Administration of the policy governing foreign direct investment (FDI) by the government of India woefully fails such tests of good law and administration. FDI into India is regulated through "press notes" that publicly state the government's position on FDI policy. Regulations made under the Foreign Exchange Management Act (FEMA), the only statute enabling such policy always play catch up with the press notes. Often, the press notes and FEMA regulations are inconsistent.
FDI policy since India opened up in 1991 can be divided into two major eras - the first, between 1991 and 1999, when activities in which FDI was permitted were specifically spelt out. Unless specifically permitted, FDI was prohibited. Where permitted, one needed government's approval in most cases. Naturally, access to New Delhi mattered immensely. Annual FDI into India struggled to match monthly FDI into China.
Gradually more and more activities moved into the "automatic approval" list. However, in early 1999, a fundamental shift occurred. FDI in specific areas became prohibited or regulated. Except for such areas, FDI in any activity became freely permitted.
Under this regime, which coincided with FEMA being legislated, the world was put on notice that it was welcome to invest in any activity in India. If there were areas where the government found a free run of FDI undesirable, the world would be transparently told. Access to New Delhi ceased to be a key success factor. FDI inflows materially improved.
However, press notes issued in the earlier regime still continue to govern life. Some of these press notes use terms loosely. Clarifications with bad syntax and erroneous grammar compound problems. How much of disarray this can cause can be seen in the government's recent position on FDI in Indian operating companies that also play the role of a "holding company". The government is reported to have issued a show cause notice to a manufacturing company asking it to explain how it could have also played the role of a holding company, without special government approval, despite having FDI in its capital.
Under Indian company law, a "holding company" is a company that owns more than one half of the capital of another company or one that controls the board of directors of another company (the latter would be a "subsidiary company"). An Indian company could either play a solely "holding company" role, with no manufacturing or service operations of its own (example - Tata Industries in the Tata Group), or it could be a manufacturing or operating company, and yet, be a holding company for some subsidiaries (examples abound - ICICI, Tata Steel, Infosys).
In the list of prohibited or regulated activities for FDI, only FDI in holding companies whose subsidiaries provide infrastructure services is regulated. A press note issued in 1997 regulates wholly foreign-owned Indian companies that are exclusively holding companies. Another press note of 1999 deals with downstream investments by "foreign-owned Indian holding companies" - a phrase that has remained undefined even ten years later. There is no other specific provision regulating or prohibiting FDI in holding companies. Whether the term "foreign-owned Indian holding company" would include companies with minority FDI stake (ranging from one share to 50%) or majority FDI stake (anything above 50%) has remained unclarified.
The issue of a show cause notice to the manufacturing company that also played a holding company role, underlines the government view - namely, that any Indian company that has any subsidiary, would need government approval for any level of FDI (one share to 100%) regardless of the nature of activities that the company and its subsidiaries are engaged in.
Logical extensions of this indiscriminate principle lead to absurd propositions. For instance, if Tata Steel or Infosys desired to issue stock to a foreign investor, it would have to plead with New Delhi for approval. They may be India's flagship enterprises in the steel and information technology sectors, where 100% FDI is freely permitted. However, since they have subsidiaries, New Delhi would decide whether they could issue a single share to a foreign investor.
Another extension of this principle is that each of Hindustan Unilever (a long-standing 51%-foreign-owned Indian company), and a small-time auto ancillary company with a minuscule FDI stake would each have to plead for approval from New Delhi every time they wish to set up a subsidiary.
Strangely, no strain of such a principle is found in any provision of law or FDI policy.
Imposition of unwritten policy has led foreign investors who have already invested in sectors where FDI is freely permitted, to worry about whether their compliance status.
The government ought to urgently clarify that no approval is necessary for FDI into activities that are under the automatic approval route, even if the investment is through an Indian holding company. More importantly, it is high time transparent criteria were notified so that the world knows what would help them qualify for approval. Fast regressing to an era where a bunch of officials and ministers in New Delhi are believed to be blessed with epiphanic visions of whether an FDI proposal is good for approval, India has come to cut a sorry figure in the investment world.
(The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.)
