Finance ministry proposes new rules for FDI

The finance ministry, upset with the new rules for calculating foreign direct investment (FDI) in Indian companies, has sought to overhaul the entire policy to shut ‘loopholes’ that allow investors to breach sectoral FDI caps through investments via offshoots.

In a fresh missive to the Department of Industrial Policy and Promotion (DIPP), the government body responsible for framing foreign investment policy, the ministry has asked for a review of the policy that has caused much confusion among investors, foreign and Indian.

"The finance ministry wants the DIPP to address the issue of downstream investments in restricted sectors by companies that have foreign investment," said a senior finance ministry official. The se companies, said the official who did not want to be named, breach FDI caps through multi-layered indirect investments.

Under the new rules for indirect foreign investments, issued through Press Notes 2 and 3 last year, all investments by an Indian-owned and controlled company will be classified as domestic investments even if the company has significant foreign stakes. The earlier norms counted only the proportionate amount as FDI in the downstream subsidiary.

For example, if a 51 per cent Indian-owned company floats a subsidiary with a 50 per cent stake and the balance 50 per cent is held by foreign investors, its entire 50 per cent investment in the subsidiary would be counted as local investment under the new norm. This will allow the company to invest in any sector, even those closed to foreign investment.

In telecom, for instance, which has a foreign investment limit of 74 per cent, companies can now get foreign investment above the allowed cap through a multilayered subsidiary structure. The flip side for companies is that the total investments of those with more than 50 per cnet foreign holding in a subsidiary would be counted as foreign investment.

Leading Indian banks such as ICICI Bank, HDFC Bank, and Development Credit Bank would be considered foreign for the same reason. Investments of these banks in a subsidiary would also be classified foreign. That is not only a check on their investments in sectors with limits on foreign investments, but also branch expansion.

Though the finance ministry had written to the DIPP earlier, the communications were largely centered around the impact of the new FDI norms on banking sector. The ministry’s missives came after the RBI highlighted the implications of the new norms on the banking sector.

The latest move comes after FIPB found that some FDI proposals could have breached the sectoral FDI caps as per the earlier rules though they passed muster as per current norms. The finance ministry wants re-examination as exempting one or two private banks or the banking sector as a whole will not resolve this issue thrown open by the new norms.