Context

• The debate over Chinese foreign direct investment (FDI) into India oscillates between the economic benefits and potential security risks.
• This discourse is critical, as it not only addresses the immediate concerns of economic competition and sovereignty but also prompts the question of whether India has an adequate legislative framework to manage FDI and international trade in the context of national security.
• Despite widespread discussion, the answer remains that India lacks a comprehensive legal structure to address these concerns effectively.

India’s Existing FDI Regulation: Press Note 3 (PN3)

• India’s approach to regulating FDI underwent a significant shift in April 2020, when the government introduced Press Note 3 (PN3) in response to economic vulnerabilities worsened by the COVID-19 pandemic.
• PN3 is enforced through the Foreign Exchange Management Act (FEMA) — a law that provides the architecture for the orderly development and maintenance of the foreign exchange market in India.
• PN3 represents a crucial regulatory measure designed to curb opportunistic takeovers of Indian companies by foreign investors, particularly from neighbouring countries.
• While the pandemic weakened several sectors of the Indian economy, there was growing concern that foreign investors, especially from China, might exploit the situation by acquiring distressed Indian companies.
• PN3 was seen as a protective response to these concerns, but its scope and impact are much broader, with profound implications for India's FDI policy.

Key Features of PN3: Geographical Focus and Scope

• Geographical Focus
  • While many countries share land borders with India, the primary target of this regulation was China, given the growing economic and geopolitical tensions between the two nations.
  • China had been a significant investor in various sectors of the Indian economy, including technology, manufacturing, and infrastructure.
  • PN3 sought to limit this influence by increasing the scrutiny of Chinese investments.
• Scope of the Regulation
  • PN3 applies to both new investments and changes in ownership of existing investments.
  • This means that even if a company was already operating in India with foreign investment, any future changes in shareholding or ownership would require government approval if the investment originated from a bordering country.
  • This aspect of the regulation was designed to prevent indirect acquisitions or changes in control of Indian companies.

Strategic Importance of PN3 in India’s FDI Policy

• Geopolitical Context
  • The introduction of PN3 should be understood in the context of India’s broader geopolitical strategy.
  • Relations between India and China have been fraught, particularly considering border disputes, trade imbalances, and strategic competition in the Indo-Pacific region.
  • By tightening control over Chinese investments, India is asserting its economic sovereignty and reducing the risk of foreign entities exerting undue influence on its domestic industries.
• Economic Protectionism vs. National Security
  • PN3 reflects a growing trend of economic protectionism driven by national security concerns.
  • While traditionally, FDI has been seen as a means of fostering economic growth and development, PN3 represents a shift towards a more cautious and defensive stance, where security considerations take precedence over economic liberalisation.
  • This shift aligns India with other major economies, such as the US, Canada, and Australia, which have also introduced measures to screen FDI based on national security concerns.

Limitations and Criticisms of PN3

• Absence of Direct National Security Provisions
  • One of the major limitations of PN3 is its failure to explicitly mention national security as a basis for restricting FDI.
  • Although national security concerns are clearly the driving force behind the regulation, the lack of explicit language leaves India’s FDI regime vulnerable to legal challenges.
  • In the absence of a well-defined national security law, the reliance on FEMA to screen FDI for security risks may not be legally sufficient in international arbitration or dispute resolution settings.
• Impact on Business and Economic Relations
  • The requirement for prior government approval can slow down investment processes and may act as a deterrent for foreign investors.
  • By creating additional layers of bureaucracy, PN3 potentially hampers the ease of doing business, particularly for companies that may not pose any security risks but are still subject to the same scrutiny as those from countries with a contentious relationship with India, like China.
  • For instance, investments from friendly neighbouring countries, such as Bhutan or Nepal, are subjected to the same regulations, even though they do not pose significant security concerns.
• Targeted at China but Broader in Scope
  • While PN3 was largely seen as a response to Chinese investments, the regulation applies to all land-bordering countries, many of which have friendly relations with India.
  • This broad-brush approach has raised concerns that it may unnecessarily restrict beneficial investments from countries like Nepal, Bhutan, and Bangladesh.
  • This general application could hinder regional cooperation and economic integration, especially when such investments do not raise security alarms.
• Indirect Effects on Multinational Corporations (MNCs)
  • PN3 could have an impact on MNCs with Chinese ownership or investments, even if these companies are headquartered in countries outside the region.
  • For example, if a U.S. or European company with significant Chinese shareholding wants to invest in India, it may be subject to the same scrutiny as a direct Chinese investor.
  • This could complicate the investment landscape for global companies that have complex ownership structures, creating uncertainty and additional compliance burdens.

The Need for a Coherent Approach to FDI and National Security

• A Legal Disconnect
  • The disparity between India’s domestic legal framework and its international treaty obligations further underscores the need for a more coherent approach to FDI and national security.
  • India’s past and current international investment treaties, such as the 2015 Model Bilateral Investment Treaty (BIT), include specific provisions for managing issues related to foreign exchange and national security.
  • For example, Article 6 of the BIT deals with exchange control issues, while Article 33 allows the state to take measures to protect national security, even if these actions violate the treaty’s substantive provisions.
• The Broader Legal Vacuum in India’s National Security Legislation
  • India’s legal gap extends beyond FDI to encompass international trade as well.
  • A notable example is India’s response to the Pulwama terror attack in February 2019, which led to the imposition of 200 percent customs duties on Pakistani imports.
  • The measure was justified on the grounds of national security, yet India invoked Section 8A (1) of the Customs Tariff Act — a provision designed for economic emergencies, not for security threats.
  • This reflects a broader pattern in which India repurposes existing economic laws to address national security concerns, rather than developing dedicated legislation for such scenarios.

Way Forward: Need for Dedicated National Security Legislation

• The ongoing debate about the security risks posed by Chinese FDI presents an opportunity to launch a broader national discussion on the need for a comprehensive legal framework that aligns with global best practices.
• Countries like Canada and Australia have demonstrated the importance of having dedicated laws to manage the national security risks associated with FDI and international trade.
• India should follow suit by developing legislation specifically designed to address these concerns.

Conclusion

• While India has taken steps to manage foreign investment through regulations like PN3, the absence of a comprehensive national security framework remains a critical gap.
• As India continues to attract FDI and engage in global trade, it is imperative that the country develops a clear legal mechanism to safeguard its national security.
• By learning from the practices of other nations and aligning its domestic laws with its international treaty obligations, India can better protect its sovereignty and economic interests in the face of emerging global challenges.