Foreign Investment in India – FDI and FPI

Syllabus part- Primary and Secondary Markets (Forex, Money, Bond, Equity, etc.), functions, instruments, recent developments.

It refers to the investment from residents, investors or corporation of other countries into India. Foreign capital can help fill the gaps between domestic savings and investment requirements. Government of India classifies the investments made by the foreign bodies based on various factors. The three major types of investments are:

  1. Foreign Direct Investment
  2. Foreign Institutional Investment
  3. NRI Investment

Foreign Direct Investment

These are the investments which are made into the management and production processes of a company. It is an equity based investment which means the company/body investing in the company acquires a piece of ownership in the company.

As per Arvind Mayaram committee report, which defined FDI and FII, foreign investment of more than 10% in a listed public company to be treated as FDI. An investor who invests below 10% can be treated as FDI provided the investor raises the stake to 10% or more within a year of first purchase. But in case the FDI stake drops below 10% it still remains FDI. Foreign investment in an unlisted company is to be treated as FDI irrespective of the stake purchased.

Foreign direct investment policy in India is regulated under the Foreign Exchange Management Act (FEMA) 2000 by the Reserve Bank of India (RBI).

Important Terms Related to FDI are

  1. Inward FDI:  When a foreign country invests in the country in focus.
  2. Outward FDI:  When the home country invests abroad
  3. Greenfield Investment: A green field investment is a type of foreign direct investment (FDI) where a parent company creates a subsidiary in a different country, building its operations from the ground up. In addition to the construction of new production facilities, these projects can also include the building of new distribution hubs, offices and living quarters.
  4. Brownfield Investment: A brownfield investment is a type of FDI in which a company or government entity purchases or leases existing production facilities to launch a new production activity. 

Importance of FDI for Indian economy:

  1. Balances the International Payments: FDI is the major source of foreign exchange inflow in the country. The inflow of FDI is added as ‘credit’ in the capital account of Balance of Payment. It helps in balancing the ‘debits’ from capital account and balance of payment overall.
  2. FDI boosts development and employment in various fields: FDI along with money brings in new technology, practices, management standards which are important for a developing nation. It helps in achieving competitiveness of global level. FDI leads to expansion in sectors thus boosting the employment.
  3. FDI encourages export: Foreign companies have extensive international marketing network and marketing information which helps in promoting domestic products across the globe. Hence, FDI promotes the export-oriented activities that improve export performance of the country.

Apart from these advantages, FDI helps in creating a competitive environment in the country which leads to higher efficiency and superior products and services.

FDI Limits

Foreign Direct Investment in India does not have a uniform rate across industries. The percentages vary from 26% to 49% to 51% with few industries having 100% FDI allowed. The decision to open a sector is taken by the government. There are a few industries where FDI is strictly prohibited under any route. These industries are

  1. Atomic Energy Generation
  2. Any Gambling or Betting businesses
  3. Lotteries (online, private, government, etc)
  4. Investment in Chit Funds
  5. Nidhi Company
  6. Agricultural or Plantation Activities (although there are many exceptions like horticulture, fisheries, tea plantations, Pisciculture, animal husbandry, etc)
  7. Housing and Real Estate (except townships, commercial projects, etc)
  8. Trading in TDR’s
  9. Cigars, Cigarettes, or any related tobacco industry

The routes under which foreign investment can be made is as under:

  1. Automatic Route: Foreign Investment is allowed under the automatic route without prior approval of the Government or the Reserve Bank of India, in all activities/ sectors as specified in the Regulation 16 of FEMA 20 (R). However, they have to inform the RBI about the amount of investment within a stipulated time period
  2. Government Route: Foreign investment in activities not covered under the automatic route requires prior approval of the Government. 

Key Developments

  1. In the Union Budget 2018, the cabinet approved 100% FDI under the automatic route for single-brand retail trading. Under this change, the non-resident entity is permitted to commence retail trading of ‘single brand’ product in India for a particular brand.
  2. The Indian government has also permitted 100% FDI for construction sector under the automatic route. Foreign airlines are permitted to invest up to 49% under the approval route in Air India.
  3. According to Department for Promotion of Industry and Internal Trade (DPIIT), FDI equity inflows in India in 2018-19 stood at US$ 44.37 billion, indicating that government’s effort to improve ease of doing business and relaxation in FDI norms is yielding results.
  4. As per data for 2018-19, the services sector attracted the highest FDI equity inflow. The total FDI equity inflows for the month of March 2019 touched US$ 3.60 billion. The table below shows the FDI inflows in major sectors for 2018- 19
Sector Amount Inflow
Service USD 9.16 billion
Computer Software and Hardware USD 6.42 billion
Trading USD 4.46 billion
Telecommunication USD 2.67 billion

5. During 2018-19, India received the maximum FDI equity inflows from Singapore. The table below shows the FDI inflows from major countries for 2018- 19

Country Amount Inflow
Singapore USD 16.23 billion
Mauritius USD 8.08 billion
The Netherlands USD 3.87 billion
The USA USD 3.14 billion
Japan USD 2.97 billion

Foreign Portfolio investment/ Foreign Institutional Investors

Investments made into the primary and secondary financial markets are known as Foreign Institutional Investments (FIIs). They can invest in bonds debentures, shares but not T-bills. For corporate bonds too they have a maximum limit. A foreign individual seeking to invest in Indian stocks has to be registered as a sub-account of an FII. FII in turn has to be registered to SEBI on the behalf of such sub-account holder.

India allows only wealthy foreign individuals or high net-worth individuals (HNIs) to register as a sub-account of a foreign institutional investor (FII) to invest directly in local equities. This is done to protect the investors and prevent money laundering.

Investments by FIIs/FPIs in India are regulated by the Securities and Exchange Board of India (SEBI) while the ceilings on such investments are maintained by the Reserve Bank of India (RBI). Following are the few types of FIIs investing in India:

  1. Hedge Funds
  2. Foreign Mutual Funds
  3. Sovereign Wealth Funds
  4. Pension Funds
  5. Trusts
  6. Asset management Companies
  7. Endowments, University Funds, etc.

FII money is called hot money sometimes as they leave the market at slight hint of any negative news. The most suitable conditions for FII are attractive interest rates, adequate money supply and stable rate of inflation, stable exchange rates, and low deficit in Balance of payments, whichever country has these conditions attracts the investment.

Key Developments

Some of the recent significant FII/FPI developments are as follows:

  1. In India almost 60-65% FIIs are into equity and rest majorly in debt while minuscule share goes into hybrid instruments.
  2. In FY19, FIIs have been key sellers in the Indian market to the tune of about USD 5.4 billion.
  3. Among the sectors that lost out were auto and components, software services, material and mining, construction material and capital goods while sectors like pharmaceutical, oil and gas and transportation gained.
  4. In April 2019, inflow of FIIs in Indian equity market increased in anticipation of incumbent government coming to power again.
  5. In March 2019, initial public offer (IPO) of India’s first real estate investment trust (REIT) was subscribed 2.6 times.
  6. In February 2019, net inflows from foreign portfolio investors (FPI) in India reached a 15-month high of Rs 17,220 crore (US$ 2.49 billion).
  7. Union Bank of Switzerland (UBS) maintained its Nifty target at 9,500 by March 2019.
  8. Morgan Stanley expects the BSE Sensex to reach 42,000 by December 2019 end.
  9. In September 2018, Embassy Office Parks filed the papers for India’s first Real Estate Investment Trusts (REIT).

Government/Regulatory Initiatives

  1. A report filed by a panel appointed by the Securities and Exchange Board of India (SEBI) on December 04, 2018 has proposed direct overseas listing of Indian companies and other regulatory changes.
  2. In September 2018, the Securities and Exchange Board of India (Sebi) relaxed the Know-Your-Client (KYC) requirement for Foreign Portfolio Investors (FPIs).
  3. In September 2018, SEBI allowed Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) to start commodity derivate segments.
  4. SEBI has also allowed foreign entities to participate in the commodity derivatives segment of Indian stock exchanges, to help them hedge their exposures. It has also proposed to allow Non Resident Indians (NRIs) to invest through FPI route after meeting specific KYC norms .