The new PN3 norms and lack of clarity on what constitutes beneficial ownership are the primary reasons for the decline in investments from China and Hong Kong.
Private equity/venture capital (PE/VC) investments into India from China and Hong Kong have seen a substantial drop in 2020.
Investments from these two regions combined have declined 72 per cent to $952 million this calendar year, from $3.4 billion in 2019, the data from Venture Intelligence shows.
Investments from Mainland China have reduced 64 per cent to $377 million, while those from Hong Kong have fallen 75 per cent to $575 million in 2020.
Also, over 150 applications concerning investments from Chinese entities have been pending since the introduction of press note 3 (PN3) for FDI in April, according to law firm Khaitan & Co.
The new PN3 norms and lack of clarity on what constitutes beneficial ownership are the primary reasons for the decline in investments from China and Hong Kong, experts believe.
PN3 has especially dealt a major blow to start-ups by depriving them of funds from cash-rich China/Hong Kong-based investors.
The PN3 guidelines state that an entity of a country that shares a land border with India can invest only under the government route.
The guidelines also included the beneficial owner (BO) of an investment into India who is located in any such country and also its citizens.
The note, however, does not define the term “beneficial owner”.
Authorised dealer banks are applying different thresholds for determining BO for FDI coming into India — ranging from 25 per cent to 10 per cent, to even 1 per cent.
“The language of the regulation is very broad and it is silent on what constitutes beneficial ownership.
"So, there is very little flexibility for parties looking at alternative structures that are permissible under the FDI route.
"This leaves very little leeway for any form of investments from these jurisdictions,” said Vivek Sriram, partner, Khaitan & Co.
Investments that have Chinese, Taiwanese, Hong Kong, and Macau beneficial ownership now require prior government nod, irrespective of the percentage or quantum of investment.
All applications from these regions are also required to undergo a mandatory security clearance by the Ministry of Home Affairs.
In the past few years, sectors — such as technology and internet businesses — have been the chief beneficiaries of PE/VC investments from China.
Sectors, such as financials and pharma, have also seen significant Chinese interest.
“China is a key contributor to India FDI and industry players are hopeful that the government will soon clarify on the threshold for determining beneficial ownership.
"That will give a little more clarity for Chinese entities to structure their investments,” Sriram said.
Before the introduction of PN3, only FDI from entities which were based in Pakistan or Bangladesh required prior government approval.
India behind only China in cornering EM inflows
India has cornered the biggest chunk of overseas investor flows into the emerging markets, after China, in CY20.
FPI flows in India for the year stood at $22.6 billion, 58 per cent higher than that in 2019, with energy and financials absorbing the biggest share of flows.
The flows were largely driven by easy liquidity sloshing across the globe which found its way into emerging markets.
India-dedicated funds, however, have seen outflows to the tune of $9.1 billion in CY20, the EPFR data compiled by Kotak Institutional Equities shows.
India also benefited from relatively low flows to China as global sentiment towards that country soured somewhat after the Covid outbreak.
Yet, China managed to edge out India, with foreign flows to the tune of $104 billion, but 21 per cent lower than $132 billion it saw in 2019.
Photograph: Dado Ruvic/Reuters
