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CONTENT
Sr. No. PARTICULARS Page No.
1 Introduction 2
2 Need and Forms of Foreign Capital 4
3 Foreign Capital in India-Introduction 7
4 Foreign Capital in India-Historical sketch 9
5 Foreign Capital in India and World-Trends 13
6 India’s journey from license raj era to globalization 16
7 Determinants of Foreign Capital Inflow 17
8 Current regulation to manage Capital inflow in India 19
9 Benefits of Foreign Capital 22
10 Disadvantages of FDI 30
11 Case study 33
12 Make in India 34
13 Road ahead 35
14 Bibliography
INTRODUCTION:
In this 21st century globalization has made this planet as a global village and people of different
countries are getting closer and closer. Due to immense development of technologies investors of
different countries are looking forward to find business opportunities beyond the conventional
territory and as a result one of the most popular and highlighted terms in modern business-“FDI”
is evolving at a greater pace than ever before. Business and trade has become more competitive
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and diversified, traditional market is shrinking down at a faster pace and operators are looking
for options for expansion and international trade is getting accelerated. In this era of
globalization and intense competition, foreign direct investment (FDI) has become a very
common and immensely important phenomenon for consumers, producers and different
governments.
Foreign direct investment (FDI) refers to the net inflows of investment in an enterprise operating
in an economy other than that of the investor. It is the sum of equity capital, other long-term
capital and short term capital as shown in the balance of payments. It usually involves
participation in management, joint venture, transfer of technology and expertise.
Foreign capital has significant role for every national economy regardless of its level of
development. It helps in transferring of financial resources, technology and innovative and
improved management techniques along with raising productivity. For the developed countries it
is necessary to support sustainable development. For the developing countries, it is used to
increase accumulation and rate of investments to create conditions for more intensive economic
growth. For the transition countries, it is useful to carry out the reforms and cross to open
economy and to create conditions for stable and continuous growth of GDP as well as integration
in world.
Entities making direct investments typically have a significant degree of influence and control
over the company into which the investment is made. Open economies with skilled workforces
and good growth prospects tend to attract larger amounts of foreign direct investment than
closed, highly regulated economies.
The investing company may make its overseas investment in a number of ways - either by setting
up a subsidiary or associate company in the foreign country, by acquiring shares of an overseas
company, or through a merger or joint venture.
An example of foreign direct investment would be an American company taking a majority stake
in a company in China. Another example would be a Canadian company setting up a joint
venture to develop a mineral deposit in Chile.
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Over the past few decades emerging countries have become the major recipients of FDI as
MNCs have started expanding their business operations beyond their national borders to the
countries offering various advantages which they seek to exploit to gain. Foreign Direct
Investment (FDI) has appeared to be the most important source of external flow of resources to
the developing countries and has become an integral part of capital formation despite of their
small share in global distribution of FDI. While the large Multi National Corporations of the
West are getting advantages of market expansion from FDI, the host countries are also utilizing it
as a major mechanism and source for accelerating their domestic economic growth.
NEED AND FORMS OF FOREIGN CAPITAL:
Everywhere in the world, including the developed countries, governments are vying with each
other to attract foreign capital. The belief that foreign capital plays a constructive role in a
country’s economic development has become more stronger since mid-1980’s.The experience of
South East Asian countries has especially confirmed this belief and has led to a progressive
reduction in regulations and restraints that could have inhibited the inflow of foreign capital.
Need of Foreign capital:
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Prof. John P. Lewis, an American academic and presidential advisor who was a strong advocate
of aid to help build developing countries as a matter of foreign policy had pointed out “that
almost every developed country of the world in its developing stage had made the use of foreign
capital to make up deficiency of domestic savings”. In the seventeenth and eighteenth century
England borrowed from Holland and in the nineteenth and twentieth century England gave loans
to almost every other country. United State of America, today the wealthiest country of the
world, had borrowed heavily in the nineteenth century. The half century prior to the First World
War was a period uniquely favorable to the free movement of international capital. Even before
1914, certain changes were taking place in the character and in the industrial distribution of the
international capital movements. After the First World War US emerged as the prime lender and
the transformation of continental Europe from a substantial creditor into a substantial debtor.
Even by 1919, the US had invested $6.5 billion abroad, excluding the large war loans to the
allies. In the following decades, her foreign investments rose by US $8.3 billion-about two-thirds
of the world total investment raising America’s total capital stake in 1930 to US $15.7 billion.
By contrast, most European countries were forced to relinquish large quantities of their foreign
assets during the war; UK gave up 15% of hers, France over half of hers and Germany nearly the
whole. Since the war, a remarkable resurgence has taken place in the international capital
movements, the volume of which has risen much faster than that of world trade and industrial
production. The 1970s witnessed a remarkable boom of capital flows to emerging economies17.
The dramatic surge in international capital flows was triggered by the oil shock in 1973-1974,
the growth of the Eurodollar market and the remarkable increase in bank lending during 1979-
1981. Latin America was the main recipient of this heavy capital inflow, with capital flows to the
region peaking at US $44 billion in 1981. Overall, capital inflows to this region, which mostly
took the form of syndicated bank loans, reached about 6 per cent of the region’s gross domestic
product (GDP).
The need for foreign capital arises because of domestic capital inadequacy. In most developing
countries like India, domestic capital is inadequate for the purpose of economic growth. Foreign
capital is typically seen as a way of filling in gaps between the domestically available supplies of
savings, foreign exchange, government revenue and the planned investment necessary to achieve
developmental targets.
To give an example of this ‘savings-investment’ gap, let us suppose that planned rate of growth
output per annum is 7 percent and the capital-output ratio is 3 percent, then the rate of saving
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required is 21 percent. If the saving that can be domestically mobilized is 16 percent, there is a
shortfall or a savings gap of 5 percent. Thus the foremost contribution of foreign capital to
national development is its role in filling the resource gap between targeted investment and
locally mobilized savings. Foreign capital is needed to fill the gap between the targeted foreign
exchange requirements and those derived from net export earnings plus net public foreign aid.
This is generally called the foreign exchange or trade gap. An inflow of private foreign capital
helps in removing deficit in the balance of payments over time if the foreign-owned enterprise
can generate a net positive flow of export earnings.
Another gap that the foreign capital and specifically, foreign investment helps to fill is that
between governmental tax revenue and the locally raised taxes. By taxing the profits of the
foreign enterprises the governments of developing countries are able to mobilize funds for
projects (like energy, infrastructure) that are badly needed for economic development.
Foreign investment meets the gap in management, entrepreneurship, technology and skill. The
package of these much-needed resources is transferred to the local country through training
programmes and the process of learning by doing’. Further foreign companies bring with them
sophisticated technological knowledge about production processes while transferring modern
machinery equipment to the capital-poor developing countries.
In fact, in this era of globalization, there is a great belief that foreign capital transforms the
productive structures of the developing economics leading to high rates of growth. Besides the
above, foreign capital, by creating new productive assets, contributes to the generation of
employment a prime need of a country like India.
Forms of Foreign Capital:
Foreign Capital can be obtained in the form of foreign investment or non-concessional assistance
or concessional assistance.
1. Foreign Investment includes Foreign Direct Investment (FDI) and Foreign Portfolio
Investment (FPI). FPI includes the amounts raised by Indian corporate through Euro
Equities, Global Depository Receipts (GDR’s), and American Depository Receipts
(ADR’s).
2. Non-Concessional Assistance mainly includes External Commercial Borrowings
(ECB’s), loans from governments of other countries/multilateral agencies on market
terms and deposits obtained from Non-Resident Indians (NRIs).
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3. Concessional Assistance includes grants and loans obtained at low rates of interest with
long maturity periods. Such assistance is generally provided on a bilateral basis or
through multilateral agencies like the World Bank, International Monetary Fund (IMF),
and International Development Association (IDA) etc. Loans have to be repaid generally
in terms of foreign currency but in certain cases the donor may allow the recipient
country to repay in terms of its own currency. Grants do not carry any obligation of
repayment and are mostly made available to meet some temporary crisis. Foreign Aid can
also be received in terms of direct supplies of agricultural commodities or industrial raw
materials to overcome temporary shortages in the economy. Foreign Aid may also be
given in the form of technical assistance.
FOREIGN CAPITAL IN INDIA-INTRODUCTION:
India is believed to be a good investment destination among global investors despite challenging
hurdles like political uncertainty, bureaucratic hassles, shortages of power facilities, and
infrastructural deficiencies. At present, the country has a promising potential in terms of growth
and diversification possibilities. India offers a high growth potential in practically all areas of
business. It has slowly transformed itself from a highly protected, semi -socialist, autarkic
economy since post-independence period into a country which is smashing barriers and seeking
foreign investments.
The economic liberalization in India refers to ongoing economic reforms in India that started on
24 July 1991. After Independence in 1947, India adhered to socialist policies. Attempts were
made to liberalize economy in 1966 and 1985. The first attempt was reversed in 1967.
Thereafter, a stronger version of socialism was adopted. Second major attempt was in 1985 by
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Prime Minister Rajiv Gandhi. The process came to a halt in 1987, though 1966 style reversal did
not take place. In 1991, after India faced a balance of payments crisis, it had to pledge 20 tons of
gold to Union Bank of Switzerland and 47 tons to Bank of England as part of a bailout deal with
the International Monetary Fund (IMF). In addition, the IMF required India to undertake a series
of structural economic reforms. As a result of this requirement, the government of P. V.
Narasimha Rao and his finance minister Manmohan Singh (who later on became Prime Minister)
started breakthrough reforms, although they did not implement many of the reforms the IMF
wanted. The new neo-liberal policies included opening for international trade and investment,
deregulation, initiation of privatization, tax reforms, and inflation-controlling measures. The
overall direction of liberalization has since remained the same, irrespective of the ruling party,
although no party has yet tried to take on powerful lobbies such as the trade unions and farmers,
or contentious issues such as reforming labour laws and reducing agricultural subsidies. Thus,
unlike the reforms of 1966 and 1985 that were carried out by the majority Congress
governments, the reforms of 1991 carried out by a minority government proved sustainable.
The 1990s have seen a marked increase in private capital flows to India, a trend that represents a
clear break from the two decades before that. In the 1970s there was hardly any new foreign
investment in India: infact some firms left the country. Inflows of private capital remained
meagre in the 1980s: they averaged less than $0.2 billion per year from 1985 to 1990. In the
1990s, as part of wide ranging liberalization of the economy, fresh foreign investment was
invited in a range of industries. Inflows to India rose steadily through the 1990s, exceeding $6
billion in 1996-97. The fresh inflows were primarily as portfolio capital in the early years (that
is, diversified equity holdings not associated with managerial control), but increasingly, they
have come as foreign direct investment (equity investment associated with managerial control).
India was not unique as a recipient of increased inflows in the 1990s.International flows of
private capital to most developing countries rose sharply over this period. The historically low
interest rates in the US encouraged global investment funds to diversify their portfolios by
investing in emerging markets. International flows of direct investment, which had averaged
$142 billion per year over 1985-90, more than doubled to $350 billion in 1996, with the
developing countries receiving $130 billion. Host country policies did influence the choice of
location for this investment.
The problems of foreign investment in India have been an issue of outstanding importance ever
since the days of the East India Company and added significance after Indian Independence in
1947. In the 1950s and 1960s, the dominant form of foreign capital was foreign aid, mainly
through government to government transfer of resources. In the late 1960s and early 1970s,
foreign direct investment (FDI) came into prominence. The dominant form of foreign capital in
the 1970s was the foreign private loan (FPL). In the late 1970s there was hardly any new foreign
investment in India: indeed, some firms left the country. Inflows of private capital remained
meager in the 1980s: they averaged less than $0.2 billion per year from 1985 to 1990. In the
1990s, as part of wide ranging liberalization of the economy, fresh foreign investment was
invited in a range of industries. Inflows to India rose steadily through the 1990s.The fresh
inflows were primarily as portfolio capital in the early years (that is, diversified equity holdings
not associated with managerial control), but increasingly, they have come as foreign direct
investment (equity investment associated with managerial control).
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Though dampened by global financial crises after 1997, net direct investment flows to India
remain positive. Under the liberalized foreign exchange transactions regime, the results were
dramatic. The liberalization of portfolio investment led to a surge in inflow of capital for
investment in the primary and secondary market for Indian equity and corporate and
subsequently sovereign bond market.
FOREIGN CAPITAL IN INDIA-HISTORICAL SKETCH:
Indus Valley Civilization:
During Indus Valley Civilization Indian economy was very well developed. It had very good
trade relations with other parts of the world, which is evident from the coins of various
civilizations found at the site of Indus valley. Before the advent of East India Company, each
village Food Commodities in India was a self sufficient entity. Each village was economically
independent as all the economic needs were fulfilled with in the village. Cotton, grain, livestock,
and other food stuffs were the major commodities of internal trade. There was also external trade
with Central Asia, the Arabian Gulf region, and the distant Mesopotamian cities, such as Susa
and Ur. Trade also existed with Northern Afghanistan from where the Harappans bought the
famous blue gemstones, Lapis Lazuli.
Mauryan period-The Northern Silk route:
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Under Chandragupta, the Mauryan Empire conquered the trans -Indus region, which was under
Macedonian rule. Chandragupta then defeated the invasion led by Seleucus, a Greek general
from Alexander's army. Under Chandragupta and his successors, both internal and external trade,
and agriculture and economic activities, all thrived and expanded across India thanks to the
creation of a single and efficient system of finance, administration and security. After the
Kalinga War, the Empire experienced half a century of peace and security under Ashoka. India
was a prosperous and stable empire of great economic and military power whose political
influence and trade extended across Western and Central Asia and Europe. Mauryan India also
enjoyed an era of social harmony, religious transformation, and expansion of the sciences and of
knowledge. The Silk-Road is a unique example from history, of inter-continental cooperation
and collaboration not only in the field of trade and commerce but also in the realm of ideas and
culture. The Silk Road spanned a distance of almost 7000 miles from China through Central
Asia, northern India and Parthian Empire, to the Roman Empire during the period of 200 BC to
14 century AD circa. It connected the Yellow River valley in China to the Mediterranean Sea,
virtually connecting two continents, Asia and Europe, the east and the west. The German Baron
Ferdinand von Richthofen coined the term ―Silk Road in the 1870s to describe what was, at its
peak, one of the most important and dynamic centers of economic activity in the world, and the
greatest trade route linking East to West. It was more than just a single route; rather, it was a
river of connections stretching from south to north, and from East Asia to as far West as Europe,
Egypt and other countries in Africa.
Mughal Empire:
The political economy of the Mughal Empire and of the European trade with India clearly marks
out the age of Mughal rule as a distinct phase in the country's economic history. The centralized
authority created by the Mughals had manifold implication for the economic life of the Indian
people. The Mughals rendered possible a very substantial expansion in inter -regional trade,
anticipating the emergence of an integrated market. In course of time the trade contributed to an
undoubted increase in the absolute volume of India's exports and imports, stimulated Indian
participation in overseas commerce and induced some positive developments in the
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manufacturing section of the economy and affected the fortunes of the Indian merchants in
different ways by the patterns of competition and collaboration with the traders from abroad.
The nature of India‘s trade, inland and foreign, has practically been the same in the ancient and
medieval ages. During the medieval period t he whole of Northern and Western India had
commercial relations with West Asia and extending through it to the Mediterranean world, as
also to Central Asia, South-East Asia and China both oversea and overland routes.
Throughout the Mughal period, the volume of Indian export through the north-western land
routes continued fluctuating according to the atmosphere of amity or hostility prevailing between
India and Persia on the question of the possession of Qandahar and sometimes on the relations
between the Mughal government and the Portuguese.
British/French/Portuguese:
The period spanning a hundred and fifty years, between the death of the Mughal emperor
Aurangzeb in 1707 AD, and the Sepoy mutiny in 1857 witnessed the gradual increase of the
European influence in India. This was the time when the Europeans actually got involved in
trade and commerce. Prior to this period, Europeans did arrive in India from time to time but
these were no more than isolated incidents. All historians agree that the Portuguese explorer and
adventurer Vasco da Gama was the first known European to reach India in 1498. It is believed
that Gama had landed at Calicut (modern Kerala) in quest of spices and the famous Calico (fine
cotton) cloth. The other Portuguese nationals who accompanied him were motivated by either
missionary zeal or trading prospects. The Portuguese eventually settled down to a very
prosperous trade in spices with India. The Muslim rulers (including the Mughals) were averse to
the idea of a foreign power carrying on commercial activities on the high seas bordering India.
Although the erstwhile French ruler Louis XII had granted letters of monopoly to French traders
as early as 1611, it was only in 1667 that a French company was set up at Surat (Gujarat) with
Francis Caron as its Director-General. In 1669, another French company was set up in
Masulipatnam (Andhra Pradesh), after the then king of Golconda, exempted the French from
paying import and export duty.
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Post Independence:
The post independence period of economy of India was a litmus test for the economic planners.
Having come out of the shadow of colonial rule, the nation had a huge challenge of undoing the
exploitation of colonial era. The founding fathers had to use economic upliftment as a tool for
nation building. The economy then was backward in nature.
Indian economic policy after independence, influenced by the colonial experience (which was
seen by Indian leaders as exploitative in nature), became protectionist in nature, implementing a
policy of import substitution, industrialization, state intervention in labor and financial markets, a
large public sector, overt regulation of business, and central planning. Jawaharlal Nehru, the first
prime minister of India, along with the statistician Prasanta Chandra Mahalanobis, formulated
and oversaw the economic policy of independent India. They expected favorable outcomes from
this strategy since it involved both the public and private sectors and was based on direct and
indirect state intervention instead of a Soviet-style central command system. The policy of
concentrating simultaneously on capital and technology intensive heavy industry and subsidizing
hand based and low - skilled cottage industries was criticized by economist Milton Friedman,
who thought it would not only waste both capital and labor, but also retard the development of
smaller manufacturers. The economic reforms that surged economic growth in India after 1980
can be attributed to two stages of reforms. The pro-business reform of 1980 initiated by Indira
Gandhi and carried on by Rajiv Gandhi, eased restrictions on capacity expansion for incumbents,
removed price controls and reduced corporate taxes. The economic liberalization of 1991,
initiated by then Indian prime minister P. V. Narasimha Rao and his finance minister Manmohan
Singh in response to a macroeconomic crisis did away with the License Raj (investment,
industrial and import licensing) and ended public sector monopoly in many sectors, thereby
allowing automatic approval of foreign direct investment in many sectors. Since then, the overall
direction of liberalization has remained the same, irrespective of the ruling party at the centre,
although no party has yet tried to take on powerful lobbies like the trade unions and farmers, or
contentious issues like labor reforms and cutting down agricultural subsidies. Industry was
characterized by ill equipped technology and unscientific management. Agriculture was still
feudal in nature and characterized by low productivity. Transport and communication systems
were not properly developed, educational and health facilities insufficient and the complete
absence of social security measures. By the beginning of 1990‘s, the Indian Economy was under
great crisis and faced its stiffest challenge. India faced a serious balance of payment problem and
foreign exchange reserves were at record low. That is when the government decided to alter the
course of the Indian economy. The introduction of reforms in 1991 resulted in sweeping changes
in the Indian Economy.
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FOREIGN CAPITAL IN INDIA & WORLD-TRENDS:
During the early phase of planning era, the national policy towards foreign capital did recognize
the need of foreign capital, but decided not to permit it a dominant position19. Consequently,
foreign collaboration had to keep their equity within the ceiling of 49 per cent and allow the
Indian counterpart a majority stake. Moreover, foreign collaborations were to be permitted in
priority areas, more especially those in which India had not developed capabilities. But in an
overall sense, India’s policy towards foreign collaborations remained restrictive and selective.
Consequently, during 1948 to 1960, a total of 1,080 foreign collaborations were approved and
during the next decade (1961-70), a total of 2, 475 foreign collaborations were approved. During
1971-80 and 1981-90 the collaborations were 3,041 and 7,436 respectively
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It is revealed from the table that 78 per cent of total agreements (14,032) were technical
collaboration agreements and only 22 per cent were related to direct foreign investment. With the
introduction of reforms process in the early 1990s and after the announcement of New Industrial
Policy, 1991, India has witnessed a significant increase in cross-border capital flows, a trend that
represents a clear break form the previous two decades.
India has one of the highest net capital flows among the emerging market economies (EMEs) of
Asia. Prior to the recent global financial crisis, India achieved above 9% GDP growth for three
years in a row21 (2005-06 to 2007-08). A strong global growth environment and large capital
inflows played a significant role in this growth acceleration trend. The 2008 crisis abruptly
interrupted this story, pushing the country’s GDP growth down to 6.7, reminding India the
importance of capital inflows, which was believed to be underappreciated by policymakers
during the pre-crisis period. As the adverse impact of credit crisis in US ebbed, the capital flows
into India again accelerated.
The trends in Capital inflows into India follow the same momentum as that for other emerging
markets.
As per UN report, below are the top 10 destination for FDI in 2014.
Foreign direct investment (FDI) inflows to India increased by about 26 per cent to $35 billion in
2014, despite macroeconomic uncertainties and financial risks.
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China, however, received inflows worth $128 billion and with a modest increase of 3 per cent,
went on to become the world's largest recipient of FDI. Brazil, another BRICS country and an
emerging market like India, received $62 billion of FDI inflows. The U.S. fell to the third
position, with inflows plummeting to almost a third of the 2013 level.
Among the top 5 except US, others are developing economies — Hong Kong ($111 billion),
Singapore ($81 billion) and Brazil ($62 billion).
It's clear what India's next step should be to achieve growth: make foreign direct investment
(FDI) a top priority. However, India offers only a hesitant welcome to FDI. It seeks investment
in several industries, including manufacturing, construction, telecommunications and financial
services, but not in others like multi-brand retail.
Often, regulation allows only a minority investment for fear of losing domestic management
control. For example, FDI in insurance companies is permitted up to 49% with restrictions on
voting rights to ensure that management control of an insurance firm doesn't shift to a foreign
entity.
Concern of loss of management control is of much less importance compared to sacrifice of
economic growth. Considering the potential of FDI to spur growth, India's ambivalence toward
FDI is completely misplaced. If India wants to accelerate growth, it is imperative that the country
attracts FDI in large, really large amounts.
Growth results from domestic investment from savings, from productivity improvements and
from foreign investments. Countries like China that have grown rapidly in recent decades have
taken advantage of all three sources of economic growth. India, on the other hand, has tried to
achieve growth without much FDI.
However, India's approach to growth is like bringing a knife to a gunfight: it's destined to fail
relative to other countries' growth strategies, which take advantage of FDI. To transcend from 5-
7% growth to 10-12% growth, FDI is essential.
To put India's track record in attracting FDI in an international context, it's been at best a trickle
compared to FDI into countries like Mexico and China. In the last 10 years, Mexico has attracted
$247 billion of FDI net inflows and China $2 trillion, compared to India's $229 billion.
From the standpoint of an average citizen, the comparison is worse because Mexico is far less
populous than India or China. What matters to an average citizen is per-capita investment. On a
per-capita basis, FDI net inflows for Mexico, China and India are $2,017, $1,531 and $183,
respectively. No wonder the per-capita GDP of Mexico is $10,300, China $6,800 and India
$1,500.
Similarly Overseas direct investment by Indian companies fell by 72 per cent to $2.05 billion in
January 2015,
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INDIA’S JOURNEY FROM LICENSE RAJ ERA TO GLOBALIZATION:
Phase I: (1947-65)
• Focus on government led investments in manufacturing
• Several large PSUs in steel, chemicals, and power were set up
• Many of these companies exist even today and are among the largest companies in their
sectors
Phase II: (1965-80)
• Government involvement in industry increased
• Strong licensing laws were introduced with a sustained focus on import substitution
• PSUs and formation of several small-scale private sector manufacturing entities grew
Phase III: (1980-90)
• The government partially opened its economy to external trade
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• De-licensed some key sectors for private participation, leading to strong growth in a few
sectors
• Formation of Maruti Suzuki a s government’s 50:50 Joint Venture with Japan’s Suzuki
Motors
Phase IV: (Since early 1990s)
• The industry was further liberalized
• The scope of licensing was significantly reduced
• Custom duties were slashed
• FDI in various sectors was opened up
Phase V: (2000 onwards)
• Companies began to reap the rewards of the various phases of development learning Many
Indian business enterprises became quite competitive and looked at taking on global players
DETERMINANTS OF FOREIGN CAPITAL INFLOW:
The factors that encourage or hinder international flows of capital can categorized into those that
are external to the economies receiving the flow and the factors internal to those economies. For
small open economies fluctuations in the world interest rates are a key factor inducing capital
flows. Other external factors include terms of trade developments, the international business
cycle and its impact on profit opportunities and any regulatory changes that affect the
international diversification of investment portfolio at the main financial centers. Internal factors
are most often related to domestic policy. For e.g. effective inflation stabilization programs can
reduce macroeconomic risk and capital inflows. As the experience of various Latin American
countries in the late 1970s shows, domestic policies may also attract speculative capital when
policies may also attract speculative capital when policies are not fully credible often partial
credibility of these policies leads to relatively high returns on short term assets, which attract
foreign capital on grounds of inter temporal speculation. Several of these factors and trends
interacted in the early 1990s to make to developing countries of Latin America and Asia fertile
territory for the renewal of foreign lending.
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Lower interest rates in the developed nations attracted investors to the high-investment yields
and improving economic prospects of economies in Asia and Latin America. Given the high
external debt burden of many of these countries, low world interest rates also appear to have
improved the creditworthiness of debtor countries that borrow at these rates.
A large shift in capital flows to one or two large countries in a region may generate externalities
for the smaller neighboring countries. These are the so-called contagion effects. for example, it
could be argued that Mexico’s and Chile’s reentry into international capital markets in 1990
made investors more familiar and more willing to invest emerging markets in Latin America.
Indeed, the more recent events suggest that the Mexican crisis of late 1994 tended to make the
attitude of investors toward emerging markets more discriminating. Thus, foreign capital flow is
affected by a number of factors. These factors depend on the nature of foreign capital.
Below are host country determinants of Foreign Direct Investment
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CURRENT REGULATIONS TO MANAGE CAPITAL INFLOWS IN
INDIA:
Capital flows contribute in filling the resource gap in country like India where the domestic
savings are inadequate to finance investment. Today, India requires approximately 500 billion
US $ investment in infrastructure sector alone in the next 5 years for sustaining present growth
rate of approximately 8-9 per cent. This amount is around 2.5 times more than the 10th Plan.
Added to this, already, several infrastructure projects have reportedly been shelved and
indefinitely delayed. Such huge mobilization of resources is not possible from India’s internal
resources. Therefore, India need for capital in the form of ECBs and other foreign loans and aids.
The broad principles that have guided India after the Asian crisis of 1997 are:
(i) Careful monitoring and management of the exchange rate without a fixed or pre-announced
target or a band;
(ii)Flexibility in the exchange rate together with ability to intervene, if and when necessary;
(iii)A policy to build a higher level of foreign exchange reserves which takes into account not
only anticipated current account deficits but also ‘liquidity at risk’ arising from unanticipated
capital movements; and
(iv)A judicious management of the capital account. India’s exchange rate policy of focusing on
managing volatility with no fixed rate target while allowing the underlying demand and supply
conditions to determine the exchange rate movements over a period in an orderly way has stood
the test of time.
As a result of these timely and coordinated measures, India was successful in containing the
contagion effect of the Asian crisis
Keeping in view the growing requirements of foreign capital in India, Indian government has
come up with many policies and liberalized regulations to manage foreign capital in India. Some
of the important and recent measures taken by Indian government to manage foreign investments
in India are as under:
Foreign Direct Investment: FDI is permitted under the Automatic Route in items / activities in all
sectors up to the sectoral caps except in certain sectors where investment is prohibited.
Investments not permitted under the automatic route require approval from Foreign Investment
Promotion Board (FIPB). The receipt of remittance has to be reported to RBI within 30 days
from the date of receipt of funds and the issue of shares has to be reported to RBI within 30 days
from the date of issue by the investee company.
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Advance against Equity: An Indian company issuing shares to a person resident outside India can
receive such amount in advance. The amount received has to be reported within 30 days from the
date of receipt of funds. There is no provision on allotment of shares within a specified time. The
banks can refund the amount received as advance, provided they are satisfied with the bonafides
of the applicant and they are satisfied that no part of remittance represents interest on the funds
received.
Foreign Portfolio Investment: FIIs: FIIs Investment by non-residents is permitted under the
Portfolio Investment scheme to entities registered as FIIs and their sub accounts under SEBI
(FII) regulations. Investment by individual FIIs is subject to ceiling of 10 percent of the PUC
(Pollution under Control) of the company and limit for aggregate FII investment is subject to
limit of 24 percent of PUC of the company. This limit can be increased by the company subject
to the sectoral limit permitted under the FDI policy. The transactions are subject to daily
reporting by designated ADs (Authorized Dealers) to RBI for the purpose of monitoring the
adherence to the ceiling for aggregate investments.
NRIs: The investment by NRIs under the Portfolio Investment Scheme is restricted to 5% by
individual NRIs/OCBs (not incorporated in Bangladesh and Pakistan) and 10% in aggregate
(which can be increased to 24 percent by the company concerned).
ADR/GDR: Indian companies are allowed to raise resources through issue of ADR/GDR and
the eligibility of the issuer company is aligned with the requirements under the FDI policy. The
issues of sponsored ADR/GDR require prior approval of ministry of finance.
Foreign Venture Capital Investors: FVCIs (Foreign Venture Capital Investors) registered with
SEBI are allowed to invest in units of venture capital funds any limit. FVCI investment in equity
of Indian venture capital undertakings is also allowed. The limit for such investments would be
based on the sectoral limits under the FDI policy. FVCIs are also allowed to invest in debt
instruments floated by the IVCUs (InVacare Corporation-US). There is no separate limit
stipulated for investment in such instruments by FVCIs.
External Commercial Borrowings: Under the Automatic Route, ECB up to US $ 500 million
per borrowing company per financial year is permitted only for foreign currency expenditure for
permissible end-uses of ECB. Borrowers in infrastructure sector may avail ECB up to US $ 100
million for Rupee expenditure for permissible end-uses under the Approval Route. In case of
other borrowers, the limit for Rupee expenditure for permissible end-uses under the Approval
Route has been enhanced to US$ 50 million from earlier limit of US $ 20 million. Entities in the
services sector, viz., hotels, hospitals and software companies have been allowed to avail ECB
up to US $ 100 million, per financial year, for the purpose of import of capital goods under the
Approval Route. The all-in-cost interest ceiling for borrowings with maturity of 3-5 years has
been increased from 150 basis points over 6-month LIBOR18 (London Inter-bank Offered Rate)
to 200 basis points over 6-month LIBOR. Similarly, the interest ceiling for loans maturing after 5
20
years period has been raised to 350 basis points over 6-month LIBOR from 250 basis points over
6-month LIBOR.
Investment by NRIs in Immovable Properties: The NRIs are permitted to freely acquire
immoveable property (other than agricultural land, plantations and farmhouses). There are no
restrictions regarding the number of such properties to be acquired. The only restriction is that
where the property is acquired out of inward remittances, the repatriation is restricted to principal
amount for two residential properties. There is no such restriction in respect of commercial
property. NRIs are also permitted to avail of housing loans for acquiring property in India and
repayment of such loans by close relatives is also permitted.
BENEFITS OF FOREIGN CAPITAL:
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Foreign direct investment has many advantages for both the investor and the recipient. One of
the primary benefits is that it allows money to freely go to whatever business has the best
prospects for growth anywhere in the world. That's because investors aggressively seek the best
return for their money with the least risk. This profit motive is color-blind, doesn't care about
religion or form of government. This gives well-run businesses -- regardless of race, color or
creed -- a competitive advantage. It reduces (but, of course, doesn't eliminate) the effects of
politics, cronyism and bribery. As a result, the smartest money goes to the best businesses all
over the world, bringing these goods and services to market faster than if unrestricted FDI
weren't available. Individual investors receive additional benefits. Their risk is reduced because
they can diversify their holdings outside of a specific country, industry or political system.
Diversification always increases return without increasing risk.
Recipient businesses benefit by receiving management, accounting or legal guidance in keeping
with the best practices used by their lenders. They can also incorporate the latest technology,
innovations in operational practices, and new financing tools that they might not otherwise be
aware of. By adopting these practices, they enhance their employees' lifestyles. This raises the
standard of living for more people in the recipient country. FDI rewards the best companies in
any country. This reduces the influence of local governments over them, making them less able
to pursue poor economic policies. The standard of living in the recipient country is also
improved by higher tax revenue from the company that received the foreign direct investment.
However, sometimes countries neutralize that increased revenue by offering tax incentives to
attract the FDI in the first place.
Another advantage of FDI is that it can offset the volatility created by "hot money." Short-term
lenders and currency traders can create an asset bubble in a country by investing lots of money in
a short period of time, then selling their investments just as quickly. This can create a boom-bust
cycle that can ruin economies and political regimes. Foreign direct investment takes longer to set
up, and has a more permanent footprint in a country.
One of the advantages of foreign direct investment is that it helps in the economic development
of the particular country where the investment is being made. This is especially applicable for
developing economies. During the 1990s, foreign direct investment was one of the major
external sources of financing for most countries that were growing economically. It has also been
noted that foreign direct investment has helped several countries when they faced economic
hardship.
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An example of this can be seen in some countries in the East Asian region. It was observed
during the 1997 Asian financial crisis that the amount of foreign direct investment made in these
countries was held steady while other forms of cash inflows suffered major setbacks. Similar
observations have also been made in Latin America in the 1980s and in Mexico in 1994-95.
Further than economic benefits FDI can help the improvement of environment and social
condition in the host country by relocating ‘cleaner’ technology and guiding to more socially
responsible corporate policies.
For host countries, inward FDI has the potential for job creation and employment, which is often
followed by higher wages. Resource transfer, in terms of capital and technical knowledge, is also
a key motivator that encourages inward FDI.
In recent years, FDI has been used more as a market entry strategy for investors, rather than an
investment strategy. Despite the decline in trade barriers, FDI growth has increased at a higher
rate than the level of world trade as businesses attempt to circumvent protectionist measures
through direct investments. With globalization, the horizons and limits have been extended and
companies now see the world economy as their market.
Additionally for investors, FDI provides the benefits of reduced cost through the realization of
scale economies, and coordination advantages, especially for integrated supply chains. The
preference for a direct investment approach rather than licensing and franchising can also been
viewed in terms of strategic control, where management rights allows for technological know-
how and intellectual property to be kept in-house.
Apart from being a critical driver of economic growth, foreign direct investment (FDI) is a major
source of non-debt financial resource for the economic development of India. Foreign companies
invest in India to take advantage of cheaper wages, special investment privileges like tax
exemptions, etc. For a country where foreign investments are being made, it also means
achieving technical know-how and generation of employment.
The continuous inflow of FDI in India, which is now allowed across several industries, clearly
shows the faith that overseas investors have in the country's economy.
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The Indian government’s policy regime and a robust business environment have ensured that
foreign capital keep flowing into the country. The government has taken many initiatives in
recent years such as relaxing FDI norms across sectors such as defense, PSU oil refineries,
telecom, power exchanges and stock exchanges, among others.
Some of the features of FDI in India are as follows:
Market Size
According to a recent report by global credit rating agency Moody’s, FDI inflows have increased
significantly in India in the current fiscal. This, according to Moody’s, is due to India’s current
pro-growth policies. Net FDI inflows totalled US$ 14.1 billion in the first five months of 2014-
15, representing a 33.5 per cent increase from the same period in 2013-14.
Total FDI inflows into India in the period April 2000–November 2014 touched US$ 350,963
million. Total FDI inflows into India during the period April–November FY15 was US$ 18,884
million. Mauritius is again emerging as the largest source of FDI in India, accounting for an
inflow of US$ 83,730 million in the April 2000-November 2014 period. According to official
data, the inflow of foreign investment from Singapore amounted to US$ 29,193 million,
followed by the UK at US$ 21,761 million and Japan at US$ 17,557 million during April 2000-
November 2014.
Government Initiatives
India’s cabinet has cleared a proposal which allows 100 per cent FDI in railway infrastructure,
excluding operations. Though the initiative does not allow foreign firms to operate trains, it
allows them to do other things such as create the network and supply trains for bullet trains etc.
The government has notified easier FDI rules for construction sector, where 100 per cent
overseas investment is permitted, which will allow overseas investors to exit a project even
before its completion. It also said that 100 per cent FDI will be permitted under automatic route
in completed projects for operation and management of townships, malls and business centres.
With the objective of encouraging foreign firms to transfer state-of-the-art technology in defence
production, the government may increase the FDI cap for the sector to 74 per cent from 49 per
cent at present. India is expected to spend US$ 40 billion on defence purchases over the next 4-5
years, mostly from abroad.
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The Union Cabinet has cleared a bill to raise the foreign investment ceiling in private insurance
companies from 26 per cent to 49 per cent, with the proviso that the management and control of
the companies must be with Indians.
The Reserve Bank of India (RBI) has allowed a number of foreign investors to invest, on
repatriation basis, in non-convertible/ redeemable preference shares or debentures which are
issued by Indian companies and are listed on established stock exchanges in the country.
In an effort to bring in more investments into debt and equity markets, the RBI has established a
framework for investments which allows foreign portfolio investors (FPIs) to take part in open
offers, buyback of securities and disinvestment of shares by the Central or state governments.
One who has studied finance would not deny the fact that there are many benefits of FDI for any
country. It certainly gives an opportunity to the economy to improve its foreign exchange and
thus stand on a more stable financial platform. At the same time, FDI directly increases the
number of employment available in the country. With every FDI coming into the country, new
and new jobs would be created.
FDI brings fresh capital and helps the economy build a healthy capital along with helping the
domestic market learn better technology, intellectual property and management skills. In short,
FDI is a means for any developing economy to keep abreast with the latest in the world.
Nevertheless, FDI increases the exports directly and helps economy generate higher tax
revenues.
Some of the advantages of Foreign Capital are:
Integration into global economy - Developing countries, which invite FDI, can gain access to a
wider global and better platform in the world economy.
Economic growth - This is one of the major sectors, which is enormously benefited from
foreign direct investment. A remarkable inflow of FDI in various industrial units in India has
boosted the economic life of country.
Trade - Foreign Direct Investments have opened a wide spectrum of opportunities in the trading
of goods and services in India both in terms of import and export production. Products of
Superior quality are manufactured by various industries in India due to greater amount of FDI
Inflows in the country.
Technology diffusion and knowledge transfer – FDI apparently helps in the outsourcing of
knowledge from India especially in the Information Technology sector. Developing countries by
inviting FDI can introduce world-class technology and technical expertise and processes to their
existing working process.
MNCs may not only invest in new capacity. They may also introduce new working practices that
help increase labour productivity. For example, when Japanese firms invested in the UK, it was
said that they helped to improve labour relations and get more out of the workforce. Therefore, it
can contribute to increased labour productivity.
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Foreign expertise can be an important factor in upgrading the existing technical processes.
For example, the civilian nuclear deal led to transfer of nuclear energy know-how between the
USA and India.
Surplus on the Financial Account of the Balance of Payments-Capital inflows from abroad
can help to balance out a current account deficit. Without the inflows, a current account deficit
could cause devaluation in the exchange rate. One time effect is that the capital account of the
host country benefits from the initial capital inflow. Also foreign capital is a substitute for
imports of goods or services, it can improve the current account of the host country’s balance of
payment. Much of the FDI by Japanese automobile companies in the US and UK, can be seen as
substitute for imports from Japan. At times Multinational company uses foreign subsidiary to
export goods and services to other countries.
Lower Prices for Consumers: Investment from foreign firms offers the chance for goods to be
produced more efficiently and could lead to lower prices for domestic firms.
Increased competition - FDI increases the level of competition in the host country. Other
companies will also have to improve on their processes and services in order to stay in the
market. FDI enhanced the quality of products, services and regulates a particular sector.
Linkages and spillover to domestic firms- Various foreign firms are now occupying a position in
the Indian market through Joint Ventures and collaboration concerns. The maximum amount of
the profits gained by the foreign firms through these joint ventures is spent on the Indian market.
Human Resources Development - Employees of the country which is open to FDI get acquaint
with globally valued skills. By transferring knowledge, FDI will increase the existing stock of
knowledge in the host country through labour training, transfer of skills, and the transfer of new
managerial and organizational practice. Foreign management skills acquired through FDI may
also produce important benefits for the host countries. Beneficial spin-off effect arise when local
personnel who are trained to occupy managerial, financial and technical posts in the subsidiary
of a foreign MNE leave the firm and help to establish local firms. Similar benefits may arise if
the superior management skills of a foreign MNE stimulate local suppliers, distributors and
competitors to improve their own management skills. Workers gain new skills through explicit
and implicit training. In particular, training in foreign firms may be of a higher quality given that
only the most productive firms trade. Workers take these skills with them when they re-enter the
domestic labour market. Training received by foreign companies sometimes may be considered
under the general heading of ‘organization and management’, meaning that the host country will
benefit from the ‘managerial superiority’ of MNCs.
Increased productive capacity- Inward investment will not only increase Aggregate Demand,
but also increase Aggregate Supply. Investment in new factories increases productive capacity
and Aggregate Supply should shift to the right. This enables an increase in economic growth
without inflation.
Employment - The effects on employment associated with FDI are both direct and indirect. In
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countries where capital is relatively scarce but labour is abundant, the creation of employment
opportunities – either directly or indirectly – has been one of the most prominent impacts of FDI.
The direct effect arises when a foreign MNE employs a number of host country citizens.
Whereas, the indirect effect arises when jobs are created in local suppliers as a result of the
investment and when jobs are created because of increased local spending by employees of the
Multinational enterprises.
Investment- The government has announced that foreign investors can put in as much as Rs
90,300 crore (US$ 14.65 billion) in India’s rail infrastructure through the FDI route, according to
a list of projects released by the Ministry of Railways. The Rs 63,000 crore (US$ 10.22 billion)
Mumbai-Ahmedabad high-speed corridor project is the single largest. The other big ones include
the Rs 14,000 crore (US$ 2.27 billion) CSTM-Panvel suburban corridor, to be implemented in
public-private partnership (PPP), and the Rs 1,200 crore (US$ 194.79 million) Kachrapara rail
coach factory, besides multiple freight line, electrification and signalling projects.
Israel-based world's seventh largest agrochemicals firm ADAMA Agrochemicals, formerly
known as Makhteshim Agan Industries, plans to invest at least US$ 50 million over the next
three years. ADAMA's global president and Chief Executive Chen Lichtenstein said the idea was
to expand both manufacturing and research and development facilities in India aimed at growing
better than the average industry growth.
Apple - world's most admired electronics brand - that sells devices such as the iPhone, iPad
tablet and iPod media player – is planning to open 500 'iOS' stores in India in its first major push
that will include moving into smaller towns and cities.
The Department of Industrial Policy and Promotion (DIPP) has moved a Cabinet note to allow
100 per cent FDI in medical devices as part of a strategy to not only reduce imports but also
promote local manufacturing for the global market, which will be worth over US$ 400 billion
next year.
Real estate private equity FDI is set to double after the Indian government ended the three-year
lock-in and has introduced 100 per cent FDI for completed assets, according to JLL India. With
India now allowing 100 per cent FDI in the construction sector, real estate private equity
investment could double – and boost demand from overseas property buyers, according to sector
experts.
FDI real estate private equity, which is currently estimated at around US$ 1billion - US$ 1.5
billion per annum, could reach to up to US$ 3 billion in the next few years, according to leading
agency, JLL India.
The Ministry of Finance has announced that it has cleared 15 FDI applications, including that of
Panacea Biotech and Sanofi-Synthelabo (India), and recommended HDFC Bank's proposal to
hike foreign holding to the Cabinet for consideration.
Some of the advantages of FDI in India to the investing country are
1. Huge Market Size and a Fast Developing Economy:
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India is the second largest country in the world just behind China in terms of population.
Currently the total population is about 1.2 billion. This huge population base
automatically makes a huge market for the business operators to capture and also a major
part of it is still can be considered as un-served or not yet been penetrated. Therefore FDI
investors automatically get a huge market to capture and also ample opportunity to
generate cash inflows at relatively quicker times. The economy of India is also moving at
faster pace than most of the economy of the world and inhabitants of the country also
obtaining purchasing power at the same rate.
2. Availability of Diversified Resources and Cheap Labor Force:
The huge advantage every company gets by investing in India is the availability of
diversified resources. It is a country where different kinds of materials and technological
resources are available. India is a huge country and has forest as well as mining and oil
reserve as well. These are also coupled with availability of very cheap labour forces at
almost every parts of the country. From Mumbai which is in the west to Bengal which is
in the east there is ample opportunity to set up business venture and location and most
importantly labour is available at low cost.
3. Increasing Improvement of Infrastructure:
A lot of research study in India finds out that historically the country fails to attract a
significant amount of FDI mainly because of problems in infrastructure. But the scenario
is changing. The Indian government has taken huge projects in transportation and energy
sectors to improve the case. The projects for developing road transport is worth of $90
billion, for rail it has undertaken several projects each worth of $20 million and for ports
and airports the value of development projects is around $ 80 billion. In addition the
investment in energy development is worth of $167 billion and investment in nuclear
energy development is outside that calculation. These huge investments are changing the
investment climate in the country and investors will benefit hugely by that.
4. Public Private Partnerships:
Another significant advantage foreign investors experience in India today is the
opportunities of PPP or Public private Partnership in different important sectors like
energy, transportation, mining, oil industry etc. It is advantageous in several ways as it
has eliminated the traditional trade barriers and also joint venture with government is risk
free up to the great extent.
5. IT Revolution and English Literacy:
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Today the modern India is considered to be one of the global leaders in IT. India has
developed its IT sectors immensely in last few years and as of today many leading firms
outsource their IT tasks in India. Because of IT advancement the firm which will invest in
India will get cheap information access and IT capabilities as Indian firms are global
leader. Along with that Indian youth are energetic and very capable in English language
which is obligatory in modern business conduction. This capability gives India an edge
over others. Foreign firms also find it profitable and worthy investment by recruiting
Indians.
6. Openness towards FDI:
Recently the Government of India has liberalized their policies in certain sectors, like
Increase in the FDI limits in different sectors and also made the approval system far
easier and accessible. Unlike the historical tradition, today for investing in India
government approval do not require in the special cases of investing in various important
sectors like energy, transportation, telecommunications etc
7. Regulatory Framework and Investment Protection:
In the process of accelerating FDI in the country the government of India has make the
regulatory framework lot more flexible. Now a day’s foreign investors get different
advantages of tax holiday, tax exemptions, exemption of service and central taxes. The
government also opened few special economic zones and investors of those zones also
get a lot of benefits by investing money. Apart from that there are number of laws has
been passed and executed for making the investments safe and secure for the foreign
investors
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DISADVANTAGES OF FOREIGN CAPITAL
FDI comes with various benefits for any economy, however, is a fear to the local businesses.
Domestic companies see it as a threat to their business, since they find themselves nowhere to
compete with global companies. They surely would edge out somewhere in their businesses.
One of the major drawbacks of FDI, however, is that larger companies monopolize the market
and make it quite tougher for the small enterprises, leaving no room for budding companies.
Moreover, government has lesser controls over these global giants as they work as a subsidiary
of a global overseas entity.
Too much foreign ownership of companies can be a concern, especially in industries that are
strategically important. Second, sophisticated foreign investors can use their skills to strip the
company of its value without adding any. They can sell off unprofitable portions of the company
to local, less sophisticated investors. Or, they can borrow against the company's collateral
locally, and lend the funds back to the parent company.
The net benefits from FDI do not accrue automatically, and their importance differs according to
host country and condition. Recognition of the economic benefits afforded by freedom of capital
movements sometimes clash with concerns about loss of national sovereignty and other possible
adverse consequences. FDI, even more than other types of capital flows, has historically given
rise to these conflicting views, because FDI involves a controlling stake by often large
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Multinational enterprises over which domestic governments, it is feared, have little power. In
small economies, large foreign companies can and often do, abuse their dominant market
positions. Based on the literature, it is eminent that FDI is not always in the host county’s best
interest and therefore it should be controlled.
The experience of the past two decade has shown that with capital flows can bring substantial
risks to both the providers and the recipients of international capital flows. During the 1970s, the
banks of the United States and other industrial countries recycled OPEC surpluses and their own
national savings to eager borrowers abroad, particularly in Latin America. Low real interest rates
and high commodity prices encouraged borrowers to accept more credit and expand their
activities. But when the U.S. Federal Reserve finally acted decisively to reduce the spiraling
double digit inflation, real dollar interest rates rose sharply, reducing economic activity and
lowering commodity prices and demands. The debtor countries of Latin America, led by Mexico
in the summer of 1982, found that they could not get the increased credit that would be needed to
pay the high interest rates and to offset the shortfall of export earnings. The result was a debt
moratorium that engulfed nearly all of the Latin American countries.
During the rest of the decade, the borrower countries went through a painful transition as they
lowered domestic consumption in order to reduce their dependence on imported capital, to pay
the high interest rates on their growing debts, and to compensate for the decline in exports. The
creditor banks that had lent to the Latin American countries were also hard hit during this period
as the loan write-downs impaired bank capital, causing bank regulators to require dividend
suspensions and other changes in the banks' activity. Further defaults by the borrower countries
could have made major commercial banks technically insolvent and led to their being closed by
the regulators.
Countries facing increased inflows of Foreign capital have often experienced unease. Many
developing countries have until recently been wary of inward FDI. Even in the United States, the
surge of Japanese FDI in the 1980s led to widespread concerns about excessive foreign control
and adverse effects on national security, as expressed in the popular press, and in legislative
action.
Moreover, sometimes some estimated benefits may prove elusive if the host economy, in its
current state of economic development, is not able to take advantage of the technologies or
know-how transferred through FDI.
The factors that hold back the full benefits of FDI in some developing countries include the level
of general education and health, the technological level of host-country enterprises, insufficient
openness to trade, weak competition and inadequate regulatory frameworks. On the other hand, a
level of technological, educational and infrastructure achievement in a developing country does,
other things being equal, equip it better to benefit from a foreign presence in its markets
Investing in India definitely has some negative sides as well. Most noticeably India considered as
a huge market but a major portion of that is a lower and middle class person who still suffers
from budget shortage. The infrastructure of the country also needs to be improved a lot and
already it is under huge strain. There are also problems exists in the power demand shortfall, port
traffic capacity mismatch, poor road conditions deal with an inefficient and sometimes still slow-
moving bureaucracy. The huge market in India is an advantage but it is also very diverse in
nature. India has 17 official languages, 6 major religions, and ethnic diversity as wide as all of
Europe. This makes the tasks difficult for the companies to make appropriate product or service
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portfolio. India is not a member of the International Centre for the Settlement of Investment
Disputes also not of the New York Convention of 1958. That make life bit difficult for the
foreign investors. India still has a heavy regulation burden among other countries, for example
the time taken to start business or to register a property is higher in India. Similarly, indirect
taxes, entry-exit barriers and import duties have been major disadvantages.
Some of the disadvantages of foreign capital and FDI in particular are:
1. Adverse Effects on Employment:
Critics about FDI note that not all the ‘new jobs’ created by Foreign capital flow
represent net additions in employment. In the case of FDI by Japanese auto companies in
the US, some argue that the jobs created by this investment have been more than offset by
the jobs lost in US- owned auto companies, which have lost market share to their
Japanese competitors. As a consequence of such substitution effects, the net number of
new jobs created by FDI may not be as great as initially claimed
2. Adverse Effect on Competition:
Although previously I have outlined how FDI can boost competition, host governments
sometimes worry that the subsidiaries of foreign Multinational Enterprises may have
greater economic power than local competitors. If it is a part of large international
organization, the foreign Multinational Enterprises may be able to draw on funds
generated elsewhere to subsidize its costs in the host market, which could drive local
companies out of business and allow the firm to monopolize the market.
3. Adverse Effects on Balance of Payments:
There are two main areas of concern with regard to the adverse effects of FDI on a host
country’s balance of payments. First, set against the initial capital inflow that comes with
FDI must be the subsequent outflow of earnings from the foreign subsidiary to its parent
company. Such outflows show up as a debit on the capital account. Some governments
have responded to such outflows by restricting the amount of earnings that can be
repatriated to a foreign subsidiary’s home country. A second concern arises when a
foreign subsidiary imports a substantial number of inputs from abroad, which results in a
debit on the current account of the host country’s balance of payment.
4. Environmental impact:
Another major concern regarding Foreign Capital is its environmental impact. Local
enforcement of environmental protection legislation that is negligent or weak in relation
32
to foreign firms has led to disastrous consequences in many parts of the world. However,
in the global competition among developing country governments to attract Foreign
CapitaI, there is often a race to the bottom, which leads countries to offer more relaxed
regulations in order to attract foreign investment.
5. Sweatshops:
The working conditions of workers in firms sponsored by FDI have also been a concern.
The presence of sweatshops in some countries, which subject laborers, who are
sometimes child laborers, to dangerous, sub-human working conditions, often in violation
of local workplace regulations, is a serious issue. The race to the bottom phenomenon is
also present here, as governments minimize the enforcement of workplace regulations in
order to attract FDI. Although multinationals pay their workers more than their
competitors, many people have complained that multinationals abuse their workers in
sweatshop conditions, and have demanded that products from these sweatshops be
banned.
CASE STUDY
Emerging India in modern times prove to be one of the perfect destination for foreign investors
to put their money and get expected return. Historical scenario reveals that a few numbers of
foreign companies were really successful in doing business in the country. Along the way they
have faced few drawbacks but they were really efficient in keeping away those drawbacks and
move along. The success of few Korean companies is remarkable in India. Ever since the Indian
Government reform the policy Korean companies have come up and make a lot of investment in
India by forming joint ventures and also made few Greenfield investments in the sectors of
automobiles, consumer goods and other sectors.
The success of Korean companies mainly highlighted by three big companies Hyundai, LG and
Samsung. Among those the case of Hyundai Motor Corporation is most remarkable and worth of
noticing and analyzing. The company manufactures 120000 cars annually in India and it is the
second largest production base of Hyundai Motors only next best to the domestic one in Korea.
That picture tells the whole story of the advantage the organization gets in investing in India.
Apart from manufacturing, India is the second largest overseas market for the company after the
US, where it sells 5, 00,000 cars a year. They only get this huge advantage because of a larger
population base in India that always provides unlimited opportunity for growth. The operation of
the company is bit different and it gets backed by the local authority. Unlike the most
multinational companies of the world it invests in an aluminum foundry and also a transmission
line so that it could increase indigenization levels and cut costs.
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As a result, HMI has achieved indigenization levels of over 85 per cent. They exercise such
R&D practice and it is also supported by the regulatory reform of the India. Apart from market,
development and regulatory advantages the company also benefited from forming joint venture
with Indian companies and by that they get involved in very profitable Greenfield investment.
Hyundai motors also allowed developing large industrial clusters in Chennai and a huge
manufacturing base. From that location they serve the demand of neighbouring markets like
Bangladesh, Pakistan, Nepal, Srilanka and also of ASEAN countries
FDI in India also helped the company in gaining local human resources and cheap labour costs.
In India they also benefited by increasing demand of growing Indian economy and people
interest of having car in their property base. Hyundai motors huge success in India also rooted
into the fact that India is proved to be one of the most convenient place for investing specially
considering its very bright future prospects and un-served market to capture.
The journey of Hyundai motors in India is always not smooth, though. Over the years it has to
deals with problems like labour dispute, energy shortage, bureaucratic hassles etc. But even
considering those issues the advantages outweigh the disadvantages by great margin.
MAKE IN INDIA
'Come, Make in India'! Prime Minister Narendra Modi's aggressive push to revive an ailing
manufacturing sector, has found resonance not only across India Inc but also world over.
Make in India is an initiative of the Government of India, to encourage companies to invest in
the manufacturing sector in India. It was launched by Prime Minister, Narendra Modion 25
September 2014.
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The major objective behind the initiative is to focus on 25 sectors of the economy for job
creation and skill enhancement. Some of these sectors are: automobiles, chemicals, IT,
pharmaceuticals, textiles, ports, aviation, leather, tourism and hospitality, wellness, railways,
auto components, design manufacturing, renewable energy, mining, bio-technology, and
electronics. The initiative aims at high quality standards and minimizing the impact on the
environment and hopes to attract foreign capital and technological investment in India
In February 2015, Hitachi said it was committed to the initiative. It said that it would increase its
employees in India from 10,000 to 13,000 and it would try to increase its revenues from India
from ¥100 billion in 2013 to ¥210 billion.
Other countries like Turkey and Israel have also agreed to be part of this program.
ROAD AHEAD
Foreign capital has a key role to play in the economic development of India. There are several
ways in which capital flows and economic growth are related. However, impact of capital flows
35
on economic growth ultimately depends on their being stable and less volatile. Indian
government has been continuously proceeding for economic reforms and is quiet assured to
secure legislation to allow more foreign investment in various sectors. The size of net capital
inflows to India has increased significantly in the post reform period. It is also important to note
that capital inflows increased extensively since 2005.
Foreign investment inflows are expected to increase by more than two times and cross the US$
60 billion mark in FY15 as foreign investors start gaining confidence in India’s new government,
as per an industry study. Riding on huge expectations from the incoming Modi government,
global investors are gung ho on the Indian economy which is expected to witness over 100 per
cent increase in foreign investment inflows – both FDI and FIIs – to above US$ 60 billion in the
current financial year, as against US$ 29 billion during 2013-14," according to the study.
India will require around US $1 trillion in the 12th Five-Year Plan (2012–17), to fund
infrastructure growth covering sectors such as highways, ports and airways. This requires
support in terms of FDI. The year 2013 saw foreign investment pour into sectors such as
automobiles, computer software and hardware, construction development, power, services, and
telecommunications, among others.
In fact, India has experienced both sudden increase and sudden declines of capital flows. Various
studies explored that both excess and sudden declines (siphoning-off) of capital inflows are
harmful for an economy. But sudden declines in capital inflows are more harmful as sudden
declines of capital inflows may lead any economy into insolvency and affect the various
macroeconomic variables. Therefore, effective buttressing of these capital inflows is a key
economic policy issue today. Countries with sound macroeconomic policies and well-
functioning institutions are in the best position to reap the benefits of capital flows and minimize
the risks. India's inability to deal with capital inflows is partly a result of the government doing
less of what it should do more of, and doing more of what it should do less of.
The government’s decision to open up Foreign Direct Investment (FDI) in the retail sector has
created uproar however FDI will give ample opportunities to the unemployed (lower class) and
also improve the quality of the product. Beyond the power of the kirana lobby, public sentiment
runs high on this issue because in a poor country where there is no insurance in the form of
social safety nets, a very large number of people view such stores as insurance. In the short run,
there is little cost but much political gain in opposing modern retail. . There is precious little in
terms of economic reforms, but the government has gone to great lengths to encourage more
capital inflows. It is important to understand that the perceived threat of modern retail for kiranas
is much larger than the reality. Even as modern retail gains market share, kiranas are not going
extinct—at least not in the foreseeable future. As India’s incomes rise, so will consumption; with
increased consumption, both kiranas and modern retail will continue to grow by sharing in a
larger pie. The overall expansion of the market would be much higher than the effect of the loss
in share. In addition, the increased efficiencies and reduced losses due to superior cold-chain and
supply-side infrastructure means that manufacturers can increase profits without squeezing retail
margins as much.
36
Also foreign retail investments would be only establishing themselves in metropolitan and
centralized cities whereas in India most of the local areas and villages already have the local
retail shops.
In this hyper competitive and ever changing business environment no business organization is
certain about tomorrow. That forces them to look for new destination and new market to capture.
The emerging market of India without any doubt poses suitable choice for those companies.
Huge population and huge countryside is certainly making it even more attractive. There are
several benefits in investing like-very bright future, cheap labor and raw materials, sound
infrastructure, huge market availability. Easiness in regulatory framework, efficient human
resources, investment protect and also efficient promotion mechanisms. However, factors
like hugely diversified culture in India make life bit difficult for the operators, but the benefits
are overwhelming in compare to drawbacks. That is the prime reason why it will keep attracting
foreign investors and will remain as the most attractive paces to put the money and earn future
dividend. The experience of Hyundai Motor Corporation in India also reveals the same picture
and thus supports the above mentioned conclusion.
BIBLIOGRAPHY:
1. Effects of FDI in Indian Economy – Sourangsu Banerji.
37
2. Foreign Direct Investment & Developing Countries. Its Impact and Significance – Dr. Lalita
Shukla
3. Foreign Direct Investment in India – Punjab University
4. Foreign Capital & Economic Growth – Raghuram G. Rajan and Eswar S. Prasad.
38

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Project on Benefits of Foreign Capital

  • 1. CONTENT Sr. No. PARTICULARS Page No. 1 Introduction 2 2 Need and Forms of Foreign Capital 4 3 Foreign Capital in India-Introduction 7 4 Foreign Capital in India-Historical sketch 9 5 Foreign Capital in India and World-Trends 13 6 India’s journey from license raj era to globalization 16 7 Determinants of Foreign Capital Inflow 17 8 Current regulation to manage Capital inflow in India 19 9 Benefits of Foreign Capital 22 10 Disadvantages of FDI 30 11 Case study 33 12 Make in India 34 13 Road ahead 35 14 Bibliography INTRODUCTION: In this 21st century globalization has made this planet as a global village and people of different countries are getting closer and closer. Due to immense development of technologies investors of different countries are looking forward to find business opportunities beyond the conventional territory and as a result one of the most popular and highlighted terms in modern business-“FDI” is evolving at a greater pace than ever before. Business and trade has become more competitive 1
  • 2. and diversified, traditional market is shrinking down at a faster pace and operators are looking for options for expansion and international trade is getting accelerated. In this era of globalization and intense competition, foreign direct investment (FDI) has become a very common and immensely important phenomenon for consumers, producers and different governments. Foreign direct investment (FDI) refers to the net inflows of investment in an enterprise operating in an economy other than that of the investor. It is the sum of equity capital, other long-term capital and short term capital as shown in the balance of payments. It usually involves participation in management, joint venture, transfer of technology and expertise. Foreign capital has significant role for every national economy regardless of its level of development. It helps in transferring of financial resources, technology and innovative and improved management techniques along with raising productivity. For the developed countries it is necessary to support sustainable development. For the developing countries, it is used to increase accumulation and rate of investments to create conditions for more intensive economic growth. For the transition countries, it is useful to carry out the reforms and cross to open economy and to create conditions for stable and continuous growth of GDP as well as integration in world. Entities making direct investments typically have a significant degree of influence and control over the company into which the investment is made. Open economies with skilled workforces and good growth prospects tend to attract larger amounts of foreign direct investment than closed, highly regulated economies. The investing company may make its overseas investment in a number of ways - either by setting up a subsidiary or associate company in the foreign country, by acquiring shares of an overseas company, or through a merger or joint venture. An example of foreign direct investment would be an American company taking a majority stake in a company in China. Another example would be a Canadian company setting up a joint venture to develop a mineral deposit in Chile. 2
  • 3. Over the past few decades emerging countries have become the major recipients of FDI as MNCs have started expanding their business operations beyond their national borders to the countries offering various advantages which they seek to exploit to gain. Foreign Direct Investment (FDI) has appeared to be the most important source of external flow of resources to the developing countries and has become an integral part of capital formation despite of their small share in global distribution of FDI. While the large Multi National Corporations of the West are getting advantages of market expansion from FDI, the host countries are also utilizing it as a major mechanism and source for accelerating their domestic economic growth. NEED AND FORMS OF FOREIGN CAPITAL: Everywhere in the world, including the developed countries, governments are vying with each other to attract foreign capital. The belief that foreign capital plays a constructive role in a country’s economic development has become more stronger since mid-1980’s.The experience of South East Asian countries has especially confirmed this belief and has led to a progressive reduction in regulations and restraints that could have inhibited the inflow of foreign capital. Need of Foreign capital: 3
  • 4. Prof. John P. Lewis, an American academic and presidential advisor who was a strong advocate of aid to help build developing countries as a matter of foreign policy had pointed out “that almost every developed country of the world in its developing stage had made the use of foreign capital to make up deficiency of domestic savings”. In the seventeenth and eighteenth century England borrowed from Holland and in the nineteenth and twentieth century England gave loans to almost every other country. United State of America, today the wealthiest country of the world, had borrowed heavily in the nineteenth century. The half century prior to the First World War was a period uniquely favorable to the free movement of international capital. Even before 1914, certain changes were taking place in the character and in the industrial distribution of the international capital movements. After the First World War US emerged as the prime lender and the transformation of continental Europe from a substantial creditor into a substantial debtor. Even by 1919, the US had invested $6.5 billion abroad, excluding the large war loans to the allies. In the following decades, her foreign investments rose by US $8.3 billion-about two-thirds of the world total investment raising America’s total capital stake in 1930 to US $15.7 billion. By contrast, most European countries were forced to relinquish large quantities of their foreign assets during the war; UK gave up 15% of hers, France over half of hers and Germany nearly the whole. Since the war, a remarkable resurgence has taken place in the international capital movements, the volume of which has risen much faster than that of world trade and industrial production. The 1970s witnessed a remarkable boom of capital flows to emerging economies17. The dramatic surge in international capital flows was triggered by the oil shock in 1973-1974, the growth of the Eurodollar market and the remarkable increase in bank lending during 1979- 1981. Latin America was the main recipient of this heavy capital inflow, with capital flows to the region peaking at US $44 billion in 1981. Overall, capital inflows to this region, which mostly took the form of syndicated bank loans, reached about 6 per cent of the region’s gross domestic product (GDP). The need for foreign capital arises because of domestic capital inadequacy. In most developing countries like India, domestic capital is inadequate for the purpose of economic growth. Foreign capital is typically seen as a way of filling in gaps between the domestically available supplies of savings, foreign exchange, government revenue and the planned investment necessary to achieve developmental targets. To give an example of this ‘savings-investment’ gap, let us suppose that planned rate of growth output per annum is 7 percent and the capital-output ratio is 3 percent, then the rate of saving 4
  • 5. required is 21 percent. If the saving that can be domestically mobilized is 16 percent, there is a shortfall or a savings gap of 5 percent. Thus the foremost contribution of foreign capital to national development is its role in filling the resource gap between targeted investment and locally mobilized savings. Foreign capital is needed to fill the gap between the targeted foreign exchange requirements and those derived from net export earnings plus net public foreign aid. This is generally called the foreign exchange or trade gap. An inflow of private foreign capital helps in removing deficit in the balance of payments over time if the foreign-owned enterprise can generate a net positive flow of export earnings. Another gap that the foreign capital and specifically, foreign investment helps to fill is that between governmental tax revenue and the locally raised taxes. By taxing the profits of the foreign enterprises the governments of developing countries are able to mobilize funds for projects (like energy, infrastructure) that are badly needed for economic development. Foreign investment meets the gap in management, entrepreneurship, technology and skill. The package of these much-needed resources is transferred to the local country through training programmes and the process of learning by doing’. Further foreign companies bring with them sophisticated technological knowledge about production processes while transferring modern machinery equipment to the capital-poor developing countries. In fact, in this era of globalization, there is a great belief that foreign capital transforms the productive structures of the developing economics leading to high rates of growth. Besides the above, foreign capital, by creating new productive assets, contributes to the generation of employment a prime need of a country like India. Forms of Foreign Capital: Foreign Capital can be obtained in the form of foreign investment or non-concessional assistance or concessional assistance. 1. Foreign Investment includes Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI). FPI includes the amounts raised by Indian corporate through Euro Equities, Global Depository Receipts (GDR’s), and American Depository Receipts (ADR’s). 2. Non-Concessional Assistance mainly includes External Commercial Borrowings (ECB’s), loans from governments of other countries/multilateral agencies on market terms and deposits obtained from Non-Resident Indians (NRIs). 5
  • 6. 3. Concessional Assistance includes grants and loans obtained at low rates of interest with long maturity periods. Such assistance is generally provided on a bilateral basis or through multilateral agencies like the World Bank, International Monetary Fund (IMF), and International Development Association (IDA) etc. Loans have to be repaid generally in terms of foreign currency but in certain cases the donor may allow the recipient country to repay in terms of its own currency. Grants do not carry any obligation of repayment and are mostly made available to meet some temporary crisis. Foreign Aid can also be received in terms of direct supplies of agricultural commodities or industrial raw materials to overcome temporary shortages in the economy. Foreign Aid may also be given in the form of technical assistance. FOREIGN CAPITAL IN INDIA-INTRODUCTION: India is believed to be a good investment destination among global investors despite challenging hurdles like political uncertainty, bureaucratic hassles, shortages of power facilities, and infrastructural deficiencies. At present, the country has a promising potential in terms of growth and diversification possibilities. India offers a high growth potential in practically all areas of business. It has slowly transformed itself from a highly protected, semi -socialist, autarkic economy since post-independence period into a country which is smashing barriers and seeking foreign investments. The economic liberalization in India refers to ongoing economic reforms in India that started on 24 July 1991. After Independence in 1947, India adhered to socialist policies. Attempts were made to liberalize economy in 1966 and 1985. The first attempt was reversed in 1967. Thereafter, a stronger version of socialism was adopted. Second major attempt was in 1985 by 6
  • 7. Prime Minister Rajiv Gandhi. The process came to a halt in 1987, though 1966 style reversal did not take place. In 1991, after India faced a balance of payments crisis, it had to pledge 20 tons of gold to Union Bank of Switzerland and 47 tons to Bank of England as part of a bailout deal with the International Monetary Fund (IMF). In addition, the IMF required India to undertake a series of structural economic reforms. As a result of this requirement, the government of P. V. Narasimha Rao and his finance minister Manmohan Singh (who later on became Prime Minister) started breakthrough reforms, although they did not implement many of the reforms the IMF wanted. The new neo-liberal policies included opening for international trade and investment, deregulation, initiation of privatization, tax reforms, and inflation-controlling measures. The overall direction of liberalization has since remained the same, irrespective of the ruling party, although no party has yet tried to take on powerful lobbies such as the trade unions and farmers, or contentious issues such as reforming labour laws and reducing agricultural subsidies. Thus, unlike the reforms of 1966 and 1985 that were carried out by the majority Congress governments, the reforms of 1991 carried out by a minority government proved sustainable. The 1990s have seen a marked increase in private capital flows to India, a trend that represents a clear break from the two decades before that. In the 1970s there was hardly any new foreign investment in India: infact some firms left the country. Inflows of private capital remained meagre in the 1980s: they averaged less than $0.2 billion per year from 1985 to 1990. In the 1990s, as part of wide ranging liberalization of the economy, fresh foreign investment was invited in a range of industries. Inflows to India rose steadily through the 1990s, exceeding $6 billion in 1996-97. The fresh inflows were primarily as portfolio capital in the early years (that is, diversified equity holdings not associated with managerial control), but increasingly, they have come as foreign direct investment (equity investment associated with managerial control). India was not unique as a recipient of increased inflows in the 1990s.International flows of private capital to most developing countries rose sharply over this period. The historically low interest rates in the US encouraged global investment funds to diversify their portfolios by investing in emerging markets. International flows of direct investment, which had averaged $142 billion per year over 1985-90, more than doubled to $350 billion in 1996, with the developing countries receiving $130 billion. Host country policies did influence the choice of location for this investment. The problems of foreign investment in India have been an issue of outstanding importance ever since the days of the East India Company and added significance after Indian Independence in 1947. In the 1950s and 1960s, the dominant form of foreign capital was foreign aid, mainly through government to government transfer of resources. In the late 1960s and early 1970s, foreign direct investment (FDI) came into prominence. The dominant form of foreign capital in the 1970s was the foreign private loan (FPL). In the late 1970s there was hardly any new foreign investment in India: indeed, some firms left the country. Inflows of private capital remained meager in the 1980s: they averaged less than $0.2 billion per year from 1985 to 1990. In the 1990s, as part of wide ranging liberalization of the economy, fresh foreign investment was invited in a range of industries. Inflows to India rose steadily through the 1990s.The fresh inflows were primarily as portfolio capital in the early years (that is, diversified equity holdings not associated with managerial control), but increasingly, they have come as foreign direct investment (equity investment associated with managerial control). 7
  • 8. Though dampened by global financial crises after 1997, net direct investment flows to India remain positive. Under the liberalized foreign exchange transactions regime, the results were dramatic. The liberalization of portfolio investment led to a surge in inflow of capital for investment in the primary and secondary market for Indian equity and corporate and subsequently sovereign bond market. FOREIGN CAPITAL IN INDIA-HISTORICAL SKETCH: Indus Valley Civilization: During Indus Valley Civilization Indian economy was very well developed. It had very good trade relations with other parts of the world, which is evident from the coins of various civilizations found at the site of Indus valley. Before the advent of East India Company, each village Food Commodities in India was a self sufficient entity. Each village was economically independent as all the economic needs were fulfilled with in the village. Cotton, grain, livestock, and other food stuffs were the major commodities of internal trade. There was also external trade with Central Asia, the Arabian Gulf region, and the distant Mesopotamian cities, such as Susa and Ur. Trade also existed with Northern Afghanistan from where the Harappans bought the famous blue gemstones, Lapis Lazuli. Mauryan period-The Northern Silk route: 8
  • 9. Under Chandragupta, the Mauryan Empire conquered the trans -Indus region, which was under Macedonian rule. Chandragupta then defeated the invasion led by Seleucus, a Greek general from Alexander's army. Under Chandragupta and his successors, both internal and external trade, and agriculture and economic activities, all thrived and expanded across India thanks to the creation of a single and efficient system of finance, administration and security. After the Kalinga War, the Empire experienced half a century of peace and security under Ashoka. India was a prosperous and stable empire of great economic and military power whose political influence and trade extended across Western and Central Asia and Europe. Mauryan India also enjoyed an era of social harmony, religious transformation, and expansion of the sciences and of knowledge. The Silk-Road is a unique example from history, of inter-continental cooperation and collaboration not only in the field of trade and commerce but also in the realm of ideas and culture. The Silk Road spanned a distance of almost 7000 miles from China through Central Asia, northern India and Parthian Empire, to the Roman Empire during the period of 200 BC to 14 century AD circa. It connected the Yellow River valley in China to the Mediterranean Sea, virtually connecting two continents, Asia and Europe, the east and the west. The German Baron Ferdinand von Richthofen coined the term ―Silk Road in the 1870s to describe what was, at its peak, one of the most important and dynamic centers of economic activity in the world, and the greatest trade route linking East to West. It was more than just a single route; rather, it was a river of connections stretching from south to north, and from East Asia to as far West as Europe, Egypt and other countries in Africa. Mughal Empire: The political economy of the Mughal Empire and of the European trade with India clearly marks out the age of Mughal rule as a distinct phase in the country's economic history. The centralized authority created by the Mughals had manifold implication for the economic life of the Indian people. The Mughals rendered possible a very substantial expansion in inter -regional trade, anticipating the emergence of an integrated market. In course of time the trade contributed to an undoubted increase in the absolute volume of India's exports and imports, stimulated Indian participation in overseas commerce and induced some positive developments in the 9
  • 10. manufacturing section of the economy and affected the fortunes of the Indian merchants in different ways by the patterns of competition and collaboration with the traders from abroad. The nature of India‘s trade, inland and foreign, has practically been the same in the ancient and medieval ages. During the medieval period t he whole of Northern and Western India had commercial relations with West Asia and extending through it to the Mediterranean world, as also to Central Asia, South-East Asia and China both oversea and overland routes. Throughout the Mughal period, the volume of Indian export through the north-western land routes continued fluctuating according to the atmosphere of amity or hostility prevailing between India and Persia on the question of the possession of Qandahar and sometimes on the relations between the Mughal government and the Portuguese. British/French/Portuguese: The period spanning a hundred and fifty years, between the death of the Mughal emperor Aurangzeb in 1707 AD, and the Sepoy mutiny in 1857 witnessed the gradual increase of the European influence in India. This was the time when the Europeans actually got involved in trade and commerce. Prior to this period, Europeans did arrive in India from time to time but these were no more than isolated incidents. All historians agree that the Portuguese explorer and adventurer Vasco da Gama was the first known European to reach India in 1498. It is believed that Gama had landed at Calicut (modern Kerala) in quest of spices and the famous Calico (fine cotton) cloth. The other Portuguese nationals who accompanied him were motivated by either missionary zeal or trading prospects. The Portuguese eventually settled down to a very prosperous trade in spices with India. The Muslim rulers (including the Mughals) were averse to the idea of a foreign power carrying on commercial activities on the high seas bordering India. Although the erstwhile French ruler Louis XII had granted letters of monopoly to French traders as early as 1611, it was only in 1667 that a French company was set up at Surat (Gujarat) with Francis Caron as its Director-General. In 1669, another French company was set up in Masulipatnam (Andhra Pradesh), after the then king of Golconda, exempted the French from paying import and export duty. 10
  • 11. Post Independence: The post independence period of economy of India was a litmus test for the economic planners. Having come out of the shadow of colonial rule, the nation had a huge challenge of undoing the exploitation of colonial era. The founding fathers had to use economic upliftment as a tool for nation building. The economy then was backward in nature. Indian economic policy after independence, influenced by the colonial experience (which was seen by Indian leaders as exploitative in nature), became protectionist in nature, implementing a policy of import substitution, industrialization, state intervention in labor and financial markets, a large public sector, overt regulation of business, and central planning. Jawaharlal Nehru, the first prime minister of India, along with the statistician Prasanta Chandra Mahalanobis, formulated and oversaw the economic policy of independent India. They expected favorable outcomes from this strategy since it involved both the public and private sectors and was based on direct and indirect state intervention instead of a Soviet-style central command system. The policy of concentrating simultaneously on capital and technology intensive heavy industry and subsidizing hand based and low - skilled cottage industries was criticized by economist Milton Friedman, who thought it would not only waste both capital and labor, but also retard the development of smaller manufacturers. The economic reforms that surged economic growth in India after 1980 can be attributed to two stages of reforms. The pro-business reform of 1980 initiated by Indira Gandhi and carried on by Rajiv Gandhi, eased restrictions on capacity expansion for incumbents, removed price controls and reduced corporate taxes. The economic liberalization of 1991, initiated by then Indian prime minister P. V. Narasimha Rao and his finance minister Manmohan Singh in response to a macroeconomic crisis did away with the License Raj (investment, industrial and import licensing) and ended public sector monopoly in many sectors, thereby allowing automatic approval of foreign direct investment in many sectors. Since then, the overall direction of liberalization has remained the same, irrespective of the ruling party at the centre, although no party has yet tried to take on powerful lobbies like the trade unions and farmers, or contentious issues like labor reforms and cutting down agricultural subsidies. Industry was characterized by ill equipped technology and unscientific management. Agriculture was still feudal in nature and characterized by low productivity. Transport and communication systems were not properly developed, educational and health facilities insufficient and the complete absence of social security measures. By the beginning of 1990‘s, the Indian Economy was under great crisis and faced its stiffest challenge. India faced a serious balance of payment problem and foreign exchange reserves were at record low. That is when the government decided to alter the course of the Indian economy. The introduction of reforms in 1991 resulted in sweeping changes in the Indian Economy. 11
  • 12. FOREIGN CAPITAL IN INDIA & WORLD-TRENDS: During the early phase of planning era, the national policy towards foreign capital did recognize the need of foreign capital, but decided not to permit it a dominant position19. Consequently, foreign collaboration had to keep their equity within the ceiling of 49 per cent and allow the Indian counterpart a majority stake. Moreover, foreign collaborations were to be permitted in priority areas, more especially those in which India had not developed capabilities. But in an overall sense, India’s policy towards foreign collaborations remained restrictive and selective. Consequently, during 1948 to 1960, a total of 1,080 foreign collaborations were approved and during the next decade (1961-70), a total of 2, 475 foreign collaborations were approved. During 1971-80 and 1981-90 the collaborations were 3,041 and 7,436 respectively 12
  • 13. It is revealed from the table that 78 per cent of total agreements (14,032) were technical collaboration agreements and only 22 per cent were related to direct foreign investment. With the introduction of reforms process in the early 1990s and after the announcement of New Industrial Policy, 1991, India has witnessed a significant increase in cross-border capital flows, a trend that represents a clear break form the previous two decades. India has one of the highest net capital flows among the emerging market economies (EMEs) of Asia. Prior to the recent global financial crisis, India achieved above 9% GDP growth for three years in a row21 (2005-06 to 2007-08). A strong global growth environment and large capital inflows played a significant role in this growth acceleration trend. The 2008 crisis abruptly interrupted this story, pushing the country’s GDP growth down to 6.7, reminding India the importance of capital inflows, which was believed to be underappreciated by policymakers during the pre-crisis period. As the adverse impact of credit crisis in US ebbed, the capital flows into India again accelerated. The trends in Capital inflows into India follow the same momentum as that for other emerging markets. As per UN report, below are the top 10 destination for FDI in 2014. Foreign direct investment (FDI) inflows to India increased by about 26 per cent to $35 billion in 2014, despite macroeconomic uncertainties and financial risks. 13
  • 14. China, however, received inflows worth $128 billion and with a modest increase of 3 per cent, went on to become the world's largest recipient of FDI. Brazil, another BRICS country and an emerging market like India, received $62 billion of FDI inflows. The U.S. fell to the third position, with inflows plummeting to almost a third of the 2013 level. Among the top 5 except US, others are developing economies — Hong Kong ($111 billion), Singapore ($81 billion) and Brazil ($62 billion). It's clear what India's next step should be to achieve growth: make foreign direct investment (FDI) a top priority. However, India offers only a hesitant welcome to FDI. It seeks investment in several industries, including manufacturing, construction, telecommunications and financial services, but not in others like multi-brand retail. Often, regulation allows only a minority investment for fear of losing domestic management control. For example, FDI in insurance companies is permitted up to 49% with restrictions on voting rights to ensure that management control of an insurance firm doesn't shift to a foreign entity. Concern of loss of management control is of much less importance compared to sacrifice of economic growth. Considering the potential of FDI to spur growth, India's ambivalence toward FDI is completely misplaced. If India wants to accelerate growth, it is imperative that the country attracts FDI in large, really large amounts. Growth results from domestic investment from savings, from productivity improvements and from foreign investments. Countries like China that have grown rapidly in recent decades have taken advantage of all three sources of economic growth. India, on the other hand, has tried to achieve growth without much FDI. However, India's approach to growth is like bringing a knife to a gunfight: it's destined to fail relative to other countries' growth strategies, which take advantage of FDI. To transcend from 5- 7% growth to 10-12% growth, FDI is essential. To put India's track record in attracting FDI in an international context, it's been at best a trickle compared to FDI into countries like Mexico and China. In the last 10 years, Mexico has attracted $247 billion of FDI net inflows and China $2 trillion, compared to India's $229 billion. From the standpoint of an average citizen, the comparison is worse because Mexico is far less populous than India or China. What matters to an average citizen is per-capita investment. On a per-capita basis, FDI net inflows for Mexico, China and India are $2,017, $1,531 and $183, respectively. No wonder the per-capita GDP of Mexico is $10,300, China $6,800 and India $1,500. Similarly Overseas direct investment by Indian companies fell by 72 per cent to $2.05 billion in January 2015, 14
  • 15. INDIA’S JOURNEY FROM LICENSE RAJ ERA TO GLOBALIZATION: Phase I: (1947-65) • Focus on government led investments in manufacturing • Several large PSUs in steel, chemicals, and power were set up • Many of these companies exist even today and are among the largest companies in their sectors Phase II: (1965-80) • Government involvement in industry increased • Strong licensing laws were introduced with a sustained focus on import substitution • PSUs and formation of several small-scale private sector manufacturing entities grew Phase III: (1980-90) • The government partially opened its economy to external trade 15
  • 16. • De-licensed some key sectors for private participation, leading to strong growth in a few sectors • Formation of Maruti Suzuki a s government’s 50:50 Joint Venture with Japan’s Suzuki Motors Phase IV: (Since early 1990s) • The industry was further liberalized • The scope of licensing was significantly reduced • Custom duties were slashed • FDI in various sectors was opened up Phase V: (2000 onwards) • Companies began to reap the rewards of the various phases of development learning Many Indian business enterprises became quite competitive and looked at taking on global players DETERMINANTS OF FOREIGN CAPITAL INFLOW: The factors that encourage or hinder international flows of capital can categorized into those that are external to the economies receiving the flow and the factors internal to those economies. For small open economies fluctuations in the world interest rates are a key factor inducing capital flows. Other external factors include terms of trade developments, the international business cycle and its impact on profit opportunities and any regulatory changes that affect the international diversification of investment portfolio at the main financial centers. Internal factors are most often related to domestic policy. For e.g. effective inflation stabilization programs can reduce macroeconomic risk and capital inflows. As the experience of various Latin American countries in the late 1970s shows, domestic policies may also attract speculative capital when policies may also attract speculative capital when policies are not fully credible often partial credibility of these policies leads to relatively high returns on short term assets, which attract foreign capital on grounds of inter temporal speculation. Several of these factors and trends interacted in the early 1990s to make to developing countries of Latin America and Asia fertile territory for the renewal of foreign lending. 16
  • 17. Lower interest rates in the developed nations attracted investors to the high-investment yields and improving economic prospects of economies in Asia and Latin America. Given the high external debt burden of many of these countries, low world interest rates also appear to have improved the creditworthiness of debtor countries that borrow at these rates. A large shift in capital flows to one or two large countries in a region may generate externalities for the smaller neighboring countries. These are the so-called contagion effects. for example, it could be argued that Mexico’s and Chile’s reentry into international capital markets in 1990 made investors more familiar and more willing to invest emerging markets in Latin America. Indeed, the more recent events suggest that the Mexican crisis of late 1994 tended to make the attitude of investors toward emerging markets more discriminating. Thus, foreign capital flow is affected by a number of factors. These factors depend on the nature of foreign capital. Below are host country determinants of Foreign Direct Investment 17
  • 18. 18
  • 19. CURRENT REGULATIONS TO MANAGE CAPITAL INFLOWS IN INDIA: Capital flows contribute in filling the resource gap in country like India where the domestic savings are inadequate to finance investment. Today, India requires approximately 500 billion US $ investment in infrastructure sector alone in the next 5 years for sustaining present growth rate of approximately 8-9 per cent. This amount is around 2.5 times more than the 10th Plan. Added to this, already, several infrastructure projects have reportedly been shelved and indefinitely delayed. Such huge mobilization of resources is not possible from India’s internal resources. Therefore, India need for capital in the form of ECBs and other foreign loans and aids. The broad principles that have guided India after the Asian crisis of 1997 are: (i) Careful monitoring and management of the exchange rate without a fixed or pre-announced target or a band; (ii)Flexibility in the exchange rate together with ability to intervene, if and when necessary; (iii)A policy to build a higher level of foreign exchange reserves which takes into account not only anticipated current account deficits but also ‘liquidity at risk’ arising from unanticipated capital movements; and (iv)A judicious management of the capital account. India’s exchange rate policy of focusing on managing volatility with no fixed rate target while allowing the underlying demand and supply conditions to determine the exchange rate movements over a period in an orderly way has stood the test of time. As a result of these timely and coordinated measures, India was successful in containing the contagion effect of the Asian crisis Keeping in view the growing requirements of foreign capital in India, Indian government has come up with many policies and liberalized regulations to manage foreign capital in India. Some of the important and recent measures taken by Indian government to manage foreign investments in India are as under: Foreign Direct Investment: FDI is permitted under the Automatic Route in items / activities in all sectors up to the sectoral caps except in certain sectors where investment is prohibited. Investments not permitted under the automatic route require approval from Foreign Investment Promotion Board (FIPB). The receipt of remittance has to be reported to RBI within 30 days from the date of receipt of funds and the issue of shares has to be reported to RBI within 30 days from the date of issue by the investee company. 19
  • 20. Advance against Equity: An Indian company issuing shares to a person resident outside India can receive such amount in advance. The amount received has to be reported within 30 days from the date of receipt of funds. There is no provision on allotment of shares within a specified time. The banks can refund the amount received as advance, provided they are satisfied with the bonafides of the applicant and they are satisfied that no part of remittance represents interest on the funds received. Foreign Portfolio Investment: FIIs: FIIs Investment by non-residents is permitted under the Portfolio Investment scheme to entities registered as FIIs and their sub accounts under SEBI (FII) regulations. Investment by individual FIIs is subject to ceiling of 10 percent of the PUC (Pollution under Control) of the company and limit for aggregate FII investment is subject to limit of 24 percent of PUC of the company. This limit can be increased by the company subject to the sectoral limit permitted under the FDI policy. The transactions are subject to daily reporting by designated ADs (Authorized Dealers) to RBI for the purpose of monitoring the adherence to the ceiling for aggregate investments. NRIs: The investment by NRIs under the Portfolio Investment Scheme is restricted to 5% by individual NRIs/OCBs (not incorporated in Bangladesh and Pakistan) and 10% in aggregate (which can be increased to 24 percent by the company concerned). ADR/GDR: Indian companies are allowed to raise resources through issue of ADR/GDR and the eligibility of the issuer company is aligned with the requirements under the FDI policy. The issues of sponsored ADR/GDR require prior approval of ministry of finance. Foreign Venture Capital Investors: FVCIs (Foreign Venture Capital Investors) registered with SEBI are allowed to invest in units of venture capital funds any limit. FVCI investment in equity of Indian venture capital undertakings is also allowed. The limit for such investments would be based on the sectoral limits under the FDI policy. FVCIs are also allowed to invest in debt instruments floated by the IVCUs (InVacare Corporation-US). There is no separate limit stipulated for investment in such instruments by FVCIs. External Commercial Borrowings: Under the Automatic Route, ECB up to US $ 500 million per borrowing company per financial year is permitted only for foreign currency expenditure for permissible end-uses of ECB. Borrowers in infrastructure sector may avail ECB up to US $ 100 million for Rupee expenditure for permissible end-uses under the Approval Route. In case of other borrowers, the limit for Rupee expenditure for permissible end-uses under the Approval Route has been enhanced to US$ 50 million from earlier limit of US $ 20 million. Entities in the services sector, viz., hotels, hospitals and software companies have been allowed to avail ECB up to US $ 100 million, per financial year, for the purpose of import of capital goods under the Approval Route. The all-in-cost interest ceiling for borrowings with maturity of 3-5 years has been increased from 150 basis points over 6-month LIBOR18 (London Inter-bank Offered Rate) to 200 basis points over 6-month LIBOR. Similarly, the interest ceiling for loans maturing after 5 20
  • 21. years period has been raised to 350 basis points over 6-month LIBOR from 250 basis points over 6-month LIBOR. Investment by NRIs in Immovable Properties: The NRIs are permitted to freely acquire immoveable property (other than agricultural land, plantations and farmhouses). There are no restrictions regarding the number of such properties to be acquired. The only restriction is that where the property is acquired out of inward remittances, the repatriation is restricted to principal amount for two residential properties. There is no such restriction in respect of commercial property. NRIs are also permitted to avail of housing loans for acquiring property in India and repayment of such loans by close relatives is also permitted. BENEFITS OF FOREIGN CAPITAL: 21
  • 22. Foreign direct investment has many advantages for both the investor and the recipient. One of the primary benefits is that it allows money to freely go to whatever business has the best prospects for growth anywhere in the world. That's because investors aggressively seek the best return for their money with the least risk. This profit motive is color-blind, doesn't care about religion or form of government. This gives well-run businesses -- regardless of race, color or creed -- a competitive advantage. It reduces (but, of course, doesn't eliminate) the effects of politics, cronyism and bribery. As a result, the smartest money goes to the best businesses all over the world, bringing these goods and services to market faster than if unrestricted FDI weren't available. Individual investors receive additional benefits. Their risk is reduced because they can diversify their holdings outside of a specific country, industry or political system. Diversification always increases return without increasing risk. Recipient businesses benefit by receiving management, accounting or legal guidance in keeping with the best practices used by their lenders. They can also incorporate the latest technology, innovations in operational practices, and new financing tools that they might not otherwise be aware of. By adopting these practices, they enhance their employees' lifestyles. This raises the standard of living for more people in the recipient country. FDI rewards the best companies in any country. This reduces the influence of local governments over them, making them less able to pursue poor economic policies. The standard of living in the recipient country is also improved by higher tax revenue from the company that received the foreign direct investment. However, sometimes countries neutralize that increased revenue by offering tax incentives to attract the FDI in the first place. Another advantage of FDI is that it can offset the volatility created by "hot money." Short-term lenders and currency traders can create an asset bubble in a country by investing lots of money in a short period of time, then selling their investments just as quickly. This can create a boom-bust cycle that can ruin economies and political regimes. Foreign direct investment takes longer to set up, and has a more permanent footprint in a country. One of the advantages of foreign direct investment is that it helps in the economic development of the particular country where the investment is being made. This is especially applicable for developing economies. During the 1990s, foreign direct investment was one of the major external sources of financing for most countries that were growing economically. It has also been noted that foreign direct investment has helped several countries when they faced economic hardship. 22
  • 23. An example of this can be seen in some countries in the East Asian region. It was observed during the 1997 Asian financial crisis that the amount of foreign direct investment made in these countries was held steady while other forms of cash inflows suffered major setbacks. Similar observations have also been made in Latin America in the 1980s and in Mexico in 1994-95. Further than economic benefits FDI can help the improvement of environment and social condition in the host country by relocating ‘cleaner’ technology and guiding to more socially responsible corporate policies. For host countries, inward FDI has the potential for job creation and employment, which is often followed by higher wages. Resource transfer, in terms of capital and technical knowledge, is also a key motivator that encourages inward FDI. In recent years, FDI has been used more as a market entry strategy for investors, rather than an investment strategy. Despite the decline in trade barriers, FDI growth has increased at a higher rate than the level of world trade as businesses attempt to circumvent protectionist measures through direct investments. With globalization, the horizons and limits have been extended and companies now see the world economy as their market. Additionally for investors, FDI provides the benefits of reduced cost through the realization of scale economies, and coordination advantages, especially for integrated supply chains. The preference for a direct investment approach rather than licensing and franchising can also been viewed in terms of strategic control, where management rights allows for technological know- how and intellectual property to be kept in-house. Apart from being a critical driver of economic growth, foreign direct investment (FDI) is a major source of non-debt financial resource for the economic development of India. Foreign companies invest in India to take advantage of cheaper wages, special investment privileges like tax exemptions, etc. For a country where foreign investments are being made, it also means achieving technical know-how and generation of employment. The continuous inflow of FDI in India, which is now allowed across several industries, clearly shows the faith that overseas investors have in the country's economy. 23
  • 24. The Indian government’s policy regime and a robust business environment have ensured that foreign capital keep flowing into the country. The government has taken many initiatives in recent years such as relaxing FDI norms across sectors such as defense, PSU oil refineries, telecom, power exchanges and stock exchanges, among others. Some of the features of FDI in India are as follows: Market Size According to a recent report by global credit rating agency Moody’s, FDI inflows have increased significantly in India in the current fiscal. This, according to Moody’s, is due to India’s current pro-growth policies. Net FDI inflows totalled US$ 14.1 billion in the first five months of 2014- 15, representing a 33.5 per cent increase from the same period in 2013-14. Total FDI inflows into India in the period April 2000–November 2014 touched US$ 350,963 million. Total FDI inflows into India during the period April–November FY15 was US$ 18,884 million. Mauritius is again emerging as the largest source of FDI in India, accounting for an inflow of US$ 83,730 million in the April 2000-November 2014 period. According to official data, the inflow of foreign investment from Singapore amounted to US$ 29,193 million, followed by the UK at US$ 21,761 million and Japan at US$ 17,557 million during April 2000- November 2014. Government Initiatives India’s cabinet has cleared a proposal which allows 100 per cent FDI in railway infrastructure, excluding operations. Though the initiative does not allow foreign firms to operate trains, it allows them to do other things such as create the network and supply trains for bullet trains etc. The government has notified easier FDI rules for construction sector, where 100 per cent overseas investment is permitted, which will allow overseas investors to exit a project even before its completion. It also said that 100 per cent FDI will be permitted under automatic route in completed projects for operation and management of townships, malls and business centres. With the objective of encouraging foreign firms to transfer state-of-the-art technology in defence production, the government may increase the FDI cap for the sector to 74 per cent from 49 per cent at present. India is expected to spend US$ 40 billion on defence purchases over the next 4-5 years, mostly from abroad. 24
  • 25. The Union Cabinet has cleared a bill to raise the foreign investment ceiling in private insurance companies from 26 per cent to 49 per cent, with the proviso that the management and control of the companies must be with Indians. The Reserve Bank of India (RBI) has allowed a number of foreign investors to invest, on repatriation basis, in non-convertible/ redeemable preference shares or debentures which are issued by Indian companies and are listed on established stock exchanges in the country. In an effort to bring in more investments into debt and equity markets, the RBI has established a framework for investments which allows foreign portfolio investors (FPIs) to take part in open offers, buyback of securities and disinvestment of shares by the Central or state governments. One who has studied finance would not deny the fact that there are many benefits of FDI for any country. It certainly gives an opportunity to the economy to improve its foreign exchange and thus stand on a more stable financial platform. At the same time, FDI directly increases the number of employment available in the country. With every FDI coming into the country, new and new jobs would be created. FDI brings fresh capital and helps the economy build a healthy capital along with helping the domestic market learn better technology, intellectual property and management skills. In short, FDI is a means for any developing economy to keep abreast with the latest in the world. Nevertheless, FDI increases the exports directly and helps economy generate higher tax revenues. Some of the advantages of Foreign Capital are: Integration into global economy - Developing countries, which invite FDI, can gain access to a wider global and better platform in the world economy. Economic growth - This is one of the major sectors, which is enormously benefited from foreign direct investment. A remarkable inflow of FDI in various industrial units in India has boosted the economic life of country. Trade - Foreign Direct Investments have opened a wide spectrum of opportunities in the trading of goods and services in India both in terms of import and export production. Products of Superior quality are manufactured by various industries in India due to greater amount of FDI Inflows in the country. Technology diffusion and knowledge transfer – FDI apparently helps in the outsourcing of knowledge from India especially in the Information Technology sector. Developing countries by inviting FDI can introduce world-class technology and technical expertise and processes to their existing working process. MNCs may not only invest in new capacity. They may also introduce new working practices that help increase labour productivity. For example, when Japanese firms invested in the UK, it was said that they helped to improve labour relations and get more out of the workforce. Therefore, it can contribute to increased labour productivity. 25
  • 26. Foreign expertise can be an important factor in upgrading the existing technical processes. For example, the civilian nuclear deal led to transfer of nuclear energy know-how between the USA and India. Surplus on the Financial Account of the Balance of Payments-Capital inflows from abroad can help to balance out a current account deficit. Without the inflows, a current account deficit could cause devaluation in the exchange rate. One time effect is that the capital account of the host country benefits from the initial capital inflow. Also foreign capital is a substitute for imports of goods or services, it can improve the current account of the host country’s balance of payment. Much of the FDI by Japanese automobile companies in the US and UK, can be seen as substitute for imports from Japan. At times Multinational company uses foreign subsidiary to export goods and services to other countries. Lower Prices for Consumers: Investment from foreign firms offers the chance for goods to be produced more efficiently and could lead to lower prices for domestic firms. Increased competition - FDI increases the level of competition in the host country. Other companies will also have to improve on their processes and services in order to stay in the market. FDI enhanced the quality of products, services and regulates a particular sector. Linkages and spillover to domestic firms- Various foreign firms are now occupying a position in the Indian market through Joint Ventures and collaboration concerns. The maximum amount of the profits gained by the foreign firms through these joint ventures is spent on the Indian market. Human Resources Development - Employees of the country which is open to FDI get acquaint with globally valued skills. By transferring knowledge, FDI will increase the existing stock of knowledge in the host country through labour training, transfer of skills, and the transfer of new managerial and organizational practice. Foreign management skills acquired through FDI may also produce important benefits for the host countries. Beneficial spin-off effect arise when local personnel who are trained to occupy managerial, financial and technical posts in the subsidiary of a foreign MNE leave the firm and help to establish local firms. Similar benefits may arise if the superior management skills of a foreign MNE stimulate local suppliers, distributors and competitors to improve their own management skills. Workers gain new skills through explicit and implicit training. In particular, training in foreign firms may be of a higher quality given that only the most productive firms trade. Workers take these skills with them when they re-enter the domestic labour market. Training received by foreign companies sometimes may be considered under the general heading of ‘organization and management’, meaning that the host country will benefit from the ‘managerial superiority’ of MNCs. Increased productive capacity- Inward investment will not only increase Aggregate Demand, but also increase Aggregate Supply. Investment in new factories increases productive capacity and Aggregate Supply should shift to the right. This enables an increase in economic growth without inflation. Employment - The effects on employment associated with FDI are both direct and indirect. In 26
  • 27. countries where capital is relatively scarce but labour is abundant, the creation of employment opportunities – either directly or indirectly – has been one of the most prominent impacts of FDI. The direct effect arises when a foreign MNE employs a number of host country citizens. Whereas, the indirect effect arises when jobs are created in local suppliers as a result of the investment and when jobs are created because of increased local spending by employees of the Multinational enterprises. Investment- The government has announced that foreign investors can put in as much as Rs 90,300 crore (US$ 14.65 billion) in India’s rail infrastructure through the FDI route, according to a list of projects released by the Ministry of Railways. The Rs 63,000 crore (US$ 10.22 billion) Mumbai-Ahmedabad high-speed corridor project is the single largest. The other big ones include the Rs 14,000 crore (US$ 2.27 billion) CSTM-Panvel suburban corridor, to be implemented in public-private partnership (PPP), and the Rs 1,200 crore (US$ 194.79 million) Kachrapara rail coach factory, besides multiple freight line, electrification and signalling projects. Israel-based world's seventh largest agrochemicals firm ADAMA Agrochemicals, formerly known as Makhteshim Agan Industries, plans to invest at least US$ 50 million over the next three years. ADAMA's global president and Chief Executive Chen Lichtenstein said the idea was to expand both manufacturing and research and development facilities in India aimed at growing better than the average industry growth. Apple - world's most admired electronics brand - that sells devices such as the iPhone, iPad tablet and iPod media player – is planning to open 500 'iOS' stores in India in its first major push that will include moving into smaller towns and cities. The Department of Industrial Policy and Promotion (DIPP) has moved a Cabinet note to allow 100 per cent FDI in medical devices as part of a strategy to not only reduce imports but also promote local manufacturing for the global market, which will be worth over US$ 400 billion next year. Real estate private equity FDI is set to double after the Indian government ended the three-year lock-in and has introduced 100 per cent FDI for completed assets, according to JLL India. With India now allowing 100 per cent FDI in the construction sector, real estate private equity investment could double – and boost demand from overseas property buyers, according to sector experts. FDI real estate private equity, which is currently estimated at around US$ 1billion - US$ 1.5 billion per annum, could reach to up to US$ 3 billion in the next few years, according to leading agency, JLL India. The Ministry of Finance has announced that it has cleared 15 FDI applications, including that of Panacea Biotech and Sanofi-Synthelabo (India), and recommended HDFC Bank's proposal to hike foreign holding to the Cabinet for consideration. Some of the advantages of FDI in India to the investing country are 1. Huge Market Size and a Fast Developing Economy: 27
  • 28. India is the second largest country in the world just behind China in terms of population. Currently the total population is about 1.2 billion. This huge population base automatically makes a huge market for the business operators to capture and also a major part of it is still can be considered as un-served or not yet been penetrated. Therefore FDI investors automatically get a huge market to capture and also ample opportunity to generate cash inflows at relatively quicker times. The economy of India is also moving at faster pace than most of the economy of the world and inhabitants of the country also obtaining purchasing power at the same rate. 2. Availability of Diversified Resources and Cheap Labor Force: The huge advantage every company gets by investing in India is the availability of diversified resources. It is a country where different kinds of materials and technological resources are available. India is a huge country and has forest as well as mining and oil reserve as well. These are also coupled with availability of very cheap labour forces at almost every parts of the country. From Mumbai which is in the west to Bengal which is in the east there is ample opportunity to set up business venture and location and most importantly labour is available at low cost. 3. Increasing Improvement of Infrastructure: A lot of research study in India finds out that historically the country fails to attract a significant amount of FDI mainly because of problems in infrastructure. But the scenario is changing. The Indian government has taken huge projects in transportation and energy sectors to improve the case. The projects for developing road transport is worth of $90 billion, for rail it has undertaken several projects each worth of $20 million and for ports and airports the value of development projects is around $ 80 billion. In addition the investment in energy development is worth of $167 billion and investment in nuclear energy development is outside that calculation. These huge investments are changing the investment climate in the country and investors will benefit hugely by that. 4. Public Private Partnerships: Another significant advantage foreign investors experience in India today is the opportunities of PPP or Public private Partnership in different important sectors like energy, transportation, mining, oil industry etc. It is advantageous in several ways as it has eliminated the traditional trade barriers and also joint venture with government is risk free up to the great extent. 5. IT Revolution and English Literacy: 28
  • 29. Today the modern India is considered to be one of the global leaders in IT. India has developed its IT sectors immensely in last few years and as of today many leading firms outsource their IT tasks in India. Because of IT advancement the firm which will invest in India will get cheap information access and IT capabilities as Indian firms are global leader. Along with that Indian youth are energetic and very capable in English language which is obligatory in modern business conduction. This capability gives India an edge over others. Foreign firms also find it profitable and worthy investment by recruiting Indians. 6. Openness towards FDI: Recently the Government of India has liberalized their policies in certain sectors, like Increase in the FDI limits in different sectors and also made the approval system far easier and accessible. Unlike the historical tradition, today for investing in India government approval do not require in the special cases of investing in various important sectors like energy, transportation, telecommunications etc 7. Regulatory Framework and Investment Protection: In the process of accelerating FDI in the country the government of India has make the regulatory framework lot more flexible. Now a day’s foreign investors get different advantages of tax holiday, tax exemptions, exemption of service and central taxes. The government also opened few special economic zones and investors of those zones also get a lot of benefits by investing money. Apart from that there are number of laws has been passed and executed for making the investments safe and secure for the foreign investors 29
  • 30. DISADVANTAGES OF FOREIGN CAPITAL FDI comes with various benefits for any economy, however, is a fear to the local businesses. Domestic companies see it as a threat to their business, since they find themselves nowhere to compete with global companies. They surely would edge out somewhere in their businesses. One of the major drawbacks of FDI, however, is that larger companies monopolize the market and make it quite tougher for the small enterprises, leaving no room for budding companies. Moreover, government has lesser controls over these global giants as they work as a subsidiary of a global overseas entity. Too much foreign ownership of companies can be a concern, especially in industries that are strategically important. Second, sophisticated foreign investors can use their skills to strip the company of its value without adding any. They can sell off unprofitable portions of the company to local, less sophisticated investors. Or, they can borrow against the company's collateral locally, and lend the funds back to the parent company. The net benefits from FDI do not accrue automatically, and their importance differs according to host country and condition. Recognition of the economic benefits afforded by freedom of capital movements sometimes clash with concerns about loss of national sovereignty and other possible adverse consequences. FDI, even more than other types of capital flows, has historically given rise to these conflicting views, because FDI involves a controlling stake by often large 30
  • 31. Multinational enterprises over which domestic governments, it is feared, have little power. In small economies, large foreign companies can and often do, abuse their dominant market positions. Based on the literature, it is eminent that FDI is not always in the host county’s best interest and therefore it should be controlled. The experience of the past two decade has shown that with capital flows can bring substantial risks to both the providers and the recipients of international capital flows. During the 1970s, the banks of the United States and other industrial countries recycled OPEC surpluses and their own national savings to eager borrowers abroad, particularly in Latin America. Low real interest rates and high commodity prices encouraged borrowers to accept more credit and expand their activities. But when the U.S. Federal Reserve finally acted decisively to reduce the spiraling double digit inflation, real dollar interest rates rose sharply, reducing economic activity and lowering commodity prices and demands. The debtor countries of Latin America, led by Mexico in the summer of 1982, found that they could not get the increased credit that would be needed to pay the high interest rates and to offset the shortfall of export earnings. The result was a debt moratorium that engulfed nearly all of the Latin American countries. During the rest of the decade, the borrower countries went through a painful transition as they lowered domestic consumption in order to reduce their dependence on imported capital, to pay the high interest rates on their growing debts, and to compensate for the decline in exports. The creditor banks that had lent to the Latin American countries were also hard hit during this period as the loan write-downs impaired bank capital, causing bank regulators to require dividend suspensions and other changes in the banks' activity. Further defaults by the borrower countries could have made major commercial banks technically insolvent and led to their being closed by the regulators. Countries facing increased inflows of Foreign capital have often experienced unease. Many developing countries have until recently been wary of inward FDI. Even in the United States, the surge of Japanese FDI in the 1980s led to widespread concerns about excessive foreign control and adverse effects on national security, as expressed in the popular press, and in legislative action. Moreover, sometimes some estimated benefits may prove elusive if the host economy, in its current state of economic development, is not able to take advantage of the technologies or know-how transferred through FDI. The factors that hold back the full benefits of FDI in some developing countries include the level of general education and health, the technological level of host-country enterprises, insufficient openness to trade, weak competition and inadequate regulatory frameworks. On the other hand, a level of technological, educational and infrastructure achievement in a developing country does, other things being equal, equip it better to benefit from a foreign presence in its markets Investing in India definitely has some negative sides as well. Most noticeably India considered as a huge market but a major portion of that is a lower and middle class person who still suffers from budget shortage. The infrastructure of the country also needs to be improved a lot and already it is under huge strain. There are also problems exists in the power demand shortfall, port traffic capacity mismatch, poor road conditions deal with an inefficient and sometimes still slow- moving bureaucracy. The huge market in India is an advantage but it is also very diverse in nature. India has 17 official languages, 6 major religions, and ethnic diversity as wide as all of Europe. This makes the tasks difficult for the companies to make appropriate product or service 31
  • 32. portfolio. India is not a member of the International Centre for the Settlement of Investment Disputes also not of the New York Convention of 1958. That make life bit difficult for the foreign investors. India still has a heavy regulation burden among other countries, for example the time taken to start business or to register a property is higher in India. Similarly, indirect taxes, entry-exit barriers and import duties have been major disadvantages. Some of the disadvantages of foreign capital and FDI in particular are: 1. Adverse Effects on Employment: Critics about FDI note that not all the ‘new jobs’ created by Foreign capital flow represent net additions in employment. In the case of FDI by Japanese auto companies in the US, some argue that the jobs created by this investment have been more than offset by the jobs lost in US- owned auto companies, which have lost market share to their Japanese competitors. As a consequence of such substitution effects, the net number of new jobs created by FDI may not be as great as initially claimed 2. Adverse Effect on Competition: Although previously I have outlined how FDI can boost competition, host governments sometimes worry that the subsidiaries of foreign Multinational Enterprises may have greater economic power than local competitors. If it is a part of large international organization, the foreign Multinational Enterprises may be able to draw on funds generated elsewhere to subsidize its costs in the host market, which could drive local companies out of business and allow the firm to monopolize the market. 3. Adverse Effects on Balance of Payments: There are two main areas of concern with regard to the adverse effects of FDI on a host country’s balance of payments. First, set against the initial capital inflow that comes with FDI must be the subsequent outflow of earnings from the foreign subsidiary to its parent company. Such outflows show up as a debit on the capital account. Some governments have responded to such outflows by restricting the amount of earnings that can be repatriated to a foreign subsidiary’s home country. A second concern arises when a foreign subsidiary imports a substantial number of inputs from abroad, which results in a debit on the current account of the host country’s balance of payment. 4. Environmental impact: Another major concern regarding Foreign Capital is its environmental impact. Local enforcement of environmental protection legislation that is negligent or weak in relation 32
  • 33. to foreign firms has led to disastrous consequences in many parts of the world. However, in the global competition among developing country governments to attract Foreign CapitaI, there is often a race to the bottom, which leads countries to offer more relaxed regulations in order to attract foreign investment. 5. Sweatshops: The working conditions of workers in firms sponsored by FDI have also been a concern. The presence of sweatshops in some countries, which subject laborers, who are sometimes child laborers, to dangerous, sub-human working conditions, often in violation of local workplace regulations, is a serious issue. The race to the bottom phenomenon is also present here, as governments minimize the enforcement of workplace regulations in order to attract FDI. Although multinationals pay their workers more than their competitors, many people have complained that multinationals abuse their workers in sweatshop conditions, and have demanded that products from these sweatshops be banned. CASE STUDY Emerging India in modern times prove to be one of the perfect destination for foreign investors to put their money and get expected return. Historical scenario reveals that a few numbers of foreign companies were really successful in doing business in the country. Along the way they have faced few drawbacks but they were really efficient in keeping away those drawbacks and move along. The success of few Korean companies is remarkable in India. Ever since the Indian Government reform the policy Korean companies have come up and make a lot of investment in India by forming joint ventures and also made few Greenfield investments in the sectors of automobiles, consumer goods and other sectors. The success of Korean companies mainly highlighted by three big companies Hyundai, LG and Samsung. Among those the case of Hyundai Motor Corporation is most remarkable and worth of noticing and analyzing. The company manufactures 120000 cars annually in India and it is the second largest production base of Hyundai Motors only next best to the domestic one in Korea. That picture tells the whole story of the advantage the organization gets in investing in India. Apart from manufacturing, India is the second largest overseas market for the company after the US, where it sells 5, 00,000 cars a year. They only get this huge advantage because of a larger population base in India that always provides unlimited opportunity for growth. The operation of the company is bit different and it gets backed by the local authority. Unlike the most multinational companies of the world it invests in an aluminum foundry and also a transmission line so that it could increase indigenization levels and cut costs. 33
  • 34. As a result, HMI has achieved indigenization levels of over 85 per cent. They exercise such R&D practice and it is also supported by the regulatory reform of the India. Apart from market, development and regulatory advantages the company also benefited from forming joint venture with Indian companies and by that they get involved in very profitable Greenfield investment. Hyundai motors also allowed developing large industrial clusters in Chennai and a huge manufacturing base. From that location they serve the demand of neighbouring markets like Bangladesh, Pakistan, Nepal, Srilanka and also of ASEAN countries FDI in India also helped the company in gaining local human resources and cheap labour costs. In India they also benefited by increasing demand of growing Indian economy and people interest of having car in their property base. Hyundai motors huge success in India also rooted into the fact that India is proved to be one of the most convenient place for investing specially considering its very bright future prospects and un-served market to capture. The journey of Hyundai motors in India is always not smooth, though. Over the years it has to deals with problems like labour dispute, energy shortage, bureaucratic hassles etc. But even considering those issues the advantages outweigh the disadvantages by great margin. MAKE IN INDIA 'Come, Make in India'! Prime Minister Narendra Modi's aggressive push to revive an ailing manufacturing sector, has found resonance not only across India Inc but also world over. Make in India is an initiative of the Government of India, to encourage companies to invest in the manufacturing sector in India. It was launched by Prime Minister, Narendra Modion 25 September 2014. 34
  • 35. The major objective behind the initiative is to focus on 25 sectors of the economy for job creation and skill enhancement. Some of these sectors are: automobiles, chemicals, IT, pharmaceuticals, textiles, ports, aviation, leather, tourism and hospitality, wellness, railways, auto components, design manufacturing, renewable energy, mining, bio-technology, and electronics. The initiative aims at high quality standards and minimizing the impact on the environment and hopes to attract foreign capital and technological investment in India In February 2015, Hitachi said it was committed to the initiative. It said that it would increase its employees in India from 10,000 to 13,000 and it would try to increase its revenues from India from ¥100 billion in 2013 to ¥210 billion. Other countries like Turkey and Israel have also agreed to be part of this program. ROAD AHEAD Foreign capital has a key role to play in the economic development of India. There are several ways in which capital flows and economic growth are related. However, impact of capital flows 35
  • 36. on economic growth ultimately depends on their being stable and less volatile. Indian government has been continuously proceeding for economic reforms and is quiet assured to secure legislation to allow more foreign investment in various sectors. The size of net capital inflows to India has increased significantly in the post reform period. It is also important to note that capital inflows increased extensively since 2005. Foreign investment inflows are expected to increase by more than two times and cross the US$ 60 billion mark in FY15 as foreign investors start gaining confidence in India’s new government, as per an industry study. Riding on huge expectations from the incoming Modi government, global investors are gung ho on the Indian economy which is expected to witness over 100 per cent increase in foreign investment inflows – both FDI and FIIs – to above US$ 60 billion in the current financial year, as against US$ 29 billion during 2013-14," according to the study. India will require around US $1 trillion in the 12th Five-Year Plan (2012–17), to fund infrastructure growth covering sectors such as highways, ports and airways. This requires support in terms of FDI. The year 2013 saw foreign investment pour into sectors such as automobiles, computer software and hardware, construction development, power, services, and telecommunications, among others. In fact, India has experienced both sudden increase and sudden declines of capital flows. Various studies explored that both excess and sudden declines (siphoning-off) of capital inflows are harmful for an economy. But sudden declines in capital inflows are more harmful as sudden declines of capital inflows may lead any economy into insolvency and affect the various macroeconomic variables. Therefore, effective buttressing of these capital inflows is a key economic policy issue today. Countries with sound macroeconomic policies and well- functioning institutions are in the best position to reap the benefits of capital flows and minimize the risks. India's inability to deal with capital inflows is partly a result of the government doing less of what it should do more of, and doing more of what it should do less of. The government’s decision to open up Foreign Direct Investment (FDI) in the retail sector has created uproar however FDI will give ample opportunities to the unemployed (lower class) and also improve the quality of the product. Beyond the power of the kirana lobby, public sentiment runs high on this issue because in a poor country where there is no insurance in the form of social safety nets, a very large number of people view such stores as insurance. In the short run, there is little cost but much political gain in opposing modern retail. . There is precious little in terms of economic reforms, but the government has gone to great lengths to encourage more capital inflows. It is important to understand that the perceived threat of modern retail for kiranas is much larger than the reality. Even as modern retail gains market share, kiranas are not going extinct—at least not in the foreseeable future. As India’s incomes rise, so will consumption; with increased consumption, both kiranas and modern retail will continue to grow by sharing in a larger pie. The overall expansion of the market would be much higher than the effect of the loss in share. In addition, the increased efficiencies and reduced losses due to superior cold-chain and supply-side infrastructure means that manufacturers can increase profits without squeezing retail margins as much. 36
  • 37. Also foreign retail investments would be only establishing themselves in metropolitan and centralized cities whereas in India most of the local areas and villages already have the local retail shops. In this hyper competitive and ever changing business environment no business organization is certain about tomorrow. That forces them to look for new destination and new market to capture. The emerging market of India without any doubt poses suitable choice for those companies. Huge population and huge countryside is certainly making it even more attractive. There are several benefits in investing like-very bright future, cheap labor and raw materials, sound infrastructure, huge market availability. Easiness in regulatory framework, efficient human resources, investment protect and also efficient promotion mechanisms. However, factors like hugely diversified culture in India make life bit difficult for the operators, but the benefits are overwhelming in compare to drawbacks. That is the prime reason why it will keep attracting foreign investors and will remain as the most attractive paces to put the money and earn future dividend. The experience of Hyundai Motor Corporation in India also reveals the same picture and thus supports the above mentioned conclusion. BIBLIOGRAPHY: 1. Effects of FDI in Indian Economy – Sourangsu Banerji. 37
  • 38. 2. Foreign Direct Investment & Developing Countries. Its Impact and Significance – Dr. Lalita Shukla 3. Foreign Direct Investment in India – Punjab University 4. Foreign Capital & Economic Growth – Raghuram G. Rajan and Eswar S. Prasad. 38