Foreign Direct Investment In The Sector

Published Date: 02 Nov 2017

Introduction

1.1 Background

Foreign Direct Investment (FDI) is an investment made by Multi-National Enterprises (MNEs) or by a non-resident in an enterprise of host (recipient) countries over which they have a control and earn private return. The most outstanding developments during the past few decades are the impressive growth of FDI in the global economic background. This extraordinary growth of global FDI during the period of 1990 made FDI a vital element of progress tactic in developed as well as developing nations. Therefore policies were formulated to encourage inward flows. In effect FDI offers a great lot of benefit to both host and home countries. It gives way for a win – win game, as on one side the home countries are interested in taking all advantage of global market resulted by industrial growth and on the other side the host countries are interested in getting a hold on technological and managerial proficiency and increase domestic savings and foreign exchange reserves. The developing countries accept FDI as solution to scarcities with respect to resources like capital, technology, entrepreneurship, finance, etc. More over it provides an access for these countries to the global market. Another reason for a sudden growth in FDI around the world is the integration of global financial market.

In an open economy, technology and trade, especially through exports and imports and thus promote economic growth (Grassman and Gelpman, 1997, Chapter 9; Frankel and Romer, 1999; Frankel, Romer, Cyrus, 1996). However, growth also has effects on trade (Rodriguez and Rodrik, 2000). In theory and from a Macroeconomic viewpoint FDI means elevated exports, entrance to international markets and international currencies. In this context FDI is a particular kind of capital flows across borders, from home country to host countries.

FDI can be categorized into two types: A) Horizontal and B) Vertical. When an industry replicates activity that’s based on home country and at the same value series phase in a host country via FDI then it’s called Horizontal FDI. For example "FIRM A" assembles AIRCRAFT in USA, and via Horizontal FDI, it does the same activity in different host countries like United Kingdom (UK), France, Australia. Hence Horizontal FDI refers to manufacturing / assembling the same products or providing the same kind of service in a host country as the firms perform in their home country.

When a firm via FDI moves upstream or downstream in various value chains it is said to be a Vertical FDI. In other words when firms carry out value-adding activities stage by stage in a vertical trend in a host country it is said to be performing Vertical FDI. It arises when a multinational firm parts the production process internationally, by placing each stage of production in the country where it can be prepared at the lowest cost. For example "COMPANY B"( US based digital products) only assembles MID’s and do not manufacture components in US, but in India it develops the software require for the respective devise and in China it manufactures the hardware components required for the devise, via FDI. This kind of model is called as "upstream vertical FDI". Another example can be if "COMPANY C" (China based Telecom Company) do not engage distribution of Mobile phones in China, instead, invests in Mobile phone dealerships in UAE, it can be stated that "COMPANY C" is performing "downstream vertical FDI".

An Overview

The economy of India has in recent years constantly recorded high growth rates and has become a striking destination for investments. A growing country like India has a vast amount of space for consumer as well as capital goods. For draw FDI inflow attention, advantages that country like India possess are political steadiness, stable and continued economic expansion, notably an enormous domestic market, access to skilled and scientific labor at cutthroat charges,. It is important to note that the developing countries had significantly eased restrictions on FDI inflows and operations of MNEs in the early 1980s. This trend became even more widespread during the 1990s, which brought a significant FDI inflow into the developing countries. In fact, developing countries received nearly 40 percent global PDI inf10ws in 1994-96 compared to 25 per cent in 1980-84 (United Nations Conference on Trade and Development, UNCTAD 1994). Foreign Direct Investment has achieved the position of worldwide significance for the reason that it is useful as an mechanism for worldwide economic integration. Investments from foreign countries are also attracted with benefits arising from trade agreements like ASEAN, with objectives of strengthening and enhancing trade, industry and investment teamwork amid the countries; increasingly slackening and encouraging deal in goods and services as well as generate an apparent, moderate and easy venture system; investigating innovative region and build up suitable procedures for more rapidly economic collaboration between the countries; and aid additional efficient economic assimilation of the latest ASEAN constituent States and link the progress gap amid the countries.

Commencing at the baseline fewer than USD 1 billion in 1990, a latest UNCTAD study anticipated India as the 2nd most significant Foreign Direct Investment target (after China) for international companies for the period 2010 to 2012. While reviewing the historical setup in India we are able to trace flow of FDI in India with the founding of East India Company of Britain. During the colonial period of British in India British capital arrived India. To the matter of fact these dates to early 1940’s and lack of data as well as its concerns of authenticity, most literatures are unable to reveal complete history of FDI flow into India during that period. Prior to independence the major source of FDI was British companies, however these companies had placed themselves in a way that benefits their own economy and business. However after independence, in view of nation’s interest, the Indian policy makers formulated the FDI policy that aims FDI as a means for obtaining tech. and to activate foreign exchange resources. During 1965 the industrial policy was formulated, that permitted Multi National Corporation’s to venture via technical cooperation in India. During the 2nd five year plan India faced two major crisis; 1) Foreign exchange 2) Financial resources mobilization. In this view govt. of India adopted a liberal attitude, by which it allowed role to foreign enterprises and also it accepted equity capital in tech. collaborations. While being liberal on policy side and providing many incentives like concession in tax and simplifying licensing procedures, the country attracted more FDI inflow. However in 1970 there was a strict measure adopted in policy as it came into notice of policy makers that huge amount of foreign reserves were flowing out of the country in the form of dividends, profits, etc. The govt. set up Foreign Exchange Board to control the flow of foreign capital. During 1980 the export performance of India was not on an impressive level and this in turn affected the nations BOP. In this context govt. allowed MNCs to operate in India, as well they introduced reform in industrial division, with the objective of increasing efficiency, competency, and growth. In 1973 sectors like banking, tel-com, govt. infrastructure, etc. were open to foreign and domestic investors.

In 1991, India liberalized its highly regulated FDI regime. Along with the virtual abolition of the industrial licensing system, controls over foreign trade and FDI were considerably relaxed. As a result of reforms the post reform period showed a considerable amount of increase in inflow of FDI to India (Chart 1.1). In other words moving from a restrictive regime to liberal one India has attracted significant amount of FDI in the following years. FDI was allowed without restraints in all sectors including the service sector. Only few of sectors where having the ceiling cap with respect to FDI. FIPB (Foreign Investment Promotion Board) was formed as a part of new foreign investment policy. It functioned as a single window system from the Prime Minister’s office, inviting and facilitating foreign investment.

Chart 1.1: Foreign direct investment, Trend in India during the period 1978-79 to 2010-11

Reformation period

Source: International Monetary Fund, Balance of Payments database, supplemented by data from the United Nations Conference on Trade and Development and official national sources.

However a fact to be noted is that some policies in India are not still in favor of FDI inflows, like delays in the approval of big-ticket investment proposals or the pursuit of ‘environmentally sensitive’ policies in denying forest clearances for projects in steel manufacturing and mining (FDI intelligence Oct 2011). The Cumulative FDI equity inflows has been recorded to Rs. 6,40,944 crore (1,46,319 Million US$) for the period August 1991 to March 2011(RBI Bulletin 2011). The sectors that attract major inflow of FDI in India are Service sector, Computer Software and Hardware, Telecommunications, Housing and Real Estate, Constructional Activities, Automobile industry, Power, Metallurgical Industries, Petroleum and Natural Gas and Chemicals.

Chart 1.2: FDI approved and realized during the period 1991 to 2007

Source: SIA Bulletin, Ministry of Commerce, Govt. of India.

The observation of data (Chart 1.2) indicates that these are a huge gap between FDI approved and realized. One possible reason for such difference could be the category or kind of investment projects involved. It is obvious that this flow of FDI has contributed to the growth of international trade in India. In 2011 China, India and Singapore attracted 57% of FDI projects in Asia-Pacific in 2011. India was the strongest performing country with a 21% growth in FDI projects in 2011. FDI inflows to South Asia have turned around. Inflows rose by 23 per cent to $39 billion in 2011 (2.6 per cent of global Foreign Direct Investments Inflows) subsequent to a go down during 2009 / 2010. The mending largely was result of the inflows of USD 32 billion to India, the leading Foreign Direct Investment beneficiary in South of Asia. However as per UNCTAD’s World Investment Report 2012, India’s FDI Attraction Index during 2011 is below prospects in contrast to the country’s Foreign Direct Investment Potential Index in the year 2011.

Sector Wise classification of Foreign Direct Investment in India

We will now discuss the sector wise classification of Foreign Direct Investment in India; this will give an insight on what sectors foreign investors can invest and to what extend these foreign investors are allowed to invest in India.

Foreign Direct Investment in the sector of Hotel & Tourism.

Via automatic route there is allowance of 100% Foreign Direct Investment in this specific sector of Hotel and Tourism. Point to be considered is expression hotels comprises of beach, restaurant tourist facilities offering accommodation and / or food facility to tourist, and resort. Tourism linked industry comprises of tourist agents/agencies, tour service agents/agencies and tourist conveyance service agencies, agencies offering facilities for wild life and culture activity to tourists. Transportation facility via Sea, road and flight to tourist. Vacation, amusement, sport, entertaining, and other tour related activity entity for visitors and organizations.

Automatic approval is given to foreign tech. agreements in the below cases.

Fee paid to tech. and consulting services that also includes charges for supervisors, designers, architect etc consist up to three percent of the cost of capital of the project.

The fee for marketing and franchising support need to be up to three percent of the net turnover ; The fee for management that includes fee charges for incentive need to be up to ten percent of gross profit.

Foreign Direct Investment in the sector of Banking:

Non-Banking Financial Companies (NBFC)

Based on periodical guide lines issued by Reserve Bank of India Foreign Direct Investment is allowed to the extent of forty nine per cent on automatic route from all sources.

Foreign Direct Investment / Non Residential Indian / Overseas Body Corporate investments allowed in the below mentioned Non Banking Financial Companies activity shall be as per levels indicated below:

Merchant banking / Underwriting / Portfolio Management Services / Investment Advisory Services / Financial Consultancy / Stock Broking / Asset Management / Venture Capital / Custodial Services / Factoring / Credit Reference Agencies / Credit rating Agencies / Leasing & Finance / Housing Finance / Foreign Exchange Brokering / Credit card business / Money changing Business / Micro Credit / Rural Credit.

Min. Capitalisation standard for fund based Non Banking Financial Companies:

1) USD 0.5 million is to be brought upfront in case of Foreign Direct Investment to 51%

2) USD5 million to be brought upfront in case of Foreign Direct Investment over 51% and to 75%

3) USD 7.5 million to be brought up front and USD 42.5 million to be brought in 2 years period of time in case of Foreign Direct Investment over 75% and up to 100%

Min, capitalisation standard 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.

    d.   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 b) (iii) above (without any restriction on number of operating subsidiaries without bringing in additional capital)

    e.  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. (b)(i) and (b)(ii) above.

   f.   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 in Insurance sector in India

FDI up to 26% in the Insurance sector is allowed on the automatic route subject to obtaining license from Insurance Regulatory & Development Authority (IRDA)

 Telecommunication: FDI in Telecommunication sector

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.

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.

No equity cap is applicable to manufacturing activities.

FDI up to 100% is allowed for the following activities in the telecom sector :

ISPs not providing gateways (both for satellite and submarine cables);

Infrastructure Providers providing dark fiber (IP Category 1);

Electronic Mail; and

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: FDI in Trading Companies in India

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:-

100% FDI is permitted in case of trading companies for the following activities:

exports;

bulk imports with ex-port/ex-bonded warehouse sales;

cash and carry wholesale trading;

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.

ii. The following kinds of trading are also permitted, subject to provisions of EXIM Policy:

Companies for providing after sales services (that is not trading per se)

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.

Trading of hi-tech items/items requiring specialized after sales service

Trading of items for social sector

Trading of hi-tech, medical and diagnostic items.

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.

Domestic sourcing of products for exports.

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: FDI in Power Sector in India

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.

Roads, Highways, Ports and Harbors

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 Centers 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:

Direct investment in industry, trade, infrastructure etc.

Up to 100% equity with full repatriation facility for capital and dividends in the following sectors:

34 High Priority Industry Groups

Export Trading Companies

Hotels and Tourism-related Projects

Hospitals, Diagnostic Centers

Shipping

Deep Sea Fishing

Oil Exploration

Power

Housing and Real Estate Development

Highways, Bridges and Ports

Sick Industrial Units

Industries Requiring Compulsory Licensing

Industries Reserved for Small Scale Sector 

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.

On non-repatriation basis: Up to 100% Equity in any Proprietary or Partnership engaged in Industrial, Commercial or Trading Activity.

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.

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.

Other Facilities: Income Tax is at a Flat Rate of 20% on Income arising from Shares or Debentures of an Indian Company.

Why is the study important?

Review of various literatures indicates that Foreign Direct Investment is an important driver for growth of economy as well as trade. It is also observed that economic growth induces FDI into the country; however to what degree these tend to affect or influence each other is to be estimated. The large amount of worldwide flow of FDI has provided and incentive for the study on this subject. Also the shift in economic growth in Asian countries (India and China moving towards strong world economies) is another reason for the study on this topic.

This study will analyze major determinants of FDI in India. From trading perspective an increase in exports will lead to an increase in FOREX reserves. This will further assist the nation in meeting its external demands. High level of FOREX is an indication of a positive economy and effective source for growth. Some studies suggests that there can be found no influence of FDI on exports of India, instead it is the fall in export price with relation to world prices that leads to rise in exports. However a point to be noted is that it was during July 1991 India opened its doors to private sector and liberalized its economy, this was the period of reformation of countries policies towards an open economy. This change brought effect in inflow of FDI as well as export growth. In this context it can be said that FDI has affected the growth of economy there by inducing export growth. In other words Foreign Direct Investment tends to indirectly affect trade in India after post reform period. The study will also be focusing on various major players in FDI investors in India. This will help in analyzing investors main objectives with relation to investments in India As to the variables that will be studied in this research, it is of important value that it can help predict future trends among the studied variables.. The study is intended to arrive with outcomes that would help policy makers, researchers etc. in further decision making, research respectively.

Study Review

2.1 Review Classification

The review of most literatures that focus on economies in relevance to their findings and hypothetical analysis states that FDI is essential for sustenance of trade and economic growth. The reviewed literature is classified as follows

Country based study

Study between Industries

2.2 Country based study

Various theories present controversial forecasts concerning the growth of effect on Foreign Direct Investment. Foreign investment is a source of sharing technology and knowledge to deprived countries (Romer1993) and the same may advance the productivity in all the sectors (Rappaport 2000). FDI is a composite multiple bunch of capital and knowledge which boosts the prevailing level of technology in recipient country (Balasubramanyam et al 1996; DE Mello (1999).

Chowdhury and Mavrotas (2005), found sturdy two way causality in Thailand and Malaysia and it is also found that causality runs from GDP to FDI for Chilian economy but not the reverse is true. Export growth helps in better employment of the resources; this in turn leads to total up rise in factor productivity.

There are many past studies which have emphasized the role of GDP growth, wage rate, trade rate, real interest rates, inflation, and stock of FDI, domestic investment in attracting FDI into a country. Burak Camurdan and Ismail Cevis (2009) develop an empirical framework to estimate the economic determinants of FDI inflows by employing a panel data set of 17 developing countries and transition economies for the period of 1989-2006. Seven independent variables were taken for this research namely, the previous period FDI, GDP growth, wage, trade rate, the real interest rates, inflation rate, and domestic investment. The results conclude that the previous period FDI is important as an economic determinant. Besides, it is also understood that the main determinants of FDI inflows are the inflation rate, the interest rate, the growth rate and the trade (openness) rate.

Hosein Elboiashi et al (2009) investigate the causal relationships between foreign direct investment (FDI), domestic investment (DI) and economic growth (GDP) in Egyptian, Moroccan and Tunisian economies. This paper applies a co integration time series techniques; vector error correction (VEC) model over the sample period for the period from1970 to 2006. They find a unidirectional causality between FDI and GDP in Egypt and Morocco, and bi-directional causality between FDI and GDP in Tunisia. Domestic investment has played a great role for driving FDI into these countries more than GDP. The study also shows that FDI is more effective than DI for promoting growth.

A study by Ana Marr (1997), reviews the evidence on the scale of FDI to low-income countries over the period 1970- 96 and major factors determining foreign companies’ decisions to invest in a particular country. The paper concludes that large market size, low labor costs and high returns in natural resources are amongst the major determinants in the decision to invest in these countries. China, as a major emerging market, has attracted significant flows of FDI, to become the second largest receipt.

Gazioglou S. and McCausland W.D.21 (2000), in their study "An International Economic Analysis of FDI and International Indebtedness" developed a micro – foundations framework of analysis of FDI and integrated it into a macro level analysis. They highlighted the importance of profit repatriation in generating different effects of FDI on net international debt, trade and real exchange rate in developed economies compared to less developed economies.

Salisu A. Afees56 (2004) in his study "The Determinants and Impact of Foreign Direct Investment on economic Growth in Developing Countries: A study of Nigeria" examines the determinants and impact of Foreign Direct Investment on economic Growth in Developing Countries using Nigeria as a case study. The study observed that inflation, debt burden, and exchange rate significantly influence FDI flows into Nigeria. The study suggests the government to pursue prudent fiscal and monetary policies that will be geared towards attracting more FDI and enhancing overall domestic productivity, ensure improvements in infrastructural facilities and to put a stop to the incessant social unrest in the country. The study concluded that the contribution of FDI to economic growth in Nigeria was very low even though it was perceived to be a significant factor influencing the level of economic growth in Nigeria.

Rabin Hattari* and Ramkishen s. Rajan (2008) in their study "Trends and drivers of bilateral FDI flows in developing Asia" investigated trends, patterns and drivers of intra-Asian FDI flows using bilateral FDI flows involving 15 developing Asian countries for the period 1990 to 2005. In other words, the primary contribution of this paper is that it one of the first -- if not the first -- to examine the magnitudes and determinants of FDI flows from developing Asian sources to other developing Asian hosts. The data from their study indicated around 35 percent of FDI flows to developing Asia between 1990 and 2005 has come from within the region, with three-quarters of the flows originating from Hong Kong, China, Singapore and Taiwan. Clearly some of these flows are overstated as they involve recycling or round-tripping of funds (especially between China and Hong Kong). Against this, trans-shipping from offshore financial centers have not been included, implying a degree of understating..

Dilek Aykut (2007) In his study "Emerging Trends in FDI flows to Asia" One of the major factors that led to the rise in FDI in services sector is the considerable progress in their investment and trade policies, opening up the services sector to foreign participation and provoking a significant shift in the composition of FDI towards services. He concluded that as a result of technological progress and policy reforms both in developed and developing countries, FDI flows have evolved in terms of its mode, the sectors it goes to and in terms of who is investing over the years.

2.2 Industry based study

Shaukat Ali and Wei Guo (2005) briefly examine the literature on FDI and focuses on likely determinants of FDI in China. They analyze responses from 22 firms operating in China on what they see as the important motivations for them to undertake FDI. Results show that market size (in terms of GDP) is a major factor for FDI especially for the United States firms. For local, export-orientated, Asian firms, low labor costs are the main factor.

Park Jongsoo (2004) conducted a study on "Korean Perspective on FDI in India: Hyundai Motors’ Industrial Cluster" indicates that industrial clusters are playing an important role in economic activity. The key to promoting FDI inflows into India may lie in industries and products that are technology – intensive and have economies of scale and significant domestic content.

Sarma EAS (2005) in his paper ‘Need for Caution in Retail FDI" examines the constraints faced by traditional retailers in the supply chain and give an emphasis on establishment of a package of safety nets as Thailand has done. India should also draw lessons from restrictions placed on the expansion of organized retailing, in terms of sourcing, capital requirement, zoning etc, in other Asian countries. The article comments on the retail FDI report that as commissioned by the Department of Consumer Affairs and suggests the need for a more comprehensive study.

Gonzalez J.G (1988) in his study "Effect of Foreign Direct Investment in the presence of sector specific unemployment" extends the work done by Srinivasan (1983) "International factor movements, commodity trade and commercial policy in a specific factor model", by making an analysis of the welfare effects of foreign investment. The study shows that if there are no distortions, foreign investment enhances the social uplift of the people.

Sharma Rajesh Kumar (2006) in his article "FDI in Higher Education: Official Vision Needs Corrections", examines the issues and financial compulsions presented in the consultation paper prepared by the Commerce Ministry, which is marked by Shoddy arguments, perverse logic and forced conclusions. This article raises four issues which need critical attention: the objectives of higher education, its contextual relevance, the prevailing financial situation and the viability of alternatives to FDI. The conclusion of the article is that higher education needs long – term objectives and a broad vision in tune with the projected future of the country and the world. Higher education will require an investment of Rs. 20,000 to 25,000 crore over the next five or more years to expand capacity and improve access. For such a huge amount the paper argues, we can look to FDI.

To sum up, it can be said that industrial clusters are playing a significant role in attracting FDI at Inter – industry level. It is argued that industries and products that are technology – intensive and have economies of scale and significant domestic content attract FDI at industrial level.

TRENDS IN FDI INFLOW

3.1 INTRODUCTION

FDI contributes to export growth, productivity growth and finance for balance of payments; it supports increase in national income. An outstanding element of current globalized economies in the world is the exponential growth of FDI in developed, as well as developing nations. In comparison to other economic activities in recent years FDI has shown considerable amount of growth than any of the other activities. FDI is also considered to be one of the safest means of finance, as it supports growth, increases competition and also acts as long term financial source.

Being 3rd largest economy of the world in terms of PPP and Having an advantage of technical skills, human and natural resources, English speaking population and growing middle class market of more than 300 million, India have achieved its position to top 2nd position among world destinations in receiving FDI (UNCTAD, 2012). The Indian economy recovered from the slowdown at the time of the global financial crisis with strong GDP growth, in particular over the first half of FY2010-11.Despite political uncertainty, bureaucratic hassles, shortages of power and infrastructural deficiencies, foreign investors still consider India as a favorable destination for Investment.

India’s financial steadiness in the present situation of financial unrest and a possible unraveling of overall disparities sends clear message to the potential foreign investors about India's stand as an expanding investment destination. India's external sector has presented extensive potency and pliability since the reforms in 199. The country process solid macroeconomic fundamentals, one of the results economic reforms process aimed at opening up the economy and acceptance of globalization, has led to remarkable increase in FDI inflows into India.

Indian Government has permitted access to FDI through automatic route, except for a small negative list. Time to time there has been revision in liberalization of the FDI. This chapter will cover the trends and patterns of Foreign Direct Investment (Inflow) in the World, Asian and Indian economy during past few decades.

3.2 TRENDS OF FDI FLOW IN THE WORLD

Global foreign direct investment (FDI) flows exceeded the pre-crisis average in 2011, reaching $1.5 trillion despite turmoil in the global economy (UNCTAD, WIR 2012). As per WIR of UNCTAD the FDI growth in 2012 is to be on a slower phase, with flows leveling off at about $1.6 trillion (Chart3.1). Even though there continues negative affects of the global financial crisis of 2008-2009, the global Foreign Direct Investment inflow increased by 16% in 2011, this exceeded the inflow level achieved during the pre-crisis period of 2005-2007.

Chart 3.1 Global FDI flows, 2002–2011, and projection, 2012–2014(Billions of dollars)

Source: UNCTAD, World Investment Report 2012.

In the past two decades the economy the economy has undergone various changes in terms of globalization, widening of domestic market, cheaper resources, low labor cost, technological advancements, etc. This change has brought great lot of effect in inflow of FDI towards the developing economies. Chart 3.2 indicates that the developing economies have captured a great share and have a considerable level of increase in percentage share of FDI absorption in a global scale. As per statistical data compiled from various issues of WIR (UNCTAD) we can see that developing economies share of total FDI inflow in global scale increased from 34.22% in 1995to 44.90% in 2011.

Chart 3.2 Percentage wise share of World FDI among Developing and Developed countries.

Source: World Investment Report (UNCTAD), various issues.

Table 3.1: World FDI share of Developed and Developing Countries from 1989-2011 (Billions of dollars)

Years / Countries

World FDI

Developed Countries share in world FDI

Developed Countries % share in world FDI

Developing Countries

share in world FDI

Developing Countries

% share in world FDI

1989-1994

(Annual average)

200.10

137.10

68.52

59.60

29.79

1995

331.10

203.50

61.46

113.30

34.22

1996

384.90

219.70

57.08

152.50

39.62

1997

477.90

271.40

56.79

187.40

39.21

1998

690.90

472.50

68.39

194.10

28.09

1999

1086.80

828.40

76.22

231.90

21.34

2000

1388.00

1108.00

79.83

252.50

18.19

2001

817.60

571.50

69.90

219.70

26.87

2002

678.80

489.90

72.17

157.60

23.22

2003

565.20

361.30

63.92

184.00

32.55

2004

734.90

414.20

56.36

290.40

39.52

2005

973.30

613.10

62.99

329.30

33.83

2006

1461.10

972.80

66.58

433.80

29.69

2007

1978.80

1358.60

68.66

529.30

26.75

2008

1697.40

962.30

56.69

620.70

36.57

2009

1197.80

606.20

50.61

519.20

43.35

2010

1309.00

618.60

47.26

616.70

47.11

2011

1524.40

747.90

49.06

684.40

44.90

Source: World Investment Report (UNCTAD), various issues.

During the period from 1998 to 2003 we can see a downfall trend in inflow of FDI among world developing countries; however this was on a recovery level during the year 2006. From chart 3.2 and Table 3.1 it is clearly visible that there is a sharp and consistent rise in FDI inflow to developed countries, also we can see that the FDI inflow towards the developed countries has reduced sharply during the periods 2008, 2009, 2010 and 2011 respectively.

Chart3.3: Total FDI Flow in India during the period 2000-01 FY to 2010-11 FY

US$ million

Sources: RBI‟s Bulletin May 2012 dt. 10.05.2012 (Table No. 44 – FOREIGN INVESTMENT INFLOWS).

India has shown a steady patter of FDI inflow during the period 2000 to 2009 (Chart 3.3). During FY 2006-07 India market a record growth of 146% in terms of FDI flows. A possible reason for downward trend in inflows of Foreign Direct Investment after 2009 could be the after effect of economic meltdown of 2008. From table 3.1 it is clearly visible that during the period of 2006 developing countries share in world inflow of FDI was on a diminishing trend, in spite of this India managed to have a record growth rate in the same period. This clearly indicates India’s position in attracting FDI inflows among developing countries as well as on a global scale.

3.2.1 TOP GLOBAL DESTINATIONS FOR FDI

China, with its Infrastructural facilities, less bureaucratic structure and conducive business environment, has managed to be top in the chart of major emerging destination of global FDI inflows. In the early half of 2012 China has surpassed the US for the first time since 2003 as the world’s largest recipient of Foreign Direct Investment. This indicates that global investors are still having positive expectation from Chinese economy. In view of early indications UNCTAD forecasts FDI flows to the US might be stronger in the second half of 2012. During 2012 first half there was also indication of developing economies absorbing half of global FDI.

Chart 3.4: Top priority host economies for FDI for the 2010-2012 period

Source: UNCTAD survey.

Other than China and US the most attractive destinations for Foreign Direct Investment are India, Brazil, Russia, Indonesia, Germany, Australia, Mexico, Canada, and UK. As per the United Nations Conference on Trade and Development (UNCTAD) WRI for 2012, India is the third most desirable destination after China and US for Foreign Direct Investment by global industrial giants. In a survey of 179 top global firms around the world conducted by United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP), India ranked as third favorable destination for investors plan for investing during the period from 2012 to 2014. Compared to 2010 FDI inflows in India went up to 32 billion USD in 2012. This accounts for 33 percent of growth in the respective year, indicating the potential of the country.

Chart 3.5: TNCs’ top 10 prospective host economies for 2012–2014. (Percentage of respondents selecting economy as a top destination)

Source: UNCTAD, World Investment Report 2012.

India’s share of FDI has shown an increase in the past two decades, however compared to emerging economies it is still at the bottom line in absorbing FDI (Chart 3.6).

Chart 3.6: Percentage share of World FDI inflow among top FDI attracting countries from 1994-2011

Source: OECD International direct investment database, Eurostat, IMF.

The reason could be bureaucratic hurdles, infrastructural problems, business environment, or government stability.

3.3 TRENDS OF FDI FLOW IN ASIA

Among Asian countries China mainland and Hong Kong are the two giants with highest magnitude of Foreign Direct Investment inflows and outflows. As per UNCTAD 2012 overview rising FDI to developing countries was driven by a 10 per cent increase in Asia and a 16 per cent increase in Latin America and the Caribbean. The report suggests that the growth in Asian countries for FDI will be on a temperate scale.

Table 3.2: Summary of econometric results of medium-term baseline scenarios of FDI flows (Billions of dollars)

Averages

Projections

Host region

2005–2007

2009–2011

2009

2010

2011

2012

2013

2014

Global FDI flows

1473

1344

1198

1309

1524

1495–1695

1630–1925

1700–2110

Developing countries

443

607

519

617

684

670–760

720–855

755–930

Africa

40

46

53

43

43

55–65

70–85

75–100

Latin America and the

Caribbean

116

185

149

187

217

195–225

215–265

200–250

Asia

286

374

315

384

423

420–470

440–520

460–570

Source: UNCTAD, World Investment Report 2012.

In the developing regions of East Asia and South-East Asia, FDI inflows reached new records, with total inflows amounting to $336 billion, accounting for 22 per cent of global inflows. South-East Asia, with inflows of $117 billion, up 26 per cent, continued to experience faster FDI growth than East Asia, although the latter was still dominant at $219 billion, up 9 per cent. Four economies of the Association of Southeast Asian Nations (ASEAN) – Brunei Darussalam, Indonesia, Malaysia and Singapore – saw a considerable rise (UNCTAD, 2012). Projections for coming years (Table 3.2) for the Asian region show considerable increase in FDI inflows.

FDI inflows to West Asia declined for the third consecutive year, to $49 billion in 2011. Inflows to the Gulf Cooperation Council (GCC) countries continued to suffer from the effects of the cancellation of large-scale investment projects, especially in construction, when project finance dried up in the wake of the global financial crisis, and were further affected by the unrest across the region during 2011. As a result of rising Foreign Direct Investments India, the inflows to South Asia have turned around after slip during 2009-2010. Reaching around 39 billion USD India accounted for more than fifths of the regions FDI’s.

Table 3.3: Doing business indicators 2012 (India)

INDIA

Ease of doing business (rank)

132

Starting a business (rank)

166

Procedures (number)

12

Time (days)

29

Cost (% of income per capita)

46.8

Minimum capital (% of income per capita)

149.6

Dealing with construction permits (rank)

181

Getting credit (rank)

40

Getting electricity (rank)

98

Registering property (rank)

97

Trading across borders (rank)

109

Cost to export (US$ per container)

1,095

Cost to import (US$ per container)

1,070

Protecting investors (rank)

46

Paying taxes (rank)

147

Source: INF (International Finance Corporation) the World Bank Group 2012.

As per "Doing Business,2012" by the World Bank Group China stands at rank 91 compared to India at rank 132 in ease of doing business. This attracts flow of FDI towards the higher ranked countries compared to other countries. A possible reason for this in Indian could be:

High trade transaction cost

Deficiency in infrastructure

Late opening of India’s doors (1991) to foreign investment compared to China (1978).

India however has made its presence in the east Asia region by entering into Comprehensive Economic Cooperation Agreement (CECA) with Singapore, Free Trade Agreements (FTAs) with Singapore, Thailand and Malaysia. The Foreign Trade Agreement is aimed at achieving new heights in the coming years. As a result of CECA and FTA with Singapore, it has emerged as one of the biggest investing countries in India.

3.4 Trends of FDI in India

The economy of India is the tenth largest in the world by nominal GDP and the third largest by purchasing power parity (PPP). The country is one of the G-20 major economies and a member of BRICS. On a per capita income basis, India ranked 140th by nominal GDP and 129th by GDP (PPP) in 2011(IMF)

3.4.1 Pre-liberalization period (1947–1991)

Indian economic policy after independence was influenced by the colonial experience, which was seen by Indian leaders as exploitative, and by those leaders' exposure to British social democracy as well as the progress achieved by the planned economy of the Soviet Union. Domestic policy tended towards protectionism, with a strong emphasis on import substitution industrialization, economic interventionism, a large public sector, business regulation, and central planning,[54] while trade and foreign investment policies were relatively liberal. Five-Year Plans of India resembled central planning in the Soviet Union. Steel, mining, machine tools, telecommunications, insurance, and power plants, among other industries, were effectively nationalized in the mid-1950s.

3.4.2 Post-liberalization period (since 1991)

GDP of India has risen rapidly since 1991. In the late 1970s, the government led by Morarji Desai eased restrictions on capacity expansion for incumbent companies; removed price controls, reduced corporate taxes and promoted the creation of small scale industries in large numbers. However, the subsequent government policy of Fabian socialism hampered the benefits of the economy, leading to high fiscal deficits and a worsening current account. The collapse of the Soviet Union, which was India's major trading partner, and the Gulf War, which caused a spike in oil prices, resulted in a major balance-of-payments crisis for India, which found itself facing the prospect of defaulting on its loans. India asked for a $1.8 billion bailout loan from the International Monetary Fund (IMF), which in return demanded reforms.

In response, Prime Minister Narasimha Rao, along with his finance minister Manmohan Singh, initiated the economic liberalization of 1991. The reforms did away with the License Raj, reduced tariffs and interest rates and ended many public monopolies, allowing automatic approval of foreign direct investment in many sectors. Since then, the overall thrust of liberalization has remained the same, although no government has tried to take on powerful lobbies such as trade unions and farmers, on contentious issues such as reforming labor laws and reducing agricultural subsidies.

3.4.3 Impact of reforms

The impact of these reforms may be gauged from the fact that total foreign investment (including foreign direct investment, portfolio investment, and investment raised on international capital markets) in India grew from a minuscule US$132 million in 1991–92 to $5.3 billion in 1995–96. Cities like Chennai, Bangalore, Hyderabad, NOIDA, Gurgaon, Gaziabad, Pune, Jaipur, Indore and Ahmedabad have risen in prominence and economic importance; become centers of rising industries and destination for foreign investment and firms.

3.5 Foreign direct investment in India:

Regulatory reforms were undertaken in India in the early 1990s to encourage FDI inflows to the country. Foreign investment in India is allowed through joint ventures, preferential allotments, capital markets, and financial collaborations. There is a positive link between FDI and India’s growth story. India has been observing a consistent growth in net FDI flow.

The total amount of foreign direct investment in India came to around US$ 4,222 million in 2001- 2002 and the next year, this figure stood at US$ 3,134 million. The advantages of foreign direct investment in India are that it has led to transfer of technology, generation of new opportunities for employment, and infrastructure development. India’s 83% of cumulative FDI is contributed by nine countries while remaining 17 per cent by rest of the world. Country-wise, FDI inflows to India are dominated by Mauritius (44 percent), followed by the Singapore (9 per cent), United States (8 percent) and UK (4 percent) [Government of India (GOI) (2009). FDI Statistics, Ministry of Commerce & Industry, Department of Industrial Policy and Promotion]. Countries like Singapore, USA, and UK etc. invest in India mainly in service, power, telecommunication, fuels, electric equipments, food processing sector.

Countries sending FDI to India:

Mauritius / U.K / U.S.A / Sweden / France / Switzerland / Malaysia / Singapore / Japan / Germany / Netherlands

Sectors in India attracting FDI from foreign countries:

Telecommunications that includes services of cellular mobile, radio paging, and basic telephone

Chemicals

Metallurgical industries

Food processing industries

Transportation industry

Pharmaceuticals and drugs

Fuels

Electrical equipments that includes electronics and computer software

Services sector that includes non- financial and financial

Gypsum and cement products

Amount of FDI inflows from top investing countries in India (1991 to 2002):

FDI from Mauritius US$ 6,811.1 million

FDI from Japan US$ 1,254.8 million

FDI from U.S.A US$ 3,194.6 million

FDI from Germany US$ 3,603.94 million

FDI from Netherlands US$ 3,251.65 million

FDI from Singapore US$ 1,648.22 million

FDI from France US$ 1,995.79 million

FDI from U.K US$ 3,768.77 million

4. Analysis of data

4.1 Variables explained

FDIINF: Foreign direct investment, net inflows (BoP, current US$)

Foreign direct investment are the net inflows of investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy other than that of the investor. It is the sum of equity capital, reinvestment of earnings, other long-term capital, and short-term capital as shown in the balance of payments. This series represents net inflows (new investment inflows less disinvestment) in the reporting economy from foreign investors. Data are in current U.S. dollars.

GDP: Gross Domestic Product (current US$)

GDP at purchaser's prices is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products. It is calculated without making deductions for depreciation of fabricated assets or for depletion and degradation of natural resources. Data are in current U.S. dollars. Dollar figures for GDP are converted from domestic currencies using single year official exchange rates.

TDOP: Trade Openness

Trade Openness refers to the degrees to which countries or economies permit or have trade with other countries or economies. It is calculated as export plus import as percentage of GDP.

Trade openness = ((Export + Import) x 100) / Gross Domestic Product

Export : Exports of goods and services (BoP, current US$)

Exports of goods and services comprise all transactions between residents of a country and the rest of the world involving a change of ownership from residents to nonresidents of general merchandise, goods sent for processing and repairs, nonmonetary gold, and services. Data are in current U.S. dollars.

Import: Imports of goods and services (BoP, current US$)

Imports of goods and services comprise all transactions between residents of a country and the rest of the world involving a change of ownership from nonresidents to residents of general merchandise, goods sent for processing and repairs, nonmonetary gold, and services. Data are in current U.S. dollars.

5. Analysis & Findings

From the above results it is clearly visible that Trade openness has a positive influence on GDP. However GDP and Trade openness shows no influence on FDI. In this view the study followed the direction of why or what was affecting FDI inflow (that on a theoretical basis need to be influenced by GDP and Trade openness). The answer to this question is found perhaps by studying who is investing to India.

5.1 Who is investing to India and why?

In the year 2010 Foreign Direct Investment from Mauritius, regard as tax heaven, has been more than $50 billion. This actually accounts for around 42% of the total FDI inflow into the country. Why and how such a small nation with a lower economy can invest such huge funds into a developing nation is a question of concern.

Source: Accumulated data from RBI’s annual report

Source: Reserve Bank of India Annual report dated 25/08/2011

It is for certain that Mauritius with such a small economy cannot be the source for such huge investment, the key to this question lies in the Global Business License companies incorporated in Mauritius and which will have been the medium for all these investments and also in provisions of bilateral agreement, between India and the Mauritius, Double Taxation Avoidance Agreement (DTAA). India and Mauritius entered into a double taxation avoidance agreement (Mauritius Treaty) in April 1, 1983 with the objective of avoidance of double taxation and the prevention of fiscal evasion. A large number of foreign institutional investors who trade on the Indian stock markets operate from Mauritius and the second being Singapore. According to the tax treaty between India and Mauritius, capital gains arising from the sale of shares are taxable in the country of residence of the shareholder and not in the country of residence of the company whose shares have been sold. Therefore, a company resident in Mauritius selling shares of an Indian company will not pay tax in India. Since there is no capital gains tax in Mauritius, the gain will escape tax altogether. It is estimated that the government may be losing Rs 2,000 crore per annum because of the Double Taxation Avoidance Agreement. It is also reported that Indian residents using Mauritius for "round tripping" funds back into India, tax avoidance and money laundering. Of the total USD 121.26 billion FDI that has come between April 2000 and August 2010, Mauritius accounted for USD 50.16 billion, according to the official data. Though India has a DTAA with about 75 countries like the US, UK, Japan, France, and Germany, it is Mauritius which is the most preferred route for FDI inflows because of low or zero corporate tax.

5.2 One Cathedral Square, the Main Source of FDI for India.

It is the building, One Cathedral Square, the heart of the capital of Mauritius, which is the main source of foreign direct investment into India. The 12-storey building is of a crucial importance for the Great Peninsula, as it is responsible for 40% of the flow of foreign direct investment (FDI) into India. Several companies dealing with India are indeed located in this building in the rue Jules Koenig. Among TMI Ltd, which has its headquarters on the sixth level One Cathedral Square. It is through this firm qu'Axiata Group Bhd took uneparticipation in Idea Cellular. Transaction amount, over Rs 1 billion. The investment TMI Mauritius is part of a large flow of capital between the months of April 2000 to January 2011, and is the head of the Top Ten ranking FDI Equity Inflow, Department of Policy and Industrial Promotion in India. Oracle Mauritius company which is the second largest provider of FDI in India, is located on the fifth floor of the building. Note that the One Cathedral Square is also home to the Board of Investment (BoI) and the Registrar of Companies. Other companies that have their offices in the building and dealing with India Blackstone Capital Partners, Blackstone FP Capital Partners. But GPV. Intel Capital, part of the venture capital firms most active and provide seed money for startups is also in the same building.

5.3 Mauritius top destination for Indian investments

Mauritius has emerged as favorite destination for overseas investment by Indian corporate, replacing Singapore, accounting for USD 2.27 billion outward FDI during April-February, 2012.

During 2008-09 and 2009-10, Singapore attracted the highest FDI from India, but in the following two years Mauritius becomes the top destination for such outflows from the country.

In 2010-11, Indian FDI into Mauritius stood at USD 5.08 billion as against USD 3.99 billion to Singapore. In 2008-09 and 2009-10, Indian FDI outflows to Singapore totaled USD 4.06 billion and USD 4.20 billion, respectively, while it was USD 2.08 billion and USD 2.15 billion in Mauritius, respectively. As per a RBI data, Indian investments in Mauritius has totaled USD 11.57 billion since 2008-09. Emergence of Mauritius as a top destination for Indian investments calls for suspicion of process of round tripping, where by Indian residents invest their funds in Mauritius and the same funds are rerouted to India.