Three years after India imposed sweeping restrictions on the flow of Chinese investment, including a ban on apps such as TikTok, investment from China is slowly returning through new avenues and routes, official data shows. While the April 2020 ban on investment from China amid a boom in Chinese acquisitions during the pandemic was driven by national security concerns, the bans have resulted in more opaque investment structures with new implications for regulation and national security, says Santosh Pai, Honorary Fellow at the Institute of Chinese Studies, New Delhi and partner at Dentons Link Legal who has tracked Chinese investments in India. Edited excerpts:
What has been the impact of the sanctions imposed in April 2020 on Chinese investment, which had been on the rise since 2014?
The 2014 period, with the launch of the Make in India programme, is the time when Chinese FDI inflows into India really picked up. From 2000 to 2013, Chinese investment in India was negligible, but from 2014 to 2020, annual inflows increased almost every year, both in terms of the number of transactions and the value of transactions. The number of transactions actually peaked in 2019 at 527, while the annual value peaked in 2015 when we managed to attract $859 million in a single year.
But this is only direct investment. In addition, there was a substantial chunk of indirect investment that is not shown as Chinese investment in the RBI data. For example, start-ups alone attracted about $5 billion in that period. Overall, you can definitely call this the golden age of Chinese investment in India.
What is very important, from a regulatory perspective, is that during this boom period, Chinese investments did not really face any scrutiny in India, which is very unusual as many other countries saw Chinese investments at the same time. had begun to investigate, pick and choose what they wanted, or formulate a policy on what types of investments were welcome. It happened in Europe, it happened in the US, in retrospect, maybe it took a while for India to understand the need to check Chinese investments. But as you said, it certainly happened in 2020 and thereafter, there has been a huge impact on direct investment flows.
So what changed in 2020, when the Indian government issued Press Note 3 in April, shortly before the border crisis began, and later banned the apps and other rules as relations deteriorated?
Many people are confused that Press Note 3 was due to the Galwan Valley incident. [in June 2020], But it came out a few weeks ago. Press Note 3 There is a comprehensive requirement to scrutinize all kinds of Chinese investment, whatever the sector, whatever the amount, whether you own 1% or 100%, you need approval. It is a due diligence mechanism where every single investment will be scrutinized and approved by the Government of India.
What triggered Press Note 3 is still somewhat debatable. At the time, there was a stock exchange filing by a Chinese sovereign wealth fund that had amassed a more than 1% stake in India’s largest mortgage lender HDFC, so apparently, that was the immediate trigger.
But if you look at the figures, perhaps there is a case to be argued that in January-March 2020, we received around 161 transactions. That was the highest quarter in the last 20 years. In 2019, the annual number of transactions was 527 and the year before that, 404. In the first quarter of 2020, there was an epidemic that was spreading around the world, and at the same time, the number of investment transactions also increased. China really accelerated.
Looking back, one can say that someone in the government saw this and said look, Chinese investment has increased in three months, and it coincides with COVID. And then after that the HDFC filing came out. So all this could have contributed to Press Note 3, which stated that beneficial ownership by an entity or individual in a country that has a land border with India would require government approval.
Earlier, for historical reasons, the only geographical restrictions on India were on investments from Pakistan and Bangladesh. From a regulatory point of view, what Press Note 3 actually did was that it put other border countries including Afghanistan, China and Myanmar in the same category as Pakistan and Bangladesh. This was the first time in 20 years of liberalisation, that India took a sort of regressive step, which actually made foreign investment difficult. So it was of regulatory importance. In the end, it was probably too little, too late as we should have started examining investments a little earlier, as this was already an emerging global trend and as a major economy, we need to be more concerned about national security. From the point of view these railings should have been implemented.
How has this new testing mechanism affected incoming investments?
In March 2022, in response to parliamentary questions, we received some statistics which showed that in the last two years, 347 applications were received and 66 were approved, 193 were rejected. The key figure was that ₹13,635 crore was approved.
There is a time lag between the approval being given and the actual investment coming into India, but I think we should focus on the actual investment coming in. We do not have data on approvals, but investment data is published regularly by RBI. In the last three years, we have received a little less than $10 million from mainland China and a little less than $60 million from Hong Kong, or about ₹565 crore in total. The approval rate is around 20%, and conversion after that, is in the low single digits. So if $100 worth of investment is actually approved, maybe about 5% of that actually comes through.
This is the new reality – investing directly in India with approval is a huge disincentive for Chinese investors. If we want to take a larger takeaway from this, what we are seeing is that indirect Chinese investments coming through other jurisdictions have increased – not only increased, but they have become more and more Chinese investments. They are not even coming in form.
Press Note 3 clarifies that no matter how the investment is made, approval must be obtained as long as the beneficial ownership is with the Chinese investor. But a lot of indirect investment is coming without approval. It only means that opaque investment structures are being used in other countries to, in fact, conceal Chinese beneficial ownership. There are many ways in which one can do this. I don’t know whether it bodes well for the investment climate in India because at one level, you would say that it is better to know which are the Chinese investments, and investigate them. But if you’re pushing most investments into opaque domains, by a very strict vetting mechanism, it’s arguable whether that’s good for the long term, because then we don’t even know what kind of Chinese investments is coming. , where are they going, etc. And today we are there.
We are also seeing some Chinese companies coming back to the India market with a fresh approach, such as the once-banned online fashion company Shein which has tied up with Reliance Industries. Are we seeing more such arrangements?
Sheen is a very good example as it was one of over 300 internet applications banned from India, but it seems that Sheen has been able to differentiate itself from the others, as it is just a technology layer to the retail business, where It sells fast-fashion clothing, etc. It’s a really good template – if a Chinese investor can demonstrate value to the domestic economy in India, either by sourcing their products or creating jobs, such approval will be granted. In this case, there is no equity investment, hence the question of approval of Press Note 3 does not arise.
I see other discussions happening. MG Motors is in discussions to sell the stake as they have not been able to bring in fresh equity investment and the automotive sector is highly capital intensive. Hence some Indian business houses are in fray to take equity stake in MG Motors. Overall, a template is emerging and the red lines are moving a bit. For the digital economy, I would still say there is a red line. I don’t think the arrival of Sheen will allow many other internet applications to re-enter the Indian market as India has concerns from a data and national security perspective.
In manufacturing, things are definitely changing. If you look at the actual approvals given under Press Note 3, we see that there is a heavy concentration of manufacturing investments, about 70-80% of them are actual investments that are going to result in some sort of manufacturing activity in India. Either for renewable energy products or for automotive products. This is the new template – if India lacks domestic production in a particular sector, or we have excessive import dependence in a sector, and a Chinese company comes and manufactures in India as a joint venture partner with an Indian company wants to do Minority stake for Chinese company.
When we look at the investments coming through other countries, late last year the Cayman Islands became one of the top sources of investment in India. This raised some eyebrows because globally, the Cayman Islands is a very popular destination for sending Chinese money to different countries. The Cayman Islands is a very popular jurisdiction whenever Chinese companies invest. So last year there was a discussion on how Chinese money could come. Singapore is, of course, the more logical and visible source of Chinese investment at this point in time.
In the period 2014-2019, the start-up sector attracted a lot of Chinese funding. Are restrictions on tech start-up funding due to security and data concerns now a non-negotiable issue for India?
When we are talking about start-ups, we need to focus on the types of businesses because today a start-up could be, hypothetically speaking, one that could launch a new electric vehicle And is like a physical business. I think these kinds of investments will still be possible. But if you’re talking about a start-up in the sense of a pure Internet company, for example a social media app, then I think it’s still a red line. For example, I don’t think any WeChat or TikTok will be able to come back in India in the current scenario, but as we have seen, these red lines may move a bit further. It largely depends on what is happening globally. For example, now that there is talk of banning TikTok in the US, it will be even more difficult for India to do so, as India was actually one of the first countries to ban TikTok.
If we see this trend growing up, many of these start-ups are moving away from China and establishing themselves as Singapore companies for example, which is what Sheen is doing – and many more There are Chinese companies that are positioning themselves as global companies. Nothing to do with China – it is possible that India will allow some of these companies as well, as it welcomes foreign companies. But we are still a long way from there.
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