Need for a New FDI Law

Reports and the buzz in the business community suggests that India may paritally relax its positition on foreign direct investments (FDI) from China. Last April, India had subjectecd all Chinese FDI to mandatory government screening. The aim was to curb opportunistic takovers of Indian companies, a concern fuelled by sharp corrections in equity markets in March 2020. With market indices now hovering at their peaks, reportedly India may allow Chinese FDI up to 25 per cent in equity under the automatic route. This could offer immediate relief to many investors and entrepreneurs alike.

This episode holds a deeper policy lesson. India’s concerns about opportunistic takeovers were not unique. Several economies including the US, Australia, Canada and Germany faced similar concerns. They blocked specific takeover attempts, using special laws for negotiation security screening of inwards FDI. In the absence of similar legislation, India did not differentiate between invstments which raised genuine national security concerns and those that did not. This is a crucial shortcoming, rather another policy hysteria of the BJP government.

India regulates foreign investments primarialy through FEMA. The preamble to FEMA clearly provides two specific macro-prudential objectives- facilitating external trade and payments; and promoting orderly development and maintenance of foreign exchange markets in India. Accordingly, it empowers the central government and the RBI, acting in consultation with each other, to regulate capital account transactions. These regulations determine who can invest through the FDI route, in which sector and how much.

In practice, however, FEMA regulations have often responded to concerns not strictly related to macro-prudential objectives. One such concern has been national security. Which such applications of FEMA may have served their purpose ducing crises, it is time India emulates its western peers and enacts security screening of strategic FDI.

Unike FEMA, this new statute must explicitly lay down legal principles for determining when a foreign acquistion of an Indian company poses genuine national security threats from foreign acquisitions.

The first threat arises if a foreign acquisition renders India dependent on a foreign controlled supplier of goods or services crucial to the functioning of the Indian economy. For this threat to be credible, it is not enough that the goods or services supplied by the target company are “crucial” to India. It needs to be further established that the industry in which the acquisition is supposed to take place is tightly concentrated, the number of close substitutes limited, and the switching costs are high. Only if these conditions exisxt, could there be a credible security threat to India arising from dependency on a foreign controlled supplier.

The second threat emanates from a proposed acquistion transferring a technology or a expertise to a foreign-controlled entity that might be deployed by that entity or a foreign government in a manner harmful to India’s national interests. The credibility of this threat again depends on whether the market for such technology or expertise is tightly concentrated or if they are readily available elsewhere.

The third threat arises if a proposed acquistion allows insertion of some potential acqusistion allows insertion of some potential capability for infiltration, surveillance or sabotage via human or non-human agents into the provision of goods or services crucial to the functioning of Indian economy. This threat is particularly credible when the target company supplies crucial goods or services to the Indian government, its military or even critical infrastructure units and the switching costs are high.

When competition among rival suppliers is high and switching costs are low, there is no genuine security justification for blocking a proposed foriegn acquistion no matter how crucial the goods and services the target domestic company supplies. Such conceptual clarity in the new statute cold make national security assessments objective, transparent and amenable to the rule of law.

On procedure, the statute must empower only the finance minister to reject certain strategic foreign accquistions on national security grounds. Both the power and accountability mechanisms should be hardcoded into the statute itself,as is the case in some mature parliamentary democracies.

For instance, the Australian Foreign Acquistions and Takeovers Act, 1975 empowers the treasurer to block certain foreign acquistions on national security grounds. The treasurer is advised on such matters by a non-statutory Foreign Investent Review Board, which reviews the proposal for national interst implications. The law requires the treasurer to give her decision within 30 days, extendable by another 90 days. If the treasurer rejects a foreign acquisition, she has to issue an order in writing which must be registered on the Federal Register of Legislation.

Similarly, the Investment Canada Act, 1985 empowers a minister to reject certain foreign acquistions. She receives advice and assistance from the director fo investments. The minister has 45 days to decide, extendable by another 30 days. If the minster does not approve or reject the acquistions within that time, the acquistion is likely to benefit Canada, the investor has a right to make representations in person or through a representative. If the minister is stil unsatisfied, she may rject the foreign acquistions through a reasoned decision. Similar procedural clarity is required in India, but it must be severed from mere political aspirations of the ruling government since the issues at large would alter or rather narrate the course of lives of not just the present populations but also those that are yet to come.

Being open to business does not imply being open to exploitation in the name of alleviation of standard of living, or increasing the ease of living. Such narratives must be practiced with the sense of equity and should preserve the global multilateral economic relations and global peace as well.

Thus a dedicated statute for national security screening of inward FDI would be best suited for handing such issues.