FOREIGN DIRECT INVESTMENT & REAL

ESTATE SECTOR IN INDIA

PREPARED BY:

HRISHIKESH BARUAH
PARTNER
BBPM LAW ASSOCIATES
hrishikeshbaruah@bbpmlaw.com

KAVITA MALHOTRA
ASSOCIATE
BBPM LAW ASSOCIATES
kavitamalhotra@bbpmlaw.com

For further information-Please contact:

BBPM LAW ASSOCIATES

A-13, FIRST FLOOR, NIZAMUDDIN EAST
NEW DELHI-110 013
TELEPHONE: 011-418925911/22

www.bbpmlaw.com
I. INTRODUCTION1:

I.1 As per the World Investment Report 20082, India is the second
most attractive location for Foreign Direct Investment [FDI] for the years
2008-20103. As per the said report, the total FDI that had come into India
during the year 2005 was 7,606 Million US Dollars. The said amount
increased to 19,662 Million US Dollars for the year 2006 and it further
increased to an amount of 22,950 Million US Dollars for the year 2007.4 It
is also stated in the said report that there is a substantial increase in the
flow of FDI in South Asia and more particularly to India5.

I.2 The importance of the Real Estate Sector in FDI inflows into India
is well established. According to the report published by the India Brand
Equity Foundation6 [2005], the total size of the Real Estate Sector Market
was around 12 Billion US Dollars and it was estimated to grow at a
‘Steady Clip’ of over 30 percent per annum. The Report, mentioned above,
also pointed out a Report by McKinsey [2003] in relation to the
Construction Housing Sector in India. The McKinsey Report pointed out
that the Construction Housing Sector in Developed Countries constitutes
around 3 to 5 percent of its Gross Domestic Product [GDP]. However in

1 Disclaimer: The information contain herein is of a general nature and is not intended to

address the circumstances of any particulars individual or entity. Although, we endeavor

to provide accurate and timely information, there can be no guarantee that such
information is accurate as of the date it is received or that it will continue to be accurate
in the future. No one should act on such information without appropriate professional
advice after a thorough examination of the particular situation.

2 The World Investment Report 2008 is prepared by the United Nation Conference on

Trade and Development.

3 The World Investment Report 2008: United Nation Conference on Trade and
Development [Page 34]. In terms of Table I.20, India is ranked as the second most
attractive location for FDI in the next 3 years. It is important to point out that China is
the most preferred location during this period. This is based on the UNCTAD Survey
conducted for the years 2008-2010.

4These figures have been provided in the World Investment Report 2008 at Annex Table
B.1 [Page 255].

5 World Investment Report 2008: United Nations Conference on Trade and Development

[Page 47]

6 Real Estate: India’s Coming Reality Show: India Brand Equity Foundation. This Article

can be downloaded from http://www.ibef.org. The Indian Brand Equity Foundation is a

Public-Private Partnership between the Ministry of Commerce, Government of India and
the Confederation of Indian Industry.
India, the Housing Construction Sector constituted only around 1 percent
of the GDP. The Report further pointed out that the Capital Housing Stock
in India constitutes around 5sq.mtr. per capita which is extremely low
compared to other Develop or Developing Countries.

I.3 Having underlined the need and prospect for growth in the
Housing and Real Estate Sector in India, it will be relevant to point out the
contribution of Real Estate in FDI inflows to India. According to a Survey
conducted by the Federation of Indian Chambers of Commerce and
Industry7 [FICCI], the share of Real Estate in the Total Foreign Direct
Investment into India have increased from 4.5 percent in the year 2003 to
10.6 percent in the year 2004.

I.4 In terms of the said survey, it was estimated that the component of
Real Estate in the total FDI for the year 2005 would be between 10 to 20
percent. This exponential growth of the component of Real Estate in the
total FDI inflows has been due to the trigger provided by the liberalized
FDI Policy as provided by the Press Note 2 [ 2005 series]. According to
FICCI, this decision of the Government of Indian to liberalize the FDI
announced in the construction sector is perhaps the most significant
economic policy decision taken by the Union Government8.

II TRANSITION:

II.1 Prior to the present Regime, the Foreign Exchange Regulation Act,
1973 [FERA] was in force. FERA was repealed by the Foreign Exchange
Management Act, 1999 [FEMA]9. At the time when FEMA came into
existence, Press Note 2 [2000 Series] dated 11.02.2000 was governing the

7 Survey report on Foreign Direct Investment in Real Estate: Federation of Indian

Chambers of Commerce and Industry: 2005. This can be downloaded
fromhttp://www.ficci.com/surveys/fdi-survey-real.pdf

8 Ibid Foot Note 7.

9The Foreign Exchange Management Act, 1999 was notified vide Notification No. GSR.
371[E] dated 01.05.2000.
field. Press Note 2 provided that no Foreign Investment will be permitted
in the Housing and Real Estate Sector. However, NRIs/OCBs were allowed
to invest on certain specific schemes.

II.2 With the repeal of the FERA, the field came to be governed by the
FEMA. In regard to the Transfer or Issue of Security by a Person Resident
outside India, the same was regulated by the Foreign Exchange
Management [Transfer or Issue of Security by a Person Resident outside
India] Regulations 200010. Regulation 6 of the said Regulation, provided
that a person resident outside India may purchase ‘equity or preference
shares or convertible debentures’ only in terms of the Foreign Direct
Investment Scheme provided in schedule 1 of the said regulations.

II.3 Therefore, Foreign Direct Investment in India has to follow the

procedure and the limitations prescribed in Schedule 1 of the said
regulation i.e. it has to follow the Foreign Direct Investment Scheme. Rule
2 of the scheme prescribe that an India Company can issue shares or
convertible debentures to any person resident outside India provided
that the Indian Company is not ‘engaged in any activity or in
manufacturing of item included in Annexure-A’. Annexure- A, at the time
when the said regulation was introduced [i.e. 03.05.2002] had an entry at
serial no. 5, which read as under:-

“5. Housing and Real Estate Development sector for

investment from persons other than NRIs/OCBs.”

Annexure B of the said regulations provided for the sectoral caps for FDI
in various sectors. Item No. 2 of Annexure B provided the NRIs/OCBs11

10 The Foreign Exchange Management [Transfer or Issue of Security by a Person

Resident outside India] Regulations 2000 was notified vide Notification No. GSR 406 (E)
dated 03.05.2000.

11The expression OCBs was omitted by the FEMA [Withdrawal of Genuine Permission to
Overseas Corporate Bodies (OCBs)] Regulations 2003 with effect from 03.10.2003.
were allowed to invest in certain specific schemes. Therefore, there was
no difference between the Regime which existed prior to the coming into
force of the FEMA and the Regime prescribed by the Original Regulations
of FEMA. Therefore, the Limitations and Scope of Press Note No. 2 [2000
Series] was applicable at this stage.

II.4 Thereafter, Press Note No. 4 [2001 series]12 revised the existing
sectoral guidelines on FDI. It inter-alia permitted the following:-

iv. FDI up to 100% is permitted for development of

integrated townships, including housing, commercial
premises, hotels, resorts, city and regional level urban
infrastructure facilities such as roads and bridges, mass
rapid transit systems, and manufacture of building
materials. Development of land and providing allied
infrastructure will form an integral part of township’s
development, for which necessary guidelines/norms
relating to minimum capitalization, minimum land area,
etc., will be notified separately by the Government. FDI in
this sector would be permissible with prior Government
approval.

Although, the FDI policy was changed as per the Press Note 4 [2001
series] there was no corresponding amendment to the Regulation
mentioned herein above13.

II.5 The guidelines in relation to the implementation of the FDI policy

[in regard to the development of integrated township including housing
and building material] as change by Press Note No.4 [2001 Series] was

12Press Note 4 [2001 Series] was issued by the Department of Industrial Policy and
Promotion, Ministry of Commerce and Industry, Government of India on 04.01.2001.

13The effect of not incorporating the change in the Regulation is significant. In terms of
the Regulations, the only way that a Person resident outside India can invest is by way of
the manner prescribed by the Regulations. The effect, therefore, is that no one can by
way of any right claim under the Press Notes. However, the Union Government cannot
act except in accordance with the said Press Notes as it is the ‘avowed policy of the
Government’. Therefore, from a jurisprudential point of view there is a huge difference
between the two situations. Yet, for all practical purpose the Government has to follow
the Press Notes. However, this was very different under the earlier FERA Regime
whereby by a mere issuance of a Press Note, the Policy in relation to FDI could be
changed. This is however not true to the FEMA Regime.
given by Press Note No. 3[2002 series]14. It provided for certain minimum
requirements, such as:-

i) The Foreign Company seeking to invest shall be registered

as an Indian Company and would be allowed to take up
land assembly and its development as a part of Integrated
Township Development.

ii) All cases will be processed by FIPB on the recommendation

of the Ministry of Urban Development & Poverty
Alleviation.

iii) The core business of the company seeking to make

investments should be integrated township development
with a record of successful execution.

iv) The minimum area to be developed by such company

should be 100 acres.

v) The minimum capitalization norm was 10 Million US

Dollars for a wholly owned subsidiary and 5 Million US
Dollars for joint ventures with Indian partners.

II.7 It is important to point out that the aforementioned regulations

were amended from time to time. One of such amendments was the
Foreign Exchange Management [Transfer or Issue of security by a person
resident outside of India] [Second Amendment] Regulations 200315. The
Second Amendment substituted Annexure A and B of the Regulations. In
the list of activities for which FDI was prohibited, the following were
included:-

“5. Housing and Real Estate Business”

14Press Note No. 3 [2002 series] was issued by the Department of Industrial Policy and
Promotion, Ministry of Commerce & Industry, Government of India on 04.01.2002.

15The Foreign Exchange Management [Transfer or Issue of security by a person resident

outside of India] [Second Amendment] Regulations 2003 were notified in the Official
Gazette dated 18.06.2003.
However, Annexure B which provided the sectoral caps on investments
by person’s resident outside India included an entry relating to ‘Housing
and Real Estate Business.’

II.8 It is significant to note that the expression ‘Housing’ was introduce

[for the first time] in Annexure A as an activity to where FDI is prohibited.
At the same time, Annexure B had an entry in relation to Housing and
Real Estate. However, Annexure B only allowed NRIs/OCBs to invest in
specified scheme. This is a serious anomaly. However, by way of a
reasonable construction it can be assumed that except the permitted
activity provided in Annexure B, the other areas of the Housing and Real
Estate Sector is barred from any FDI. This was in line with Press Note 2
[2000 series]. However, it did not incorporate the change provided by
Press Note 4 [2001 series] as well as Press Note No. 3 [2002 series].

III. PRESS NOTE NO. 2 [2005 SERIES]:

III.1 In this backdrop, the Government of India issued Press Note No. 2
[2005 Series]16. Press Note No. 2 substantially liberalized the ‘FDI Policy'
in relation to ‘townships, housing, built-up infrastructure and
construction-development project’. The objective of this new policy is to
ensure that investments in these areas ‘create new employment
opportunities and add to the available housing stock and built-up
infrastructure’17.

Press Note No. 2 [2005 Series] was Department of Industrial Policy & Promotion,
16

Ministry of Commerce & Industry, Government of India

17 Press Note No. 2 [2005 Series]. It is important to note that there is a greater
realization with the Policy Makers that there is a need to increase FDI in Real Estate and
Housing Sector. The Eleventh Five Year Plan [2007-2011] in Chapter 11 [Urban
Infrastructure, Housing, Basic Service & Poverty Alleviation] has commented that the
ratio of urbanization in India is the lowest [at 27.8%] and has lead to ‘tremendous
pressure’ on civic infrastructure. The Eleventh Plan further points out that there is an
urgent need to create urban infrastructure by way of private participation.
III.2 As per Press Note No. 2 [2005 Series], the Government has
decided to allow FDI up to 100% under the automatic route in
‘townships, housing, built-up infrastructure and construction-
development projects [which would include, but not restricted to,
housing, commercial premises, hotels, resorts, hospitals, educational
institutions, recreational facilities, city and regional infrastructure’.
Therefore, Press Note 2 [2005 Series] included a specific as well as at the
same time a more comprehensive and exhaustive list of activities where
FDI up to 100% were allowed under the Automatic Route. This is the first
and most significant change in the Policy as compared to the FDI Policy in
terms of Press Note 4 [2001 Series]18. Therefore, Press Note 2 [2005
Series] brought about a more crystallized policy.

III.3 The other significant change brought about by Press Note 2 [2005
Series] was the changes brought about in the development criteria,
investment criteria as well as other conditions required to avail the
benefit of Press Note 4 [2001 Series]19. The fresh conditions required the
following:-
i) The minimum area to be developed in relation to the
development of a serviced housing plot is 10 hectares, in
relation to a construction-development project the
minimum built up area was 50,000 sq meters, and in
relation to a combination of the two any one of the
conditions; [Development Criteria]

ii) The minimum capitalization that was required for a wholly

onwed subsidiary was 10 Million US Dollars and for a Joint
Venture with an Indian Partner the minimum capitalization
required was 5 Million US Dollars. It was also mandatory
that the funds have to be brought in within 6 months of
commencement of business. [Investment Criteria]

18 A Comparison between Press Note No. 4 [2001 Series] and Press Note No. 2 [2005

Series] would clearly reveal that hospitals, educational institutions, recreational

facilities etc. do not find mention in Press Note No. 4.

19The criteria/condition for availing the benefit of Press Note 4 [2001 Series] was
prescribed in Press Note No. 3 [2002 Series] and briefly described in Para II.5 herein
above.
iii) The other conditions that were required to be followed
were as follows:-

a) Atleast 50% of the project must be developed within

5 years from obtaining all statutory clearances;

b) Investors were not permitted to sell undeveloped

plots20.

c) The Project has to conform to the norms &

standards laid down by respective State authorities.

d) Investor is responsible for obtaining all necessary

approvals as prescribed under the applicable laws
etc.

e) The State Government/ Municipal Board/ Local

Body, which approves development plan, would
monitor compliance of all the criteria mentioned
herein above.

III.4 The significant change brought about by the new Policy was that
the Development and Investment Criteria has been reduced. This
reduction enables a FDI in a project within or near about an existing
Urban Area. Previously, the Development criteria [100 acres] were so
large that it was practically not possible for an FDI investor to invest in a
Project near an existing urban centre.

III.5 The change in the FDI Policy brought about by Press Note No. 2
[2005 Series] was incorporated in the Regulations mentioned herein
above. The Foreign Exchange Management [Transfer or Issue of Security
by a Person Resident Outside India] [Third Amendment] Regulations
200521 included Item No. 23 in Annexure B. Item No. 23 created a new
sector which reads as under:-

20 Undeveloped Plots has been defined in Press Note No. 2[2005 Series] to mean a plot
where roads, water-supply, street lighting, drainage, sewerage & other conveniences, as
applicable under the prescribed regulations, have not been made available. It will be
necessary that the investor provided this infrastructure and obtains a completion
certificate from the concerned local body/ service authority before he sells such a plot.
21 The Foreign Exchange Management [Transfer or Issue of security by a person resident

outside of India] [Third Amendment] Regulations 2005 were notified in the Official
Gazette dated 19.07.2005.
 “23. Townships, housing built-up infrastructure and
construction development projects. The sector would
include, but not be restricted to, housing, commercial
premises, hotels, resorts, hospitals, educational facilities,
city and regional level infrastructure.

The conditions mentioned in Press Note No. 2 [2005 Series] was

introduced in the said Regulations. It is important to still note that the
anomaly pointed out at Para II.8 hereinabove still existed.

III.6 The anomaly mentioned herein before, was however rectified by

The Foreign Exchange Management [Transfer or Issue of Security by a
Person Resident outside India] [Second Amendment] Regulations 200822.
The said amendment Regulations amended Annexure-A [i.e. which
provided for the Sectors prohibited for FDI]. By way of this amendment
Regulations, the entry being ‘Housing and Real Estate Business’ 23has

been removed from the list of sectors prohibited for FDI. Further, the
earlier Entry at Annexure B [being Entry No. 6 being ‘Housing and Real
Estate’ was also removed. With this amendment the position has become
clear.

III.7 The position in relation to FDI in the Real Estate Sector is

permitted only for the activities mentioned in Item No. 23 of the
Regulations or the Press Note No. 2 [2005 Series]. The advantages of the
change in policy have already been dealt with while commenting on Press
Note No. 2.

III.8 While concluding, it would also be pertinent to point out that that
for the Objective of the New Policy to be implemented, it is required that
huge systematic and regulatory changes are conducted at the State Level.

22The Foreign Exchange Management [Transfer or Issue of security by a person resident

outside of India] [Second Amendment] Regulations 2008 were notified in the Official
Gazette dated 22.08.2008.

23 Please see Paras II.7 & II.8 of the present Note as well as The Foreign Exchange

Management [Transfer or Issue of security by a person resident outside of India]

[Second Amendment] Regulations 2003.
One of the inhibiting factors in the free flow of FDI in the housing and
township sector is the varied legal framework of each Indian state. This is
evident from the fact that availability of land for housing has been
constrained by various laws like the Land Reforms Laws etc. This brings
confusion to the investor, and makes it all the more necessary to have a
consolidated document specifying the approvals required from the
concerned authorities & procedure thereof so that they are clear on the
legal requisites before investing.