Can India’s new FDI restrictions be challenged under the India-China investment treaty?

India recently introduced FDI restrictions to curb opportunistic acquisitions by investors from neighbouring countries taking advantage of the economic distress caused by COVID-19.[1] The restrictions apply to foreign investment by investors from countries sharing a land border with India and to foreign investment having a beneficial owner from such countries. The restrictions stipulate that such foreign investment can be made only after government approval and shall be subject to conditions specified in such approval.

The restrictions are clearly intended as a check on Chinese investors specifically since no other country sharing a land border with India is a significant source of foreign investment. While the nature and extent of the economic impact of the restrictions is a hotly debated topic, a separate but equally important issue is whether the restrictions can be challenged under the India-China investment treaty. If a challenge is possible, then India could eventually face claims from Chinese investors under such treaty that could effectively undermine the restrictions and India’s FDI regime.

The India-China investment treaty, which came into force on 1 August 2007, was unilaterally terminated by India with effect from 3 October 2018 as part of India’s strategy to renegotiate investment treaties based on its 2015 model treaty.[2] However, because of a sunset clause in the India-China investment treaty, it continues to apply for a period of 15 years from the date of termination “in respect of investments made or acquired before the date of termination”.[3] As a result, only Chinese investments made or acquired before 3 October 2018 are protected by the treaty. This limitation itself offers a degree of protection from claims.

The key question, however, is whether the restrictions can affect existing Chinese investments protected by the India-China investment treaty. At first glance, it appears that the restrictions cannot affect such investments since the restrictions apply prior to making an investment and therefore do not apply to existing investments. However, this analysis clearly oversimplifies the issue because it fails to consider the possibility of the restrictions applying to additional investments made to maintain an existing investment or pursue business opportunities through an existing investment and thereby affecting such existing investment.

Two examples can illustrate these scenarios clearly. First, consider a Chinese investor holding an existing investment comprising 25% shareholding in an Indian company. Such investor could make an additional investment as part of a rights issue or bonus issue to ensure that its shareholding is not diluted and thereby maintain its existing investment. Such investor could also make such additional investment to provide additional capital for the benefit of the Indian company and thereby pursue business opportunities through its existing investment. Second, consider a Chinese investor holding an existing investment comprising 45% shareholding in an Indian company and such Indian company incorporating a subsidiary or a joint venture company as part of its business activities. Such subsidiary or joint venture company is treated as a recipient of indirect foreign investment as per the FDI regime which constitutes additional investment by such investor to pursue business opportunities through its existing investment.

These examples illustrate how the restrictions could affect existing Chinese investments protected by the India-China investment treaty if the restrictions are applied to certain types of additional investments. In the first example, the restrictions are unlikely to be applied to additional investment as part of a rights issue or bonus issue since the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 specifically permit foreign investors to participate in rights issues and bonus issues without government approval.[4] In the second example, however, the restrictions shall be applied to additional investment made as indirect foreign investment and therefore shall affect existing Chinese investments protected by the India-China investment treaty.

As a result,the question that urgently needs consideration is whether the restrictions could be challenged under the India-China investment treaty. The answer to this question is in the affirmative. The treaty requires India to treat Chinese investors not less favourably than other foreign investors[5] and the restrictions plainly violate this stipulation as they explicitly discriminate between foreign investors from neighbouring countries and foreign investors from all other countries.

In light of this analysis, there is a likelihood of the restrictions being challenged under the India-China investment treaty. India must therefore remain aware of this risk and ensure that all actions taken pursuant to the restrictions are fair, reasonable and carefully evaluated. The assessment and approval of indirect foreign investment is an area of particular concern. India could consider limiting the scope of the restrictions to exclude indirect foreign investment if such limitation does not defeat the purpose of the restriction.

India must also remain cautious about the risks to its FDI regime from investment treaties– even if such treaties have been terminated. The existence of sunset clauses in such treaties and the expansive definition and understanding of investment and rights relating to investment under such treaties can present serious obstacles for India’s FDI regime.

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[1] See Press Note 3 of 2020 dated 17 April 2020 (available at: https://dipp.gov.in/sites/default/files/pn3_2020.pdf) and the Foreign Exchange Management (Non-debt Instruments) Amendment Rules, 2020 (available at: http://egazette.nic.in/WriteReadData/2020/219107.pdf).

[2] See relevant details of the India-China investment treaty available on the UNCTAD database (available at: https://investmentpolicy.unctad.org/international-investment-agreements/treaties/bilateral-investment-treaties/912/china---india-bit-2006-); see also Nicholas Peacock and Nihal Joseph, Mixed messages to investors as India quietly terminates bilateral investment treaties with 58 countries (available at: https://hsfnotes.com/arbitration/2017/03/16/mixed-messages-to-investors-as-india-quietly-terminates-bilateral-investment-treaties-with-58-countries/).

[3] See Article 16(2) of the India-China investment treaty.

[4] See Rule 7 of the Foreign Exchange Management (Non-debt Instruments) Rules, 2019.

[5] See Article 4(2) of the India-China investment treaty.