Apr 26, 2020

Ring Fencing India’s Foreign Direct Investment Framework

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COVID-19 which has been declared as a pandemic by W.H.O, while causing a havoc on human life across globe, has also deeply impacted economies across borders. The alarm caused by pandemic, hit Indian Stock Exchanges hard, and saw a drop of more than 20-30% in just couple of trading days while marginally recovering in last week or so. The turmoil has resulted in a majority of listed entities trading at their yearly low price besides creating huge cash crunch for start-ups and unlisted firms.  

While the world continues to fight against the COVID-19 pandemic, business wise, it presents a great opportunity for investors with big pockets, to acquire or takeover businesses with future potential while they are vulnerable as they either trade at their lowest price or are cash starved.

In order to prevent Indian businesses from such opportunistic takeovers or acquisitions, the Government of India has ring fenced the Foreign Direct Investment (“FDI”) provisions vide Press Note No. 3(2020) dated April 17, 2020 (“PN”).

It is important to note that India is not the only country, which has proposed tightening of its foreign investment norms, various other countries like Australia, Spain, Italy, Canada etc., have also taken such protectionist measures.

What is Foreign Direct Investment

As per the Foreign Exchange Management (Non-debt Instruments) Rules, 2019  (“Non-Debt Instrument Rules”) which were notified by Ministry of Finance in supersession of Foreign Exchange Management (Transfer of Issue of Security by a Person Resident outside India) Regulations, 2017 (“RBI FDI Regulations”), FDI means investment through equity instruments by a person resident outside India in an unlisted Indian company; or in ten per cent or more of the post issue paid-up equity capital on a fully diluted basis of a listed Indian company.

While in case of unlisted entities, any investment by non-resident will be treated as FDI but in case of listed entities, only investment beyond 10% on a fully diluted basis, shall be treated as such.

What are the existing norms:

As per the current FDI norms, a Person resident outside India is eligible to subscribe, purchase or sell equity instruments of an India company under the following routes:

Automatic Route Government Route Hybrid route
Under this route, Indian company engaged in specified business activities can take investment from non-resident investor without the approval of Government of India. Under this route, all proposals for investment by non-resident investors will require approval of specified authority. Under this route, investment by non-residents upto certain specified percentage of capital of an Indian company is allowed without any approval and thereafter with requisite approval

Further a person who is a citizen of Bangladesh or Pakistan or is an entity incorporated in Bangladesh can’t make any investment in any sector without the prior government approval. Further a citizen of Pakistan or an entity incorporated in Pakistan cannot invest in defence, space, atomic energy and sectors or activities prohibited for foreign investment even through the government route.

What are the proposed changes:

Vide PN, the Government of India has extended the restrictions applicable on a citizen or entity incorporated in Bangladesh or Pakistan with respect to FDI in India, to the neighbouring countries, which share land border with India. Accordingly, in addition to Pakistan and Bangladesh, a citizen or entity incorporated in countries like China, Afghanistan, Nepal, Myanmar and Bhutan cannot make FDI in India without prior approval of Government of India. Such restriction also extends to an entity of a country, the beneficial owner of whom is situated in or is a citizen of neighbouring countries, which share land border with India.

Further proposal to acquire shares or any convertible instrument of any Indian entity from resident or a non-resident, directly or indirectly, resulting in the beneficial ownership falling within the restriction/purview of the aforesaid para will also require Government approval.  

Who is a Beneficial Owner:

The Non-Debt Instrument Rules doesn’t define the terms ‘Beneficial Owner’. In general terms, a beneficial owner is a person who enjoys the benefits of ownership even though the title to some form of property is in another name. The Government needs to clarify the manner in which the beneficial owner will be ascertained otherwise this will certain doors open for investment.

In essence, the objective to cover beneficial owner, is to bring in ambit the ultimate person, who enjoys the benefit of ownership over any investment.

Whether changes are effective now?

The PN mentions that the changes will come into effect from the date of FEMA notification. Accordingly, the Government has notified Foreign Exchange Management (Non-debt

Instruments) Amendment Rules, 2020 vide notification dated April 22, 2020, which amends the Non-Debt Instrument Rules to provide for the changes in FDI regime as proposed by the PN. So, until April 22, 2020, any FDI by citizens of or entities incorporated in countries sharing land borders with India except Pakistan and Bangladesh, in sectors under automatic route was allowed without any Government approval.

Until notification of Non-Debt Instrument Rules, there was already controversy surrounding FDI provisions, since it was governed by two parallel set of documents i.e. Foreign Exchange Management (Transfer of Issue of Security by a Person Resident outside India) Regulations, 2017 notified by RBI and Consolidated FDI Policy issued by Department of Industrial Policy & Promotion.

With the notification of Non-Debt Instrument Rules in supersession of RBI FDI Regulations, one would have thought that Non-Debt Instrument Rules shall be the way forward, so far as FDI provisions are governed but the Government has once again, caused confusion by amending the Consolidated FDI Policy first and then the Non-Debt Instrument Rules, to introduce the restriction on investment through PN.

Impact of changes in FDI Policy on existing investment proposals

The changes proposed by the Press Note once notified, will have the following implications in case of investment obligations/proposals involving citizen of, or entity incorporated in or the beneficial owner of an investment into India by a citizen of, any neighbouring country which shares land border with India.

  1. Obligations arising out of Agreement: All investment obligations arising out of existing agreements will require approval of the Government of India
  2. Conversion of convertible instruments into equity: Conversion of existing instruments Compulsorily Convertible Preference Shares or Compulsorily Convertible Debentures, into equity shares will not require any approval, since the right to equity shares was created at the time of issuance of the convertible security
  3. ESOP: The existing ESOP’s held by citizen of any neighbouring country which shares land border with India, can be exercised by such persons since as per the Non-Debt Instrument Rules, in case of ESOP being issued in sector, which require Government approval, such approval must be obtained before issuance of ESOP. Considering the same, exercise of such ESOP will not require any Government approval.
  4. Further issue of any fresh ESOP’s to citizens of neighbouring countries as covered by the PN, will require approval of the Government.

  5. Ongoing private placement or rights issue: Ongoing fund-raising exercise like private placement or rights issue, where application money has already been received, will not be impacted with changes proposed in the Press Note.
Other Investment Modes:

While the under the route of FDI is subject to Government approval, investor from countries like China etc., can still make investment in India through the following routes

Investment as Foreign Portfolio Investor:

A FPI registered with SEBI may purchase or sell equity instruments of an Indian company listed or to be listed on a recognised stock exchange in India provided that the total holding by each FPI or an investor group, shall be less than 10 percent of the total paid-up equity capital on a fully diluted basis or less than 10 percent of the paid-up value of each series of debentures or preference shares or share warrants issued by an Indian company

Investment in units of Investment Vehicle

A person resident outside India (other than a citizen of Pakistan or Bangladesh) or an entity incorporated outside India (other than an entity incorporated in Pakistan or Bangladesh) may invest in units of Investment Vehicles like REITS, InvITs in accordance with the regulations framed by SEBI.

Process of obtaining approval for FDI proposals:

Department for Promotion of Industry and Internal Trade (“DPIIT”) is the nodal agency for filing application in connection with the FDI proposals requiring the approval of Central Government. DPIIT will identify and will transfer the application to the concerned Administrative Ministry/ Department, if any.  Proposal for investment in sectors requiring security clearance shall be forwarded to by Ministry of Home Affairs. In case of proposals involving total foreign equity inflow of more than INR 5000 crore, Competent Authority shall place the same for consideration of Cabinet Committee on Economic Affairs.

Approximate time involved in processing of application is around 12-15 weeks. But as per media reports, DPIIT may fast track application received from China and will try to process same in shorter period of time where the investment is in non-sensitive sector or stake proposed to be acquired is not significant.

Which Countries will be hit hard

FDI proposals from Pakistan and Bangladesh were always subject to approval of Government of India. The current changes intend to extend the aforesaid restrictions to countries like China, Bhutan, Afghanistan and Myanmar.

While India would have hardly seen any investment from countries like Bhutan, Afghanistan and Myanmar, the biggest fall out of this decision will be felt by China and in real sense, the whole objective of current changes is to actual restrict the flow of money from China to India.

It is also important to know that as per reports released by DPIIT, Mauritius and Singapore still continue to dominate the list of top FDI contributors but if one looks into detail the actual flow of money from these countries, China would appear as the major source. This is also evident from the fact that Chinese investors have invested in 18 of India’s 30 Unicorns. But investors such China can still continue to invest in stock exchange through the FPI route.


While the growing investment from China in our country was always a matter of concern for the Government of India but due to international obligations, it hesitated from taking a strong decision. The current situation presented a window of opportunity to ring-fence the investment from China.  But considering China, as one of the biggest investors of start-ups in India, with investment in most of unicorns, such an action, will also have wide scale repercussion on the start-up ecosystem in India. Startups will find difficult in coming times to raise funds with all major economies of world grappling due to COVID-19 pandemic. It is also to be seen whether restrictions imposed by the Government of India are a temporary measure or a permanent policy decision. 


Mr. Ankit Singhi

Head of Corporate Affairs & Compliances



+91 9910888952

Mr. Nitesh Latwal

Associate Partner



+91 11 40622249

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