FDI Policy in South Asia

South Asian countries had a fairly restrictive regime in the early years after independence, and it is only in the last decade that they have opened up and made their FDI policy environments conducive to foreign investment. Initially, FDI was allowed in a restrictive manner and on mutually advantageous terms with the majority stake held by domestic firms. However, all five south Asian countries tried to encourage FDI more aggressively in the nineties, by making changes in their macroeconomic policies along with trade and FDI policies. A summary of FDI policy frameworks in South Asia is presented in Table 1 [ PDF 48.4KB | 1 pages ] at the end of this section. In this section, an attempt is made to briefly review the FDI policies of the five South Asian countries by analyzing past policies and future prospects of FDI into South Asia.

Evolution of the FDI policy in India: There has been a gradual change in the government's attitude to FDI since 1948. Being a resource-poor country, especially in capital resources, India was always receptive to foreign investment. The foreign exchange crisis of 1957-58 led to a further liberalization of the government's attitude towards FDI (See Kumar, 2003 for details). However, the government adopted a more restrictive attitude towards FDI in the late 1960s as local industries developed. In 1973, the new Foreign Exchange Regulation Act (FERA) came into force, requiring all foreign companies operating in India to register under Indian corporate legislation with up to 40 percent equity. In the 1980s, as a part of the industrial policy resolutions, the attitude towards FDI was liberalized. However, through the new economic policy and the new industrial policy of 1991, a series of policy measures were announced to liberalise the FDI environment in the country. As a result, India today has one of the most attractive FDI policies in the South Asian region.

FDI policy framework and incentives for FDI in India: The first and secondgeneration reforms created a conducive environment for foreign investment in India. The Foreign Direct Investment (FDI) policy is reviewed on a regular basis and changes in sectoral policy/sectoral equity caps are notified through Press Notes ¹³ by the Secretariat for Industrial Assistance (SIA), Department of Industrial Policy & Promotion. The FDI policy is also notified by the Reserve Bank of India (RBI) under the Foreign Exchange Management Act (FEMA). ¹⁴ Most of the sectors/activities are under the Automatic Approval Route, except for a few sectors where there are additional restrictions on FDI such as equity caps, divestment conditions, lockin periods on investment, etc. These restrictions have been imposed in view of sectoral requirements, security and strategic concerns and in the interest of the domestic investments. There are only a few sectors where FDI is not permitted.

Industrial Licensing: Industrial licensing policies and procedures have also been liberalized from time to time. All industrial undertakings are exempt from obtaining an industrial license to manufacture, except for: (i) industries retained under compulsory licensing, ¹⁵ (ii) items of manufacture reserved for the small-scale sector; and (iii) when the proposed location attracts locational restriction. ¹⁶

FDI Related institutions

Foreign Investment Promotion Board (FIPB): The Foreign Investment Promotion Board (FIPB), Ministry of Finance, is the nodal, single window agency for all matters relating to FDI, whose objective is to promote FDI into India, [ i ] by undertaking investment promotion activities, [ ii ] facilitating foreign investment, [ iii ] purposeful negotiation/discussion with potential investors, [ iv ] early clearance of proposals, and [ v ] reviewing policy and putting in place appropriate institutional arrangements, transparent rules and procedures and guidelines for investment promotion and approvals.

Secretariat for Industrial Assistance (SIA): The Secretariat for Industrial Assistance (SIA), Ministry of Commerce & Industry, provides a single window service for entrepreneurial assistance, investor facilitation, receiving and processing all applications, assisting entrepreneurs and investors in setting up projects (including liaison with other organisations and state governments) and in monitoring the implementation of projects. ¹⁷

Foreign Investment Implementation Authority (FIIA): FIIA provides a pro-active one stop after service care to foreign investors by helping them obtain necessary approvals, sort out operational problems and meet with various Government agencies to find solution to their problems.

Foreign Investment Policy

Foreign investment is permitted in virtually every sector, except those of strategic concern such as defense ¹⁸ and transport. Foreign companies are permitted to set up 100 percent subsidiaries in India. No prior approval from exchange control authorities (the Reserve Bank of India, or RBI) is required, except for certain specified activities. Under current policy, FDI can come into India in two ways.

Automatic route: FDI in sectors/activities, to the extent permitted under the automatic route does not require any prior approval either by the Government or RBI. The investors are only required to notify the proper regional office of the RBI within 30 days of the receipt of inward remittances and file the required documents with that office within 30 days of the issue of shares to foreign investors.

Prior Government Approval route (for both foreign investment and foreign technical collaboration): In the limited category of sectors requiring prior government approval, proposals are considered in a time-bound and transparent manner by the Foreign Investment Promotion Board (FIPB). For all activities that are not covered under the automatic route, government approval through the FIPB is necessary. The Foreign Direct Investments under Automatic Approval and Government Approval are regulated by the Foreign Exchange Management Act, 1999 (FEMA). There are also provisions for automatic approval for new and existing companies.

FDI in SEZs /EOUs/Industrial Parks/EHTP/STP: Special Economic Zones (SEZs) are specifically delineated duty free enclaves and are deemed to be foreign territory for the purposes of trade operations and duties and tariffs. FDI up to 100 percent is permitted under the automatic route for the establishment of SEZs. Proposals not covered under the automatic route require approval by FIPB. FDI up to 100 percent is permitted under the automatic route for setting up 100 percent Export Oriented Units (EOUs), subject to sectoral policies. FDI up to 100 percent is permitted under the automatic route for the establishment of Industrial Parks. Proposals for FDI/NRI (Non-Residents Indian) investment in EHTP Units are eligible for approval under the automatic route, subject to certain parameters listed by the government. Similarly, proposals for FDI/NRI investment in Software Technology Park (STP) units are eligible for approval under the automatic route, subject to parameters listed by the government.

Repatriation of investment capital and profits: All foreign investments are freely repatriable except for cases where NRIs choose to invest specifically under non-repatriable schemes. Non-residents can sell shares on the stock exchange and repatriate sale proceeds if they hold a tax clearance certificate issued by authorities in charge of income tax. Profits, dividends, etc. (which are remittances classified as current account transactions) can be freely repatriated.

Important Labor Rules/Regulations Applicable in India: Under the Constitution of India, labor is a subject in the "concurrent list," under which both the central and state governments are competent to enact legislation subject to certain matters being reserved for the centre. There are several important Labor Acts since 1952, which are highly protective of labor.

Policy regarding intellectual property rights: India is a signatory to the agreement concluding the Uruguay Round of GATT negotiations and establishing the World Trade Organization (WTO). This Agreement contains an Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS), which lays down minimum standards for the protection and enforcement of intellectual property rights.

Taxation Policy in India and Tax Incentives

India is moving towards a reform of its tax policies and systems to facilitate the globalization of economic activities. ¹⁹ Tax holidays are available in Special Economic Zones set up to make industry globally competitive. Infrastructure Sector Projects enjoy special tax treatment and holidays. Since 31 March 2004, a user-friendly tax administration has been introduced with round-the-clock electronic filing of customs documents. Foreign nationals working in India are generally taxed only on their Indian income. Income received from sources outside India is not taxable unless it is received in India. Further, foreign nationals have the option of being taxed under the tax treaties that India may have signed with their country of residence. India has entered into Double Taxation Avoidance Agreements (DTAA) with 65 countries including the U.S., U.K., Japan, Germany, and Mauritius. Though the Indian government gives different kinds of investment incentives, major incentives are given in the form of tax exemptions on profit from the development and operation of infrastructure projects including power.

Overall, FDI in India is allowed in all sectors except the four mentioned below, where it is prohibited. They are: (i) Retail trading (except for single brand product retailing), (ii) atomic energy, (iii) lotteries, and (iv) gambling and betting. In all other sectors, it is allowed with different equity limits ranging from 26 percent to 100 percent. The FDI environment in India has undergone a sea change since the inception of economic reforms in 1991. India's strengths as an investment destination rest on strong fundamentals, including a large and growing market; world-class scientific, technical and managerial manpower, cost-effective and highly skilled labor, an abundance of natural resources, a large English-speaking population and an independent judiciary.

Pakistan

Evolution of FDI policy in Pakistan: The first step toward the liberalization of FDI by Pakistan was taken in 1984 with the announcement of the industrial policy statement giving an equal plank to the public and private sectors. Foreign private investment was encouraged in the form of joint equity participation with local investors and in areas where advanced technology, managerial and technical skills and marketing expertise were needed. An adequate legal framework for foreign investment was provided through the Foreign Private Investment Act (Promotion and Protection Act) 1976. The Act also guaranteed the remittance of profit and capital, and the appreciation of agreements on the avoidance of double taxation.

However, Pakistan began to actually open up its economy and liberalize its FDI policies towards the end of the 1980s. A new industrial policy package was introduced in 1989 recognizing the role and importance of the private sector, and a number of regulatory measures were taken to improve the business environment in general and attract FDI in particular. The Board of Investment (BOI) was set up, attached to the PM's secretariat, to help generate opportunities for FDI and provide investment services. BOI is a "one window facility" which helps the establishment of new industries. To facilitate foreign investment, Pakistan has signed bilateral agreements on the promotion and protection of investment with 46 countries.

FDI policy framework in Pakistan: In November 1997, the government of Pakistan announced the New Investment Policy that included major policy initiatives to attract FDI, which had earlier been restricted to the manufacturing sector. It was now opened up to sectors like services and agriculture, which constitute three fourths of GNP. The main objective of the new policy is to enhance the level of foreign investment in the fields of industrial base expansion, infrastructure and software development, electronics, engineering, agri-food, valueadded textile items, tourism and construction industries. Foreign investment on a repatriable basis is also allowed in agriculture, services, infrastructure and social sectors, subject to the following conditions: (a) the basis for joint venture is (60:40), (b) foreign equity will be at least $1 million, (c) foreign companies registered in Pakistan will be allowed to invest; and (iv) for social sector and infrastructure projects, the joint venture requirement is waived (100 percent foreign equity may be allowed).

Investment in the manufacturing sector and non-manufacturing sector: Foreign investors are allowed to hold up to 100 percent equity of industrial projects without any permission from the government except in certain fields of activity such as: (a) arms and ammunition (b) high explosives (c) radioactive substances (d) security printing, currency and mint; and (e) alcoholic beverages and liquors.

Foreign investment at 100 percent equity on a repatriable basis is allowed in the service, infrastructure and social and agricultural sectors subject to certain conditions including registration of company with the Security and Exchange Commission of Pakistan (SECP) and also intimation to the State Bank of Pakistan. Foreign equity of 100 percent is allowed in the service sector, infrastructure projects and social sector projects on a repatriable basis. FDI is also actively encouraged in tourism, housing and construction, information technology, etc.

Incentives for FDI, tax incentives/tariffs, exchange control, and technical fees in Pakistan: Since 1997, attractive tariff and tax incentives have been given to foreign investors. Remittances of royalties, technical and franchise fees, capital, profits and dividends are allowed. Further, foreign investment is fully protected through the Foreign Investment (Promotion and Protection) Act 1976, Protection of Economic Reforms Act 1992 and Foreign Currency Accounts (Protection) Ordinance, 2001.

In the manufacturing sector, the customs duty on imported raw materials used in producing for exports is zero percent, while a customs duty of 5 percent is charged on imports of plants, machinery and equipment not manufactured locally. The import of raw materials, sub-components, components for the manufacture of plants for sugar, cement, power, chemical, fertilizers, oil and gas, etc., is free. In all these cases, the sales tax is zero. The corporate tax rate is around 35 percent. The government of Pakistan has signed agreements for the avoidance of double taxation with 52 countries including developed countries.

The full repatriation of capital, capital gains, dividends and profits is allowed. A facility for contracting foreign private loans (Which does not involve any guarantee by the government) is available to all foreign investors who make investments in sectors open to foreign investment, for the cost of plant and machinery required for setting up the project.

There are no restrictions on the payment of royalties or technical service fees for the manufacturing sector. The payment of royalties and technical service fees to foreign companies is taxed at 15 percent. However, concessions under different treaties with different countries apply.

Labor laws: One major drawback to FDI in Pakistan is its labor laws, which are overprotective and complicated, discouraging job creation, inhibiting business expansion and thereby discouraging much-needed productive investment. Labor disputes are common, creating problems for management, and productivity losses have acted as an impediment to foreign investment.

Based on its efforts to globalize, Pakistan has a decent foreign investment policy in place that encourages foreign investors in almost all economic sectors, based on a single window clearance. However, given its image as an extremely corrupt country, with overprotective labor laws and political and military strife and with no likelihood of democracy in the near future, Pakistan needs to ensure that all its FDI policies are implemented smoothly to facilitate the foreign investment it needs so much.

Sri Lanka

Evolution of FDI policy in Sri Lanka: There are basically two distinctive phases in Sri Lanka's FDI policy. The first phase was from 1948-1977, when the public sector was the dominant entity and controlled the country's resources. The second distinctive phase is of course the post 1977 period, when Sri Lanka launched its economic reform which favoured private-sector led, export-oriented development including a greater role for FDI. Many barriers were dismantled, including trade and payment barriers, the exchange rate was unified, agricultural and export taxes were restructured, administered prices were adjusted, and restrictions on pricing and investment by the private sector were reduced. The most important feature of FDI policy measure in Sri Lanka was the establishment in 1992 of the Board of Investment (BOI), with wide powers of tax relief and administrative discretion in all matters related to FDI.

Entry and establishment of FDI: FDI is permitted in most sectors but like most of its neighbouring South Asian economies such as India, Sri Lanka has a long negative list of sectors where FDI is barred completely or where foreign investors may only take a minority stake in an enterprise. However, a comparative study among Asian countries shows that Sri Lanka's list of restricted activities is relatively small. However, there are a few areas totally reserved for Sri Lankans, such as money lending, pawn broking, retail trade investment, providing personal services other than for the export of tourism sectors, coastal fishing, education of students and award of local educational degrees. However, there are regulated areas such as the growing and processing of primary commodities, mining, timber-based industries, education, etc., where foreign investment is restricted to 40 percent and approval by the BOI is required. In a few cases, FDI entry and incentives are subject to performance requirements. ²⁰

Treatment and protection of FDI ²¹: Sri Lanka does not set out principles of foreign investor treatment and protection in its national law. However, it has a network of Bilateral Investment Treaties with almost 24 countries. The repatriation of capital and profits is guaranteed. In practice, there is ready access to foreign exchange and the prospect of the nearly full abolition of exchange controls.

Labor laws and regulations: Labor policies in Sri Lanka are extremely restrictive, and pose impediments to foreign investors and investment in the country. Most of the laws favour the employee and in case of retrenchment, the decisions and the compensation package is largely in favour of the employee. Further, like other South Asian countries such as India, Sri Lanka has industrially active and politically influential trade unions. Another serious restrictive labor law in Sri Lanka is the Termination of Employment of Workmen (special provisions) Act (TEWA) of 1971, which restricts employers from dismissing employees except for serious disciplinary infractions.

Following the example of its counterparts such as India, Sri Lanka provides a range of tax incentives to foreign investors including breaks on taxes on corporate profits and dividends, value added tax and import and excise duties. Sri Lanka has also signed a wide net of double taxation treaties. ²² Some of the fiscal incentives include an initial tax holiday of five years followed by a long-term concessionary rate, varying from 15-20 percent depending on the industry, import duty exemptions on capital equipment in some industries and zero duties in raw materials in the export of manufactured goods.

Intellectual property law: Sri Lanka's intellectual property law is WTO compliant, under the trade related intellectual property rights agreement. Both process and product patents are recognized, and the patent period also complies with international standards. Copyright protection is available, and the period of protection conforms to international standards.

Overall, the Board of Investment (BOI) of Sri Lanka provides all services for foreign investors including approval of projects, grant of licenses and tax incentives, etc. Foreign investment is mainly encouraged in enterprises that make extensive use of foreign capital or technology, in export-oriented industries and in infrastructure projects. In many sectors, automatic approval is given for equity participation up to 100 percent. For restricted sectors such as telecommunication, education, mass transportation, mining, etc., permits are required from other government agencies for more than 49 percent equity participation. There are no exchange controls on current account transactions and no barriers to the remittance of corporate profits and dividends for foreign enterprises.

Bangladesh

Evolution of the FDI policy in Bangladesh: In the late 1980s and the 1990s, Bangladesh announced a series of measures and liberalized its FDI policy framework. In recent years, Bangladesh has significantly improved its investment and regulatory environment, including the liberalization of the industrial policy, abolition of performance requirements and allowance of full foreign-owned joint ventures. Since 1996, new sectors have been opened up for foreign investment, including the telecommunications sector.

FDI policy framework: Foreign direct investment is encouraged in all industrial activities in Bangladesh excluding those on the list of reserved industries such as production of arms and ammunitions; forest plantation and mechanized extraction within the bounds of a reserved forest, production of nuclear energy and printing and minting fresh currency notes. Such investments may be undertaken either independently or through joint ventures, either with the local, private or public sector. The capital market also remains open for portfolio investment. The policy framework for foreign investment in Bangladesh is based on the Foreign Private Investment (Promotion and Protection) Act, 1980, which provides measures for the non-discriminatory treatment and protection of foreign investment.

Incentives to foreign investment: The government has liberalized its industrial and investment policies in recent years by reducing bureaucratic control over private investment and opening up many areas. Some of the major incentives are tax exemptions for power generation, import duty exemptions for export processing, an exemption of import duties for export oriented industries, and tax holidays for different industries. Double taxation can be avoided by foreign investors on the basis of bilateral agreements. Facilities for the full repatriation of invested capital, profit and dividend exist.

Concessionary duty on imported capital machinery: An import duty, at the rate of 5 percent ad valorem, is payable on capital machinery and spares imported for initial installation. ²³ For 100 percent export oriented industries, no import duty is charged in the case of capital machinery and spares. Duties and taxes on the import of goods that are produced locally are higher than those applicable to imports of raw materials for the production of such goods.

Intellectual property rights and investment protection: The government recognizes the importance of intellectual property rights for attracting FDI and is making efforts to update its legislation and improve enforcement. The country has been a member of the World Intellectual Property Organisation (WIPO) since 1985 and signed the Paris Convention on Intellectual Property in 1991. The Foreign Private Investment (Promotion and Protection) Act of 1980 guarantees protection against expropriation. If a foreign investor becomes subject to a legal measure that has the effect of expropriation, adequate compensation will be paid to the investor and it will be freely repatriatable.

Labor laws: Workers are entitled to elect collective bargaining agents (CBAs) to negotiate their demands with management. A trade union may be formed if 30 percent of employees support it. All trade unions need to be registered. There are 47 labor laws covering matters such as wages, industrial disputes, working conditions, etc. Foreign nationals can be employed as long as their number does not exceed 15 percent of the total number of employees.

On the whole, Bangladesh has taken considerable steps to reform and liberalize all its economic policies including FDI. With low labor costs and almost no restrictions on the entry and exit of foreign investors, Bangladesh on the track toward becoming an attractive destination for FDI in the South Asian region.

Nepal

Evolution of the FDI policy: A clear-cut policy towards foreign investment was introduced in Nepal in the 1980s, with the enactment of the Investment and Industrial Enterprise Act of 1987. In its pursuit of outward oriented policies, Nepal began to encourage private foreign investment in every industrial sector (medium and large-scale), with the exception of defense activities. Joint ventures were the preferred form of investment, and limitations were set on the level of foreign equity holdings. In the case of medium sized industries, foreign equity of 50 percent was allowed. ²⁴

In large industries exporting more than 90% of their total production, foreign equity was allowed up to 100 percent. In other large industries, the maximum was set at 80 percent foreign equity. New projects by foreign investors required the formal approval of the Foreign Investment Promotion Division of the Ministry of Industry. In a step to further liberalize its foreign investment policy, Nepal announced a new set of incentives through the 1987 Act, under which the full remittance of dividends for investments in convertible currency was allowed. The repatriation of capital was made possible and foreign workers were allowed to be brought in when nationals were not available. A five-year tax holiday on profits was allowed, and this was later extended to 10 years. Importers were allowed to import their inputs duty free, either through a duty drawback or bonded warehouse facility.

Framework and incentives for FDI: Most sectors have been opened up to foreign investors, allowing 100 percent equity or joint ventures with Nepalese investors. ²⁵ The sectors that have been opened up to foreign investment are manufacturing, energy based industries, tourism, mineral resource based industries, and agro based industries and services. However, there are a few industries where investment is prohibited, including national security; cottage (i.e. craft) industries; personal services of a kind that would normally be performed by selfemployed people; and real estate. FDI is also not permitted in the retail business; travel agencies; cigarette, tobacco and alcohol production other than for export; a range of small tourist related activities, including tourist lodging, etc.

Investment incentives: The government of Nepal provides several incentives to industries that are set up for export purposes. They include an income tax exemption on export income, exemption on foreign investor's interest income earned abroad, and a relaxation of taxes on specific industries.

Foreign exchange regulation: Nepal maintains a formal foreign exchange control regime that requires the surrender of foreign currency export proceeds. The foreign investment law provisions cover convertibility only for capital ²⁶ and dividend repatriation and foreign debt service.

Labor law: The labor law is highly restrictive from an investor standpoint. By modern commercial standards, it impedes business flexibility in many instances. There are protective labor laws relating to retrenchment, wages, promotion, etc.

Intellectual property protection: Nepal recently became a member of the WTO and therefore is still in the process of making its intellectual property rights TRIPS WTO compliant. Only process patents are protected and not product patents. Though all trademarks are registered with the department of industries, it is believed that infringements of trademarks are quite common, as is the case with copyrights.

It is said that Nepal has the maximum potential to attract foreign investment among the low-income countries in the region. It is considered to be a friendly country that offers market potential, flourishing local entrepreneurial culture in both small and large business, etc. The only drawback of late has been political instability. If Nepal can overcome that, it will be able to grow fast with the help of FDI.

Conclusion

Overall, we can conclude that there has been a positive change in policies with regard to FDI in all the South Asian Countries. These low-income economies have realised that FDI is not only good debt, but also has a major role in enhancing economic development. Stepping up the economic reform process and making their economies politically stable and free from internal conflict would go a long way toward making South Asia an attractive destination for FDI. Ongoing initiatives such as the further simplification of rules and regulations and improvements in infrastructure are expected to provide the necessary impetus to increase FDI inflows in the future. However, the image of South Asian countries as corrupt nations, with overprotective labor laws and internal law and order problems, will have to be mitigated to facilitate the entrance of much needed foreign investment.

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