25

CHAPTER II

CONCEPTS AND REVIEW OF LITERATURE

In any research work, certain concepts are repeatedly used.

The scholar must be familiar with the concepts related with the area

of her interest. Going through related literature gives an idea of the

basic concepts used in the study area. In this chapter an attempt is

made to review some of the studies already made in related area.

This chapter begins with definitions of important concepts used in this

study.

CONCEPTS

Some of the important concepts used in the present study are

defined here.

Foreign Capital Inflow Foreign capital inflow is defined as a movement of capital into

a country in the form of securities trading, the acquisition of

companies and loans by foreign companies.1

Foreign Investment

Foreign investment is the investment in the domestic economy

by foreign individuals or companies. Foreign investment takes the

26

form of either direct investment in productive enterprises or

investment in financial instruments, such as a portfolio of shares.2

Foreign Direct Investment (FDI) Foreign Direct Investment is defined as a form of long-term

international capital movement made for the purpose of productive

activity and accompanied by the intention of managerial control or

participation in the management of a foreign firm.3

Foreign Investment Promotion Board (FIPB)

The Government of India has set up a special Board known as

the Foreign Investment Promotion Board. This specially empowered

Board in the office of the Prime Minister, is the only agency dealing

with matters relating to foreign direct investment as well as promoting

investment into the country.4

Reserve Bank of India (RBI)

The Reserve Bank of India is the central banking system of

India and it acts as the bank of the national and state governments.

This institution was established on 1 April 1935 during the British-Raj

in accordance with the provisions of the Reserve Bank of India Act,

1934. It formulates, implements and monitors the Monetary Policy.5

27

Non – Resident Indian (NRI) Deposits Non-Resident Indian (NRI) deposits are a major source of

capital inflow into India. Indian nationals and persons of Indian origin,

residing abroad can open bank accounts in India freely out of funds

remitted from abroad or foreign exchange brought in India or out of

funds legitimately due to them in India.6

Equity Capital Equity capital covers equity in branches, shares in subsidiaries

and associates and other capital contributions that constitute a part of

the capital of direct investment enterprise. Equity capital also covers

the acquisition by a direct investment enterprise of shares in its direct

investor.7

Reinvested Earnings Reinvested earnings comprise the direct investor’s share (in

proportion to direct equity participation) of earnings not distributed as

dividends by affiliates or earnings not remitted to the direct investors.

Reinvested earnings are considered to be additional capital of the

direct investment enterprises.8

Other Capital Other capital covers the borrowing and lending of funds,

including debt securities and trade credits, between direct investors

28

and direct investment enterprises, and between two direct investment

enterprises resident in different countries that share the same direct

investment.9

Limited Liability Partnerships (LLPs)

Limited Liability Partnerships is a business set up that

combines the benefits of limited liability while retaining the flexibility in

operations of a partnership firm.10

Repatriation

Repatriation means return of financial assets deposited in a

foreign bank or foreign branch of a domestic bank to a home country.

Repatriation of assets denominated in a foreign currency may be

impeded by exchange controls limiting the ability of residents of

another country to transfer assets.11

Foreign Portfolio Investment Foreign portfolio investments are purely financial assets, such

as bonds, denominated in national currency. With bonds, the investor

simply lends capital to get fixed payouts or a return at regular

intervals and then receives the face value of the bond at a pre-

specified date.12

29

Foreign Portfolio Investment is the entry of funds into a country

where and foreigners make purchases in the country’s stock and

bond markets, usually for speculation.13

Global Depository Receipts (GDRs)

Global Depository Receipt (GDR) is a certificate issued by

International Bank, which can be subject of worldwide circulation on

capital markets. GDRs are issued by banks, which purchase shares

of foreign companies and deposit it on the accounts. Global

Depository Receipt facilitates trade of shares, especially those from

emerging markets. Prices of GDR's are often close to values of

related shares.14

American Depositary Receipts (ADRs) American Depository Receipts popularly known as ADRs were

introduced in the American market in 1927. ADR is a security issued

by a company outside the U.S. which physically remains in the

country of issue, usually in the custody of a bank, but is traded on

U.S. Stock Exchanges. In other words, ADR is a stock that is traded

in the United States but represents a specified number of shares in a

foreign corporation.15

30

Foreign Institutional Investor (FII) Foreign institutional investor is an investor or investment fund

that is registered in a country outside the one in which it is currently

investing. Institutional investors include hedge funds, insurance

companies and mutual funds.16

Offshore Funds An offshore fund is a collective investment scheme domiciled in

an offshore financial centre and typically sold exclusively to foreign

investors.17

Overseas Corporate Body (OCB)

Overseas Corporate Body (OCB) means a company,

partnership firm, society and other corporate body owned directly or

indirectly to the extent of at least 60 per cent by Non Resident Indians

and includes overseas trust in which not less than 60 per cent

beneficial interest is held by Non Resident Indians directly or

indirectly but irrevocably.18

External Commercial Borrowing (ECB) External Commercial Borrowing refer to the loans floated by

the financial institutions and the public sector undertakings in the

external commercial market. Thus, external commercial borrowing

are defined to include loans from commercial banks and other

31

financial institutions, suppliers, credits, bonds and loans from semi-

government export credit agencies, IFC, DEG Germany, CDC and

U.K. These loans are procured at the market rate of interest.19

Commercial Bank Loans

A basic commercial bank loan is called a bank term loan. A

bank term loan has a particular term or length of maturity and usually

a fixed interest rate. The repayment of the principal of bank term

loans are usually amortised, which means that the principal and

interest are set up as periodic payments designed to pay-off the loan

in a certain period of time.20

Foreign Currency Convertible Bonds (FCCBs)

FCCB is a foreign currency denominated quasi-debt instrument

which can be converted into equity in accordance with a pre-

determined formula or may be retained as a bond as per the

investor’s choice.21

Self-Liquidating Loans It is a loan used to finance the purchase of assets intended to

be sold within a short period of time. For example, a company may

use a self-liquidating loan to pay for its inventory, which it intends to

sell quickly. It is called a self-liquidating loan because the proceeds

32

from the sale of the assets provide the capital with which the debtor

may repay the loan.22

External Assistance

It refers to the assistance to foreign nations ranging from the

sale of military equipment to donations of food and medical supplies

to aid survivors of natural and man made disasters. US assistance

takes three forms development assistance, humanitarian assistance

and security assistance.23

Loans

A loan is a type of debt. Like all debt instruments, a loan entails

the redistribution of financial assets over time, between the lender

and the borrower. In a loan, the borrower initially receives or borrows

an amount of money, called the principal, from the lender, and is

obligated to pay back or repay an equal amount of money to the

lender at a later time. Typically, the money is paid back in regular

installments or partial repayments.24

Grants The grants are defined as ‘something for nothing’ to the

recipient country.25

33

Foreign Aid Foreign aid refers to the transfer of resources at concessional

terms and conditions from the donor countries and multilateral

institutions to the recipient under developed countries.26

Debt Service Payments The series of payments of interest and principal required on a

debt over a given period of time is termed as debt service

payments.27

Amortisation

Amortisation is the distribution of a loan repayment into

multiple cash flow installments, as determined by an amortisation

schedule. Unlike other repayment models, each repayment

installment consists of both principal and interest. Amortisation is

chiefly used in loan repayments and in sinking funds. Payments are

divided into equal amounts for the duration of the loan, making it the

simplest repayment model. A greater amount of the payment is

applied to interest at the beginning of the amortisation schedule,

while more money is applied to principal at the end.28

34

Review of Literature A researcher must update knowledge about the studies related

to her own problem already made by others. For any worthwhile

study the researcher needs an adequate familiarity with the library

and its resources.

A survey of related literature not only forms one of the early

chapters of the thesis, but also serves other useful purposes. A brief

summary of the previous research and writings of recognised experts

provides evidence that the researcher is familiar with what is already

known and with what is still unknown and untested. This step helps to

eliminate the duplication of what has been done and provides

suggestions for significant investigation. The literature in any field

forms the foundation upon which all future work will be built.

The key to the vast store house of published literature may

open doors to sources of significant problem and explanatory

hypothesis and provide helpful orientation for definition of the

problem, the background for selection procedure and comparative

data for interpretation of results. The review of literature is a crucial

aspect of the planning of the study. The review of some studies on

the area of interest of the scholar is presented in this chapter.

35

Foreign Capital Suresh K. Chadha (2000)29 indicates that, foreign capital is the

engine of economic development and this statement is gaining

importance in recent times. Traditionally, the various sources of

capital for developing countries were either the demand for their

output by industrial countries, or foreign aid, or loans from foreign

banks, or foreign direct investment. This is considered to be the major

source of fund which may contribute considerably to growth rate of

the developing countries. Trans National Corporations (TNCs)

account for two-thirds of the world trade in services and goods. The

government policy since 1991 has been aimed at encouraging

foreign investment particularly, in core and infrastructure sectors and

in other wide ranging activities, such as chemicals, food processing

industries, metallurgical industries, etc. In order to provide a level

playing field to the domestic industry and to protect national interests,

several measures have been initiated to attract foreign investment in

the form of dividend balancing, foreign equity neutrality, foreign equity

capital etc. based on sectorial sensitivities.

Veena Pailwar (2001)30 states that, capital formation plays an

important role in the process of development. However, in the initial

stages of development, developing countries are unable to generate

36

sufficient resources over and above their consumption requirement

and therefore the level of investment remains low in these countries.

To overcome the vicious circle of low capital formation and low

growth, developing countries seek to look for help from external

sources. Foreign capital, by supplementing internal resources fills the

resource gap of developing countries. However, even when internal

resources are sufficient for the development needs of a country,

foreign capital is essential as improved machinery and technology

and imported raw-material can only be bought by paying in terms of

foreign exchange. Thus besides filling the resource gap, foreign

capital fills the foreign exchange gap of developing countries.

Renu Kohil (2003)31 reveals that, the last decade has

witnessed a tremendous increase in international capital mobility.

Cross-country trends in capital flows reveal that private capital flows

now dominate the official capital. It has tilted the composition of

international capital flows towards short-term investments, exposing

individual countries to enhanced volatility and sudden withdrawal

risks. These trends have been driven by globalisation, which has

enabled pursuit of higher returns and portfolio diversification, as well

as market-oriented reforms in many countries, which have liberalised

access to financial market.

37

Foreign Investment

Kutty Krishnan Nambiar (2005)32 mentions that, foreign

investment implies the flow of investment funds, from countries where

the capital is relatively abundant, to countries where capital is

relatively scarce. In other words, it moves from countries with low

marginal productivity of capital to countries where marginal

productivity of capital is high.

Foreign Direct Investment (FDI) Bhalla, V.K., (2003)33 states that, foreign direct investment is

one of the most dynamic resources to the developing countries.

Foreign direct investment flows are particularly important because

foreign direct investment is a package of tangible and intangible

asset.

Ruddar Datt (2003)34 reveals that, foreign direct investment

flows are usually preferred over other forms of external finance

because they are non-debt creating, non-volatile and their returns

depend on the performance of the projects financed by the investors.

Bhatt, P.R., (2008)35 points out that, foreign direct investment

is an investment involving a long-term relationship and reflecting a

lasting interest and control by a resident entity in one country (foreign

direct investor or parent enterprise) in an enterprise resident in an

38

economy other than that of the foreign direct investor (FDI enterprise

or affiliate enterprise or foreign affiliate). Foreign direct investment

implies that the investor exerts a significant degree of influence on

the management of the enterprise in the other country.

Kamaraj, C., (2009)36 states that, foreign direct investment is

any form of investment that earns interest in enterprises which

functions outside the domestic territory of the investor. Foreign direct

investment requires a business relationship between a parent

company and its foreign subsidiary. For an investment to be regarded

as foreign direct investment, the parent firm needs to have at least 10

per cent of the ordinary shares of its foreign affiliates. The investing

firm may also qualify for an foreign direct investment if it owns voting

power in a business enterprise operating in a foreign country.

Foreign Portfolio Investment (FPI) Parthapratimpal (1998)37 points out that, during the late 1980s,

foreign portfolio investment to developing countries was perceived as

a symbiosis that benefited everyone. Less developed countries were

eager to welcome any kind of foreign capital inflow because after the

debt crisis of early 1980s, they were facing a shortage of both foreign

capital and invisible resources. The low correlation between

movements in developed and developing countrys’ stock markets,

39

the deceleration in industrial countrys’ markets and the high growth

prospects of the less developed markets made them an attractive

option for portfolio diversification. The most important benefit from

foreign portfolio investment is that it gives an upward thrust to the

domestic stock market prices. Foreign Institutional Investors (FIIs) are

the primary source of portfolio investment in India. FIIs can invest in

all the listed and unlisted securities traded on the primary and

secondary markets, including the equity and other securities-

instruments of companies. These would include shares, debentures,

warrants and schemes floated by domestic mutual funds.

Bhalla, V.K., (1999)38 indicates that, portfolio investment in

India takes a variety of forms such as investment by Foreign

Institutional Investors (FIIs), issue of Global Depository Receipts

(GDRs), abating of off shore funds by Indian Corporates aboard and

those under special investment schemes designed for Non-Resident

Indians. Portfolio investments have favourable implication for overall

market discipline and monitoring of economic fundamentals by both

the authorities and market players. These factors play a catalytic role

in attracting foreign portfolio investment.

Sanjay K. Hansda and Partha Ray (2002)39 are of the opinion

that, among the significant measures of integration, portfolio

40

investment by Foreign Institutional Investors (FIIs) allowed since

September 1992, has undoubtedly been the turning point for the

Indian stock market. Now FIIs are allowed to invest in all categories

of securities traded in the primary and secondary segments including

unlisted ones. FIIs are also allowed from June 1998 to trade in

exchange-traded derivatives and take forward exchange cover for

equity investment. While there is no restriction on the volume of FIIs

investment or any lock-in-period, preferential allotment to FIIs is

restricted to a maximum of 15 per cent equity of a company.

External Commercial Borrowing (ECB) Kalpana Rajaram (2004)40 states that, external commercial

borrowings are non-concessional borrowings at market rates with the

obligation of payment of the interest as well as the principal. A

number of changes were announced in June 1996 in ECB guidelines

governing the maximum borrowing limits and end-use restrictions.

External commercial borrowings act as window for resources

mobilisation

NRI Investments

Haja Shareeff, K.S.G., (1989)41 indicates that, the Government

of India has initiated a number of steps to augment inflow of

investment from Non-Resident Indians. To establish a continuous

41

dialogue with the NRI community, a committee on NRI matters has

been constituted in the Department of Economic Affairs. The

committee has representatives from government, trade and industry

and NRIs representing all the continents. This has so far held a

number of meetings with Non-Resident Indians both in India and

abroad. In order to provide prompt escort services to NRI

entrepreneurs, nodal officers have been designated in most of the

central ministries and also at state government level for NRI work.

Quarterly meetings of nodal officers are held to review problems in

implementation of industrial projects taken up by NRIs.

Sumanjeet (2009)42 states that, the NRIs are permitted to

acquire immoveable property (other than agricultural land, plantations

and farm houses) easily. There are no restrictions regarding the

number of such properties to be acquired. The only restriction is that

where the property is acquired out of inward remittances, the

repatriation is restricted to principal amount for two residential

properties. There is no such restriction in respect of commercial

property. NRIs are also permitted to avail housing loans for acquiring

property in India and repayment of such loans by close relatives.

42

Foreign Aid Kalpana Rajaram (2004)43 states that, the public bilateral/

multilateral development assistance is called foreign aid. It is different

from other private flows which are prompted by commercial

considerations of profits and rate of return. Foreign aid as any flow of

foreign capital to an underdeveloped country should be non-

commercial from the point of view of the donor, and the interest rate

and repayment period for borrowed capital should be softer than

commercial terms.

Foreign Loans Pragati Kapoor (2002)44 states that, getting loans from relatives

abroad is made easier by the Reserve Bank of India. The RBI has

also liberalized rules to enable residents to get foreign exchange for

medical treatment abroad without much loss of time. Earlier, Indian

residents had general permission to borrow up to $250,00 from their

close relatives living outside India provided the loan was interest free

and was not repayable before seven years. The seven years

moratorium was obviously a hurdle in obtaining loans from relatives

abroad. Following due representations, RBI has decided to reduce

the minimum period, after which such loans can be repaid in one

year. According to RBI’s spokesperson, Killawala, residents are now

43

able to borrow up to $ 250,000 from their close relatives residing

abroad.

Foreign Direct Investment and GDP Rajan Bharti Mittal (2010),45 President of the Federation of

Indian Chambers of Commerce and Industry (FICCI), stressed the

need to allow greater foreign direct investment in the country to

achieve 10 per cent GDP growth. He further stressed upon the need

to open up retail sector to more foreign direct investment. A retail

sector is a huge employment generator and it is a sector that needs

more foreign investment. He also states that Federation of Indian

Chambers of Commerce and Industry will focus on making India the

global investment destination with a target of US $75 billion FDI by

the year 2015. To reach this target FICCI will also undertake efforts

and advocate policy issues and changes needed therein to improve

the policy framework.

Determinants of Foreign Investment

Agarwal, R.N., (1997)46 indicates that, inflation rate, real

exchange rate, index of economic activity and the share of domestic

capital market in the world stock market capitalization are the four

statistically significant determinants of foreign portfolio investment.

44

Gopinath,T., (1997)47 indicates that, market size is the

important determinant of foreign capital inflow. Positive relationship is

postulated between the market size variable and the flow of foreign

investment. The high level of foreign exchange reserves in terms of

the import cover reflects the strength of the external payment position

and helps to improve the confidence of the prospective investors.

Negative relationship has been hypothesised between the rate of

inflation and the flow of foreign investment. It is postulated that Gross

Fiscal Deficit (GFD) and Debt Service Ratio (DBR) also have a

negative relationship with the flow of foreign investment.

Purna Chandra Dash (2000-2001)48 states that, the major

determinant of foreign direct investment in the host country is the FDI

policies which consists of rules and regulations governing the entry

and operations of foreign investors, the standard of treatment

accorded to them and the functioning of the markets within which

they operate. The other economic determinants of foreign direct

investment are availability of raw materials, low cost unskilled labour

and skilled labour, technological innovatory and other created assets

and physical infrastructure such as ports, roads, power and

telecommunication, income of the population, market growth, access

to regional and global markets, country-specific consumer

preferences and structure of market.

45

Arindam Banik, Pradip K. Bhaumik and Sunday O. Iyer

(2004)49 point out that, foreign direct investment flows are generally

believed to be influenced by indicators like market size, export

intensity, institutions etc. irrespective of the source and the

destination. This study looks at foreign direct investment inflows in an

alternative approach based on the concepts of neighbourhood and

extended neighbourhood. The study shows that the neighbourhood

concepts are widely applicable in different contexts-particularly for

China and India. Foreign direct investment inflow in the extended

intermediate neighbourhood has been facilitated significantly by

financial markets. The process of global financial integration has

been fuelled primarily by the liberalisation of markets. Capital inflows

to the extended intermediate neighbourhood has also been benefitted

from technological progress that improves the timeliness, accuracy

and analysis of information. Improved information and communication

technology have played major role in financial integration. Foreign

direct investment inflows to both the original and intermediate

neighbourhoods attained their peak at the end of the 1980s.

Jongsoo Park (2004)50 indicates that, in developing countries,

there has been a remarkable shift in attitude towards many aspects

of foreign investment. The Indian Government’s attitude towards

46

foreign investment has been changing in the Post-Independence

period. Industrial clusters are playing an important role in economic

activity. The key to promoting foreign direct investment inflows into

India may lie in industries and products that are technology-intensive

and have economies of scale and significant domestic content.

Investors in India

Rahulsen, Mukul G. Asher and Ramkishen S. Rajan (2004)51

reveal that, investment relation between ASEAN and India have until

now remained rather limited. Among the ASEAN countries, Malaysia

and Singapore have been the major investors in India. The findings of

a recent survey based on interviews with firms from Malaysia and

Singapore have suggested that ASEAN investors developed

relatively more positive attitude towards investing in India in the mid-

1990s. The survey indicated a high level of satisfaction among those

firms that decided to invest in India and many of them were

considering expansion or diversification of investment in India. This

emphasises the point that those who are able to change the mindset

and overcome their negative bias towards India will have positive

experience and more importantly, profitability of their Indian

operations.

47

Maathai K. Mathiyazhagan and Dukhabandhu Sahoo (2008)52

find out that, total foreign direct investment inflows into India reached

Rs.706.30 billion (US$15.73 billion) in 2006-2007, with the largest

share coming from Mauritius, followed by the United States, the

United Kingdom, the Netherlands and Singapore. The sectors that

received the largest share of total foreign direct investment inflows

between August 1991 and March 2007 were electrical equipment and

the service sector, accounting for 18.77 per cent and 17.84 per cent

of total foreign direct investment respectively.

Liberalisation and Foreign Capital

Radhakrishnan, K.G., and Jaya Prakash Pradhan (2000)53

point out that, the liberalisation policy of 1991 had a distinct impact in

boosting up the flow of foreign direct investment into the country.

Service sector attracts more amount of foreign direct investment.

There has been a continuous diversification of foreign direct

investment inflows and that indicates the expedited globalisation of

economy.

Prabha Shastri Ranade (2001)54 indicates that, after economic

liberalisation, India has been able to attract foreign capital in a bigger

way. The issues such as size, composition and determinant of foreign

capital inflows have developed considerable interest among scholars.

48

India aims at accelerating and strengthening industrial development

and attracting more foreign capital.

Nalini Praba Tripathi (2002)55 explains that, rapid development

of the capital market and financial liberalisation have brought a

profound change in perception of entrants in the capital market. The

large sum of foreign direct investment in the country is an obvious

outcome of India’s commitment to the process of liberalisation. India

has emerged as one of the most attractive investment markets in the

world. The Global Depositary Receipts issues of Indian companies

received an overwhelming response abroad.

Sahana Joshi and R.V. Dadibhavi (2008)56 state that, since

1991, the role of foreign direct investment in Indian economy is

increasing due to a number of measures undertaken to liberalise the

FDI policy and expand many economic areas to foreign capital which

were earlier closed. Following economic reforms, governments at the

state level are initiating measures to attract more financial resources

into the states. To attract foreign investors in their states, many of

them are offering incentive packages in the form of various tax

concessions, capital and interest subsidies, reduced power tariff etc.

49

Government Measures towards Foreign Capital

Sarda, D.P., (1998)57 points out that, in line with the industrial

policy announced by the Government of India on 24th July 1991,

several steps have been taken to encourage foreign investments. As

a result of the new policy, a large amount of foreign investment is

flowing into the country to finance new projects as well as

expansion/diversification/modernisation/rehabilitation projects of

existing companies. A wide range of facilities for making investments

in India have been provided to individuals of Indian nationality or

origin staying abroad (NRIs) and Overseas Corporate Bodies (OCBs)

predominantly owned by NRIs. Foreign Institutional Investors (FIIs)

are also permitted to invest in securities in primary and secondary

markets in India. Certain Indian companies have been allowed to

issue Global Depository Receipts (GDRs) and Foreign Currency

Convertible Bonds (FCCBs) in the international market.

Radhakrishnan, K.G., and Jaya Prakash Pradhan (2000)58

mention that, the Government of India has been taking several

measures to attract foreign direct investment into India. The

Government has set up a separate body. Foreign Investment

Promotion Board (FIPB) is created for the sole purpose of attracting

foreign direct investment into the nation. Its prime duty is to check the

process of applications for foreign direct investment which are not

50

covered in automatic route. Many other measures have also been

taken to facilitate foreign investment.

Veena Pailwar (2001)59 states that, for speedy approval of

various foreign direct investment proposals, Foreign Investment

Promotion Board (FIPB) has been set up. For reducing the time lag

between approval and implementation of these projects, Foreign

Investment Implementation Authority (FIIA) has been set up. Apart

from the various structural reform measures and regulatory changes,

the government is continuously evolving and implementing foreign

direct investment promotion measures. As part of these measures,

the government has opened up all sectors of the economy except

agriculture and plantation for foreign investors. Government of India

is following a more systematic export promotion approach in the

aftermath of balance of payment crisis of 1991-1992. The thrust

areas of the export promotion policies in the post 1991 period have

been exchange rate management, reduction in tariff and non-tariff

barriers, direct export incentives such as duty exemption scheme,

export promotion of capital goods scheme, special import licenses,

setting up of various types of technology parks, Export Processing

Zones and Special Economic Zones with special incentives to units in

these zones and various tax exemption schemes. The Ministry of

Commerce has also come out with the Medium Term Export Strategy

51

Document in 1997. Establishment of Export Processing Zones was

supposed to increase the inflow of foreign direct investment in these

areas and boost the export of the country.

Pulak Mishra and Ramakanta Prusty (2002)60 point out that, the

New Industrial Policy (NIP) of 1991 accords a much liberal attitude

towards foreign direct investment to exploit the opportunities for

promoting foreign investment in the form of simplification of

procedural rules and regulations and removal of entry barriers. These

measures have created a favourable environment for the foreign

investors. The new policy framework not only permits the firm to have

higher equity participation in their ventures in India, but also opens up

many new sectors to them that were earlier reserved exclusively for

the domestic firms.

Siddharthan, N.S., (2004)61 explains that, realising the benefits

of foreign direct investment flow in the development process of the

country the Government of India has adopted various structural

reform measures and made changes in the regulatory framework to

promote the flow of foreign direct investment to the country. Foreign

direct investment companies are also suffering from declining export

intensity of sales and increasing import intensity of exports. One of

the major challenges facing the country is to devise the mechanism to

52

improve export intensity of sales in general and foreign direct

investment companies in particular.

Ajit Kumar Sinha (2005)62 mentions that, the Government of

India has initiated major structural changes in its economic policy

since July 1991. The main aim of the policy is to make Indian industry

more competitive. These changes include some critical reforms in its

industrial policy, trade policy, policy towards financial markets and

institutions and towards foreign direct investment. The role of foreign

direct investment has been clearly mentioned in the process of

economic development of India. India has taken active steps for the

reduction of administrative and regulatory barriers to foreign direct

investment, providing various fiscal incentives and other measures

aimed at improving the climate for foreign direct investment.

Foreign Investment and Capital Formation

Nagaraj, R., (2003)63 indicates that, India followed a fairly

restrictive foreign private investment policy until 1991. After

liberalisation foreign investment is seen as a source of scarce capital,

technology and managerial skills. India not only permits foreign direct

investment but also foreign portfolio investment in almost all sectors

of the economy. The flow of foreign investment reflects in capital

formation, formation of new firms and factories and increase in

53

foreign equity holding in the existing firms. Foreign investment

creates tangible assets in host country.

Foreign Investment and Economic Growth

Pami Dua and Aneesa I. Rashid (1998)64 indicate that, foreign

investment have positive effects on growth in the host country. It is an

important vehicle for the transfer of technology and knowledge.

Foreign investment also have long-run effects on growth by

generating increasing returns in production via externalities and

productivity spillovers. It contributes more to growth than domestic

investment when there is sufficient absorptive capacity available in

the host country. Foreign investment lead to higher growth by

incorporating new inputs and techniques. It is also an important

source of human capital augmentation and provides specific

productivity increasing labour training and skill acquisition through

knowledge transfers.

Pulak Mishra and Ramakanta Prusty (2002)65 state that, inflow

of foreign direct investment for an economy in transition like India can

never be ignored, as the foreign direct investment inflow not only

integrates the host country, but also acts as a capital, technology,

managerial and marketing knowhow and market access required for

sustained economic growth and development. Besides, a large and

54

quality inward foreign direct investment can make the relationship

between the domestic and foreign enterprises more dynamic in terms

of both technology and environment, which is very urgent particularly

in the present era of globalisation and competition compared to the

earlier restrictive.

Ramakrishnan S. Rajan (2004)66 reveals that, foreign direct

investment is attracted into countries for different reasons. Foreign

direct investment brings in much needed capital, technical know-how,

organisational, managerial and marketing practices and global

production networks, thus facilitating the process of economic growth

and development in host countries.

Suresh K. Chadha (2004)67 states that, foreign investment has

been instrumental in the economic growth of the developed countries.

This has inspired the developing countries to reform their economic

policies to attract foreign investment. Since 1991, the Government of

India has been laying down the road map for foreign direct

investment reforms to encompass relaxation of procedural as well as

investment norms. Foreign direct investment provides financial

resources for investment in the host country and thereby augments

the domestic savings efforts to achieve sustained economic growth.

The investment saving gap can be bridged by attracting foreign direct

55

investment. Foreign direct investment facilitates technology

upgradation and introduction of modern production and management

practices. Thus it is anticipated that with the economic reforms and

adequate supplies of capital, India can come out of the vicious circle

of poverty and help creating more jobs.

Arabi, U., (2005)68 states that, foreign direct investment is an

important channel for accessing resources for economic

development. Foreign direct investment represents transfer of a

bundle of assets like capital, technology and access to export

markets, skills and management techniques and modern environment

management system.

Neera Verma (2007)69 indicates that, foreign direct investment

has emerged as the most important external resource flow to

developing countries. Foreign direct investment can be expected to

contribute to growth more than proportionately compared to domestic

investments in the host country. Foreign direct investment is also

viewed as a way of increasing the efficiency with which the world’s

scarce resources are used. Most of the countries have experienced

positive spillovers from foreign direct investment.

Smitha Francis (2010)70 reveals that, the principal contribution

to a host country are the financial capital invested by foreign firms,

56

the export market access provided by them and the faster technology

development. Foreign investment helps the host country to achieve

faster industrial growth and contribute to the host country’s economic

growth and development.

Foreign Investment and Foreign Exchange

Bishwanath Goldar and Esturo Ishigami (1999)71 state that,

foreign direct investment is the important source of external finance

for developing countries. Foreign direct investment provides the

needed foreign exchange to bridge the balance of trade deficit.

Foreign investment helps to improve the export performances. It

makes a positive impact on the host country’s export competitiveness

by raising the level of efficiency and the standard of product quality

and contributes to the growth of the host economies by relaxing

demand side constraints on growth.

Foreign Investment and Technological Knowledge

Bernard Tao Khium Mien (1999)72 reveals that, foreign firms

brought with them not only capital and foreign exchange but also

technological knowledge, production techniques, marketing,

managerial and administration skills. Other benefits of foreign

investment are the generation of employment opportunities,

contribution of taxes and royalties and creation of external

economies.

57

Foreign Investment and Balance of Payment Kutty Krishnan Nambiar (2005)73 indicates that, foreign capital

brings in enormous social benefits such as transferring production

technology, skills, innovative capacity, organizational and managerial

practices that are vital for open competitive economies. They can

access external markets by sourcing manufactured goods and

services from domestic firms thus boosting exports and easing the

balance of payment problems. Foreign capital also contributes more

to domestic savings, foreign exchange and to the exchequer by way

of corporate tax.

Foreign Investment and Employment

Manash Ranjan Gupta (1999)74 points out that, foreign capital

inflow creates additional employment opportunities in the economies

suffering from unemployment. Inflow of foreign capital does not affect

the domestic factor income. Technology transfer in the domestic sub-

sectors of the economy takes place through foreign capital.

Jaya Prakash Pradhan (2006)75 states that, inward foreign

capital is an important contributing factor in changing the patterns of

employment in a host country. Foreign firms are more productive,

more capital intensive, employ more skilled workers and pay higher

wages.

58

Foreign Investment and Trade

Siddharthan, N.S. and Hirashima, S., (1999)76 reveal that,

foreign direct investment has been instrumental in changing the

structure of the manufacturing and trade sectors. It plays an important

role in promoting trade and changing the industrial structure through

transfer of technology and management. Foreign direct investment

helps in the expansion of domestic market.

Bernard Tao Khium Mien (1999)77 indicates that, the industrial

and trade structure of a country is determined by both endogenous

and exogenous factors. Endogenous factors comprise industrial and

trade policies that are implemented and factor endowment of a

country. Exogenous factors encompass external influences which are

beyond the control of a country, including impacts from foreign

investments. Different forms of foreign investment determines the

industrial and trade structure of the economy. The manufacturing

sector is driven strongly by foreign investment.

Impediment to Foreign Capital

Siddharthan, N.S., (2004)78 points out that, the main constraint

for investing in India seem to be corruption, infrastructure bottlenecks

and policy instability. These three are directly related to government

infrastructure that turns out to be a crucial factor influencing

59

investments in India. While the role of government in tackling

corruption and policy instability is obvious, its role in transport

infrastructure is less obvious. For instance Indian road transport is

plagued by delays. Commercial vehicles in India run only about 250

km per day compared to about 600 km in several other countries. The

poor mileage in India could not be only due to bad roads but also,

due to delays in road check posts, toll gates etc. Corruption and

unpredictability or frequent changes in policies are the two most

important factors that adversely affect investment.

Nagson, D.S.V., (2004)79 indicates that, the lack of clear cut

policy and complicated legal procedures lead the international

investors into confusion. Political instability due to coalition

government may be another problem to the international investors.

However, this will not make changes in India’s economic policies.

This is evident from the commitment shown by all the successive

political parties in power for continuing the reforms towards

liberalisation since 1991. During the recent interactions with CEO of

European Companies Hon. Prime Minister of India said that “Several

parties across the political spectrum have been in government at the

centre and the state level and there has been continuity in policy . . . .

there is a broad base consensus on the direction of a economic

policy liberalisation with a human face has come to stay.” Extreme

60

north eastern part of India and Kashmir insurgence activities of

terrorist create an unsecured situation to international investors and

create risk.

Majumdar, S., (2004)80 is of the opinion that, India lags several

countries in the matter of attracting foreign investment. The main

reason for the low foreign investment inflow into India is the

bureaucratic tangle.

61

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