Amid a global health pandemic and economies in recession, the prospects for FDI appear bleak this year. Battling Covid-19 has accelerated an inward-looking trend in national policies, with many governments intensifying the screening of FDI to protect strategic domestic firms which are vulnerable to hostile takeovers. India has joined the ranks of Spain, Germany, Italy, Australia and Japan, among others, in tweaking its FDI regime to prevent opportunistic takeovers of domestic companies. 

India’s response, however, is somewhat different from the developed countries that are scrutinising all foreign investments as it targets its most powerful neighbour, notably China. It now mandates that all investments from neighbouring countries that share a land border with India will require government approval. 

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On the FDI front, China is the most important country sharing India’s borders generating investment inflows of $2.34bn in the past 20 years, while investments from smaller neighbours like Bhutan, Nepal, Afghanistan and Myanmar are negligible at a combined $14.7m against total inflows of $457bn into India between April 2000 and December 2019, according Indian government statistics (which do not track FDI from Pakistan). 

A proximate trigger for India’s new FDI screening mechanism was the People’s Bank of China purchasing 17.5m shares worth $395m in lender Housing and Development Finance Corporation, which would take its stake above 1%, in April. Unsurprisingly, China reacted to the Indian government’s move stating it violated the World Trade Organisation’s principle of non-discrimination and hoped that New Delhi would treat investments from different countries equally. India responded that Beijing has no cause for worry as the “procedural change” doesn’t bar its investments.

India’s move to scrutinise Chinese FDI does raise questions: “If it is to prevent distress sales of Indian companies to foreign entities, I can think of plenty of non-Chinese entities that would not hesitate in the least to buy good assets that happen to be in distress. Nor is the objective to exclude Chinese investors since the regulation is about scrutiny and not denial. The only plausible explanation to me is that the government has certain security concerns and therefore it wants to examine the proposals,” says Professor Arvind Panagariya of Columbia University and former vice-chairman of India’s official think-tank NITI Aayog.

Alibaba and Tencent have invested $3.5bn in Indian companies between 2014 and 2019

Chinese participation

Chinese firms have participated in India’s growth story since 2015 with investments in industrial parks, real estate development, steel, renewable energy, automobiles and telecoms and funding Indian startups in the tech space according to AEI’s global investment tracker. 

Construction of a $1.2bn steel plant in Gujarat began within a year of inking a memorandum of understanding in 2017. When US auto giant General Motors left the Indian market, SAIC Motor Corp, which acquired a 50% stake in GM India in December 2009, seized the opportunity to enter. Its subsidiary MG Motors India has taken over GM’s car facility in Gujarat and has launched SUV models. Three years ago, drugmaker Fosun Pharma acquired a majority stake in Gland Pharma, a contract manufacturer of injectables, for $1.09bn.

Chinese investors often use third countries to reroute their investments in India, in the process weakening the reach of the new rules. China’s investments are much more than is indicated in DPIIT’s database; with opaque beneficial structures, several companies are investing more through offshore financial centres than from mainland China. China’s accumulated FDI in India reached as much as $14.7bn at the end of 2019, according to American Enterprise Institute’s China global investment tracker that registers individual transactions of $100m plus, which is six-times higher than India’s official estimates till 2019.

Hong Kong operations

Several Asia-focused funds that manage $1bn plus have set up operations in Hong Kong and Singapore and route their investments into the country. An example of Chinese FDI entering through third countries is the inflows by a leading smartphone manufacturer Xiaomi. Last year, it opened its seventh factory in the country and announced $500m of investments but these do not even figure in the radar of AEI’s global investment tracker. This investment was in fact made in March 2019 from Xiaomi Singapore. This subsidiary also routed smaller investments to India totaling $10m in Hungama Digital Media Entertainment between 2016 and 2019 and $22m in Mohalla Tech in 2018, according to the database of the New Delhi-based Institute for Studies in Industrial Development.

India’s regulator, the Securities and Exchange Board of India, has accordingly written to custodians, seeking information as to whether funds routed through Hong Kong, Singapore and other hubs have mainland Chinese investors as the ultimate beneficial owners. The regulator will also have to be notified of any change in information that was previously provided in this regard. Beneficial ownership implies not only economic ownership but also control. 

India’s Department for Promotion of Industry and Internal Trade (DPITT) is considering setting a 10% beneficial ownership cap in line with the Companies Act, 2013. Any investments in companies where Chinese citizens own over 10% will thus need government approval.

The heightened scrutiny of Chinese investments is set to impact Indian start-ups in the tech space. Several of these were funded by Alibaba and Tencent, for instance, which have invested $3.5bn in companies like One 97 Communications, Snapdeal, Paytm Mall, Flipkart, Ola and Swiggy between 2014 and 2019, according to AEI’s global investment tracker. 

Indian start-ups that require fresh investments are concerned that follow-up funding by Chinese investors will reduce; that they will roll back term sheets and seek out options in Asia. About 70% of start-ups have cash to last for three months, and 92% have seen their revenues decline according to a survey done by the National Association of Software and Service Companies.

The government estimates that India needs investments of $1.5trn over the next five years to modernise its infrastructure. China has played a vital role in the development of such infrastructure across Asia, Africa and elsewhere. Beijing has shown growing interest in becoming a prominent investor in India too, but the new rules slow down this process – or just foster rerouting of Chinese FDI through the likes of Singapore or Mauritius.