Fdi in India

VIVEK COLLEGE OF COMMERCE
CHAPTER-1:
INTRODUCTION
The last two decade of the 20th century witnessed a dramatic world-wide
increase in foreign direct investment (FDI), accompanied by a marked
change in the attitude of most developing countries towards inward FDI. As
against a highly suspicious attitude of these countries towards inward FDI in
the past, most countries now regard FDI as beneficial for their development
efforts and compete with each other to attract it. Such shift in attitude lies in
the changes in political and economic systems that have occurred during the
closing years of the last century.
The wave of liberalisation and globalization sweeping across the world has
opened many national markets for international business. Global private
investment, in most part, is now made by multinational corporations
(MNCs). Clearly these corporations play a major role in world trade and
investments because of their demonstrated management skills, technology,
financial resources and related advantages. Recent developments in global
markets are indicative of the rapidly growing international business. The end
of the 20th century has already marked a tremendous growth in international
investments, trade and financial transactions along with the integration and
openness of international markets.
FDI is a subject of topical interest. Countries of the world, particularly

developing economies, are vying with each other to attract foreign capital to
Foreign Direct Investment in India Page | 1

boost their domestic rates of investment and also to acquire new technology
and managerial skills. Intense competition is taking place among the fund-
starved less developed countries to lure foreign investors by offering
repatriation facilities, tax concessions and other incentives. However, FDI is
not an unmixed blessing. Governments in developing countries have to be
very careful while deciding the magnitude, pattern and conditions of private
foreign investment.
In the 1980s, FDI was concentrated within the Triad (EU, Japan and US).
However, in the 1990s, the FDI flows to developed countries declined, while
those to developing countries increased in response to rapid growth and
fewer restrictions. Most FDI flows continue still to be concentrated in 10 to
15 host countries overwhelmingly in Asia and Latin America. South, East
and Southeast Asia has experienced the fastest economic growth in the
world, and emerged as the largest host region. China is now the largest host
country in the developing world.
However, small markets with low growth rates, poor infrastructure, and high
indebtedness, slow progress in introducing market and private-sector
oriented economic reforms and low levels of technological capabilities are
not attractive to foreign investors.
The remarkable expansion of FDI flows to developing countries had belied

the fear that the opening of central and Eastern Europe and the efforts of the
countries of that region to attract such investment would divert investment

flows from developing countries. The most important factors making

developing countries attractive to foreign investors are rapid economic
growth, privatization programmes open to foreign investors and the
liberalisation of the FDI regulatory framework.
In India, prior to economic reforms initiated in1991, FDI was discouraged

by
• Imposing severe limits on equity holdings by foreigners and
• Restricting FDI to the production of only a few reserved items.
The Foreign Exchange Regulation Act (FERA), 1973 (now replaced by

Foreign Exchange Management Act [FEMA]), prescribed the detailed rules
in this regard and the firms belonging to this group were known as FERA
firms. All foreign investors were virtually driven out from Indian industries
by FERA. Technology transfer was possible only through the purchase of
foreign technology. However, due to severe limits on royalty payments to
foreigners to reduce foreign exchange use, this option was ineffective.
However, the government granted liberal tax incentives to encourage
indigenous generation of technology by domestic firms. In the absence of
foreign technology, Indian industry suffered both in terms of cost of
production and quality.
The initial policy stimulus to foreign direct investment in India came in July
1991 when the new industrial policy provided, inter alia, automatic approval
for project with foreign equity participation up to 51 percent in high priority

areas. In recent years, the government has initiated the second generation
reforms under which measures have been taken to further facilitate and
broaden the base of foreign direct investment in India. The policy for FDI
allows freedom of location, choice of technology, repatriation of capital and
dividends. As a result of these measures, there has been a strong surge of
international interest in the Indian economy. The rate at which FDI inflow
has grown during the post-liberalisation period is a clear indication that India
is fast emerging as an attractive destination for overseas investors.
Encouragement of foreign investment, particularly for FDI, is an integral
part of ongoing economic reforms in India.
Though India has one of the most transparent and liberal FDI regimes
among the developing countries with strong macro-economic fundamentals,
its share in FDI inflows is dismally low. The country still suffers from
weaknesses and constraints, in terms of policy and regulatory framework,
which restricts the inflow of FDI.
Foreign investment policies in the post-reforms period have emphasized

greater encouragement and mobalisation of non-debt creating private
inflows for reducing reliance on debt flows. Progressively liberal policies
have led to increasing inflows of foreign investment in the country.

CHAPTER-2:
WHAT IS FOREIGN DIRECT INVESTMENT?
FDI is the process whereby residents of one country (the home country)
acquire ownership of assets for the purpose of controlling the production,
distribution and other activities of a firm in another country (the host
country).
IMF Definition
According to the BPM5, FDI is the category of international investment that
reflects the objective of obtaining a lasting interest by a resident entity in
one economy in an enterprise resident in another economy. The lasting
interest implies the existence of a long-term relationship between the direct
investor and the enterprise and a significant degree of influence by the
investor on the management of the enterprise.
UNCTAD Definition
The WIR02 defines FDI as ‘an investment involving a long-term
relationship and reflecting a lasting interest and control by a resident entity
in one economy (foreign direct investor or parent enterprise) in an enterprise
resident in an economy other than that of the FDI enterprise, affiliate
enterprise or foreign affiliate. FDI implies that the investor exerts a
significant degree of influence on the management of the enterprise resident
in the other economy. Such investment involves both the initial transaction
between the two entities and all subsequent transaction between them among

foreign affiliates, both incorporated and unincorporated. Individuals as well

as business entities may undertake FDI.
Flows of FDI comprise capital provided (either directly or through other

related enterprises) by a foreign direct investor to an FDI enterprise, or
capital received from an FDI enterprise by a foreign direct investor. FDI has
three components, viz., equity capital, reinvested earnings and intra-
company loans.
• Equity capital is the foreign direct investor’s purchase of share of an

enterprise in a country other than its own.
• Reinvested earnings comprise the direct investors share (in proportion
to direct equity participation) of earnings not distributed as dividends
by affiliates, or earnings not remitted to the direct investor. Such
retained profits by affiliates are reinvested.
• Intra-company loans or intra-company debt transactions refer to short
or long term borrowing and lending of funds between direct investors
(parent enterprises) and affiliate enterprises.
OECD Benchmark Definition of Foreign Direct Investment (Third

Edition)
FDI reflects the objective of obtaining a lasting interest by a resident entity
in one economy (direct investor) in an entity resident in an economy other
than that of the investor (direct investment enterprise). The lasting interest
implies the existence of a long term relationship between the direct investor

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

of the enterprise. Direct investment involves both the initial transaction
between the two entities and all subsequent capital transactions between
them and among affiliated enterprises, both incorporated and
unincorporated.
As is evident from the above definitions, there is a large degree of

commonality between the IMF, UNCTAD and OECD definitions of FDI.
The IMF definition is followed internationally.

CHAPTER-3:
FOREIGN DIRECT INVESTMENT (FDI): THEORITICAL
SETTINGS
Most of the present day underdeveloped countries of the world have set out a
planned programme for accelerating the pace of their economic
development. In a country planning for industrialization and aiming to
achieve a target rate of growth, there is a need for resources. The resources
can be mobilized through domestic as well as foreign sources. So far as, the
domestic sources are concerned, they may not be sufficient to acquire the
fixed rate of growth. Generally domestic savings are less than the required
amount of investment. Also the very process of industrialization calls for
import of capital goods which can not be locally produced. Hence comes the
need for foreign sources. They not only supplement the domestic savings but
also provide the recipient country with extra foreign exchange to buy
imports essential for filling the saving investment gap and foreign exchange
gap.
The means of getting foreign resources available to a developing country are

mainly three:
1. Through export of goods and services

2. External aid
3. Foreign investment

Export of goods and services do contribute to foreign resources but they can
meet only a small part of the total demand for foreign resources.
External Aid from foreign governments and international institutions, by

increasing the rate of home savings and removing the foreign gap allows the
utilization of previously under utilized resources and capacity. But generally
the aid is tied and distorts the allocation of resources. So its use has been on
the decline.
Foreign investment is of following two types.

1. Foreign Direct Investment (FDI) and
2. Portfolio Investment.
Foreign Direct versus Portfolio Investment
By Foreign Direct Investment (FDI) we mean any investment in a foreign

country where the investing party (corporation, firm) retains control over
investment. A direct investment typically takes the form of a foreign firm
starting a subsidiary or taking over control of an existing firm in the country
in question. FDI consists of equity capital, technical and managerial
services, capital equipment and intermediate inputs and legal rights to
patented or secret products, processes or trade marks. It is the direct type of
foreign investment which is associated with multinational corporations
because most of FDI is transferred through firms and remains outside of
ordinary, functioning markets.

FDI can be done in the following ways

1. In order to participate in the management of the concerned enterprise, the
stocks of the existing foreign enterprise can be acquired.
2. The existing enterprise and factories can be taken over.
3. A new subsidiary with 100% ownership can be established abroad.
4. It is possible to participate in a joint venture through stock holdings.
5. New foreign branches, offices and factories can be established.
6. Existing foreign branches and factories can be expanded.
7. Minority stock acquisition, if the objective is to participate in the
management of the enterprise.
8. Long term lending, particularly by a parent company to its subsidiary,
when the objective is to participate in the management of the enterprise.
Portfolio investment, on the other hand, does not seek management control,
but is motivated by profit. Portfolio investment occurs when individual
investors invest, mostly through stockbrokers, in stocks of foreign
companies in foreign land in search of profit opportunities.
FDI flows are usually preferred over other forms of external finance because
they are non-debt creating, non-volatile and their returns depend on the
performance of the projects financed by the investors. FDI also facilitates
international trade and transfer of knowledge, skills and technology. In a
world of increased competition and rapid technological change, their
complimentary and catalytic role can be very valuable.

Superiority of FDI over Other Forms of Capital Inflows
FDI is perceived superior to other types of capital inflows for several

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

host country. Hence, FDI inflows are less volatile and easier to sustain at
times of crisis.
2. While debt inflows may finance consumption rather than investment in
the host country, FDI is more likely to be used productively.
3. FDI is expected to have relatively strong effects on economic growth, as
FDI provides for more than just capital. FDI offers access to
internationally available technologies and management know-how, and
may render it easier to penetrate word markets.
A recent United Nations report has revealed that FDI flows are less volatile
than portfolio flows. To quote, “FDI flows to developing and transition
economies in 1998 declined by about 5 percent from the peak in 1997, a
modest reduction in relation to the effects on the other capital flows of the
spread of the Asian financial crisis to global proportions. FDI flows are
generally much less volatile than portfolio flows. The decline was modest in
all regions, even in the Asian economies most affected by the financial
crisis.”
FDI is the appropriate form of external financing for developing countries,
which have less capacity than highly developed economies to absorb
external shocks. Likewise, the evidence supports the predominant view that

FDI is more stable than other types of capital inflows. Moreover, the
volatility of FDI remained exceptionally low in the 1990s, when several
emerging economies were hit by financial crisis.
FDI is widely considered an essential element for achieving sustainable

development. Even former critics of MNCs expect FDI to provide a stronger
stimulus to income growth in host countries than other types of capital
inflows. Especially after the recent financial crisis in Asia and Latin
America, developing countries are strongly advised to rely primarily on FDI,
in order to supplement national savings by capital inflows and promote
economic development.
Macro-economic and Micro-economic Aspects of FDI
In judging the significance of FDI, especially from the view point of

developing countries, it is useful to make a distinction between macro-
economic and micro-economic effects. The former is connected with issues
of domestic capital formation, balance of payments, and taking advantage of
external markets for achieving faster growth, while the latter is connected
with the issues of cost reduction, product quality improvement, making
changes in industrial structure and developing global inter-firm linkages.
In this context, it needs to be recognized that FDI is an aggregate entity, the

sum total of the investments made by many diverse multinationals, each
with its own corporate strategy. The micro-economic effects of the

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

another multinational even if the investments are made in the same industry.
Also, what benefits the local economy will depend on the capabilities of the
host country in regard to technology transfer and industrial restructuring.
Resource-seeking and Market-seeking FDI
Two major types of FDI are typically differentiated: resource-seeking FDI

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

the host countries. This type of FDI was historically important and remains a
relevant source of FDI for various developing countries. However, on a
world-wide scale, the relative importance of resource-seeking FDI has
decreased significantly.
The relative importance of market-seeking FDI is rather difficult to assess. It

is almost impossible to tell whether this type of FDI has already become less
important due to economic globalization. Regarding the history of FDI in
developing countries, various empirical studies have shown that the size and
growth of host country markets were among the most important FDI
determinants. It is debatable, however, whether this is still true with ongoing
globalization.

Globalisation essentially means that geographically dispersed

manufacturing, slicing up the value chain and the combination of markets
and resources through FDI and trade are becoming major characteristics of
the world economy. Efficiency-seeking FDI, i.e. FDI motivated by creating
new sources of competitiveness for firms and strengthening existing ones,
may then emerge as the most important type of FDI. Accordingly, the
competition for FDI would be based increasingly on cost differences
between locations, the quality of infrastructure and business-related services,
the ease of doing business and the availability of skills. Obviously, this
scenario involves major challenges for developing countries, ranging from
human capital formation to the provision of business-related services such as
efficient communication and distribution systems.
Nature of FDI
Almost all modern (FDI) is carried out by corporations rather than

individuals. Somewhat like portfolio investment, the flows of FDI have
historically been highly concentrated, both in terms of geography and by
industry and at both the investor and receptor poles. Geographically, the
ownership of global stocks of FDI is highly skewed towards only a few
large, high income countries. Each investing country has, whether by
accident or design , tended to direct the major part of its FDI to only a very
few receiving countries; in fact the pattern of global distribution of FDI have
been highly similar to historical relationships based on colonial ties or other
forms of political hegemony.

Viewed industrially, for any given country, FDI generally comes from less
than four or five out of twenty or so major industry groups and inflows into
those same industries in the receptor country.
General attribute of FDI is that it has evoked by type over time. Prior to First
World War, a crude but valid generalization would that a large part of FDI
was in service sector of the host economy (particularly transportation,
power, communication and trading) while most of the rest was of the
“backward vertical integration” type. During the inter-war period, most of
the currently largest manufacturing multinational corporations (MNCs)
made their initial foreign investments, but these horizontal or market
extension types of investments have now become major category.
The fourth recognized characteristic of manufacturing FDI is that it

originates in industries that are technologically intensive, “skill oriented” or
progressive. In addition, the FDI prone industries are typically more
concentrated, have higher advertising outlays per unit of sales and exhibit
above average export propensities. Industries from which FDI tends to
originate display many characteristics associated with oligopoly.
Another universal property of FDI is that it is really a package of

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

FDI in Developing Countries
FDI is now increasingly recognized as an important contributor to a

developing country’s economic performance and international
competitiveness.
After the debt-crisis that hit the developing world in early 1980s, the
conventional wisdom quickly became that it had been unwise for countries
to borrow so heavily from international banks or international bond markets.
Rather countries should try to attract non-debt-creating private inflows
(DFI). The financial advantage is that such capital inflows need not be
repaid and that outflow of funds (remittance of profits) would fluctuate with
the cycle of the economy. It has also been widely observed that the structural
adjustment efforts of the 1980s failed to lead to new patterns of sustained
growth in developing countries. In particular, structural adjustment programs
failed to restore private investment to desirable levels. Again it is hoped that
FDI could play an important role; the World Bank observes that FDI can be
an important complement to the adjustment effort, especially in countries
having difficulty in increasing domestic savings.
Against this background of balance of payments problems and low level of

private investment, it is probably not surprising that attitudes in developing
countries towards FDI have shifted. In the 1960s and 1970s many countries
maintained a rather cautious, and sometimes an outright negative position
with respect to FDI. In the 1980s, however the attitudes shifted radically

towards a more welcoming policy stance. This change was not so much due
to new research finding on the impact of FDI but to the economic problems
facing the developing world.
Developing countries are liberalizing their foreign investment regimes and

are seeking FDI not only as a source of capital funds and foreign exchange
but also as a dynamic and efficient vehicle to secure the much needed
industrial technology, managerial expertise and marketing know-how and
networks to improve on growth, employment, productivity and export
performance.
At the global level the flows of FDI and PFI to developing countries have
indeed increased. The average net inflow of FDI in developing countries had
been US$ 11 billion in 1980-86, but in 1987 it started to increase, by 1991
the annual net inflow had risen to US$ 35 billion and by 2004 to US$ 233
billion. The share of developing economies in total inflow of Foreign Direct
Investment in the world has been rising continuously since 1989.

CHAPTER-4:
ADVANTAGES AND DISADVANTAGES OF FDI FOR THE HOST
COUNTRY
Advantages of Foreign Direct Investment
Foreign Direct Investment has the following potential benefits for less
developed countries.
1. Raising the Level of Investment: Foreign investment can fill the gap
between desired investment and locally mobilised savings. Local capital

markets are often not well developed. Thus, they cannot meet the capital
requirements for large investment projects. Besides, access to the hard
currency needed to purchase investment goods not available locally can
be difficult. FDI solves both these problems at once as it is a direct
source of external capital. It can fill the gap between desired foreign
exchange requirements and those derived from net export earnings.
2. Upgradation of Technology: Foreign investment brings with it
technological knowledge while transferring machinery and equipment to

developing countries. Production units in developing countries use out-
dated equipment and techniques that can reduce the productivity of
workers and lead to the production of goods of a lower standard.

3. Improvement in Export Competitiveness: FDI can help the host
country improve its export performance. By raising the level of

efficiency and the standards of product quality, FDI makes a positive
impact on the host country’s export competitiveness. Further, because of
the international linkages of MNCs, FDI provides to the host country
better access to foreign markets. Enhanced export possibility contributes
to the growth of the host economies by relaxing demand side constraints
on growth. This is important for those countries which have a small
domestic market and must increase exports vigorously to maintain their
tempo of economic growth.
4. Employment Generation: Foreign investment can create

employment in the modern sectors of developing countries. Recipients of
FDI gain training of employees in the course of operating new
enterprises, which contributes to human capital formation in the host
country.
5. Benefits to Consumers: Consumers in developing countries stand to
gain from FDI through new products, and improved quality of goods at
competitive prices.
6. Resilience Factor: FDI has proved to be resilient during financial
crisis. For instance, in East Asian countries such investment was

remarkably stable during the global financial crisis of 1997-98. In sharp
contrast, other forms of private capital flows like portfolio equity and

debt flows were subject to large reversals during the same crisis. Similar
observations have been made in Latin America in the 1980s and in
Mexico in 1994-95. FDI is considered less prone to crises because direct
investors typically have a longer-term perspective when engaging in a
host country. In addition to risk sharing properties of FDI, it is widely
believed that FDI provides a stronger stimulus to economic growth in the
host countries than other types of capital inflows. FDI is more than just
capital, as it offers access to internationally available technologies and
management know-how.
7. Revenue to Government: Profits generated by FDI contribute to
corporate tax revenues in the host country.
Disadvantages of Foreign Direct Investment
FDI is not an unmixed blessing. Governments in developing countries have

to be very careful while deciding the magnitude, pattern and conditions of
private foreign investment. Possible adverse implications of foreign
investment are the following:
1. When foreign investment is competitive with home investment,

profits in domestic industries fall, leading to fall in domestic savings.
2. Contribution of foreign firms to public revenue through corporate

taxes is comparatively less because of liberal tax concessions, investment

allowances, disguised public subsidies and tariff protection provided by

the host government.
3. Foreign firms reinforce dualistic socio-economic structure and

increase income inequalities. They create a small number of highly paid
modern sector executives. They divert resources away from priority
sectors to the manufacture of sophisticated products for the consumption
of the local elite. As they are located in urban areas, they create
imbalances between rural and urban opportunities, accelerating flow of
rural population to urban areas.
4. Foreign firms stimulate inappropriate consumption patterns through

excessive advertising and monopolistic market power. The products
made by multinationals for the domestic market are not necessarily low
in price and high in quality. Their technology is generally capital-
intensive which does not suit the needs of a labour-surplus economy.
5. Foreign firms able to extract sizeable economic and political

concessions from competing governments of developing countries.
Consequently, private profits of these companies may exceed social
benefits.
6. Continual outflow of profits is too large in many cases, putting

pressure on foreign exchange reserves. Foreign investors are very
particular about profit repatriation facilities.

7. Foreign firms may influence political decisions in developing

countries. In view of their large size and power, national sovereignty and
control over economic policies may be jeopardized. In extreme cases,
foreign firms may bribe public officials at the highest levels to secure
undue favours. Similarly, they may contribute to friendly political parties
and subvert the political process of the host country.
Key question, therefore, is how countries can minimize possible negative

effects and maximize positive effects of FDI through appropriate policies.

CHAPTER-5:
DETERMINANTS OF FDI
To understand the scale and direction of FDI flows, it is necessary to

identify their major determinants. The relative importance of FDI
determinants varies not only between countries but also between different
types of FDI. Traditionally, the determinants of FDI include the following.
1. Size of the Market: Large developing countries provide substantial
markets where the consumers demand for certain goods far exceed the
available supplies. This demand potential is a big draw for many
foreign-owned enterprises. In many cases, the establishment of a low
cost marketing operation represents the first step by a multinational into
the market of the country. This establishes a presence in the market and
provides important insights into the ways of doing business and possible
opportunities in the country.
2. Political stability: In many countries, the institutions of government are
still evolving and there are unsettled political questions. Companies are
unwilling to contribute large amounts of capital into an environment
where some of the basics political questions have not yet been resolved.
3. Macro-economic Environment: Instability in the level of prices and
exchange rate enhance the level of uncertainty, making business

planning difficult. This increases the perceived risk of making

investments and therefore adversely affects the inflow of FDI.
4. Legal and Regulatory Framework: The transition to a market
economy entails the establishment of a legal and regulatory framework

that is compatible with private sector activities and the operation of
foreign owned companies. The relevant areas in this field include
protection of property rights, ability to repatriate profits, and a free
market for currency exchange. It is important that these rules and their
administrative procedures are transparent and easily comprehensive.
5. Access to Basic Inputs: Many developing countries have large reserves
of skilled and semi-skilled workers that available for employment at

wages significantly lower than in developed countries. This provides an
opportunity for foreign firms to make investments in these countries to
cater to the export market. Availability of natural resources such as oil
and gas, minerals and forestry products also determine the extent of FDI.
The determinants of FDI differ among countries and across economic

sectors. These factors include the policy framework, economic determinants
and the extent of business facilitation such as macro-economic fundamentals
and availability of infrastructure.

CHAPTER-6:
FOREIGN DIRECT INVESTMENT IN INDIA
Since independence till 1990, the performance of Indian economy has been
dominated by a regime of multiple controls, restrictive regulations and wide
ranging state intervention. Industrial economy of the country was protected
by the state and insulated from external competition. As a result of which,
India was thrown a long way behind the world of rapid expanding
technology. The cumulative effect of these policies started becoming more
and more pronounced. By the year 1989-90, the situation on the balance of
payment and foreign exchange reserves became precarious and the country
was driven to the brink of default. The credibility reached the sinking level
that no country was willing to advance or lend to India at any cost. In such
circumstances, the government quickly followed a liberalized economic
policy in July 1991.
The main objectives of the liberalized economic policy are two fold. At the
country level the reform aims at freeing domestic investors from all the
licensing requirements, virtual abolition of MRTP restriction on the
investment by large houses, and a competitive industrial structure for Indian
companies to achieve a global presence by becoming as competitive as their
counterparts worldwide. Secondly, the focus on structural reforms intended
to tap foreign investment for economic growth and development.

Gradually & systematically the government has taken a series of measures

like devaluation of rupee, lowering of import duties and allowing foreign
investment upto 51% of the equity in a large number of industries and
investment of large foreign equity (even up to 100%) in selected areas
especially for export oriented products.
In India, since the 1960’s foreign investment and/or foreign collaborations

by the multinationals have been principally viewed as an instrument to
facilitate the much needed ‘transfer of technology’. In technological as well
as financial collaborations with foreign firms, the approval and extent of
ownership participation had been predominantly determined by the
technology component of the respective products. ‘Import of technology’ as
against the direct foreign investment was the main focus of the policies till
mid-eighties.
The New Industrial Policy (NIP) of July 1991 and subsequent policy
amendments have significantly liberalized the industrial policy regime in the
country especially as it applies to FDI. The industrial approval system in all
industries has been abolished except for some strategic or environmentally
sensitive industries. In 35 high priority industries, FDI up to 51% is
approved automatically if certain norms are satisfied. FDI proposals do not
necessarily have to be accompanied by technology transfer agreements.
Trading companies engaged primarily in export activities are also allowed
up to 51% foreign entity. A Foreign Investment Promotion Board (FIPB) has
been set up to invite and facilitate investment in India by international

companies. The use of foreign brand names for goods manufactured by

domestic industry which had earlier been restricted was also liberalized.
New sectors have been opened to private and foreign investment. The
international trade policy regime has been considerably liberalized too. The
rupee was made convertible first on trade and finally on the current account.
Capital market has been strengthened. In spite of all these liberalization
measures taken by the Indian government- foreign investments have not
been up to expectations. Actual inflow of FDI has been less than the
approval FDI.

CHAPTER-7:
POLICIES AND PROCEDURES OF FDI
The initial policy stimulus to foreign direct investment in India came in July
1991 when the new industrial policy provided, inter alia, automatic route
approval for projects with foreign equity participation up to 51 percent in
high priority areas. In recent years, the government has initiated the second
generation reforms under which measures have been taken to further
facilitate and broaden the base of FDI in India. The policy of FDI allows
freedom of location, choice of technology repatriation of capital and
dividends. The rate at which FDI inflow has grown during the post-
liberalisation period is a clear indication that India is a fast emerging as an
attractive destination for overseas investors.
As part of the economic reforms programme, policy and procedures

governing foreign investment and technology transfer have been
significantly simplified and streamlined. Today FDI is allowed in all sectors
including the service sector except in cases where there are sectoral ceilings.
FDI Policy Regime
Most of the problem for investors arises because of domestic policy, rules
and procedures and not the FDI policy per se or its rules and procedure.
India has one of the most transparent and liberal FDI regimes among the
emerging and developing economies. By FDI regime it means those
restrictions that apply to foreign nationals and entities but not to Indian

nationals and Indian owned entities. The differential treatment is limited to a

few entry rules, spelling out proportion of equity that the foreign entrant can
hold in an Indian company or business. There are a few banned sectors and
some sectors with limits on foreign equity proportion. The entry rules are
clear and well defined and equity limits for FDI in selected sectors such as
telecom quite explicit and well-known.
Subject to these foreign equity conditions a foreign company can set up a

registered company in India and operate under the same laws, rules and
regulations as any Indian owned company would. There is absolutely no
discrimination against foreign invested companies registered in India or in
favour of domestic owned ones. There is however a minor restriction on
those foreign entities who entered a particular sub-sector through a joint
venture with an Indian partner. If they want to set up another company in the
same sector it must get a no-objection certificate from the joint venture
partner. This condition is explicit and transparent unlike many hidden
conditions imposed by some other recipients of FDI.
Routes for Inward Flows of FDI
FDI can be approved either through the automatic route or by the

Government.
1. Automatic Route: Companies proposing FDI under automatic route do

not require any government approval provided the proposed foreign equity is
within the specified ceiling and the requisite documents are filed with
Reserve Bank of India (RBI) within 30 days of receipt of funds. The

automatic route encompasses all proposals where the proposed items of

manufacture/activity does not require an industrial license and is not
reserved for small-scale sector.
The automatic route of the RBI was introduced to facilitate FDI inflows.
However, during the post-policy period, the actual investment flows through
the automatic route of the RBI against total FDI flows remained rather
insignificant. This was partly due to the fact that crucial areas like
electronics, services and minerals were left out of the automatic route.
Another limitation was the ceiling of 51 percent on foreign equity holding.
Increasing number proposals were cleared through the FIPB route while the
automatic route was relatively unimportant. However, since 2000 automatic
route has become significant and accounts for a large part of FDI flows.
2. Government Approval: For the following categories, government

approval for FDI through the Foreign Investment Promotion Board (FIPB) is
necessary:
• Proposals attracting compulsory licensing

• Items of manufacture reserved for small scale sector.
• Acquisition of existing shares.
FIPB ensures a single window approval for the investment and acts as a
screening agency. FIPB approvals are normally received in 30 days. Some
foreign investors use the FIPB application route where there may be absence
of stated policy or lack of policy clarity.

3. Industrial Licensing in FDI Policy: Industrial Licensing is regulated by

Industries (Development and Regulation) Act 1951. Following are
the sectors which require Industrial Licensing:
• Industries which abide by compulsory licensing

• Manufacturing of items by the larger industrial units for small sector
industries
• Locational restrictions on the proposed sites
Sectors Which Require Industrial Licensing:
• Electronic aerospace and defense equipment

• Alcoholics drinks
• Explosives
• Cigarettes and tobacco products
• Hazardous chemicals such as, hydrocyanic acid, phosgene, isocynates
and di-isocynates of hydro carbon and derivatives.
4. Restricted List of sectors: FDI is not permissible in the following cases:

• Gambling and Betting, or
• Lottery Business, or
• Business of chit fund
• Housing and Real Estate business (to a certain extent has been
opened.)
• Trading in Transferable Development Rights (TDRs)
• Retail Trading
• Railways,
• Atomic Energy , atomic minerals,
• Agricultural or plantation activities or Agriculture (excluding
Floriculture, Horticulture, Development of Seeds, Animal Husbandry,
Pisiculture and Cultivation of Vegetables, Mushrooms etc. under
controlled conditions and services related to agro and allied sectors)
and Plantations(other than Tea plantations)
The new polices have substantially relaxed restrictions on foreign

investment, industrial licensing and foreign exchange. Capital market has
been opened to foreign investment and banking sector controls have been
eased. As a result, India has been rapidly changing from a restrictive regime
to a liberal one and FDI is encouraged in almost all economic activities
under the automatic route. The Government is committed to promoting
increased flow of FDI for better technology, modernization, exports and for
providing products and services of international standards. Therefore, the
policy of the Government has been aimed at encouraging foreign
investment, particularly in core infrastructure sectors so as to supplement
national efforts.
Post-approval Procedures
1. Project Clearance: After the approval has been obtained, the applicant
may get his unit/company registered with the Registrar of Company.
Subsequently, the company needs to obtain various clearances such as land

clearance, building design clearance, pre-construction clearance, labour

clearance, etc. from different authorities before beginning its operations.
These clearances differ from sector to sector and may also differ from state
to state.
2. Registration and Inspection: Each industrial unit is supposed to

maintain records in regard to production, sale and export, use of specified
raw materials including public utilities like water and electricity, labour
related details financial details and details in regard to industrial safety and
environment.
The unit is also subject to periodic inspection by the factories inspector,

labour inspector, food inspector, fire inspector, central excise inspector, air
and water inspector, mines inspector, city inspector and the like, the list of
which may go up to thirty or more.
3. Foreign Exchange Management Act (FEMA), 2000: The additional

provisions which apply only to entry of FDI emanate from the provisions of
FEMA. According to FEMA, no person resident outside India shall without
the approval/knowledge of the RBI may establish in India a branch or a
liaison office or a project office or any other place of business.
FDI in a particular industry may, however, be made through the automatic

route under powers delegated to the RBI or with the approval accorded by
the FIPB. The automatic route means that foreign investors only need to

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

getting foreign investment approval through FIPB route do not require any
further clearance from RBI for the purpose of receiving inward remittance
and issue of shares to foreign investors. RBI has granted general permission
under FEMA in respect to proposals approved by FIPB. Such companies
are, however, required to notify the concerned regional office of the RBI of
receipt of inward remittances within 30 days of such receipts and again
within 30 days of issue of shares to the foreign investors.
Entry Options for Foreign Investors
A foreign company planning to set up business operations in India has the

following options:
By incorporating a company under the Companies Act, 1956 through
• Joint Ventures; or
• Wholly Owned Subsidiaries
Foreign equity in such Indian companies can be up to 100% depending on
the requirements of the investor, subject to equity caps in respect of the area
of activities under the Foreign Direct Investment (FDI) policy.
Enter as a foreign Company through
• Liaison Office/Representative Office
• Project Office
• Branch Office
Such offices can undertake activities permitted under the Foreign Exchange
Management Regulations, 2000.

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

company has been duly registered and incorporated as an Indian
company, it is subject to Indian laws and regulations as applicable to
other domestic Indian companies.
2. Liaison Office/Representative Office: The role of the liaison office
is limited to collecting information about possible market opportunities

and providing information about the company and its products to
prospective Indian customers. It can promote export/import from/to India
and also facilitate technical/financial collaboration between parent
company and companies in India. Liaison office can not undertake any
commercial activity directly or indirectly and can not, therefore, earn any
income in India. Approval for establishing a liaison office in India is
granted by Reserve Bank of India (RBI).
3. Project Office: Foreign Companies planning to execute specific
projects in India can set up temporary project/site offices in India. RBI

has now granted general permission to foreign entities to establish Project
Offices subject to specified conditions. Such offices can not undertake or
carry on any activity other than the activity relating and incidental to
execution of the project. Project Offices may remit outside India the
surplus of the project on its completion, general permission for which has
been granted by the RBI.

4. Branch Office: Foreign companies engaged in manufacturing and
trading activities abroad are allowed to set up Branch Offices in India for
the following purposes:
• Export/Import of goods
• Rendering professional or consultancy services
• Carrying out research work, in which the parent company is
engaged.
• Promoting technical or financial collaborations between Indian
companies and parent or overseas group company.
• Representing the parent company in India and acting as
buying/selling agents in India.
• Rendering services in Information Technology and development of
software in India.
• Rendering technical support to the products supplied by the parent/
group companies.
• Foreign airline/shipping Company.
A branch office is not allowed to carry out manufacturing activities on its
own but is permitted to subcontract these to an Indian manufacturer. Branch
Offices established with the approval of RBI may remit outside India profit
of the branch, net of applicable Indian taxes and subject to RBI guidelines
Permission for setting up branch offices is granted by the Reserve Bank of
India (RBI).
5. Branch office on Stand-Alone Basis in Special Economic Zones
(SEZs): Such branch offices would be isolated and restricted to the SEZ
and no business activity/transaction will be allowed outside the SEZ in

India, which include branches/subsidiaries of their parent office in India.
No approval shall be necessary from RBI for a company to establish a
branch/unit in SEZs to undertake manufacturing and service activities,
subject to specified conditions.
6. Investment in a Firm or a Proprietary Concern by NRIs: A Non-
Resident Indian (NRI) or a Person of Indian Origin (PIO) resident outside

India may invest by way of contribution to the capital of a firm or a
proprietary concern in India on non-repatriation basis provided:
• The amount is invested by inward remittance or out of specified
account types (NRE/FCNR/NRO accounts) maintained with an
Authorized Dealer.
• The firm or proprietary concern is not engaged in any
agriculture/plantation or real estate business, i.e. dealing in land and
immovable property with a view to earning profit or earning income
there from.
• The amount invested shall not be eligible for repatriation outside
India. NRIs/PIOs may invest in sole proprietorship
concerns/partnership firms with repatriation benefits with the approval
of Government/ RBI.
7. Investment in a Firm or a Proprietary concern Other Than NRIs:
No person resident outside India other than NRI/PIO shall make any
investment by way of contribution to the capital of a firm or a

proprietorship concern or any association of persons in India. The RBI

may, on an application made to it, permit a person resident outside India
to make such an investment subject to such terms and conditions as may
be considered.
Other Modes of Foreign Direct Investments
1. Global Depository Receipts (GDR)/American Deposit Receipts

(ADR)/Foreign Currency Convertible Bonds (FCCB): Foreign
Investment through GDRs/ADRs, Foreign Currency Convertible Bonds
(FCCBs) are treated as Foreign Direct Investment. Indian companies are
allowed to raise equity capital in the international market through the issue
of GDR/ADRs/FCCBs. These are not subject to any ceilings on investment.
An applicant company seeking Government's approval in this regard should
have a consistent track record for good performance (financial or otherwise)
for a minimum period of 3 years. This condition can be relaxed for
infrastructure projects such as power generation, telecommunication,
petroleum exploration and refining, ports, airports and roads.
There is no restriction on the number of GDRs/ADRs/FCCBs to be floated

by a company or a group of companies in a financial year. A company
engaged in the manufacture of items covered under Automatic Route is
likely to exceed the percentage limits under the Automatic Route, whose
direct foreign investment after a proposed GDR/ADR/FCCBs issue is likely
to exceed 50 per cent/51 per cent/74 per cent as the case may be, or which is
implementing a project not contained in project falling under Government

Approval route, would need to obtain prior Government clearance through

FIPB before seeking final approval from the Ministry of Finance.
There are no end-use restrictions on GDR/ADR issue proceeds, except for

an express ban on investment in real estate and stock markets. The FCCB
issue proceeds need to conform to external commercial borrowing end use
requirements; in addition, 25 per cent of the FCCB proceeds can be used for
general corporate restructuring.
2. Preference Shares:
Foreign investment through preference shares is treated as foreign direct

investment. Proposals are processed either through the automatic route or
FIPB as the case may be. The following guidelines apply to issue of such
shares:-
• Foreign investment in preference share are considered as part of share

capital and fall outside the External Commercial Borrowing (ECB)
guidelines/cap
• Preference shares to be treated as foreign direct equity for purpose of
sectoral caps on foreign equity, where such caps are prescribed,
provided they carry a conversion option. If the preference shares are
structured without such conversion option, they would fall outside the
foreign direct equity cap.
• Duration for conversion shall be as per the maximum limit prescribed
under the Companies Act or what has been agreed to in the share
holders agreement whichever is less.

• The dividend rate would not exceed the limit prescribed by the
Ministry of Finance.
• Issue of Preference Shares should conform to guidelines prescribed by
the SEBI and RBI and other statutory requirements.
Foreign Technology Agreements
Foreign technology induction is encouraged both through FDI and through

foreign technology agreements. India has one of the most liberal policy
regimes in regard to technology agreements. Foreign technology
collaboration is permitted either through automatic route or through FIPB.
1. Automatic Approval: RBI accords automatic approval for foreign
technology collaboration agreements for all industries subject to the
following:
• The lump sum payment should not exceed US$ 2 million.
• Royalty payable is limited to 5 percent for domestic sales and 8
percent for exports subject to total payment of 8 percent on sales over
a 10 year period.
• The period for payment of royalty not exceed 7 years from the date of
commencement of commercial production, or 10 years from the date
of agreement whichever is earlier.
2. FIPB Route: For the following categories, Government approval is

necessary:
• Proposals attracting compulsory licensing.

• Items of manufacture reserved for small-scale sector.

• Proposals involving any previous joint venture or technology
transfer/trade mark agreement in the same or allied field in India.
• Extension of foreign technology collaboration agreements.
• Proposals not meeting any or all of the parameters for automatic
approval.
The different components of foreign technology collaboration such as

technical know how fees, payment for design and drawing, payment for
engineering service and royalty are eligible for approval through the
automatic route, and by the Government.

CHAPTER-8:
SECTOR SPECIFIC GUIDELINES FOR FDI IN INDIA
Hotel & Tourism Sector

100% FDI is permissible in the sector on the automatic route.
The term hotels include restaurants, beach resorts, and other tourist
complexes providing accommodation and/or catering and food facilities to
tourists. Tourism related industry include travel agencies, tour operating
agencies and tourist transport operating agencies, units providing facilities
for cultural, adventure and wild life experience to tourists, surface, air and
water transport facilities to tourists, leisure, entertainment, amusement,
sports, and health units for tourists and Convention/Seminar units and
organizations.
For foreign technology agreements, automatic approval is granted if

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

supervision, etc.
2. Up to 3% of net turnover is payable for franchising and
marketing/publicity support fee, and up to 10% of gross operating profit
is payable for management fee, including incentive fee.
Private Sector Banking:

49% FDI is allowed from all sources on the automatic route subject to
guidelines issued from RBI from time to time.

1. FDI/NRI/OCB investments allowed in the following 19 NBFC

activities shall be as per levels indicated below:
a. Merchant banking
b. Underwriting
c. Portfolio Management Services
d. Investment Advisory Services
e. Financial Consultancy
f. Stock Broking
g. Asset Management
h. Venture Capital
i. Custodial Services
j. Factoring
k. Credit Reference Agencies
l. Credit rating Agencies
m. Leasing & Finance
n. Housing Finance
o. Foreign Exchange Brokering
p. Credit card business
q. Money changing Business
r. Micro Credit
s. Rural Credit
2. Minimum Capitalization Norms for fund based NBFCs:

a. For FDI up to 51% - US$ 0.5 million to be brought upfront

b. For FDI above 51% and up to 75% - US $ 5 million to be brought

upfront
c. For FDI above 75% and up to 100% - US $ 50 million out of which
US $ 7.5 million to be brought upfront and the balance in 24 months
3. Minimum capitalization norms for non-fund based activities:

Minimum capitalization norm of US $ 0.5 million is applicable in respect
of all permitted non-fund based NBFCs with foreign investment.
4. Foreign investors can set up 100% operating subsidiaries without the
condition to disinvest a minimum of 25% of its equity to Indian entities,

subject to bringing in US$ 50 million as at 2.(c) above (without any
restriction on number of operating subsidiaries without bringing in
additional capital)
5. Joint Venture operating NBFC's that have 75% or less than 75%
foreign investment will also be allowed to set up subsidiaries for

undertaking other NBFC activities, subject to the subsidiaries also
complying with the applicable minimum capital inflow i.e. 2.(a) and 2.(b)
above.
6. FDI in the NBFC sector is put on automatic route subject to

compliance with guidelines of the Reserve Bank of India. RBI would
issue appropriate guidelines in this regard.

Insurance Sector
FDI up to 26% in the Insurance sector is allowed on the automatic route
subject to obtaining licence from Insurance Regulatory & Development
Authority (IRDA)
Telecommunication sector
1. In basic, cellular, value added services and global mobile personal
communications by satellite, FDI is limited to 49% subject to licensing
and security requirements and adherence by the companies (who are
investing and the companies in which investment is being made) to the
license conditions for foreign equity cap and lock- in period for transfer
and addition of equity and other license provisions.
2. ISPs with gateways, radio-paging and end-to-end bandwidth, FDI is

permitted up to 74% with FDI, beyond 49% requiring Government
approval. These services would be subject to licensing and security
requirements.
3. No equity cap is applicable to manufacturing activities.
4. FDI up to 100% is allowed for the following activities in the telecom

sector :
a. ISPs not providing gateways (both for satellite and submarine cables);
b. Infrastructure Providers providing dark fiber (IP Category 1);
c. Electronic Mail; and

d. Voice Mail
The above would be subject to the following conditions:
• FDI up to 100% is allowed subject to the condition that such
companies would divest 26% of their equity in favor of Indian public
in 5 years, if these companies are listed in other parts of the world.
• The above services would be subject to licensing and security
requirements, wherever required.
Proposals for FDI beyond 49% shall be considered by FIPB on case to case
basis.
Trading Companies
Trading is permitted under automatic route with FDI up to 51% provided it
is primarily export activities, and the undertaking is an export house/trading
house/super trading house/star trading house. However, under the FIPB
route:-
1. 100% FDI is permitted in case of trading companies for the following
activities:
a. exports;
b. bulk imports with ex-port/ex-bonded warehouse sales;
c. cash and carry wholesale trading;
d. Other import of goods or services provided at least 75% is for
procurement and sale of goods and services among the companies of the
same group and not for third party use or onward
transfer/distribution/sales.

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

of EXIM Policy:
a. Companies for providing after sales services (that is not trading per
se)
b. Domestic trading of products of JVs is permitted at the wholesale
level for such trading companies who wish to market manufactured
products on behalf of their joint ventures in which they have equity
participation in India.
c. Trading of hi-tech items/items requiring specialized after sales service
d. Trading of items for social sector
e. Trading of hi-tech, medical and diagnostic items.
f. Trading of items sourced from the small scale sector under which,
based on technology provided and laid down quality specifications, a
company can market that item under its brand name.
g. Domestic sourcing of products for exports.
h. Test marketing of such items for which a company has approval for
manufacture provided such test marketing facility will be for a period
of two years, and investment in setting up manufacturing facilities
commences simultaneously with test marketing.
FDI up to 100% permitted for e-commerce activities subject to the condition

that such companies would divest 26% of their equity in favor of the Indian
public in five years, if these companies are listed in other parts of the world.
Such companies would engage only in business to business (B2B) e-
commerce and not in retail trading.

Power Sector
Up to 100% FDI allowed in respect of projects relating to electricity
generation, transmission and distribution, other than atomic reactor power
plants. There is no limit on the project cost and quantum of foreign direct
investment.
Drugs & Pharmaceuticals

FDI up to 100% is permitted on the automatic route for manufacture of
drugs and pharmaceutical, provided the activity does not attract compulsory
licensing or involve use of recombinant DNA technology, and specific cell /
tissue targeted formulations. FDI proposals for the manufacture of licensable
drugs and pharmaceuticals and bulk drugs produced by recombinant DNA
technology, and specific cell / tissue targeted formulations will require prior
Government approval.
Infrastructure Sector
FDI up to 100% under automatic route is permitted in projects for
construction and maintenance of roads, highways, vehicular bridges, toll
roads, vehicular tunnels, ports and harbors.
Pollution Control and Management

FDI up to 100% in both manufacture of pollution control equipment and
consultancy for integration of pollution control systems is permitted on the
automatic route.

Call Centers in India / Call Centres in India

FDI up to 100% is allowed subject to certain conditions.
Business Process Outsourcing BPO in India

FDI up to 100% is allowed subject to certain conditions.
Special Facilities and Rules for NRI's and OCB's

NRI's and OCB's are allowed the following special facilities:
1. Direct investment in industry, trade, infrastructure etc.
2. Up to 100% equity with full repatriation facility for capital and dividends
in the following sectors:
a. 34 High Priority Industry Groups
b. Export Trading Companies
c. Hotels and Tourism-related Projects
d. Hospitals, Diagnostic Centers
e. Shipping
f. Deep Sea Fishing
g. Oil Exploration
h. Power
i. Housing and Real Estate Development
j. Highways, Bridges and Ports
k. Sick Industrial Units
l. Industries Requiring Compulsory Licensing
m. Industries Reserved for Small Scale Sector

n. Up to 40% Equity with full repatriation: New Issues of Existing

Companies raising Capital through Public Issue up to 40% of the new
Capital Issue.
o. On non-repatriation basis: Up to 100% Equity in any Proprietary or
Partnership engaged in Industrial, Commercial or Trading Activity.
p. Portfolio Investment on repatriation basis: Up to 1% of the Paid up
Value of the equity Capital or Convertible Debentures of the
Company by each NRI. Investment in Government Securities, Units
of UTI, National Plan/Saving Certificates.
q. On Non-Repatriation Basis: Acquisition of shares of an Indian
Company, through a General Body Resolution, up to 24% of the Paid
Up Value of the Company.
r. Other Facilities: Income Tax is at a Flat Rate of 20% on Income
arising from Shares or Debentures of an Indian Company.
Certain terms and conditions do apply.
Foreign Direct Investment in Small Scale Industries (SSI's) in India

Recently, India has allowed Foreign Direct Investment up to 100% in many
manufacturing industries which were designated as Small Scale Industries.
India further ended in February 2008 the monopoly of small-scale units on
79 items, leaving just 35 on the reserved list that once had as many as 873
items.

CHAPTER-9:
FACTORS AFFECTING FDI
The factors that can narrow the gap between FDI approvals and actual
foreign direct investment inflows and indeed make India a preferred
destination for global capital are,
1. Availability of infrastructure in all areas i.e. transports hospitality,

telecom, power, etc.
2. Transparency of processes, policies and decision making and
reduction of government decision making lead time.

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

4. Acceptance of International Standards including accounting standards.
5. Capital account convertibility so that all capital and payments can
flow easily in and out of the economy.
6. Simplification of the regulatory framework in general and tax laws.
7. Improvement in bandwidth for internet and data communication.
8. Improvement in the enforcement of intellectual property rights.
9. Implementation of the WTO agreement full.
All investments foreign and domestic are made under the expectation of
future profits. The economy benefits if economy policy fosters competition,
creates a well functioning modern regulatory system and discourages
artificial monopolies created by the government through entry barriers. A

recognition and understanding of these facts can result in a more positive

attitude towards FDI. The future policies should be designed in the light of
the above observations. The most important initiatives that need attention
are:
1. Empowering the State Governments with regard to FDI.
2. Developing fast track clearance system for legal disputes.
3. Changing the mind set of bureaucracy through HR practices.
4. Developing basic infrastructure.
5. Improving India’s image as an investment destination.
While the magnitudes of inflows have recorded impressive growth, they are
still at a small level compared to India’s potential. The policy reforms
undertaken have undoubtedly enabled the country to widen the sectoral and
source composition of FDI inflows. Within a generation, the countries of
East Asian transformed themselves. China, Indonesia, Korea, Thailand and
Malaysia today have living standards much above ours.
When competing for FDI, policy makers have to be aware that various
measures intended to induce FDI are necessary. These include liberalisation
of FDI regulations and various business facilitation measures. Other reforms,
such as privatization, tend to be more effective in stimulating FDI inflows,
but need to be complemented by reform in other areas, in order to ensure
that FDI inflows are beneficial. Other determinants of FDI, which were
sufficient in the past, may prove to be less relevant in the future

CHAPTER-10:
FDI TRENDS IN INDIA
India is the second most populous country and the largest democracy in the
world. The far reaching and sweeping economic reform undertaken since
1991 have unleashed the enormous growth potential of the economy. There
has been a rapid, yet calibrated, move towards deregulation and
liberalisation, which has resulted in India becoming a favourite destination
for investment. Undoubtedly, India has emerged as one of the most vibrant
and dynamic of the developing economies.
India as an Investment Destination
FDI is seen as a means to supplement domestic investment for achieving a

higher level of economic growth and development. FDI benefits domestic
industry as well as the Indian consumers by providing opportunities for
technological upgradation, access to global managerial skills and practices,
optimal utilization of human and natural resources, making Indian industry
internationally competitive, opening up export markets, providing backward
forward linkages and access to international quality goods and services. FDI
policy has been constantly reviewed and necessary steps have been taken to
make India a most favourable destination for FDI. There are several good
reasons for investing in India.
1. Third largest reservoir of skilled manpower in the world.
2. Large and diversified infrastructure spread across the country.

3. Abundance of natural resources and self-efficiency in agriculture.

4. Package of fiscal incentives for foreign investors.
5. Large and rapidly growing consumer market.
6. Democratic government with independent judiciary.
7. English as the preferred business language.
8. Developed commercial banking network of over 63000 branches
supported by a number of National and State level financial institutions.
9. Vibrant capital market consisting of 22 stock exchanges with over 9400
listed companies.
10.Congenial foreign investment environment that provides freedom of
entry, investment, location, choice of technology, import and export, and
11.Easy access to markets of Bangladesh, Bhutan, Maldives, Nepal,
Pakistan and Sri Lanka.
India’s Performance in the Global Context
According to UNCTAD World Investment Report, 2007, FDI inflows to

South Asia surged by 126% amounting to $22 billion in 2006, mainly due to
investment in India. The country received more FDI than ever before
equivalent to the total inflows during 2003-2005. Inward FDI inflows to
China declined for the first time in 7years. The modest decline by 4% or $69
billion was mainly due to reduced inflows of financial services.
UNCTAD’s World Investment Report publishes a set of benchmarks for

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

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

economic growth India ranked 120th on UNCTAD’s inward FDI
performance index 1999-2001, far below China which ranked 59th and lower
than both Pakistan (116th) and Srilanka (111th). As far as inward FDI
potential index is concerned, India ranks 84th as against China’s 40th rank.
The World Investment Report, 2005 noted, “While India has been catching
up in inward FDI, it still ranks near the bottom”.
Top Investing Countries FDI Inflows in India
In FDI equity investments Mauritius tops the list of first ten investing
countries followed by US, UK, Singapore, Netherlands, Japan, Germany,
France, Cyprus and Switzerland. Between April 2000 and July 2008 FDI
inflows from Mauritius stood at $ 30.18 billion followed by $5.80 billion
from Singapore; $ 5.47 billion from the US; $ 4.83 billion from the UK;
$ 3.12 billion from the Netherlands; $ 2.26 billion from Japan; $1.83 billion
from Germany; $ 1.41 billion from Cyprus; and $1.02 billion from France.

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

2008-09 Cumulative % with
(from (From April total
Country 2005-06 2006-07 2007-08 April- 2000 to April (inflows
March, 2009) in terms
2009) of
rupees)
11441 28759 44483 50794 168485
Mauritius 44%
(2570) (6363) (11096) (11208) (38305)
2210 3861 4377 8002 28303
USA 7%
(502) (856) (1089) (1802) (6404)
1164 8389 4690 3840 23002
UK 6%
(266) (1878) (1176) (864) (5246)
1218 2662 12319 15727 34467
Singapore 9%
(275) (578) (3073) (3454) (7934)
340 2905 2780 3922 15957
Netherlands 4%
(76) (644) (695) (883) (3611)
925 382 3336 1889 12041
Japan 3%
(208) (85) (815) (405) (2694)
1345 540 2075 2750 9580
Germany 3%
(303) (120) (514) (629) (2191)
82 528 583 2098 5489
France 1%
(18) (117) (145) (467) (1229)
310 266 3385 5983 11140
Cyprus 3%
(70) (58) (834) (1287) (2491)
219 1174 1039 1133 4146
UAE 1%
(49) (260) (258) (257) (948)
Total FDI 24613 70630 98664 122919 404728
-
inflows* (5546) (15726) (24579) (27309) (92158)
Figures in bracket are in US$ million
SOURCE: DIPP, Federal Ministry of Commerce & Industry, Government of

India
Top Sectors in India attracting FDI

The average FDI inflows per year during the 9th Plan were $ 3.2 billion and
during the 10th Plan it increased manifold to stand at $ 16.33 billion the
annual average being $ 6.16 billion. The top five sectors attracting FDI in
fiscal 2007-08 included Services sector; Housing and Real Estate;
Construction activities; Computer Software & hardware; and
Telecommunications. The infrastructure sector that offers massive potential
to attract FDI witnessed marked increase in FDI inflows during this five-
year period. The extant policy for most of the infrastructure sectors permits
FDI up to 100 percent on the automatic route. From $ 1902 million in fiscal
2001-02 the foreign investment in India's infrastructure sector increased to $
2179 million in 2006-07. But fiscal 2007-08 witnessed significant increase
in the FDI inflows in the infrastructure. In first nine months till December
2007 of fiscal 2007-08 stood at $ 4095 million. From 2000-01 to December
2007, total FDI in India's infrastructure sector stood at $ 10575 million.
SECTORS ATTRACTING HIGHEST FDI Inflows (In Rs crore)

Cumulat
2008-09 ive % of
SECTOR 2005-06 2006-07 2007-08 (April- (Apr.200 total
Jan '09) 0- Jan inflows*
2009)
Services (Financial 2399 21047 26589 23045 78742
22%
& non-financial) (543) (4664) (6615) (5061) (181189)
Computer Software 6172 11786 5623 6944 39111
11%
& Hardware (1375) (2614) (1410) (1599) (8876)
2776 2155 5103 10797 27544
Telecommunications 8%
(624) (478) (1261) (2374) (6216)
667 4424 6989 6224 19606
Construction 6%
(151) (985) (1743) (1483) (4646)
630 1254 2697 1792 11648
Automobile 4%
(143) (276) (675) (441) (2678)
Housing and Real 171 2121 8749 10632 21794
6%
estate (38) (467) (2179) (2408) (5119)
386 713 3875 4079 13709
Power 4%
(87) (157) (967) (924) (3130)
6540 7866 4686 3608 10956
Metallurgical 3%
(147) (173) (1177) (850) (2613)
Chemicals (Other 1731 930 920 2561 9442
2%
than fertilizers) (390) (205) (229) (579) (2244)
Petroleum & 64 401 5729 1196 8509
3%
Natural Gas (14) (89) (1427) (263) (2043)
Figures in bracket are in US$ million. * In terms of Rs.

India
FDI Inflows Year-wise (1990-2009)
Fiscal Year Equity Reinvested Other Total YOY

FDI growth
earnings+ capital+
inflows (%)
(April- FIPB
Equity capital
March) Route/
of
RBI's
unincorporated
Automatic
bodies#
Route
1991(Aug)-
15483 - - - 15483 -
2000 (Mar)
2000-01 2339 61 1350 279 4029 -
2001-02 3904 191 1645 390 6130 (+) 52
2002-03 2574 190 1833 438 5035 (-) 18
2003-04 2197 32 1460 633 4322 (-) 14
2004-05 3250 528 1904 369 6051 (+) 40
2005-06 5540 435 2760 226 8961 (+) 48
2006-07 15585 896 5828 517 22826 (+) 146
2007-08 24575 2292 7168 327 34362 (+) 51
2008-09
23885 334 3004 203 27426 -
(April-Dec)
Cumulative
Total
(From Aug 99332 4959 26952 3382 134625 -
1991-Jan
2009)
India
Foreign Technology Transfer
Country Wise Technology Transfer Approvals (Aug 1991-Feb 2008)

% with total technical

COUNTRY No. of FTA
approvals
USA 1772 22.31
Germany 1106 13.93
Japan 868 10.93
UK 860 10.83
Italy 484 6.09
Other countries 2851 35.91
All Countries 7941 100.00
India
Sector Wise Technology Transfer Approvals (Aug 1991-Feb 2008)

No. Technical % of total Technical
SECTOR Collaborations Collaborations
approved approved
Electrical Equipments
(Incl. computer 1255 15.80
software & electronics)
Chemicals (other than
886 11.16
fertilizers)
Industrial Machinery 869 10.94
Transportation
742 9.34
Industry
Misc. Mach.
442 5.57
Engineering Industry
Other sectors 3747 47.19
Total all sectors 7941 100.00
India
CHAPTER-11:
CONCLUSION

Economic reforms in India have deregulated the economy and stimulated

domestic and foreign investment, taking India firmly into the forefront of
investment destinations. The Government, keen to promote FDI in the
country, has radically simplified and rationalized policies, procedures and
regulatory aspects. Foreign direct investment is welcome in almost all
sectors; expect those strategic concerns (defence and atomic energy).
Since the initiation of the economic liberalisation process in 1991, sectors

such as automobiles, chemicals, food processing, oil and natural gas, petro-
chemicals, power, services, and telecommunications have attracted
considerable investments. Today, in the changed investment climate, India
offers exciting business opportunities in virtually every sector of the
economy. Telecom, electrical equipment (including computer software),
energy and transportation sector have attracted the highest FDI.
Despite its market size and potential, India has yet to convert considerable
favourable investor sentiment into substantial net flows of FDI. Overall,
India remains high on corporate investor radar screens, and is widely
perceived to offer ample opportunities for investment. The market size and
potential give India a definite advantage over most other comparable
investment destinations.
India’s investment profile, however, is also conditioned by factors that affect

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

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

property regime.
A perceived slowdown in the process of reforms generates doubts about the

market’s long-term potential. To capitalize on its potential for FDI, would
seem that India needs to accelerate efforts to institutionalize government
efficiency and advance the implementation of promised reforms. Other
strategic efforts should include focusing the market on India’s relatively
higher rates of return on existing investments and long-term potential,
addressing the issue of transforming the country into a viable export
platform and encouraging strategic alliances with foreign investors. In short,
this means accelerating India’s integration with the global economy.

 BIBLIOGRAPHY
Books:
 Foreign Investment in India: 1947-48 to 2007-08, Dr. Kamlesh
Gakhar
 Foreign Direct Investment in India: 1947 to 2007, Dr. Nitin Bhasin
Websites:
 http://business.mapsofindia.com
 http://www.economywatch.com
 http://siadipp.nic.in

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VIVEK COLLEGE OF COMMERCE

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

Foreign Direct Investment in India Page | 1

The remarkable expansion of FDI flows to developing countries had belied

Foreign Direct Investment in India Page | 2

flows from developing countries. The most important factors making

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

The Foreign Exchange Regulation Act (FERA), 1973 (now replaced by

Foreign Direct Investment in India Page | 3

Foreign investment policies in the post-reforms period have emphasized

Foreign Direct Investment in India Page | 4

Foreign Direct Investment in India Page | 5

foreign affiliates, both incorporated and unincorporated. Individuals as well

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

• Equity capital is the foreign direct investor’s purchase of share of an

OECD Benchmark Definition of Foreign Direct Investment (Third

Foreign Direct Investment in India Page | 6

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

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

Foreign Direct Investment in India Page | 7

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

1. Through export of goods and services

Foreign Direct Investment in India Page | 8

External Aid from foreign governments and international institutions, by

Foreign investment is of following two types.

Foreign Direct versus Portfolio Investment

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

Foreign Direct Investment in India Page | 9

FDI can be done in the following ways

Foreign Direct Investment in India Page | 10

Superiority of FDI over Other Forms of Capital Inflows

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

investors typically have a longer-term perspective when engaging in a

Foreign Direct Investment in India Page | 11

FDI is widely considered an essential element for achieving sustainable

Macro-economic and Micro-economic Aspects of FDI

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

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

Foreign Direct Investment in India Page | 12

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

Resource-seeking and Market-seeking FDI

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

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

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

Foreign Direct Investment in India Page | 13

Globalisation essentially means that geographically dispersed

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

Foreign Direct Investment in India Page | 14

The fourth recognized characteristic of manufacturing FDI is that it

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

Foreign Direct Investment in India Page | 15

FDI in Developing Countries

FDI is now increasingly recognized as an important contributor to a

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

Foreign Direct Investment in India Page | 16

Developing countries are liberalizing their foreign investment regimes and

Foreign Direct Investment in India Page | 17

Advantages of Foreign Direct Investment

between desired investment and locally mobilised savings. Local capital

2. Upgradation of Technology: Foreign investment brings with it

technological knowledge while transferring machinery and equipment to

Foreign Direct Investment in India Page | 18

3. Improvement in Export Competitiveness: FDI can help the host