular that, neighbouring countries that share borders with India have to consider the approval route/government route. Therefore future investments from neighbouring countries would be subject to more scrutiny.

FDI is one of the types of foreign investment which can be made through the above routes.

Procedure for investing in the Automatic Route- Types of Foreign Investment

  • The applicant has to make an online application has to be made through the Standard Operating Procedure (SOP) forms.
  • This is forwarded to the DIPP.
  • DIPP has to liaise with the other authorities that govern specific areas related to foreign direct investment.
  • DIPP takes consultation with the RBI regarding any form of compliance with Foreign Exchange Management Act 1999.
  • RBI will get back with the compliances related to FEMA.
  • The DIPP would provide clarifications within two weeks.
  • Depending on the area of investment, the approval time may take longer. This would depend on the time in which other authorities take in getting back.

Read our article:Foreign Investment: Compliance under RBI/FEMA

Prohibited areas for Foreign Direct Investment in India- Types of Foreign Investment

  • Lotteries
  • Chit Funds
  • Nidhi Companies
  • Gambling and Gaming
  • Trading in Transferable development rights (TDR)
  • Dealings which are considered as the real estate business/ construction business
  • Automatic Energy
  • Operations in Railway Business

Therefore FDI is one of the types of foreign investment in India. There are various compliances related to Foreign Direct Investment in India.

Foreign Investment (FI) – Types of Foreign Investment

Foreign Investment is an investment made by an individual outside India. The following have to be satisfied for foreign investment:

  • The investment must be made on a repatriable basis; and
  • The investment must be made on the capital instruments of a company or a partnership.

Conclusion

Types of foreign investment in India include- Foreign Portfolio Investment, Foreign Direct Investment, and Foreign Investment. Based on the requirement of the investor, the Government of India has brought out various modes for foreign investment in India. For investing in a Foreign Portfolio Investment, the applicant would require to register with the concerned authority. Apart from this, the applicant has to open a bank account for dealing with remittances. If an investor wants to invest in capital and security markets, then foreign portfolio investment would be a credible option. If an investor wants to invest in a capital instrument in a company, then the foreign direct investment route would be considered. If an investor wants to repatriate the funds back to the investor country and such investment is made in capital instruments of a company, then the investment is considered as a foreign investment. Therefore the types of foreign investments have different compliances in India.

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Varun Hariharan

Varun Hariharan has completed the Legal Practice Course from BPP Law School, Manchester. He has a Masters in Commercial and Corporate Law from the Queen Mary University of London and LLB Honours from Bangor University, UK. He specialises in law related to corporate, artificial intelligence and technology law.

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