By Arnav Bose
Introduction
Recently, the Department for Promotion of Industry and Internal Trade (‘DPIIT’) released a press note which modified the Foreign Direct Investment (‘FDI’) policy in India.[1] Following this, on 22nd April 2020, an amendment was introduced to the Foreign Exchange Management (Non-Debt) Instrument Rules, 2019 (‘FEMI Rules’) to ratify the changes.[2] The press note stated that it was obligatory for investors from neighboring countries to seek the government approval prior to investing. Additionally, the amended FDI policy blocked the direct acquisition of investment by entities belonging to these countries by implementing non-tariff barriers.[3] The aim behind amending the FDI policy was to curb the recent trend of the opportunistic hostile takeover of Indian companies by foreign entities. This trend had emerged post the Covid-19 crisis as they are considered weak/sick firms by foreign companies according to the Ministry of Commerce (‘MoC’).[4] This move marked a significant shift from the investment-friendly rules adopted by the Bharatiya Janata Party (‘BJP’) led government to a regime that was in line with the recent uptrend of adopting protectionist trade policies.
Interestingly, the application of the FDI policy released by the Indian government only covers the countries which share the land border with India.[5] Prior to the amendment, the Indian government had a liberal approach regarding investments in the country where they were permitted automatically, except Pakistan and Bangladesh.[6] Moreover, this move was undertaken by the Indian government immediately after the People’s Bank of China acquired over a 1% stake in HDFC Ltd., which is India’s largest private sector lender.[7] In that context, it is also pertinent to note that the investments from the other neighboring countries in the aggregate are insignificant compared to those from China.[8] This indicates a recognition of the threat posed by the Chinese investors against the Indian government since there is no delineation between public and private companies in China, due to which most corporations function in a manner akin to a state-owned enterprise.[9] Therefore, China’s increasing role or shares in the technology sector and the penetration of technological support across the Indian economy, especially in areas of security or strategic implications, leaves India particularly vulnerable to the Chinese State.
Currently, the changes in the FDI policy has the potential to affect investments worth 8 billion USD in the Indian market.[10] This will have huge implications on the start-up industry where Chinese investors currently own a majority stake in 18 out of the top 30 unicorns (privately owned start-ups with a valuation of more than 1 billion USD) in India.[11] However, a recent trend of the pattern has been observed where Indian companies, groups like RSS-affiliate Swadeshi Jagaran Manch (‘SJM’) and several associations belonging to the Micro, Small and Medium Enterprises (‘MSME’) sector have also requested the government to curb the investment from China in the Indian market.[12] This is in consonance with the severe backlash China has been facing worldwide due to the mismanagement regarding the spread of Covid-19. In response, other than the amendment in the FDI policy, the government has also attempted to implement self-sustaining measures like ‘Aatma Nirbhar Bharat’, which ties into their agenda of promoting a self-reliant model.[13] This interest has recently piqued due to the ongoing conflict between the USA and China which has escalated in the form of a trade war and necessitated the need for alternate global supply chains in response to retaliatory tariffs between the USA and China.
In light of this, the article explores the start-up industry’s role and the ramifications it can suffer post the implementation of the amended FDI policy. This is analysed in a backdrop where it has been noted that these industries are heavily reliant on Chinese investors for its sustenance. While doing so, the article also attempts to shed some light on the importance of Chinese investments in the Indian landscape along with the viability of possible recourse which may be available under legal obligations.
The magnitude of Chinese Investments and the Role of Start-ups in India
Although India did not sign off to the Belt & Road Initiative (‘BRI’), Chinese investors have successfully managed an invaluable place for themselves through FDI.[14] There are a few critical reasons for the rise of Chinese investments in the Indian economy. Firstly, with the competition in their home market being cramped up, India is viewed as one of the fast emerging markets with untapped potential.[15] Moreover, it has been observed that Indian markets more often than not suffer from a lack of capital, due to which investment sources are readily welcomed in the market for the economy to prosper.[16] Secondly, the Indian market’s modalities are extremely similar to the Chinese market where the governments have pre-existing trade relations established and a lot of human resources to avail. This has led the investors to believe that there is a scope to succeed in this market if it is harnessed efficiently. [17] Thirdly, there is an immense amount of potential in terms of creativity and ideas in the Indian market.[18] It is easier for Chinese investors to gamble on mid-low tier companies and convert it into a high stake cash cow for their benefit.[19] By these investments China also furthers it animosity against the USA by competing with their investors in different markets to create an ecosystem that mirrors their start-up culture intending to make it a norm in the global order.[20]
The lucrative investments on the table did lure India to adopt a policy of excessive liberalization of financial markets on the external front, which has left them particularly vulnerable to global economic crises. The current capital outflow from Indian markets has weakened the domestic industries due to the excessive reliance on foreign investors, leaving them vulnerable to hostile takeovers/acquisitions which is also a result of the same policy that was adopted by India pre- Covid-19 outbreak. Historically, during both the Asian Crisis and the 2008 Financial Crisis, India could recover relatively faster as it had low exposure to external finances.[21] This helped the Indian market recover internally since the companies had less external involvement and reliance to recover their business assets than the status quo. However, there is no doubt that while some amount of protection is necessary at this time, it is also important to look into the implications that such protections have on the start-up industry in India, which is primarily funded by investors from China.
In the past few years, the trend of promoting start-ups has been revived with the government aiming to create a conducive environment with schemes like ‘Startup India’ that have been followed up by complementary initiatives like ‘Make in India’, ‘Skill India’ and ‘Digital India’ that were aimed at targeting the human resource available to contribute in this sector.[22] As per a report titled “The State of Startup Ecosystem”, start-ups in India have grown and reached an estimate of around 40,000 start-ups by 2020.[23] The increase in growth can be attributed to a number of factors that have significantly changed the landscape of the Indian economy in the past decade. On the demand front, an increase in smartphone penetration has led to a significant increase in the number of consumers connected to the internet. As per the Internet and Mobile Association of India (‘IAMAI’), in November 2019, the number of active internet users in India has grown to 504 million active users.[24] The sheer size of these users, and the increasing need for consumption make them an attractive customer base. On the supply side, the country is home to a huge technology talent base. The Availability of adequate human resources coupled with changing views of the traditional mercantile community towards ‘business’ as a career drives the growth of the Start-up based in India.
Lastly, huge capital inflows from global investors and the governments’ extensive focus on providing a conducive business environment facilitate the entrepreneurial spark in the country. As a result, it has provided a mass amount of employment within the community and helped the economy to stretch its branches and grow further in novel areas.[25] According to the Brookings report, “In 2017 alone, when investments in this space peaked, e-commerce start-ups were the biggest destination, with US$3 billion in funding.”[26]
Economic And Legal Implication of The FDI Policy
The implications of the FDI policy are largely expected to be felt by the big giants in the start-up industry like PayTM, Dream 11, Big Basket etc. These are massively backed by Chinese investors and are expected to face delay and barriers in raising funds.[27] There have been scathing criticisms against the policy as it is alleged to be a counter-productive exercise to the economy in a capital deficit country where there is a lack of requisite domestic capital to sustain economic growth. There have been reservations against implementing it efficiently due to well-documented bureaucracy in the country, which has led to speculation regarding the slowdown of such companies’ growth.[28] Further, it has been alleged that if the de-facto share-holding capacity of these investors in the unicorns is altered, then it may demotivate the erstwhile Chinese investors to continue funding these companies.[29]
However, considering these concerns, companies are exploring possible avenues for alternative investments. But, with the entire global economy grappling with the Covid-19 crisis, prospects for FDI from other sources seem bleak. Currently, there appears to be a vast restructuring in the process of globalization at the international policy level as well, where most nations are adopting a regionalized framework that helps them to ensure a self- sustaining model.[30] This will ultimately result in the weakening of these companies, which may throw many out of employment, particularly those among the most educated in the country, accentuating the economy’s demand crisis. Prior to the amendments, companies like Zomato had already forced their employees to take a 50% pay cut and lay off 13% of their employees.[31] Similar steps have been followed by other major start-up players in the Indian market like Uber due to the repercussions the economy had to face cause of the ongoing Covid-19 crisis.[32] Also, the pervasive growth that these start-ups have witnessed in the past few years may have adverse effects since their downfall may penetrate other sectors. For example, currently, the hospitality industry is currently heavily reliant on the delivery apps as customers are apprehensive about having food at their restaurant. Adverse effects on the start-ups like Swiggy and Zomato will eventually trickle down to affecting the amount of income these restaurants make in the long run, which will invariably hamper the economy. It has also been speculated and noted that lengthy documentation and procedural delays for approval seeking might deter investment by Chinese investors for newer or smaller start-ups.[33] It will be likely that this will create huge barriers for companies to raise new investments or in the alternative generate revenue via follow-on rounds from existing backers. This could force the company to take significant cuts that may hamper the operations and result in a resource drain in limited access to innovations or technology or even brain drain.
Considering the huge amount of short-term loss potentially suffered by the Chinese investors they may have certain recourses available based on the legal obligations both countries are subject to. On the legal front, China can raise a claim against India as per the 2006 Bilateral Investment Treaty (‘BIT’), which was terminated in 2018. According to Article 16.2 of the BIT, there exists a sunset clause which ensures that the mechanisms of the same remain in force for 15 years since termination.[34] However, the aforementioned clause only encompasses existing measures that deal with the protection of investments and does not extend the same to any future action which may be undertaken.[35] The crux of such a claim lies in the interpretation of the clause that provides certain leeway to China for indirect application which can possibly raise a claim in front of an arbitral tribunal.[36] On the alternative, a possible claim in front of a World Trade Organisation (‘WTO’) Dispute Settlement Body (‘DSB’) can be raised by China for violation of the Most Favored Nation (‘MFN’) clause under the General Agreement of Trade and Services (‘GATS’)[37] and the General Agreement on Trade and Tariff (‘GATT’).[38] The Chinese government can designate the adopted FDI policy to function as a disguised protectionist measure and violate the principle of non-discrimination under the international trade law. In response, the Indian government may seek protection under the general exceptions[39], or possible recourse may lie under the security exceptions[40] of the trade agreements. The exception clause provides justification in case trade restrictive measures are taken in the interest of public morals or taken during emergencies to secure national security interests. Nevertheless, in this context, it is important to recognize the geo-economic shift global trade has undergone in the past few months, with countries willing to pull their investments out of China due to the trust deficit caused by the ongoing pandemic. This puts China in a precarious position if they choose to raise a claim to protect their practice of opportunistic takeovers as they will aim to avoid the negative branding they are receiving on an international scale for the mismanagement of the Covid-19 crisis.
Conclusion
A blanket ban on all direct investments can have adverse fallouts for the current economy although it is recognized that scrutinizing the policy for specific strategic reasons is needed. Therefore, if the Government of India (‘GoI’) continues with its decisions, it also needs to provide comprehensive planning and clarity to support these businesses backed by China in case funding becomes an issue. It also needs to then work towards developing a national fervor for Resource & Development (‘R&D’) as well as technological innovations in the market for a holistic framework to function in. This can be supported by encouraging more public-private collaborations, which may ease the pressure and help India work towards a self-sustaining economy. To that end, there is a need for the Indian government to relax the amended policy and opt for alternatives. This can be done by allowing Chinese investments to take place automatically on furnishing of a self-declaration certificate and introducing stringent pricing restrictions to exclude Chinese investors. They have minority shareholding and have no possible impact on the objective of the government. This can ensure that the Indian government protects its companies from opportunistic takeovers while allowing it to exist in the start-up ecosystem on a limited basis.
The author, Arnav Bose, is currently a law student at the National University of Juridical Sciences (NUJS), Kolkata.
[1] Department For Promotion of Industry and Internal Trade, ‘Review of Foreign Direct Investment (FDI) policy for curbing opportunistic takeovers/acquisitions of Indian companies due to the current Covid-19 Pandemic’, April 17, 2020, available https://dipp.gov.in/sites/default/files/pn3_2020.pdf (last visited on August 30, 2020).
[2] Department of Economic Affairs, ‘Notification’, April 22, 2020, available http://egazette.nic.in/WriteReadData/2020/219107.pdf (last visited on August 30, 2020).
[3] Payaswini Upadhyay, ‘FDI Policy: Investors From Border States Need Government Approval To Invest In Indian Companies’, April 18, 2020, available https://www.bloombergquint.com/law-and-policy/fdi-policy-investors-from-border-states-need-government-approval-to-invest-in-indian-companies (last visited on August 30, 2020).
[4] Elisabeth Braw, ‘China is Bargain Hunting- and Western Security is at Risk’, April 15, 2020, available https://foreignpolicy.com/2020/04/15/china-is-bargain-hunting-and-western-security-is-at-risk/ (last visited on August 30, 2020).
[5] R Suryamurthy, ‘Delhi share wall to stall China’, April 19, 2020, available https://www.telegraphindia.com/business/coronavirus-outbreak-fdi-riders-in-place-with-eye-on-china/cid/1766149 (last visited on August 30, 2020).
[6] Ashima Obhan and Vrinda Patodia, ‘Curtailing Foreign Direct Investment in India’, April 27, 2020, available https://www.mondaq.com/india/inward-foreign-investment/923918/curtailing-foreign-direct-investment-in-india (last visited on August 30,2020).
[7] Partha Sinha, ‘China’s Central Bank takes 1% stake in HDFC’, April 13, 2020, available https://timesofindia.indiatimes.com/business/india-business/central-bank-of-china-holds-1-in-hdfc/articleshow/75113286.cms (last visited on August 30, 2020).
[8] Pranav Atit and Armann Srinivasan, ‘The Covid-19 FDI Amendments- India not alone’, April 29, 2020 available https://www.azbpartners.com/bank/the-covid-19-fdi-amendment-india-not-alone/ (last visited on August 30, 2020).
[9] Priscilla Jebaraj, ‘Government nod mandatory for FDI from neighbouring countries’, April 19, 2020, available https://www.thehindu.com/business/Economy/government-nod-mandatory-for-fdi-from-neighbouring-countries/article31379229.ece (last visited on August 30, 2020).
[10] Dipanjan Roy Choudhary, ‘A new approval route, no WTO rules breach: India on Chinese investment block’, April 21, 2020, available https://economictimes.indiatimes.com/news/economy/indicators/a-new-approval-route-no-wto-rules-breach-officials/articleshow/75262838.cms?from=mdr> (last visited on August 30, 2020).
[11] Palak Shah, ‘How China dominates tech investments in India’, April 19, 2020, available https://www.thehindubusinessline.com/info-tech/how-china-dominates-tech-investments-in-india/article31380773.ece (last visited on August 30, 2020).
[12] Vasudha Venugopal, ‘Time to re-negotiate equations with China: Swadeshi organisations to govt’, April 20, 2020, available https://economictimes.indiatimes.com/news/politics-and-nation/time-to-re-negotiate-equations-with-china-swadeshi-organisations-to-govt/articleshow/75242555.cms?from=mdr (last visited on August 30, 2020).; Shariq Khan, ‘A $163 billion industry struggles to reduce its dependency on Chinese imports’, April 6, 2020, available https://economictimes.indiatimes.com/small-biz/sme-sector/a-163-billion-industry-struggles-to-reduce-its-dependency-on-chinese-imports/articleshow/74942617.cms (last visited on August 30, 2020).
[13] Abhishek Vasudev, ‘PM Modi announces economic package worth Rs 20 lakh crore aimed at self-reliant India’, May 12, 2020, available https://www.ndtv.com/business/coronavirus-package-atma-nirbhar-bharat-pm-modi-announces-economic-package-worth-rs-20-lakh-crore-aimed-at-self-reliant-india-2227717 (last visited on August 30, 2020).
[14] Sabrina Korreck, ‘Chinese Funding of Indian startups: Key investors and patterns of investment’,October 3, 2019, available https://www.orfonline.org/expert-speak/chinese-funding-indian-startups-key-investors-patterns-investment/ (last visited on August 30, 2020).
[15] Samidha Sharma,‘Shunwei Capital is here to play the long game: CEO Tuck Lye Koh’,April 8, 2019, available https://tech.economictimes.indiatimes.com/news/startups/shunwei-capital-bets-on-16-local-startups-over-the-past-two-years/68767390 (last visited on August 30, 2020).
[16] Mihir Sharma, ‘View: India’s economy is ailing from more than Covid-19’, June 26,2020, available
https://economictimes.indiatimes.com/news/economy/indicators/view-indias-economy-is-ailing-from-more-than-covid-19/articleshow/76637162.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst (last visited on August 30, 2020).
[17] M. Sriram, ‘Tencent bets big on Indian tech startups amid China slowdown’, July 25, 2019, available https://www.livemint.com/companies/start-ups/tencent-bets-big-on-indian-tech-startups-1563989087962.html (last visited on August 30, 2020).
[18] Rajnish Tiwari, ‘Frugality in Indian Context: What makes India a lead market for affordable experience? in Lead Market India: Key Elements And Corporate Perspectives For Frugal Innovations 37-61 (1st ed., 2016).
[19] Priyanka Pani, ‘Fosun eyes Indian start-ups with $200-m fund’, January 16, 2018, available https://www.thehindubusinessline.com/companies/fosun-eyes-indian-startups-with-200m-fund/article9211995.ece (last visited on August 30, 2020).
[20] Sayan Chakraborty, ‘Ecommerce wars: It’s Alibaba vs Amazon in India’, December 26, 2017, available https://www.forbesindia.com/article/leaderboard/ecommerce-wars-its-alibaba-vs-amazon-in-india/48981/1 (last visited on August 30, 2020).
[21] K.G. Vishwanathan, The Global Financial Crisis and its impact on India, 9 Journal of International Business and Law 1 (2010).
[22] Samidha Sharma, ‘What’s next for Indian startups?’, January 25, 2020, available https://economictimes.indiatimes.com/small-biz/startups/newsbuzz/the-bell-tolls-for-indian-startup-superstars-now/articleshow/73570397.cms?from=mdr (last visited on August 30, 2020).
[23] Inc 42, ‘The State of Startup Ecosystem Report 2020’, August 18, 2020, available https://inc42.com/datalab/presenting-the-state-of-indian-startup-ecosystem-report-2020/#:~:text=From%2029K%20startups%20in%202014,combined%20valuation%20of%20%24115.5%20Bn. (last visited on August 30, 2020).
[24] Nandita Mathur, ‘India now has over 500 million active Internet users: IAMAI’, May 5, 2020, available https://www.livemint.com/news/india/india-now-has-over-500-million-active-internet-users-iamai-11588679804774.html (last visited on August 30, 2020).
[25] Supra note 12.
[26] Ananth Krishnan, ‘Following The Money: China Inc’s Growing Stake in India-China Relations’, March 5, 2020, available https://www.brookings.edu/wp-content/uploads/2020/03/China-Inc%E2%80%99s-growing-stake-in-India-China-relations_F.pdf (last visited on August 30, 2020).
[27] Biswarup Gooptu and Aditi Shrivastava, ‘Funding for unicorns, smaller startups may be hit as India reinforces FDI wall, June 26, 2020, available https://tech.economictimes.indiatimes.com/news/startups/funding-for-unicorns-smaller-startups-may-be-hit-as-india-reinforces-fdi-wall/75239816 (last visited on August 30, 2020).
[28] Rahul Pandey, ‘The Modi Government’s New FDI Policy will hurt Indian interests’, June 21, 2016, available https://thewire.in/economy/governments-new-fdi-policy-will-hurt-indias-interests (last visited on August 30, 2020).
[29] KS Kumar, ‘Future uncertain for Chinese Investments in India’, June 18, 2020, available https://asiatimes.com/2020/06/future-uncertain-for-chinese-investment-in-india/ (last visited on August 30, 2020).
[30] Frederik Van Til, ‘Three Scenario’s for Globalisation in a Post Covid-19 World’, April 1, 2020, available https://spectator.clingendael.org/en/publication/three-scenarios-globalisation-post-covid-19-world (last visited on August 30, 2020).
[31] Aditi Shrivastava, ‘Zomato to lay off 520 people as Covid- 19 hurts business’, May 16, 2020, available https://tech.economictimes.indiatimes.com/news/internet/zomato-to-lay-off-13-if-its-staff-as-covid-19-severely-impacts-food-ordering-business/75755416 (last visited on August 30, 2020).
[32] Aditi Shrivastava, ‘Uber lays off 600 employees in India as Covid-19 hits ride- hailing businesses, May 26, 2020, available https://tech.economictimes.indiatimes.com/news/internet/uber-lays-off-600-employees-in-india-as-covid-19-hits-ride-hailing-business/75991007 (last visited on August 30, 2020).
[33] Supra note 23.
[34] Agreement Between The Government of The Republic of India and The Government of The People’s Republic of China For The Promotion and Protection of Investments, Art.16.2.
[35] Smriti Kalra, ‘India’s FDI Policy Distances Itself from Neighbours: Can China bring an MFN Claim?’, April 23, 2020, available https://indiacorplaw.in/2020/04/indias-fdi-policy-distances-itself-from-neighbours-can-china-bring-an-mfn-claim.html (last visited on August 30, 2020).
[36] Id.
[37] General Agreement on Trade and Services, 1994, Art. II:1.
[38] General Agreement on Trade and Tariff, 1994, Art. I:1.
[39] General Agreement on Trade and Tariff, 1994, Art. XX; General Agreement on Trade and Services, 1994, Art. XIV.
[40] General Agreement on Trade and Tariff, 1994, Art. XXI; General Agreement on Trade and Services, 1994, Art. XVI.
The Journal of Indian Law and Society 