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Now, DEA questions Press Notes 2 & 4

June 17, 2009 02:24 IST
For the second time since Press Note 2 and 4 were issued in February 2009, the Department of Economic Affairs in the finance ministry has raised questions on their implementation, this time over an application before the Foreign Investment Promotion Board.

This case, which has been deferred pending further examination, has thus emerged as the first test case of the implementation of the new press notes. The objection has been raised even though Commerce Minister Anand Sharma said there would be no changes to Press Notes 2 and 4, when he took charge last month.

The issue arose a few weeks ago when India Rizing Fund,  the country's first defence venture capital fund promoted by some former bankers, asked the FIPB to delete a clause stipulating approval for all downstream investments in those areas of defence production that are subject to foreign direct investment limits.

There is an FDI limit of 26 per cent in defence production of items that are subject to government licences. However, for unlicensed products in the defence sector, companies with foreign investment can go through the automatic route, which would require informing the RBI.

Last year, FIPB approved a proposal by Rizing India Fund to raise Rs 500 crore from foreign investors. The company proposed to launch a defence SME fund to invest in companies producing radars, sonars, military aircraft, submarines, flight simulators, rocket launchers, naval ships and so on. Many of these SMEs were producing these items under the defence offsets policy that requires foreign companies supplying defence equipment in India to source 30 to 50 per cent of their overall contract value from local manufacturers. Companies producing these products also attract FDI sectoral limit.

A few weeks ago, the company put in a revised application saying the initial proposal was considered under Press Note 9 (which requires foreign holding companies to take fresh permission for investment in downstream projects). It has now requested a re-examination in the light of Press Notes 2 and 4.

The company said under the new guidelines, foreign investment routed through an Indian company that is owned and controlled by resident Indian citizens would not be considered in calculations of indirect foreign investment, as was the case before.

For this purpose, an Indian-owned company is defined in which resident Indians or Indian companies own more than a 50 per cent beneficial stake and control means that they also have the power to appoint a majority of the directors.

Based on the new rules the Rizing India Fund has argued that it is now a fully-owned and -controlled Indian entity and therefore will not require any FIPB permission for its downstream ventures.

The DEA, however, has argued that such an arrangement would make sectoral FDI limits meaningless. 

Rizing India Fund has also reiterated that the fund is structured like a trust. So it will get foreign investors to subscribe to its units but these units will be denominated in rupees. And since the fund is issuing only "units" and not "equity shares" to its investors they would have no ownership or any other rights in the company.

The company's application quotes the example of unit-holders in SBI Mutual Fund who do not have any rights or ownership or control over the asset management company or in the companies in which the mutual fund has made downstream investments.

Meanwhile, the department of industrial policy and planning in the commerce ministry has said it has no objection to the proposal subject to the condition that the fund is controlled by resident Indians and foreign contribution to the fund is less than 50 per cent.

The department of revenue has said it cannot comment on the case as the foreign investors are not specified in the application.

Earlier this year, the Reserve Bank of India had argued that new guidelines may encourage investors to set up companies in which non-resident entities hold 49 per cent. In this event, downstream investments by such companies might cause them to breach sectoral FDI limits or direct investments into companies in which FDI was prohibited.

Surajeet Das Gupta & Arun Kumar