• UGI USER
  • Jun 15, 2024
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INDIA’S GROWTH STORY FACES ‘BENEFICIAL OWNERSHIP’ HURDLE

Syllabus:

GS-3:

Indian Economy :

Economic Development ,

Capital Market.

Focus:

  • India’s goal to become a $5 trillion economy by 2025-26 faces challenges due to unclear ‘beneficial ownership’ rules in FEMA NDI.
  • Regulatory clarity is urgently needed to attract foreign investments.
source:indiatimes

Understanding Importance of Foreign Investments:

  • Economic Goal: Foreign investments are crucial to achieving India’s $5 trillion economy target by the financial year 2025-26.
  • Removal of Bottlenecks: For Indian companies to receive foreign investments smoothly, it is essential to remove existing bottlenecks.
  • Attracting Investors: Simplifying regulations is necessary to attract foreign investors willing to support India’s growth story.
  • Government Initiatives: The Indian government must create a favorable environment to boost investor confidence.
  • Economic Growth: Foreign investments play a significant role in enhancing economic growth and development.
Understanding Foreign Exchange Management Act (FEMA), 1999:

  • Legal Framework: Governs foreign exchange transactions in India.
  • Effective Date: 1st June 2000.
  • Current Account Transactions: No change in assets/liabilities outside India (e.g., foreign trade payments).
  • Capital Account Transactions: Alters assets/liabilities outside India (e.g., foreign investments).
  • Resident Indians: Defined by residency over 182 days in the preceding year and includes registered entities in India or Indian-controlled offices abroad.

About New Provision in FEMA NDI Rules:

  • Strategic Disinvestment of BPCL: New provision facilitates up to 100% foreign investment under automatic route.
  • In-Principle Approval: Applies if the government grants strategic disinvestment approval for a PSU.
  • Existing Provision: Allows up to 49% FDI in petroleum refining PSUs without equity dilution.
  • FDI Cap Issue: 49% cap hindered selling 53% BPCL stake.
  • Disinvestment Target: Government aims to raise ₹1.75-lakh crore in 2021-22 from PSU disinvestment.

About Foreign Exchange Management (Non-debt Instruments) (Second Amendment) Rules 2021:

  • FDI in Insurance: FDI limit in the insurance sector raised from 49% to 74%.
  • Regulatory Oversight: RBI and IRDAI ensure compliance with the 74% limit.
  • Legislative Changes: Amendments to the FEMA Non-debt Instruments Rules, 2019.
  • Parliament Approval: Bill passed in March to implement the changes.

Key Facts about  “Foreign Owned and Controlled Company” (FOCC):

  • Foreign Investment Channels: FDI and FOCCs.
  • FOCC Definition: Indian-incorporated, foreign-owned, and controlled.
  • Downstream Investment: Lesser compliance compared to direct FDI.
  • Regulatory Framework: Governed by NDI Rules, FEMA.
  • Regulatory Gaps: Issues in pricing guidelines, reporting, non-capital instruments, deferred consideration.
  • Proposed Solutions: Addressing drafting oversights for clarity.

Understanding Multiple Initiatives for Growth in Different Sectors of India’s Economy:

  • New Economic Policy 2020: Rs 20 lakh crore stimulus; reforms in agriculture, labor, education, health, defense, mining, power, and taxation to foster self-reliance post-Covid-19.
  • Strategic Disinvestment: Privatization of over 60 PSEs since 1991, raising Rs 3 lakh crore.
  • Comprehensive Labour Codes: Four codes consolidating labor laws to enhance flexibility, simplify compliance, and expand social security.
  • Production-Linked Incentive (PLI): Boosts domestic manufacturing.
  • PM Gati Shakti: Multimodal connectivity infrastructure project.
  • Bharatmala Project: Enhances connectivity in Northeast India.
  • Start-up India: Promotes startup culture.
  • Make in India 2.0: Aims to make India a global design and manufacturing hub.

Key Amendment Conundrum:

  • FEMA NDI Amendment: The amendment to the Indian Foreign Exchange Management (Non-debt Instruments) Rules, 2019, has created challenges for Indian companies.
  • PN3 Requirement: This amendment mandates prior government approval for investments from entities in countries sharing land borders with India.
  • Beneficial Ownership: The term ‘beneficial owner’ is not clearly defined, leading to confusion and uncertainty.
  • Initial Industry Response: Initially, the industry took a lenient view, relying on thresholds from other laws, but this has changed.
  • RBI’s Conservative Stance: The Reserve Bank of India has adopted a more conservative view, increasing scrutiny on these investments.

Regulatory Challenges:

  • Downstream Investments: Foreign Owned or Controlled Companies (FOCCs) face challenges regarding their downstream investments under the PN3 Requirement.
  • Legal Uncertainty: Investors and law firms are now uncertain about the application of beneficial ownership thresholds.
  • Approval Process: The prior government approval route is time-consuming and has a high rejection rate.
  • Pending Applications: Many proposals from neighboring countries are pending, withdrawn, or rejected, affecting potential investments.
  • Compliance Burden: Indian companies bear the responsibility of compliance, with severe penalties for non-compliance.

Impact on Start-ups and Smaller Enterprises:

  • Financial Risks: Start-ups receiving investments beyond their revenue or assets face significant financial risks due to potential fines.
  • Survivability Concerns: The vague legislation and severe penalties cast doubts on the survivability of these companies.
  • Insolvency Threats: Large fines could lead to insolvency for start-ups, even with liquidation.
  • Legal Battles: Non-compliance would likely result in legal battles, adding to India’s court case backlog.
  • Investment Hesitancy: The regulatory uncertainty may discourage foreign investors from supporting Indian start-ups.

Issues and Solutions:

  • Indemnity Challenge: Indian companies could require foreign investors to provide indemnities regarding PN3 compliance, though this may deter investment.
  • Defining Beneficial Owners: There is a need to clearly define ‘beneficial owner’ with specific ownership thresholds and control tests.
  • Ownership Thresholds: The definition should specify thresholds, such as 10% to 25%, to align with government scrutiny levels across sectors.
  • Control-Conferring Rights: Beyond ownership, the definition should include rights that confer control, such as veto powers over operational matters.
  • Consultation Mechanism: Incorporating a time-bound consultation mechanism with regulatory authorities can help resolve ambiguities in control-conferring rights.

Indemnity and Investor Confidence:

  • Investor Assurance: Clear guidelines and definitions will provide assurance to foreign investors, boosting their confidence.
  • Government’s Role: The government must actively engage with industry stakeholders to address concerns and improve the regulatory framework.
  • Sector-Specific Scrutiny: Different sectors may require varying levels of scrutiny, tailored to their sensitivity and capital needs.
  • Exclusion of Investor Rights: Investor protection rights, like veto powers over mergers, should be excluded from control definitions to encourage investment.
  • Regulatory Clarity: Providing clarity on beneficial ownership and control-conferring rights will streamline the investment process and attract more foreign investments.

Navigating the Prior Approval Process:

  • Simplifying Approvals: The government should streamline the prior approval process to make it less time-consuming and more efficient.
  • Reducing Rejection Rates: Efforts should be made to reduce the rejection rates of investment proposals to encourage more foreign investments.
  • Transparency in Data: Publishing consolidated data on pending and rejected applications will improve transparency and trust in the process.
  • Regulatory Support: Providing regulatory support and guidance to companies will help them navigate the approval process more effectively.
  • Mitigating Compliance Risks: Clear guidelines and definitions will mitigate compliance risks, reducing the likelihood of fines and legal battles.

Enhancing Investment Climate:

  • Policy Reforms: Implementing necessary policy reforms will enhance the investment climate and attract more foreign investments.
  • Investor-Friendly Environment: Creating an investor-friendly environment with clear and consistent regulations is crucial for attracting foreign capital.
  • Government Initiatives: Government initiatives aimed at improving the ease of doing business will support the growth of Indian companies.
  • Long-Term Vision: A long-term vision and commitment to regulatory clarity will ensure sustainable growth and attract global investors.
  • Collaborative Approach: A collaborative approach between the government, industry stakeholders, and investors will address challenges and drive economic growth.

Way Forward:

  • Define Beneficial Ownership: Clearly define ‘beneficial owner’ in regulatory terms to eliminate ambiguities.
  • Streamline Approval Process: Simplify and expedite the prior government approval process for foreign investments.
  • Sector-Specific Regulations: Implement differentiated scrutiny levels for sensitive and non-sensitive sectors.
  • Enhance Transparency: Publish data on pending and rejected investment applications to improve transparency.
  • Provide Regulatory Guidance: Offer clear guidelines and support to companies navigating compliance requirements.
  • Reduce Rejection Rates: Work towards lowering the rejection rates for investment proposals to attract more investors.
  • Encourage Investor-Friendly Policies: Foster an investor-friendly environment with consistent and transparent regulations.

Conclusion:

Addressing the ‘beneficial ownership’ hurdle through clear definitions, streamlined approval processes, and sector-specific regulations is crucial for India to attract foreign investments. These reforms will not only support economic growth but also enhance investor confidence, ensuring sustainable development and progress towards the $5 trillion economy goal.

Source:

https://www.thehindu.com/opinion/op-ed/india-growth-story-has-a-beneficial-ownership-hurdle/article68290282.ece

Mains Practice Question:

Discuss the impact of the ‘beneficial ownership’ clause under the Indian Foreign Exchange Management (Non-debt Instruments) Rules, 2019, on foreign investments in India. Suggest measures to address the challenges posed by this clause to promote economic growth.

Associated Article:

https://universalinstitutions.com/the-growth-story/