India opens to Chinese investment: What amending PN3 means for India-China relations
Yesterday, India announced a significant change in the restrictions on investment from neighbouring countries — regulations that came into place through “Press Note 3” (PN3) in April 2020, at the start of the pandemic.
In this post, I will look at what the changes are, and ask if the amendments matter.
First, the announcement from Delhi is worth reading in full:
The Union Cabinet chaired by Prime Minister Shri Narendra Modi has approved change in guidelines on investments from countries sharing land border with India (LBCs).
The existing policy has been reviewed and amended as follows:
Incorporation of the definition and criteria for determination of ‘Beneficial Owner’ (BO) – The amendment provides for a definition and criteria for determination of Beneficial Ownership that is widely used by investing community, under the Prevention of Money Laundering Rules, 2005. The Beneficial Ownership test shall be applied at the level of the investor entity. Investors with non-controlling LBC Beneficial Ownership of up to 10 percent shall be permitted under the automatic route as per the applicable sectoral caps, entry routes, attendant conditions. Such investments shall be subject to the reporting of relevant information/details by the investee entity to DPIIT.
Expedited clearance of investments in specific sectors – Proposals for LBC investments in specified sectors/activities of manufacturing in capital goods, electronic capital goods, electronic components, polysilicon and ingot-wafer, shall be processed and decided within 60 days. CoS under the Cabinet Secretary may also revise the list of specified sectors. In these cases, the majority shareholding and control of the Investee entity will be with resident Indian citizen(s) and/or resident Indian entity(ies) owned and controlled by resident Indian citizen(s), at all times.
Background -- In order to curb opportunistic takeovers/acquisitions of Indian companies due to the COVID-19 pandemic, Government had amended the extant FDI Policy vide Press Note 3(2020) dated 17.04.2020 (PN3). Pursuant to PN3, an entity of a country, which shares land border with India or where the beneficial owner of an investment into India is situated in or is a citizen of any such country, can invest only under the Government route. Additionally, any transfer of ownership of any existing or future FDI in an entity in India resulting in the beneficial ownership falling within the aforesaid jurisdiction(s) also require Government approval. Applicability of PN3 restrictions to cases where LBC investors may have only non-strategic, non-controlling interests was seen as adversely affecting investment flows from investors including global funds such as PE/ VC funds.
Benefits -- It is expected that the new guidelines will provide clarity and ease of doing business in India, and facilitate investments which can contribute towards greater FDI inflows, access to new technologies, domestic value addition, expansion of domestic firms and integration with global supply chain. This would help in leveraging and enhancing India’s competitiveness as a preferred investment and manufacturing destination. Increased FDI inflows would supplement domestic capital, support the objectives of Atmanirbhar Bharat, and accelerate overall economic growth.
Here’s what a Commerce Ministry official had to say to my colleague TCA Sharad Raghavan in The Hindu:
“There is a logic for this,” a senior official in the Ministry of Commerce told The Hindu. “The appetite for capital in India and the overcapacity in China presents a case to relook at the restrictions, while also maintaining our strategic considerations.”
He added that there are several sectors such as highways, bridges and other infrastructure where the strategic consideration or data sovereignty issues are not that pressing. “China also has huge foreign exchange reserves and India can provide much better returns for their investments than the US treasury bonds that they are currently investing in,” the official said.
Santosh Pai, who is a lawyer who has worked in the India-China investment space for years, an honorary fellow at the Institute of Chinese Studies and a frequent visitor to Beijing who has his pulse on the relationship, offered these initial thoughts, which he kindly allowed me to share:
1) 10% de-minimis rule: This is mostly a formalization of current market practice for ease of PE funds and other financial investors. It also signals that such investors have a role to play in acting as a geopolitical buffer. Expect to see more deals like the recent US TikTok and Indian Haier deals.
2) Priority sectors: Manufacturing of Capital Goods, Electronics Capital Goods, Electronic Components, Polysilicon and Ingot wafers form the first tranche of priority sectors. These constituted around 58% by value of imports from China in 2025. Polysilicon and Ingot wafers are not significant by value but constitute a barrier in backward integration since India already has capacity for panels, modules and cells.
3) 60-day timeline: Until now the JV and technology licensing route has been taken by select large Indian business groups. The 60-day timeline for approvals will encourage more such partnerships.
Expected benefits: Will these amendments result in increased FDI flows, access to new technologies, greater integration with global supply chains, larger domestic value addition and expansion of domestic firms? Difficult to predict. These amendments were necessary to eliminate contradictions in India-China economic ties. But are they sufficient? Several unknowns remain.
Ivan Lidarev at the Institute of South Asian Studies (ISAS) at the National University of Singapore (NUS) in a recent piece (before yesterday’s announcement) made this pertinent point on what the impact of India easing restrictions would likely mean:
Initially Chinese investment in India will grow slowly. Chinese investors are likely to be cautious as the improvement in bilateral relations is recent and still uncertain. The post-2020 period demonstrated to Chinese investors how political tensions can obstruct investment and even impact Chinese companies with strong Indian partnerships, such as BYD. Moreover, a potential trade deal with Washington could affect both Chinese investment in India and the exports to the United States of India-based Chinese companies. After years of heightened tensions with the US, many Chinese firms have already diversified their supply and production chains by relocating to other parts of Asia. Finally, New Delhi is likely to ease its curbs only partially and gradually, ensuring that any increase in Chinese investment remains slow and limited.
Former Foreign Secretary Shyam Saran recently offered his thoughts in The Hindu on curbs on Chinese FDI:
It is for the national security establishment within the Indian government to determine which sectors are considered very sensitive. For example, it was decided that we should be careful not to invite Chinese investment or participation in projects on our coast, which may be near our naval bases. The digital economy of India is considered a sensitive sector, and if it is dominated by Chinese investment and companies, our security may be compromised due to potential invisible data flows. There could also be kill switches that can be shut off during a period of emergency. Consumer items may not pose the same kind of concerns.
Our view in the Ministry of External Affairs, when I was serving there, was that we should not make some of these limitations China-specific. If there is an area of security concern, the basic effort should be to ensure it is not open to foreign investment. Such a policy is better than being country-specific.
First, we should recognise that it is not such a simple matter to say we want to be part of this supply chain. Supply chains work efficiently in a low-tariff regime. Unless you make your market open to very easy imports of components, these items cross borders several times before a final product is made. Second, we have to determine the components of that supply chain in which we have competitiveness. I think we also have to study the experience of some Chinese FDI, already present in India, which is actually quite successful, such as Xiaomi and Oppo. We should also see if there are any other areas where Chinese FDI could be invited. Off the cuff, Chinese EV manufacturers may have a lot of interest in India. So why not consider that favourably?
Finally, a few thoughts from me:
1) I agree with Shyam Saran’s point: I think PN3 being so obviously country-specific (despite the use of neighbouring countries and not China) was ill-advised. What it should have done in the first place -- what yesterday’s announcement also does -- is introduce sector-specific regulations and limitations. By being country-specific, a clear message was sent that Chinese investors were not welcome, and that’s a sentiment that is now deeply pervasive and will not be easy to undo, now that policymakers have changed their mind on Chinese investment. Sure, investors will always put their money where they see value, but in my limited interactions, I’ve found a common perception now that “India is difficult”, quite a profound shift from the dominant view pre-2020 that India was, for many Chinese companies, the single biggest opportunity outside China.
2) It’s worth noting that Chinese outbound investment, especially to Asia, is growing at a much slower pace. Last year, it was up 7% overall — but only by 1.2% to Asia (and that too, mostly ASEAN). Africa and Europe were higher.
3) I’m still a bit unclear as to what PN3 achieved, partly because I’m unclear as to what its objectives were. It’s often wrongly reported as a response to the border clashes. That’s not the case. It came out in April 2020, weeks before the border flared up. It was officially prompted by concerns that the pandemic would lead to hostile takeovers.
Up until then, the Modi government was extremely welcoming of Chinese investment. In the period from 2014-2019, India received more investment from China than in the 20 years before 2014. The numbers are somewhat hard to estimate as some of it is routed through third countries. Official Chinese figures pegged it at around $8billion; it was probably more, when you take into account all the acquisitions in the e-commerce sector then by Alibaba, Tencent and others.
When I was reporting in Beijing for India Today from 2014 to 2018, there was a concerted effort under “Make in India” to get Chinese companies to start manufacturing in India the goods they were selling in huge numbers. Two outcomes then were deals for an industrial park in Maharashtra to get some of the biggest Chinese auto manufacturers to produce auto components (a huge import) and vehicles, and another in Gujarat in new energy, to produce among other things solar components (another big import). It was touted as a $7 billion investment to build two dedicated Chinese manufacturing clusters. Neither took off for various reasons. Political will (or a lack of it) to see it through was one of them.
Was PN3 also an attempt to diversify and reduce reliance on China? Things didn’t quite pan out that way. In years since PN3, India’s imported more from China than it did previously, each year registering record figures. Trade data that came out in Beijing yesterday showed India imported more in the first 2 months of this year from China than any year on record. We bought $25 billion worth of Chinese goods, and exported only around $3 billion. Imports are up 20% year on year. Last year, we bought a record $150 billion worth of goods from China.
4)Finally, it’s difficult to not lament the lack of a carefully thought-out trade and investment strategy to deal with the China economic challenge — a strategy that has some resilience. The reasoning in the 2014-2019 period was sound. Yet the execution was, in hindsight, half-hearted — the industrial parks are a case in point — and then the strategy entirely abandoned.
The China-Japan parallel is interesting. Beijing decided, for better or worse, it needed Japanese companies and technology to move up the value chain, despite the baggage of history — and it’s a far weightier baggage than on the India-China front — and decided to stick with it despite the ups and downs in relations with Japan. I asked Doubao (the Chinese AI platform that’s become, for me, an essential tool in sifting through official data) how many Japanese companies were in China today. The answer was more than I thought: 27,148 Japan-invested enterprises and 5,139 Japanese manufacturing firms with production bases in China, employing more than 1 million people, and a cumulative investment of $280 billion - only behind Hong Kong and Singapore. Opening to Japanese investment was looked less as a favour being done to Japan than a cold, pragmatic calculation of self-interest.
Thank you for reading.
Nicely summarized. It's not just the China strategy of the govt that's faulty, many other similar failures are visible. The worrying thing is that self correction also takes too long or in some cases, never happens.
Insightful