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Foreign Direct Investment One of the most high-flying and remarkable attribute of today‟s globalised world is the exponential growth of FDI in both developed and developing countries. In the last two decades the rapidity of FDI flows are intensifying faster than almost all other indicators of economic activity worldwide. Developing countries, in particular, considered FDI as the safest type of external finance as it not only supplement domestic savings, foreign reserves but promotes growth even more through spillovers of technology, skills, amplified innovative capacity, and domestic competition. Now days, FDI has become an instrument of international fiscal integration. Foreign Direct Investment (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 under the sponsorship of the investors. FDI also facilitates international trade and transmittance of knowledge, skills and technology. In a world of augmented competition and brisk technological alteration, their complimentary and catalytic role can be very valuable. FDI is a primary and fundamental factor in empowering the contemporaneous progression of worldwide monetary developmental enlargements. It was during July 1991 that India opened its doors to private sector and liberalized its economy. Moreover, the experiences of South-East Asian countries by liberalizing their economies in 1980s became luminaries of economic growth and development in early 1990s. Noteworthy is India‟s experience with its first generation economic reforms and viewed in this light the country‟s economic growth performance was considered safe havens for FDI which led to second generation of economic reforms in India in first decade of this century. There is a considerable change in the attitude of both the developing and developed countries towards FDI. They both consider FDI as the most suitable form of external finance. There has also been an increase in competition for FDI inflows particularly among the developing nations. The shift of the power center from the western countries to the Asia sub –continent is yet another reason of vital concern for us. FDI incentives, removal of restrictions, bilateral and regional investment agreements among the Asian countries and emergence of Asia as an economic powerhouse (with China and India emerging as the two most promising economies of the world) urbanized new economics in the world of industrialized nations. Foreign Direct Investment plays an astonishing and emergent character in worldwide business. It can provide a firm with new markets and marketing channels, cheaper production facilities 1 way in to up-to-the-minute technology, products, skills and financing. For a host country or the foreign firm which receives the investment, it can provide a source of new technologies, capital, processes, products, organizational technologies and management skills and as such can provide a strong impulsion to the economic development. FDI, in its traditional definition is defined as a company from one country making a corporeal investment into building a factory in another country. The direct investments in buildings, machinery and equipment are in contrast with making a portfolio investment, which is considered an indirect investment. In recent years, given swift economic growth and alter in global investment patterns, the definition has been broadened to include the acquisition of a lasting management interest in a company or enterprise outside the inventing firms‟ home country. As such, it may take many forms, such as a direct acquisition of a foreign firm, construction of a facility, or investment in a joint venture or strategic alliance with a local firm with attendant input of technology, licensing of intellectual property. In the past decade, FDI has come to play a major role in the internationalization of business. Reacting to changes in technology, mounting liberalization of the national regulatory framework governing investment in enterprises, and changes in capital markets profound changes have occurred in the size, scope and methods of FDI. New information technology systems, decline in global communication costs have made management of foreign investments far easier than in the past. The sea change in trade and investment policies and the regulatory environment globally in the past decade, including trade policy and tariff liberalization, easing of restrictions on foreign investment and acquisition in many nations, and the deregulation and privatization of many industries, has probably been the most momentous catalyst for FDI‟s expanded role. The most profound effect has been seen in the developing countries, where yearly FDI flows have increased from an average of less than $ 10 billion in the 1970s to a yearly average of less than $20 billion in the 1980s, to explode in the 1990s from $26.7 billion in 1990 to $ 179 billion in 1998 and $ 208 billion in 1999 and now comprise a large proportion of global FDI. Driven by mergers and acquisitions and the internationalization of production in a range of industries, FDI into developed countries last year rose to $ 636 billion, from $ 481 billion in 1998 [ from UNCTAD]. The proponents of foreign investment point out that the exchange of investment flows benefits both the home country [the country from which the investment originates] and the host country (the destination of the investment). Opponents of FDI note that multinational conglomerates are able to wield great power over smaller and weaker 2 economies and can drive out a great deal local competition. The reality lies someplace at the focal point. For diminutive and medium sized companies, FDI represents an opportunity to become more dynamically involved in the international business activities. In the past 15 years, the classic definition of FDI as noted above has changed substantially. This notion of a change in the classic definition, however, must be kept in the appropriate context. Very eloquently, over 2/3rd of foreign investment is still made in the form of fixtures, machinery, equipment and buildings. Moreover, larger multinational corporations and conglomerates still make the aweinspiring percentage of FDI. But with the advent of internet, the increasing role of technology, slackening off of direct investment restrictions in many markets and decreasing communication costs means that newer, non-traditional forms of investment will play an imperative role in the future. Many governments, particularly in the industrialized and developed nations, pay very close attention to FDI because the investment flows into and out of their economies can and does have a noteworthy impact. In the United States of America, the Bureau of Economic Analysis, a section of the U.S. Deptt. Of Commerce, is in charge for collecting economic data about the financial system including information about FDI flows. Monitoring this data is very helpful in trying to determine the impact of such investments on the overall economy, but is especially helpful in estimating industry segments. State and local governments watch closely because they want to follow their foreign investment attraction programmes for triumphant outcomes. Early studies on FDI traced its roots to the international trade theory and identified comparative advantage of the host countries as the most important determinant of FDI. This view successfully explained “resource-seeking”, FDI. However, since 1960s and 1970s the relative importance of this approach declined as it was unable to explain why countries chose FDI and not trade. Alternatively, market access was put forward as an explanation for FDI. The market imperfection hypothesis postulated that FDI is the direct result of an imperfect global market environment (Hymer 1976). This view successfully explained the “tariff jumping” FDI, which was most prevalent in the import-substituting industrialization wave of 1970s. However, with the rising integration of the world markets in the 1980s and 1990s there raised the need to explain FDI that occurred even with greater access to integrated markets. An alternative explanation came forth in the corresponding stream of thought that proposed internalization 3 theory (Rugman 1986). This theory explained FDI in terms of a need to internalize transaction costs so as to improve profitability and explained the emergence of “efficiency-seeking” FDI. However, the above theories were not able to explain why FDI chose to exploit relevant assets in some countries but not in others. In this regard, the eclectic approach to international production gave locational issues explicit importance by coalescing them with firm-specific advantages and transaction costs elements India has among the most liberal and transparent policies on FDI among the emerging economies. FDI up to 100% is allowed under the automatic route in all activities and sectors except the following which require prior approval of the Government: (a) Manufacture of cigars and cigarettes of tobacco and manufactured tobacco substitutes (b) Manufacture of electronic aerospace and defence equipments: all types (c) Manufacture of items exclusively reserved for small scale sector with more than 24% FDI (d) Proposals in which the foreign collaborator has an existing financial or technical collaboration in India and in the “same” field. (e) All proposals falling outside the notified sectoral policy/ caps. The FDI policy is reviewed on continued basis and changes in sectoral policy or sectoral equity cap are notified through Press Notes by the Secretariat for Industrial Assistance (SIA), Department of Industrial Policy and Promotion (DIPP). All Press Notes are available at DIPP website. FDI Policy is also notified by the Reserve Bank of India (RBI) under the Foreign Exchange Management Act, 1999 (FEMA). A number of studies in the recent past have illuminated the mounting efficiency of India as an investment destination. According to the study “Dreaming with BRICS” by Goldman Sachs, Indian economy is expected to continue growing at the rate of 5% or more till 2050. Some of these conclusions are listed below: a. 2nd most attractive destination- A. T. Kearney Business confidence Index, 2005 b. 2nd most attractive investment destination among TNCs- UNCTAD‟s „World Investment Report, 2005‟ c. Most attractive location for “off-shoring” of services activities- A. T. Kearney Global services Location Index, 2005. The extant policy does not permit FDI in the following cases: 4 a. Gambling and betting b. Lottery business c. Atomic energy d. Retail trading (except single branded product retailing) Moreover, 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: a. Amount invested by inward remittance or out of NRE/FCNR/NRO account maintained with Authorized Dealer (AD). b. The firm or proprietary concern is not engaged in any agricultural/plantation or real estate business i.e. dealing in land and immovable property with a view to earning profit or earning income there from. c. Amount invested shall not be eligible for repatriation outside India NRIs or PIO may invest in sole proprietorship concerns or partnership firms with repatriation benefits with the approval of Department of Economic Affairs, Govt. of India or RBI. Under the FDI policy, for promoting technological capability and competitiveness of the Indian industry, acquisition of foreign technology is encouraged through foreign technology collaboration agreements. Induction of know-how through such collaborations is permitted either through automatic route or with prior Government approval. Furthermore, a foreign company planning to set up business operations in India has the following options: 1) As an incorporated entity: by incorporating a company under the Companies Act, 1956 through a) Joint ventures; or b) Wholly owned subsidiaries Foreign equity in such Indian companies can be up to 100% depending on the requirements of the investor, subject to any equity caps prescribed in respect of the area of activities under the FDI policy. 2) As an unincorporated entity: As a foreign company through: 5 a) Liaison Office /Representative Office: its role 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 in conjunction with working under the existing Foreign trade Policy and also facilitate technical or financial collaboration between parent company and companies in India. They cannot undertake any commercial activity directly or indirectly and cannot therefore, earn any income in India. b) 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, after meeting the tax liabilities, on its completion. c) Branch Office: foreign companies engaged in manufacturing and trading activities abroad are allowed to set up Branch offices in India for, inter alia, the following purposes: i) Export/Import of goods ii) Carrying out research work, in which the parent company is engaged iii) Rendering professional or consultancy services iv) Foreign airline or shipping company Such offices can undertake activities permitted under the Foreign Exchange Management (Establishment in India of Branch Office of other place of Business) Regulations, 2000. In addition to this, for incorporation and registration, an application has to be filed with the 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. Under the FEMA, 1999, all foreign investments are freely repatriable, subject to sectoral policies and except for cases where NRIs choose to invest specifically under non-repatriable schemes. Dividends declared on foreign investments can be remitted freely through an Authorized Dealer. In addition to that, non-residents can sell shares on stock exchange without prior approval of RBI and repatriate through a bank the sale proceeds if they hold the 6 shares on repatriation basis and if they have necessary NOC or tax clearance certificate issued by Income tax authorities. The current account transactions are regulated under the Foreign Exchange Management (Current Account Transaction) Rules, 2000 [No. G. S. R. 381(E), dated 3.5.2000]. Prior approval of RBI is required for acquiring foreign currency above specified limits for, inter alia, the following purposes: a. Holiday travel over US$ 10,000 p.a. b. Gift/donation over US$ 5,000 or US$ 10,000 per beneficiary p.a. c. Business travel over US$ 25,000 per person d. Foreign studies as per estimate of the institution or US$ 100,000 per academic year. e. Architectural or consultancy services procured from abroad over US$1,000,000 per project. Under the FDI policy, the Foreign Institutional Investors (FIIs) registered with SEBI and NRIs are eligible to purchase shares and convertible debentures under the portfolio Investment Scheme. The FII should apply to the designated AD for opening a foreign currency account and/or a Non-Resident rupee account. Investment by FIIs is regulated under the SEBI (FII) Regulations, 1995 and Regulation 5 (2) of FEMA Notification No.20 dated 3rd May 2000. SEBI acts as the nodal point in the entire process of FII registration. FII include Asset Management Companies, Pension Funds, Mutual Funds, Investment Trusts as Nominee Companies, Incorporated or Institutional Portfolio Managers or their Power of Attorney holders, University Funds, Endowment Foundations, Charitable Trusts and Charitable Societies. FIIs are required to supply to SEBI in a common application form in duplicate. RBI approval is also required under FEMA to enable an FII to buy/sell securities on Stock Exchanges and open foreign currency and Indian Rupee accounts with a designated bank branch. Thus, apart from the financially viable brass tacks of the economy, which may magnetize FDI inflows, FDI policies of the host governments and investment agreements also play an imperative role. Within the national FDI policies adopted by the government, it is the removal of restrictions on the operations of foreign firms in the host country that matter the most, especially to FDI coming from the developed countries. Bilateral investment agreements that focus on the non-discrimination in the treatment of foreign firms lay specific standards of 7 investment protection and contain provisions for the settlement of disputes, have an important impact on FDI inflows. BITs and regional investment agreements can therefore form an important policy instrument for attracting FDI inflows into developing countries like India. 8