FDI policy changes to impact investments from China amid Covid-19 lockdown

The government's change in foreign direct investment (FDI) policy and strict measures to curb opportunistic takeover due to Covid-19 crisis is expected to have a significant impact on investment by Chinese players like Alibaba, Tencent and Xiaomi in companies such as Paytm, Ola, Bigbasket, Byju's, Dream11, MakeMyTrip and Swiggy for follow up funding. 

This is also expected to reduce the inflow of investments in new companies as well as the merger and acquisition scenario in the country. However, there is a view that the press note 3 regarding FDI in India will have a greater impact on listed entities. 

"There are three ways in which Chinese money comes into India - 100% FDI in setting up say a manufacturing plant, taking a stake in Indian companies, whether listed or unlisted and a stake through FII. It is the last two that would be impacted by press note 3," said Amit Bhandari, Fellow, Energy and Environment Studies Programme, Gateway House. 

Welcoming the note, Swadeshi Jagran Manch said on Monday, "This had been SJM’s demand for long and became more necessary after the reports surfaced of Chinese funds and banks started picking up stocks of various Indian or India based critical companies," said Ashwani Mahajan, co-convenor, SJM. 

There are also other issues that are left unanswered in the note, released by the Department for Promotion of Industry and Internal Trade (DPIIT) on Saturday, an entity of a country that shares a land border with India can invest only after receiving government approval.  "A non-resident entity can invest in India, subject to the FDI policy, except in those sectors/activities which are prohibited. However, an entity of a country, which shares a land border with India or where the beneficial owner of investment into India is situated in or is a citizen of any such country, can invest only under the government route," the note stated.

There are other issues that require clarity as well, according to experts.  

“For instance, while existing FDI will be grandfathered, what about rights issue where shareholders subscribe only to maintain pro-rata shareholding? What about investments through special purpose vehicles from Singapore and other jurisdictions? Would it be all right if beneficial ownership of those special purpose vehicles is less than 49 per cent or would control also need to be with persons of other countries? How would beneficial ownership be understood? What about Hong Kong, will it be treated differently from China?" asked  Salman Waris, managing partner at New Delhi-based specialist technology law firm TechLegis Advocates & Solicitors.

China is a big investor in Indian tech

In India, China’s tech giant companies and venture capital funds have become the primary vehicle for investments in the country – largely in tech start-ups. This is different from other emerging markets where Chinese investments are mostly in physical infrastructure. Chinese FDI into India is at $6.2 billion, according to a report by foreign policy think tank Gateway House, but its impact is already outsized, given the increasing penetration of tech in India.  

"There is likely to be a greater level of scrutiny with regard to existing Chinese investments in India - especially with follow on rounds of funding in Indian start-ups where Chinese capital has already been invested. Local Indian capital may be able to rise to the occasion to some level, but lack of Chinese investment is likely to create a vacuum in the investment space. Hopefully, funds domiciled in other countries can help fill this vacuum," said Sid Pai, founder and managing partner, Siana Capital.

However, apart from startups, there will be other sectors that are likely to see an impact from the recent notification from DPIIT. 

The single largest Chinese investment in India is the $1.1 billion acquisition of Gland Pharma by Fosun in 2018. This accounts for 17.7 per cent of all Chinese FDI into India, but it is unique. This includes the $300-million investment by MG Motors. 

China is most active in India in the start-up space. Gateway House in its research study on Chinese Investments in India has identified over 75 companies, with Chinese investors concentrated in e-commerce, fintech, media, social media, aggregation services and logistics.  A majority – more than half – of India’s 30 Indian unicorns (start-ups with a valuation of over $1 billion) have a Chinese investor. 

Startup and Tech ecosystem impact

Analysts said the government's change in FDI policy and strict measures to curb opportunistic takeover due to Covid-19 crisis should impact technology and the startup ecosystem in the country if the existing investors would want to increase their stake in the investee company directly or indirectly convert existing convertible instruments into equity.

While there is a broad consensus that the new FDI rules will not affect existing investments, further investment in India from China will most certainly see an impact. "Deep technology and social media-related investments may see an impact for a while. There is a lot of Chinese money in the country already, investments in Paytm and others for example. Even large companies like Xiaomi have come in through the FDI route. The Press Note 3 may delay some of these investments by some time," said Anand Lunia, general partner, IndiaQuotient, an early-stage venture capital fund.

Bhandari of Gateway House agreed, "The aim of a new directive like press note 3 is not punishment but a deterrent. So future investments from China will be scrutinised more," he said.

Analysts also expect similar retaliatory restrictions regarding ECB (external commercial borrowings) from the persons of such countries as well. Any loan taken from these persons which are convertible into equity will also get affected (if such a loan was taken prior to the amendment of Companies Act), for an average maturity period of more than 10 years.