Earlier this month, alarm bells went off when HDFC disclosed that the People’s Bank of China increased its stake to 1.01% from 0.8% in India’s largest private bank. Even the Indian government took notice. Soon after, the government tweaked its Foreign Direct Investment (FDI) policy to curb “opportunistic takeovers/acquisitions of Indian companies” due to the pandemic.
The government stated that as per the revised policy, any entity of a country that shares a land border with India or if the owner of the investment belongs to such a country, will have to go through the government to invest in India.
"An entity of a country, which shares land border with India or where the beneficial owner of an investment into India is situated in or is a citizen of any such country, can invest only under the government route," a press note from the Department for promotion of Industry and Internal Trade (DPIIT) stated.
The government stated that this will take effect from the date of notification under the Foreign Exchange Management Act (FEMA).
India shares land borders with Pakistan, Afghanistan, China, Nepal, Bhutan, Bangladesh and Myanmar. However, China’s investment into India outweighs investment by the other countries combined at over $8 billion.
Chinese companies and funds also have significant investments in Indian companies and startups. From Paytm, Swiggy and OYO to Ola, Practo, PolicyBazaar and Dream11, 18 out of 30 unicorns (startups which have more than $1bn valuation) in India have some degree of Chinese funding, as do private equity funds. Chinese investment is also present in a variety of sectors in India — from automobile, mobiles and primarily, technology.
This move by the Indian government has drawn mixed reactions. While many have said that this was the need of the hour, especially at a time when the Indian stock markets are at hitting historic lows, making company shares available at a low price, some say that adding a barrier to Chinese investments could hurt the Indian economy. This, at a time when the economy is seeing one of its worst growth phases.
Impact
Santosh Pai, a partner at Link Legal India Law Services says that among the Chinese investor community, sentiment has already been damaged, and says that it was a broad move without much consultation or thinking.
“I think the big impact is for ongoing transactions. We have a lot of clients who are in the middle of making investments in India. They are very worried because they don't know whether they have to wait or continue making the investment; will they get into trouble if they make an investment, will they be asked to get approval after that? There is a lot of uncertainty for people. Typically, a cross border transaction might take about 4-6 weeks to come back,” he says.
Vikrant Varshney, the founder and managing partner of SucSEED ventures says that this move by the government risks bringing back red-tape.
“If China's investment is going to be scrutinized at a deal-by-deal level, red-tapism is coming back. Instead of having a framework, the government is now saying we'll investigate every case. Power then comes back in the hands of the ministers and officers who will take their own sweet time for every transaction to pass through. It's not ease of doing business,” Vikrant adds.
For startups, Murali Bukkapatnam, an angel investor and the chairman of venture development firm Volksy Technologies, says it is going to bring a lot of down rounds. “In the tech space, I would see these startups being beaten down a little bit by the investors in the next round, whenever they go to raise money. Sentiment takes a lot more precedence over the value a particular startup is creating. Any valuation game is driven by hype and sentiment, so I do see that the valuation will come down,” he says.
Rajeev Menon, a partner at Anthill Ventures, says that a large percentage of our unicorns and smaller early-stage companies have received investments from funds in China, for whom issues can be two-fold.
“...in raising fresh funding rounds (from existing investors), and also at the time of exit and consequent transfer of ownership. For the companies that are looking for new funding. The learning opportunity for the smaller companies is a benefit from partnering with the Chinese ecosystem, that will be sorely missed,” he says.
In the medium term, Santosh says that companies, which want to set up factories may still do so because India is still a big market. For large-scale acquisitions, however, he says that it will take a long time to recover and is likely to take a permanent hit because that is where the government wants to prevent a Chinese takeover.
Clarity on policy
Many experts seem to agree that while the move has been done largely as a signal to the Chinese, its intent is unclear.
Santosh Pai echoes this and says that while the circular states that it is to prevent opportunistic acquisitions and takeovers during COVID-19, amendments have been made to the entire FDI policy and places all investments under government control.
“The reason why this is confusing is that opportunistic takeovers can happen on listed companies because the share market has gone down, and listed shares are undervalued due to the crisis. But if you take the example of startups, most of the investments happen at a very high valuation because of various reasons. So, there is no opportunistic takeover or acquisition happening there,” he says
Furthermore, he stated that if one looks at greenfield acquisitions, that is not opportunistic “because there's no valuation angle there. Whether you bring in money today or tomorrow or last year or next year, you bring in money to pay salaries to buy land to set up factories”.
Madhukar Sinha, Founding Partner at India Quotient says that in the short term, startups will struggle due to a lack of clarity in policy pertaining to the ‘beneficial owner of an investment’.
“A lot of funds have capital from Chinese limited partners and Chinese investors. “Also, in the short term, it will have problems only for Indian startups and companies because the companies where the Chinese investors are already existing investors, they will struggle to give any short-term financing or bridge financing to the company. Due to the lack of proper clarity on the policy, these companies will struggle to get the money,” he says.
Impact on FDI outflows?
Kartick Maheshwari, a partner at law firm Khaitan & Co, states that all large Asia-dedicated private equity funds have Chinese Limiter Partners (LPs) or investors. So, as long as the Chinese LPs don’t control them and decisions are taken by a third-party investment manager, they should not be subjected to the new prior approval requirements for their investments in India.
“The circular says that going forward any direct or indirect beneficial ownership by a Chinese entity / citizen also requires prior approval. On that basis, the timelines of the FDI process in this country will be affected. The private equity industry in particular relies upon the ability to keep capital flows moving quickly and agility in its investments; so unless, more clarity is provided on the meaning of beneficial ownership, there could be potential delay in their deployment of capital (which could aggravate the current economic shock)” he says.
However, Murali and Rajeev said that they don’t expect this to hamper FDI into the country from other countries.
“I don’t see this impacting fund flows from other countries as the objective is fairly clear and some of these other countries have also adopted similar changes to their FDI policies. With the economy the way it is, the bigger issue is which country will have the funds,” Rajeev says.
According to Vikrant, Japan and China are the two biggest sources of investment in the Indian tech space. In the case of Japan, the biggest source of funding was Softbank. And Softbank has been in difficult space for a couple of years now especially after its WeWork debacle and in India, its investment in OYO is under the scanner. Softbank will continue to remain in a difficult spot, which means it may hit a pause on investments.
“So where will money come from? Japanese funding could be on hold, South Korea is not keeping too high hopes on India. So, it was only the Chinese firms which were investing. And if we are going to stop all of those, then we'll certainly see our sectorial growth stopping as well,” Vikrant adds.
However, Murali says that it is possible there may even be a slight uptick from countries that have an antagonistic view of China.
How it should have been done
Rajeev says that the announcement has dug a moat around Indian companies, and further clarification is necessary. “They could restrict based on a combination of factors like cheque size, equity holding, market value, management control etc. to reduce the impact on early-stage companies,” he says.
According to Kartick, instead of having blanket regulation, it should have been put in place in a way that approvals are needed the minute a company is taking control or is going beyond a certain threshold.
The processing time of FDI applications for government approvals is about 8-10 weeks, and Chinese investments are subject to an additional security clearance which takes an additional 1-2 weeks.
“With the advent of these new developments, the volume of applications from Chinese investors seeking government approval is expected to rise exponentially, which could increase timelines for transactions in this corridor, apart from adding the obvious new layer of regulatory uncertainty (especially in terms of which economic sectors the government perceives as “benefitting” from Chinese participation),” Kartick said.
It is clear the government, by subjecting Chinese investments to a case-by-case approval, is looking to monitor capital flows and look at which sectors capital is welcome in.
“Given that the fund-raising attempts presently underway by various Indian companies may also be potentially impacted, it is hoped that the government will come out with clarifications, and hopefully exclude “non-sensitive” sectors as well as sectors having employment / large capex potential from the ambit of this new policy,” Kartick stated.
China’s response and the inclusion of Hong Kong
In response to India’s move, the spokesperson of the Chinese Embassy in India said that where companies choose to invest depends on the country’s economic fundamentals and business environment. “The additional barriers set by Indian side for investors from specific countries violate World Trade Organisation’s (WTO) principle of non-discrimination and go against the general trend of liberalization and facilitation of trade and investment,” they said. Companies make choices on market principles, stated the Chinese Embassy in India.
Many questions arose about whether or not Hong Kong, which is China’s Special Administrative Region (SAR) that has some autonomy, will be included under the new rules. According to Reuters, the government intends to include Hong Kong under this ambit, and won’t make a distinction between China and Hong Kong.
For now, all stakeholders are waiting for the notification under FEMA, which is expected to bring more clarity.