India’s Foreign Direct Investment Framework: A Look Back at 2024 and the Road Ahead for 2025

The Indian Government has always maintained a balanced approach in regulating foreign investments into India, with the goal of strengthening the country’s investment landscape to attract global investors while safeguarding economic interests. In  2024, significant policy decisions were made to ease restrictions in the foreign investment framework, a momentum that has continued into 2025. A key development in this regard is the issuance of the updated Master Direction on Foreign Investment in India (“Master Direction”) by the Reserve Bank of India (“RBI”)[i] on January 20, 2025.

The Master Direction provides general guidance on foreign investments into India and should be read along with the specific rules, and regulations issued under the Foreign Exchange Management Act, 1999 (“FEMA”). The Master Direction introduces certain additional provisions and clarifications that address the ambiguities and gaps that were not addressed under the existing rules and regulations, including the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“NDI Rules”)[ii].

This article highlights the key changes and updates introduced to India’s foreign investment framework in the years 2024 and 2025.

Key Updates for the Year 2024

1. Permission for Cross-Border Share Swaps

   An amendment to the NDI Rules in August 16, 2024, eased cross-border share swaps.

   Prior to this amendment, share swaps were permitted only in a very limited manner, where an Indian company was allowed to issue its equity instruments[iii] to non-residents, in exchange for the equity instruments of another Indian company. This meant that an Indian company could issue its  equity instruments to non-residents, who, in turn, could transfer the equity shares of another Indian company held by them as consideration. Since the term ‘issue’ indicates the primary issuance of equity instruments by a company, the secondary transfer of equity instruments of an Indian company by a resident to a non-resident in consideration for the swap of equity instruments held in another Indian company by the non-resident was not permitted. As a result, prior approval of the RBI was required for such transactions.

   Rule 9A has now been inserted into the NDI Rules, and Schedule I of the NDI Rules has been amended to permit the swap of equity instruments (by way of either issuance or transfer of shares) of an Indian company with the equity capital of an Indian company or a foreign company without the prior approval of RBI. In other words, the following share swaps are now permitted:

   1. An Indian resident holding equity instruments of an Indian company can transfer such instruments to a non-resident in consideration for the equity instruments held by the non-resident in another Indian company or a foreign company.
   2. A non-resident holding equity instruments of an Indian company can transfer such instruments to an Indian resident in consideration for the transfer of the equity instruments held by the resident in another Indian company or a foreign company.
   3. An Indian company can issue shares to a person resident outside India in consideration for the transfer of shares of an Indian company or a foreign company.

   Any acquisition of shares by the non-resident of the Indian company by way of share swap must be compliant with all the rules prescribed by the Central Government and the regulations specified by the RBI (such as sectoral caps, valuation report, pricing guidelines and reporting requirements) and the acquisition of shares of a foreign company by the Indian resident must be compliant with rules for overseas direct investment by Indian residents.   Further, the prior approval of the Indian Government will be required for a share swap if the Indian investee company is engaged in business where foreign direct investment is subject to approval or in any other case where approval is otherwise required

2. Liberalisation of the Space Sector

   The NDI Rules were amended on April 16, 2024, to permit 100% (hundred percent) foreign direct investment (“FDI”) in the space sector, providing liberalized entry routes for the following activities within the space sector:

   1. FDI up to 74% (seventy – four percent) is allowed under the automatic route for satellites manufacturing & operation, satellite data products and ground & user segments. FDI beyond 74% (seventy four percent), will require the approval of the Indian Government.
   2. FDI up to 49% (forty – nine percent) is allowed under the automatic route for launch vehicles and associated systems or sub-systems and creation of spaceports for launching and receiving spacecraft. FDI beyond 49% (forty nine percent), will require the approval of the Indian Government.
   3. FDI up to 100% (hundred percent) is allowed under the automatic route for manufacturing of components and systems / sub-systems for satellites, ground segment and user segment.

3. Operational Framework for Reclassification of Foreign Portfolio Investment

   The NDI Rules prescribe that a foreign portfolio investor and its investor group should collectively hold less than 10% (ten percent) of the total paid-up equity capital on a fully diluted basis of an Indian listed company, or less than 10% (ten percent) of the paid-up value of each series of equity instruments of a listed Indian company. In the event, such investment exceeds 10% (ten percent), the investor has the option to either divest its excess investment or reclassify the entire investment as FDI.

   On November 11, 2024, the RBI issued directions establishing an operational framework for the reclassification of such investments as FDI. The framework includes the following:

   1. The reclassification option is not permitted in the sectors where FDI is prohibited such as lottery business, chit fund, gambling and betting, agriculture, nidhi company, real estate.
   2. The investor must obtain necessary government approvals and secure the concurrence of the Indian investee company to ensure compliance with the conditions for receiving FDI, including entry routes, sectoral caps, investment limits, pricing guidelines, and other applicable conditions prescribed under the NDI Rules.
   3. The investor must clearly communicate its intent to reclassify the foreign portfolio investment (“FPI”) into FDI and must provide necessary approvals and concurrence to the custodian pursuant to which the custodian will freeze the purchase transactions by such investor in equity instruments of the concerned company, till the completion of the reclassification process.
   4. The Indian investee company, the investor, and the authorized dealer banks must fulfil all reporting obligations necessary for FDI.
   5. Once the concerned parties undertake all the reporting, the investor must approach the custodian requesting transfer of the equity instruments of the company from its demat account maintained to hold FPI to its demat account maintained to hold FDI. The custodian, after ensuring that the reclassification is complete as per the operational framework, will unfreeze the equity instruments and process the request.

Key Updates For the Year 2025

1. 1. Clarification Regarding Downstream Investments

      Downstream investment is the investment made by an Indian entity which has received foreign investment or an investment by an investment vehicle[iV] in the equity instruments or capital of another Indian entity.

      The Master Direction have provided clarity on the longstanding uncertainty regarding whether foreign owned and controlled companies (“FOCCs”) making downstream investments are permitted to structure the payments for such investments on a deferred basis. Under the existing regulations, in cases involving the transfer of equity instruments between a person resident in India and a non-resident, up to 25% (twenty five percent) of the aggregate consideration may be deferred for a period not exceeding 18 (eighteen) months from the date of the transfer agreement. The deferred consideration can be settled through an escrow arrangement or maybe indemnified by the seller if the total consideration has already been paid. This ensured that M&A transactions could be structured for post-closing price adjustments, for making earnout or milestone based payments and for any indemnity payments. However, FOCCs were not explicitly allowed to seek the benefit of this provision, leading to ambiguity and causing practical challenges in structuring M&A transactions.

      Due to this uncertainty, multiple authorized dealer banks (banks authorised by the RBI to deal in foreign exchange business) adopted divergent interpretations. Further, the RBI had issued notices to several FOCCs that had structured deferred payments as part of their downstream investments. This approach appeared inconsistent with the spirit of the regulations, wherein indirect foreign investments were subject to more stringent regulations as compared to foreign direct investment.

      However, the recent clarification provided by the Master Direction has resolved this ambiguity. It expressly states that, based on the guiding principles of downstream investment, arrangements permitted for foreign direct investment under the NDI Rules such as investment through equity instrument swaps (as explained earlier in the 2024 updates) and deferred payment arrangements will also be available for downstream investments, provided that they comply with the relevant provisions under the NDI Rules.

      Therefore, FOCCs can now structure their downstream investments with the same flexibility as that of foreign direct investments.

   2. Form DI Filing Requirement by an Entity that has Subsequently Become an FOCC

      The Master Direction now extend the requirement to file Form DI in cases where an investor having originally invested in an investee entity as a resident, later becomes an FOCC. Such investor entity must report the reclassification of its investment as a downstream investment in Form DI within 30 (thirty) days of acquiring the FOCC status.

   3. Simplification of Payment Procedure

      The Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019 previously mandated specific types of bank accounts, such as Non-Resident External Accounts and Foreign Currency Non-Resident (Bank) Accounts., for inward remittances, refunds, or remittance of sale proceeds outside India, depending on the nature of the foreign investor.

      Under the amended framework, the RBI has relaxed these specific requirements and now allows the use of any repatriable foreign currency accounts, or Rupee accounts (including the Special Non-Resident Rupee, Rupee Vostro and Special Rupee Vostro accounts)  maintained by the foreign investor in accordance with the Foreign Exchange Management (Deposit) Regulations, 2016.

      These amendments aim to streamline payment modes, investment structures, and the remittance process for sale or maturity proceeds and also promote the use of the Indian Rupee, for cross-border transactions.

   4. Calculation of Foreign Investment in case of issuance of employee’s stock options, sweat equity shares and share based employee benefits to persons resident outside India

      The Master Direction provide that the percentage of foreign investment is to be calculated on a fully diluted basis, upfront,  at the time of issue / grant of employee stock options, sweat equity shares and share based employee benefits to persons resident outside India. This means that at the time of issuance of such instruments the company should be able to ascertain whether such issuance is within the prescribed limits for FDI.

   5. Specific Clauses to be Contained in the Purchase/Transfer Agreement

      The Master Direction provide that in case of any deferred payment / indemnification / escrow arrangements in a transaction involving transfer of equity instruments between a person resident in India and a person resident outside India such arrangements, along with their related conditions, should be appropriately captured in the share purchase or transfer agreement.

Conclusion

These amendments and clarifications to the foreign investment framework mark a significant step forward in promoting foreign investments and streamlining the regulatory landscape. They are part of Indian Government’s broader plan to modernise and simplify the rules and regulations issued under FEMA. This reform aims to enhance the ease of cross-border transactions and alleviate the long-standing regulatory ambiguities, which will position India as a more attractive and investment-friendly destination, ultimately boosting the country’s global competitiveness.

The Government’s goal of making India an appealing investment destination is further reinforced by the recent Union Budget announced on February 1, 2025, wherein foreign direct investment of up to 100% (hundred percent) (earlier 74% (seventy four percent)) was permitted in the insurance sector without requiring prior approval, for companies which invest their entire premium in India.

Author: Aishwarya H, Rohit Dhingra

Publication Date: 6^th February 2025

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[i]RBI is the central bank of India and the body regulating the banking system and the Indian currency.

[ii]NDI Rules are the rules issued by the Central Government under FEMA that govern foreign investments in India through non-debt instruments.

[iii]Equity instruments are equity shares, convertible debentures, preference shares and share warrants issued by an Indian company.

[iv]Investment Vehicle is an entity registered and regulated under the relevant regulations framed by SEBI or any other authority for that purpose and can be a Real Estate Investment Trust, Infrastructure Investment Trusts or an Alternative Investment Fund.