Three years after India put in place sweeping curbs on inflows of Chinese investments, including bans on apps such as TikTok, official data shows investments from China are slowly returning through new avenues and routes. While the curbs on investments from China, put in place in April 2020 amid a spurt of Chinese acquisitions during the pandemic, were prompted by national security concerns, the restrictions 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 restrictions put in place in April 2020 on Chinese investments, that were booming from 2014 onwards?
The period from 2014, with the launch of the Make in India programme, is when Chinese FDI flows into India really took off. From 2000 to 2013, Chinese investment in India was negligible, but from 2014 to 2020, the annual flow both in terms of number of transactions, and the value of transactions increased almost every year. The number of transactions actually peaked in 2019 at 527, whereas the annual value peaked in 2015 when in a single year we managed to attract $859 million.
But this is only the direct investments. In addition to that, there was a large proportion of indirect investments which are not shown as Chinese investments in Reserve Bank of India statistics. For example, start-ups alone attracted about $5 billion in that period. Taken together, you can definitely call it the golden age of Chinese investments in India.
From a regulatory perspective, what is very significant is during this booming period, Chinese investments actually faced next to no scrutiny in India, which is very unusual because at the same time many other countries had started scrutinising Chinese investments, picking and choosing what they want, or having a policy on what kind of investments were welcome. It happened in Europe, it happened in the U.S. In hindsight, maybe India was a little late in realising the need to scrutinise Chinese investments. But as you said, it definitely did happen in 2020 and after that, there’s been a huge impact on direct investment flows.
So what changed in 2020, when the Government of India issued Press Note 3 in April, shortly before the border crisis began, and later brought the ban on apps and other regulations as relations deteriorated?
Many people tend to confuse this, that Press Note 3 was because of the Galwan Valley incident [in June 2020], but it came out a few weeks before. Press Note 3 is a blanket requirement for scrutiny of all types of Chinese investment, regardless of sector, regardless of quantum in the sense that whether you were 1% or 100%, you need approval. It’s a proper scrutiny mechanism where every single investment will be vetted and approved by the Indian Government.
What triggered Press Note 3 is still somewhat debatable. At that time, there was a stock exchange filing made by the Chinese sovereign wealth fund, which had accumulated a stake in excess of 1% in HDFC, India’s largest mortgage lender, so that, apparently, was the immediate trigger.
But if you look at the statistics, perhaps there is a case to be argued that in January-March 2020, we received about 161 transactions. That was the single 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 the pandemic which was breaking out all around the world, and at the same time, the number of investment transactions from China really accelerated.
In hindsight, one might say someone in government saw this and said look, there’s been a spurt of Chinese investments in three months, and this coincides with COVID. And then the HDFC filing came out after that. So all of this could have contributed to Press Note 3, which said beneficial ownership by any entity or individual in a country, which has a land border with India, will require government approval.
Before this, the only geographical restriction that India had was for investments from Pakistan and Bangladesh, for historical reasons. From a regulatory perspective, what Press Note 3 did in effect was it placed the other bordering 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 made sort of a regressive move actually making it harder for foreign investment. So that was the regulatory significance. In hindsight, this was probably too little, too late because we should have started scrutinising investments a little earlier, as it was already an emerging global trend and as a major economy, we should have had these guardrails in place from a national security perspective.
How has this new scrutiny mechanism impacted the investments coming in?
In March 2022, in response to parliamentary questions, we received some statistics which disclosed 347 applications were received in the last two years and 66 were approved, 193 were rejected. The headline figure was that ₹13,635 crore worth of approvals were given.
There is a time lag between approval being given and the actual investment coming into India, but I think we should focus on the actual investments that are coming in. We don’t have the data on approvals, but the investment data is published regularly by the 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 around ₹565 crore in total. The approval rate is approximately about 20%, and the conversion thereafter, is in the low single digits. So if there are $100 worth of investment actually approved, maybe about 5% of that actually comes in.
This is the new reality - it’s a huge disincentive for Chinese investors to invest in India directly by taking approval. If we want to take one big observation from this, that is what we are seeing is indirect Chinese investments coming in through other jurisdictions have increased - not only increased, but they are also not even coming in as Chinese investments.
Press Note 3 makes it very clear that no matter how the investment is routed, as long as the beneficial ownership is with the Chinese investor, approval must be taken. But a lot of indirect investments are coming without approval. It only means that opaque investment structures are being used in other countries, to, in effect, conceal the Chinese beneficial ownership. There are many ways one can do that. I don’t know whether that is good for the investment environment in India, because at one level, you would say it is better to know which are the Chinese investments, and scrutinise them. But by having an extremely harsh scrutiny mechanism, if you’re pushing most of the investments into the opaque domain, then it’s arguable whether that’s good in the long term, because then we don’t even know what kind of Chinese investments are coming in, where are they going, and so on. And that’s where we are today.
We are also seeing some Chinese companies come back into the India market with new approaches, such as the once banned online fashion company Shein which has tied up with Reliance Industries. Are we seeing more such arrangements?
Shein is a very good example because it was one of the more than 300 Internet applications banned from India, but it looks like Shein has been able to distinguish itself from others, as it is just a technology layer to a retail business, where it sells fast-fashion clothing and so on. This is actually a good template - if a Chinese investor can demonstrate value to the domestic economy in India, either by sourcing its products or in generating employment, these are the kind of approvals that will likely be given. In this case, there is no equity investment, so the question of Press Note 3 approval doesn’t arise.
I see other discussions happening. MG Motors is in discussion to offload a stake, because they are simply not able to bring in fresh equity investment and the automotive sector is extremely capital intensive. So some Indian business houses are in the fray to pick up an equity stake in MG Motors. Put together, there is a template that’s emerging and the red lines are moving a little bit. For the digital economy, I would still say there’s a red line. I don’t think Shein coming in is going to result in a number of other Internet applications being allowed to reenter the Indian market because India has concerns on data and from a national security perspective.
In the manufacturing sector, things are definitely changing. If you look at the actual approvals that have been given under Press Note 3, we see there’s a heavy concentration of manufacturing investments, almost 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 automotive products. This is the new template - if India lacks domestic production in a particular area, or we have extreme import dependency in one area, and a Chinese company comes in and wants to manufacture in India, along with an Indian company as a joint venture partner with a minority stake for the Chinese company.
When we look at investments coming through other countries, late last year Cayman Islands became among the top sources of investment in India. That raised some eyebrows because globally, Cayman Islands is very popular spot for routing Chinese money to different countries. Whenever Chinese companies invest, Cayman Islands is a very popular jurisdiction. So last year there were discussions about how this might be Chinese money coming in. Singapore, of course, is the more logical and visible source of Chinese investments right now.
In the 2014-2019 period, the start-up space attracted a lot of Chinese funding. Are the curbs on tech start-up funding now a non-negotiable issue for India because of security and data concerns?
When we’re talking about start-ups, we need to focus on the type of businesses because there can be a start-up today, hypothetically speaking, which could launch a new electric vehicle and is more like a physical business. Those kinds of investments I think would still be possible. But if you’re talking of start-ups in the sense of a pure Internet company, for instance a social media app, I think that is still a red line. I don’t think for example, a WeChat or TikTok will be able to come back to India in the current scenario, but as we have seen, these red lines can move a little bit. It depends a lot on what is happening globally. For instance, with this talk about banning Tiktok in the U.S. now, then India would find it even more difficult to do so, as India was actually one of the first countries to ban TikTok.
If we see this trend becoming larger, of many of these start-ups moving away from China and positioning themselves as Singapore companies for example, which is what Shein is doing – and there are many other Chinese companies which are positioning themselves as global companies with no connection to China – it is possible that India will allow some of these companies as well, as it welcomes foreign companies. But we are still a fair distance from there.
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