India integration with the world economy some emerging issues by bhawani nandan prasad iim calcutta
India’s Integration with the WorldEconomy: Some Emerging IssuesBHAWANI NANDAN PRASADSMP – IIM CalcuttaMBA – Stratford UniversityB.E. ( Computer Sc. IT )
Channels of Integration with the world economy• Economic– International Trade in goods and services– International investment flows– International financial markets– Exchange rates• Integration driven by technology• Integration due to increased diplomatic and strategicpresence in international forums
International Economics-linkages• Current AccountTransactions– Trade in goods (merchandisetrade)– Trade in services– Other current accounttransactions• Capital Account Transactions– Inflow and outflow of capital– Includes foreign direct investment,foreign portfolio capital flows– Other debt creating capital flows likeexternal commercial borrowingExchange ratesForeign Exchange Reserves
India’s Current Account‘Government not included elsewhere (GNIE)’ receipts represent inward remittances towards maintenance of foreignembassies, diplomatic missions and offices of international/regional institutions in India, while GNIE paymentsrecord the remittances on account of maintenance of Indian embassies and diplomatic missions abroad andremittances by foreign embassies on their account.
Trade Balance to GDP ratio of India (as a % of GDP)-15-10-50510152025301970-711971-721972-731973-741974-751975-761976-771977-781978-791979-801980-811981-821982-831983-841984-851985-861986-871987-881988-891989-901990-911991-921992-931993-941994-951995-961996-971997-981998-991999-002000-012001-022002-032003-042004-052005-062006-072007-082008-092009-102010-11Export to GDP Import to GDP Trade Balance to GDP
Trade to GDP ratio of India (as a % of GDP)0510152025303540451970-711971-721972-731973-741974-751975-761976-771977-781978-791979-801980-811981-821982-831983-841984-851985-861986-871987-881988-891989-901990-911991-921992-931993-941994-951995-961996-971997-981998-991999-002000-012001-022002-032003-042004-052005-062006-072007-082008-092009-102010-11Export to GDP Import to GDP Trade to GDP
Other Terms in Current Account• Transfers (Official, Private)– Transfers represent one-sided transactions, i.e., transactions that do not have any quid pro quo, such as grants, gifts, and migrants’transfers by way of remittances for family maintenance, repatriation of savings and transfer of financial and real resources linked tochange in resident status of migrants.– Official transfer receipts include grants, donations and other assistance received by the Government from bilateral and multilateralinstitutions. Similar transfers by Indian Government to other countries are recorded under official transfer payments.• Income– Transactions are in the form of interest, dividend, profit and others for servicing of capital transactions.– Investment income receipts comprise interest received on loans to nonresidents, dividend/profit received by Indians on foreigninvestment, reinvested earnings of Indian FDI companies abroad,– interest received on debentures, floating rate notes (FRNs), Commercial Papers (CPs), fixed deposits and funds held abroad by ADsout of foreign currency loans/export proceeds,– payment of taxes by nonresidents/refunds of taxes by foreign governments, interest/discount earnings on RBI investment etc.– Investment income payments comprise payment of interest on non-resident deposits, payment of interest on loans fromnonresidents, payment of dividend/profit to nonresident share holders,– reinvested earnings of the FDI companies, payment of interest on debentures, FRNs, CPs, fixed deposits, Governmentsecurities, charges on Special Drawing Rights (SDRs) etc.– In accordance with the IMF’s Balance of Payments Manual (5th edition), ‘compensation of employees’ has been shown underhead, “income” with effect from 1997-98; earlier, ‘compensation of employees’ was recorded under the head “Services –miscellaneous
For India, remittances to GDP ratio is about 4%Top recipient of remittances among developing countries
What Are Foreign Exchange Reserves?• Reserves as external assets that are readilyavailable to and controlled by monetaryauthorities– for direct financing of external paymentsimbalances,– for indirectly regulating the magnitudes of suchimbalances through intervention in exchangemarkets to affect the currency exchangerate, and/or– for other purposes
Sources of Accretion to Foreign Exchange Reserves since 1991(US$ billion)Items 1991-92 to 2010-11(Upto September 2010)A Reserves as at end-March 1991 5.8B.I. Current Account Balance -144.7B.II. Capital Account (net) (a to e) 415.7a. Foreign Investment 236.2Of whichFDI 102.7FII 103.0b. Other Deposits 39.1c. External Assistance 24.3d. External Commercial Borrowings 76.7e. Other items in Capital Account* 39.0B.III. Valuation Change 16.5Reserves as at end-September 2010 (A+BI+BII+BIII) 292.9* : Include errors and omissions.
Optimum level of Reserve…1• The optimal level of reserves is neither infinite since reservesentail costs, nor zero since reserves yield benefits.• Calculation of optimum or sufficient reserve is important fromthe point of view of developing SWFs.• Nature of the foreign exchange and composition of assets andliabilities are important to understand when calculatingoptimum reserve.
Sovereign Wealth Funds• SWFs generally refer to special purpose investment vehicles created to managenational savings to generate higher returns.• The non-commodity SWFs are usually carved out of the official reserves of acountry. Countries having large balance of payments surpluses have been able totransfer excess foreign exchange reserves to such investment vehicles.• Typically, countries that have set up SWFs have surplus on the current account dueto “windfall” or sustained current account surpluses, and usually a fiscal surplus aswell.• The main policy rationale behind setting up a SWF is not to acquire strategic assetsand secure supply of natural resources. Such funds are established to manageexcessive foreign exchange reserves, commodity exports, the proceeds ofprivatisations and fiscal surpluses. For instance, China established its SWF, ChinaInvestment Corporation, with a $200 billion corpus to manage its excessive forexreserves, which reached 2.4 trillion by end-June 2010.
Different Modes of Entry in a foreign market• Through trade: movements of goods and services• Through establishing a presence in the foreignterritory– Foreign Direct Investment– Foreign Portfolio Investment• Through non-equity modes of International production(like outsourcing, franchise model, licensing etc.)
Foreign Direct Investment• FDI refers to international capital flows inwhich a firm in one country creates orexpands a subsidiary in another• It involves not only a transfer of resources butalso the acquisition of control• The subsidiary does not simply have a financialobligation to the parent company; it is part of the sameorganizational structure.
Types of FDI: Based on Modes of Entry• Greenfield investment:– Greenfield FDI is when acompany builds a newproduction facilityabroad.• Acquisition• Merger• Joint ventureBrownfield FDI
Types of FDI: Horizontal FDI• Horizontal FDI is dominated by flows between developed countries.– Both the multinational parent and the affiliates are usually located indeveloped countries.• The main reason for this type of FDI is to locate production near afirm’s large customer bases.– Hence, trade and transport costs play a much more important role thanproduction cost differences for these FDI decisions.• With FDI in a large market, it is possible to:– Avoid transport costs– Avoid tariffs– Build/develop more close link with the market through local presence(better after sales service, consumer interaction, market understanding)
Types of FDI: Vertical FDI• Vertical FDI takes place when the production chain is broken up, and parts of theproduction processes are transferred to the affiliate location.• Vertical FDI, is not primarily or even necessarily aimed at production for sale in theforeign market, but rather seeks to avail of lower production costs there.• Vertical FDI is growing fast and is behind the large increase in FDI inflows todeveloping countries.• The vertical FDI decision involves a trade-off between cost savings due toproduction relocation and the fixed cost F of setting up an additional productionfacility.– Cost savings related to comparative advantage make some stages ofproduction cheaper in other countries.
Some empirical facts• Developed countries have been the biggestrecipients of inward FDI.– much more volatile than FDI going to developing andtransition economies.• Steady expansion in the share of FDI flowing todeveloping and transition countries.– Accounted for half of worldwide FDI flows in 2009.• Among developing countries, FDI is concentratedin a few large developing countries.
Potential Benefits of FDI to Host Country• Increased output• Increased wages• Increased employment• Increased exports• Increased tax revenues• Realization of economies of scale• Import of technical and managerial skills• Weakening power of domestic monopolyDifferent impact of Greenfield vis-à-vis Brownfield Investment?
Potential Costs of FDI to Host Country• Technology transfer vs. appropriateness of technology• Transfer pricing• Increased competition for domestic firms• Decrease in domestic investment (crowding out)• Instability in the balance of payments through profitrepatriation and transfer payments• Loss of control over domestic policy
What is Foreign Portfolio Investment• Portfolio investment is defined as cross-border transactions andpositions involving debt or equity securities• Portfolio investment includes investments by a resident entity in onecountry in the equity and debt securities in another country which seekprimarily capital gains and do not necessarily reflect a significant andlasting interest in the enterprise.• The category includes investments in bonds, notes, money marketinstruments and financial derivatives other than those included underdirect investment, or in other words, investments which are both belowthe ten per cent rule and do not involve affiliated enterprises.• In addition to securities issued by enterprises, foreigners can alsopurchase sovereign bonds issued by governments
Foreign Portfolio Capital flows and FDI inflows to India(in US$ millions)
Major differences between FDI and FPI• FDI involves the transfer of other resources thancapital (technology , management, organizational andmarketing skills, etc.) and it is the expected return onthese, rather than on the capital per se, whichprompts enterprises to become MNEs. Thus capital issimply a conduit for transfer of other resources thanthe raisond’être for direct investment.• Second, in the case of direct investment, resourcesare transferred internally within the firm rather thanexternally between two independent parties: de jurecontrol is still retained over their usage.
Foreign Institutional Investors• India does not have convertibility in capital account so foreigners are not free to invest in Indian assetsincluding Indian securities.• Only foreign investors who are registered with the Securities and Exchange Board of India (SEBI) areallowed to invest in Indian security markets. These investors are called the Foreign InstitutionalInvestors or FIIs.• FIIs include asset management companies, pension funds, mutual funds, incorporated/institutionalportfolio managers or their power of attorney holders, university funds, endowment foundations,charitable trusts and charitable societies.• FIIs need to comply with certain foreign exchange regulations laid down by RBI.• The initial registration is valid for five years and is renewable for similar five year periods.• RBIs general permission granted under FERA enables the registered FII to buy, sell and realize capitalgains on investments made through the initial corpus remitted to India, subscribe/renounce rightsofferings of shares, invest on all recognized stock exchanges• The investments by FIIs enjoy full capital account convertibility.• Presently, SEBI had more than 1700 registered FIIs.
Others who can invest in Indian Capital Markets• Indian laws also allow Non Resident Indians (NRIs) and PIOs(People of Indian Origin) to invest in the Indian capitalmarkets subject to certain restrictions.• Foreign Venture Capital Firms (FCVIs) are also allowed toinvest subject to certain ceilings.
Example of FII Registration detailfrom SEBI website:http://www.sebi.gov.in/FIIIndex.jsp?fiiIndxName=M
Policy Change- QFIs!!• In a major policy decision, the government has decided to allow QualifiedForeign Investors (QFIs) to directly invest in Indian equity market• This has been done to widen the class of investors, attract more foreign funds,and reduce market volatility and to deepen the Indian capital market.• The QFIs shall include individuals, groups or associations, resident in a foreigncountry which is compliant with Financial Action Task Force and that is asignatory to IOSCO’s multilateral MoU. QFIs do not include FII/sub-accounts.• The individual and aggregate investment limit for QFIs will be 5% and 10%,respectively, of the paid up capital of company• QFIs shall be allowed to invest through SEBI registered Qualified DepositoryParticipant (DP). A QFI shall open only one demat account and a tradingaccount with any of the qualified DP. The QFI shall make purchase and sale ofequities through that DP only.
Entering Foreign Market:Equity and ControlEquity and ControlEquity but no ControlNo Equity but ControlForeign Direct Investment, Joint VenturesForeign Portfolio InvestmentNon Equity Mode of Production
Non-Equity Mode (NEM) of TNC Operations• A cross-border nonequity mode of TNCoperation arises when a TNC externalizespart of its operations to a host-country-based partner firm in which it has noownership stake, while maintaining a levelof control over the operation bycontractually specifying the way it is to beconducted.• Specifications may relate to, for example,the design and quality of the product orservice to be delivered, the process andstandards of production, or the businessmodel that the partner firm must adhereto.• Thus the defining feature of cross-borderNEMs, as a form of governance of a TNC’sglobal value chain, is control over a host-country business entity by means otherthan equity holdings, although each typeof NEM has its own particularities