FDI Framework: Whither are we Bound?

Regulations & Agencies
The FDI Framework in India stands on a threelegged tripod consisting of three Regulations ~ the Foreign Exchange Management Act, 1999 along with its Regulations, the Consolidated FDI Policy, and the Circulars to Authorised Person issued from time to time by the Reserve Bank of India.

Interestingly, just as there are three Regulations, there are also three Agencies/Ministries/Regulators which are involved in the FDI Regime – the Reserve Bank of India (RBI), the Department of Industrial Policy and Promotion (DIPP), Ministry of Commerce & Industry and the Foreign Investment Promotion Board (FIPB), Ministry of Finance. Each of these three agencies has an important role to play.

FEMA and RBI
The Foreign Exchange Management Act, 1999 (FEMA) is a Central Statute of the Parliament and is the supreme Act, when it comes to regulating all foreign transactions in India, including those pertaining to FDI. The FEMA also consists of Regulations issued by the RBI from time to time. The relevant Regulations for FDI are the Foreign Exchange Management (Transfer or Issue of Security by Persons Resident Outside India) Regulations, 2000 (Notification No. FEMA 20/2000-RB dated May 3, 2000). U/s. 46 of the FEMA, the RBI has power to make Rules to carry out the provisions of the Act. Further, u/s. 47, it has the powers to make Regulations to carry out the provisions of the Act and the Rules.

The RBI is the nodal regulatory authority for all matters connected with foreign exchange transactions in India. It is the authority which has powers to launch prosecution, levy penalties, allow compounding of offences, etc., as well as the agency which lays down rules for valuation, reporting requirements, etc.

One feature of the FEMA Regulations is the Directions issued by the RBI u/s. 10(4) and 11(1) of the FEMA to various Authorised Persons, popularly known as “A.P.(DIR Series) Circulars”. Authorised Persons are Authorised Dealers, Money Changers, Banks, etc., who are authorised by the RBI to deal in foreign exchange. Thus, these Circulars are operational instructions from the RBI to Banks, etc. The legal validity of these Circulars has been upheld by the Bombay High Court in the case of Prof. Krishnaraj Goswami v. the RBI, 2007 (6) Bom CR 565. The Court held as follows:

“………the Reserve Bank of India issued the impugned circular by way of directions as contemplated under Sections 10(4) and 11(1) of the Act. A bare reading of these provisions clearly show that the Reserve Bank of India has the power to issue directions to the authorised persons and this power is wide enough to cover any kind of directions so far it provide for the regulation of the Foreign Exchange management. We are unable to find any merit in the contention raised on behalf of the petitioner that the Reserve Bank of India has no jurisdiction to issue such circulars. Section 10(4) of the Act clearly stipulates that an authorised person shall, as contemplated under Section 10(1) of the Act, in all his dealings is bound by the directions, general or special, issued by the Reserve Bank of India. Similarly, Section 11(1) of the Act provides that the Reserve Bank of India may, for the purpose of securing compliance with the provisions of the Act and of any Rules, Regulations and directions made under the provisions of the Act, give to the authorised persons any direction in regard to making of payment or the doing or desist from doing of any act relating to foreign exchange or foreign security….”

Once a year on 1st July of every year and occasionally, on a half-yearly basis, the RBI issues a Master Circular which consolidates all the existing Circulars at one place. Master Circulars are issued with a sunset clause of one year. Master Circulars were introduced in accordance with the recommendations of the Tarapore Committee. This Committee recommended that every year, the RBI should consolidate all the instructions and Regulations on each subject into a Master Circular for use by the public. It also recommended that the Master Circulars should be prepared in an unambiguous language without using jargons.

Whilst the FEMA, the Rules and the Regulations have legal force, the Circulars and Master Circulars are only directions.

CFIP and DIPP
The DIPP frames the Foreign Direct Investment Policy in India which lays down the sectors in which FDI is allowed, the conditions attached and the sectoral caps. It also lays down the sectors in which FDI is Automatic and those in which it requires Approval of the Government of India. The FDI Policy is prepared in the form of the Consolidated FDI Policy (“CFDIP”). The Policy defines FDI to mean investment by non-resident entities in the capital of an Indian company under Schedule 1 of FEMA No. 20/2000-RB dated 3rd May, 2000.

Earlier, the DIPP used to issue Press Notes from time to time, which used to lay down the FDI Policy and changes made to the same. Since the past two years, it has started the practice of preparing a Consolidated FDI Policy which subsumes all Press Notes/Press Releases/ Circulars issued by DIPP till date. In the first two years, the DIPP came out with a Consolidated FDI Policy twice a year, i.e., on a half-yearly basis – in April and in October. However, it has now clarified that henceforth, it would be an annual event. Thus, the next CFDIP would be in April 2013.

The power of the Government to lay down economic policy has been the subject-matter of great judicial interest. In Balco Employees Union v UOI, (2002) 2 SCC 333, the Supreme Court laid down the prerogative of the Government to frame the economic policy:

“……The Courts have consistently refrained from interfering with economic decisions as it has been recognised that economic expediencies lack adjudicative disposition and unless the economic decision, based on economic expediencies, is demonstrated to be so violative of constitutional or legal limits on power or so abhorrent to reason, that the Courts would decline to interfere. In matters relating to economic issues, the Government has, while taking a decision, right to “trial and error” as long as both trial and error are bona fide and within limits of authority. ….”

Again in Federation of Railway Officers Association v. UOI (2003) 4 SCC 289, the Apex Court laid down the following principle:

The validity of the FDI Policy laid down by the Government, has come in for review by the Courts. In the decision of Radio House v UOI, 2008 (2) Kar. LJ 695 (Kar), the Karnataka High Court held while dealing with the definition of ‘wholesale trading’ laid down in an earlier version of the FDI Policy:

“………The task of defining the term ‘cash and carry wholesale trade’ is to be best left to the Government, which has formulated the policy of inviting the FDI. No directions can be given to the Government to accept a particular definition of the term ‘cash and carry wholesale trade’ in preference to or to the exclusion of its other definitions from other sources. Therefore the challenge to the approval order, dated 5th December, 2000 (Annexure-B) fails. …………..

………But it is for the Government to evolve a policy to safeguard the interest of the retailers. It is trite position in law that the Court should not substitute its wisdom for the wisdom of the Government in policy matters.”

The FDI Policy on Wholesale Trading was also the subject-matter of review in the case of Federation of Associations of Maharashtra v UOI, W.P. (C) Nos. 9568-70 of 2003 (Del) where the Court held as follows:

“…….The aforesaid is apparent from the fact that no one is disputing the right of the Government to lay down its policy……….. once it is recognised that the Government can amend its policy, nothing pre-cludes the Government from issuing a clarification even if it is read in the nature of an amendment of the policy. ……………The matter in issue is not even of any statutory interpretation, but of the policy. The policy-framer is the concerned Ministry which itself has issued the clarification / modification. The learned ASG is right in his submissions that the matter is one of policy decision and allocation of businesses and FIPB functions as part of the concerned Ministry. ………The relevant authority is the Government itself which had framed the policy. ……………..

59.    The interpretation of the Government is also not out of thin hair. It is trite to say that with the expansion of international commerce and trade, there are certain internationally understood concepts, which have come into play. Is the Court to look to the traditional definition of what may be wholesale or retail as may be considered in the dictionaries and in the country earlier or is the Court to accept the definition adopted by the Government on international practice? The Government’s view is based on the WTO definition of wholesale trade. The Government can hardly be faulted on this account and it is not for the Court to go into this question……….….This being the position, it is the stand of the Government, which has to be given the greatest weight in such matters. There cannot be any knit-picking on this issue of the definition when the stand of the Government has come clearly in its affidavit as enunciated by its clarification. The Government wants B2B sales to form a part of wholesale cash and carry business. So be it.”

A decision of the Delhi High Court in the case of Putzmeister India Private Limited and others vs. UOI, W.P.(C) 5633-35/2006 Order dated July 1, 2008 (Del) is also relevant. This case examined the validity of the erstwhile Press Note 1 of 2005 issued by the DIPP requiring the FIPB’s permission in cases where the foreign investor had a prior joint venture in the same / allied field:

“27. Issues pertaining to foreign investment and attendant modalities are largely a matter of executive policy; to some extent, these are also governed by provisions of the Foreign Exchange Management Act and the guidelines issued by the Reserve Bank of India. The three press notes fall in the domain of enunciation of executive policy………A large number of decisions have ruled that the wisdom of an executive policy does not fall within the domain of judicial review; nor does Article 226 permit High Courts to sit in appellate judgment over executive decisions, made in legitimate bounds of exercise of power……….When two views are reasonably possible about the interpretation of an executive order, the court is of the opinion that unless strong and compelling reasons exist, it should not supplant the views of the executive government.”

FIPB

The Foreign Investment Promotion Board (FIPB) is a part of the Department of Economic Affairs, Ministry of Finance. As explained above, FDI could be Automatic or it may require the Approval of the Government of India. The FIPB is a nodal authority for approving all FDI proposals which require prior Government Approval. The FIPB provides a single-window mechanism for all such FDI proposals, which are not permissible under the automatic route. The FIPB has been a part of several Ministries. It initially started as a part of Prime Minister’s Office, later on it became a part of the DIPP and now is a part of the DEA, Ministry of Finance. All FDI proposals up to an investment amount of Rs. 1,200 crores are approved by the Finance Minister, while those in excess of Rs. 1,200 crores are approved by the Cabinet Committee on Economic Affairs (CCEA). The FIPB consists of Secretaries from various Ministries, such as, Finance, DIPP, External Affairs, Department of Commerce, etc.

It may be noted that the FIPB is a body without any statutory backing nor can it make any law. In the case of Zippers Karamchari Union vs. UOI, 2000 (10) SCC 619, the Supreme Court while dealing with the grant of an approval by the FIPB to YKK, Japan to set up a subsidiary in India, held as follows:

“….It is a matter of government policy and in our opinion no sustainable ground was urged before us to hold that the approval granted to YKK was contrary to the government policy. The Court would not be justified in interfering in such matters when it is satisfied that a grant of approval to YKK was neither irrational, nor for any extraneous consideration….”

CFDIP or FEMA, Which One Prevails?

One question which has often been raised has been-which one is supreme – the FDI Policy or the FEMA Regulations? The answer to this is very simple. It is the FEMA and the Regulations issued thereunder which are superior to the FDI Policy. The Policy is notified by the RBI as amendments to the Foreign Exchange Management (Transfer or Issue of Security by Persons Resident Outside India) Regulations, 2000. Schedule 1 of these Regulations deals with “Foreign Direct Investment Scheme”. Para 2 of Schedule 1 gives recognition to the FDI Policy by providing that the Automatic Route for FDI is available to a company in accordance with Annex B to the Schedule and the provisions of the FDI Policy, as notified by the Ministry of Commerce, from time to time. Annex B contains the “Sectoral Specific Policy for Foreign Investment”. This Annex B is based on the FDI Policy issued by the DIPP.

The FDI Policy itself provides that in the case of any conflict with the FEMA Regulations, the FEMA Notifications would prevail.

Thus, the descending order of hierarchy amongst various pronouncements would be: FEMA -> Rules & Regulations ->  AP Dir Circulars ->  Master Circulars -> FDI Policy by DIPP -> Press Notes/Clarifications by DIPP.

PIL before SC

An interesting question recently arose before the Supreme Court in a Public Interest Litigation (PIL) – Manohar Lal Sharma v UOI, Writ Petition (Civil) 417 of 2012 (SC), Order dated 15th October, 2012. Before going into the facts of this case, a background to this case merits attention. The DIPP vide Press Note No. 5 of 2012 dated 20th September 2012, permitted FDI in Multi-brand Retail Trading under the Approval Route of the FIPB. Prior to this, FDI in this sector was altogether prohibited. Annex A to Schedule 1 of the Foreign Exchange Management (Transfer or Issue of Security by Persons Resident Outside India) Regulations, 2000 as well as the CFDIP both provided that FDI in “Retail Trading (except single brand product retailing)” is a “Sector prohibited for FDI”. Press Note 5/2012 modified the CFDIP by permitting 51% FDI in Multi-brand Retail Trading. Subsequently, the RBI issued Directions to Authorised Persons vide A.P. (DIR Series) Circular No. 32 dated 21st September 2012, specifying that the FDI Policy has been modified to permit 51% FDI in Multi-brand Retailing. It also mentioned that neces-sary amendments to the FEMA Regulations are being notified separately.

However, the FEMA Regulations No. 20-2000/RB have yet not been modified. They yet contain the old Annex B which provides that FDI is not permitted in Multi-brand Retailing. Thus, a PIL was filed which stated that in the absence of amendment to the FEMA Regulations, the FDI Policy could not prevail over it and hence, a petition was made to the Supreme Court asking for a stay on the Press Notes allowing FDI in Multi-brand Retailing.

In the above-mentioned PIL, the Supreme Court up-held the superiority of the FEMA Regulations over the FDI Policy. However, it also upheld the amendments to the FDI Policy on Retail Trading but asked the Government to bring the FEMA Notifications up to date with the FDI Policy. The Court held that amending the FEMA Regulations is a legal process which has to be taken to logical conclusion. It is a routine thing and it has to be done. It also held that not amending the FEMA Regulations was at best, an irregularity that is curable and as soon as amendment is brought, it would be cured.

The Bench added that there is no question of any stay on the FDI policy. It held that the FDI policy was prepared by the Central Government and it is not that RBI had been kept in the dark by the Centre. RBI had already issued a Circular amending the FDI limits but it had not formally amended the Regulations. Accordingly, the Court asked the Attorney General when RBI would do so. It gave RBI time to do so by noting as follows:

“….but you have to give the policy a legal shape by amending the regulation. These matters have huge impact….”

On the allegation in the PIL that the Centre’s notification was issued without the authority of law as approval of neither the President nor the Parliament was secured, the Supreme Court rejected the same by saying that the assumption that the policy has to be in the name of the President is flawed and unfounded. It further said that a policy is never required to be placed before the Parliament.

This decision clearly establishes the supremacy of the FEMA Regulations over the FDI Policy and that the Regulations must be amended to reflect the FDI Policy.

Contrasting Stands

The above was an instance where the RBI had not yet modified the FEMA Regulations to be in touch with the CFDIP. However, what about cases where the RBI’s view is exactly opposite to that of the CFDIP? A case in point is the issue of FDI instruments with Put and Call Options. Since the last 2-3 years, the RBI has been taking a view that exit options, such as put and call options, attached to Compulsorily Convertible Debentures/Preference Shares/Equity Shares for FDI are not valid. The view being taken was that, a fixed exit option makes the equity instrument equivalent to a debt instrument. The DIPP in its CFDIP issued vide Circular 2/2011, contained a Clause that only instruments with no in-built options of any type would qualify as eligible instruments for FDI. Instruments issued/transferred to non-residents with in-built options would lose their equity character and such instruments would have to comply with the ECB guidelines. Within a month of its issuance, the CFDIP was modified and a Corrigendum was issued by the DIPP deleting the above Clause. Thus, the DIPP’s stance on the issue is now very clear, i.e., FDI can have in-built options. However, the RBI’s stance on this issue has yet not mellowed. Such divergent views between the FDI Policy and the FEMA Regulations are best avoided, since they do nothing but add to the regulatory confusion and mayhem.

FDI v FII / PIS
While on the subject of FDI, it would not be out of place to highlight the distinction between FDI inflows on the one hand and inflows from Foreign Institutional Investment (FII) / Portfolio Investment Schemes (PIS) on the other hand. FDI is primary market investment by non-resident entities in the capital of an Indian company, i.e., money directly comes to the Indian company. FII and PIS on the other hand are secondary market investments, in which foreign investment is made by acquiring the shares of an Indian company from other resident/non-resident shareholders. It may be noted that FII investment is not subject to the sectoral caps and conditions laid down in the CFDIP. In cases where the RBI also wants to prevent, investment under the FII/PIS, it has expressly done so. For instance, earlier, FII/NRI investment was prohibited under the print media sector. No such restriction is now found.

Another analogy is in the real estate sector. Under the PIS, FIIs can also acquire shares of real estate company making an IPO. The conditions of lock-in, minimum capitalisation, minimum area, etc., which are associated with FDI in real estate are not applicable to a Portfolio Investment made by FIIs, including that made under the IPO of a real estate company. However, FII investments in any pre-IPO placement are treated on par with FDI and are subject to all conditions of the erstwhile Press Note 2 /2005.

Conclusion
India’s FDI Policy is multi-faceted and is often prone to pulls and tugs from within the system. Is it not strange that for a country which aims to be the cynosure of the global attention and which is constantly vying with China, Brazil, Russia, etc., for FDI, India continues to have contrasting stands from Ministries and Regulators on the FDI Policy. FDI loves certainty as explained by Justice Kapadia, in the celebrated decision of Vodafone International Holdings, 341 ITR 1 (SC):

“…FDI flows towards location with a strong governance infrastructure which includes enactment of laws and how well the legal system works. Certainty is integral to rule of law. Certainty and stability form the basic foundation of any fiscal system…”

Maybe it is time to disband multiple agencies, such as, the FIPB and the DIPP and replace them with one Super Regulator for all things connected with FDI in India. Should we not get over our hangover of the “Licence Raj” once and for all? It would be desirable if we have a clear FDI Policy devoid of confusion and ambiguity. One may sum up with a quote from Henry Miller, the noted American Author:

“Confusion is a word we have invented for an order which is yet not understood!”