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Introduction to FDI

Foreign Direct Investment is very important for multiple reasons – few of which are mentioned below:

1. FDI often provides exits to existing shareholders and promoters, who can make a lot of money even by selling a small component of their stake in the venture to a foreigner. The most lucrative strategic acquisitions very often come through FDI.

As risk capital available globally is many thousand times more compared to what is available within India for investment, entrepreneurs try to tap into the global investment market. Such investment comes in form of FDI. Also, when foreign buyers/ investors are attracted to a company, valuation usually drastically improves as result of increased competition amongst investors themselves.

The government encourages FDI in most cases as it helps to expand Indian economy, increases our GDP and our foreign currency reserves. Unlike hot money that comes from Foreign Institutional Investors (FIIs) into the stock markets (which can be pulled out very quickly by the FIIs), FDI is a source of long term investment and is not quickly exited, thus contributing to long term growth.

Transactional lawyers and law firms are obsessed about FDI as foreign companies investing in India require legal services and are often some of the biggest and most well-paying clients. A significant share of the practice of top Indian law firms are owed to such foreign clients investing through FDI route in India.

Before reading this chapter, you should ideally read the previous chapter on the bank accounts that can be opened in India in rupee and foreign currency for various commercial transactions.

This chapter will cover the issue of investment by a foreigner/ foreign entity into an Indian legal entity. This is commonly known as Foreign Direct Investment (FDI) route. FDI in India is governed by the Foreign Exchange Management Act, 2000 (FEMA). Pursuant to the FEMA, the Reserve Bank and the Government of India issue regulations, circulars and notifications to regulate the provisions for investment.

FDI has been historically a very contentious issue in India. Many political parties oppose FDI on the ground that it harms interests of local businesses and merchants. On the other hand, FDI has been an important source of capital, business growth, employment generation and foreign exchange for India. The rules with respect to FDI have been going through frequent changes.

Prior to April 2010, the FDI Policy of the government was contained in 177 ‘press notes’, which became unwieldy. From April 2010, the Central Government released a consolidated circular on FDI Policy every six months (twice a year), and from 2012 a consolidated circular is published once a year,  which consolidates all the provisions relating to FDI contained in previous press notes. The Consolidated FDI Policy 2014 (Circular 1 of 2014) dated 17 April 2014 (FDI Policy) sets out the latest applicable legal regime for FDI in India. The updates to the FDI Policy are followed by amendments to corresponding RBI regulations, which are notified by RBI. When there is a time difference between the
government amendment to the RBI policy and the amendments by RBI, the stipulations in the FDI Policy are still observed as a matter of economic policy.

FDI is allowed up to 100% in most sectors or activities. FDI in private and public limited Indian companies is the most common. The discussion below explains regulation of FDI in different business structures.

FDI in Limited Liability Partnerships

Although FDI in LLPs is permitted, the conditions on which it is allowed are restrictive compared to the conditions for FDI in a company. The key features of FDI into an LLP, compared to a company are given below:

FDI is allowed in LLPs only through the approval route. The sectors must also satisfy both of the following criteria:


a. 100% FDI must be allowed in that sector for a company-structure without government approval under the FDI policy (see discussion below to understand which sectors are under automatic route), and

There should be no ‘performance-related’ conditions in the FDI policy. For certain sectors such as construction development, the FDI policy stipulates minimum amount of investment, or there is a lock-in period prescribed before which the investor cannot exit from the venture. In such sectors FDI is not permitted.


There is no method by which FDI can be made in LLPs without government approval.

 LLP's with FDI are not eligible to make downstream investments.

 Foreign capital participation is allowed only by way of cash consideration. (In case of a company, foreign capital can also be injected in form of import of capital goods or technology.)

 LLPs are also not eligible to avail external commercial borrowings i.e., to raise overseas debt.

LLPs cannot seek investment from FIIs and FVCIs.

FDI in Trusts

FDI is not permitted in trusts, other than venture capital funds which are registered with SEBI. FDI in a venture capital fund structured as a trust requires approval of the Foreign Investment Promotion Board (FIPB). However, FDI investment into a venture capital fund structured as a company is permitted under the automatic route.

Opting for LLP or trust structure is very rare as it results in delay in investment and over-regulation. Companies are the most convenient vehicles for FDI. Provisions for FDI into a company are described below.

FDI in Companies

In order to prevent cumbersome scrutiny of the venture by Indian regulators and to establish operations faster, it may be advisable to avoid an LLP or trust structure and opt for a company. As per the FDI Policy, foreign direct investment into an Indian company may fall under one of three categories:

  • Automatic route – Sectors where foreign investment is permitted (up to 100%) without approval of the Foreign Investment Promotion Board (FIPB) qualify under the automatic route. 


    This is the default route for FDI in absence of any specific rules - all sectors which are not prohibited or fall under the approval route (which are listed out in the FDI policy) belong to the automatic routePractically, barring a handful of sectors which are regulated, FDI in most cases happens through the automatic route. Many high growth sectors such as software, biotechnology, manufacturing, exploration of petroleum and natural gas etc. are in automatic route, signifying that no FIPB approval is required for FDI.  

    Approval route – 
    For various sectors, approval of the FIPB is required to take foreign investment into an Indian entity

There are also a number of sectors which have sectoral caps on FDI through automatic route. For instance, in a certain sector the government may allow 74% FDI under automatic route, but may require FIPB approval for FDI above that limit.


What does it mean when we say that sectoral cap for FDI is 74% in a sector?


It means that a company in that particular sector can issue upto 74% of all of its shares to foreign investors (including shares of different classes, such as equity shares, preference shares and convertible debt instruments; please see part II of this document to see the different instruments that can be issued to foreign investors) irrespective of the number of investors.


It is also possible that a sector can have different caps under approval route and automatic route. For instance, if a sector has a cap of 49% under automatic route and 74% under approval route, then the company can issue up to 49% of all of its share to foreign investors without seeking approval from the FIPB, and can issue up to 74% of all of its shares to foreign investors if FIPB approves of the same. Companies in such a sector can not take more than 74% foreign investment in any circumstances. This cap works as a limit on the maximum shareholding percentage foreigners can acquire. For example, FDI in telecom is permitted up to 49% without approval.  FDI between 49 to 74% in the telecom sector requires FIPB approval. FDI in excess of 74% is not permitted.


Defense, air transport services, courier services, telecom, print media, private security agencies, insurance, banking companies are some examples of sectors under the approval route. The full list of sectors under approval route can be found in the Consolidated FDI Policy Circular of April 2014 on the link here.


In addition, compliance to regulations made by a sectoral regulator may also be necessary. For example, foreign investment in insurance is also governed by regulations of the Insurance Regulatory and Development Authority (IRDA) in addition to the FDI Policy. Similarly, foreign investment under the airlines sector is governed by the Directorate General of Civil Aviation (DGCA). 

  • Prohibited sector - FDI is prohibited under 9 sectors specified under the FDI Policy. Note that FDI is prohibited is Gambling and Betting, including casinos, etc. The FDI Policy further specifies that foreign technology collaboration in any form, including licensing for franchise, trademark, brand name, management contract is also prohibited in respect of lotteries, gambling and betting activities. The full list of prohibited sectors is attached as Annex A

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