FDI policy: Need to separate chaff from grain

LEGAL EYE

Finally, the Foreign Investment Promotion Board (FIPB) has given a clean chit to Vodafone's Hutch acquisition, the first instance of FDI achieving the enhanced sectoral limit. The fact scenario is now familiar.

Hutchison Essar limited (HEL), the target telecom provider, is a wholly owned subsidiary of Telecom Investments India (TII), an investment company in which the offshore Hutchison Telecommunications International (HTIL) is the foreign majority holder.

Vodafone sought to acquire the HTIL stake as well as the 15 per cent holding of resident Indians Analjit Singh and Asim Ghosh in TII.

The red flag, which provoked the institution of a PIL by Telecom Watchdog, was based on the allegation that Singh and Ghosh's shares were benamdar holdings on behalf of HTIL, constituting part of foreign equity, thereby breaching the sectoral cap. The reason: HTIL had provided a guarantee for the loans utilised by Singh and Ghosh to acquire the shares. The PIL highlighted further grey areas "" the acquisition price paid by Ghosh and Singh was Rs 3,841 per share, whereas the Vodafone valuation was around Rs 15,000 per share. Transfer of these shares required HTIL's consent, and the pricing mechanism for their transfer under an option was at par.

All these have been justified on account of a holding company discount, substantial levels of debt and transfer price formula of the option shares taking, as also providing downside protection to the holders in the long term.

The law ministry, on the basis of the Attorney General's advice accepted these explanations to FIPB's satisfaction. The board has further held the AS and AG stakes to be Indian holding, which it was directed by the Delhi High Court to investigate, but has recommended that these shares can be sold only to Indian residents, with prior governmental approval. It's unlikely that the court will interfere further.

As a macro-level aftermath, FIPB required the government to review FDI guidelines and norms relating to direct and indirect foreign shareholdings so that sectoral caps are not circumvented. Days before the FIPB determination, the home ministry cautioned close monitoring of FDI proposals to avoid issues of possible breach.

India's sectoral policy on FDIs has been governed by various considerations ranging from political, security and permissibly protectionist. There is no separate law for this, covered by FEMA regulations. Currently, most FDIs in India is covered under the automatic route, while few specific sectors remain under the FIPB approval route, which is where the confusion stems on the definition and scope of FDI, what constitutes direct and indirect investments and how it operates.

The genesis of confusion lies in Press Note 2/2000 which places all items/activities under the automatic route, except those where notified sectoral caps apply for FDI/NRI investment. Having clubbed the two, general permission for NRI investments have been accorded, irrespective of the cap in various sectors, creating an erroneous impression that, if an non-repatriation undertaking is provided, NRI investment may be made regardless of caps. But in retail, though Press Note 6/06 does not state so upfront, the FIPB does not permit the 49 per cent Indian shareholding to be represented by NRIs on non-repatriable basis or otherwise.

In case of domestic airlines, FDI is permitted up to 49 per cent under the automatic route, but 100 per cent NRI investment is allowed, subject to no direct or indirect equity participation by a foreign airline, and other guidelines of the Ministry of Civil Aviation, such as FIIs not having foreign airlines as shareholders.

In atomic minerals and mining, FDI up to 74 per cent is permitted through the approval route, covering NRI investments, as in defence and strategic industries, where permissible FDI is 26 per cent. The insurance sector, which also permits FDI up to 26 per cent, does not clarify whether NRI funds are distinct.

Other than the airline industry, telecom is a sector where distinction between direct and indirect holdings is made. FDI ceiling in telecom takes into consideration the FIIs, NRIs, FCCBS, ADR/GDRs, and defines indirect investments to include investments in companies holding shares of the licencee, whether through mutual funds, or otherwise.

It appears that the approach in making these distinctions, including the ad hoc use of the terms, "FDI" and "foreign investment" has been random; it's not clear how indirect investment through mutual funds or portfolio investments could be a potential threat. There is also no clarity on the circumstances wherein NRI investments would constitute indirect investment.

With multi-tiered structures of holdings becoming common, there has to be a mechanism to discern chaff from gold.

Kumkum Sen is a Partner at Rajinder Narain & Co and can be reached at kumkumsen@rnclegal.com