UPSC Prelims 2021 Q7: What Counts as FDI? FCCB, GDR, FII, NRE

Consider the following:

1. Foreign currency convertible bonds

2. Foreign institutional investment with certain conditions

3. Global depository receipts

4. Non-resident external deposits

Which of the above can be included in Foreign Direct Investments?

  1. 1, 2 and 3
  2. 3 only
  3. 2 and 4
  4. 1 and 4

Answer: (a) 1, 2 and 3

Statement-wise explanation

  • 1: correct — A Foreign Currency Convertible Bond (FCCB) is a bond that an Indian company issues abroad in foreign currency and that can be converted into the company's ordinary shares. India's Consolidated FDI Policy, 2020, para 3.3.3, says money an Indian company receives from issuing FCCBs is treated as FDI and counted towards FDI. FCCBs are issued under the FCCB and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993.
  • 2: correct — Investment by foreign institutional investors (today called foreign portfolio investors, FPIs) is normally portfolio investment. In 2014 the government accepted the Arvind Mayaram committee's test: foreign investment of 10% or more in a listed company is treated as FDI. Under Schedule II of the FEM (Non-Debt Instruments) Rules, 2019, an FPI's holding must stay below 10% of a listed company's paid-up equity on a fully diluted basis. An FPI that crosses this limit must sell the excess or have the holding reclassified as FDI. Those are the 'certain conditions'.
  • 3: correct — A Global Depository Receipt (GDR) is a security issued outside India by a depository bank against underlying shares of an Indian company. Because the foreign holder ultimately holds equity in the Indian company, the Consolidated FDI Policy (para 3.3.3) treats money raised through Depository Receipts as FDI and counts it towards FDI. DRs are now governed by the Depository Receipts Scheme, 2014, which took effect on 15 December 2014.
  • 4: incorrect — A Non-Resident External (NRE) deposit is a rupee bank account that a non-resident Indian holds with an Indian bank. It is a bank deposit, which is a debt liability of the bank. It is not an equity stake in an Indian company. RBI reports NRI deposits (NRE, NRO and FCNR(B)) as a separate series, under banking capital in the capital account, apart from foreign direct and portfolio investment.

How to eliminate

Begin with statement 4, which you can settle from basic knowledge. FDI means a lasting ownership interest in a business. An NRE deposit is money in a bank account that earns interest and gives no ownership, so it is not FDI. Striking out every option that contains 4 leaves only two options: '1, 2 and 3' and '3 only'. Then look at statement 2. The phrase 'with certain conditions' is the examiner signalling that FII money becomes FDI only after some test, which is the 10% threshold. A hedged statement like this is usually meant to be true. Also, FCCBs and GDRs are issued together under the same 1993 Scheme and treated alike in FDI policy, so an answer that accepts GDRs but rejects FCCBs is unlikely. To answer with certainty, remember two facts: (i) the Consolidated FDI Policy counts money raised through Depository Receipts and FCCBs as FDI; (ii) a foreign holding of 10% or more of a listed company's equity counts as FDI, and below 10% it counts as portfolio investment.

Know more

FDI vs FPI vs debt flows: what decides the label

India sorts foreign money by what is bought and how much control it gives.

  • FDI: investment through equity instruments in an unlisted Indian company, or 10% or more of the post-issue paid-up equity of a listed company (FEM Non-Debt Instruments Rules, 2019). The idea is a lasting interest in the business.
  • FPI: holdings of shares and bonds below 10% of a listed company, without control. FPIs are regulated by SEBI's FPI Regulations, 2019. An FPI that crosses 10% must sell the excess or be reclassified as FDI. In November 2024, RBI issued an operational framework for this reclassification.
  • Debt flows: external commercial borrowings (ECBs), NRI deposits and trade credit. These are loans and deposits, not ownership.
Instrument What it is How it is classified
Equity shares, compulsorily convertible preference shares (CCPS) and debentures (CCDs) Equity or quasi-equity FDI (or FPI if below 10% of a listed company)
ADR / GDR Receipt issued abroad against Indian shares Counted as FDI under FDI policy (para 3.3.3)
FCCB Foreign-currency bond convertible into shares Counted as FDI under FDI policy; must also follow ECB guidelines
Masala bond Rupee-priced bond issued abroad Debt (ECB)
NRE / NRO / FCNR(B) deposits Bank deposits of NRIs Debt; banking capital

Two classifications can differ. The policy treatment (FDI Policy, which counts DR and FCCB money against sectoral caps) is not always the same as the statistical treatment in RBI's balance-of-payments tables, which follow IMF definitions. UPSC asks about the policy treatment.

Why it matters: FDI is seen as stable, long-term capital. FPI ('hot money') can leave quickly, as the rupee's moves during FPI outflows show. That is why the 10% line and sectoral caps are watched closely.

In the news

The Consolidated FDI Policy Circular of 2020 took effect on 15 October 2020. In May 2021 the Commerce Ministry reported a record total FDI inflow of US$ 81.72 billion for 2020-21, counting equity, reinvested earnings and other capital. Both came out before the 2021 Prelims and kept 'what counts as FDI' in the news.

NCERT Concepts to Revise

  • Foreign Direct Investment: The whole question asks which instruments fit the official meaning of FDI, so start from its definition and the 'lasting interest' idea.
  • Foreign portfolio investment: Statement 2 depends on where portfolio investment ends and direct investment begins for an institutional investor.
  • Foreign Currency Convertible Bond: Statement 1 turns on how money raised through an Indian company's foreign-currency bond issue is classified.
  • Convertible bond: Shows how a bond can become shares, which bears on how a convertible instrument is classified.
  • Capital account: All four instruments are capital-account flows; this explains how equity, portfolio and deposit flows are recorded separately.
  • Automatic route and government route: Instruments counted as FDI must enter through the automatic or government route and within sectoral caps.

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