Foreign Direct Investment

in India
 Phases of Indian Economy
1947-1980

• Command and Control Economy

– Allocation of resources by the Government
(budgetary grants)
– Government took active part in setting priorities
for the economy
– Self-Reliance was the buzz word
– Nationalisation of Banks
– Limited scope for private participation

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 Phases of Indian Economy
1991-2000
• Liberalization and Globalization of Indian
Economy
– Increased emphasis on private sector
participation
– Limited extent of FDI participation
– Gradual improvement in the enabling
environment

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 Phases of Indian Economy
post 2000
• Political Coalitions have started providing
stable governments
• Government to get out of owning and
managing businesses: Disinvestment Policy
• Gradual relaxation in the FDI Policy

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 Progressive Liberalisation
Pre-1991 FDI was allowed selectively up to 40% under FERA
This period was dominated by the Congress party
1991 35 high priority industry groups were placed on the Automatic Route for FDI up
to 51%
Minority Congress government: Initiated economic reforms in a big way
1997 Automatic Route expanded to 111 high priority industry groups up to 100%/
74%/ 51%/50%
United Front Government: Inclusive of ‘left parties’, was perceived as
traditionally opposed to FDI, but continued with the reforms.

2000 All sectors placed on the Automatic Route for FDI except for a small negative list
BJP coalition government:(coalition of Left and Right wing parties) was
traditionally seen as opposed to FDI, but continued with economic reforms.
Post 2000 Many new sectors opened to FDI; viz., insurance (26%), integrated townships
(100%), mass rapid transit systems (100%), defence industry (26%), tea
plantations (100%), print media (26%).
Sectoral caps in many other sectors relaxed;
BJP coalition government: pursued reforms vigorously and initiated second
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Consensus on Economic Liberalisation
• Change in perception
– Indian Business Houses
– Government
– Legal Framework: shift from a Positive List to a
Negative List (FERA  FEMA)
• Gradually all sectors moving to ‘Choice’ and
‘Competition’ (Multiple Player Model)

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Current economic situation in india
Present Picture
• India: Fourth largest economy in terms of
Purchasing Power Parity
• Tenth most industrialized economy
• GDP growth rate of 8.1% - Second highest in the
world.
• Considerable improvement in FDI inflows
• FII inflows:
– For the period, July 2003 – Jan 2004 FII inflow has
exceeded USD 7 bn, which is more than the cumulative
FII inflow in the last five years.
• Still a big gap between India and China

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 Foreign Direct Investment
Foreign direct investment (FDI) is defined as "investment made
to acquire lasting interest in enterprises operating in the host
economy of the investor.“

The FDI relationship, consists of a parent enterprise and a

foreign affiliate which together form a
transnational corporation (TNC).

In order to qualify as FDI the investment must afford the

parent enterprise control over its foreign affiliate.

The UN defines control in this case as owning 10% or more of

the ordinary shares or voting power of an incorporated firm
or its equivalent for an unincorporated firm; lower
ownership shares are known as portfolio investment.
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 Foreign Direct Investment
The IMF definition of FDI includes as many as
twelve different elements, namely: equity
capital, reinvested earnings of foreign
companies, inter-company debt transactions,
short-term and long-term loans, financial
leasing, trade credits, grants, bonds, non-cash
acquisition of equity, investment made by
foreign venture capital investors, earnings data
of indirectly held FDI enterprises and control
premium, non-competition fee, and so on.
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 Foreign Direct Investment
FDI definition in India is restricted mainly to hard
cash unlike other countries which include non-
cash such as technology and machinery in the
FDI flows.
It also excludes;
-reinvested earnings
-subordinated debt
-overseas commercial borrowings
which are included in other country statistics.
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Entry Process & Entry
Strategies

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 The Industrial Policy
Industrial Licensing
• All Industrial undertakings exempt from obtaining an
industrial license to manufacture, except for:
– Industries reserved for the Public Sector
– Industries retained under compulsory licensing
– Items of manufacture reserved for the Small Scale
Sector
– If the proposal attracts locational restriction
• Industrial Entrepreneur Memorandum

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 The Industrial Policy
• Industries reserved for the Public Sector: (1) Atomic
Energy and (2) Railway Transport
• Compulsory licensing needed in the following
industries:
– Distillation and brewing of alcoholic drinks
– Cigars and cigarettes and manufactured tobacco substitutes
– Electronic aerospace and defence equipment of all types
– Industrial explosives including detonating fuses, safety fuses,
gun powder, nitrocellulose and matches
– Certain hazardous chemicals
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 The Industrial Policy
Locational Policy
• Industrial undertakings are free to select the location
• Location to be 25 km away from any city with a
million strong population
– Exceptions:
• When located in an area designated as an
“Industrial Area” before the 25th July, 1991.
• Electronics, Computer Software and Printing (and
any other industry which may be notified in future
as ‘non polluting industry’).

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 The Industrial Policy
Small Scale Industries
• Suitable for Foreign Investment?
– Cap on Investment in fixed assets (plant and machinery) is Rs.
10 million (approx. SGD 3,70,000)
– Not more than 24 per cent of total equity can be held by
any industrial undertaking either foreign or domestic
– Upon such equity exceeding 24% the SSI status is lost.
Carry-on-Business (COB) Licence required.
• Various items reserved exclusively for SSIs.

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.
The Entry Process
Investing in India

Automatic Route Prior Permission

General rule By exception

•Inform RBI within 30 days of Approval of Foreign
inflow/issue of shares Investment Promotion
• Pricing: FEMA Regulations Board needed.
•Unlisted – CCI (Comp Comm of India) Decision generally
•Listed – SEBI within 4-6 weeks
• Cap of Rs. 600 Crore

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The Entry Process: Automatic Route
• All items/activities for FDI investment up to 100% fall
under the Automatic Route except the following:
– All proposals that require an Industrial Licence.
– All proposals in which the foreign collaborator has a
previous venture/ tie up in India.
– All proposals relating to acquisition of existing shares in
an existing Indian Company by a foreign investor.
– All proposals falling outside notified sectoral policy/
caps or under sectors in which FDI is not permitted.

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The Entry Process: Government Approval

Foreign Investment Promotion Board

(FIPB) Approval
• For all activities, which are not covered
under the Automatic Route
• Composite approvals involving foreign
investment/ foreign technical collaboration
• Published Transparent Guidelines vs.
Earlier Case by Case Approach
• Downstream Investment
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 Acquisition of shares in a
Listed Company
Takeover Code
• Acquisition of more than specified equity stakes
would entail public offer
• Pricing: Average of 26 weeks or 2 weeks,
whichever is higher
• No takeover of management before completion of
Takeover Code formalities

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 Foreign Technology Collaboration

• Foreign technology collaborations are permitted either

through the automatic route or by the Government.

Policy for Automatic Approval

• To all industries for foreign technology collaboration
agreements, irrespective of the extent of foreign equity in the
shareholding, subject to:
– The lump sum payments not exceeding US $ 2 Million;

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Foreign Technology Collaboration

Policy for Automatic approval (contd.)

– Royalty payable being limited to 5 per cent for
domestic sales and 8 per cent for exports, subject to
a total payment of 8 per cent on sales
– No restriction on the duration of the royalty
payments
– The aforesaid royalty limits are net of taxes and are
calculated according to standard conditions.

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Foreign Technology Collaboration

Policy for Automatic approval (contd.)

– Payment of royalty up to 2% for exports and 1% for
domestic sales is allowed under automatic route on
use of trademarks and brand name of the foreign
collaborator without technology transfer.
– Registration of FC Agreement with RBI.

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 The Entry Strategy

• Forms in which Business can be conducted in

India
• Wholly owned subsidiary
• Joint Venture Company
• Branch Office
• Project Office
• India Presence: Liaison Office

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 Exit Issues
• Transfer of shares from non-resident to non-resident
does not require RBI approval for pricing
• Transfer of shares from non-resident to resident does
not require any FIPB Approval, though RBI approval is
required for pricing
– Pricing as per FEMA – listed and unlisted securities
– RBI permission not required if sale through Stock Exchange
• Mauritius Route: Capital Gain Advantage

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Legal Structures
facilitating FDI

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 Facilitating FDI in India
Emergence of Independent Regulators:
Electricity, Telecom, Insurance, Capital
Market and Competition Law
• Ensuring level playing field vis-à-vis
Government Corporations and inter se private
players
• Expertise in the subject matter involved
• Expeditious resolution of dispute

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 Facilitating FDI in India
Emergence of Independent Regulators (Contd.)

• Regulators under consideration: Petroleum,

Railways, Information and Broadcasting
• Regulator to curb Anti-Competitive Practices
• Government Directives

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 Facilitating FDI in India
Labour laws – a more contractual approach.
• Move towards: hire and fire
• Progressive use of discretionary executive powers
– Permissions granted for closure of unviable units
– Inspections only upon workers’ grievances
– Voluntary Retirement Schemes
– EPZs, SEZs etc may be exempted from application of certain
labour laws
– Amendment to Industrial Disputes Act under consideration
– Amendment to Contract Labour (Regulation & Abolition) Act,
1970 under consideration.

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Investment Incentives

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 Incentives for investment in
Telecom Sector
Permission for Inter-Circle & Intra-Circle Mergers
• Exemplary growth in teledensity, subscriber base etc.
• Companies commencing operations before 31st March,
2004, would enjoy tax benefits:
– 100% deduction for first five years
– 30% deduction for next five years
• Exemption from tax on interest income and long term
capital gains in certain cases
• Import duty rates have been reduced for various telecom
equipment

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 Investment Incentive for
IT Industry
• Software companies have a ten year tax holiday
on their export income
• In 1998 the Government set up a new Ministry of
Information Technology
• The Information Technology Act, 2000 was
passed to tackle cyber crimes and facilitate e-
commerce

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 Incentives for Investment in
Power Sector
• New Legal Regime: Electricity Act, 2003
• The Act provides for: Multiple Buyer Model,
Independent Regulatory Body, Open Access,
Power Trading as an independent business,
delicensing of generation
• 100% FDI Automatic Route in:
– Hydro-electric power plants;
– Coal/lignite based thermal power plants;
– Oil/gas based thermal power plants.

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Incentives for Investment in Power Sector

• Other investment incentives:

– New Power Projects eligible for 100% tax holiday in any
block of ten years, within first fifteen years of operation.

– The Deadline for income tax exemption for new power

projects extended from 2006 to 2012.

– Various indirect tax incentives:

• Concessional rate of import duties
• Special project import scheme
• Deemed export benefit for certain categories of power projects.

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 Reforms in Financial Sector
• FIIs allowed in Capital Market, can invest
both in Debt and Equity
• FDI cap in private sector banks raised to
74%
– 10% cap on voting rights
• The Mutual Fund market is also open now
to foreign players.
• Equity issue pricing is market determined

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 FDI in Real Estate: Policy & Issues
• Press Note 4 (2002 Series)
– 100% FDI under Automatic Route PERMITTED FOR Integrated
Townships, subject to following conditions:
• Foreign company to be registered as Indian company under Companies Act,
1956
• Core Business - Integrated Township Development with a successful track
record.
• Minimum area of development: 100 acres as per local bylaws/rules. In absence
of such by laws/rules, minimum of 2000 dwelling houses for about 10,000
population to be developed by the investor.
• Conditions post acceptance of FDI proposal
• Minimum capitalization norms
• Upfront payment
• Minimum lock-in period
• Time bound completion of project

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 FDI in Hotel and Tourism:Policy
and Issues
• 100% FDI under Automatic Route
• “Hotel” includes Restaurant, beach resorts and other tourist
complexes providing accommodation and/or Catering
• “Tourism related industries” includes travel agencies, tour
operating agencies, units providing facilities for cultural,
adventure and wild life experience to tourists; surface, air
and water transport facilities to tourists; leisure,
entertainment, amusement, sports and health units for
tourists and Convention/ Seminar units and organizations.
• Automatic approval for Technical, Consultancy, Marketing,
Publicity, Managerial services subject to specified limits.
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 Conclusion

• Economics occupies centre stage in various

elections
• Rising expectations; rising prosperity
• Legal regime: more stable and predictable
• Bureaucracy: changing with the times
• The Future beckons

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FDI IN INDIA: FACTS AND FIGURES

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FDI IN INDIA: FACTS AND FIGURES

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FDI IN INDIA: FACTS AND FIGURES

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 LOCATIONAL DETERMINANTS OF
FDI
A firm becomes multinational mainly for three
reasons.
-Ownership advantages,
-Location-specific advantages
-Internalization.
Large market size, proximity to home market, low-
cost labor and favorable tax treatment in the host
country are all considered as location advantages

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LOCATIONAL DETERMINANTS OF FDI
Location-specific advantages are further classified
by three types of motives of FDI.

First, market-seeking investment is undertaken to

sustain existing markets or to exploit new
markets.
For example, due to tariffs and other forms of
barriers, the firm has to relocate production to
the host country where it had previously served
by exporting

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 LOCATIONAL DETERMINANTS OF
FDI
Second, when firms invest abroad to acquire
resources not available in the home country, the
investment is called resource- or asset-seeking.

Resources may be natural resources, raw materials,

or low-cost inputs such as labor.

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 LOCATIONAL DETERMINANTS OF FDI

Third, the investment is rationalized or efficiency-

seeking when the firm can gain from the common
governance of geographically dispersed activities in
the presence of economies of scale and scope.

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 The Model

FDI = f (MS, OE/FT, I, DMA, EE, IE)

• Where FDI = Foreign direct Investment,

• MS = Size of domestic market,
• OE/FT = openness of the economy to foreign trade,
• I = Infrastructure of the host country,
• DMA = Domestic market Attractiveness,
• EE = External economic stability,
• IE = Internal economic stability.
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 The Model
The economic theory suggests that a positive relationship
between FDI and size of domestic market, openness of the
economy to foreign trade, and infrastructure of the
country.

While a negative relationship between FDI and External

economic stability, internal economic stability.

The larger the market size, the more demand for the products
or services to be provided by the FDI.
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Share of Five Top States Attracting FDI Approvals
(January 1991 to March 2004)
No. of FDI Approvals Amount of FDI
US $ in % FDI
Bill Approv
Rank Name of the State Total Technical Financial Rs. In Crores ion al

1 Maharashtra 4,816 1,308 3,508 51,114.68 13.18 17.48

2 Delhi 2,638 304 2,334 35,250.74 9.78 12.06

3 Tamil Nadu 2,607 613 1,994 25,071.77 6.52 8.58

4 Karnataka 2,467 494 1,973 24,138.44 6.15 8.26

5 Gujarat 1,204 556 648 18,837.30 4.81 6.44

Source: Economic Survey-2003-04
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 LOCATIONAL DETERMINANTS OF
FDI
Four states namely Karnataka, Maharashtra, Tamilnadu and
Gujarat accounted for over one-third of total FDI
approvals.
The shares of these individual states were, respectively,
7.6%, 13.7%, 6.7% and 5.3%. The shares of other major
states were considerably lower: West Bengal (3.7%),
Andhra Pradesh (4.2%), Madhya Pradesh (4.5%) and
Orissa (3.8 %).
The shares of Kerala, Haryana, Punjab and Rajasthan were
comparatively smaller whereas the flow of FDI into
populous states such as Bihar and Uttar Pradesh has been
virtually negligible.
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Luthra & Luthra Law Offices 49
Conclusion
As far as the economic interpretation of the
model is concerned, the size of the domestic
market is positively related to foreign direct
investment.

The greater the market, the more customers and

the more opportunities to invest.

Since FDI is mostly in the form of physical

investment, investors would prefer the markets
with better infrastructure.
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