How Foreign Investments Are Holding Out Promises For Small Businesses And Startups?
6 min read
Foreign Investment In India And Its Regulations
The impromptu implementation of the lockdown due to Covid-19 had led to the closing down of businesses.
Many Indian promoters of small businesses are looking to exit the joint ventures they had set up before the pandemic.
But there is good news for them! India is seen as a good investment destination despite the slowdown caused by the coronavirus.
According to Commerce and Industry Minister, Piyush Goyal, FDI in India has grown by 13 percent to $ 40 billion, during April-September, 2020.
This is the highest ever FDI in the first five months of a fiscal year.
According to the Department for Promotion of Industry and Internal Trade (DPIIT), FDI equity inflows have increased from $ 23 billion in 2000 to $ 500 billion in 2020.
The sectors which have received maximum FDI include automobiles, industrial chemicals, software, services (including BFSI), and trading.
The computer software and hardware sector received the highest FDI of $ 17.55 billion in the first half of FY-21, followed by services ($ 2.25 billion) and trading ($949 million).
The most notable countries investing in India are the Cayman Islands, France, Japan, Mauritius, Singapore, UK, and the US.
The largest investments nearing 30 percent of the total has come through the Mauritius route.
Facebook made the largest FDI investment in India in 2020, when it invested $5.7 billion in India’s largest internet company, Reliance Jio, in 2020.
Importance Of FDI
Getting foreign equity for startups is important because these new businesses require a lot of capital to maintain their solvency.
Also, a small business owner looking for an exit can be bought out by his foreign partner.
So, FDI brings a lot of liquidity to the economy.
Foreign companies not only bring funds with them but also knowledge, skill, and technology.
With the pandemic putting a brake on India’s economic growth, the government is inviting FDI to get back on the growth path once again.
Various infrastructure projects such as airports, highways, railways, and logistic parks can attract large-scale foreign investment.
To achieve this, the government is trying to get some investors from Dubai and the US on board.
FDI In India
Foreign Direct Investment (FDI) in India is a major monetary source for economic development where foreign companies invest directly in fast-growing private businesses.
The investors want to take benefit of the cheaper wages and changing business environment here.
Since economic liberalisation started in 1991, FDI has steadily increased and has generated more than one crore jobs since then.
India is in the top 100 in the list of countries in the Ease of Doing Business (EODB), and as per a UNCTAD report ranks 12th among the top 20 host economies for FDI.
Reasons For FDI Inflow To India
There are lots of rules and regulations governing foreign money coming to India, and these are governed by the RBI.
The Department of Industrial Policy and Promotion (DIPP) makes and notifies FDI policies.
Owners of small businesses in India should carefully read these rules, otherwise, they have to pay very heavy penalties.
100% FDI in India has been sanctioned under the automatic route in many sectors.
In the past year, the Government has eased the FDI norms in sectors like defense and insurance.
100% FDI is allowed in Asset Management Companies (AMC)s, software, and Non- Banking Finance Companies(NBFC)s and 74% foreign investment is allowed for banks.
The government has relaxed the norms for foreign holdings in insurance by raising the limit from 26% to 49%, a few years ago.
In certain sectors like aviation, insurance, media, pharmaceuticals, and telecom, government permission is required for FDI.
FDI is prohibited in nine sectors such as cigarettes, chit funds, betting and gambling, lottery, real estate, etc.
It is interesting to note that any FDI proposal from a Chinese company will require government approval.
Routes for FDI
There are two kinds of channels available to startups in India for attracting foreign investment-one is the automatic or pre-approved route, and the second is the approval route for which they have to seek permission.
1. Automatic Route
In this route, the foreign investor can invest in certain sectors as covered under the FEMA Act.
Neither the Indian partner nor the foreign entity requires any approval from the Government of India or the RBI for the investment.
If your industry falls under the pre-approved category, then you can get the money from the foreign investor and then intimate RBI about the FDI.
It is for those sectors that are less restricted or more liberalised.
2. Approval Route
In the second case, if you are planning to get any FDI for those sectors which require permission, then you have to first apply to RBI.
You also have to give details to the Foreign Investment Promotion Board (FIPB) about your project plan, how much money you are trying to raise, etc.
Another governmental agency for approval is the Cabinet Committee on Economic Affairs (CCEA).
After going through all the details, FIPB takes a call whether they would allow it or not.
Once they approve it you can get the money in India.
FIPB considers investments up to Rs 5000 crore for approval.
Above this limit, approval will be done by CCEA.
DPIIT issues the Standard Operating Procedure (SOP) for the processing of applications.
This classification of FDI aims to monitor the investment and avoid wasteful procedural delays.
The trend in FDI shows that around 90% of foreign investments are being made under the automatic route.
Valuation of FDI
RBI wants to know the grounds on which a promoter of a company that has applied for FDI, is diluting his stake.
Suppose you, a small business owner, has told RBI that you would be giving up a 10% share of your company to a foreign investor for $ 1 million.
That would imply that the total value of your company is $ 10 million.
So, you have to justify that valuation to RBI.
This valuation is important for calculating Capital Gains when the foreign investor wants to exit the joint venture.
Foreign Investment Opportunities in India in 2021: Focus on Small
Businesses and Startups
The high growth story of FDI into India is expected to continue in 2021, as there is still confidence among the global investors about the country’s reforms.
Japanese investment company Nomura expects India to be the fastest-growing Asian economy in 2021, at 9.9 percent.
The following factors have contributed to positive sentiments:
High liquidity and low bond yields in global markets will push foreign investors to park their investments in India for higher returns. The interest rates in developed economies are near zero.
‘Ease of Doing Business’ in India is getting better due to an investor-friendly FDI policy.
Continuing global negative sentiments about China will push investments in India’s way.
Global investors strongly believe that India will be one of the growth engines of Asia’s recovery from the pandemic.
Attractive incentives for new manufacturing units, coupled with low wages, have contributed to make India a global manufacturing hub. The thrust areas in manufacturing are electrical components, mobiles, and pharmaceuticals.
The government has relaxed Foreign Direct Investment norms in defense production, so that is one area that is expected to receive good foreign inflows.
In 2020, the government had increased the FDI limit in defense manufacturing under the automatic route from 49% to 74%.
Other focus areas to receive FDI are animation and gaming, visual effects, coal mining, contract manufacturing, and single-brand retail trading.
Services, IT, and telecom are expected to receive more FDI in 2021 than the previous year.
Google’s Digitalisation India Fund will pump capital into India’s startup ecosystem this year.
Unicorn startups are considered as those startups which have a valuation of $ 1 billion or more.
At present, there are 30 unicorn startups in India, out of which 18 including Flipkart, Ola, and Oyo have received significant FDI.
In 2020, DPIIT had processed 26 FDI applications.
An Investment Clearance Cell (ICC) is being planned to set up in 2021 in select states which will provide facilitation and support to businesses.
According to the World Bank, India received the highest foreign inflow of $ 74.39 billion during 2019-20, and this momentum will continue in 2021.
Since the MSME and startup sectors are starved of funds, it will be a golden opportunity for them to scale up.
It will be a good symbiosis between “Atmanirbhar Bharat” and foreign collaboration.