Why do some countries impose special screening on foreign direct investment (FDI) from land-neighboring countries?

Short answer

Special screening of foreign direct investment (FDI) from land-neighboring countries is a policy balancing mechanism that host countries establish between attracting international capital and safeguarding national security. It usually requires investments from specific geographic neighboring countries to obtain prior government approval, and it identifies the ultimate controller of funds through beneficial ownership standards. India's Press Note 3 (PN3) issued in 2020 is a typical example; its March 2026 amendment, while retaining security screening, introduced a 10% beneficial ownership threshold for the automatic route and a 60-day approval channel for critical manufacturing, reflecting that such screening is shifting from across-the-board strictness to targeted management.

Detailed explanation

Definition

Foreign direct investment (FDI) refers to cross-border investment in which an investor from one country or region acquires a lasting interest in an enterprise in another country and has significant influence over its management. The International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD) generally use lasting interest and 10% or more voting rights as reference benchmarks for statistics and definitions.

Foreign investment national security screening (investment screening) refers to institutional arrangements under which a host country government conducts ex ante assessment, conditional approval, or prohibition of specific foreign investment transactions on grounds such as national security, public order, or protection of critical infrastructure.

Land-border country rules are a special form of national security screening: the screening criteria depend not only on the transaction amount or industry but also on whether the investor's place of registration and the country of the actual controller share a land border with the host country. India's PN3 in 2020 belongs to this category.

Beneficial ownership refers to the natural person or entity that ultimately owns or controls an investment. It is the technical core of whether land-border country rules can be effectively enforced—if only nominal shareholders are screened, investors may evade restrictions through multi-layer offshore structures.

Automatic route and approval route are a dual-track structure in many countries' foreign investment management systems: the former requires no prior approval, while the latter must obtain government permission.

Background

Foreign investment screening is not new. Since the 1990s, most economies have undergone foreign investment liberalization reforms, but they still retain screening authority in sensitive sectors such as defense, energy, telecommunications, ports, and data. In 2019, the EU adopted an FDI screening regulation; the United States has long operated the CFIUS mechanism; Australia has a Foreign Investment Review Board (FIRB); Japan relies on the Foreign Exchange and Foreign Trade Act to implement a prior notification system; all are part of this framework.Around 2020, global supply chain disruptions and geopolitical tensions prompted many countries to tighten rules. In April 2020, India issued PN3, requiring all investments from land-border countries or their beneficial owners, regardless of size, to go through the government approval route. The rule was introduced in the early stage of the COVID-19 pandemic, and one of its policy goals was to prevent opportunistic acquisitions during periods of asset price volatility.

Since then, two types of problems emerged in the implementation of the rules: first, the lack of a clear definition of beneficial ownership led to a backlog of a large number of investment proposals; second, approval uncertainty dampened the willingness of compliant capital to enter. According to relevant public reports, India's net FDI inflows fell by about 27% in the 2022–2023 fiscal year. This provided the policy impetus for subsequent revisions.

On March 10, 2026, India announced adjustments to the FDI rules for land-border countries, effective from March 2026, aimed at improving the predictability of the rules while not abandoning security screening itself.

Operational Mechanism

An FDI review mechanism for land-border countries typically operates along the following chain:

First, identify the investor. The subjects of review are not only direct shareholders, but also their jurisdictions and ultimate controllers.

Second, determine beneficial ownership. India's revised rules align the definition of beneficial ownership with the standards under the Prevention of Money Laundering Act (PMLA), providing a relatively clear basis for determining ownership and control.

Third, classify review pathways. The revised rules set a 10% beneficial ownership threshold: minority stakes below this threshold can take the automatic route, thereby avoiding lengthy government review; investments above the threshold or involving control still require approval.

Fourth, establish sector-specific fast-track channels. For key manufacturing sectors such as electronics, capital goods, and polysilicon, the approval time limit has been shortened to 60 days to support joint ventures and technology cooperation.

Fifth, retain control restrictions. In some sectors with accelerated approval, majority equity and operational control must still be held by domestic residents. This shows that the policy welcomes capital but remains cautious about control over strategic assets.

Sixth, post-approval supervision and list adjustments. The list of applicable sectors is dynamically maintained by an inter-ministerial committee; the long-term effectiveness of the rules depends on the speed of list updates and consistency of enforcement.

Key Elements

• Scope of review: investor nationality, location of beneficial owners, target industry, shareholding ratio, and whether control is acquired.
• Determination criteria: definition of beneficial ownership and how ultimate effective control applies in multi-layered structures.
• Procedural timelines: automatic route, regular approval, and fast-track channels coexist.
• Transparency: the clearer the definitions, the greater the certainty in investor expectations and the fewer the backlogged proposals.
• Supporting systems: security review, director nationality and security clearance requirements, and sector access lists.

CasesCase 1: India's PN3 and the 2026 Amendment. The 2020 PN3 brought all investments from land-border neighboring countries under the approval requirement; the policy's original intent was to guard against opportunistic acquisitions. The 2026 amendment introduced a 10% beneficial ownership threshold and a 60-day fast-track channel for manufacturing, and aligned the beneficial ownership standard with the PMLA. This evolution shows that national security review can be retained, but its friction on normal commercial investment can be reduced through more refined design.

Case 2: Manufacturing and global supply chain restructuring. Electronics, capital goods, polysilicon, and other intermediate-goods industries are key nodes in the adjustment of global supply chains. India hopes to attract joint ventures and technological cooperation by accelerating approvals, while raising manufacturing's share of GDP, working in tandem with industrial policies such as Make in India and the Production Linked Incentive (PLI) scheme, to serve its economic growth goals for 2030. This type of policy mix can be seen in multiple emerging economies: use foreign investment review to screen risks and industrial policy to attract capital.

Case 3: Common features of mature review systems. The foreign investment review mechanisms of economies such as the United States, EU member states, Australia, and Japan generally have three features: review focuses on sensitive sectors rather than imposing a blanket prohibition; most transactions are approved with conditions; and the review process itself can be subject to administrative or judicial review. These features can serve as a reference framework for assessing national rules.

(These cases are used only to explain institutional logic and do not involve investment evaluations or business recommendations for any company.)

Related Concepts

FDI and Foreign Portfolio Investment (FPI): FDI seeks long-term interests and operational influence, whereas FPI is usually financial portfolio investment that can enter and exit quickly. Review mechanisms are generally stricter on FDI.

Greenfield Investment and Cross-Border M&A: Greenfield investment refers to building new capacity, while mergers and acquisitions (M&A) refer to acquiring control of existing enterprises. Review is more sensitive to M&A because it involves existing assets and key technologies.

Inbound FDI and Outbound FDI: Inbound FDI refers to foreign investors entering the home country, while outbound FDI refers to domestic investors investing abroad. National security review mainly targets the inbound direction.

Foreign Investment Review and Antitrust Review: The former focuses on national security and control, while the latter focuses on market competition structure; the two often apply in parallel.

Automatic Route and Approval Route: The same country may apply the automatic route to most sectors and the approval route to sensitive sectors or specific source countries.

Common Misconceptions

Misconception 1: FDI simply means foreign companies coming to build factories. In fact, FDI includes multiple forms such as greenfield investment, cross-border M&A, joint ventures, capital increases and share expansions, and reinvested earnings; review mechanisms usually cover several of these forms.Misconception 2: National security review only targets specific countries. Most review frameworks apply in their text to all foreign investors, but differentiated rules can be set for specific source countries; the land-neighbor rule is one such example.

Misconception 3: A shareholding below 10% is completely exempt from review. Beneficial ownership rules may look through multi-layer structures. Even if nominal shareholding is low, if the ultimate controller falls within the scope of review, the transaction may still be required to be submitted for approval.

Misconception 4: Review equals prohibition. Most reviewed transactions are approved unconditionally or with conditions, and the proportion actually prohibited is relatively limited. The main function of review is screening and imposing conditions, not comprehensive blocking.

Misconception 5: Once rules are set, they will not change. Foreign investment review regimes usually adjust with geopolitics, industrial policy, and supply chain conditions. Applicable industry lists, thresholds, and time limits may all change, and long-term investment planning needs to consider the risk of regulatory changes.

Misconception 6: As long as the provisions are clear, enforcement will necessarily be consistent. Abstract standards such as ultimate effective control may still leave room for interpretation when applied in complex multi-layer structures; enforcement consistency is a key variable determining the actual effect of policy.

Common Related Questions

Q: What is the main difference between FDI and foreign portfolio investment? A: FDI aims to obtain long-term benefits and operational influence, and is usually accompanied by management participation; foreign portfolio investment aims at financial returns, is more liquid, and involves less control. International statistics generally use 10% voting rights as a reference dividing line.

Q: What is beneficial ownership, and why is it important in FDI review? A: Beneficial ownership refers to the natural person or entity that ultimately owns or controls the investment. If nominal shareholders are not looked through, investors can use multi-layer offshore structures to circumvent source-country restrictions; therefore, beneficial ownership is the technical foundation for whether a review regime can be effectively implemented.

Q: Will national security review reduce FDI inflows? A: The impact depends on the clarity and predictability of the rules. Strict rules with vague definitions and approval backlogs often deter compliant capital; whereas rules with clear thresholds, controllable time limits, and expedited channels can reduce friction while preserving security objectives.

Q: Which industries are most susceptible to foreign investment review? A: They are usually concentrated in fields such as defense, critical infrastructure, energy, telecommunications, data and personal information, advanced manufacturing, and key technologies. The specific scope is determined by each country's list and will adjust over time.

Q: What is the difference between the automatic route and the government approval route? A: Under the automatic route, investment requires no prior approval and only requires reporting or statistical obligations; under the approval route, investment must obtain government permission and may be approved with conditions or rejected. Most countries adopt a dual-track structure in which both operate in parallel.Q: Why do some countries set review rules based on geographic adjacency rather than only by industry? A: Geographic adjacency is often intertwined with supply chain dependencies, infrastructure connectivity, and political relations, giving neighboring-country investment both economic and strategic significance. As a result, some regimes add additional review requirements based on the investor's place of origin on top of general industry lists.