Foreign Capital

1. Unit-Vb (iii)
Foreign Capital
Prof. Mahendra Kumar Ghadoliya

2. Contents
• Introduction
• Forms of Foreign capital
• Advantages of foreign Capital
• Disadvantages of Foreign Capital
• Government Policy

3. Introduction
• Relationship between capital and development
• To raise rate of growth through rapid industrialization
• Low saving, low rate of capital formation
• Lack of skills and technical know-how
• Shortage of resources for development
• Foreign capital is an important source of finance in the development.
• Overcome BoP crisis
• Foreign capital is needed for competition and break domestic
monopolies, to raise investment and employment

4. Components of Foreign Capital in India
1. Foreign Capital Investments
2. Foreign Aid
3. External Commercial Borrowings
1. Foreign Capital Investments:-
• Foreign capital investments refer to investments made by an
entity which is not the resident of the country. In India there are
two components of foreign capital Investments:
(i) Foreign Direct Investments (FDI)
(ii) Foreign Portfolio Investments (FPI)

5. (i) Foreign Direct Investments (FDI):
• FDI refers to the physical investments made by foreign investors in
the domestic country. The physical investments refer to the direct
investments into building, machinery and equipment.
• The direct investor can be an individual, public or private
enterprises (referred to multinational corporations or MNCs) or
Government.
• The important forms of FDI are investments through:
(i) Financial Collaboration
(ii) Joint Ventures and Technical Collaboration
(iii) Capital Markets
(iv) Private Placements.

6. (ii) Foreign Portfolio Investments (FPI):
FPI refers to the short-term investments by foreign entity in the financial markets.
These are indirect investments and include investment in tradable securities, such
as shares, bonds, debenture of the companies. Foreign Portfolio investors don’t
exert management control on the enterprise in which they invest.
There are three kinds of FPI in India:
a) Foreign Institutional Investment: These are the investments made by foreign
institutions like pension funds, foreign mutual funds etc. in the financial markets.
b) Funds raised through Global Depository Receipts or American Depository
Receipts (GDRs/ADRs): GDRs and ADRs are instruments which signify the
purchase of share of Indian companies by foreign investors or American investors
respectively.
c) Off-shore funds: The schemes of mutual funds that are launched in the foreign
country.

7. 2.External Aid
• External aid refers to the concessional foreign finance with flexible
terms and conditions. It may be in the form of long term concessional
debt or grants (doesn’t involves any repayment obligations). The
tenure of the aid is generally very long. The important sources of
foreign aid in India are:
(i) Official Aid:
• It is given by foreign governments or international official bodies such
World Bank, International Monetary Fund (IMF), Asian Development
Bank (ADB) etc. It can be:
• Bilateral Aid- It is between government to government basis.
• Multilateral Aid –It is Foreign Assistance through International Institutional
Agencies- World Bank, IMF.

8. 2.External Aid-2
• Further, official aid (Bilateral or Multilateral) can be Government
Aid (i.e. aid that passes through government) or Non-
Government Aid (i.e. aid received by non-government bodies
directly from bilateral or multilateral agencies).
• (ii) Private Aid: It is the fund which is received from private
individuals, firms or institutions.

9. External aid may also be distinguished as:
Tied aid
Untied aid.
• The tied aid is given with conditions in terms of its use e.g for the
purchase of goods for specific purpose or to be spent on specific
country.
• The untied aid can be used freely by the recipient country. Foreign
aid allows an access to foreign funds without putting pressures of
their repayment.

10. Problems with Foreign Aid-
• Political Pressures:
• Uncertainty of Aid:
• Restrictive Use:
• Low Utilization Rate:
• Complacent domestic initiatives:
• Despite the problems associated with foreign aid, factors, such as
lower cost, long-term nature of aid, have encouraged the
dependence on foreign aid in comparison to commercial funds. In
the recent years however, there is a significant decline in foreign
aid as a percentage of GDP.

11. 3. External Commercial Borrowings
• Any money that has been borrowed from foreign sources for
financing the commercial activities in India are called External
Commercial Borrowings. The Government of India permits ECBs
as a source of finance for Indian Corporates for expansion of
existing capacity as well as for fresh investment.

12. Foreign Sources
• The ECBs are defined as money borrowed from foreign resources
including the following:
• Commercial bank loans
• Buyers’ credit and suppliers’ credit
• Securitised instruments such as Floating Rate Notes and Fixed
Rate Bonds etc.
• Credit from official export credit agencies and Commercial
borrowings from the private sector window of Multilateral
Financial Institutions such as International Finance Corporation
(Washington), ADB, AFIC, CDC, etc.

13. How ECB is different from FDI?
• External Commercial Borrowings is not meant for Equity
participation. If the foreign capital is used to finance the Equity
Capital, it would be termed as Foreign Direct Investment.
• The ECB should satisfy the RBI regulations in this regard.
• The Bonds, Credit notes, Asset Backed Securities, Mortgage Backed
Securities or anything of that nature are included in ECB.
• The following are not included in the ECBs: Any Investment made
towards core capital of an organization such as equity shares,
convertible preference shares or convertible debentures.
• The convertible instruments are covered under the FDI Policy.

14. Advantages of foreign Capital
• Technical and Managerial Improvement
• Supplement domestic resources
• Human Capital improvement
• Ease balance of payment position
• Infrastructure development
• Create competitive and efficient Business Environment
• Augmentation of employment opportunities
• Better corporate practice
• Improvement in financial System
• Contribution to national exchequer

15. Disadvantages of foreign Capital
• Can Aggravate Monopolistic Tendencies
• Old technology
• Income Inequalities
• Profit goes out of the country
• Luxury consumption pattern
• Reduce foreign exchange
• Volatility in the market
• Regional disparities
• Crowds out local entrepreneur and Growth