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China Cries Foul Over India’s Revised FDI Rules
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China Cries Foul Over India’s Revised FDI Rules

In light of the economic outlook during the COVID-19 outbreak, the availability of credit in the market will decide the sustainability of a country. India has taken caution to combat “opportunistic takeovers/acquisitions” by tightening its foreign direct investment (FDI) rules for all border-sharing nations. This has particularly affected China, due to its major role in the Indian market as compared to other neighboring states. On April 17, the consolidated FDI Policies were revised. An earlier provision stated:

A non-resident entity can invest in India, subject to the FDI rules except in those sectors/activities which are prohibited. However, a citizen of Bangladesh or an entity incorporated in Bangladesh can invest only under the Government route. Further, a citizen of Pakistan or an entity incorporated in Pakistan can invest, only under the Government route, in sectors/activities other than defense, space, atomic energy, and sectors/activities prohibited for foreign investment.

This provision permitted a non-resident to invest in FDI without prior government approval or under an automatic route. The revised position has two changes:

  1. All the seven border sharing countries of India now require government approval, which shuts down the automatic route for China, Pakistan, Bangladesh, Myanmar, Bhutan, Nepal, and Afghanistan.
  2. If there lies an investor who is permitted to invest in India through FDI under automatic route but the “beneficial owner” belongs to any of India’s neighboring countries, in such cases prior government approval is also required. It extends the impact of this Press Note beyond the border sharing countries. In all likelihood, the definition of “beneficial owner” will be drawn from the Companies Act and the Companies (Significant Beneficial Owners) Rules and affect deal exits and transfers of ownership. Exit and transfer might be impacted as far as the transfer results in the transferee becoming a shareholder in an Indian company and such transactions could require government approval as well. There is no clarity in determining whether the beneficial owner is the significant beneficial owner (per the rules) or not and it should be further clarified by the government.

A Protectionist Measure

The decision was made just days after the People’s Bank in China (PBoC) raised its stakes in India’s largest non-banking mortgage provider (HDFC) by over one percent. In addition, the center has blocked the indirect acquisition of investments by entities based in China. The new rules will also apply to all the existing and planned investments by foreign firms in Indian businesses.

Impact on Chinese Funded Companies

The change in the FDI rules was a timely decision to prevent any kind of hostile takeovers. Some experts say that the government could look at a blanket ban on the automatic route, not just for the neighboring nations, and others suggest how naming some specific sectors would have been a better option as it would not have impacted overall FDI flow in India. Top Indian start-ups, such as Big Basket, Ola, and Paytm, could become collateral damage as they are funded by Chinese players who could be deterred by the new rules. Eighteen of India’s thirty “unicorn” start-ups are Chinese funded. Fresh investments from these companies will now face additional scrutiny. Removal of the automatic route could increase approval time and lengthen the timelines of the deals going forward. This could also force such start-ups to look elsewhere for funding. Due to the lockdown, the operational requirements of the start-up Big Basket were not met, therefore Alibaba had to provide $50 million in funding. The revised FDI rules may force a company to look for other options for meeting funding requirements. Similarly, Indian company Flipcart has about five percent of its investment from Tencent; Paytm raised $1 billion from Japan’s SoftBank and Alibaba’s Ant Financial; Zomato is backed by Chinese venture capital, which will be severely impacted by the revised rule. In a competitive market where a company needs more investments to remain in the market, the new rules can stifle the growth of the company.

Apart from the start-ups, the new rules might also impact other sectors. For example, the Chinese company Fosun acquired Indian Gland Pharma for $1.1 billion in 2018. This accounted for almost eighteen percent of Chinese FDI into India. This is inclusive of the $300 million investment by MG Motors. Companies such as Xiaomi have also come to India via the FDI route. Similar restrictions can also be imposed on External Commercial Borrowings (ECB) from these countries in the future. These revised rules can impact the investment in processing these deals as well.

With the US and European economies taking significant hits from the spread of the coronavirus, foreign investors might look for other places to invest where there are lower production and operational costs and fewer restrictions. India may be a perfect fit if it matches the high paced manufacturing in Special Economic Zones (SEZ) and free trade zones.

Is China’s Cry of Foul Justified?

China protested against these changes in FDI policies and claimed India violated WTO Principles of non-discrimination. The Chinese Embassy stated:

The additional barriers set by Indian for investors from specific countries violates WTO’s principle of non-discrimination and goes against the general trend of liberalization and facilitation of trade and investment. We hope India would revise relevant discriminatory practices, treat investments from different countries equally, and foster an open, fair and equitable business environment.

The tweaking of the FDI rules of India did not violate WTO principles, as there exists no agreement directly in relation to Foreign Direct Investment in the WTO. Article 1 of the Agreement on Trade-Related Investment Measures (TRIMs) states that it is applicable to investment measures related to trade in goods only, which rules out any connection to the revised FDI with WTO. As the revised rules do not directly affect goods, put caps on equity, restrict market access, or place restrictions on specific nations, they are not in violation of any WTO agreement. It only proposes another route for FDI, which is for India to protect its companies from hostile acquisitions or takeovers by China. India is protecting its industry and is well within its right to do so, just like Australia, Germany, and the European Union have recently tightened their investment rules.

Conclusion

The global pandemic of Covid-19 has raised concerns of the global economic recession. As a protectionist approach, India has altered its FDI rules to curb hostile takeovers from its border-sharing countries by closing the door to automatic investments for all such countries and mandating government approval. No open reference to any discrimination is made amongst these countries but the focus of this regulatory change is undoubtedly China. It will be interesting to see how India will tackle and regulate the uncertainty of investments from China in coming future after revised FDI rules. Big Indian corporations like Tata and Adani have huge investments in China and the annual revenue of Indian companies in China ranges from three to twenty percent of the global total. Bilateral investment relations are the key to trade for India. These investments will be affected in the near future, but to what extent is yet to be seen. India has taken a defensive approach while dealing with FDI due to the coronavirus pandemic but is only a temporary measure and what its impact after the pandemic will be can only be answered in the future. A major portion of start-ups are dependent upon China’s investment and China’s urge to revise the rules clearly shows that these start-ups will be affected in the future. There have been different reactions to the rule changes, which mostly portray the need for a check on FDI from China.

 

Ankana Mukherjee is a final-year law student at the National Law University in Lucknow, India.

 

Suggested Citation: Ankana Mukherjee, China Cries Foul Over India’s Revised FDI Rules, JURIST – Student Commentary, May 5, 2020, https://www.jurist.org/commentary/2020/05/ankana-mukherjee-fdi-rules-india/.


This article was prepared for publication by Gabrielle Wast, Assistant Editor for JURIST Commentary. Please direct any questions or comments to her at commentary@jurist.org


 

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