Context:

Recently, the Reserve Bank of India (RBI) has issued a new framework for reclassifying FPI to FDI.

More on News:

• The RBI in consultation with the Government of India and the Securities & Exchange Board of India (SEBI) finalised rules for Foreign Portfolio Investors (FPIs).
• The RBI introduced a streamlined operational framework to allow FPIs to convert their investments to foreign direct investment (FDI) when equity holdings in Indian companies surpass the prescribed 10% limit.

About Foreign Portfolio Investors (FPIs) and Foreign Direct Investment (FDIs):

FPIs involve investment in financial assets such as stocks, bonds, and mutual funds without significant control over the operations of Indian companies. Generally, FPIs are defined as those who hold less than 10% of a company.

• Generally, investors in FPIs seek quick returns and liquidity that are relatively more volatile and sensitive to market conditions.
• FPIs are popular among institutional investors who can easily enter and exit markets based on global economic conditions and portfolio strategies. 

FDIs involve direct investments in Indian businesses, usually with a stake exceeding 10%, which grants foreign investors a controlling interest in management and operations.

• FDIs are typically long-term and associated with setting up or expanding business facilities, creating jobs, and transferring technology and expertise.
• Due to their stable nature, FDIs contribute positively to economic growth and are less affected by short-term market fluctuations. 

In India, FPIs and FDIs are governed by the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI), with regulations for sectoral caps, pricing guidelines, and compliance requirements.

New Guidelines:

Mandatory Government Approval: FPIs must obtain government approval when their equity holdings exceed the 10% threshold, then their investment will be reclassified as Foreign Direct Investment (FDI).

• This government approval is mandatory for countries sharing land borders with India.

Timely Reclassification: The RBI requires that the reclassification process be completed within five trading days from the transaction date that exceeds this limit.

Compliance Requirements:

• Investments must comply with entry routes, sectoral caps, investment limits, pricing guidelines, and other FDI-specific conditions under current regulations.
• The RBI mandates thorough reporting in line with the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019.

Updated SEBI Guidelines: The SEBI requires FPIs choosing reclassification to notify their custodian, who will temporarily freeze any further equity transactions in the affected company until the reclassification is complete.

Relaxation for Investors from Non-Bordering Countries: Investors from countries (not land-boarding with India) will be no requirement for prior government approval. But, the RBI approval is mandatory for investors.

Restrictions in Some Sectors: Reclassification will not be permitted in sectors where FDI is restricted such as Real Estate Business, Gambling, Nidhi Companies etc. 

Significance of New Guidelines:

• Regulatory Clarity: The new framework provides clear guidelines for the transition from FPI to FDI, reducing ambiguity in the reclassification process and ensuring better compliance.
• Market Stability: By establishing a structured approach to reclassification, the framework helps maintain market stability and prevents sudden disruptions in investment patterns.
• Investment Monitoring: The guidelines enable better monitoring of foreign investments, helping authorities track the nature and source of foreign capital entering the Indian market.
• Economic Security: The framework strengthens India's economic security by ensuring proper scrutiny of investments, particularly from neighbouring countries, while maintaining an open investment environment.
• Corporate Governance: The requirement for investee company concurrence promotes better corporate governance and transparency in foreign investment management.