Despite the progressive opening up
of the Indian economy to foreign investment in 1991, there has been tight
control over the entry and exit prices for foreign investors into and from
investments in Indian companies through the foreign direct investment route
(FDI). While the initial approach was to benchmark the transaction prices to
the erstwhile formula prescribed by the Controller of Capital Issues (CCI),
more lately (since 2010) the benchmark was altered
to the discounted cash flow (DCF) valuation. While unlisted company investments
were subject to these benchmarks, listed companies were entitled to the benefit
of market efficiency and prevailing stock exchange prices that provided proxies
for company valuation. Further
relaxations were made more recently in January this year.
of the Indian economy to foreign investment in 1991, there has been tight
control over the entry and exit prices for foreign investors into and from
investments in Indian companies through the foreign direct investment route
(FDI). While the initial approach was to benchmark the transaction prices to
the erstwhile formula prescribed by the Controller of Capital Issues (CCI),
more lately (since 2010) the benchmark was altered
to the discounted cash flow (DCF) valuation. While unlisted company investments
were subject to these benchmarks, listed companies were entitled to the benefit
of market efficiency and prevailing stock exchange prices that provided proxies
for company valuation. Further
relaxations were made more recently in January this year.
Latest reports and analyses (here
and here)
have alerted us to the possibility that the Reserve Bank of India (RBI) is set
to further rationalize the pricing of entry and exit of foreign investment into
Indian companies. This is based on a statement in the First Bi-monthly Monetary
Policy Statement, 2014-15 by Dr. Raghuram Rajan, Governor of the RBI, as
follows:
and here)
have alerted us to the possibility that the Reserve Bank of India (RBI) is set
to further rationalize the pricing of entry and exit of foreign investment into
Indian companies. This is based on a statement in the First Bi-monthly Monetary
Policy Statement, 2014-15 by Dr. Raghuram Rajan, Governor of the RBI, as
follows:
As regards foreign
direct investment (FDI), it has been decided to withdraw all the existing
guidelines relating to valuation in case of any acquisition/sale of shares and
accordingly, such transactions will henceforth be based on acceptable market
practices. Operating guidelines will be notified separately.
direct investment (FDI), it has been decided to withdraw all the existing
guidelines relating to valuation in case of any acquisition/sale of shares and
accordingly, such transactions will henceforth be based on acceptable market
practices. Operating guidelines will be notified separately.
This potential change represents an
important development in FDI structuring. Hitherto, investors have been
hamstrung by unduly stringent pricing norms that have adversely affected the
commercials of investment transactions. While entry-pricing norms for FDI have
imposed floor prices on foreign investors thereby disabling them from investing
at low prices (that may be necessary for specific types such as early-stage
investments), the exit pricing norms have imposed caps that disallow foreign
investors from exiting their Indian investments at commercially attractive
prices. The policy rationale for the pricing norms is understandable – as it is
a measure of regulating the inflow and outflow of foreign exchange. However,
the rigidity in its implementation acts as a disincentive to foreign
investments and not only curbs foreign investors from investing into India but
also limits the availability of foreign capital to Indian companies.
important development in FDI structuring. Hitherto, investors have been
hamstrung by unduly stringent pricing norms that have adversely affected the
commercials of investment transactions. While entry-pricing norms for FDI have
imposed floor prices on foreign investors thereby disabling them from investing
at low prices (that may be necessary for specific types such as early-stage
investments), the exit pricing norms have imposed caps that disallow foreign
investors from exiting their Indian investments at commercially attractive
prices. The policy rationale for the pricing norms is understandable – as it is
a measure of regulating the inflow and outflow of foreign exchange. However,
the rigidity in its implementation acts as a disincentive to foreign
investments and not only curbs foreign investors from investing into India but
also limits the availability of foreign capital to Indian companies.
The regulatory progression in the
recent years coupled with the latest announcement seems to rationalize the
policy in a manner that favours foreign investment. It is certainly not the
case that FDI pricing must be free from any regulation whatsoever so as to
permit the parties to contractually determine any manner of pricing conditions.
That might move matters away from the policy goal of regulating foreign
exchange, a role that the RBI has discharged quite effectively over the years.
However, the pricing norms must be in tune with reality and must provide the necessary
flexibility to promote ordinary commercial transactions without imposing
unnecessary hindrances.
recent years coupled with the latest announcement seems to rationalize the
policy in a manner that favours foreign investment. It is certainly not the
case that FDI pricing must be free from any regulation whatsoever so as to
permit the parties to contractually determine any manner of pricing conditions.
That might move matters away from the policy goal of regulating foreign
exchange, a role that the RBI has discharged quite effectively over the years.
However, the pricing norms must be in tune with reality and must provide the necessary
flexibility to promote ordinary commercial transactions without imposing
unnecessary hindrances.
At
the same time, what we currently have is only a broad policy pronouncement. It is
necessary to await the details in the form of “operating guidelines” before
their efficacy or impact can be judged more specifically.
the same time, what we currently have is only a broad policy pronouncement. It is
necessary to await the details in the form of “operating guidelines” before
their efficacy or impact can be judged more specifically.