PE firms express concerns over new FDI rules, say investments will get hit

Private equity (PE) and venture capital (VC) funds operating in India have expressed serious concerns over the modification in foreign direct investment (FDI) norms, which brings all foreign investments from China under government scrutiny. They point out this would seriously impact their inflows into the country.

Under the new rules, any ‘entity’ or ‘beneficial owner’ or ‘citizen’ of a country (read China) having borders with India, who wants to invest in India, has to go through the government route and cannot avail of the automatic route allowed to others for up to 100 per cent investment in certain sectors or up to the relevant percentage cap in others.

VCs and global PEs say many of them raise money directly or indirectly from Chinese investors for a portion of their funds. They also raise money from fund of funds (global funds which pool in funds and provide finance to other PE funds), which in turn are financed, amongst others, by Chinese investors, many of whom are based in Hong Kong and Singapore.

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In their representation to the government, PE and VC players have explained that the funds they raise are a “pooled vehicle”, and no investor has any say or control over the underlying assets. They have also pointed out to the Department for Promotion of Industry and Internal Trade that it is the manager who has control and influence over the funds, and unless he or she is a citizen of a neighbouring country (say China) or the fund is registered in the neighbouring country, this rule should not apply to it.

However, a top PE player said they were still awaiting clarification on this contentious issue. Meanwhile, talks are on to urge the Centre not to slap the rule on those PE funds, which have already raised their money and, instead, apply it to future funds whose money is yet to be raised.

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PE funds say that the move could be a big dampener, as they constituted over 50 per cent of the country’s FDI in 2019.

Furthermore, with an inflow of $71 billion, they were over three times the size of net foreign institutional investor (FII) flows, which was at $22 billion the same year.

The importance of PE funds, especially in a post Covid-19 world, is reflected in the fact that they will play a key role in investing in the country. In fact, according to estimates, PEs could shoot over their 50 per cent contribution to FDI in the next couple of years. This view is based on the fact that PEs’ contribution to total FDI inflows has seen a steady rise — from 21 per cent in 2016 to 34 per cent in 2017, and to 40 per cent in FY18.

Under a new press note 3 (2020 series) issued in April this year, an entity of a country which shares a land border with India or where the beneficial owner of an investment into India is situated in or is a citizen of any such country, they can invest only under the government route. However, other foreign entities can invest in India, in all sectors, except those which are prohibited though the automatic route, up to 100 per cent or up to the cap applicable to the sector.

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Experts say the government’s move is clearly directed against China, and is essentially to prevent any “opportunistic acquisition or takeover” during the Covid-19 pandemic and the stress in business.

The new rules came into place just after the People’s Bank of China raised its stake in HDFC, leading to fears that the Chinese might be looking for more deals.

The Chinese have been substantial investors in India, especially in sunrise sectors like e-commerce, e-payments and start-ups, among others. According to Gateway House, Chinese tech investors had pumped in over $4 billion into Indian start-ups till March 2020, and more than 18 of India’s 30 unicorns are now Chinese-funded. The total Chinese FDI in the country is around $6.2 billion, the report stated.