How best to stop China's takeover attempts

By Pratik Datta

India recently made a crucial change to its Foreign Direct Investment (FDI) policy. Effectively, Chinese FDI will now be subject to screening by Indian government under the exchange control law – the Foreign Exchange Management Act, 1999 (FEMA). This is intended to curb opportunistic takeovers of Indian companies by Chinese investors in the wake of Covid-19 crisis.

India’s move is not an aberration. Western liberal democracies have also adopted measures to curb similar takeover attempts. However, there is a fundamental difference in approach. While the western countries have used special laws for national security screening of FDI to tackle opportunistic takeovers, India used exchange control law for the same purpose.

Exchange control restricts free convertibility of domestic currency into foreign currency. Restricted convertibility reduces exchange rate volatility of domestic currency. A stable domestic currency facilitates external trade and payments. And higher volumes of external trade and payments help deepen the foreign exchange market. These happen to be the twin objectives of FEMA, as evident from its preamble.

National security is unrelated to exchange control. It is an important, but separate policy objective. Many western countries have dedicated legislation for national security screening of inward FDI.

For instance, in the USA, the Defence Production Act, 1950, empowers the President, acting through the Committee on Foreign Investments in the United States (‘CFIUS’), to review foreign investment transactions for ‘national security’. In March 2020, President Trump used this power to issue an executive order prohibiting the acquisition of StayNTouch, Inc. by Beijing Shiji Information Technology Co. Ltd. on the ground of ‘national security’.

Similarly, in Australia, the Foreign Acquisition and Takeovers Act, 1975 empowers the Treasurer, acting on recommendations of the Foreign Investment Review Board (‘FIRB’), to prohibit certain foreign investment transaction on grounds of ‘national interest’. Similar laws exist in many European countries. In the wake of Covid-19, these laws are being used to curb opportunistic takeovers.

The UK is an outlier. Its national security screening process for inward FDI is fused into its merger control regime. This unique institutional arrangement has proved inadequate. In 2018, the UK government recommended shifting towards a national security screening framework for FDI.

Evidently, most advanced jurisdictions prefer a dedicated legislation for national security screening of inward FDI. In sharp contrast, India does not have a similar legislation. Nor is such screening a part of Indian merger control regime. Faced with such acute legislative vacuum, FEMA has gradually doubled up as the national security screening law for inward FDI into India. Clearly, this institutional framework is not in sync with the global best practice.

Indian policymakers should rethink this ill-conceived institutional arrangement. National security and exchange control are separate and independent policy objectives. It would be wise to have a separate law for national security screening of inward FDI. This could offer three potential benefits.

First, ad hoc changes to exchange controls to disadvantage investors from a particular country could lead to legal challenges. For instance, it could violate the Most Favoured Nation (MFN) or Fair and Equitable Treatment (FET) clauses in the bilateral investment treaty between India and that foreign country, which require India to maintain a transparent regulatory framework and not take any discriminatory measures. Such legal risks could be substantially mitigated if due process under a robust FDI screening law is strictly followed.

Second, at a time when global supply chains are getting disrupted and India is trying to attract these businesses through the FDI route, India may need to relax exchange controls while simultaneously tightening national security screening. Separate institutional architectures would be necessary to pursue such divergent policy goals.

Third, Indian policymakers have long aspired for full capital account convertibility. When this actually happens, FEMA will be dismantled. But national security concerns will remain and FDI screenings must still continue. Therefore, national security screening of inward FDI should ideally be taken out of FEMA and housed in a separate legislative framework.

(Pratik Datta is a Senior Research Fellow at Shardul Amarchand Mangaldas & Co, New Delhi. The author acknowledges the useful discussions with Prashant Saran, Sudarshan Sen, Rishab Gupta and Siddharth Nair. All views expressed are personal.)

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