The Reserve Bank of India (RBI) has advised the government to impose strict new riders and set up a monitoring mechanism to prevent a real estate bubble. That, the central bank fears, may be created due to diversion of foreign funds meant for hotels and tourism to acquisition of immovable property, circumventing foreign direct investment (FDI) rules.

Currently 100 per cent FDI is allowed in the hotel and tourism sector through the automatic route. The new riders suggested by RBI include a lock-in period for the original investment, which means foreign investors cannot sell and walk out of the Indian company whenever they choose.

For hotels and tourism, RBI has also suggested a quarterly or annual reporting on the receipt and usage of foreign inward remittance, granting permission or licence for running a hotel under which construction of the hotel should be completed within a stimulated period, and clauses under which the investor or the investee company would not be allowed to sell undeveloped plots.

There are numerous restrictions on buying of property by non-residents. If they are setting up an office in India, which is not merely a liaison office, RBI allows them to acquire immovable property. However, in such cases, a declaration is required to be filed with RBI within 90 days of acquiring the property.

Foreign nationals of non-Indian origin who have acquired immovable property in India cannot transfer the property without RBI’s permission.

Suggestions

• Lock-in period for original investment, which means foreign investors cannot sell and walk out of the Indian company whenever they choose
• A monitoring mechanism to check FDI violations
• A quarterly/annual reporting on receipt and usage of foreign inward remittance
• Granting permission/licence to run hotel under which construction of hotel should be completed within stimulated period
• Clauses under which investor/investee company would not be allowed to sell undeveloped plots
• Put onus of checking FDI violations on administrative ministry or states concerned

The central bank has stated that, as regards FDI in hotels and tourism, once the inward remittance received by the Indian company has been taken on record, there is no mechanism — neither under the FDI policy nor under the Foreign Exchange Management Act (FEMA) — to monitor the end use as such investments are spread across the country.

RBI believes that non-residents set up companies for building hotels or tourism-related infrastructure and divert the money coming as FDI to buy immovable property in India, which is not allowed. This leads to macroeconomic concerns and creates an asset bubble in real estate by pushing prices up artificially. This, according to the central bank, can be detrimental to the domestic economy. It has called for post-investment monitoring of FDI, or suitable tweaking of the policy, as reporting under FEMA does not capture intentional violations.

The central bank adds that a violation of FEMA (which it is in this case) can be dealt with by compounding (by the RBI as well as the Department of Economic Affairs), since RBI does not monitor the end use and only looks at cases which have been bought to its notice.

RBI points out that in order to curtail arbitrage the government should put the onus of checking FDI violations in hotels and tourism on the administrative ministry or the states concerned, as has been done in certain other sectors. FDI in power, for instance, is in the automatic list but subject to the provisions of the Electricity Act. The same applies to distillation and brewing of alcoholic beverages, where a licence has to be obtained.