Any foreign investment policy deals with the sensitivities around a sector while formulating the rules to govern investment into that sector.
But it is equally critical for the policymaker to ensure that the rules of the investment game are equally beneficial or rigorous on fundamental aspects.
One such aspect is downstream investment norms, which apply to all sectors. It would then be natural to expect that these norms are implemented on a similar footing in all sectors. Two key regulated sectors in this context are non-banking finance companies and construction development.
Guidelines issued as per Press Note 9 issued in October 2012 permit NBFCs having foreign investments above 75 per cent and up to 100 per cent, and with a minimum capitalisation of $50 million to set up step-down subsidiaries for specific NBFC activities, without any restriction on the number of operating subsidiaries and without bringing in additional capital.
Previously, only 100 per cent foreign owned NBFCs with a minimum capitalisation of $50 million were permitted to do so, and the permission now extends even to NBFCs operating as joint ventures.
While a plain reading of Press Note 9 may not convey a very significant change, at least from a foreign exchange inflow perspective (given that the capitalisation compliance required for NBFCs that are 100 per cent foreign owned and NBFCs that have foreign investment above 75 per cent is the same), what may be relevant to notice is the approach of the government to permit downstream investments once capitalisation norms are complied with.
Joint venture arrangement
Downstream investment norms: The downstream investment norms, when introduced, were intended to clarify the manner in which foreign investment will be counted in an entity engaged in an activity that was sought to be regulated.
The concepts of “ownership” and “control” were also introduced and it was clarified that where Indian parties do not have ownership ‘and’ control of an Indian entity, any downstream investment by such entity would be counted as indirect foreign investment. A few exceptions and illustrations were also included while formulating the policy.
Thought process: The permission available to NBFCs under the extant consolidated FDI policy could have been on the basis that although NBFCs are permitted to have foreign investment under the automatic route only in the specified 18 activities, there was no restriction on the number of activities that a particular NBFC could undertake, if it satisfied the minimum capitalisation norms based on the level of ‘foreign capital’.
Further, given that the extent of ‘foreign capital’ was the same for NBFCs that were 100 per cent foreign owned and if the foreign capital was more than 75 per cent, there seemed to be no reason (from a foreign exchange inflow perspective) why the ability to set up step-down subsidiaries for specific NBFC activities, without any restriction on the number of operating subsidiaries and without bringing in additional capital, should not extend to NBFCs operating under a joint venture arrangement. This is now permitted under Press Note 9.
Other sectors waiting: The mindset of the government to extend the permission to NBFCs operating as joint ventures makes one wonder to why the benefit of such permission should not extend to other sectors with “minimum capitalisation” norms prescribed, i.e., “multi brand retail trading” and “construction development”. Leaving aside “multi brand retail trading” as a unique and recent policy announcement, the “construction development” sector, for which the policy has been in place for a while, would welcome such a change.
Compelling argument
In a way, there are some similar provisions that apply to foreign investment in NBFCs engaged in specific activities and entities engaged in construction development projects. Both are under the 100 per cent automatic route for FDI, with the “minimum capitalisation” for 100 per cent foreign owned subsidiaries higher than in joint ventures with Indian parties.
Just as more than one permitted activity can be carried out in an NBFC, more than one eligible project can be carried out in an entity engaged in “construction development” projects. The minimum capitalisation for an NBFC is the same whether it is engaged in one activity or more. Similarly, the minimum capitalisation for an entity/ special purpose vehicle engaged in “construction development” is the same whether the number of eligible projects being implemented is one or more.
A compelling argument, therefore, would be that the benefit of the exemption from “minimum capitalisation norms” extended to NBFCs should also logically extend to entities engaged in construction development projects. Accordingly, an entity/special purpose vehicle implementing a construction development project and having received the prescribed foreign investment should be permitted to set up downstream operating subsidiaries without having to meet the downstream investment conditions that ordinarily require complying with the minimum capitalisation norms each time.
The three-year lock-in applicable for each tranche of investment would continue at the holding-cum-operating company, along with the other obligations, such as project completion timelines.
Simplifying transactions
Such flexibility would encourage simpler structuring of transactions between Indian promoters and foreign investors with downstream special purpose vehicles for implementing different projects, be it in terms of type (residential, commercial, mixed use), or size of project, or nature of investment.
This may also result in foreign investment remaining in the country to be utilised for follow-on projects in downstream special purpose vehicles without the requirement for foreign investors to seek repatriation of monies from one project for re-investing and satisfying the minimum capitalisation requirement for follow-on projects.
It may be in the order of things to review downstream investment norms, to encourage inter alia a stable foreign exchange market, simplify the investment patterns and potentially provide the now much needed boost to the construction development sector.
(The author is Partner, J. Sagar Associates)