RBI nod to foreign VCs, but sectors limited to 10

The Reserve Bank of India recently started approving applications from foreign venture capital investors (FVCI) that were kept on hold for a considerable period of time. While this led to some excitement among the applicants, it was short-lived.
In what has surprised the venture capital firms, the approval letters issued by RBI to FVCIs provide for a new clause that significantly curtails the investment horizons for such entities to a narrow band of 10 investible sectors. These include infrastructure, biotechnology, information technology, nanotechnology, research in new chemical entities in the pharmaceuticals sector, dairy and poultry industry, among others.
The sectors prescribed are similar to those provided under section 10 (23FB) of the Income Tax Act, 1961, for availing tax pass-through treatment for domestic VC funds.
The intention behind introducing the FVCI regime was to provide such investors a favorable investment environment in India, in comparison with foreign direct investment (FDI), as envisaged by the KB Chandrasekhar Committee Report of January 2000. The report emphasized the importance of sectoral flexibility for FVCIs and noted sectoral restrictions for investment by VC funds are not consistent with the start-up ventures that are built on innovation and technology and can emerge in any business.
Then, the sectoral restrictions prescribed are likely to create unnecessary obstacles and hamper the growth of VC activity. Further, it seems that the regulators do not wish to promote VC investment in several other sectors, including manufacturing, media, outsourcing, among others, many of which are still in a growth phase, have dearth of capital, and have high employment generation capabilities.
If FVCI investment in the real estate sector was indeed a concern to the regulators, we believe that the same is unfounded as RBI has been disallowing applicants from investing in real estate since 2006. To our understanding, it has not cleared any real-estate-focused FVCI applications.
The regulator may have intended to bring the investment opportunities open to FVCIs on the same footing as domestic VC funds, but effectually this is not the case. In fact, this has led to the creation of more disparity between offshore and local funds since domestic VC funds are allowed to invest in all sectors, except a small negative list of sectors.
Some of the offshore funds have been sector-specific and target a few industries. Had such funds known at the time of making the application that such restrictions will be prescribed, they may not have continued with the applications, assuming they do not focus on the sectors prescribed by the regulators. However, several other funds have been sector agnostic and typically spell out broad investment horizons as their investment strategy. The intent being to invest in sectors that provide growth opportunities and the VC is able to provide a value addition through management support, and to take the investee entity to the next level. It is highly unlikely that these funds alter their sectoral focus based on the regulator’s move.
Specifying sectors without any definition ascribed to them further adds to the investors’ woes. While infrastructure is recognized as a crucial input for economic development, lack of clear definition leaves it omnibus and deters investors who are unclear about what it includes and, critically, excludes.
Globally, there is a fight for capital and given the present scenario in financial markets, it is imperative that VC investors be encouraged as they bring long-term capital to portfolio companies. The new restrictions may discourage foreign investment in India by sending negative signals in terms of consistency of the regulations and the regulators’ willingness to attract foreign investment.

2 Comments

  1. Suzy Orman
    Posted December 23, 2008 at 2:24 am | Permalink

    The regulator may have intended to bring the investment opportunities open to FVCIs on the same footing as domestic VC funds, but effectually this is not the case. In fact, this has led to the creation of more disparity.

  2. rk89
    Posted May 25, 2009 at 3:42 am | Permalink

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