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FDI in India

Introduction Most of the countries have been making use of foreign capital and foreign

technology to accelerate the pace of their economic growth. There is

hardly any advanced country the development of which was not assisted by foreign capital or technology. India being a developing country, technology transfer needs no emphasis. Foreign investment has long been a subject of interest. This is evident by

the rapid growth in the global foreign investment flows in the 1980s.

Types of Foreign Investment

There are two types of foreign investment, namely:
1. 2. Foreign direct investment (FDI) Portfolio investment (PI)

Advantages And Disadvantages Of FDI

Foreign Direct Investment is preferred to portfolio investment also because portfolio investment is more volatile and has lesser commitments. In the case of FDI, there is little risk involved for the host country, as the foreign investor has to bring in his capital and set up production or trading facilities in the host countries.

The major advantage of direct foreign investment over borrowings or portfolio investment is that the country in which the investment is made incurs no fixed charges. This possibility has led some countries to insist that foreigners who make direct investments within its borders put up the total cost of the investment in foreign exchange. Business enterprises normally expect a new venture to pave its way on a balanced proportion of equity and debt.

FDI in India
Foreign Direct Investment (FDI) is defined as an investment made by an investor of one country to acquire an asset in another country with the intent to manage that asset (IMF, 1993). The IMF definition of FDI includes as many as following elements: equity, capital, reinvested earning of foreign companies, intercompany debt transactions including short-term and long term loans, overseas commercial borrowings, non-cash acquisition of equity, investment made by foreign venture capital investors, earnings data of indirectly-held FDI enterprises, control premium, non-competition fee and so on. Foreign investment and technology play an important role in the economic

development of a nation and have been exploited by a number of developing


Theory of Comparitive Advantages and FDI

One of the eternal principles propounded by classical economies is Comparative Advantage, which is used to denote a nations advantage over others with respect to production technique, craftsman skills, physical resources and mode of transportation. According to David Ricardos principle of relative (or comparative) advantage, a country may be better than another country in producing many products but should only produce what it produces best. Essentially, it should concentrate on either a product with the greatest comparative advantage or a product with the least comparative disadvantage. Ricardo pointed out that nations possess different production endowments: Natural resources, labour, technology, management, capital, etc., which result in different relative production capabilities. Michael Porter has identified four major determinants of international competitiveness: (1) Factor conditions (i.e. factors of production) (2) Demand condition (3) Related and supporting industries (4) Firm strategy, structure a rivalry.

Indias FDI Policy

Flow of substantial foreign investment began in India in the 1980s. At that time Suzuki entered India with a joint venture with the Indian Government. The then prime minister Rajiv Gandhi initiated the reforms and allowed FDI in certain

cases and because of these liberal policies Pepsi was able to entered India.
Foreign direct investment is freely allowed in all sectors (except railways and atomic energy) including the services sector, except a few sectors where the existing and notified sectoral policy does not permit FDI beyond a ceiling. FDI for

virtually all items/activities can be brought in through the automatic route under powers delegated to the Reserve Bank of India (RBI), and for the remaining items/activities through, government approval. Government approvals are accorded on the recommendation of the Foreign Investment Promotion Board (FIPB).

Foreign Direct Investment

1. a. b. 2. 3. 4. 5. 6. 7. Automatic Routs New Ventures Existing Ventures Government Approval Issue and Valuation of Shares in Case of Existing Companies Foreign Investment in the Small Scale Sector Foreign Investment Policy for Trading Activities Other Modes of Foreign Direct Investments Preference Shares

Foreign Technology Agreements (FTA)

Foreign technology collaborations are permitted either through the automatic route under delegated powers exercised by the RBI, or by the government. FTAs are allowed either through the automatic route or through prior government approval. Automatic Route The Reserve Bank of India, through its regional offices, accords automatic approval to all industries for foreign technology collaboration agreements subject to (i) the lump sum payments not exceeding US $2 million; (ii) royalty payable being limited to 5% for domestic sales and 8% for exports, subject to a total payment of 8% on sales over a 10 year period Government Approval a. Proposals attracting compulsory licensing b. Items of manufacture reserved for the small-scale sector c. Proposals involving any previous joint venture or technology transfer/trademark agreement in the same or allied field in India.

100% Export Oriented Units/Export Zones/Special Economic Zones

Automatic Approval


The Development Commissioners (DCs) of Export Processing Zones (EPZs)/Free Trade Zones (FTZs) /Special Economic Zones (SEZs) accord automatic approval to projects where: Activity proposed does not attract compulsory licensing or falls in the services sector, except IT enabled services; Location is in conformity with the prescribed parameters;

Units undertake to achieve exports and value addition norms as prescribed in the Export and Import Policy in force;
Unit is amenable to bonding by customs authorities; and Unit has projected the minimum export turnover, as specified in the Handbook of Procedures for Export and Import, 2002-07.Cont.

Fdi Policy for 100% Eou/Epz Units All proposals for FDI/NRI/OCB investments in EOU/EPZ units qualify for

approval through the automatic route, subject to sectoral norms. Proposals not covered under the automatic route would be considered and approved by FIPB.
Fdi Policy for Units in Sez FDI upto 100% is allowed through the automatic route for all manufacturing activities in Special Economic Zones (SEZs), except if the activity proposed does not attract compulsory licensing or falls in the services sector. FDI limit for a few sectors is as follows (source: Banking: FDI cap in Private Sector Banking has been increased to 74% from 49%. Insurance: FDI of up to 26% in the insurance sector is allowed.

FDI in India
In the recent few years, the outlook of India as an investment destination has been growing. This is indicated by surveys of different consultancy groups on the outlook of different countries as a host to FDI, which are consistently upgrading the rank of India. In JBIC surveys India has moved up with its rank increasing from 7th in 1996 to

5th in 2001. India is ahead of countries like Vietnam, Taiwan, South Korea,
Malaysia and Singapore as promising destinations for FDI over the medium term but lagging behind countries such as China, US, Thailand, and Indonesia. In terms of Kearneys FDI confidence index, India is moving in the narrow range of

5th -7th position between 1998 and 20031 ( 1 Business Line (18.9.2003) India
moves up in Kearneys FDI Confidence Index)

present figures on FDI actual inflows of foreign direct investment from 1992-93-

2003-04. The actual flow shows fluctuating trends in different years. It an peaked at US $ 4700 million in 2002-03 and was its lowest at US $ 279.5 million in 199293. The trend shows an upward direction which is very significant for the country.
FDI Inflow in India (year wise )
Year 1992 -93 1993 -94 1994 -95 1995 -96 Amount in Million US $ 279.50 369.00 872.10 1418.00 Share of total Inflow 1.06 1.41 3.32 5.40

1996 -97
1997 -98 1998 -99 1999 -00

3560.00 2000.00 2160.00

13.56 7.62 8.23

2000 -01
2001 -02 2002 -03 2003 -04 Total

3900.00 4700.00 3570.00 26260.20

14.85 17.90 13.59 100.00

During the post liberalization period, Mauritius and the USA are the largest sources of FDI for India. Mauritius being the tax heaven companies route their

FDI through Mauritius. A part from Mauritius and USA, Japan U.K. and Netherland respectively were major contributors of FDI during 2002-03.
Country Mauritius USA Japan U.K. Netherland Germany France South Korea Singapore Switzerland Total Rs. in Crore 33820.73 15409.92 7430.64 6648.56 5969.43 4512.30. 2656.57 2489.66 2348.04 1842.79 83128.64 Share in Total Investment 40.68 18.54 8.94 7.80 7.18 5.43 3.20 2.99 2.82 2.22 100.00

Source: Economic Survey 2003-04

Determinants of FDI
Liberalization is not the sole reason to attract FDI. There are many other determinant of FDI, India may lagging there. As at Kearneys FDI Confidence Audit: India, February 2001 said India gains in attractiveness because of its market size and its potential is diminished by negative assessment of its regulatory environment. Other important determinant are rule of law, competitive wages, labour skill, infrastructure and well developed financial institutions . Determinants of FDI can be better understood by the Porters diamond model of international competitiveness, which has identified four major determinants: 1.
2. 3. 4.

Factor Conditions (i.e. factor of production)

Demand condition Related and supporting industries, Firm strategy, structure a rivalry.

Michael Porters International Competitiveness Model

Firm Strategy, Structure, & Rivalry

Factor Endowment

Local Demand Condition

Relating and Supporting Industries

Impact of FDI
FDI has a wide spread impact on an country not only economically but also socially. Foreign investment is always accompanied by superior technology and transfer of technical knows how. It has an impact on local industry as it provides them both opportunity and threat. It gives consumers a wide choice that too at

reasonable price. FDI increases not only GDP but also exports and therefore
results in higher per capita income and large forex reserves. Impact on Local Industry Impact on Employment Impact on Consumer

Entry Strategies for Foreign Investors

Starting Operations In India
A foreign company planning to set up business operations in India has the following options: AS AN INDIAN COMPANY: A foreign company can commence operations in India by incorporating a company under the Companies Act, 1956 through Joint Ventures; or Wholly Owned Subsidiaries

Joint Venture With An Indian Partner: Foreign Companies can set up their operations in India by forging strategic alliances with Indian partners. Liaison Office/Representative Office: Liaison office acts as a channel of communication between the principal place of business or head office and entities in India. Its role is limited to collecting information about possible market opportunities and providing information about the company and its products to Cont. prospective Indian customers.

Project Office: Foreign companies planning to execute specific projects in India can set up temporary project/site offices in India. Branch Office: Foreign companies engaged in manufacturing and trading activities abroad are allowed to set up branch offices in India. Branch Office on Stand Alone Basis: Such branch offices would be isolated and restricted to the Special Economic zone (SEZ) alone and no business activity/transaction will be allowed outside the SEZs in India, which include branches/subsidiaries of its parent office in India.

Total Foreign Investment, FDI and FII flows (net): 1995-96 to 2004-05


FDI Inflows
FDI Inflow s

94-95 95-96

586 1,314 2,144 3,557 2,462 2,155 2,339 1,653 0 1,000 2,000 3,000 4,000


96-97 97-98 98-99 99-00 00-01 2-Jan

Source: Economic Survey 2002

Industry-Wise FDI Inflows


Source: Economic Servey 2002