Reclassification of FPI to FDI

Why in news?

The Reserve Bank of India (RBI) introduced a streamlined operational framework to allow foreign portfolio investors (FPIs) to convert their investments to foreign direct investment (FDI).

Foreign investment in India is governed by sub-section (3) of Section 6 of the Foreign Exchange Management Act, 1999.

What are FDI and FPI?

What are the Pros and cons of FPI?

Single FPI Regime came into effect from 1st June, 2014 by subsuming FIIs, their sub-accounts and qualified foreign investors (QFIs).

What is the new regulatory framework on FPI?

• FPI threshold - Under Foreign Exchange Management (Non-debt Instruments) Rules, 2019, investment made by the FPI should be less than 10 % of the total paid-up equity capital.
• Crossing threshold - FPIs exceeding a 10% stake in a company must divesting their holdings or reclassifying such holdings as within 5 trading days following the transaction that breaches the limit.
• Approvals - It is subject to approvals from both the Indian government and the invested company.
• Increased disclosure requirements - To ensure compliance, the RBI requires full reporting under the Foreign Exchange Management  Regulations, 2019.
• They need to identify and disclose their ownership structure and the ultimate beneficial owners.
• SEBI’s revised guidelines - It mandates that any FPI choosing reclassification must notify its custodian.
• The custodian will then facilitate the transfer of securities to the designated FDI account, ensuring compliance with all reporting requirements.
• Prohibited sectors -The facility of reclassification shall not be permitted in any sector prohibited for FDI, such as defense and telecom, to protect national security.

What are the implications of the framework?

• Streamline foreign investments - Providing a structured path to retain the investment , When an FPI, along with its investor group, inadvertently crosses the threshold.
• Market stability - This shift could bring more stability and reduce market volatility associated with short-term foreign investments.

FPIs have pulled out over Rs 1.36 lakh crore from the cash market since October 1 this year.

• Enhanced governance - The compliance requirements, especially those related to beneficial ownership, improve transparency in the market.
• Increased compliance costs - Stricter disclosure norms and other regulatory requirements increase compliance costs for foreign investors.
• Promotion of  long-term investment - By encouraging FPIs to convert substantial investments into FDI, the government aims to promote long-term foreign investments.
• Change in investment patterns - The restrictions may redirect FPI interest toward non-sensitive sectors with fewer ownership caps.
• Sensitive sectors might experience reduced foreign investment due to regulatory hurdles and caps on ownership.

• Prevent tax evasion – The rules aimed to prevent any attempts at tax evasion or money laundering.

What lies ahead?

• Focus on maintaining transparency while ensuring India remains competitive in attracting foreign capital.
• Reduce market volatility to make resilient economic foundation less susceptible to short-term market shocks.

References

1. Mint |Framework for Reclassification Of FPI
2. RBI | Master Circular on Foreign Investment in India