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Mainstream, Vol 64 No 21, August 25, 2026

Press Note 3 At A Crossroad: The Legal Architecture Of India’s Investment Screening Regime | Lakshmi Karlekar and Tanishaa Pandey

Tuesday 25 August 2026

1. Introduction

The liberalisation of India’s economy in 1991 opened the country to “foreign direct investment (FDI)” as a matter of deliberate policy, gradually replacing a regime of pervasive licensing with one of graded, sector-specific openness. For roughly three decades, the trajectory of India’s FDI policy was almost uniformly expansionary: caps were raised, approval requirements were relaxed, and new sectors were opened to non-resident capital. Foreign investment law during this period was treated primarily as an instrument of “economic policy”, administered through the “Foreign Exchange Management Act, 1999” “(FEMA)” and delegated legislation made under it.

The framework for foreign direct investment (FDI), with a focus on investments when the ultimate beneficial ownership originates from nations that share a land border with India (LBCs). On March 15, 2026 (PN2), the Department for Promotion of Industry and Internal Trade (DPIIT) released Press Note 2 (2026 Series), which amended the current FDI Policy. However, unless the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (FEM NDI Rules) are modified appropriately, the updated framework will not have full legal force. During the COVID-19 epidemic, the Press Note 3 of 2020 (PN3) was implemented as an emergency measure to stop opportunistic purchases of Indian enterprises.

This purely economic framing shifted with the introduction of Press Note 3 of 2020 (PN3), which for the first time made the “nationality and beneficial ownership of an investor”, rather than the sector of investment alone, a formal trigger for mandatory government approval (Department for Promotion of Industry and Internal Trade [DPIIT], 2020). PN3 marked a doctrinal shift in Indian investment law from a purely liberalised, sector-based FDI regime to one that also screens investment by reference to the identity and control structure of the investor. This paper restricts itself to that legal transformation: the statutory and regulatory architecture of PN3, its interpretive difficulties, and its most recent amendment in 2026. Questions of “geopolitical strategy”, economic statecraft, and “India-China relations”, while relevant to the wider project, are deliberately left outside the scope of this section and are being developed separately.

2. Evolution of India’s FDI Framework

India’s modern “FDI” architecture rests on FEMA, which replaced the restrictive “Foreign Exchange Regulation Act, 1973” and reoriented foreign exchange law from control to management (Foreign Exchange Management Act, 1999). Capital account transactions, including FDI, are regulated under Section 6 of FEMA, and rule-making power over “non-debt instruments” the category within which equity FDI falls was vested in the Central Government by amendments made through the “Finance Act, 2015” (Foreign Exchange Management Act, 1999; Ministry of Finance, Department of Economic Affairs, 2019). Pursuant to this power, the Central Government notified the “Foreign Exchange Management” “(Non-Debt Instruments) Rules, 2019” “(NDI Rules)”, which superseded the earlier Transfer or Issue of “Security Regulations, 2017” and now form the operative legal text governing the entry, pricing, and reporting of foreign investment into India (Ministry of Finance, Department of Economic Affairs, 2019).

Substantively, FDI into India is permitted either through the Automatic Route, where no prior government approval is required and the investor need only comply with sectoral conditions, or the Government Route, where approval from the concerned administrative ministry is mandatory before investment. The Consolidated FDI Policy, periodically issued by the “Department for Promotion of Industry and Internal Trade (DPIIT)”, lays down which sectors fall into which route, along with applicable sectoral caps and performance conditions. Historically, this classification depended almost entirely on the sector of investment telecom, insurance, defence, and multi-brand retail, for instance, attracted caps or approval requirements irrespective of the investor’s nationality. Paragraph 3.1.1 of the “Consolidated FDI Policy Circular of 2020” embodied this position, permitting any non-resident entity to invest except in prohibited sectors. It is this paragraph that PN3 was to amend within days of the Circular’s issuance (Department for Promotion of Industry and Internal Trade [DPIIT], 2020).

3. Press Note 3: Legal Text and Regulatory Mechanics

PN3 was issued by the DPIIT on 17 April 2020, amending “Paragraph 3.1.1 of the FDI Policy” to provide that “an entity of a country, which shares land border with India or where the beneficial owner of an investment into India is situated in or is a citizen of any such country, can invest only under the Government route” (DPIIT, 2020). The stated trigger was the risk of opportunistic takeovers of Indian companies whose valuations had fallen sharply during the COVID-19 pandemic, following reports that entities linked to a neighbouring country’s central bank had acquired a toehold stake in a major Indian financial institution (Kaizen Law, 2023; Press Information Bureau [PIB], 2020). PN3 was subsequently given statutory effect through the “Foreign Exchange Management (Non-Debt Instruments) Amendment Rules, 2020”, which inserted a corresponding proviso into “Rule 6 of the NDI Rules” (PIB, 2020).

Three features of the drafting have generated sustained interpretive difficulty. First, PN3 does not itself define “beneficial owner”; (Kaizen Law, 2023). practitioners have had to import the concept either from the “Reserve Bank of India’s” Know Your Customer norms (which use a 25 percent ownership or control threshold) or from the “Prevention of Money-Laundering Act, 2002”. Second, the term “transfer” under PN3 draws on the wide “definition in Section 2(ze) of FEMA”, meaning that not only a sale but also a pledge, gift, or other change in title triggers the approval requirement, and this extends to indirect, downstream transfers of ownership as well (Deconstructing Press Note 3, 2021). Third, because approval applications are routed through the “Foreign Investment Facilitation Portal” and processed by the concerned administrative ministry in consultation with the “Ministry of Home Affairs”, actual processing timelines have often extended well beyond the 8–10 week period contemplated by the Standard Operating Procedure dated 9 November 2020, in practice taking anywhere from six to ten months (Beacon Filing, 2026). A failure to obtain approval before allotment renders the relevant shares liable to cancellation and refund, and exposes the investee company to compounding proceedings under FEMA for contravention (Beacon Filing, 2026).

On the narrow legal question of whom PN3 was addressed to: as a matter of drafting, PN3 is nationality-neutral it applies to any land-bordering country, and separately preserves pre-existing, more stringent restrictions applicable to Pakistan. As a matter of practical effect, however, it is undisputed that the overwhelming majority of investments actually screened and delayed under PN3 have originated from, or been beneficially owned by, Chinese entities, a point independently confirmed in the United States government’s own assessment of India’s investment climate (U.S. Department of State, 2026). This paper does not examine the strategic or diplomatic reasoning behind that outcome; it is flagged here only because it is legally relevant to the 2026 amendment discussed below.

4. Rationale and Assumptions

The first is that significant financial inflows from international investors into Indian start-ups and deep-technology companies would be made possible by relaxing prohibitions on minority, non-controlling Chinese shares. In a limited sense, this is conceivable. Limited partners or co-investors with Chinese beneficial ownership are common in private equity and venture capital firms, which are commonly organized through Singapore and other countries. The recently stated 10 percent automatic route barrier will assist resolve the genuine misunderstanding caused by Press Note 3’s previous reluctance to set beneficial ownership criteria. It’s unclear, though, if this will result in an increase in transformational capital. The regulatory monitoring of funds with ties to China has seldom been the cause of India’s deep-tech investment bottleneck.

The second premise is that knowledge transfer, domestic value addition, and integration into global value chains will result from Chinese FDI. There are limits to this premise. Vietnam, which is frequently referenced in the "Economic Survey of 2023–2024" as the paradigm for doing more with China, did not draw significant Chinese investment in high-tech sectors; instead, investments were made as part of China’s de-risking strategy rather than to increase Vietnam’s industrial capacity. According to a Bank for International Settlements report included in the Economic Survey for 2023–2024, Chinese companies’ rerouting of their supply chains through Vietnam and Mexico is largely responsible for the increase in trade through these nations.

The third premise is that the enormous trade gap between China and India won’t be made worse by this action. Scepticism is justified in this situation. Electronics, machinery, organic chemicals, and items that are "difficult to substitute quickly" are the main components of India’s import bill from China. Just four product categories account for about 80% of India’s imports from China: "electronics ($38 billion in the first ten months of 2025 alone), machinery ($26 billion), organic chemicals ($12 billion), and plastics ($6 billion)". These are the main forces behind Indian manufacturing; they are not optional consumer items. (Department for Promotion of Industry and Internal Trade [DPIIT], 2026).

5. Trusted Supply Chain Paradox

The amendment’s geopolitical ramifications go far beyond the two countries’ relationship. The "Committee on Foreign Investment in the United States (CFIUS)" is the focal point of the United States’ increasingly complex investment screening framework, which is now enhanced by outbound investment regulations. China is specifically listed as a foreign foe in the America First Investment Policy of February 2025, which also instructs CFIUS to increase monitoring of investments with Chinese ties. Investors having substantial connections to Chinese supply chains, investors, or activities would not be allowed to participate in the recently proposed Known Investor Program, even if such connections are otherwise legal in the United States.

The move by India to loosen limits on Chinese foreign direct investment comes at a time when Washington is taking the opposite stance. There are significant ramifications for Indian companies involved in international supply chains. If an Indian semiconductor packaging business or AI startup receives Chinese minority investment and then looks for collaborations or acquisitions in the United States, the CFIUS may flag it. The CFIUS priority areas—cybersecurity, key communications, and ports—all substantially overlap with the industries where Chinese investment interest is strongest, and the law’s illustrative list of national security risk elements is purposefully incomplete.

An additional layer of complication is introduced by the activity known as "Singapore washing," in which Chinese capital is passed via Singaporean organizations in order to conceal its source. Finding beneficial ownership at the 10 percent level is essential to the modified Press Note 3. However, determining ultimate beneficial ownership is a difficult forensic accounting task in the stacked fund arrangements that frequently define venture capital. The implications for India’s standing in reliable supply chain frameworks might be substantial if the easing permits a flow of finance whose Chinese origins are hidden by intermediary states.

The irony in this situation is undeniable: India markets itself as a "China plus one" substitute, a location for businesses looking to diversify away from China. The value proposition of "China plus one" starts to appear uncomfortably weak if Chinese capital and components are integrated across the Indian manufacturing base. Furthermore, Washington has already shown that it has influence over Indian economic choices, such as when it comes to Indian purchases of Russian oil. Future trade discussions may bring up the claim that Indian technological goods have elements of Chinese origin, maybe even derived from stolen U.S. intellectual property.

Although semiconductors are sourced in large quantities, the U.S. government recently conducted a Section 232 examination into the semiconductor industry to identify potential security vulnerabilities in semiconductors or any derivative equipment. Projects that rely on Chinese suppliers should be aware of the United States’ possible disapproval and develop suitable plans for such scenario. In spite of this, India is unlikely to let the US influence its economic decisions.

6. The Current Position: Press Note 2 (2026) and the Partial Liberalisation of PN3

The single most significant legal development affecting PN3 since its enactment occurred in 2026. On 10 March 2026, the Union Cabinet approved amendments to the PN3 framework, and “DPIIT” gave effect to this decision through Press Note No. 2 (2026 Series), issued on 15 March 2026, formally reviewing “Paragraph 3.1.1 of the FDI Policy” as it stood post-PN3 (Department for Promotion of Industry and Internal Trade [DPIIT], 2026). Two changes are of direct legal consequence. First, investors from land-bordering countries including China holding a “non-controlling beneficial ownership stake of up to 10 percent” may now invest through the Automatic Route, without prior government approval, subject to the applicable sectoral cap (Nandi, 2026). Second, the amendment introduces a defined processing timeline proposals in specified manufacturing sectors such as capital goods, electronic components, and semiconductor inputs are now required to be decided within sixty days, provided majority shareholding and control of the Indian investee company remains with resident Indian citizens or Indian-owned entities (DPIIT, 2026). Press Note 2 (2026) has also, for the first time, formally tied the definition of “beneficial owner” under the FDI Policy to the criteria already used under the “Prevention of Money-Laundering Act, 2002”, addressing one of the principal interpretive gaps identified in Section 3 above (Beyond Press Note 3, 2026).

Legally, this is best understood not as a repeal of PN3 but as a recalibration of it: the Government Route requirement for controlling or majority stakes from land-bordering countries remains fully intact, and the core architecture nationality- and ownership-linked screening rather than purely sectoral screening is preserved. What has changed is the threshold at which screening is triggered, and the certainty with which applications that do require approval are now expected to be processed. Commentators have accordingly characterised the 2026 amendment as a shift “from pandemic protectionism to strategic liberalisation” rather than a reversal of the underlying policy rationale, while other analyses caution that the practical benefit to investors depends heavily on how strictly DPIIT enforces the new beneficial-ownership and control conditions in individual cases (From Pandemic Protectionism, 2026), (Beyond Press Note 3, 2026).

7. Where This Leaves the Legal Analysis

Read together, Sections 2 to 4 show a clear legal arc: an economically liberal, sector-based FDI regime (pre-2020) was overlaid, in a matter of days during the pandemic, with a nationality- and ownership-based screening layer (PN3, 2020) whose central terms were left undefined and whose approval process proved administratively slow; six years later, that layer has been narrowed rather than removed, with a de minimis carve-out for minority stakes and firmer procedural timelines (PN2, 2026), while the underlying approval requirement for controlling investments from land-bordering countries continues to apply. “Whether this recalibrated, still nationality-anchored model should now be replaced by a more sophisticated, risk-based screening mechanism targeting specific strategic sectors along the lines of the CFIUS model in the United States or the National Security and Investment Act 2021 in the United Kingdom is a normative question this paper leaves open for the comparative and policy sections that follow” (National Security and Investment Act, 2021; U.S. Department of the Treasury, n.d.).

The lack of a precise definition or standard for "beneficial ownership" was the main practical challenge under PN3. Wherever the investment’s "beneficial owner" lived or was a citizen of an LBC, the clause required government permission. Nevertheless, neither PN3 nor the corresponding proviso in Rule 6 of the "Foreign Exchange Management (Non-debt Instruments) Rules, 2019 provided a definition of "beneficial owner" in this context, nor did they specify the extent to which investors were expected to trace beneficial ownership.
Investors, regulators, and Authorized Dealer Banks ("AD Banks") frequently took distinct approaches to the same transaction. Applications pertaining to LBC exposure sometimes languished in regulatory limbo for months or even years without being definitively accepted or rejected. Some banks effectively blocked transactions that did not really constitute a national security risk by treating even small, indirect LBC holdings as triggering the government clearance requirement. For cross-border M&A deals including any investor exposure to LBCs, this caused a great deal of uncertainty.

(Authors: Dr. Lakshmi Karlekar, Assistant Professor, School of Law, Christ University, Central Campus, Hosur Road, Bengaluru | lakshmi.karlekar[at]christuniversity.in
and Tanishaa Pandey, BBA LLB Student, School of Law, Christ University, Central Campus, Hosur Road, Bangalore, Karnataka)

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