FDI – Direct & Indirect Investment

When analyzing foreign investment, it is essential to understand the concepts of direct and indirect investment and how they are computed.

Direct Foreign Investment

Direct Foreign Investment refers to investments made by foreign entities directly into a country’s domestic assets, such as businesses, properties, or infrastructure. It involves a significant level of ownership and control by the foreign investor. Direct investment can be in the form of equity, reinvested earnings, or intracompany loans. Here’s an example to illustrate direct foreign investment:

Example: ABC Inc., a foreign company based in Country A, decides to establish a manufacturing plant in Country B. It invests $10 million to set up the plant, purchases machinery, and hires local employees. ABC Inc. now owns and controls the manufacturing plant, making it a direct foreign investment in Country B.

Indirect Foreign Investment

Indirect Foreign Investment refers to investments made by foreign entities into the securities markets of a country. In this case, foreign investors purchase stocks, bonds, or other financial instruments of domestic companies or investment funds. Indirect investment does not involve direct ownership or control over the underlying assets. Here’s an example to illustrate indirect foreign investment:

Example: XYZ Fund, a foreign mutual fund based in Country C, invests $5 million in the stock market of Country D. The fund purchases shares of various domestic companies listed on Country D’s stock exchange. Since the foreign fund holds shares of domestic companies without direct control, this represents an indirect foreign investment in Country D.

Pricing of shares issued by an Indian company under FDI Policy

The pricing is determined based on the mode of investment, the type of security, and the sector in which the company operates. Here are the key points regarding the pricing of shares issued to foreign investors under the FDI policy:

Valuation Guidelines

The RBI and SEBI prescribe specific valuation guidelines for different modes of FDI, such as equity shares, preference shares, and convertible instruments like convertible debentures or convertible equity instruments.

Fair Market Value (FMV)

For shares issued to foreign investors, the pricing is often linked to the fair market value (FMV) of the shares. The FMV is determined based on various factors, including the company’s financial performance, future growth prospects, and prevailing market conditions.

Sectoral Caps

The FDI policy may impose sectoral caps or limits on foreign investment in certain industries or sectors. The pricing of shares issued under FDI must comply with these sectoral caps.

Pricing Guidelines

For certain sectors or specific types of transactions, the FDI policy may provide specific pricing guidelines. For instance, the pricing of shares issued to foreign investors for transfer of ownership from one non-resident to another may be based on the guidelines specified by the RBI.

External Commercial Borrowings (ECBs)

In cases where foreign investors invest in the form of ECBs, the pricing is determined based on the interest rate and terms agreed upon by the parties involved.

Reporting and Compliance

The company issuing shares to foreign investors must comply with the reporting requirements as per the RBI guidelines. The pricing details, the mode of payment, and other relevant information must be reported to the RBI and other regulatory authorities as required.