Foreign Direct Investment (FDI)

Direct Investment represents acquisition of some

amount of permanent interest in the enterprise, implying a degree of control over the management of the company in which the investment is made.
Foreign Direct Investment involves the ownership &

control of a foreign company in a foreign country. In exchange for this ownership, the investing country usually transfers some of its financial, technical, managerial trademark & other resources to the foreign country.

FDI has been defined to include investment in :

Indian Companies which were subsidiaries of foreign companies. 2. Indian Cos in which 40% or more of the equity capital was held outside India in any one country. 3. Indian Cos in which 25% or more of the equity capital was held by a single investor abroad. From 1992 FDI was fixed at 10% ownership of ordinary share capital for a single investor in keeping with the IMF guidelines.
1.

Foreign Investment Policy

The Indian Govts attitude towards foreign direct

investment can be divided into 2 phases. 1. Is the period from Independence to the late 1980s where gradual liberation of attitude towards FDI. 2. Is the period from 1980s onwards where a liberal policy towards FDI was accepted, India became host to a large body of foreign capital. The foreign investment policy was revised in 1980 in order to encourage direct & portfolio investment by NRIs & OCB & investors on Oil Exporting Developing countries to invest their money in India.

The following FDI schemes were introduced :

1. 2. 3.

4.

5. 6.

40% equity on repatriation basis for investment in new issues of new or existing cos in manufacturing sectors. 100% equity participation in housing & real estate development with in a lock in period of 3 yrs & a ceiling of 16 % on remittable profit. Sick unit scheme in which NRIs & OCBs are allowed to make investment on repatriation basis up to 100% subject to certain conditions like lock in period of 5 yrs & the shares of the companies should be quoted below par for 2 yrs. 100% equity participation by NRIs on repatriation basis under the air taxi scheme. 40% participation on repatriation basis in private banks. 100% equity on repatriation basis in any company, proprietary or partnership concerns engaged in any industrial, commercial or trading activities.

 As a result of the policy changes in 1991 and active

promotion of India as a destination, the amount of FDI approved & received has increased sharply. The policy relating to foreign investments was radically changed in 1991 with the introduction of structural changes in the economy . A 3 tier systems for approvals for foreign investments was introduced : 1. Reserve Bank Of India (RBI). 2. Secretariat for Industrial Approvals. 3. Foreign Investment Promotion Board (FIPB).

 The existing cos in India with foreign participation wishing to

increase 51% will be granted automatic approvals provided that the expansion programme is in the high priority industries & the cost of import of capital goods is covered by foreign equity. The proposals of foreign investment within the general framework but outside the powers delegated to the RBI would be considered by Secretariat for Industrial Approvals. FIPB was specifically created to invite, negotiate & facilitate substantially large investment by international cos which would provide access to high technology & world markets. FII such as Mutual Funds, Pension Funds were permitted to invest in Indian Stock Markets.

In 1995, a working group was set up to examine the existing schemes & incentives available to NRIs for investments. The recommendations were as follows:
OCBs are allowed to sell, transfer shares, bonds, debentures of Indian cos reqd with repatriation benefits thru stock exchange. 2. Foreign investors are allowed to disinvest equity shares thru stock exchanges in India. 3. Permission is also granted to foreign investors for disinvestments of listed equity shares thru private placements subject to certain conditions. 4. Restrictions relating to the 5 yrs lock in period for issue of equity shares on preferential basis are removed.
1.

UNCTAD World Investment Report 2000-2001

The United Nations Conference on Trade & Development

was established in 1964 for the purpose of removing barriers in international trade & also to promote international business. The UN conference on Trade & development works very closely with & oversees all commodity agreements becoz of the impact of commodity prices on poverty & development. The World Investment Report (WIR) 2000-2001 was published by UNCTAD in 2002 which includes Indias Inward FDI Performance Index as follows :

Indias Inward FDI Performance Index Comparison

Country 1988-1990 1998-2000

India
Pakistan Sri Lanka Mongolia Chinese Taipei Brunei Indonesia

0.1
0.6 0.5 0.8 0.9 0 0.8

0.2
0.2 0.4 0.5 0.3 0.1 -0.6

Malaysia
Myanmar Philippines Singapore Thailand

4.4
1.9 1.7 13.8 2.6

1.2
0.6 0.6 2.2 1.3

Year 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-2000

FDI Inflow (In Million US$) 167 393 654 1374 2141 2770 3682 3083 2439

2000-01
2001-02 2002-03 2003-04 2004-05 2005-06 2006-07

2908
4212 3134 2634 3755 5546 15725

Foreign Direct Investment Inflows In India (US$Mn) - Country Wise

Country Mauritius 2000-01 843 2001-02 1863 2002-03 534 2003-04 381 2004-05 820 2006-07 3780

USA
Japan Germany South Korea Netherlan ds Others

320
156 113 24

364
143 74 3

268
66 103 15

297
67 69 22

469
122 143 14

706
80 116 68

76

68

94

197

196

559

378

473

578

429

556

2998

TOTAL

1910

2988

1658

1462

2320

8307

FDI Inflows (Industry wise) in US$Mn

Industry Electronics & Electrical Equipment Engineering Services Chemicals& allied Products Finance Computers TOTAL 1999-2000 172 2000-01 213 2001-02 659 2002-03 95 2003-04 103

326 116 120 20 99 1581

273 226 137 40 306 62 1910

231 1128 68 22 368 69 2988

262 209 53 54 297 44 1658

274 431 46 4 151 79 1462

Pharmaceuticals 54

FDI Inflows (State wise) in Rs Crores

State 2002-03 2003-04 2004-05

Delhi
Maharashtra Karnataka Andhra Pradesh Gujarat West Bengal Tamil Nadu Total

3062.2
2366.4 975.2 242.7 550.7 118.0 990.2 12870.7

2123.5
1355.3 926.5 353.5 917.1 84.5 603.8 10064.1

3717.5
3183.1 1131.3 747.9 610.5 427.4 358.5 14652.7

FDI Openness
FDI Openness measures FDI stock as a percentage of GDP,

it shows the amount of foreign participation in the economic activity of a country.

Country China
Hong Kong India Indonesia Malaysia Pakistan Singapore Thailand

FDI as a % to GDP 14.3

299.9 5.8 7.7 36.5 8.8 158.6 33.5

However Indias FDI openness has increased 10 fold from

0.5% in 1990 to 5.8 % in 2005-06

Investment Of Indian Cos in Foreign Countries

The Government has permitted Indian cos to invest in foreign

countries at 4 times of their net worth. The net worth includes equity capital and reserves and surplus. It is not necessary to take permission from RBI for making such investments.
Sr. No. 1. 2. 3. 4. 5. Sector Manufacturing Financial Services Non Financial Services Trading Others TOTAL Investments In US $ Mn. 2005-06 3407 160 895 378 205 5,045 2006-07 3544 28 7486 655 1479 13,192

The Cos. or firms are motivated to invest in foreign markets for various reasons :
Access to Factors of Production. 2. Access to Products. 3. Access to Customers. 4. Access to Markets.
1.

Growth of FDI
Year World Developed Countries Developing Countries

US $ Billion
1980 1985 1990 1995 2000 2005 2006 56 58 202 343 1411 946 1376 48 44 166 222 1146 530 657

%
86 76 82 65 81 56 48

US $ Billion
8 14 13 116 256 314 379

%
14 24 06 34 18 33 28

Growth of FDI
FDI inflows have increased from 56 billion dollars in

1980 to 1376 billion dollars in 2006. There was more inflow after 1995. The FDI inflows of developed countries were higher than the inflows of developing countries.

Is FDI preferable to FII?

1. FDI is defined as a long term investment by a foreign direct investor in an enterprise resident in an economy other than that in which the foreign direct investor is based. The FDI relationship, consists of a parent enterprise & a foreign affiliate must together form a Transnational Corporation. FII generally means portfolio investment by foreign institutions in a market which is not their home country. These institutions are generally Mutual Funds, Investment Cos., Pension Funds, Insurance Houses.

2. FDI flows in to the Primary market. They are long term investments. FII flows in to the secondary market. They are short term investments. 3. FDI have to follow a no. of rules and regulations to enter the market and are subject to heavy taxes. So FDIs cannot enter & exit that easily. FII can enter the stock market easily & also withdraw from it easily. 4. FDI only targets a specific enterprise. It aims to increase the enterprises capacity or productivity or change its management control. FII investment flows only into the secondary market, it helps to increase capital availability in general rather than enhancing the capital of a specific enterprise.

4. FDI not only brings in capital but also helps in good governance practices & better management skills & even technology transfer. FII helps in promoting good governance & improving accounting it does not come out with any other benefits of the FDI. 5. FDI is perceived to be more beneficial becoz it increases production, brings in more & better products & services besides increasing the employment opportunities & revenue for the government by way of taxes. FII, on the other hand, is perceived to be inferior to FDI becoz it only widens & deepens the stock exchanges & provides a better price discovery process for the scrips.

Conclusion : FII is a fair weather friends & can desert the nation , thereby pulling down not only our share prices but also wrecking havoc with the Indian Rupee because when FIIs sell in a big way & leave India they take back the dollars they had brought in. While both forms of capital involve financial flows, FDI is considered to be more stable than FII & most beneficial kind of foreign investment for the whole economy.

Changing Pattern of FDI

Approvals worth Rs 157356 crores of FDIs have been granted

for the period from August 1991 to June 1994. Out of these 80% of the FDIs are in the high priority industrial sectors like power, metallurgical industry fuels etc. FDI inflows give a boost to Indian economy. GOI has simplified the procedure for FDI approvals after 1991. The policy of privatization has also helped for attracting FDI inflows. There has been continuous increase in the no of FIIs registered with SEBI & in the volume of investments effected by them in India. Till Jan 1994, 134 FIIs were registered by SEBI.

 European countries have been major sources of FDI

inflows in India till 1990. They accounted for 69% of FDI in 1980 and 66% in 1990. However their importance has steadily declined in the post liberalization period. They accounted for 18% of FDI only b/w 1991-97. Mauritius & USA continue to be the largest sources of FDI for India. Japan, Italy & Netherlands were the other major contributors of FDI during 1999-2000.

 The engineering industry continues to attract the

largest volume of FDI inflows (US $326million). Electronics & electrical equipments inds. were the second largest recipient of FDI (US $ 172) Food & diary products & pharmaceutical industry has also been witnessing increase in FDI.

FDI & Trade Liberalizing Aspects

Regional integration leads to reductions in tariffs & other

barriers to trade between the member states & this liberalization has a no of effects on both trade & FDI. There is a dynamic effect on trade thru the creation of a large unrestricted domestic market which allows efficient domestic manufacturers to take advantage of economies of scale, which results in fall in average cost of production. The firms increase their investments in this larger markets or rationalize their production to lower cost locations within the block, this benefits in terms of efficiency & welfare. FDI should also be stimulated by the relaxation of ownership & entry requirements & other liberalizing measures to open markets to greater competition.

 Normally firms are motivated to invest overseas for a

variety of reasons which are as follows : 1. To again access to specific factors of production owned by a firm in the host country. 2. To gain access to cheaper factors of production such as low cost labour, materials etc. 3. To undertake mutual investment in one anothers country in order to gain access to each others product ranges. 4. To secure access to customers in the host country market.

Bilateral Investment Treaties (BIT)

BIT were originally concluded b/w developed & developing

countries with a view to promote investment b/w the treaty partners. The no. of treaties increased significantly in the 1990s. There are over 1500 treaties in existence at the end of 1997. BIT exert some influence on the policy framework of FDI, contributing to the improvement of an investment climate. They influence by strengthening the bilateral standards of protection & treatment of foreign investors & establishing mechanisms for dispute settlement. They help to reduce the risk of investing in countries a party to these treaties. BIT do not alter the economic determinants of FDI & they seldom provide for proactive promotion measures by government.

Regional Integration Frameworks.

The impact integration framework which range from free

trade areas to complete economic integration on FDI determinants depends on a variety of factors. It is the scope & depth of the integration envisaged by a regional integration framework (RIF) which determines the extent of policy harmonization & varies by type of economic integration. As a region becomes more integrated as the result of a RIF, the influence of RIF on FDI determinants can work thru more channels. The majority of RIFs do not explicitly address FDI policy although there is an increasing tendency for free trade agreements to include investment. The RIFs may also influence the speed of FDI & trade policy liberalization.

Protectionism
Some countries follow the protectionism policy. These countries use several barriers to protect industries

from competition from foreign firms. The barriers generally include tariff & non tariff strategies. India had also used the protectionism policy till 1991. However these countries have adopted a strategy of export promotion. Arguments for protection of domestic firms fall into 2 categories Political & Economic.

Political Arguments :
Political rationale for protectionism include national

security, retaliation, protecting jobs & human rights. Countries enforce barriers in the name of National Security. Thus, no foreign firm or Indian private sector enterprise can set up a production unit in defense related items. Retaliation means government puts threat to intervene in trade policy as a bargaining tool to help over foreign markets & force trading partners to provide true access. The retaliation argument carries the dimension that it makes no sense for one nation to allow true trade if the nations actively protest their own industries.

 Governments also intervene when imports threaten

jobs created by domestic business. For ex Japans quotas on rice imports are aimed at protecting jobs in that countrys agriculture sector. Protecting & prompting Human Rights in other countries is an important element of foreign trade policy in several democracies. For ex. Entry of China in to WTO was opposed becoz the country has poor record of Human Rights.

Economic Arguments
Economic Arguments for protectionism are Infant

Industry Arguments & Strategic Trade Policy. A countrys Infant Industry needs protection from foreign competition during early phases of their development & until they become internationally competitive. The argument is based on the assumption that infant industries need protection becoz of a steep learning curve. In other words as an industry grows, it gains the required capabilities to become more innovative, efficient & competitive. Till such time it needs to be insulated from foreign competition.

 The Strategic Trade Policy helps build global

conglomerates. According to the protectionism, countries shall dominate in the export of certain products simply becoz of first mover advantage enjoyed by some of their domestic industries. Such companies can capture foreign markets, earn goods profits & plough the money back to the country of origin.

Arguments Against Protectionism

Trade theory is useful becoz it helps explain what might be produced competitively in a given locality. 2. Mercantilist theory proposes that a country should try to achieve favorable BOT. 3. The theory of absolute advantage proposes specialization thru free trade because consumers will be better if they can buy foreign made products that are priced more cheaply than domestic ones. 4. According to theory of absolute advantage, a country may produce more goods more efficiently because of natural advantages.
1.

5. Comparative advantage theory also proposes

specialization thru free trade becoz it says that total global output can increase even if one country has an absolute advantage in the production of all products. 6. Much of the pattern of 2 way trading partners may be explained by cultural similarity b/w the countries, political & economic arguments & by the distance b/w them.

Impact of FDI on Distribution of Wealth

The investments made by a company in a foreign country

over a period of time is called as Flow of FDI. FDI has a powerful impact on distribution of wealth in a country/world. The flow of FDI had been increasing during 1975-1995. the reason for increase was the desire of many foreign cos to establish manufacturing facilities in foreign countries and the significant development of globalisation throughout the world.

 USA was a major source of FDI. During 1970s half of

the outflows of FDI was held by USA. The second position was occupied by UK. By the end of 1990, Japan occupied the first position followed by the USA. However Japans FDI declined from US $48 billion in 1990 to US$ 17.9 billion in 1994, due to recession in Japan Other major source of FDI are Germany, France & UK.

 Thus USA occupies the first place in terms of total FDIs &

Singapore occupies the first place in terms of FDI per capita during 1985-95. China occupies the 4th place in terms of total FDI & the 20th place in term of per capita FDI. India did not figure in the list of 20 leading countries of FDI.