2.1. PERFECT MARKET THEORY
To begin with the perfect market theory, G.D.A. MacDougall (1958) and Kemp (1964) assume a
two- country model- one being the capital-abundant country and the other being the capital-
scarce country-- and the price of capital being equal to its marginal productivity. It is the process
of foreign investment -- capital moving from a capital- abundant economy to a capital scarce
economy-- that helps increase in marginal productivity in the former and lower it in the latter.
The result is that the marginal productivity of capital in the two sets of countries tend to be equal.
They also explain that the output in the investing country decreases in the wake of foreign
investment outflow but national income does not fall insofar as the country receives return on
capital invested abroad. The host country too witnesses increase in national income as a sequel to
greater magnitude of investment that is not possible in absence of foreign investment inflow.
2.2. IMPERFECT MARKET THEORY
Hymen (1976) bases his argument on imperfect market conditions that arise in many cases, such
as product managerial skills, better access to capital, economies of scale and government-
imposed market distortions, etc. The investing firm possesses such advantages that confer on it
an edge over its competitors in foreign locations and thus help compensate the additional cost of
operating in an unfamiliar environment. These firm specific advantages are primarily the
technological advantages which help the investing firm to produce a new product different from
the existing one. Since the market is imperfect, rival firms do not avail of the technological
Hoods and Young (1979) stress the location- specific factors. Firms with low-cost technology
move to low-wage countries.
Vernon (1966) feels that most of the products follow a life cycle. Buckley and Casson (1976) too
assume market imperfections, but imperfection, in their view, is related to the transaction cost
that is involved in the intra-firm transfer of intermediate products, such as knowledge or
2.3. IMPERFECT CURRENCY MARKET THEORIES
The foreign exchange market or capital market is normally imperfect. Within this framework,
Aliber (1971) opines that firms from a strong currency country move out to a weak- currency
country. In a weak- currency country, the income stream is fought with greater exchange rate
risk. As a result, the income of a strong- currency country firm is capitalized at a higher rate.
2.4. THEORY BASED ON STRENGTH OF CURRENCY
This theory has been developed by Kenneth Froot and Jeremy Stein (1989). The view is that
depreciation in the real value of currency of a country lowers the wealth of domestic resident vis-
a-vis the wealth of the foreign residents.
2.5. POLITICO EONOMIC THEORY
The politico-economic theories explain that political stability in the host countries lead to foreign
investment therein (Fatehi-Sedah and Safizedah, 1989).
Similarly, presence of political instability in the home country encourages investment in foreign
countries (Tallman, 1988). However, Schneider and Frey (1985) believe that the theory
underlying the political determinants of FDI is less well developed than those involving
economic determinants. The political factors are only additive ones influencing foreign
2.6. ENTRY OPTIONS
Investments can be made by non-residents in the equity shares/fully, compulsorily and
mandatorily convertible debentures/fully, compulsorily and mandatorily convertible preference
shares of an Indian company, through the Automatic Route or the Government Route. Under the
Automatic Route, the non-resident investor or the Indian company does not require any approval
from Government of India for the foreign investment. Under the Government Route, prior
approval of the Government of India is required. Proposals for foreign investment under
Government route, are considered by respective Administrative Ministry/Department
The Foreign Investment Facilitation Portal (“FIFP”) is the new online single point interface of
the Government of India for investors to facilitate Foreign Direct Investment. This portal is being
administered by the Department of Industrial Policy & Promotion (“DIPP”), Ministry of
Commerce & Industry. This portal will continue to facilitate the single window clearance of
applications which are through approval route. Upon receipt of the FDI application, the
concerned Administrative Ministry/Department shall process the application as per the Standard
Operation Procedure (“SOP”). If the online filing of application is with digital signature by
authorised signatory, physical submission of the copy is not required.
For applications without digital signature, once the e-filing of the application is completed, the
applicant is required to file/courier only SINGLE signed copy of the printed version of the online
application, along with the duly authenticated copy of the documents attached with the
application, to the Nodal Officers of the concerned Administrative Ministry/Department as per
the SOP. The additional features such as: e-communication, quicker processing, reduced
paperwork, SMS/email alert and many more continue to exist.
‘Government route’ means that investment in the capital of resident entities by non-resident
entities can be made only with the prior approval of Government (Competent
Ministry/Department for grant of approval)
Proposals for foreign investment would be examined by Competent Authorities as per the
Standard Operating Procedure laid down by DIPP.
Investing Companies in NBFC's Activities in
Infrastructure & Service Financial Services Sector
Venture Capital Fund Civil Aviation
and Venture Capital
Housing & Real Estate Petroleum Including
Development Sector for Exploration/Refinery/
Investment from Persons
other than NRIs/ OCBs. Marketing
FDI is prohibited in the following sectors:
Lottery Business including Government/private lottery, online lotteries, etc.
Gambling and Betting including casinos etc.
Trading in Transferable Development Rights (TDRs)
Real Estate Business or Construction of Farm Houses (REITs) registered and regulated
under the SEBI (REITs) Regulations 2014.
Manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco
Activities/sectors not open to private sector investment e.g.(I) Atomic Energy and (II)
Railway operations (other than permitted activities mentioned in FDI Policy).
Real estate business or construction of farm houses - This shall not include construction
of townships, residential or commercial premises, roads, bridges and Real Estate.
2.8. GREEN FIELD INVESTMENT V. MERGER AND ACQUISITION1
To understand the concept of Greenfield and Brownfield Investment, at first we need to know
about the concept of mergers and takeovers. The Takeover Code, 2011 or the SEBI (Substantial
Acquisition of Shares and Takeovers) Regulations, 2011 provides for corporate management
considerations associated with takeovers as well as some of the important consideration required
at macroeconomic levels.
A takeover can take place in many ways, though we should not confuse between a takeover and a
merger. A ‘merger’ takes place when two different entities combine to form one entity whereas a
takeover may involve the existence of two separate entities but not equal in value. Takeover
involves purchase of a company by a larger one. It may be possible that the benefits of merger
and takeover resemble to some extent but a line of differentiation is important.
Greenfield and Brownfield investments are two different faces of same coin in FDI. These words
just like their names resemble their characteristics. In a Greenfield Investment, a new company is
established by a parent company where construction is done on a field that was previously
completely green. In business communication it means that a new physical facility is created
where no facilities existed previously. Greenfield investment takes place when a parent company
begins a new venture outside the country where the company is headquartered. Brownfield
investments on the other hand is an investment strategy where it is a Brownfield where the
building is already constructed and instead of creating a new building, an already constructed
building is put to use where the cost and time is reduced and the investment is more like a two
minute noodles. Brownfield investments however, involve a risk of suitability because an already
structured thing may not be perfectly suitable to the investor company.
Both Greenfield investment and merger and acquisitions have their own pros and cons.
2.9. CAPITAL MARKET DEPOSITORIES
Capital market Indian instruments. Section 2(e) of Depositories Act, 1996. It is discussed
elaborately in the coming chapters. Two depositories exist in India, i.e. NSDL and CDSL.
Depository and depository participants, all are regulated by SEBI.
1 C.S. Balasubramaniam: Takeover Code available at www.taxmann.com 169 (Article).
Legal frame Participants
Foreign investment in sectors/activities under government approval route will be subject to
government approval where:
(i) An Indian company is being established with foreign investment and is not owned by a
resident entity or;
(ii) An Indian company is being established with foreign investment and is not controlled by a
resident entity or;
(iii) The control of an existing Indian company, currently owned or controlled by resident Indian
citizens and Indian companies, which are owned or controlled by resident Indian citizens, will
be/is being transferred/passed on to a non-resident entity as a consequence of transfer of shares
and/or fresh issue of shares to non- resident entities through amalgamation, merger/demerger,
acquisition etc. or;
(iv) The ownership of an existing Indian company, currently owned or controlled by resident
Indian citizens and Indian companies, which are owned or controlled by resident Indian citizens,
will be/is being transferred/passed on to a non-resident entity as a consequence of transfer of
shares and/or fresh issue of shares to non- resident entities through amalgamation,
merger/demerger, acquisition etc.
(v) It is clarified that Foreign investment shall include all types of foreign investments, direct and
indirect, regardless of whether the said investments have been made under Schedule 1 (FDI), 2
(FII), 2A (FPI), 3 (NRI), 6 (FVCI), 9 (LLPs), 10 (DRs) and 11(Investment Vehicles) of FEMA
(Transfer or Issue of Security by Persons Resident Outside India) Regulations. FCCBs and DRs
having underlying instruments which can be issued under Schedule 5, being in the nature of debt,
shall not be treated as foreign investment. However, any equity holding by a person resident
outside India resulting from conversion of any debt instrument under any arrangement shall be
reckoned as foreign investment.
(vi) Investment by NRIs under Schedule 4 of FEMA (Transfer or Issue of Security by Persons
Resident outside India) Regulations will be deemed to be domestic investment at par with the
investment made by residents.
(vii) A company, trust and partnership firm incorporated outside India and owned and controlled
by non-resident Indians will be eligible for investments under Schedule 4 of FEMA (Transfer or
issue of Security by Persons Resident outside India) Regulations and such investment will also
be deemed domestic investment at par with the investment made by residents.
2.10. SECTORIAL ANALSIS
List of activities or items for which automatic route for foreign investment is not available,
include the following:
Investing Companies NBFC's Activities in
in Infrastructure & Financial Services
Service Sector Sector
Venture Capital Fund Civil Aviation
and Venture Capital Petroleum Including
Housing & Real Estate Marketing
for Investment from
Sector wise Regulation in Foreign Investment
I) Automatic route for specified activities subject to Sect oral cap and conditions.
Air Transport Services 100%
Non Resident Indians
Alcohol distillation and brewing 100%
Banking (Private Sector) 74%
Coal and Lignite mining (specified) 100%
Coffee, Rubber processing and warehousing 100%
Construction and Development (Specified projects) 100%
Floriculture, Horticulture and Animal Husbandry 100%
Specified Hazardous chemicals 100%
Industrial Explosives Manufacturing 100%
Mining (Precious metals, Diamonds and stones) 100%
Non banking finance companies ( conditional) 100%
Petroleum and Natural gas 100%
Refining (private companies)
Power generation, transmission, distribution 100%
Wholesale cash and carry
Trading of Exports
SEZ’s and Free Trade 100%
Basic and cellular services 49%
ISP with gateways, radio paging, end-end bandwidth 100%
ISP without gateway (specified)
Manufacture of telecom equipment
Prior Approval where investment is above Sectorial caps for activities listed below.
New Investment by a foreign investor in a field in which the investor already has an existing
joint venture or collaboration with another Indian partner
New investment sought to be made in manufacture of items reserved for Small Scale
· Existing Airports
· Asset reconstruction companies 49%
· Atomic Minerals 74%
o FM Radio 20%
o Cable network 49%
o Direct-To-Home (DTH) 49%
o Setting up hardware facilities 49%
o Uplinking news and current affairs 26%
o Uplinking non-news, current affairs TV channel
Cigarette manufacturing 100 %
Courier services other than those under the ambit of 100 %
Indian Post Office Act, 1898
Defense manufacture 74 %
Investment companies in infrastructure / service sector 49 %
Petroleum and natural gas refining (PSU) 26 %
Tea Sector – including Tea plantation 100 %
Trading items sourced from Small scale sector 100 %
Test marketing for equipment for which company has 100 %
approval for manufacture
Single brand retailing 100 %
Satellite establishment and operations 74 %
o Newspapers and periodicals dealing with news and 26 %
current affairs 100 %
o Publishing of scientific magazines / specialty
o Digital media
o Basic and unified access services 49 % to 74 %
o ISP with gateways, radio paging, end to end 49 % to 74 %
49 % to 100 %
o ISP with gateway (specified)
2.11. GOVERNMENT GUIDELINES
The Department of Industrial Policy and Promotion (“DIPP”), Ministry of Commerce &
Industry, Government of India makes policy pronouncements on FDI through Press Notes/Press
Releases which are notified by the Reserve Bank of India as amendments to the Foreign
Exchange Management (Transfer or Issue of Security by Persons Resident Outside India)
Regulations, 2000.DIPP released the Consolidated FDI Policy Circular of 2017 with intent and
object to attract more foreign investment. The said Circular took effect from August 28, 2017.
The guidelines issued included a chapterised and comprehensive content about FDI Policy. It
acts as a primary source of information for the regulatory mechanism as well as invitation intent
for various investors. The summary of the report is presented in brief below:
1. The policy is divided into chapters where the first chapter deals with the intent and object
of the policy and the second chapter describes the definitions of some terms such as
foreign currency convertible bonds, foreign venture capital investment, capital competent
authority, control, depository receipt, employee stock option and other terms or jargons
associated with foreign investments.
2. The third chapter deals with the eligible investors and discusses the general conditions on
FDI. It provides for instrument of investments such as bonds, equity instruments etc.
3. Moreover, the entry rotes in detail are discussed in this policy with Caps and entry
conditions associated with investments. It deals with the Foreign Investment
into/downstream Investment by eligible Indian entities.
4. It provides for Remittance, Reporting and Violation.
5. In chapter four the general Procedure for Government Approval and the Competent
Authority associated for that approval is discussed in detail. The Cases which do not
require Fresh Approval are also elucidated along with Online Filing of Applications for
6. The Sector Specific Conditions on FDI, Prohibited and Permitted Sectors and an
elaborate information about the sectors where FDI though may be allowed but subject to
certain complex conditions such as Agriculture, Animal Husbandry, Plantation Sector,
Mining, Petroleum & Natural Gas, Mining, Manufacturing, Defence, Services Sector,
Broadcasting, Print Media, Civil Aviation, Construction Development: Townships,
Housing, Built-up Infrastructure, Industrial Parks, Satellites- establishment and operation
,Private Security Agencies Telecom Services, Trading, Railway Infrastructure, Financial
Services, Asset Reconstruction Companies, Banking- Private Sector, Banking- Public
Sector, Credit Information Companies (CIC), Infrastructure Company in the Securities
Market, Insurance ,Pension ,Power Exchanges, White Label ATM Operations, Other
Financial Services, Pharmaceuticals etc.
7. It contains certain annexure at the end where certain forms and sector specific relevant or
important information is provided.
2.11.1. FDI Policy on e-commerce2.
FDI policy on e-commerce, first pronounced through Press Note 2 of 2000, permitted 100% FDI
in B2B e-commerce activities. With a view to clarify the already existing policy framework,
after extensive stakeholder consultations, Press Note 3 was issued by DIPP in 2016. B2C e-
commerce, that is multi-brand retail through inventory-based model, has all along remained
prohibited for FDI. Through the latest Press Note (2/2018), Government has only reiterated the
policy provisions to ensure better implementation of the policy in letter and spirit.
As FDI is allowed only in B2B e-commerce, it was provided in Press Note 3/2016 that, an e-
commerce entity providing marketplace will not, directly or indirectly, influence the sale price of
goods or services, which also renders such business as an inventory-based model. However,
Government continued to receive complaints that certain marketplace platforms were violating
the policy by influencing the price of products and indirectly engaging in inventory-based model.
An e-commerce platform operating an inventory-based model does not only violate the FDI
policy on e-commerce but also circumvents the FDI policy restrictions on multi-brand retail
trading. Therefore, latest Press Note on FDI policy on e-commerce sector was needed to ensure
that the rules are not circumvented.
Certain averments suggest that Press Note 3/2016 had covertly allowed multi-brand retail
trading. Such a view is completely contrary to the specific provisions of Press Note 3/2016,
which unambiguously provided that FDI is not permitted in inventory-based model of e-
commerce which amounts to multi-brand retail.
Fair, competitive and transparent business practices which are in compliance with law will better
protect consumers in both short as well as medium and long term.
The present policy does not impose any restriction on the nature of products which can be sold
on the marketplace.
Press Note 2/2018 is applicable only to entities which operate a marketplace for e-commerce.
FDI in other sectors continue to be governed by the specific provisions pertaining to them. For
instance, there is no change in the FDI policy on food product retail trading, which permits 100%
FDI under approval route, including through e-commerce, in respect of food products
manufactured and/or produced in India.
Inventory based model of e-commerce- Inventory based model of e-commerce means an e-
commerce activity where inventory of goods and services is owned by e-commerce entity and is
sold to the consumers directly.
Marketplace based model of e-commerce- Marketplace based model of e-commerce means
providing of an information technology platform by an e-commerce entity on a digital &
electronic network to act as a facilitator between buyer and seller.
2.11.2. Other Guidelines by the Government3
In January 2018, Government of India allowed foreign airlines to invest in Air India up to
49 per cent with government approval. The investment cap could not exceed 49 per cent
directly or indirectly. However, in March 2020, government permitted non-resident
Indians (NRIs) to acquire up to 100 per cent stake in Air India.
In September 2018, the Government of India released the National Digital
Communications Policy, 2018 which envisaged increased FDI inflows in the
telecommunications sector to US$ 100 billion by 2022.
In August 2019, government permitted 100 per cent FDI under the automatic route in
coal mining for open sale (as well as in developing allied infrastructure like washeries).
In December 2019, government permitted 26 per cent FDI in digital sectors.
In May 2018, the government permitted higher FDI in the defence manufacturing sector
with a cap upto 74% from the previous 49%.
2.12. LISTING TRENDS
‘Depository Receipt’ (“DR”) means a negotiable security issued outside India by a Depository
bank, on behalf of an Indian company, which represent the local Rupee denominated equity
shares of the company held as deposit by a Custodian bank in India. DRs are traded on Stock
3 ‘Foreign Direct investment’ (IBEF) https://www.ibef.org/economy/foreign-direct-investment.aspx last accessed
on 18 May 2020.
Exchanges in the US, Singapore, Luxembourg, etc. DRs listed and traded in the US markets are
known as American Depository Receipts (ADRs) and those listed and traded
anywhere/elsewhere are known as Global Depository Receipts (GDRs). DRs are governed by
notifications issued by RBI.
Parties involved under the DR scheme:
Issuing Company: It is the company which intends to raise its capital from foreign
a) Any Indian listed/ unlisted/ private/public company
b) any other issuer of permissible securities;
c) any person holding permissible securities;
which has not been specifically prohibited from accessing the capital market or dealing in
Lead Manager: responsible for setting into motion the process of raising capitals by
issuing DRs. They are responsible for drafting of various agreements that will be required
by the company, drawing up various marketing strategies for the issue post Offer
activities for the offer will involve essential follow-up steps, which include the
finalization of trading and dealing of instruments and dispatch of certificates and demand
of delivery of shares.
Depository bank – Bank which holds the securities of the issuing company and transfer
the same to the custodian banks. They decide the design of the DRs.
Custodian Bank – Domestic bank who holds the underlying shares/bonds against which
the DRs are issued. They are banks defined under SEBI Custodian Regulation, 1996.
New format of the return that is to be filed by the Domestic Custodian bank has been
notified and is annexed here.
Investor – Ultimate buyer/ seller of the DRs.
Stock exchange, Debt money market, foreign venture capital, Resource Mobilization in
International Capital Markets, ICDR Capital and Disclosure, ESOP, ESPS all are discussed in
detail in the next module.