Foreign Direct Investment (FDI) in India: What Investors Need to Know About Regulations

India has consistently attracted substantial foreign direct investment (FDI), with the government reporting $44.42 billion in equity investment in the fiscal year ending March 31, 2024. Although foreign direct equity investments fell this year, they are expected to increase in the next financial year with a surge in investment in sectors such as services, construction, software and hardware development, non-conventional energy, and sea transport.  

In this blog post, we will share the regulatory framework of foreign direct investment in India and how it works. Let’s get started!
 

How is FDI Regulated in India?  

The regulatory framework governing FDI in India is anchored by the Foreign Exchange Management Act of 1999 (FEMA). FEMA is the base for India's foreign exchange regulations, facilitating and regulating foreign investments in conjunction with its associated rules, regulations, and policies.   

The Department for Promotion of Industry and Internal Trade (DPIIT), operating under the Ministry of Commerce and Industry, collaborates with various governmental departments to regulate FDI inflows. In addition, the Reserve Bank of India (RBI) plays a crucial role in administering FEMA, ensuring compliance with its provisions and regulations.
 

Routes for FDI in India  

1. Automatic Route

Under the Automatic Route, non-resident investors or Indian companies do not require prior approval from the Government of India to make investments. This route streamlines the FDI process for eligible sectors.  

2. Government Route

On the contrary, the Government Route mandates prior approval from the Government of India before making investments in certain sectors, specified as sensitive or requiring closer scrutiny.   

Proposals under the Government Route are evaluated by the respective Administrative Ministry or Department to ensure alignment with national interests and regulatory guidelines.
 

Prohibited Sectors for FDI  

Although India has an open approach to foreign investment, certain sectors remain prohibited from receiving FDI. These sectors include:  

- Lottery business  

- Gambling and betting, including casinos  

- Chit funds  

- Nidhi companies  

- Real estate (except construction of certain types of buildings)  

- Manufacturing of cigars, cheroots, cigarillos, and cigarettes of tobacco or tobacco substitutes  

- Activities or sectors not open to private sector investment, such as atomic energy and railway operations (except as specifically permitted under the FEMA regime)
 

Eligible Entities for FDI  

According to the FEMA framework, eligible Indian entities include Indian companies and Limited Liability Partnerships (LLPs) working in sectors where 100% FDI is permitted under the Automatic Route without performance-linked conditions.   

On March 14, 2022, DPIIT issued Press Note No. 1 of the 2022 Series that expanded the definition of Indian entities to include corporations established under central or state acts. The primary goal of this amendment was to include 'corporations' as eligible Indian entities and encourage FDI in entities like the Life Insurance Corporation (LIC) of India. LIC, being the largest public sector insurance company established under the Life Insurance Corporation Act of 1956, became eligible for up to 20% FDI under the automatic route from April 2022 onwards.  

However, under FEMA regulations, societies, trusts, and any other entities explicitly excluded do not qualify as Indian companies. As a result, these entities cannot receive foreign direct investment under the FEMA framework.   

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Security Guidelines for FDI in India

According to FEMA regulations, non-resident investors have various avenues to invest in Indian companies. These include:  

1. Equity Shares: This category includes both fully paid and partly paid shares.  

2. Fully Paid and Mandatory Convertible Preference Shares: Investors can opt for preference shares that they can convert into equity shares after a specified period.  

3. Fully Paid and Mandatory Convertible Debentures: Investors can convert these debt instruments into equity shares upon fulfilling predetermined conditions.  

4. Share Warrants: Warrants allow investors to buy equity shares at a specific price on or before a specified date.  

The FEMA regulations also accommodate optionality clauses in equity instruments, typically requiring a minimum lock-in period of one year or as specified for specific sectors. Once this period elapses, non-resident investors can exit without a guaranteed return.  

In addition, foreign investors can participate in the capital contribution of Limited Liability Partnerships (LLPs) to expand their investment options.  

Convertible Notes for FDI under FEMA

In addition to equity instruments, the FEMA regulation allows foreign investment through another way, i.e., convertible notes.   

Convertible notes are exclusively issued by start-up companies for amounts exceeding 2.5 million rupees in a single tranche. They function as hybrid instruments, which include the features of both debt and equity. Although convertible notes are initially treated as debt, they can be converted into equity shares within ten years of the note's issuance.  

Issuance and transfer of convertible notes to non-residents must comply with FEMA's pricing guidelines, entry routes, and sector-specific conditions.
 

Pricing Guidelines for FDA in India   

• Issuance and Transfer to Non-Residents 

Equity instruments of a listed Indian company issued or transferred to non-residents must adhere to pricing determined by guidelines from the Securities Exchange Board of India (SEBI).  

For equity instruments of an unlisted Indian company, pricing should not fall below the fair value determined by SEBI-registered professionals using internationally accepted methodologies on an arms-length basis.
  

• Transfer from Non-Residents to Residents

When transferring equity instruments of a listed Indian company from non-residents to residents, the pricing should not exceed the prevailing market price.  

Similarly, in the case of equity instruments in an unlisted Indian company, pricing should not exceed the fair value determined through SEBI guidelines.  

Government Approval Procedures

1. Application Filing

To initiate foreign investment, submit your proposal and requisite documents online through the Foreign Investment Facilitation Portal at www.fifp.gov.in.  

2. Internal Approval Procedures

Upon submission, DPIIT will identify the relevant Ministry or Department and circulate the proposal within 2 days. Simultaneously, the proposal is also shared online with RBI for their input from the FEMA perspective.  

3. Comment Timelines

It is mandatory for DPIIT to provide feedback within 4 weeks of receiving the application online. If the process involves the Ministry of Home Affairs, it takes around 6 weeks to get feedback.   

4. Additional Information Requests

Following initial submission, further details or clarifications may be requested from the applicant, which must be submitted within 1 week.  

For high-value proposals exceeding INR 50 billion (approximately $775 million), the Cabinet Committee of Economic Affairs will also receive the application for consideration.
 

5. Final Approval Timeline 

Once all requirements are met comprehensively, final approval typically takes 8-10 weeks.
 

Reporting Requirements under FDI  

After receiving foreign investment, Indian companies must fulfil specific reporting obligations. To streamline the reporting process for various types of foreign investments, the RBI introduced the Foreign Investment Reporting and Management System (FIRMS) Portal.  

Here’s how to file on the FIRMS portal:  

1. Update the entity master form with comprehensive details about the company and its foreign investment profile. Authorized personnel within the company, known as the Entity User, are responsible for updating this form.  

2. The Business User, authorized by the company, will handle the actual reporting of transactions on behalf of the company.  

3. Submit a Single Master Form (SMF), which is the primary form for reporting various types of foreign investments, including FC-GPR, FC-TRS, LLP-I, LLP-II, Convertible Notes (CN), Employee Stock Option Plans (ESOP), Direct Investment (DI), and others.
  

Recent Amendments and Liberalizations in India's FDI Policy

On April 17, 2020, the Indian government revised the FDI Policy to require mandatory government approval for foreign direct investment (FDI) originating from countries that share a land border with India. These countries include China, Bangladesh, Pakistan, Bhutan, Nepal, Myanmar, and Afghanistan.  

India has also liberalized its FDI policy framework to attract more investments across diverse sectors. Key amendments are as follows:  

• Increasing the FDI limit from 49% to 74% under the Automatic Route  

• Significantly liberalizing FDI limits, allowing up to 74% under the Automatic Route  

• Allowing 100% FDI under the Automatic Route, aiming to bolster infrastructure and connectivity  

• Facilitating 100% FDI in oil and gas PSUs undergoing strategic disinvestment
 

Legal Consequences of Non-Compliance  

The legal repercussions for violating the NDI Rules and other FDI laws fall under FEMA's penal provisions, enforced by the Directorate of Enforcement (ED). Offenders may face fines up to three times the amount involved in the violation, if quantifiable, or up to INR 200,000 (approximately US$2,400) if not.   

For ongoing violations, the ED can impose additional penalties of up to INR 5,000 (roughly US$60) per day beyond the initial breach date. These measures underscore the stringent enforcement and consequences aimed at ensuring compliance with India's foreign investment regulations.  

India's robust FDI framework, coupled with proactive policy reforms, positions it as a preferred destination for global investors seeking growth opportunities in emerging markets. Despite global economic uncertainties, India's resilience and progressive policies continue to attract significant FDI inflows, contributing to its economic development and global integration.  

*Business Standard. (2024, May 30). India’s FDI equity inflow at a five-year low of $44 billion in FY24.   

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Advocate Prerna Oberoi

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