KPMG UK Talkbook Fullpage LB1 (Aug 04)

Foreign Direct Investment (FDI)
&
Foreign Institutional Investment (FII)

A Presentation by:

Kedar Gharat 20 Manoj Gupta 21Pramod Jadhav 24Ashish Lalpuria 34Arun Pacheco 38Nilesh Raut 49Anand Singh 60Sachin Dsouza 63

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*Road Map for Presentation What is FDI & FII

FII GuidelinesDistinction between FDI & FII

Case Studies

FDI GuidelinesBackground

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*India Transformed !!

India -- the largest Democracy - one of the fastest growing economies in the World!

Slow rate of growthBureaucraticProtected and slowSmall consumer marketsWeak infrastructureYesterdayTodayStrong macro economic fundamentalsEncouraging foreign investmentOutsourcing destination Growing consumerismImpetus on infrastructure development

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ADVANTAGES INDIA HAS TO OFFERStable democratic environment over 60 years of independenceLarge and growing marketWorld class scientific, technical and managerial manpowerCost-effective and highly skilled labourAbundance of natural resourcesLarge English speaking populationWell-established legal system with independent judiciaryDeveloped banking system and vibrant capital market Well developed accountancy, legal, actuarial and consultancy profession

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What is FDI & FII

Foreign Direct Investment (FDI): FDI stands for Foreign Direct Investment, a component of a country's national financial accounts. Foreign direct investment is investment of foreign assets into domestic structures, equipment, and organizations. It does not include foreign investment into the stock markets. FDI is thought to be more useful to a country than investments in the equity of its companies because equity investments are potentially "hot money" which can leave at the first sign of trouble, whereas FDI is durable and generally useful whether things go well or badly.Foreign Institutional Investment (FII): FII denotes all those investors or investment companies that are not located within the territory of the country in which they are investing. SEBIs definition of FIIs presently includes foreign pension funds, mutual funds, charitable/endowment/university funds etc. as well as asset management companies and other money managers operating on their behalf.

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*Distinction between FDI and FII FDI It is long-term investmentInvestment in physical assetsAim is to increase enterprise capacity or productivity or change management control Leads to technology transfer, access to markets and management inputsFDI flows into the primary marketEntry and exit is relatively difficultFDI is eligible for profits of the companyDoes not tend be speculativeDirect impact on employment of labour and wagesAbiding interest in mgt.

FIIIt is generally short-term investmentInvestment in financial assets Aim is to increase capital availability

FII results in only capital inflows

FII flows into the secondary marketEntry and exist is relatively easyFII is eligible for capital gainTends to be speculativeNo direct impact on employment of labour and wagesFleeting interest in mgt.

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Overview

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*Foreign Direct Investment PolicyForeign Direct Investment (FDI) cross border investment with an objective to establish lasting interestObjective - to encourage FDI to promote industrial & socio-economic development; supplement domestic capital/ technologyForeign investment in India is regulated by Government of Indias FDI policy. The FDI guidelines administered by the Ministry of Commerce and Industry.Department of Industrial Policy & Promotion (DIPP), Foreign Investment Promotion Board (FIPB) and Secretariat of Industrial Assistance (SIA) regulate the FDI PolicyAdministrative and compliance aspects of FDI monitored by RBISince 1991, policy has been liberalized substantially to facilitate foreign investment

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*Foreign Direct Investment
Snapshot* April 2009 January 2010184%56%Figures in Million US$Mauritius, Singapore and Cyprus are the favorite jurisdictions for investment into IndiaForeign investment (FI) from Mauritius constituting 43%* of Indias total FI*as per information in the Press

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*The Roadmap so farAllowed selectively up to 40%Up to 51% under Automatic Route for 35 Priority Sectors Up to 74/51/50% in 111 Sectors under Automatic Route100% in some sectorsUp to 100% under Automatic Route in all sectors except a small negative listSectoral caps raised;Conditions relaxed;Pre 1991199119972000Post 2000

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*Foreign Direct Investment PolicyOnly for cases other than Automatic Route and those mentioned in sectoral policy

Applies to cases with existing venture/ tie up in same filed

Applies to investment over 24% in SSI reserved itemsGovernment RouteAllowed for Most sectorsLimits : Sectoral caps/ stipulated sector specific guidelinesInward remittances through proper banking channels Pricing valuations prescribedPost facto filing with 30 days of fund receiptFilings within 30 days of share allotment Includes Technical Collaboration/ Brand Name/ RoyaltyAutomatic Route FDI Guidelines for Investing in Indian Wholly Owned Subsidiary / Joint VentureForeign Investment Promotion Board (FIPB) No Prior Regulatory Approval but only Post Facto Filings to RBI, through AD

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*Foreign Direct Investment PolicyExisting Airports 100%Asset Reconstruction Companies 49%Titanium Minerals 100%Broadcasting (a) Cigars & Cigarettes 100%Courier 100% Print Media (a) 26%Single brand retailing 51%Agriculture (b)Atomic energyRetail trading (except single brand up to 51%)Lottery, betting and gamblingChit fund, Nidhi companyTrading in Transferable Development RightsNegative List (Illustrative)Prior Approval (Illustrative)NBFC (minimum capitalization norms)IT / ITesFinancial services(a)Telecom Sector (74% cap)(a)Insurance (26 % cap)(a)Real Estate(a)Special Economic ZonesInfrastructureShippingManufacturing sectorHotels and tourismAutomatic Route (Illustrative)Note: (a) Sector specific guidelines (b) Subject to certain exceptionsFDI limits Illustrative list

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Recent Developments

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*Setting the contextContribution of FDI in Indias economic development is an acknowledged fact.From inception policy subject to extensive amendments from time to time through Press Notes, circulars and clarificationsPress Note 2,3 and 4 of 2009 issued to provide clarity on indirect FDI and downstream investmentFM stressed the need for a consolidated FDI policy in Budget 2010-11Draft consolidated policy issued in late 2009 for public commentsConsolidated FDI policy issued effective from 1 April, 2010

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*Consolidated FDI Policy
Salient FeaturesConsolidated document of all foreign investment policies /regulations under FEMA, Press Notes, Press Releases and Clarifications issued by DIPPUnderlying rationale to promote FDI through a policy framework that is transparent, predictable, simple and clear and which reduces regulatory burdenAs an investor friendly measure, a new Circular is proposed to be issued every six monthsPress Notes/Press Releases/Clarifications on FDI in force as of 31 March 2010 will stand rescinded. Savings for actions taken under earlier press notesUse of chapters, headings and definitionsTwo kinds of foreign investment (i) FDI and (ii) Foreign Portfolio Investment (FPI)FDI strategic long term relationship and establish a lasting interestFPI no intention to influence the management of the investee entity

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*FDI Policy PrinciplesCapital defined as Equity, Compulsorily Fully Convertible Preference Shares and Compulsorily Fully Convertible DebenturesWarrants, partly paid up shares other hybrid instruments not permitted for FDIInvestment in other instruments such as:Non Convertible Preference Shares/ Debenture (NCP) Optionally Convertible Preference Shares/ Debentures (OCP)Partially Convertible Preference Shares/ Debentures (PCP)treated as External Commercial Borrowings (ECB) - subject to ECB guidelinesExisting NCP/ OCP/ PCP on cut off date outside sectoral cap till current maturity

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*FDI Policy Principlescontd.FDI permitted in:Indian companies including micro & small enterprise Partnership firm/ proprietorship concern only by NRI/PIOsTrust only in the form of VCFsNot permitted in LLPs or any other entities under considerationInvestment by FIIs permitted upto 10% for individual FII and 24% in aggregatePricing of capital instruments (including conversion price for convertible instruments) is now required to be decided upfront at the time of issue of instrumentsInvestment by FVCI in DVCF set up as trust would now require specific Government approval; FVCI can directly invest subject to FDI policy

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*Royalty/ Foreign Technology
Agreement

Brand name/ trade mark royaltyPayment of royalty upto 1% of domestic sales and 2% of exports permitted (without technology transfer)Where royalty for brand name/ trademark and technology, then overall limits of 5% of domestic sales and 8% of exportsForeign Technology AgreementsLumpsum payments not to exceed USD 2 mn (per technology)Royalty upto 5% of domestic sales and 8% of exports The Government has liberalized the aforesaid limits by permitting, under the automatic route, and without any restrictions:All payments for royaltyLump sum fee for transfer of technologyPayments for use of trademark/ brand nameEarlierNow

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*Calculation of Indirect FDIForeign Co.I Co1 OverseasIndiaI Co1 OverseasIndiaI Co2Foreign Co.Direct FIIndirect FIDirect Foreign InvestmentIndirect Foreign Investment

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*Calculation of Indirect FDIEarlierDifferent methods of computing Indirect FI prescribed for different sectors. E.g.Telecom/ Broadcasting: Proportionate methodInvesting companies in Infrastructure/ Services sector: Management + Ownership TestForeign Co.Co1 OverseasIndiaTelecom sectorCo290%60%FI in Co2 is 54% (90*60%)Co1* OverseasIndiaInfrastructure sectorCo249%100%FI in Co2 is NILForeign Co.*Management of Co1 with Indians

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Calculation of Indirect FDI*NowTotal FI is sum of Direct FI and Indirect FIFI to include all types of foreign investmentsFor RIC own and control are cumulative conditions; for NRE these are non-cumulativeThe methodology to apply to every stage of investment at Indian companyDirect FI in Co2 = 39%Indirect FI in Co2 = NilTotal FI in Co2 = 39%Non Resident Entity (NRE) Co1 (Owned and Controlled by RIC) Co2 (Owned and Controlled by RIC)OverseasIndia40% 10% 39% Direct FI in Co2 = 51%Indirect FI in Co2 = 49%Total FI in Co2 = 100%NRE Co1 (Owned or Controlled by NRE)Co2 (Owned and Controlled by NRE)OverseasIndia51% 49% 51%

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*Downstream Investment Co1 OverseasIndia Co2Foreign Co.Downstream InvestmentCo1 could be An investing company; orAn investing-cum-operating company

Co2 is an operating company

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Transfer of securities
basic rules

Type of transferWindowKey conditionsNR to NR orNRI to NRIAutomaticSubject to prior venture/ tie up conditionR to NRAutomatic- Min. valuation and compliances- Activities not under approval routeNR to RAutomaticMax. valuation and compliancesR to NR in financial servicesRBI approval--Control or ownership from R to NR pursuant to M&AGovt. approvalOnly for sectors with sectoral capsGift by R to NRRBI approvalGift not to exceed 5% of paid-up capitalSubject to sectoral caps- Cap of USD 25,000 per calendar year

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Procedural Aspects

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*FDI Policy Procedural AspectsIntimation of receipt of share application money within 30 daysPurpose of inward remittance clearly stated on FIRCAllotment of shares within 180 days of receipt of fundsFunds against which shares not allotted to be refundedReporting in Form FC GPR within 30 days of allotmentIn case of Approval route, application to FIPB along with supporting documentsAll applications to be placed before FIPB within 15 daysFIPB empowered to prioritise applications based on sector, export potential etc.Violations of regulations attract penal provisions under FEMA

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Sector Specific Guidelines

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*Sector Specific Guidelines
Prohibited sectorsFDI not allowed in the following:Retail trading (except single brand)Atomic EnergyLottery businessGambling & BettingChit fund and Nidhi companyTrading in Transferable Development RightsReal Estate business or construction of Farm HousesSectors not opened for private sector investments

Prohibition extended to foreign technology collaboration including licensing for franchisee, trademark, brand name or management contract for lottery, betting and gambling business

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*Sector Specific Guidelines
TelecommunicationFDI allowed in the following (illustrative):Basic and cellularUnified Access ServicesNational/ International Long DistanceGlobal Mobile Personal Communications Services (GMPCS)Other value added telecom servicesFDI in ISPs without gateways now capped at 74% in line with DoT guidelines of 2007Subject to guidelines issued DOT

FDI Limits:

Automatic RouteApproval RouteUpto 49%Upto 74%

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*Sector Specific Guidelines
Private sector banks/ Civil AviationNo change in existing conditionsFDI permitted under automatic route upto 49% and thereafter upto 74% under Approval RouteBanksCivil AviationNo change in existing conditionsFDI in Non-scheduled air transport services/ non-schedule airlines, Chartered and Cargo airlines permitted under automatic route upto 49% and thereafter upto 74% under Approval Route

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*Sector Specific Guidelines
BroadcastingIn the Broadcasting sector, all FDI are under the Approval routeFor reckoning the FDI limits, FII investment also to be consideredSubject to guidelines issued by I&B ministryFDI permitted in broadcasting sector:* FDI component not to exceed 20%** May be raised to 49% as per recent press reports

ActivityLimitRadio20%Cable Networks49%Direct to Home*49%Uplinking news/ current affair TV channel**26%Uplinking non news/ current affair TV channel100%

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*Sector Specific Guidelines
Print MediaFDI is permitted under Approval route based on nature of publicationInvestment subject to sectoral policy issued by Ministry of Information and BroadcastingFDI limits on publications:* May be raised to 49% as per recent press reports

ActivityLimitNewspapers/ periodicals dealing with news and current affairs*26%Scientific magazines/ specialty journals/ periodicals100%

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*INSURANCEFDI upto 26% allowed on the automatic route

However, license from the IRDA has to be obtained & There is a proposal to increase this limit to 49%.FDI upto 100% is permitted under the automatic route for manufacture of drugs and pharmaceuticals (The following is the current position)

i. FDI upto 74% in the case of bulk drugs, their intermediates Pharmaceuticals and formulations (except those produced by the use of recombinant DNA technology) would be covered under automatic route. ii. FDI above 74% for manufacture of bulk drugs will be considered on case to case basis.Foreign Investment up to 100% is allowed in green field projects under automatic route Foreign Direct Investment is allowed in existing projects- up to 74% under automatic route - beyond 74% and up to 100% subject to Government approval DRUGS & PHARMACEUTICALSAIRPORTS

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INFRASTRUCTURE100% FDI is permitted for the following activities:

Electricity Generation (except Atomic energy)Electricity TransmissionElectricity DistributionMass Rapid Transport SystemRoads & HighwaysToll RoadsVehicular BridgesPorts & HarborsHotel & Tourism

FDI in Investing companies in infrastructure/service sector (except telecom sector) will not be counted towards sectoral cap provided: - Such investment is up to 49% & - The management of the company is in Indian hands. FDI in such companies will be through the FIPB route *

FOREIGN INSTITUTIONAL INVESTORS*

PORTFOLIO INVESTMENT TYPES OF PORTFOLIO INVESTMENT:-

Investment by FIIsInvestment in GDRs & FCCBs*

What are Foreign Investors looking for? Good projects Demand Potential Revenue Potential Stable Policy Environment/Political Commitment Optimal Risk Allocation FrameworkRate of interestSpeculationProfitabilityCosts of productionEconomic conditionsGovernment policiesPolitical factorsFactors affecting foreign investment*

Foreign Institutional Investors

FIIs can individually purchase upto 10% and collectively upto 24% of the paid-up share capital of an Indian company

This limit of 24% can be increased to sectoral cap/ statutory limit applicable to the Indian company by passing a board resolution/shareholder resolution

FIIs can purchase shares through open offers/private placement/stock exchange

Shares purchased by FII through stock exchange cannot be sold through a private arrangement

Proprietary funds, foreign individuals and foreign corporates can register as a sub- account and invest through the FII. Separate limits of 10% / 5% is available for the sub-accounts

FIIs can raise money through participatory notes or offshore derivative instruments for investment in the underlying Indian securities

FIIs in addition to investment under the FII route can invest under FDI route

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Investment limits on Equity &
Debt investments by FII

FII, on its own behalf, shall not invest in equity more than 10% of total issued capital of an Indian company. Investment on behalf of each sub-account shall not exceed 10% of total issued capital of an India company. For the sub-account registered under Foreign Companies/Individual category, the investment limit is fixed at 5% of issued capital. These limits are within overall limit of 24% / 49 % / or the sectoral caps a prescribed by Government of India / Reserve Bank of India.

investment limits on debt investments by FIIFor FII investments in Government debt, currently following limits are applicable: 100 % Debt Route US $ 1.55 billion70 : 30 Route US $ 200 millionTotal Limit S $ 1.75 billion

For corporate debt the investment limit is fixed at US $ 500 million.

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PARTICIPATORY NOTES

What is P-Note:PNs are instruments issued by registered FIIs to overseas investors, who wish to invest in the Indian stock markets without registering themselves with SEBI.

Why is P-Note: More than 30% of foreign institutional money coming into India is from hedge funds. Hedge funds, which thrive on arbitrage opportunities, rarely hold a stock for a long time.

P-Notes are issued to the real investors on the basis of stocks purchased by the FII.

To monitoring investments through P Notes, Sebi decided that FIIs must report P-Notes details.

Reporting by FIIsP-Notes issued - 7th day of the following month.

The FII merely investing for themselves through P-Notes Quarterly basis

FIIs who do not issue PNs but have trades File 'Nil' undertaking on a quarterly basis.

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Importance of FII Inflow - FMs View October 26, 2010No controls on FII inflowsRBI may check rupee appreciation

The upward movement of the rupee against the dollar was sharp in recent weeks as the Indian currency has climbed about 5.6% since the beginning of September due to sustained capital inflows.

The FM believes that with FII inflows and forex reserves, the current account deficit should be contained at around 3% of the gross domestic product (GDP) (this fiscal).

The current account deficit is the gap between the amount the country pays to the external world against what it receives from abroad, barring capital movement. It was around 3.6% of GDP in the first quarter of 2010-11.

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Advantages of FIIEnhanced flows of equity capital FIIs have a greater appetite for equity than debt in their asset structure. It improve capital structures.Managing uncertainty and controlling risks. FII inflows help in financial innovation and development of hedging instruments. Improving capital markets. FIIs as professional bodies of asset managers and financial analysts enhance competition and efficiency of financial markets. Equity market development aids economic development. By increasing the availability of riskier long term capital for projects, and increasing firms incentives to provide more information about their operations, FIIs can help in the process of economic development. Improved corporate governance. FIIs constitute professional bodies, improve corporate governance.

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Disadvantages of FII

Problems of InflationProblems for small investorAdverse impact on ExportsHot Money

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FII Investments & Market Reaction

While strong inflow of funds from foreign institutional investors (FIIs) has been a reason to cheer, it could turn into a nightmare and if the global investors make a sudden exit can send the bourses crashing.*

FII Inflows Vs Sensex

FII Investment from 2005 - 2010

BSE Sensex

FII Investment Vs Sensex

FII average holding in BSE 500*

ADRAn American Depositary Receipt (or ADR) represents ownership in the shares of a foreign company trading on US financial markets. The stock of many non-US companies trades on US exchanges through the use of ADRs. ADRs enable US investors to buy shares in foreign companies without undertaking cross-border transactions. ADRs carry prices in US dollars, pay dividends in US dollars, and can be traded like the shares of US-based companies.Each ADR is issued by a US depositary bank and can represent a fraction of a share, a single share, or multiple shares of foreign stock. An owner of an ADR has the right to obtain the foreign stock it represents, but US investors usually find it more convenient simply to own the ADR. The price of an ADR is often close to the price of the foreign stock in its home market, adjusted for the ratio of ADRs to foreign company shares.

GDRA negotiable certificate held in the bank of one country representing a specific number of shares of a stock traded on an exchange of another country. They are traded and settled independently of the underlying share, and such are commonly used to invest in companies in developing or emerging markets - especially Russia.They trade on the International Order Book (IOB) of the LSE.

FCCBA type of convertible bond issued in a currency different than the issuer's domestic currency. In other words, the money being raised by the issuing company is in the form of a foreign currency. A convertible bond is a mix between a debt and equity instrument. It acts like a bond by making regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock.

These types of bonds are attractive to both investors and issuers. The investors receive the safety of guaranteed payments on the bond and are also able to take advantage of any large price appreciation in the company's stock. Issuers take advantage of this appreciation by means warrants attached to the bonds, which are activated when the price of the stock reaches a certain point.

Recommendations for India

There are several caps within FDIs; a 26%, 20%, 49%, 51% and 74% and a 20% for e.g. is only in one case and perhaps that could be done away because there are just too many caps in the overall regulatory regime.Foreign investors should be allowed to establish the company which facilitates them 100% ownership. They should not be restricted for joint venture with Indian companies to enter into Indian market.FII & FDI locking period to be liberalized.Allow FDI in investment companies "Better Investment Climate" Need of the Hour.Increase FDI limit for Insurance Sector to 49% from current 26%.Increase FDI limit for Retail Sector.Government bodies should take less time for the foreign investment approval.Government should maintain a balance between domestic companies and foreign companies so as domestic companies could survive in front of foreign giants.The procedure for approval and industrial license should be made simple so that foreign investors can easily access in India.Government should liberalise the economic policies further so as to overcome the fiscal deficits faced by Indian economy from a last decade.Government should invite corporate giants from countries like USA, China and south Korea which can enhance foreign capital inflows into India.

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*India is Relatively Stable and Growing !"If there is one place on the face of this Earth where all the dreams of living men have found a home when man began the dream of existence, it is India".Romain Rolland, French philosopher

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*India's Hottest FDI Destinations

1. Maharashtra Maharashtra received the lion's share of the FDI $2.43 billion (Rs 11,154 crore), which is 35% of the total FDI inflows in to the country,.2. National Capital RegionNCR received $1.85 billion (Rs 8,476 crore) in FDI during the period. The region accounted for 20% of the total FDI.3. West Bengal, Sikkim, Andaman & Nicobar IslandsThese states attracted the third highest FDI inflows worth $1.416 billion (Rs 6,050 crore)4. Karnataka - $936 million (Rs 4,333 crore) 5. Punjab, Haryana, Himachal Pradesh - $904 million (Rs 4,141 crore)

Data: Jan Jun 2010

*Rated as the fourth preferred destination for US and British investorsRated as the sixth preferred destination for manufacturing

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*Rated as the fourth preferred destination for US and British investorsRated as the sixth preferred destination for manufacturing