TOPIC-7: FOREIGN INVESTMENT

-by Jayant Parikshit

Page 1 of 13
 ECONOMICS HANDOUT (TOPIC NO. 7)
by Jayant Parikshit
SYLLABUS:
SYLLABUS:
1. Definition of Foreign Investment

2. Types of Foreign Investment

1. Foreign Institutional Investment (FII)
2. Foreign Direct Investment (FDI)
3. Sub-Accounts
4. Qualified Foreign Investment (QFI)
5. Foreign Portfolio Investment (FPI)
6. NRI Investment

3. Two Categories of FPI: Category-I & Category-II

4. Routes of Investment:
a. Automatic Route
b. Government Route/Approval route
5. Prohibited areas for Foreign Investment
6. NRI Investment in India
7. Major Reforms related to Foreign Investment:
a. FPI regulations (2014), Chandrasekhar Committee
b. H.R.Khan Working Group (2018-19)
c. Voluntary Retention route (VRR)-2019
d. Fully Accessible Route (FAR)-2020
e. Amended FDI Policy for border sharing-April 2020

8. Current Affairs:
a. List of Sectors for automatic route, government route
b. FDI in Retail Sector:
I. Single Brand Retail
II. Multi-Brand Retail

Page 2 of 13
 MCQ FOR “SELF” PRACTICE
Question-1: Which of the following are capital instruments permitted for receiving foreign
investment in an Indian company?
1. Equity shares
2. Preference Shares
3. Debentures

Choose the correct option:

a. Only1
b. Both1&2
c. Both2&3
d. 1,2&3

Question-2: Which of the following are the features of FDI?

1. They are considered to be long term & steady investments.
2. They are likely to finance import of superior technology.
3. They most likely bring with them the superior global management practices
4. They exploit hitherto untapped business opportunities thereby generating employment
opportunities.

Choose the correct option:

a. Both1&2
b. 1,2&3
c. 1,3&4
d. 1,2,3&4

Question-3: Which of the following is an example of “Hot Money”?

1. Foreign Direct Investment (FDI)
2. Foreign Institutional Investment (FII)
3. Foreign Portfolio Investment (FPI)

Choose the correct option:

a. Only1
b. Only2
c. Both1&2
d. Both2&3
e. 1,2&3

Question-4: Consider the following statements regarding foreign investment in India:

1. Portfolio Investment in India is relatively lower than China mainly because of restrictive
policies and volatile environment.
2. FDI is sufficient but not a necessary condition for stimulating economic growth in a
country like India.

Page 3 of 13
Choose the correct statement:
a. Only1
b. Only2
c. Both1&2
d. None of these

Question-5 [2019]: Which of the following is issued by registered foreign portfolio investors
to overseas investors who want to be part of the Indian stock market without registering
themselves directly?
a. Certificate of Deposit
b. Commercial Paper
c. Promissory Note
d. Participatory Note

Question-6 [2020]: With reference to Foreign Direct Investment in India, which one of the
following is considered its major characteristic?
a. It is the investment through capital instruments essentially in a listed company.
b. It is a largely non-debt creating capital flow.
c. It is the investment which involves debt-servicing.
d. It is the investment made by foreign institutional investors in the Government securities.

Page 4 of 13
 FOREIGN INVESTMENT
MEANING OF FOREIGN INVESTMENT
§ Foreign investment is when a company or individual from one nation invests in assets or
ownership stakes of a company based in
another nation. BASIC FORMS OF FOREIGN INVESTMENT
§ The government of India has brought out 1. Foreign Institutional Investment (FII)
various modes of foreign investment 2. Foreign Direct Investment (FDI)
through which an individual or a company 3. Sub-Accounts
can invest in. Ever since the liberalization 4. Qualified Foreign Investment (QFI)
of markets in 1991, the amount of foreign 5. Foreign Portfolio Investment (FPI)
investment in India improved at a rapid 6. NRI Investment
pace.

BASICS OF FOREIGN INVESTMENT

FOREIGN INSTITUTIONAL INVESTMENT (FII)
§ FII means an institution incorporated outside India which proposes to make investment
in India. They are registered as FIIs in accordance with SEBI Regulations.
§ FIIs are interested in capital gain and momentary price differences.
§ FIIs do not generally influence the management of the enterprise.
§ FIIs may include mutual funds, hedge funds, insurance firms, pension funds, financial
institutions, etc.

FOREIGN DIRECT INVESTMENT (FDI)

§ FDI is an investment made by a company or individual who is an entity in one country, in
the form of controlling ownership in business interests in another country.
§ FDI could be in the form of establishing business operations or by entering into joint
ventures by mergers and acquisitions, building new facilities etc.
§ With FDI, foreign companies are directly involved with day-to-day operations in the other
country. This means that they aren’t just bringing money with them, but also knowledge,
skills and technology.
§ Generally FDI involves a lasting interest in the management of an enterprise and includes
reinvestment of profits.

SUB-ACCOUNTS
§ Sub-Account means a person resident outside India, on whose behalf an FII proposes to
invest in India. Parties who wish to make international investments have to open a sub-
account with a FII already registered with SEBI. Sub-Account & FII are governed by the
SEBI Regulations.

QUALIFIED FOREIGN INVESTMENT (QFI)

§ QFI means a person who is (i) resident of a country that is a member of Financial Action
Task Force (FATF) or a member of a group which is a member of FATF; and (ii) resident of
a country that is a signatory to MMOU.

Page 5 of 13
§ QFI is a qualified foreign investor that
maybe an individual, firm or fund that is Multilateral Memorandum of Understanding
located outside India. These firms can Concerning Consultation and Cooperation
directly make investments in the India and the Exchange of Information (MMoU-
without the requirement of opening a 2002) was developed by the International
sub-account with other FIIs. Organization of Securities Commissions
§ QFIs are governed by the guidelines (IOSOC). It’s aim is to enhance the level of co-
issued by SEBI and RBI. operation and information exchange to
combat cross-border fraud and other
FOREIGN PORTFOLIO INVESTMENT (FPI) securities violations.

§ On the basis of Chandrasekhar

Committee Report, SEBI in 2014 FII or FPI enter a country and invest in stocks.
merged the existing classes of They do not have direct control over securities
investors namely FII, their sub or business. Their intention is to take advantage
accounts, and Qualified Foreign of interest rate differential between foreign and
investors (QFI) into a new class – domestic economy. They are also called “Fly-by-
Foreign Portfolio Investor (FPI). night” money or “hot money”. The intention is
§ FPI means an investment by any not to take controlling interest, but to diversify
single investor or investor group, portfolio ensuring hedging and to gain high
which shall not exceed 10% of the returns with quick entry and exit.
equity of an Indian company. Any
investment beyond the threshold of 10% shall be considered as Foreign Direct
Investment (FDI).

TWO CATEGORIES FOR FPI

1. Category I FPI which mainly include: Government and Government related investors as
central banks, sovereign wealth funds, international or multilateral organizations.
a. Pension funds and university funds
b. Appropriately regulated entities such as asset management companies, banks,
investment managers, investment advisors, portfolio managers
c. Eligible entities from the Financial Action Task Force (FATF) member countries

2. Category II FPI which include: All investors not eligible under Category I such as:
a. appropriately regulated funds not eligible as Category-I foreign portfolio investor
b. endowments and foundations
c. charitable organizations
d. corporate bodies
e. family offices
f. Individuals
g. Unregulated funds in the form of limited partnership and trusts

Page 6 of 13
ROUTES FOR INVESTMENT
1. Automatic Route: It means the entry route through which investment by a person
resident outside India does not require the prior approval of the Reserve Bank of India or
the Central Government. Examples of sectors under the automatic route include, among
others, infrastructure, healthcare, manufacturing and renewable energy.

2. Government/Approval Route:
NEW REFORM (2020):
Under this route, prior approval of
§ On April 18, 2020, via new regulation dubbed
the Government of India is
Press Note 3, the GOI added all FDI by non-
required. Proposals for foreign
resident entities located in (or having
investment under Government
"beneficial owners" in) countries that share a
Route, are considered by
land border with India to the approval route,
respective Administrative
regardless of the quantum of investment or
Ministry/Department. Sectors
sector.
under the approval route include,
§ Countries that share a border with India
among others, multi-brand retail,
include Pakistan, Bangladesh, China, Nepal,
broadcasting, banking, defense,
Myanmar and Bhutan.
mining, print media and
biotechnology.

SECTORS PROHIBITED FOR FOREIGN INVESTMENT IN INDIA

Prohibited areas for Foreign Investment in India are:
1. Lottery Business
2. Gambling and Betting including casinos
3. Chit Funds
4. Nidhi Company
5. Trading in Transferable Development Rights (TDR)
6. Real Estate Business or Construction of farm houses
7. Manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco
substitutes
8. Sectors not open to private sector investment- atomic energy, railway operations (other
than permitted activities mentioned under the Consolidated FDI policy)

OTHER CONDITIONS ON INVESTMENT BESIDES ENTRY CONDITIONS

Besides the entry conditions on foreign investment, the investment/investors are required to
comply with all relevant sectoral laws, regulations, rules, security conditions, and state/local
laws/regulations.

HOW CAN NRIs INVESTMENT IN INDIA?

NRI can invest directly in IPO (i.e. primary market instruments) as well as buy and sell stocks
in the secondary market (i.e. stock exchange). Along with these, NRIs can also invest in other
capital market instruments like Mutual Funds, Derivative trading (Futures and
Options),Bonds, and Exchange Traded Funds.

Page 7 of 13
1. To invest in IPO, NRIs need to open
demat and trading account with SEBI FACTS FOR PRELIMS:
registered broker in India. § An NRI or an OCI may subscribe to National
Pension System governed and
2. NRIs can invest in the secondary administered by Pension Fund Regulatory
capital markets in India through the and Development Authority (PFRDA).
portfolio investment scheme (PIS). § An NRI is not allowed to invest in a firm
Under this scheme, NRIs can acquire engaged in any agricultural/plantation
shares of Indian companies through activity or real estate business or print
the stock exchanges in India. PIS media.
account is basically required by the SEBI to monitor the investment limit by NRIs in stock
market. PIS bank account is not required for making investments in mutual funds and
applying in IPOs.

3. To invest in Mutual funds, NRIs need to open demat and trading account with SEBI
registered broker in India.

Non-Resident Ordinary (NRO) Bank Account & Non-Resident External (NRE) Bank Account

§ NRIs must have a saving bank account before they start to invest. There are two types of
bank accounts NRIs can operate depending upon their income:

1. Non-Resident Ordinary (NRO) Bank Account (Income from India)

2. Non-Resident External (NRE) Bank Account (Income out of India)

§ Both the accounts are savings accounts maintained in Indian Rupees. You can remit your
foreign income earned outside India in NRE bank account, which is fully repatriable.
Income in India is parked in NRO bank account, which is partially repatriable.
§ In case of an NRO account, the interest amount can be repatriated; however, in case of
the principle amount, one can remit only up to USD 1 million in a financial year.

PROCESS OF FOREIGN INVESTMENT IN INDIA

Procedures for Investment Under Government Route:
Step 1: Filing of Application Proposal for foreign investment, along with supporting
documents to be filed online, on the Foreign Investment Facilitation Portal.
Step 2: Internal procedure for Approvals
§ DPIIT will identify the concerned Ministry/ Department and thereafter, circulate the
proposal. A single governmental department relevant to the sector (subject to security
clearance, if applicable) identified by the DPIIT is required to take the lead in
processing the application.
§ In addition, once the proposal is received, the same would also be circulated online to
the RBI within 2 days for comments from FEMA perspective.
§ Proposed investments from Pakistan and Bangladesh would also require clearance
from the Ministry of Home Affairs.

Page 8 of 13
 § Proposals involving FDI exceeding INR 50 bn (approx. $775 Mn) shall be placed before
the Cabinet Committee of Economic Affairs
§ Proposed investments in certain sectors such as defense, broadcasting and
telecommunication also go through an additional layer of security clearance from the
Ministry of Home Affairs.
§ And, all investments from countries that share a land border with India are subject
to review by the DPIIT and the Competent Authority.
§ The DPIIT has been tasked with the responsibility of facilitating FDI. The DPIIT's
concurrence is mandatory for a Competent Authority to reject an application or to
impose any additional conditions not provided in the FDI Policy or applicable law.
§ The GOI has not laid out specific criteria for evaluation of investments, and appears to
be mainly concerned with national security.

FOREIGN INVESTMENT REFORMS

[NOTE: All these reforms are related to current developments/affairs. These must be
updated before exam.]

H.R.KHAN WORKING GROUP ON FPI (2018-19)

§ Constituted by SEBI
§ Duration: March 26, 2018 to May 2019
§ Chairman: Mr. H.R. Khan, RBI Deputy Governor (Retired)

OBJECTIVE:
1. To advise SEBI to simplify SEBI FPI Regulations, 2014.
2. To advise SEBI on incorporating the provisions contained in the circulars, FAQs and
operational guidelines issued by SEBI concerning FPIs.
3. To advise on any other issue relevant to FPIs.

MAIN POINTS IN KHAN REPORT

1. FPIs were re-categorised into 2 categories:
a. Category I: Investors related to government (like Central Banks) & regulated entities
(like Banks, MFs).
b. Category II: Appropriately regulated funds not eligible as Category I (example:
charitable societies, corporate bodies, Trusts etc.)
2. Merger of FPI & NRIs routes to bring in a single regime for foreign investors and regulate
NRI and PIO fund inflows.
3. Easing the regulatory framework of FPI, SEBI simplified KYC requirements for them and
permitted them to carry out off-market transfer of securities.

VOLUNTARY RETENTION ROUTE (VRR)-2019

§ Reserve Bank of India (RBI) introduced a scheme for Voluntary Retention Route (VRR) for
investments by Foreign Portfolio Investors (FPIs) in debt markets in India on 1 March 2019.
§ This scheme enables FPIs to invest in debt markets free of the general regulatory norms
applicable to FPI investments, provided FPIs voluntarily commit to retain a required

Page 9 of 13
 minimum percentage of their investments in India for a specified period of time.
Participation through this route is entirely voluntary.

Features of VRR:
1. It was a new channel of investment for FPIs.
2. Any FPI registered with SEBI can participate in the VRR.
3. FPIs under the VRR must voluntarily commit to retain a required minimum percentage of
their investments in India for a defined period of time.
4. RBI has put a higher investment cap under the voluntary retention route (VRR) to Rs
1,50,000 crore with a view to attract long-term and stable FPI investments into debt
markets.

FULLY ACCESSIBLE ROUTE (FAR)-2020:

§ RBI has introduced a separate channel, namely ‘Fully Accessible Route’ (FAR), to enable
NRIS to invest in specified government bonds with effect from April 1, 2020.
§ RBI also enabled a Fully Accessible Route (FAR) for investment by NRIs in government
securities.
§ Under FAR there won’t be any limits on investment in G-Secs by NRIs.
§ These securities will continue to be eligible for investment by residents too.
§ All new issuances of government securities of 5-year, 10-year and 30-year tenors from the
financial year 2020-21, will be eligible for investment under the FAR.

AMENDED FDI POLICY (APRIL 2020)

§ China has been trying to acquire distressed assets in strategic sectors globally during the
pandemic. China has been buying stakes across major financial institutions in Asia amid
the stock market crash in major economies.

§ The People’s Bank of China (PBoC) already owned 0.8% shareholding in HDFC Ltd. In 2020,
PBoC bought 1.75 crore shares, & reached 1.01% of the shareholding in HDFC Ltd.

§ Department for Promotion of Industry and Internal Trade (DPIIT) under the Ministry of
Commerce and Industry released an amendment of the FDI Policy. An entity of a country
which shares land border with India or where the beneficial owner of an investment into
India is situated in or is a citizen of any such country can invest only under the government
route.

Bordering States:
1. Afghanistan
2. Bangladesh
3. Bhutan
4. China
5. Myanmar
6. Nepal
7. Pakistan

Page 10 of 13
 CURRENT AFFAIRS
Note: This section is for general reading. Since it is current in nature, one must update it two-
three weeks prior to UPSC Examination.

SECTOR SPECIFIC CONDITION FOR FDI

100% Automatic route

Agriculture & Animal Husbandry, Air-Transport Services (Non Scheduled Air Transport Service
/ Helicopters services/ seaplane services requiring DGCA approval), Airports (Greenfield +
Brownfield), Asset Reconstruction Companies, Auto-components, Automobiles,
Biotechnology (Greenfield), Broadcast Content Services (Up-linking & down-linking of TV
channels, Broadcasting Carriage Services, Capital Goods, Cash & Carry Wholesale Trading
(including sourcing from MSEs), Chemicals, Coal & Lignite, Construction Development,
Construction of Hospitals, Credit Information Companies, Duty Free Shops, E-commerce
Activities, Electronic Systems, Food Processing, Gems & Jewellery, Healthcare(Greenfield),
Industrial Parks, IT & BPM, Leather, Manufacturing, Mining & Exploration of metals & non-
metal ores, Other Financial Services, Services under Civil Aviation Services such as
Maintenance & Repair Organizations, Petroleum & Natural gas,
Pharmaceuticals (Greenfield), Plantation sector, Ports & Shipping, Railway Infrastructure,
Renewable Energy, Roads & Highways, Single Brand Retail Trading, Textiles & Garments,
Thermal Power, Tourism & Hospitality, White Label ATM Operations and Insurance &
Insurance Intermediaries.

Upto 100% Automatic route

1. Infrastructure Company in the Securities Market - 49%
2. Insurance - upto 49%
3. Medical Devices - upto 100%
4. Pension - 49%
5. Petroleum Refining (By PSUs) – 49%
6. Power Exchanges – 49%

Upto 100% FDI permitted under Government route

1. Banking (Public sector) – 20%
2. Broadcasting Content Services (FM Radio, uplinking of news and current affairs TV
Channels)– 49%
3. Uploading/Streaming of ‘News & Current affairs’ through digital media – 26%
4. Investment by Foreign airlines – 49%
5. Core Investment Company – 100%
6. Food Products Retail Trading – 100%
7. Mining & Minerals separations of titanium bearing minerals and ores, Its value addition
and integrated activities – 100%
8. Multi-Brand Retail Trading – 51%
9. Print Media (publications/ printing of scientific and technical magazines/speciality
journals/ periodicals and facsimile edition of foreign newspapers) – 100%

Page 11 of 13
10. Print Media (publishing of newspaper, periodicals and Indian editions of foreign
magazines dealing with news & current affairs) – 26%
11. Satellite (Establishment and operations) – 100%

Upto 100% FDI permitted under Automatic & Government

1. Air transport services (Scheduled Air Transport Service/ Domestic Scheduled Passenger
Airline; Regional Air Transport Service) – upto 49% (auto) (Upto 100% under automatic
route for NRIs) + above 49% and up to 74% (Govt.)
2. Banking (Private sector) – upto 49% (auto) + above 49% and up to 74% (Govt)
3. Biotechnology (brownfield) – upto 74% (auto) + above 74% (Govt)
4. Defence – upto 74% (auto) + above 74% (Govt)
5. Healthcare (Brownfield) – upto 74% (auto) + above 74% (Govt)
6. Pharmaceuticals (Brownfield) – upto 74% (auto) + above 74% (Govt)
7. Private Security Agencies – upto 79% (auto) + above 49% and up to 74% (Govt)
8. Telecom Services – upto 49% (auto) + above 49% (Govt)

2021-22 REFORMS:
GOI did introduce several progressive changes to the FDI Policy. The changes to the FDI
Policy are expected to drive significant inbound investments in the strategically
important sectors of insurance and telecom. In particular:
1. In a long-awaited move, the cap for FDI (under the automatic route) in insurance
companies has been increased from 49% to 74%
2. The FDI cap in the telecom sector (under the automatic route) has been increased
from 49% to 100%.

FDI IN RETAIL SECTOR

SINGLE BRAND RETAIL TRADE (SBRT):
§ The FDI cap on the single-brand retail trading is set at 100% through the automatic route.
The automatic route means where the foreign investor or the Indian company does not
require any prior permission or approval from the Reserve Bank of India or the
Government of India.
§ Under FDI Policy of SBRT model, international retailers that enters India can sell through
their stand-alone stores in shopping locations/streets. Examples of Companies: H&M (CP
Street, New Delhi), IKEA (Hyderabad, Telangana)
§ 100% FDI through automatic route is also allowed in Single Brand Retail Trade through
online platforms provided company establishes physical stores within 2 years from date
of start of online retail.
§ FDI in Single Brand product retail trading would be subject to the following
conditions:
a. Products to be sold should be of a ‘Single Brand’ only.
b. ‘Single Brand’ product-retail trading would cover only products which are branded
during manufacturing.
c. In respect of proposals involving foreign investment beyond 51%, sourcing of 30%
of the value of goods purchased, will be done from India, preferably from MSMEs,
village and cottage industries, artisans and craftsmen, in all sectors.

Page 12 of 13
MULTI BRAND RETAIL TRADE (MBRT):

Foreign direct investment (FDI) is allowed under Multi-Brand Retail Trading upto 51% through
the government approval route. FDI in multi brand retail trading, in all products, will be
permitted, subject to the following conditions:
a. Minimum amount to be brought in, as FDI, by the foreign investor, would be US $ 100
million.
b. At least 50% of total FDI brought in the first tranche of US $ 100 million, shall be invested
in 'back-end infrastructure' within three years, where ‘back-end infrastructure’ will
include capital expenditure on activities like investment made towards processing,
manufacturing, distribution, design improvement, quality control, packaging, logistics,
storage, ware-house, agriculture market produce infrastructure etc. Expenditure on land
cost and rentals, if any, will not be counted for purposes of backend infrastructure.
c. At least 30% of the value of procurement of manufactured/processed products
purchased shall be sourced from Indian micro, small and medium industries, which have
a total investment in plant & machinery not exceeding US $ 2.00 million.
d. Government will have the first right to procurement of agricultural products.
e. FDI is not allowed in e-commerce of Multi-brand Retail trading.

Page 13 of 13