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Final 1


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Final 1

  4. 4. EXECUTIVE SUMMARY With the initiation of new economic policy in 1991 and subsequent reforms process, India has witnessed a change in the flow and direction of foreign direct investment (FDI) into the country. This is mainly due to the removal of restrictive and regulated practices. Foreign direct investment in India increased from US $ 129 millions in 1991-92 to US $ 40,885 million in March, 2005, and US$ above 1, 00,000 million in 2010 an increase of about 1026 times. However, the country is far behind in comparison to some of the developing countries like China. In so far as growth trend of FDI is concerned, there has been quite impressive growth of FDI inflow into the country during this period. However, negative growth rate is noticed during the period 1998-2000 primarily due to falling share of major investor countries, steep fall of approval by 55.7% in 1998 compared to 1997 and slackening of fresh equity. However, traditional industrial sectors like food processing industries, textiles, etc. which were once important sectors attracting larger FDI, have given way to modern industrial sectors like electronics and electrical equipments, etc. In this paper analyze the FDI flows in the country and also is discussed the direct proportionate of the economic growth of the country.
  5. 5. 1. INTRODUCTION FDI has been recognized as an important driver for economic growth and development. One of the most striking developments during the last two decades is the spectacular growth of FDI in the global economic landscape. This unprecedented growth of global FDI in 1990 around the world make FDI an important and vital component of development strategy in both developed and developing nations and policies are designed in order to stimulate inward flows. In fact, FDI provides a win – win situation to the host and the home countries. Both countries are directly interested in inviting FDI, because they benefit a lot from such type of investment. The „home‟ countries want to take the advantage of the vast markets opened by industrial growth. On the other hand the „host‟ countries want to acquire technological and managerial skills and supplement domestic Savings and foreign exchange. Moreover, the paucity of all types of resources viz. financial, capital, entrepreneurship, technological know- how, skills and practices, access to markets- abroad- in their economic development, developing nations accepted FDI as a sole visible panacea for all their scarcities. Further, the integration of global financial markets paves ways to this explosive growth of FDI around the globe.
  6. 6. 1.1 AN OVER VIEW of FDI in INDIA The historical background of FDI in India can be traced back with the establishment of East India Company of Britain. British capital came to India during the colonial era of Britain in India. After Second World War, Japanese companies entered Indian market and enhanced their trade with India, yet U.K. remained the most dominant investor in India. Further, after Independence issues relating to foreign capital, operations of MNCs, gained attention of the policy makers. Keeping in mind the national interests the policy makers designed the FDI policy which aims FDI as a medium for acquiring advanced technology and to mobilize foreign exchange resources. With time and as per economic and political regimes there have been changes in the FDI policy too. The industrial policy of 1965, allowed MNCs to venture through technical collaboration in India. Therefore, the government adopted a liberal attitude by allowing more frequent equity participation to foreign enterprises, and to accept equity capital in technical collaborations. But due to Significant outflow of foreign reserves in the form of remittances of dividends, profits, royalties etc, and the government has to adopt stringent foreign policy in 1970s. During this period the government adopted a selective and highly restrictive foreign policy as far as foreign capital, type of FDI and ownerships of foreign companies was concerned. Government setup Foreign Investment Board and enacted Foreign Exchange Regulation Act in order to regulate flow of foreign capital and FDI flow to India. The soaring oil prices continued low exports and deterioration in Balance of Payment position during 1980s forced the government to make necessary changes in the foreign policy. Thus, resulting in the partial liberalization of Indian Economy. The government introduces reforms in the industrial sector, aimed at increasing competency, efficiency and growth in industry through a stable, pragmatic and non-discriminatory policy for FDI flow. In this critical face of Indian economy the government of India with the help of World Bank and IMF introduced the macro – economic stabilization and structural adjustment program. As a result of these reforms India open its door to FDI inflows and adopted a more liberal foreign policy in order to restore the confidence of foreign investors. Further, under the new foreign investment policy Government of India constituted FIPB (Foreign Investment Promotion Board) whose main function was to invite and facilitate foreign investment through single window
  7. 7. system from the Prime Minister‟s Office. The foreign equity cap was raised to 51 percent for the existing companies. Government had allowed the use of foreign brand names for domestically produced products which was restricted earlier. India also became the member of MIGA (Multilateral Investment Guarantee Agency) for protection of foreign investments.
  8. 8. 1.2 FDI INFLOWS IN INDIA IN POST REFORM ERA India‟s economic reforms way back in 1991 has generated strong interest in foreign investors and turning India into one of the favourite destinations for global FDI flows. According to A.T. Kearney, India ranks second in the World in terms of attractiveness for FDI. A.T. Kearney‟s 2007 Global Services Locations Index ranks India as the most preferred destination in terms of financial attractiveness, people and skills availability and business environment. Similarly, UNCTAD‟ World Investment Report, 2010 considers India the 2nd most attractive destination among the TNCS after the China. The positive perceptions among investors as a result of strong economic fundamentals driven by 18 years of reforms have helped FDI inflows grow significantly in India. The FDI inflows grow at about 20 times since the opening up of the economy to foreign investment. India received maximum amount of FDI from developing economies. Net FDI flow in India was valued at US$ 33029.32 million in 2008. It is found that there is a huge gap in FDI approved and FDI realized. It is observed that the realization of approved FDI into actual disbursements has been quite slow. The reason of this slow realization may be the nature and type of investment projects involved. Beside this increased FDI has stimulated both exports and imports, contributing to rising levels of international trade. India‟s merchandise trade turnover increased from US$ 95 in FY02 to US$391 in FY08 (CAGR of 27.8%). India ranked at 26th in world merchandise exports in 2007 with a share of 1.04 percent. Further, the explosive growth of FDI gives opportunities to Indian industry for technological Up gradation, gaining access to global managerial skills and practices, Optimizing utilization of human and natural resources and competing internationally with higher efficiency. Most importantly FDI is central for India‟s integration into global Production chains which involves production by MNCs spread across locations all over the world.
  9. 9. 1.3 OBJECTIVES OF THE STUDY The study covers the following objectives: 1. To study the trends and patterns of flow of FDI 2. To assess the determinants of FDI inflows. 3. To evaluate the impact of FDI on the Economy
  10. 10. 1.4 HYPOTHESES The research questions were translated into the following hypothesis, which were then tested Using statistical analysis: The study has been taken up for the period 1991-2010 with the following hypotheses: 1. Flow of FDI shows a positive trend over the period 1991-2010. 2. FDI has a positive impact on economic growth of the country.
  11. 11. 1.5 RESEARCH METHODOLOGY DATA COLLECTION This study is based on secondary data. The required data have been collected from various sources i.e. World Investment Reports, Asian Development Bank‟s Reports, various Bulletins of Reserve Bank of India, publications from Ministry of Commerce, Govt. of India, Economic and Social Survey of Asia and the Pacific, United Nations, Asian Development Outlook, Country Reports on Economic Policy and Trade Practice- Bureau of Economic and Business Affairs, U.S. Department of State and from websites of World Bank, IMF, WTO, RBI, UNCTAD, EXIM Bank etc.. It is a time series data and the relevant data have been collected for the period 1991 to 2010. ANALYTICAL TOOLS In order to analyze the collected data the following mathematical tools were used. To work out the trend analyses the following formula is used: a.) Trend Analysis i.e. ŷ = a + b x Where ŷ = predicted value of the dependent variable a = y – axis intercept, b = slope of the regression line (or the rate of change in y for a given change in x), x = independent variable (which is time in this case). b.) Annual Growth rate is worked out by using the following formula: AGR = (X2- X1)/ X1 Where X1 = first value of variable X X2 = second value of variable X c.) Compound Annual Growth Rate is worked out by using the following formula: CAGR (t0, tn) = (V(tn)/V(t0))1/tn – t 0-1 Where V (t0): start value, V (tn): finish value, tn − t0: number of years. In order to analyze the collected data, various statistical and mathematical tools were used.
  12. 12. MODEL BUILDING Further, to study the impact of foreign direct investment on economic growth, two models were framed and fitted. The foreign direct investment model shows the factors influencing the foreign direct investment in India. The economic growth model depicts the contribution of foreign direct investment to economic growth. The two model equations are expressed below: 1) FDI = f [TRADEGDP, RESGDP, R&DGDP, FIN. Position, EXR.] 2) GDPG = f [FDIG] Where, FDI = Foreign Direct Investment GDP = Gross Domestic Product FIN. Position = Financial Position TRADE GDP= Total Trade as percentage of GDP. RES GDP = Foreign Exchange Reserves as percentage of GDP. R&D GDP = Research & development expenditure as percentage of GDP. FIN. Position = Ratio of external debts to exports EXR = Exchange rate GDPG = level of Economic Growth FDIG = Foreign Direct Investment Growth.
  13. 13. Regression analysis (Simple & Multiple Regression) was carried out using relevant econometric techniques. Simple regression method was used to measure the impact of FDI flows on economic growth ( peroxide by GDP growth) in India. Further, multiple regression analysis was used to identify the major variables which have impact on foreign direct investment. Relevant econometric tests such as coefficient of determination R2, Durbin – Watson [D-W] statistic, Standard error of coefficients, T Statistics and F- ratio were carried out in order to assess the relative significance, desirability and reliability of model estimation parameters.
  14. 14. 1.6 SIGNIFICANCE OF THE STUDY The period under study is important for a variety of reasons. 1) First of all, it was during July 1991 India opened its doors to private sector and liberalized its economy. 2) The experiences of South-East Asian countries by liberalizing their economies in 1980s became stars of economic growth and development in early 1990s. 3) India‟s experience with its first generation economic reforms and the country‟s economic growth performance were considered safe havens for FDI which led to second generation of economic reforms in India in first decade of this century. 4) There is a considerable change in the attitude of both the developing and developed countries towards FDI. They both consider FDI as the most suitable form of external finance. 5) Increase in competition for FDI inflows particularly among the developing nations. The study is appropriate in understanding inflows during 1991- 2010.
  15. 15. 1.7 LIMITATIONS OF THE STUDY The various limitations of the study are: 1. At various stages, the basic objective of the study is suffered due to inadequacy of time series data from related agencies. There has also been a problem of sufficient homogenous data from different sources. 2. The assumption that FDI was the only cause for development of Indian economy in the post liberalized period is debatable. No proper methods were available to segregate the effect of FDI to support the validity of this assumption. 3.Time Pressure : Time limit was not enough for through completion of the research. 4.The data used are taken from published record.
  16. 16. REVIEW OF LITERATURE 1) Nayak D.N46 (2004) in his paper “Canadian Foreign Direct Investment in India: Some Observations”, analyse the patterns and trends of Canadian FDI in India. He finds out that India does not figure very much in the investment plans of Canadian firms. The reasons for the same is the indifferent attitude of Canadians towards India and lack of information of investment opportunities in India are the important contributing factor for such an unhealthy trends in economic relation between India and Canada. He suggested some measures such as publishing of regular documents like newsletter that would highlight opportunities in India and a detailed focus on India‟s area of strength so that Canadian firms could come forward and discuss their areas of expertise would got long way in enhancing Canadian FDI in India. 2) Balasubramanyam V.N Sapsford David (2007) in their article “Does India need a lot more FDI” compares the levels of FDI inflows in India and China, and found that FDI in India is one tenth of that of china. The paper also finds that India may not require increased FDI because of the structure and composition of India‟s manufacturing, service sectors and her endowments of human capital. The requirements of managerial and organizational skills of these industries are much lower than that of labour intensive industries such as those in China. Finally, they conclude that the country is now in a position to unbundle the FDI package effectively and rely on sources other than FDI for its requirements of capital. 3) Naga Raj R (2003) in his article “Foreign Direct Investment in India in the 1990s: Trends and Issues” discusses the trends in FDI in India in the 1990s and compare them with China. The study raises some issues on the effects of the recent investments on the domestic economy. Based on the analytical discussion and comparative experience, the study concludes by suggesting a realistic foreign investment policy. 4)Morris Sebastian (1999) in his study “Foreign Direct Investment from India: 1964-83” studied the features of Indian FDI and the nature and mode of control exercised by Indians and firms abroad, the causal factors that underlie Indian FDI and their specific strengths and weaknesses using data from government files. To this effect, 14 case studies of firms in the
  17. 17. textiles, paper, light machinery, consumer durables and oil industry in Kenya and South East Asia are presented. This study concludes that the indigenous private corporate sector is the major source of investments. The current regime of tariff and narrow export policy are other reasons that have motivated market seeking FDI. 5) Nirupam Bajpai and Jeffrey D. Sachs (2006) in their paper “Foreign Direct Investment in India: Issues and Problems”, attempted to identify the issues and problems associated with India‟s current FDI regimes, and more importantly the other associated factors responsible for India‟s unattractiveness as an investment location. Despite India offering a large domestic market, rule of law, low labour costs, and a well working democracy, her performance in attracting FDI flows have been far from satisfactory. The conclusion of the study is that a restricted FDI regime, high import tariffs, exit barriers for firms, stringent labor laws, poor quality infrastructure, centralized decision making processes, and a very limited scale of export processing zones make India an unattractive investment location. 6) Kulwinder Singh (2005) in his study “Foreign Direct Investment in India: A Critical analysis of FDI from 1991-2005” explores the uneven beginnings of FDI, in India and examines the developments (economic and political) relating to the trends in two sectors: industry and infrastructure. The study concludes that the impact of the reforms in India on the policy environment for FDI presents a mixed picture. The industrial reforms have gone far, though they need to be supplemented by more infrastructure reforms, which are a critical missing link.
  18. 18. SECTION 2 TRENDS AND PATTERNS OF FDI FLOWS 2.1 INTRODUCTION 2.2 TRENDS AND PATTERNS OF FDI FLOWS AT GLOBAL LEVEL 2.3 TRENDS AND PATTERNS OF FDI FLOWS AT INDIAN LEVEL Although India‟s share in global FDI has increased considerably, but the pace of FDI inflows has been slower than China, Singapore, Brazil, and Russia. Due to the continued economic liberalization since 1991, India has seen a decade of 7 plus percent of economic growth. In fact, India‟s economy has been growing more than 9 percent for three consecutive years since 2006 which makes the country a prominent performer among global economies. At present India is the 4th largest and 2nd fastest growing economy in the world. It is the 11th largest economy in terms of industrial output and has the 3rd largest pool of scientific and technical manpower. India has considerably decreased its fiscal deficit from 4.5 percent in 2003-04 to 2.7 percent in 2007-08 and revenue deficit from 3.6 percent to 1.1 percent in 2007-08. There has been a generous flow of FDI in India since 1991 and its overall direction also remained the same over the years irrespective of the ruling party. India has received increased NRI‟s deposits and commercial borrowings largely because of its rate of economic growth and stability in the political environment of the country. Economic reform process since 1991 have paves way for increasing foreign exchange reserves to US$ 251985 millions as against US$ 9220 millions in 1991- 92. During the period under study it is found that India‟s GDP crossed one trillion dollar mark in 2007. Its domestic saving ratio to GDP also increases from 29.8 percent in 2004-05 to 37 percent in 2007-08. An analysis of last eighteen years of trends in FDI inflows in India shows that initially the inflows were low but there is a sharp rise in investment flows from 2005 onwards. It is observed that India received FDI inflows of Rs.492302 crore during 2000- 2010 as compared to Rs. 84806 crore during 1991-1999. India received a cumulative FDI flow of Rs. 577108 crore during 1991to march 2010. A comparative analysis of FDI approvals and inflows reveals that there is a huge gap between the amount of FDI approved and its realization into actual disbursements. A difference of almost 40 percent is observed between investment committed and actual inflows during the year 2005-06. It is observed that major FDI inflows in
  19. 19. India are concluded through automatic route and acquisition of existing shares route than through FIPB, SIA route during 1991-2010. The results of Foreign Direct Investment Model shows that all variables included in the study are statistically significant. Except the two variables i.e. Exchange Rate and Research and Development expenditure (R&DGDP) which deviates from their predicted signs. All other variables show the predicted signs. Exchange rate shows positive sign instead of expected negative sign. This could be attributed to the appreciation of Indian Rupee in international market which helped the foreign firms to acquire the firm specific assets at cheap rates and gain higher profits. Research and Development expenditure shows unexpected negative sign as of expected positive sign. This could be attributed to the fact that R&D sector is not receiving enough FDI as per its requirement. but this sector is gaining more attention in recent years. Another important factor which influenced FDI inflows is the Trade GDP. It shows the expected positive sign. In other words, the elasticity coefficient between Trade GDP and FDI inflows is 11.79 percent which shows that one percent increase in Trade GDP causes 11.79 percent increase in FDI inflows to India. The next important factor which shows the predicted positive sign is Reserves GDP. The elasticity coefficient between Reserves GDP and FDI inflows is 1.44 percent which means one percent increase in Reserves GDP causes an increase of 1.44 percent in the level of FDI inflows to the country. Another important factor which shows the predicted positive sign is FIN. Position i.e. financial position. The elasticity coefficient between financial position and FDI inflows is 15.2 percent i.e. one percent increase in financial position causes 15.2 percent increase in the level of FDI inflows to the country. In the Economic Growth Model, the variable GDPG (Gross Domestic Product Growth i.e. level of economic growth) which shows the market size of the host economy revealed that FDI is a vital and significant factor influencing the level of economic growth in India. In a nutshell, despite troubles in the world economy, India continued to attract substantial amount of FDI inflows. India due to its flexible investment regimes and policies prove to be the horde for the foreign investors in finding the investment opportunities in the country.
  20. 20. 2.4 DETERMINANTS OF FDI INFLOW TO INDIA The FDI inflows into India have gone up especially in the post-reform period. The share of FDI inflows to India is not significant when it is compared to other developing economies. However, India is a competitor in the market for FDI inflows with the other developing countries. In this context, it is pertinent to assess the determining forces of the FDI inflows into India so as to take policy initiative to create a favorable atmosphere for FDI. Thus, the present section tries to explore the determining factors of FDI inflows into India at the macro level and the factors are known as the pull factors of FDI inflows. 2.5 DISTRIBUTION OF FDI WITHIN INDIA Mumbai and New Delhi have been the top performers, with the majority of FDI inflows within India being heavily concentrated around these two major cities. Chennai, Bangalore, Hyderabad and Ahmadabad are also drawing significant shares of FDI inflows. For statistical purposes, India‟s Department of Industrial Policy and Promotion (DIPP) divides the country into 16 regional offices. The top 6 regions account for more than two-thirds of all FDI inflows to India The foregoing data is based on both Greenfield and Mergers and Acquisitions (M&As). However, a recent study that examines only Greenfield projects makes a largely similar set of points (USITC, 2007). That data shows that the 5 Indian states that received the largest number of Greenfield FDI projects in 2006, based on the total number of projects reported, were Maharashtra (20 percent, includes the city of Mumbai). The key sectors attracting FDI to the Mumbai-Maharashtra region are energy, transportation, services, telecommunications, and electrical equipment. Delhi attracts FDI inflows in sectors like telecommunications, transportation, electrical equipment
  21. 21. (including software), and services. Karnataka (15 percent, includes the city of Bangalore), Tamil Nadu (13 percent, includes the city of Chennai), Delhi (9 percent, includes the city of New Delhi), and Andhra Pradesh (8 percent, includes the city of Hyderabad). The states of Uttar Pradesh and Haryana (especially those parts of the National Capital Region) have also performed really well in recent years. Due to its abundance of natural resources, Uttar Pradesh attracts FDI in chemicals, pharmaceuticals, and mining and minerals whereas Haryana attracts FDI in the electrical equipment, transportation, and food processing sectors. Tamil Nadu has done well in sectors related to automotive and auto components. Ford, Hyundai, and Mitsubishi have made major investments in Tamil Nadu. The state has attracted FDI in other sectors as well such as port infrastructure, ICT, and electronics. Andhra Pradesh and Karnataka have attracted FDI mainly in areas associated with software and, to a lesser extent, hardware for computers and telecom. Hyderabad and Bangalore are the cities which received the major share of the projects in these two states. Karnataka has done well in the automotive sector as well. India‟s rural areas have also attracted some big projects. Orissa, for example, has secured some large Greenfield FDI projects in bauxite mining, aluminum smelting operations as well as in steel and automotive facilities.
  22. 22. Policy Recommendations Table 7 shows the level of FDI that has been forecasted by the EIU for India. The numbers, by any stretch, show a quantum leap in terms of levels of inward FDI with big numbers such as $50 billion for 2011 and $60 billion for 2012. However, it should be noted that India will still only account for 4.2% of total world inward FDI flows. Clearly forecasts have flaws, especially those that look beyond a year; the forecasts in Table 7 are based on expectations that India has a great growth story.8 They also are forecasts made on the expectation that the government will fix the impediments that are responsible for the current low of levels of FDI. T The remainder of this section focuses on ideas as to what India can do to ensure that actual match.
  23. 23. It is well known that FDI can complement local development efforts in a number of ways, including boosting export competitiveness; generating employment and strengthening the skills base; enhancing technological capabilities (transfer, diffusion and generation of technology); and increasing financial resources for development. It can also help plug a country in the international trading system as well as promote a more competitive business environment. In view of this, India should continue to take steps to ensure an enabling business environment to improve India‟s attractiveness as an investment destination and a global manufacturing hub. The investment climate in India has undoubtedly become friendlier and investing in India is a much more attractive proposition today than in yesteryears. Much of the FDI has been in the form of M&A activities rather than Greenfield investment and a great deal is aimed at the attractive domestic consumer market.
  24. 24. 2.7 International investment agreement An International Investment Agreement (IIA) is a type of treaty between countries that addresses issues relevant to cross-border investments, usually for the purpose of protection, promotion and liberalization of such investments. Most IIAs cover foreign direct investment (FDI) and portfolio investment, but some exclude the latter. Countries concluding IIAs commit themselves to adhere to specific standards on the treatment of foreign investments within their territory. IIAs further define procedures for the resolution of disputes should these commitments not be met. The most common types of IIAs are Bilateral Investment Treaties (BITs) and Preferential Trade and Investment Agreements (PTIAs). International Taxation Agreements and Double Taxation Treaties (DTTs) are also considered as IIAs, as taxation commonly has an important impact on foreign investment. Bilateral investment treaties deal primarily with the admission, treatment and protection of foreign investment. They usually cover investments by enterprises or individuals of one country in the territory of its treaty partner. Preferential Trade and Investment Agreements are treaties among countries on cooperation in economic and trade areas. Usually they cover a broader set of
  25. 25. issues and are concluded at bilateral or regional levels. In order to classify as IIAs, PTIAs must include, among other content, specific provisions on foreign investment. International taxation agreements deal primarily with the issue of double taxation in international financial activities (e.g., regulating taxes on income, assets or financial transactions). They are commonly concluded bilaterally, though some agreements also involve a larger number of countries. Bilateral investment treaties To a large extent, the international legal aspects of the relationship between countries and foreign investors are addressed bilaterally between two countries. The conclusion of BITs has evolved from the second half of the 20th century onwards, and today these agreements constitute a key component of the contemporary international law on foreign investment. The United Nations Conference on Trade and Development (UNCTAD) defines BITs as "agreements between two countries for the reciprocal encouragement, promotion and protection of investments in each other's territories by companies based in either country."[2] While the basic content of BITs has largely remained the same over the years, focusing on investment protection as the core issue, matters reflecting public policy concerns (e.g. health, safety, essential security or environmental protection) have in recent years more frequently been incorporated into BITs.[3] A typical BIT starts with a preamble that outlines the general intention of the agreement and provisions on its scope of application. This is followed by a definition of key terms, clarifying amongst others the meanings of "investment" and "investor". BITs then address issues related to the admission and establishment of foreign investments, including standards of treatment enjoyed by foreign investors (minimum standard of treatment, fair and equitable treatment, full protection and security, national treatment and most-favored nation treatment). The free transfer of funds across national borders in connection with a foreign investment is usually also regulated in BITs. Moreover, BITs deal with the issue of expropriation or damage to an investment, determining that – and in what manner - compensation be paid to the investor in such a situation. They also specify the degree of protection and compensation that investors should expect in situations of war or civil unrest. Another core element of BITs relates to the settlement of disputes between an investor and the country in which the investment took place. These
  26. 26. provisions, often called investor-state dispute settlement, usually mention the forums to which investors can resort for establishing international arbitral tribunals (e.g. ICSID, UNCITRAL or ICC) and how this relates to proceedings in host countries' domestic courts. BITs also typically include a clause on State-State dispute settlement. Finally, BITs usually refer to the time frame of the treaty, clarifying how the agreement is extended and terminated, and specifying to what extent investments conducted prior to conclusion and ratification of the treaty are covered.[4] Preferential trade and investment agreements Preferential Trade and Investment Agreements (PTIAs) are broader economic agreements among countries that are concluded for the purpose of facilitating international trade and the transfer of factors of production across borders. They can be economic integration agreements, free trade agreements (FTAs), economic partnership agreements (EPAs) or similar types of agreements that cover, among many other things, provisions dealing with foreign investment. In PTIAs, the section dealing with foreign investment forms only a small part of the treaty, usually encompassing one or two chapters. Other issues dealt with in PTIAs are trade in goods and services, tariffs and non-tariff barriers, customs procedures, specific provisions pertaining to selected sectors, competition, intellectual property, temporary entry of people, and many more. PTIAs pursue the liberalization of trade and investment in the context of this broader focus. Frequently, the structure and appearance of the respective chapter on foreign investments is similar to a BIT. There exist many examples of PTIAs. A notable one is the North American Free Trade Agreement (NAFTA). While the NAFTA agreement deals with a very broad set of issues, most importantly cross-border trade between Canada, Mexico and the United States, chapter 11 of this agreement covers detailed provisions on foreign investment similar to those found in BITs.[5] Other examples of PTIAs concluded bilaterally can be found in the EPA between Japan and Singapore, the FTA between the Republic of Korea and Chile, and the FTA between the United States and Australia. International taxation agreement The main purpose of international taxation agreements is to regulate how taxes imposed on the global income of multinational enterprises are distributed among countries. In most cases, this is done through the elimination of double taxation. The core of the problem lies in the
  27. 27. disagreements among countries on who has jurisdiction over the taxable income of multinational corporations. Most commonly, such conflicts are addressed through bilateral agreements that deal solely with taxation on income and sometimes also capital. Nevertheless, a few multilateral agreements on taxation as well as bilateral agreements that address taxation together with other issues have also been concluded in the past. In contemporary treaty practice, avoidance of double taxation is achieved by concurrently applying two separate approaches. The first approach is the elimination of definition mismatches for terms such as "residence" or "income" that could otherwise be a cause of double taxation. The second approach constitutes the relief from double taxation through one of three methods. The credit method allows foreign tax to be credited against the tax paid in the residence country. According to the exemption method, foreign income and resulting taxation is simply disregarded by the residence country. The deduction method taxes income net of foreign tax, but it is rarely applied
  28. 28. SECTION 3 FDI & INDIAN ECONOMY 3.1 INTRODUCTION Foreign direct investment (FDI) has played an important role in the process of globalization during the past two decades. The rapid expansion in FDI by multinational enterprises since the mid-eighties may be attributed to significant changes in technologies, greater liberalization of trade and investment regimes, and deregulation and privatization of markets in many countries including developing countries like India. Capital formation is an important determinant of economic growth. While domestic investments add to the capital stock in an economy, FDI plays a complementary role in overall capital formation and in filling the gap between domestic savings and investment. At the macro-level, FDI is a non-debt-creating source of additional IRJC International Journal of Marketing, Financial Services & Management Research external finances. At the micro-level, FDI is expected to boost output, technology, skill levels, employment and linkages with other sectors and regions of the host economy. In India FDI inflow made its entry during the year 1991-92 with the aim to bring together the intended investment and the actual savings of the country. To pursue a growth of around 7 percent in the Gross Domestic Product of India, the net capital flows should increase by at least 28 to 30 percent on the whole. But the savings of the country stood only at 24 percent. The gap formed between intended investment and the actual savings of the country was lifted up by portfolio investments by Foreign Institutional Investors, loans by foreign banks and other places, and foreign direct investments. Among these three forms of financial assistance, India prefers as well as possesses the maximum amount of Foreign Direct Investments. Hence FDI is considered as a developmental tool for growth and development of the country. Therefore, this study is undertaken to analyze the flow of FDI into the country identifying the various set of factors which determine the flow of FDI.
  29. 29. 3.2 SELECTION OF VARIABLES Macroeconomic indicators of an economy are considered as the major pull factors of FDI inflows to a country. The analysis of various theoretical rationale and existing literature provides a base in choosing the right combination of variables that explains the variations in the flows of FDI in the country. In order to have the best combination of variables for the determinants of FDI inflows into India, different alternative combination of variables were identified and then estimated. The alternative combinations of variables included in the study are in tune with the
  30. 30. famous specifications given by United Nations Conference on Trade and Development. In order to choose the best variables, firstly, the major factors which influence the flow of FDI into the country are identified. Then, proxy variables representing the factors are selected for the purpose of analysis. However, the following are the factors and the proxy variables which are selected for analysis. 3.3 PROBLEMS FOR LOW FDI FLOW TO INDIA India, the largest democratic country with the second largest population in the world, with rule of law and a highly educated English speaking work force, the country is considered as IRJC International Journal of Marketing, Financial Services & Management Research a safe haven for foreign investors. Yet, India seems to be suffering from a host of self-imposed restrictions and problems regarding opening its markets completely too global investors by implementing full scale economic reforms. Some of the major impediments for India‟s poor performance in the area of FDI are: political instability, poor infrastructure, confusing tax and tariff policies, Draconian labor laws, well entrenched corruption and governmental regulations. LACK OF ADEQUATE INFRASTRUCTURE: It is cited as a major hurdle for FDI inflows into India. This bottleneck in the form of poor infrastructure discourages foreign investors in investing in India. India‟s age old and biggest infrastructure problem is the supply of electricity. Power cuts are considered as a common problem and many industries are forced to close their business. STRINGENT LABOR LAWS: Large firms in India are not allowed to retrench or layoff any workers, or close down the unit without the permission of the state government. These laws protect the workers and thwart legitimate attempts to restructure business. To retrench unnecessary workers, firms require approval from both employees and state governments-approval that is rarely given. Further, Trade Unions extort huge sums from companies through over-generous voluntary retirement schemes.
  31. 31. CORRUPTION: Corruption is found in nearly every public service, from defense to distribution of subsidized food to the poor people, to the generation and transmission of electric power. Kumar (2000)observes that a combination of legal hurdles, lack of institutional reforms, bureaucratic decision-making and the allegations of corruption at the top have turned foreign investors away from India. Vittal (2001) states that corruption and misuse of public office for private gain are capable of paralyzing a country‟s development and diverting its precious resources from public needs of the entire nation. Corruption is against the poor people because it snatches away food from the mouths of the poor. If corruption levels in India come down to those of Scandinavian countries, India‟s GDP growth will increase by 1.5 per cent and FDI will grow by 12 per cent (Vittal, 2001). LACK OF DECISION MAKING AUTHORITY WITH THE STATE GOVERNMENTS: The reform process of liberalizing the economy is concentrated mainly in the Centre and the State Governments are not given much power. In most key infrastructure areas, the central government remains in control. Brazil, China, and Russia are examples where regional governments take the lead in pushing reforms and prompting further actions by the central government. LIMITED SCALE OF EXPORT PROCESSING ZONES: India‟s export processing zones have lacked dynamism because of several reasons, such as their relatively limited scale; the Government‟s general ambivalence about attracting FDI; the unclear and changing incentive packages attached to the zones; and the power of the central government in the regulation of the zones. India which established its first Export Processing Zone (EPZ) in 1965 has failed to develop the zones when compared to China which took initiative for establishment only in 1980. IRJC International Journal of Marketing, Financial Services & Management Research HIGH CORPORATE TAX RATES:
  32. 32. Corporate tax rates in East Asia are generally in the range of 15 to 30 percent, compared with a rate of 48 percent for foreign companies in India. High corporate tax rate is definitely a major disincentive to foreign corporate investment in India. INDECISIVE GOVERNMENT AND POLITICAL INSTABILITY: There were too many anomalies on the government side during past two decades and they are still affecting the direct inflow of FDI in India such as mismanagement and oppression by the different company, which affect the image of the country and also deject the prospective investor, who are very much conscious about safety and constant return on their investment.
  33. 33. SECTION 4 SUGGESTIONS FLEXIBLE LABOUR LAWS NEEDED: China gets maximum FDI in the manufacturing sector, which has helped the country become the manufacturing hub of the world. In India the manufacturing sector can grow if infrastructure facilities are improved and labour reforms take place. The country should take initiatives to adopt more flexible labour laws. RE LOOK AT SECTORAL CAPS: Though the Government has hiked the sectoral cap for FDI over the years, it is time to revisit issues pertaining to limits in such sectors as coal mining, insurance, real estate, and retail trade, apart from the small-scale sector. Government should allow more investment into the country under automatic route. Reforms like bringing more sectors under the automatic route, increasing the FDI cap and simplifying the procedural delays has to be initiated. There is need to improve SEZs in terms of their size, road and port connectivity, assured power supply and decentralized decision-making. GEOGRAPHICAL DISPARITIES OF FDI SHOULD BE REMOVED: The issues of geographical disparities of FDI in India need to address on priority. Many states are making serious efforts to simplify regulations for setting up and operating the industrial units. However, efforts by many state governments are still not encouraging. Even the state like West Bengal which was once called Manchester of India attracts only 1.2% of FDI inflow in the country. West Bengal, Bihar, Jharkhand, Chhattisgarh are endowed with rich minerals but due to lack of proper initiatives by governments of these states, they fail to attract FDI.
  34. 34. PROMOTE GREENFIELD PROJECTS: India‟s volume of FDI has increased largely due to Merger and Acquisitions (M&As) rather than large Greenfields projects. M&As not necessarily imply infusion of new capital into a country if it is through reinvested earnings and intra company loans. Business friendly environment must be created on priority to attract large Greenfields projects. Regulations should be simplified so that realization ratio is improved (Percentage of FDI approvals to actual flows). To maximize the benefits of FDI persistently, India should also focus on developing human capital and technology. DEVELOP DEBT MARKET: India has a well developed equity market but does not have a well developed debt market. Steps should be taken to improve the depth and liquidity of debt market as many companies may prefer leveraged investment rather than investing their own IRJC International Journal of Marketing, Financial Services & Management Research . Therefore it is said that countries with well-developed financial markets tend to benefits significantly from FDI inflows. EDUCATION SECTOR SHOULD BE OPENED TO FDI: India has a huge pool of working population. However, due to poor quality primary education and higher education, there is still an acute shortage of talent. FDI in Education Sector is lesser than one percent. By giving the status of primary and higher education in the country, FDI in this sector must be encouraged. However, appropriate measure must be taken to ensure quality education. The issues of commercialization of education, regional gap and structural gap have to be addressed on priority. STRENGTHEN RESEARCH AND DEVELOPMENT IN THE COUNTRY: India should consciously work towards attracting greater FDI into R&D as a means of strengthening the country‟s technological prowess and competitiveness.
  35. 35. CONCLUSION FDI plays an important role in the long-term development of a country not only as a source of capital but also for enhancing competitiveness of the domestic economy through transfer of technology, strengthening infrastructure, raising productivity and generating new employment opportunities. India emerges as the fifth largest recipient of foreign direct investment across the globe and second largest among all other developing countries (World Investment Report 2010). The huge market size, availability of highly skilled human resources, sound economic policy, abundant and diversified natural resources all these factors enable India to attract FDI. Further, it was found that even though there has been increased flow of FDI into the country during the post liberalization period, the global share of FDI in India is very less when it is compared to other developing countries. Lack of proper infrastructure, instable government and political environment, high corporate tax rates and limited export processing zones are considered to be the major problems for low FDI into the country. To overcome this situation, the Government should revise the sector cap and bring more sectors under the automatic route. Further, India should sign the agreement of Double Taxation treaties with other countries in order to increase bilateral trade. Therefore, there is an urgent need to adopt innovative policies and good corporate governance practices on par with international standards, by the Government of India, to attract more and more foreign capital in various sectors of the economy to make India a developed economy.