Impact of the revised FDI policy on Indian economy

Last Updated on Apr 6, 2021 by Manonmayi

There’s a thin line between owning a stake in a company and having the influential power over its management. And when the foreign entity owning a stake in a company belongs to a foreign country, the entire affair calls for scrutiny. That is why, we have a foreign direct investment policy in place, to govern and monitor investments flowing from foreign countries in India.

You may be familiar that the government made certain revisions to the FDI policy. Well, this announcement made on Saturday has received both appreciation and criticism from within and outside the country (China). Let us take a look at the revisions:

Foreign direct investment policy, investments from countries that share borders with India can only flow into domestic companies after the government’s approval
Approval from the government is also required when entities based out of China make changes in the existing or future ownership of their investments in Indian companies

Well, these only sound fair. But why has this simple piece of news created a massive fuss? We’ll tell you why and more around FDI in this article. Before understanding why China has raised a concern about the revision in FDI policy, let us understand what is FDI and the role it plays in an economy.

FDI meaning

FDI is investment flowing from foreign countries (individuals and companies) into domestic companies. But there’s a limit to the foreign investment to qualify as an FDI. That is, an investment is considered as an FDI only is the foreign company owns a stake equal to or greater than 10% in a domestic company. Conversely, if the investor holds less than 10% stake in a domestic company, it is not an FDI, but just an investment forming a part of their portfolio.

Now that you have understood the FDI meaning, learn about how foreign companies can invest in our country. In India, foreign direct investment is allowed in two ways:

Automatic mode, where the foreign company doesn’t require government’s approval
Government mode, where the foreign company has to get the government’s nod

The role of foreign direct investment in the Indian economy

India, being a developing economy could use some foreign investments in India to fuel its growth. Not only does the FDI boost the business receiving funds, but it also fuels the economy. Here’s how:

FDI opens doors to many possibilities. Apart from funds, the domestic company can also benefit from technological, legal, and other expertise that the MNC has to offer
Economy-wise, FDIs boost business in various sectors, which, in turn, generate employment opportunities and improves the standard of living in the domestic country

You can read more about FDI here.

What was the FDI policy before the revision?

Previously, only companies belonging to Pakistan and Bangladesh were required to seek the government’s approval before investing in Indian companies. Others foreign investors were allowed to invest in the country via the automatic route. However, such FDIs were not free from conditions. The government required them to conform to sectoral rules and caps before investing.

Now let us delve into the matter.

Why did the government revise the FDI policy for neighbouring countries?

As per the government, the revision in the FDI policy was crucial to protect domestic companies from opportunistic takeovers and acquisitions due to coronavirus (COVID-19) pandemic. It’s not like our economy is all well. It is hit by the coronavirus, which has stressed businesses, small and big, alike. Unable to run the business seamlessly, these cash-strapped entities would but naturally look for financial resources including investments.

So, what’s the harm if they get an investment proposal from a foreign company? They would heartily accept it and run their operations rather easily. But this whole thing has a catch to it. Now, as per the FDI policy, an investment qualifies to be an FDI if a foreign company holds 10% or higher stake in a domestic entity. This 10% will obviously not give the foreign company major ownership rights in the domestic entity’s affairs but, being a minority stakeholder it can still influence the management of the Indian company.

On observing closely, you’ll find that China has been investing a lot more in India lately. People’s Bank of China’s (PBOC) stake purchase in HDFC is just one instance. Recently, PBOC increased its stake in the home-grown HDFC bank from 0.8% to 1.01%. Even so, PBOC’s stake in HDFC (India’s largest non-banking mortgage) is lesser than 10%, meaning it does not qualify for an FDI. So, why did the government revise the policy and why did the Chinese Embassy react so harshly on the revision, accusing India of discriminatory FDI rules?

Given that the entire world is combating with the COVID-19 impact, the stake purchase by Chinese entities received a lot of doubts. Now, imagine not one, but several foreign companies owning a stake in Indian companies. Yes, look at the bigger picture and you’ll know why the government promptly introduced a new FDI policy for the neighbouring countries. That is, if China or any other neighbouring country for that matter—Pakistan, Nepal, Bangladesh, Bhutan, Myanmar, and Afghanistan—has to seek the coronavirus, government’s approval before increasing or buying a fresh stake in Indian companies.

Understanding the impact of the new FDI rules on Indian economy

Now that the government has increased the scrutiny on FDIs from neighbouring companies, let us understand what the new FDI policy means to the economy and domestic companies:

Companies belonging to neighbouring countries have to pass the test of government before investing in Indian companies. Should the policymakers find something dicey in the investor’s agenda, any damage intended can be controlled or dodged
Foreign investors will have to abide by lengthy FDI norms and undergo thorough scrutiny, which is time-consuming. This may discourage them from investing in Indian companies. Moreover, this revision will delay investments, which may force companies to look for funding elsewhere
Since the revised FDI norms subject neighbouring countries to additional scrutiny compared to other economies, the commercial relationship between the investing country and India may bear damage to an extent
The revision in the foreign direct investment policy may also pose a threat to the existing business relationships. Notably, China is an investor in 18 of 30 Indian unicorns

China’s accusation on India regarding the revised FDI policy

Seems like the revised FDI norms didn’t bode well with China. Here’s what the Chinese embassy had to say:

The new FDI rules were discriminatory

The new FDI policy violates WTO and G20’s global trading norms

The revised FDI policy challenges liberalisation

To add to this, Ji Rong, the Spokesperson of the Chinese Embassy in India tweeted that they hoped India would revise the new norms and make way for a fair and equitable business environment. Notably, India had received a cumulative investment of over $8 billion alone from China as of Dec 2019.

India’s answer to China’s criticism

India retorted to Chinese accusation saying that its new FDI policy didn’t violate the WTO norms. The government clarified by saying that the new FDI rules simply required its approval. The norms didn’t ban neighbouring countries from investing in India.

India is not alone in this; other countries such as Germany and Australia have also revised their FDI policies to protect their distressed companies. Should we applaud the government for the timely move? Let us know what you think in the comments below.

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Aradhana Gotur

Senior Content Writer at Tickertape

Aradhana Gotur is a Content Writer with 4 years of experience in personal finance, stock markets, and lifestyle areas. Having recognised the power of words, she constantly works on using them to enhance financial awareness among the masses and meet business objectives. One of her greatest strengths is breaking complex concepts in an easy-to-understand way.

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