How India’s relaxation of Chinese investment rules benefits US, EU funds

The government had introduced PN3 in 2020 amidst the Covid-19 outbreak amidst concerns that Chinese investors may lap-up shares of distressed companies at low valuations potential leading to hostile takeovers of the company.

• India relaxes PN3 rules, permits sub-10% FDI stakes sans approval
• US and EU funds may increase investments due to new threshold
• Fast-track approval for Chinese EV sector investors

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India’s proposed changes to the Press Note 3(PN3) rules may have an unexpected beneficiary: large institutional funds from the US and EU. This could translate into significantly higher FDI flows into India.

PN3 restricted Chinese entities from making FDI investments into India under the automatic route and made it mandatory for such entities to take prior government approval for the investment. Further, PN3 was silent on what was the threshold—terms of equity stake--- for which prior government approval was required, with some funds taking the interpretation that government approval is mandatory even if the fund buys a single share.

Due to lack of clarity many global elite funds, which had Chinese LPs along with investors from other countries such as the US, stayed away from investing into India since they had a Chinese connection. Several US and Europe based institutions were reluctant to include Indian companies in the portfolio of specific funds they ran in which there were Chinese investors.

The Indian government has now said any investments amounting to less than 10% of the company’s equity will not need pre-approval from the government. Institutional investors generally make passive investments which are often less than 10% of stake in a company.

“Large US and European PE funds, pension funds, and sovereign wealth vehicles that had even a minor Chinese LP in their investor base were technically caught by PN3, and many simply chose to bypass India rather than face indefinite approval timelines. The 10% de minimis threshold now separates passive financial capital from strategic Chinese investment, which is the distinction the policy always needed but never had,” said Binoy Parikh, partner, Katalyst Advisors.

Apart from the 10% threshold, the government has also created a fast-track approval window for Chinese investors seeking to invest in sectors like electronics and components for Electric Vehicles(EV). Through this window, any application made would be decided by the government in 60 days. Currently, there is no specific timeline for approval of Chinese investments and proposals often remain unapproved for months.

“The proposed relaxation of the Press Note 3 (PN3) rules is a pragmatic recalibration that moves beyond a blanket restriction towards a more nuanced, threshold-based regime. By clarifying that investments under 10% will not require prior government approval, India is effectively removing a major compliance bottleneck for global elite funds based in the US and Europe,” said Ankita Singh, founder, Sarvaank Associates.

The government had introduced PN3 in 2020 amidst the Covid-19 outbreak. There were concerns that Chinese investors may lap-up shares of distressed companies at low valuations potential leading to hostile takeovers of the company. PN3 rules doesn’t mention China by name. Instead they talking about countries sharing land borders with India.

Also, PN3 rules deal with only Foreign Direct Investment(FDI) i.e. investments into unlisted companies. Whereas, the foreign portfolio investor(FPI) route is used by foreign entities to invest in Indian listed companies. There was never a restriction on FPI investments coming from China. However, most FPIs had adopted a cautious approach.