international capital movement

1. International Capital Movements

2. Readings
• Chapter 12: “International Resource
Movements and Multinational Corporations”
in Dominick Salvatore
• “Capital Flows to India”, by Rakesh Mohan, BIS
Papers 44, 2009
• “Global Capital Flows and the Indian Economy:
Opportunities and Challenges” Deepak
Mohanty, ED, RBI, 2012

3. Cross Border Movements
• Two kinds of cross border movements
– Commodity trade
• Merchandise imports / exports
• Services imports / exports
– Factors of production / resource movement
• Capital
• Labour
• technology

4. Why factors of production move?
• To exploit higher returns / remuneration
• Returns Equalisation process leading to
general welfare rise
• Impacts of capital movement may be different
from that of trade movements

5. Capital Movements
• Two types
– Portfolio investments
• Purely financial assets like bonds, stocks
– Direct investments
• Factories, land, capital goods,
• Control on both capital and management

7. Foreign Investments In to India
Year
Direct investment Portfolio investment Total
US $ million US $ million US $ million
1999-00 2155 3026 5181
2000-01 4029 2760 6789
2001-02 6130 2021 8151
2002-03 5035 979 6014
2003-04 4322 11377 15699
2004-05 6051 9315 15366
2005-06 8961 12492 21453
2006-07 22826 7003 29829
2007-08 34835 27271 62106
2008-09 37838 -13855 23983
2009-10 37763 32376 70139
2010-11 30380 31471 61851

8. -20000
-10000
0
10000
20000
30000
40000
50000
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
FDI
FII

9. Motives for Portfolio Investments
• To avail higher returns
– Buying securities across border with expected
higher returns
• Portfolio diversification
– To balance overall risk and returns of portfolio

10. Motives for FDI
• Same motives as that of portfolio capital
– Higher returns (because of growth, favourable tax
systems, better infra)
– Diversification of risk
• In addition, other reasons may also be there
– To enter foreign market
– To retain control on technology
– To retain control on management
– In some cases supply of raw material (ex: mines)

11. Value
of
Marginal
Product
N-1
Value
of
Marginal
Product
N-2
Nation 1 Nation 2
Capital stock of Nation 1 and Nation 2
O B A O’
VMPK2
VMPK1
E
M
F J
H
R
G T
N
C

12. • Nation 1
– Increase in GDP from OFRA to OFGRA: a net rise of EGR
– Capital contribution increase from OCRA to ONGA
– Labour and other’s contribution decrease from CFR to NFE
• Nation 2
– Increase in GDP from O’JMA to O’JEB: a net rise of AMEB
– Out of net rise AMEB, ABEG goes to foreigners, leaving GME
– Labour and other’s contribution increases from TJMG to TJE, a net rise of GME
– Capital contribution reduces from O’HMA to O’TGA

13. Effects of Foreign Investment
• Foreign investment effects: a) global incomes
increase and b) redistribution of income between
capital and other factors of production in both
the countries and c) bop effects
• In the investing country, income due to capital
increases and incomes due to other factors
reduce
• In the host country, income due to capital
decreases whereas income due to other factors
increase

14. Multinational Corporations
• Firms that invest across the borders in real
production sectors (FDI)
• Firms that control, own, manage production
facilities in a number of countries
• Prolific growth in recent times
– About 25% of world output
– About one third world trade is intra MNCs trade

15. Reasons for Existence of MNCs
• Competitive advantage
– Both vertical and horizontal integration
– Economies of scale
– Greater access to capital
– Greater information across the world which may
lead to better planning and strategies
– Risk diversification
– Tax advantages

16. Problems created by MNCs at Home
country
• By investing abroad, MNCs cause lower
employment at home country
• Cause technology transfer to other countries
and thus undermine tech superiority of home
• Circumventing domestic Monetary policy by
accessing capital markets abroad
• Lower tax collections at home country

17. Problems created by MNCs at Host
country
• MNCs may dominate the local economy
• Technological dependency and lower attention
on local R&D
• Inappropriate technology
• Over exploitation of natural resources
• Conflict of interests
• Host countries generally put tight restrictions to
ward off negative effects of MNCs investments

18. Foreign Investment
• Globally, Foreign investment started growing
significantly from 1980s, mainly as private
debt
• Series of crises relating to sudden withdrawal
of funds: Latin American crisis in 1980s, East
Asian in 1990s
• In the later part, foreign capital flow was
predominantly as FDI and Portfolio Investment

19. Foreign Investment
• FDI is more stable and risk sharing
• Most countries accumulated Forex reserves as
a security against sudden outflows

20. Steady flow of FDI

21. Volatility of Net Capital Flows

22. Volatility of Flows
• It is generally observed that volatile capital
flows could have undesirable effects
– Exchange rate and monetary policy management
– Financial stability
– Domestic economy effects
• Recommend policy measures to contain
undesirable effects of volatile flows
– Controls
– Tobin Tax

23. Indian Case
• “Consolidated FDI Policy”, Department of
Industrial Policy and Promotion, Ministry of
Commerce and Industry, govt of India, April, 2012
– http://dipp.nic.in/English/Policies/FDI_Circular_01_20
12.pdf
• “Master Circular on Foreign Investment in India,”
Reserve bank of India, July 2011
– http://rbidocs.rbi.org.in/rdocs/notification/PDFs/15M
FI300611F.pdf

24. Indian Case
• “Report of Expert Group on Encouraging FII Flows and Checking the
Vulnerability of Capital Markets to Speculative Flows”, Ministry of
Finance, November, 2005
– http://finmin.nic.in/the_ministry/dept_eco_affairs/capital_market_div
/ReportEGFII.pdf
• Foreign Investment in India by NSE-ISMR
– http://www.nseindia.com/content/us/ismr2011ch7.pdf
• “FDI in India and its Growth Linkages” Report by NCAER, New Delhi
– http://dipp.nic.in/english/publications/reports/fdi_ncaer.pdf
• “India’s FDI Inflows: Trends and Concepts”, K S Chalapathi Rao and
Biswajit Dhar, Working Paper 2011/01, Institute for Studies in
Industrial Development (ISID), New Delhi
– http://isid.org.in/pdf/WP1101.pdf

25. Indian Case
• Early stages, it was mostly official debt
• Policy was self reliance and therefore no
policy to attract foreign capital
• 1990s serious balance of payments problem
• Policy measures initiated
– C Rangarajan Committee (1991) (report of the
High Level Committee on BoP)
– S S Tarapore (1997 and 2006) committees on
capital account

26. Indian Case
• Measures
– To encourage capital inflows
– Shift from debt to non-debt capital flows
– Shift from short-term to long-term flows
– Tight monitoring of External Commercial
Borrowings
– Gradual liberalisation of capital outflows

27. Indian Case
• Measures for Residents and Non-Residents
• More liberal measures for non-residents than
residents

28. Measures for Residents
• Liberal In the order of: corporates, financial intermediaries and
individuals
• Corporates are allowed to raise equity capital through ADR/GDR
• Corporates can borrow abroad as ECB
– Automatic route
– Approval route
– End use restrictions
• Price and quantity restrictions
– Overall restriction of $750 million
– Maximum of 300 – 500 bp over 6m libor
• Minimum maturity of 3 to 5 years
• Banks can borrow up to 50% Tier I Cap

29. Measures for Residents
• Outflows are generally restricted
• Corporates can invest in joint or wholly owned
subsidiaries upto 400 % of their net worth
• Indian Banks can invest upto 25% of their
NDTL
• Domestic mutual funds investment cap at $7 b
• Individuals can remit upto $200000 per year

30. Non-Residents
• Two schemes
– FDI
– Portfolio Investment Scheme (PIS)
• For both non-residents and NRI/PIO

31. Foreign investment in India

32. FDI
• As a major non-debt inflow of investment and
also as a investment booster at domestic
economy, FDI is given priority
• Prohibited sectors – sectors with socio-
economic implications: lottery, chit funds,
tobacco products, agril plantation, atomic
energy, defense, railways etc,
• Govt is actively debating on relaxing
investment in multibrand retail sector

33. FDI
• FDI scheme for non-resident investors, either
individuals or corporates
– (no pakistani citizens, Bangla citizens need approval)
• Two routs
– Automatic: no special permission required
– Govt approval: under the approval of Foreign
Investment Promotion Board (FIPB)
• Restrictions on the pricing of the securities as laid
down by SEBI

34. Portfolio Investment Scheme
• Policy approach is to allow quality investment
funds from abroad
• Preference to institutional funds over natural
persons
• NRI/PIO

35. Portfolio Investments
• In 1992, for the first time in FIIs are allowed to
invest in Indian markets
• FIIs with good track record, financial soundness,
professional competency could be allowed
• Special provisions for NRI / PIO
• Portfolio could be held in equity as well as in debt
• Government to have important control of issuing
guidelines

36. FII
• FII consists of entities like pension funds, mutual funds,
investment funds, investment trusts, insurance
companies, sovereign wealth funds, foreign central
banks, asset management company, university funds,
etc..
• FIIs are to be registered as Qualified Foreign Investor
(QFI) with SEBI (earlier until 2003 with SEBI and RBI)
• Recognition valid for 5 years, renewable
• FIIs allowed to invest in primary, secondary markets of
shares, debentures, warrants traded on stock markets
in India as well in unlisted companies
• Can also invest in schemes floated by mutual funds

37. Policy evolution
• Gradual and continuous liberalisation over years
– Relaxation of limits for the FIIs
– Relaxation of eligibility conditons
– Relaxation of access to Instuments

38. Policy evolution
Sep-92 FIIs allowed to make investments; upto 5% of issued capital;
collectively 24% limit
Apr-98 allowed to invest in G-Secs upto $ 1 billion
Jun-98 individual holding limit rised to 10%; separate ceiling for
FII/NRI/PIO
Feb-00 allowed for sub-accounts with FIIs; domestic funds could
manage sub-accounts; sub-accounts to be registred with
SEBI
Mar-01 collective ceiling of FIIs raised to 49% under special
provisions; later relaxed upto to sectoral caps with the
approval of general body of the company
Dec-03 Duel reigstration removed; registration with only SEBI
Nov-04 corporate debt limit was put at $ 500 million
Oct-08 corporate debt limit raised to $ 6 billions
Nov-10 FIIs allowed to invest upto $10 billion in G-Secs; corporate
debt limit raised to $20 billions
Mar-11 corporate debt limit raised to $ 25 billions
Jun-12 G-sec limit hiked to $ 20 billions, ECBs upt o $ 10 billions

39. FIIs monitoring
• Designated banks to report positions of FII
holdings to RBI on daily basis
• RBI publishes Caution List and Ban List
– Caution list: companies in which FII holdings limits
(either individual or combined limits) reach 2%
below the allowed limits. Further investments
only with the RBI approval – first come first serve
– Ban List: companies in which limits are exhausted

40. FIIs monitoring
• FIIs could invest in both Portfolio Investment
Scheme (PIS) and FDI scheme. Designated banks
are to report these two investments separately
• FIIs could be allowed for forward cover for their
inward remittances of dissolved investment
proceeds
– No rebooking of cancelled Fwd contracts
– Only based on the underlying, which is market value
of dissolved investment

41. Other provisions
• SEBI and RBI circulars prescribe some certain
general obligations. For instance, FIIs are to
put up investment advises in general public,
employ domestic custodians, etc.