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Capital Transfers and Economic Growth


Types of Foreign Capital




Government Policy towards Foreign Capital

Policy Changes 1991-2005

Critical Evaluation of the New Policy



Characteristics of Multinational Corporations

Importance and Significance of MNCs
Need for Regulation of MNCs

Foreign Capital in India



Sources of Private Foreign Capital

Types of FDI

Multinational Corporations


Savings Gap
Trade Gap or Foreign Exchange Gap
Technological Gap

Points of Concern to Foreign Investors

Criticism of Inflows and Need for Corrective Action

Let Us Sum Up
Key Words
Some Useful Books
Answers or Hints to Check Your Progress Exercises


After reading this unit, you shall be able to:

state the role of foreign capital in the growth process of a developing


differentiate between different types and sources of foreign capital;

explain the nature of multinational corporations and their role in the

process of economic growth;

describe the different phases in the growth of Government of Indias

policy towards foreign capital;

explain the changes in the policy towards foreign capital in the recent
years; and

identify the weaknesses in the government policy and make relevant

suggestions in this regard.


Sectoral Performance-III



Spread of information technology and recent technological advances have

opened up the economies the world over as never before, and, hence,
increasing multinational role for enterprise and capital. For a developing
economy, it is all the more critical, as it is required to fill: (i) investment
saving gap, (ii) technology gap, and (iii) foreign exchange gap. But
unregulated flow of foreign enterprise and capital may go against the
economic interests of sovereign nations, and, hence, the need for regulations.
Till 1991, India allowed selective foreign investment in collaboration with
domestic enterprise; the majority control was preferred to be with the
residents. Beginning with July, 1991, there has been a change in the policy. A
large number of high-tech areas have been left open to foreign investment that
has come to be regarded as a better vehicle of capital inflows than loans.
The response of foreign capital to policy initiatives can only be described as
mixed. Although proposals have been plenty, and approvals many, actual
inflows have been limited. In this unit, we shall discuss the various issues
involved in the foreign capital and role of MNCs in this regard. Let us begin
with discussing the importance of foreign capital in economic growth.


Inflow of capital from abroad is vital for the growth of a developing economy,
especially in the initial stages of its economic development. Modern economic
history abounds with examples of countries which have successfully drawn
upon the capital resources of the more advanced industrial countries for the
sake of economic development.
The role of foreign capital can be explained in terms of gap-filling functions.
Three such gaps can be identified, viz., (a) Savings gap, (b) Trade gap and (c)
Technology gap. The function of foreign capital is to fill these gaps and create
conditions suitable for fast economic growth.

18.2.1 Savings Gap

The key to the development problem lies in raising the rate of capital
formation. Such a raise envisages a much higher level of investment than is
warranted by the present level of savings in a developing economy. The scope
for a sharp rise in domestic savings is limited by the prevailing low level of
income, slow rates of growth and rising consumption needs in these
The gap between investment requirements and domestic savings can be filled
in by foreign capital. A little simple algebra will show why.
The fundamental proposition of national income accounting is that
Y = C + I + (X M)
Where Y = Gross national product (total spending), C = Consumption, I =
Investment, X = Exports of Goods and Services plus income received from
abroad, and M = Imports of goods and services plus income paid abroad.


All this spending generates an identical flow of income (Y); this total income
equals total spending: of all income, some is consumed (C) and some is saved
(S). Thus,

Then, since total spending equals that income, by substitution

Multinational Corporations
and Foreign Capital

C + I + (X M) = C + S
From this equation, we can, by simple manipulation, easily discover the
essential constraints on capital formation. Move (X M) to to the right hand,
reversing its sign; cancel C on both sides. The result is
I= S + (M X)
The algebra is clear. A countrys investment opportunities are determined by
its potential for domestic saving plus any net capital inflows from abroad
(M > X). The only way for imports to exceed exports is for the country to get
capital from abroad; M > X is thus equivalent to a capital inflow.
The availability of foreign capital increases the availability of total resources
in the economy. The increase in total resources helps a developing economy
primarily in two ways:
One, It influences investment decisions. It makes possible construction of
many projects which would not have been possible otherwise. Certain
programmes of development can give optimum results if all the components
of the programme are undertaken simultaneously in a phased manner. The
availability of foreign capital makes this type of investment possible.
Two, establishment of bigger projects and projects with a high investment
component open up new opportunities of investment and, thus, encourage
domestic entrepreneurs and savers to supply their services and savings. The
addition to the total volume of resources generated thereby exceeds the
addition made by foreign resources.

18.2.2 Trade Gap or Foreign Exchange Gap

A developing economy is faced with two structural constraints: (i) a minimum
requirement of inputs to sustain a given rate of growth of GNP, and (ii) an
actual or potential ceiling on export earnings which are insufficient to finance
the required imports.
The foreign exchange gap, i.e., the difference between the required imports
and total exports is given by
Mn Xn = Mo + (Vn Vo) Xo (1 + x)n
Where, Mo = Observed initial level of imports,
Vo = The GNP in the initial year,
Vn = Vo (1 + r)n, r being the compound growth rate and n the number
of years after o,
Xo = The initial level of export,
= The marginal rate of imports per additional unit of GNP,
r = Rate of growth of exports.
In a situation where the foreign exchange gap is dominant, the total import
capacity, i.e.,
Xn = Xo (1 + x)n
will effectively set the limit to the increase in GNP.

Sectoral Performance-III

The constraint will be more severe if any of the following two situations
One, some Strategic Goods like capital equipment and technical know-how,
etc. are not available locally and could be procured only from external
Two, technical conditions of industrialisation require a complement of foreign
resources along with domestic resources, so that the latter would lie idle if the
former are not available.
In either of the above two situations, the availability of foreign exchange can
save an economy from an impasse in which it may find otherwise, and place
at her disposal high quality factors such as improved machinery, technical
know-how and qualified foreign technicians which may have a beneficial
effect on her development by, what Harrod called, fertilising productivity of
common labour.

18.2.3 Technological Gap

The role of technology in bringing about economic growth is obvious. The
level of technology in a developing economy can be raised through: (a) the
internal evolutionary process of education, research, training and experience,
or (b) the external process of importing from other countries. In respect of the
import of technology, contemporary developing countries have the added
advantages of the latecomers. This has received much attention lately. Since
development has actually proceeded in the rest of the world, these countries
have a rather whole range of technology to choose from and do not have to
repeat the process of evolving it. The import of technology, however, raises
two issues, viz., (a) the choice of technology and (b) local adaptation. The act
of choosing a particularly technology is dependent on the state of domestic
complementary research. Only then a country will be able to know the
quantity and quality of the know-how to be imported and the price to be paid
for it. Adaptation of technology contemplates that the process of import of
technology should be accompanied by indigenous research and development.
Analogous to technology gap is a gap in management, entrepreneurship and
skill. Foreign capital can supply a package of needed resources that can be
transferred to their local counterparts by means of training programmes and
the process of learning by doing.
To sum up, foreign capital touches three sensitive areas crucial in the
development strategy of a developing country. It is almost true to say that the
growth, at least in the initial stages, in the present times cannot be a selfgenerating process. Indeed, with a sole dependence on the domestic resources,
it may be difficult to breach the vicious circle within which a developing
country is usually caught.
Check Your Progress 1
Note: i) Space is given below each question for your answer.
ii) Check your answer(s) with those given at the end of the unit.
1) What do you mean by saving gap? How foreign capital helps to fill this


2) Explain the gap-filling functions of foreign capital.


Multinational Corporations
and Foreign Capital

3) Explain the nature of technology gap faced by a developing economy.



The inflow of capital from abroad may take place either in the form of: (a)
foreign aid, or (b) private investment.
Foreign aid includes loans and grants from foreign governments and
institutions. This source of foreign capital, especially loans, has an important
limitation in the form of repayment obligations.
As regards private foreign capital investment, the intense academic debate
relating to its effects remains inconclusive. The opponents of foreign
investment have drawn attention to several imperfections and adverse effects,
such as capital intensity of such investment, inappropriate technology, the
possible adverse effects on income distribution, transfer pricing and the
negative contribution that such investment often makes to the balance of
payments. The advocates of foreign investment, on the other hand, have
highlighted the beneficial effects in terms of encouragement to the
development of technology, managerial expertise, integration with the world
economy, exports and higher growth. It has also been claimed that debt
financing generates fixed debt servicing obligations, while equity needs to be
serviced only after profits are made.
There is also sufficient empirical evidence to support both points of view. For
example, in recent years, foreign investment seems to have contributed
enormously to the growth of several Asian countries, including China. There
are examples, particularly from Latin America and Africa, where the
contribution of foreign investment has not been so encouraging.

18.3.1 Sources of Private Foreign Capital

The two important sources of foreign private capital are: (a) Portfolio
Investment and (b) Direct Business Investment, also known as Foreign Direct
Investment (FDI).
a) Portfolio Investment
It comprises the following:
i) Equity holdings by non-residents in the recipient countrys joint stock
ii) Creditor capital from private sources abroad invested in recipient
countrys joint stock companies, and

Sectoral Performance-III

iii) Creditor capital from official sources in recipient countrys joint stock
b) Foreign Direct Investment
There are three main categories of FDI:
i) Equity Capital: It is the value of the Multinational Corporations
(MNCs) investment in shares of an enterprise in a foreign country. An
equity capital stake of 10 per cent or more of the ordinary shares or
voting power in an incorporated enterprise or its equivalent in an
unincorporated enterprise is normally considered a threshold for the
control of assets. This category includes both mergers and
acquisitions, and green field investment (the creation of new facilities).
ii) Reinvested Earnings: These are the MNCs share of affiliate earnings
not distributed as dividends or remitted to the MNCs. Such retained
profits by affiliates are assumed to be reinvested in the affiliate.
iii) Other Capital: It refers to short-term or long-term borrowing and
lending of funds between the MNCs and the affiliate.

18.3.2 Types of FDI

Looked at from the point of view of the investors, the FDI inflows can be
classified into three groups:
i) Market-seeking: These are attracted by the size of the local market which
depends on the income of the country and its growth rate.
ii) Efficiency-seeking: In developing countries where capital is relatively
scarce the marginal efficiency of capital tends to be higher than in the
developed world where it is abundant. Assuming that interest rates
broadly reflect Marginal Efficiency of Capital (MEC), it follows that
lending rates in Western financial centres are below MECs in developing
countries. Hence, economic efficiency and commercial logic dictate that
capital should flow from the relatively less-profitable developed world to
the relatively more profitable developing countries.
iii) Other Location Advantages: These include the technological status of a
country, brand name and goodwill enjoyed by the local firms, openness of
the economy, trade and macro policies pursued by the Government and
intellectual property protection granted by the Government. Whatever
form of FDI, in modern times, Multinational Corporations (MNCs) have
become the major carriers of foreign capital and technical know-how. We
shall examine in brief the major characteristics of this form of



An MNC is one which undertakes foreign direct investment, i.e., it owns or

controls income generation assets in more than one country, and in so doing
produces goods or services outside its country of origin, i.e., engages in
international production. As per the estimates made available by the UN
Centre on Transnational Corporations, there are more than eleven thousand
MNCs with more than eighty-two thousand subsidiaries in operation abroad.

18.4.1 Characteristics of Multinational Corporations


The MNCs have certain characteristics among which the more important are
as follows:

i) Giant Size: The assets and sales of MNCs run into billions of dollars and
they also make supernormal profits. The Economist estimates that the
worlds top 300 MNCs now control over 25 per cent of the 20 trillion
stock of productive assets. No size, howsoever big, is perceived to be
sufficient. Hence the MNCs keep on growing even through the route of
mergers and acquisitions.

Multinational Corporations
and Foreign Capital

ii) International Operations: In such a corporation, control resides in the

hands of a single institution. But its interests and operations sprawl across
national boundaries. MNCs have become in effect global factories
searching for opportunities anywhere in the world.
iii) Oligopolistic Structure: Through the process of merger and takeover,
etc., in course of time, an MNC acquires awesome power. This coupled
with its giant size makes it oligopolistic in character.
iv) Spontaneous Evolution: MNCs usually grow in a spontaneous and
unconscious manner. Very often they develop through creeping
incrementalism. Many firms have become international by accident. At
times, firms have also established subsidiaries abroad due to wage
differentials and better opportunities prevailing in the home country.
v) Collective Transfer of Resources: An MNC facilitates a multilateral
transfer of resources. Usually this transfer takes place in the form of a
package which includes technical know-how, equipments and
machinery, raw materials, finished product, managerial services and so on.
MNCs are composed of a complex of widely varied modern technology
ranging from production and marketing to management and finance.

18.4.2 Importance and Significance of MNCs

With the retreat of socialism, MNCs have become a powerful force in the
world economy.
The Case for MNCs
The case for MNCs revolves around that the potential benefits that a
developing economy can hope to get from MNC operations. These benefits
are summarised in Table 18.1.
Table 18.1: Potential Benefits from MNC Operations
Impact Area

Potential Benefits



Provision of scarce capital resources

internally generated
externally generated.
(privileged access to global capital markets)



Provision of sophisticated technology and other

technology not available in the host country.


Exports and Balance of


Access to superior global distribution and marketing

MNCs may increase exports and create positive
balance of payments effects.



MNCs command technology and skills required for

diversification of the industrial base and for the
creation of backward and forward linkages.


Sectoral Performance-III

A recent study on the subject concludes that in todays world of global

capitalism, foreign investment is the only instrument that can reduce the
inequalities between nations.
The Case against MNCs
In actual operations, in the past half a-century or so, the experience with
MNCs has not been an unmixed blessing. Main points of criticism can be
summarised as in Table 18.2.
Table 18.2: Actual Impact of MNCs Operations


Impact Area

Potential Benefits


Insignificant net inflow,

Large dividend remittances,
Large technical payments,
Progressive fall of foreign participation in
corporate capital formation.



Costly over-import,
Problems with advanced technology and updating,
Problems with technical support.


Exports and Balance of


Export performance
Higher import








Some import substitution but negative BDP



Preemption of growth
substitution of domestic
promisive areas,

opportunities and
capital in several

Increased foreign influence in key sectors.

In a partial response to the above propositions, it may be stated that the

modern MNCs acknowledge their responsibility to the concerns and interests
of the host country and basically operate on the basis of mutuality of interests.
In fact, in present times international capital has no loyalty towards any
nationality. MNCs realise they cannot be oriented toward the state of their
origin. They have to be the citizens of the country they are in. If they are not,
they cannot succeed.


Need for Regulation of MNCs

In view of the fact that MNCs do possess a potential that can be gainfully
exploited, most of the developing countries have chosen to regulate their
activities rather than to dispense with them altogether.
i) Threat of nationalisation is an important tool of regulation.
ii) The Government may allow or deny permission in identified areas.
iii) MNCs may be allowed to invest for specific periods. Thus, after a certain
period of time, restrictions may be imposed on foreign holdings, or there
may be provision for gradual disinvestments.

iv) A multi-tax system may be followed by the Government. The MNCs may
be taxed at a higher rate.

v) The host country may lay down certain export criteria.

vi) MNCs may be asked to carry out a minimum fixed share of their total
research and development activities within the host countries.

Multinational Corporations
and Foreign Capital


In the planned economy of India, foreign capital has been assigned a
significant role, although it has been changing over time. In the earlier phase
of planning, foreign capital was looked upon as a means to supplement
domestic investment. Many concessions and incentives were given to foreign
investors. Later on, however, the emphasis shifted to encouraging
technological collaboration between Indian entrepreneurs and foreign
entrepreneurs. In more recent times, efforts are on to invite free flow of
foreign capital. It would be instructive in this background to examine the
Governments policy towards foreign capital.

18.5.1 Government Policy towards Foreign Capital

Foreign investment in India is subject to the same industrial policy as all other
business ventures, plus some additional policies and rules specially governing
foreign collaborations.
The first articulate expression of free Indias attitude towards foreign capital
was embodied in the Industrial Policy Resolution, 1948 (IPR, 1948). The IPR,
1948 emphasised the need for carefully regulating as well as inviting private
foreign capital. It laid special stress, inter-alia, on the need to ensure that in all
cases of foreign collaboration, the majority interest was always Indian. This
was followed by the Fiscal Commission of 1949-50 which recommended that
foreign investment may be permitted, first, in the public sector projects
needing imported capital good, and secondly, in new capital industries where
no indigenous capital or technical know-how was likely to be available.
This was followed by a statement on policy towards foreign capital made by
the Government on April 6, 1949. The underlying principles of the policy by
and large are valid even now. These may be enumerated as follows:

Foreign capital once admitted will be treated at par with indigenous


Facilities for remittance of profits abroad will continue.

As a rule, the major interest in ownership and effective control of an

undertaking should be in Indians hands.

If an enterprise is acquired, compensation will be paid on a fair and

equitable basis.

The Government would not object to foreign capital having control of a

concern for a limited period and each individual case will be dealt with on
its merits.
In short, the Government promised non-discriminatory treatment of foreign
investment and free remittance facilities for both profits and capital. An
emphasis was laid down on the employment and training of the Indians in
higher positions. In keeping with these guidelines, the general policy was to
allow such foreign investments and collaborations as were in line with the
priorities and targets of the Five-Year Plans. The policy was to restrict foreign
collaboration to those cases which would bring technical know-how into the
country such as was not available indigenously for developing new lines of


Sectoral Performance-III

These principles define the broad contours within which the state policy
towards foreign capital has been framed all through the different five-year
plans. Beginning with the First Five-Year Plan in 1951, three distinct phases
as follows can be marked:

The First Phase lasted till 1965 and was characterised by a liberal attitude
towards foreign capital. Many concessions and incentives were given to
foreign capital participation in the industrial development of the country.

In the Second Phase beginning with the mid-1960s, the liberal attitude of
the state yielded place to strict controls and the broad policy was to restrict
the area of operation of foreign capital.

The Third Phase, beginning with the adoption of economic reforms

programme since July, 1991, has adopted a more liberal attitude towards
foreign capital and has aimed at attracting a free flow of FDI.

18.5.2 Policy Changes 1991-2005

The New Industrial Policy, 1991, can be described as a minor revolution as far
as decisions concerning foreign investment and foreign technology
agreements are concerned.
The various changes in the policy can be broadly classified into four
categories as follows:
1) Choice of Product: The number of products in which foreign investment
is freely permitted has been significantly increased.
2) Choice of Market: The foreign investors are now free to compete with
the domestic producers in the Indian market.
3) Choice of Ownership Structure: In most cases, the foreign investor is
free to own a majority share in equity.
4) Simplification of Procedures: India has opened two routes for FDI
inflows. First, the RBI route (or the Mumbai route). This is transparent in
the sense that the guidelines are clear. If projects satisfy the guidelines, the
approvals are practically automatic.
FDI proposals which fall under the automatic route are listed in Annexure
III of the industries list; it consists of 42 industries. This annexure has four
categories: industries where foreign equity capital limit is pegged at 50 per
cent, 51 per cent, 74 per cent and 100 per cent, respectively. 50 per cent
through the automatic route is allowed in the mining sector. 51 per cent
through the automatic route is allowed in 51 industries, whereas 9
industries quality for 74 per cent equity. 100 per cent foreign equity
through the automatic route is allowed only in a handful of industries,
such as power, roads and ports. In this category, there is a maximum
foreign investment limit of Rs. 1,500 crores.
The second route is the Foreign Investment Promotion Board (FIPB) route
(or the Delhi route). Foreigners are welcome to make proposals that do not
fit into the first case. Such proposals are considered case by case. Detailed
guidelines covering this route were issued on January 20, 1997. The
Government has also set up Foreign Investment Implementation
Authority, independent of the FIPB, to act as a single point interface
between the investor and Government agencies.

The above changes are pointers to the fact that, lately, the Government is keen
to attract more of foreign investment. It seems it has come to be believed that:

It is better to allow equity than to go out to borrow. For one thing,

dividend remittance on equity will start only when the unit starts

Capital is generally never repatriated. Profit also is normally reinvested.

The company meanwhile makes a substantial contribution to GNP and
domestic market becomes competitive.

FDI brings technology. This technology spills over into other sectors
which supply components and inputs. Also when FDI firms produce
cheaper and better capital goods or intermediate products, the
competitiveness of sectors which use these, improves. The competitive
edge will spur development and accelerate the growth process.

Multinational Corporations
and Foreign Capital

Check Your Progress 2

Note: i) Space is given below each question for your answer.
ii) Check your answer(s) with those given at the end of the unit.
1) Distinguish between loans and private investment as sources of foreign
2) Distinguish between foreign direct investment and portfolio investment as
sources of private foreign capital.
3) What are multinational corporations? Highlight their role in the growth
process of a developing economy.
4) Discuss the different changes in the Government policy towards foreign


Sectoral Performance-III


The economic reforms have, undoubtedly, improved the foreign investment
environment in India. As a matter of fact, the success of the new economic
policy hinges in a large measure on the liberal response of the foreign capital.
Let us examine what has been the response of the foreign capital to the policy
The response of the foreign capital, however, going by the trends, has not
been ungrudging. Where a deluge was expected, only trickle has flowed in, as
would be seen from Table 18.3.
Table 18.3: Inflows of FDI ($ billion)






























Note: The Government has reorganised FDI data for 2000-01, 2001-02 and 2002-03
along the lines recommended by the IMF to include some hitherto uncaptured
elements of capital. The fresh items have been classified under equity capital,
reinvested earnings and other capital. As per the revised data, FDI inflows
during 2000-01 would now be $4.03 billion, while these would be $6.13 billion
in 2001-02, and $4.67 billion in 2002-03.

Less than 40 of the top 100 MNCs and none of the top small MNCs
operate in this country. This shows what a long way we have to go to become
a multinational heaven.

18.6.1 Points of Concern to Foreign Investors

It might be of interest to analyse main points of concern at this stage to
foreign investors in relation with the new policy.
1) Comparative Advantage among Different Investment Markets: India
offers three basic advantages to foreign investors:

i) Availability of inexpensive manpower.

ii) Existence of vast domestic market.

iii) Easy availability and lower costs of inputs.

Multinational Corporations
and Foreign Capital

Foreign investors have their own apprehensions in regard to each of these.

As to the first, it is argued that low wage levels may be offset by
productivity level to a large extent. For example, notwithstanding sizeable
improvement in productivity in almost all the sectors over the last five
decades, labour productivity is one of the lowest in the world. Productivity
in China is 30 per cent higher than here. Other Asian countries like
Thailand and Indonesia have productivity levels that are 300 to 400 per
cent that of India.
Further, industrial relations may have a direct bearing on productivity.
This is consequence of the fact that the FDI operations in developing
countries are labour rather than capital intensive.
As to the second, for taking hard investment decisions, consumption
patterns are more relevant than classifications based on incomes. In this
regard, India may not score very high in foreigners projections.
As to the third, the number of industries where India can offer such input
advantages are few and not all of them will be considered by foreign
companies that are sensitive to the possibility of their technologies being
cloned in an environment where patent laws are weak. For such
companies Indias trained manpower may even be a liability, as this
manpower has the ability to recreate technology that they have worked on.
The benefit of lower costs of inputs can also be eroded if increased
demand raises prices.
2) Permanence of New Policy: The foreign investors would wish to be
assured of the liberalisation policy in the future. The absence of trust
provides formidable obstacles to the creation of public institutions.
3) Exit Policy: Disinvestment by foreign partners in joint ventures in India is
at present under a highly restrictive control by the Government. Required
approvals are both cumbersome and time-consuming and the sale price of
equity shares to be disposed of by foreign investors are virtually dictated
by the RBI. While the underlying thinking behind such a system is not
incomprehensible, it has probably been making potential foreign investors
more cautious in considering investment proposals in India.
4) Procedural Simplifications: In this respect, the country seems to be
known more for erecting hurdles in the investors path.
5) Removal of Comparative Disadvantages: Foreign investors would have
to be convinced that the existing comparative advantages are not offset by
the comparative disadvantages they have to cope with:
i) They would wish to examine security situation and living conditions
affecting foreign residents in India.
ii) They would also be concerned with the availability, quality and
reliability of local vendors producing parts and components.
iii) They would have to look into whatever shortcomings may be found in
infrastructural facilities and services, including telephone and
telecommunication services, power supply, water supply, and road and
railway transportation.
iv) Cost of doing business in India continues to be high.

Sectoral Performance-III

v) The regulatory system is still non-transparent. Bureaucratic maze and

redtapism abound.
vi) Intellectual property rights regime continues to be weak.
A recent editorial comment has to say: Indian form of controlling economic
activity has proved as hardy and survival-prone as the cockroach.

18.6.2 Criticism of Inflows and Need for Corrective Action

MNCs are being increasingly criticised for their investment policies and
behaviour, specially on the following counts:
One, cowboy approach of landing in India, hastily choosing a partner, making
a mistake and then breaking the relationship.
Two, leverage an Indian partner to get in, and then move quickly to a 51 per
cent equity, and if possible a near total takeover. Indeed, a recent study brings
out that 35 to 40 per cent of FDI inflows in recent years have been trigerred by
mergers and acquisitions by foreign companies and not for fresh projects.
Three, setting up a 100 per cent owned subsidiary despite a joint venture. It
only goes to show how sensitive foreign firms are about the managerial
control. However, it is often argued that majority equity holding is necessary
for international firms to be assured enough to bring in the latest technology
that could have positive spillover in the host economy.
Four, some of them have transferred their brands to 100 per cent subsidiaries.
Indeed, a recent study on the subject concludes that the days of the joint
ventures were over.
Five, supply second hand plant and machinery declared obsolete in their
Six, short-term focus for quick results.
Seven, sales approach to India as distinct from manufacturing.
Lastly, using expatriate management and CEOs rather than competitive
Indian management.

18.6.3 Suggestions
Policy reform is an on-going process. Following suggestions can be made to
make policy towards foreign capital more meaningful and effective:
1) State infrastructure is a major constraint and things can worsen if quick
action is not taken to watch the quality and size of all infrastructure
components like transport, communication and energy, comparable with
that in other countries competing for the same capital.
2) Attention need be paid to restructuring education, training and skills the
process must begin at the level of primary education upwards with
emphasis on absorption of appropriate skills and through upgradation.
3) India should promote quality standards. The present mindset favouring
cheapness of the cost of capital needs a change.
4) The existing framework of legislation and practices related to industrial
action should be reorganised so as to make it conducive to the promotion
of productivity oriented measures.
5) The operating environment need be made investor-friendly. For this
purpose, following suggestions can be made:


At the entry level, there are two alternative routes, viz., the Automatic
Approval Route (AA) of RBI and the Foreign Investment Promotion
Board (FIPB). The policy framework should be liberalised to make the
AA route more effective. An increased share of the AA route in the
FDI approvals will concurrently reduce the pressures on the FIPB

Multinational Corporations
and Foreign Capital

ii) The efficiency of the state-level frontline bureaucracy is absolutely

critical to keep up investors confidence to prevent cost and time
overruns which, unless prevented, will have adverse effect not only on
individual investors but also on the economy as a whole.
6) We need to be tough with MNCs. But the real way to be tough with
MNCs is to make the domestic market a ruthlessly competitive place by
doing away with discretionary FDI approvals. Otherwise, corporates
would be back at the old game of maximising gains by taking advantage
of opportunities to politically manage the market place.
7) FDI may actually be harmful to the recipient country if the economy is
highly protected and foreign investment takes place behind high tariff
walls. This type of investment is generally referred to as the tariffjumping variety of foreign investment, whose primary objective is to take
advantage of the protected markets in the host country. The longer the
Government shields its home market with tariffs, the more will the
foreigner come in to exploit that protected market, and more acute will be
the conflict between him and the domestic entrepreneur. In view of this,
an appropriate policy framework must respond to two conflicting
objectives: the need to liberalise rules governing such investment in view
of the growing integration of the world economy, and the need to ensure
that such investment has positive effects on the countrys economy and
does not lead to negative welfare effects.
Check Your Progress 3
Note: i) Space is given below each question for your answer.
ii) Check your answer(s) with those given at the end of the unit.
1) State the major drawbacks in the inflows of foreign capital as experienced
in recent times.
2) Make suggestions to remove hurdles in the path of inflow of foreign


Sectoral Performance-III



In an increasingly globalising world where the different economies are getting

more integrated than ever before, flows of capital from one place to another
acquire added significance, both quantitative and qualitative. Capital moves
from less productive uses to more productive ones. Developing economies
provide foreign capital with an opportunity to earn better returns. Hence,
developing economies always work as magnets for multinational corporations,
the carriers of foreign capital. Foreign capital performs three critical gapfilling functions. However, for foreign capital to play a critical role, it is
necessary that a suitable environment is provided. A suitable environment
enables an MNC to work at and exploit its potential. India has virtually
thrown open its doors to foreign capital. Despite that, however, the response
of foreign capital has not been very encouraging. It is important to have a
fresh look at the policy framework so that a balance is struck between the
interests of the host country and foreign capital.

1) Critically examine the role of multinational corporations in a developing
economy. In this context, would you advocate a policy of encouraging
investment by multinationals in India?
2) What are the arguments advanced against multinational corporations
operating in India?
3) Response of foreign capital to recent policy initiatives is considered as
lukewarm. Make suggestions to change this trend.
4) The new industrial policy can be described as a minor revolution as far as
decisions concerning foreign capital are concerned. Elaborate what has
the impact of the new policy.


Capital Transfers: Inflows and outflows of capital from one country to
Savings Gap: The difference between the required rate of investment and the
actual rate of saving available in an economy.
Trade Gap: The difference between the expenditure of foreign exchange and
receipts of foreign exchange in transactions of goods and services.
Multinational Corporations: A business organisation which owns or
controls income generation assets in more than one country, and in so doing
produces goods or services outside its country of origin.
Foreign Direct Investment: More generally refers to the value of the MNCs
investment in equity shares of an enterprise in a foreign country.
Greenfield Investment: Refers to an investment in building up a new
production facility.
Portfolio Investment: Refers to equity holdings by a non-resident in the
recipient counrys joint stock companies.




Multinational Corporations
and Foreign Capital

Basu, Kaushik (ed.) (2004); Indias Emerging Economy, MIT Press.

Bhagwati, Jagdish (2004); In Defence of Globalisation, Oxford University
Press, New Delhi.
Bhattacharya, Aditya and Marzit, Sugata (eds.) (2004); Globalisation and the
Developing Economies: Theory and Evidence, Manohar, New Delhi.
Jha, Raghbendra (ed.) (2003); Indian Economic Reforms, Hampshire, U.K.
Kalirazan, K.P. and Sankar, U. (eds.) (2002); Economic Reform and the
Liberalisation of the Indian Economy, Cheltenham, Edgar Elgar.


Check Your Progress 1
1) See Sub-section 18.2.1
2) See Sub-section 18.2.2
3) See Sub-section 18.2.3
Check Your Progress 2
1) See Section 18.3
2) See Sub-section 18.3.1
3) See Sub-section 18.4.1
4) See Sub-section 18.5.2
Check Your Progress 3
1) See Sub-section 18.6.2
2) See Sub-section 18.6.3