International Investment and Finance

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International Investmentand Finance

320

International business has been propelled by large cross-border flows of finance. While the

private financial flows are, invariably, commercial in nature, financial flows related to

Official Development Assistance (ODA) have also implications for business.

Official Development Assistance refers to grants and soft loans from official sources,with the objective of promoting economic development and social welfare. There are two

channels of aid flows: (i) between governments and government agencies (bilateral flows),and (ii) through multilateral institutions like the World Bank and Regional Development

Banks like the Asian Development Bank (multilateral flows). The poor countries are not ableto raise much money on commercial terms. ODA or Aid is, therefore, very important for

them. Investments resulting from ODA also provide opportunities for private business,besides the general economic improvements such investments may promote.

As explained in the preceding chapter, countries facing Balance of Payments problemsmay take financial assistance from the IMF.

The economic liberalisations that swept across the world, particularly since the late1980s, have very significantly changed the environment for international private financial

flows. At the same time, the surging international capital flows, in its turn, are substantiallyimpacting the business environment.

C H A P T E R

To understand the types of foreign investment.

To get an idea of the theories of FDI and factors influencing FDI.

To examine the effects and consequences of FDI.

To get a picture of the trends in FDI.

To get an idea of foreign investment in India.

LEARNING OBJECTIVES



International Investment and Finance 321

TYPES OF FOREIGN PRIVATE INVESTMENT

Broadly, there are two types of foreign investment, namely,

foreign direct investment (FDI) and portfolio investment .

Foreign Direct Investment (FDI)

FDI refers to investment in a foreign country where the investor retains control over the

investment. It typically takes the form of starting a subsidiary, acquiring a stake in an

existing firm or starting a joint venture in the foreign country. Direct investment and

management of the firms concerned normally go together.

UNCTAD’s World Investment Report defines foreign direct investment (FDI) as aninvestment 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

resident in an economy other than that of the foreign direct

investor (FDI enterprise or 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 transactions between them and among foreign affiliates, both

incorporated and unincorporated, FDI may be undertaken by individuals as well as business

entities. 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: equity capital,reinvested earnings and intra-company loans. It may be noted that the Government of India

used to exclude reinvested earnings from the estimation of FDI in India. Government

sources have, however, indicated that Government would redefine FDI including reinvested

earnings also. Box 9.1 shows the growing role of Foreign Investment.

BOX 9.1 The Growing Role of Foreign Investment

The expansion of international investment, facilitated by the almost universal liberali-sation, (see Box 1.6, Chapter 1), has resulted in a substantial increase in their role inglobal production, employment generation and trade. The ratio of world FDI inflows toglobal gross domestic capital formation increased more than seven-fold between 1980(2 per cent) now. Similarly, the ratio of world FDI stock to world GDP witnessed a spurt. In2002 the inward FDI stock of developing countries was about a third of their GDP, almosttwice the 19 per cent for developed countries. Back in 1980 the respective ratios were13 per cent and 5 per cent—the growth of FDI stock exceeded GDP growth in bothgroups of countries.

The massive FDI flows and the steep increase in the FDI stock have been significantlyaccelerating the integration of global production activity. In 2002 the world FDI stockstood at $ 7.1 trillion, up more than 10 times since 1980. Ebbs and flow in the yearlyvalue of FDI, while important, augment the stock of FDI as long as they are positive. Sothe stock of FDI matters more than flows—for the structure of global specialisation, fordeepening global integration through production networks, and for generating the

FDI is akin to promoters’investment and portfolioinvestment is akin tostock market investment.

In case of FDI, equitystake and managementcontrol of the enterprisego hand in hand.



322 International Business: Text and Cases

benefits associated with FDI and international production. It also matters for new FDIcapital flows through the reinvestment of earnings and sequential flows to FDI. In 2002the estimated value added of foreign affiliates, at $ 3.4 trillion, accounted for about atenth of world GDP, or twice the share in 1982. The world stock of FDI generated sales byforeign affiliates of an estimated $ 18 trillion, compared with world exports of less than$ 8 trillion. Nearly a third of world exports of goods and non-factor services takes placewithin the networks of foreign affiliates, but that has not changed much since 1982.Employment by foreign affiliates reached an estimated 53 million workers in 2002, two andhalf times the number in 1982.

Source: UNCTAD, World Investment Report , 2000, 2003 and 2004.

FDIs are governed by long-term considerations because these investments cannot be

easily liquidated. Hence factors like long-term political stability, government policy,industrial and economic prospects, etc. influence the FDI decision. However, portfolio

investments, which can be liquidated fairly easily, are influenced by short-term gains.

Portfolio investments are generally much more sensitive than FDIs. Direct investors havedirect responsibility with the promotion and management of the enterprise. Portfolio

investors do not have such direct involvement with the promotion and management.

Foreign Portfolio Investment (FPI)

If the investor has only a sort of property interest in investing the capital in buying equities,

bonds, or other securities abroad, it is referred to as portfolioinvestment. That is, in the case of portfolio investments, the

investor uses his capital in order to get a return on it, but has no

much control over the use of the capital. There are mainly tworoutes of portfolio investments in India, viz., by Foreign Institutional Investors (FIIs) like

mutual funds and through Global Depository Receipts (GDRs), American DepositoryReceipts (ADRs) and Foreign Currency Convertible Bonds (FCCBs).

GDRs/ADRs and FCCBs are instruments issued by Indian companies in the foreign

markets for mobilising foreign capital by facilitating portfolio investment by foreigners inIndian securities. Since 1992, Indian companies, satisfying certain conditions, are allowed to

access foreign capital markets by Euro issues.

Since the economic liberalisation of 1991, there has been a substantial increase in

foreign investments in India.

With reference to foreign investment in India, foreign investment may be classified as

shown in Figure 9.1.Foreign Investment

Direct investment Portfolio investment

Whollyowned

subsidiary

Jointventure

AcquisitionInvestments

by FIIs

Investment inGDRs, ADRs,FCCBs, etc.

FIGURE 9.1 Types of Foreign Investment.

FPI is lured by theattractiveness of investible

securities.




As Peter Drucker in his Managing for the Future observes, “...increasingly worldinvestment rather than world trade will be driving the international economy. Exchange

rates, taxes, and legal rules will become more important than wage rates and tariffs.”1

THEORIES OF INTERNATIONAL INVESTMENT

A number of attempts have been made to formulate a theory to

explain the international investment. A brief outline of the

important attempts in this direction is given below.

Theory of Capital MovementsThe earliest theoreticians, who assumed, in the classical tradition, the existence of a perfectly

competitive market, considered foreign investments as a form of factor movement to take

advantage of the differential profit.

The validity of this theory is clear from the observation of the noted economist

Charles Kindleberger that under perfect competition, foreign direct investment would not

occur and that would be unlikely to occur in a world wherein the conditions were even

approximately competitive.2

Market Imperfections Theory

One of the important market imperfections approach to the explanation of the foreigninvestments is the Monopolistic Advantage Theory propounded by Stephen in 1960.According to this theory, foreign direct investment occurred largely in oligopolistic

industries rather than in industries operating under near perfect competition. Hymersuggested that the decision of a firm to invest in foreign markets was based on certain

advantages the firm possessed over the local firms (in the foreign country) such aseconomies of scale, superior technology or skills in the fields of management, production,

marketing and finance.Kindleberger also argued that market imperfections were the basis of foreign

investment.The Market Imperfections Theory does not answer several questions related to foreign

investment. For example, why does a firm prefer foreign investment to other alternative

market entry modes like exporting, licensing, franchising, etc.?

Internalisation Theory

According to the Internationalisation Theory, which is an extension of the MarketImperfections theory, foreign investment results from the decision of a firm to internalise a

superior knowledge (i.e., keeping the knowledge within the firm to maintain the competitiveedge). For example, if a firm decides to externalise its know-how by licensing a foreign

firm, the firm (the licensor) does not make any foreign investment in this respect but, on

Theoretical explanationsof FDI include location-specific advantage, firm-specific advantage, inter-nationalisation advantageand competitive strategies.




the other hand, if the firm decides to internalise, it may invest abroad in productionfacilities.

Methods of internalisation include formal ways like patents and copy rights and

informal ways like secrecy and family networks.

Appropriability Theory

According to the Appropriability Theory, a firm should be able to appropriate (to keep for

its exclusive use) the benefits resulting from a technology it has generated. If this conditionis not satisfied, the firm would not be able to bear the cost of technology generation and,

therefore, would have no incentive for research and development. MNCs tend to specialisein developing new technologies which are transmitted efficiently through their internal

channels.It is obvious that the Appropriability Theory is similar to the internalisation theory in

terms of creating an internal market (internal channels) for exploiting the firm specific

advantages.

Location Specific Advantage Theory

The Location Specific Advantage Theory suggests that foreign investment is pulled bycertain location specific advantages.

According to Hood and Young, there are four factors which are pertinent to theLocation Specific Theory. They are:

1. Labour costs.2. Marketing factors (like market size, market growth, stages of development and

local competition).

3. Trade barriers.

4. Government policy.

The above factors have, of course, a very important bearing on foreign investment.

However, there are also other factors like cultural factors which influence foreigninvestment. Further, it is the total cost, and not labour cost alone, that is important.

International Product Life Cycle Theory

According to the Product Life Cycle Theory developed by Raymond Vernon and Lewis T.

Wells, the production of a product shifts to different categories of countries through thedifferent stages of the product life cycle.

According to this theory, a new product is first manufactured and marketed in a

developed country like the US (because of favourable factors like large domestic market,entrepreneurship and ease of organising production). It is then exported to other developed

markets. As competition increases in these markets, manufacturing facilities are establishedthere to cater to these markets and also to export to the developing countries. As the product

becomes standardised and competition further intensifies, manufacturing facilities areestablished in developing countries to lower production costs and due to other reasons. The




developed country markets may also be serviced by exports from the production units in thedeveloping countries [see the chapter on International Product Decisions for further

elaboration and diagrammatic presentation of the international product life cycle].

The International Product Life Cycle model is true of several products like television

sets, as is illustrated by the case on the Television Receiver Industry.

Eclectic Theory

John Dunning has attempted to formulate a general theory of international production by

combining the postulates of some of the other theories. According to Dunning, foreign

investment by MNCs results from three comparative advantages which they enjoy, viz.,

1. Firm specific advantages2. Internalisation advantages

3. Location specific advantages

Firm specific advantages result from the tangible and intangible resources held

exclusively, at least temporarily, by the firm and which provide the firm a comparative

advantage over other firms.

The firm specific advantages would not result in foreign investments unless the firm

internalises these advantages.

Even when a firm internalises its exclusive resources, it may be able to serve a foreign

market without foreign investment (for example by exporting). Therefore, for the

production to take place in the foreign country there should be some location specific

advantages. One important drawback of the Eclectic theory is that it does not explain

the foreign investment for acquisitions which have become a very important route to

internationalisation.

Other Theories

According to Knickerbocker’s theory of Oligopolistic Reaction and Multinational Enterprise,

when one firm, especially the leader in an oligopolistic industry, entered a market, otherfirms in the industry followed as a defensive strategy i.e., to defend their market share from

being taken away by the initial investor with the advantage of local production.Graham noted that there was a tendency for across investment by European and

American firms in certain oligopolistic industries. When American firms invested in Europe,the European firms retaliated by investing in America and vice versa. This was mostly a

retaliatory strategy.There are also other reasons for investment like following the customer (for example

the Japanese automobile ancillary firms to foreign markets) and seeking knowledge (forexample, Japanese and European investment in Silicon Valley).

These theories at best explain the reasons for some of theforeign investments only.

The theories provide onlya partial explanation of the reasons for FDI.




SIGNIFICANCE OF FOREIGN INVESTMENT

Foreign investment is playing an increasing role in economic development. Economicreforms and the far-reaching political changes have resulted in very substantial changes in

the international capital flows. FDI now contributes to a significant share of the domesticinvestment, employment generation, exports, etc. in a number of economies. China is a

classic example, where, in 1997, FDI contributed about 15 per cent of domestic investment,41 per cent of total exports, 19 per cent of industrial output, 13 per cent of tax revenue and

18 million employment.The changes in the composition of the capital flows and the substantial increase in

the magnitude of some of the flows, like FDI, have remarkably changed the balance of payments and foreign exchange reserves position of several countries. The debt creating

flows as a percentage of total flows in the BOP of India averaged as much as 97 per centduring the Seventh Plan (1985–90) but declined to less than 20 per cent by the mid-1990s.

Eventually, India began to experience a surplus on the BOP and a very remarkableimprovement in the reserves position.

Foreign investment has assisted and is assisting the economic growth of manycountries. As a World Bank report points out, for the developing countries FDI has the

following advantages over the official development assistance (ODA):3

FDI shifts the burden of risk of an investment from

domestic to foreign investors.

Repayments are linked to profitability of the underlying

investment, whereas under debt financing the borrowed

funds must be serviced regardless of the project costs. Further, it has also been observed that FDI is the only capital inflow that has been

strongly associated with higher GDP growth since 1970.

The contribution of FDI to economic growth is highlighted by the fact that the ratio of FDI flow to domestic investment (gross capital formation) rose for most developed and

developing countries in the past. Although the bulk of the FDI goes to developed countries,its share in their Gross Fixed Capital Formation (GFCF) is only about half of that in

developing countries because of the massiveness of their GFCF.Apart from potential gains through technology transfer, FDI has generated large

employment opportunities in a number of countries.Given the limitations of domestic savings, many developing countries will have to rely

on foreign investment to accelerate economic growth. It may be noted that China has beenable to maintain a high GDP growth-rate for a long time because of a high savings rate and

huge inflow of FDI.Addressing a session on infrastructure at the seminar on ‘moving to the market:

sustaining reforms in India and Asia’, organised by the Confederation of Indian Industry(CII) and Asian Society, in New Delhi on March 9, 1997, M. Gordon Wu has observed that

foreign investment brings four ‘E’s—efficiency, equity, experience and expertise. In return,there is a fifth ‘E’—expatriation of profits.

FDI helps fill the savings,technological, managerialand foreign exchangegaps.




TABLE 9.1 Backward Linkages and Other Relationships between Foreign Affiliates andLocal Enterprise and Organisations*

Form

* Source: UNCTAD, reproduced in World Investment Report, 2001.

Backward

(sourcing)

Forward

(distribution)

Horizontal

(cooperationin production)

Relationship of foreign affiliateto non-business

institution

Relationship of foreign affiliate to local enterprise

‘Pure’markettransaction

Short-termlinkage

Longer-termlinkage

Equityrelationship

‘Spillover’

• ‘Off-the-shelf’purchases

• Once-for-all orintermittent pur-chases (on contract)

• Longer-term(contractual)arrangement for theprocurement of inputs for furtherprocessing

• Subcontracting of the production of final or inter-mediate products

• Joint venture withsupplier

• Establishment of new supplier-affiliate (by existingforeign affiliate)

• ‘Off-the shelf’sales

• Once-for-all orintermittent sales(on contract)

• Longer-term(contractual)relationship withlocal distributoror end-customer

• Outsourcing fromdomestic firms toforeign affiliates

• Joint venturewith distributoror end-customer

• Establishment of new distributionaffiliate (byexisting foreignaffiliate)

• Joint projectswith competingdomestic firm

• Horizontal jointventure

• Establishment of new affiliate (byexisting foreignaffiliate) for theproduction of same goods andservices as itproduces

• R&D contractswith local insti-tutions such asuniversities andresearch centres

• Training pro-grammes for firmsby universities

• Traineeships forstudents in firms

• Joint public-privateR&D centres/training centres/universities

• Demonstration effects in unrelated firms

– Spillover on processes (including technology)– Spillover on product design– Spillover on formal and on tacit skills (shopfloor and managerial)

• Effects due to mobility of trained human resources• Enterprise spin-offs• Competition effects

FDI AND PRODUCTION LINKAGES

The contribution of FDI to sustainable economic development of the host countries depends to a large extent on the production

linkages between foreign affiliates and domestic firms. Suchlinkages can take the form of backward, forward or horizontal.

The contribution of FDIto development of hostcountry also depends onthe linkages it generates.




most important inputs. On the other hand, when TNCs have a strong self-interest indeveloping their supplier base in a host country, foreign affiliates can extend considerable

support to enhance the competitiveness of their domestic suppliers.

The transfer of information on technical specifications and production requirements is,

of course, a necessary part of all linkages; beyond this, there are generally considerable

flows of advice, information, assistance and support from buyers to suppliers. The shape that

linkages take varies by location, activity, firm, the state of domestic and other local firms,

the nature of activities, the duration and closeness of the buyer-seller-relationship and the

costs and risks involved. The general picture is, however, clear: TNCs invest in linkages if

and when they are expected to yield a positive (and competitive) return. Indeed, a survey of

84 companies in Japan, the Republic of Korea, United Kingdom and United States in a wide

range of industries showed that most, but not all, buying firms found that supplier develop-

ment activities did improve suppliers’ cost, quality, delivery performance and cycle time.

TRADE AND INVESTMENT

Foreign trade and foreign direct investment (FDI) are mutually

influential.

FDI in the natural resource sectors, including plantations, in developing countriesincrease trade. FDIs in several other sectors also increase international trade.

While on the one hand investment increases trade, as stated above, on the other,foreign production by FDI substitutes foreign trade in many cases. Due to factors like

foreign exchange problems, desire to industrialise fast, etc. the policies of many developingcountries prefer foreign investment (for import substitution) to imports. As pointed out in

Box 9.1, the sales of firms established by FDI far exceed the world exports. A part of thisrepresents substitution of foreign production for trade and a part of this generates trade—

about one-third of the world trade in manufactures is intra-company trade.Due to the protectionism and some other factors, large amounts of FDI have been

taking place in the developed countries leading to substitution of foreign production forforeign trade. The regional integration schemes also tend to increase such investments to

substitute production for trade. For example, many foreign companies have been setting upmanufacturing and assembly facilities in the European Community to overcome the fortress

EC-92.It may also be pointed out that, to a considerable extent, such investments are made

possible by the past trade; the funds generated by trade are ploughed back to investment inthe foreign markets. The massive foreign investments made by the Japanese companies since

the mid-1980s deserve a special mention in this context.

While the international investment replaces international trade in certain products,

it may generate trade in some other products. Drucker, who observes that although

traditionally investment has followed trade, trade is increasingly becoming dependent on

investment, points out that US exports in the years of the over-valued dollar would have

been even lower had the European subsidiaries of American companies and American joint

ventures in Japan not continued to buy machinery, chemicals, and parts from the US.

While some of the FDIsincrease internationaltrade, some decrease trade.




Similarly, the foreign subsidiaries of America’s financial institutions, such as the majorbanks, accounted for something like one half of US service income during those dismal

years.7 Foreign investment has been significantly contributing to the export performance of

some countries. The case of China deserves a special mention here.

FACTORS AFFECTING INTERNATIONAL INVESTMENT

International investments are influenced by a number of factors given in Box 9.3.

BOX 9.3 12 Commandments of Foreign Direct Investment

1. Stable, predictable macro economic policy. Companies must have the confidence that

the economy in which they make an investment will be managed in a competent andpredictable way. Simply stated, investors must believe that the rules of the game will not change in the middle of a contest.

2. An effective and honest government. An investor must be able to rely upon theintegrity of the host government and its ability to maintain law and order.

3. A large and growing market. The size and potential for growth of a country’sdomestic market, especially the purchasing power of its customers, are key. Companiesdo not seek to invest in a market where there is little potential to make a profit.

4. Freedom of activity in the market. The strength of the competition, as well as thedegree of government (theirs and ours) interference to entering a country’s market,are important factors. The freer the market, the more attractive it becomes as aninvestment site for international investors.

5. Minimal government regulation. The cost of government regulation and intervention

in the affairs—and profits—of private companies must be kept to a minimum.6. Property rights and protection. Private property must be protected. The likelihood thata company’s real or intangible (patents, copy-rights, etc.) property will be stolenmust be avoided.

7. Reliable ‘infrastructure’. The ability to consummate transactions and get products andservices to market is also critical. Whether it be reliable transportation, powergeneration, insurance and accounting services, a competent financial system or otherbasic factors, investments cannot yield a sufficient or reliable financial return withoutthem.

8. Availability of high-quality factors of production. While the investor brings capital,technology and management to the table, the quality of the indigenous work forceand the availability of local raw materials are also key ingredients in the recipe forsuccess.

9. A strong local currency. The local currency must retain its value. If you make aninvestment in dollars and then the local assets (valued in the local currency) aredevalued, you have lost part—or possibly all—of your original dollar-basedinvestment.

10. The ability to remit profits, dividends and interest. If you cannot get your money outof the country, why invest?

11 . A favourable tax climate. Although tax incentives geared to attract initial investmentsare important, a company’s final investment decision is usually based on how acountry’s taxation will affect the normal operating environment once the venture isoff the ground.




12. Freedom to operate between markets. A company must be able to source goods andservices from its operating unit in one market in order to serve other markets or tomaximize its global efficiency by trading among its operating entities in differentcountries to ‘round out’ its product lines.

Courtesy : John D. Sullivan, ‘Prospering in the Global Economy’, Economic Reforms Today ,No. 1, 2000.

Host Country Economic Determinants

Traditionally, the economic determinants of inward FDI have been grouped, for analytical

convenience, into three clusters, each of them reflecting the principal motivations of

investing in foreign countries: resources seeking, market seeking and efficiency seeking.

Resources

Historically, the most important motivation of FDI has been the exploitation of naturalresources. Dunning points out that in the nineteenth century,

much of the FDI by European, United States and Japanese firmswere promoted by the need to secure an economic and reliable

source of minerals, primary products for the investing industrial-ising nations of Europe and North America. Up to the eve of the Second World War, about

60 per cent of the world stock of FDI was in natural resources. The post-war period,particularly since the 1960s and 1970s, witnessed a decline in the share of natural resources

in the FDI. Besides the decline in the importance of the primary sector in world output, thisdecline was caused by factors such as the development of the indigenous enterprises in this

sector. In a number of developing economies, the public sector came to play an importantrole in the resources based industries. Public sector efforts also included equity or technical

collaborations with MNCs.8

Although, the share of the primary sector in FDI has declined, there has been

a substantial increase of the FDI in this sector in absolute terms. The FDI stock in theprimary sector of developed countries increased more than five fold between 1975–1990,

while in the developing countries it increased more than six fold. According to the World

Investment Report 1998 , though declining in importance, the availability of natural resources

is still a determinant of FDI and continues to offer important possibilities for inwardinvestment in resource—rich countries. Natural resources still explain much of the inward

FDI in a number of countries, developing (e.g. countries in sub-Sahara, Africa), developed(e.g. Australia) and countries in transition (Azerbaijan, Kiazakhistan and Russian

Federation).9

Markets

Another important traditional determinant of FDI has been market seeking. Markets

protected from international competition by high tariffs or quotas triggered tariff jumping

FDI. Dunning points out that market access became the predeterminant motive for investing

in the manufacturing sector of developed countries between the two world wars and of

The exploitation of naturalresources has been animportant motive of FDI.




developing countries in the 1960s and 1970s, during the heyday of import substitutionindustrialisation. This motive was paramount, for example, in the wave of United States

investments in Europe, especially in the United Kingdom, during the early post-war period

and in Japanese investments in the United States after the mid-1980s, following voluntary

export restrictions and the possibility of further protectionist measures in the automobile

industry.10

It is very relevant to note here that the largest markets in the world, USA and China,

are among the largest recipient of FDI. As UNCTAD points out,

some of the largest national markets remain unmatched in size

by the largest regional markets or even by entire continents. For

example, the market of the European Union during most of its

existence has been smaller than the United States market; the market of the African

continent (without South Africa) is smaller than that of Republic of Korea; and thecombined markets of the 14 Central and Eastern European countries are smaller than the

market of Brazil.11

The lion’s share of FDI flow to the developing countries goes to the larger markets

with comparatively good infrastructure and political stability in general.

The growing importance of the service sector has also been resulting in increasing FDI

because of the fact that most services are not tradable and, therefore, the only way to deliver

them to foreign markets is through establishment abroad. However, the highly regulated

nature of the services sector has been a deterrent to the FDI flow in its full potential.

Efficiency

Another important motivation of FDI is efficiency seeking. Low cost of production,deriving mostly from cheap labour, is the driving force of many FDIs in developing

countries. Export processing zones have been developed by developing countries mostly to

take advantage of the efficiency seeking FDI flows.

It may be noted that the presence of any of the three determinants mentioned before

alone need not attract FDI. For example, even if a country has natural resources or

abundance of cheap labour, FDI would not take place in the absence of required

infrastructural facilities to develop the industry or trade. Besides, several other factors such

as political environment, government policies, bureaucratic culture, social climate, etc. are

also important determinants of FDI. Figure 9.2 shows the economic determinants of FDI.

BOX 9.4 China and India—What Explains the Different FDI Performance?

There are significant differences in the FDI performance of China and India. The Worldinvestment Report, 2003, citing several studies, makes the following observations.

FDI in Indian manufacturing has been and remains domestic market-seeking. FDI in China,in contrast, has been market-seeking, efficiency seeking and resource seeking.

The above difference in the motives of FDI is reflected in the contribution of the FDI toexport performance of both the countries. FDI has contributed to the rapid growth of China’s merchandise exports, at an annual rate of 15 per cent between 1989 and 2001. In1989, foreign affiliates accounted for less than 9 per cent of total Chinese exports; by

The motive of exploita-tion of markets has beena major driver of FDI.




2002 they provided half. In some high-tech industries in 2000 the share of foreignaffiliates in total exports was as high as 91 per cent in electronics circuits and 96 percent in mobile phones. In contrast, FDI has been much less important in driving India’s

export growth, except in information technology. FDI accounted for only 3 per cent of India’s exports in the early 1990s. Even today, FDI is estimated to account for less than10 per cent of India’s manufacturing exports.

On the basic economic determinants of inward FDI, China does better than India. China’stotal and per capita GDP are higher, making it more attractive for market-seeking FDI.Rapid growth in China has increased the local demand for consumer durables andnondurables, such as home appliances, electronics equipment, automobiles, housing andleisure. This rapid growth in local demand, as well as competitive business environmentand infrastructure, have attracted many market-seeking investors. It has also encouragedthe growth of many local indigenous firms that support manufacturing.

Its higher literacy and education rates suggest that its labour is more skilled, making itmore attractive to efficiency-seeking investors. In addition, China’s physical infrastructureis more competitive, particularly in the coastal areas.

India may have an advantage in technical manpower, particularly in informationtechnology. It also has better English language skills.

Some of the differences in competitive advantages of the two countries are illustrated bythe composition of their inward FDI flows. In information and communication technology,China has become a key centre for hardware design and manufacturing by a number of well-known companies across the world. India specialises in IT services, call centres,business back-office operations and R&D.

Item Country 1990 2000 2001 2002

FDI inflows China 3,487 40,772 46,846 52,700(Million dollars) India 379 4,029 6,131 5,518

Inward FDI stock China 24.762 348.346 395.192 447.892(Million dollars) India 1,961 29,876 36,007 41,525

Growth of FDI inflows China 2.8 1.1 14.9 12.5(annual, %) India –6.1 16.1 52.2 –10.0

FDI stock as percentage China 7.0 32.3 33.2 36.2of GDP (%) India 0.6 6.5 7.4 8.3

FDI flows as percentage of China 3.5 10.3 10.5 –gross fixed capital formation (%) India 0.5 4.0 5.8 –

FDI flows per capita China 3.0 32.0 36.5 40.7(Dollars) India 0.4 4.0 6.0 5.3

Share of foreign affiliates China 12.6 47.9 50.0 –in total exports (%) India 4.5 – – –

GDP (billion dollars) China 388 1,080 1,159.1 1,237.2India 311 463 484 502

Real GDP growth China 3.8 8.0 7.3 8.0(%) India 6.0 5.4 4.2 4.9




As per the information available in 2001, nearly 80 per cent of all Fortune 500 companiesare in China, while 37 per cent of the Fortune 500 outsource from India.

FDI in China is very broad-based whereas in India the FDI destinations are relativelynarrow. For example, in 2000–2001 the lion’s share of FDI inflows to China went to abroad range of manufacturing industries. For India most went to services, electronics andelectrical equipment and engineering and computer industries.

Other determinants related to FDI attitudes, policies and procedures also explain whyChina does better in attracting FDI. China has ‘more business-oriented’ and more FDI-friendly policies than India. China’s FDI procedures are easier, and decisions can be takenrapidly. China has more flexible labour laws, a better labour climate and better entry andexit procedures for business.

A recent business environment survey has indicated that China is more attractive thanIndia in the macroeconomic environment, market opportunities and policy towards FDI.India scored better on the political environment, taxes and financing. A confidencetracking survey in 2002 indicated that China was the top FDI destination, displacing theUnited States for the first time in the investment plans of the TNCs surveyed; India came15th. A Federation of Indian Chambers of Commerce and Industry (FICCI) survey suggeststhat China has a better FDI policy framework, market growth, consumer purchasing power,rate of return, labour laws and tax regime than India.

The different FDI performance of the two countries is also related to the timing, progressand content of FDI liberalisation in the two countries and the development strategiespursued by them. China opened its doors to FDI in 1979 and has been progressivelyliberalizing its investment regime. India allowed FDI long before that but did not takecomprehensive steps towards liberalisation until 1991.

China’s accession to the WTO in 2001 has led to the introduction of more favourable FDImeasures. With further liberalisation in the services sector, China’s investment environmentmay be further enhanced. For instance, China will allow 100 per cent foreign equityownership in such industries as leasing, storage and warehousing, wholesale and retail trade, advertising, multimodal transport services, insurance brokerage, and transportationof goods (railroad).

In retail trade, China has already opened and attracted FDI from nearly all the big-namedepartment stores and supermarkets such as Auchan, Carrefour, Diary Farm, Ito Yokado,Jusco, Makro, Metro, Pricesmart, 7-Eleven and Wal-Mart. It may be noted that in India theGovernment has not yet formed clear view and policy in respect of foreign investment inseveral of these areas.

In addition to economic and policy-related factors, an important explanation for China’slarger FDI flows lies in its position as the destination of choice for FDI by Chinese

businesses and individuals overseas, especially in Asia. The role of the Chinese businessnetworks abroad and their significant investment in mainland China contrasts with themuch smaller Indian overseas networks and investment in India. Why? Overseas Chinese aremore in number, tend to be more entrepreneurial, enjoy family connections ( guanxi ) inChina and have the interest and financial capability to invest in China—and when theydo, they receive red-carpet treatment. Overseas Indians are fewer, more of a professional group and, unlike the Chinese, often lack the family network connections and financial resources to invest in India.

Both China and India are good candidates for the relocation of labour-intensive activities




by TNCs, a major factor in the growth of Chinese exports. In India, however, this has beenprimarily in services, notably information and communication technology. Indeed, almostall major United States and European information technology firms are in India.

The prospects for FDI flows to China and India are promising, assuming that bothcountries want to accord FDI a role in their development process—a sovereign decision.The large market size and potential, the skilled labour force and the low wage cost will remain key attractions. China will continue to be a magnet of FDI flows and India’sbiggest competitor. But, FDI flows to India are set to rise—helped by a vibrant domesticenterprise sector and if policy reforms continue and the Government is committed to theobjective of attracting FDI flows to the country.

FIGURE 9.2 Host Country Determinants of FDI(Reproduced from UNCTAD, World Investment Report, 2002).

Economic Determinants

Policy framework for FDI

• Economic, political and social stability

• Rules regarding entry and operations

• Standards of treatment of foreign affiliates

• Policies on functioning and structure of markets (especially competition and M&Apolicies)

• International agreements on FDI

• Privatisation policy

• Trade policy (tariffs and NTBs) and coherenceof FDI and trade policies

• Tax policy

Market-seeking FDI

• Market size and percapita income

• Market growth

• Access to regional andglobal markets

• Country-specific consumerpreferences

• Structure of markets

Business facilitation

• Investment promotion (including image-building and investment—generating activitiesand investment—facilitation services)

• Investment incentives

• Hassle costs (related to corruption,administrative efficiency, etc.)

• Social amenities (bilingual schools, quality of life, etc.)

• After—investment services

Host Country Determinants of FDI

Resource/Asset-seeking FDI

• Raw materials

• Low-cost unskilled labour

• Skilled labour

• Technological, innovatory andother created assets (e.g.brand names), including asembodied in individuals, firmsand clusters

• Physical infrastructure (ports,roads, power,telecommunication)

Efficiency-seeking FDI

• Cost of resources and assetslisted under resource/assetseeking FDI, adjusted forproductivity for labourresources

• Other input costs, e.g. transportand communication costs to/from and within host economyand costs of other intermediateproducts

• Membership of a regionalintegration agreementconductive to the establishmentof regional corporate networks




LIMITATIONS AND DANGERS OF FOREIGN CAPITAL

Foreign capital, both private and official (governmental and institutional), have certainlimitations. Certain additional risks are associated with private foreign capital.

One of the important limitations to utilise the foreign capital is the absorptive capacity

of the recipient country, i.e., the capacity of the country to utilise

the foreign capital effectively. Lack of infrastructural facilities,technical know-how, personnel, inputs, market, feasible projects,

inefficiency or inadequacy of administrative machinery, etc. areimportant factors that affect the absorptive capacity.

Sometimes ‘strings’ are attached to the official assistance—the recipient country maybe pressurised to fall in line with the ideology or direction of the donor.

The following criticisms are levelled against foreign capital:

1. Private foreign capital tends to flow to the high profit areas rather than to the

priority sectors.

2. The technologies brought in by the foreign investor may not be adapted to the

consumption needs, size of the domestic market, resource availabilities, stages of

development of the economy, etc.

3. Through their power and flexibility, the multinational corporations can evade or

undermine national economic autonomy and control, and their activities may be

inimical to the national interests of particular countries.

4. Foreign investments, sometimes, have unfavourable effect on the Balance of

Payments of a country such as when the drain of foreign exchange by way

of royalty, dividend, etc., is more than the investment made by the foreign concern.5. Foreign capital sometimes interferes in the national politics.

6. Foreign investors sometimes engage in unfair and unethical trade practices.

7. Foreign investment in some cases leads to the destruction or weakening of small

and traditional enterprises.

8. Sometimes foreign investment can result in the dangerous situation of minimising/

eliminating competition and the creation of monopolies or oligopolistic structures.

9. FDI can also potentially displace domestic producers by preempting their invest-

ment opportunities.

10. The evolution of private capital flows, characterised by fluctuations (which are

sometimes violent), suggests that they are not a reliable source of

financing for development, partly because portfolio equity flows

are very volatile and because financial liberalisation has led to anincrease in short-term speculative flows. Moreover, private capital flows, including

FDI, are concentrated in a small number of emerging-market economies, while

most low-income and least developed countries, which are the most dependent on

external financing, receive no or very small amounts of such flows.12

11. Often, several costs are associated with encouraging foreign investment. Meier

observes13 that these costs may arise from special concessions offered by the host

country, adverse effects on domestic saving, deterioration in the terms of trade, and

problems of balance of payments adjustment.

Capital absorptive capacityis a constraint of FDIinflow.

FDI has several risks andcosts.




(a) The incentives (including tax concessions), services and facilities which thegovernments of the host countries offer to encourage foreign investment have

opportunity cost and the opportunity cost tends to be very high in developing

countries. The competition between countries and provinces to woo foreign

investment makes matters worse.

(b) Although foreign investment may have an income effect that will lead to

a higher level of domestic savings, this effect may be offset, however, by a

redistribution of income away from capital if the foreign investment reduces

profits in domestic industries (because of factors such as increased competition).

The consequent reduction in home savings would then be another indirect cost

of foreign investment. But it is unlikely to be of much consequence in practice

because of the favourable effects of the foreign investment.

(c) Foreign investment might also affect the recipient country’s commodity termsof trade through structural changes associated with the pattern of development

that results from the capital inflow. If the foreign capital causes an increase in

the exportables to such an extent of resulting in a deterioration in the terms of

trade, the rise in real income of the country will be less than that in output,

and the worsening terms of trade may be considered another indirect cost of

the foreign investment. Whether the terms of trade will turn against the

capital-receiving country is problematical depending on various possible

changes at home and abroad in the supply and demand for exports, import

substitutes, and domestic commodities. It is unlikely, however, that private

foreign investment would cause any substantial deterioration in the terms of

trade. In fact, private foreign investment can help bring about a favourable

structural change in the countries’ foreign trade.

(d) The servicing of foreign debt capital, both public and private, can cause

balance of payments problems. Further, as has already been indicated above,

repatriation of profits can also cause problems.

GROWTH OF FDI

As Table 9.2 clearly shows, there has been a surge in foreign investment, supported by the

sweeping changes in the economic policy in many countries (see Box 9.1).

Although foreign direct investment flows had their ups and downs, the stock of FDI

has increased tremendously over time. Between 1982 and 2000, Foreign Direct Investment

(FDI) inflows and outflows increased from $ 59 billion and $ 27 billion respectively to$ 1271 billion and $ 1150 billion respectively. After reaching its peak in 2000, the FDI

inflows experienced a decline in the next three years. However, after declining in 2001 and

2002, outflows increased slightly in 2003. In 2003, the FDI flows were less than half of the

peak levels of 2000. The 2001 decline was the first drop in inflows since 1991 and outflows

since 1992. The dramatic increases in cross-border M&As led to record flows in 1999 and

2000.10 Cross-border M&As made its contribution to the decline in the FDI too. The FDIflows again reached a record level in 2007, but declined in 2008 and 2009.




Some cyclical pattern is observed in the foreign investment flows. The decline in FDI

flows in 2001 followed rapid increases during the late 1990s. As

the World Investment Reports point out, there was a similar

pattern during the late 1980s and early 1990s, and in 1982–1983.

Thus, this is the third downward cycle in FDI, each punctuating a

long upward trend in FDI every ten years or so. These swings reflect changes in several

factors. The main ones are business cycles, stock market sentiment and M&As. These short-

term factors (including factors such as the terrorist attack of September 11, 2000) work intandem with longer-term factors, sometimes offsetting and at other times reinforcing them.

There is, on the other hand, a stable and positive relationship between global FDI flows and

the level and growth of world GDP. Technological change, shrinking economic distance and

new management methods favour international production. Their impact is, however,

countered by cyclical fluctuations in income and growth. The decline in FDI in 2001

reflected a slow down in the world economy. More than a dozen countries—including the

world’s three largest economies—fell into recession. On the supply side, FDI is affected by

the availability of investible funds from corporate profits or loans, which in turn is affected

TABLE 9.2 Selected Indicators of FDI and International Production, 1982–2005

Items

1982 1990 2003 2007 1986– 1991– 1996– 2001 2002 2003 20071990 1995 2000

FDI inflows 59 208 633 1,833 22.8 21.2 39.7 –40.9 –13.3 –11.7 29.9

FDI outflows 27 239 617 1,997 25.4 16.4 36.3 –40.0 –12.3 –5.4 50.9

FDI inward stock 628 1,769 7,987 15,211 16.9 9.5 17.3 7.1 8.2 19.1 22.0

FDI outward stock 601 1,785 8,731 15,602 18.0 9.1 17.4 6.8 11.0 19.8 22.3

Cross-border M&As – 151 297 1,637 25.9 24.0 51.5 –48.1 –37.8 –19.6 46.4

Sales of foreignaffiliates 2,765 5,727 16,963 31,197 15.9 10.6 8.7 –3.0 14.6 18.8 20.7

Gross product of foreign affiliates 647 1,476 3,573 6,029 17.4 5.3 7.7 –7.1 5.7 28.4 19.4

Total assets of foreign affiliates 2,113 5,937 32,186 68,716 18.1 12.2 19.4 –5.7 41.1 3.0 23.1

Exports of foreignaffiliates 730 1,498 3,073 5,714 22.1 7.1 4.8 –3.3 4.9 16.1 15.4

Employment of foreign affiliates(thousands) 19,579 24,471 53,196 81,615 5.4 2.3 9.4 –3.1 10.89 11.1 16.6

GDP (in currentprices) 11,758 22,610 36,327 54,568 10.1 5.2 1.3 –0.8 3.9 12.1 11.5

Gross fixed capitalformation 2,398 4,905 7,853 12,356 12.6 5.6 1.6 –3.0 0.5 12.9 13.1

Royalties andlicence fee receipts 9 30 93 164 21.2 14.3 8.0 –2.9 7.5 12.4 15.4

Exports of goodsand non-factorservices 2,247 4,261 9,216 17,138 12.7 8.7 3.6 –3.3 4.9 16.1 15.4

Source: UNCTAD, World Investment Report, 2005 and 2007.

Value at current prices(Billions of dollars)

Annual growth rate(Per cent)

FDI flows, cyclical innature, show a robustgrowth trend.




by domestic economic conditions. On the demand side, growing overseas markets lead TNCsto invest, while depressed markets inhibit them. The more interdependent host and home

economies become, and the more widely a recession or upswing spreads, the greater are the

corresponding movements in global FDI.

Data for 1980–2001 show that a bulge in global FDI accompanies high economic

growth, and a trough accompanies low growth. However, the relationship between GDP

growth and FDI is not uniform across groups of economies. They go together in developed

but not in developing countries. One explanation for the different patterns of FDI flows is

that business cycles spread much faster across developed countries than others. A

supplementary explanation may be that some countries (as in CEE) had been cut off from

substantial FDI flows for so long that they have a lot of ‘catching up’ to do—short-term

cycles do not affect their attractiveness.

The economic liberalisation in many countries, including the erstwhile communistcountries and countries which still claim to be communist or socialist like the Peoples

Republic of China, should be expected to enlarge the FDI flows in future.

DISPERSION OF FDI

Concentration of FDI

A small number of countries account for the major chunk of the FDI. FDI outflow showsmore concentration than inflow.

The major chunk of the FDI flows takes place between the developed countries. Fornearly three decades till the early 1990s, about three-quarters of

the FDI have gone to the developed countries. Now nearly two-thirds of the flows take place between the countries of the

Triad —the US, the European Community and Japan.

FDI is concentrated in a handful of countries. For instance, ten countries received

74 per cent of global FDI flows in 1999. Just ten developing countries received 80 per cent

of total FDI flows to the developing world. More importantly, there are no signs that the

concentration of international production across countries has been declining over time.

FDI in Developing Countries

The share of the FDI going to the developing countries declined substantially from 25 percent during 1980–85 to 17 per cent during 1986–90. There was, however, an increase in the

absolute amount of FDI flows to the developing countries. The economic liberalisations inthe developing countries have helped increase the FDI to them (see Tables 9.3 and 9.4).

TABLE 9.3 Distribution of Annual FDI Inflow by Category of Economies, 1993–2007 (Percentage)

Category of economies 1993–98 1999 2000 2001 2002 2003 2005–07

Developed economies 63.8 77.7 81.2 72.2 76.5 69.9 66.6Developing economies 34.6 21.3 18.1 26.4 21.7 26.3 29.2South East Europe and CIS 1.6 1.0 0.6 1.4 1.8 3.8 4.1

Source: UNCTAD, World Investment Report, 2005, 2006 and 2008.

A small number of countries receive the lion’sshare of FDI flows.




TABLE 9.4 Distribution of Annual FDI Outflow by Category of Economies, 1993–2007 (Percentage)

Category of economies 1993–1998 1999 2000 2001 2002 2003 2005–07

Developed economies 85.9 91.8 88.2 89.1 92.0 93.6 84.0Developing economies 13.8 8.0 11.6 10.6 7.3 4.7 13.8South East Europe and CIS 0.3 0.2 0.3 0.4 0.7 1.7 2.1


FDI in developing countries has been larger than official

inflows for every year since 1993. It was 10 times larger thanbilateral official development assistance (ODA) in 2000; this

contrasts with the latter half of the 1980s, when the two were

about equal.Within the group of the developing countries, the relatively developed among them

get the lion’s share of the FDI. Very little FDI has taken place

in low income economies leaving exceptions like China andIndia. In most cases, this has been due to the small size of the

domestic market and other adverse factors such as poor infra-structure, lack of skilled labour.

The lion’s share of the FDI flows to the developing countries has been cornered bytwo regions, viz., East Asia and the Pacific and Latin America while Sub-Saharan/Africa,

and Middle East and North Africa got very low shares. In 2001, the five largest recipients

attracted more than 60 per cent of the total inflows to the developing countries. South

Asia’s share has been very dismal. The least developed countries (numbering 50) get only

about half a per cent of the world FDI flows.

However, in many least developed countries that have received only small amounts of

FDI, such investment is important vis-a-vis the size of domestic investment. What remains a

challenge for these countries is the ability to attract not only more, but also higher quality

FDI—broadly defined as investment with strong links to the domestic economy, export

orientation, advanced technology and skill or spillover effects.

One traditional attraction of foreign investment, viz., cheap labour, is becoming less

important. Foreign investment today is not merely for exploitation of local resources.

Foreign companies today evaluate the market potential and production and related facilities

and their efficiencies, inter alia, for investment decision making. Countries with large and

growing markets, fairly developed infrastructures and efficient input supplies, conducive

trade policies, favourable political environment, required type of manpower supplies, etc.

rank high for investment. An encouraging government policy alone is not sufficient. China

has been able to attract huge FDI because its economic growth for quite some time now has

been very good, it is one of the largest potential markets in the world, because of the statist

policy until recently it is virtually a virgin market for many products, the labour force is

‘disciplined’ by the State and China has favourable political and bureaucratic environment.

Although India is not as attractive as China in terms of the aforementioned factors, its

potential is enormous. FDI flows to India have, however, been discouraged by such factors

as confusing political environment, agitation against certain multinationals etc. and

FDI is the largest sourceof external finance fordeveloping countries.

FDI flows to developingcountries are mostlydirected to the relativelydeveloped among them.




bureaucratic problems (see Boxes 9.4 and 9.5). Countries which are at very low levels of development would not be attractive to foreign investors due to factors such as constraints of

domestic markets and absence of infrastructural and other input supplies of the quantity and

quality needed to make the enterprises competitive.

BOX 9.5 Sources and Destinations of FDI

The developed world hosts two-thirds of world inward FDI stock and accounts for nine-tenths of the outward stock. The most striking change is that the EU has become by farthe largest source. In 1980 the outward stocks of the EU and the United States werealmost equal at around $ 215 billion. But by 2002, the EU’s stock (including intra-EUstock) reached $ 3.4 trillion, more than twice that of the United States ($ 1.5 trillion).Japan has been stable relative to the EU, with its outward stock about a tenth that of the

EU.In 1980 the FDI stock originating from developing countries (at $ 65 billion) accounted for11 per cent of the global outward FDI stock; by 2002 the corresponding share was12 per cent. South, East and South-East Asia is the most important developing region foroutward FDI stock, with its stock exceeding Japan’s for the first time in 1997 andbecoming almost twice Japan’s by 2002. The Latin America and Caribbean region registereda threefold increase in its outward FDI stock between 1980 and 2002. The concentrationof FDI within the Triad (EU, Japan and the United States) remained high between 1985and 2002 (at around 80 per cent for the world’s outward stock and 50–60 per cent forthe world’s inward stock).

Clusters of non-Triad countries have strong FDI links to each Triad member.

This pattern reveals the emergence of FDI blocks, each comprising one Triad country andseveral associate partner countries. They overlap somewhat with trade blocks, eachcomprising a Triad member and a cluster of trading partners with strong trade links to it.

The FDI block pattern is also roughly mirrored in—and supported by—international investment agreements (IIAs)—agreements that, at least in part, address FDI issues. Toimprove the investment climate in their partners, associate partners and Triad membershave been concluding DTTs and BITs with them.

Courtesy: UNCTAD, World Investment Report , 2004.

Outward FDI from developing countries

FDI outflows from developing economies have been significantly increasing, reflecting the

recognition of firms that in a globalising world economy, they need a portfolio of locational

assets to be competitive internationally. In fact, countries like Malaysia, the Republic of theKorea and Singapore already have an established track record and some others such as Chile,

Mexico and South Africa have become players relatively recently. Countries like Brazil,

China and India are at the take-off stage. Their investments span all sectors and country

groups and involve complex as well as simple industries. Annual FDI outflows from

developing countries have grown faster than those from developed countries in the 15 years

prior to 2003. Negligible until the beginning of the 1990s, outward FDI from developingcountries accounted for over 15 per cent of the world total stock in 2009. 14

FDI flows between developing countries seem to be growing faster than from




developing countries to developed countries. The growing importance of South-South FDIindicates that developing countries are more financially integrated with one another than was

previously believed. Thus, a typical developing country has access to more sources of

investment than before. This is particularly important for small economies, as TNCs from

the South, because of their comparative advantages, tend to invest in countries with similar

or lower levels of development than their home countries.15

Regional pattern

An examination of the investment pattern of the major sources of FDI shows that they,

generally, had a regional bias in their investment in the developing countries. The US

investments were largely in Latin America. Japan’s investments went mostly to the Asian

neighbours. There has, however, been some significant changes in the Japanese investmentsrecently. Much of the United Kingdom’s investment has gone to the Commonwealth nations,

and France had a favour for countries with past colonial ties, mainly Africa.

Mega blocks of FDI flows appear to be emerging, with clusters of developing

countries linked to a triad country (see Box 9.5).

It has also been observed that direct investment is concentrated in particular economic

sectors. For instance, investment by UK and German firms has been mainly in manufactur-

ing while US and Japanese investment, although more evenly spread over the major econo-

mic sectors, has a bias towards manufacturing and primary industries; within manufacturing

direct investment has been made mainly in transportation equipment, chemicals and

machinery (which includes electronics).

The vast expansion of the investment opportunities across the world should be expected

to encourage some changes in the directional pattern of the foreign investment flows.

Sectoral trends

Although FDI has grown over time in all three economicsectors—primary, manufacturing and services—the sectoral

composition has undergone significant changes with marked shifttowards services.16

The primary sector’s share in world FDI stock decreased from 9 per cent in 1990 to

6 per cent in 2002. However, in the case of FDI flows between 1989–1991 and 2001–2002,

the share of the primary sector did not decline: it rose from 7 per cent to 9 per cent. While

nearly all FDI in the sector continues to originate from developed countries, developing

countries–many of them rich in natural resources, but lacking internationally competitivenational firms–attract considerable FDI (32 per cent of total primary-sector FDI in 2002).

Within the primary sector, mining, quarrying and petroleum dominate: the primary sector

FDI with over 90 per cent of inward FDI stock.

The share of manufacturing in global FDI stock worldwide fell from 42 per cent in

1990 to 34 per cent in 2002. Manufacturing FDI is increasingly geared to more capital and

knowledge-intensive activities because of two developments. There has been a decline in

labour-intensive manufacturing in general, and the share of traditional manufacturing

employment has also steadily declined. Technological changes leading to increasing

The share of services inFDI increased substantiallywhile those of primaryand manufacturing sectorsdeclined.




replacement of labour by capital and knowledge have been a key element in the decline of labour-intensive FDI in manufacturing. Secondly, firms in more and more countries,

especially developing countries, have developed their own ownership-specific advantages

based on different factor endowments, particularly low-cost labour, vis-à-vis developed

countries.

During the period 1990–2002, while the global FDI stock in the primary sector nearly

doubled and in the manufacturing sector increased nearly threefold, in the services sector it

is more than quadrupled. As a result of more rapid growth in this sector than in the other

sectors, services accounted for about 60 per cent of the global stock of inward FDI in 2002,compared to less than one-half in 1990 and only one-quarter in the early 1970s. In 2009,

services sector continued to receive an increasing share of FDI.

CROSS-BORDER M&As

A very significant aspect of the recent FDI surge is that it is

triggered to a large extent by cross border M&As. For instance,

in some of the recent years cross-border M&As accounted for

three-fourths of the value of global FDI (see Table 9.5).

TABLE 9.5 Cross-border M&As with Values of over $1 billion, 1987–2007

Year Number of deals Percentage of total Value ($ billion) Percentage of total

1987 14 1.6 30.0 40.31988 22 1.5 49.6 42.9

1989 26 1.2 59.5 42.41990 33 1.3 60.9 40.41991 7 0.2 20.4 25.21992 10 0.4 21.3 26.81993 14 0.5 23.5 28.31994 24 0.7 50.9 40.11995 36 0.8 80.4 43.11996 43 0.9 94.0 41.41997 64 1.3 129.2 42.41998 86 1.5 329.7 62.01999 114 1.6 522.0 68.12000 175 2.2 866.2 75.72001 113 1.9 378.1 63.72002 81 1.8 213.9 57.8

2003 56 1.2 141.1 47.52006 215 2.4 711.2 63.62007 300 3.0 1161.0 70.9


Cross-border mergers and acquisitions (M&As) involve FDI in a host country by

merging with or acquiring an existing local firm. In the latter case, the acquisition involves

an equity stake of 10 per cent or more. The share of FDI accounted for by cross-borderM&As is difficult to determine, since data sets are not directly comparable. First, the value

Cross-border mergers andacquisitions (M&As) havebeen the key driver of global FDI since the late1980s.




of cross-border M&As includes funds raised in local and international financial markets.Secondly, FDI data are reported on a net basis, using the balance-of-payments concept, while

data on cross-border M&As purchases or sales report only the total value of the transaction.Finally, payments for cross-border M&As are not necessarily made in a single year but may

be spread over a longer period.17

As an UN report points out, one recent feature is that M&As among large or dominant

TNCs, resulting in even larger TNCs, seem to impel other major TNCs to move towards

restructuring or making similar deals with other TNCs. The pharmaceutical, automobile,

telecommunications and financial industries are typical examples of industries in which such

concentration can be observed. This trend significantly changes the industry structure. In the

automobile industry, for example, the total number of major automobile makers may well

decline to 5–10 by 2010, from the 1998 figure of 15. In the pharmaceutical industry, many

markets are now controlled by a small number of firms. In both these industries, there havebeen a string of M&As. Major M&As in the pharmaceuticals include Glaxo-SmithKline

Beecham, Pfizer Warner Lambert and Hoechst–Rhone.

The trend towards M&As is also accelerating the sale of non-core operations or

affiliates by firms and the acquisition of similar operations from other firms (of divisions or

affiliates, or firms that have similar businesses). This indicates a strategic shift by TNCs to

focus on their core activities. Unlike in the 1980s, there were fewer deals among unrelated

businesses. In addition to strategic considerations of firms, liberalisation and deregulation are

the other main factors behind the dramatic increases in M&As in both developed and

developing countries.

Developed countries account for the lion’s share of the mega mergers (nearly 90 per

cent of the total). However, an upward trend in M&As sales by developing countries and

countries in transition is noticeable. Among developing countries, majority M&As, sales in

South, East and South–East Asia have been increasing recently, in particular after the 1997

financial crisis. Latin America and Central and Eastern Europe also recorded significant

increases in M&A sales.

There has been a substantial shift towards services in cross-border M&As as it became

a widely used mode of TNC entry in such service industries as banking, telecommunications

and water. While in the late 1980s services accounted for some 40 per cent of global cross-

border M&As, their share rose to more than 60 per cent by the end of the 1990s.

The liberalisation and deregulation of several vital industries in many countries across

the world have given an impetus to cross-border M&As in both developed and developing

countries. Increasing M&As in the service sector in general and financial industries in

particular reflect the impact of liberalisation. Privatisation has been a very importantstimulant to M&As. Banking, finance, insurance and telecommunication industries have been

witnessing a spate of M&As.

The Indian Scene

The liberalisation—the privatisation, delicensing, liberalisation of foreign investment policy,

scrapping of MRTP restrictions on M&A, et al.—and the SEBI Takeover Code have opened

the doors for cross-border M&As in India.




The FDI inflow to India on account of acquisition of shares increased from $ 11million in 1995–96 to $ 916 million in 2002–03.

Foreign MNCs have been using M&A as a market entry strategy and competitive

strategy. The soft drink industry witnessed the use of M&A to increase market share and

shrink competition. The Indian cement industry, which has witnessed a number of domestic

M&As and resultant consolidation, has also witnessed the entry and expansion of global

cement majors by M&As. The French cement major, Lafarge, which made a market entry

with the acquisition of Tisco’s cement unit for Rs. 550 crore has moved on to strengthen its

position by acquiring Raymond’s cement unit for Rs. 785 crore. It then eyed Madras

Cements, a leading player in South India. Italcementi, the Italian cement major, through

its group company Ciments Francais, opened its door to India by the acquisition of the

K.K. Birla group’s Zuari Cements. Other global majors like Cemex of Mexico, Holder Bank

of Switzerland and Blue Circle of UK have been reported to be interested in India.Several MNCs have acquired the partner’s stake in their joint ventures or have hiked

the stake in the joint ventures and subsidiaries.

Acquisitions by India Inc Strategic M&As have been finding favour with corporate Indiatoo. M&As by Indian companies involving foreign firms fall into three categories, viz.,

Acquisition of firms in foreign countries. Acquisition of MNC affiliates in India.

Acquisition of foreign brands.

Acquisition of foreign firms by Indian companies is not something new. Acquisition

of foreign firms has been an important element of the inter-

nationalisation strategy of a number of Indian firms. Severalpharmaceutical companies, for example, have done it. A veryimportant foreign acquisition has been the $ 271 billion (Rs. 1870

crore) leveraged buy–out of Tetley by Tata Tea. With this, TataTea, the largest integrated tea producer in the world, got

possession of the second largest global tea marketer which has avariety of tea products and number one position in some of the advanced markets. Other

Tata companies like Tata Steel and Tata Motors have also been expanding globally byacquisitions. The acquisition of the Canadian aluminium major Alcan’s stake in its Indian

subsidiary, Indal, by the A.V. Birla Group’s Hindalco for Rs. 1008 crore, was the largestall-cash acquisition in the history of corporate India. Acquisition has been an important

globalisation strategy of Indian pharma and IT firms too.

Some Indian companies have acquired certain foreign brands. For example, theNicholas Piramal India has acquired the Indian rights for three anti-infective brands fromthe US firm Eli Lilly which gave Piramal a strategic entry into this generation of antibiotic.

The acquisition of the $ 4 million generics business of Bayer AG has given Ranbaxy anentry into Germany, the third largest generics market in the world. Sun Pharmaceuticals’

acquisition of Caraco Pharma Labs, which has a FDA approved formulations manufacturingplant, gave it a strategic entry into the US generics market ‘with lightening speed’. It may

be viewed in the light of the fact that 178 molecules valued at $ 43 billion is going off

In some of the recentyears, acquisitions of foreign firms by Indiancompanies exceeded thevalue of acquisitions of Indian firms by foreigncompanies.




patent by 2003 in the US. Similarly, the acquisition of MJPL gave it an entry to the Europeangenerics market.

The acquisition of Madura Garments, the ready-made garments business of Madura

Coats, a subsidiary of the UK based Coats Viyella, for nearly Rs. 236 crores by the Indian

Rayon of the A.V. Birla group gave it some overseas brand rights too.

Liberalisation, privatisation and growing competition have been stimulating restructur-

ing industries globally and cross-border M&A has become a necessitating and facilitating

force (see Table 9.6). The Takeover Code put in place by the SEBI has imparted clarity and

order to the acquisition scene in India.

TABLE 9.6 Cross-border M&As—India ($ million)

Period Sales Purchases

1990–95 (annual average) 159 721997 1520 12871998 361 111999 1044 1262000 1219 9102001 1037 21952002 1698 2702003 949 13622006 6716 47402007 18830 11256

Source: UNCTAD.

PORTFOLIO INVESTMENTS

Portfolio equity flows to developing countries was conspicuous by their absence prior to

1982. The average annual portfolio flows to developing countries, which was $ 1.3 billion

during 1983–1990, shot up substantially in the 1990s. The portfolio inflows are likely to

significantly increase in future, supported by such factors as further capital market

liberalisation and reforms in developing countries, growth in global financial assets, growth

in developing countries’ exports and capacity to service foreign liabilities, industrial and

general economic growth in developing countries, increased diversification of investor

portfolios, growing resources of the investors and faster equity market capitalisation indeveloping countries.

The fact that this very small share of the total investment by the developed countryportfolio investment would amount to large chunk of investment in the developing country

markets has serious implications because of the high sensitivity and volatility of the portfolioinvestments. The Mexican crisis and the South-East Asian crisis may be remembered here.

Further, large foreign portfolio investment in companies could have other implications.

FOREIGN INVESTMENT IN INDIA

The flow of direct foreign investment to India has been comparatively limited because of

the type of industrial development strategy and the very cautious foreign investment policyfollowed by the nation.




Direct foreign investment (private) in India was adversely affected by the followingfactors:

1. The public sector was assigned a monopoly or dominant position in the most

important industries and, therefore, the scope of private investment, both domestic

and foreign, was limited.

2. When the public sector enterprises needed foreigntechnology or investment, there was a marked preference for the

foreign government sources.3. Government policy towards foreign capital was very selective. Foreign investment

was normally permitted only in high technology industries in priority areas and inexport oriented industries.

4. Foreign equity participation was normally subject to a ceiling of 40 per cent,although exceptions were allowed on merit.

5. Payment of dividends abroad, repatriation of capital, etc., as well as inwardremittances were subject to stringent laws like the Foreign Exchange Regulation

Act (FERA), 1973. These discouraged foreign investment.6. Corporate taxation was high and tax laws and procedures were complex.

These factors either limited the scope of or discouraged the foreign investment in

India.

Government Policy

The following paragraphs give a very brief account of Government of India’s policy

towards foreign capital and technology. First, the salient features of the policy followed till

the economic liberalisation introduced in July 1991 are given. This is followed by an

account of the new policy.

India was following a very restrictive policy towards foreign capital and technology.

Foreign collaboration was permitted only in fields of high priority and in areas where the

import of foreign technology was considered necessary. In other areas, import of technology

was considered on merits if substantial exports were guaranteed over a period of 5 to 10

years and if there were reasonable proposals for such exports. The government had issued

lists of industries where:

(a) (i) Foreign investment may be permitted.(ii) Only foreign technical collaboration (but no foreign investment) may be

permitted.(b) No foreign collaboration (financial or technical) was considered necessary.

The government policy on foreign equity participation was, thus, selective. Such

participation had to be justified with regard to factors such as the nature of technology

involved, whether it would promote exports which might not otherwise take place and the

alternative terms available for securing the same or similar technological transfers. Foreign

equity participation was limited to 40 per cent, although exceptions were allowed on merit.

Prior to 1991, Govern-ment policy severelyrestricted FDI into India.




The foreign share capital was to be by way of cash without being linked to tied imports of machinery and equipment or to payments for know-how, trade marks, brand names, etc.

Technical collaborations were to be considered on the basis of annual royalty payments

which were linked with the value of actual production. The percentage of royalty was

dependent on the nature of technology. Whenever possible, the payment of fixed amount of royalty per unit of production was preferred. Royalty payments were limited to a period

of 5 years.

The Foreign Exchange Regulation Act (FERA), 1973, served as a tool for implement-ing the national policy on foreign private investment in India. The FERA empowered the

Reserve Bank of India to regulate or exercise direct control over the activities of foreign

companies and foreign nationals in India. A foreign company was defined as one (other thana banking company) which was not incorporated in India or in which non-resident interest

was more than 40 per cent or any branch of such a company.According to the FERA, non-residents (including Indian citizens), foreign citizens

resident in India and foreign companies required the permission of the RBI to accept

appointment as agents or technical management advisers in India, of any person or company,or permit the use of their trade marks.

The trading, commercial and industrial activities in India of persons resident abroad,foreign citizens in India and foreign companies were regulated by the FERA. They had

to obtain permission from the RBI for carrying on in India any activity of a trading,

commercial or industrial nature; opening branches/offices or other places of business in Indiaacquiring any business undertaking in India; and purchasing shares of Indian companies.

RBI had given general permission for certain matters. For example, general permission

was granted to foreign companies to acquire or hold any immovable property in India which

was necessary for, or incidental to, any activity undertaken by them with the permission of the RBI.

The New Policy

The Industrial policy statement of July 24, 1991, which observes that while freeing theIndian economy from official controls, opportunities for promot-

ing foreign investment in India should also be fully exploited, has

liberalised the Indian policy towards foreign investment andtechnology.

As pointed out earlier, in the pre-liberalisation era, foreign equity participation was

restricted normally to 40 per cent and foreign investment and technology agreements needed

prior approval. As against this, the new policy has allowed 100 per cent and majority of foreign equity with automatic approval in a large number of industries.

The foreign investment policy has been further modified and liberalised now and then,

so that there is a very liberal, transparent and investor-friendly FDI policy, wherein FDI upto 100 per cent is allowed under automatic route for most of the sectors/activities, where the

investor does not require any prior approval. Only notification to the Reserve Bank of India

within 30 days of inward remittance or issue of shares to nonresidents is required. There areseveral sectors/activities subject to ceiling for foreign equity participation, ranging from 25

per cent to 74 per cent.

The economic reformssubstantially increased thescope of FDI.




Cases requiring prior Government approval are considered by the Foreign InvestmentPromotion Board (FIPB) in a time-bound and transparent manner.

Other measures which encourage foreign investment include the following: ending the

government monopoly in insurance; opening up of the banking sector; divesting public

sector enterprises; protection of international trade marks and patent by legislation;

conclusion of bilateral investment treaties and double taxation treaties; and establishment of

a Foreign Investment Implementation Authority (FIIA) in order to ensure that approvals for

foreign investments (including NRI investments) are quickly translated into actual investment

inflows and the proposals fructify into projects.

Recently, there has been a very significant improvement in the perception of India as an

investment destination. The FDI policy in India is considered as

one of the most liberal, with very few barriers. The Global

Competitiveness Report 2003–04 by the World Economic Forumranks India at 41st place on barriers to foreign ownership, against

67th for Malaysia, 75th for Thailand and 81st for China. A recent confidence survey by

global consultancy AT Kearney rated India as the third most favoured FDI destination, next

only to China and United States. Moreover, for the first time, manufacturing investors

surveyed by AT Kearney considered India as a superior manufacturing location than even

the US.

FII Investments

The Indian stock market was opened up to FII investment in 1992–93 and since then there

has been a significant increase in the portfolio investment by FIIs.

The Regulations on Foreign Institutional Investors, which were notified on November

14, 1995, contains various provisions relating to the definition of FIIs, eligibility criteria,

investment restrictions, procedures of registration and general obligations and responsibilities

of FIIs.

According to the Regulations, FIIs may invest only in:

(a) securities in the primary and secondary markets including shares, debentures and

warrants of companies listed on a recognised stock exchange in India, and

(b) units of schemes floated by domestic mutual funds including Unit Trust of India,

whether listed on a recognised stock exchange or not.

Joint ventures between a variety of domestic and foreign securities firms have been

approved in the stock broking, merchant banking, assets management and other non-banking

financial services sectors. The overall effect of FII investment and financial joint ventures

has been the introduction of international practices and systems to the Indian Securities

industry.

FIIs are permitted to invest in a company up to an aggregate of 24 per cent of equity,

which can be increased to 40 per cent subject to approval by the Board of Directors and a

Special Resolution of the General Body.

In 1996–97, Government liberalised the FII investment policy, allowing them to invest

in unlisted companies and in corporate and government securities.

India now is perceived as

a very attractive FDIdestination.




FII investment has become an important determinant of the stock market trends inIndia. FII investments reached records levels in 2010.

Euro/ADR Issues

Since 1992–93, Indian companies satisfying certain conditions are allowed to access foreign

capital markets by Euro-issues of Global Depository Receipts (GDRs) and Foreign CurrencyConvertible Bonds (FCCBs).

“A Depository Receipt (DR) is basically a negotiable certificate, denominated in USdollars, that represents a non-US company’s publicly-traded local currency (Indian Rupee)

equity shares. DRs are created when the local currency shares of an Indian company (forexample) are delivered to the depository’s local custodian bank, against which the

Depository Bank (such as the Bank of New York) issues DRs in US dollars. The DepositoryReceipts may trade freely in the overseas markets like any other dollar denominated security,

either on a foreign stock exchange, or in the over-the counter market, or among a restricted

group such as qualified institutional buyers.”18

The prefix global implies that the ADRs are marketed globally rather than in a specific

country or market.

Companies with good track record of three years may avail of Euro-issues for

approved purposes. According to the revised guidelines issued in November 1995 companies

investing in infrastructure projects, including power, petroleum exploration and refining,

telecommunications, ports, roads and airports are exempted from the condition of three-year

track record. It is expected to help companies in the infrastructure sectors to access cheap

overseas funds.

Earlier companies had to keep the funds raised through Euro-issues in foreign currency

deposits with banks and public financial institutions in India to be converted into Indian

rupees as and when required for expenditure on approved end uses up to 25 per cent of

the Euro-issue proceedings for meeting corporate restructuring and working capital

requirements. Companies are also permitted to raise funds through issue of Foreign Currency

Convertible Bonds (FCCBs) and ADRs.

An Evaluation of the New Policy

Until about the middle of the present decade, the FDI flow to India was very low for

example, in 2003 while China received nearly 10 per cent of the global FDI inflows, India’s

share was only 0.8 per cent. It was only 0.4 per cent in 2001 and 0.5 per cent in 2002. The

FDI inflow was nowhere near the annual target of $ 10 billion set by the Government many

years ago. This was because the infrastructural facilities were poor, several factors were

costly and the policy and procedural environment in India in several respects was far from

encouraging. However, recently there has been a significant pick up in FDI and FIIinvestments in India. FDI reached $ 25 billion in 2007 and $ 40 billion in 2008.

One important criticism of the liberalisation of foreign

investment has been that foreign investment would take place

mostly in non-priority sectors. However, the lion’s share of the

Most of the FDI in Indiahas gone to prioritysectors.




foreign investment in India since the liberalisation has gone to priority sectors. Now severalof the priority industries, including the infrastructural sector which were earlier exclusively

reserved for the public sector, are opened to foreign investment. Statistics of sector-wise FDIinflows from August 1991 until November, 2004, indicates that the highest shares of FDI

inflows have gone to the data-processing software and consultancy services, followed by

pharmaceuticals and automobile industry (see Table 9.7).

TABLE 9.7 Sectors Attracting Highest FDI Flows(Inflows in Rs. crores)

Sector Amount of FDI inflows Cumulative Share of inflowsinflows (per cent)

2004–05 2005–06 2006–07 2007–08 (April 2000 April April–(April– (April– (April– (April– to Nov. 2000 to Nov. to

March) March) March) Nov.) 2007) Nov. 2007 2007

Services sectora 1,986 2,399 21,047 9,121 38,228 19.86 20.22Computer software and hardware 2,441 6,172 11,786 4,217 30,760 15.98 9.35Telecommunicationsb 570 2,776 2,155 3,963 15,607 8.11 8.79Constructionc 696 667 4,424 3,593 9,989 5.19 7.97Automobile industry 559 630 1,254 1,191 8,350 4.34 2.64Power 241 386 713 206 5,958 3.09 0.46Chemicals except fertilizers 909 1,979 930 733 5,956 3.09 1.63Housing and real estate 0 171 2,121 5,161 7,573 3.93 11.44Drugs and pharmaceuticals 1,343 760 970 353 4,633 2.41 0.78Metallurgical industries 836 654 787 1,909 4,572 2.37 4.23

a. Financial and non-financial services.b. Radio paging, cellular mobile, basic telephone services.

b. Construction including roads and highways.

Source: Government of India, Economic Survey 2007–2008.

Country-wise, FDI inflows to India are dominated by Mauritius (34.49 per cent),

followed by the United States (17.08 per cent) and Japan (7.33 per cent).

There is high regional contribution of FDI in India. Five States—Maharashtra, Delhi,

Tamil Nadu, Karnataka, and Gujarat—which were the top recipients of FDI approvals,

accounted for nearly half of the FDI approvals in the country (see Table 9.8).

TABLE 9.8 State-wise FDI Approvals (From August 1991 to November 2004)

Rank State Approvals Amount of FDI approved Percentage

Total Tech. Financial Rupees US $ of total FDI

in crore in million approved

1 Maharashtra 5,037 1,318 3,719 37,020 9,621 14.80

2 Delhi 2,810 307 2,503 30,519 8,445 12.203 Tamil Nadu 2,681 618 2,063 22,642 5,894 9.054 Karnataka 2,639 502 2,137 19,075 4,833 7.635 Gujarat 1,236 568 668 12,437 3,273 4.97

Note: RBI provides regional office wise information based on the intimation of investment received frominvestors under the automatic route. Consequently, the above table may not necessarily indicate state-wiseinvestment intentions of investors.




Items like reinvested earnings used to be excluded from the estimation of FDI in India.However, in June 2003 Government has aligned the methodology of compilation of FDI with

the international best practices.13 The revised definition includes three categories of capitalflows under FDI: equity capital, reinvested earnings and other direct capital. Previously, the

data on FDI reported in the balance of payments statistics used to include only equitycapital. The revised estimates of FDI in India as per the new definition give a much high

figures.

There are many ardent critics of foreign investment and technology. Foreign invest-

ment and technology is not without problems. However, the opening up of the economies of

a number of nations for foreign companies and the several measures they have taken to woo

foreign companies are a clear indicators of the positive contribution foreign capital and

technology can make.

BOX 9.6 India vs. Other Nations

It is pointed out that one drawback of the Indian foreign investment policy is the lack of focus. For instance, on FDI, there’s been no clear policy focus to attract investments inspecific sectors or specified regions or even specific companies. Countries following suchroutes have been fairly successful in attracting FDI, such as China Focusing on a particularregion and decentralisation has proved beneficial for countries like China and Malaysia.China improved its infrastructure and changed its labour laws for the southern coastal areas like Shanghai and Shenzhen. Now, it is introducing incentives for cities like Wuhanand Chengdu in the Hinterland that have been largely ignored in the past.

Bureaucratic hurdles need to be removed too. The implementation phase often proves tobe the toughest for foreign investors. Once these companies get their FIPB or RBI

clearances, they still need to obtain between 41 and 61 clearances from variousgovernment departments, before they can start their projects. According to an official inthe industry ministry, “FIPB clearance is the easiest. It’s when companies start dealing atthe district level with fire and labour inspectors that things turn sour”. Comparing thatwith China where once the investment has been cleared, a government official is entrustedwith the task obtaining all other clearances from both central and provincial departments.

A World bank study shows that the time required to complete business procedures arerelatively very high in India. Table 9.9 shows the time required to complete businessprocedures of different countries.

Courtesy : ‘Outward bound’, The Economic Times (Editorial), 12 June, 2001; Anjuli Bhargavaand Alam Srinivas, ‘Where Is The Money’, Businessworld , 23 April, 2001.

TABLE 9.9 Doing Business Indicators

Procedure Brazil China India Sweden

Time required for Starting a Business (Days) 152 41 89 16

Time required for registering a property (Days) 42 32 67 2

Time required for enforcing contracts (Days) 566 241 425 208

Time required to complete insolvency proceedings (Year) 10 2.4 10 2

Courtesy: World Bank and IFC Doing Business in 2005, Oxford University Press, 2005.




FOREIGN INVESTMENT BY INDIAN COMPANIES

Until 1991, Indian companies made very little investment abroad. Although government of

India’s policy had been one of encouraging foreign investment by Indian companies, subject

to certain conditions, several factors like the domestic economic policy and the domesticeconomic situation were deterrents to foreign investment by Indian companies.

By restricting the areas of operation and growth, the government policy seriouslyconstrained the potential of Indian companies to make a foray into the foreign countries

through investment. Added to this was the attraction of the protected domestic market whichwas, in many cases, a seller’s market and this made the Indian companies ignore the foreign

markets.Indian companies have established subsidiaries and joint ventures in a number of

countries in different manufacturing industries and service sectors. The liberalisation, bothglobal and domestic, has imparted a global orientation to Indian business so that there hasbeen a substantial increase in Indian investments abroad. FDI outflow from India crossed

$ 18 billion in 2008 compared to the annual average of $ 121 million during 1900–2000.

An UNCTAD report observes that India also stands out among Asian investors, not somuch because of its recent and significant increase in outward FDI and because of its

potential to be a large outward investor, but because of the new trend set by some of its information technology (IT) firms. Most Indian outward FDI is in manufacturing (about

55 per cent), but non-financial services also account for a significant share (25 per cent).FDI in IT services in particular has begun to grow rapidly. The growing technological

capabilities of Indian firms and their rising exports, particularly in IT services andpharmaceuticals, are driving the FDI growth. Access to markets, distribution networks,

foreign technology and strategic assets such as brand names, are the main motivations.Securing natural resources is also becoming an important driver for FDI in the oil and gas

industries and mining.19

The most important destination for Indian FDI has been the United States, accounting

for nearly one-fifth of its total outward flows since the mid-1990sto 2003, followed by the Russian Federation (with 18 per cent)

mainly due to acquisitions in the oil and gas industries. Overall,however, about half of total Indian outward FDI has gone to other developing countries.20

Strategic M&As have been finding favour with corporate India too. M&As by Indiancompanies involving foreign firms fall into three categories, viz., acquisition of foreign

firms, acquisition of MNC affiliates in India and acquisition of foreign brands.

Foreign investment, both in greenfield enterprises and mergers and acquisitions(M&A), is clearly a part of the globalisation strategy of many Indian companies. Recently,there has been a spurt in FDI by Indian companies.

In light of the economic liberalisation and the growing competition at home, manyIndian companies have been planning for a major thrust abroad. The value of a single

foreign acquisition in early 2007 (Corus by Tata Steel) was much more than the total FDIinflow to India in the previous year.

Although there is a lot of talk about the procedural simplification, foreign companiesstill find the procedures very perplexing and unbearably time-consuming.

FDI by Indian companieshas been rising fast.




One important criticism of the liberalisation of foreign investment has been that foreigninvestment would take place mostly in non-priority sectors. However, the foreign investment

in India since the liberalisation has gone largely to priority sectors. Now several of thepriority industries, including the infrastructural sector which were earlier exclusively

reserved for the public sector, are opened to foreign investment. Foreign investment needs to

be directed to priority sectors.

INTERNATIONAL TRADE FINANCING

The international market is generally very competitive and sensitive and the credit facilities

made available to the buyers are one of the important determinants of export business.

The extent to which credit must be extended to the importer depends on the sale terms.If the exporter gets cash in advance, there will not be any problem in respect of finance; but

this is not common. Even if the exporter gets the payment at the time of the shipment of

the goods, he has to make his own arrangements to meet his financial needs at the pre-

shipment stage. If the sale is on credit, as it usually is, the exporter will be still more

constrained financially. It is, therefore, necessary to make institutional credit available to the

export sector to meet its pre-shipment and post-shipment financial requirements; for such

credit facilities will enable the exporters not only to meet their financial requirements at the

pre-shipment stage but also to extend reasonable credit facilities to foreign buyers.

Sometimes, institutional credit is extended to foreign buyers instead of exporters. The

buyer’s credit is extended, usually, to the buyers of capital goods.

Payment Terms

Some knowledge of the important payment terms and methods of effecting payment would

be useful to understand the export financing methods and process. The credit requirements

of the exporter depend to a very large extent on the sale terms.

A sale contract should clearly specify when the payment will be made, where it will be

made, and how it will be made. As the payment terms are determined on the basis of the

specific circumstances of the particular buyer and seller, it would be difficult to make any

generalisation about payment terms. However, there are certain standard terms, which are in

common use.

Cash in advance

The most advantageous payment term from the seller’s point of view is the remittance with

the order, or sometimes, before the shipment of goods. The remittance may be by draft,cheque, mail or telegraphic transfer. Very seldom is an importer prepared to make cash

payments in advance; but in certain cases it becomes necessary. For instance, advancepayment may be insisted upon when goods ordered are those manufactured to order in

accordance with the specifications of the buyer. Further, when the buyer is unknown to theseller or his creditworthiness is doubtful, the seller would like to get the payment in

advance.




If the seller enjoys a monopoly position or if there is a seller’s market, it is easyto obtain advance payment; but when the market is very competitive, it is very difficult

to do so.

Open account

Under trading on open account, the exporter ships the goods with no financial documents to

his advantage except the commercial invoice. Under this method, therefore, the seller carries

the entire financial burden with little or no documentary evidence. Because of the great risks

associated with the open account method, it is generally restricted to cases of transactions

between inter-connected companies, or where the exporter and overseas buyers have had a

long and well-established commercial relationship, and when there is no exchange

restrictions that complicate the settlement. Indian exporters are allowed to abroad on theopen account basis only with the special permission of the Reserve Bank of India. Normally,

this permission is given only to foreign companies operating in India.

Consignment sale

Under the consignment sale, the exporter consigns the goods to his agent representative inthe foreign markets, who arranges for the sale of the goods and makes payments to the

exporter. Goods consigned abroad include tea, coffee, wool, etc. which cannot be easilystandardised. Under this method, the exporter retains the title to the goods until the sale of

the goods is effected in the foreign market. The consignment sale involves a number of risksfor the exporter. As no bill of exchange is involved under this method, the seller is not

protected against default. He is also exposed to such risks as exchange rate fluctuations andthe loss that may arise if the consignee is inefficient or is not sincere and honest.

An Indian exporter selling goods on consignment basis must furnish a declarationregarding the full export value of the goods, or if the full export value of the goods is not

ascertainable at the time of export, the value which the exporter, having regard to theprevailing market conditions, expects to receive on the sale of the goods in the overseas

market.

Documents against payment

Under the D/P terms, also known as cash against documents (c.a.d.), the exporter ships

goods to the foreign buyer, but the documents giving title to the goods will be handed overto the buyer through the bank only on payment. Under this type of transaction, until and

unless the buyer makes the payment, the ownership of the goods remains with the seller.The exporter may obtain bank finance against D/P bills. If the bank is satisfied, it may

finance the exporter by purchasing the D/P bills, usually on a with recourse basis, so in theevent of non-payment by the drawee, the bank has recourse to the drawer.

Documents on acceptance

Under the D/P method, the documents and the title to the goods are handed over to the

buyer when he accepts the bill of exchange by signing it. The usance of the bill of exchange




may be 30 days, 60 days or 90 days. The exporter, thus, extends credit to the importer forsuch periods. Under the D/A terms, the exporter relies on the honesty and creditworthiness

of the buyer; and therefore this facility is normally extended only to parties who have

proven business integrity and financial standing. Banks may finance to exporters by

purchasing the D/P bills with recourse.

Documentary letter of credit

The documentary letter of credit covers the major part of the export business. A letter of

credit is a document containing the guarantee of a bank to honour on it by an exporter,

under certain conditions and up to certain amounts. Instead of being drawn on the importer,

the draft is drawn on the importer’s bank. A letter of credit eliminates the risk for an

exporter, he will be definitely paid for his shipment provided, of course, that he fulfils hisobligations. He, therefore, ordinarily requests the importer to arrange for a letter of credit.

Apart from avoiding the risk of non-payment, an important advantage of a documentary

letter of credit from the point of view of the exporter is that, immediately after the

shipment of the goods, he can present the bill of exchange and other relevant documents and

obtain payment from a bank at his own centre. For details of the letter of credit financing

of the export business, see the appendix to the chapter.

We have outlined above the important payment terms. The actual payment term

adopted in a particular transaction is influenced by a number of factors, such as the

individual circumstances of the buyer and the seller, the nature of the product, the profit

margin, customs of the trade, the organisation of the firm, the legal limitations and the cost

and availability of credit.

INSTITUTIONAL FINANCE FOR EXPORT

Even if the exporter gets payment at the time of the shipment of goods, he has to arrange

for finance to meet the expenses involved until the time of shipment. These includeexpenditure on the purchase of materials and components, processing, packaging, packing,

marking, transaction, warehousing, etc. In many instances, the exporter is compelled toextend credit to the overseas buyer. In fact, in international marketing, the nature of the

sale/credit term offered is a very decisive factor in obtaining business. In many cases, theexporter has to wait for a period of time—short, medium or long—even after the shipment

of goods to obtain payment from the overseas buyer. He has, therefore, to arrange for post-

shipment finance, covering the period between the shipment of the goods and the receipt of payment. All the countries which are serious about export promotion have, therefore, madeinstitutional arrangements for the provision of both pre-shipment and post-shipment finance.

In India, the export sector is regarded as a priority sector.

Pre-Shipment Credit

As the name indicates, pre-shipment finance, also known as packing credit, refers to the

credit extended to the exporter prior to the shipment of goods. Pre-shipment credit enables




him to meet his working capital requirements for the purchase of raw materials andcomponents, processing, packing, transportation, warehousing, etc. Packing credit is short-

term finance. It is also advanced against export incentives.

In India, pre-shipment credit is provided by Indian and foreign commercial banks

which are members of the Foreign Exchange Dealers’ Association. The packing credit

advances by commercial banks in India are governed by the Packing Credit Scheme of the

Reserve Bank.

The loan is advanced only on receipt of an export order.

To obtain the loan, the exporter should deliver to the bank either a letter of credit

established in his favour or a confirmed export order. However, where the letter of credit or

the confirmed export order is yet to be received, relevant evidence in the form of a cable,

letter, etc. is acceptable, provided that such cable, letter, etc. contains information regarding

at least the value of the order, the quantity and particulars of goods, the date of shipmentand the name of the buyer.

All the packing credit advances must be repaid from the proceeds of the relative export

bills negotiated or from the remittances received from abroad for the relative goods.

Packing credits are eligible for interest subsidy, normally for a period not exceeding

90 days, although the credits may be given for a period of 180 days for specified items,

such as engineering goods, with the permission of the Reserve Bank of India. In genuine

cases of delay of shipment of specified items, a further period of 90 days may be allowed

by the Reserve Bank of India. Packing credit is also available against certain incentives; such

advances should be repaid by the exporter as soon as these are realised.

Where a letter of credit or an export order is received in the name of an export house

or any merchant exporter, an advance made even to a sub-supplier falls within the Packing

Credit Scheme. In such a case the sub-supplier should submit a letter to the bank from the

export house/merchant exporter, giving details of export house/merchant and of the supply

allotted, and confirming that the export house/merchant exporter, will not avail itself/himself

of packing credit from any other source on the quantity so allotted. Since export bills are

negotiated in the name of the export house/merchant exporter, the repayment of such

packing credit should be made by inland letters of credit opened by the export house/

merchant exporter in favour of the sub-supplier, or by proceeds of bills drawn by the sub-

supplier on the export house/merchant exporter. Whenever the bill on the export house/

merchant exporter is not accompanied by a bill of lading, a certificate should be obtained

from the export house/merchant exporter for every quarter, stating that the goods have

actually been exported.

An undertaking from the sub-supplier shall be obtained that any advance paymentreceived towards the supply of goods would be adjusted to the packing credit.

Post-Shipment Finance

As has already been mentioned, the international market is, by and large, very competitive,

and the extension of credit facility to the buyers is one of the important determinants of the

expansion in the export business. Most exporters are not in a position to extend credit to

overseas buyers. To promote the export business, therefore, the burden of credit should be




shifted from the exporters by either the financial institutions providing credit, directly orindirectly, to the buyers, or by extending credit to the exporters to enable them to extend

credit to their buyers. Accordingly, financial institutions provide buyer’s credit, line of

credit, and supplier’s credit.

Buyer’s credit

Under the buyer’s credit system, credit is extended to the overseas buyer by either a

financial institution or a consortium of financial institutions. This credit enables the buyer to

pay for the goods he imports if the financial institution that provides the buyer’s credit is

located in the exporter’s country. The loan does not involve transfer of funds from the

supplier’s country to the buyer’s country; the exporter may obtain the payment directly from

the financial institution on presentation of the relevant export documents. Buyer’s credit isgenerally advanced for capital goods.

Line of credit

Line of credit is a sort of buyer’s credit. When a number of buyers are involved, instead of

negotiating credits with each one, the financial institutions in the supplier’s country mayextend a line of credit to a financial institution in the buyers’ country which, in turn, will

disburse the credit to the buyers in respect of approved transactions. Apart from avoidingthe problem of dealing with several individual transactions, the great advantage of the line

of credit is that the responsibility for judging the credit worthiness of the buyers is shiftedto the financial institution in the buyer’s country.

Short-Term Finance

Short-term post-shipment credit is usually provided by the commercial banks, mainly bynegotiating documents under letters of credit, by purchasing D/P and D/A bills, by lending

against export bills tendered for collection abroad, and by advancing money against suchreceivables as export incentives like cash assistance, refund of excise and customs duty

and reimbursement of the differentials between indigenous and international prices of certainraw materials.

Medium and Long-Term Finance

In India, commercial banks, which provide most of the short-term post-shipment credit, playan important role in offering medium and long-term post-shipment finance.

The Industrial Development Bank of India (IDBI) played a very important role inlong-term post-shipment finance. It provided re-finance facilities to commercial banks

against the long-term export credit extended by them, and had a scheme for direct financialassistance to exporters in collaboration with approved commercial banks. The IDBI was also

operating a Buyer’s Credit Scheme for the promotion of capital goods exports from India.Under this scheme, it provided credit to eligible foreign buyers for the purchase of goods

from India.




With the establishment of the Export-Import (Exim) Bank in 1982, export creditfunctions performed by the IDBI were transferred to the Exim Bank.

EXIM BANK

The Export-Import Bank of India, set-up in 1982 by an Act of Parliament for the purpose

of financing, facilitating and promoting foreign trade of India, is the principal financial

institution in the country for coordinating working of institutions engaged in financing

exports and imports.

The Exim Bank is fully owned by the Government of India and is managed by a

Board of Directors which has representatives from the Government, Reserve Bank of India,

Export Credit Guarantee Corporation of India, a financial institution, public sector banks,and the business community.

Mission

The mission statement of Exim Bank: to develop commercially

viable relationships with externally oriented companies by

supporting their internationalisation efforts, through a diverse

range of products and services.

Objectives

The objectives of the Exim Bank are:1. To translate national foreign trade policies into concrete action points.

2. To provide alternate financing solutions to the Indian exporter, aiding him in his

efforts to be internationally competitive.

3. To develop mutually beneficial relationships with the international financial

community.

4. To initiate and participate in debates on issues central to India’s international trade.

5. To forge close working relationships with other export development and financing

agencies, multilateral funding agencies and national trade and investment promotion

agencies.

6. To anticipate and absorb new developments in banking, export financing and

information technology.

7. To be responsive to export problems of Indian exporters and pursue policy

resolutions.

Figure 9.3 shows the role of Exim Bank.

Global Networking

Exim Bank is quite unique in its global and national network of institutional and

professional linkages. Its several overseas offices in places such as Budapest, Johannesburg,

Exim Bank’s mission is tofacilitate globalisation of Indian business.




Milan, Singapore and Washington D.C.—have forged strategic institutional linkages for the

Bank with Multilateral agencies such as World Bank, Asian Development Bank, etc; Export

Credit Agencies; Trade and Investment Promotion Agencies abroad; and Trade and Industry

Associations in India.

The Bank’s extensive global network, supported by the Indian Missions abroad, makes

it uniquely capable of offering advisory services to Indian companies looking for market

opportunities, buyer information, technology suppliers and partners for overseas and

domestic joint ventures. Further, our overseas offices enable us to garner economic andcommercial intelligence on countries, companies and projects, assess credit risks, review

competitive export practices and provide alerts on new export opportunities.

The domestic offices of the Bank in several places are intended to help to respond to

regional developmental activities in the export sector. They are expected to identify special

needs of the export business through close interaction with existing and prospective clients

and suggest innovative instruments appropriate to the region’s potential. They also regularly

interact with commercial/developmental/government agencies, and strengthen the Bank’s

policy mechanism with their critical inputs on market perceptions and the export

environment.

Functional organisation

The Bank’s functions are segmented into four major operating groups:

1. Overseas Investment Finance handles a variety of financing programmes for

Export Oriented Units (EOUs), importers, and overseas investment by Indian

companies.

2. Project Finance/Trade Finance handles the entire range of export credit services

such as supplier’s credit, pre-shipment credit, lines of credit, buyer’s credit, finance

for export of projects and consultancy services, guarantees, forfeiting, etc.

FIGURE 9.3 Evolving role of EXIM Bank.

From financing,facilitating and

promoting India’sforeign trade.

To creating exportcapability by

arranging competitivefinancing at variousstages of the export

cycle.

To developingcommercially viablerelationship with a

target set of externallyoriented companies by

offering them acomprehensive range of products and services,

aimed at enhancing theirinternationalisation

efforts.




3. Export Services Group offers a variety of advisory and value-added informationservices aimed at investment promotion.

4. Agri-Business Group has been put in place to spearhead the initiative to promote

and support Agri-exports. The Group handles projects and export transactions in the

agricultural sector for financing.

Apart from these, there are the Support Services groups, which include: Planning &

Research, Corporate Finance, Management Information Services, Information Technology,Legal, Human Resources Management and Corporate Affairs.

Assistances

Exim Bank plays a four-pronged role with regard to India’s foreign trade: those of a

coordinator, a source of finance, consultant and promoter.The Bank finances exports of Indian machinery, manufactured goods, consultancy and

technology services on deferred payment terms. It also seeks toco-finance projects with global and regional development agencies

to assist Indian exporters in their efforts to participate in suchoverseas projects.

The Bank is involved in promotion of two-way technology transfer through theoutward flow of investment in Indian joint ventures overseas and foreign direct investment

flow into India. The Bank is also a Partner Institution with European Union and operatesfor facilitating promotion of joint ventures in India through technical and financial

collaboration with medium sized firms of the European Union.

The Exim Bank, thus, extends both funded and non-funded assistance for promotion of foreign trade.The funded assistance programme of the Bank includes direct financial assistance to

exporters, rediscounting of export bills, technology and consultancy services financing,

refinancing of export credit and re-lending facility to banks abroad.

The non-funded assistance is in the form of guarantees which are in the form of bid

bonds, advance payment and performance guarantees, retention money guarantees, and

guarantees for raising finance abroad.

Financing Services

Exim Bank offers a diverse range of financing services for the Indian exporter, including

a variety of Export Credit facilities, and Finance for Export Oriented Companies (seeFigure 9.4).

Export credits

Exim Bank offers the following Export Credit facilities, which can be availed of by Indiancompanies, commercial banks and overseas entities.

The Exim Bank operates awide range of financingand promotionalprogrammes.




For Indian companies executing contracts overseas

Pre-shipment credit Where the manufacturing cycle of the export contract exceeds six

months, Exim Bank’s Pre-shipment Credit facility provides access to finance at the

manufacturing stage—enabling exporters to purchase raw materials and other inputs.Pre-shipment Rupee Credit is extended to finance temporary funding requirement

of export contracts. This facility enables provision of rupee mobilisation expenses for

construction/turnkey projects. Exporters could also avail of pre-shipment credit in foreign

currencies to finance cost of imported inputs for manufacture of export products to be

supplied under the projects. Commercial banks also extend this facility for definite periods.

Supplier’s credit At the post-shipment stage, this facility enables Indian exporters to

extend term credit to importers (overseas) of eligible goods. Exim Bank offers Supplier’s

Credit in Rupees or in Foreign Currency at post-shipment stage to finance export of eligible

goods and services on deferred payment terms. Supplier’s credit is available both for supply

contracts and project exports; the latter includes construction, turn key or consultancy

contracts undertaken overseas.Exporters can seek Supplier’s credit in Rupees/Foreign Currency from Exim Bank in

respect of export contracts on deferred payment terms irrespective of the value of export

contracts.

For project exporters Indian project exporters incur Rupee expenditure while executing

overseas project export contracts. Exim Bank’s facility helps them meet these expenses.These would generally include costs of mobilisation/acquisiton of materials, personnel and

equipment, payments to be made in India to staff, subcontractors and consultants, andproject-related overheads in Indian Rupees.

FIGURE 9.4 Scope of EXIM Bank’s Financing Programmes.

EXIM Bank’s Range of Financing Programmes

Forfaiting, GuaranteesExport Credits Finance for EOUs

Finance for (EOUs)

1. Project Finance for setting up EOUs;for textile and jute industries; forSoftware industry; for Indiancompanies involved in portdevelopment and related activities

2. Equipment Finance for productionequipment; for vendors of EOUs

3. Working Capital Finance4. Other Facilities. Finance for R&D

and export product development;underwriting; export marketingfinance; import loans; guarantee; forJVs between Indian and East Asiancompanies

For Indian Companies

1. Pre-shipment credit2. Post-shipment supplier’s credit3. Finance for deemed exports4. Financing rupee expenditure for project

exports5. Finance for consultancy and

technology services

For Commercial Banks

1. Export bills rediscounting2. Refinance of export (supplier’s) credit3. Refinancing of foreign currency pre-shipment credit

For OverseasEntities

1. Buyer’s credit2. Lines of

credit




For exporters of consultancy and technological services Exim Bank offers a specialcredit facility to Indian exporters of consultancy and technology services, so that they can,

in turn, extend term credit to overseas importers. The services covered include providing

personnel for rendering technical services, transfer of technology/know-how, preparation of

project feasibility reports, maintenance and management contracts, etc.

Guarantee facilities Indian companies can avail of these facilities to furnish requisite

guarantees to facilitate execution of export contracts and import transactions.

Forfaiting Forfaiting is a financing mechanism that enables a company to convert credit

sale to cash sale, on ‘without recourse’ basis. Exim Bank acts as a facilitator for the Indian

exporter, enabling him to access the services of an overseas forfaiting agency. Forfaiting is

dealt in detail later in this chapter.

Other facilities for Indian companies Indian companies executing contracts within India,but which are financed by multilateral funding agencies, can avail of credit under the Bank’s

Finance for Deemed Exports facility, aimed at helping them meet cash flow deficits.

For overseas entities

Buyer’s credit Overseas buyers can avail of Buyer’s credit from Exim Bank, for importof eligible goods from India on deferred payment terms.

Lines of credit Exim Bank extends Lines of credit to overseas financial institutions,

foreign governments and their agencies, enabling them to onlend term loans to finance

import of eligible goods from India.

The lines of credit is extended by the Bank to overseas governments/agenciesnominated by them or financial institutions overseas to enable buyers in those countries to

import capital/engineering goods, industrial manufactures and related services from India on

deferred payment terms. This facility enables importers in those countries to import from

India on deferred credit terms as per the terms and conditions already negotiated between

Exim Bank and the overseas agency. The Indian exporters can obtain payment of eligible

value from Exim Bank against negotiation of shipping documents, without recourse to them.

The lines of credit are denominated in convertible foreign currencies or Indian Rupees

and extended to sovereign governments/agencies nominated by them or financial institutions.

Such governments/agencies/institutions are the borrowers and Exim Bank the lender. Terms

and conditions of different lines of credit are varying and details in respect of each line of

credit can be obtained from Exim Bank. It would need to be ascertained from time to time

that the lines of credit have come into effect and uncommitted balance is still available forutilisation. Indian exporters also need to ascertain the quantum of service fees payable to

Exim Bank on account of pro rata export credit insurance premium and/or interest rate

differential cost that they can then add up in their prices to their importers.

Finance for Export Oriented Units (EOUs)

For the purpose of our financing, an Export Oriented Company is defined as any company




with a minimum export orientation of 10% of net sales, or annual export sales of Rs. 5crores, whichever is lower.

Project finance

For setting up EOUs Exim Bank offers term loans for setting up new projects, and for

acquisition of assets for modernisation/upgradation/expansion of existing units. The Bank

also extends 100 per cent refinance to commercial banks, for term loans sanctioned by the

lending bank to an EOU.

For textile and jute industries The Bank also extends finance to eligible units in textileand jute industries under the Technology Upgradation Fund Scheme, to enable them to

upgrade their manufacturing facilities.

For software industry The Bank offers a comprehensive financing/services package for

the software industry. These include project/equipment finance, working capital finance,

overseas investment finance, besides support for obtaining product/process certification,

export marketing, and export product development.

The Exim Bank extends term loans to software exporters for establishment/expansion

of software training institutes. Further, the Bank also facilitates setting up of Software

Technology Parks (STPs).

For Indian companies involved in port development and related activities Exim Bank extends term loans to Indian companies involved in construction of ports/jetties, and for

acquisition of fixed assets for stevedoring, cargo handling, storage and related activities likedry docks and ship breaking.

Equipment finance

Finance for production equipment To cater to the non-project related capital expenditure

of EOUs, Exim Bank offers a line of credit for acquisition of imported/indigenous

equipment, including equipment for packaging, pollution control, etc.

For vendors of EOUs Under the Export Vendor Development Finance facility, Exim

Bank offers term loans to vendors of EOUs, to enable them to acquire plant and machineryand other assets required for increasing export capability.

Working capital finance

Exim Bank provides term loans (of 1 year, 1–2 years, and up to 5 years tenor) to eligibleEOUs, to help them meet their working capital (loan component) requirements.

Other facilities

Finance for R&D and export product development Exim Bank offers term loans to

EOUs for development of new technology to satisfy domestic and international environmentand standards, and to help them develop and/or commercialise new product/process

applications.




Underwriting Exim Bank extends underwriting commitment to Indian exporters, to helpthem raise finance from capital markets through public/rights issues of equity shares/

debentures.

Export marketing finance Exim Bank offers term loans to Indian companies, to aid them

in their efforts to penetrate and retain their presence in overseas markets, particularly in

developed countries.

Import loans Exim Bank finances bulk imports of consumable inputs and canalised items

undertaken by manufacturing companies.

Guarantee facility Exim Bank issues different kinds of guarantees for EOUs. These

include: (a) export obligation guarantees; (b) deferred payment guarantees; and (c) guaran-

tees in favour of commercial banks/lending institutions abroad on behalf of Indian exporters.For JVs between Indian and East Asian companies Under the Asian Countries

Investment Partners Programme, Exim Bank provides finance at various stages of a joint

venture project cycle viz., sector study, project identification, feasibility study, prototype

development and technical, managerial assistance.

Finance for ventures overseas

Exim Bank offers term loans to Indian companies, both for equity investment in their

ventures overseas and for onlending purposes.

Besides, Exim Bank also undertakes Direct Equity Stake in Indian Ventures Abroad, to

enable Indian companies to supplement their equity with Exim Bank’s equity contribution.

For commercial banks

Exim Bank offers Rediscounting facility to commercial banks, enabling them to rediscount

export bills of their SSI customers, with usance not exceeding 90 days. It also offers Refinance of Supplier’s Credit , enabling commercial banks to offer credit to Indian exporters

of eligible goods, who in turn extend term credit over 180 days to importers overseas.Authorised dealers in foreign exchange can obtain from Exim Bank hundred per cent

refinance of deferred payment loans extended for export of eligible Indian goods.

Export services

Exim Bank offers a diverse range of information, advisory and support services, which

enable exporters to evaluate international risks, exploit export opportunities and improvecompetitiveness.

For multilateral agencies funded projects overseas (MFPO) Exim Bank offers value-

added information and support services to Indian companies seeking business in projects

funded by multilateral agencies such as the World Bank, Asian Development Bank, African

Development Bank, European Bank for Reconstruction and Development, and other official

Development Agencies like the Overseas Economic Cooperation Fund of Japan. Services

offered include identification of business opportunities in funded projects; details on specific




projects of interest; information on procurement guidelines, policies and practices of multilateral agencies; assistance for registration with multilateral agencies; advice on

preparation of Expression of Interest, Capability Profile, etc.; advice on bids, with regard to

bid evaluation, review of bid documents, etc.

Apart from these, the Bank also offers support services, such as liaising with Indian

missions, monitoring bid performance, aids in prequalification.

Commercial services Exim Bank undertakes customised research on behalf of interested

companies, in areas such as establishing market potential, defining marketing arrangements

and specifying distribution channels. It also assists companies in developing export market

entry plans, obtaining quality certifications and display of their products in their overseas

offices.

Country profiles Exim Bank also undertakes country profiles, which assess the economic,political, currency and credit risks involved, along with the export opportunities in the

country concerned.

Financial counselling Exim Bank offers advice on how to access foreign currency finance

from multilateral institutions and import lines of credit, trade finance alternatives, collection/

payment systems, as well as on the credit worthiness of business entities and banks.

Internationalisation support Exim Bank helps in identifying technology suppliers,

partners, and in consummation of domestic and overseas joint ventures, through its network

of alliances and its overseas offices. It also advises companies on regulatory clearances, and

facilitates tying-up finance for equity and working capital.

Information access Exim Bank issues business opportunities alerts, which communicatebusiness leads, acquisition opportunities, industry trends, as well as collaboration oppor-

tunities from the European Commission’s network, Bureau de Rapprochement des

Enterprises, of which Exim Bank is a partner institution.

Building export capability The Bank’s Eximius Learning Centres in Bangalore and

Ahmedabad organise training programmes, workshops and seminars for exporters. These

programmes, often on sector-specific issues, are conducted by international experts from

trade promotion organisations and multinational companies.

The Bank also carries out research on issues related to international trade, economics,

and sector/product/country studies, which it publishes in the form of Occasional Papers.

The Bank disseminates information on export opportunities and highlights develop-

ments that have a bearing on Indian exports, through its periodicals.International merchant banking services Exim Bank provides advisory services to Indianexporters to enable them to offer competitive financial packages when they bid for exports.

Joint Ventures

• Global Procurement Consultants Limited (GPCL), is a successful consultancy

company, promoted by Exim Bank in 1996, in partnership with leading private and

public sector consultancy firms in India. GPCL provides procurement related




services to multilateral agencies such as World Bank, Asian Development Bank andAfrican Development Bank.

• Global Trade Finance Private Limited (GTF), a Joint Venture, promoted by

Exim Bank with Westdeutsche Landesbank Girozentrale (WestLB), Germany and

International Finance Corporation (IFC), Washington, commenced business in

September 2001. GTF offers, for the first time in India, structured foreign trade

financing products such as forfaiting and factoring.

Promotional Programmes

Exim Bank, in association with Confederation of Indian Industry (CII), presents an Annual

Award for Business Excellence for the best TQM practices adopted by an Indian company.

The high performance standards set down in order to qualify for the Award serve to fosterstrong commitments to TQM in the company’s journey towards Business Excellence.

Under the Project Preparatory Services Overseas (PPSO) Programme, Exim Bank

provides loan/grant finance to enable Indian consultancy firms to take up project preparatory

studies in developing countries.

Under an arrangement with the International Finance Corporation (IFC), Washington,

Exim Bank is a participant in the trust funds set up by the IFC in different parts of the

world. As a result of this arrangement, Indian consultants can avail of grant finance for

undertaking specific assignments in select countries in Africa, Eastern Europe, and the

Mekong delta region (see Figure 9.4).

FORFAITINGThe word ‘forfait’ is derived from the French word ‘a forfait’ which means the surrender of

rights. In a forfaiting transaction, the exporter surrenders, without

recourse to him, his rights to claim for payment on goods

delivered to an importer, in return for immediate cash payment

from a forfaiter. As a result, an exporter in India can convert a

credit sale into a cash sale, with no recourse to the exporter or his banker.

Forfaiting, in short, is a mechanism of financing exports:

By discounting export receivables. Evidenced by bills of exchange or promissory notes.

Without recourse to the seller (viz. exporter). Carrying medium to long-term maturities.

On a fixed rate basis (discount). Up to 100 per cent of the contract value.

All exports of capital goods and other goods made on medium to long-term credit are

eligible to be financed through forfaiting.

Receivables under a deferred payment contract for export of goods, evidenced by bills

of exchange or promissory notes, can be forfaited. Bills of exchange or promissory notes,

backed by co-acceptance from a bank (which would generally be the buyer’s bank), are

Forfaiting is the non-recourse discounting of export receivables.




endorsed by the exporter, without recourse, in favour of the forfaiting agency in exchangefor discounted cash proceeds. The banker’s co-acceptance is known as avalisation. The co-

accepting bank must be acceptable to the forfaiting agency.

Exim Bank has been authorised by the Reserve Bank of India to facilitate export

financing through forfaiting.

The role of Exim Bank will be that of a facilitator between the Indian exporter and

the overseas forfaiting agency. On a request from an exporter, for an export transaction

which is eligible to be forfaited, Exim Bank will obtain indicative and firm forfaiting

quotes—discount rate, commitment and other fees—from overseas agencies. The Bank will

receive avalised bills of exchange or promissory notes, as the case may be, and send them to

the forfaiter for discounting and will arrange for the discounted proceeds to be remitted to

the Indian exporter. It will issue appropriate certificates to enable Indian exporters to remit

commitment fees and other charges.To be eligible for forfaiting, the export contract can be executed in any of the major

convertible currencies e.g., US dollar, Deutsche mark, Pound sterling, Japanese yen.

The duration of receivables eligible for forfaiting is normally between 1 year and

5 years.

The minimum value of an export contract eligible for forfaiting and acceptable to a

forfaiting agency will generally be the equivalent of US $ 1,00,000.

Eligibility of an export transaction for forfaiting can be determined when the forfaiting

agency is approached for a forfait quote. The availability of a forfaiting quote for a

particular country will depend on the forfaiting agency’s perception of risk quality of export

receivables from that country. The forfaiting agency will indicate the maximum amount and

the period of discount while giving quote for forfaiting.

A forfaiting transaction has typically three cost elements: Commitment fee; Discount

fee; and Documentation fee. Exim Bank will charge a service fee for facilitating the

forfaiting transaction which will be payable in Indian rupees.

Benefits of Forfaiting

Converts a deferred payment export into a cash transaction, improving liquidity and

cash flow.

Frees the exporter from cross-border political or commercial risks associated with

export receivables.

Finance up to 100 per cent of the export value is possible as compared to 80–85

per cent financing available from conventional export credit programmes. As forfaiting offers without recourse finance to an exporter, it does not impact the

exporter’s borrowing limits. Thus, forfaiting represents an additional source of

funding, contributing to improved liquidity and cash flow. Provides fixed rate finance; hedges against interest and exchange risks arising from

deferred export credit.

Exporter is freed from credit administration and collection problems.

Forfaiting is transaction specific. Consequently, a long-term banking relationship

with the forfaiter is not necessary to arrange a forfaiting transaction.




Exporter saves on insurance costs as forfaiting obviates the need for export creditinsurance.

Simplicity of documentation enables rapid conclusion of the forfaiting arrangement.

(More details about forfaiting are available on the www.eximindia.com)

Maturity Factoring by ECGC

Factors in general offer their clients bill discounting, credit protection, ledger maintenanceand receivable management in respect of approved customers.

Maturity factoring facility offered by the Export Credit Guarantee Corporation of IndiaLtd. (ECGC) provides the following, viz., credit protection, ledger maintenance, receivable

management, enables client to avail discounting facility from bank by guaranteeing the

advances granted against the bill.Thus, the facility offered by ECGC provides you the benefits of the traditional

factoring without disturbing your existing banking arrangement. Apart from this, it also

provides for sharing of losses where the goods/documents are not accepted due to insolvencyor financial condition of the buyer.

The following are the benefits to exporters: 100 per cent risk protection in respect of transactions where the buyer accepts the bills/documents without recourse to the exporter;

sharing of loss in case of non-acceptance of goods/documents due to insolvency or financial

difficulty; receivable management and sales ledger maintenance; enables the exporter to avail

bank finance on easier terms. The exporter can avail of the above benefits without

disturbing existing system of banking arrangements.

EXPORT CREDIT RISK INSURANCE

The Export Credit Guarantee Corporation of India Ltd. (ECGC), a company wholly owned

by Government of India and which functions under the administrative control of the

Ministry of Commerce, has a number of schemes to cover several risks which are notcovered by general insurers.

The primary role of ECGC is to support and strengthen the export development of

India by:

Providing a range of credit risk insurance covers to exporters against loss of goods

and services. Offering guarantees to banks and financial institutions to enable exporter obtain

better facilities from them.

In other words, the objectives of ECGC are:

1. To provide insurance cover to exporters against political and commercial risks.2. To provide insurance cover to exporters against the risk of exchange rate

fluctuations in respect of deferred payments.

3. To provide insurance cover to banks against export credit and guarantees extendedby them.

4. To provide insurance cover to Indian investors abroad against political risks.




Insurance Covers

The covers issued by ECGC may be broadly divided into the following four groups:

1. Standard policies issued to exporters to protect them against payment risks involved

in exports on short-term credit.

2. Specific policies designed to protect Indian firms against payment risks involved

in exports on deferred terms of payment, services rendered to foreign parties

construction works and turnkey projects undertaken abroad.

3. Financial guarantees issued to banks in India to protect them from risks of loss

involved in their extending financial support to exporters at the pre-shipment as

well as post-shipment stages.

4. Special schemes.

SUMMARY

Broadly, there are two types of foreign investment: (1) Foreign direct investment (FDI),

where the investor has control over/participation in the management of the firm;

(2) Portfolio investment, where the investor has only a sort of property interest in investing

the capital in buying equities, bonds, or other securities abroad.

There are three broad economic motives of FDI, viz., resources seeking (i.e.,

exploiting the natural resources of the host country); market seeking (i.e. to exploit the

market opportunities of the host countries); and efficiency seeking (like low cost of

production deriving from cheap labour). The presence of any (or even all) of these

determinants alone need not attract FDI. Several other factors such as political environment,government policies, bureaucratic culture, social climate, infrastructural facilities, etc. are

also important determinants of FDI.

There have been several attempts to provide theoretical explanation for foreign

investment.

Encouraged by the favourable business environment, fostered by the global

liberalisation, the international private capital flows have been increasing rapidly, with

periodic downturns. Cross-border M&As have been the major driver of the recent surge in

FDI.

Although foreign capital has many beneficial effects, it also has several limitations

and can have adverse effects too. However, foreign capital now contributes a significant

share of the domestic investment, employment generation, industrial production and exports

in a number of economies.Although the international capital flows to the developing countries have increased

substantially in the last one decade or so, the FDI flow is still predominant between the

developed countries. A small number of countries account for the lion’s share of the

international capital inflows to the developing world. There has also been a significant

increase in FDI flows between the developing economies. Although India has substantially

liberalised its foreign investment policy, FDI inflows have been much below the targets.

International Investment and Finance

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Transcript of International Investment and Finance