This article has been written by Mahita Swamy, Law Graduate from BMS College of Law, Bengaluru, Karnataka.
Abstract
When one is trying to step into the corporate world, there are too many terminologies that goes over the head. Funds and Investments is one such thing. FDI in that is a game played at in international footing. Feeling lost is easy here, as understanding the same is difficult. But a look at SEBI and other government agencies and their functioning will help in making sense of where to start looking and reading about the corporate world and its financing. SEBI is an important player in the Indian market and as such plays a vital role in protecting an investors’ money and promoting beneficial policies and schemes to the citizens.
Introduction
Before diving into this topic blindly, let’s see how to go about this one question. A college graduate, Manu, has believed in the business idea of an online platform for writers and readers and the whole set-up of how it will benefit everyone involved. But the major problem encountered by Manu is that of funds to not only start but also run this online platform. Initially, Manu was able to save about 4,000/- and develop the online platform, which took close to 5 months to make. In that time, most of the money saved for the company was given as salary to the developers. As the 6th month came to an end, Manu wasn’t able to save money due to a medical emergency in the family. So, Manu decided to raise funds by pitching the online platform idea to investors, who would lend money for certain say/stake in the business and its day-to-day functioning.
Manu found an investor in Light Pvt. Ltd., a venture capitalist/VC (someone who specializes in investing their money in various businesses). The VC gave Manu about 10,000/- and expected to see at least 10% growth of the online platform in the next 6 months, otherwise Manu will have to replay the same amount as loan with interest. Manu now has to decide whether to accept it or to look for a better investment offer, as the VC had been in bad media presence in the recent times.
Anyone in Manu’s place would take the offer and kick start the platform and work on getting that 10% growth. The bad media presence will not affect Manu as long as anything of it is proven with evidence. Hence, it is a good offer. The topic you will read about is about Foreign Direct Investments and how it is regulated by the SEBI in India and the impacts of such regulations. Though the above example is not directly related to FDI, it explains the basic understanding of raising funds for a business and investments. If that is clear, let’s understand FDI and SEBI before looking at the impact of regulations on FDI.
Understanding FDI
Foreign Direct Investment or FDI is that form of investment through which foreign companies or individuals invest in listed or unlisted companies. This investment in the company will lead to acquiring certain percentage of the shareholding, like if the investment is in a listed company, it can be 10% or more of that company’s equity capital. In the example from the introduction, FDI can be understood by the VC investing in Manu’s online platform – though this VC should be from a country other than Manu’s country, only then will it be considered as a foreign investment.
Something interesting to know about FDIs is that it is not a foreign citizen investing, rather a foreign company or a foreign venture capital firm. FDIs are helpful in many ways, like when the boost a certain sector of the market or boost the income spending of the employees of that sector and in turn driving the entire economy spending, etc. It has a chain reaction on various aspects of the economy, by going beyond only being a capital investment. This means that sometimes, a foreign direct investment is not only in terms of money but also in terms of technology, labor force, company structure or equipment.
As such, FDI becomes a very significant factor to boost the economies of two or more countries. How? That is as simple as this statement – “China’s economy is currently smaller than the U.S. economy in nominal terms.” This mainly happens because the country that invests more through FDIs has more market presence, as FDIs allows them to have control over the company they are investing in. At the same time, when a home country, that is a country that is investing or putting FDIs, invests more in FDIs, it shows that there is an appeal in the international market for that country and are preferred over other countries, boosting their own GDP or Gross Domestic Product.
The main disadvantage of selecting to go through the FDI route is that there are too many regulations involved from both the countries involved so as to the investment not becoming a risk in the later years. Due to the amount of regulations, there is also the possibility of delay in approving the investment and only selected, abled or seasoned investors to further invest in the market. Therefore, the Indian markets were not open for FDI until 1991, when the LPG or Liberalization, Privatization and Globalization was introduced by the government.
Governing of FDI
Something we need to understand about the Indian market is that there is not one sector that runs the economy. As such, all sectors must grow together to give the best standard of living to all the citizens. To ensure that, DPIIT was established.
Foreign Direct Investments are looked through not only by the SEBI but also through DPIIT/Department for Promotion of Industry and Internal Trade. Established for overall policy formulation and execution in 1995, Department of Industrial Policy & Promotion, renamed to DPIIT in 2019, is a nodal government agency. This agency is also in charge of formulating, promoting and facilitating policies of FDIs and encouraging collaborations.
Certain programmes and schemes of DPIIT are Transport Subsidy Scheme(1970), Industrial Development Scheme 217 and the recent Make In India and Startup India schemes. Any investments made through FDIs is governed through The Automatic Route and The Government Route of the Consolidated FDI Policy that is framed by the agency.
The Automatic Route – is where the foreign entity or the home country investor does not need prior approval of the host country government or the central financial institution or in the case of India, the Reserve Bank of India (RBI). Certain sectors that can be invested in through this route are Petroleum Refining (up to 49%), Medical Devices (up to 100%), Infrastructure company in securities market (up to 499%), Ports and shipping, railway infrastructure, etc.
The Government Route – is where the foreign entity or the home country investor goes through all the compulsory approval steps that the government requires, to invest in the host country. Through this route, the few sectors that can be invested in the Banking & Public sector (20%), Broadcasting Content Services (49%), Print Media (26%), Core Investment Company (100%), etc.
As we learn about FDIs, we must also look at those sectors prohibited by the government for foreign investments. These are major sectors of the economy like Agricultural or Plantation Activities, Atomic Energy Generation, Nidhi Company, Lotteries, Investment in Chit Funds, Trading in TDR’s, Cigars, Cigarettes, or any related tobacco industry and Housing and Real Estate sector.
Understanding SEBI
SEBI or Securities and Exchange Board of India is an autonomous organization that has been established under the Securities and Exchange Board of India Act, 1992 to protect the interests of the investors in securities along with promoting and regulating the securities market. To any layman, this may seem complex to understand. The way I understood this organization and its functions was first through a show on a scam, which further made me learn more about laws protecting layman from complex systems and processes. Securities and Exchange means shares, bonds and other secure forms of money certificates that people can buy or sell, which belongs to certain companies or sectors of the government, to invest in and be a part of that particular company. In recent times, it has become as easy as opening your bank account, through a long-standing history of certain people finding loopholes in the then existing systems and processes.
SEBI, for the Indian citizens, monitors these people exploiting loopholes, as these acts have a large and long-standing impact on all walks of life, through the financial market. SEBI, on one hand regulates the financial market and on the other hand, has the power to frame rules, regulations and other necessary guidelines for the smooth functioning of this market as well as catching anyone who is defying the rules. FDIs or Foreign Direct Investment are also one of the many things in the securities market the SEBI governs and makes rules for, so as to protect not only the foreign investment coming in, but also the sovereignty of the company so invested in.
Impact of SEBI regulating FDIs
In the budget presented by the Financial Minister in July 2024, it was said that there will be relaxation of rules with respect to FDIs, which means that the process of FDIs coming into India will be simplified, so as to ease the flow of foreign investments coming into the country. One point to keep in mind is that any policy formed or regulation made will have multiple-aspect effect on the entire economy. There is no one-way effect or one-way benefit. In this article, the impacts are divided as follows: –
The Positive Approach
Through FDIs, as mentioned above, money, as investments, is one such commodity that comes into the economy. There is transfer of technology, equipment and other infrastructural commodities that will be introduced into the host country’s market. This transfer will have lasting impact on the growth of the economy through –
- Pushing more employment in the sector so invested in,
- Changes in the functional structure of the business/company
- Advancements in the host country’s technical powers and abilities
- Stepping into different market areas for more growth
This is possible if only the FDIs are not regulated too much, that is, there is more FDIs flowing into the economy.
As a business/company improves its stance in the market, they will look for ways to innovate, that is, try to better themselves and make themselves a market monopoly. With a push from foreign investment, the company/business will be able to focus on just that. Like in our example before, Manu will not have to worry about paying the salary of the developer, rather be able to focus on bring the best version of the online platform to the market.
With more presence in market, the business/company will not have to spend much on marketing and will be able to focus on Research and Development (also known as R&D). This will help the business/company to develop products related to or in line with the vision of the company into existence. This is only possible due to the extra funds that come in as FDIs.
The companies will also be able to pay yearly/quarterly dividend to the shareholders of the companies. This will in return increase the trust of the common people in the company, who might invest in them in the future. This is also a sure way of public investment/public funds for the company.
The Negative Approach
SEBI regulates FDIs not only to protect the domestic market from harmful investments but also to get the tax payables out of the investors yearly. In an ideal situation, any tax collected by any government agency should be used in the infrastructure and other government projects that help the citizens of the country. This is ideal for a reason.
Therefore, regulations on FDIs are necessary, just like the belief in the law community, “Law is a necessary evil”. Regulations will increase government involvement in the projects/companies – which is helpful when doing audits of the same. Any other use of the FDIs will be immediately caught and can be rectified as soon as possible. But this regulation is seen as a hinderance in most of the business community, for the reason that it blocks possible good investments to turn their back, due to such a complex approval process.
Regulating FDIs will also include the percent of tax that should be collected from such foreign entities. If not paid, such investors are blacklisted from further investments in the country. Therefore, it is seen as possible hazard to FDIs. Though, the other argument would be that taxes run the country and they are just as important, if not more important than FDIs. As such, the regulations on FDIs by SEBI remain.
Regulations on FDIs will also protect the sovereignty of the company and the host country. Strict FDI regulations will push back the bad investments and will make more room for better investments to flow through. No regulation will put an image of poor infrastructure of the government in the host country and as such, the foreign investments and investors will have their say in the functioning of the company, indirectly impacting their economy. For this very reason, there are certain sectors of the economy that isn’t open to FDIs even today in India.
Conclusion
No matter how many voices criticize the Securities and Exchange Board of India, the functional growth they have helped the Indian Economy in the recent times cannot be forgotten. The board handles the citizens money like a responsible parent, teaching their teenage child about the financial market and how and where to save your money. Foreign Direct Investments are risky for the added factor of the money coming from another country and there is as much control on it as much as we have of another’s emotions. Therefore, we should understand why certain prohibitions are applicable. Though, the only advice that given to anyone investing in the markets is to read and learn more about the companies.
Reference
- GCR Blog, “India: Overview of Legal Framework and Treatment of FDI” (December 2023) < https://globalcompetitionreview.com/guide/foreign-direct-investment-regulation-guide/third-edition/article/india-overview-of-the-legal-framework-and-treatment-of-fdi>
- Byju’s Exam Prep Blog, “Foreign Direct Investment (FDI)”, < https://byjus.com/free-ias-prep/fdi/>
- S&R Associates Blog, “Investing in India: An Overview of Legal Considerations” (February 2024) < https://www.snrlaw.in/investing-in-india-an-overview-of-legal-considerations/>
- Byju’s Exam Prep Blog, “Securities and Exchange Board of India (SEBI)” < https://byjus.com/free-ias-prep/securities-and-exchange-board-of-india/>
- Investopedia, “Foreign Direct Investment (FDI): What It Is, Types, and Examples”, < https://www.investopedia.com/terms/f/fdi.asp>
- Byju’s Exam Prep Blog, “Department for Promotion of Industry and Internal Trade (DPIIT) earlier known as DIPP”, < https://byjus.com/free-ias-prep/dipp/>
