FEMA

FDI Policy in India – A Complete Analysis

When a foreign entity takes ownership in a business entity situated in another country it is known as FDI. It is also known as ‘Inbound investment’. FDI Policy in India allows a foreign entity to participate in the day-to-day working of the business entity in the other country. It leads to the economic development of the country as the foreign entity brings wealth, technology, and knowledge to the country. It also creates jobs in the country. It bridges the gap between domestic savings and investments. In this blog, we will discuss FDI Policy in India.

FDI In India

FDI is a significant non-debt financial source for the development of an economy. These investments have been on the rise in India because of the government’s policy framework, vast resources, economic influence, and global competitiveness.

The nodal department for the formulation of policies on Foreign Direct Investment (FDI) is the Department for Promotion of Industry & Internal Trade (DPIIT) under the Ministry of Commerce and Industry. Based on the remittance report framed by the Reserve Bank of India (RBI), DPIIT maintains a track record of all the inward FDI into India.

How were the FDI Policies developed in India?

FDI is generally made in open economies which have growth prospects, skilled workforce, and fewer entry barriers. Before the LPG Reform, FDI in India was low and limited to a few sectors only. As India had just become independent, there was fear in the mind of Indians to open up the economy for foreign capital due to the previous exploitation. In 1990, India suffered from a huge financial crisis. The inflation rates were high, political instability reduced the international credit of the country. The foreign exchange went so low that it was difficult to pay even for a week’s imports.  Thus, the FDI growth in India was stunted.

After the LPG Reform in 1991, India liberalized the process of foreign investments with the help of the International Monetary Fund & World Bank. Policy changes were made to make India an investor-friendly destination. Even after the policy changes, many sectors were kept outside the purview of FDI and most of the foreign investments came through the government route. There were also gaps between the FDI approved and the actual FDI inflows which narrowed down the FDI Policy in India. India was receiving FDIs but it was far from satisfactory when compared to the global market. The Government kept on making efforts to improve the FDI Policy in India. 

Finally, the Make in India program was launched in 2014. It is a flagship program of the Government to promote investment. It introduced liberal and transparent rules and opened FDI in almost all sectors through an automatic route. This program made substantial accomplishments across 27 sectors including manufacturing and service. Post the Make in India program, FDI inflows rose rapidly. With USD 45.15 billion in 2014-2015 set a record for the highest FDI at USD 83.6 billion in 2021-2022. The key sectors in which FDIs are made include the service sector, IT and software, real estate, automobiles, and pharmaceuticals. For the current financial year I.e. 2022-2023 the FDIs in India are projected to be healthy despite the Ukraine-Russia war, U.S. monetary policy, global recession, and other global issues. Recently India has also rolled out the production-linked incentive (PLI) scheme to attract further investments.

What are the routes through which FDI can flow in India?

There are four routes through which FDI can flow into India. They are:

Category 1- 100% FDI is permitted through Automatic Route.

Category 2- 100% FDI is permitted with Government Approval.

Category 3- FDI beyond a specific limit requires Government Approval.

Category 4- FDI is permitted under both routes subject to a limit.

Sectors that fall under Category 1 are:

• Civil Aviation Services
• Thermal Power
• Medical Devices
• Insurance
• Petroleum Refining
• Railway infrastructure
• Ports and Shipping
• Power Exchanges
• Infrastructure in the securities market

Sectors that fall under Category 2 are:

• Food Products Retail Trading
• Core Investment Company
• Mines and Minerals
• Print Media publishing or printing scientific and technical magazines and a facsimile edition of foreign newspapers
• Satellite establishments and operations
• Broadcasting content services

In what sectors is FDI completely prohibited?

As per Regulation 15 of the Foreign Exchange Management (Transfer/Issue of Security by a Person Resident outside India) Regulation, 2017 the following activities are completely prohibited from receiving FDI:

• Lottery Business including Government/private lottery, online lotteries
• Gambling & betting including casinos
• Chit funds
• Nidhi company^[1]
• Trading in Transferable Development Rights
• Real Estate Business/Construction of Farm Houses.
• Manufacturing of Cigars, cheroots, cigarillos & cigarettes, of tobacco/tobacco substitutes
• Activities/sectors not open to private sector investment e.g. Atomic energy & Railway operations
• Foreign technology collaboration in any form including licensing for franchise, trademark, brand name/management contract is also prohibited for Lottery Business & Gambling & Betting activities

Further, the FDI Policy in India, 2020 also prescribes that an entity of a country that shares borders with India or where the beneficial owner of the investment into India is located in a country sharing its borders with India can invest only through the government route. Even the case of transfer of ownership which benefits a country that shares with India requires Government approval. Earlier the FDI Policies covered only bordering countries like Pakistan and Bangladesh; however, the revision in FDI Policy in 2020 also brought China under the government route.

Government measures to increase FDI

• The FDI Policy in India (2019) permitted 100% FDI through automatic routes in coal mining activities. As India has abundant coal mining resources, the FDI inflow rose.
•   In addition to the 100% FDI in manufacturing via automatic route, the Government in 2019 also allowed entities engaged in contract manufacturing to invest 100% through automatic route.
• The Government allowed 26% FDI in digital sectors which is the most developing sector at present.
• The Government has made FDI easy by reducing the procedural aspect. There is only one single-point interface to facilitate investment and that is the Foreign Investment Facilitation Portal (FIFP). The FIFP is administered by the Department for Promotion of Industry and Internal Trade, Ministry of Commerce and Industry.
• As discussed earlier, the government has also launched the production-linked incentive (PLI) scheme in 2020 for electronics manufacturing for attracting FDI.
• Further, FDI is expected to increase as the government has allowed investment in private train operations and bid out airports.
• Schemes like Gati-mapped land bank, PM Fati Shakti, etc are also expected to boost FDI inflows in India.
• In May 2020, the government enhanced the FDI limit under the automatic route from 49% to 74% to attract large investments.
• In 2021, UK and India have entered into a bilateral bond to boost investment via an Enhanced trade partnership.
• The Government increased the FDI limit from 49% to 100% in the telecom sector and up to 74% in the insurance sector.

What are the merits of having an FDI Policy in India?

The following are the merits of having an FDI Policy in India:

• It attracts non-debt financial resources for economic development.
• With FDI come new technologies, skills, knowledge, and opportunities.
• It makes the business environment more competitive.
• The standard of living and quality of products and services increase.
• It supplements domestic growth and investment.
• It boosts foreign relations among nations.

What are the demerits of having an FDI Policy in India?

The following are the demerits of having an FDI Policy in India:

• It adversely affects domestic companies and domestic investment.
• Small companies may not be able to compete with MNCs. The risk of shutting down as a risk of increased FDI arises.
• The exchange rates of the country might be affected.
• The demand for international goods and services rises and that for domestic goods and services goes down.
• It erodes the existing culture of a nation by bringing in a new culture.

Conclusion

FDI is an important facet of non-debt financial investment in a country and is a source of economic growth. Therefore, a robust and easy FDI policy should be promoted. Just as India’s FDI Policy has made FDI in India easy and a one-step process. An easy and liberal FDI policy results in higher investments just as India witnessed after amending its policies in recent years.

Also Read: FDI Compliances in India: A Complete Overview