When a foreign investor wishes to incorporate a company in India, or seeks to invest in an existing company in India, the transaction is termed as Foreign Direct Investment or more popularly, FDI.

Laws Governing FDI in India

The Foreign Exchange Management Act of 1999 is an "inclusive" Act, enlisting all the sectors where foreign investment is allowed. The Government issues restrictions and conditions as and when required through notifications, circulars, press notes and clarifications on the Act.

Categories of FDI

a) Cases where FDI is not allowed
b) Cases in which FDI is allowed with Government approval
c) Cases in which FDI is allowed without Government approval, i.e. automatic route

In the case of (b) and (c), any investment would require investigation into aspects of structuring the deal, especially the financial implications of direct and indirect taxes, stamp duties, excise and the like.

Rules and Regulations of FDI

The law governing FDI is contained in Foreign Exchange Management (Transfer or issue of security by a person resident outside India) Regulations, 2000. The Regulations have been notified vide Notification No.FEMA 20/2000-RB dated May 3, 2000.

The Act has been amended since through press notes and circulars.

The sectors in which FDI is not allowed

• Retail Trading
• Atomic Energy
• Lottery Business
• Gambling and Betting
• Agriculture (excluding Floriculture, Horticulture, Development of Seeds, Animal Husbandry, Pisciculture and Cultivation of Vegetables, Mushrooms etc. under controlled conditions and services related to agro and allied sectors) and Plantations (Other than Tea plantations).

Sectors Permitted for FDI

• Petroleum Sector (except for private sector oil refining), Natural Gas/LNG Pipelines
• Investing companies in Infrastructure and Services Sector
• Defence and Strategic Industries
• Atomic Minerals
• Print Media
• Broadcasting
• Postal Services
• Courier Services
• Establishment and Operation of Satellite
• Development of Integrated Township
• Tea Sector

Sectors for FDI with Government Approval

In the last category, a scrutiny of the proposed investment would be based on
a) The sector,
b) The investment cap, and
c) A description of the activity, items and conditions.

The investment cap or sectoral cap refers to the maximum percentage of shares that is allowed for the foreign investor. If the quantum of the proposed investment is within the prescribed limit, no Government sanction is required.

Conversely, Government approval is sought in case the investment is expected to cross set limits.

With 23 items on the list in this category, the last entry is a General entry which specifies that for any of the 22 items listed before, and other than those covered in categories a) and b), 100% FDI is allowed under the automatic route. Listed below are the sectors with the investment cap in brackets:

1) Private Sector Banking (49%)
2) Non-Banking Financial Company (100%)
3) Insurance (26%)
4) Telecommunications (74%)
5) Petroleum Refining, Marketing, Pipelines (100%)
6) Housing & Real Estate (100%)
7) Coal & Lignite (100%)
8) Venture Capital Fund / Venture Capital Undertaking (100%)
9) Trading (51%/100% )
10) Power (100%)
11) Drugs & Pharmaceuticals (100%)
12) Roads and Highways, Ports & Harbors (100%)
13) Hotel & Tourism (100%)
14) Mining (51% / 74%)
15) Advertising (100%)
16) Films (100%)
17) Airports (74%)
18) Mass Rapid Transit System (100%)
19) Pollution Control (100%)
20) Special Economic Zones (100%)
21) Air Transport Services (49% / 100%)
22) Townships (100%)
23) Any other activity other than the ones mentioned above or not following in categories 'a' and 'b' above. (100%)

Some sectors have differential investment caps for different investors. For example, mining can have an investment of 51% from foreign investors, but 74% can be invested by NRIs. Besides, each industry has a set of regulations attached, which need to be met before an investment is made.

Other modes of FDI

Global Depository Receipts (GDR), American Deposit Receipts (ADR), Foreign Currency Convertible Bonds (FCCB) are treated as Foreign Direct Investment. Indian companies are allowed to raise equity capital in the international market through the issue of GDRs, ADRs and FCCBs.

There are no caps to this investment; the pre-requisite being that a company applying for approval should have a good financial record for three years. The conditions can be relaxed for infrastructure projects such as power generation, telecommunication, petroleum exploration and refining, ports, airports and roads.

There is no constraint on the number of GDRs, ADRs and FCCBs a company or a group of companies can float in a financial year. A company engaged in the manufacture of items covered under the Automatic Route, whose direct foreign investment after a proposed GDR/ADR/FCCBs issue is likely to exceed the percentage limits under the automatic route, or which is implementing a project falling under Government approval route, would need to obtain prior Government consent through FIPB before seeking final approval from the Ministry of Finance.

Foreign investment through preference shares is also treated as foreign direct investment. Proposals are processed either through the automatic route or FIPB as the case may be.