ISSUE VI : RBI – Regulating investment flow


The figures relating to inflow of foreign funds into Indian markets and Indian companies investing abroad have reached astronomical heights. The main task for the regulator is to keep a tab on the utilization of funds and ensuring that companies have enough flexibility to deploy money in ventures which provides them with a global presence. The Reserve Bank of India (RBI) has issued various guidelines regarding investment.

1.RBI guidelines

1.1 Foreign Investment in Debentures – Revised Guidelines [A.P. (DIR Series) Circular No. 74 dated June 8, 2007]

In terms of Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside  India)  Regulations,  2000  a  foreign  resident  can  purchase  convertible  (partly/optionally/fully) debentures issued by an Indian company. But many Indian companies started raising funds under the Foreign Direct Investment (FDI) route through issue of optionally/partially convertible debentures which are intrinsically debt-like instruments and were outside the sectoral caps of FDI. This form of raising capital circumvented the framework in place for regulating debt flow into the country. Therefore, to make the policy more transparent and ensure that the debentures are not left out of the FDI net, RBI has clarified that debentures issued to a person resident outside India have to be fully and mandatorily convertible into equity within a stipulated time period. However, Foreign Institutional Investors (FIIs) registered with Securities and Exchange Board of India (SEBI) are eligible to invest in listed non-convertible debentures/bonds issued by the Indian companies. A precondition imposed is, that the, FIIs would have to comply with the RBI/SEBI  norms  on  investment  in  rupee  debt  instruments  and  the  investment  should  be  within  the prescribed ceiling of the guidelines issued.

1.2 Foreign Investment in Preference Shares – Revised Guidelines [A.P. (DIR Series) Circular No. 73 dated June 8, 2007

Further to the Press Note dated April 30, 2007 issued by Ministry of Finance relating to treatment of preference shares for the purpose of FDI or debt instrument, RBI has issued certain clarifications, which are as follows:

  • foreign investment inducted into a company via issue of fully convertible preference shares would be treated as part of the share capital for the purpose of FDI and sectoral cap requirements. For example, in aviation sector there is a sectoral cap of 49% on FDI. Prior to the issue of guidelines Indian companies looking to raise funds would issue 49% shares to foreigners as equity and beyond 49% as preference shares. This would enable them to circumvent the prescribed FDI limit. Now the RBI has clarified that if the preference shares are convertible at the end of the maturity period then they would constitute as the part of FDI. So, now an Indian company can only issue 49% (equity plus convertible preference) to foreign shareholder.
  • foreign investment by means of issue of non-convertible, optionally convertible or partly convertible preference shares would be considered as debt instruments and would have to conform with the External

Commercial Borrowing (ECB) guidelines/caps. Accordingly, all the norms applicable to ECBs viz. eligible borrowers, recognized lenders, amount and maturity, end use stipulations, shall apply. As the instrument will have rupee denomination the interest rate on these debt instruments shall be computed on the swap equivalent of LIBOR plus the spread as permissible for ECBs of corresponding maturity.

  • preference shares shall be issued to the foreign investor after compliance with the RBI/SEBI and other applicable guidelines issued by statutory authorities.

The guidelines have been made effective from May 1, 2007.

1.3 Investment by Mutual Funds in Overseas Securities – Liberalization [A.P. (DIR Series) Circular No. 72 dated June 8, 2007]

Investments in mutual funds have increased many folds over the years. However, mutual funds could only make investments in limited avenues to earn money and give interest to their investors. Earlier these were American Depository Receipts (ADR)/Global Depository Receipts (GDR) of Indian companies, rated debt instruments, and equity of overseas company listed on the recognized stock exchanges abroad. In order to broaden the scope of their investments, mutual funds are allowed to invest in:

  • Overseas mutual funds that make nominal investments of about 10% of the net asset value in unlisted overseas securities;
  • Overseas exchange traded funds that invest in securities; and
  • ADRs/GDRs of foreign companies.

1.4 Overseas Direct Investment – Liberalization [A.P. (DIR Series) Circular No. 75 dated June 14, 2007]

RBI has issued guidelines liberalizing the investments norms for Indian companies foraying into foreign markets. These include relaxation in the norms relating to:

  • Enhancement of limit for Overseas Direct Investment

The old guidelines had stipulated that the total investment of an Indian party in all its Joint Ventures (JV) and/or Wholly Owned Subsidiaries (WOS) abroad should not exceed 200% of its net worth. This limit has been enhanced to 300% of the net worth of the Indian company as per the last audited balance sheet. However, the limit applicable to registered partnership firms for overseas investment will continue to be 200% of their net worth.

  • Financial commitment for overseas investment – guarantees issued by an Indian Party to or on behalf of the JV/WOS

As per the earlier guidelines issued by RBI, Indian parties could make direct investment in overseas JV/WOS by way of contribution to equity, loan and 50% of the amount of guarantee issued on behalf of the foreign party. These contributions are defined as ‘financial commitment’. According to the revised norms the guarantee limit has been raised to 100%.

  • Portfolio Investment by listed Indian companies

According to Regulation 6B of the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 20041 listed companies were permitted to invest up to 25% of their net worth in the equities of listed foreign companies, listed on a recognized foreign exchange abroad. The permitted limit of investment has now been enhanced to 35% of the net worth of the investing company as per the last audited balance sheet. The guidelines prescribe that the foreign company in which the investment is made should have 10% holding of the listed Indian company and the rated bonds/fixed income securities issued by overseas companies should be issued under the portfolio investment scheme.

1 No. FEMA 120/RB-2004 dated July 7, 2004.


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