Trade Sector Updates – Falling Exports, TIES, MEIS, Foreign Trade Policy, etc.

India’s growth story has a ‘beneficial ownership’ hurdle

Explained | Governance | Mains Paper 2: Governance, Transparency & Accountability, Citizens Charters
Note4Students

From UPSC perspective, the following things are important :

Prelims level: Indian Foreign Exchange Management (Non-debt Instruments) Rules

Mains level: Challenges with the Recent Amendment

Why in the News?

To achieve a $5 trillion economy by 2025-26, India must eliminate obstacles hindering Foreign Investments and facilitate smoother processes for companies and investors.

About the Indian Foreign Exchange Management (Non-debt Instruments) Rules

  • FEMA outlines the formalities and procedures for the dealings of all foreign exchange transactions in India. These foreign exchange transactions have been classified into two categories — Capital Account Transactions and Current Account Transactions.
  • The Indian Foreign Exchange Management (Non-debt Instruments) Rules, 2019, commonly referred to as FEMA NDI, regulates foreign investments in Indian companies. These rules are critical for overseeing the flow of foreign capital into the country, ensuring that investments align with national interests and do not pose security risks.
  • The amendment to the Indian Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“FEMA NDI”) was again made through press note number 3 in the year 2020.
  • In exercise of the powers conferred by section 47 of the Foreign Exchange Management Act, 1999 (42 of 1999) and consequent to the Foreign Exchange Management (Non-Debt Instrument) Rules, 2019, the Reserve Bank of India makes the following regulations relating to mode of payment and reporting requirements for investment in India by a person resident outside India.
    • ‘Act’ means the Foreign Exchange Management Act, 1999 (42 of 1999);
    • ‘Rules’ means Foreign Exchange Management (Non-Debt Instrument) Rules, 2019;
  • On April 16, 2024, the Ministry of Finance, through the Department of Economic Affairs, notified the Foreign Exchange Management (Non-debt Instruments) (Third Amendment) Rules, 2024 (the “Amendment“), prescribing new entry routes for foreign investment in activities under the space sector.

Introduction of Press Note 3 (PN3) Requirement:

  • What does it mean?: This amendment requires prior government approval for any investments from entities or individuals in countries that share a land border with India. This rule applies if the investment comes directly from these countries or if the beneficial owner (the real person who ultimately owns or controls the investment) is a citizen or resident of these countries.
  • The purpose: Implemented during the COVID-19 pandemic, the rule aims to prevent opportunistic takeovers of struggling Indian companies by neighboring countries

Challenges with the Recent Amendment

  • Undefined ‘Beneficial Owner’: The term ‘beneficial owner’ isn’t clearly defined in the PN3 Requirement, leading to confusion. Different laws define the term differently, making it hard for companies to know which standards to follow.
  • Regulatory Uncertainty: Since the latter half of 2023, the Reserve Bank of India (RBI) has adopted a stricter interpretation of these rules. This shift has caused anxiety among investors and companies, as practices previously deemed acceptable are now being scrutinized.
  • Regulatory Burden: Companies now face significant delays and a high rate of rejection when seeking approval for investments. According to some officials, proposals worth ₹50,000 crore have been stalled or rejected in the past three years, with 201 applications being turned down.
  • Severe Fines: Non-compliance with the PN3 Requirement can result in fines up to three times the amount of the investment. For many startups, this could mean financial ruin, as the fines could exceed their revenue or assets.
  • Legal Battles: Violations could lead to lengthy and costly legal disputes, further burdening the already slow judicial system in India.

What can be the better solution? (Way forward) 

  • Ownership Thresholds: Define beneficial ownership with clear thresholds, such as 10% to 25% ownership stakes. This would help companies understand whether they need to seek approval.
  • Control-Conferring Rights: Specify which rights indicate control, such as the ability to influence board decisions or veto significant operational changes. Exclude rights that merely protect investor interests, such as veto powers over mergers.
  • Investor Representations: Allow Indian companies to require foreign investors to provide assurances about their compliance with the PN3 Requirement, backed by indemnities.It would provide a safety net for Indian companies.
  • Time-Bound Reviews: Introduce a system where companies can seek timely advice from regulatory authorities on whether specific clauses in their investment agreements confer control. This would be similar to mechanisms in competition law, offering clarity and reducing the risk of penalties for inadvertent non-compliance.

Mains PYQ:

Q Foreign Direct Investment (FDI) in the defence sector is now set to be liberalized: What influence this is expected to have on Indian defence and economy in the short and long run? (UPSC IAS/2014)

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