FOREIGN

MANAGERIAL
CAPITAL
ECONOMICSIN
INDIA

PROJECT ON

TABLE OF CONTENTS

What is Foreign Capital

Need for Foreign Capital
Forms of Foreign Capital
Pre-Liberalisation Period(1947-1991)
Foreign Institutional Investors
Liberalisation of FIIs into India
FDI
-What is FDI?
-Routes available for FDI

Sources of FDI
Merits and Demerits of FDI
Loans taken from World Bank by India

What is foreign capital?

Foreign capital is money entering the country in the form
of concessional assistance or non concessional flows.
Need for Foreign capital:

1.
2.
3.
4.
5.

1.
2.
3.
4.
5.

Inadequacy of domestic capital

Foreign capital can show the way for domestic capital
For speeding up economic activity in a developing country
Financing of projects needed for economic development
Brings in technical know how, business experience and
knowledge
Forms of Foreign capital:
Direct Foreign investment
Foreign collaboration
Inter-Government loans
Loans from International institutions
External Commercial Borrowing(ECB)

Pre Liberalisation period in India:

After independence from British colonial rule in 1947, India
opted a socialist economy which was influenced by the Soviet
Union, with government control over private sector
participation, foreign trade and foreign direct investment.

This economic policy aimed to substitute products which India

imports with locally produced substitutes, industrialization, and
state intervention in labour and financial markets, a large public
sector, business regulation and centralized planning. Policies
were protectionist in nature and the government made efforts
to reduce the import to the minimum level to safeguard the
interests of the domestic Industries.
Plus at the time of Independence, the attitude towards foreign
capital was that of fear and suspicion. The common belief was
that foreign capital was draining away resources from the
economy.
As a result the Prime Minister had to give following assurance
to foreign capitalists in 1949:
1.)
2.)
3.)

No discrimination between foreign and Indian Capital

Full opportunities to earn profits
Guarantee of compensation

Jawaharlal Nehru, who formulated and oversaw this economic

policy, expected a favourable outcome from this strategy
because it features both capitalist market economy and
socialist command economy.
But the outcome was unfavourable to the country and lead to
liberalization and privatization in India.
Government made large investments in heavy industries and
expects these industries will produce enough capital for
investment in other sectors of the economy. But it didn't
happen. In the other hand, government has to invest more
money for the survival of these companies because of poor
management and low productivity. For example, the public
sector steel company losses were more than its initial
investment while the private sector steel company was making
profit.
India's average annual growth rate from 1950-1980 was 3.5%.
At the same time other Asian countries like Hong Kong,

Singapore, South Korea and Taiwan recorded an annual growth

rate of 8%. Now 'Hindu rate of growth' is an expression to refer
low annual growth rate.
The failure of pro-socialist economic policy to produce an
annual growth rate comparable to its neighbours leads to the
economic reforms going on now.

Foreign institutional investors:

FII means an entity established or incorporated outside India

which proposes to make investment in India. Foreign
Institutional Investors (FII) include the following foreign based
categories: Pension Funds, Mutual Funds, Investment Trust,
Insurance or reinsurance companies, Investment Trusts, Banks,
Endowments, University Funds, Foundations, Charitable Trusts
or Charitable Societies.
Portfolio investors provide institutional character to the capital
markets, flavoured by highly intensive research and diversified
investments. FII investments seek to inject global liquidity into
the markets, raise the price-earning ratio and thus reduce the
cost of capital.
Portfolio investment represents purchases and sales of foreign
financial assets such as stocks and bonds that do not involve a
transfer of management control. International portfolio
investments have become popular in recent years due to the
desire of investors to diversify risk globally. Global investors
may feel that they may also benefit from higher expected
returns from some foreign markets. Such investments can be in
the form of bonds (convertible and non-convertible) as well as
equity (say in the form of ADRs/ GDRs). Investments may be
made directly or through institutional investments (say FIIs).
Liberalisation of Portfolio Investment Flows into India:
Prior to 1992, only NRIs and OCBs were allowed to undertake
Portfolio Investment in India. In line with the recommendations
of High Level Committee on Balance of Payments, FIIs were
allowed to invest in Indian Debt market and Equity market. FII
Investment first started flowing into India in 1993.
In the case of FIIs, the total holding of each FII/SEBI approved
sub account shall not exceed 10% of the total paid up capital or
10% of the paid up value of each series of convertible
debentures issued by an Indian company and the total holdings
of all FIIs/sub-accounts of FIIs put together shall not exceed
24% of the paid-up capital or paid-up value of each series of

convertible debentures. Sub-account includes those foreign

corporations, foreign individuals, and institutions, funds or
portfolios established or incorporated outside India on whose
behalf investments are proposed to be made in India by a FII.
This limit of 24% can be increased to the sectorial cap/statutory
limit as applicable to the Indian company concerned by passing
a resolution by its Board of Directors followed by passing of a
special resolution to that effect by its General Body. Guidelines
were originally issued in Sept.1992. It consists of pension funds,
mutual funds, investment trusts, AMCs, endowments, etc.
There is a good track record, competence, financial soundness,
registration from regulatory authority in the home country.
Registration of 5 years by the nodal agency - SEBI, also RBI. Is
required. They are allowed to invest in all the securities traded
on the primary and secondary markets. Foreign Institutional
Investors can buy dated Government securities/ treasury bills,
non-convertible debentures /bonds issued by Indian companies
and units of domestic mutual funds either directly from the
issuer of such securities or through a registered stock broker on
a recognised stock exchange in India.
FII net inflows are as follows: $10.7 billion in 2005, $9.2 billion
in 2004 and $ 6.6 billion in 2003. Total net inflow since 1993:
$42 billion in a total market capitalisation of $ 550 billion.
Investments can be performed through three routes: registered
FII, registered as a sub-account of a sponsoring FII, and
indirectly through access products or Participatory Notes (PNs).
Estimated 90% investment through sub-accounts, as this
avoids procedural problems: establishing broker and custodian
relationships, filing of tax certificates, etc. PNs account for
about 25% of total FII investment, including sub-accounts.
Participatory Notes (PNs):
In view of the concerns of some unregulated entities taking
positions in the stock market through the mechanism of PNs
issued by FIIs, the issue was examined by the Ministry of
Finance in consultation with the Reserve Bank of India (RBI) and

Securities and Exchange Boards of India (SEBI). Following these

consultations, in January 2004, SEBI stipulated that PNs are not
to be issued to any non-regulated entity, and the principle of
know your clients may be strictly adhered.

FDI
What is FDI?
Foreign direct Investment or FDI is a measure of foreign
ownership of domestic productive assets such as factories,
land and organizations. Foreign direct investments have
become the major economic driver of globalization,
accounting for over half of all cross border investments.
The most profound effect is seen in developing countries that
use FDI to boost their economic growth
Now two routes available for FDI:1. Automatic approval by RBI
2. Govt. Approval via Foreign Investment Promotion Board
(FIPB)
FDI in India
Substantial liberalization was announced in the New Industrial
Policy declared by the government in July 1991 and doors of
several industries have opened up for investment. Prior to this
policy, foreign capital was generally permitted only in those
industries where Indian capital was scarce and was not
normally permitted in trading activities, plantations, banking
and financial institutions. It was not permitted in those
industries which had received government protection or which
are of basic and/ or strategic importance to the country. The
declared policy of the government was to discourage foreign
capital in certain inessential consumer goods and services
industries.
In a bid to attract foreign capital and investments from NRIs,
the government has in recent years announced a number of tax

concessions, lower rates of taxation for certain designated

priority industries; tax holidays on profits for a certain period to
new industrial undertakings, etc. NRIs investing in India were
allowed higher investment limits, priority allotment of items in
short supply, permission to buy shares in Indian companies,
etc. however the real opening up came with the announcement
of the new industrial policy in July 1991. In subsequent period,
several other measures for promoting foreign investment in
India were announced.
After the announcement of the new industrial policy, larger
foreign investments were allowed in industries such as NBFCs
(Non Banking Financial Companies) such as merchant banking,
stock broking, foreign exchange banking, financial consultancy,
housing finance, venture capital, financial consultancy, etc.,
business to business e commerce, oil refining, mining,
plantations, aviation, real estate, commodity exchanges, credit
formation companies, tourism sector, infrastructure,
advertising, films, telecom and IT, etc.

Sources of FDI
Largest inflows of FDI over the period January 2000 to April
2008 have been received from Mauritius, its share in inflows
being as high as 40.5% ($27,118 million out of $66,938 million).
Singapore was second with a share of 7.1%, UK third with a
share of 6.6%, USA fourth with a share of 2.8% and Cyprus fifth
with a share of 1.6%. However it should be noted here that
Mauritius based investments are nothing but US investments
and investments from other developed countries. They are
routed through Mauritius because of the tax advantages. The
tax advantage emanates from the double taxation avoidance
agreement (DTAA) that India has with that country. This
agreement implies that any foreign investor has the option of
paying tax either in India or in Mauritius. Since the tax rates
prevailing in Mauritius are amongst the lowest in the world,
many multinational companies prefer to route their
investments to India through Mauritius.
According to the OECD (organization for Economic Co operation
and Development, Mauritius is an important tax haven. Other

tax havens are Cyprus, British Virgin Islands, Cayman Islands,

Bahamas, Hong Kong, Malta, etc. Tax havens are characterized
by low or zero taxation, a lack of transparency and a refusal to
provide information to foreign tax authorities. Thus they
become a preferred route of investment by MNCs in other
countries. Tax havens lead to tax avoidance. The most obvious
method is for an individual method is for an individual to move
to the tax haven country and become a resident for the
purpose of paying taxes. Another was is to incorporate a
business in the tax haven country and then move all the
companys assets to it. Any new income made by the
incorporated company would then be subject to taxation only in
the tax haven country

Merits and Demerits of FDI:

Merits:
1.

Risk taking: Undertaking the initial risk of developing new lines of

production in an underdeveloped country is of great significance because of
the in adequacy of native innovators, risk takers or industrial entrepreneurs.
Foreign capital brings with it expertise, experience and resources to explore
new lines.

2.

Technical know-how: Foreign capital brings with it technical know-how

which enables the recipient nation to organize its resources in the most
efficient manner i.e. least cost production methods are adopted.

3.

High Standards: Private foreign capital brings with it traditions of keeping

high standards in respect of quality of goods, salary and wages to employees,
business practices, etc. Such things not only serve the interest of these
ventures but act as an important factor in raising the quality of products of
native concerns, improving payments to employees, etc.

Demerits:
Increase in dependence: India is now facing these problems. We have taken
so much from the foreign technical know-how that we have not yet developed
what may be described as an appropriate technology suited to our resources
and needs.

Remittance of large amounts: Remittance of profits is a normal facility but

often the profits in the early stages are high and in many collaborations
contracts, it is this very amount that must be paid back wholly to the foreign
investor. Hence large remittances are made.
Limited Sphere: Private foreign investors usually choose those industries
where it can make large and quick profits irrespective of the fact whether
development of those industries is in the national interest. Further that does
not take much interest in collaborating with the public sector. Hence in this
hence, the function in a very limited sphere

Loans taken by India from the World Bank:

1. The World Bank approved four loans worth $4.345 billion
dollars on 23/8/2009, which is the second largest volume of
lending to a single country in a year.
The goal of the four projects is to contribute to improving
India's infrastructure and help bolster the country's response to
the global economic and financial crisis and lay the foundations
for stronger growth in the future.
The financial package consists of:
-Banking Sector Support: $2 billion
-Support for India Infrastructure Finance Company Limited:
$1.195 billion
-The Fifth Power Sector Support Project: $1 billion
-The Andhra Pradesh Rural Water Supply and Sanitation Project:
$150 million.
2. On June 1, 2010, the World Bank approved a Statistical
Strengthening Loan for India of US$107 million. This loan
supports institutional and policy based reform by the
Government of India to strengthen state statistical systems
within a national policy framework. This project was
developed to enable States and Union Territories of India to
progress towards common national standards for key

statistical activities and improve the credibility, timeliness

and accuracy of statistics at both central and state levels.
One of the World Banks main priorities is to help countries
develop National Strategies for the Development of Statistics as
well as helping countries invest in statistical capacity
improvement and helping mobilize the expertise of the
international statistical system. The Bank has been working
with India for over a decade on statistical reforms and the India
Statistical Strengthening Loan is the result of detailed analytical
work and a rigorous consultative process that the Bank
supported in identifying a core area of intervention.
This loan is the first Bank-wide Development Policy Loan in
statistics and is innovative in several aspects:
it supports an institutional and policy based framework for
a centrally sponsored scheme, i.e. voluntary participation
of states and provision of financial resources from center
to states on a grant basis;
it allows states to design, prioritize and implement their
own statistical reform strategies within the national policy
in statistics;
it provides adequate space and flexibility for states to
adapt to the institutional framework; and
it establishes performance linked criteria for central
government transfer of resources to states.
India has been a leader in the use and collection of statistics
including the designing and implementation of large scale
surveys. Through this operation, India adds a new dimension
globally on sub-national statistical reforms.
The World Banks work to improve statistical capacity focuses
on helping countries and the international community to better
monitor Poverty Reduction Strategies and Millennium
Development Goals, and enhance the Results Measurement
System agreed for the 14th replenishment of the International
Development Association. The overarching strategy is guided
by a global action plan (commonly referred to as the Marrakech

Action Plan for Statistics (MAPS) to improve national and

international statistics. We provide financial and advisory
services, in addition to tools to help our clients develop better
statistical systems.

The country has become the largest recipient of the World Bank
loans with over $9 billion worth assistance this fiscal ending
June 2010, up fourfold over the previous fiscal.
The Washington-based multilateral lender had extended only
$2.2 billion loan to the country for the year ended June 2009.
India's share among the various recipients of the Bank is 15
percent in terms of loans, followed by Mexico with 11 percent
and South Africa with 7 per cent as of June 20, 2010.
As of June 20, the Bank has lent $9.26 billion to India and is
expected to provide another $0.04 billion in the remaining
period of June. The Bank follows a fiscal year from July to June.