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U.S. Department of State

Diplomacy in Action

2009 Investment Climate Statement - India


2009 Investment Climate Statement
Bureau of Economic, Energy and Business Affairs
February 2009
Report
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Openness To Foreign Investment

India continues controlling foreign investment with limits on equity and voting rights, mandatory government approvals, and capital controls. Since 1991, as it has slowly implemented a program of economic reform, the GOI has gradually relaxed many of these constraints. Nonetheless, a complex array of restrictions remains, along with an undercurrent of resentment towards foreign investment from some quarters. Foreign direct investment (FDI) is still prohibited in some sectors or sub-sectors.

Since the mid 1990s, India has allowed "automatic" FDI approvals in many sectors, gradually expanding the list over time. Where applicable, foreign investors do not need government licenses or approvals and simply notify the Reserve Bank of India (RBI) of their investments. Other sectors require approval by either the Foreign Investment Promotion Board (FIPB) or the Cabinet Committee on Foreign Investment. Under the Government approval route, applications for FDI proposals, other than by Non-Resident Indians and proposals for FDI in Single Brand product retailing, are received in the Department of Economic Affairs of the Ministry of Finance. Proposals for FDI in Single Brand product retailing and by NRIs are received in the Department of Industrial Policy and Promotion, Ministry of Commerce and Industry. The rules vary from industry to industry and are frequently changed.

Although the changes have tended toward greater liberalization, the investment process is not always transparent or straightforward. In January 2005, for example, the GOI relaxed restrictions on new FDI in India by foreign partners of joint ventures. The previous rules, issued in Press Note 18 in 1998, had required a release by the Indian partner and GOI approval for any new investment, a provision often subject to abuse. The new rules maintain restrictions on the majority of existing joint ventures, but leave new ones to negotiate their own terms on a commercial basis. A local firm's ability to restrict its foreign partner's business strategy has been reduced, but exit strategies and dissolution procedures for existing joint ventures remain uncertain.

Equity caps for foreign portfolio investment are sometimes included in FDI caps. There are no universal rules specifying the combination of FDI and foreign portfolio investment allowed in share holding of a particular company. In some cases, the portfolio investment is included within the FDI cap; in others, foreign portfolio investment is not subject to the FDI cap, although the government of India does spell out where different caps are in place. The GOI is planning to formulate uniform guidelines on FDI across all sectors. An amendment to the Companies Act denies voting rights to foreign investors holding preferred stock in Indian companies if their holdings exceed the FDI limit.

Foreign investment is prohibited in many areas or subsectors of real estate, multi-brand retailing, legal services, security services, nuclear energy, and railways. Some forms of realty development, such as integrated townships, are permitted FDI. Non-Resident Indians (NRIs), however, are allowed to invest in housing and real estate development. They are also allowed to hold up to 100 per cent equity in civil aviation companies, where foreign equity is otherwise limited to 49 percent. NRIs are allowed to claim dual citizenship and enjoy new investment opportunities in India as citizens. Capital outflow restrictions for Indian citizens are incrementally being relaxed.

To curb the flow of funds by Indian residents through their NRI counterparts overseas, the Indian government in 2003 banned all investments by Overseas Corporate Bodies
(OCBs -- a company or other entity owned by NRIs directly or indirectly to the extent of at least 60 percent) in Indian companies through the portfolio as well as FDI routes. The GOI also withdrew the facility of opening and maintaining new Non-Resident External accounts, foreign currency non-resident accounts and non-resident ordinary accounts in India by OCBs. A ban on OCB investment in the stock market under the portfolio investment scheme remains in place.

The GOI's privatization policy permits foreign investors to bid for the sale of the state-owned units. Its privatization program, however, stalled after a change in government in May 2004. Foreign investors are given national treatment at the time of initial investment or after the investment are made. In sectors where licensing is required, procedures do not discriminate against foreign companies. However, in certain consumer goods industries export obligations and local content requirements are imposed on foreign investors.

Existing companies can also use automatic FDI approval to obtain foreign equity for FDI/NRI investment, provided the sector falls under the "automatic" route. Requirements are (i) the equity increase must accompany an expansion of the company's equity base (i.e., the NRI/foreign investors cannot simply acquire existing shares); (ii) the investment must involve a foreign currency remittance; and (iii) the Indian company's Board of Directors must give its approval.

Sector-Specific Guidelines for FDI in key industries (alphabetical order):

  • Advertising and Films: 100 percent FDI with automatic approval is allowed, but certain conditions apply in film industry.
  • Agriculture: No FDI is permitted in farming, nor may foreigners own farmland. FDI in the seed industry/ floriculture, horticulture, animal husbandry, aquaculture and cultivation of vegetables and mushrooms is permitted without any limits under the automatic route. 100 percent FDI is also permitted in tea plantations, but proposals require prior government approval. However, there is compulsory divestment of 26 percent equity of the company in favor of an Indian partner or the Indian public within five years. In Floriculture/Horticulture/ Aquaculture/Seed Development/Services related to agro and allied products, 100 percent FDI is allowed through the automatic approval process without any condition.
  • Airport Infrastructure: 100 percent FDI allowed for fresh projects through automatic route. FDI up to 74 percent is allowed in existing projects through the automatic route; for higher FDI in existing projects FIPB approval is required. To participate in a ground handling business at the airports, foreign companies can hold up to a 74 percent share. NRIs are allowed 100 percent FDI in ground handling services. 100-percent FDI is allowed on automatic route for maintenance and repair organizations, flying training institutes and technical training institutes.
  • Alcoholic Distillation and Brewing: No FDI limit is applicable. The automatic approval route is available in this area but a license from the GOI is required.
  • Asset Reconstruction Companies: FDI is limited to 49 percent. Prior government approval is required. No portfolio investments are allowed. Where any individual investment exceeds 10 percent of the equity, the approval is subject to Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.
  • Nuclear energy: FDI is limited to 74 percent for mining and mineral separation, integration, and value addition in mining and mineral separation. FIPB approval is subject to guidelines issued by Department of Atomic Energy.
  • Automobiles: No FDI caps or local content requirements or export obligations are applicable. FDI in automobile manufacturing is allowed under the automatic approval route.
  • Banking: The FDI limit for private banks is 74 percent, including all foreign portfolio investments. Automatic approvals are granted, however, no individual foreign bank may own more than 5 percent in an Indian bank, and no non-bank, foreign or otherwise, may own more than 10 percent without prior approval of the Reserve Bank of India. For state-owned banks, the FDI limit remains at 20 percent. At all times, at least 26 percent of the paid up capital must be held by residents. Wholly owned subsidiaries of foreign banks are exempt from this requirement. The Foreign Institutional Investment (FII) limit remains at 49 percent. Foreign banks in India have the option to operate as branches of their parent banks or as subsidiaries. Shareholders of banking companies may exercise their voting rights to a maximum of 10 percent of equity, even if they hold more equity. Legislation to remove this voting rights cap is stalled in Parliament.
  • Broadcasting: FDI (including portfolio investments) is limited to 20 percent in FM terrestrial broadcasting, with prior government approval, subject to guidelines issued by Ministry of Information and Broadcasting. For direct-to-home broadcasting and up-linking hubs, foreign investment from all sources is limited to 49 percent (with a maximum FDI component of 20 percent), again with prior government approval. In satellite broadcasting also, FDI is limited to 49 percent with prior government approvals. TV channels, irrespective of the ownership or management control, have to up-link from India provided they comply with the broadcast code. FDI is limited to 26 percent (including portfolio investment) in news and current affairs channels up-linking from India. 100 percent FDI is permitted in entertainment and general interest channels. Under the revised Up-linking policy announced by the GOI in December 2005, FDI up to 49 percent is permitted with prior approval of the Government for setting up Up-linking HUB/Teleports.
  • Cable Network: FDI is limited to 49 percent (inclusive of both FDI and portfolio). Prior approval is required and the approval is subject to Cable Television Networks Rules, 1994.
  • Cigars/cigarettes of tobacco: There is no FDI limit but prior government approval and an industrial license is required.
  • Civil Aviation (domestic airlines): FDI is limited to 49 percent under the automatic route for air transport services including domestic scheduled passenger airlines. For non-scheduled/chartered/cargo airlines, the FDI limit is 74 percent. Helicopter services are allowed 100 percent FDI on automatic approval basis. Foreign airlines are allowed to own the equity of companies operating helicopter services/cargo services, however, they may not make either a direct or indirect investment in an Indian domestic airline. NRIs and domestic companies may own 100 percent of a domestic airline. Although frequently debated, India has yet to open its state-run international airlines to outside investment. The US-India "Open Skies" agreement, signed in April 2005, allows unrestricted access by U.S. carriers to the Indian market, and by India carriers to the U.S. market. 100 percent FDI is permitted to new and existing airport construction projects under the automatic route subject to Ministry of Civil Aviation regulations. Existing projects, however, have to seek FIPB approval beyond 74 percent FDI.
  • Coal/Lignite: FDI is allowed up to 100 percent in coal processing plant/power projects, but limited to 74 percent for exploration and mining for captive consumption. Proposals in private sector companies are approved automatically. FDI is limited to 49 percent in state-owned units.
  • Coffee Processing and Warehousing: 100 percent FDI is permitted under the automatic route without any condition.
  • Commodity exchanges: Overall FDI of up to 49 percent (including FII) is allowed with prior government approval, however, FDI equity limit is 26 percent. FII purchases are restricted to secondary market subject to certain conditions.
  • Construction Development Projects: Construction and maintenance of roads, highways, vehicular bridges, tunnels, ports and harbors, housing, commercial premises, resorts, educational institutions, infrastructure and township is allowed at 100 percent FDI, with automatic approval subject to certain minimum capitalization, minimum area of development conditions issued under Press Note 2 of 2005.
  • Courier Services other than distribution of letters: 100 per cent FDI is permitted; however, FIPB approval is required.
  • Defense and strategic industries: FDI is limited to 26 percent, subject to a license from the Defense Ministry and guidelines on FDI in production of arms and ammunition. There are no automatic approvals.
  • Drugs/Pharmaceuticals: FDI is allowed up to 100 percent for drug manufacturing on automatic approval route
  • E-commerce: FDI up to 100 percent is allowed in business-to-business e-commerce with no divestment requirements. FDI is limited to 49 percent under the automatic approval route. No FDI is allowed in retail e-commerce.
  • Hazardous chemicals: 100 percent FDI is allowed through the automatic approval route. However, a license is needed.
  • Food Processing: 100 percent FDI is allowed with automatic approval for most products with the exception of malted foods, alcoholic beverages including beer, and in a protected category reserved for "small scale industries" where foreign equity ownership up to 24 percent is allowed. FDI up to 74 percent is allowed with automatic approval for cold storage facilities.
  • Health and Education Services: FDI is limited to 51 percent with automatic approval. Higher equity proposals need FIPB approval.
  • Hotels, Tourism and Restaurants: FDI at 100 percent is allowed with automatic approval.
  • Housing/Real Estate: No FDI is permitted in the retail housing sector. NRIs, however, may invest up to 100 percent. FDI up to 100 percent, on prior government approval, is permitted for projects such as the manufacture of building materials and the development of integrated townships, including housing, commercial premises, resorts, and hotels.
  • Industrial explosives: FDI at 100 percent on automatic route is allowed subject to obtaining license from appropriate authorities.
  • Information Technology: FDI at 100 percent is allowed with automatic approval in software and electronics, except in the aerospace and defense sectors.
  • Insurance: FDI is limited to 26 percent in the insurance and insurance brokering. While FDI approval is automatic, a license must first be obtained from the Insurance Regulatory and Development Authority. In July 2004, the GOI announced its intention to increase the FDI cap to 49 percent, but this change first requires parliamentary approval of an amendment to the Insurance Regulatory and Development Authority (IRDA) Act. In December 2008, the GOI introduced this amendment bill in the upper House of the Parliament (Rajya Sabha). However, the introduction of the bill is the first step in a lengthy process and an increase in the FDI limit to 49 percent would take effect only after approval from both Houses of Parliament.
  • Investing companies in infrastructure sector other than telecommunication sector: FDI at 100 percent is allowed with prior government approval subject to sector-specific conditions.
  • Legal services: No FDI is allowed. The GOI is currently engaged in consultation with local law associations for exploring possibilities of opening up the sector to foreign lawyers.
  • Lottery, Gambling, Betting: No FDI in any form is allowed.
  • Manufacturing: FDI at 100 percent is allowed, with automatic approval, in the manufacture of textiles, paper, basic chemicals, rubber, plastic, non-metallic mineral products, metal products, ship building, machinery and equipment. FDI had been limited to 24 percent in a protected category reserved for "small scale industries" (SSI), but the government announced in December 2007 that it intended to remove that cap and allow SSI FDI caps to be governed by the overall FDI policies in their sectors. The FDI change had not yet been made effective as of December 2008. The government has been steadily decreasing the number of industry sectors reserved under the SSI policy - from a peak of 800 industries in the late 1990s - and currently reserves just 35 specific goods/services for SSIs with a capital investment of less than $250,000. A higher percentage of foreign equity may also be approved if the company obtains a license and undertakes to export 50 percent or more of its product.
  • Mining: 100 percent FDI is allowed, with automatic approval, for diamond and precious stone, gold/silver and other mineral mining.
  • Non-Banking Financial Companies (NBFCs - Merchant banking, underwriting, portfolio management, financial consulting, stock-brokerage, asset management, venture capital, credit rating, housing finance, leasing & finance, credit card business, foreign exchange brokerage, factoring and custodial services, investment advisory services): FDI is allowed up to 100 percent with automatic approval. For joint venture operating NBFCs, subsidiaries for undertaking other NBFC activities are allowed. Foreign investors can set up 100 percent operating subsidiaries without any conditions if they bring in $50 million in capital. Capital norms are as follows: if FDI is less than 51 percent, $500,000 needs to be provided up front; if FDI is between 51 percent and 75 percent, $5 million must be invested up front; and if FDI exceeds 75 percent, $50 million is needed, out of which $7.5 million must be fronted and the balance invested in two years. Approvals may not be used to undertake holding company operations pertaining to downstream investments.
  • Petroleum: FDI limits (along with tax incentives, production sharing and other terms and conditions) vary according to the sub-sector. Foreign Investment Promotion Board (FIPB) approval is required for refining with public sector unit; automatic approval is granted to all other activities.
    • Discovered small fields 100 percent
    • Unincorporated joint venture 60 percent
    • Incorporated joint venture 51 percent
    • Refining with domestic private 100 percent
    • Refining with public company 49 percent
    • Petroleum product/pipeline 100 percent
    • Marketing and marketing infrastructure 100 percent
    • LNG Pipeline 100 percent
    • Exploration 100 percent
    • Investment Financing 100 percent
    • Market study and formulation 100 percent
  • Pollution Control: FDI up to 100 percent is allowed with automatic approval for equipment manufacture and for consulting and management services.
  • Ports and harbors: FDI up to 100 percent with automatic approval is allowed in construction and manufacturing of ports and harbors.
  • Power: FDI up to 100 percent is permitted with automatic approval in projects relating to electricity generation, transmission, distribution, and power trading other than nuclear reactor power plants.
  • Print Media: Foreign investment is restricted to 26 percent for news publications with editorial/management control in the hands of resident Indians. 74 percent cap is applied to non-news publications. FDI is permitted up to 100 percent in printing Science and Technology magazines/journals, subject to prior government approval and guidelines issued by Ministry of Information and Broadcasting.
  • Professional services: FDI is limited to 51 percent in most consulting and professional services, with automatic approval. Legal services, however, are not open to foreign investment.
  • Railways: FDI is not allowed in train operations, although 100 percent FDI is permitted in auxiliary areas such as rail track construction, ownership of rolling stock, provision of container services, and container depots.
  • Retailing: The government allows 51 percent FDI for retail trade in Single Brand products, subject to Government approval. FDI is still not allowed in any other retail activities, including in retailing of goods of multiple brands where the same manufacturer produces such branded products. However, large multinational retailers are exploring franchise-like joint venture deals with Indian partners that do not violate the FDI bar.
  • Roads, Highways, and Mass Rapid Transport Systems: FDI up to 100 percent is allowed with automatic approval for construction and maintenance.
  • Satellites: FDI is limited to 74 percent for the establishment and operation of satellites with prior government approval.
  • Shipping: FDI is limited to 74 percent with automatic approval for water transport services.
  • Special Economic Zones: For setting up the Zones and for setting up individual units in the SEZs, 100 percent FDI is allowed through the automatic route, subject to Special Economic Zones Act, 2005 and India's Foreign Trade Policy.
  • Stock Exchanges: FDI including FII up to 49 percent is allowed in stock exchanges through FIPB approval. FDI limit is 26 percent and FII ceiling is 23 percent. No single foreign investor can hold more than 5 percent stake.
  • Telecommunications: FDI limits are listed below. FDI can be made directly or indirectly in the operating company or through a holding company subject to licensing and security requirements. FDI up to 74 per cent is allowed under the automatic route in all telecom services; higher FDI needs FIPB approval. All FDI limits are inclusive of portfolio investments. The revised GOI guidelines on telecom services mandate Indian shareholding not less than 26 percent in any case. The Department of Industrial Policy and Promotion's Press Note No. 3 of 2007 sets out new security conditions which have to be adhered to by prospective investors in the telecom sector.
    • National and International 74 percent
    • Long Distance 74 percent
    • Equipment manufacturing 100 percent (automatic approval)
    • Global Mobile Communication 49 percent
    • Radio paging, Internet Service 74 percent Providers (ISP) with international
    • gateways and end-to-end bandwidth
    • ISP without international 100 percent gateways, voice-mail and e-mail (FDI proposals above 49 percent require GOI approval, 26 percent divestment within 5 years)
  • Trading/Wholesale: FDI at 100 percent is allowed through automatic route, for activities like exports, bulk imports with export warehouse sales, as well as cash and carry wholesale trading. However, in case of test marketing or if the items are sourced from the small scale sector, then FIPB approval is required. Single brand retailing is allowed subject to the FIPB approval and FDI limited to 51 percent.
  • Venture Capital: FDI is allowed up to 100 percent in venture capital funds (VCF) and venture capital companies (VCC) through the automatic route, subject to Securities and Exchange Board of India (SEBI) regulations and sector specific FDI limits. VCFs and VCCs may own up to 40 percent of unlisted Indian companies. Investment in a single company by a VCF or VCC may not exceed five percent of the paid up corpus of a domestic VCF or VCC.

Conversion and Transfer Policies

There are no restrictions on remittances for debt service or payments for imported inputs. In some sectors, investments in the development of integrated townships and NRI investment in real estate may be subject to a "lock-in" period. Profits and dividend remittances are permitted without approval from the Reserve Bank of India (RBI). Income tax payment clearance is required, but there are generally no delays beyond 60 days. RBI approval is required to remit funds from asset liquidation. Foreign partners may sell their shares to resident Indian investors without approval of RBI, provided shares were held on a repatriation basis. GDR/ADR proceeds from abroad may be retained without restrictions except for an end-use ban on investment in real estate and stock markets. FIPB approval is required for converting non-repatriable shares to repatriable ones. Up to $1 million may be remitted for transfer of assets into India. Individual professionals including journalists and lawyers are allowed to keep 100 percent of their earnings from consultancy services rendered abroad in foreign currency accounts.

The Indian rupee is fully convertible for current account transactions. Current account transactions are regulated under the Foreign Exchange Management Rules, 2000. Prior RBI approval is required for acquiring foreign currency above certain limits for specific purposes (foreign travel, consulting services, foreign studies). Capital account transactions are open for foreign investors, subject to various clearances. In recent years, with growing foreign exchange reserves, the Indian government has taken additional steps to relax foreign exchange and capital account controls for Indian companies and individuals. For example, individuals are now permitted to transfer abroad for any purpose up to $200,000 a year without approval. The GOI now allows all NRI proposals for conversion of non-patriable equity into repatriable equity under the automatic approval route. At the end of 2008, the exchange rate was Rs.47.10 to $1, compared to Rs.39.80 at the end of 2007.

Foreign Institutional Investors (FIIs) may transfer funds from rupee to foreign currency accounts and vice versa at the market exchange rate. They may also repatriate capital, capital gains, dividends, interest income, and any compensation from the sale of rights offerings, net of all taxes without approval.

The RBI accords automatic approval to Indian industries for foreign collaboration agreements up to 400 per cent of the net worth of the Indian company. For technology-transfer agreements with foreign companies, Indian firms may remit royalties up to 5 percent for domestic sales and 8 percent for exports without approval; but recurring royalty payments, such as patent licensing, are normally limited to eight percent of the selling price over a ten-year period. Royalties and lump sum payments are taxed at 20 to 30 percent. Where technology transfer is not involved, royalty payments for the use of trademarks and brand names are limited to 2 percent on exports and 1 percent on domestic sales. In case of technology transfer, payment of royalty includes the payment of royalty for use of trademark and brand name of the foreign collaborator.

Foreign banks may remit profits and surpluses to their headquarters, subject to the banks compliance with the Banking Regulation Act, 1949. Banks may also issue credit cards without RBI approval. Banks are permitted to offer foreign currency-rupee swaps without any limits to enable customers to hedge their foreign currency liabilities. They may also offer forward cover to non-resident entities on FDI deployed after 1993.

Expropriation and Compensation

There have been few instances of direct expropriation since the 1970s. While a program of privatization of state-owned enterprises stalled since 2004 with a change in the ruling government, there has been no reversal in the overall movement away from public ownership of industry.

After years of negotiation, the Government of India in 2005 persuaded state-owned financial institutions and the State of Maharashtra to reach a settlement with U.S. investors, the Overseas Private Investment Corporation, and other foreign lenders on the investment dispute surrounding the Dabhol power project. A comprehensive commercial settlement was subsequently achieved in 2006. There has been significant progress in resolving several payment disputes that American power sector investors have with the State of Tamil Nadu. The GOI, which has limited jurisdiction over commercial disputes involving matters under state jurisdiction, has been helpful in convincing Tamil Nadu to settle these commercial disputes. The United States continues to urge the GOI that to create an attractive and reliable investment climate, India and its political subdivisions need to provide a secure legal and regulatory framework for the private sector, as well as institutionalized dispute resolution mechanisms to expedite resolution of commercial issues.

At least two U.S. pharmaceutical companies with production and distribution facilities in India have yet to resolve long-standing disputes with the GOI (dating from the 1980s) resulting from India's drug price-control regime.

Dispute Settlement

Foreign investors frequently complain about a lack of "sanctity of contracts." Although Indian courts are independent, they are backlogged with unsettled dispute cases. Critics say that liquidating a bankrupt company may take as long as 20 years. In an attempt to unify its adjudication of disputes over commercial contracts with the rest of the world, India enacted the Arbitration and Conciliation Act of 1996, based on the UNCITRAL (United Nations Commission on International Trade Law) Model Law. Foreign awards are enforceable under multilateral conventions like the Geneva Convention. The International Center for Alternative Dispute Resolution (ICADR) has been established as an autonomous organization under the Ministry of Law and Justice and Company Affairs to promote settlement of domestic and international disputes through different modes of alternate dispute resolution. India is not a member of the International Center for the Settlement of Investment Disputes, but is a member of the New York Convention of 1958. The Permanent Court of Arbitration (PCA, Hague) and the Indian Law Ministry have agreed to establish the regional office of the PCA in New Delhi to make available an arbitration forum to match the facilities offered at The Hague at a far lower cost. The work to set up the court in New Delhi is progressing.

Performance Requirements and Incentives

Local sourcing is generally not required, but has been mandated for certain sectors in the past. In some consumer goods industries, the GOI requires the foreign party to ensure that the inflow of foreign exchange and foreign equity covers the foreign exchange requirement for imported goods. In 2002, the GOI removed measures previously requiring local content and foreign exchange balancing in the automobile industry.

Plant Location: Industrial undertakings are free to select the location of a project. The earlier restriction prohibiting location of factories near urban settlements was lifted in July 2008. However, projects will still need clearance by the concerned state pollution board and the environment ministry.

Employment: There is no requirement to employ Indian nationals. Restrictions on employing foreign technicians and managers have been eliminated, though companies complain that hiring and compensating expatriates is time-consuming and expensive. The RBI permits remittance of a per-diem rate up to $1000, with an annual ceiling of $200,000 for services provided by foreign workers payable to a foreign firm. Employment of foreigners in excess of 12 months requires approval from the Ministry of Home Affairs. In addition, there are certain employment restrictions in the telecommunications industry. Majority directors on the boards of telecom companies including the Chairman, Managing Director and Chief Executive Officer, should be resident Indians. The Chief Technical Officer and the Chief Finance Officer should also be resident Indian citizens. The chief officer in charge of the technical network operations and the chief security officer for all telecom companies have to be resident Indian citizens.

Taxes: The GOI provides a 10-year tax holiday for knowledge-based start-ups. Most state governments also offer fiscal concessions. Large state and central government fiscal deficits, along with attempts to reform both the direct and indirect tax regimes throughout India, have increased uncertainty over tax liability for investors. The general trend, however, has been toward simplification of the tax code, a reduction in tax rates and exceptions, and greater transparency in tax administration.

The 2008 annual supplement to the FTP announced some incentives for the export community, including a duty reduction to 3 percent from 5 percent for capital goods imported under the Export Promotion Capital Goods scheme (EPCG is an export incentive scheme that seeks to modernize production facilities); and sector-specific incentives in farm products, toys/sports goods, gems/jewelry, IT hardware and telecommunication sectors. India’s Foreign Trade Policy exempts exporters from service tax, and provides for duty-free import of inputs and capital goods, exemption from excise taxes on capital goods, textile machinery, components and raw materials, as well as exemption on sales tax at the federal and state level. Import of consumables, professional equipment, and spare parts in the service sector are allowed duty-free up to 10 percent of the average foreign exchange export earnings in the preceding three years. Tax holidays are available in the form of deductions for priority sectors. Deduction of 100 percent of the profits from business for a period of 10 years is available for infrastructure industries. Income by way of dividend, interest, or long term capital gains in respect of infrastructure companies is 100 percent tax exempt.

Right to Private Ownership and Establishment

Subject to certain sector-specific restrictions, foreign and domestic private entities may establish and own businesses in trading companies, subsidiaries, joint ventures, branch offices, project offices and liaison offices. The GOI does not permit investment in real estate by foreign investors, except for company property used to do business and the development of most types of new commercial and residential properties. NRIs are permitted 100 percent equity investment in real estate. FIIs can now invest in real estate Initial Public Offerings (IPOs). They can also participate in pre-IPO placements undertaken by such real estate companies without regard to the FDI stipulations.

To establish a business, various approvals and clearances are required such as: incorporation of the company; registration and allotment of land; permission for land use in case of industry located outside an industrial area; environmental site approval; sanction of power and finance; approval for construction activity and building plan; registration under State Sales Tax Act and Central and State Excise Acts; and consent under Water and Air Pollution Control Acts. Industries such as petrochemicals complexes, petroleum refineries, cement thermal power plants, bulk drugs, fertilizers, dyes, and paper (among others) need to obtain environment clearance from the Ministry of Environment and Forest.

The GOI passed the Securitization Act in 2002 to introduce bankruptcy laws. The requirement to obtain government permission before shutting down some businesses, however, makes it difficult to dispose of company assets.

Protection of Property Rights

The legal system puts a number of restrictions and imposes a stamp tax on the transfer of land, making title unclear, often making buying and selling transactions difficult. There is no reliable system for recording secured interests in property, making it difficult to use property as collateral or to foreclose against such property.

India has generally adequate copyright laws, but enforcement is weak and piracy of copyrighted materials is widespread. India is a party to the Geneva Convention for the Protection of Rights of Producers of Phonograms and the Universal Copyright Convention, and a member of the World Intellectual Property Organization (WIPO) and UNESCO. India has not yet ratified and incorporated into domestic law the WIPO Internet treaties. The nodal ministry has reportedly prepared the draft amendments to update the Copyright Act, which still need intra-agency approval before they can be approved by the Cabinet.

Trademark protection is good and meets international standards. The Trade Marks Act (1999) and implementing regulations accord national treatment for trademark owners and statutory protection of service marks. Although U.S. firms report few trademark related problems, India's weak judicial system can make it difficult to exercise rights established by the law. India is currently working on amending its Trademark Laws to make them compliant with the Madrid Protocol. The Indian government in November 2008 approved modification of the Trade Marks (Amendment) Bill, 2007 to ensure better protection for Indian trademarks in designated member countries and afford reciprocal protection to trade marks from member countries abroad. The amendment Bill is expected to be passed by the Parliament.

In 2005, India expanded product patent coverage to include pharmaceuticals and agro-chemicals, sectors of significant interest to U.S. firms. Embedded software may also now be patented. The GOI introduced these changes through presidential ordinance in order to meet on time India's commitments under the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS). On March 23, 2005, the Indian Parliament approved legislation to make permanent the change to India's patent law that the GOI had introduced by temporary ordinance. The new law extends product patent protection to pharmaceuticals and agricultural chemicals. However, the new law lacks specificity in several important areas such as compulsory license triggers, pre-grant opposition provisions, and defining the scope of patentable inventions. India also provides protection for plant varieties through the Plant Varieties and Farmers' Rights Act.

Indian law does not provide for protection against unfair commercial use of test or other data that companies submit to the government in order to obtain marketing approval for their pharmaceutical or agricultural chemical products. The GOI is working on legislative changes based on recommendations made by the GOI data protection inter-ministerial group, also known as the Reddy report. A small but growing domestic constituency of Indian pharmaceutical companies, technology firms, and educational institutions favors improved patent protection.

Indian law provides no protection of trade secrets. The GOI in October 2008 put forth draft legislation for public comment. In 2000, India passed legislation (Designs Act 2000) to meet its obligations under the TRIPS Agreement for industrial designs. The Indian government in September 2008 announced Design Rules 2008 detailing classification of design to conform to the international system and to take care of the proliferation of design related activities in various fields. India's semiconductor Integrated Circuits Layout Designs Act 2000 is based on standards developed by WIPO. However, this law remains inoperative due to the lack of implementing regulations.

Transparency of the Regulatory System

Even though India has made much progress on economic reform since 1991, the economy is still constrained by excessive rules and a powerful bureaucracy with broad discretionary powers. Moreover, India has a decentralized federal system of government in which the state governments possess broad regulatory powers. Regulatory decisions governing important issues such as zoning, land-use and environment can vary from one state to another. Opposition from labor unions and political constituencies has slowed reform in such areas as exit policy, bankruptcy, and labor law reform.

Despite these shortcomings, central government efforts to establish independent and effective regulators in some sectors, such as telecommunications, securities, and insurance, have shown positive results. In December 2004, the GOI also created an independent pension regulator as part of its larger program to reform India's pension system. It also established a Competition Commission and has indicated its intention to strengthen the commodities futures markets. SEBI enforces corporate governance, which is considered better than in many other emerging markets by foreign institutional investors. Financial disclosures are strict though there is scope for improvement.

Efficiency of Capital Markets and Portfolio Investment

The Indian capital market has grown rapidly in recent years, with market capitalization on the Bombay Stock Exchange hitting new highs before the 2008 financial crisis battered stock markets around the world. Spot prices for index stocks are usually market-driven and settlement mechanisms are close to international standards. India's debt and currency markets lag behind its equity markets. Although private placements of corporate debt have been increasing, the daily trading volume remains low. The Indian stock markets lack broad liquidity, although high transaction costs and systemic risk have come down with recent regulatory and administrative improvements. Institutional improvements and better regulations have helped to reduce episodes of market manipulation, which had caused a lack of confidence by retail investors who invested primarily in public sector debt instruments and debt-oriented mutual funds. SEBI has initiated further policy changes such as allowing all investors to short sell, introducing borrowing and lending of shares, and introducing Real Estate Investment Trusts that would be listed in the market. These measures add depth and breadth to the market making it more liquid than before.

In 2004, the GOI announced its intentions to integrate the commodities and securities markets and to revamp taxes on securities transactions, although this is still being debated. The GOI eliminated the tax on long-term capital gains on stocks and this year increased the tax on short-term capital gains to 15 percent from 10 percent. The GOI imposes a securities transaction tax of 0.075-0.012 percent.

Foreign Institutional Investors (FIIs) have a relatively small (compared to their global portfolios) but growing presence in India. However, after 11 consecutive years of net inflows, FIIs made net sales of about $13 billion in the Indian capital markets as of year-end 2008. The 2008 net outflow contrasts with net inflows of approximately $17 billion in 2007. While FIIs are allowed to invest in all securities traded on India's primary and secondary markets, in unlisted domestic debt securities, and in commercial paper issued by Indian companies, the GOI imposes several restrictions that vary by type of investment. For example, the GOI has hiked the amount of FII investment in government securities and corporate debt by taking the total investment to $8 billion. The FII limit in corporate debt was raised in 2008 and again in early 2009 in light of reduced capital inflows. The new limit is $15 billion in a single fiscal year on a first-come, first-serve basis subject to a ceiling of $200 million per registered entity. FII equity holdings in a single company are also capped at a level below the overall sector-specific foreign investment limits unless specifically authorized by that company's board of directors.

FIIs investing in India's capital markets must register with the Securities and Exchange Board of India (SEBI). They are divided into two categories: (a) Regular FIIs - those which are required to invest not less than 70 per cent of their Indian exposure in equity-related instruments, and (b) 100 percent debt-fund FIIs -- those which are permitted to invest only in debt instruments. The list of eligible FIIs has been expanded to include endowment and university funds, foundations, charitable trusts, and hedge funds. SEBI allows foreign brokers to work on behalf of registered FIIs. The FIIs can also bypass brokers and deal directly with companies in open offers. FII bank deposits are fully convertible and their capital, capital gains, dividends, interest income, and any compensation from the sale of rights offerings, net of all taxes, may be repatriated without prior approval.

Non-resident Indians (NRIs) are subject to separate investment limitations. They can repatriate dividends, rents and interest earned in India and their specially designated bank deposits are fully convertible.

The National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE), both based in Mumbai, use screen-based trading systems. Computers and telecommunications links permit automated buy/sell transactions. Other regional exchanges and the National Over-the-Counter Exchange in Delhi also have computer-trading systems. The efficiency of the capital market has improved because of the compulsory depository system for most stocks, abolition of the traditional speculative "badla" system of carry forward trades, and introduction of derivatives trading by way of stock options and index trading. SEBI regulates all market intermediaries. Securities can be transferred through electronic book entry. The National Securities Depository Limited, which is promoted by the NSE, commenced operation in 1996. The BSE, the other market with national reach, has also set up a depository system. Together, the NSE and BSE account for 96 percent of total turnover in the stock markets. The NSE and BSE are the world's fourth and fifth largest stock exchanges in terms of volume of transactions, although they are smaller in terms of market capitalization compared to the world's largest markets.

Companies incorporated outside India can raise resources in India's capital market through the issuance of Indian Depository Receipts (IDRs), subject to certain conditions established and monitored by SEBI. Companies are required to have pre-issue paid-up capital and free reserves of least $100 million, as well as an average turnover of $500 million during the three financial years preceding the issuance.

India's banking industry (with total assets of about $1082 billion in March 2008) is split into three categories - - 28 public sector banks (70 percent of total assets in the banking system), 23 private banks (21 percent), and 28 foreign banks (about 8.4 percent). According to official figures, the ratio of non-performing loans to total assets for public sector banks was 2.3 percent in 2007-08 compared to 2.7 percent the previous year. A Board for Financial Supervision ensures compliance with guidelines on loan management, capital adequacy, and asset classification. All banks operating in India are regulated through the Reserve Bank of India (RBI) whose authority the GOI has limited gradually as part of the economic reform process.

Domestic banks are mandated to extend 40 percent of their loans to "priority" borrowers (agriculturists, exporters, and small businesses). A similar requirement for foreign banks is 32 percent of loans to exporters and small businesses. In April 2003, the lending commitment for regional rural banks in priority sectors was raised to 60 (from 40) percent. In addition to imposing sector lending requirements, the dominance of state-owned banks in the market also allows the GOI to exert influence over individual lending decisions.

The GOI has been slowly liberalizing external commercial borrowings (ECBs) in the last few years, although in the last two years it has treated it as a source of foreign capital to turn on and off in response to currency and balance of payment needs. It currently allows ECBs under the automatic route up to $500 million for meeting rupee expenditure/foreign currency expenditure for permissible end-uses for all borrowers. In October 2008, the requirement of a minimum average maturity period of seven years for ECBs of more than US$ 100 million for rupee capital expenditure by the borrowers in the infrastructure sector was abolished. In August 2007, the GOI had permitted ECBs of more than US$ 20 million per borrower per financial year only for foreign currency expenditure for permissible end-uses and those up to US$ 20 million were permitted under the automatic route. In June 2008, hotels, hospitals and software companies were allowed to use ECBs of up to US$ 100 million per fiscal year, for the purpose of import of capital goods under the approval route. The definition of infrastructure for the purpose of utilizing ECBs was expanded in October 2008 to include mining, exploration and refining while payments for obtaining licenses/permits for 3G spectrum by telecom companies were classified as eligible end-uses for the purpose of ECB. The central bank also authorizes an additional $250 million in ECBs with an average maturity of at least 10 years, under the approval route. All companies except banks, financial institutions and non-banking financial companies (NBFCs) are eligible to pursue ECB or provide guarantees for such loans. In January 2009, in order to enable more ECBs, the GOI removed interest rate ceiling caps on ECBs and allowed NBFCs to access multilateral or bilateral official ECB loans for infrastructure. ECB funds cannot be used for investment in the stock market or real estate.

Takeover regulations require disclosure on acquisition of shares exceeding five percent of total capitalization. Acquisition of 15 percent or more of the voting rights in a listed company triggers a public offer for an additional 20 percent stake as per SEBI's Substantial Acquisition of Shares & Takeovers Regulations. Companies may buy back their shares in the market to make inter-corporate investments. From October 2008 consolidation through creeping acquisition up to 5percent has been allowed to persons holding 55 percent and above but below 75 percent, subject to the condition that such acquisition can only be via open market purchases in the normal segment, and no consolidation via bulk/ block/ negotiated deal or through preferential allotment would be permitted. RBI and FIPB clearances are required to acquire a controlling stake in Indian companies. Cross shareholding and stable shareholding are not prevalent in the Indian market. The Hostile Takeover Code and the SEBI Takeover Committee regulate hostile takeovers. The Committee makes ad hoc decisions on takeovers, and tends to protect the target firm when takeover bids come from foreign entities.

Political Violence

In general, there have been few incidents of politically motivated attacks on foreign projects or installations in recent years. There were no politically motivated attacks on U.S. companies operating in India in 2008. There are some violent insurgent movements in Kashmir and some northeastern states, as well as a Maoist guerilla movement in some eastern states. In addition, India has been the target of Islamist terrorist attacks, including bombings in 2008 in Jaipur, New Delhi, Bangalore, Hyderabad, Guwahati, and Ahmedabad, as well as the November 2008 sea-borne terrorist attacks on Mumbai, which killed six Americans and other foreigners. Prior to Mumbai, major terrorist attacks had not specifically targeted hotels and facilities frequented by American travelers.

Corruption

Corruption is a major concern. In the past, the government procurement system, especially for telecommunications, power and defense, has been particularly subjected to allegations of corruption. Several government employees and public figures have been indicted or convicted under anti-corruption laws over the last eight years.

The legal framework for fighting corruption is provided in the following laws: the Prevention of Corruption Act, 1988; the Code of Criminal Procedures, 1973; the Companies Act, 1956; and the Indian Contract Act, 1872. Amended anti-corruption laws since 2004 have given additional powers to vigilance departments in government bodies and made the Central Vigilance Commission (CVC) a statutory body. The GOI intends to amend the Prevention of Corruption Act (PCA), 1988 through an inter-ministerial group to prescribe a sanction-granting authority for prosecution of Members of Parliament, Members of State Legislatures and local bodies.

U.S. firms have identified corruption as one obstacle to foreign direct investment. Indian businessmen agree that red tape and wide-ranging administrative discretion serve as a pretext to extort money. According to some foreign business representatives in India, corruption lies in the lack of transparency in the rules of governance, extremely cumbersome official procedures, and excessive and unregulated discretionary power in the hands of politicians and bureaucrats. Clusters have developed, however, such as in the New Delhi suburb of Gurgaon, where the business climate is relatively free of corruption. Officials of foreign businesses in these areas say that local political and bureaucratic machinery generally leaves them alone.

Bilateral Investment Agreements

The GOI states that it has concluded 57 bilateral investment promotion agreements (BIPAs). These included agreements with the United Kingdom, France, Germany, Malaysia, and Mauritius. Negotiations are also underway with other countries. The United States does not have a bilateral investment treaty (BIT) with India as yet, but the two countries launched BIT exploratory discussions in 2008, with formal negotiations scheduled to commence in early 2009. India and the US already have a double taxation avoidance treaty. Several tax disputes are pending which are addressed during regular meetings between the two countries' Competent Authorities.

OPIC and Other Investment Insurance Programs

The U.S. and India signed an Investment Incentive Agreement in 1987 that covers the Overseas Private Investment Corporation (OPIC) programs. OPIC is currently open in India for all its programs, specifically supporting three regional private equity funds and five global funds. OPIC projects in India are in the following sectors: energy and power, telecommunications, manufacturing, and services. India is a member of the World Banks Multilateral Investment Guarantee Agency (MIGA).

Labor

Although there are more than 7 million unionized workers, unions represent less than one-seventh of the workers in the organized sector (primarily in state-owned concerns), and less than two percent of the total work force. Most unions are linked to political parties. Worker-days lost to strikes and lockouts dropped 50 percent during the decade 1991-2000 from the previous decade.

The payment of wages is governed by the Payment of Wages Act 1936, and the Minimum Wages Act, 1948. Industrial wages range from about $3.50 per day for unskilled workers, to over $150 per month for skilled production workers. Retrenchment, closure and layoffs are governed by the Industrial Disputes Act, which requires prior government permission to layoff workers or close businesses employing 100 or more workers. Permission is not easily obtained. Private firms have successfully downsized using voluntary retirement schemes. Foreign banks are also required to get the RBI's approval for closing branches.

Comprehensive Legislation on Labor Reforms was introduced several years ago but is still stalled in the Parliament Consultative Committee. The prospect of a new government in 2009 will require the reintroduction of this legislation. The proposed law contains stringent provisions for strikes and lockouts. The Comprehensive legislation was meant to integrate both the Trade Unions Act and the Industrial Disputes Act in a single piece of legislation. In addition, a key amendment to the Industrial Disputes Act would increase the threshold limit to 300 employees for seeking government approval before laying-off workers.

Foreign Trade Zones/Free Trade Zones

The GOI has established several foreign trade zone schemes to encourage export-oriented production. These provide a means to bypass many of the domestic economy's fiscal and infrastructural obstacles that otherwise make Indian goods and services less competitive in international markets. The most recent of the schemes is the Special Economic Zone (SEZ), a duty-free enclave with separately developed industrial infrastructure. Other schemes include the Export Processing Zone (EPZ) and the Software Technology Park (STP), both of which are designated areas for export-oriented activities. In addition, India allows an individual firm to be designated an Export Oriented Unit (EOU). All of these schemes are governed by separate rules and granted different benefits. In May 2005, the GOI passed new legislation called the "Special Economic Zones (SEZ) Bill 2005" endorsing its commitment to a long-term and stable policy for the SEZ structure which had previously been only an administrative construct. Pursuant to certain controversies over land acquisition for SEZ development projects, the GOI issued new guidelines for SEZ in 2006. Although legislative changes have been introduced through a new Land Acquisition and Rehabilitation Act, some political unrest over SEZ development projects continue.

SEZs are regarded as foreign territory for the purpose of duties and taxes, and operate outside the domain of the custom authorities. SEZ units are allowed to retain 100 percent of their foreign exchange earnings in special Export Earners Foreign Currency Exchange accounts. They are free to sell goods in the domestic tariff area (DTA) on payment of applicable duties. Sales from DTA firms to SEZ units are on par with regular trade transactions and hence eligible to benefit from all export incentive and foreign currency exemption schemes. In addition, many state governments have granted a sales-tax exemption for DTA-SEZ sales. SEZ units are also exempt from the central government's service and excise tax regimes.

SEZ businesses are expected to be a positive foreign exchange earner within five years from the commencement of production. None of the FDI equity caps are applicable to units in SEZs, including those sectors reserved for small-scale industries. SEZs are exempted from the requirements of industrial licensing.

The new law increased the tax holiday period (phased out over time) from 10 years to 15-years for both SEZ developers and SEZ production units. The SEZ legislation also provides for the establishment of an International Financial Services Centre to facilitate financial services for SEZ units. Offshore banking units (OBUs) are permitted to operate in SEZs, virtually like a foreign branch of a bank, to make available financing at international rates. The OBUs enjoy some exemptions from Reserve Bank (central bank) of India requirements, but other limitations have constrained their popularity.

Subsequent to the first and main promulgation of SEZ Rules in February, 2006, 531 SEZ projects have been approved so far, and formal notifications for 260 SEZs have been issued. Land acquisition for SEZs has become a controversial issue because of the alleged allocation of large blocks of agricultural lands to upcoming SEZs. This has prompted the government to issue guidelines that only uncultivable land can be acquired for SEZ development or if fertile land is involved then it should not be more than 10 percent of the total area and adequate compensation and rehabilitation need to be provided. However, the compensation and rehabilitation provisions are not transparent. There is also land ceiling of 5000 hectares on large SEZs which has become a contentious issue for many SEZ developers.

EPZs are industrial parks with incentives for foreign investors in export-oriented business. STPs are special zones with similar incentives for software exports. EPZ/STP units may import intermediate goods duty-free. The minimum net foreign exchange earning as a percentage of exports by EPZ/STP units is required to be at least 3 percent. EPZ/STP units may sell up to 50 percent of their level of exports on the domestic market after payment of taxes, with the exception of motor cars, alcoholic beverages, tea, books, and refrigeration units.

EOUs are industrial companies established anywhere in India that export their entire production. There are approximately 2300 fully operational EOUs in India. They are granted: duty-free import of intermediate goods duty- free; income tax holiday up to 2009; exemption from excise tax on capital goods, components, and raw materials; and waiver of sales taxes. EOUs may sell up to five percent of "seconds" on the domestic market after paying appropriate taxes.

Foreign Direct Investment Statistics

Table A: Inflow of FDI by top 5 countries ($ million)
(IFY)
Year
2000-05 2005-06 2006-07 2007-08 2008-09*
-------------------------------------------
Total16,6575,54615,72624,57917,211
Of which
Mauritius
5,6062,5706,36311,0967,014
Singapore4312755783,0731,751
U.S.A.2,0865028561,0891,229
U.K.1,0432661,8781,176695
Netherlands1,29076644695714
FDI/GDP(%)0.90.92.5N/AN/A

Note: Indian Fiscal Year (IFY) is from April to March.
* FDI inflows for April 2008-September 2008 only.

Source: Secretariat for Industrial Assistance Newsletters,
Ministry of Commerce and Industry, GOI

Table B: Top 10 New FDI proposals approved in IFY 2008-09
(April-September)

CompanyProject Equity ($ million)
DE Shaw CompositeConstruction385
Investments, Mauritius
Fiat AutomobilesAuto Manufacturing288
Italy
New Opportunities LtdReal Estate197
Mauritius Construction
Holdrind InvestmentsCement Manufacturing189
Mauritius
BNP Paribas LeasingFinancial Services184
Group, France
Lehman BrothersOther Banking141
SingaporeServices
BOC Group PlcIndustrial Gas139
U.K.Manufacturing
Morgan StanleyFinancial Services132
Mauritius
CRH India InvestmentsCement Manufacturing121
Netherlands
Cisco Systems CapitalCredit Services118
Mauritius

Note: The Indo-Mauritius investment agreement provides tax advantages that have attracted U.S. and businesses of other countries to make FDI into India from Mauritius, rather than the headquarter country.

Table C: FDI Inflows by Sector - Top 5

Sector FDI (US millions)
IFYApril 2000-Sept 2008 2008-09*
All Services (fin and non-fin)15,6342,576
Computers/Software8,6781,400
Telecommunication5,7961,954
Construction Activities(roads/hwys)4,8851,722
Housing and Real Estate4,3351,624

Note: * data is for April - September 2008 only
Source: Secretariat for Industrial Assistance, Ministry of
Commerce and Industry, GOI



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