Foreign Direct Investment

Chapter 15Foreign Direct Investment in India

“

Before we can feel much for others, we must in some measure be atease ourselves. If our own misery pinches us very severely, we have noleisure to attend to that of our neighbour; and all savages are too muchoccupied with their own wants and necessities, to give much attention tothose of another person.”

[ Adam Smith in

Theory of Moral Sentiments

]

15.1. Introduction

Since 1991-92 India has been trying to attract foreign capital to bridge the gap between intended investment and actual saving of the country. To increase the rate of growth of GDP in the range of 7 per cent, the rate of net capital formation should beincreased in the vicinity of 28 to 30%. The savings of the country has been hangingaround 24%. There is a gap and this gap is to be bridged by (a) Portfolio investment byforeign financial institutions (b) lending by foreign banks and other institutions and (c)Foreign Direct Investment. Of these three routes, developing countries prefer the thirdthat is Foreign Direct Investment, as this gives certain advantages to the host country.The advantages of foreign direct investment (FDI) are:i)It increases capital for investment automatically. If we compare this with theacquisition route, we see that foreign capital replaces the domestic capital by atake over or purchase. The released domestic capital may be invested in someother sectors of the economy.ii)FDI in green field ventures brings new technology and modern managementtechnique. In these areas, developing countries are lagging behind.iii)Foreign capital inflow through FDI route creates a permanent stake of foreigncapital in the domestic economy. This may be beneficial for the host country inthe sense that it brings a stabilizing force in the economy.The world investment report 2000 reveals that in the line of countries receivingforeign direct investment, India ranks 17

th

that means that 16 countries are ahead of Indiaregarding their ability to attract FDI. Countries like Vietnam are also ahead of India.India's share of total FDI inflow into developing countries for the period 1997 to 2000 is1.4% only. There is no point of comparison with China and this is for two reasons.1)China could attract about 25% of total FDI inflow into the developing countries.The next country in the line, that is, Brazil could attract only 10%. The

1

This Chapter is written jointly with Dr. Biswajit Nag and Dr. Soma Mukhopadhyay, both of them areAssistant Professors of Indian Institute of Foreign Trade, New Delhi.

198

predominant position of China in attracting FDI from 1995 onwards cannot beexplained by normal economic parameters.2)Second, some economists point out huge amount of capital flight from China thatis very high compared to countries of the similar situations. This reminds one therevolving door situations of some countries suffering from capital flight.

15.2. Objective

The objective of this present chapter is to give a fair account of the status of FDIin India during the recent period. The study focuses attention at three levels:i)At the level of the statesii)At the level of the sectorsiii)At the level of the industryThis is the usage side of FDI. We are to see also the source side. So far FDIinflow into India is concerned, the USA and the European Indian provides the lion's shareof FDI to India. Japan comes next in importance of source. For some years Mauritius became important and the role of Non-Residents Indians (NRI) is a bit complex. Some people argue that many NRI's are taking advantage of the Mauritius route regarding thesupply side of FDI. There is another problem and this is the widening gap between theapproval and actual inflow of FDI. If we see the international situation, we find that thereis normally a gap of 30% between the approval and the actual inflow. But, in India thegap is much wider and sometimes it becomes difficult to give explanation for that gap.There have been some studies on the determinants of FDI inflow into the hostcountries in the literature. The economic parameters often mention as explanatoryvariables are : Growth rate of GDP, state of infrastructure, exchange rate stability,equitable value of the exchange rate, openness of the economy, legal structure of the hostcountry and the attitude of the Government. The models, which are implicit in the studyof these variables, are based on a market economy framework. In India the paradigmshift occurred from 1991-92, that is, the Indian think-tank became accustomed to explorethe role of market mechanism in explaining the movement of economic variables. Thishappened from 1991-92 onwards. A broad section of people - executives in thecorporate, officials of foreign Embassies, academicians, independent consultants andindustrialists - often express the opinion that India has a great problem regarding themind set, that is, a popular belief is that foreign capital inflow leads to the exploitation of the domestic economy by the owners of foreign capital. There is another popular belief that India suffers from "too much government Syndrome". The latter means that the roleof government in India is spread everywhere, but ironically the governance is weak inareas where it is called for. The latter are areas of external security, true safeguards of thedowntrodden people, preservation of the environment and a true reform in the financialsector. The perception is partly qualitative in nature. The extent to which this perceptionexists can be measured only by a survey method, and this is beyond the scope of thischapter 199

15.3. Approach towards FDI in India

The exact position of FDI in India will be put up first at three levels; at the levelof the State, at the level of the sector and at the level of the industry. The objective of doing this is to examine several hypotheses like the role of infrastructure in attractingFDI, the role of labor situation, the role of law and order etc. We are to see also whether the inflow of FDI in India has certain favourable destination - region wise or sector wise.A broad explanation of the above will enable us to zero in to certain areas thatcould be explored further to ascertain the causes of a slow inflow of FDI. It can facilitatethe drawing of our conclusion.

15.4. Role of Infrastructure

There is a popular perception that Foreign Direct Investment flows to the regionwhere infrastructure is better. But state of infrastructure in a particular region coversmany aspects. Broadly infrastructure can be placed under two categories.a)Physical infrastructure, which may be called as social capital. This categoryincludes roads, railways and other communication system, the availability of power and other viable inputs. b)The second category includes those aspects which are non-physical in nature likelaw and order system, availability of efficient work force, education system, work culture and a common growth oriented human psychology. In many developingcountries the work culture may be not conducive to modern age industrial society.Also the over all impression regarding the work culture on the mind of the potential investors is important.The role of Government in the development of the economy is important factor inthe second category of infrastructure. While Government as a facilitator is appreciatedeverywhere as it helps rapid economic development, too much Government control, and particularly bureaucratic red-tapism is not liked by foreign investors.In spite of planned economic development in India during the last five decades,the development of infrastructure has not been uniform in 28 States/Regions of thecountry. One study places the situation of infrastructure in the form of an index. Takingthe average India situation as a hundred, the study shows the index of Delhi 730, Kerala162, Punjab 172 ,Tamil Nadu 195, while Gujarat is 105 West Bengal 102. States likeRajasthan, Meghalaya, Manipur are lagging behind as their index is far below 100. Whenwe place the flow of FDI in different States in contrast to the indices of infrastructure of different states, we find that while the states successfully attracting FDI are generally the200

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