Investment Policy in India: Performance and Perceptions

CUTS Centre for Competition, Investment & Economic Regulation Discussion Paper
Investment Policy in India Performance and Perceptions
#0332
Investment Policy in India Performance and Perceptions
CUTS Centre for Competition, Investment & Economic Regulation
Investment Policy in India

Performance and Perceptions
Published by: CUTS Centre for Competition, Investment & Economic Regulation D-217, Bhaskar Marg, Bani Park, Jaipur 302 016, India Ph: +91.141.220 7482, Fax: +91.141.220 7486 Email: c-cier@cuts.org, Website: www.cuts.org
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Acknowledgement: This report* is being published as a part of the Investment for Development Project, with the aim to create awareness and build capacity on investment regimes and international investment issues in seven developing and transition economies: Bangladesh, Brazil, Hungary, India, South Africa, Tanzania and Zambia. It is supported by:
DFID
Department for International Development, UK
UNCTAD
Copyright:
CUTS, 2003 The material in this publication may be reproduced in whole or in part and in any form for education or non-profit uses, without special permission from the copyright holders, provided acknowledgment of the source is made. The publishers would appreciate receiving a copy of any publication, which uses this publication as a source. No use of this publication may be made for resale or other commercial purposes without prior written permission of CUTS.
Citation:
CUTS, 2003, Investment Policy in India Performance and Perceptions
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*Other country reports are also available with CUTS
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Contents
Foreword ........................................................................................................................ 8 Preface .......................................................................................................................... 10 Introduction .................................................................................................................. 12
1. Overview of Macroeconomic Context ................................................................... 15 1.1. Market Size and Growth ...................................................................................... 15 1.2. Rates of Interest and Inflation .............................................................................. 15 1.3. Investment Inflow ................................................................................................. 17 1.4. Balance of Payments: Capital and Current Accounts .......................................... 22 2. Overview of Main Policy Trends ............................................................................. 25 2.1. Economic Reforms in India .................................................................................. 25 2.2. Membership in International and Regional Trade Agreements .............................. 26 2.3. Capital Controls: Capital Account Liberalisation .................................................. 26 3. Investment Policy Audit .......................................................................................... 31 3.1. Liberalisation of Inward FDI Policies .................................................................... 31 3.2. Entry and Establishment ..................................................................................... 32 3.3. Registration Procedure ........................................................................................ 32 3.4. Repatriation of Profits .......................................................................................... 35 3.5. Investment Facilitation Initiatives/Institutions ....................................................... 35 4. Evaluation of Foreign Investment Policy Regime ................................................ 37 4.1. Regime for FDI .................................................................................................... 37 4.2. Policy Regime: the Reality .................................................................................. 38 5. Analysis of Civil Society Surveys ........................................................................... 43 5.1. Introduction ......................................................................................................... 43 5.2. Sectoral Destination of FDI .................................................................................. 43 5.3. Impact of FDI ....................................................................................................... 44 5.4. Indias Experience with FDI Flows ....................................................................... 44 5.5. General Policy Implications ................................................................................. 46 6. Case Studies ............................................................................................................ 49 6.1. The IT Sector ....................................................................................................... 49 6.2. Automobile Sector .............................................................................................. 52 6.3. The Power Sector ................................................................................................ 55 Conclusion ................................................................................................................... 61 Annexure ...................................................................................................................... 63 Bibliography ................................................................................................................ 64 Endnotes ....................................................................................................................... 66
List of Tables
Table 1: Table 2: Table 3: Table 4: Table 5: Table 6: Table 7: Table 8: Table 9: Table 10: Table 11: Table 12: Table 13: Table 14 Table 15: Table 16: Table 17: Table 18: Table 19: Table 20: Table 21: Growth Rate of GDP and Industrial Production in India .............................................................. 15 Domestic Prime Lending Rates ................................................................................................. 16 Domestic Inflation Rates ........................................................................................................... 17 Total Foreign Investment Inflows over the 1990s ........................................................................ 18 Industry Distribution of FDI Approvals Between 1991-2001 ........................................................ 19 Actual FDI Inflow into India in the 1990s .................................................................................... 19 Sectoral Distribution of Foreign Direct Investment ...................................................................... 20 FDI Inflow & Cross-border Acquisitions in India, 1991-December 1998 ...................................... 21 Number of Technical and Technical-cum-Financial Foreign Collaborations in India ..................... 21 Indias Overall Balance of Payments ......................................................................................... 22 Exchange Rate of Rupee & Foreign Exchange Reserves of RBI. ............................................... 23 Savings, Investment Rates, Current Account (CAD) & Trade Deficit (TD); as Percentage of GDP in Current Prices ................................................................................... 24 Significant Regulatory Changes Involving FII in India over 1990s ................................................ 29 Proposed Changes in Sectoral Limits on FDI ............................................................................ 40 Negative Perceptions of Civil Society ......................................................................................... 45 Positive Perceptions of Civil Society .......................................................................................... 45 Civil Societys Inclination towards FDI ....................................................................................... 46 Policies to Increase the Benefits of FDI ..................................................................................... 47 Growth of Indian Software Industry Revenues ............................................................................ 50 Automobile Industry- Selected Statistics ................................................................................... 52 Index of Concentration, Market Size and Domestic Consumption of Various Segments of Auto industry .................................................................. 54
Acronyms
ADRs CAD CBU CCFI CEA CKD CMM CUTS DFID DGFT DPC ECB EEFC EPZ ESI FCB FCCB FCRC FDI FERA FI FIIs FIPB FIPL FPO GDI GDP GDR IDBI IIA IFD IMF IPP IPR IRDA IS IT American Depository Receipts Current Account Deficit Completely Built Unit Cabinet Committee on Foreign Investment Central Electricity Authority Completely Knocked Down Capability Maturity Model Consumer Unity & Trust Society Department for International Development Director General of Foreign Trade Dabhol Power Company External Commercial Borrowing Export Earners Foreign Currency Export Processing Zone Electricity Supply Industry Foreign Currency Bond Foreign Currency Convertible Bonds Foreign Controlled Rupee Companies Foreign Direct Investment Foreign Exchange Regulation Act Financial Institution Foreign Institutional Investors Foreign Investment Promotion Board Foreign Investment Promotion Law Fruit Product Order Gross Domestic Income Gross Domestic Product Global Depository Receipt Industrial Development Bank of India International Investment Agreement Investment for Development International Monetary Fund Independent Power Producer Intellectual Property Rights Insurance Regulatory and Development Authority Import Substitution Information Technology
6 w Investment Policy in India Performance and Perceptions
JV MNE MoU MRTP MSEB MUL NASSCOM NEP NIE NRG NRI OCBs ODA OEM PLF PLR QR RBI REER RoE SAARC SAFTA SAPTA SBA SEBs SEI SEZ SIA SKD SOE SSI STP TD TEC TI TRAI TRIPs UNCTAD WOS WPI WTO
Joint Ventures Multinational Enterprise Memorandum of Understanding Monopolies and Restrictive Trade Practices Maharashtra State Electricity Board Maruti Udyog Ltd. National Association of Software and Service Companies New Economic Policy Newly Industrialised Economy National Reference Group Non-resident Indian Overseas Corporate Bodies Overseas Development Assistance Original Equipment Manufacturers Plant Load Factor Prime Lending Rate Quantitative Restrictions Reserve Bank of India Real Effective Exchange Rate Return on Equity South Asian Association for Regional Cooperation South Asian Free Trade Arrangement Agreement on SAARC Preferential Trading Arrangement Stand-by Arrangement State Electricity Boards Software Engineering Institute Special Economic Zones Secretariat of Industrial Assistance Semi Knocked Down State-owned Enterprise Small Scale Industry Software Technology Parks Trade Deficit Techno-economic Clearance Texas Instruments Telecom Regulatory Authority of India Trade Related Intellectual Property Rights United Nations Conference on Trade and Development Wholly Owned Subsidiaries Wholesale Price Index World Trade Organisation
Investment Policy in India Performance and Perceptions w 7
Foreword
India continued with its receptive attitude towards FDI for about a decade after it gained independence in 1947. This was on account of limited domestic base of created assets viz., technology, skills and entrepreneurship. During this period foreign investors were assured of free remittances of profits and dividends, fair compensation in the event of acquisition, and were promised national treatment. However, the second five-year plan (1956-61) made a significant departure by emphasising self-reliant economic development and adopting a restrictive attitude towards FDI in order to protect the domestic base of created assets. Further in 1973, the Foreign Exchange Regulation Act (FERA) came into force which prescribed a ceiling of 40 percent in equity by foreigners in Indian companies. This resulted in many foreign companies leaving India in the late 1970s. However, there was a reversal in the policy stance during 1980s. The liberalisation of industrial and trade policies during this decade was accompanied by an increasingly receptive attitude towards FDI and foreign collaborations. In order to modernise the Indian industry greater role was sought to be given to trans-national corporations (TNCs). Further, exceptions from the general ceiling of 40 percent on foreign equity were allowed on the merits of individual investment proposals. Riding on the wave of reforms, full-scale liberalisation measures were initiated in 1990s with a view to integrating the Indian economy with the world economy. The policy allowed automatic approval system for priority industries by the Reserve Bank of India. For the purpose of granting automatic approval three slabs of foreign ownerships were defined viz., up to 50 percent, up to 51 percent and up to 74 percent. Albeit such limits were relaxed year after year. For instance, in some sectors, up to 100 percent foreign investment on automatic basis is allowed now. Foreign Investment Promotion Board (FIPB) was set up to process applications for cases not covered by automatic approval. Replacement of FERA by Foreign Exchange Management Act (FEMA) removed shareholding and business restrictions on TNCs. Further policies relating to foreign technology purchase and licensing were liberalised to improve access to foreign technology. Finally, outward investments by Indian enterprises were liberalised and proposals satisfying certain specified norms were given automatic approval. These changes in national FDI policies were complemented by bilateral investment treaties (BITs) and double taxation avoidance treaties (DTATs), many of which have been signed by India in recent years. Foreign investment started pouring in after India launched its liberalisation programme in 1991. However, Indias performance in terms of attracting foreign investment has not been very encouraging. Indias inward FDI stock as a percentage of GDP in 2001 stood at 4.7, one of the lowest in the world. The factors that determine location decision of the TNCs, which make most of FDI may be tax structure, special programmes and schemes, competition regime, entry and establishment requirements, investment protection, technology transfer, natural resources and skill levels, incentives and institutional mechanism. However, what actually determines the flow of FDI (and how) is quite a complex issue. For example, on most of these accounts, India may look to be more attractive than China, but fails to attract even one-tenth of FDI inflows that China receives. It is however often argued that such great enthusiasm towards attracting FDI shown by most developing countries is more because of ideological factors rather than changes on the ground. It is also widely recognised that receiving more FDI is not the route for development in developing countries. China has maintained high GDP growth along with huge FDI flows.
Brazil, however, has shown lacklustre economic performance despite an impressive record in attracting FDI. India, on the other hand, managed to perform reasonably well in terms of GDP growth despite its poor performance in attracting FDI. The issue, therefore, needs careful analysis.The challenge before India is not only to attract more FDI that matches its size and potential but also to get quality FDI that fosters development. It is therefore important to carefully look at the different aspects of FDI and its impact. For each of the stakeholders it is important to understand the issues so that they can play their appropriate role in fostering development through FDI. The present volume would hopefully contribute in promoting such understanding and awareness. November 2003 Pradeep S. Mehta Secretary General
Preface
Many developing countries, once hostile to the entry of foreign direct investment (FDI) or inclined to restrict it severely, now compete to attract foreign firms. Experience with the development process over the last couple of decades is partly responsible for these attitudes. Foreign investment operating through multiple channels is seen as an important tool for raising productivity in the economy. There are other reasons for this change in attitude. Firstly, there has been a rise in multinational enterprises (MNEs), which command over the most productive segments of the world economy. Recent evidence indicates that workers in MNE affiliates produce about seven times as much as the national average output per worker. The margin in developing countries is even greater, perhaps as much as 15 times the average output per worker. Thus MNEs are highly productive firms, and their operations in host countries reflect the productivity of the parent firms. Indeed MNE plants in emerging markets are often the world leaders in productivity. Secondly, FDI may increase productivity of capital in the host country more widely by introducing methods of production more efficient than those of local firms. Moreover, FDI promotes growth by introducing new industries into the host country and into its portfolio of export products. Another source of productivity gains for the host country, which has received considerable research attention, is the possibility of so called spillover effects: productivity advances passing from foreign affiliates to locally owned firms. Locally owned firms might increase their efficiency by copying foreign firms (such as through marketing/managerial know-how) to raise profits, reach export markets, or merely survive in the domestic market. It should be noted that most of the benefits are more likely to accrue if the domestic market remains competitive, rather than being monopolised by either domestic players or individual multinationals. In the light of the importance of FDI in the framework of developing countries, Consumer Unity & Trust Society (CUTS), Jaipur with the support of Department for International Development (DFID), UK and, in collaboration with the United Nations Conference on Trade and Development (UNCTAD) has undertaken a study to analyse the investment regimes of seven developing / transition economies and build capacity of civil society on these issues. The emphasis is on co-operation between countries and within regions, sharing information and experience and engineering joint initiatives. The National Council of Applied Economic Research (New Delhi) is working with CUTS as the partner organisation in India. I would like to thank CUTS for its continuing partnership with NCAER in areas of common interest. This report attempts to study the investment regime and actual performance of India with a view to build capacity and awareness in investment issues and draw out the lacuna of the present system. The study is based on existing literature along with feedback obtained from surveys of stakeholders, namely civil society groups and local firms. I would like to thank Dr. Sanjib Pohit and Ms. Shalini Subramanyam for their hard work in preparing this report.
Authors have benefited from the participants comments at the second and third NRG meetings held in June 2002 and March 2003 respectively and the Asia-Pacific Regional Meeting held at New Delhi in November 2002. We have also gained from the participants comments at the International Conference on Investment for Development, 9-10 May 2003, Geneva, Switzerland. We would also like to thank John.H.Dunning - Emeritus Professor of International Business, University of Reading, UK and Pradeep Mehta - Secretary General, CUTS for their thoughtful comments. We are grateful to Aradhna Agarwal, Senior Fellow, Indian Council for Research on International Economic Relations (ICRIER) and Richard Eglin of the World Trade Organisation for reviewing the paper. We have benefited from the comments provided by Laveesh Bhandari of Indicus Analytics, New Delhi and the CUTS team. Finally NCAER would like to thank Praveen Sachdeva for Computer and Design Support. Portion of the report has been taken from two other reports prepared for the CUTS-Investment for Development Project namely, Report A: Investment Policy - India (authored by Biswatosh Saha of Xavier Labour Relations Institute (XLRI), Jamshedpur, India) and Report B: Perceptions of Impact of FDI on Economy (authored by Poonam Munjal, Sanjib Pohit and Shalini Subramanyam). November 2003 Suman Bery Director General National Council of Applied Economic Research New Delhi, India
Introduction
Since the 1980s, a consensus has been growing, even among the developing countries, that the net result of foreign direct investment (FDI) can be positive. The phenomenal drop in total Overseas Development Assistance (ODA) in the 1990s has also forced most of the countries to increasingly look at FDI as an alternative source for financing development. It is considered to be a better option compared to bank credit, because of high and variable interest rates, and portfolio investment, which carries its own risks. It is also being considered as the principal channel for the transfer of long-term private capital, technology and managerial knowhow, as well as a link between national economies and the world market. The importance of FDI in development has dramatically increased in recent years. FDI is now considered to be an instrument through which economies are getting integrated at the level of production into the global economy by accessing a package of assets, which include capital, technology, managerial capacities and skills, and foreign markets. It also stimulates technological capacity building for production, innovation and entrepreneurship within the larger domestic economy through catalysing backward and forward linkages1 . The trade effects of FDI depend on whether it is undertaken to gain access to natural resources or consumer markets, or whether FDI is aimed at exploiting locational comparative advantage and other strategic assets such as research and development capabilities2 . By its very nature, FDI brings into the recipient economy resources that are only imperfectly tradable in markets, especially technology, management know-how, skilled labour, access to international production networks, access to major markets and established brand names. In addition, FDI can make a contribution to growth in a more traditional manner, by raising the investment rate and expanding the stock of capital in the host economy. It has thus been widely recognised by governments that FDI could play a key role in the economic growth and development process.
Glancing back at the pages of history, India if not completely hostile,was not very receptive to foreign private capital. Today, the Indian government is openly welcoming foreign direct investment. Though the Government of India has been trying hard to attract FDI, the flows in India (as a share of Gross Domestic Product) have been modest.
FDI is now considered to be an instrument through which economies are being integrated at the level of production into the global economy by bringing a package of assets.
Glancing back at the pages of history, India, if not completely hostile,was not very receptive to foreign private capital. Long cherished dreams of the nationalists to build strong home-grown champions and apprehensions about FDI eroding sovereignty and culture dominated Indian economic scenario. Today, such fears look vastly overblown, and the Indian policymakers openly welcome FDI. Though the Government of India has been trying hard these days to attract FDI, the flows into India as a share of Gross Domestic Product (GDP) have been much more modest than many other developing countries. In the light of this shift in policy regime and Indias inability to attract FDI in a big way, this report attempts to study the investment regime and actual performance of India with a view to build capacity and awareness in investment issues and draw out the lacuna of the present system. The study is based on existing literature along with feedback obtained from surveys of stake holders, namely civil society groups, and local firms.
The report is organised in the following manner: Chapter 1 gives a broad macro-view of India in recent years, while Chapter 2 discusses the main policy trends since launching of the economic reforms in 1991. In Chapter 3 the discussion on Investment Policy Audit, highlights the parameters of investment policy, including registration, rights to entry and establishment, investor protection, dispute settlement, international investment agreements, taxation, movement of capital, intellectual property rights regime, performance requirements, incentives for investment and export, characteristics of the regulatory regime, etc. In Chapter 4, an attempt is made to evaluate the present investment policy regime. Chapter 5 examines the perception of the civil society on FDI flows, impact of FDI on specfic sectors, means to increase FDI flows and benefits thereof. Chapter 6 follows up the Indian experience of FDI inflows with three case studies. Finally, the conclusion summarises the main findings.
CHAPTER-1
Brief Overview of Macroeconomic Context

1.1. Market Size and Growth
While the popular view is that growth has accelerated after the implementation of the reforms package, Nagaraj argues that there is no significant increase in the trend rate of growth of GDP in the 1990s.
In terms of the overall market size of the economy (as measured by GDP at current market prices), Indias GDP was around US$510bn in 200001. A cursory look at Table 1 illustrates that the growth rate of both GDP and industrial production shows a decline to very moderate levels in the late 1990s after a brief spurt in the mid-1990s. There has been a debate among economists centring on the growth performance of the economy in the post reform period. While the more popular view is that growth has accelerated after the implementation of the reforms package, Nagaraj (2000), after a more robust statistical analysis of growth rates of GDP and its various components using data for 1980-2000 argues that there is no significant increase in the trend rate of growth of GDP in the 1990s. According to this estimate, the average growth rate during 1980-81 to 1999-2000 was 5.7 percent while the same during 1980-81 to 1990-91 was 5.6 percent. In fact, a statistically significant decline in the secondary sector can be identified over the last decade, i.e. post reforms.
Table 1: Growth Rate of GDP and Industrial Production in India (in percent) 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-2000 2000-01 GDP growth 6.2 7.8 7.2 7.8 4.8 6.6 6.4 5.2 Growth in IIP* 6 8.4 12.7 6.1 6.6 4.1 6.7 5.1
Source: RBI Annual Report, various issues * Index of Industrial Production
1.2. Rates of Interest and Inflation
1.2.1. Rates of Interest

Table 2 shows the movement of nominal interest rates of scheduled commercial banks in India over the 1990s. Over the 1980s, interest rates were regulated, the prime lending rate (PLR) of State Bank of India (the largest scheduled commercial bank) being pegged at about 16 percent and that of Industrial Development Bank of India (IDBI, which is a term lending institution; also called a financial institution, FI) pegged at 14 percent. Domestic interest rates were raised sharply in mid-1991, as a result of the monetary contraction that was part of the International Monetary Fund (IMF) style stabilisation package. Mid-1992 onwards, however, interest rates were slowly brought down to lower levels, the declining trend continuing till date. Since October 1994, banks were allowed freedom to set their own lending rates for most categories of advances. As a result, different banks started announcing different lending rates according to their own business judgements so data for the later period shows the range within which PLRs of the five largest scheduled commercial banks in the country varied. As the data in Table 2 show, the declining trend in nominal interest rates was reversed in early 1995.
Domestic interest rates were raised sharply in mid-1991, as a result of the monetary contraction that was part of the International Monetary Fund style stabilisation package. Mid-1992 onwards, however, interest rates were slowly brought down to lower levels, the declining trend continuing till date.
Table 2: Domestic Prime Lending Rates (% per annum) Year Average interest rates 1990-91 16.5 1991-92 16.5 1992-93 19.0 1993-94 19.0 1994-95 15.0 1995-96 16.5 1996-97 14.5 1997-98 14.0 1998-99 13.0 1999-00 12.0 2000-01 11.9 2001-02 11.5 2002-03 11.3
Source: RBI Annual Report, various issues
Figure 1: Real Prime Lending Rates in India in the 1990s. (Figures in %)1
14
12
10
% per annum
4/13/91
1
4/13/92
4/13/93
4/13/94
4/13/95
4/13/96
4/13/97
4/13/98
4/13/99
Figures relate to the minimum PLR among the 5 major scheduled commercial banks during the period. Real interest rates were calculated using annual average inflation rates for manufactured goods. Source: RBI Annual Report, various issues
It is worth mentioning here that banks could set their lending rates freely from October 1994, and this rise in interest rates was, perhaps, a reflection of banks strategy. This was mainly because recovery in industrial growth in 1994-95 and 1995-96 resulted in rising demand for credit from industry from around early 1995. Though Reserve Bank of India (RBI), in general, has tried to bring down the interest rate structure, its efforts were circumvented every time due to depreciation in the foreign exchange market forcing it to raise shortterm domestic interest rates (in order to encourage inflow of foreign exchange through banking channels as well as from exporters/importers).
1.2.2. Rates of Inflation

Of course, it is real rather than nominal interest rates that are of importance as far as economic activity is concerned. Table 3 shows different measures of inflation in the economy through the 1990s. Figure 1 plots the trends in movement of real interest rates using the average annual changes of price of manufactured goods to derive the real rates. As shown in figure 1, real interest rates remained high, at more than 8 percent, through most of the 1990s - except for a brief period in 1994-95, when real rates declined to about 4-6 percent. So, the decline in nominal rates in the later half of the 1990s was not accompanied by a decline in real rates as inflation rates, especially that for manufactured goods, fell sharply during that period. Table 3: Domestic Inflation Rates1 All commodities Point to point Average 12.1 10.3 13.6 13.7 7.0 10.0 10.8 8.3 10.4 5.0 6.9 5.3 4.8 6.5 4.9 1.5 6.5 10.9 7.8 6.4 4.8 6.9 3.3 7.2 3.6 3.4 Manufactured products Point to point Average 8.9 8.4 12.6 11.3 7.9 10.9 9.9 7.8 10.7 5.0 4.9 4.0 3.7 2.4 3.8 0.5 5.4 10.5 9.1 4.1 4.1 4.5 2.7 3.1 1.9 2.6
1990-91 1991-92 1992-93 1993-94 1994-95 2 1995-962 1996-972 1997-98 1998-992 1999-2000 2000-2001 2001-02 2002-03
1 2
Figures based on Wholesale Price Index (WPI) calculated by RBI with base 1981-82 = 100 Figures from 1994-95 onwards are based on the new WPI series with 1993-94 = 100 Source: RBI Annual Reports, various issues
The high real rates of interest prevailing in the domestic economy creates a cost of capital disadvantage for domestic enterprises, vis--vis their foreign competitors, headquartered in economies with lower interest rates, which can translate into a strategic disadvantage as well.
The high real rates of interest prevailing in the domestic economy creates a cost of capital disadvantage for domestic enterprises, vis--vis their foreign competitors, headquartered in economies with lower interest rates, which can translate into a strategic disadvantage as well. Domestic business groups and chambers of commerce have, in fact, been complaining about the high cost of capital that they are facing over the last decade. 1.3. Investment Inflow (1992-2001) After the liberalisation of capital controls in 1991, there has been a substantial increase in the inflow of foreign investments into India. Table 4 gives the year-wise break-up of foreign investment inflows. Though liberalisation in the foreign investment regime for direct investment occurred in July 1991 and for portfolio investment in September 1992, foreign investment inflows picked up in earnest only from the last quarter of 1993. As Table 4 indicates, FDI as percent of GDP has increased significantly in the last decade.
However, portfolio investment did not show a consistent trend after 1995 and even touched a negative figure in 1998 and then again started increasing in 1999-2000 followed by marginal decline in 2000-2001. Movement in direct investment flow reflected considerable rise from US$6mn in 1990-91 to US$4784mn in 1997-98, but beyond 1998 there came a brief period of downtrend. But soon resurgence came with a rise in FDI to US$5102 in 2000-01. Table 4: Total Foreign Investment Inflows over the 1990s in US$mn 90-91 91-92 92-93 93-94 94-95 95-96 96-97 97-98 98-99 99-00 00-01 Direct Investment 280 403 872 1419 2058 2956 2000 1581 2342 Portfolio Investment 6 4 244 3567 3824 2748 3312 1828 -61 3026 2760 Total 6 4 524 3970 4696 4167 5370 4784 1939 4607 5102 FDI as % of GDP 0.03 0.05 0.14 0.21 0.41 0.60 0.73 0.87 0.59 0.48 0.49 FDI as % of GDI 0.12 0.21 0.55 0.93 1.57 2.25 2.99 3.47 2.56 2.05 2.08
Source: Report B
It must be mentioned that the definition of FDI and computation of FDI statistics used by Reserve Bank of India (RBI) does not conform to the guidelines of the IMF. Some of the main discrepancies are that India excludes reinvested earnings in its estimate of actual FDI inflows. It does not include the proceeds of the foreign equity listings and foreign subordinated loans to domestic subsidiaries which, according to IMF guidelines, are part of inter-company loans (long- and short-term net loans from the parents to the subsidiary) and which should be a part of FDI inflows. India also excludes overseas commercial borrowings, whereas according to IMF guidelines financial leasing, trade credits, grants, bonds, etc should be included in FDI estimates. Box A: FDI Definition Widened The composition of balance of payments would change after the inclusion of these items although it would not alter the balance of payments for the last three financial years. Component-wise revised FDI data (in US$mn) Year 2000-01 2001-02 2002-03* Equity 2400 4095 2700 Reinvested Other FDI Inflows toIndia FDI Inflows to India Difference Earnings Capital Revised Data Current Data 1350 279 4029 2342 1687 1646 390 6131 3905 2226 1498 462 4660 2574 2086
Source: Business Standard, July 1, 2003. * Figures for 2002-03 are estimates.
Recently, the government has reorganised FDI data for 2000-01, 200102, and 2002-03 along the lines recommended by the IMF, to include some uncaptured elements of capital, to end under-reporting of FDI.3 The new formula would include control premiums, non-competition fees, reinvested earnings and intercorporate borrowings as FDI.
1.3.1. Approved and Actual Inflows of FDI

After the liberalisation of entry norms for foreign investors in India in 1991, FDI flows into the economy have increased, especially in comparison to the levels of inflow experienced prior to 1991. Table 5 summarises the industry-wise distribution of foreign collaboration approvals granted over the 1990s (between August 1991 and August 2001). The total approved amount of FDI in these proposals was US$56.5bn.4 Only about 8 18 w Investment Policy in India Performance and Perceptions
Table 5: Industry Distribution of FDI Approvals Between 1991-2001 Industry Metallurgical industry Fuels Power Oil Refinery Computer software Electronics Telecommunications Transportation industry Chemicals (other than fertiliser) Drugs Textiles Paper and pulp Food processing Services Financial services Hotel & Tourism Total No. of Approvals 314 575 229 136 1846 303 617 768 852 225 561 116 662 838 370 324 13028 Amount of FDI Approved (US$mn) 3076 16004 7909 5206 1206 677 11269 4033 2641 573 718 682 1879 3493 2388 1019 56511 Percent of Total Amount Approved 5.44 28.32 14 9.21 6.39 1.2 19.94 7.14 4.67 1.01 1.27 1.21 3.32 6.18 4.23 1.8 100
All approvals given between August 1991 and August 2001 have been included. Data includes approvals given through FIPB for GDR/FCCB issues. Note: Approved amount of FDI is calculated using Exchange rate prevailing in the month of Aug 2001 Source: Secretariat of Industrial Assistance Newsletter, August 2001, Ministry of Industry, Government of India
Table 6: Actual FDI Inflow into India in the 1990s (in US$mn) 1991 Govt. Approval, FIPB, SIA RBI approval 78.36 1993 321.35 78.63 182.70 1995 1232.18 168.79 627.71 143.31 1996 1674.65 180.29 599.61 478.35 1997 2823.51 241.70 289.93 957.90 1998 2085.94 154.67 90.88 12.91 1999 1473.50 181.18 83.09 1595.40 2000 1476.38 393.83 81.19 1626.51 2001 2043 687 49 527 2002 1432 803 2 636
NRI Schemes operated by RBI 65.64 GDR/FCCB Inflow on transfer of shares from resident to non-resident Sub-Total Advance pending issue of shares under FIPB/SIA/ RBI approval Total 144.00
582.67
2172.00
88.40 3021.29
265.96 4579.00
1027.53 3371.94
465.22 3798.39
665.22 4056.73
628 3934
1083 3956
144
583
2172
3021
4579
3377
215.94 4016
445.27 4502
149.8 4083.8
406.8 4362.8
Notes: Special NRI Schemes were administered by RBI from 1st January 1991 Source: Secretariat of Industrial Assistance Newsletter, various issues. January 2001, Ministry of Commerce and Industry, Government of India.
industries accounted for about 70 percent of the approved FDI amount, signifying that FDI inflow has remained confined/concentrated within a few industrial sectors. Table 7 shows the sectoral distribution of FDI. Until the early 1990s, FDI was heavily concentrated in manufacturing. Table 7: Sectoral Distribution of Foreign Direct Investment (as a percentage of total) Sector/Industry Chemicals & Allied Products Engineering Domestic Appliances Finance Services Electronics & Electrical Equipment Food & Dairy Products Computers Pharmaceuticals Others Total 92-93 17 25 6 1 1 12 10 3 1 25 100 93-94 18 8 1 10 5 14 11 2 12 19 100 94-95 16 15 12 11 11 6 7 1 1 19 100 95-96 9 18 0 19 7 9 6 4 4 24 100 96-97 15 35 1 11 1 7 12 3 2 14 100 97-98 9 20 2 5 11 22 4 5 1 22 100 98-99 19 21 0 9 18 11 1 5 1 13 100 99-00 8 21 0 1 7 11 8 6 3 35 100 00-01 7 14 0 2 12 11 4 16 3 30 100
Source: RBI Annual Reports, various issues
Following 1991 liberalisation programme, however, there has been a sharp rise in approved foreign investment in tertiary sector that encompasses critical elements of the modern economy namely Information Technology (IT) sector (comprising telecommunications, computer software, consulting services, etc), power generation and hotel & tourism.
Increased FDI flows to service sector and power generation is a welcome development because these areas had long been reserved for the public sector enterprises which were inefficient in managing these services.
Increased FDI flows to service sector and power generation is a welcome development because these areas had long been reserved for the public sector enterprises which were inefficient in managing these services, making Indias trade and industrial sector least competitive in international context. The share of service sector rose significantly from one percent in 1992-93 to about 12 percent in 2000-01.
1.3.2. Cross-border Mergers & Acquisitions Cross-border mergers and acquisitions (M&As) has been a very important feature of inward FDI flow into India over the 1990s. Table 8 shows the relative importance of the various categories of cross-border M&As in India between 1991-1998. FDI, involving financial inflow of over US$3691mn, financed cross-border M&A activity, either through acquisition of substantial equity stakes in existing ventures or through buy-out of real assets through asset sales.
Among the categories of cross-border M&As shown in Table 8, the most important in the early part of the 1990s was investment by foreign parents in erstwhile Foreign Controlled Rupee Companies (FCRC) to raise their equity stake after the relaxation of restrictions on foreign equity investment imposed by FERA. 20 w Investment Policy in India Performance and Perceptions
Table 8: FDI Inflow & Cross-border Acquisitions in India, 1991-December 1998 Category Number Amount Amount as percentof Cases (US$mn) age of Total FDI Inflows and Acquisitions 1 Erstwhile FCRC companies 80 407.72 11.0 2 To increase stake in Joint Ventures 123 1279.53 34.7 To acquire stake in Indian company3 155 1379.15 37.4 4 Strategic alliance or portfolio investment 85 448.95 12.2 5 Asset Sale 15 176.15 4.8 Total 458 3691.50 100
1 Denotes cases where FDI inflow financed rise in equity stake of foreign parents in their Indian subsidiaries, or the erstwhile FCRC. 2 Denotes cases where FDI inflow financed rise in equity stakes of foreign partners in their existing joint ventures with Indian promoter groups. 3 Denotes cases where FDI inflow financed acquisition of equity stake by foreign companies in Indian firms, where they did not have any previous equity participation. 4 Denotes cases where FDI inflow financed acquisition of minority stake (less than 26 percent) by foreign firms in Indian companies. 5 Denotes cases of asset sales (like brands or manufacturing assets) by Indian companies to foreign controlled firms.
Source: Saha 2001.
1.3.3. Technology Collaborations A sectoral break-up of FDI inflow in India showed (as discussed earlier) that a large part of FDI inflow came into medium or low technology industries, in which case the positive externality arising from technology spillovers would also be limited. A liberal FDI regime might also weaken the bargaining position of domestic firms in the international technology licensing market, as foreign firms make equity participation a precondition for technology transfers.
Data for India actually shows a very sharp increase in the share of technology-cum-financial collaborations approved in total foreign technology collaboration approvals (which includes foreign technology collaborations with or without financial collaboration) from 1991 to 2000 (see Table 9). Table 9: Number of Technical and Technical-cum-Financial Foreign Collaborations in India 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 1.Technical collaborations 661 828 691 792 982 744 660 595 498 418 2.Technical-cum-financial collaborations 289 3.Total foreign collaborations 950 692 1520 785 1476 1062 1854 1355 2337 1559 2303 1665 2325 1191 1786 1726 2224 1726 2144
Source: SIA Newsletter, October 2001, Ministry of Industry, Government of India
Table 10: Indias Overall Balance of Payments (in US$mn) 91-92 Current Account Deficit Capital Account External Assistance, net Commercial Borrowing, net Short term credit, net NRI Deposits, net Foreign Investment, net Rupee debt service Other capital, net Total capital account Overall Balance IMF, net Reserves and monetary gold (increase -, decrease +) Foreign investment as % of total capital account surplus 1178 92-93 3526 93-94 1158 94-95 2701 95-96 5910 96-97 4619 97-98 5500 98-99 4038 99-00 4698 00-01 2579
3037 1456 -515 290 139 -1240 801 3968 2790 786
1859 -358 -1079 2001 555 -878 866 2966 -560 1288
1901 607 -769 1205 4235 -1053 3709 9835 8677 187
1434 1029 330 847 4895 -1050 1321 8806 6105 -1146
883 1275 49 1103 4805 -952 -3074 4089 -1221 -1715
1109 2848 838 3350 6153 -727 -1565 12006 6793 -975
907 3999 -96 1125 5390 -767 -714 9844 4511 -618
820 4362 -748 1742 2412 -802 779 8565 4222 -393
901 313 377 1540 5191 -711 2833 10444 6402 -260
427 4011 105 2317 5102 -617 -2322 9023 5856 -26
-3576
-728
-8864
-4959
2936
-5818
-3893
-3829
-6142
-5830
3.5
18.7
43.1
55.6
117.5
51.2
54.8
28.2
49.7
56.54
Source: RBI Annual Reports, 1995-96 (for 1991-95) and 1998-99, for the rest.
1.4. Balance of Payments: Capital and Current Accounts Table 10 shows the overall balance of payments data and composition of the total capital account in India over the 1990s. Average foreign investment inflows between 1993-2001 were more than 20 times the average levels between 1985-1991.
Sharp increase in the level of foreign investment flows, however, did not lead to an equally sharp increase in the total capital account surplus (i.e. net capital account inflows), because of offsetting declines in other components of the capital account, particularly in net aid flows and net NRI Deposits.
This sharp increase in the level of foreign investment flows, however, did not lead to an equally sharp increase in the total capital account surplus (i.e. net capital account inflows), because of offsetting declines in other components of the capital account, particularly in net aid flows and net NRI Deposits5. The increase in foreign investment inflows nonetheless led to a change in the composition of the capital account, with foreign investment becoming a more important component of the capital account in the 1990s.
1.4.1. Foreign Exchange Rate

The RBI, over the period 1993/94-2000/01, intervened aggressively in the foreign exchange market as a net buyer of foreign exchange which had the effect of resisting the upward pressure on the exchange rate of the Rupee. 22 w Investment Policy in India Performance and Perceptions
Table 11 shows the nominal exchange rate of the Rupee against the US Dollar at end-March of each year during this period. As the figures indicate, RBI successfully prevented any nominal appreciation of the Rupee with respect to all major currencies. Over this period, it in fact, allowed a depreciation of the domestic currency to the extent of about 48 percent Table 11: Exchange Rate of Rupee & Foreign Exchange Reserves of RBI.1 1993 1994 1995 1996 1997 1998 1999 2000 2001
Nominal exchange rate r 2 Rs./US$ Annual % change in r (- implies depreciation) REER

3 4 5
31.5 _
31.4 0.32
31.44 -0.13 63.2 25.19 5.94
34.35 -9.2 61.92 21.70 -3.49
35.9 -4.5 65.87 26.42 4.72
39.5 -10.03 66.04 29.38 2.96
42.43 -7.42 68.33 32.49 3.11
43.62 46.64 -2.8 -6.9
59.15 63.55 9.8 19.25 0.6 9.45
63.30 66.46 38.04 42.28 5.55 4.24
Reserves
Changes in reserves
1 All data relate to March-end figures for corresponding years 2 Nominal exchange rate of the Rupee in terms of 1 US$; RBI Reference Rate 3 36-country trade weighted Real Effective Exchange Rate published by RBI. Base 1985=100; a decrease in REER implies a real depreciation of the Rupee 4 Foreign exchange reserves of RBI, in billions of US dollars 5 Change in foreign exchange reserves of RBI, over last year (in US$bn )
Source: RBI Annual Reports, various issues
in nominal terms, with respect to the US Dollar. However, in terms of the REER (Real Effective Exchange Rate), based on the 36-country trade-weighted series published by the RBI6, the Rupee shows an appreciation of 12 percent between 1993-2001. If we look into the foreign exchange reserves of the RBI, between March 1993, and March 2001, it shows an accretion to the tune of about US$32bn.
1.4.2. Savings and Investment Rates

Table 12 gives gross domestic savings and investment rates as also trade and current account7 deficits, as a percentage of GDP at current market prices, that the economy has been running over the recent years. The figures show that between 1992-93 and 2000-01, the economy has been running, on an average, a current account deficit of only 1.1 percent of GDP, which is slightly lower than the current deficit in the early 1980s (1.3 percent of GDP) and substantially lower than that in the second half of 1980s (2.2 percent of GDP).
In spite of larger foreign capital inflows in the 1990s, foreign financial inflows hardly played any significant role in augmenting domestic investment rates.
The average current account deficit during 1991-2001 was around 1.04 percent of GDP at current market prices, much lower than the average for the second half of the 1980s, i.e. 2.2 percent of GDP. Therefore, it implies that in spite of larger foreign capital inflows in the 1990s, foreign financial inflows hardly played any significant role in augmenting domestic investment rates.
Table 12: Savings, Investment Rates, Current Account (CAD) & Trade Deficit (TD); as Percentage of GDP in Current Prices 85-901 90-91 91-92 92-93 93-94 94-95 95-96 96-97 97-98 98-99 2 Gross Domestic Savings Gross Domestic Investment CAD TD
1
99-00 00-01
20.6
24.3
22.8
22.1
22.5
25
25.5
23.3
24.7
22.3
22.3
23.1 2.2 3.2
27.7 3.2 3.2
23.4 0.5 1.0
24 1.5 2.0
23.1 0.5 0.5
26.1 1.1 1.4
27.2 1.8 3.1
24.6 1.2 3.7
26.2 1.3 3.7
23.4 1.0 3.2
23.3 1.0 4
0.5 3
Provisional Figures. Figures from 1996-97 onwards are based on the new series of GDP estimates being calculated from 1994-95, which gives a higher estimate of GDP compared to the old series. Notes: 1. Difference between gross domestic savings and investment rates do not equal current deficit due to rounding off. 2. CAD and TD figures for 1980s and 1990s are not strictly comparable, as the 1990s figures are reported according to the revised format suggested by the High Level Committee (constituted in November, 1991) on Balance of Payments, headed by Dr.C.Rangarajan. The trade deficit figures for the 1990s includes gold brought in by NRIs with baggage, with a contra entry in private transfers, and some non-customs defence related imports funded through bilateral debts. Therefore, TD and CAD in the 1990s has an upward bias compared to the figures for the 1980s. (RBI Bulletin, August 1993, pp.1139-1180)
Source: RBI Annual Reports; Economic Survey, Ministry of Finance, Government of India, various issues.
Issues for Comments

l
Domestic firms are at a comparative disadvantage due to high cost of capital as against foreign firms headquartered in economies with lower interest rates. What steps do we need to take to restructure the real interest rates for attaining equilibrium in interest rates between domestic and foreign competitors? Why FDI inflows in India remain concentrated within a few industrial sectors? In spite of liberalising capital controls in 1991, why is India not receiving FDI flows commensurate with the size of the economy? What might be the factors behind lower actual FDI flows against higher approved FDI flows? In India there is sharp increase in the share of technology-cumfinancial collaborations in total foreign technology collaboration approvals. Is it good for the economy? Has the policy of maintaining a large foreign exchange reserve resulted in marginalising the role of foreign financial inflows in augmenting domestic investment rates? Does FDI in India serve as an engine of growth?
CHAPTER-II
Overview of Main Policy Trends

2.1. Economic Reforms in India The economic reforms or economic liberalisation programme was implemented with the announcement of the New Economic Policy (NEP) in 1991. It included wide-ranging changes in industrial policy, trade policy and foreign investment policy, a redefinition of the role of the public sector in the economy and a redesigning of the architecture of the domestic financial system. These radical policy changes were, however, not strategy-driven8. It was more a crisis-driven response.
The implementation of the conventional IMF-World Bank prescription of short-term stabilisation, consisting of devaluation, temporary import compression, fiscal and monetary compression with a rise in interest rates, was followed by more longterm structural adjustment measures, seeking to restructure the domestic economy. The New Economic Policy was an outcome of implementation of the structural adjustment programme.
2.1.1. Background Between late 1990 and the middle of 1991, the economy faced severe balance of payments difficulties, coming close to defaulting on its external payment obligations in January and June of 1991. In January 1991, the Government accessed the Compensatory and Contingency Financing Facility of the International Monetary Fund (IMF) and in June 1991 negotiations were initiated for loans under SBA (Stand-by Arrangement) lending facility of the IMF.
What followed was the implementation of the conventional IMF-World Bank prescription of short-term stabilisation, consisting of devaluation, temporary import compression, fiscal and monetary compression with a rise in interest rates. This was followed by more long-term structural adjustment measures, seeking to restructure the domestic economy. The New Economic Policy was an outcome of implementation of the structural adjustment programme9.
2.1.2. Domestic Opinion Though the initiation of the economic reform program was crisis-driven, it is also true that domestic opinion favouring a more liberal economic policy environment was building up over the 1980s. Concerns about inward looking trade regime, public sector inefficiencies and a restrictive industrial license policy (the license-permit Raj, in popular parlance) were being raised generating a debate and rethinking on the development policy of the country10.
Though the initiation of the economic reform program was crisis-driven, it is also true that domestic opinion favouring a more liberal economic policy environment was building up over the 1980s.
2.1.3. Changes in Industrial Policy The main industrial policy changes, brought in trail of NEP, were as follows: l Industrial licensing system was abolished except for a very short list of 18 industries (Appendix II of Statement on Industrial Policy, 1991), where compulsory licensing was retained. In many sectors within these 18 industries (like white goods and entertainment electronics), licensing was discontinued from 1993.
l
The Monopolies and Restrictive Trade Practices (MRTP) Act 1969 was amended to abolish pre-investment scrutiny of the investment decisions of the MRTP companies (large firms with assets higher than the threshold limit as declared in the Act from time to time) and
to obtain prior approval of central government for expansion, establishment of new undertakings, mergers, amalgamations and takeover of other firms by firms that came under the purview of MRTP Act. Though the MRTP Act was diluted, a new competition law has not yet been put in place.
l
Financial liberalisation has been the other important cornerstone of the economic reform programme. It followed the well-known path of deregulation to allow greater freedom for cross-border capital flows.
The list of industries reserved for the public sector was reduced from 17 to 6. Privatisation of state-owned enterprises (SOEs) has, however, been very slow and the government has not been able to meet its targets for divestment of government stake in SOEs. Unlike in many other developing economies, particularly in Latin America and Eastern Europe, FDI inflow into India has not been driven by privatisation and sale of SOEs to foreign investors. Norms for foreign technological and financial collaboration were considerably liberalised and foreign firms were allowed greater freedom to enter and operate in the economy.
2.1.4. Financial Liberalisation

Financial liberalisation has been the other important cornerstone of the economic reform programme. It followed the well-known path of deregulation of capital markets and banks, deregulation of interest rates, withdrawal of credit targeting and interest subsidies, introduction of stricter accounting norms in the banking sector (following the Basle Standards) and integration of domestic financial markets with the global financial system through liberalised capital control measures to allow greater freedom for crossborder capital flows. All this, again, can be expected to have effects on the domestic industry by affecting costs and availability of capital. 2.2. Membership in International and Regional Trade Arrangements India has been a member of the WTO since its inception in 1995. Certain policies of trade liberalisation have been driven by WTO conditionalities, the most recent being the removal of Quantitative Restrictions on imports by April 2001 after India lost a dispute at the WTO with the USA11.
The industrial policy changes, permitted business firms to pursue their own investment and expansion strategies without being restricted by the licensing requirements. However, simultaneous lowering of trade barriers and liberalisation of foreign investment regime, exposed domestic firms to significant foreign competition.
The industrial policy changes, particularly the discontinuance of the licensing system permitted business firms to pursue their own investment and expansion strategies without being restricted by the licensing requirements. However, simultaneous lowering of trade barriers and liberalisation of foreign investment regime, allowing foreign firms to enter and operate in the domestic economy, exposed domestic firms to significant foreign competition. India, as a member of the SAARC, is also part of SAPTA (Agreement on SAARC Preferential Trade Arrangement). However, there has been little progress in dismantling trade barriers among the member countries as yet, though India has made a start in reducing barriers bilaterally with Nepal, Sri-Lanka and vis-a-vis Pakistan. 2.3. Capital Controls: Capital Account Liberalisation
2.3.1. GDR/ADR issues by domestic firms Indian companies were allowed to raise capital in overseas markets by issuing Global Depository Receipts (GDRs), American Depository Receipts (ADRs) and Foreign Currency Convertible Bonds (FCCB) from 1992.
The first Indian GDR issue (by Reliance Industries) was made in May 1992. There were no limits to the amount that could be raised through GDR issues, but only companies having a good track record (for three consecutive years prior to the issue) were given permission to access the GDR market12. The funds raised through GDR issues could be utilised in any manner, except that such funds could not be invested in the stock market and used for real estate investments.
Indian companies were also permitted to raise debt from the international market through External Commercial Borrowings (ECBs). Reserve Bank of India set overall limits on the level of aggregate ECBs and borrowings beyond that stipulated limit were not allowed.
The end-use restrictions began to be enforced from September 1994. Inflows through GDR issues are considered by the Ministry of Industry as part of FDI inflow and are, hence, subject to the limits/sectoral caps according to the FDI policy. GDR issues, not falling within the automatic FDI approval category, therefore, have to seek FIPB approval prior to the issue13. Indian companies were also permitted to raise debt from the international market through External Commercial Borrowings (ECBs). Debt issues, however, were more regulated with the necessary precondition of prior RBI permission14. RBI set overall limits on the level of aggregate ECBs and borrowings beyond that stipulated limit were not allowed.
2.3.2. Other Capital Account Liberalisation Measures

Though capital controls were considerably liberalised for inflows of foreign capital, either in the form of direct investment or portfolio investment, restrictions continued to exist for outflows on the capital account, especially for domestic residents, the domestic non-banking corporate sector and the banking sector. The norms for outward FDI by Indian companies were also much more stringent than inward investment rules. The limits and conditions under which Indian companies could invest abroad (outward FDI) are discussed below (Guidelines, as existing in May 2001). 1. Less than 25 percent of the annual average export/foreign exchange earnings of the Indian firm in the preceding three years. 2. Funded out of GDR proceeds (upto 100 percent of GDR issue) or out of Export Earners Foreign Currency (EEFC) Account balances upto US$15mn16. Indian companies investing in Wholly Owned Subsidiaries (WOS) and Joint Ventures (JVs) abroad are given automatic approval by RBI, if the amount of investment is less than US$30mn for SAARC countries, US$15mn15 for elsewhere and US$25mn for Nepal and Bhutan for a period of three years.
The investment norms were liberalised further in 1999-2000 and then in 2000-2001 by raising the limit for automatic approval for outward FDI.
2.3.3. Outward FDI: Automatic Approval

Automatic approval is subject to the condition that the full amount of the investment17 has to be repatriated by way of dividends, royalty, technical fees etc. within a period of 5 years from the date of first remittance of equity to the foreign concern. Only one such automatic approval (for a single proposal) is provided for a company within a block of three years. (Government of India, 1999) The investment norms were liberalised further in 1999-2000 by raising the limit for automatic approval for outward FDI to US$50mn (instead of US$15mn, as indicated above) and further on in 2000-2001, to US$ 50mn
every year (instead of every three years). The limit for external investment by computer software companies with export/ foreign exchange earnings was raised to a higher level of US$100mn in a block of three years18 .
2.3.4. Outward FDI: Case-by-case Approvals

Investments not eligible for automatic approval are approved on a caseby-case basis. The RBI notification states that investments beyond US$15mn (revised to US$50mn from 1999-2000) can be approved only in exceptional circumstances, where the company has a strong track record of exports or where other compelling benefits exist for the Indian company (Government of India, 1999).
The outward FDI regime is, therefore, much more stringent than the inward FDI regime.It precludes aggressive investment behaviour by Indian companies in overseas markets as they are under pressure to generate profits within a short period of investing in overseas markets.
The outward FDI regime is, therefore, much more stringent than the inward FDI regime. The clause subjecting Indian overseas investment to full repatriation of the invested amount within 5 years, by way of dividend, technical fee etc., is particularly restrictive. It precludes aggressive investment behaviour by Indian companies in overseas markets as they are under pressure to generate profits within a short period of investing in overseas markets.
2.3.5. Trade Liberalisation

Apart from the domestic corporate sector, capital controls were liberalised for other domestic economic agents as well, but very cautiously mostly through the second half of 1990s. Exporters were permitted to retain their export earnings abroad for upto 180 days before repatriating it. Exporters and importers were also allowed to take forward cover for their trade-related transactions (either forward sale or purchase of foreign exchange) in the foreign exchange market, on the basis of business projections and documents substantiating the trade-related transaction. Though trade-related transactions continue to be the basis of exporters'/ importers participation in the foreign exchange market, the limited freedom allowed does enable them to take positions with respect to their foreign currency exposure, depending on their expectations (or speculations) about movements of the domestic currency. This also established a link between the current and capital accounts.
2.3.6. Liberalisation in the Banking Sector

The domestic banking sector was allowed limited freedom on its capital account transactions. Exporters, importers and domestic commercial banks participated in the foreign exchange market.
The domestic banking sector was allowed limited freedom on its capital account transactions. Banks could borrow or invest up to 15 percent of their Tier I capital abroad. They were allowed to engage in swap transactions19 in the foreign exchange market without seeking prior RBI approval. Banks could also maintain open positions20 with respect to their foreign currency exposure, within limits (called gap limits) specified by the RBI for each bank. This limited freedom allowed to banks enabled them to engage in arbitraging between the domestic money market and foreign exchange market, thus, forging links between two segments of the financial system21 . Exporters, importers and domestic commercial banks thus participated in the foreign exchange market, their transactions being guided, at least in part, by speculation motives and driven by expectations about movement of the exchange rate of domestic currency.
Table 13: Significant Regulatory Changes Involving FII in India over 1990s Date 14 September, 1992 December 1993 May 1994 14 November, 1995 Regulatory change RBI notification permitting FII in Indian securities. FIIs allowed to invest in the new schemes of mutual funds Companies allowed to issue preferential equity to FIIs Securities and Exchange Board of India (SEBI) (FII) Regulations, 1995 introduced; SEBI levies a registration fee of US$10,000 per sub-account of an FII for registering as an approved FII for a period of 5 years. The category of eligible FIIs expanded to include university funds, endowments, foundations or charitable trusts or charitable societies. FIIs were also allowed to invest in warrants of unlisted firms. FIIs are permitted to invest upto 100 percent of funds of dedicated debt subaccounts in debt securities. Previously only 30 percent of the total investment could be put into debt instruments. FIIs are allowed to invest in dated Government securities; also allowed to lend securities through approved intermediaries. FIIs are allowed to invest in Treasury Bills. FIIs are allowed to invest in derivatives listed in recognised stock exchanges; also allowed to invest in unlisted debt securities. FIIs are allowed forward foreign exchange cover on their investments (full amount) remitted after 31 March 1999. The total amount of outstanding investments that can be hedged, however, was limited to 15 percent on outstanding investments of an FII and an additional 15 percent, on a case by case basis after RBI approval. FIIs are allowed to participate in open offers in accordance with SEBI Takeover Code, 1997.
9 October, 1996
19 November 1996
20 April, 1998 18 May, 1998 30 June, 1998 31 March, 1999
6 April, 1999
Source: SEBI (1995), and newspaper reports retrieved from VANS, various dates
2.3.7. Foreign Institutional Investors (FIIs) Since 1991, Government of India has undertaken several steps to liberalise the norms for FII in the country (see Table 13).
Approved categories of FIIs were allowed to engage in purchase and trading of securities in the country and were given full rights to repatriate their capital and income/profits. Total FII (along with NRI investments)22 was limited to 24 percent of paid-up capital of a company, with an additional limit of 5 percent (raised to 10 percent through an amendment on October 9, 1996) on the investment made by a single FII sub-account. In 1996, two changes raised the limit on total FII in a company. Firstly, by separating FII and NRI investments and making the limit on FII alone 24 percent, and secondly, by allowing FII up to 30 percent in companies which obtained shareholders' permission to allow the enhanced level of FII. 23 With the passage of the SEBI (FII) Regulations Act, 1995, regulations governing FII investments, which were initially under administrative jurisdiction of RBI and Ministry of Finance, were brought under the jurisdiction of the independent stock-market regulator, SEBI in 1995. The regulations were amended a number of times over the 1990s, allowing greater freedom to FIIs for their operations (SEBI, 1995).
2.3.8. Fiscal Regime for FIIs

FIIs were given favourable tax treatment compared to Indian investors. Many of these asymmetries were eventually addressed, by lowering the tax rates for domestic companies and NRI investors to bring them at par with the rates applicable to FIIs in 1996-97
Initially, FIIs were given favourable tax treatment compared to Indian investors with respect to taxation of dividend income and capital gains arising from their trading in securities. The favourable tax treatment prevailed right from the announcement of the entry norms for the FIIs. They were taxed at 20 percent on income received from securities, 10 percent on long-term capital gains24 and 30 percent on short-term capital gains realised from trading of securities. In contrast, the tax rate on long-term capital gains was 46 percent for domestic companies (23 percent for venture capital funds) and that on short-term capital gains was 51.75 percent for widely held domestic companies and 57.5 percent for closely held domestic companies. The rates on investment income were the same as the ones on short-term capital gains. The FIIs tax rates were also lower than those applicable for NRI investments. Many of these asymmetries were eventually addressed, by lowering the tax rates for domestic companies and NRI investors to bring them at par with the rates applicable to FIIs in 1996-97 (VANS, various dates). Issues for Comments
l
Were the 1991 economic reforms a strategy-driven choice or a crisis-driven response? Does a mechanism exist ensuring positive externalities of foreign investment along with FDI flows? Would financial liberalisation reduce the cost and availability of finance to the domestic industry? Would the liberalisation of norms for outward FDI flow for computer software companies benefit the same? Is the impact of liberalisation of banking sector postive on foreign exchange market and should the banks be allowed more freedom on their capital account transactions? Are domestic investors now on a level playing field vis--vis Foreign Institutional Investors with respect to taxation of dividend income and capital gains arising from their trading activation in securities?
CHAPTER-3
Investment Policy Audit

3.1. Liberalisation of Inward Foreign Direct Investment Policies
Under the current policy regime, there are, for FDI, three broad categories of industries. In a few industries, FDI is not allowed at all; in another small category, FDI is permitted only till a specified level of foreign equity participation; and finally a third category, comprising the overwhelming bulk of industrial sectors, where FDI upto 100 percent equity participation is allowed.
Very few industries are actually out of bounds for FDI under the present policy. Defence and strategic industries, agriculture (including plantation), and broadcasting are some of the few sectors where FDI is not allowed. In some sectors like insurance, FDI upto 26 percent foreign equity participation has been allowed only recently. In other sectors, like telecommunications services (paging, cellular and basic services), direct FDI participation is allowed to the extent of 49 percent of the paid-up capital of licensees. Therefore, under the current policy regime, there are, for foreign direct investors, three broad categories of industries. In a few industries, FDI is not allowed at all; in another small category, foreign investment is permitted only till a specified level of foreign equity participation; and finally a third category, comprising the overwhelming bulk of industrial sectors, where foreign investment upto 100 percent equity participation by the foreign investor is allowed. The third category has two subsets one subset consisting of sectors where automatic approval is granted for foreign direct investment (often foreign equity participation less than 100 percent ) and the other consisting of sectors where prior approval from the FIPB is required. 3.2. Entry and Establishment Currently, foreign investors are allowed to set up a liaison office, representative office or wholly or partially owned subsidiary (or joint venture) in India. Here we discuss the entry restrictions and the changes in the regulations governing FDI (defined to include all investment where foreign investor owns greater than 10 percent of the paid-up capital of a company registered in India).
The Statement on Industrial Policy made FDI in 34 industries eligible for automatic approval upto a foreign equity participation level of 51 percent of the paid-up capital of a company.
The Statement on Industrial Policy (Government of India, 1991), made FDI in 34 industries (listed in Annex III of Statement on Industrial Policy, 1991) eligible for automatic approval upto a foreign equity participation level of 51 percent of the paid-up capital of a company. The automatic approval was, however, conditional on the requirement that capital goods import be financed out of foreign equity inflow and dividend repatriation be balanced by export earnings over a period of time (though the time period was not stated in the Policy Statement; these restrictions, moreover were further liberalised subsequently). The new policy (announced in 1991) was far more liberal in comparison with the then existing Act, FERA, that limited foreign equity participation to a maximum of 40 percent, except in very few special cases. (Chaudhuri, 1977) The policy revision, therefore, was more important in terms of the change in the level of control allowed to foreign firms over their Indian operations.
The FDI policy has undergone a number of changes over the 1990s, with a further expansion of the list of industries eligible for automatic approval upto 51 percent foreign equity participation and a general movement towards further liberalisation of the foreign investment regime. Without going into an enumeration of these changes, we are studying in somewhat greater detail the policy regime governing foreign investment, as it existed in August 200125. 3.3. Registration Procedure Foreign investors setting up operations in India have to register themselves with the Registrar of Companies (just like domestic investors). Tax holidays and other such special incentives are available for investment in certain sectors (like infrastructure projects), but these policies are sector specific and also apply to domestic investment in the relevant sectors. Incentives have been rule-based to a large extent (the most important incentive was perhaps the grant of guaranteed return at excessive levels to the fast track power projects promoted by foreign investors in the early 1990s; such policies were, however, discontinued after series of protests by civil society and litigation in courts). However, lobbying (both by domestic interests opposed to entry of foreign firms and by foreign firms willing to invest in the country) has played a role in setting the rules/policies regarding entry of foreign firms. Notable among them being the intense lobbying that was witnessed when the telecom or insurance sectors were being opened.
Foreign investors setting up operations in India have to register themselves with the Registrar of Companies (just like domestic investors). Tax holidays and other such special incentives are available for investment in certain sectors (like infrastructure projects) but these policies are sector specific and also apply to domestic investment in the relevant sectors as well.
3.3.1. Routes of Approval There are two major procedural routes currently available for approval of FDI proposals, besides simplified mechanisms with the Secretariat for Industrial Assistance (SIA).
3.3.1a Automatic Approval All investment proposals, except those listed below, are eligible for automatic approval, which is given by the Reserve Bank of India (RBI). Currently, in areas where automatic approval is applicable, investors are even allowed to make the investment prior to seeking RBI approval with the statutory requirement that they inform the RBI Department concerned within a month of making the investment. The cases not eligible for automatic approval are 1. Proposals where investment is in Annexure II26 industries, i.e. those requiring compulsory industrial licensing. There are 6 industries in Annexure II, including distillation and brewing of alcoholic drinks, manufacture of cigars and cigarettes, electronic aerospace and defence equipment, industrial explosives, hazardous chemicals and drugs and pharmaceuticals. 2. Proposals where 24 percent or more foreign equity investment is being sought to be made in manufacturing units reserved for the small-scale sector (If FDI beyond 24 percent is made in such small scale industry (SSI) units, the unit loses its SSI status. As per the Reservation Policy of SSI, units not falling under the SSI Sector have to take a license and export 50 percent of their production for producing items reserved for SSI Sector) and where FDI falls under the restrictions imposed due to locational policy of the Industrial Policy.
All investment proposals, except a few, are eligible for automatic approval, which is given by the Reserve Bank of India.
3. Proposals with a foreign collaborator who has a previous tie-up/venture in India. 4. Cases that involve acquisition of shares of existing Indian companies (only cases involving transfer of existing shares from residents to nonresidents; so cases where foreign investor gets higher equity stake through preferential issue of shares by its subsidiary does not come under this provision). The Government notifies different lists of industries, through Gazette notifications, for which automatic approval is to be granted upto 51, 74 and 100 percent of foreign equity participation. In 1991, only the list with approval upto 51 percent was there. The original list of 34 industries was expanded to include other industries and new lists of industries, eligible for automatic approval for foreign equity participation upto 74 and 100 percent, over the 1990s. These lists were also altered a number of times over the 1990s, to transfer industries in the 51 percent list to the 74 or 100 percent list. In general, the direction of change has been towards a more liberal regime. 3.3.1b FIPB Approval
The Foreign Investment Promotion Board (FIPB) is, in principle, a single window facility made available to foreign investors for seeking approval.
FDI proposals, which do not fall within these notified lists (for automatic approval) or fall under categories 1-4 above, are required to go through the second procedural route. Such proposals are scrutinised by the Foreign Investment Promotion Board (FIPB) for approval. The FIPB is, in principle, a single window facility made available to foreign investors for seeking approval. Before each proposal is considered in the FIPB, the comments and observations (concurrence or opposition) of the relevant administrative ministry/ministries (for instance, a FDI proposal in oil refining would come under jurisdiction of the Petroleum Ministry) on the proposal are made available to the FIPB. The FIPB follows some general guidelines in taking its decisions. One important guideline relates to proposals where the foreign investor already has an existing tie-up/joint-venture operating in India or the foreign company wishes to acquire shares in existing Indian companies. In such cases, a no-objection certificate from the Indian partner of the existing venture or a resolution adopted in the Annual General Meeting of the companys shareholders approving the investment by the foreign collaborator is essential to get an FIPB approval.
FIPB approval is granted easily if the ministries, having administrative jurisdiction over the concerned industry, do not have any objection to the proposal. In cases where such objection exists, FIPB has to deliberate and arrive at a decision.
There are, however, instances where the domestic promoters/majority shareholders are unwilling to cede or reduce equity control, and thus domestic companies are provided with protection from hostile take-over attempts by foreign investors. In general, FIPB approval is granted easily if the ministries, having administrative jurisdiction over the industry concerned, do not have any objection to the proposal. In cases where such objection exists, FIPB has to deliberate and arrive at a decision. In cases where the foreign investment amounts to less than US$130mn, the Ministry of Industry approves the FDI proposal directly on the basis of the recommendation of FIPB and in cases where the proposed investment is greater than US$130mn, the proposals are given final approval by the Cabinet Committee on Foreign Investment (CCFI). However, FIPB may also refer proposals with investment less than US$130mn to CCFI.
3.3.1c Simplified Mechanisms Under the existing Industrial Policy, a short list of only six industries is kept under licensing. All applications for which approval is required from the Government, are to be filed with SIA and considered by subject specific Committees/Boards and decisions are taken in a time bound manner. These Committees include the Project Approval Board (PAB) for foreign technology agreement cases; the Board of Approval (BOA) for 100 percent Export Oriented Units; the Licensing Committee (LC) for industrial licence, the Inter Ministerial Committee for Electronic Software & Electric Hardware Technology Park Sectors (EHTPs & STPs), Empowered Committee for granting concessions under the Income Tax Act for Industrial Model Towns, Industrial Parks, etc.
3.3.2. Special Provisions

In addition to the general policies on FDI, certain special provisions have been made for direct investment by NRI and Overseas Corporate Bodies (OCBs), where NRIs hold at least 60 percent equity. For example, NRI/ OCBs are allowed to invest upto 100 percent equity in air taxi operations and civil aviation, where the general limit for FDI is 40 percent27.
In addition to the general policies on FDI, certain special provisions have been made for direct investment by Non-resident Indians (NRI's) and Overseas Corporate Bodies (OCBs).
NRI investments are also allowed in housing and real estate, where general foreign investors are not allowed. NRI investment in housing/real estate, however, carries restrictions of a 3-year lock-in period for the investment and a limit of 16 percent on dividend repatriation. Further, NRI investments are allowed in sick industries, for the purpose of their revival.
3.3.3. Requirements for Foreign Technology Collaborations

Along with the liberalisation of FDI rules, norms for foreign technology collaboration (with or without equity participation of the foreign collaborator), payment of technology fees, royalties on technology, brands or copyrights have also been made liberal. Foreign firms, for instance, obtained an automatic right over their international brands in Indian market from 1992 onwards, after the provision, requiring foreign firms to seek special Government permission for using their international brands in the domestic market was revoked. (Recall that when PepsiCo launched soft drinks in India in 1989-90, it had to use the Lehar-Pepsi brand name) A royalty payment of 2 percent for exports and 1 percent for domestic sales is also allowed under automatic RBI approval for use of trademark or brand name of any foreign firm without technology transfer. Currently, the RBI, through its regional offices, accords automatic approval to all industries for foreign technology collaboration agreements subject to:
Although there is some amount of pre-investment scrutiny by the Government, foreign firms operating in India are given national treatment, post-entry, except that the incidence of corporate tax is higher.
1. lump sum payments not exceeding US$2mn; 2. payable royalty amount being limited to 5 per cent for domestic sales and 8 per cent for exports, subject to a total payment of 8 per cent on sales over a 10 year period; 3. the period for payment of royalty not exceeding 7 years from the date of commencement of commercial production, or 10 years from the date of agreement, whichever is earlier (the aforesaid royalty limits are net of taxes and are calculated according to standard conditions); and 4. payment of royalty upto 8 percent on exports and 5 percent on domestic sales by wholly owned subsidiaries to offshore parent companies without any restriction on the duration of royalty payments.
For technology collaboration arrangements not covered under the above categories and cases of collaboration in industries requiring compulsory licensing or in sectors reserved for small-scale enterprises, approval is required from the Ministry of Industry, Government of India28.
Foreign direct investors have, moreover, been allowed full repatriability of their investment capital and the income/dividend generated therefrom, except in cases where dividend balancing conditions applied. Dividend balancing has, however, been discontinued from 2000 end.
Although there is some amount of pre-investment scrutiny by the Government, foreign firms operating in India are given national treatment post-entry, except that the incidence of corporate tax is higher (40 percent as compared to 35 percent for domestic firms). 3.4. Repatriation of Profits Foreign direct investors have, moreover, been allowed full repatriability of their investment capital and the income/dividend generated therefrom, except in cases where dividend balancing conditions applied. In 22 industries, FDI approval was accompanied by dividend balancing conditionalities, whereby the foreign investor has to balance the dividend repatriated over a seven year period (from date of remittance) with export earnings, either through export of products manufactured by the investor in India or products sourced from other producers29. The 22 sectors were all consumer goods industries, including white goods, entertainment, motor cars, leather manufacturing/processing and footwear manufacturing, soft drinks and carbonated water, food products (including dairy and bakery products), tea, coffee, wood products/furniture, spirits and wine, tobacco products and manufacture of sugar, common salt and hydrogenated oil30. Dividend balancing has, however, been discontinued from 2000 end. Apart from the dividend balancing conditions, FDI approval through the automatic route does not involve imposition of any other conditions, unless a sectorspecific guideline imposes anything additional31. 3.5. Investment Facilitation Initiatives/Institutions The Government has also taken steps to smoothen the process of investment facilitation. The Industry Ministry website of Government of India has all relevant information regarding the policies and restrictions on FDI. Approval (where one is required) is granted through the singlewindow facility, through FIPB where foreign investors can send proposals to FIPB for approval even through the Internet. The status of any application is conveyed within 30 working days (the status can be either accepted, rejected or put on hold, which implies that the FIPB could not resolve the issue in its meeting).
The Government has also taken steps to smoothen the process of investment facilitation. The Industry Ministry website of Government of India has all relevant information regarding the policies and restrictions on FDI. Foreign investors can send proposals to FIPB for approval even through the Internet.
However, investors also need to get other statutory approvals, including environmental clearance, clearance for land acquisition (many of these clearances are given by the state government departments) and approvals from sectoral regulatory agencies (like Insurance Regulatory and Development Authority for insurance, Telecom Regulatory Authority of India for telecom services, Telecom Evaluation Committee for telecom equipment etc.) if the investment is made in those sectors. These statutory clearances are, however, required for domestic investors as well. It is often argued that the procedural impediments faced by foreign investors in getting these clearances from different levels of bureaucracy is acute, but it needs to be realised that these hurdles adversely affect domestic investments as well.
3.5.1. Institutions
The FIPB and other facilitation agencies in the Industry Ministry of Central Government help and guide foreign investors in getting the approvals and all large projects are monitored by the Ministry of Industry32 to smoothen their actual implementation. There are also Country Focus Windows, within Ministry of Industry, (of Central Government) for countries with sizeable investment interest in India. At present, the Focus Window covers countries such as USA, Germany, France, Switzerland, UK, Australia, Japan and Korea. For each focus window a senior officer in the department provides facilitation and assistance. However, FDI approval by the FIPB can be accompanied by other conditions, imposed on the recommendation of ministries concerned, like export obligations, local content requirements (imposed, for instance, in motor cars and automobile sector till it was revoked after an adverse WTO ruling in 2001 after US registered a complaint), restriction on import of capital goods, imposition of a floor on foreign equity investment (to have adequately capitalised domestic operations) etc. Issues for Comments
l
Do official procedures and regulations governing the pre-investment scrutiny of FDI proposals act as a barrier to FDI flows in India? What would be the impact of lobbying in setting the rules/policies regarding entry of foreign firms in India? Is there a need to simplify the RBI automatic approval and FIPB approval - the currently available procedural routes for approval of FDI? Is the sector specific limit on foreign equity participation inhibiting FDI flows to India? What other steps should be taken to enhance the flow of foreign technology collaboration? Is there a scope for improving the functioning of investment facilitation institution? Does the single window in reality serve the purpose of providing all relevant information as also of sending prompt feedback to FDI applications?
CHAPTER -IV
Evaluation of Foreign Investment Policy Regime

4.1. Regime for FDI
Post-entry, foreign firms are afforded national treatment while there are some pre-investment scrutiny requirements depending on the industry in which the investment is being made.
The current policies with regard to inward FDI flow in India can be argued to be liberal. Post-entry, foreign firms are afforded national treatment in general, while there are some pre-investment scrutiny requirements depending on the industry in which the investment is being made. The differential treatment is limited to a few entry rules spelling out the proportion of equity that the foreign firm can hold in an Indian (registered) company or business. There are only a few banned sectors (like lotteries and gaming and legal services) and some sectors with limits on foreign equity proportion. Box A: Stylised Facts on FDI Procedures and Delay in India
l
According to Boston Consulting Group, investors find it frustrating to navigate through the tangles of bureaucratic controls and procedures in India. McKinsey (2001) found that the time taken for application/bidding/ approval of FDI projects was too long. Multiple approvals, excessive time taken (2-3 years) such as in food processing and long lead times of up to six months for licenses for duty free exports, lead to loss of investors confidence despite promises of a considerable market size. According to a CII study, a typical power project requires 43 central government and 57 state government (including local administration) clearances. Similarly, the number of clearances for a typical mining project is 37 at the central government and 47 at the state government level.
Source: Report of the Steering Group on FDI, 2001.
As noted earlier, the entry rules are clear and well defined and equity limits for foreign investment in selected sectors are quite explicit and well known. The procedural route has now been made more simple and non-discriminatory. There exist sector specific incentives, but these are also accorded to domestic investors. To a large extent, the incentives have been made transparent and rule-based.
India now has in place a liberal policy regime towards FDI. However, investment climate in India is far less than satisfactory as reflected by a huge difference between the approved and actual inflows of FDI.
What emerges from the above discussion is that India now has in place a liberal policy regime towards FDI. However, investment climate in India appears to be far less than satisfactory as reflected by a huge difference between the approved and actual inflows of FDI. As The Economist (22 February 1997: 23) points out (taken from Srinivasan, 1998): the system simply does not work as it is supposed to. The rules may be liberal in principle(but) delays, complexities, obfuscation, overlapping jurisdictions and endless requests for more information remain much the same as they have always been.
To identify factors inhibiting higher FDI flows, Government of India constituted in August 2001 a Steering Group on Foreign Direct Investment under the chairmanship of Mr N K Singh. The group has recently submitted its report with recommendation of accelerating the rate of growth of FDI flows. In the section below, we would briefly look at their findings. 4.2. Policy Regime: the Reality33
The report of the Steering Group on Foreign Direct Investment (N.K. Singh Report) has mentioned that the domestic policy framework affects all investment, whether the investor is an Indian or a foreigner. The policy problems, identified by the report, acting as additional hurdles for FDI are laws, regulatory systems and government monopolies that do not have contemporary relevance.
At the outset, it should be noted that the delays mentioned by foreign investors are not at the stage of FDI approval per se, i.e., at the entry point, whether through RBI automatic route or FIPB approval. By and large, the FIPB considers applications on the basis of notified guidelines and disposes them within a 6-8 weeks timeframe, as has been laid down by the Cabinet34. The major implementation problems are encountered at the state level, as project implementation takes place at the state level. The report of the Steering Group has mentioned that the domestic policy framework affects all investment, whether the investor is an Indian or a foreigner. The policy problems, identified by the report, acting as additional hurdles for FDI are laws, regulatory systems and government monopolies that do not have contemporary relevance. This is based on feedback of different consulting firms who made presentation to the Steering Group (see Box A for an overview). Bureaucracy and red tapism topped the list of investor concerns as they were cited by 39 percent of respondents in the A T Kearney survey. Of the three stages of a project, namely general approval, clearance and implementation, the second was the most oppressive. The respondents of the survey also indicated that the division of execution mechanism between the central and state governments in the treatment of foreign investors could undermine the FDI promotion efforts of the central government. Bureaucracy in general is quite uncooperative in extending the necessary facilities to any project that is being set up. It is important to note that weak credibility of regulatory systems and multiple and conflicting roles of agencies and government can have more adverse impact on new FDI investors compared to domestic investors. For example, the outdated Fruit Product Order (FPO) and Prevention of Food Adulteration Act is a major hurdle for FDI in food processing. As a Task Force had recommended some years ago, we need to formulate a single integrated Food Act (including weights & measures).
It is important to note that weak credibility of regulatory systems and multiple and conflicting roles of agencies and government can have more adverse impact on new FDI investors.
Similarly, labour laws discourage the entry of Greenfield FDI because of the fear that it would not be possible to downsize if and when there is a downturn in business. Labour laws, rules and procedures have led to deterioration in the work culture and the comparative advantage recognised by responsible trade unions. The Urban Land Ceiling Act and Rent Control Act are serious constraints on the entire real estate sector35. Recently the Centre has repealed the Urban Land Ceiling Act, but each state has to issue a notification to repeal the Act in that state. The Central Government has set up an Urban Reform Facility to provide funds to states that repeal the State Land Ceiling Act, reform the Rent Control Act and carry out other urban reforms.
At present, the entire FDI policy and procedures, as notified by the government from time to time, are duly incorporated under Foreign Exchange Management Act (FEMA) regulations. Many of the entry conditions had greater justification at the time they were imposed. With a much stronger and more competitive economy many of these can be removed. To increase FDI flows, the Steering Committee has recommended that the entry barriers to FDI should be further relaxed (see Table 14). With regard to policy regime, the committee has recommended the following:
l
Enact a Foreign Investment Promotion Law (FIPL) that incorporates and integrates aspects relevant to promotion of FDI. Encourage states to enact a special investment law relating to infrastructure to expedite all investments in infrastructure sectors. FIPB should be encouraged to give initial central level approvals where possible. Change governments Rules of Business to empower FIIA to expedite the processing of administrative and policy approvals. Sectoral FDI caps should be reduced to the minimum and entry barriers eliminated. To attract FDI, the broad approach should be one of targeting specific companies in specific sectors. The informational aspects of the strategy should be refined in the light of the perceived advantages and disadvantages of India as an investment destination. The Special Economic Zones (SEZs) should be developed as the most competitive destination for export related FDI in the world, by simplifying applicable laws, rules and administrative procedures and reducing red tape levels. Domestic policy reforms in the power sector, urban infrastructure and real estate, and de-control/de-licensing should be expedited to promote private, domestic and foreign investment.
Table 14 Proposed Changes in Sectoral Limits on FDI Sector Equity Limits (percent) Existing Proposed
1 1.1 1.2 1.3 1.4 2 2.1 2.2 2.3 2.4 2.5 Manufacturing Drugs (recombinant DNA) Petroleum, Refining-PSUs Oil marketing SSI Mining & Quarrying Diamond, Precious Stones Petro Explore: Small Field, bid Petro Explore:Un incorp JV Petro Explore: Incorp JV Coal & Lignite Power User Other User Coal Washery 100 26 74 24 100 100 100 49
Entry Route Existing

FIPB FIPB FIPB FIPB
Change in Conditions
Proposed
Automatic Automatic Automatic Automatic
Export 50% ->0%
74 100 60 51 50 100 74 50 100
100 No change 100 100 100
Automatic FIPB FIPB FIPB Automatic FIPB FIPB Automatic FIPB
Automatic Automatic Automatic Automatic Automatic Automatic Automatic Automatic Automatic
2.6
100
3 3.1 3.2 3.3 3.3.1 3.3.2 3.3.3 3.4 4 4.1 4.2 4.3 5 5.1 5.1.1 5.1.2 5.1.3 5.2 5.2.1 6 6.1 6.2 6.3 7 7.1 7.2 7.2.1 7.2.2
Infrastructure Services Airports Civil Aviation Telecom Basic & Mobile Total Bandwidth Gateway Pipeline: Oil & Gas Financial Services Banking (private) Insurance Investing Companies Knowledge Services Information Tech ISP (Internet Service Provider) Email, Voicemail Radio Paging Broadcasting - DTH, KU Up Linking Other Services Advertising Trading (Export, SSI.) 100 percent Courier Service Currently Banned Sectors Plantations (other) Real Estate Complexes (all Categories) Individual House/Building/Shed
74 100 40 49 74 74 51
100 49 74 100 100 100
Automatic FIPB FIPB FIPB FIPB FIPB FIPB
Automatic Automatic Automatic No change Automatic Automatic Automatic
Incld Foreign Airlines
49 26 49
100 49 100
Automatic Automatic FIPB
No change No change Automatic
100 100 74 20 49
No change No change 100 49 No change
FIPB FIPB FIPB FIPB FIPB
Automatic Automatic Automatic No change No change
Remove sub-limits (FDI, FII)
74 51 FIPB 100
100 100 Automatic No change
Automatic Automatic FIPB
No change
Automatic
0 0 0
49 100 100
FIPB Automatic FIPB
Source: Report of the Steering Group on FDI, 2002.
Issues for Comments

l
What steps should be taken to translate approved foreign investment into actual inflows of FDI? How to encounter the implementation lag and lack of administrative co-ordination between the central and state governments resulting in discriminatory treatment to foreign investors? Would it undermine the FDI promotion efforts by the central government? To what extent are bureaucratic tangles and red-tapism inhibiting Indias industrial growth? How soon would the government accept the recommendations of the Steering Group on FDI?
CHAPTER-V
Analysis of Civil Society Surveys

5.1 Introduction It is clear from the above discussion that India has put in place a liberal policy regime for foreign investment. However, a liberal policy for foreign investment may not turn out to be a liberal one at the implementation stage unless the government officials or the implementers take a positive view towards FDI flows. Since they are a part of the civil society, it is important to know for the study the civil societys perception of the investment environment in India.
A liberal policy for foreign investment may not turn out to be a liberal one at the implementation stage unless the government officials or the implementers take a positive view towards FDI flows.
In this chapter, we have done the same by a primary survey conducted by e-mail all over India during the months of February 2002 and January 2003. The survey questionnaire was designed to elicit information on contribution of FDI on the development, sector-wise distribution of FDI, as well as impact of FDI on various parameters relating to economy, technology, policies, etc. What needs to be mentioned here is that it was not a random sample with the population being largely the mailing lists of National Resource Group (NRG) of CUTS. We have in all only 38 responses, and thus the results of the survey findings can only be considered as indicative and not conclusive. 5.2. Sectoral Destination of FDI Is our sample of civil society group well informed about the destination of FDI? To check this, we have displayed in Chart 1 perception of our civil society group regarding the top 9 sector-wise recipients of FDI flows in the recent years (1996-2001) and their ranks based on actual FDI approvals during the same period.
Chart 1: Perception of Destination of FDI by Civil Society and Actual Inflows (Ranked in Decreasing Order)
10 9 8 7
1 1 2 2 3 3 4 5 7 8
Insurance and Banking Automobiles Chemicals Telecom & IT Engineering Consumer Goods Power
Ranks
6 5 4 3 2 1 0
4 5 6 7 8
Petroleum
6 9
Infrastructure
Sectors Ranking of sectors Perception Ranking of sectors byby Perception Ranking of sector by Actual Inflows Ranking of sectors by Actual Inflows
It is interesting to note that our survey has been able to pick out correctly most of the sectors receiving the largest amount of FDI in the recent years. As Chart 1 shows, our survey has identified the Information Technology (IT) sector as the maximum recipient of FDI flows in the past 5 years. The other sectors of importance are power, automobiles, etc36. 5.3. Impact of FDI Given the fact that India has been attracting FDI in a big way only in the years after liberalisation, it is not unexpected that majority of respondents responded by saying that FDI did not have much role in the past in national development.However, their perception differs significantly when information was sought regarding the sectoral impact of FDI on the local economy, society and environment in the last 5 years. Among the sectors which have attracted most of the FDI flows as perceived by civil society, namely IT, power, automobiles, chemical, engineering goods (Chart 1), civil society has responded that FDI has definitely imparted considerable impact on these sectors. As Chart 2 shows, telecom/IT, automobiles and engineering/electronics are the sectors in which the respondents perceived that FDI has maximum impact. Note that FDI has an impact on power sectors as well, albeit on a lower scale.
Chart 2: Sectorwise Impact on Economy
60.0
Majority of respondents responded by saying that FDI did not have much role in the past in national development. However, their perception differs significantly when information was sought regarding the sectoral impact of FDI on local economy, society and environment in the last 5 years.
Percent of respondents
50.0
50.0 40.0
30.8
30.0 20.0 10.0 0.0

15.4 14.3 14.3 7.7 7.1 7.7
Telecom
Automobiles
Engineering
Pow er
Sectors Placed at 1st Rank Placed at 2nd Rank
5.4. Indias Experience with FDI Flows As noted earlier, FDI can supplement domestic investible resources in a developing economy like India, enabling higher rates of growth. Foreign firms contribute to the technological base of the host economy, both directly and also through technological spillovers, thereby increasing productivity and international competitiveness of the host economy. Global linkages of multinational firms may facilitate the marketing of exports. Against these positive features of FDI, critics claim that multinational enterprises (MNEs) monopolise resources, supplant domestic enterprise, introduce inappropriate products and technology and often exploit the weak environmental standards in developing countries (recall the Union Carbide disaster at Bhopal in 1984) etc. Our questionnaires were designed to get feedback on these issues from the civil society based on Indias experience in the last decade. The results are summarised in tables 15 and 16.
Majority of the respondents are of the opinion that MNEs are only interested in getting access to domestic market. FDI brings in environmentally harmful technologies and reduces the profitable opportunities available to domestic investors. The civil society is also of the opinion that the foreign investors do not care about their impact on civil society.
Majority of the respondents are of the opinion that MNEs are only interested in getting access to domestic market (see Table 15). FDI brings in environmentally harmful technologies and reduces the profitable opportunities available to domestic investors. The respondents are also of the opinion that the foreign investors do not care about their impact on civil society. However, most of our sample of respondents agree that FDI brings in valuable new technologies as well as management techniques, improves the access to world markets, and increases the competitiveness of the economy. It is interesting to point out that our surveys of local firms in the IT and automobiles sectors did capture these positive aspects of FDI viz. improved product quality and precision, efficient management techniques, shop floor practises, and new technologies (see Annex 1). Furthermore, it is an important source of foreign capital and supplements domestic investment. There is no clear agreement among the survey respondents on the impact of FDI on exports. Note that while 18 respondents agree that FDI helps in increasing exports, 12 have reserved their comments on the role of FDI in enhancing exports. Does FDI flows help in reducing imports? Again there is no consensus: one-third have responded affirmative, one-third have answered negative while one-third have reserved their opinion.
Table 15: Negative Perceptions of Civil Society Negative Perceptions

Agree Agree Neither Agree Disagree Disagree Total Strongly Partly nor Disagree Partly Strongly Responses
FDI brings in environmentally harmful technologies Foreign investors are only interested in getting access to the domestic market FDI reduces the profitable opportunities available to domestic investors FDI results out of unfair advantages of multinational firms Foreign investors do not care about the impact of their investments on civil society
3 16 4 6 10
12 10 8 7 7
14 6 9 15 12
8 3 9 5 7
1 1 6 1 2
38 36 36 34 38
Table 16: Positive Perceptions of Civil Society Negative Perceptions FDI makes up for insufficient domestic investment FDI brings in valuable new technologies FDI brings in valuable new management techniques FDI improves the competitiveness of the national economy FDI increases access to world markets FDI is a valuable source of foreign capital FDI helps to enhance exports FDI helps to reduce imports
Agree Agree Neither Agree Disagree Disagree Total Strongly Partly nor Disagree Partly Strongly Responses
7 8 13 12 10 14 5 2
13 23 19 18 13 20 13 11
8 4 4 5 5 2 12 12
8 3
36 38 36 2 5 4 6 38 38 38 38 38
1 5 2 4 7
5.5. General Policy Implications

There is a strong agreement (about 88 percent of the respondents) in our survey that India has attracted less foreign investment than it should, given the size of her economy.
There is a strong agreement (about 88 percent of the respondents) in our survey that India has attracted less foreign investment than it should, given the size of her economy. When the respondents were asked to identify the reasons for it, most agreed that bureaucracy and the regulatory environment were the two most important factors inhibiting FDI flows to India. In this connection, it is important to point that a global survey conducted by AT Kearney has also found that bureaucracy and regulatory environment top the list of investor concerns inhibiting FDI flows to India37 . Most of our respondents felt that regulatory environment was not transparent, leading to bureaucratic hassles and corruption. The other notable factors identified by a majority of the civil society respondents were the infrastructural shortages, political instability and lack of consensus among the political leadership with regard to FDI flows. According to the respondents, to increase FDI flows, the policy framework needs to be reoriented in terms of transparency, simplifying bureaucratic procedures and time bound clearance of proposals. Some opine that easier policy for entry/exit rules for firms and improved infrastructure facilities are essential if India has to increase FDI flows substantially. Nearly 80 percent agreed that the policy framework should be less restrictive. By and large, civil society is now positively inclined towards FDI. As Table 17 shows, nearly 80 percent of our respondents are positively inclined towards FDI against 20 percent of the same being negatively inclined. Our sample of civil society strongly felt (75 percent of respondents) that certain sectors should specifically be targeted for FDI. Probably because of the poor state of infrastructure in India, most have agreed that infrastructure should be the focus area for FDI.
When the respondents were asked to identify the reasons for it, most agreed that bureaucracy and regulatory environment were the two most important factors inhibiting FDI flows to India.
Civil society respondents perceive (80 percent of our sample) that government policies can be fine-tuned to increase the benefits of FDI flows to the local economy and the society. Opinions of the respondents across various realms of government policies and the results are summarised in Table 18. For maximising the benefits from FDI, the civil society observes the need to strengthen the environmental, labour, sectoral, and Intellectual Property Rights (IPR) regulations, to introduce competition policy and to support local businesses to upgrade technology/gain access to finance. Majority of the respondents felt that there should be specific requirements on foreign firms in respect of job creations, export commitments, transfer of technology, transferring skills and know-how to local subsidiary and nonaffiliate firms, and training local technical and managerial manpower. The survey also reflects that any foreign exchange impact needs to be balanced to endow the economy with greater benefits of FDI. Table 17: Civil Societys Inclination towards FDI Numbers Percent Positively inclined towards FDI Negatively inclined towards FDI Total 30 8 38 78.9 21.1 100
Table 18: Policies to Increase the Benefits of FDI

Alternative Policies Positively Inclined Negatively Inclined to FDI to FDI All
Yes a) Support local businesses to upgrade technology/gain access to finance, etc. b) Strengthen environmental regulation c) Introduce/strengthen competition policy d) Strengthen sectoral regulation e) Strengthen labour legislation f) Strengthen intellectual property rights legislation g) Impose requirements on firms to: i) Create jobs ii) Employ local managers iii) Transfer technology iv) Source supplies from local firms or impose local content norms v) Export from the economy vi) Balance foreign exchange impact vii) Transfer skills and know-how to local subsidiary firms viii) Transfer skills and know-how to local non-affiliate firms ix) Train local technical and managerial manpower 17 15 18 16 15 15
Dont Know 4 5 1 3 4 -
Yes 7 7 7 4 4 5
Dont Know 1 1 2 1
Yes 24 22 25 20 19 20
Dont Know 4 5 5 4 6 1
13 8 15 12 13 5 14 9 15
2 3 2 4 3 8 5 6 3
4 4 4 3 4 4 6 5 5
1 1 3 2 1 -
17 12 19 15 17 9 20 14 20
2 4 3 7 3 10 5 7 3
Issues for Comments

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Are the stakeholders well informed regarding the sectoral destination of FDI flows? What are the impacts of FDI flows on Indian economy perceived through the survey of civil society? Is the civil society positively inclined towards FDI flows? What should the government do to maximise the benefits from FDI? What changes in policies does the civil society feel are necessary? What are the factors that the civil society group consider as inhibiting FDI flows to India?
CHAPTER-VI
Case Studies
This section reports the findings of three case studies of sectoral performance of FDI in India. In view of the importance in respect of FDI flows and civil societys perceptions, we have chosen three sectors: automobiles, telecom/IT and power, to study in detail. To be specific, these case studies have been selected to explore and investigate a number of areas of concern about investment in India. The studies embrace issues like contribution of FDI to the government development objectives premised on generating employment, technology transfer and spurring economic growth; success of government polices in attracting FDI and required policy changes to be made in order to attract and benefit from increased FDI flows. The case studies have been selected for the following reasons:
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IT sector: This sector probably had the most remarkable development of the 1990s in India. This sector is of particular importance for economic development because it has direct impact on the nature and level of economic activity, specially when the global trend of communication rests largely on computerisation. Among all the sectors, this is the one which has benefited the earliest and the most from FDI flows. Automobiles: For long, a few firms controlled the automobile sector in India. The technology was obsolete and there was almost no penetration in the export market. These all have now changed with FDI flows in this sector. This sector has now definitely become more productive and is able to compete globally. Power: Since the economic reforms of the 1990s, the government has been actively seeking FDI flows for this sector to meet the rising demand for power within the country. The policies have been liberalised time and again. However, despite significant amount of approved FDI in the power sector, actual FDI flows have been minimal.
IT, automobiles and power sectors have attracted large FDI flows. The positive impact of FDI flows on the economy is visible in the first two sectors, while the experience of the third sector (power) in the past 5-6 years has shown that mere policy changes may not be enough for realising the gains from FDI flows in an infrastructure sector like power.
All these sectors have attracted large FDI flows. At the same time, the positive impact of FDI flows on the economy is visible in the first two sectors, while the experience of the third sector (power) in the past 5-6 years has shown that mere policy changes may not be enough for realising the gains from FDI flows in an infrastructure sector like power. An analysis of these case studies should, therefore, provide valuable insights into the performance of FDI flows in India. 6.1. The IT Sector One of the most remarkable developments of the 1990s in India has been the growing emergence of the new economy or the IT economy. To be specific, the IT economy comprises all the activities involved in value addition (i.e. GDP), adjusted for exports and imports, by way of IT services, software systems and communication equipment, such as computer companies, telecommunications utilities and related enterprises. The major segments of IT-enabled services are content development, medical
transcription, call centres, database services, support and maintenance, training/retraining products and packages, projects and professional services.
6.1.1 Stylised Facts of IT Sector

Total revenues of the software sector, may cross US$10bn in 200102. The other segments of the ITeconomy notably telecommunications and infotainment, are also expanding fast though still remain narrow, compared with aggregate GDP of about $500bn.
The IT economy in India is no more a myth. Total revenues of the software sector, a symbol of the IT economy, may cross US$10bn in 2001-02. The other segments of the IT economy, notably telecommunicationss and infotainment, are also expanding fast, compared with aggregate GDP of about US$500bn. As Table 19 shows, the fastest growing segment of the IT economy, viz. the software industry has grown at an astonishing rate of 46 percent over 1994-2001. Unlike the other industries in India, growth of the software industry has been fuelled by external demand. This sector is likely to have a stable growth due to expanding human resources (a bank of 4-5 million technical/professional workers, incrementally 85,000 professionals per annum), skills and credibility38. Table 19: Growth of Indian Software Industry Revenues (US$mn) Year 1989-90 1994-95 1995-96 1996-97 1997-98 1998-99 1999-2000 2000-01 Total n.a. 835 1224 1755 2700 3900 5750 8300 Domestic n.a. 350 490 670 950 1250 1750 2100 Exports 105.4 485 734 1085 1750 2650 4000 6200
Compound Annual Growth Rate (%) 1994/2001 46.63 34.80 229.44
Source: Kumar (2002), Raipuria (2002).
Unfortunately, national accounts statistics have not yet provided separate estimates of the share of IT sector in GDP. IT application at aggregate level in agriculture, mining, and most of the manufacturing and transport sectors seems to be insignificant and also there remains minimal application of IT components in the service sectors. But recognising the GDP contribution of the software sector with domestic and export revenues respectively of about US$200mn in 1997-98 and US$790mn in 2000-01, the total size of the IT economy in India is estimated by Raipuria (2002) to be 1.7 percent of aggregate GDP in 1997-98 and about 3.7 percent in 2000-0139. According to Raipuria, even if one takes into account second or third-tier links of IT, the share of IT economy may still be below 10 percent in the medium term. The evolution of the Indian software industry is intimately linked to the trend of globalisation of the value adding activities in large MNEs. It was Texas Instruments (TI), a US based MNE, which had set up a software development centre in Bangalore as far back as 1986, to tap the highly qualified workforce available in the vicinity. Subsequently, a host of other MNEs began to follow the footsteps of TI. 50 w Investment Policy in India Performance and Perceptions
Realising the potential, a number of Indian companies engaged in computer hardware started to spin-off their software divisions. Despite the entry of leading MNEs in India for software development, the industry is still dominated by domestic companies and talent. The top six software companies in India, ranked either on the basis of overall sales or the overall turnover, are all domestically owned. Among the top 20 software companies too, no more than five or six are MNE affiliates or joint ventures.
The Indian software exporting companies themselves are sufficiently global in their outlook. As many as 212 Indian software companies have either subsidiaries or branch offices overseas.
The Indian software exporting companies themselves are sufficiently global in their outlook. As many as 212 Indian software companies have either subsidiaries or branch offices overseas. Nearly 32 Indian software companies have received Software Engineering Institute (SEI) USAs Capability Maturity Model (CMM) Certification40 . Six of them have reached Level 5 of this certification scheme, a distinction, which has been awarded only to 12 companies worldwide. Indian companies cater to the needs of large MNEs (203 of the Fortune 1000) in the developed countries which outsource their software requirement from India. Many of them have got listed on the Nasdaq stock exchange in the USA. Hence, the Indian software industry is intimately linked to the emerging trend of globalisation and outsourcing that is taking place worldwide.
6.1.2 Policy Framework and FDI Flows

To a large extent, the success of the Indian IT sector has been attributed to the role played by the government in providing an enabling framework. It was way back in 1984 that a new computer policy was introduced that facilitated import of computers at a significantly reduced tariff rate. Subsequently in 1986, a computer software policy was formulated, a Software Development Agency was set up and entry into the software industry was de-licensed. In 1988, the Electronics and Computer Software Export Promotion Council was set up to provide marketing help to software companies in their export and the industry also re-organised itself and set up the NASSCOM as their apex body to lobby for their common cause with the government. 1988 onwards, the government focused on providing telecommunications infrastructure, and its Software Technology Parks (STP) scheme began to evolve slowly.
1988 onwards, the government focused on providing telecommunications infrastructure, and its Software Technology Parks (STP) scheme began to evolve slowly.
Gradually, the STP of India Limited has evolved into an autonomous organisation under the Department of Electronics to provide a conducive environment to entrepreneurs operating under the STP scheme. This scheme offers zero import duty on import of all capital goods, a special 10 year income tax holiday and it also provides infrastructual facilities like high speed data-communication links etc. Having recognised the potential of the software industry, the government set up a National Task Force on Information Technology and Software Development in May 1998. The Taskforce submitted the Information Technology Action Plan comprising 108 recommendations in July 1998. All these recommendations have since been accepted by the government through a Gazette Notification issued in July 1998 itself. The Action Plan includes opening of internet gateway access, encourage private STPs, zero duty on IT software, income tax exemptions to software and services' exports, etc. As a follow-up of the Action Plan, a new Internet
policy has come into being and a large number of internet service providers have been licensed. Now, a separate Ministry of Information Technology has been set up to co-ordinate the promotional role of the government and the industry.
India now has a liberal policy for FDI in the telecom sector. FDI up to 100 percent is allowed in various categories of this sector, such as, manufacturing of telecom equipment, internet service (not providing international gateways), e-mail service and voice-mail service.
India now has a liberal policy for FDI in the telecom sector. FDI up to 100 percent is allowed in various categories of this sector, such as, manufacturing of telecom equipment, internet service (not providing international gateways), e-mail service and voice-mail service. Upto 74 percent FDI is allowed in two major areas of telecom sector, namely, internet service (providing international gateways) and radio paging service. On the other hand, FDI upto 49 percent is permitted for national long distance service, basic telephone service, cellular mobile service and for value-added service. During the period August 1991 to January 2002, actual inflow of FDI in the telecom sector has been US$1696mn and out of this, US$794mn has come in the year 2001 alone. Out of the actual inflows, the cellular services has attracted about US$443mn, contributing about 30 percent of overall telecom FDI flows during the period. On the other hand, basic telephone services attracted FDI inflows to the tune of US$80mn. The actual flow for the telecom sector during the same period is about 20.11 percent of total FDI approved. It deserves mention here that in terms of approval of FDI, the telecom sector is the second largest after the energy sector. 6.2. Automobile Sector The automobile industry has emerged as an important driver of the economy. Although the automobile industry in India is nearly six decades old, until 1982, it had only three manufacturers - M/s. Hindustan Motors, M/s. Premier Automobiles and M/s. Standard Motors which ruled the motor car sector. Owing to low volumes, it perpetuated obsolete technologies and was out of line with the world industry. In 1982, Maruti Udyog Ltd. (MUL) came up as a government initiative in collaboration with Suzuki of Japan to establish volume production of contemporary models. With launching of the economic reforms in 1991 and lifting of licensing in auto-sector in 1993, 17 new ventures have come up of which 16 are for manufacture of cars, while the 17th is by Volvo for investment in heavy vehicles.
The automobile industry has emerged as an important driver of the economy. Although the automobile industry in India is nearly six decades old, until 1982, it had only three manufacturers.
The industry encompasses commercial vehicles, multi-utility vehicles, passenger cars, two wheelers, three wheelers, tractors and auto components. There are in place 15 manufacturers of cars and multi utility vehicles, 9 of commercial vehicles, 14 of two/three wheelers and 10 of tractors besides 5 of engines. India manufactures about 38,00,000 twowheelers, 5,70,000 passenger cars, 1,25,000 multi utility vehicles, 1,70,000 commercial vehicles and 2,60,000 tractors annually. India ranks second in the production of two wheelers and fifth in commercial vehicles in the world. With an investment of $10000mn, the turnover was $11900mn in automotive sector during 1999-2000. It employs 4,50,000 people directly and 1,00,00,000 people indirectly and is now inhabited by global players. Indias automotive component industry manufactures the entire range of parts required by the domestic automobile industry and currently employs about 2,50,000 persons. Auto component manufacturers supply to two kinds of buyers original equipment manufacturers (OEM) and the replacement market.
The replacement market is characterised by the presence of several smallscale suppliers who score over the organised players in terms of excise duty exemptions and lower overheads. The demand from the OEM market, on the other hand, is dependent on the demand for new vehicles. Automotive components manufactured in India are of top quality and are used as original components for vehicles made by such top international companies as General Motors, Mercedes, IVECO and Daewoo among others.
The Indian automobile industry is still too small to influence the world market. Currently, almost half of the global car production comes from three countries: the US (20 percent), Japan (19 percent), and Germany (12 percent).
The Indian automobile industry is still too small to influence the world market. Currently, almost half of the global car production comes from three countries: the US (20 percent), Japan (19 percent), and Germany (12 percent)41. Countries such as France, Spain, Canada, South Korea, Italy and the UK contribute another quarter. India and China contribute 1 per cent each. All major car manufacturers target the US market vigorously. Until now, no Indian company has been able to set up its units there.
6.2.1 Stylised Facts of Auto industry

Since delicensing, automobile industry including auto component sectors has shown great advances. The contribution of the automotive industry to GDP has risen from 2.77 percent of GDP in 1992-93 to current (2002) value of 4 percent of the GDP. It contributes about 17 percent of the indirect tax revenue. The rapid growth in the automobile sector and the automobile ancillaries is shown in Table 20. The turnover of the automobile sectors has jumped nearly three times from US$3646mn in 1993-94 to US$10463.8mn in 1999-2000. The auto component industry has also achieved rapid growth. Not only that, exports have also increased sharply between the years, more so in the case of ancillary units. These sectors have been doing well as indicated by rising ratios of retained profits/total sources of funding. Both these sectors have attracted large FDI inflows, as a result of which capital employed in the automobile industry (auto component sectors) has risen from US$1554mn in 199394 to US$5384.4mn in 1999-00. Table 20: Automobile Industry- Selected Statistics (US$mn ) Automobile Sector Gross Sales Total Exports Capital Employed Retained Profits/Total Sources (percent ) External Sources/Total Sources (percent ) Automobile Ancillary Units Gross Sales Total Exports Capital Employed Retained Profits/Total Sources (percent ) External Sources/Total Sources (percent )
Source: CMIE Corporate Sector, 2001
1993-94 3646 242.8 1553.8 3.5 83.3 860.4 58 412 18.3 48.9
1995-96 6631 402 2400.4 16.2 73 1536.8 99 703 19.3 65.3
1997-98 7652.8 417.8 4605.2 19.6 64.4 1879.4 147.4 1024.4 25.6 40.4
1998-99 7769.6 433.2 5202.8 16.6 72.1 1917.2 166.6 1105 11.5 53.4
1999-00 10463.8 419.4 5384.4 56.9 -18.8 2390.8 169 1232 19.9 44.2
The entry of new firms in the automobile industry has led to reduction in the market concentration ratios of some of the segments of the industry as revealed by Herfindahl Index of Concentration (see Table 21)42 . The reduction is evident particularly in passenger cars and scooters' segments of the industry. It can also be seen from the table that market size has increased significantly in different segments of the industry. Surely this is the result of delicensing of the sector. Table 21: Index of Concentration, Market Size and Domestic Consumption of Various Segments of Auto industry Various Segments 1994-95 0.570 836.8 0.382 549.6 0.475 1142.6 0.247 338.2 0.401 343.6 0.291 180 1995-96 0.584 1136.2 0.424 769.4 0.502 1718 0.241 432.4 0.392 466.2 0.262 220 1996-97 1997-98 0.574 1407.2 0.57 717.8 0.458 2187.6 0.220 536 0.376 521.6 0.227 250 0.538 927 0.51 547.2 0.513 2182.4 0.257 655.8 0.336 500.4 0.215 260 1998-99 0.515 889.8 0.512 500 0.491 2111.6 0.261 802.2 0.322 600 0.243 280 1999-00 0.521 1219.2 0.422 558.2 0.310 3290.2 0.283 1018 0.303 588.8 0.262 310
Medium and Heavy Commercial Vehicles Herfindahl Index of Concentration Market Size (Value ) US$mn Light Commercial Vehicles Herfindahl Index of Concentration Market Size (Value) US$mn Passenger Cars Herfindahl Index of Concentration Market Size (Value) US$mn Motorcycles Herfindahl Index of Concentration Market Size (Value) US$mn Scooters Herfindahl Index of Concentration Market Size (Value) US$mn Bicycles Herfindahl Index of Concentration Market Size (Value) US$mn
Source: CMIE, Corporate Sector, May 2002
6.2.2 Policy Framework Before the removal of quantitative restrictions (QRs) with effect from 1st April 2001, the policy placed import of capital goods and automotive components under open general licence, but restricted import of cars and automotive vehicles in Completely Built Unit (CBU) form or in Completely Knocked Down (CKD) or in Semi Knocked Down (SKD) condition. Car manufacturing units were issued licences to import components in CKD or SKD form only on executing a Memorandum of Understanding (MOU) with the Director General of Foreign Trade (DGFT). The MOU laid down the following conditions for the signing companies: 1. Establish actual production of cars and not merely assemble vehicles; 2. Minimum foreign equity of US$50mn is a must for joint venture involving majority foreign equity ownership; 3. Indigenise components upto a minimum of 50 percent in the third and 70 percent in the fifth year or earlier from the date of clearance of the first lot of imports. This condition is, however, no longer in place as a result of a ruling by the WTO. 4. Neutralise foreign exchange outgo on imports (CIF) by export of cars, auto components etc. (FOB). This obligation was to commence from the third year of start of production and to be fulfilled during the functioning of the MOU. From the fourth year imports were to be regulated in relation to the exports made in the previous year.
Prior to 2000, automatic approval in the automobile sector was granted only for FDI with a maximum equity participation of 51 percent . Since early 2000, 100 percent FDI was allowed only on a case to case basis. Under the new auto policy announced in March 2002, the government has permitted 100 percent FDI in the automobile and component sectors under the automatic route.
The lack of investment norms may open the door for small Chinese firms to set up shops in India and virtually trade their products rather than resort to local manufacturing.
The new automobile policy does not prescribe any minimum investment norms. As part of the policy, the government has promised to give adequate accommodation to indigenous industry in respect of items such as buses, trucks, tractors, completely built units and auto components, which have bound rates under the World Trade Organisation guidelines. In respect of items such as cars, utility vehicles, motorcycles, mopeds, scooters and auto rickshaws (which do not have a bound rate), the new policy proposes to design import tariff so as to give maximum fillip to manufacturing in the country without extending undue protection to the domestic industry. The policy intends to further improve research and development by vehicle manufacturers by considering a rebate on the applicable excise duty for every one per cent of the gross turnover of the company spent on research activities. The lack of investment norms may open the door for small Chinese firms to set up shops in India and virtually trade their products rather than resort to local manufacturing. Almost all countries including China now allow 100 percent FDI. The new policy only gives minor tax benefits on R&D investment. No other incentive is offered for improved technology such as fuel saving, non-pollution of the environment etc, which is imperative for meeting targeted objectives on which the new auto policy has discussed extensively. Most important, the new policy has ignored the current global auto-manufacturing trend of close co-operation between assemblers and component-makers; this is crucial for the survival of major global players. Global car factories are reeling under excessive over-capacity, ranging from 25 percent in North America to 30 percent in Europe. Shutdown of major car factories has become common. The entire industry is disintegrating and vehicle assemblers are increasingly out-sourcing. The auto-policy should have set the tone for an effective assembler-componentmaker equation to take over the global competition. In sum, the new policy depicts a domestic-oriented industry, relying more on home demand, regardless of the fact that India can be a good workshop for its neighbours. The Indian auto market is growing fast and is well supported by the economic reforms that have been put in place, particularly in the financial sector, and FDI participation. However, the industry needs to be exposed to foreign competition under realistic bound rates. The domestic market needs to be enlarged through fiscal changes and particular attention needs to be paid to the development of the components sector. 6.3 The Power Sector
The new policy depicts a domesticoriented industry, relying more on home demand, regardless of the fact that India can be a good workshop for its neighbours. The Indian auto market is growing fast and is well supported by the economic reforms that have been put in place in the financial sector, and FDI participation.
However, as per the 1991 census, only 42 percent of the Indian households had electricity facility, with about 71 percent in the rural and 24 percent in the urban households remaining unelectrified.
The Indian power sector grew from a mere 1700 MW of installed capacity in 1950 to 1,00,136 MW in 2000. However, as per the 1991 census, only 42 percent Indian households were electrified, with about 71 percent rural and 24 percent urban households remaining unelectrified. In the context of persistent shortages in the supply of electricity, and the inability of the government sector to mobilise funds for establishing the
necessary electricity generating capacity, the Central Government announced a series of policy measures to allow the participation of private power companies (domestic and foreign) in the power sector since launching of the economic reforms in 1991. The new policy on power comprises initiatives with respect to legislative, administrative and financial aspects. The salient features of the policy, announced in October 1991, (including amendments and additions) are: Legal Private Indian and foreign promoters were allowed to set up power plants of any size and based on any source, including hydroelectric plants. Accordingly, the Electricity (Supply) Act and the Indian Electricity Act were amended. Administrative 1. For projects awarded through competitive bidding, the limit on capital outlay for mandatory concurrence of the Central Electricity Authority (CEA) was raised to US$86mn (with effect from December 1995). 2. A two-stage clearance procedure was adopted for granting the CEA clearance. The first-stage is granted on the basis of the pre-feasibility report of the project. The 2nd-stage techno-economic clearance (TEC) is on the basis of the detailed project report. 3. The number of clearances required for obtaining TEC for thermal power projects was reduced to 5 from 17. 4. Renovation and modernisation schemes involving outlay of less than US$107.5mn are exempted from CEA clearance. 5. Co-generation plants were exempted from obtaining TEC from CEA.
The new policy on power comprises initiatives with respect to legislative, administrative and financial aspects.
Financial 1. Up to 100 percent foreign equity participation was allowed and the requirement to balance dividends by export earnings was waived. 2. A debt-equity ratio of 4:1 was allowed. 3. Promoters contribution required to be at least 11 percent of the total outlay. 4. Minimum 60 percent of the project outlay required to be arranged from sources other than Indian Public Financial institutions. 5. Average rate of depreciation under the Electricity Supply Act was raised to 7.84 percent . 6. Five-year income tax holiday was extended to power generation companies. 7. Customs duty on power plant equipment was progressively reduced. 8. FDI proposals involving up to 74 percent equity would be accorded approval by the RBI, without having to go through the FIPB. 9. Relaxation in foreign debt equity norm to be 3:1. In order to determine the tariff for the purchase of power, a notification which laid down the guidelines for a two-part tariff, was issued. The main features of the notification were: l The tariff would constitute two parts - a fixed part comprising return on equity (RoE), interest on loan capital, depreciation, operations and a variable part comprising fuel costs. l A maximum of 16 percent RoE (with protection against fluctuations in exchange rate) was allowed to be included in the tariff. l Fixed costs could be recovered at a Plant Load Factor (PLF) of 68.5 percent (revised subsequently to 70 percent ) in case of thermal plants and at an availability factor of 90 percent in case of hydro power. l As an incentive, a maximum of 0.7 percent additional RoE could be given for every 1 percent increase in PLF or availability.
Subsequently, with a view to promote more investment in the power sector, the government has decided to permit 100 percent foreign equity for automatic approval of companies undertaking power projects including electricity generation, transmission, and distribution provided that foreign equity in any such project does not exceed US$300mn and the electrical energy is not produced in atomic reactor power plants. The new policy also permits 100 percent foreign owned companies to set up power projects and repatriate profits without any export obligations.
The new policy also permits 100 percent foreign owned companies to set up power projects and repatriate profits without any export obligations.
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Since private power companies have to sell their power to the financially weak state electricity boards (SEBs), there are concerns about whether the foreign investors would get their money back. To allay their fears, the government provides guarantees to foreign investors in projects found viable. Various attempts have also been made by the World Bank and independent researchers to improve the financial health of SEBs. Such attempts to attract private investors have resulted in little success. Despite great interest shown by private investors, the progress in terms of capacity building has been miniscule. Thus, the Independent Power Producer (IPP) Policy is broadly viewed as a flawed and half-hearted approach to reforms. For easy reference, the chronology of electricity sector reforms in India over the 1990s is shown in Box B. Box B: Chronology of Electricity Sector Reforms in India
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1991: Electricity Laws (Amendment) Act allows private sector participation in power generation, with 11 percent ownership for foreign investors. 1992-97: Eight projects were given fast-track approval status and sovereign guarantees by the central government. 1995: Orissa Electricity Reform Act established the Orissa Electricity Regulatory Commission and provided for unbundling of Orissa State Electricity Board. 1996: World Bank approved support for Orissa Power Sector Restructuring Project Loan. 1996: Chief Ministers conference formulated a common minimum action plan for electricity. 1997: World Bank approved Haryana Power Sector Restructuring Project Loan, and Haryana State Government passed the Haryana Electricity Reform Act. 1998: Electricity Regulatory Commission's Ordinance Notification provides for establishment of a Central Electricity Regulatory Commission and state-level electricity regulatory commissions. 1999-2001: Andhra Pradesh, Karnataka and Uttar Pradesh proceed with preparation of Electricity Reform Acts. The World Bank has prepared and approved projects supporting reform in each of these states. 2001: Energy Conservation Bill passed by Parliament. 2000-2002: Draft of Central Government Electricity Bill prepared and introduced in Parliament.
Source: Power Politics Edited by Navroz.K.Dubash (2002).
Since the primary reason for the poor health of SEBs stems from supplying power to the agriculture sector at highly subsidised rates, the central government, in 1991, made an attempt to solve the problem of subsidised electricity supply to farmers. A committee recommended the establishment of a common minimum agricultural tariff, and a subsequent Chief Ministers conference proposed that agricultural tariffs should meet the modest target of 50 percent of average cost of supply. However, in the face of mobilised farmer vote banks, state governments took little action.
In the mid-90s, the World Bank played a major role in arguing for fundamental reforms of SEBs, and in persuading a few states, led by Orissa, to initiate reforms.
In the mid-90s, the World Bank played a major role in arguing for fundamental reforms of SEBs, and in persuading a few states, led by Orissa, to initiate reforms (see Box C). Of course, the Banks policy of not financing or providing guarantees for electricity projects in states that did not undertake restructuring was the very element in persuading many of the states to reform their SEBs. By 1998, Orissa had managed to demonstrate that it could privatise its distribution business. However, the results have not been positive. Since privatisation, the new owners have brought neither new funds nor discernible management skills to the newly established companies. Revenues from privatisation were not ploughed back into the sector, but absorbed into the government budget for other purposes. The public has faced substantial tariff increases but has seen few benefits in service, which has led to growing political discontent with the reform process and a call to bring back the publicly owned system.
By 1998, Orissa had managed to demonstrate that it could privatise its distribution business. However, the results have not been positive.
Despite these problems, the fact that Orissa has embarked on and been through several stages of reform process, including privatisation provided a powerful demonstration effect within India. Many states have followed the basic parameters of the Orissa model, in many cases guided by the same consultants, but with significant differences. States like Gujarat, Madhya Pradesh and Tamil Nadu have decided to focus on commercialisation of their SEBs rather than going down the road towards privatisation. Box C: The World Bank Led Orissa Model The World Banks Orissa Power Sector Restructuring Project required US$997.2mn, and was partially funded by the then Overseas Development Agency, now DFID, of the United Kingdom. Almost threefourths (74 percent) of the financing went to rehabilitation of distribution and transmission and 23 percent was allotted to demand side management and the rest to support reform process. Content of Reforms: Unbundling generation, transmission and distribution. Allowing for private participation in generation and distribution utilities. Establishing an autonomous regulatory agency. Reforming tariffs at the bulk electricity, transmission and retail levels.
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The Orissa Electricity Reform Act, 1995 provided for the establishment of an independent regulatory commission and the divestment of equity in generation and distribution to the private sector. Attracting investors for privatisation in Orissa proved to be a difficult task. Privatisation was carried out, but there was limited interest and few bids.
Source: Power Politics Edited by Navroz.K.Dubash (2002).
The Central Government has introduced a new Act, the Electricity Bill, 2000 that replaces the Indian Electricity Act, 1910, Indian Electricity (Supply) Act, 1948 and the Electricity Regulatory Commissions Act, 1998. A very significant provision in the Bill is that all the existing State Electricity Boards (SEBs) will wither away within six months of the new Act coming into effect.
Recently, the Central Government has introduced a new Act, the Electricity Bill, 2000 that replaces the Indian Electricity Act, 1910, Indian Electricity (Supply) Act, 1948 and the Electricity Regulatory Commissions Act, 1998. A very significant provision in the Bill is that all the existing State Electricity Boards (SEBs) will wither away within six months of the new Act coming into effect. The Bill envisages time-bound radical restructuring in terms of unbundling and corporatisation. All the states have to establish State Regulatory Commissions, authorised to supervise, direct and control all the activities in the electricity supply industry (ESI). This implies that government interference in the day to day affairs of the sector will be minimised, though the government will still be allowed to wield significant powers. The Bill also seeks to establish spot market for electricity through pooling arrangements. A major criticism levelled against the Bill is that there is not much emphasis on rural electrification. The Bill as such has caused much protest and many states and SEB employees suspect the central move as an attempt to usurp the states authority on the ESI, and impose restructuring where the state is unwilling. Between 1991 and 2001, only about 4000 MW of capacity has been added by the private power projects. Out of these, there was only one mega project (Dabhol, developed by Enron, USA) involving foreign investment, which led to an addition of 740 MW of capacity (see Box D). The project soon started generating severe financial problems for Maharashtra. Maharashtra State Electricity Board (MSEB), which had been profitable in 1998-1999, plunged into losses exceeding US$300mn (excluding subsidies received from the state government) in 1999-2000. Box D: The Enron Affair The fast-track Dabhol power project, promoted by the US utility giant Enron had soon turned into a bitter pill for all the players concerned. The root of the problem was that not only Enron succeeded in obtaining guarantees and counter-guarantees from the government, but also managed to sign a purchasing power agreement (PPA) with the Maharashtra State Electricity Board that committed the MSEB to pay for 86 per cent of Dabhols capacity, irrespective of how much power it would actually pick up. In other words, the rate of electricity, to some extent, was inversely proportional to the amount of electricity purchased. The MSEB would end up paying more even if it would buy less. In October 1992, the Congress-led Government of Maharashtra announced that it had signed a memorandum of understanding with the DPC, the Indian subsidiary of the US based Enron Corporation, for a liquefied natural gas plant of 2000 to 2400 megawatt capacity, and to purchase electricity for 20 years. In what later became a source of controversy, the deal was completed with alacrity and secrecy, despite the considerable size and financial obligations of the project, amounting to an expenditure of roughly US$1.3bn per year. Despite strong reservations expressed by some state and central government bureaucrats and by the World Bank, the project was cleared.
The Enron saga has definitely affected further FDI flows in the power sector. The domestic private power companies would also think twice before investing their capital in it.
In December 2000, the Maharashtra government sought a review of the project, saying that the tariff was too high. It then wanted the centre to bear the burden of buying Dabhol power and route it through the National Power Grid. Enron, in turn, invoked the Centres counter-guarantee when the MSEB defaulted on its November and December payments. Subsequently, the Dabhol Power Company (DPC) issued a preliminary termination notice, initiating the process to invalidate the power purchase agreement. The government, in turn, had also backed out of the agreement. The Enron saga has definitely adversely affected further FDI flows in the power sector. The domestic private power companies would also think twice before investing their capital in it. Whether the Enron case would affect FDI flows in other infrastructure sectors or not, only time would tell. Electricity sector policy in India has been locked into adverse arrangement at least twice in its history. The first was when agriculture consumption was demetered and extensive subsidies were offered. The second was when the SEBs signed IPP contracts with major fiscal implications. A third set of circumstances, with the potential for equally powerful forms of institutional rigidities, seems to be coming up with the reproduction of the Orissa model on a national scale. These circumstances may yield favourable institutions, like democratic and transparent regulation, but may also result in unfavourable ones, such as locking out integrated resource planning or scaling back programmes to expand services to rural areas. Issues for Comments
l
Do the liberal government policies and various promotional roles by the Ministry of Information Technology help to benefit the IT sector most from FDI flows in India? How far the new automobile policy will be able to boost the domestic car manufacturing industry, against the backdrop of global recession in the industry? Will the absence of close co-operation between assemblers and component-makers in the new automobile policy cost dear for the domestic automotive industry? What are the impediments of getting desired flow of FDI in the power sector for meeting the rising demand for power within the country? Did the precarious financial condition of the SEBs discourage flow of FDI to the power sector? Did the World Bank policy of initiating reforms to the SEBs mitigate the problem or aggravate it? Is the provision of replacing the SEBs with State Regulatory Commissions under the new Electricity Bill 2000 a right step towards the power sector reform? Will the new power sector reforms have any adverse impact on the expansion of electricity services to rural areas?
Conclusion
With the initiation of the economic reform process in 1991, India also started to open up her economy and now India has stepped into a liberalised foreign investment regime. This is definitely a positive development. Rising and continuous inflows of FDI could promise a variety of potential benefits to India. Apart from providing a relatively stable and growing source of finance, FDI inflows could impart positive impact in India though various channels like: (a) FDI inflows can raise domestic investment rates in India if its mode of entry is greenfield investment; (b) FDI can promote technology spillovers; (c) Export-oriented FDI can play an important role in the process of exportled industrialisation in India; and (d) FDI can enhance the marginal productivity of the capital stock in the Indian economy and thereby promote growth. Though the Government of India has been trying hard these days to attract FDI, FDI inflows into India (as a share of GDP) have been much more modest than many other developing countries. Indias glaring failure obviously warrants introspection. In this context, this report has attempted to study the investment regime and actual performance of India with a view to build capacity and awareness in investment issues and draw out the lacuna of the present system. The study is based on the existing literature along with the feedback obtained from the surveys of stakeholders, namely civil society groups and local firms.
India now has in place a liberal policy regime towards FDI. Though it has done well in attracting FDI flows of late, given her size, India attracts only small amounts of FDI flows.
India has started to open up her economy and has stepped into a liberalised foreign investment regime. However, FDI flows into India have been much more modest than many other developing countries.
The biggest stumbling block is Indias bloated bureaucracy. The initial enthusiasm to invest peters out by the time companies actually go through the process. Environmental clearances and legal work are still timeconsuming.
The following points have emerged from this report: l India now has in place a liberal policy regime towards FDI. Though it has done well in attracting FDI flows of late, given her size, India attracts only small amounts of FDI flows. This is the general opinion of all the stake holders. l Most of the FDI flows have gone to the IT industry, automobile, chemicals and power sectors. l The government is working on ways to double FDI to over $8bn in a year. The Steering Committee on FDI has proposed a number of measures to attract more FDI. These include opening up of new sectors for FDI, reforming sectors like power to bring in functional market structures and easing procedural hurdles. The idea is to identify sectors with vast potential to woo FDI and fix specific targets. l The Steering Group has advocated that a Foreign Investment Promotion Law (FIPL) be enacted to incorporate and integrate aspects relevant to promotion of FDI. It has also suggested that the informational aspects of the policy strategy should be refined in the light of the perceived advantages and disadvantages of India as an investment destination. l The biggest stumbling block is Indias bloated bureaucracy. Approximately, only 20 percent of FDI approvals translate into actual investment. This implies that the initial enthusiasm to invest peters out by the time companies actually go through the process. According to investors feedback, environmental clearances and legal work are still time-consuming.
The present Indian federal structure where many of the clearance authorities are the state governments, adds to procedural delays. Moreover, there is political uncertainty at the central and the state levels.
The policy framework needs to be re-oriented in terms of transparency, along with simplification of bureaucratic procedures to attract more FDI. The respondents from local and foreign firms support these views and are of the opinion that improved infrastructural facilities are essential if India has to attract FDI in a big way.
To some extent, the present Indian federal structure where many of the clearance authorities are the state governments, adds to procedural delays. Moreover, there is political uncertainty at the central and the state levels. Unlike the past, civil society is now more open towards FDI. According to the perception of the civil society group, FDI brings in valuable new technologies as well as management techniques, improves the access to world markets, and increases the competitiveness of the economy. It is expected that the local firms would gain from the spill-over effect with the entry of MNEs. Indeed our surveys of local firms have revealed that they are now more conscious to adopt new management techniques, new technologies and improve qualities. The majority of respondents from the civil society group agree that bureaucracy and regulatory environment are the two most important factors inhibiting FDI flows to India. Most agree that regulatory environment is not transparent, leading to bureaucratic hassles and corruption. Understandably, the policy framework needs to be reoriented in terms of transparency, along with simplification of bureaucratic procedures to attract more FDI. By and large, the respondents from local and foreign firms in our case studies support these views. All the stake-holders are of the opinion that improved infrastructural facilities are essential if India has to attract FDI in a big way. Currently, the local firms are also positively disposed towards FDI. They also want the government to take a very pro-active stand to maximise the benefits from FDI. Given the present circumstances, the present environment is not very conducive towards FDI flows in the power or infrastructure sectors in general. There is an urgent need to get an action plan to give an impetus to FDI. In this regard, the state governments should be encouraged to enact a special investment law to expedite all investment in infrastructural sectors. As per the recommendation of Steering Group on FDI, the Special Economic Zones (SEZs) should be developed as the most competitive destinations for export related FDI in the world, by simplifying applicable laws, rules and administrative procedures and reducing red tape levels. Domestic policy reforms in the power sector, urban infrastructure and real estate and de-control/de-licensing should be expedited to promote private, domestic and foreign investment.
Annexure
It is expected that entry of foreign firms would benefit the local firms (through technological spillovers) in terms of better management techniques and better quality. Has it really happened in the Indian context? To answer this question, we conducted a small survey (30 respondents) of local firms in the IT and automobile sectors to solicit information on some of these aspects. The findings are shown in Table A1. As table A1 shows, by and large, the local firms have attempted to learn from the MNEs operations. The learning process has been applied to manage time effectively to increase productivity, to adopt new technology and global quality standard. Table A1: Impact on Local Firms Due to MNEs Entry (Percentage of Respondents) Impact on the firm Positive because of MNC presence Available technologies Know-how including shop floor practices Product quality/precision Management techniques 52 60 56 49 Negative 10 12 8 17 No Impact 38 28 36 34 Total 100 100 100 100
Endnotes
1 2 3 4 5 6 UNCTAD IX, 1996, A Partnership for Growth and Development, paragraph 36. UNCTAD, 1999, Foreign Direct Investment and Development, UNCTAD Series on issues in international investment agreements. The Economic Times, July 1, 2003. This includes approved amounts towards GDR/FCCB(Global Depository Receipt/Foreign Currency Convertible Bonds) issues for which Foreign Investment Promotion Board (FIPB) approval was required There was a substantial decline in net aid flows during 1991-98. Net NRI deposits also declined, but to a much lesser extent. The 36-country trade weighted REER is the trade weighted average of real exchange rates of the Indian Rupee vis--vis currencies of the 36 most-important trading partners of the country. The real exchange rates between Indian Rupee and the various currencies are calculated on the basis of nominal exchange rates and the inflation differential (the Indian inflation rate used being that based on the WPI). An increase in the REER suggests a real appreciation. Current Account deficit is equal to the domestic savings-investment gap and signifies the net transfer of foreign financial resources into the economy. See Bhaduri and Nayyar, 1996, pp 48 - 53. However, it is not clear whether, external compulsions through World Bank - IMF conditionalities, would have forced the government to go the whole hog, as it actually did, in embracing the new policy package, though a tactical acceptance of the conditionalities was almost a sine-qua-non (see Bhaduri and Nayyar, 1996, pp 4853). See Chaudhuri, 1998 for a review of major debates and Bhaduri and Nayyar, 1996, p 49. India also has to change its domestic IPR regulations by 2005 to comply with the agreement on TRIPs. The changes will be relevant, mostly, for the pharmaceutical industry as the Indian Patent Act recognised process patents, which is not permissible under TRIPS. The amendment to Indian Patent Act has, however, not been made yet. GDR issues to finance projects in power generation, telecommunications, petroleum exploration and refining, ports, airports and hotels were exempt from consistent track record criterion. Some of the GDR issues require FIPB approval and these are categorised as FDI inflows by the Ministry of Industry. Total GDR inflows are, however, recorded as portfolio flows by RBI. ECB issues are subject to maturity restrictions; a minimum maturity of 3 years for ECBs less than US$ 15 million and 7 years for amounts greater than that. ECBs by 100% EOUs can have a maturity of three years even for amounts greater than US$15mn. It also has end-use restrictions. ECB proceeds cannot be invested in stock market and real estate. ECB proceeds can be utilised only for project-related foreign exchange expenses (capital goods imports). Rupee expenses are allowed only for infrastructure projects. This limit was US$4mn earlier, which was raised in December 1998. Before 2000-2001, upto 50% of funds raised through GDR could be used for overseas investments. Except if the investment is financed from an EEFC account balance or the proceeds from GDR issue. See RBI Annual Report, 1999-2000 and RBI Press Notification, no. 2000-2001/1225, dated March 2, 2001. Currency swaps basically involve an exchange of one set of financial obligations denominated in one currency, with another set denominated in another currency. When an agent has a currency mismatch between its assets and liabilities that is not hedged through forward cover, and the agent remains susceptible to exchange rate fluctuations, he/she is said to have an open position. Depending on a banks expectation about movement of the domestic currency and existing interest rate differential between domestic and foreign money markets, it can, within limits, transfer funds into or out of the country, forging a link between foreign exchange and money market. See RBI Annual Report, various issues. Hence, in companies where NRIs held part of the equity, the effective limit for FII investment got decreased. This limit was raised to 40 percent in 1999-2000 and 49 percent in 2000-2001 (RBI Press Notification, no. 20002001/1225, dated March 2). Investments in shares held for over one-year are classified as long-term investments for tax purposes, while for other securities the period is 36 months. See Manual on Industrial Policy and Procedures, Secretariat of Industrial Assistance, Ministry of Industry, Government of India, 2001, available at www.nic.in/indmin. Annexure to the Manual on Industrial Policy and Procedures in India, Secretariat of Industrial Assistance, Government of India, August 2001, available at Ministry of Industry website at www.nic.in/indmin. Operators of airlines were also barred from making any direct investment in the aviation sector till the recent policy change in 2000.
7 8 9
10 11
12 13 14
15 16 17 18 19 20 21
22 23 24 25 26 27
28 29 30 31
32
33 34 35 36 37 38 39
40 41 42
In the case of ventures where prior foreign equity participation existed, the condition applies to dividend on incremental foreign equity investments only. Information from Manual on Industrial Policy and Procedures, available at SIA website, http://indmin.nic.in. See Annexure VI to Manual on Industrial Policy and Procedures in India. Automatic approval for FDI up to 51 percent in hotel and tourism industry, for instance, is subject to a limit of three percent on share of capital cost payable for technical and consultancy services, three percent on the share of turnover payable as franchising/marketing fee and ten percent on the share of gross operating profit payable as management fee to foreign collaborator. Foreign Investment Implementation Authority has been set up around late 1990s to liase with other government agencies whose statutory clearances are essential before project implementation can begin and to look into any problems being faced by investors. This section draws from Mr N K Singhs report. See Report of the Steering Group on FDI, 2002. This is another sector that has attracted large amounts of FDI in many countries including China. In Chart 1, engineering goods sector also includes electronics. See Business Line, 24.7.2001. See Raipuria (2002), pp.1062. The marginal share of IT in GDP in India is not surprising. Even in the US, with a very high IT spending and penetration, the share of the IT economy in GDP according to US Commerce Department (2000), was 8.1 percent. See Kumar, Nagesh 2002, for details. Kanhaiya Singh, Automotive industry: Perspectives and Strategies. The Herfindahl Index of Concentration is a summary of statistics denoting the level of concentration of the market share in the hands of a few companies. The index takes value between 0 and 1, where 0 indicates no concentration at all and 1 indicates monopoly. It is computed as follows: H = S12 + S22 + S32 + + Sn2, where Si is the market share of the ith company, and there are n companies in the industry.
Bibliography
Bhaduri, Amit and Nayyar, Deepak, The Intelligent Persons Guide to Liberalization, Penguin Books, New Delhi, 1996. Bhattacharya.B and Palaha, Satinder, Policy Impediments to Trade and FDI in India, Indian Institute of Foreign Trade, 1996. Business Line, 2001, July 24. Business Standard, 2003, July 1. Byung-Hwa Lee, FDI from Developing Countries: A Vector for Trade and Development, Organisation for Economic Co-operation and Development, 2002. Chaudhuri. S, Debates on Industrialization, in T.J.Byres (Ed.), The Indian Economy: Major Debates Since Independence, Oxford University Press, 1979. Chaudhuri. S, FERA: Appearance and Reality, in Economic and Political Weekly, April 1979. Chopra, Chanchal, Foreign Investment in India: Liberalisation and WTO-The Emerging Scenario, Deep & Deep Publication Pvt. Ltd., New Delhi, 2003. Dikshit, Pratima, Dynamics of Indian Export Trade, Deep & Deep Publication Pvt. Ltd., New Delhi, 2002. Dubash, Navroz.K. (Ed.), Power Politics: Equity and Environment in Electricity Reform, World Resources Institute, 2002. Kannan K.P. and Pillai, Vijayamohanan.N, Plight of the Power Sector in India: Inefficiency, Reforms and Political Economy, Centre for Development Studies, 2002. Kathuria, Vinish, Liberalisation, FDI and Productivity Spillovers - An Analysis of Indian Manufacturing Firms, Institute of Economic Growth, 2002. Kumar, Nagesh, Globalization and the Quality of Foreign Direct Investment, Oxford University Press, 2002. Kundra, Ashok, The Performance of Indias Export Zones: A Comparison with the Chinese Approach, Sage Publications, New Delhi, 2000. Nagaraj. R, Indian Economy since 1980: Virtuous Growth or Polarisation, in Economic and Political Weekly, pp 2831-2838, August 2000. Narula, Rajneesh (Ed.), Trade and Investment in a Globalising World, Series in International Business and Economics, Elsevier Science Ltd., 2001. Oberai.A.S and Chadha.G.K (Ed.), Job Creation in Urban Informal Sector in India: Issues and Policy Options, International Labour Organisation, 2001. Raipuria, Kalyan, What Size the New Economy? A Conduit Approach, Economic and Political Weekly, vol 37, pp 1062-1067, March 2002.
RBI Annual Report (various issues), Economic Survey, Ministry of Finance, Government of India. Report of the Steering Group on Foreign Direct Investment, Planning Commission, Government of India, New Delhi, August 2002.
Saha, Biswatosh, Foreign Investment, Financial Markets and Industry: India in the 1990s, Unpublished Doctoral Dissertation, mimeo. Indian Institute of Management, Calcutta, May 2001.
SIA Newsletter (various issues), Ministry of Industry, Government of India.

SEBI, Securities and Exchange Board of India (Foreign Institutional Investment), 1995, SEBI, Mumbai 1995 (Available at SEBI website at www.sebi.gov.in).
Statement on Industrial Policy 1991, Ministry of Industry, Government of India.

Saggi, Kamal, Trade, Foreign Direct Investment, and International Technology Transfer: A Survey, The World Bank Research Observer, vol 17, no. 2, pp 191-235, Fall 2002. Singh, Kanhaiya, Automotive Industry: Perspectives and Strategies, Margin, vol 35, January-March 2003. The Economic Times, 2003, July 1. The Financial Express, 2003, July 1. VANS: Database of business newspaper clippings maintained by Vans Information Services Limited. World Bank, 1999, World Development Indicators, CD Rom. 52 w Investment Policy in India Performance and Perceptions
ISBN 81-8257-007-7
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CUTS Centre for Competition, Investment & Economic Regulation Discussion Paper

Investment Policy in India Performance and Perceptions

Investment Policy in India Performance and Perceptions

CUTS Centre for Competition, Investment & Economic Regulation

Investment Policy in India

CUTS, 2003, Investment Policy in India Performance and Perceptions

Jaipur Printers P. Ltd., Jaipur 302 001

*Other country reports are also available with CUTS

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6 w Investment Policy in India Performance and Perceptions

8 w Investment Policy in India Performance and Perceptions

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Investment Policy in India Performance and Perceptions w 13

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Brief Overview of Macroeconomic Context

1.2. Rates of Interest and Inflation

1.2.1. Rates of Interest

16 w Investment Policy in India Performance and Perceptions

1.2.2. Rates of Inflation

Investment Policy in India Performance and Perceptions w 17

1.3.1. Approved and Actual Inflows of FDI

Investment Policy in India Performance and Perceptions w 19

Source: RBI Annual Reports, various issues

Source: Saha 2001.

Source: SIA Newsletter, October 2001, Ministry of Industry, Government of India

Investment Policy in India Performance and Perceptions w 21

883 1275 49 1103 4805 -952 -3074 4089 -1221 -1715

1.4.1. Foreign Exchange Rate

Nominal exchange rate r 2 Rs./US$ Annual % change in r (- implies depreciation) REER

31.44 -0.13 63.2 25.19 5.94

34.35 -9.2 61.92 21.70 -3.49

35.9 -4.5 65.87 26.42 4.72

39.5 -10.03 66.04 29.38 2.96

42.43 -7.42 68.33 32.49 3.11

43.62 46.64 -2.8 -6.9

59.15 63.55 9.8 19.25 0.6 9.45

63.30 66.46 38.04 42.28 5.55 4.24

Source: RBI Annual Reports, various issues

1.4.2. Savings and Investment Rates

Investment Policy in India Performance and Perceptions w 23

23.1 2.2 3.2

27.7 3.2 3.2

23.4 0.5 1.0

23.1 0.5 0.5

26.1 1.1 1.4

27.2 1.8 3.1

24.6 1.2 3.7

26.2 1.3 3.7

23.4 1.0 3.2

Issues for Comments

24 w Investment Policy in India Performance and Perceptions

Overview of Main Policy Trends

2.1.4. Financial Liberalisation

2.3.2. Other Capital Account Liberalisation Measures

2.3.3. Outward FDI: Automatic Approval

2.3.4. Outward FDI: Case-by-case Approvals

2.3.5. Trade Liberalisation

2.3.6. Liberalisation in the Banking Sector

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