Investment into Businesses

Investment business is done with the expectation of capital appreciation, dividends, and interest earnings. Such investment is critical for the growth of the country as it brings employment and enables the skilling of the workforce.

There are several ways through which investment can happen into businesses, that we will learn in this chapter.

Direct Investment v/s Indirect Investment

Direct Investment:

Direct Investment involves investing directly in a specific asset or enterprise, giving the investor control over the enterprise.

For example, own assets such as real estate. In the enterprise, direct investment enables the investor to participate in the governance of a company. This provides greater control over investment decisions and strategies. Foreign Direct Investment (FDI) is a direct investment.

Direct Investment generally takes place at the formative stages of a business. It can take the shape of seed investment or venture capital. This serves the following advantages:

• Technology and Skills: A direct investor has greater involvement in the businesses. This ensures that the investors bring their own experiences, skills and technology into the business.
• It has a higher potential for returns, but also greater risk associated with the specific asset or business.
• Important for startups: It enables newer business ideas to grow and prosper.
• An Important Financial Mechanism: In the formative stages, it is difficult for a business to raise money through banks or the issuance of bonds or shares to the general public.
• Greater Multiplier effect on the economy: Money that comes into newer businesses

Indirect Investment:

Indirect Investment involves investing in financial instruments or funds that hold a variety of assets, rather than directly owning the assets themselves. For example, Stocks, bonds, mutual funds, exchange-traded funds (ETFs), or real estate investment trusts (REITs).

Such investment has its own advantages:

1. Securitisation: It allows for a bigger asset to be broken into smaller securities/financial instruments such as bonds and shares.
2. This allows easier participation by the public, with a smaller capital base. It often provides greater diversification by pooling funds to invest in a range of assets.
3. Regulatory oversight: Since public money is involved, regulatory agencies like the SEBI ensure transparency in the businesses through its compliance mechanisms.
4. Easy Exit: Due to securitisation, such assets can be easily sold through stock exchanges like National Stock Exchange (NSE) and Bombay Stock Exchange (BSE).
5. Less Risky: Generally such investment is less risky than direct investment due to diversification and easier exit, but may also offer lower returns.

Foreign direct investment (FDI)

FDI is an investment made by a firm or individual in one country into business interests located in another country. Generally, FDI takes place when an investor establishes foreign business operations or acquires foreign business assets in a foreign company.

Foreign Direct Investment Policy is issued by DPIIT, Mo Commerce and Industry.

Importance of FDI:

• Introduction of Foreign Skills and Technology: Often Investors through FDI introduce their own ways, Technologies, Skills, New management processes/ business analytical techniques and intellectual properties at a cheaper rate.
• Supply chain Connectivity – Foreign direct investors can play a vital role in ensuring supply chain connectivity. For example, access to critical raw materials, and foreign markets.
• Capital: Indian investors and banks have a limited capacity to fund Indian businesses. FDI gives direct access to a larger pool of capital.
• It is an important source of Foreign Exchange Earning.

FDI routes:

According to the Foreign Direct Investment Policy, Department for Promotion of Industry and Internal Trade (DPIIT), FDI can come under two routes:

• Automatic: There are investment plans that come under “do not require prior approval of the government and RBI”. Under this route, an investor can invest in any entity, generally after registering a company in India.
• Government route: Investment under this route requires prior permission from individual departments such as DPIIT (M/o Commerce) and DEA (M/o Finance).

Note: Before 2017, all projects above the cost of ₹5000Cr had to be passed by the Foreign Investment Promotion Board (FIPB), which was a regulatory body under DPIIT. It was abolished in 2017 as “more than 90% of the total FDI inflows” were “now through the automatic route.”

Current Provisions:

According to the existing FDI Policy and FEMA regulations:

• Individual departments of the government have been empowered to clear FDI proposals in consultation with DPIIT which will also issue the standard operating procedures for processing applications.
• Further, the government has successfully implemented e-filing and online processing of FDI applications.”

Should India remove the Approval route for FDI?

Advanced countries, by and large, welcome all foreign investment but have institutional mechanisms to block any foreign investment proposal that hurts national interest and security. As per the current provisions, Different ministries are better placed to defend sectorial interests.

Further, RBI is the best place to play as the nodal agency for review; after all, all foreign investment into the country has to comply with its foreign exchange reporting requirement.

Sectoral Provisions for FDI

As per India’s FDI Policy, India does not restrict FDI in most of the sectors. In fact, 100% FDI is permitted in all 25 sectors, except for space (74%), defence (49%) and news media(49%). It means foreign entities can take full stake in businesses or open new businesses in most of the sectors.

• 100% FDI is allowed in the Construction sector, the Television sector (including non-news TV channels, Teleports, DTH, Cable networks, and Mobile TV), the insurance sector, coal mining, contract manufacturing, and Plantations.
• NRI-owned companies are now treated as domestic.
• FIIs/FPIs are allowed to invest in Power Exchanges through the primary market.

Restrictions in the FDI

• Foreign airlines are allowed to invest up to 49% under the approval route in Air India.
• Defence: Only 49% of FDI is allowed under automatic route for portfolio investors.
• Broadcasting: In News channels, only 49% of FDI is allowed under the automatic.

FDI in Banking:

As per the FDI policy, the following limits are in force:

• PSBs: 49% under the automatic route as per the FDI policy,
• Private: 74% under automatic route; No sub-limits for FDI and FII; Govt. Planning for 100%.

But as per the RBI, no foreign entity can own more than 20% of the Banks. Therefore, effectively 20% of FDI is allowed in banks.

FDI in E-commerce:

FDI in E-commerce is a sticky issue for the government, as it has the potential to disrupt the market. The following provisions are made in this context:

• No government permission is required to sell products under the marketplace model. This means that when companies like Amazon and Flipkart act as only the marketplace for selling other products, they can invest in India.
• But for the Inventory-based model, no FDI is allowed. It means that such e-commerce entities that own the inventory of goods and services cannot have any FDI.

Thus ideally, Amazon basics cannot exist. And it should be impossible for Amazon to place its own products on its platform. But it does this with the help of several loopholes in the policy.

• 100% FDI under automatic route for Single Brand Retail Trading. It means that if you sell products of only one brand, 100% FDI is allowed.

FDI hits all-time high in FY21; forex reserves jump over $100 bn

1. Net foreign direct investment (FDI) into the country hit a fresh high of $43.366 billion.

Limitations of FDI:

It is often found that the FDI’s advantages on our economy might be overstated:

1. FDI flows not growing: The foreign investors are just reaping the benefits of past investments and reinvesting those earnings in the new ventures. According to UNCTAD, the share of reinvested earnings is 4/5^th in developing economies.
2. Low FDI percentage: India accounted for merely 3-4% of total world FDI.
3. Ownership of Intellectual property has not increased: While developing countries have not been able to acquire technologies, they have to make a variety of payments for the use of Intellectual properties. About half of the inflows into India are balanced out by outflows in the past six years for buying technologies.
4. Tax havens: India should be careful about creating two classes of investors wherein foreign investors are given a disproportionate advantage. UNCTAD had underlined large amt. of losses to the exchequer of developing countries; about $100bn/year due to the routing of FDI through tax havens.
5. Uneven Spread:
   • States dominance: Maharashtra(46.67%), Gujarat(24.38%), Karnataka and NCT of Delhi — accounted for nearly 90% of the FDI inflows.
   • Sector dominance: IT, pharma, telecom and digital economy sectors attracted most of the flows.

Foreign Institutional Investor (FII)

They include all foreign financial institutions allowed to invest, subject to FCRA regulations; such as – [1995 Regulation]

• An institution established or incorporated outside India as a pension fund, mutual fund, investment trust, insurance company or reinsurance company;
• An International or Multilateral Organisation or an agency thereof or a Foreign Governmental Agency,
• [Sovereign Wealth Fund] or a Foreign Central Bank;
• Asset management company, investment manager or advisor
• Bank or institutional portfolio manager, established or incorporated outside India and proposing to make investments in India on behalf of broad-based funds and its proprietary funds, if any;
• A trustee of a trust established outside India and proposing to make investments in India on behalf of broad-based funds and its proprietary funds, if any;
• University funds, endowments, foundations, charitable trusts or charitable societies.

RBI Definition of FDI or FPI

Foreign Exchange Management Regulations, 2017 defines FDI and FPI as the following: FDI is the investment through capital instruments by a person resident outside India: Either in an unlisted Indian company; or In 10% or more of the post-issue paid-up equity capital on a fully diluted basis of a listed Indian company. FPI  is any investment made by a person resident outside India in capital instruments where such investment is: Less than 10% of the post-issue paid-up equity capital on a fully diluted basis of a listed Indian company or Less than 10% of the paid-up value of each series of capital instruments of a listed Indian company.

Foreign Portfolio investor (FPI)

When Investors invest in a portfolio it is known as the Portfolio Investment.

Foreign Portfolio Investment consists of securities and other financial assets held by investors in another country. It does not necessarily provide the investor with direct ownership of a company’s assets.

A Foreign Portfolio Investor (FPI) is a financial institution/bank-

• A resident of a country whose central bank is a member of the Bank for International Settlements;
• belonging to a country whose securities market regulator is a  signatory to the International Organization of Securities Commission‘s Multilateral MoU
• And not prevented from investing under FATF rules.

3 Categories of FPI

According to the 2014 Regulation of SEBI, FPIs are of three categories

• Category 1: Government and government-related foreign investors such as Central Banks and sovereign Wealth Funds.
• Category 2: Funds, which are broad-based and (i) appropriately regulated, or (ii) whose investment manager is appropriately regulated
  • It may include mutual funds (‘MF’), investment trusts, insurance/reinsurance companies, Asset Management Companies, investment managers/advisors, portfolio managers, broker-dealers, swap dealers, University funds/University endowments, and Pension funds.
• Category 3: All other FPIs not eligible under Category I and II such as Endowments, Charitable societies, Corporate bodies, Trusts, Family offices, and Individuals.

Limitations of FPI

Only a broad-based fund can hold more than 49% of shares/securities.

“broad-based fund” means a fund, established or incorporated outside India, which has at least 20 investors, with no single individual investor holding more than 49% of the shares/units.

Way Forward: Production-linked incentive(PLI) scheme offered by the government for several sunrise sectors, potential growth in digital economy segments, as well as privatisation plans of the Central government are being seen as the pull factors for foreign investors.

FAQs related to Investment Business