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Fissures in FDI regulatory framework

January 20, 2010 15:38 IST

Draft Press Notes on FDI regulatory framework fail to address the gap between the domestic and foreign regulatory regimes, says Prabhash Ranjan.

A few days ago, Commerce and Industry Minister Anand Sharma unveiled the draft Press Note (PN) 2010 on Foreign Direct Investment (FDI) regulatory framework. This PN consolidates into one document all the prior regulations on FDI and reflects the current "regulatory framework" for FDI.

Such a consolidated document serves as a one-point reference guide for all the regulations on foreign investment in India, as against the older system where a foreign investor had to go through different PNs for different sectors.

Notwithstanding this positive aspect of the new draft PN, it, like all the other PNs, has failed to plug an important policy gap in the Indian foreign investment regulatory regime.

This regulatory gap relates to the absence of an unequivocal relationship between the domestic regulatory regime on foreign investment and the international regulatory regime on foreign investment, of which India is a part.

Every sovereign nation has the right to regulate foreign investment entering its territory.

However, this sovereign right is subject to various international regulations that nation-states develop and adopt in the form of treaties, or legally binding instruments.

These treaties act as regulatory frameworks at the international level to ensure that national regulatory frameworks are adopted in accordance with international regulations for the mutual benefit of all signatories.

In international economics, the most prominent example of such a supra-regulatory international treaty is the World Trade Organisation (WTO) treaty, which makes it legally binding for all WTO member countries to adopt standards at the domestic level in accordance with the regulations given in the WTO treaty.

India has amended many of its laws and policies, such as on patents and quantitative restrictions, in order to make them WTO-compatible.

In the case of investment, the international regulatory framework, of which India is a part, is contained partly in the WTO in the form of the Trade Related Investment Measures (TRIMS) agreement  (which bars imposition of conditions such as mandatory export requirements on foreign investors) and mainly in the numerous Bilateral Investment Promotion Agreements (BIPAs), or Bilateral Investment Treaties (BITs), as they are popularly called.

BITs, often perceived as admission tickets to foreign investment, are international agreements signed between two countries to provide a framework for regulating investments made by one BIT country into another.

Thus, BITs contain legal promises made by two countries to each other, at the international level, on how to regulate investments of the other country once they enter their territories.

The offshoot of these promises is that each BIT-signing country has to develop its domestic regulations as per these international legal promises. Thus, if a BIT has a national treatment provision, then the two BIT-signing countries cannot adopt a national regulation that favours domestic investments over foreign investments.

In case the investment recipient country adopts a national regulation that is inconsistent with the international legal promises made in the BIT, then the foreign investor, using the investor-state dispute settlement mechanism, can challenge the domestic regulatory mechanism. 

India has entered into close to 70 BITs in the last 15 years as part of its overall strategy of liberalisation, to attract investment. It has negotiated BITs with key countries like Canada and the UK, and also wishes to enter into a BIT with the US.

According to the finance ministry -- the nodal ministry dealing with BITs -- entering into BITs results in more foreign investment inflows. Thus, BITs are an integral part of India's foreign investment policy.

Though BITs have a prominent place in India's overall investment policy framework and India's domestic regulations on investment need to be compatible with international obligations, the foreign investment regulatory policy contained in the draft PN 2010 has no reference, whatsoever, to India's international regulatory framework contained in the BITs.

The document states that the regulatory framework on foreign investment consists of Acts, regulations, PNs, press releases, and does not mention the most important regulatory framework (BITs) to which all the other regulations owe their sustenance.

In other words, a careful reading of the draft PN 2010 reveals that India's domestic regulatory framework on foreign investment has been adopted independently from India's international regulatory framework on foreign investments. As a result, quite a few domestic regulations run contrary to India's international obligations contained in the BITs.

Let's look at a few such examples. According to the draft PN 2010, original investment going into townships and the housing sector cannot be repatriated earlier than a period of three years from completion of minimum capitalisation.

However, this domestic regulation is inconsistent with the provision on capital transfer contained in India's BITs. The majority of Indian BITs allows for free repatriation of profits or other funds related to investments by the investors to their home country, without providing for any specific exception, barring exceptions related to national security or to situations of extreme emergency.

None of the capital transfer provisions in any of the Indian BITs creates an exception of a mandatory lock-in period of three years for the township and housing sector. Thus, in case an international dispute arises between a foreign investor and India on repatriation of investment in the township sector, India will not be able to invoke national regulations contained in the draft PN 2010 as a defence to escape liability from treaty violations.

Such a provision can be sustained only in two circumstances. First, the concerned BIT itself allows for such an exception. Second, India imposes this regulation on a foreign investor from a country with whom India does not have a BIT, and hence is under no obligation to have domestic regulations as per international regulations. However, the draft PN 2010 does not draw these fine distinctions, leaving a big gap in the overall investment regulatory policy framework.     

Another example is from the telecom sector. The draft PN 2010 imposes a security regulation on all foreign telecom companies that the chief officer in-charge of technical network operations and the chief security officer should be resident Indian citizens.

While one fully appreciates the rationale behind a policy regulation like this, it goes against India's international regulatory framework contained in its BITs. None of the Indian BITs allows for adopting a regulation like this and the possibility of a foreign telecom investor challenging such a regulation  -- as a violation of fair and equitable treatment -- under the BIT cannot be ruled out.

Critics may dismiss the argument by pointing out that except for the Dabhol power project case, there has not been any BIT dispute involving India. However, the fact that there was little or no dispute in the past does not mean that such disputes cannot arise in future, especially at a time when the Indian economy is fast integrating with the global economy.

There is a plethora of examples from Latin American countries that show how regulatory measures of sovereign states have been successfully challenged by individual foreign investors in international arbitral bodies as breaches of BITs.

In order to address these missing links, it is important that domestic regulations on foreign investments are developed after taking cognisance of India's international regulatory framework on foreign investment.

More important, India should make sure that its international regulatory framework, contained in its BITs, provides space for the adoption of such domestic regulations. Lack of policy synchronisation in this area may become a fertile ground for international investment disputes in future.

The author is assistant professor at NUJS Kolkata, and a PhD candidate at King's College London.

Prabhash Ranjan
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