New RBI Framework for Reclassifying FPI to FDI

November 13, 2024

GS Paper III Economy

New RBI Framework for Reclassifying FPI to FDI

The Reserve Bank of India (RBI) has released an operational framework for reclassifying investments by foreign portfolio investors (FPI) to foreign direct investment (FDI) when certain limits are breached.

FDI Routes for Foreign Investment in India

Automatic Route: Under the Automatic Route, a non-resident investor or the Indian company does not need approval from the Government of India to make an investment.
Government Route:Investments under the Government Route require prior approval from the Government of India.
- Proposals for FDI through this route are reviewed and approved by the respective Administrative Ministry or Department.
- Foreign Investment Facilitation Portal (FIFP): FIFP serves as a single-window clearance portal for applications requiring government approval.
- It is administered by the Department for Promotion of Industry and Internal Trade (DPIIT) under the Ministry of Commerce and Industry.
Reclassification of FPI to FDI: The facility for reclassifying FPI investment to FDI is not allowed in sectors where FDI is prohibited.
FDI-Prohibited Sectors in India
- Gambling and Betting
- Chit Funds
- Nidhi Company
- Trading in Transferable Development Rights (TDR)
- Real Estate Business
- Manufacturing of Tobacco Products
- Lottery Business, including government and private lotteries, and online lotteries
- Restricted Private Sector Investments
Certain sectors, such as atomic energy and railway operations, are not open to private sector investment except for activities permitted under the Consolidated FDI policy.

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Key Highlights of the RBI Framework for Reclassifying FPI to FDI

FPI Investment Limit: Under the Foreign Exchange Management Act (FEMA), foreign portfolio investors (FPIs) are permitted to hold up to 10% of a company’s total paid-up equity capital.
- If an FPI or its investor group breaches this limit, reclassification to foreign direct investment (FDI) becomes mandatory.
Options for FPIs Breaching the 10% Limit: FPIs that exceed the 10% threshold must either divest their excess holdings or reclassify their investment as FDI.
- They have a five-day window from the date of trade settlement to comply with this requirement, according to RBI guidelines.
Conditions for Reclassification: Once reclassified, the entire investment by the FPI will be deemed FDI and will remain categorised as such, even if holdings drop below the 10% threshold later on.
- For reclassification purposes, the FPI and its investor group will be treated as a single entity.
Required Government Approvals: The FPI seeking reclassification must secure necessary approvals from the Indian government, especially for investments originating from countries that share a land border with India.
- Additional approvals are needed if the beneficial owner of the investment is a citizen or resident of these bordering countries as they require a Government Route for any type of FDI.
Relaxation for Non-Bordering Country Investors: Investors from countries not subject to this policy are only required to notify the RBI post-transaction, without the need for prior government permission.
Coordination with SEBI: Alongside RBI, SEBI has issued its own circular detailing the procedure for FPI to FDI reclassification, ensuring regulatory alignment and procedural clarity.

Types of Foreign Investment

Basis	Foreign Direct Investment (FDI)	Foreign Portfolio Investor(FPI)	Foreign Institutional Investors (FII)
Meaning	Long-term investment where a foreign entity acquires a controlling interest in a domestic company or sets up operations It is Non debt creating.	Investment in financial assets such as stocks and bonds, without a controlling interest. It is a short-term investment.	Institutional investors (e.g., pension funds, mutual funds) who invest in a country’s financial markets.
Ownership Control	Involves significant ownership & control over a domestic company’s management making the investment stable and long-lasting.	Does not involve control over the company; typically involves minority shareholding.	Similar to FPI
Sector Restrictions	Subject to sector-specific caps and government approval in certain sectors.	Fewer restrictions, as it involves passive investment in listed securities.	Fewer restrictions but must adhere to SEBI guidelines and regulations.
Market	In primary market	In secondary market	In secondary market
Nature of Investment	Involves physical assets	Investment in financial assets	Primarily in financial assets
Regulatory Body in India	Department for Promotion of Industry and Internal Trade (DPIIT)	Securities and Exchange Board of India (SEBI)	Securities and Exchange Board of India (SEBI)

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FDI Trends in India for FY 2023-24

Aspect	Details
Total FDI Inflows	$70.95 billion
FDI Equity Inflows	$44.42 billion
Top Contributing Countries	Mauritius (25%)>Singapore (23%)> USA (9%)> Netherlands (7%)> Japan (6%)
Top Sectors Receiving FDI	Services Sector (16%) (includes finance, banking, insurance, business outsourcing, R&D, etc.) >Computer Software & Hardware (15%)>Trading (6%)> Telecommunications (6%)> Automobile Industry (5%)
Top Recipient States	Maharashtra (30%)> Karnataka (22%)> Gujarat (17%)> Delhi (13%)> Tamil Nadu (5%)

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