Contents

1 History 2 Types 3 Methods 4 Global Foreign Direct Investment 5 Foreign direct investment in the United States 6 Foreign direct investment in China 7 Foreign direct investment in India 8 Foreign direct investment and the developing world 9 References 10 External links

Introduction
Foreign Direct Investment (FDI) from the viewpoint of the Balance of Payments and the International Investment Position (IIP) share a same conceptual framework given by the International Monetary Fund (IMF). The Balance of Payments is a statistical statement that systematically summarises, for a specific time span, the economic transactions of an economy with the rest of the world (transactions between residents and non-residents) and the IIP compiles for a specific date, such as the end of a year, the value of the stock of each financial asset and liability as defined in the standard components of the Balance of Payments. We will not deal in this note with other relevant statistical concepts for operations overseas, particularly for financial institutions, such as exposure (foreign claims, international claims, etc.), which belong to the realm of the BIS statistics.3 Sections 2, 3 and 4 give an overview of FDI definitions, concepts and recommendations adopted by the IMFs Balance of Payments Manual (5th Edition, 1993) and by the OECDs Benchmark Definition of Foreign Direct Investment (3rd Edition, 1996). Both provide operational guidance and detailed international standards for recording flows and stocks related to FDI. Section 5 gives a quick overview of trends in FDI inward flows and stocks for the period 1980-2001. Section 6 reports on onward FDI flows for Spain, with particular attention to the financial sector. Finally a brief description of the main available sources of FDI is found in an annex. I.

Introduction

i. Section 39 of the Federal Deposit Insurance Act1 (FDI Act) requires each Federal banking agency (collectively, the agencies) to establish certain safety and soundness standards by regulation or by guidelines for all insured depository institutions. Under section 39, the agencies must establish three types of standards: (1) Operational and managerial standards; (2)

compensation standards; and (3) such standards relating to asset quality, earnings, and stock valuation as they determine to be appropriate. ii. Section 39(a) requires the agencies to establish operational and managerial standards relating to: (1) Internal controls, information systems and internal audit systems, in accordance with section 36 of the FDI Act (12 U.S.C. 1831m); (2) loan documentation; (3) credit underwriting; (4) interest rate exposure; (5) asset growth; and (6) compensation, fees, and benefits, in accordance with subsection (c) of section 39. Section 39(b) requires the agencies to establish standards relating to asset quality, earnings, and stock valuation that the agencies determine to be appropriate. iii. Section 39(c) requires the agencies to establish standards prohibiting as an unsafe and unsound practice any compensatory arrangement that would provide any executive officer, employee, director, or principal shareholder of the institution with excessive compensation, fees or benefits and any compensatory arrangement that could lead to material financial loss to an institution. Section 39(c) also requires that the agencies establish standards that specify when compensation is excessive. iv. If an agency determines that an institution fails to meet any standard established by guidelines under subsection (a) or (b) of section 39, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. In the event that an institution fails to submit an acceptable plan within the time allowed by the agency or fails in any material respect to implement an accepted plan, the agency must, by order, require the institution to correct the deficiency. The agency may, and in some cases must, take other supervisory actions until the deficiency has been corrected. v. The agencies have adopted amendments to their rules and regulations to establish deadlines for submission and review of compliance plans.2 vi. The following Guidelines set out the safety and soundness standards that the agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The agencies believe that the standards adopted in these Guidelines serve this end without dictating how institutions must be managed and operated. These standards are designed to identify potential safety and soundness concerns and ensure that action is

taken to address those concerns before they pose a risk to the Deposit Insurance Fund.

A. Preservation of Existing Authority

Neither section 39 nor these Guidelines in any way limits the authority of the agencies to address unsafe or unsound practices, violations of law, unsafe or unsound conditions, or other practices. Action under section 39 and these Guidelines may be taken independently of, in conjunction with, or in addition to any other enforcement action available to the agencies. Nothing in these Guidelines limits the authority of the FDIC pursuant to section 38(i)(2)(F) of the FDI Act. .

Definitions
1. In general. For purposes of these Guidelines, except as modified in the Guidelines or unless the context otherwise requires, the terms used have the same meanings as set forth in sections 3 and 39 of the FDI Act (12 U.S.C. 1813 and 1831p--1). 2. Board of directors, in the case of a state-licensed insured branch of a foreign bank and in the case of a federal branch of a foreign bank, means the managing official in charge of the insured foreign branch. 3. Compensation means all direct and indirect payments or benefits, both cash and non-cash, granted to or for the benefit of any executive officer, employee, director, or principal shareholder, including but not limited to payments or benefits derived from an employment contract, compensation or benefit agreement, fee arrangement, perquisite, stock option plan, postemployment benefit, or other compensatory arrangement. 4. Director shall have the meaning described in 12 CFR 215.2(c). 5. Executive officer shall have the meaning described in 12 CFR 215.2(d).
6. Principal shareholder shall have the meaning described in 12 CFR 215.2(l+2p).

Operational and Managerial Standards

A. Internal controls and information systems. An institution should have internal controls and information systems that are appropriate to the size of the institution and the nature, scope and risk of its activities and that provide for: 1. An organizational structure that establishes clear lines of authority and responsibility for monitoring adherence to established policies; 2. Effective risk assessment; 3. Timely and accurate financial, operational and regulatory reports; 4. Adequate procedures to safeguard and manage assets; and 5. Compliance with applicable laws and regulations. B. Internal audit system. An institution should have an internal audit system that is appropriate to the size of the institution and the nature and scope of its activities and that provides for: 1. Adequate monitoring of the system of internal controls through an internal audit function. For an institution whose size, complexity or scope of operations does not warrant a full scale internal audit function, a system of independent reviews of key internal controls may be used; 2. Independence and objectivity; 3. Qualified persons; 4. Adequate testing and review of information systems; 5. Adequate documentation of tests and findings and any corrective actions; 6. Verification and review of management actions to address material weaknesses; and 7. Review by the institution's audit committee or board of directors of the effectiveness of the internal audit systems.

C. Loan documentation. An institution should establish and maintain loan documentation practices that: 1. Enable the institution to make an informed lending decision and to assess risk, as necessary, on an ongoing basis; 2. Identify the purpose of a loan and the source of repayment, and assess the ability of the borrower to repay the indebtedness in a timely manner; 3. Ensure that any claim against a borrower is legally enforceable; 4. Demonstrate appropriate administration and monitoring of a loan; and 5. Take account of the size and complexity of a loan. D. Credit underwriting. An institution should establish and maintain prudent credit underwriting practices that: 1. Are commensurate with the types of loans the institution will make and consider the terms and conditions under which they will be made; 2. Consider the nature of the markets in which loans will be made; 3. Provide for consideration, prior to credit commitment, of the borrower's overall financial condition and resources, the financial responsibility of any guarantor, the nature and value of any underlying collateral, and the borrower's character and willingness to repay as agreed; 4. Establish a system of independent, ongoing credit review and appropriate communication to management and to the board of directors; 5. Take adequate account of concentration of credit risk; and 6. Are appropriate to the size of the institution and the nature and scope of its activities. E. Interest rate exposure. An institution should: 1. Manage interest rate risk in a manner that is appropriate to the size of the institution and the complexity of its assets and liabilities; and

2. Provide for periodic reporting to management and the board of directors regarding interest rate risk with adequate information for management and the board of directors to assess the level of risk. F. Asset growth. An institution's asset growth should be prudent and consider: 1. The source, volatility and use of the funds that support asset growth; 2. Any increase in credit risk or interest rate risk as a result of growth; and 3. The effect of growth on the institution's capital. G. Asset quality. An insured depository institution should establish and maintain a system that is commensurate with the institution's size and the nature and scope of its operations to identify problem assets and prevent deterioration in those assets. The institution should: 1. Conduct periodic asset quality reviews to identify problem assets; 2. Estimate the inherent losses in those assets and establish reserves that are sufficient to absorb estimated losses; 3. Compare problem asset totals to capital; 4. Take appropriate corrective action to resolve problem assets; 5. Consider the size and potential risks of material asset concentrations; and 6. Provide periodic asset reports with adequate information for management and the board of directors to assess the level of asset risk. H. Earnings. An insured depository institution should establish and maintain a system that is commensurate with the institution's size and the nature and scope of its operations to evaluate and monitor earnings and ensure that earnings are sufficient to maintain adequate capital and reserves. The institution should: 1. Compare recent earnings trends relative to equity, assets, or other commonly used benchmarks to the institution's historical results and those of its peers;

2. Evaluate the adequacy of earnings given the size, complexity, and risk profile of the institution's assets and operations; 3. Assess the source, volatility, and sustainability of earnings, including the effect of nonrecurring or extraordinary income or expense; 4. Take steps to ensure that earnings are sufficient to maintain adequate capital and reserves after considering the institution's asset quality and growth rate; and 5. Provide periodic earnings reports with adequate information for management and the board of directors to assess earnings performance. I. Compensation, fees and benefits. An institution should maintain safeguards to prevent the payment of compensation, fees, and benefits that are excessive or that could lead to material financial loss to the institution.

I. Sectors prohibited for FDI

i. Retail Trading (except single brand product retailing) ii. Atomic Energy iii. Lottery Business iv. Gambling and Betting v. Business of chit fund vi. Nidhi Company vii. Trading in Transferable Development Rights (TDRs). viii. Activity/sector not opened to private sector investment

II.

Sector-specific policy for FDI:

In the following sectors/activities, FDI is allowed up-to the limit indicated below subject to other conditions as indicated.

Sector/Activity FDI Cap / Equity Entry

Route Other conditions

Foreign Direct Investment (FDI)

Foreign Direct Investment, or FDI, is a measure of foreign ownership of domestic productive assets such as factories, land and organizations. Foreign direct investments have become the major economic driver of globalization, accounting for over had of all crossborder investments.
The most profound effect has been seen in developing countries, where yearly foreign direct investment flows have increased from an average of less than $10 billion in the 1970s to a yearly average of less than $20 billion the 1980s. From 1998 to 1999 itself, FDI grew from $179 billion to $208 billion and now comprise a large portion of global FDI. According to UNCTAD, spurred on by mergers and acquisitions and the internationalization of production in a range of industries, inward FDI for developing countries rose from $481 billion in 1998 to $636 billion in 2006. And China is at the forefront of FDI growth, followed by Russia, Brazil and Mexico.

Image: The Economist FDIs do not only provide an foreign capital and funds, but also provides domestic countries with an exchange of skill sets, information and expertise, job opportunities and improved productivity levels. The "Asian Tiger" economies such as China, South Korea, Singapore and the Philippines benefited tremendously and experienced high levels of economic growth at the onset of foreign direct investment into their economies. Given the high growth rates and changes to global investment patterns, the definition to FDI has evolved to include foreign mergers and acquisitions, investments in joint ventures or strategic alliances with local enterprises.

With the advent and growth of the internet, many traditional cases of FDI which required huge amount of capital and physical investments are

slowly becoming obsolete, especially for developed countries. The rise of small internet startups that require less research and development investment and the shift towards knowledge based economies, where the emphasis is placed on human capital rather than manual labour, has altered the playing field for FDIs.

History :
FDI is a measure of foreign ownership of productive assets, such as factories, mines and land. Increasing foreign investment can be used as one measure of growing economic globalization. The figure below shows net inflows of foreign direct investment in the United States. The largest flows of foreign investment occur between the industrialized countries (North America, Western Europe and Japan). But flows to non-industrialized countries are increasing sharply.

US International Direct Investment Flows:

Period 1960-69 1970-79 1980-89 1990-99 2000-07 Total

FDI Inflow FDI Outflow Net Inflow $ 42.18 bn $ 5.13 bn + $ 37.04 bn $ 122.72 bn $ 40.79 bn + $ 81.93 bn $ 206.27 bn $ 329.23 bn - $ 122.96 bn $ 950.47 bn $ 907.34 bn + $ 43.13 bn $ 1,629.05 bn $ 1,421.31 bn + $ 207.74 bn $ 2,950.69 bn $ 2,703.81 bn + $ 246.88 bn

Types
A foreign direct investor may be classified in any sector of the economy and could be any one of the following:

an individual; a group of related individuals; an incorporated or unincorporated entity; a public company or private company; a group of related enterprises; a government body; an estate (law), trust or other social institution; or any combination of the above.

Foreign Direct investment classification, components and sectorian breakdown

The classification of direct investment is based firstly on the direction of investment both for assets or liabilities; secondly, on the investment instrument used (shares, loans, etc.); and thirdly on the sector breakdown. As for the direction, it can be looked at it from the home and the host perspectives. From the home one, financing of any type extended by the resident parent company to its non- resident affiliated would be included as direct investment abroad. By contrast, financing of any type extended by non-resident subsidiaries, associates or branches to their resident parent company are classified as a decrease in direct investment abroad, rather than as a foreign direct investment. From the host one, the financing extended by non-resident parent companies to their resident subsidiaries, associates or branches would be recorded, in the country of residence of the affiliated companies, under foreign direct investment, and the financing extended by resident subsidiaries, associates and branches to their non-resident parent company would be classified as a decrease in foreign direct investment rather than as a direct investment abroad. This directional principle does not apply if the parent company and its subsidiaries, associates or branches have cross-holdings in each others share capital of more than 10%. As for the instruments, direct investment capital comprises the capital provided (either directly or through other related enterprises) by a direct investor to a direct investment enterprise and the capital received by a direct investor from a direct investment enterprise. Direct investment capital transactions are made up of three basic components:
(i) Equity capital:

comprising equity in branches, all shares in subsidiaries and associates (except nonparticipating, preferred shares that are treated as debt securities and are included under other direct investment capital) and other capital contributions such as provisions of machinery, etc. (ii) Reinvested earnings:

consisting of the direct investors share (in proportion to direct equity participation) of earnings not distributed, as dividends by subsidiaries or associates and earnings of branches not remitted to the direct investor. If such earnings are not identified, all branches earnings are considered, by convention, to be distributed. (iii) Other direct investment capital (or inter company debt transactions): covering the borrowing and lending of funds, including debt securities and trade credits, between direct investors and direct investment enterprises and between two direct investment enterprises that share the same direct investor. As it has been mentioned before, deposits and loans between affiliated deposit institutions are recorded as other investment rather than as direct investment. Finally, there are several sector breakdowns of FDI flows and of IIP. The IMF has chosen a breakdown by four institutional sectors (see table 1 below), defined according to the sector to which the resident party belongs.

Methods
The foreign direct investor may acquire voting power of an enterprise in an economy through any of the following methods:

by incorporating a wholly owned subsidiary or company by acquiring shares in an associated enterprise through a merger or an acquisition of an unrelated enterprise participating in an equity joint venture with another investor or enterprise

Foreign direct investment incentives may take the following forms:

low corporate tax and income tax rates tax holidays other types of tax concessions preferential tariffs special economic zones EPZ - Export Processing Zones Bonded Warehouses Maquiladoras investment financial subsidies soft loan or loan guarantees free land or land subsidies relocation & expatriation subsidies job training & employment subsidies infrastructure subsidies R&D support

derogation from regulations (usually for very large projects)

Global Foreign Direct Investment :

UNCTAD said that there was no significant growth of Global FDI in

2010. In 2010 was $1,122 billion and in 2009 was $1.114 billion. The figures was 25 percent below the pre-crisis average between 2005 to 2007.[4]

Foreign direct investment in the United States

The United States is the worlds largest recipient of FDI. More than $325.3 billion in FDI flowed into the United States in 2008, which is a 37 percent increase from 2007. The $2.1 trillion stock of FDI in the United States at the end of 2008 is the equivalent of approximately 16 percent of U.S. gross domestic product (GDP).55 Benefits of FDI in America: In the last 6 years, over 4000 new projects and 630,000 new jobs have been created by foreign companies, resulting in close to $314 billion in investment Unarguably, US affiliates of foreign companies have a history of paying higher wages than US corporations Foreign companies have in the past supported an annual US payroll of $364 billion with an average annual compensation of $68,000 per employee Increased US exports through the use of multinational distribution networks. FDI has resulted in 30% of jobs for Americans in the manufacturing sector, which accounts for 12% of all manufacturing jobs in the US. Affiliates of foreign corporations spent more than $34 billion on research and development in 2006 and continue to support many national projects. Inward FDI has led to higher productivity through increased capital, which in turn has led to high living standards.

Foreign direct investment in China

Starting from a baseline of less than $19 billion just 20 years ago, FDI in China has grown to over $300 billion in the first 10 years. China has continued its massive growth and is the leader among all developing nations in terms of FDI Even though there was a slight dip in FDI in 2009 as a result of the global slowdown, 2010 has again seen investments increase

Foreign direct investment in India

Starting from a baseline of less than USD 1 billion in 1990, a recent UNCTAD survey projected India as the second most important FDI destination (after China) for transnational corporations during 2010-2012. As per the data, the sectors which attracted higher inflows were services, telecommunication, construction activities and computer software and hardware. Mauritius, Singapore, the US and the UK were among the leading sources of FDI. FDI for 2009-10 at USD 25.88 billion was lower by five per cent from USD 27.33 billion in the previous fiscal. Foreign direct investment in August dipped by about 60 per cent to aprox. USD 34 billion, the lowest in 2010 fiscal, industry department data released showed. [6]In the first two months of 2010-11 fiscal,FDI inflow into India was at an all-time high of $ 7.78 billions up 77% from $ 4.4 billions during the corresponding period in the previous year.

Foreign direct investment and the developing world

FDI provides an inflow of foreign capital and funds, in addition to an increase in the transfer of skills, technology, and job opportunities Many of the Four Asian Tigers benefited from investment abroad A recent metaanalysis of the effects of foreign direct investment on local firms in developing and transition countries suggest that foreign investment robustly increases local productivity growth. The Commitment to Development Index ranks the "development-friendliness" of rich country investment policies.

References:
Human body says global foreign direct investment inflows remain stagnant in 2010,

FDI Markets Newswire: Martin Bencher (Scandinavia) (Denmark) is investing in United States in the Transportation sector in a Sales, Marketing & Support project

Top Stories

From LOCATIONS

Political chaos fails to shake Thailand's business prospects

While Thailand has been rocked politically in the past few years, industry and FDI inflows have remained stable, proving that the country is far more robust than it first appears

From LOCATIONS

The race back to Myanmar

Only the most tenacious of backers have stayed in Myanmar in recent years, but a new wave of investment could follow the country's recent forays into democracy, which have included the release of campaigner Aunt San SUV Key and the formation of a new constitution and parliament

From LOCATIONS

Export-orientated Swaziland emerges

For years Swaziland has hung on the coat-tails of South Africa. Now the country is coming into its own, thanks to a rise in the World Bank's Doing Business report, strong infrastructure and government support for manufacturing. However, protests over jobs and democracy are increasing

Trend Tracker
From SECTORS / AEROSPACE

US dominates aerospace FDI

US remains the top country for aerospace-related FDI projects, but in terms of regions, North America trails Asia-Pacific and western Europe.

From LOCATIONS / EUROPE / IRELAND

FDI into Irelands financial services sector doubles

Despite the banking crisis, Ireland has seen a huge increase in FDI this year.

From LOCATIONS / EUROPE / ROMANIA

Romania sees FDI project numbers drop, but capex and jobs rise
Figures suggests that Romania has fewer, but larger investments this year.

Rankings

From SPECIAL REPORTS

Asia-Pacific continues to top global FDI destination rankings

Asia-Pacific has retained its position as top FDI destination region, while the US remains the lead destination country and Singapore stays at the helm of the city rankings

From RANKINGS

Shanghai tops transport technology rankings

fDi Benchmark rankings show Shanghai is lead world city for transport technology projects, with US the top country

From LOCATIONS / AMERICAS

American Cities of the Future 2011/12

In the first ever fDi ranking of cities across the American continents, New York has been crowned the leading American 'City of the Future' for 2011/12. Jacqueline Walls reports on the leading performers across the region

Trends in Foreign Direct Investment (FDI)

Historically, FDI has been directed at developing nations as firms from advanced economies invested in other markets, with the US capturing most of the FDI inflows. While developed countries still account for the largest share of FDI inflows, data shows that the stock and flow of FDI has increased and is moving towards developing nations, especially in the emerging economies around the world.

Aside from using FDIs as investment channel and a method to reduce operating costs, many companies and organizations are now looking at FDI was a way to internationalize. FDIs allow companies to avoid governmental pressure on local production and cope with protectionist measures by circumventing trade barriers. The move into local markets also ensures that companies are closer to their consumer market, especially if companies set up locally-based (national) sales offices.

Foreign Direct Investment

Last Updated: May 2011 India has been ranked at the second place in global foreign direct investments in 2010 and will continue to remain among the top five attractive destinations for international investors during 2010-12 , according to United Nations Conference on Trade and Development (UNCTAD) in a report on world investment prospects titled, 'World Investment Prospects Survey 2009-2012'. The 2010 survey of the Japan Bank for International Cooperation released in December 2010, conducted among Japanese investors, continues to rank India as the second most promising country for overseas business operations. A report released in February 2010 by Leeds University Business School, commissioned by UK Trade & Investment (UKTI), ranks India among the top three countries where British companies can do better business during 2012-14. India is ranked as the 4th most attractive foreign direct investment (FDI) destination in 2010, according to Ernst and Young's 2010 European Attractiveness Survey. However, it is ranked the 2nd most attractive destination following China in the next three years. Moreover, according to the Asian Investment Intentions survey released by the Asia Pacific Foundation in Canada, more and more Canadian firms are now focusing on India as an investment destination. From 8 per cent in 2005, the percentage of Canadian companies showing interest in India has gone up to 13.4 per cent in 2010. India attracted FDI equity inflows of US$ 1,274 million in February 2011. The cumulative amount of FDI equity inflows from April 2000 to February 2011 stood at US$ 128.642 billion, according to the data released by the Department of

Industrial Policy and Promotion (DIPP). The services sector comprising financial and non-financial services attracted 21 per cent of the total FDI equity inflow into India, with FDI worth US$ 3,274 million during April-February 2010-11, while telecommunications including radio paging, cellular mobile and basic telephone services attracted second largest amount of FDI worth US$ 1,410 million during the same period. Housing and Real Estate industry was the third highest sector attracting FDI worth US$ 1,109 million followed by power sector which garnered US$ 1,237 million during AprilDecember 2010-11. The Automobile sector received FDI worth US$ 1,320 million. During April-February 2010-11, Mauritius has led investors into India with US$ 6,637 million worth of FDI comprising 42 per cent of the total FDI equity inflows into the country. The FDI equity inflows from Mauritius is followed by Singapore at US$ 1,641 million and the US with US$ 1,120 million, according to data released by DIPP. Investment Scenario The Government has approved 14 FDI proposals amounting to US$ 288.05 million, based on the recommendations of Foreign Investment Promotion Board (FIPB) in its meeting held on March 11, 2011. These include:

Kolkata based Dhunseri Investments got approval for FDI worth US$ 159.62 million Mauritius based Ghir Investments got the approval of the Board for induction of foreign equity in an investing company. The company had proposed to get FDI worth US$ 118.36 million. Unihorn India Pvt Ltd got approval for issue and allotment of partly paid up Rights Equity shares to carry out the business of technical and engineering consultants, advisors, planners, engineering for construction of roads, airports and bridges. PCRD Services Pte Limited, Singapore, got approval to increase the foreign equity percentage in an investing company G+J International Magazines GmbH, Germany, got clearance for induction of foreign equity to carry out the business of publication and sale of specialty and life style magazines in India. Kyuden International Corporation, Japan got approval for setting up a joint venture (JV) company that will make downstream investments in the business of developing and establishing renewable power projects.

The total merger and acquisitions (M&A) and private equity (PE) (including qualified institutional placement (QIP)) deals in the month of February 2011were valued at US$ 8.27 billion (76 Deals) as compared to US$ 1.95 billion (84 Deals)

in the corresponding month of 2010, according to the monthly deals data released by Grant Thornton India.

FOREIGN DIRECT INVESTMENT

1) Foreign Direct Investment (FDI) is now recognized as an important driver of growth in the country. 2) Government is , therefore, making all efforts to attract and facilitate FDI and investment from Non Resident (NRIs) including Overseas Corporate Bodies (OCBs), that are predominantly owned by them, to complement and supplement domestic investment. To make the investment in India 3) attractive, investment and returns on them are freely repatriable, except where the approval is

APPENDIX - A

GUIDELINES FOR FOREIGN DIRECT INVESTMENT (FDI) IN THE BANKING SECTOR

1. Limit for FDI under automatic route in private sector banks a. In terms of the Press Note no. 4 (2001 series) dated May 21, 2001 issued by Ministry of Commerce & Industry, Government of India, FDI up to 49% from all sources will be permitted in private sector banks on the automatic route, subject to conformi with the guidelines issued by RBI from time to time.

Subject to licensing by the Insurance Regulatory & Development Authority

b.

For the purpose of determining the above-mentioned ceiling of 49% FDI under the automatic route in respect of private sector banks, following categories of shares will be included.

(i) IPOs, (ii) Private placements, (iii) ADRs/GDRs, and (iv) Acquisition of shares from existing shareholders [subject to (d) below] c. It may be clarified that as per Government of India guidelines, issue of fresh shares under automatic route is not available to those foreign investors who have a technical collaboration in the same or allied field. This category of investors require d. Under the Insurance Act, the maximum foreign investment in an insurance company has been fixed at 26%. Application for foreign investment in banks,

which have joint venture/subsidiary in insurance sector, should be made to RBI. Such applications will

RBI in consultation with Insurance Regulatory and Development Authority (IRDA).

1. Foreign banks having branch presence in India are eligible for FDI in the private sector banks subject to the overall cap of 49% mentioned above with the approval of RBI. 2. Limit for FDI in public sector banks FDI and portfolio investment in nationalised banks are subject to overall statutory limits of 20% as provided under Section 3 (2D) of the Banking Companies (Acquisition and Transfer of Undertakings) Acts, 1970/80. The same ceiling would also apply in respect of such 3. investments in State Bank of India and its associate banks. 4. Voting rights of foreign investors In terms of the statutory provisions under the various banking acts, the voting rights, when exercised, which are stipulated as under:

5. Private sector banks [Section 12 (2) of Banking Regulation Act, 1949]No person holding shares, in respect of any share held by him, shall exercise voting rights on poll in excess of ten per cent of the total voting rights of all the share holders 6. Nationalised Banks [Section 3(2E) of Banking Companies (Acquisition and Transfer of Undertakings) Acts, 1970/80] No shareholder, other than the Central Government, shall be entitled to exercise voting 7. rights in respect of any shares held by him in excess of one per cent of the total voting rights of all the share holders of the nationalised banks 8. State Bank of India (SBI) (Section 11 of State Bank of India Act, 1955) No shareholder, other than RBI, shall be entitled to exercise voting rights in excess of ten per cent of the issued capital (Government, in consultation with RBI can raise the above voting rate to more than ten per cent). 9. SBI Associates [Section 19(1)&(2) of SBI (Subsidiary Bank) Act, 1959] No person shall be registered as a shareholder in respect of any shares held by him in excess of two hundred shares. 10. For FDI of 5 per cent and more of the paidup capital, the private sector banking

stage reporting to the ECD as follows:

a. In the first stage, the Indian company has to submit a report within 30 days of the date of receipt of amount of consideration indicating the name and address of foreign investors, date of receipt of funds and their rupee equivalent, name of

bank through whom funds were received and details of Government approval, if any. b. In the second stage, the Indian banking company is required to file within 30 days from the date of issue of shares, a report in form FC-GPR together with a certificate from the Company Secretary of the concerned company certifying that various regulations have been complied with. The report will also be accompanies by a certificate from a Chartered Accountant indicating the manner of arriving at the price of the shares issued.

APPENDIX-B

GUIDELINES FOR LICENSING PRODUCTION OF ARMS & AMMUNITIONS OF FDI

1) In pursuance of the Government decision to allow private sector participation up to 100% in the defense industry sector with foreign direct investment (FDI) permissible up to 26%, both subject to licensing as notified vide Press Note No. 4 (2001 series), the following guidelines for licensing STEPS FOR ISSUING LICENCE OF FDI 1. Licence applications will be considered and licences given by the Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, in consultation with Ministry of defence.

2. Cases involving FDI will be considered by the FIPB and licences given by the Department of Industrial Policy & Promotion in consultation with Ministry of Defence. 3. The applicant should be an Indian company / partnership firm. 4. The management of the applicant company / partnership should be in Indian hands with majority representation on the Board as well as the Chief Executive of the company / partnership firm being resident Indians. 5. Full particulars of the Directors and the Chief Executives should be furnished along with the applications. 6. The Government reserves the right to verify the antecedents of the foreign collaborators and domestic promoters including their financial standing and credentials in the world market. Preference would be given to original equipment manufacturers or design establishments, and companies having a good track record of past supplies to Armed Forces, Space and Atomic energy sectors and having an established R & D base. 7. There would be no minimum capitalization for the FDI. A proper assessment, however, needs to be done by the management of the applicant company depending upon the product and the technology. The licensing authority would satisfy itself about the adequacy of the net worth of the foreign investor taking into account the category of weapons and equipment that are proposed to be manufactured. 8. There would be a three-year lock-in period for transfer of equity from one foreign investor to another foreign investor (including NRIs & OCBs with 60% or more NRI stake) and such transfer would be subject to prior approval of the FIPB and the Government.

9. The Ministry of Defence is not in a position to give purchase guarantee for products to be manufactured. However, the planned acquisition programme for such equipment and overall requirements would be made available to the extent possible. 10. The capacity norms for production will be provided in the licence based on the application as well as the recommendations of the Ministry of Defence, which will look into existing capacities of similar and allied products.

Foreign Direct Investment (FDI): a methodological note

The main purpose of this note is to deal with methodological aspects related to Foreign Direct Investment (FDI) from the viewpoint of the Balance of Payments and the International Investment Position (IIP). Special attention is paid to the financial system both as a sector investing directly abroad (home perspective) and receiving investment (host perspective). The note clarifies concepts such as direct investor, direct investment enterprise (subsidiary, associate and branch) and describes the different sector breakdowns available and what they imply for financial sector FDI. The main statistical sources for FDI are reviewed and the discrepancies are shown for total inward FDI flows and stocks both for emerging and industrial countries. Discrepancies appear much larger for stocks particularly for emerging countries. Some very general trends can be found from this data: First, even if FDI flows to emerging countries have grown, the bulk of them

continue to be directed to industrial countries. Second, the large reduction in FDI flows to emerging countries in 2001 in the UNCTAD statistics is much milder in the IMF statistics and is not perceived in the stock data. Total stocks, as well as the stock of FDI received by industrial countries, seem to have reached a plateau in IMF statistics but not in the UNCTAD ones. As for the sector breakdown, and in particular financial sector FDI, no readably comparable and reliable enough - data is available on an international basis. Even in national statistics the sector breakdown might not correctly reflect the total amount of foreign direct investment outflows from the financial system, particularly if the investment is carried out by holding companies. In the case of Spain, the re-estimation of outward FDI flows of the financial sector including the transactions carried out by resident holding companies, implies an increase of over 50% for the period 1997-2001.

How Beneficial is Foreign Direct Investment for Developing Countries?

The resilience of foreign direct investment (FDI) during financial crises may lead many developing countries to regard it as the private capital inflow of choice. While there is substantial evidence that FDI benefits host countries, they should assess its potential impact carefully and realistically.

Foreign direct investment (FDI) has proven to be resilient during financial crises. For instance, FDI in East Asian countries was remarkably stable during the global financial crises of 1997-98. In sharp contrast, other forms of private capital flows--portfolio equity and debt flows, and particularly short-term flows--were subject to large reversals during the same period (see Dadush, Dasgupta, and Ratha, 2000, and Lipsey, 2001). The resilience of FDI during financial crises was also evident during the Mexican crisis of 1994-95 and the Latin American debt crisis of the 1980s. This experience could lead many developing countries to favor FDI over other forms of capital flows, furthering a trend that has been in evidence for many years (see Chart 1). Is the preference for FDI over other forms of private capital inflows justified? This article sheds some light on this issue by reviewing recent theoretical and empirical work on the impact of FDI on developing countries investment and growth.

Free capital flows: the case in theory

Economists tend to favor the free flow of capital across nations because it allows capital to seek out the highest rate of return. Unrestricted capital

flows may also offer several other advantages, as noted by Feldstein (2000). First, international flows of capital reduce the risk faced by owners of capital by allowing them to diversify their lending and investment. Second, the global integration of capital markets can contribute to the spread of best practices of corporate governance, accounting rules, and legal traditions. Third, the global mobility of capital limits the ability of governments to pursue bad policies. In addition to these advantages, which in principle apply to all kinds of private capital inflows, Feldstein (2000) and Razin and Sadka (forthcoming) note that the gains to host countries from FDI can take several other forms: FDI allows the transfer of technology--particularly in the form of new varieties of capital inputs--that cannot be achieved through financial investments or trade in goods and services. FDI can also promote competition in the domestic input market. Recipients of FDI often gain employee training in the course of operating the new businesses, which contributes to human capital development in the host country. Profits generated by FDI contribute to corporate tax revenues in the host country.

(Of course, countries often choose to forgo some of this revenue when they cut corporate tax rates in an attempt to attract FDI from other locations. For instance, the sharp decline in corporate tax revenue in some of the member countries of the Organization for Economic Cooperation and Development (OECD) may be the result of such competition. For a discussion, see FDI and Corporate Tax Revenues in the OECD and European Union: Tax Harmonization or Competition? by Kristina Kostial and Reint Gropp in this issue of Finance and Development.)

In principle, therefore, FDI should contribute to investment and growth in host countries through these various channels.

FDI versus other flows

Despite the strong theoretical case for the advantages of free capital flows, the conventional wisdom now seems to be that many private capital flows pose countervailing risks. Hausmann and Fernndez-Arias (2000) suggest why many host countries, even when they are in favor of capital inflows, view international debt flows, especially of the short-term variety, as bad cholesterol:

It is driven by speculative considerations based on interest rate differentials and exchange rate expectations, not on long-term

considerations. Its movement is often the result of moral hazard distortions such as implicit exchange rate guarantees or the willingness of governments to bailout the banking system. It is the first to run for the exits in times of trouble and is responsible for the boom-bust cycles of the 1990s.

In contrast, FDI is viewed as good cholesterol for it can confer the benefits enumerated earlier. An additional benefit is that FDI is thought to be bolted down and cannot leave so easily at the first sign of trouble. FDI is not immobile because it is bolted down in the form of machines that are firm-specific, but rather because it is immediately repriced in the event of the crisis, unlike short-term debt.

Recent evidence
To what extent is there empirical support for such claims of the beneficial impact of FDI? A comprehensive study by Bosworth and Collins (1999) provides evidence on the effect of capital inflows on domestic investment for 58 developing countries during 1978-95. The sample covers nearly all of Latin America and Asia, as well as many countries in Africa. They distinguish among three

types of inflows: FDI, portfolio investment, and other financial flows (primarily bank loans). Bosworth and Collins find that an increase of a dollar in capital inflows is associated with an increase in domestic investment of about 50 cents. (Both capital inflows and domestic investment are expressed as percentages of GDP.) This result, however, masks significant differences among types of inflow. FDI is associated with a one-for-one increase in domestic investment; portfolio inflows have virtually no association with investment; and the impact of loans falls between those of the other two. These results hold both for the 58-country sample and for a subset of 18 emerging markets. (See Chart 2.) Bosworth and Collins conclude: Are these benefits of financial inflows sufficient to offset the evident risks of allowing markets to freely allocate capital across capital across the borders of developing countries? The answer would appear to be a strong yes for FDI. The World Banks latest Global Development Finance (2001) report summarizes the findings of several other studies on the relationships between private capital flows and growth, and also provides new evidence on these relationships. (For a summary, see Private Capital Flows and

Growth by Ashoka Mody, Deepak Mishra, and Antu Panini Murshid in this issue of Finance and Development.)

Reasons for caution?

Despite the evidence presented in recent studies, recent work cautious against taking too uncritical an attitude toward the benefits of FDI. Is a high FDI share a sign of weakness? Hausmann and FernndezArias (2000) and Albuquerque (2000) point to reasons why a high share of FDI in total capital inflows may be a sign of a host countrys weakness rather than its strength. One striking feature of FDI flows is that the share of FDI in total inflows is higher in riskier countries, as measured either by countries credit ratings for sovereign (government) debt or other indicators of country risk (see Chart 3). There is also some evidence that the FDI share is higher in countries where the quality of institutions is lower. What can explain these

seemingly paradoxical findings? One explanation is that FDI is more likely, compared with other forms of capital flows, to take place in countries with missing or inefficient markets. In such settings, foreign investors will prefer to operate directly instead of relying on local financial markets, suppliers, or legal arrangements. The policy implications of this view, according to Albuquerque (2000, page 30), are that countries trying to expand their access to international capital markets should concentrate on developing credible enforcement mechanisms instead of trying to get more FDI. In a similar vein, Hausmann and Fernndez-Arias (2000, page 5) suggest that

. . . a high share of FDI in capital inflows is not a sign of good health, as evidenced by the industrial countries where it is barely 12 percent. Consequently policies directed at expanding that share are unwarranted. Instead, countries should concentrate on improving the environment for investment and the functioning of markets. They are likely to be rewarded with increasingly efficient overall investment as well as with more capital inflows.

While it is very likely that FDI is higher as a share of capital inflows where domestic policies and institutions are weak, this cannot be regarded as a criticism of FDI per se. Indeed, without the FDI, the countries could well be much poorer.

Fire sales, adverse selection, and leverage. FDI is not only a transfer of ownership from domestic to foreign residents but also a mechanism that makes it possible for foreign investors to exercise management and control over host country firmsthat is, it is a corporate governance mechanism. The transfer of control may not always benefit the host country because of the circumstances under which it occurs, problems of adverse selection, or excessive leverage. Krugman (1998) notes that sometimes the transfer of control occurs in the midst of a crisis and asks:

Is the transfer of control that is associated with foreign ownership appropriate under these circumstances? That is, loosely speaking, are foreign corporations taking over control of domestic enterprises because they have special competence, and can run them better, or simply because they have cash and the locals do not? . . . Does the

firesale of domestic firms and their assets represent a burden to the afflicted countries, over and above the cost of the crisis itself?

Even outside of such fire-sale situations, FDI may not necessarily benefit the host country, as demonstrated by Razin, Sadka, and Yuen (1999) and Razin and Sadka (forthcoming). Through FDI, foreign investors gain crucial inside information about the productivity of the firms under their control. This gives them an informational advantage over uninformed domestic savers, whose buying of shares in domestic firms does not entail control. Taking advantage of this superior information, foreign direct investors will tend to retain high-productivity firms under their ownership and control and sell low-productivity firms to the uninformed savers. As with other so-called adverse-selection problems of this kind, this process may lead to overinvestment by foreign direct investors. Excessive leverage can also limit the benefits of FDI. Typically, the domestic investment undertaken by FDI establishments is heavily leveraged owing to borrowing in domestic credit market. As a result, the fraction of domestic investment actually financed by foreign savings through FDI flows may not be as large as it seems, since the FDI investor can repatriate the

borrowing, and the size of the gains from FDI may be limited by the sizeable quantity of domestic borrowing relative to the quantity of capital inflows

FDI reversals?

The evidence on the stability of FDI has also been cast in a new light in recent work. Though it is true that the machines are bolted down and, hence, difficult to move out of the host country on short notice, financial transactions can sometimes accomplish a reversal of FDI. For instance, the foreign subsidiary can borrow against its collateral domestically and then lend the money back to the parent company. Likewise, because a significant

portion of FDI is intercompany debt, the parent company can recall it on short notice.

Other considerations: There are some other cases in which FDI might not be beneficial to the recipient country. This can occur, for instance, when FDI is geared toward serving domestic markets that are protected by high tariff or non-tariff barriers. FDI under these circumstances may become a political-economy lobbying facility to perpetuate the misallocation of resources. There could also be a loss of domestic competition that can arise when foreign acquisitions lead to a consolidation in the number of domestic producers, either through takeovers or corporate failures.

Conclusion Both economic theory and recent empirical evidence suggest a beneficial impact of FDI on developing host countries. But recent work also points to some sources of potential risks: FDI can be reversed through financial

transactions; there can be excessive FDI owing to adverse selection and fire sales; the benefits of FDI can be limited by leverage; and a high share of FDI in a countrys total capital inflows may reflect its institutions weakness rather than their strength. Though the empirical relevance of some of these sources remains to be demonstrated, they do appear to make a case for taking a nuanced view of the likely effects of FDI. Policy recommendations for developing countries should focus on improving the investment climate for all kinds of capital, domestic as well as foreign.

Chart 1 The composition of capital inflows has shifted away from bank loans toward FDI and portfolio investment
1978-81 1982-89 1990-95

FDI 11%

Portfolio 9%

FDI 16% Loans 36% Loans 55% Portfolio 29%

FDI 20%

Loans 80%

Portfolio 44%

FDI

Portfolio

Loans

FDI

Portfolio

Loans

FDI

Portfolio

Loans

Source: Based on Bosworth and Collins (1999).

Chart 2 FDI has a stronger impact on domestic investment than do loans or portfolio investment Emerging markets sub-sample
(18 countri e s) 1 0.8 0.6 0.4 0.2 0 FDI Port folio Loans FDI Portfolio Loans

Developing countries
(58 countrie s) 1 0.8 0.6 0.4 0.2 0

Source: Based on Bosworth and Collins (1999). The height of the bar represents the estimated impact of the indicated capital flow on domestic investment.

Chart 3 FDI's share in total inflows is higher in countries with weaker credit ratings

Share of FDI in total inflows

0.25 0.2 0.15 0.1 0.05 0 Aaa Aa A Baa Ba B Moody's Credit Ratings

Source: Albuquerque (2000).

Ground Handling Services 74%- FDI 100%- for NRIs investment

Where there is a prescribed cap for foreign investment, only the direct investment will be considered for the prescribed cap and foreign investment in an investing company will not be set off against this cap provided the foreign direct investment in such investing company does not exceed 49% and the management of the investing company is with the Indian owners.

Investing companies in infrastructure / services sector (except telecom sector) 100%

a) Merchant b) Banking c) Underwriting d) Portfolio e) Management f) Services g) Investment h) Advisory i) Services j) Financial

k) Consultancy l) Stock Broking m) Asset n) Management o) Venture Capital p) Custodial q) Services r) Factoring s) Credit Rating t) Agencies u) Leasing & Finance v) Finance w) Housing x) Finance y) Forex Broking z) Credit card Business Money

CONCLUSION

The government of India has taken several initiatives to attract foreign investments in India. Not only foreign establishments but also entrepreneurs from India can reap the benefits of the growing Indian Market.