Do We Really Need the “Approval” Route?

The announcement in the Budget Speech that the Foreign Investment Promotion Board (FIPB) is going to be wound down in 2017-18, has led to speculation amongst consultants, lawyers, foreign investors and the media as to what will take its place. After all, the FIPB, an institution that has been around for more than two decades, epitomises, inter alia, the “government approval” route for foreign investment in sensitive sectors and has been the bedrock of the Foreign Direct Investment (FDI) Policy. It has been the “go-to” body for approvals, clarifications, waivers of conditions and post facto approvals of transgressions, etc.

After successive liberalisations, the “approval route “ now accounts for only 10% or so of the FDI inflows and, therefore, the real question to ask should not be as to how or which agency(ies) will give the required approval for FDI in the sensitive sectors, but whether approval is required at all. Following from my earlier blog piece on “FIPB – The Sunset Year”, I would like to make the case that in the sectors, currently still under the FIPB route as per the contours of the FDI policy, an FDI approval per se is not required at all.

FDI Approval an Additional Layer

First, it may be observed that in the approval route sectors, the FIPB approval forms only one layer of approval, even though the FIPB process is indeed “single window” (in the sense that it brings all the stakeholders to the table). There is another very vital approval required from the administrative ministry, the regulator or the licensor concerned, which gives the operating license/approval. This includes the allocation of the resource (spectrum/ airwaves/mine etc.) as per the laid down procedures. This is true for all the extant FIPB mandated sectors viz. mining, telecom, defence, media, etc, except single brand and multi-brand trading (this has been discussed later). The policy also prescribes follow-on FIPB approvals for changes in ownership, additional capital etc in these “licensed sectors”. The need for engagement by two separate government layers is clearly debatable.

Foreign Ownership is Not a Concern

Second, also as a result of the periodic liberalisation of the FDI Policy, the sectoral cap in nearly all the approval route sectors has gone up progressively along the usual pattern of 26% to 49% to 51% over the years and now stands at 74% or even 100%[1] in some cases. This clearly implies that in respect of these sectors, where the FDI sectoral cap is at 51% or above, there are no real concerns as regards to foreign ownership and control of entities from a sectoral perspective. In such a situation, therefore, the exact percentage of foreign investment in an entity becomes merely a matter of record, rather than one requiring a formal approval from a high powered government inter-ministerial body.

Instruments of Foreign Investment Inflow

Third, the FDI policy and Foreign Exchange Management Act, 1999 (FEMA) had, in the past, restrictions not only in terms of the sectoral cap but also in terms of instruments (partly paid shares, warrants, preference shares, units, convertibles, etc) so as to check any indirect breaching of sectoral caps. These have all been rationalised and now stand at par with the Companies Act, 2013 (Companies Act) and the Securities and Exchange Board of India (SEBI) requirements for listed companies. They have been recognised as “securities” and made eligible instruments for foreign investment. The sectoral caps have also now reached 51% or above in most cases and present no barrier to foreign investment. Thus, there is really no reason for any arbitrage between the instruments to circumvent the sectoral caps or restrictions.

Concerns on Indirect Foreign Investment Flows

Fourth, there were concerns regarding “indirect” foreign investment into the recipient entity by circumventing the sectoral cap / restrictions. This has been substantially put at rest after the issuance of Press Notes 2, 3 and 4 of 2009 and further supported by the changed definition of “control” in Press Note 4 of 2013 duly notified under FEMA, consistent with the Companies Act and SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (SEBI (ICDR) Regulations). Hence this is again not an aspect that justifies the existence of a specific agency to check out foreign ownership or control; especially when most of the sectors concerned now permit foreign investment to the extent of 100%.

Investment for Considerations other than Inflow of Forex

Fifth, the FDI policy/FEMA also contained specific stipulation of funds flowing in through banking channels and did not allow issuance of shares for considerations other than cash, except for conversion of External Commercial Borrowing (ECB), in lieu of lump sum fees, technical know-how or royalty payments due. The rationale for this was to boost actual forex inflow into the country. The issuance of shares for non-cash considerations was later re-examined due to the relatively eased forex position and was expanded to include the issue of shares against import of capital goods and pre-incorporation expenses, and this was placed on the approval route. However in 2014, other than the above cases, the Reserve Bank of India (RBI) allowed issuance of shares to the foreign investor[2] under the automatic route for any other residuary legitimate payables. This has opened the window very wide and technically obviates the need for any approval at all.

Sourcing and Routing of Foreign Inflows

Sixth, in the sensitive sectors there was always an abiding anxiety about the source of funds and their routing. This was a matter especially examined by the Department of Revenue as a part of the “approval route” deliberations at the FIPB. Recently tax treaties between India and the various countries have been duly renegotiated and should lay to rest treaty shopping anxieties. Further, since 2010, India has been admitted as a fully fledged member of Financial Action Task Force (FATF) and all financial intermediaries have adopted the FATF guidelines. There are specific directions by the regulators for strict compliance with Know Your Customer (KYC) norms by banks and other intermediaries. There are therefore clearly sufficient checks available in the financial ecosystem to ensure clean inflows, instead of these being subjected to yet another set of scrutiny and examination. As a further fall back there are enough legal and regulatory provisions which are a deterrant, including in the licensing phase itself. There does not seem to be a need for the FDI policy/FIPB to try to perform the gate-keeping function.

For the above reasons, there seems to be a strong case for amending the FDI policy and doing away with the FDI approval altogether along with the FIPB.

Foreign investment – The Retail Sector Promise

The sectors of single brand, multi brand and food processing retail are currently mandated for FIPB approval. Prescribing FIPB approval for food processing retail seems quite strange as it is expected to cover only foods manufactured and produced in India, which is in the stratagem of the “Make in India” campaign and should have been allowed freely under the automatic route. The market response to these sectors has not been enthusiastic because stand-alone Indian manufactured and produced food retail may be unviable and also perhaps not entirely consumer-centric

However, permitting retail of other items within the same business would bring it within the ambit of the multi brand sector, which has its own issues. As there is no regulator for the retail sector, the current procedure is that proposals for these sectors are received and processed at the Department of Industrial Policy and Promotion (DIPP) and approved by the Commerce Minister, before being placed before the FIPB/Finance Minister. Removal of FIPB for this sector clearly does away with one additional layer of review and increases ease of doing business, provided of course the various anomalies in the sector including the overlap with e-commerce retail business are reviewed and reformed.

An Economy Truly Open for Foreign Investment

In conclusion, what is required is a fundamental change in the FDI policy itself to remove the term “FIPB Approval Route” from the foreign investment lexicon. Further, a clarification that other than the sectors prohibited for foreign investment, no prior approval for foreign investment is required, would simplify the FDI policy structure. Only in certain sectors, does an Indian entity require appropriate licenses prior to commencing operations. The foreign investors should proceed in such instances with the full potential investment only after securing the necessary licenses and approvals and complying with the terms thereof.


[1] FDI in Private security agencies and air transport services stand enhanced to 74% vide Press Note 5 of 2016 , though the same is yet to be notified in FEMA as the sectoral laws/regulations stand in the way

[2] Notified as FEMA 315 (A.P. DIR Circular 31 dated September 17, 2014 )