Chapter I

Introduction
Economic reforms and far-reaching political changes have resulted in a very substantial
reorientation of the international cash flows. Foreign trade and foreign investment appear to
be mutually influential. While some of the FDI increased international trade, some lead to its
decrease. FDI in the natural recourse sector in developing countries increase trade. In the
1970s bank lending was the largest component of capital flows to the developing countries.
The most important recipient of this war the public sector. In the 1990s by contrast, the surge
in the capital flows was dominated by bonds. It is misleading to suggest that India is new to
foreign capital. Foreign capital had substantial presence in Indian industry prior to 1947, and
was mostly concentrated in the primary sectors and services. Foreign firms, mostly British,
dominated Indias mining, plantations, trade and much of the fledgling manufacturing base.
Further FDI flows played an important role in the early post-Independence years, as India
turned abroad for both technology and capital. By the late 1950s, the Indian government
invited foreign capital in many sectors, including pharmaceutical drugs, aluminum, heavy
electrical and chemicals. During the 1960s inflows concentrated on manufacturing, especially
the technology-intensive industries. By the end of the 1960s, around 60 per cent of all foreign
direct capital was concentrated in the manufacturing industries. However, in the aftermath of
two famines and the devaluation of the Rupee in the 1960s, there was a hardening of policy.
Foreign oil majors were nationalized in the early 1970s. The government did not rule out new
foreign investment but now wanted it on restrictive terms. The Foreign Exchange Regulation
Act (FERA) of 1973 introduced a clause that required firms to dilute their foreign equity
holdings to 40 per cent if they wanted to be treated as Indian companies. There were new
restrictions on technology imports, with a preference for licensing over Financial collaboration
and restricted rates of royalty payment. Intellectual Property rights were severely curtailed by a
revised Patents Act in 1970: product-patents were abolished in industries such as
pharmaceuticals and chemicals. By the mid-1980s, growing concern about stagnation and
technological obsolescence in Indian industry led to a push for economic reform and
1

deregulation. To encourage exports, export-intensive firms were granted exemptions from the
usual FERA limits on Foreign equity ownership. In an attempt to modernize manufacturing
industry, restrictions on technology transfers and royalty payments were relaxed. However,
despite official claims, foreign investment projects were still very vulnerable to bureaucratic
discretion. Foreign equity inflows remained paltry and, to a large extent, Indian industry came
to relyon foreign debt capital to meet its Foreign exchange needs. The 1990s began with a
major crisis. In the wake of the Gulf War, and the consequent expulsion of Indian expatriate
labor from the Middle-East, Foreign exchange remittances fell. As the balance of payments
position deteriorated, a panicked withdrawal of funds deposited in Foreign by Non Resident
Indians exacerbated the problem. The real possibility that Foreign might default on its external
obligations led to a downgrading of Indias credit rating. As part of the reforms agreed with the
IMF, the Rupee was devalued, and fresh attempts were made to liberalize the trade regime and
the regulatory framework. Industrial licensing was abolished in all but a handful of industries.
FDI was now permitted in many sectors from which foreign capital had been excluded in the
past. These included the infrastructure sectors previously monopolized by state enterprises:
power generation, highway and port construction, telecommunications, oil and natural gas
exploration. The services Sector, where foreign capital had been eliminated as a matter of
deliberate policy, was reopened: fresh investment was approved in financial services, retail
banking, insurance, and recently in the media and retailing. The cap on foreign equity
participation was raised to 51 per cent for most industries, and even 100 per cent in some
cases. Restrictions on the use of international brand names were removed. Reforms in the
technology policy provided greater recognition of intellectual property rights. FDI may be
defined as an investment involving a long-term relationship, and Reflecting a lasting interest
and control, of a firm or individual from one country in another. Foreign Direct Investment (FDI)
in India in growing rapidly. Foreign direct investment is an integral part of an open and effective
international economic system and a major catalyst to

Foreign
Investment
Foreign Direct
Investment
Wholly Owned
Subsidiary

Joint
Venture

Portfolio
Investment

Acquisition

Investment by
FIIs

Investment by
ADR/GDR

Graph No.1.1
development. FDI is highly beneficial for a country like India. Empirical studies suggest that FDI
triggers technology spillovers, assists human capital formation, contributes to international
trade integration, helps create a more competitive business environment and enhances
enterprise development. All these factors contribute to higher economic growth and
consequently aid in alleviating poverty. Apart from bestowing economic benefits FDI may also
help improve environmental and social conditions by transferring "cleaner" technologies and
leading to more socially responsible corporate policies.
Opening up of doors by many countries of the world has resulted foreign participation in the
financial sectors of emerging market economies (EMEs) during the 1990s. It has continued to
expand so far in this decade, on balance - although its pace fell somewhat following problems in
Argentina in 2002 and the global slowdown in mergers and acquisitions. It is seen that banks
accounted for the majority of financial sector foreign direct investment (FSFDI). In a number of
countries in Latin America and central and eastern Europe (CEE), foreign banks now account for
a major share of total banking assets. In Asia, the share of foreign banks is, overall, much lower,
but still substantial. The growing involvement of foreign firms in the financial systems of EMEs
3

has given rise to a situation where majorities of EME banking assets have become foreign
owned. India's cabinet on Wednesday 11 February 2009 relaxed norms governing what
constitutes foreign equity in companies that operate in sectors that have a cap on overseas
investment in a bid to rationalize procedures. Announcing the cabinet decision, based on the
advice of an empowered group of ministers, Home Minister P. Chidambaram, as cabinet
spokesman, said foreign investment in a domestic holding company would be considered
foreign equity. The objective is to make the norms simple and transparent," Chidambaram
added, while briefing reporters on decisions taken by the cabinet meeting, presided over by
External Affairs Minister Pranab Mukherjee who also headed the ministerial group.

DIMENSIONS OF FDI IN INDIA

The dimensions of FDI flows into India can be explained in terms of their growth and size,
sources and sectorial compositions. The growth of FDI inflows in India was not significant until
1991, due to its regulatory policy framework. However, under the new policy regime, it is
expected to assume a much larger role in Indias economic development. It can be observed
that there has been a steady build up in the actual FDI inflows in the post-liberalization period.
The actual FDI inflows have steadily increased from Rs.4,090 million (US$167 million) in 1991 to
Rs.706,300 million (US$15,726 million) in 2008. This reflected an annual average growth rate
close to 52.44 percent. While the annual percentage growth is large, compared to the global
average in recent three years, the value of FDI inflows to India, relative to all developing
countries, remains small. However, FDI inflows to India surpassed inflows to South Korea in
2006, making India the fourth largest destination for FDI in Asia, behind China, Hong Kong and
Singapore. Nevertheless, India has also registered a declining trend of FDI inflows and the FDIGDP ratio, especially in 1999-00 and 2002-04, can be attributed to many factors, including the
United States sanctions imposed in the aftermath of the nuclear tests, the East Asian meltdown and the perceivedSwadesh image of the Bharathi Janatha Party, which formed the
government during this period in India. It is also important to note that financial collaborations
have out numbered technical collaborations over the years.
4

Forms of Investment Where FDI is Permitted

The FDI in India is permitted through various forms as fellows:

Through financial collaborations

Through joint ventures and technical collaborations

Through capital markets via Euro issues

Through private placements or preferential allotments

Where FDI is not permitted

FDI is not permitted in the following industrial sectors:

Arms and Ammunition

Atomic Energy

Railway Transport

Coal and Lignite

Mining of iron,gold,diamond,copper and zinc

Foreign direct investments in India are approved through two routes:

1. Automatic approval by RBI: The Reserve Bank of India accords automatic
approval within a period of two weeks (provided certain parameters are met) to
all proposals involving:

Foreign equity up to 50% in 3 categories relating to mining activities.

Foreign equity up to 51% in 48 specified industries.

Foreign equity up to 74% in 9 categories.

2. FIPB Route: Foreign Investment Promotion Board (FIPB) is a competent body to

consider and recommend foreign direct investment, which do not come under
the automatic route. Normal processing time of an FDI proposal in FIPB is 4 to 6
weeks. FIPB is located in the Department of Economic Affairs, Ministry of
Finance. Its constitution is as follows:
5

Secretary, Department of Economic Affairs (Chairman)

FDI is allowed up to the limits indicated below subject to other conditions as

indicate:
Table No. 1.1 FDI in India through Two Routes
Sr.No.
1.

Sector/Activities

Entry Route

Agriculture

2.

FDI Route

100 %

Tea Sector

FIPB

Industry

Mining

Manufacturing

100%

Automatic

1. Cigarettes

100%

FIPB

2. Coffee

100%

Automatic

3. Defence Products

26%

FIPB

100%

Automatic

100%

Automatic

4. Drugs

3.

Power

Services

Banking

74%

Automatic

Cable Network

49%

FIPB

Courier Services

100%

FIPB

Insurance

26%

Automatic

Merchant Bank

100%

Automatic

Telecommunication

74%

Automatic

Secretary, Department of Industrial Policy & Promotion (Member)

Secretary, Department of Commerce (Member)

Secretary, (Economic Relation), Ministry of External Affairs (Member)

6

INDIA ranks second in the world in terms of financial attractiveness, people and skills
availability and business environment. This is revealed in AT Kearney's 2007 Global Services
Location Index. Country's financial stability in the current environment of financial turbulence
and a possible unwinding of macro imbalances sends clear message to the prospective foreign
investors about India's position as an expanding investment destination. "India's external sector
has displayed considerable strength and resilience since the reforms in 1991- despite several
domestic as well as global political events and supply shocks in food and fuel........we partner
with the global economy fully on the trade and current account while there is progressive
liberalization of the capital account, consistent with the progress in reforms in the real, fiscal
and financial sectors", observed Dr Y.V.Reddy, Governor of India's central banking authorities,
Reserve Bank of India (RBI) at the World Leaders Forum in New York in April this year. "The
strong macro economic fundamentals, growing size of the economy and improving investment
climate has attracted global corporation to invest in India.

Table 1.2
A. FDI EQUITY INFLOWS (MONTH-WISE) DURING THE FINANCIAL YEAR 2011-12:

Financial Year 2011-12

( April-March )
(In Rs. Crore)
1.
April, 2011
2.
May, 2011
3.
June, 2011
4.
July, 2011
5.
August, 2011
6.
September, 2011
7.
October, 2011
8.
November, 2011
9.
December, 2011
10
January, 2012
11.
February, 2012
12
March, 2012
2011-12 (up to
173,947
March, 2012) #
2010-11 (up to
88,520
March, 2011)
%age growth over
( + ) 97 %
last year

Amount of FDI inflows

(In US$ mn)
13,847
20,946
25,371
4,886
12,814
8,407
5,715
12,909
7,124
10,288
10,874
40,766
36,504

3,121
4,664
5,656
1,099
2,830
1,766
1,161
2,538
1,353
2,004
2,211
8,101

19,427
( + ) 88 %
7

Table 1.3
B. SHARE OF TOP INVESTING COUNTRIES FDI EQUITY INFLOWS (Financial years):

Amount
Rupees
in
crores
(US$ in
million)
Ranks
1.

Country

2009-10
(AprilMarch)

2010-11
( AprilMarch)

2011-12
( AprilMarch)

MAURITIUS

2.
3.

SINGAPOR
E
U.K.

4.

JAPAN

5.

U.S.A.

6.
7.

NETHERLA
NDS
CYPRUS

8.

GERMANY

FRANCE

10.

U.A.E.

49,633
(10,376)
11,295
(2,379)
3,094
(657)
5,670
(1,183)
9,230
(1,943)
4,283
(899)
7,728
(1,627)
2,980
(626)
1,437
(303)
3,017
(629)
88,520
(19,427)

31,855
(6,987)
7,730
(1,705)
3,434
(755)
7,063
(1,562)
5,353
(1,170)
5,501
(1,213)
4,171
(913)
908
(200)
3,349
(734)
1,569
(341)
173,946
(36,504)

46,710
(9,942)
24,712
(5,257)
45,229
(9,257)
14,089
(2,972)
5,347
(1,115)
6,698
(1,409)
7,722
(1,587)
7,452
(1,622)
3,110
(663)
1,728
(353)
775,006
(170,407)

TOTAL
FDI
INFLOWS
*

123,120
(25,834)

Cumulativ
e
Inflows
(April 00
March
12)
289,471
(64,169)
77,588
(17,153)
74,661
(15,896)
57,851
(12,313)
47,889
(10,564)
32,325
(7,109)
29,670
(6,400)
20,828
(4,621)
13,378
(2,927)
10,320
(2,243)
-

%age to
total
Inflows
(in terms
of US $)

38 %
10 %
9%
7%
6%
4%
4%
3%
2%
1%

C. SECTORS ATTRACTING HIGHEST FDI EQUITY INFLOWS: Table 1.4

Amount
inRs.
crores
(US$ in
million)
Ranks
1.

2.

3.

4.

5.

6.

7.

8.
9.

10.

Sector

2009-10
(AprilMarch)

2010-11
( AprilMarch)

2011-12
(AprilMarch)

Cumulative
Inflows
(April 00 March 12)

% age to
total
Inflows
(In terms of
US$)

SERVICES
SECTOR
(financial &
nonfinancial)
TELECOM
MUNICATI
ONS
(radio
paging,
cellular
mobile,
basic
telephone
services)
CONSTRU
CTION
ACTIVITIES
(including
roads &
highways)
COMPUTE
R
SOFTWAR
E&
HARDWAR
E
HOUSING
& REAL
ESTATE
CHEMICAL
S (OTHER
THAN
FERTILIZE
RS)
DRUGS &
PHARMAC
EUTICALS
POWER

19,945
(4,176)

15,053
(3,296)

24,656
(5,216)

145,764
(32,351)

19 %

12,270
(2,539)

7,542
(1,665)

9,012
(1,997)

57,078
(12,552)

7%

13,469
(2,852)

4,979
(1,103)

13,672
(2,796)

52,253
(11,433)

7%

4,127
(872)

3,551
(780)

3,804
(796)

50,118
(11,205)

7%

14,027
(2,935)

5,600
(1,227)

3,443
(731)

49,717
(11,113)

7%

1,726
(366)

1,812
(398)

36,227
(7,252)

47,904
(9,844)

6%

1,006
(213)

961
(209)

14,605
(3,232)

42,868
(9,195)

5%

6,138
(1,272)
5,893
(1,236)

5,796
(1,272)
5,864
(1,299)

7,678
(1,652)
4,347
(923)

33,214
(7,299)
30,785
(6,758)

4%

1,999
(420)

5,023
(1,098)

8,348
(1,786)

26,936
(6,041)

4%

AUTOMOBI
LE
INDUSTRY
METALLUR
GICAL
INDUSTRIE
S

4%

Foreign Direct Investment Decision

Direct investment in and management of foreign firms normally go together. FDI are governed
by long term consideration, because these investments can not be easily liquidated. Hence,
factors like long term political stability, government policies, industry climate and economic
prospectus influence FDI invest their money and establish manufacturing and marketing
facilities through ownership and control. There is urgent need to fill this void. The process of
Policymaking has matured in the democratic Indian polity since the independence. It is thus
predicted that the growing problems will receive mature response and policy will be articulated
in such a way to use FDI the way China has used to enhance economic growth while taking
more and more investment to industrialize the rural sector of the Indian economy. As the thirdlargest economy in the world in PPP terms, India is a preferred destination for foreign direct
investments (FDI); India has strengths in information technology and other important areas
such as auto components, apparels, chemicals, pharmaceuticals, jewellery and so on. Although
India has always held promise for global investors, but its rigid FDI policies was a significant
hindrance in this context. However, as a result of a series of ambitious and positive economic
reforms aimed at deregulating the economy and stimulating foreign investment, India has
positioned(projected) itself as one of the front-runners in Asia Pacific Region. India has a large
pool of skilled managerial and technical expertise. The question that begs for an elaboration is
that is high growth and inflows of FDI solve structural imbalance of Indian economy and will it
succeed in improving the lot of bottom section of the Indian economy, which are living in
abysmally poor socio-economic conditions in the countryside. The employment elasticity in the
agriculture and industrial sector has gone down in the post-reform period, therefore, the
creation of employment opportunities will be a gigantic task for the policy makers. The
committee on infrastructure headed by the Prime Minister has estimated the investment
requirements as: Rs. 1, 72,000crore in the National Highways sector by 2020; Rs. 40,000crore
for Airports in 2010; and Rs.50, 000 crore for Ports by 2012. A substantial share of this

10

investment is expected to come from the private sector. It has been estimated that India has
the potential to absorb US$150billion of FDI in the next five years in infrastructure sector.

The firms and its

Competitive
advantages

Change competitive
advantages

Exploit existing
Competitive
advantages abroad

Production at home
exporting

Production abroad

Licencing
management
contract

Control assets
abroad

Wholly Owned
affiliate

Joint Venture

Greenfield
investment

Acquisition of
foreign enterprise

Graph No.1.2

11

The FDI decisions in some firms is initially at least considered in the context of 100 percent
ownership. The reason may have an ethnocentric basis i.e. management may believe that no
outside entity should have an impact on corporate decision making.
Foreign Investment Implementation Authority (FIIA)
The Government of India has set up the Foreign Investment implementation Authority (FIIA) to
facilitate the process of translating FDI approvals into implementation. The agency provides
services to foreign investors to help obtain necessary approvals, sort out operational problems
and seek intervention of various government agencies to find solution to their problems. The
functions of the FIIA are as under:

Expediting various approvals/permissions;

Fostering partnership between investors and government agencies concerned;

Resolve difference in perceptions;

Enhance overall credibility;

Review policy framework; and

Liaise with the Ministry of External Affairs for keeping Indias diplomatic missions abroad
informed about translation of FDI approvals into actual investment and implementation.

The FIIA acts as a single point interface between the investor and Government agencies
including

Administrative

Ministries/State

Governments/Regulatory

Authorities/Tax

Authorities/Company Law Board, etc.Foreign Direct Investment (FDI) inflows into the country
dipped 26 per cent in this October at $1.49 billion, as compared to $2.02 billion in the same
month a year ago. Foreign equity inflows into the country had increased by 19.5 per cent in the
same month last year. If the decrease in the pace of FDI inflows continues in the November,
India may miss the $35 billion FDI target set for 2008-09. FDI inflows help bridge the current
account deficit and slowdown in equity capital into the country would widen the deficit,
thereby putting further pressure on Indian rupee. This is the first time FDI inflows dipped in 10
months. In the April-October 2008, FDI inflows to India stood at $16.67 billion, which is 80.2 per
cent higher than $9.25 billion seen in the same period last year. The October FDI numbers come
at a time when the Indian economy is facing headwinds arising out of the global financial
12

meltdown. Foreign Institutional Investors have so far pulled out nearly $14 billion from Indian
equity markets since January this year, as their parent companies are in need of liquidity.
Moreover, exports during the month had dipped over 12 per cent, the most in five years, while
industrial production also dipped by 0.4 per cent in for the first time in the 15 years, as Indian
factories cut down production on account of waning demand from both domestic and global
markets. Meanwhile, the Department of Industrial Policy and Promotion (DIPP) had proposed a
series of measures for the consideration of the Union Cabinet to attract more FDI into India.
Proposals include scaling up of FDI in single brand retail to 100 per cent, as well as allow 51 per
cent FDI in multi-brand retail of electronics goods, computers, sports goods as well as watches.
FDI in India has increased over the years due to the efforts that have been made by the Indian
government. The increased flow of FDI in India has given a major boost to the country's
economy and so measures must be taken in order to ensure that the flow of FDI in India
continues to grow. The Indian government made several reforms in the economic policy of the
country in the early 1990s. This helped in the liberalization and deregulation of the Indian
economy and also opened the country's markets to foreign direct investment. As a result of
this, huge amounts of foreign direct investment came into India through non- resident Indians,
international companies, and various other foreign investors. The growth of FDI in India
boosted the economic growth of the country.
Some of advantages of FDI enjoyed by India have been listed as under:

Enhancement of Export Potential:

By raising the level of efficiency and the

standards of product quality, FDI makes a positive impact on the host Countrys
export competitiveness. It provides the host country a better access to foreign
markets due to internationalization linkages.

Economic Growth: this is one of major sectors, which is enormously benefited from
FDI. A remarkable inflow of FDI in various industrial units in India has boosted the
economic life of the country.

Employment Generations: the FDI has also ensured a number of employment

opportunities by aiding the setting up of industrial units in various corners of India.
13

The training obtained by the employees in the receipts of FDI also contributes to
human capital formation.

Consumer Benefits: the consumers of the host country benefited through better
variety of products at competitive prices due to the inflow of FDI.

Trade Benefits: the FDI has opened a wide spectrum of opportunities in the trading
of goods and services in India both in terms of import and export production. It
provides the much needed foreign exchange which helps bridge the balance of trade
deficit which otherwise would add to the external debt of the country.

Technology Diffusion and Knowledge Transfer: the FDI apparently helps in the
outsourcing of knowledge from India, especially in the information technology
sector. It helps in developing the know-how process in India in terms of enhancing
the technology advancement in India.

Benefit to Government: profits generated by FDI contribute to corporate tax

revenues in the host country. The FDI is non-volatile and non-debt creating and
hence avoids debt servicing. The macroeconomics effects of FDI is connected with
issues of domestic capital formation, balance of payments and taking advantages of
external markets for achieving faster growth. The macroeconomics effects are
connected with cost reductions, improvements in the quality of the products,
making changes industrial structure and global inter firm linkages.

The Indian economy is the third largest in the world as measured by Purchasing Power Parity,
with a gross domestic product of US $3.611 trillion. When measured in USD exchange-rate
terms, it is the 10th largest in the world, with a GDP of US $800.8 billion (2006). India 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 Indian economy is diverse and encompasses
agriculture, handicrafts, manufacturing, textile, and a multitude of services. Although twothirds of the Indian workforce still earn their livelihood directly or indirectly through agriculture,
service sector is a growing one and are play 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
14

English, is gradually transforming India as an important 'back office' destination for global
(multinational) companies for the outsourcing of their customer services and technical support.
India is a major exporter of highly talented workforce in software and financial services, and
software engineering. India adopted 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 nineties, India has gradually opened up its
markets through economic reforms by reducing government controls on foreign investment.
The privatization of publicly owned industries and the opening up of some sectors to private
and foreign investors has proceeded slowly amid political debate. India faces a burgeoning
population and the challenge of reducing social and economic inequality. Even though Poverty
remains a serious problem, it has declined considerably 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 sectors, which will require approval of the Government. The
question that begs for an elaboration is that is high growth and inflows of FDI solve structural
imbalance of Indian economy and will it succeed in improving the lot of bottom section of the
Indian economy, which are living in abysmally poor socio-economic conditions in the
countryside. The employment elasticity in the agriculture and industrial sector has gone down
in the post-reform period, therefore, the creation of employment opportunities will be a
gigantic task for the policy makers. FDI has come in the most capital-intensive sectors;
therefore, the required employment opportunities could not be created especially for the
manual and the semi skilled labor. High skilled workforce gained substantially. That is why high
growth is called urban centric and thus has developed a wedge between the urban and rural
economy. The size of the middle-class population at 300 million exceeds the population of both
the US and the EU, and represents a powerful consumer market. India's recently liberalized FDI
policy permits up to a 100% FDI stake in ventures. Industrial policy reforms have substantially
reduced industrial licensing requirements, removed restrictions on expansion and facilitated
easy access to foreign technology and FDI. The upward moving growth curve of the real-estate
sector owes some credit to a booming economy and liberalized FDI regime. A number of
changes were approved on the FDI policy to remove the cap in most of the sectors. Restrictions
15

will be relaxed in sectors as diverse as civil aviation, construction development, industrial parks,
commodity exchanges, petroleum and natural gas, credit-information services, mining and so
on. The GDP investments will likewise increase from current 5% to 35% by 2010. No wonder
India has tremendous potential to attract USD 50 billion FDI in the next 5 years. With so much
of visibility of MNCs, JVs, foreign investors etc it is little contradictory to say that the current
flow of foreign direct investment India has been only 0.8% of GDP, compared to other nations
of south-east Asia like Malaysia and Thailand with a FDI flow of 3% of GDP. Hence with more
liberalization and opening of other sectors of the economy like the latest relaxation in FDI
policies in real estate or direct foreign investment in real estate India etc, FDI will increase by at
least 1.6% of GDP in the next 5 years. Indian Government has a key role to play as far as
investment laws are concerned. In this regard it is noteworthy to highlight some of the positive
reforms that have brought a positive growth in the Indian economy in terms of GDP growth.
Foreign Direct Investment in India is prohibited in some cases:
FDI is not permissible in Gambling and Betting, or Lottery Business, Business of chit fund,
Nidhis, Housing and Real Estate business, Trading in Transferable Development Rights (TDRs),
Retail Trading, Atomic Energy Agricultural or plantation activities or Agriculture (excluding
Floriculture, Horticulture, Development of Seeds, Animal Husbandry, Pisciculture and
Cultivation of Vegetables, Mushrooms etc. under controlled conditions and services related to
agro and allied sectors) and Plantations(other than Tea plantations).
General Permission of RBI under FEMA
RBI has granted general permission under Foreign Exchange Management Act (FEMA) in
respect of proposals approved by the Government. Indian companies getting foreign
investment approval through FIPB route do not require any further clearance from RBI for the
purpose of receiving inward remittance and issue of shares to the foreign investors. The
companies are, however, required to notify the Regional office concerned of the RBI of receipt
of inward remittances within 30 days of such receipt and to file the required documents with
the concerned Regional offices of the RBI within 30 days after issue of shares to the foreign
investors or NRIs. Besides new companies, automatic route for FDI/NRI investment is also
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available to the existing companies proposing to induct foreign equity. For existing companies
with an expansion programme, the additional requirements include: The increase in equity
level resulting from the expansion of the equity base of the existing company without the
acquisition of existing shares by NRI/foreign investors, the money to be remitted should be in
foreign currency and proposed expansion programme should be in the sector(s) under
automatic route. Otherwise, the proposal would need Government approval through the FIPB.
For this a Board Resolution of the existing Indian company must support the proposal. For
existing companies without an expansion programme, the additional requirements for eligibility
for automatic approval are: that they are engaged in the industries under automatic route; the
increase in equity level must be from expansion of the equity base and the foreign equity must
be in foreign currency. The earlier SEBI requirement, applicable to public limited companies,
that shares allotted on preferential basis shall not be transferable in any manner for a period of
5 years from the date of their allotment has now been modified to the extent that not more
than 20 per cent of the entire contribution brought in by promoter cumulatively in public or
preferential issue shall be locked-in. Equity participation by international financial institutions
etc. in domestic companies is permitted through automatic route subject to SEBI/RBI
regulations and sector specific cap on FDI. An Indian corporate can raise foreign currency
resources abroad through the issue of American Depository Receipts (ADRs) or Global
Depository Receipts (GDRs). Regulation 4 of Schedule I of FEMA Notification no. 20 allows an
Indian company to issue its Rupee denominated shares to a person resident outside India being
a depository for the purpose of issuing Global Depository Receipts (GDRs) and/ or American
Depository Receipts (ADRs), subject to the conditions such as: the ADRs/GDRs are issued in
accordance with the Scheme for issue of Foreign Currency Convertible Bonds and Ordinary
Shares (Through Depository Receipt Mechanism) Scheme, 1993 and guidelines issued by the
Central Government there under from time to time The Indian company issuing such shares has
an approval from the Ministry of Finance, Government of India to issue such ADRs and/or GDRs
or is eligible to issue ADRs/ GDRs in terms of the relevant scheme in force or notification issued
by the Ministry of Finance, and There are no end-use restrictions on GDR/ADR issue proceeds,
except for an express ban on investment in real estate and stock markets. The FCCB issue
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proceeds need to conform to external commercial borrowing end use requirements; in

addition, 25 per cent of the FCCB proceeds can be used for general corporate restructuring. Is
not otherwise ineligible to issue shares to persons resident outside India in terms of these
Regulations. There is no limit upto which an Indian company can raise ADRs/GDRs. However,
the Indian company has to be otherwise eligible to raise foreign equity under the extant FDI
policy. A company engaged in the manufacture of items covered under Automatic route, whose
direct foreign investment after a proposed GDRs/ADRs/FCCBs issue is likely to exceed the
percentage limits under the automatic route, or which is implementing a project falling under
Government approval route, would need to obtain prior Government clearance through FIPB
before seeking final approval from the Ministry of Finance.
Entry strategy into India
A business presence in India may be established by a foreign entity through:
Company: A company may be incorporated, inter alia, using the following modes:

Incorporating an Indian company with 100% foreign equity, operating as a wholly

owned subsidiary;

Incorporating a Joint Venture Company (JVC) with an Indian partner and/or with the
general public and operating as a listed company; or

Incorporating a JVC with an Indian partner and operating as an unlisted company.

Branch Office A branch would mean an establishment carrying on substantially the same
activity as its Head Office. Foreign companies intending to open a Branch Office (BO) in India
need to obtain prior permission of RBI which would encompass even approval to the scope of
activities that are intended to be carried out in India. As per the guidelines laid down by the RBI,
the BO in India is allowed to carry on only the following activities:

Export / Import of goods;

Rendering professional or consultancy services;

Carrying out research work, in which the parent company is engaged;

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Promoting technical or financial collaboration between Indian companies and parent or

overseas group company;

Representing the parent company in India and acting as buying / selling agent in India;

Rendering services in Information Technology and development of software in India;

Rendering technical support to the products supplied by parent / group companies;

Foreign airline / shipping company.

Liaison Office A Liaison Office (LO) is in the nature of a representative office set up primarily to
explore and understand the business and investment climate. A LO is not permitted to
undertake any commercial / trading / industrial activity, directly or indirectly, and is required to
maintain itself out of inward remittances received from abroad through normal banking
channels. The LO is permitted to undertake only the following activities:

Representing in India the parent Company / group Company;

Promoting export/ import from/ to IndiaPromoting technical / financial collaborations

between the parent / group companies and companies in India;

Acting as a communication channel between the parent Company and Indian

companies. Any company intending to open a LO in India is required to obtain prior
approval from the RBI, the apex foreign exchange management authority in India.
Approval is usually granted for three years and can be renewed on expiry thereof.

Project Office: Foreign companies can establish Project Offices (POs) in India specifically for the
purpose of execution of specific projects. A PO is similar to a branch office opened for the
limited purpose of executing a particular contract. As POs are opened for undertaking a specific
activity they cannot perform any other function or undertake any other activity. Generally,
companies engaged in turnkey projects or installation projects set up POs. All expenses of POs
must be met through inward foreign currency remittances if the rupee component of the
contract, if any, is not sufficient to meet the said expenses.
Foreign Direct Investment Policy during 2011
Foreign direct investment (FDI) has become an integral part of national development strategies
for almost all the nations globally. Its global popularity and positive output in augmenting of
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domestic capital, productivity and employment; has made it an indispensable tool for initiating
economic growth for countries. India is evolving as one of the 'most favored destination' for FDI
in Asia and the Pacific. All Press Notes are available at the website of Department of Industrial
Policy & Promotion.
Role of FDI in the World
Following India's growing openness, the arrival of new and existing models, easy availability of
finance at relatively low rate of interest and price discounts offered by the dealers and
manufacturers all have stirred the demand for vehicles and a strong growth of the Indian
automobile industry. The role of Foreign Direct Investment in the present world is noteworthy.
It acts as the lifeblood in the growth of the developing nations. Flow of the FDI to the countries
of the world truly reflects their respective potentiality in the global scenario. Flow of FDI truly
reflects the country's both economic and political scenario. The flow of FDI over the Globe is as
follows: Opening up of doors by many countries of the world has resulted foreign participation
in the financial sectors of emerging market economies (EMEs) during the 1990s. It has
continued to expand so far in this decade, on balance - although its pace fell somewhat
following problems in Argentina in 2002 and the global slowdown in mergers and acquisitions.
It is seen that banks accounted for the majority of financial sector foreign direct investment
(FSFDI). In a number of countries in Latin America and central and eastern Europe (CEE), foreign
banks now account for a major share of total banking assets. In Asia, the share of foreign banks
is, overall, much lower, but still substantial. The investors are required to notify the Regional
office concerned of RBI of receipt of inward remittances within 30 days of such receipt and will
have to file the required documents with that office within 30 days after issue of shares to
foreign investors
The integration of EME financial firms into the global market has resulted a wider diversity of
financial institutions operating in EMEs and given greater emphasis on risk-adjusted
profitability. These include expansion into local retail banking and securities markets, where
elements such as client relationships and reputation are important components of the franchise
value of operations. Such factors have tended to raise the costs of exiting a country and hence
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increased the permanence of FSFDI. FSFDI was fostered by financial liberalization and marketbased reforms in many EMEs. The liberalization of the capital account and financial
deregulation paved the way for foreign acquisitions and the integration of EME financial firms
into an expanding global market for corporate control. This is the character of FSFDI as part of a
broader trend towards consolidation and globalization in the financial industry. In some cases
competition in traditional markets increased pressure on major international banks to find new
areas for growth. Financial institutions in advanced economies increasingly searching for profit
opportunities at the customer and product level, FSFDI offered a means of access to EME
markets with attractive strategic opportunities to expand. Local financial infrastructure is
growing which reduces the risks of conducting business in EMEs.but events such as the Russian
default in 1998 and Argentine actions in 2002 also made financial institutions more sensitive.
Thus, financial institutions in industrial countries now tend to evaluate country risk separately.
An important benefit of FSFDI is its effect on financial sector efficiency that arises from local
banks' exposure to global competition. Host countries benefit from the technology transfers
and innovations in products and processes commonly associated with foreign bank entry.
Foreign banks exert competitive pressures and demonstration effects on local institutions. This
results better risk management, more competitive pricing and in general a more efficient
allocation of credit in the financial sector as a whole. Foreign banks presence help to achieve
greater financial stability in host countries. Host countries benefit immediately from foreign
entry. The better capitalization and wider diversification of foreign banks, along with the access
of local operations to parent funding, may reduce the sensitivity of the host country banking
system to local business cycles and changing financial market conditions. Their use of risk-based
credit evaluation tends to reduce concentration in lending and in times of financial distress,
fosters prompter recognition of losses and more timely resolution of problems. The growing
involvement of foreign firms in the financial systems of EMEs has given rise to a situation where
majorities of EME banking assets have become foreign owned. The growing involvement of
foreign firms in the financial systems of EMEs has given rise to a situation where majorities of
EME banking assets have become foreign owned. Accordingly, developing pertinent technical
skills is considered be an important area of cooperation between authorities in advanced and
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EME countries. In some markets, foreign-owned banks have been prominent in the rapid
expansion of consumer lending and foreign currency lending to both households and
businesses. Appropriate supervision is needed to assess such credit managed by banks, and
authorities in charge of financial stability. Accordingly, public policy should be focused on
maximizing these benefits by continuing to encourage diversity and competition in financial
systems not only between foreign and domestic banks but also between banks and other
financial institutions. One essential component among host country policy is commitment for
growth and stability. Another is the protection of property rights and equal treatment of banks
irrespective of ownership. From this point of view a more extensive implementation of the
internationally recognized set of financial standards and codes can help to reduce country risk.
Strengthening of legal frameworks act as a parameter for reducing country risk. Smooth
functioning of the market for corporate control would be assisted by greater international
compatibility of accounting standards, takeover rules, and insolvency codes. Regional
integration among EME financial systems, often within a framework for broader economic
integration in the region, is another complementary approach to this objective. There is
substantial evidence of major benefits from regional compacts such as those of the European
Union and NAFTA. In the case of very poor countries where there is some special support for
FSFDI may be merited provided political risk insurance if properly designed, could be useful. The
massive fraud at India's software services firm Satyam Computer faced brick bats in the foreign
media with some saying that this episode could threaten investment from abroad in the
country and is likely to cast a cloud over growth in its outsourcing sector. The scandal
threatened to gobble up not just Raju, who resigned, but his company, Satyam Computer
Services. Far beyond Satyam, it raised fears that similar problems might lurk in other Indian
companies, particularly in its vaunted outsourcing industry. In what could be termed as the
biggest corporate fraud, Satyam on 8 January 2009 made a shocking disclosure of accounts
fudging by its founder Ramalinga Raju, who then quit as chairman, leaving an uncertain future
for the company and its 53,000 employees. Raju, in a statement on 8 January 2009, said that
Satyam's profits had been massively inflated over recent years but no other board member was
aware of the financial irregularities. The chairman of one of India's largest technology
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companies said he concocted key financial results, ... sending shock waves across India and
likely prompting investors to question other corporate results as the once-hot economy slows".
Satyam disclosure will ring alarm bells for hundreds of Fortune 500 companies across the world
that entrust their most critical data and computer systems to Indian outsourcing companies and
threatens to damage the country reputation as a place to do business. Some of India's biggest
conglomerates started out as family-run companies, and analysts fear the taint of corruption
from Satyam's poor governance, lax accounting controls and a lack of transparency could sully
any of those big companies for investors and customers. India's Corporate Affairs Ministry and
SEBI announced that the episode would be probed into and action taken against the
perpetrators of the fraud that entails inflating profits and creating fictitious assets.
However, are greater FDI inflows desirable? The case for greater foreign Capital is usually made
as follows. Foreign investment can supplement domestic investible resources, especially in
large infrastructure projects, thereby removing an important constraint on growth. Foreign
firms contribute to the technological base of the host economy through technological
spillovers, and may be critical to maintaining high growth rates and exports in the software and
business services outsourcing sectors. Besides, in the right circumstances, the presence of
foreign firms reduces market concentration and promotes a more competitive market
structure. Critics of multinational firms have often cautioned against an overly rosy picture.
They claim that foreign capital flows tend to be volatile and may exacerbate volatility. Rather
than create competitive market structures, in some sectors they may increase monopoly
distortions. Multinational firms also tend to exploit the weak environmental standards in
developing countries recall the Union Carbide disaster at Bhopal in 1980. Foreign investment is
likely to be not an engine of growth but a catalyst for growth. If so, the quality of multinational
firms than enter the country matters. Some Multinationals invest in India to benefit from better
international organization of production and location decisions, including the growing practices
of outsourcing and off-shoring. Others are attracted by the large market and the potential rents
in that. Ideally, India would like to attract efficiency-seeking FDI and exclude rent-seeking FDI,
though from practical or regulatory points of view, it is not easy to distinguish ex-ante between
the two types of FDI.
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At the end of this chapter, it can be stated that It has displaced US as the second-most favored
destination for FDI in the world after China. India attracted more than three times foreign
investment at US$ 7.96 billion during the first half of 2005-06 fiscal, as against US$ 2.38 billion
during the subsequent period of 2004-05. FDI in India has contributed effectively to the overall
growth of the economy in the recent times. FDI inflow has an impact on India's transfer of new
technology and innovative ideas; improving infrastructure, thus makes a competitive business
environment. FDI policy is reviewed on an ongoing basis and measures for its further
liberalization are taken. Change in sectorial policy/sectorial equity cap is notified from time to
time through Press Notes by the Secretariat for Industrial Assistance (SIA) in the Department of
Industrial Policy announcement by SIA are subsequently notified by RBI under FEMA. FDI Policy
permits FDI up to 100 % from foreign/NRI investor without prior approval in most of the sectors
including the services sector under automatic route. FDI in sectors/activities under automatic
route does not require any prior approval either by the Government or the RBI.

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