Neighbours and Fences - India tweaks its foreign investment law

Background 

If nothing else, the last few months have taught the world that the Coronavirus pandemic is more than a serious health hazard.  It is also the spur to a business disruption on an unprecedented scale. It has swiftly impacted every sphere of business and trade in India: the declining revenues and the crippling capital crunch have been most keenly felt by businesses across the board, and some of these businesses, more than others, have become an easy target for takeovers by foreign companies at less than optimal pricing, especially where distressed assets are involved. Alert to this imminent danger for Indian businesses, the Government of India vide Press Note 3 of 2020, on April 17, 2020, amended the extant law on foreign investment to prevent any opportunistic takeovers and acquisitions of Indian companies during the COVID-19 pandemic. The Press Note was introduced shortly after China’s central bank bought close to 1% stake in HDFC Bank after the Bank’s stocks crashed in the aftermath of the pandemic, rousing the Government to the urgency for immediate measures to protect vulnerable businesses as part of its larger design for a return to economic stability.  

The new law 

The Press Note stipulates that a non-resident entity may invest in India, but debars entities and citizens of neighbouring countries that share land borders with India (such as Afghanistan, Bangladesh, Bhutan, China, Myanmar, and Nepal) from investing in Indian entities or businesses without prior government approval. The possibility of foreign investors picking up distressed assets at throwaway prices and thereby owning controlling stakes in crucial industries and businesses prompted this protectionist measure. 

With the introduction of the Press Note, investors from India’s bordering countries (“Bordering Countries”
) will be unable to exercise many of the contractual rights that had made their investments kosher under the former eligibility norms. Included in the revised package of investment terms and conditions are standard investor protection rights such as preemptive right, right to maintain shareholding, and call option. 

Though the restriction under the Press Note triggers when a beneficial owner in connection with any foreign investment into India resides in any of the Bordering Countries, the Press Note does not define the terms ‘beneficial owner’ and ‘beneficial ownership’. 

Global trend 

India is not the only country to introduce controls against potential opportunistic takeovers and foreign investment. The pandemic’s severe toll on the world economy and the consequent turmoil in business and employment sectors have led several countries to re-evaluate foreign participation in their business sector. Canada, for example, has been examining its foreign investments to prevent control of Canadian companies passing to questionable foreign hands. The European Commission has also issued guidelines to assist member states screen foreign investment in select sectors such as health, medical research, biotechnology, and infrastructure. Australia has announced a temporary framework for advanced scrutiny, flagging longer timelines for processing and clearing foreign investment proposals. Countries such as Italy, Poland, Hungary, and Germany have all followed similar precautions.  

Effect on India’s start-up ecosystem 

Of the seven countries that share land borders with India, China, which is a prime source of India’s foreign direct investment (FDI), appears to be impacted the most by the regulatory Press Note. Unicorns such as Byju’s, Ola, Oyo, Paytm, and Bigbasket have been major beneficiaries of FDI from China. With prior government approval now required by the Press Note, Indian start-ups may need to seek alternate sources of capital. These approvals may take anywhere from four to six months, which is less than ideal for start-ups where time is of the essence in funding the projects. 

Due to this blanket measure, Indian start-ups, which have hitherto relied heavily on external funding, may be forced to consider debt financing by banks and financial institutions for their immediate capital infusion. In reality, most start-ups do not have sufficient assets to provide as collateral for the requirements of banks and traditional sources of funding. With the current restrictions under the Press Note, several Indian companies may be further impeded from obtaining funds from other sources due to built-in investor protection veto rights of existing stakeholders and, as such, they will have no option other than to close their businesses if the required government approvals are not received in time. 

Impact on employment sector 

The pandemic has also adversely impacted the job market, leading from a visible downward trend in investments and distressed start-ups burning cash at unprecedented rates. The decline in revenue and the capital crunch have further intensified the pressures. In the absence of capital infusion, many companies, including Swiggy, Curefit, Uber, Zomato, and MakeMy Trip, have resorted to lay-offs and pay-cuts. CXOs at various companies have had to forego their salaries to keep their businesses afloat. For many of these businesses, an immediate infusion or a follow-on round from existing investors may save livelihoods. 

While several industry experts have praised the Press Note, seeing it as an effective means of curbing opportunistic foreign investments, there is a flipside. Historically, India has relied on FDI from China to fund companies. A blanket approval mechanism may pose a serious threat to the Indian investment environment. The Government of India could strike a golden mean by keeping intact the overall restriction while also introducing a size threshold that would allow the survival of smaller companies receiving ‘insignificant’ investment. A regulatory landscape with provision for sectoral exemptions or exclusion of funds that are not controlled by Chinese managers but have Chinese contribution may be a lifeline for small businesses.