Chapter II (Autosaved) 2

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CHAPTER-II

PROFILE OF THE FOREIGN DIRECT INVESTMENT IN INDIA

2.1 INTRODUCTION

he last two decade of the 20th

century witnessed a dramatic world-wide

increase in foreign direct investment (FDI), accompanied by a marked change

in the attitude of most developing countries towards inward FDI. As against a

highly suspicious attitude of these countries towards inward FDI in the past,

most countries now regard FDI as beneficial for their development efforts and

compete with each other to attract it. Such shift in attitude lies in the changes

in political and economic systems that have occurred during the closing years

of the last century.

The wave of liberalisation and globalization sweeping across the world has

opened many national markets for international business. Global private

investment, in most part, is now made by multinational corporations (MNCs).Clearly these corporations play a major role in world trade and investments

because of their demonstrated management skills, technology, financial

resources and related advantages. Recent developments in global markets are

indicative of the rapidly growing international business. The end of the 20th

century has already marked a tremendous growth in international

investments, trade and financial transactions along with the integration and

openness of international markets.

FDI is a subject of topical interest. Countries of the world, particularly

developing economies, are vying with each other to attract foreign capital to

boost their domestic rates of investment and also to acquire new technology

and managerial skills. Intense competition is taking place among the fund-

starved less developed countries to lure foreign investors by offering


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repatriation facilities, tax concessions and other incentives. However, FDI is not

an unmixed blessing. Governments in developing countries have to be very

careful while deciding the magnitude, pattern and conditions of private foreign

investment.

In the 1980s, FDI was concentrated within the Triad (EU, Japan and US).

However, in the 1990s, the FDI flows to developed countries declined, while

those to developing countries increased in response to rapid growth and fewer

restrictions. Most FDI flows continue still to be concentrated in 10 to 15 host

countries overwhelmingly in Asia and Latin America. South, East and Southeast

Asia has experienced the fastest economic growth in the world, and emerged

as the largest host region. China is now the largest host country in the

developing world.

However, small markets with low growth rates, poor infrastructure, and high

indebtedness, slow progress in introducing market and private-sector oriented

economic reforms and low levels of technological capabilities are not attractive

to foreign investors.

The remarkable expansion of FDI flows to developing countries had belied the

fear that the opening of central and Eastern Europe and the efforts of the

countries of that region to attract such investment would divert investment

flows from developing countries. The most important factors making

developing countries attractive to foreign investors are rapid economic

growth, privatization programmes open to foreign investors and the

liberalisation of the FDI regulatory framework.

In India, prior to economic reforms initiated in1991, FDI was discouraged by

Imposing severe limits on equity holdings by foreigners and


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Restricting FDI to the production of only a few reserved items.The Foreign Exchange Regulation Act (FERA), 1973 (now replaced by Foreign

Exchange Management Act [FEMA]), prescribed the detailed rules in this

regard and the firms belonging to this group were known as FERA firms. All

foreign investors were virtually driven out from Indian industries by FERA.

Technology transfer was possible only through the purchase of foreign

technology. However, due to severe limits on royalty payments to foreigners to

reduce foreign exchange use, this option was ineffective. However, the

government granted liberal tax incentives to encourage indigenous generation

of technology by domestic firms. In the absence of foreign technology, Indian

industry suffered both in terms of cost of production and quality.

The initial policy stimulus to foreign direct investment in India came in July

1991 when the new industrial policy provided, inter alia, automatic approval

for project with foreign equity participation up to 51 percent in high priority

areas. In recent years, the government has initiated the second generation

reforms under which measures have been taken to further facilitate and

broaden the base of foreign direct investment in India. The policy for FDI

allows freedom of location, choice of technology, repatriation of capital and

dividends. As a result of these measures, there has been a strong surge of

international interest in the Indian economy. The rate at which FDI inflow has

grown during the post-liberalisation period is a clear indication that India is fast

emerging as an attractive destination for overseas investors. Encouragement

of foreign investment, particularly for FDI, is an integral part of ongoing

economic reforms in India.


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Though India has one of the most transparent and liberal FDI regimes among

the developing countries with strong macro-economic fundamentals, its share

in FDI inflows is dismally low. The country still suffers from weaknesses and

constraints, in terms of policy and regulatory framework, which restricts the

inflow of FDI.

Foreign investment policies in the post-reforms period have emphasized

greater encouragement and mobilisation of non-debt creating private inflows

for reducing reliance on debt flows. Progressively liberal policies have led to

increasing inflows of foreign investment in the country.

WHAT IS FOREIGN DIRECT INVESTMENT?

FDI is the process whereby residents of one country (the home country)

acquire ownership of assets for the purpose of controlling the production,

distribution and other activities of a firm in another country (the host country).

IMF Definition

According to the BPM5, FDI is the category of international investment that

reflects the objective of obtaining a lasting interest by a resident entity in one

economy in an enterprise resident in another economy. The lasting interest

implies the existence of a long-term relationship between the direct investor

and the enterprise and a significant degree of influence by the investor on the

management of the enterprise.

UNCTAD Definition

The WIR02 defines FDI as an investment involving a long-term relationship

and reflecting a lasting interest and control by a resident entity in one

economy (foreign direct investor or parent enterprise) in an enterprise


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resident in an economy other than that of the FDI enterprise, affiliate

enterprise or foreign affiliate. FDI implies that the investor exerts a significant

degree of influence on the management of the enterprise resident in the other

economy. Such investment involves both the initial transaction between the

two entities and all subsequent transaction between them among foreign

affiliates, both incorporated and unincorporated. Individuals as well as

business entities may undertake FDI.

Flows of FDI comprise capital provided (either directly or through other related

enterprises) by a foreign direct investor to an FDI enterprise, or capital

received from an FDI enterprise by a foreign direct investor. FDI has three

components, viz., equity capital, reinvested earnings and intra-company loans.

Equity capital is the foreign direct investors purchase of share of anenterprise in a country other than its own.

Reinvested earnings comprise the direct investors share (in proportionto direct equity participation) of earnings not distributed as dividends by

affiliates, or earnings not remitted to the direct investor. Such retained

profits by affiliates are reinvested.

Intra-company loans or intra-company debt transactions refer to shortor long term borrowing and lending of funds between direct investors

(parent enterprises) and affiliate enterprises.

OECD Benchmark Definition of Foreign Direct Investment (Third Edition)

FDI reflects the objective of obtaining a lasting interest by a resident entity in

one economy (direct investor) in an entity resident in an economy other than


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that of the investor (direct investment enterprise). The lasting interest implies

the existence of a long term relationship between the direct investor and the

enterprise and a significant degree of influence on the management of the

enterprise. Direct investment involves both the initial transaction between the

two entities and all subsequent capital transactions between them and among

affiliated enterprises, both incorporated and unincorporated.

As is evident from the above definitions, there is a large degree of

commonality between the IMF, UNCTAD and OECD definitions of FDI. The IMF

definition is followed internationally.

FOREIGN DIRECT INVESTMENT (FDI): THEORITICAL SETTINGS

Most of the present day underdeveloped countries of the world have set out a

planned programme for accelerating the pace of their economic development.

In a country planning for industrialization and aiming to achieve a target rate of

growth, there is a need for resources. The resources can be mobilized through

domestic as well as foreign sources. So far as, the domestic sources are

concerned, they may not be sufficient to acquire the fixed rate of growth.

Generally domestic savings are less than the required amount of investment.

Also the very process of industrialization calls for import of capital goods which

cannot be locally produced. Hence comes the need for foreign sources. They

not only supplement the domestic savings but also provide the recipient

country with extra foreign exchange to buy imports essential for filling the

saving investment gap and foreign exchange gap.

The means of getting foreign resources available to a developing country are

mainly three:


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1. Through export of goods and services2. External aid3. Foreign investmentExport of goods and services do contribute to foreign resources but they can

meet only a small part of the total demand for foreign resources.

External Aid from foreign governments and international institutions, by

increasing the rate of home savings and removing the foreign gap allows the

utilization of previously underutilized resources and capacity. But generally the

aid is tied and distorts the allocation of resources. So its use has been on the

decline.

Foreign investment is of following two types.

1. Foreign Direct Investment (FDI) and2. Portfolio Investment.

Foreign Direct versus Portfolio Investment

By Foreign Direct Investment (FDI) we mean any investment in a foreign

country where the investing party (corporation, firm) retains control over

investment. A direct investment typically takes the form of a foreign firm

starting a subsidiary or taking over control of an existing firm in the country in

question. FDI consists of equity capital, technical and managerial services,

capital equipment and intermediate inputs and legal rights to patented or

secret products, processes or trademarks. It is the direct type of foreign

investment which is associated with multinational corporations because most


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of FDI is transferred through firms and remains outside of ordinary, functioning

markets.

FDI can be done in the following ways

1. In order to participate in the management of the concerned enterprise, thestocks of the existing foreign enterprise can be acquired.

2. The existing enterprise and factories can be taken over.3. A new subsidiary with 100% ownership can be established abroad.4. It is possible to participate in a joint venture through stock holdings.5. New foreign branches, offices and factories can be established.6. Existing foreign branches and factories can be expanded.7. Minority stock acquisition, if the objective is to participate in the

management of the enterprise.

8. Long term lending, particularly by a parent company to its subsidiary, whenthe objective is to participate in the management of the enterprise.

Portfolio investment, on the other hand, does not seek management control,

but is motivated by profit. Portfolio investment occurs when individual

investors invest, mostly through stockbrokers, in stocks of foreign companies

in foreign land in search of profit opportunities.

FDI 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. FDI also facilitates

international trade and transfer of knowledge, skills and technology. In a world


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of increased competition and rapid technological change, their complimentary

and catalytic role can be very valuable.

Superiority of FDI over Other Forms of Capital Inflows

FDI is perceived superior to other types of capital inflows for several reasons:

1. In contrast to foreign lenders and portfolio investors, foreign directinvestors typically have a longer-term perspective when engaging in a host

country. Hence, FDI inflows are less volatile and easier to sustain at times of

crisis.2. While debt inflows may finance consumption rather than investment in the

host country, FDI is more likely to be used productively.

3. FDI is expected to have relatively strong effects on economic growth, as FDIprovides for more than just capital. FDI offers access to internationally

available technologies and management know-how, and may render it

easier to penetrate word markets.

A recent United Nations report has revealed that FDI flows are less volatile

than portfolio flows. To quote, FDI flows to developing and transition

economies in 1998 declined by about 5 percent from the peak in 1997, a

modest reduction in relation to the effects on the other capital flows of the

spread of the Asian financial crisis to global proportions. FDI flows are

generally much less volatile than portfolio flows. The decline was modest in all

regions, even in the Asian economies most affected by the financial crisis.

FDI is the appropriate form of external financing for developing countries,

which have less capacity than highly developed economies to absorb external

shocks. Likewise, the evidence supports the predominant view that FDI is more

stable than other types of capital inflows. Moreover, the volatility of FDI


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remained exceptionally low in the 1990s, when several emerging economies

were hit by financial crisis.

FDI is widely considered an essential element for achieving sustainabledevelopment. Even former critics of MNCs expect FDI to provide a stronger

stimulus to income growth in host countries than other types of capital

inflows. Especially after the recent financial crisis in Asia and Latin America,

developing countries are strongly advised to rely primarily on FDI, in order to

supplement national savings by capital inflows and promote economic

development.

Macro-economic and Micro-economic Aspects of FDI

In judging the significance of FDI, especially from the view point of developing

countries, it is useful to make a distinction between macro-economic and

micro-economic effects. The former is connected with issues of domestic

capital formation, balance of payments, and taking advantage of external

markets for achieving faster growth, while the latter is connected with the

issues of cost reduction, product quality improvement, making changes in

industrial structure and developing global inter-firm linkages.

In this context, it needs to be recognized that FDI is an aggregate entity, the

sum total of the investments made by many diverse multinationals, each with

its own corporate strategy. The micro-economic effects of the investment

made by one multinational may be quite different from that of another

multinational even if the investments are made in the same industry. Also,

what benefits the local economy will depend on the capabilities of the host

country in regard to technology transfer and industrial restructuring.


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Resource-seeking and Market-seeking FDI

Two major types of FDI are typically differentiated: resource-seeking FDI and

market-seeking FDI.

Resource-seeking FDI is motivated by the availability of natural resources in

the host countries. This type of FDI was historically important and remains a

relevant source of FDI for various developing countries. However, on a world-

wide scale, the relative importance of resource-seeking FDI has decreased

significantly.

The relative importance of market-seeking FDI is rather difficult to assess. It is

almost impossible to tell whether this type of FDI has already become less

important due to economic globalization. Regarding the history of FDI in

developing countries, various empirical studies have shown that the size and

growth of host country markets were among the most important FDI

determinants. It is debatable, however, whether this is still true with ongoing

globalization.

Globalisation essentially means that geographically dispersed manufacturing,

slicing up the value chain and the combination of markets and resources

through FDI and trade are becoming major characteristics of the world

economy. Efficiency-seeking FDI, i.e. FDI motivated by creating new sources of

competitiveness for firms and strengthening existing ones, may then emerge

as the most important type of FDI. Accordingly, the competition for FDI would

be based increasingly on cost differences between locations, the quality of

infrastructure and business-related services, the ease of doing business and

the availability of skills. Obviously, this scenario involves major challenges for

developing countries, ranging from human capital formation to the provision


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of business-related services such as efficient communication and distribution

systems.

2.2 Nature of FDI

Almost all modern (FDI) is carried out by corporations rather than individuals.

Somewhat like portfolio investment, the flows of FDI have historically been

highly concentrated, both in terms of geography and by industry and at both

the investor and receptor poles. Geographically, the ownership of global stocks

of FDI is highly skewed towards only a few large, high income countries. Each

investing country has, whether by accident or design , tended to direct the

major part of its FDI to only a very few receiving countries; in fact the pattern

of global distribution of FDI have been highly similar to historical relationships

based on colonial ties or other forms of political hegemony.

Viewed industrially, for any given country, FDI generally comes from less than

four or five out of twenty or so major industry groups and inflows into those

same industries in the receptor country.

General attribute of FDI is that it has evoked by type over time. Prior to First

World War, a crude but valid generalization would that a large part of FDI was

in service sector of the host economy (particularly transportation, power,

communication and trading) while most of the rest was of the backward

vertical integration type. During the inter-war period, most of the currently

largest manufacturing multinational corporations (MNCs) made their initial

foreign investments, but these horizontal or market extension types of

investments have now become major category.


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The fourth recognized characteristic of manufacturing FDI is that it originates

in industries that are technologically intensive, skill oriented or progressive.

In addition, the FDI prone industries are typically more concentrated, have

higher advertising outlays per unit of sales and exhibit above average export

propensities. Industries from which FDI tends to originate display many

characteristics associated with oligopoly.

Another universal property of FDI is that it is really a package of

complementary inputs, a collective flow of both tangible and intangible assets

& services.

2.2.1 FDI in Developing Countries

FDI is now increasingly recognized as an important contributor to a developing

countrys economic performance and international competitiveness.

After the debt-crisis that hit the developing world in early 1980s, the

conventional wisdom quickly became that it had been unwise for countries to

borrow so heavily from international banks or international bond markets.

Rather countries should try to attract non-debt-creating private inflows (DFI).

The financial advantage is that such capital inflows need not be repaid and that

outflow of funds (remittance of profits) would fluctuate with the cycle of the

economy. It has also been widely observed that the structural adjustment

efforts of the 1980s failed to lead to new patterns of sustained growth in

developing countries. In particular, structural adjustment programs failed to

restore private investment to desirable levels. Again it is hoped that FDI could

play an important role; the World Bank observes that FDI can be an important

complement to the adjustment effort, especially in countries having difficulty

in increasing domestic savings.


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Against this background of balance of payments problems and low level of

private investment, it is probably not surprising that attitudes in developing

countries towards FDI have shifted. In the 1960s and 1970s many countries

maintained a rather cautious, and sometimes an outright negative position

with respect to FDI. In the 1980s, however the attitudes shifted radically

towards a more welcoming policy stance. This change was not so much due to

new research finding on the impact of FDI but to the economic problems facing

the developing world.

Developing countries are liberalizing their foreign investment regimes and are

seeking FDI not only as a source of capital funds and foreign exchange but also

as a dynamic and efficient vehicle to secure the much needed industrial

technology, managerial expertise and marketing know-how and networks to

improve on growth, employment, productivity and export performance.

At the global level the flows of FDI and PFI to developing countries have indeed

increased. The average net inflow of FDI in developing countries had been US$

11 billion in 1980-86, but in 1987 it started to increase, by 1991 the annual net

inflow had risen to US$ 35 billion and by 2004 to US$ 233 billion. The share of

developing economies in total inflow of Foreign Direct Investment in the world

has been rising continuously since 1989.


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2.2.1 ADVANTAGES AND DISADVANTAGES OF FDI FOR THE HOST COUNTRY

Advantages of Foreign Direct Investment

Foreign Direct Investment has the following potential benefits for less

developed countries.

1. Raising the Level of Investment: Foreign investment can fill the gapbetween desired investment and locally mobilised savings. Local capital

markets are often not well developed. Thus, they cannot meet the capital

requirements for large investment projects. Besides, access to the hardcurrency needed to purchase investment goods not available locally can be

difficult. FDI solves both these problems at once as it is a direct source of

external capital. It can fill the gap between desired foreign exchange

requirements and those derived from net export earnings.

2. Upgradation of Technology: Foreign investment brings with it technologicalknowledge while transferring machinery and equipment to developing

countries. Production units in developing countries use out-dated

equipment and techniques that can reduce the productivity of workers and

lead to the production of goods of a lower standard.

3. Improvement in Export Competitiveness: FDI can help the host countryimprove its export performance. By raising the level of efficiency and the

standards of product quality, FDI makes a positive impact on the host

countrys export competitiveness. Further, because of the international

linkages of MNCs, FDI provides to the host country better access to foreign

markets. Enhanced export possibility contributes to the growth of the host

economies by relaxing demand side constraints on growth. This is

important for those countries which have a small domestic market and


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must increase exports vigorously to maintain their tempo of economic

growth.

4. Employment Generation: Foreign investment can create employment inthe modern sectors of developing countries. Recipients of FDI gain training

of employees in the course of operating new enterprises, which contributes

to human capital formation in the host country.

5. Benefits to Consumers: Consumers in developing countries stand to gainfrom FDI through new products, and improved quality of goods at

competitive prices.

6. Resilience Factor: FDI has proved to be resilient during financial crisis. Forinstance, in East Asian countries such investment was remarkably stable

during the global financial crisis of 1997-98. In sharp contrast, other forms

of private capital flows like portfolio equity and debt flows were subject to

large reversals during the same crisis. Similar observations have been made

in Latin America in the 1980s and in Mexico in 1994-95. FDI is consideredless prone to crises because direct investors typically have a longer-term

perspective when engaging in a host country. In addition to risk sharing

properties of FDI, it is widely believed that FDI provides a stronger stimulus

to economic growth in the host countries than other types of capital

inflows. FDI is more than just capital, as it offers access to internationally

available technologies and management know-how.

7. Revenue to Government: Profits generated by FDI contribute to corporatetax revenues in the host country.

2.2.2 Disadvantages of Foreign Direct Investment


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FDI is not an unmixed blessing. Governments in developing countries have to

be very careful while deciding the magnitude, pattern and conditions of private

foreign investment. Possible adverse implications of foreign investment are the

following:

1. When foreign investment is competitive with home investment, profits indomestic industries fall, leading to fall in domestic savings.

2. Contribution of foreign firms to public revenue through corporate taxes iscomparatively less because of liberal tax concessions, investment

allowances, disguised public subsidies and tariff protection provided by the

host government.

3. Foreign firms reinforce dualistic socio-economic structure and increaseincome inequalities. They create a small number of highly paid modern

sector executives. They divert resources away from priority sectors to the

manufacture of sophisticated products for the consumption of the local

elite. As they are located in urban areas, they create imbalances between

rural and urban opportunities, accelerating flow of rural population to

urban areas.

4. Foreign firms stimulate inappropriate consumption patterns throughexcessive advertising and monopolistic market power. The products made

by multinationals for the domestic market are not necessarily low in price

and high in quality. Their technology is generally capital-intensive which

does not suit the needs of a labour-surplus economy.


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5. Foreign firms able to extract sizeable economic and political concessionsfrom competing governments of developing countries. Consequently,private profits of these companies may exceed social benefits.

6. Continual outflow of profits is too large in many cases, putting pressure onforeign exchange reserves. Foreign investors are very particular about profit

repatriation facilities.

7. Foreign firms may influence political decisions in developing countries. Inview of their large size and power, national sovereignty and control over

economic policies may be jeopardized. In extreme cases, foreign firms may

bribe public officials at the highest levels to secure undue favours. Similarly,

they may contribute to friendly political parties and subvert the political

process of the host country.

Key question, therefore, is how countries can minimize possible negative

effects and maximize positive effects of FDI through appropriate policies.

2.2.2 DETERMINANTS OF FDI

To understand the scale and direction of FDI flows, it is necessary to identify

their major determinants. The relative importance of FDI determinants varies

not only between countries but also between different types of FDI.

Traditionally, the determinants of FDI include the following.


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1.Size of the Market: Large developing countries provide substantial marketswhere the consumers demand for certain goods far exceed the available

supplies. This demand potential is a big draw for many foreign-owned

enterprises. In many cases, the establishment of a low cost marketing

operation represents the first step by a multinational into the market of

the country. This establishes a presence in the market and provides

important insights into the ways of doing business and possible

opportunities in the country.

2.Political stability: In many countries, the institutions of government arestill evolving and there are unsettled political questions. Companies are

unwilling to contribute large amounts of capital into an environment where

some of the basics political questions have not yet been resolved.

3.Macro-economic Environment: Instability in the level of prices andexchange rate enhance the level of uncertainty, making business planning

difficult. This increases the perceived risk of making investments and

therefore adversely affects the inflow of FDI.

4.Legal and Regulatory Framework: The transition to a market economyentails the establishment of a legal and regulatory framework that is

compatible with private sector activities and the operation of foreign

owned companies. The relevant areas in this field include protection of

property rights, ability to repatriate profits, and a free market for currency

exchange. It is important that these rules and their administrative

procedures are transparent and easily comprehensive.


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5.Access to Basic Inputs: Many developing countries have large reserves ofskilled and semi-skilled workers that available for employment at wagessignificantly lower than in developed countries. This provides an

opportunity for foreign firms to make investments in these countries to

cater to the export market. Availability of natural resources such as oil and

gas, minerals and forestry products also determine the extent of FDI.

The determinants of FDI differ among countries and across economic sectors.

These factors include the policy framework, economic determinants and the

extent of business facilitation such as macro-economic fundamentals and

availability of infrastructure.

2.3 FOREIGN DIRECT INVESTMENT IN INDIA

Since independence till 1990, the performance of Indian economy has been

dominated by a regime of multiple controls, restrictive regulations and wide

ranging state intervention. Industrial economy of the country was protected by

the state and insulated from external competition. As a result of which, India

was thrown a long way behind the world of rapid expanding technology. The

cumulative effect of these policies started becoming more and more

pronounced. By the year 1989-90, the situation on the balance of payment and

foreign exchange reserves became precarious and the country was driven to

the brink of default. The credibility reached the sinking level that no country

was willing to advance or lend to India at any cost. In such circumstances, the

government quickly followed a liberalized economic policy in July 1991.


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The main objectives of the liberalized economic policy are two fold. At the

country level the reform aims at freeing domestic investors from all the

licensing requirements, virtual abolition of MRTP restriction on the investment

by large houses, and a competitive industrial structure for Indian companies to

achieve a global presence by becoming as competitive as their counterparts

worldwide. Secondly, the focus on structural reforms intended to tap foreign

investment for economic growth and development.

Gradually & systematically the government has taken a series of measures like

devaluation of rupee, lowering of import duties and allowing foreign

investment upto 51% of the equity in a large number of industries and

investment of large foreign equity (even up to 100%) in selected areas

especially for export oriented products.

In India, since the 1960s foreign investment and/or foreign collaborations by

the multinationals have been principally viewed as an instrument to facilitate

the much needed transfer of technology. In technological as well as financial

collaborations with foreign firms, the approval and extent of ownership

participation had been predominantly determined by the technology

component of the respective products. Import of technology as against the

direct foreign investment was the main focus of the policies till mid-eighties.

The New Industrial Policy (NIP) of July 1991 and subsequent policy

amendments have significantly liberalized the industrial policy regime in the

country especially as it applies to FDI. The industrial approval system in all


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industries has been abolished except for some strategic or environmentally

sensitive industries. In 35 high priority industries, FDI up to 51% is approved

automatically if certain norms are satisfied. FDI proposals do not necessarily

have to be accompanied by technology transfer agreements. Trading

companies engaged primarily in export activities are also allowed up to 51%

foreign entity. A Foreign Investment Promotion Board (FIPB) has been set up to

invite and facilitate investment in India by international companies. The use of

foreign brand names for goods manufactured by domestic industry which had

earlier been restricted was also liberalized. New sectors have been opened to

private and foreign investment. The international trade policy regime has been

considerably liberalized too. The rupee was made convertible first on trade and

finally on the current account. Capital market has been strengthened. In spite

of all these liberalization measures taken by the Indian government- foreign

investments have not been up to expectations. Actual inflow of FDI has been

less than the approval FDI.

2.4 POLICIES AND PROCEDURES OF FDI

The initial policy stimulus to foreign direct investment in India came in July

1991 when the new industrial policy provided, inter alia, automatic route

approval for projects with foreign equity participation up to 51 percent in high

priority areas. In recent years, the government has initiated the secondgeneration reforms under which measures have been taken to further facilitate

and broaden the base of FDI in India. The policy of FDI allows freedom of

location, choice of technology repatriation of capital and dividends. The rate at

which FDI inflow has grown during the post-liberalization period is a clear

indication that India is a fast emerging as an attractive destination for overseas

investors.


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As part of the economic reforms programme, policy and procedures governing

foreign investment and technology transfer have been significantly simplified

and streamlined. Today FDI is allowed in all sectors including the service sector

except in cases where there are sectoral ceilings.

2.4.1 FDI Policy Regime

Most of the problem for investors arises because of domestic policy, rules and

procedures and not the FDI policy per se or its rules and procedure.

India has one of the most transparent and liberal FDI regimes among theemerging and developing economies. By FDI regime it means those restrictions

that apply to foreign nationals and entities but not to Indian nationals and Indian

owned entities. The differential treatment is limited to a few entry rules, spelling

out proportion of equity that the foreign entrant can hold in an Indian company

or business. There are a few banned sectors and some sectors with limits on

foreign equity proportion. The entry rules are clear and well defined and equity

limits for FDI in selected sectors such as telecom quite explicit and well-known.

Subject to these foreign equity conditions a foreign company can set up a

registered company in India and operate under the same laws, rules and

regulations as any Indian owned company would. There is absolutely no

discrimination against foreign invested companies registered in India or in

favour of domestic owned ones. There is however a minor restriction on those

foreign entities who entered a particular sub-sector through a joint venture with

an Indian partner. If they want to set up another company in the same sector it

must get a no-objection certificate from the joint venture partner. This condition

is explicit and transparent unlike many hidden conditions imposed by some

other recipients of FDI.

2.4.2 Routes for Inward Flows of FDI


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FDI can be approved either through the automatic route or by the Government.

1. Automatic Route: Companies proposing FDI under automatic route do not

require any government approval provided the proposed foreign equity is withinthe specified ceiling and the requisite documents are filed with Reserve Bank of

India (RBI) within 30 days of receipt of funds. The automatic route

encompasses all proposals where the proposed items of manufacture/activity

does not require an industrial license and is not reserved for small-scale sector.

The automatic route of the RBI was introduced to facilitate FDI inflows.

However, during the post-policy period, the actual investment flows through the

automatic route of the RBI against total FDI flows remained rather insignificant.

This was partly due to the fact that crucial areas like electronics, services and

minerals were left out of the automatic route. Another limitation was the ceiling

of 51 percent on foreign equity holding. Increasing number proposals were

cleared through the FIPB route while the automatic route was relatively

unimportant. However, since 2000 automatic route has become significant and

accounts for a large part of FDI flows.

2. Government Approval: For the following categories, government approval

for FDI through the Foreign Investment Promotion Board (FIPB) is necessary:

Proposals attracting compulsory licensing Items of manufacture reserved for small scale sector. Acquisition of existing shares.

FIPB ensures a single window approval for the investment and acts as a

screening agency. FIPB approvals are normally received in 30 days. Some

foreign investors use the FIPB application route where there may be absence of

stated policy or lack of policy clarity.


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3. Industrial Licensing in FDI Policy: Industrial Licensing is regulated byIndustries (Development and Regulation) Act 1951. Following are the sectors

which require Industrial Licensing:

Industries which abide by compulsory licensing Manufacturing of items by the larger industrial units for small sector

industries

Locational restrictions on the proposed sitesSectors Which Require Industrial Licensing:

Electronic aerospace and defense equipment Alcoholics drinks Explosives Cigarettes and tobacco products Hazardous chemicals such as, hydrocyanic acid, phosgene, isocynates

and di-isocynates of hydro carbon and derivatives.

4. Restricted List of sectors: FDI is not permissible in the following cases:

Gambling and Betting, or Lottery Business, or Business of chit fund Housing and Real Estate business (to a certain extent has been

opened.)

Trading in Transferable Development Rights (TDRs) Retail Trading Railways, Atomic Energy , atomic minerals,


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Agricultural or plantation activities or Agriculture (excluding Floriculture,Horticulture, Development of Seeds, Animal Husbandry, Pisiculture and

Cultivation of Vegetables, Mushrooms etc. under controlled conditions

and services related to agro and allied sectors) and Plantations(other

than Tea plantations)

The new polices have substantially relaxed restrictions on foreign investment,

industrial licensing and foreign exchange. Capital market has been opened to

foreign investment and banking sector controls have been eased. As a result,

India has been rapidly changing from a restrictive regime to a liberal one and

FDI is encouraged in almost all economic activities under the automatic route.

The Government is committed to promoting increased flow of FDI for better

technology, modernization, exports and for providing products and services of

international standards. Therefore, the policy of the Government has been

aimed at encouraging foreign investment, particularly in core infrastructure

sectors so as to supplement national efforts.

2.4.3 Post-approval Procedures

1. Project Clearance: After the approval has been obtained, the applicant may

get his unit/company registered with the Registrar of Company. Subsequently,

the company needs to obtain various clearances such as land clearance,

building design clearance, pre-construction clearance, labour clearance, etc.from different authorities before beginning its operations. These clearances

differ from sector to sector and may also differ from state to state.

2. Registration and Inspection: Each industrial unit is supposed to maintain

records in regard to production, sale and export, use of specified raw materials

including public utilities like water and electricity, labour related details

financial details and details in regard to industrial safety and environment.


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The unit is also subject to periodic inspection by the factories inspector, labour

inspector, food inspector, fire inspector, central excise inspector, air and water

inspector, mines inspector, city inspector and the like, the list of which may go

up to thirty or more.

3. Foreign Exchange Management Act (FEMA), 2000: The additional provisions

which apply only to entry of FDI emanate from the provisions of FEMA.

According to FEMA, no person resident outside India shall without the

approval/knowledge of the RBI may establish in India a branch or a liaison

office or a project office or any other place of business.

FDI in a particular industry may, however, be made through the automatic

route under powers delegated to the RBI or with the approval accorded by the

FIPB. The automatic route means that foreign investors only need to inform

the RBI within 30 days of bringing in their investment. Companies getting

foreign investment approval through FIPB route do not require any further

clearance from RBI for the purpose of receiving inward remittance and issue of

shares to foreign investors. RBI has granted general permission under FEMA in

respect to proposals approved by FIPB. Such companies are, however, required

to notify the concerned regional office of the RBI of receipt of inward

remittances within 30 days of such receipts and again within 30 days of issue of

shares to the foreign investors.

2.4.4 Entry Options for Foreign Investors

A foreign company planning to set up business operations in India has the

following options:

By incorporating a company under the Companies Act, 1956 through

Joint Ventures; or


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Wholly Owned SubsidiariesForeign equity in such Indian companies can be up to 100% depending on the

requirements of the investor, subject to equity caps in respect of the area of

activities under the Foreign Direct Investment (FDI) policy.

Enter as a foreign Company through

Liaison Office/Representative Office Project Office Branch Office

Such offices can undertake activities permitted under the Foreign Exchange

Management Regulations, 2000.

1. Incorporation of Company: For registration and incorporation, anapplication has to be filed with Registrar of Companies (ROC). Once a

company has been duly registered and incorporated as an Indian company,

it is subject to Indian laws and regulations as applicable to other domestic

Indian companies.

2. Liaison Office/Representative Office: The role of the liaison office is limitedto collecting information about possible market opportunities and providing

information about the company and its products to prospective Indian

customers. It can promote export/import from/to India and also facilitate

technical/financial collaboration between parent company and companies

in India. Liaison office can not undertake any commercial activity directly or

indirectly and can not, therefore, earn any income in India. Approval for

establishing a liaison office in India is granted by Reserve Bank of India

(RBI).


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3. Project Office: Foreign Companies planning to execute specific projects inIndia can set up temporary project/site offices in India. RBI has now granted

general permission to foreign entities to establish Project Offices subject to

specified conditions. Such offices can not undertake or carry on any activity

other than the activity relating and incidental to execution of the project.

Project Offices may remit outside India the surplus of the project on its

completion, general permission for which has been granted by the RBI.

4. Branch Office: Foreign companies engaged in manufacturing and tradingactivities abroad are allowed to set up Branch Offices in India for the

following purposes:

Export/Import of goods Rendering professional or consultancy services Carrying out research work, in which the parent company is engaged. Promoting technical or financial collaborations between Indian

companies and parent or overseas group company.

Representing the parent company in India and acting as buying/sellingagents in India.

Rendering services in Information Technology and development ofsoftware in India.

Rendering technical support to the products supplied by the parent/group companies.

Foreign airline/shipping Company.A branch office is not allowed to carry out manufacturing activities on its own

but is permitted to subcontract these to an Indian manufacturer. Branch

Offices established with the approval of RBI may remit outside India profit of


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the branch, net of applicable Indian taxes and subject to RBI guidelines

Permission for setting up branch offices is granted by the Reserve Bank of India

(RBI).

5. Branch office on Stand-Alone Basis in Special Economic Zones (SEZs) : Suchbranch offices would be isolated and restricted to the SEZ and no business

activity/transaction will be allowed outside the SEZ in India, which include

branches/subsidiaries of their parent office in India. No approval shall be

necessary from RBI for a company to establish a branch/unit in SEZs to

undertake manufacturing and service activities, subject to specified

conditions.

6. Investment in a Firm or a Proprietary Concern by NRIs: A Non-ResidentIndian (NRI) or a Person of Indian Origin (PIO) resident outside India may

invest by way of contribution to the capital of a firm or a proprietary

concern in India on non-repatriation basis provided:

The amount is invested by inward remittance or out of specified accounttypes (NRE/FCNR/NRO accounts) maintained with an Authorized Dealer.

The firm or proprietary concern is not engaged in anyagriculture/plantation or real estate business, i.e. dealing in land and

immovable property with a view to earning profit or earning income

there from.

The amount invested shall not be eligible for repatriation outside India.NRIs/PIOs may invest in sole proprietorship concerns/partnership firms

with repatriation benefits with the approval of Government/ RBI.

7. Investment in a Firm or a Proprietary concern Other Than NRIs: No person


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resident outside India other than NRI/PIO shall make any investment by

way of contribution to the capital of a firm or a proprietorship concern or

any association of persons in India. The RBI may, on an application made to

it, permit a person resident outside India to make such an investment

subject to such terms and conditions as may be considered.

2.4.5 Other Modes of Foreign Direct Investments1. Global Depository Receipts (GDR)/American Deposit Receipts

(ADR)/Foreign Currency Convertible Bonds (FCCB): Foreign Investment

through GDRs/ADRs, Foreign Currency Convertible Bonds (FCCBs) are

treated as Foreign Direct Investment. Indian companies are allowed to raise

equity capital in the international market through the issue of

GDR/ADRs/FCCBs. These are not subject to any ceilings on investment. An

applicant company seeking Government's approval in this regard should have a

consistent track record for good performance (financial or otherwise) for a

minimum period of 3 years. This condition can be relaxed for infrastructure

projects such as power generation, telecommunication, petroleum exploration

and refining, ports, airports and roads.

There is no restriction on the number of GDRs/ADRs/FCCBs to be floated by a

company or a group of companies in a financial year. A company engaged in

the manufacture of items covered under Automatic Route is likely to exceed thepercentage limits under the Automatic Route, whose direct foreign investment

after a proposed GDR/ADR/FCCBs issue is likely to exceed 50 per cent/51 per

cent/74 per cent as the case may be, or which is implementing a project not

contained in project falling under Government Approval route, would need to

obtain prior Government clearance through FIPB before seeking final approval

from the Ministry of Finance.


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There are no end-use restrictions on GDR/ADR issue proceeds, except for an

express ban on investment in real estate and stock markets. The FCCB issue

proceeds need to conform to external commercial borrowing end use

requirements; in addition, 25 per cent of the FCCB proceeds can be used for

general corporate restructuring.

2. Preference Shares:

Foreign investment through preference shares is treated as foreign direct

investment. Proposals are processed either through the automatic route or FIPB

as the case may be. The following guidelines apply to issue of such shares:-

Foreign investment in preference share are considered as part of sharecapital and fall outside the External Commercial Borrowing (ECB)

guidelines/cap

Preference shares to be treated as foreign direct equity for purpose ofsectoral caps on foreign equity, where such caps are prescribed, provided

they carry a conversion option. If the preference shares are structured

without such conversion option, they would fall outside the foreign direct

equity cap.

Duration for conversion shall be as per the maximum limit prescribedunder the Companies Act or what has been agreed to in the share holders

agreement whichever is less.

The dividend rate would not exceed the limit prescribed by the Ministryof Finance.

Issue of Preference Shares should conform to guidelines prescribed by theSEBI and RBI and other statutory requirements.

2.4.6 Foreign Technology Agreements


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Foreign technology induction is encouraged both through FDI and through

foreign technology agreements. India has one of the most liberal policy

regimes in regard to technology agreements. Foreign technology collaboration

is permitted either through automatic route or through FIPB.

1. Automatic Approval: RBI accords automatic approval for foreign technology

collaboration agreements for all industries subject to the following:

The lump sum payment should not exceed US$ 2 million. Royalty payable is limited to 5 percent for domestic sales and 8 percent

for exports subject to total payment of 8 percent on sales over a 10 year

period.

The period for payment of royalty not exceed 7 years from the date ofcommencement of commercial production, or 10 years from the date of

agreement whichever is earlier.

2. FIPB Route: For the following categories, Government approval is necessary:

Proposals attracting compulsory licensing. Items of manufacture reserved for small-scale sector. Proposals involving any previous joint venture or technology

transfer/trade mark agreement in the same or allied field in India.

Extension of foreign technology collaboration agreements. Proposals not meeting any or all of the parameters for automatic

approval.

The different components of foreign technology collaboration such as technical

know how fees, payment for design and drawing, payment for engineering


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service and royalty are eligible for approval through the automatic route, and

by the Government.

CHAPTER-8:

2.5 SECTOR SPECIFIC GUIDELINES FOR FDI IN INDIA

Hotel & Tourism Sector

100% FDI is permissible in the sector on the automatic route.

The term hotels include restaurants, beach resorts, and other tourist

complexes providing accommodation and/or catering and food facilities to

tourists. Tourism related industry include travel agencies, tour operating

agencies and tourist transport operating agencies, units providing facilities for

cultural, adventure and wild life experience to tourists, surface, air and water

transport facilities to tourists, leisure, entertainment, amusement, sports, and

health units for tourists and Convention/Seminar units and organizations.

For foreign technology agreements, automatic approval is granted if

1. Up to 3% of the capital cost of the project is proposed to be paid fortechnical and consultancy services including fees for architects, design,

supervision, etc.

2. Up to 3% of net turnover is payable for franchising and marketing/publicitysupport fee, and up to 10% of gross operating profit is payable for

management fee, including incentive fee.

Private Sector Banking:

49% FDI is allowed from all sources on the automatic route subject to

guidelines issued from RBI from time to time.


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1. FDI/NRI/OCB investments allowed in the following 19 NBFC activities shallbe as per levels indicated below:

a. Merchant bankingb. Underwritingc. Portfolio Management Servicesd. Investment Advisory Servicese. Financial Consultancyf. Stock Brokingg. Asset Managementh. Venture Capitali. Custodial Servicesj. Factoringk. Credit Reference Agenciesl. Credit rating Agenciesm.

Leasing & Finance

n. Housing Financeo. Foreign Exchange Brokeringp. Credit card businessq. Money changing Businessr. Micro Credits. Rural Credit

2. Minimum Capitalization Norms for fund based NBFCs:a. For FDI up to 51% - US$ 0.5 million to be brought upfrontb. For FDI above 51% and up to 75% - US $ 5 million to be brought upfrontc. For FDI above 75% and up to 100% - US $ 50 million out of which US $

7.5 million to be brought upfront and the balance in 24 months


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3. Minimum capitalization norms for non-fund based activities: Minimumcapitalization norm of US $ 0.5 million is applicable in respect of allpermitted non-fund based NBFCs with foreign investment.

4. Foreign investors can set up 100% operating subsidiaries without thecondition to disinvest a minimum of 25% of its equity to Indian entities,

subject to bringing in US$ 50 million as at 2.(c) above (without any

restriction on number of operating subsidiaries without bringing in

additional capital)

5. Joint Venture operating NBFC's that have 75% or less than 75% foreigninvestment will also be allowed to set up subsidiaries for undertaking other

NBFC activities, subject to the subsidiaries also complying with the

applicable minimum capital inflow i.e. 2.(a) and 2.(b) above.

6. FDI in the NBFC sector is put on automatic route subject to compliance withguidelines of the Reserve Bank of India. RBI would issue appropriate

guidelines in this regard.


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Insurance Sector

FDI up to 26% in the Insurance sector is allowed on the automatic route

subject to obtaining licence from Insurance Regulatory & DevelopmentAuthority (IRDA)

Telecommunication sector

1. In basic, cellular, value added services and global mobile personalcommunications by satellite, FDI is limited to 49% subject to licensing and

security requirements and adherence by the companies (who are investingand the companies in which investment is being made) to the license

conditions for foreign equity cap and lock- in period for transfer and

addition of equity and other license provisions.

2. ISPs with gateways, radio-paging and end-to-end bandwidth, FDI ispermitted up to 74% with FDI, beyond 49% requiring Government approval.

These services would be subject to licensing and security requirements.

3. No equity cap is applicable to manufacturing activities.

4. FDI up to 100% is allowed for the following activities in the telecom sector :a. ISPs not providing gateways (both for satellite and submarine cables);b. Infrastructure Providers providing dark fiber (IP Category 1);c. Electronic Mail; andd. Voice Mail

The above would be subject to the following conditions:


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FDI up to 100% is allowed subject to the condition that such companieswould divest 26% of their equity in favor of Indian public in 5 years, if

these companies are listed in other parts of the world.

The above services would be subject to licensing and securityrequirements, wherever required.

Proposals for FDI beyond 49% shall be considered by FIPB on case to case

basis.

Trading Companies

Trading is permitted under automatic route with FDI up to 51% provided it is

primarily export activities, and the undertaking is an export house/trading

house/super trading house/star trading house. However, under the FIPB

route:-

1. 100% FDI is permitted in case of trading companies for the followingactivities:

a. exports;b. bulk imports with ex-port/ex-bonded warehouse sales;c. cash and carry wholesale trading;d. Other import of goods or services provided at least 75% is for procurement

and sale of goods and services among the companies of the same group and

not for third party use or onward transfer/distribution/sales.

2. The following kinds of trading are also permitted, subject to provisions ofEXIM Policy:

a. Companies for providing after sales services (that is not trading per se)


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b. Domestic trading of products of JVs is permitted at the wholesale levelfor such trading companies who wish to market manufactured products

on behalf of their joint ventures in which they have equity participation

in India.

c. Trading of hi-tech items/items requiring specialized after sales serviced. Trading of items for social sectore. Trading of hi-tech, medical and diagnostic items.f. Trading of items sourced from the small scale sector under which, based

on technology provided and laid down quality specifications, a company

can market that item under its brand name.

g. Domestic sourcing of products for exports.h. Test marketing of such items for which a company has approval for

manufacture provided such test marketing facility will be for a period of

two years, and investment in setting up manufacturing facilities

commences simultaneously with test marketing.

FDI up to 100% permitted for e-commerce activities subject to the condition

that such companies would divest 26% of their equity in favor of the Indian

public in five years, if these companies are listed in other parts of the world.

Such companies would engage only in business to business (B2B) e-commerce

and not in retail trading.

Power Sector

Up to 100% FDI allowed in respect of projects relating to electricity generation,

transmission and distribution, other than atomic reactor power plants. There is

no limit on the project cost and quantum of foreign direct investment.


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Drugs & Pharmaceuticals

FDI up to 100% is permitted on the automatic route for manufacture of drugs

and pharmaceutical, provided the activity does not attract compulsory

licensing or involve use of recombinant DNA technology, and specific cell /

tissue targeted formulations. FDI proposals for the manufacture of licensable

drugs and pharmaceuticals and bulk drugs produced by recombinant DNA

technology, and specific cell / tissue targeted formulations will require prior

Government approval.

Infrastructure Sector

FDI up to 100% under automatic route is permitted in projects for construction

and maintenance of roads, highways, vehicular bridges, toll roads, vehicular

tunnels, ports and harbours.

Pollution Control and Management

FDI up to 100% in both manufacture of pollution control equipment and

consultancy for integration of pollution control systems is permitted on the

automatic route.

Call Centres in India / Call Centres in India

FDI up to 100% is allowed subject to certain conditions.

Business Process Outsourcing BPO in India

FDI up to 100% is allowed subject to certain conditions.


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Special Facilities and Rules for NRI's and OCB's

NRI's and OCB's are allowed the following special facilities:

1. Direct investment in industry, trade, infrastructure etc.2. Up to 100% equity with full repatriation facility for capital and dividends in

the following sectors:

a. 34 High Priority Industry Groupsb. Export Trading Companiesc. Hotels and Tourism-related Projectsd. Hospitals, Diagnostic Centerse. Shippingf. Deep Sea Fishingg. Oil Explorationh. Poweri. Housing and Real Estate Developmentj. Highways, Bridges and Portsk. Sick Industrial Unitsl. Industries Requiring Compulsory Licensingm.Industries Reserved for Small Scale Sectorn. Up to 40% Equity with full repatriation: New Issues of Existing

Companies raising Capital through Public Issue up to 40% of the newCapital Issue.

o. On non-repatriation basis: Up to 100% Equity in any Proprietary orPartnership engaged in Industrial, Commercial or Trading Activity.

p. Portfolio Investment on repatriation basis: Up to 1% of the Paid up Valueof the equity Capital or Convertible Debentures of the Company by each


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NRI. Investment in Government Securities, Units of UTI, National

Plan/Saving Certificates.

q. On Non-Repatriation Basis: Acquisition of shares of an Indian Company,through a General Body Resolution, up to 24% of the Paid Up Value of

the Company.

r. Other Facilities: Income Tax is at a Flat Rate of 20% on Income arisingfrom Shares or Debentures of an Indian Company.

Certain terms and conditions do apply.

Foreign Direct Investment in Small Scale Industries (SSI's) in India

Recently, India has allowed Foreign Direct Investment up to 100% in many

manufacturing industries which were designated as Small Scale Industries.

India further ended in February 2008 the monopoly of small-scale units on 79

items, leaving just 35 on the reserved list that once had as many as 873 items.


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CHAPTER-9:

FACTORS AFFECTING FDI

The factors that can narrow the gap between FDI approvals and actual foreign

direct investment inflows and indeed make India a preferred destination for

global capital are,

1. Availability of infrastructure in all areas i.e. transports hospitality, telecom,power, etc.

2. Transparency of processes, policies and decision making and reduction ofgovernment decision making lead time.

3. Stability of policies i.e. entry, exit, labour laws, etc. over a definite timehorizon so that definite plans can be made.

4. Acceptance of International Standards including accounting standards.5. Capital account convertibility so that all capital and payments can flow

easily in and out of the economy.

6. Simplification of the regulatory framework in general and tax laws.7. Improvement in bandwidth for internet and data communication.8. Improvement in the enforcement of intellectual property rights.9. Implementation of the WTO agreement full.

All investments foreign and domestic are made under the expectation of

future profits. The economy benefits if economy policy fosters competition,

creates a well functioning modern regulatory system and discourages artificial

monopolies created by the government through entry barriers. A recognition


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and understanding of these facts can result in a more positive attitude towards

FDI. The future policies should be designed in the light of the above

observations. The most important initiatives that need attention are:

1. Empowering the State Governments with regard to FDI.2. Developing fast track clearance system for legal disputes.3. Changing the mind set of bureaucracy through HR practices.4. Developing basic infrastructure.5. Improving Indias image as an investment destination.

While the magnitudes of inflows have recorded impressive growth, they are

still at a small level compared to Indias potential. The policy reforms

undertaken have undoubtedly enabled the country to widen the sectoral and

source composition of FDI inflows. Within a generation, the countries of East

Asian transformed themselves. China, Indonesia, Korea, Thailand and Malaysia

today have living standards much above ours.

When competing for FDI, policy makers have to be aware that various

measures intended to induce FDI are necessary. These include liberalisation of

FDI regulations and various business facilitation measures. Other reforms, such

as privatization, tend to be more effective in stimulating FDI inflows, but need

to be complemented by reform in other areas, in order to ensure that FDIinflows are beneficial. Other determinants of FDI, which were sufficient in the

past, may prove to be less relevant in the future

CHAPTER-III


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(EFFECTIVE FROM APRIL 10, 2012)

CHAPTER-IV

FDI TRENDS IN INDIA

India is the second most populous country and the largest democracy in the

world. The far reaching and sweeping economic reform undertaken since 1991

have unleashed the enormous growth potential of the economy. There has

been a rapid, yet calibrated, move towards deregulation and liberalisation,

which has resulted in India becoming a favourite destination for investment.

Undoubtedly, India has emerged as one of the most vibrant and dynamic of

the developing economies.

India as an Investment Destination

FDI is seen as a means to supplement domestic investment for achieving a

higher level of economic growth and development. FDI benefits domestic

industry as well as the Indian consumers by providing opportunities for

technological upgradation, access to global managerial skills and practices,

optimal utilization of human and natural resources, making Indian industry

internationally competitive, opening up export markets, providing backward

forward linkages and access to international quality goods and services. FDI

policy has been constantly reviewed and necessary steps have been taken to

make India a most favourable destination for FDI. There are several good

reasons for investing in India.

1. Third largest reservoir of skilled manpower in the world.


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2. Large and diversified infrastructure spread across the country.3. Abundance of natural resources and self-efficiency in agriculture.4. Package of fiscal incentives for foreign investors.5. Large and rapidly growing consumer market.6. Democratic government with independent judiciary.7. English as the preferred business language.8. Developed commercial banking network of over 63000 branches supported

by a number of National and State level financial institutions.

9. Vibrant capital market consisting of 22 stock exchanges with over 9400listed companies.

10.Congenial foreign investment environment that provides freedom of entry,investment, location, choice of technology, import and export, and

11.Easy access to markets of Bangladesh, Bhutan, Maldives, Nepal, Pakistanand Sri Lanka.

Indias Performance in the Global Context

According to UNCTAD World Investment Report, 2007, FDI inflows to South

Asia surged by 126% amounting to $22 billion in 2006, mainly due to

investment in India. The country received more FDI than ever before

equivalent to the total inflows during 2003-2005. Inward FDI inflows to Chinadeclined for the first time in 7years. The modest decline by 4% or $69 billion

was mainly due to reduced inflows of financial services.

UNCTADs World Investment Report publishes a set of benchmarks for inward

FDI performance that ranks countries by how they do in attracting inward

direct investment. In contrast, despite enjoying a healthy rate of economic

growth India ranked 120thon UNCTADs inward FDI performance index 1999-


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2001, far below China which ranked 59th

and lower than both Pakistan (116th

)

and Srilanka (111th). As far as inward FDI potential index is concerned, India

ranks 84th

as against Chinas 40th

rank. The World Investment Report, 2005

noted, While India has been catching up in inward FDI, it still ranks near the

bottom.

Top Investing Countries FDI Inflows in India

In FDI equity investments Mauritius tops the list of first ten investing countriesfollowed by US, UK, Singapore, Netherlands, Japan, Germany, France, Cyprus

and Switzerland. Between April 2000 and July 2008 FDI inflows from Mauritius

stood at $ 30.18 billion followed by $5.80 billion from Singapore; $ 5.47 billion

from the US; $ 4.83 billion from the UK; $ 3.12 billion from the Netherlands; $

2.26 billion from Japan; $1.83 billion from Germany; $ 1.41 billion from Cyprus;

and $1.02 billion from France.


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TOP TEN INVESTING (FDI EQUITY) COUNTRIES (In Rs. Crore)

Country 2005-06 2006-07 2007-08

2008-09

(from

April-

March,

2009)

Cumulative

(From April

2000 to April

2009)

% with

total

(inflows

in terms

of

rupees)

Mauritius 11441(2570)

28759(6363)

44483(11096)

50794(11208)

168485(38305)

44%

USA2210

(502)

3861

(856)

4377

(1089)

8002

(1802)28303

(6404)7%

UK1164

(266)

8389

(1878)

4690

(1176)

3840

(864)23002

(5246)6%

Singapore1218

(275)

2662

(578)

12319

(3073)

15727

(3454)34467

(7934) 9%

Netherlands340

(76)

2905

(644)

2780

(695)

3922

(883)15957

(3611)4%

Japan925

(208)

382

(85)

3336

(815)

1889

(405)12041

(2694)3%

Germany1345

(303)

540

(120)

2075

(514)

2750

(629)

9580

(2191)

3%

France82

(18)

528

(117)

583

(145)

2098

(467)5489

(1229)1%

Cyprus310

(70)

266

(58)

3385

(834)

5983

(1287)11140

(2491)3%

UAE219

(49)

1174

(260)

1039

(258)

1133

(257)4146

(948)1%


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Total FDI

inflows*

24613

(5546)

70630

(15726)

98664

(24579)

122919

(27309)404728

(92158)-

Figures in bracket are in US$ million

SOURCE: DIPP, Federal Ministry of Commerce & Industry, Government of India

Top Sectors in India attracting FDI

Theaverage FDI inflows per year during the 9th Plan were $ 3.2 billion andduring the 10th Plan it increased manifold to stand at $ 16.33 billion the annual

average being $ 6.16 billion. The top five sectors attracting FDI in fiscal 2007-08

included Services sector; Housing and Real Estate; Construction activities;

Computer Software & hardware; and Telecommunications. The infrastructure

sector that offers massive potential to attract FDI witnessed marked increase

in FDI inflows during this five-year period. The extant policy for most of the

infrastructure sectors permits FDI up to 100 percent on the automatic route.

From $ 1902 million in fiscal 2001-02 the foreign investment in India's

infrastructure sector increased to $ 2179 million in 2006-07. But fiscal 2007-08

witnessed significant increase in the FDI inflows in the infrastructure. In first

nine months till December 2007 of fiscal 2007-08 stood at $ 4095 million. From

2000-01 to December 2007, total FDI in India's infrastructure sector stood at $

10575 million.


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SECTORS ATTRACTING HIGHEST FDI Inflows (In Rs crore)

SECTOR 2005-06 2006-07 2007-08

2008-09

(April-Jan

'09)

Cumulati

ve

(Apr.2000

- Jan

2009)

% of total

inflows*

Services (Financial &

non-financial)

2399

(543)

21047

(4664)

26589

(6615)

23045

(5061)78742

(181189)22%

Computer Software &

Hardware

6172

(1375)

11786

(2614)

5623

(1410)

6944

(1599)

39111

(8876)11%

Telecommunications2776

(624)

2155

(478)

5103

(1261)

10797

(2374)

27544

(6216)

8%

Construction667

(151)

4424

(985)

6989

(1743)

6224

(1483)

19606

(4646)6%

Automobile630

(143)

1254

(276)

2697

(675)

1792

(441)

11648

(2678)4%

Housing and Real

estate

171

(38)

2121

(467)

8749

(2179)

10632

(2408)

21794

(5119)

6%

Power386

(87)

713

(157)

3875

(967)

4079

(924)

13709

(3130)4%

Metallurgical6540

(147)

7866

(173)

4686

(1177)

3608

(850)

10956

(2613)3%

Chemicals (Other

than fertilizers)

1731

(390)

930

(205)

920

(229)

2561

(579)

9442

(2244)

2%


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Petroleum & Natural

Gas

64

(14)

401

(89)

5729

(1427)

1196

(263)

8509

(2043)3%

Figures in bracket are in US$ million. * In terms of Rs.

SOURCE: DIPP, Federal Ministry of Commerce & Industry, Government of

India

FDI Inflows Year-wise (1990-2009)

Fiscal Year

(April-March)

EquityReinvested

earnings+

Other

capital+

Total FDI

inflows

YOY

growth

(%)

FIPB Route/

RBI's

Automatic

Route

Equity capital of

unincorporated

bodies#

1991(Aug)-

2000 (Mar)15483 - - - 15483 -

2000-01 2339 61 1350 279 4029 -

2001-02 3904 191 1645 390 6130 (+) 52

2002-03 2574 190 1833 438 5035 (-) 18

2003-04 2197 32 1460 633 4322 (-) 14

2004-05 3250 528 1904 369 6051 (+) 40

2005-06 5540 435 2760 226 8961 (+) 48

2006-07 15585 896 5828 517 22826 (+) 146


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2007-08 24575 2292 7168 327 34362 (+) 51

2008-09

(April-Dec)23885 334 3004 203 27426 -

Cumulative

Total (From

Aug 1991-Jan

2009)

99332 4959 26952 3382 134625 -

SOURCE: DIPP, Federal Ministry of Commerce & Industry, Government of India

Foreign Technology Transfer

Country Wise Technology Transfer Approvals (Aug 1991-Feb 2008)

COUNTRY No. of FTA% with total technical

approvals

USA 1772 22.31

Germany 1106 13.93

Japan 868 10.93

UK 860 10.83

Italy 484 6.09

Other countries 2851 35.91

All Countries 7941 100.00


India


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Sector Wise Technology Transfer Approvals (Aug 1991-Feb 2008)

SECTOR

No. Technical

Collaborationsapproved

% of total TechnicalCollaborations approved

Electrical Equipments

(Incl. computer software

& electronics)

1255 15.80

Chemicals (other than

fertilizers)886 11.16

Industrial Machinery 869 10.94

Transportation Industry 742 9.34Misc. Mach.

Engineering Industry442 5.57

Other sectors 3747 47.19

Total all sectors 7941 100.00


India


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CHAPTER-IV

CONCLUSION

Economic reforms in India have deregulated the economy and stimulated

domestic and foreign investment, taking India firmly into the forefront of

investment destinations. The Government, keen to promote FDI in the country,

has radically simplified and rationalized policies, procedures and regulatory

aspects. Foreign direct investment is welcome in almost all sectors; expect

those strategic concerns (defence and atomic energy).

Since the initiation of the economic liberalisation process in 1991, sectors such

as automobiles, chemicals, food processing, oil and natural gas, petro-

chemicals, power, services, and telecommunications have attracted

considerable investments. Today, in the changed investment climate, India

offers exciting business opportunities in virtually every sector of the economy.

Telecom, electrical equipment (including computer software), energy and

transportation sector have attracted the highest FDI.

Despite its market size and potential, India has yet to convert considerable

favourable investor sentiment into substantial net flows of FDI. Overall, India

remains high on corporate investor radar screens, and is widely perceived to

offer ample opportunities for investment. The market size and potential give


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India a definite advantage over most other comparable investment

destinations.

Indias investment profile, however, is also conditioned by factors that affect

the flow of FDI, which are bureaucratic delays, wide spread corruption, poor

infrastructure facilities pro-labour laws, political risk and weak intellectual

property regime.

A perceived slowdown in the process of reforms generates doubts about the

markets long-term potential. To capitalize on its potential for FDI, would seem

that India needs to accelerate efforts to institutionalize government efficiency

and advance the implementation of promised reforms. Other strategic efforts

should include focusing the market on Indias relatively higher rates of return

on existing investments and long-term potential, addressing the issue of

transforming the country into a viable export platform and encouraging

strategic alliances with foreign investors. In short, this means accelerating

Indias integration with the global economy.


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BIBLIOGRAPHY

Books:

Foreign Investment in India: 1947-48 to 2007-08, Dr. Kamlesh Gakhar

Foreign Direct Investment in India: 1947 to 2007, Dr. Nitin Bhasin

Websites:

http://business.mapsofindia.com

http://www.economywatch.com

http://siadipp.nic.in
http://business.mapsofindia.com/http://business.mapsofindia.com/http://www.economywatch.com/http://www.economywatch.com/http://siadipp.nic.in/http://siadipp.nic.in/http://siadipp.nic.in/http://www.economywatch.com/http://business.mapsofindia.com/

Chapter II (Autosaved) 2

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