TITLE OF THE PAPER

ROLE OF FOREIGN DIRECT INVESTMENT

AREA OF PRESENTATION

FINANCIAL MANAGEMENT

NAME OF THE INSTITUTION

A.J.INSTITUTE OF MANAGEMENT

EMAIL ID: moras48@gmail.com

AUTHOUR’S NAME

NAVEEN RAJESH MORAS

PHONE NO: +919964071498

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 Role foreign direct investment
(How does foreign direct investment promote economic development?)

ABSTRACT

The capital and investment are the essential pillars of economic development of every country. But the
short supply of domestic capital limit the growth of developing countries. Low GDP keeps the savings
and investment rates low, which in turn, growth. Keeping in view the pivotal role played by FDI inflows,
the government of India opened the Indian economy for foreign players in 1991 when the economic
reforms process was initiated. Foreign direct investment is an investment made by a foreign individual or
company in productive capacity of another country. It is the movement of capital across national frontiers
in a way that grants the investor control over the acquired asset.

India's recently liberalized FDI policy permits up to a 100% FDI stake in ventures. Industrial policy
reforms have substantially reduced industrial licensing requirements, removed restrictions on expansion
and facilitated easy access to foreign technology and FDI.

NAVEEN RAJESH MORAS

A.J. INSTITUTE OF MANAGEMENT

MOB: +919964071498

EMAIL: moras48@gmail.com

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 SYNOPSIS

CHAPTER NO TITLE PAGE

NO.

1 INTRODUCTION 4

2 REVIEW OF LITREATURE 5

3 DETERMINANTS OF ECONOMIC GROWTH 6

4 FDI POLICY AND PROCEDURE 7

5 ROLE OF FDI IN ECONOMIC GROWTH 8

6 CONCLUSION 10

7 BIBILIOGRAPHY 11

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 INTRODUCTION
FDI refers to investment in a foreign country where the investor retains control over the
investment. It typically takes the form of starting a subsidiary, acquiring a stake in an existing
firm or starting a joint venture in the foreign country. Direct investment and management of the
firm concerned normally go together. When a firm controls (or have a strong say in) another firm
located abroad, e.g. by owing more than 10% of its equity, the former is said "parent enterprise "
(or "investor") and the latter "foreign affiliate". Its definition can be extended to include
investments made to acquire lasting interest in enterprises operating outside of the economy of
the investor. The FDI relationship consists of a parent enterprise and a foreign affiliate which
together form an international business. Since the beginning of the 1990s foreign direct
investment (FDI) has become the most important source of foreign capital for emerging market
economies (EMEs). In the era of increasingly globalized world economy, FDI is a particularly
significant driving force behind the interdependence of national economies. Even though most of
the FDI flows have always concentrated in the developed countries, its importance is undeniable
for developing countries as well.
Composition

FDI has three components:

a) Equity capital;
b) Reinvested earnings, the investor's share of earning not distributed as dividends by
affiliates, in proportion to its share in the equity (say for instance 50% in a certain joint
venture);
c) Intra-company loans, when the investor borrows funds to the affiliate, usually without the
intention of asking the money back.

To better understand their defining characteristics, we should consider that FDI are flows of
capital that share the following features:

a) They are long-te rm (in contrast to portfolio investment in bonds and in short-term
speculation in shares);
b) They give rise to a property right on the asset built or bought (in contrast to foreign aid).
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 REVIEW OF LITREATURE

The empirical literature finds mixed evidence on the existence of positive productivity
externalities in the host country generated by foreign multinational companies.

Coase (1987) argued that with certain transactional cost the firms internal procedures are better
suited than the market to organize transaction.

The economists like Rosenstein Rodan (1961), and Chenery and Strout (1966) in the early 1960s
show that foreign capital inflows have a favorable effect on economic efficiency and growth.

Experts like Schmitz and Helmberger (1970) contend that foreign direct investment creates
vertically integrated production units and therefore increases the amount of trade.

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 DETERMINANTS OF ECONOMIC GROWTH
Economic growth is an increase in activity in an economy. It is often measured as the rate of
change of gross domestic product (GDP). Economic growth refers only to the quantity of goods
and services produced; it says nothing about the way in which they are produced. Economic
development, a related term, refers to change in the way goods and services are produced;
positive economic development involves the introduction of more efficient or
"productive" technologies or forms of social organisation.

Keynesian Approaches: Keynesian economics advocates a mixed economy—predominantly

private sector, but with a large role of government and public sector—and served as the
economic model during the latter part of the Great Depression, World War II, and the post-
war Golden Age of Capitalism, 1945–1970, though it lost some influence following
the stagflation of the 1970s

Savings and Investment

Increases in the amount of capital goods are called investment. For growth to occur the level of
investment has to be greater than the amount of depreciation The higher the level of investment
above depreciation the greater the potential output of the economy in the future..

Government-Financed Investment

Investment by government injects income, which results in more spending in the general
economy, which in turn stimulates more production and investment involving still more income
and spending and so forth.

Macroeconomic Stability

General macroeconomic conditions are very important in terms of the general climate under
which investment decisions are made, so economic growth will depend to some extent upon the
stability of the economy. E.g. fiscal balance, and reasonably predictable levels of inflation.

Trade Liberalization, Capital Mobility and Exchange Rate Policy

The abolition of trade restrictions (tariffs and quotas) is often seen as a necessary condition for
growth. The idea is to widen markets and thus allow economies of scale in exporting industries.
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 FDI POLICY AND PROCEDURE
Policy on Foreign Direct Investment
India has among the most liberal and transparent policies on FDI among the emerging
economies. FDI up to 100% is allowed under the automatic route in all activities/sectors except
the following, which require prior approval of the Government:-

1. Sectors prohibited for FDI

2. Activities/items that require an industrial license
3. Proposals in which the foreign collaborator has an existing financial/technical collaboration in
India in the same field
4. Proposals for acquisitions of shares in an existing Indian company in financial service sector
and where Securities and Exchange Board of India (substantial acquisition of shares and
takeovers) regulations, 1997 is attracted
5. All proposals falling outside notified sectoral policy/CAPS under sectors in which FDI is not
permitted

Most of the sectors fall under the automatic route for FDI. In these sectors, investment could be
made without approval of the central government. The sectors that are not in the automatic route,
investment requires prior approval of the Central Government. The approval is granted by
Foreign Investment Promotion Board (FIPB). In few sectors, FDI is not allowed. After the grant
of approval for FDI by FIPB or for the sectors falling under automatic route, FDI could take
place after taking necessary regulatory approvals form the state governments and local
authorities for construction of building, water, environmental clearance, etc.

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 ROLE OF FDI IN ECONOMIC GROWTH
The most obvious effect of FDI on the growth potential of host countries may be the provision of
additional capital. The inflow of foreign funds can help overcome the pervasive investment-
saving gap, thus enabling countries to grow faster without sacrificing current consumption.
Indeed in many theories of economic development the main driving force behind a higher growth
potential is seen in an expanding capital base. In addition, the investment by one MNE in a
foreign firm can induce other MNEs to invest in the same host country as well in order to
retain a role as a supplier of intermediate products.

FDI and Capital Formation

The transfer of savings from households and governments to the business sector, resulting in
increased output and economic expansion.

Impetus to Economic Growth

The potential for fast income growth has expanded drastically over time. Before the industrial
revolution, it took European countries some 350 years for income per capita to double. As the
industrial revolution accelerated in the 19 th century, Britain, the lead country, was able to double
its per capita income in just over 60 years

Domestic labour

Domestic labour may get higher real wages because of increase in productivity.

Cons umers

If foreign investment is cost reducing in a particular industry consumers of the product may gain
through lower product price

Government

The increase in production and trade resulting from foreign capital might increase the fiscal
revenue of the government.

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External economies

Factors those are external to a firm such as locally available skilled labour, training, research and
development facilities.

Tax revenue

Foreign capital investment increases the tax revenue to the government

Foreign investment has assisted and is assisting the economic growth of many countries. As the
World Bank report point out, for the developing countries FDI has the following advantages over
the official development assistance (ODA)

1. FDI shifts the burden of risk of an investment from domestic to foreign investor.

2. Repayment is linked to profitability of the underlying investment, whereas under debt

financing the borrowed funds must be serviced regardless of the project cost.

3. It has also been observed that FDI is the only capital inflow that has been strongly
associated with the higher GDP growth since 1970

The contribution of FDI to economic growth is highlighted by the fact that the ratio of
FDI flow to domestic investment (gross capital formation) rose for most developed and
developing countries in the past. Apart from the potential gains though technology
transfer, FDI has generated large employment opportunities in a number of countries.

It will obviously stimulate economic activity in the country. Employment numbers will go up.
Existing domestic producers will have to pull up their socks due to the onset of high quality
competition. The international community will sit up and take notice. Companies with Foreign
investment generally tend to be most profitable as well as it is to have a more stable sales and
earnings.

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 CONCLUSION
Indian economy has reached in the orbit of high rate of economic growth. FDI inflows have been
increased in the post-reform period and India now seems to be quite attractive place for suc h
kind of investments. FDI has come in the most capital intensive sectors, therefore, the desired
employment opportunities could not be created especially for the manual and the semi skilled
labor. High skilled labor gained substantially. That is why high growth is called urban centric
and thus has created a wedge between the rural and urban economy.

Trade has traditionally been the principal mechanism linking national economies in order to
create an international economy. FDI is a similar mechanism linking national economies;
therefore, these two mechanisms reinforce each other. The trade effects of FDI depend on
whether it is undertaken to gain access to natural resources, to consumer markets or whether the
FDI is aimed at exploiting locational comparative advantage or other strategic assets such as
research and development capabilities. Companies are rapidly globalizing through FDI to serve
new markets and customers, map out their value chains in the most efficient locations globally,
and to access technological and natural resources. A country can only grow if the Govt. policies
allow more participation and is able to attract more and more foreign direct investment in India.
Today, India provides highest returns on FDI than any other country in the world.

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 BIBLIOGRAPHY

1. CHERUNILAM FRANCIS ―BUSINESS ENVIRONMENT‖ HIMALAYA

PUBLISHING HOUSE PVT.LTD EIGHTEENTH REVISED EDDITION,PP 642 – 645

2. BHATI USHA ―FOREGIN DIRECT INVESTMENT – CONTEMPORARY ISSUES‖

DEEP & DEEP PUBLICATIONS PVT LTD PP 1 – 9, 41 – 43

3. http://en.wikipedia.org/wiki/Foreign_direct_investment 20th sep 2009

4. http://www.indianmba.com/Faculty_Column/FC819/fc819.html 22nd sep 2009

5. http://www.indianembassy.org/newsite//Doing_business_In_India/FDI_Policy_Procedures.asp
26 sep 2009

6. http://www.edexcel.com/migrationdocuments/GCE%20Curriculum%202000/127729_5_4a_Fact
ors_affecting_economic_growth16_01_03.pdf 28 SEP 2009

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