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Gyaan@ Finstreet Nature and Trend of FDI in India

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History Concept of FDI came to India a couple of decades back. Prior to 1991 liberalization of Indian economy, FDI in India averaged about USD 200 million per year between 1985 and 1991. This was largely due to Indias protectionist and self-sufficiency targeting policy in trade and other foreign interactions. Restrictions were imposed on upper-limit equity ownership by a foreign investor and technology transfer; government approval required for almost 60 percent new FDI investments. FDI brings in necessary capital for the growth and plugs the gap between domestic savings and investments.
34,362
2007-08

6,130

5,035

2,821

3,557

2,462

1991-92

129

315

1993-94

586

1,314

1995-96

2,144

1997-98

1999-00

2,155

4,029

2001-02

2003-04

4,322

6,051

2005-06

Upsurge in arrival of multinational enterprises can be attributed to necessary changes to technologies, trade liberalization, and deregulation and privatization of markets. Mergers and acquisitions and fresh investments have been the route of FDI in India. A large part of FDI in India comes from high-income destinations such as the US and the EU. FDI inflow grew during first half of the 90s and stagnated during 1996-07 and 2003-04. However, the inflows up surged after 2006-07. FDI Policy of India India had a much closed FDI policy prior to 1991 and government controlled most of the foreign exchange transactions under Foreign Exchange Regulation Act (FERA), 1973. Violation of this act was considered a criminal offence. In 1999, this act was replaced by Foreign Exchange Management Act (FEMA). FEMA was less rigid and facilitated external trade and foreign exchange market in India. Three FDI related institutions in India - Foreign Investment Implementation Authority (FIIA), the Secretariat for Industrial Assistance (SIA), and the Foreign Investment Promotion Board (FIPB). FDI is allowed in almost all the sectors barring those of strategic concern such as defense (26 percent FDI permitted) and railways. According to the FDI policy, investments can come in two ways: Automatic route: FDI under this category does not require any prior approval (to the extent permitted) from by either government or RBI. Prior govt. approval route: Foreign Investment Promotion Board (FIPB) under the Department of Economic Affairs, Ministry of Finance regulates this route of entry.

From 1991 (liberalization) to 2000, most of the FDI came to India through the government route owing to strict monitoring of approvals. Thus FDI through government route (FIPB) was greater than that through RBI route. However, the trend has been revered in last five years with a spurt in FDI coming through RBI route.

8,961

Log scale

22,826

33,613

FDI Inflow in India, USD million

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Sectors Composition of FDI has undergone significant changes in the recent past as shown in the figure below: Sector-wise FDI Inflow (Aug. 1991 Dec. 1999) Sector-wise FDI Inflow (Jan.2000 Mar. 2009)

Service Sector, 21% Others, 50% Computer Software & Hardware, 10% Telecommu nications, Housing & 7% Constructio n Activities, 6% Real Estate, 6%

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Manufacturing A flourishing manufacturing sector in India with an average growth of 9 percent during last four years has set the tone for FDI in this area. Low cost labor has attracted a number of multinationals. Share of manufacturing in total FDI inflow in 2007 was 34.02 percent with industries such as electrical equipment (incl. software and electronics), transportation, power & refinery, chemicals, and drug & pharmaceuticals being the clear leaders.

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Services During 2005-08, India witnessed tremendous growth in FDI in service sector, of which financial services constitutes about one-half followed by banking and others. Share of services sector in FDI inflows has increased from 16.4 percent in 2005 to 35.4 percent in 2006 and declined to 18 percent in 2007. Again, in 2008, the share of services sector in FDI rose to 24.4 percent.

Country-wise inflow of FDI Leading country on the list of FDI pumpers into India is Mauritius; perhaps owing to the double taxation treaty that India signed with Mauritius and the fact that most of the US investment in India is routed through Mauritius). Singapore is the second largest investor followed by the US, the UK, and the Netherlands.

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Foreign technology transfers Coupled with rising FDI inflows, there has been an increase in foreign technology transfers approvals to India. This is mainly due to continued improvisation in technology and modernization of industries in India.

Majority of these transfers are done with the US, followed by Germany and other EU nations.

Mergers and Acquisitions and Greenfield FDI FDI comprises of three components i.e. equity, reinvested earnings, and other capital. Equity capital can be further divided into two segments i.e. Greenfield investment and acquisition of shares (M&As). Merger Two different firms belonging to two different countries join together to form a new legal entity. Stocks of two companies cease to exist and stocks of new entity are issued e.g. Essar and Hutchinson merger, Daimler-Benz and Chrysler merger. Acquisition A local company is handed over to a foreign entity. The local company ceases to exist and is called an affiliate of the foreign company. This can be a forced one through acquiring a major interest in management, purchasing shares in the open market, or through a take-over proposal to general body of shareholders e.g. Vodafones acquisition of Hutchinson Essar and Lenevos takeover of IBMs PC business.

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Graph on FDI in India suggests that major investments come as fresh foreign equity instead of acquisitions. Greenfield investments Number of Greenfield investments in India increased from 247 in 2000 to 980 in 2006, declined to 682 in 2007. Most of the Greenfield investments in India are for new facilities rather than expansion projects. Mergers and Acquisitions Based on Zephyr database, in 2007, about 167 M&A deals worth USD 5.6 billion took place in India. Several of these deals are made with the firms in the US, Mauritius, the UK, Switzerland etc.

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An Interesting Analogy On regressing Indias GDP (log) with FDI inflow (log):

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From the regression analysis, it is clear that Indias GDP is positively correlated to the FDI inflow and that FDI has contributed to Indias growth; though it may not be the sole indicator.

References: FDI in India and its Growth Linkages National Council of Applied and Economic Research Consolidated FDI Policy Dept. of Industrial Policy and Promotion, Ministry of Commerce and Industry, Govt. of India Foreign Direct Investment in India in the 1990s Trends and Issues R Nagraj