Vous êtes sur la page 1sur 90

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA 1.1 Introduction and overview What is Foreign Direct Investment?

Meaning: These three letters stand for foreign direct investment. The simplest explanation of FDI would be a direct investment by a corporation in a commercial venture in another country. A key to separating this action from involvement in other ventures in a foreign country is that the business enterprise operates completely outside the economy of the corporations home country. The investing corporation must control 10 percent or more of the voting power of the new venture. According to history the United States was the leader in the FDI activity dating back as far as the end of World War II. Businesses from other nations have taken up the flag of FDI, including many who were not in a financial position to do so just a few years ago. The practice has grown significantly in the last couple of decades, to the point that FDI has generated quite a bit of opposition from groups such as labor unions. These organizations have expressed concern that investing at such a level in another country eliminates jobs. Legislation was introduced in the early 1970s that would have put an end to the tax incentives of FDI. But members of the Nixon administration, Congress and business interests rallied to make sure that this attack on their expansion plans was not successful. One key to understanding FDI is to get a mental picture of the global scale of corporations able to make such investment. A carefully planned FDI can provide a huge new market for the company, perhaps introducing products and services to an area where they have never been available. Not only that, but such an investment may also be more profitable if construction costs and labor costs are less in the host country.

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA The definition of FDI originally meant that the investing corporation gained a significant number of shares (10 percent or more) of the new venture. In recent years, however, companies have been able to make a foreign direct investment that is actually long-term management control as opposed to direct investment in buildings and equipment. FDI growth has been a key factor in the international nature of business that many are familiar with in the 21st century. This growth has been facilitated by changes in regulations both in the originating country and in the country where the new installation is to be built. Corporations from some of the countries that lead the worlds economy have found fertile soil for FDI in nations where commercial development was limited, if it existed at all. The dollars invested in such developing-country projects increased 40 times over in less than 30 years. The financial strength of the investing corporations has sometimes meant failure for smaller competitors in the target country. One of the reasons is that foreign direct investment in buildings and equipment still accounts for a vast majority of FDI activity. Corporations from the originating country gain a significant financial foothold in the host country. Even with this factor, host countries may welcome FDI because of the positive impact it has on the smaller economy. Foreign direct investment (FDI) is a measure of foreign ownership of productive assets, such as factories, mines and land. Increasing foreign investment can be used as one measure of growing economic globalization. Figure below shows net inflows of foreign direct investment as a percentage of gross domestic product (GDP). The largest flows of foreign investment occur between the industrialized countries (North America, Western Europe and Japan).But flows to non-industrialized countries are increasing sharply. Foreign direct investment (FDI) refers to long term participation by country A into country B.
Page 2

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA It usually involves participation There outward are in management, joint-venture, transfer two types direct of FDI: inward of

technology and expertise. direct investment and

foreign in




a net FDI inflow (positive or negative) .Foreign direct investment reflects the objective of obtaining a lasting interest by a resident entity in one economy (direct investor) in an entity resident in an economy other than that of the investor (direct investment

enterprise).The lasting interest implies the existence of a long-term relationship between the direct investor and the enterprise and a significant degree of influence on the management of the enterprise. Direct investment involves both the initial transaction between the two entities and all subsequent capital transactions between them and among affiliated enterprises, both incorporated and unincorporated. Foreign Direct Investment when a firm invests directly in production or other facilities, over which it has effective control, in a foreign country. Manufacturing FDI requires the establishment of production facilities. Service FDI requires building service facilities or an investment foothold via capital contributions or building office facilities. Foreign subsidiaries overseas units or entities. Host country the country in which a foreign subsidiary operates. Flow of FDI the amount of FDI undertaken over a given time. Stock of FDI total accumulated value of foreign-owned assets. Outflows/Inflows of FDI the flow of FDI out of or into a country. Foreign Portfolio Investment the investment by individuals, firms, or public bodies in foreign financial instruments. Stocks, bonds, other forms of debt.
Page 3

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA Differs from FDI, which is the investment in physical assets.

1.2 Definition Foreign direct investment is that investment, which is made to serve the business interests of the investor in a company, which is in a different nation distinct from the investor's country of origin. A parent business enterprise and its foreign affiliate are the two sides of the FDI relationship. Together they comprise an MNC. The parent enterprise through its foreign direct investment effort seeks to exercise substantial control over the foreign affiliate company. 'Control' as defined by the UN, is ownership of greater than or equal to 10% of ordinary shares or access to voting rights in an incorporated firm. For an unincorporated firm one needs to consider an equivalent criterion. Ownership share amounting to less than that stated above is termed as portfolio investment and is not categorized as FDI. FDI stands for Foreign Direct Investment, a component of a country's national financial accounts. Foreign direct investment is investment of foreign assets into domestic structures, equipment, and organizations. It does not include foreign investment into the stock markets. Foreign direct investment is thought to be more useful to a country than investments in the equity of its companies because equity investments are potentially "hot money" which can leave at the first sign of trouble, whereas FDI is durable and generally useful whether things go well or badly. FDI or Foreign Direct Investment is any form of investment that earns interest in enterprises which function outside of the domestic territory of the investor. FDIs require a business relationship between a parent company and its foreign subsidiary. Foreign direct business

Page 4

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA relationships give rise to multinational corporations. For an investment to be regarded as an FDI, the parent firm needs to have at least 10% of the ordinary shares of its foreign affiliates.

1.3 History
In the years after the Second World War global FDI was dominated by the United States, as much of the world recovered from the destruction brought by the conflict. The US accounted for around three-quarters of new FDI (including reinvested profits) between 1945 and 1960. Since that time FDI has spread to become a truly global phenomenon, no longer the exclusive preserve countries. FDI has grown in importance in the global economy with FDI stocks now constituting over 20 percent of global GDP. Foreign direct investment (FDI) is a measure of foreign ownership of productive assets, such as factories, mines and land. Increasing foreign investment can be used as one measure of growing economic globalization. Figure below shows net inflows of foreign direct investment as a percentage of gross domestic product (GDP). The largest flows of foreign investment occur between the industrialized countries (North America, Western Europe and Japan). But flows to non-industrialized countries are increasing sharply.

Foreign Direct investor A foreign direct investor is an individual, an incorporated or unincorporated public or private enterprise, a government, a group of related individuals, or a group of related incorporated and/or unincorporated enterprises which has a direct investment enterprise that

Page 5

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA is, a subsidiary, associate or branch operating in a country other than the country or countries of residence of the foreign direct investor or investors.

1.4 Main Theories of FDI

There have been a prolific number of empirical studies on the determinants and motives of FDI. Some studies have concentrated upon the ownership specific advantages of the foreign Firms which are necessary to out weigh the disadvantage of being foreign. These studies have tried to find out the significance of various ownership advantages arising due to propriety knowledge, financial assets, product differentiation, plant economic of scale, size of the firm and multi-plant operations etc. We hereby categorizes such theories as external (supply-side) approaches. Other studies have focused on the location specific advantages as low cost of labor, reduced tariffs, fiscal incentives, market size and characteristics of the host economy, favorable FDI policies of the host government, political stability and other locational. Here this study categorizes such theories as internal (demand-side) approaches. In sum, the external factors include economic conditions outside the host country, while internal factors include the economic conditions of the host country. Traditionally, most empirical papers have focused on the role of the external factors in determining FDI flows into developing countries. These theories so far mainly stress on the ownership specific advantages of the firms and three of them are examined as follows.

Page 6


1.4.1 Industrial Organization Theory

Hymer and Kindleberger argue that the ownership advantages (including inventory, cost, financial or marketing advantages) motivate them to establish subsidiaries in the host countries. These advantages which they assume to be exclusive to the firm owing them explain why American-type FDI is predominant in a particular sector of industry but it may be unable to portray a general pattern of FDI. Another industrial organization approach, developed by Caves, is based on models of oligopolistic competition. He treats a MNC as a creature of market imperfections that lead a firm to possess specific advantages over local firms in the host country (Caves 1982).

1.4.2 Internalization Theory

The internationalization theory, created by Buckley and Casson, and developed by Rugman and Hennart, is primarily concerned with the transactions cost approach. The basic hypothesis of this theory is that MNEs emerge when it is more beneficial to internalize the use of such intermediate goods as technology than externalize them through the market. The core prediction of the theory is that, given a particular distribution of factor endowments, MNE activity will be positively related to the costs of organizing crossborder markets in intermediate products.

1.4.3 Product Life-cycle Theory

Page 7

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA In a classic article published in 1966, Vernon was the first to investigate the relationship between FDI and technology. He uses a microeconomic concept, the product cycle, to explain a macroeconomic phenomenon, which is the foreign activity of US MNCs in the postwar period (Vernon1966). He argues that the product life-cycle can be divided into three stages as new product stage, matured product stage and standardized product stage. In the early new product stage, firms place factories in the home country since the demand for a new product is too small elsewhere. Therefore it develops into the second stage of matured product. As the product turns into increasingly standardized and its competition is based on price, the product is manufactured in less developed countries (LDCs) for export. Although this theory considers changes in technology and implicitly assumes that the MNCs would acquire the manufacturing plants in the countries with abundant low-cost workers, it is not a dynamic theory for the rate of change and the time-lag between product stages are not considered. Chen rebuts that it is also unable to explain FDI in non-standardized products and special products for overseas markets. The theories explained above mention only the home country macro-economic, industry specific and firm specific external (supply-side) factors. But it is necessary to bear in mind that the host country must possess certain locational advantages to attract FDI. The O-L-I paradigm developed by Dunning seeks to offer a comprehensive framework by combining the company comparative advantages and host country location endowments.

1.4.4 Eclectic Theory of International Production

Page 8

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA The eclectic paradigm of international production, which postulates that FDI is determined by three sets of factors, namely ownership (firm-specific) advantage, internalization advantage and location (country-specific) advantage, is developed by Dunning and modified by associate Narula. According to Dunning, the rationales of FDI can be well-defined by O-L-I paradigm:

Ownership (O) advantages: economies of scale, exclusive production and technical expertise, managerial and marketing skills. These are the prerequisite to ensure or enable the MNCs to recover the costs of investing abroad. Itaki further argues that these O advantages largely take the form of privileged possession of intangible assets and the use made of them are assumed to increase the wealth-creating capacity of a MNC hence the value of its assets.

Location (L) factors: low labor costs, potential foreign market, favorable investment incentives. These pull factors of host country contribute to the MNCs decision to employ ownership advantages to produce aboard.

Internalization (I) factors: Comparing with licensing and exporting, by using greater organizational efficiency or ability to exercise monopoly power over the assets under the governance, an internal market is created between parent-company and affiliates to control key resources of competitiveness or to reduce the risk of selling them as well as the right of use of them, to foreign firms. Compared with the above theories, which were founded on ownership in the form of technology and finance, transaction costs and differential factor endowments, the unique feature of Dunnings O-L-I paradigm is to unify and summarize the various theories, although it is still a frame which synthesizes most FDI theories rather than a new theory per se.
Page 9


AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA It signified the ownership, locational and internalization advantages of the firm and, by extension, the ownership and internalization advantages of the home country, and locational advantages of the host country of FDI, which Dunning stipulates that O-L-I is applicable to home country and host country FDI (Dunning 1981). According to this theory, FDI is chosen as a market entry strategy so that a firm can exploit its ownership advantages through internalizing transaction costs in a specific location, which possess locational advantages.

1.4.5 The Dynamic Capability Perspective

A firms ability to diffuse, deploy, utilize and rebuild firm-specific resources for a competitive advantage. Ownership specific resources or knowledge are necessary but not sufficient for international investment or production success. It is necessary to effectively use and build dynamic capabilities for quantity and/or quality based deployment that is transferable to the multinational environment. Firms develop centers of excellence to concentrate core competencies to the host environment.

1.4.6 Monopolistic Advantage Theory

An MNE has and/or creates monopolistic advantages that enable it to operate subsidiaries abroad more profitably than local competitors. Monopolistic Advantage comes from: Superior knowledge production technologies, managerial skills, industrial organization, knowledge of product. Economies of scale through horizontal or vertical FDI
Page 10

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA Internationalization Theory When external markets for supplies, production, or distribution fails to provide efficiency, companies can invest FDI to create their own supply, production, or distribution streams. Advantages Avoid search and negotiating costs Avoid costs of moral hazard (hidden detrimental action by external partners) Avoid cost of violated contracts and litigation Capture economies of interdependent activities Avoid government intervention Control supplies Control market outlets Better apply cross-subsidization, predatory pricing and transfer pricing


To conclude, the relative significance of the motives and determinants as contained in the above theories differs not only between firms and regions but also from time to time for a particular firm or region. It is very difficult to generalize about the determinants of FDI and it is true that most firms are influenced in their behavior by more than one objective and sometimes different values are placed on the same objective.

Page 11

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA The difference in the strength of the determinants is most marked in India which differ radically with regard to economic structure, development characteristics and socio-economic profiles

2.1 Introduction

An analytical study of Foreign Direct Investment in India

This study aims to provide a perspective on to know in which sector we can get more foreign currency in terms of investment in India. It Examine the trends and patterns in the FDI across different sectors and from different countries in India.

2.2 Review of Literature: The comprehensive literature centered on economies pertaining to empirical findings and theoretical rationale tends to demonstrate that FDI is necessary for sustained economic growth and development of any economy in this era of globalization. The reviewed Literature is divided under the following heads:

Temporal studies Inter Country studies Inter Industry studies

Page 12


Temporal Studies

Study of Institutional Reform, FDI and European Transition Economics studied the significance of institutional infrastructure and development as a determinant of FDI inflows into the European Transition Economies. The study examines both the critical role and of the institutional and environment policies of





organizations relating to these institutions) in reducing the transaction costs of both domestic and cross border business activity. By setting up an analytical framework the study identifies the determinants of FDI, and how these had changed over recent years. The Value of Diversity: Foreign Direct Investment and Employment in Central Europe during Economic Recovery, examine the role of FDI in job creation and job preservation as well as their role in changing the

structure of employment. Their analysis refers to Czech Republic, Hungary, Slovakia and Estonia. They present descriptive stage model of FDI progression into Transition economy. They analyzed the employment aspects of the model. The study concluded that the role of FDI in employment creation/preservation has been most successful in Hungary than in Estonia. The paper also find out that the increasing differences in sectoral distribution of FDI employment across countries are closely
Page 13

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA relates to FDI inflows per capita. The bigger diversity of types of FDI is more favorable for the host economy. There is higher likelihood that it will lead to more diverse types of spillovers and skill transfers. If policy is unable to maximize the scale of FDI inflows then policy makers should focus much more on attracting diverse types of FDI Iyare Sunday O, Bhaumik Pradip K, Banik Arindam , in their work Explaining FDI Inflows to India, China and the Caribbean: An Extended Neighborhood Approach find out that FDI flows are generally believed to be influenced by economic indicators like market size, export intensity, institutions, etc, irrespective of the source and destination countries. This paper looks at FDI inflows in an alternative approach based on the concepts of neighborhood and extended neighborhood. The study shows that the neighborhood concepts are widely applicable in different contexts particularly for China and India, and partly in the case of the Caribbean. There are significant common factors in explaining FDI inflows in select regions. While a substantial fraction of FDI inflows may be explained by select economic variables, country specific factors and the idiosyncratic component account for more of the investment inflows in Europe, China and India. Foreign Direct Investment and Employment in the Industrial Countries point out that while looking for evidence regarding a possible relationship between foreign direct investment and employment, in particular between outflows and employment in the source countries in response to outflows. They also find that high labor costs encourage outflows and discourage
Page 14

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA inflows and that such effect can be reinforced by exchange rate movements. The distribution of FDI towards services also suggests that a large proportion of foreign investment is undertaken with the purpose of expanding sales and improving the distribution of exports produced in the source countries. According to this study the principle determinants of FDI flows are prior trade patterns, IT related investments and the scopes for cross border mergers and acquisitions. Finally, the authors find clear evidence that outflows complement rather than substitute for exports and thus help to protect rather than destroy jobs. The Effects of FDI Inflows on Host Country Economic Growth discusses the potential of FDI inflows to affect host country economic growth. The paper argues that FDI should have a positive effect on economic growth as a result of technology spillovers and physical capital inflows. Performing both cross section and panel data analysis on a dataset covering 90 countries during the period 1980 to 2002, the empirical part of the paper finds indications that FDI inflows enhance economic Growth in developing economies but not in developed economies. This paper has assumed that the direction of causality goes from inflow of FDI to host country economic growth. However, economic growth could itself cause an increase in FDI in flows. Economic growth increases the size of the host country market and strengthens the incentives for market seeking FDI. This could result in a situation where FDI and economic growth are mutually supporting. However, for the ease of most of the developing economies
Page 15

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA growth is unlikely to result in market seeking FDI due to the low income levels. Therefore, causality is primarily expected to run from FDI inflows to economic growth for these economies. Foreign Direct investment in Emerging Economies focuses on the impact of FDI on host economies and on policy and managerial implications arising from this (potential) impact. The study finds out that as emerging economies integrate into the global economies international trade and investment will continue to accelerate. MNEs will continue to act as pivotal interface between domestic and international markets and their relative importance may even increase further. The extensive and variety interaction of MNEs with their host societies may tempt policy makers to micro manage inwards foreign investment and to target their instruments at attracting very specific types of projects. Yet, the potential impact is hard to evaluate ex ante (or even ex post) and it is not clear if policy instruments would be effective in attracting specifically the investors that would generate the desired impact. The study concluded that the first priority should be on enhancing the general institutional framework such as to enhance the efficiency of markets, the effectiveness of the public sector administration and the availability of infrastructure. On that basis, then, carefully designed but flexible schemes of promoting new industries may further enhance the chances of developing

internationally competitive business clusters. Foreign Direct Investment in Emerging Markets: A Comparative Study in Egypt, India, South Africa and Vietnam show considerable variations of
Page 16

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA the characteristics of FDI across the four countries, all have had restrictive policy regimes, and have gone through liberalization in the early 1990. Yet the effects of this liberalization policy on characteristics of inward investment vary across countries. Hence, the causality between the institutional strategies framework, merits further including informal This institutions, analysis and has to entry find


appropriate ways to control for the determinants of mode choice, when analyzing its consequences. The study concludes that the policy makers need to understand how institutional arrangements may generate favorable outcomes for both the home company and the host economy. Hence, we need to better understand how the mode choice and the subsequent dynamics affect corporate performance and how it influences externalities generated in favor of the local economy. It is concluded from the above studies that market size, fiscal incentives, lower tariff rates, export intensity, availability of

infrastructure, institutional environment, IT related investments and cross border mergers and acquisitions are the main determinants of FDI flows at temporal level. FDI helps in creation/preservation of employment. It also facilitates exports. Diverse types of FDI lead to diverse types of spillovers, skill transfers and physical capital flows. It enhances the chances of developing internationally competitive business clusters. The increasing numbers of BITs (Bilateral Investment Treaties among nations, which emphasizes non discriminatory treatment of FDI) between nations are found to have a significant impact on attracting aggregate FDI flow as
Page 17

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA the concepts of neighborhood and extended neighborhood are widely applicable in different contexts for different countries. It is concluded that FDI plays a positive role in enhancing the economic growth of the host country.

Page 18


To analyse FDI across different sectors from different countries in India and which sector we can get more foreign currency in terms of investment in India.


Scope of the study: To know the reason for investment in India. Influence of FII on movement of Indian stock exchange. To understand the FII & FDI policy in India. The study attempts to analyze the important dimensions of FDI in India. The study works out the trends and patterns, investment flows to India. The study also examines the role of FDI on economic growth in India for the period 1991-2012. The period under study is important for a variety of reasons. First of all, it was during July 1991 India opened its doors to private sector and liberalized its economy. Indias experience with its first generation economic reforms and the countrys 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. 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. Increase in competition for FDI inflows particularly among the developing nations. The shift of the power center from the western
Page 19


AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA countries to the Asia sub continent is yet another reason to take up this study.

The study is important from the view point of the macroeconomic variables included in the study as no other study has included the explanatory variables which are included in this study. The study is appropriate in understanding inflows.

2.5 Objectives of the study: Primary objective

To know in which sector we can get more foreign currency in terms of investment in

India. To know the flow of investment in India To know how can India Grow by Investment. To Examine the trends and patterns in the FDI across different sectors and from different countries in India

Secondary objectives

To know the reason for investment in India Influence of FII on movement of Indian stock exchange To understand the FII & FDI policy in India.


Page 20


AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA The study has been taken up for the period 1991-2012 with the following hypotheses: Hypothesis Test: If the hypothesis holds good then we can infer that FIIs have significant impact on the Indian capital market. This will help the investors to decide on their investments in stocks and shares. If the hypothesis is rejected, or in other words if the null hypothesis is accepted, then FIIs will have no significant impact on the Indian bourses. Flow of FDI shows a positive trend over the period 2004-2009, after this speriod FDI shows a negative trend upto Dec 2011 . FDI has a positive impact on economic growth of the country.


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 Banks 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 2012. Data collection:

Page 21

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA Secondary Data: Internet, Books, newspapers, journals and books, other reports and projects, literatures Tools and techniques of analyzing dataFII: Correlation: We have used the Correlation tool to determine whether two ranges of data move together that is, how the Sensex, Bankex, IT, Power and Capital Goods are related to the FII which may be positive relation, negative relation or no relation. We will use this model for understanding the relationship between FII and stock indices returns. FII is taken as independent variable. Stock indices are taken as dependent variable


Limitations of the study

All the economic / scientific studies are faced with various limitations and this study is no exception to the phenomena. The various limitations of the study are: The analysis was purely based on the secondary data. So, any error in the secondary data might also affect the study undertaken. Research is done during college hence no exclusive time dedicated for this research. 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. For example, the time series used for different variables,
Page 22

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA the averages are used at certain occasions. Therefore, the trends, growth rates and estimated regression coefficients may deviate from the true ones. 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. Above all, since it is a MBA project and the research was faced with the problem of various resources like time and money. 2.9 Chapter Scheme: Chapter No. 1: Introduction Chapter No. 2: Research Design Chapter No. 3: Profiles. Chapter No.4: Applicability of foreign rating models to Indian microfinance institutions - An Analysis Chapter No. 5: Summary of Findings, Conclusions, and Suggestions

Page 23


3.1 Introduction
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. 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. However, researchers could not portray the complete history of FDI pouring in India due to lack of abundant and authentic data. Before independence major amount of
Page 24

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA FDI came from the British companies. British companies setup their units in mining sector and in those sectors that suits their own economic and business interest. 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. The first Prime Minister of India considered foreign investment as necessary not only to supplement domestic capital but also to secure scientific, technical, and industrial knowledge and capital equipments. 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. However, the country faced two severe crisis in the form of foreign exchange and financial resource mobilization during the second five year plan (1956 -61). Therefore, the government adopted a liberal attitude by allowing more frequent equity participation to foreign enterprises, and to accept equity capital in technical collaborations. The government also provides many incentives such as tax concessions, simplification of licensing procedures and de- reserving some industries such as drugs, aluminum, heavy electrical equipments, fertilizers, etc in order to further boost the FDI inflows in the country. This liberal attitude of
Page 25

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA government towards foreign capital lures investors from other advanced countries like USA, Japan, and Germany, etc. But due to significant outflow of foreign reserves in the form of remittances of dividends, profits, royalties etc, 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. It is during this period the government encourages FDI, allow MNCs to operate in India.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 nondiscriminatory policy for FDI flow. 3.2 Foreign Investment Promotion Board The FIPB (Foreign Investment Promotion Board) is a government body that offers a single window clearance for proposals on foreign direct investment in the country that are not allowed access through the automatic route. Consisting of Senior Secretaries drawn from different ministries with Secretary ,Economic Affairs in the chair, this high powered body discusses and examines proposals for foreign investment in the country for restricted sectors ( as laid out in the Press notes and extant foreign investment policy) on a regular basis.
Page 26

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA Currently proposals for investment beyond 600 crores require the concurrence of the CCEA (Cabinet Committee on Economic Affairs). The threshold limit is likely to be raised to 1200 crore soon. The Board thus plays an important role in the administration and implementation of the Governments FDI policy. In circumstances where there is ambiguity or a conflict of interpretation, the FIPB has stepped in to provide solutions. Through its fast track working it has established its reputation as a body that does not unreasonably delay and is objective in its decision making. It therefore has a strong record of actively encouraging the flow of FDI into the country. The FIPB is assisted in this task by a FIPB Secretariat. The launch of efiling facility is an important initiative of the Secretariat to further the cause of enhanced accessibility and transparency.

3.3 Types of FDI:

Page 27


Figure 3.3

Page 28

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA Types of Foreign Direct Investment: An Overview FDIs can be broadly classified into two types: 1 2 Outward FDIs Inward FDIs

This classification is based on the types of restrictions imposed, and the various prerequisites required for these investments. Outward FDI: An outward-bound FDI is backed by the government against all types of

associated risks. This form of FDI is subject to tax incentives as well as disincentives of various forms. Risk coverage provided to the domestic industries and subsidies granted to the local firms stand in the way of outward FDIs, which are also known as 'direct investments abroad.' Inward FDIs: Different economic factors encourage inward FDIs. These include interest loans, tax breaks, grants, subsidies, and the removal of restrictions and limitations. Factors detrimental to the growth of FDIs include necessities of differential performance and limitations related with ownership patterns. Other categorizations of FDI Other categorizations of FDI exist as well. Vertical Foreign Direct Investment takes place when a multinational corporation owns some shares of a foreign enterprise, which supplies input for it or uses the output produced by the MNC. Horizontal foreign direct investments happen when a multinational company carries out a similar business operation in different nations.

Page 29

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA Horizontal FDI the MNE enters a foreign country to produce the same products product at home. Conglomerate FDI the MNE produces products not manufactured at home. Vertical FDI the MNE produces intermediate goods either forward or backward in the supply stream. Liability of foreignness the costs of doing business abroad resulting in a competitive disadvantage. 3.4 Methods of Foreign Direct Investments The foreign direct investor may acquire 10% or more of the voting power of an enterprise in an economy through any of the following methods:

by incorporating a wholly owned subsidiary or company by acquiring shares in an associated enterprise through a merger or an acquisition of an unrelated enterprise participating in an equity joint venture with another investor or enterprise

Foreign direct investment incentives may take the following forms: Low corporate tax and income tax rates

tax holidays other types of tax concessions preferential tariffs special economic zones investment financial subsidies soft loan or loan guarantees
Page 30



free land or land subsidies relocation & expatriation subsidies job training & employment subsidies infrastructure subsidies R&D support derogation from regulations (usually for very large projects)

3.5 Entry Mode The manner in which a firm chooses to enter a foreign market through FDI. International franchising Branches Contractual alliances Equity joint ventures Wholly foreign-owned subsidiaries

Investment approaches: Greenfield investment (building a new facility) Cross-border mergers Cross-border acquisitions Sharing existing facilities.

Page 31


3.6 Why is FDI important for any consideration of going Global?

The simple answer is that making a direct foreign investment allows accomplish several tasks: 1 .Avoiding foreign government pressure for local production. 2. Circumventing trade barriers, hidden and otherwise. 3. Making the move from domestic export sales to a locally-based national sales office. 4. Capability to increase total production capacity. 5.Opportunities for co-production, joint ventures with local partners, joint marketing arrangements, licensing, etc; A more complete response might address the issue of global business partnering in very general terms. While it is nice that many business writers like the expression, think globally, act locally, this often used clich does not really mean very much to the average business executive in a small and medium sized company. The phrase does have significant connotations for multinational corporations. But for executives in SMEs, it is still just another buzzword. The simple explanation for this is the difference in perspective between executives of multinational corporations and small and medium sized companies to

companies. Multinational corporations are almost always concerned with worldwide manufacturing capacity and proximity to major markets. Small and medium sized companies tend to be more concerned with selling their products in overseas markets. The advent of the Internet has ushered in a new and very different mindset that tends to focus more on access issues. SMEs in particular are now focusing on access to markets, access to expertise and most of all access to technology.

3.6.1 The Strategic Logic behind FDI

Page 32

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA Resources seeking looking for resources at a lower real cost. Market seeking secure market share and sales growth in target foreign market. Efficiency seeking seeks to establish efficient structure through useful factors, cultures, policies, or markets. Strategic asset seeking seeks to acquire assets in foreign firms that promote corporate long term objectives.


Enhancing Efficiency from Location Advantages Location advantages - defined as the benefits arising from a host countrys comparative advantages.- Better access to resources Lower real cost from operating in a host country Labor cost differentials Transportation costs, tariff and non-tariff barriers Governmental policies

3.6.3 Improving Performance from Structural Discrepancies

Structural discrepancies are the differences in industry structure attributes between home and host countries. Examples include areas where:

Competition is less intense Products are in different stages of their life cycle Market demand is unsaturated There are differences in market sophistication
Page 33



3.6.4 Increasing Return from Ownership Advantages

Ownership Advantages come from the application of proprietary tangible and intangible assets in the host country. Reputation, brand image, distribution channels Technological expertise, organizational skills, experience

Core competence skills within the firm that competitors cannot easily imitate or match.

3.6.5 Ensuring Growth from Organizational Learning

MNEs exposed to multiple stimuli, developing: Diversity capabilities Broader learning opportunities

Exposed to: New markets New practices New ideas New cultures New competition

3.7 The Impact of FDI on the Host Country 3.7.1 Employment

Page 34

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA Firms attempt to capitalize on abundant and inexpensive labor. Host countries seek to have firms develop labor skills and sophistication. Host countries often feel like least desirable jobs are transplanted from home countries. Home countries often face the loss of employment as jobs move.

3.7.2 FDI Impact on Domestic Enterprises

Foreign invested companies are likely more productive than local competitors. The result is uneven competition in the short run, and competency building efforts in the longer term. It is likely that FDI developed enterprises will gradually develop local supporting industries, supplier relationships in the host country.

3.8 Foreign Direct Investment in India The economy of India is the third largest in the world as measured by purchasing power parity (PPP), with a gross domestic product (GDP) of US $3.611 trillion. When measured in USD exchange-rate terms, it is the tenth largest in the world, with a GDP of US $800.8 billion (2006). is the second fastest growing major economy in the world, with a GDP growth rate of 8.9% at the end of the first quarter of 2006-2007. However, India's huge population results in a per capita income of $3,300 at PPP and $714 at nominal. The economy is diverse and encompasses agriculture, handicrafts, textile, manufacturing, and a multitude of services. Although two-thirds of the Indian workforces still earn their livelihood directly or indirectly through agriculture, services are a growing sector and are
Page 35

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA playing an increasingly important role of India's economy. The advent of the digital age, and the large number of young and educated populace fluent in English, is gradually transforming India as an important 'back office' destination for global companies for the outsourcing of their customer services and technical support. India is a major exporter of highly-skilled workers in software and financial services, and software engineering. India followed a socialist-inspired approach for most of its independent history, with strict government control over private sector participation, foreign trade, and foreign direct investment. However, since the early 1990s, India has gradually opened up its markets through economic reforms by reducing government controls on foreign trade and investment. The privatization of publicly owned industries and the opening up of certain sectors to private and foreign interests has proceeded slowly amid political debate. India faces a burgeoning population and the challenge of reducing economic and social inequality. Poverty remains a serious problem, although it has declined significantly since independence, mainly due to the green revolution and economic reforms. FDI up to 100% is allowed under the automatic route in all activities/sectors except the following which will require approval of the Government: Activities/items that require an Industrial License; Proposals in which the foreign collaborator has a previous/existing venture/tie up in India FDI in India includes FDI inflows as well as FDI outflow from India. Also FDI foreign direct investment and FII foreign institutional investors are a separate case study while preparing a report on FDI and economic growth in India. FDI and FII in India have registered growth in terms of both FDI flows in India and outflow from India. The FDI statistics and data are evident of the emergence of India as both a potential investment market and investing country. FDI has helped the Indian economy grow, and the government continues to encourage more investments of this sort - but with $5.3 billion in FDI . India gets less than
Page 36

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA 10% of the FDI of China. Foreign direct investment (FDI) in India has played an important role in the development of the Indian economy. FDI in India has - in a lot of ways - enabled India to achieve a certain degree of financial stability, growth and development. This money has allowed India to focus on the areas that may have needed economic attention, and address the various problems that continue to challenge the country. India has continually sought to attract FDI from the worlds major investors. In 1998 and 1999, the Indian national government announced a number of reforms designed to encourage FDI and present a favorable scenario for investors. FDI investments are permitted through financial collaborations, through private equity or preferential allotments, by way of capital markets through Euro issues, and in joint ventures. FDI is not permitted in the arms, nuclear, railway, coal & lignite or mining industries. A number of projects have been announced in areas such as electricity generation, distribution and transmission, as well as the development of roads and highways, with opportunities for foreign investors. The Indian national government also provided permission to FDIs to provide up to 100% of the financing required for the construction of bridges and tunnels, but with a limit on foreign equity of INR 1,500 crores, approximately $352.5m. Currently, FDI is allowed in financial services, including the growing credit card business. These services include the non-banking financial services sector. Foreign investors can buy up to 40% of the equity in private banks, although there is condition that stipulates that these banks must be multilateral financial organizations. Up to 45% of the shares of companies in the global mobile personal communication by satellite services (GMPCSS) sector can also be purchased. By 2004, India received $5.3 billion in FDI, big growth compared to previous years, but less than 10% of the $60.6 billion that flowed into China. Why does India, with a stable democracy and a smoother approval process, lag so far behind
Page 37

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA China in FDI amounts? Although the Chinese approval process is complex, it includes both national and regional approval in the same process.


Investment Risks in India

3.9.1 Sovereign Risk India is an effervescent parliamentary democracy since its political freedom from British rule more than 50 years ago. The country does not face any real threat of a serious revolutionary movement which might lead to a collapse of state machinery. Sovereign risk in India is hence nil for both "foreign direct investment" and "foreign portfolio investment." Many Industrial and Business houses have restrained themselves from investing in the NorthEastern part of the country due to unstable conditions. Nonetheless investing in these parts is lucrative due to the rich mineral reserves here and high level of literacy. Kashmir on the northern tip is a militancy affected area and hence investment in the state of Kashmir are restricted by law. 3.9.2 Political Risk India has enjoyed successive years of elected representative government at the Union as well as federal level. India suffered political instability for a few years in the sense there was no single party which won clear majority and hence it led to the formation of coalition governments. However, political stability has firmly returned since the general elections in 1999, with strong and healthy coalition governments emerging. Nonetheless, political
Page 38

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA instability did not change India's bright economic course though it delayed certain decisions relating to the economy. Economic liberalization which mostly interested foreign investors has been accepted as essential by all political parties including the Communist Party of India Though there are bleak chances of political instability in the future, even if such a situation arises the economic policy of India would hardly be affected.. Being a strong democratic nation the chances of an army coup or foreign dictatorship are minimal. Hence, political risk in India is practically absent. 3.9.3 Commercial Risk Commercial risk exists in any business ventures of a country. Not each and every product or service is profitably accepted in the market. Hence it is advisable to study the demand / supply condition for a particular product or service before making any major investment. In India one can avail the facilities of a large number of market research firms in exchange for a professional fee to study the state of demand / supply for any product. As it is, entering the consumer market involves some kind of gamble and hence involves commercial risk 3.9.4 Risk Due To Terrorism In the recent past, India has witnessed several terrorist attacks on its soil which could have a negative impact on investor confidence. Not only business environment and return on investment, but also the overall security conditions in a nation have an effect on FDI's. Though some of the financial experts think otherwise. They believe the negative impact of terrorist attacks would be a short term phenomenon. In the long run, it is the micro and macro economic conditions of the Indian economy that would decide the flow of Foreign investment and in this regard India would continue to be a favorable investment destination.
Page 39


3.10 Foreign direct investments in India are approved through two routes 3.10.1 Automatic approval by RBI The Reserve Bank of India accords automatic approval within a period of two weeks (subject to compliance of norms) to all proposals and permits foreign equity up to 24%; 50%; 51%; 74% and 100% is allowed depending on the category of industries and the sectoral caps applicable. The lists are comprehensive and cover most industries of interest to foreign companies. Investments in high priority industries or for trading companies primarily engaged in exporting are given almost automatic approval by the RBI.

3.10.2 The FIPB Route Processing of non-automatic approval cases

FIPB stands for Foreign Investment Promotion Board which approves all other cases where the parameters of automatic approval are not met. Normal processing time is 4 to 6 weeks. Its approach is liberal for all sectors and all types of proposals, and rejections are few. It is not necessary for foreign investors to have a local partner, even when the foreign investor wishes to hold less than the entire equity of the company. The portion of the equity not proposed to be held by the foreign investor can be offered to the public.

Page 40


4.1 Government Approvals for Foreign Companies Doing Business in India Government Approvals for Foreign Companies Doing Business in India or Investment Routes for Investing in India, Entry Strategies for Foreign Investors India's foreign

trade policy has been formulated with a view to invite and encourage FDI in India. The Reserve Bank of India has prescribed the administrative and compliance aspects of FDI. A foreign company planning to set up business operations in India has the following options:

Investment under automatic route; and Investment through prior approval of Government.

4.1.1 Procedure under automatic route

FDI in sectors/activities to the extent permitted under automatic route does not require any prior approval either by the Government or RBI. The investors are only required to notify the Regional office concerned of RBI within 30 days of receipt of inward remittances and file the required documents with that office within 30 days of issue of shares to foreign investors.

List of activities or items for which automatic route for foreign investment is not available, include the following:

Banking NBFC's Activities in Financial Services Sector

Page 41



Civil Aviation Petroleum Including Exploration/Refinery/Marketing Housing & Real Estate Development Sector for Investment from Persons other than NRIs/OCBs.

Venture Capital Fund and Venture Capital Company Investing Companies in Infrastructure & Service Sector Atomic Energy & Related Projects Defense and Strategic Industries Agriculture (Including Plantation) Print Media Broadcasting Postal Services

4.1.2 Procedure under Government approval

FDI in activities not covered under the automatic route, requires prior Government approval and are considered by the Foreign Investment Promotion Board (FIPB). Approvals of
Page 42

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA composite proposals involving foreign investment/foreign technical collaboration are also granted on the recommendations of the FIPB. Application for all FDI cases, except NonResident Indian (NRI) investments and 100% Export Oriented Units (EOUs), should be submitted to the FIPB Unit, Department of Economic Affairs (DEA), Ministry of Finance. Application for NRI and 100% EOU cases should be presented to SIA in Department of Industrial Policy & Promotion. 4.1.3 Investment by way of Share Acquisition A foreign investing company is entitled to acquire the shares of an Indian company without obtaining any prior permission of the FIPB subject to prescribed parameters/ guidelines. If the acquisition of shares directly or indirectly results in the acquisition of a company listed on the stock exchange, it would require the approval of the Security Exchange Board of India. 4.1.4 New investment by an existing collaborator in India A foreign investor with an existing venture or collaboration (technical and financial) with an Indian partner in particular field proposes to invest in another area, such type of additional investment is subject to a prior approval from the FIPB, wherein both the parties are required to participate to demonstrate that the new venture does not prejudice the old one. 4.1.5 General Permission of RBI under FEMA Indian companies having foreign investment approval through FIPB route do not require any further clearance from RBI for receiving inward remittance and issue of shares to the foreign investors. The companies are required to notify the concerned Regional office of

Page 43

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA the RBI of receipt of inward remittances within 30 days of such receipt and within 30 days of issue of shares to the foreign investors or NRIs.

4.1.6 Participation by International Financial Institutions

Equity participation by international financial institutions such as ADB, IFC, CDC, DEG, etc., in domestic companies is permitted through automatic route, subject to SEBI/RBI regulations and sector specific cap on FDI. 4.1.7 FDI in Small Scale Sector (SSI) Units A small-scale unit cannot have more than 24 per cent equity in its paid up capital from any industrial undertaking, either foreign or domestic. If the equity from another company (including foreign equity) exceeds 24 per cent, even if the investment in plant and machinery in the unit does not exceed Rs 10 million, the unit loses its small-scale status and shall require an industrial license to manufacture items reserved for small-scale sector. See also FDI in Small Scale Sector in India Further Liberalized.

4.2 Sector-wise FDI allowance in India

Page 44

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA Is the process whereby residents of one country (the source country) acquire ownership of assets for the purpose of controlling the production, distribution, and other activities of a firm in another country (the host country). The international monetary funds balance of payment manual defines FDI as an investment that is made to acquire a lasting interest in an enterprise operating in an economy other than that of the investor. The investors purpose being to have an effective voice in the management of the enterprise. The united nations 1999 world investment report defines FDI as an investment involving a long term relationship and reflecting a lasting interest and control of a resident entity in one economy (foreign direct investor or parent enterprise) in an enterprise resident in an economy other than that of the foreign direct investor ( FDI enterprise, affiliate enterprise or foreign affiliate).

Foreign direct investment: Indian scenario FDI is permitted as under the following forms of investments Through financial collaborations. Through joint ventures and technical collaborations. Through capital markets via Euro issues. Through private placements or preferential allotments.

Sector Specific Foreign Direct Investment in India

4.2.1 Hotel & Tourism: FDI in Hotel & Tourism sector in India

100% FDI is permissible in the sector on the automatic route,the term hotels include restaurants, beach resorts, and other tourist complexes providing accommodation and/or
Page 45

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA catering and food facilities to tourists. Tourism related industry include travel agencies, tour operating agencies and tourist transport operating agencies, units providing facilities for cultural, adventure and wild life experience to tourists, surface, air and water transport facilities to tourists, leisure, entertainment, amusement, sports, and health units for tourists and Convention/Seminar units and organizations. For foreign technology agreements, automatic approval is granted if i. Up to 3% of the capital cost of the project is proposed to be paid for technical and consultancy services including fees for architects, design, supervision, etc. ii. Up to 3% of net turnover is payable for franchising and marketing/publicity support fee, and up to 10% of gross operating profit is payable for management fee, including incentive fee. 4.2.2 Private Sector Banking: Non-Banking Financial Companies (NBFC) 49% FDI is allowed from all sources on the automatic route subject to guidelines issued from RBI from time to time. a. FDI/NRI/OCB investments allowed in the following 19 NBFC activities shall be as per levels indicated below: i. ii. iii. iv. Merchant banking Underwriting Portfolio Management Services Investment Advisory Services
Page 46

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA v. vi. vii. viii. ix. x. xi. xii. xiii. xiv. xv. xvi. xvii. xviii. xix. Financial Consultancy Stock Broking Asset Management Venture Capital Custodial Services Factoring Credit Reference Agencies Credit rating Agencies Leasing & Finance Housing Finance Foreign Exchange Brokering Credit card business Money changing Business Micro Credit Rural Credit b. Minimum Capitalization Norms for fund based NBFCs: i) For FDI up to 51% - US$ 0.5 million to be brought upfront ii) For FDI above 51% and up to 75% - US $ 5 million to be brought upfront
Page 47

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA iii) For FDI above 75% and up to 100% - US $ 50 million out of which US $ 7.5 million to be brought up front and the balance in 24 months c. Minimum capitalization norms for non-fund based activities: Minimum capitalization norm of US $ 0.5 million is applicable in respect of all permitted non-fund based NBFCs with foreign investment. d. Foreign investors can set up 100% operating subsidiaries without the condition to disinvest a minimum of 25% of its equity to Indian entities, subject to bringing in US$ 50 million as at b) (iii) above (without any restriction on number of operating subsidiaries without bringing in additional capital) e. Joint Venture operating NBFC's that have 75% or less than 75% foreign investment will also be allowed to set up subsidiaries for undertaking other NBFC activities, subject to the subsidiaries also complying with the applicable minimum capital inflow i.e. (b)(i) and (b)(ii) above. f. FDI in the NBFC sector is put on automatic route subject to compliance with guidelines of the Reserve Bank of India. RBI would issue appropriate guidelines in this regard. 4.2.3 Insurance Sector FDI in Insurance sector in India FDI up to 26% in the Insurance sector is allowed on the automatic route subject to obtaining license from Insurance Regulatory & Development Authority (IRDA)

Page 48

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA 4.2.4 Telecommunication: FDI in Telecommunication sector i. In basic, cellular, value added services and global mobile personal communications by satellite, FDI is limited to 49% subject to licensing and security requirements and adherence by the companies (who are investing and the companies in which investment is being made) to the license conditions for foreign equity cap and lock- in period for transfer and addition of equity and other license provisions. ii. ISPs with gateways, radio-paging and end-to-end bandwidth, FDI is permitted up to 74% with FDI, beyond 49% requiring Government approval. These services would be subject to licensing and security requirements. iii. iv. No equity cap is applicable to manufacturing activities. FDI up to 100% is allowed for the following activities in the telecom sector : a. b. c. d. ISPs not providing gateways (both for satellite and submarine cables); Infrastructure Providers providing dark fiber (IP Category 1); Electronic Mail; and Voice Mail The above would be subject to the following conditions: e. FDI up to 100% is allowed subject to the condition that such companies would divest 26% of their equity in favor of Indian public in 5 years, if these companies are listed in other parts of the world.

Page 49

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA f. The above services would be subject to licensing and security requirements, wherever required. Proposals for FDI beyond 49% shall be considered by FIPB (Foreign Investment Promotion Board) on case to case basis. 4.2.5 Trading: FDI in Trading Companies in India Trading is permitted under automatic route with FDI up to 51% provided it is primarily export activities, and the undertaking is an export house/trading house/super trading house/star trading house. However, under the FIPB route:i. 100% FDI is permitted in case of trading companies for the following activities:

exports; bulk imports with ex-port/ex-bonded warehouse sales; cash and carry wholesale trading; Other import of goods or services provided at least 75% is for procurement and sale of goods and services among the companies of the same group and not for third party use or onward transfer/distribution/sales.

ii. The following kinds of trading are also permitted, subject to provisions of EXIM Policy: a. Companies for providing after sales services (that is not trading per se)

Page 50

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA b. Domestic trading of products of JVs is permitted at the wholesale level for such trading companies who wish to market manufactured products on behalf of their joint ventures in which they have equity participation in India. c. Trading of hi-tech items/items requiring specialized after sales service d. Trading of items for social sector e. Trading of hi-tech, medical and diagnostic items. f. Trading of items sourced from the small scale sector under which, based on technology provided and laid down quality specifications, a company can market that item under its brand name. g. Domestic sourcing of products for exports. h. Test marketing of such items for which a company has approval for manufacture provided such test marketing facility will be for a period of two years, and investment in setting up manufacturing facilities commences simultaneously with test marketing FDI up to 100% permitted for e-commerce activities subject to the condition that such companies would divest 26% of their equity in favor of the Indian public in five years, if these companies are listed in other parts of the world. Such companies would engage only in business to business (B2B) e-commerce and not in retail trading.

Page 51

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA 4.2.6 Power: FDI in Power Sector in India Up to 100% FDI allowed in respect of projects relating to electricity generation, transmission and distribution, other than atomic reactor power plants. There is no limit on the project cost and quantum of foreign direct investment. 4.2.7 Drugs & Pharmaceuticals FDI up to 100% is permitted on the automatic route for manufacture of drugs and pharmaceutical, provided the activity does not attract compulsory licensing or involve use of recombinant DNA technology, and specific cell / tissue targeted formulations. FDI proposals for the manufacture of licensable drugs and pharmaceuticals and bulk drugs produced by recombinant DNA technology, and specific cell / tissue targeted formulations will require prior Government approval. 4.2.8 Roads, Highways, Ports and Harbors FDI up to 100% under automatic route is permitted in projects for construction and maintenance of roads, highways, vehicular bridges, toll roads, vehicular tunnels, ports and harbors. Pollution control and management FDI up to 100% in both manufacture of pollution control equipment and consultancy for integration of pollution control systems is permitted on the automatic route.

Page 52


Page 53


4.2.9 Call Centers in India / Call Centres in India FDI up to 100% is allowed subject to certain conditions. Business Process Outsourcing BPO in India FDI up to 100% is allowed subject to certain conditions. Special Facilities and Rules for NRI's and OCB's NRI's and OCB's are allowed the following special facilities: 1. Direct investment in industry, trade, infrastructure etc. 2. Up to 100% equity with full repatriation facility for capital and dividends in the following sectors i. ii. iii. iv. v. vi. vii. viii. ix. 34 High Priority Industry Groups Export Trading Companies Hotels and Tourism-related Projects Hospitals, Diagnostic Centers Shipping Deep Sea Fishing Oil Exploration Power Housing and Real Estate Development
Page 54

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA x. xi. xii. Highways, Bridges and Ports Sick Industrial Units Industries Requiring Compulsory Licensing

3. Up to 40% Equity with full repatriation: New Issues of Existing Companies raising Capital through Public Issue up to 40% of the new Capital Issue. 4. On non-repatriation basis: Up to 100% Equity in any Proprietary or Partnership engaged in Industrial, Commercial or Trading Activity. 5. Portfolio Investment on repatriation basis: Up to 1% of the Paid up Value of the equity Capital or Convertible Debentures of the Company by each NRI. Investment in Government Securities, Units of UTI, National Plan/Saving Certificates. 6. On Non-Repatriation Basis: Acquisition of shares of an Indian Company, through a General Body Resolution, up to 24% of the Paid Up Value of the Company. 7. Other Facilities: Income Tax is at a Flat Rate of 20% on Income arising from Shares or Debentures of an Indian India further opens up key sectors for Foreign Investment India has liberalized foreign investment regulations in key sectors, opening up commodity exchanges, credit information services and aircraft maintenance operations. The foreign investment limit in Public Sector Units (PSU) refineries has been raised from 26% to 49%. An additional sweetener is that the mandatory disinvestment clause within five years has been done away with. FDI in Civil aviation up to 74% will now be allowed through the automatic route for non-scheduled and cargo airlines, as also for ground handling
Page 55

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA activities. 100% FDI in aircraft maintenance and repair operations has also been allowed. But the big one, allowing foreign airlines to pick up a stake in domestic carriers has been given a miss again. India has decided to allow 26% FDI and 23% FII investments in commodity exchanges, subject to the proviso that no single entity will hold more than 5% of the stake. Sectors like credit information companies, industrial parks and construction and development projects have also been opened up to more foreign investment. Also keeping India's civilian nuclear ambitions in mind, India has also allowed 100% FDI in mining of titanium, a mineral which is abundant in India. Sources say the government wants to send out a signal that it is not done with reforms yet. At the same time, critics say contentious issues like FDI and multi-brand retail are out of the policy radar because of political compulsions. 4.3 Sector-wise FDI Inflows ( From April 2000 to January 2012)

Page 56

Sector-wise FDI Inflows ( From April 2000 to January 2012) AMOUNT OF FDI AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA INFLOWS PERCENT OF Sl.no SECTOR In Rs CRORE 1. 2. Services Sector Housing & Real estate 124219.33 47,380.9 5 48,369.4 9 & 46,723.0 9 39,686.5 4 28,274.3 1 28,135.7 8 & 21,640.48 4,839.11 3.52 In Million 27806.80 10,630.2 5 10,622.9 9 10,500.1 6 8,885.38 7.64 6.46 20.22 7.73 TOTAL FDI US$ INFLOWS (In terms of Rs)


Telecommunications Computer hardware Software




Construction Activities



6,246.48 6,228.33

4.54 4.53


Power Drugs Pharmaceuticals


9. 10. 11.

Metallurgical industries Petroleum & Natural Gas Trading Chemicals Fertilizers) (Other

18,767.82 13,687.09 12,893.24

4,295.18 3,142.64 2,913.67

3.12 2.29 2.12


than 12,366.34



13. 14. 15.

Hotel and Tourism Electrical Equipments Cement Products &

12,108.20 11,778.25

2,687.51 2,605.69 2,370.50

1.95 1.90 1.72 1.63

Page 57

Gypsum 10,525.91


Information media)

& 10,165.24


Broadcasting (Incl. Print


17 18. 19

Consultancy Services Ports Industrial

7,793.24 6,717.36 6,540.34

1,714.31 1,635.08 1,451.66

1.25 1.19 1.06




(Amount US$ million) Sl.n o

Financial Year (AprilMarch FIPB Route/ RBIs Automatic Route/ Acquisitio n Route Equity capital ofuninc o rporate d bodies Reinveste d earning s + Other capital + FDI FLOW S INTO INDIA Investmen t by FIIs Foreign Institutiona l Investors Fund

1 2. 3.

2000-01 2001-02 2002-03

2,339 3,904 2,574

61 191 190 1,350 1,645 1,833

279 390 438

4,029 6,130 5,035


(+) 52 1,505 % (-) %

Page 58

18 377


AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA 4. 5. 6. 7. 8. 9. 10. 11. 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 (P) (+) 2010-11 (P) (+) 1 2011-2012 2. Cumulativ e Total (from April 2000 to May 2011 140,115 7740 51,528 6518 7,785 0 0 0 7,785 20,595 5 2,197 3,250 5,540 15,585 24,573 27,329 25,609 19,430 32 528 435 896 2,291 702 1,540 874 1,460 1,904 2,760 5,828 7,679 9,030 8,669 9,424 633 369 226 517 292 777 1,94 5 652 4,322 6,051 8,961 22,826 34,835 37,838 37,763 30,380 (-) 20 29,422 % 1,731 101,996 (-) 14 10,918

% (+) 40 8,686 % (+) 48 9,926 % (+) 146 3,225 % (+) 53 20,328 % (+) 09 (-) 15,017 % (-) 0.2 29,048 %

4.5 DIPPS FINANCIAL YEAR-WISE FDI EQUITY INFLOWS: (As per DIPPs FDI data base equity capital components only): %age growth S.no Financial Year (April March) Amount of FDI Inflows over / previous year/
Page 59

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA (in terms of US $) In crores 1 2 3 4 5 6 7 8 9 10 11 12 Cumulative Total Forbidden Territories:

In US$ million 2,463 4,065 2,705 2,188 3,219 5,540 12,492 24,575 27,330 25,834 19,427 7,785 137,623 ( + ) 65 % ( - ) 50 % ( - ) 19 % ( + ) 47 % ( + ) 72 % (+ )125 % ( + ) 97 % ( + ) 11 % ( - ) 05 % -

2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12

10,733 18,654 12,871 10,064 14,653 24,584 56,390 98,642 123,025 123,120 88,520 34,792 616,0 48

Arms and ammunition Atomic Energy Coal and lignite Rail Transport Mining of metals like iron, manganese, chrome, gypsum, sulfur, gold, diamonds, copper, zinc.


Foreign Investment through GDRs (Euro Issues)

Indian companies are allowed to raise equity capital in the international market through the issue of Global Depository Receipt (GDRs). GDR investments are treated as FDI and are designated in dollars and are not subject to any ceilings on investment. An applicant company seeking Government's approval in this regard should have consistent track record for good
Page 60

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA performance (financial or otherwise) for a minimum period of 3 years. This condition would be relaxed for infrastructure projects such as power generation, telecommunication, petroleum exploration and refining, ports, airports and roads.

4.6.1. Clearance from FIPB There is no restriction on the number of Euro-issue to be floated by a company or a group of companies in the financial year. A company engaged in the manufacture of items covered under Annex-III of the New Industrial Policy whose direct foreign investment after a proposed Euro issue is likely to exceed 51% or which is implementing a project not contained in Annex-III, would need to obtain prior FIPB clearance before seeking final approval from Ministry of Finance.

4.6.2. Use of GDRs

The proceeds of the GDRs can be used for financing capital goods imports, capital expenditure including domestic purchase/installation of plant, equipment and building and investment in software development, prepayment or scheduled repayment of earlier external borrowings, and equity investment in JV/WOSs in India. 4.7 Analysis of sector specific policy for FDI Sr. No. 1. 2. 3. 4. Sector/Activity Hotel & Tourism NBFC Insurance Telecommunication: cellular, value added services ISPs paging 5. Electronic Mail & Voice Mail Trading companies: primarily export activities with gateways, radio74% 100% 51% Automatic
Page 61

FDI cap/Equity 100% 49% 26% 49%

Entry/Route Automatic Automatic Automatic Automatic Above licence 49% need Govt.

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA bulk imports, cash and carry 6. 7. 8. 9. 10 11. 12. wholesale trading 100% Power(other than atomic reactor power plants) 100% Drugs & Pharmaceuticals 100% Roads, Highways, Ports and 100% Harbors Pollution Control and 100% 100% 100% Automatic Automatic Automatic Automatic Automatic Automatic Automatic

Management Call Centers BPO For NRI's and OCB's: i. ii. 34 High Priority Industry Groups Export Companies iii. Hotels and Trading



Tourism-related Projects iv. Hospitals, Diagnostic Centers v. vi. vii. viii. ix. Shipping Deep Sea Fishing Oil Exploration Power Housing and Real Estate Development x. Highways, Bridges and Ports xi. Units
Page 62



AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA xii. Industries Requiring Licensing xiii. Sector Airports: Greenfield projects 14 15. 16. 17. Existing projects Assets reconstruction company Cigars and cigarettes Courier services Investing companies in infrastructure telecom sector) (other than 100% 100% 49% 100% 100% 49% Automatic Beyond 74% FIPB FIPB FIPB FIPB FIPB Industries Reserved for Small Scale 13. Compulsory

Page 63

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA 4.8 Analysis of FDI inflow in India From April 2000 to August 2012 (Amount US$ in Millions) S.No 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. Financial Year 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 Total FDI Inflows 4,029 6,130 5,035 4,322 6,051 8,961 22,826 34,362 35,168 25069 19,430 7,785 % Growth Over Previous Year ---(+) 52 (-) 18 (-) 14 (+) 40 (+) 48 (+) 146 (+) 51 (+) 02 (-) 0.2 (-) 20 ---

40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 6,051 8,961 7,785 25069 19,430
Total FDI Inflows Series 3

34,362 35,168

Page 64

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA 4.9 Analysis of share of top ten investing countries FDI equity in flows From April 2000 to January 2012 (Amount in crore) Sr. No Country Amount of FDI Inflows % As To FDI Total 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Mauritius Singapore U.S.A. U.K. Netherlands Japan Cyprus Germany France U.A.E. 252056.85 58891.77 43730.15 40494.00 26658.28 25592.86 22748.19 13751.34 11468.89 8757.33 Inflow 40.95 9.64 7.06 6.62 4.31 4.10 3.63 2.24 1.84 1.41

F D I equity in flow bycountries

4.31 6.62 7.06 40.95 9.64 4.1
Mauritius Singapore U.S.A. U.K. Netherlands Japan



Mauritius invested Rs. 252056.85 crore in India Up to the January 2011-12, equal to 40.95 percent of total FDI inflows. Many companies based outside of India utilize Mauritian
Page 65

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA holding companies to take advantage of the India- Mauritius Double Taxation Avoidance Agreement (DTAA). The DTAA allows foreign firms to bypass Indian capital gains taxes, and may allow some India-based firms to avoid paying certain taxes through a process known as round tripping. The extent of round tripping by Indian companies through Mauritius is unknown. However, the Indian government is concerned enough about this problem to have asked the government of Mauritius to set up a joint monitoring mechanism to study these investment flows. The potential loss of tax revenue is of particular concern to the Indian government. These are the sectors which attracting more FDI from Mauritius Electrical equipment Gypsum and cement products Telecommunications Services sector that includes both non- financial and financial Fuels.

4.9.2 Singapore Singapore continues to be the single largest investor in India amongst the Singapore with FDI inflows into Rs. 58891.77 crores up to January 2012 Sector-wise distribution of FDI inflows received from Singapore the highest inflows have been in the services sector (financial and non financial), which accounts for about 9.64% of FDI inflows from Singapore. Petroleum and natural gas occupies the second place followed by computer software and hardware, mining and construction.

4.9.5 United States The United States is the third largest source of FDI in India (7.06 % of the total), valued at 43730.15 crore in cumulative inflows up to January 2012. According to the Indian government, the top sectors attracting FDI from the United States to India are fuel,
Page 66

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA telecommunications, electrical equipment, food processing, and services. According to the available M&A data, the two top sectors attracting FDI inflows from the United States are computer systems design and programming and manufacturing

4.9.4 U.K The United Kingdom is the fourth largest source of FDI in India (6.62% of the total), valued at 40494.00 crores in cumulative inflows up to January 2012 Over 17 UK companies under the aegis of the Nuclear Industry Association of UK have tied up with Ficci to identify joint venture and FDI possibilities in the civil nuclear energy sector.UK companies and policy makers the focus sectors for joint ventures, partnerships, and trade are non-conventional energy, IT, precision engineering, medical equipment, infrastructure equipment, and creative industries.

4.9.5 Netherlands FDI from Netherlands to India has increased at a very fast pace over the last few years. Netherlands ranks fifth among all the countries that make investments in India. The total flow of FDI from Netherlands to India came to Rs. 26658.28 crores between 1991 and 2002. The total percentage of FDI from Netherlands to India stood at 4.31% out of the total foreign direct investment in the country up to January 2012. Following Various industries attracting FDI from Netherlands to India are:

Food processing industries Telecommunications that includes services of cellular mobile, basic telephone, and radio paging

Page 67



Electrical equipment that includes computer software and electronics Service sector that includes non- financial and financial services


Analysis of sectors attracting highest FDI equity inflows (Amount in Millions)

From April 2000 to March 2012 Sr. No Sector Amount Inflows 1. 2 3 4 5. 6. 7. 8. 9. 10. Service Sector (Financial & Non Financial) Housing & Real Estate Telecommunication Computer Software & Hardware Construction Activities Automobile Industry Power Drugs & pharmaceuticals Metallurgical Industries Petroleum & Natural Gas 124219.33 47,380.95 48,369.49 46,723.09 39,686.54 28,274.31 28,135.78 21,640.48 18,767.82 13,687.09 of FDI % As To FDI

Total Inflow 20.22 7.73 7.73 7.64 6.46 4.54 4.53 3.52 3.12 2.29

Page 68


%AsT oT otal F D I Inflow

3.12 3.52 20.22 2.29
Service Sector (Financial & Non Financial) Housing & Real Estate Telecommunication Computer Software & Hardware Construction Activities

4.53 4.54 6.46

Automobile Industry

7.73 7.64 7.73

Power Drugs & pharmaceuticals Metallurgical Industries

The sectors receiving the largest shares of total FDI inflows up to arch 2012 were the service sector and Housing & Real Estate, each accounting for 20.22 and 7.73 percent respectively. These were followed by the telecommunications, real estate, construction and automobile sectors. The top sectors attracting FDI into India via M&A activity were manufacturing; information; and professional, scientific, and technical services. These sectors correspond closely with the sectors identified by the Indian government as attracting the largest shares of FDI inflows overall.

4.11 Foreign Institutional Investment 4.11.1 Introduction to FII

Page 69

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA Since 1990-91, the Government of India embarked on liberalization and economic reforms with a view of bringing about rapid and substantial economic growth and move towards globalization of the economy. As a part of the reforms process, the Government under its New Industrial Policy revamped its foreign investment policy recognizing the growing importance of foreign direct investment as an instrument of technology transfer, augmentation of foreign exchange reserves and globalization of the Indian economy. Simultaneously, the Government, for the first time, permitted portfolio investments from abroad by foreign institutional investors in the Indian capital market. The entry of FIIs seems to be a follow up of the recommendation of the Narsimhan Committee Report on Financial System. While recommending their entry, the Committee, however did not elaborate on the objectives of the suggested policy. The committee only suggested that the capital market should be gradually opened up to foreign portfolio investments.

From September 14, 1992 with suitable restrictions, FIIs were permitted to invest in all the securities traded on the primary and secondary markets, including shares, debentures and warrants issued by companies which were listed or were to be listed on the Stock Exchanges in India. While presenting the Budget for 1992-93, the then Finance Minister Dr. Manmohan Singh had announced a proposal to allow reputed foreign investors, such as Pension Funds etc., to invest in Indian capital market.


Market design in India for foreign institutional investors;

Foreign Institutional Investors means an institution established or incorporated outside India which proposes to make investment in India in securities. A Working Group for Streamlining

Page 70

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA of the Procedures relating to FIIs, constituted in April, 2003, inter alia, recommended streamlining of SEBI registration procedure, and suggested that dual approval process of SEBI and RBI be changed to a single approval process of SEBI. This recommendation was implemented in December 2003.

Currently, entities eligible to invest under the FII route are as follows:


As FII: Overseas pension funds, mutual funds, investment trust, asset management company, nominee company, bank, institutional portfolio manager, university funds, endowments, foundations, charitable trusts, charitable societies, a trustee or power of attorney holder incorporated or established outside India proposing to make proprietary investments or with no single investor holding more than 10 per cent of the shares or units of the fund.


As Sub-accounts: The sub account is generally the underlying fund on whose behalf the FII invests. The following entities are eligible to be registered as subaccounts, viz. partnership firms, private company, public company, pension fund, investment trust, and individuals.

FIIs registered with SEBI fall under the following categories:

a) Regular FIIs- those who are required to invest not less than 70 % of their investment in equity-related instruments and 30 % in non-equity instruments.

b) 100 % debt-fund FIIs- those who are permitted to invest only in debt instruments.

Page 71

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA The Government guidelines for FII of 1992 allowed, inter-alia, entities such as asset management companies, nominee companies and incorporated/institutional portfolio managers or their power of attorney holders (providing discretionary and non-discretionary portfolio management services) to be registered as FIIs. While the guidelines did not have a specific provision regarding clients, in the application form the details of clients on whose behalf investments were being made were sought.

While granting registration to the FII, permission was also granted for making investments in the names of such clients. Asset management companies/portfolio managers are basically in the business of managing funds and investing them on behalf of their funds/clients. Hence, the intention of the guidelines was to allow these categories of investors to invest funds in India on behalf of their 'clients'. These 'clients' later came to be known as sub-accounts. The broad strategy consisted of having a wide variety of clients, including individuals, intermediated through institutional investors, who would be registered as FIIs in India. FIIs are eligible to purchase shares and convertible debentures issued by Indian companies under the Portfolio Investment Scheme.

4.12.3 Prohibitions on Investments:

FIIs are not permitted to invest in equity issued by an Asset Reconstruction Company. They are also not allowed to invest in any company which is engaged or proposes to engage in the following activities:

1) Business of chit fund 2) Nidhi Company

Page 72

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA 3) Agricultural or plantation activities 4) Real estate business or construction of farm houses (real estate business does not include development of townships, construction of residential/commercial premises, roads or bridges). 5) Trading in Transferable Development Rights (TDRs).

4.12.4 Trends of Foreign Institutional Investments in India.

Portfolio investments in India include investments in American Depository Receipts (ADRs)/ Global Depository Receipts (GDRs), Foreign Institutional Investments and investments in offshore funds. Before 1992, only Non-Resident Indians (NRIs) and Overseas Corporate Bodies were allowed to undertake portfolio investments in India. Thereafter, the Indian stock markets were opened up for direct participation by FIIs. They were allowed to invest in all the securities traded on the primary and the secondary market including the equity and other securities/instruments of companies listed/to be listed on stock exchanges in India. It can be observed from the table below that India is one of the preferred investment destinations for FIIs over the years. As of March 2009, there were 1609 FIIs registered with SEBI.

SEBI Registered FIIs in India Year 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03

End of March 0 3 156 353 439 496 450 506 527 490 502
Page 73

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 540 685 882 996 1279 1609 1805 1976 2264

4.12.5 FII trend in India

Year Gross Purchases (a) (Rs. crore) 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 17 5593 7631 9694 15554 18695 16115 56856 74051 49920 47061 144858 16953 346978 520508 896686 548876 Gross Sales (b) (Rs.crore) 4 466 2835 2752 6979 12737 17699 46734 64116 41165 44373 99094 171072 305512 489667 844504 594608 Net (a-b) (Rs. crore) 13 5127 4796 6942 8575 5958 1584 10122 9935 8755 2688 45764 45881 41466 30841 52182 -45732 Investment % increase in FII inflow 39338.46 -6.45 44.75 23.52 -30.52 126.59 739.02 -1.85 -11.88 69.30 1602.53 0.26 -9.62 -25.62 69.20 187.64 -

2012 data was not available

Page 74


There may be many other factors on which a stock index may depend i.e. Government policies, budgets, bullion market, inflation, economic and political condition of the country, FDI, Re./Dollar exchange rate etc. But for my study I have selected only one independent variable i.e. FII and dependent variable is indices of nifty.


Co relation with Indices Co-relation with FII 0.80 0.18 0.33 0.13 0.44

Indices Sensex Banks Power IT Capital Goods

From the above table we can say that FII has a positive impact on all the indices which means that if FIIs come in India then it is goods for the Indian economy. FIIs have more co-relation with Sensex so we can say that they are mostly invest in big and reputed companies which are included in Sensex.

Page 75

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA Power and Capital Goods sector have more co-relation with FII investment which shows more interest of FIIs in those sectors.

4.12.7 Difference between FDI and FII

FDI v/s FII---Both FDI and FII are related to investment in a foreign country. FDI or Foreign Direct Investment is an investment that a parent company makes in a foreign country. On the contrary, FII or Foreign Institutional Investor is an investment made by an investor in the markets of a foreign nation. In FII, the companies only need to get registered in the stock exchange to make investments. But FDI is quite different from it as they invest in a foreign nation. The Foreign Institutional Investor is also known as hot money as the investors have the liberty to sell it and take it back. But in Foreign Direct Investment, this is not possible. In simple words, FII can enter the stock market easily and also withdraw from it easily. But FDI cannot enter and exit that easily. This difference is what makes nations to choose FDIs more than then FIIs.

FDI is more preferred to the FII as they are considered to be the most beneficial kind of foreign investment for the whole economy Specific enterprise. It aims to increase the enterprises capacity or productivity or change its management control. In an FDI, the capital inflow is translated into additional production. The FII investment flows only into the secondary market. It helps in increasing capital availability in general rather than enhancing the capital of a specific enterprise. The Foreign Direct Investment is considered to be more stable than Foreign Institutional Investor. FDI not only brings in capital but also helps in good governance practices and better management skills and even technology transfer. Though the Foreign Institutional Investor helps in promoting good governance and improving accounting, it does not come out with any other benefits of the FDI. While the FDI flows into the primary market, the FII flows into secondary market. While FIIs are short-term investments, the FDIs are long term.
Page 76

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA 1. FDI is an investment that a parent company makes in a foreign country. On the contrary, FII is an investment made by an investor in the markets of a foreign nation.

2. FII can enter the stock market easily and also withdraw from it easily. But FDI cannot enterand exit easily.

3. Foreign Direct Investment targets a specific enterprise .The FII increasing capital availability in general.

4. The Foreign Direct Investment is considered to be more stable than Foreign Institutional Investor.

5.1 Summery of the Findings Finally, it may be concluded that developing countries has make their presence felt in the Economics of developed nations by receiving a descent amount of FDI in the last three

Decades. Although India is not the most preferred destination of global FDI, but there has been a generous flow of FDI in India since 1991. It has become the 2nd fastest growing economy of the world. India has substantially increased its list of source countries in the post liberalization era. India has signed a number of bilateral and multilateral trade agreements with developed and developing nations. India as the founding member of GATT, WTO, a signatory member of SAFTA and a member of MIGA is making its presence felt in the economic landscape of globalised economies. The economic reform process started in 1991 helps in creating a conducive and healthy atmosphere for foreign investors and thus, resulting in substantial amount of FDI inflows in the country.
Page 77


5.1.1 Trends and Patterns of FDI flows at World level:

It is seen from the analysis that large amount of FDI flows are confined to the developed economies. But there is a marked increase in the FDI inflows to developing economies from 1997 onwards. Developing economies fetch a good share of 40 percent of the world FDI inflows in 1997 as compared to 26 percent in 1980s. Among developing nations, Asian countries received maximum share (16%) of FDI inflows as compared to other emerging developing countries of Latin America (8.7 %) and Africa (2%). This can be attributed to the economic reform process of the country for the last eighteen years.

5.1.2 Trends and patterns of FDI flows at Asian level: India, with a share of nearly 75% emerged as a major recipient of global FDI inflows in South Asia region in 2012. As far as South, East and South East block is concerned India is at 3rd place with a share of 9.2% while China is at number one position with a share of 33% in 2012. Other major economies of this block are Singapore, South Korea, Malaysia, Thailand and Philippines. While comparing the share of FDI inflows of China and India during this decade (i.e. 2002-20012) it is found that Indias share is barely 2.8 percent while chinas share is 21.7 percent.

Page 78

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA 5.1.3 Trends and patterns of FDI flows at Indian level: Although Indias share in global FDI has increased considerably, but the pace of FDI in flows 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, Indias 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. 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 NRIs deposits and commercial borrowings largely because of its rate of economic growth and stability in the political environment of the country. During the period under study it is found that Indias GDP crossed one trillion dollar mark in 2011. 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 onwards. 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 It is observed that major FDI inflows in India are concluded through automatic route and acquisition of existing shares route than through FIPB, SIA route during 19912008. 2005

Page 79

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA It is found that India has increased its list of sources of FDI since 1991. There were just few countries (U.K, Japan) before Independence. After Independence from the British Colonial era India received FDI from U.K., U.S.A., Japan, Germany, etc.

It is also found that although the list of sources of FDI flows has reached to 120 countries but the lions share (66 percent) of FDI flow is vested with just five countries (viz. Mauritius, USA, UK, Netherlands and Singapore). Mauritius and United states are the two major countries holding first and the second position in the investors list of FDI in India. While comparing the investment made by both countries, one interesting fact comes up which shows that there is huge difference in the volume of FDI received from Mauritius and the U.S. It is found that FDI inflows from Mauritius are more than double from that of the U.S. State- wise FDI inflows show that Maharashtra, New Delhi, Karnataka, Gujarat and Tamil Nadu received major investment from investors because of the infrastructural facilities and favorable business environment provided by these states. It is observed that among Indian cities Mumbai received maximum numbers of foreign collaborations. 5.1.4 Trends and patterns of FDI flows at Sectoral level of Indian Economy:

Infrastructure Sector: Initially, the inflows were low but there is a sharp rise in FDI inflows from 2005 onwards. Among the subsectors of Infrastructure sector, telecommunications received the highest percentage of FDI inflows. Other major subsectors of infrastructure sectors are construction activities, real estate and power. Mauritius and Singapore are the two major investors in this

Page 80

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA sector. In India highest percentage of FDI inflows for infrastructure sector is with New Delhi and Mumbai.
Services sector:

There is a continuously increasing trend of FDI inflows in services sector with a steep rise in the inflows from 2005 onwards.. In India, Mumbai and Delhi are the two most attractive locations which receives heavy investment in services sector. It is found that among the major investing countries in India Mauritius tops the chart by investing 42.5 percent in services sector followed by U.K and Singapore.

Trading sector: The sector shows a trailing pattern upto 2005 but there is an exponential rise in inflows from 2006 onwards. Major investment in this sector came from Mauritius, Japan and Cayman Island respectively during 2000-2011. In India, Mumbai, Bangalore and New Delhi are the top three cities which have received highest investment in trading sector upto Dec. 2011. Consultancy Sector: Among the subsectors of consultancy sector management services received highest amount of FDI inflows apart from marketing and design and engineering services. Mauritius invest heavily in the consultancy sector. In India Mumbai received heavy investment in the consultancy sector. Consultancy sector shows a continuous increasing trend of FDI inflows from2005 onwards. Education sector:

Page 81

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA Education sector attracts foreign investors in the present decade. It registered a steep rise in FDI inflows from 2005. Mauritius remains top on the chart of investing countries investing in education sector. Bangalore received highest of FDI inflows in India. Housing and Real Estate Sector: Housing and Real Estate sector received of total FDI inflows in India upto 2008. Major investment in this sector came from Mauritius. New Delhi and Mumbai are the two top cities which received highest percentage of FDI inflows. Housing sector shows an exponentially increasing trend after 2005.

Construction Activities Sector: Construction Activities sector received high FDI inflows. Mauritius is the major investment country in India. New Delhi and Mumbai are the most preferred locations for construction activities in India.

Automobile Sector: Earlier Automobile Industry was the part of transportation sector but it became an independent sector in 2000. Japan (27.59%), Italy (14.66%) and USA (13.88%) are the prominent investors in this sector. In India Mumbai and New Delhi with investment becomes favourites destination for this sector. Maximum numbers of technical collaborations in this sector are with Japan. Computer Hardware and Software Sector:

Page 82

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA Computer Software and hardware was the part of electrical and electronics sector. However, it was segregated from electrical and electronics sector in 2000. This sector received heavy investment from Mauritius apart from USA and Singapore. It is observed that major investment in the above sectors came from Mauritius and investments in these sectors in India are primarily concentrated in Mumbai and New Delhi.

5.1.5 FDI and Indian Economy

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

Page 83

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA 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. Another important factor which shows the predicted positive sign is FIN. Position i.e. financial position 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.

5.2 Conclusion A large number of changes that were introduced in the countrys regulatory economic policies heralded the liberalization era of the FDI policy regime in India and brought about a structural breakthrough in the volume of the FDI inflows into the economy maintained a
Page 84

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA fluctuating and unsteady trend during the study period. It might be of interest to note that more than 50% of the total FDI inflows received by India came from Mauritius, Singapore and the USA. The main reason for higher levels of investment from Mauritius was that the fact that India entered into a double taxation avoidance agreement (DTAA) with Mauritius were protected from taxation in India. Among the different sectors, the service sector had received the larger proportion followed by computer software and hardware sector and telecommunication sector. According to findings and results, we have concluded that FII did have significant impact on Sensex but there is less co-relation with Bankex and IT. One of the reasons for high degree of any linear relation can also be due to the sample data. The data was taken on monthly basis. The data on daily basis can give more positive results (may be). Also FII is not the only factor affecting the stock indices. There are other major factors that influence the bourses in the stock market.



Thus, it is found that FDI as a strategic component of investment is needed by India for its sustained economic growth and

Page 85

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA development. FDI is necessary for creation of jobs, expansion of existing manufacturing industries and development of the new one. Indeed, it is also needed in the healthcare, education, R&D, infrastructure, retailing and in long term financial projects. So, the study recommends the following suggestions: The study urges the policy makers to focus more on attracting diverse types of FDI. The policy makers should design policies where foreign investment can be utilised as means of enhancing domestic production, savings, and exports; as medium of technological learning and technology diffusion and also in providing access to the external market. It is suggested that the government should push for the speedy improvement of infrastructure sectors requirements which are important for diversification of business activities. Government should ensure the equitable distribution of FDI inflows among states. The central government must give more freedom to states, so that they can attract FDI inflows at their own level. The government should also provide additional incentives to foreign investors to invest in states where the level of FDI inflows is quite low. Government should open doors to foreign companies in the export oriented services which could increase the demand of unskilled

Page 86

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA workers and low skilled services and also increases the wage level in these services. Government must target at attracting specific types of FDI that are able to generate spillovers effects in the overall economy. This could be achieved by investing in human capital, R&D activities, environmental issues, dynamic products, productive capacity,

infrastructure and sectors with high income elasticity of demand. The government must promote policies which allow development process starts from within (i.e. through productive capacity and by absorptive capacity). It is also suggested that the government must promote sustainable development through FDI by further strengthening of education, health and R&D system, political involvement of people and by ensuring personal security of the citizens. Government must pay attention to the emerging Asian continent as the new economic power house of business transaction and try to boost the trade within this region through bilateral, multilateral agreements and also concludes FTAs with the emerging economic Asian giants. As the appreciation of Indian rupee in the international market is providing golden opportunity to the policy makers to attract more FDI in Greenfield projects as compared to Brownfield investment. So the government must invite Greenfield investments.

Page 87

AN ANALYTICAL STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA Finally, it is suggested that the policy makers should ensure optimum utilization of funds and timely implementation of projects. It is also observed that the realization of approved FDI into actual disbursement is quite low.

Page 88


Page 89


Page 90