RBI Updates Directions on Foreign Investments in India

On January 20, 2025, the Reserve Bank of India (RBI) issued an updated Master Direction on Foreign Investment in India, providing much-needed clarity on the framework for foreign investments, particularly focusing on downstream investments and related regulatory concerns.

The revision introduces crucial changes, especially in the context of downstream investments, and stock transactions, and further clarifies the regulatory framework for foreign-owned or controlled companies (FOCCs) wishing to acquire stakes in domestic businesses.

Clarification on Downstream Investments

Stock Swap Transactions Approved for Foreign-Owned Companies

Historically, foreign-owned companies had limited options when it came to acquiring stakes in local companies. Such deals often required specific regulatory clearances or were done through pure cash deals, where the FOCC would bring in new capital from abroad or use retained earnings in India. The new Master Direction eliminates this ambiguity, allowing for greater flexibility in acquiring local companies through both stock purchases and share swaps, significantly easing the process for FOCCs.

An FOCC is defined as a company where foreign ownership exceeds 50% or where foreign entities exercise control through management rights or board representation. 

Expanded Use of Compulsorily Convertible Instruments

The RBI has clarified that local companies can now modify the tenor on compulsorily convertible debentures (CCDs) or preference shares issued to overseas investors. This flexibility allows domestic companies and their foreign partners to delay the conversion of shares if, by the end of the original tenor, the share price is significantly below the conversion price. Previously, this postponement of conversion was allowed under the Companies Act, but the RBI’s new directive endorses it under the Foreign Exchange Management Act (FEMA), bringing greater certainty to such transactions.

Restrictions on Investments from Land-Border Countries

While the RBI has liberalized several aspects of the foreign investment framework, it has made one crucial exception for investors from land-bordering countries, particularly China and Hong Kong. The new Master Direction clarifies that companies in India that are owned or controlled by investors from these countries cannot freely engage in downstream investments, including utilizing retained earnings to acquire stakes in other domestic companies.

Therefore, even if a Chinese subsidiary in India wants to reinvest its Indian profits into another Indian company, it would still require approval under Press Note 3, marking a clear stance against potential indirect foreign direct investment (FDI) from such entities.

Sector-Specific Conditionalities and Government Approval

In line with these changes, the RBI reiterated that sector-specific conditionalities and government approval will continue to apply to all foreign investments, especially those from bordering nations.

FDI in Non-Banking Finance Companies (NBFCs)

Under the previous framework, banks were often reluctant to accept inward remittances to satisfy Minimum Net Owned Fund (NOF) requirements for forming an NBFC before the issuance of a license. This led to a problem where companies faced difficulties in raising funds to meet the NOF criterion without a license. The RBI has now clarified that such funds can be brought into India and later repatriated if the NBFC license is not granted, resolving a key regulatory hurdle.

Form DI Filing Requirement

The requirement for Form DI filings has been extended to include reclassification of investments. If an investor entity, originally classified as a resident, later becomes an FOCC, it must now report such reclassification of investments within 30 days from the date it transitions into an FOCC. This new filing requirement is designed to provide better transparency in tracking foreign investments.

Acquisition through Rights Issue

Previously, foreign investment in a rights issue was subject only to individual or sectoral caps. Under the updated rules, such issuances must comply with entry routes, sectoral caps, pricing guidelines, and other conditions as per the NDI Rules.

Investment by Permissible Holder

Annex 11 has been added that clarifies provisions pertaining to investment by permissible holders in equity shares of public companies incorporated in India and listed in international exchanges. Permissible holders are allowed to operate under the Direct Listing of Equity Shares of Companies Incorporated in India on International Exchanges Scheme notified by the central government. The amount shall be paid as inward remittance from abroad.

These changes mark a progressive shift in India’s approach to foreign investment, promoting a more transparent and efficient environment for cross-border transactions while also safeguarding the country’s strategic interests.