India2005 INVESTMENT CLIMATE STATEMENT -- INDIA
Openness To Foreign Investment
India controls 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 hostility 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 approval 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. 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 the
way out of a current joint venture remains uncertain.
Equity caps for foreign portfolio investment are
sometimes included in FDI caps. There are no set 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 other cases foreign
portfolio investment is not subject to the FDI cap.
A recent amendment to the Companies Act denies
voting rights to foreign investors holding preferred
stock in Indian companies if their holdings exceed the
FDI limit. This means that if the foreign equity
participation is at the maximum permissible level in a
company, the preference shareholder will not have any
voting rights.
Foreign investment is prohibited in real estate
(with limited exceptions), retailing, legal services,
agriculture and plantations (except tea), security
services, and railways. 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 40 percent. In
January 2005 the Prime Minister announced that NRI's
would be allowed to claim dual citizenship, a change
which could enable NRI's new investment opportunities in
India as citizens. Capital outflow restrictions for
India citizens, however, remain in place.
To curb the flow of funds by Indian residents
through their NRI counterparts overseas, the Indian
government in September 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 GOIs privatization policy permits foreign
investors to bid for the sale of the state-owned units.
It's 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 or OCBs own farmland. FDI in the seed
industry is permitted without any limits. FDI up to 100
percent is also permitted in tea plantations, but
proposals require prior government approval. There is
compulsory divestment of 26 percent equity of the
company in favor of an Indian partner or the Indian
public within five years.
-- Airport Infrastructure: FDI is allowed up to 74
percent. That limit was reduced to 49 percent, however,
for privatization of the Delhi and Mumbai airports; the
state-owned Airport Authority of India will hold 26
percent equity, while the remaining 25 percent equity is
reserved for Indian private investors. To participate
in a ground handling business at the airports, foreign
companies can form joint ventures with the three state-
owned companies, but their holding is limited to a 49
percent (i.e., minority) share and subject to government
approval.
-- Alcoholic beverages: No FDI limit is applicable but
prior government approval is required.
-- Atomic energy: FDI is limited to 74 percent for
mining and mineral separation, integration, and value
addition in mining and mineral separation. FDI beyond
74 percent is approved on a case-to-case basis. There
are no automatic approvals.
-- Automobiles: In 2002, the GOI abolished FDI caps as
well as local content requirements and export
obligations. FDI of 100 percent is allowed with
automatic approval.
-- Banking: The GOI increased the FDI limit for private
banks to 74 percent in March 2004, but the Reserve Bank
of India has not yet issued implementing guidelines.
For state-owned banks the FDI limit remains at 20
percent. The 74 percent cap includes all foreign
portfolio investments. 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.
-- Broadcasting: FDI is limited to 20 percent in FM
terrestrial broadcasting, with prior government
approval. NRIs and OCBs may hold as much as 49 percent.
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, FDI is also 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 channels up-linking from India.
Entertainment channels face no FDI limit.
-- Cable Network: FDI is limited to 49 percent
(inclusive of both FDI and portfolio).
-- Cigars/cigarettes of tobacco: There is no FDI limit
but prior government approval is required.
-- Civil Aviation (domestic airlines): In November 2004,
the GOI increased the FDI limit to 49 percent (from 40
percent) and permitted "automatic route" investment. No
foreign airline, however, may make either a direct or
indirect investment in an Indian domestic airline.
Nonetheless, a US-India "Open Skies" agreement,
currently being negotiated, would provide other means
for US carriers to enter the Indian market. NRIs and
OCBs may own 100 percent of a domestic airline.
Although frequently debated, India has yet to open its
state-run international airlines to outside investment.
-- 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 for up to 50 percent FDI in
private sector companies are approved automatically.
FDI is limited to 49 percent in state-owned units.
-- Construction: Construction and maintenance of roads,
highways, vehicular bridges, tunnels, ports and harbors
is allowed at 100 percent FDI, with automatic approval,
up to a ceiling of $345 million. FDI is limited to 74
percent with automatic approval for construction and
maintenance of waterways, rail beds, hydroelectric
projects, power plants and industrial plants. FDI is
not allowed in housing or office construction.
-- Defense and strategic industries: FDI is limited to
26 percent, subject to a license from the Defense
Ministry. There are no automatic approvals.
-- Drugs/Pharmaceuticals: FDI is allowed up to 100
percent for drug manufacturing. Automatic approval is
permitted at all levels of FDI, provided the activity
does not attract compulsory licensing or use recombinant
DNA technology, in which case an approval from the FIPB
is required.
-- E-commerce: FDI up to 100 percent is allowed in
business-to-business e-commerce with the condition that
foreign investors divest at least 26 percent to the
Indian public within 5 years. FDI is limited to 49
percent under the automatic approval route. No FDI is
allowed in retail e-commerce.
-- Food Processing: FDI is limited to 51 percent 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. Higher FDI is allowed on case-to-
case basis on prior approval basis. However, 100
percent FDI is allowed with automatic approval to NRI or
OCBs. 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 and OCBs, 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.
-- 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%, but this change first requires
parliamentary approval of an amendment to the Insurance
Regulatory and Development Authority Act.
-- Lottery, Gambling, Betting: No FDI in any form is
allowed.
-- Manufacturing: FDI at 100 percent FDI 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 is limited to 24 percent
in a protected category reserved for "small scale
industries" (SSI). The SSI reservation applies to 550
goods or services and enterprises with a capital
investment of less than $206,000. Higher percentages of
foreign equity may be approved if the company obtains a
license and undertakes to export 50 percent or more of
its product.
-- Mining: FDI is limited to 74 percent, with automatic
approval, for diamond and precious stone mining. FDI at
100 percent, with automatic approval, is allowed for
exploration and mining metallurgy, and processing of
gold, silver, and other minerals.
-- Non-Banking Financial Companies (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. 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 all
activities other than private sector oil-refining.
- DisQovered small fields 100 percent
- Unincorporated joint venture 60 percent
- Incorporated joint venture 51 percent
- Refining with domestic private 100 percent
- Refining with public company 26 percent
- Petroleum product/pipeline 100 percent
(auto-approval)
- Marketing and marketing infrastructure 100 percent
- LNG Pipeline 100 percent
- Exploration 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.
-- Postal/courier services: FDI up to 100 percent is
permitted in courier services, subject to prior
government approval. FDI in letter delivery is not
allowed.
-- Power: FDI up to 100 percent is permitted with
automatic approval in projects relating to electricity
generation, transmission and distribution, other than
atomic reactor power plants.
-- Print Media: In 2002, the GOI opened up the sector to
foreign investment, with a 26 percent equity cap for
news publications and a 74 percent cap for non-news
publications. FDI is permitted up to 100 percent in
printing Science and Technology magazines/journals,
subject to prior government approval.
-- 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.
-- Retailing: FDI is not allowed.
-- 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 49 percent for the
establishment and operation of satellites.
-- Shipping: FDI is limited to 74 percent with automatic
approval for water transport services.
-- Telecommunications: FDI limits vary for basic and
cellular services as follows:
- National and International 49 percent
(license required)
- Long Distance 49 percent
- Equipment manufacturing 100 percent
- Global Mobile Communication 49 percent
- Radio paging, Internet Service
Providers (ISP) with int'l
gate-ways, and End-to-End
Bandwidth 74 percent
(above 49 requires
GOI approval)
- ISP without int'l gateways,
voice-mail and e-mail 100 percent (above
49 requires GOI
approval, 25
percent divestment
within five years)
-- Trading: FDI is not allowed in the retail business.
For the export sector, FDI is allowed up to 51 percent
with automatic approval. FDI at 100 percent is allowed,
subject to FIPB approval, for activities like bulk
imports with export warehouse sales, as well as cash and
carry wholesale trading.
-- 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, like 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. Capital account transactions are
open for foreign investors, subject to various
clearances. In 2004, with growing foreign exchange
reserves, the Indian government took 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 $25,000 without approval. At the end of
2004, the exchange rate was Rs 43.58 to $1, compared to
Rs 45.61 at the end of 2003.
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 but caps
lump-sum payments at $2 million. 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. Prior to these changes, only wholly owned
subsidiaries were allowed to make royalty payments.
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.
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 in 2004
with a change in government there has been no reversal
in the overall movement away from public ownership of
industry.
In 2004, the U.S. Overseas Private Investment
Corporation (OPIC) filed for arbitration in a claim for
repayment by the Government of India due to
expropriation. This resulted from OPIC having to pay
out over $130 million to U.S firms who successfully
established before an independent U.S. arbiter that GOI
actions derailed the Dabhol power project and amounted
to expropriation. At least four other U.S. companies
with investments in Indias power sector are involved in
contractual disputes over compensation against various
Indian State governments or local electricity boards.
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.
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 automobile industry.
Plant Location: Industrial undertakings are free to
select the location of a project; in case of cities with
population of more than a million, the proposed location
should be at least 25 kilometers away from the Standard
Urban Area limits of that city. Electronics, computer,
and printing as well as other non-polluting industries
are exempt from such location restrictions.
Environmental regulations and local government zoning
policies can delay projects.
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
has raised the remittable per-diem rate from $500 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.
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 Indian, 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 new Foreign Trade Policy introduced in 2004
(replacing the Export-Import policy) continued tax-
relief incentives for export-oriented industries and
other targeted sectors. For example, the policy allows
exporting firms 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.
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. NRIs and OCBs are permitted 100
percent equity investment in real estate.
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 on
the transfer of land, making titles unclear, often
making buying and selling transactions difficult. There
is no reliable system for recording secured interest 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. Efforts to update its copyright act have been
stalled in inter-ministerial debate for several years.
Trademark protection is good and was raised to
international standards with the passage in 1999 of a
new Trademark Bill that codified the use and protection
of foreign trademarks and service marks. Implementing
regulations were not issued, however, until September
2003. The law now accords 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.
Effective January 1, 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). Parliament must
ratify the patent amendment within six months or the
ordinance will lapse. Ambiguous language on compulsory
license triggers and a narrow definition of
patentability continue to limit,patent protection in
India. 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 government has prepared legislation that would
appear to be TRIPS compliant, but has not yet introduced
it in Parliament. In 2000, India passed legislation
(Designs Act 2000) to meet its obligations under the
TRIPS Agreement for industrial designs. The GOI also
passed the Semiconductor Integrated Circuits Layout
Designs Act 2000, based on standards developed by WIPO.
Only enacting regulations for the former have been
published, leaving the latter law inoperative.
Transparency Of The Regulatory System
Even though India has made much progress on economic
reform since 1991, the economy is still hobbled 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. Lack of
oversight on corporate governance and financial
disclosure remain an obstacle to transparent and stable
markets.
Efficiency of Capital Markets and Portfolio Investment
The Indian capital market has grown in recent
years, but remains relatively small compared to other
emerging markets and developed economies. 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 insignificant. The ratio of daily
trading volume to total debt outstanding is less than
one percent in India, compared to about 7 percent in
U.S. The Indian stock markets lack broad liquidity,
although high transaction costs and systemic risk have
come down with recent regulatory and administrative
improvements. Currently, about 50 Indian stocks, out of
more than the 9,000 listed, make up over 75 percent of
trading. The proportion of stock available for trading
is limited. Institutional improvements have helped to
reduce episodes of market manipulation which have led to
a lack of confidence by retail investors who invest
primarily in public sector debt instruments. The GOI
has yet to implement "second-generation" financial
market reforms to promote liquidity and a broader
domestic investor base.
In 2004, the GOI announced its intentions to
integrate the commodities and securities markets and to
revamp taxes on securities transactions. The GOI
eliminated the tax on long-term capital gains on stocks
and reduced the tax on short-term capital gains to 10
percent. At the same time it put in place a securities
transaction tax of 0.15 percent.
Foreign Institutional Investors (FIIs) have a
relatively small (compared to their global portfolios)
but growing presence in India with net inflows for India
totaling around $11 billion for the year ending March
31, 2004. While FIIs are allowed to invest in all
securities traded on Indias primary and secondary
markets, in unlisted domestic debt securities, and in
commercial paper issued by Indian companies, the GOI
imposes several restriction that vary by type of
investment. For example, the GOI caps the amount of FII
investment in the debt market at $1.75 billion, except
for corporate debt where the limit is $500 million in a
single fiscal year. 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, and charitable trusts. 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. A
special government bond issuance, the Foreign Currency
Convertible Bonds Scheme, is available to NRIs only.
Purchases up to $500 million are allowed without prior
approval.
The National Stock Exchange (NSE) in Mumbai uses a
screen-based trading system. Computers and reliable
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 of the 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 commenced operation in 1996 as part
of the NSE. The other market with national reach, the
Bombay Stock Exchange (BSE), has also set up a
depository system. Together, the NSE and BSE account
for 96 percent of total turnover in the stock markets.
India's turnover ratio (annual value of stock traded
over market capitalization), a measure of liquidity, is
higher than those of many developed (e.g., UK, Japan,
and Germany) and emerging markets (e.g., China and
Singapore).
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 $420 billion in March 2004) is split into three
categories -- 27 public sector banks (80 percent of
total assets in the banking system), 30 regional private
banks (6 percent), and 36 foreign banks (about 8
percent). According to official figures, the ratio of
non-performing loans to total assets for public sector
banks was 8.8 percent in 2003 compared to 11.1 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 allows external commercial borrowing (ECB)
under the automatic route up to $50 million when the
average maturity exceeds 5 years, and up to $20 million
for three-five years average maturity. ECB for
financing equipment imports and infrastructure projects
can go as high as $500 million. All companies except
banks, financial institutions and non-banking financial
companies are eligible to pursue ECB or provide
guarantees for such loans. 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. In case of acquisition of over 10
percent, the buyer must make a public offer for a
minimum of 20 percent from the remaining shareholders at
a fixed price. Companies may buy back their shares in
the market to make inter-corporate investments. 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 are violent
separatist movements in Kashmir and some northeastern
states. There were no politically motivated attacks on
U.S. companies operating in India in 2004.
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 five years.
The legal framework for fighting corruption is
provide 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. The GOI is introducing legislative changes
to its anti-corruption laws that would give additional
powers to vigilance departments in government bodies and
to make the Central Vigilance Commission (CVC) a
statutory body.
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, the deluge of 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 leave them generally alone.
Bilateral Investment Agreements
The GOI states that it has concluded 57 bilateral
investment treaties. These included agreements with the
United Kingdom, France, Germany, Malaysia, and
Mauritius. Negotiations are underway with other
countries. The United States does not have a bilateral
investment treaty with India, but the two countries do
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, which covers Overseas Private
Investment Corporation (OPIC) programs. OPIC filed for
arbitration in 2004 under this agreement for a dispute
relating to the Dabhol power plant. 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
India has a very large pool of scientific and
technical personnel. Around 20% of the Fortune 500
companies have research and development operations in
India. Most managers and technicians, and many skilled
workers, speak English. Most multinationals recruit
managerial and engineering staff locally for their
Indian operations. Nonetheless, illiteracy acts as a
brake on labor productivity in the workforce as a whole.
India is a member of the International Labor
Organization (ILO) and adheres to 37 ILO conventions
that protect workers' rights. The Industrial Disputes
Act of 1947 governs industrial relations. Workers may
form or join unions of their choice. The Factories Act
regulates working conditions. Other laws regulate
employment of women and children and prohibit bonded
labor.
Although there are more than 7 million unionized
workers, unions represent less than one-fourth 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 have
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 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
RBIs approval for closing branches.
Comprehensive draft legislation on labor reforms is
pending approval in Parliament. It contains stringent
provisions for strikes and lockouts. The amendment to
the Industrial Disputes Act, if approved, 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. Seeking to promote the SEZ model,
the GOI has announced plans to introduce legislation in
2005 that would give additional fiscal incentives to SEZ
developers and member companies.
SEZs are regarded as foreign territory for the
purpose of duties and taxes, and operate outside the
domain of the custom authorities. SEZ units benefit
from a seven-year tax exemption scheme, starting at 100
percent before dropping to 50 percent in the last two
years. They are allowed to retain 100 percent of their
foreign exchange earnings in special Export Earners
Foreign Currency Exchange accounts. All SEZ units are
free to sell goods in the domestic tariff area (DTA) on
payment of applicable duties. In May 2004, the GOI put
sales from DTA firms to SEZ units 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
Indian government in April 2003 allowed branches of
foreign companies operating in India to undertake
manufacturing and trading in SEZs. To encourage
investments, SEZ units are allowed to carry forward
their losses for eight years.
To generate the infrastructure development needed
to establish an SEZ, the GOI has granted private
developers a ten-year tax holiday on the returns from
their investment. To further enhance SEZ
infrastructure, the GOI has encouraged Indian banks,
including subsidiaries (but not branches) of foreign
banks, to set up overseas banking units (OBUs) in the
SEZs in return for fiscal incentives. The GOI grants
OBUs a five-year income tax holiday on profits from SEZ
transactions at 100 percent for the first three years
and 50 percent in the remaining two. The OBUs are
barred from undertaking overseas lending.
Four SEZs have started operation since 2001
(Kandla, Mumbai, Cochin, and Surat). There are eight
government promoted and 13 private and state government
promoted SEZs in various stages of implementation.
Seven EPZs, located in Mumbai, Calcutta, Kochin, NOIDA
near Delhi, Kutch, Chennai, and Vishakhapatnam, have
been converted into Special Economic Zones (SEZs).
Although the SEZs benefit from many tax incentives and
relaxed regulatory requirements, they are still governed
by India's restrictive labor law, which some observers
say is a disincentive to investors, both foreign and
domestic.
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 2,300 fully operational EOUs in India.
They are granted; duty-free import of intermediate goods
duty-free; a ten-year income tax holiday; 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 country (in $ million)
------------------------------------------------
Year(a) 1991-95 1996-2000 2001 2002 2003 2004
---- ------- --------- ---- ---- ---- ----
Total: 768 3,729 4,281 4,435 3,109 3,330
of
which:
U.S. 102 421 323 283 414 342
Mauritius 107 732 1,625 1,518 562 420
N'rlands N/A 17 194 156 253 434
U.K. 66 81 N/A 354 188 117
Japan 20 154 211 413 95 77
FDI/GDP(%) 0.2 0.9 0.9 0.9 0.5 N/A
GDP(US bil) 309 428 483 508 595
(a) For 1991-95 and 1996-2000, the amounts are five-year
annual averages. All others, except 2004, are annual
amounts. The 2004 figures are for Jan-Aug (8 months)
only.
Source: Secretariat for Industrial Approvals, Ministry
of Industry, GOI
--------------------------------------------------
Table B: Major U.S. and other FDI APPROVED in 2003
--------------------------------------------------
Company Project Equity ($ million)
------- ------- ------------------
Shell Gas B.V Fuel Marketing 100
Netherlands
CDC FTL Holding Tractor and Special 99
CDC Financial Purpose Vehicle Manufacturing
Services
Mauritius (b)
Standard Chartered Banking 52
Bank,
U.K.
Elsberry Services -- business 51
Holdings Ltd. and branding solutions
Mauritius (b)
Hughes Investment Company 47
Electronics Co.
U.S.
Suzuki Motor Co. Automobiles 44
Japan
Hewitt IT Services 26
Associates LLC
U.K.
Richmond Restaurants/hotel 26
Enterprises SA
U.K.
GE Capital Int'l Financial services 22
Mauritius (b)
EMC Corporation IT Software 21
U.S.
(b) 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 - 2003
-------------------------------------
Sector FDI (US millions)
------ -----------------
Transportation Industry 329
Services 302
Electrical Equipment 295
Telecommunications 158
Oil Refining 120
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