The Reserve Bank of India has objected to the new foreign investment guidelines for the calculating indirect foreign holding in Indian companies, which are non-transparent and will make monitoring of sectoral caps difficult.
The central bank will send its comments to the finance ministry shortly. Sources close to the developments said a better way could have been worked out to increase the sectoral caps.
The sources said while a cap was meant to protect the interest of the Indian shareholders in sensitive sectors, the new mode of calculation of indirect foreign holding provided for a circuitous way.
This would make monitoring of inflows difficult, in terms of maintaining the cap in sensitive sectors; checking the quality of funds and ascertaining the actual owner of the Indian investing company with foreign ownership.
Indirect foreign holding is the interest of a foreign company in an Indian company through another Indian entity.
The finance ministry is expected to ask the commerce ministry for clarifications on RBI's queries. The department of industrial promotion and policy, under the commerce ministry, is the apex body for formulation of foreign investment guidelines.
In a recently-issued press note, DIPP had clarified that a company set up by another Indian company where a foreign investor has less than 49 per cent stake and the management is in the hands of the Indian owners, cannot be said to attract indirect foreign capital.
Till now, the indirect foreign stake in an Indian company was proportionate to the foreign holding in the original Indian company, which is floating the new company.
RBI, in its comments, said there were many other ways of a foreign company exercising control in an Indian firm and it need not necessarily be through buying shares or management control.
Sources explained that the other methods would be depository receipts, preferential allotment of shares, shareholder agreement or economic interest.
The Indian company could float shell firms, controlled entirely by the foreign party, which could make investments in India. In such cases, it would be difficult to monitor the actual control and the actual foreign shareholding in the company, RBI said.
Also, in cases where the foreign shareholding is scattered through holdings by foreign institutional investors or American depository receipts or global depository receipts, the voting rights rest with the custodian of the shares.
Sources said how the custodian votes is a grey area unless it is strictly mentioned in the prospectus of the ADR/GDR issue that they could vote as per the instructions of the board of the company which is managed by the Indian residents.
"In the case of Hutchinson Essar-Vodafone, the Foreign Investment Promotion Board had rejected Vodafone's investment proposal since the shareholding of two investors not only breached the shareholding cap in the sector, but was assumed to have control over the company even with minority shareholding.
"Here, we are ignoring control with even 49 per cent," the sources said.
Prior to the finalisation of the press note on indirect foreign holding, the finance ministry had taken a firm stand and advocated that all interests of foreign entities -- control, economic benefits and shareholding -- be included in calculating the effective foreign holding in a company.
Thus, it could be proportionate to the holding of the foreign investor in the original Indian company, which is in turn floating another company in India.
DIPP, on the other hand, used to follow the two-pronged method, by which the foreign company should have at least 50 per cent plus one share in an Indian company, which in turn should have at least 10 per cent stake in another Indian company, in which the indirect foreign holding is sought to be calculated.