A PROJECT REPORT ON “Role of FDI & FII in Indian Economic Growth” SUBMITTED TOWARDS PARTIAL FULFILLMENT OF POST GRADUADTE DIPLOMA IN MANGEMENT (Approved by AICTE, Govt. of India) (Equivalent to MBA) ACADEMIC SESSION 2008 – 2010 [pic] Under the guidance of : Submitted By: Dr. Tapan Kumar Nayak Gagan (61) Associate professor Karun Dev (73)
IMS Ghaziabad Kush Dixit (77) Meenu Singh (87) Nidhi Dhawal (105) Date of submission: 30-03-2009 Institute of Management Studies C-238, Bulandshahr road Lal Quan, G. T. Road Ghaziabad Acknowledgement Any assignment puts to litmus test of an individual knowledge credibility or experience and thus sole efforts of an individual are not sufficient to accomplish the desire.
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Successful completion of a project involves interest and effort of many people and so this becomes obligatory on the part to record our thanks to those who helped us out in the successful completion of our project. Life is a process of accumulating and discharging debts, not all of those can be measured. We can not hope to discharge them with simple words of thanks but we can certainly acknowledge them. At this level of understanding it is often difficult to comprehend and assimilate a wide spectrum of knowledge without proper guidance and advice.
Hence, We would like to take this opportunity to sincerely thank Dr. Tapan Kumar Nayak, Associate Professor, Institute of Management Studies, Ghaziabad, for his inspiration and affectionate encouragement throughout the tenure of the project. Last but not the least we would like to pay our sincere thanks to our parents who have constantly encouraged and blessed us. Table of contents |S. No. |Contents |Page No. |1 |Introduction |4 | |2 |Foreign Direct Investment |8 | |3 |Foreign Institutional Investment |18 | |4 |Impact of FDI on Indian Economic Growth |22 | |5 |Impact of FII on Indian Economic Growth |27 | |6 |Recent issues regarding FDI & FII |34 | |7 |Conclusion |39 | |8 |References |40 | 1. Introduction There are various links among foreign direct investment (FDI), financial markets and economic growth. We explore whether countries with better financial systems can exploit FDI more efficiently. FDI alone plays an ambiguous role in contributing to economic growth.
However, countries with well-developed financial markets gain significantly from FDI. The results are robust to different measures of financial market development, the inclusion of other determinants of economic growth, and consideration of endogeneity. The Indian government differentiates cross-border capital inflows into various categories like foreign direct investment (FDI), foreign institutional investment (FII), non-resident Indian (NRI) and person of Indian origin (PIO) investment. Inflow of investment from other countries is encouraged since it complements domestic investments in capital-scarce economies of developing countries, India opened up to investments from abroad gradually over the past two ecades, especially since the landmark economic liberalization of 1991. Apart from helping create additional economic activity and generating employment, foreign investment also facilitates flow of technology into the country and helps the industry to become more competitive. The FDI & FII mantra is considered an all-purpose panacea for the ills of the Indian economy and society. It has become routine for our finance ministers to “showcase” India in various international forums and exhort the global captains of industry and commerce to come to India. We here want to know about the far-reaching implications of FDI in our economy and, particularly, how it can stifle economic growth.
Fortunately India’s economic growth over the last decade and a half has primarily been driven by savings in the economy, especially by households. Housewives from middle-class homes should be given due credit for this. If we want to grow at 10 per cent and if our capital-output ratio is 3. 5, we need investment at 35 per cent and, if our savings rate is 28 per cent, then the gap has to be met by the investment. This is, to start with, spurious since the measurement of the capital-output ratio is not reliable and definitely not applicable to our service sector, which makes up nearly 60 per cent of the economy and is its growth engine. FDI provides us with a continuous flow of funds and an active capital market.
Actually, hundreds of MNCs have de-listed from the stock market in the last decade by converting to unlisted subsidiaries of foreign parents. An analysis of this alone will give a clue to the nature of the capital market due to foreign investment in our economy. MNC does not even bring funding from outside sources since it can access funds in the domestic market by showing “comfort letters” from its parent company. There are many local financial institutions, both Government and private, which would lend them below prime rate since they are “global”. Financial institutions in India do not deny foreigners funds. The another argument is regarding technology transfer.
In this age of information flows and market for technology any entrepreneur can purchase technology needed by him. In a country like India, which scores very high for “technology diffusion” or “absorption”, building on technology is not an issue. If we travel in the rural areas of Punjab, we find washing machines being used for churning lassi on a mass scale. Who ever thought that washing machines have alternative uses? The Indian Diaspora can be relied upon to acquire most modern technology in complex areas, and there are already significant organic links between the NRIs and the domestic capitalists. The next argument is regarding the growing global flow of funds and how nation-states cannot ignore it.
Fascinatingly, when Mr Lakshmi Mittal attempted to take over Arcelor, or when China Petroleum tried to take over a Unocal of the US, the same globalisers came down like a ton of brick on the attempts. Actually, we can see that funds are in search of markets, and not the other way. It means we are in a position to choose whom to invite. But we would rather continue to ” sell” India. Selling India is an easy skill for most of our politicians. Which sectors are “sold” globally for FDI in India? It is the retail trade, restaurants, road transport and construction. Non-corporate, family-run businesses dominate all these activities. In most of these sectors the share of partnership/proprietorship firms is more than 80 per cent. We want global corporate to come into India and turn these millions of entrepreneurs into workers.
Can there be anything more perverse than this? What they need is adequate credit at reasonable rates and less bribes demanded by government minions. What additional technological wonders will be wrought by FDI in these areas? |Year |Investments(US $ million) | |1991 |103 | |1992 |133 | |1993 |559 | |1994 |4153 | |1995 |5138 | |1996 |4892 |1997 |6133 | |1998 |5385 | |1999 |2401 | |2000 |5181 | |2001 |6789 | |2002 |8151 | |2003 |6104 | |2004 |15699 | |2005 |15366 | |2006 |21453 | |2007 |29082 | |2008 |61830 | Table 1: Foreign investments in India [pic] Fig 1: Foreign investments in India 2. Foreign Direct Investment
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. 2. 1 Classification of Foreign Direct Investment
Foreign direct investment may be classified as Inward or Outward. 2. 1. 1 Inward FDI Foreign direct investment, which is inward, is a typical form of what is termed as ‘inward investment’. Here, investment of foreign capital occurs in local resources. The factors propelling the growth of Inward FDI comprises tax breaks, relaxation of existent regulations, loans on low rates of interest and specific grants. The idea behind this is that, the long run gains from such a funding far outweighs the disadvantage of the income loss incurred in the short run. Flow of Inward FDI may face restrictions from factors like restraint on ownership and disparity in the performance standard. 2. 1. 2 Outward FDI
Foreign direct investment, which is outward, is also referred to as “direct investment abroad”. In this case it is the local capital, which is being invested in some foreign resource. Outward FDI may also find use in the import and export dealings with a foreign country. Outward FDI flourishes under government backed insurance at risk coverage. Foreign direct investment may be further classified by their set target. The areas here are Greenfield investment and Acquisitions and Mergers. ?? Greenfield investments involve the flow of FDI for either building up of new production capacities in the host nation or for expansion of the existent production facilities of the host country.
The plus points of this come in form of increased employment opportunities, relatively high wages, R&D activities and capacity enhancement. ?? The flip side comes in the form of declining market share for the domestic firm and repatriation of profits made to a foreign country, which if retained within the country of origin could have led to considerable capital accumulation for the nation. ?? Multinationals mostly rely on mergers to bring in FDI. Until 1997 mergers and acquisitions accounted for around 90% of FDI flow to the US economy. FDI flow through acquisitions does not render any long run advantage to the economy of the host nation as under Greenfield investments. ??
Some other types of foreign direct investment in vogue are termed as Horizontal FDI, Forward Vertical FDI, Vertical FDI and Backward Vertical FDI. India Foreign Direct Investment includes investments in the infrastructure development projects including construction of bridges and flyovers, finance sector including banking and insurance services, real estate development , retail sector etc. The foreign direct investment definition says the direct investments in any productive assets in a country by any foreign company is called foreign direct investment or FDI. FDI in India includes, FDI inflows as well as FDI outflow from India. FDI and FII in India have registered growth in terms of both FDI flows in India and outflow from India.
The Foreign direct investment scheme and strategy depends on the respective FDI norms and policies in India. The FDI policy of India has imposed certain foreign direct investment regulations as per the FDI theory of the Government of India. The foreign direct investment advantages lay in the fact that equity participation form foreign investors brings larger infrastructure base for the project but the FDI disadvantages of losing the ownership rights to a foreign company makes it a cautious decision. The FDI theories listing the FDI disadvantages include the increased liquidity and consequent inflation due to excessive FDI inflow in India. In order to absorb the FDI entering the Indian economy, the rupee is being pressurized.
However the FDI benefits include better efficiency in funds management in India and thus improvisations in the quality standards. |Year |FDI (US $ million) | |1991 |97 | |1992 |129 | |1993 |315 | |1994 |586 | |1995 |1314 | |1996 |2144 | |1997 |2821 | |1998 |3557 | 1999 |2462 | |2000 |2155 | |2001 |4029 | |2002 |6130 | |2003 |5035 | |2004 |4322 | |2005 |6051 | |2006 |8961 | |2007 |22079 | |2008 |32435 | Table 2: Foreign Direct Investment in India [pic] Fig 2: Foreign Direct Investment in India
The FDI policy ascertains regulations on the FDI stocks and this may reduce the foreign direct investment confidence as closing the doors of industrial relations with foreign investors with only hamper the FDI and economic growth in India coordination. FDI and GDP in India working together and brining the reforms to the economics in India. Another form of foreign investment besides FDI is FPI or foreign portfolio investment that is a more easily traded form of foreign investment and less permanent. In FPI investment is made through stocks and bonds in a foreign enterprise without long-term financial relationship plans. Steps have been taken by the government to impart technical FDI education so as to improvise the FDI database of the country. FDI and trade go hand in hand as both works in a symbiotic situation.
FDI has also created more employment opportunities as FDI trends have increased the basic infrastructure of any organization thus demanding growth in terms of organizational structure as well. The foreign direct investment news in India shows the FDI notations being adopted by India, the foreign direct investment strategies, and the FDI guidelines regulating the inflow of foreign funds in India India’s direct investment abroad was initiated in 1992. Streamlining of the procedures and substantial liberalization has been done since 1995. As of now, Indian corporate/Registered partnership firms are allowed to invest abroad upto 100% of their net worth and are permitted to make overseas investments in business activity.
FDI is not permitted in the following industrial sectors, Arms and ammunition, Atomic Energy, Railway Transport, Coal and lignite, Mining of iron, manganese, chrome, gypsum, sulphur, gold, diamonds, copper, zinc. According to the Prime Minister’s Economic Advisory Committee, net FDI inflows amounted to $8. 5 billion in 2006-07 and is estimated to have gone up to $15. 5 billion in 2007-08. The panel feels FDI inflows would increase to $19. 7 billion during the current financial year. FDI up to 100% is allowed in sectors like textiles or automobiles while the government has put in place foreign investment ceilings in case of sectors like telecom (74 per cent). In some areas like gambling or lottery, no foreign investment is allowed. 2. 2. Determinants of Foreign Direct Investment
One of the most important determinants of foreign direct investment is the size as well as the growth prospects of the economy of the country where the foreign direct investment is being made. It is normally assumed that if the country has a big market, it can grow quickly from an economic point of view and it is concluded that the investors would be able to make the most of their investments in that country. In case of foreign direct investments that are based on export, the dimensions of the host country are important as there are opportunities for bigger economies of scale, as well as spill-over effects. The population of a country plays an important role in attracting foreign direct investors to a country. In such cases the investors are lured by the prospects of a huge customer base.
Now if the country has a high per capita income or if the citizens have reasonably good spending capabilities then it would offer the foreign direct investors with the scope of excellent performances. The status of the human resources in a country is also instrumental in attracting direct investment from overseas. There are certain countries like China that have taken an active interest in increasing the quality of their workers. They have made it compulsory for every Chinese citizen to receive at least nine years of education. This has helped in enhancing the standards of the laborers in China. If a particular country has plenty of natural resources it always finds investors willing to put their money in them.
A good example would be Saudi Arabia and other oil rich countries that have had overseas companies investing in them in order to tap the unlimited oil resources at their disposal. Inexpensive labor force is also an important determinant of attracting foreign direct investment. The BPO revolution, as well as the boom of the Information Technology companies in countries like India has been a proof of the fact that inexpensive labor force has played an important part in attracting overseas direct investment. 2. 3. Benefits of Foreign Direct Investment One of the advantages of foreign direct investment is that it helps in the economic development of the particular country where the investment is being made.
This is especially applicable for the economically developing countries. During the decade of the 90s foreign direct investment was one of the major external sources of financing for most of the countries that were growing from an economic perspective. It has also been observed that foreign direct investment has helped several countries when they have faced economic hardships. Foreign direct investment also permits the transfer of technologies. This is done basically in the way of provision of capital inputs. The importance of this factor lies in the fact that this transfer of technologies cannot be accomplished by way of trading of goods and services as well as investment of financial resources.
It also assists in the promotion of the competition within the local input market of a country. The countries that get foreign direct investment from another country can also develop the human capital resources by getting their employees to receive training on the operations of a particular business. The profits that are generated by the foreign direct investments that are made in that country can be used for the purpose of making contributions to the revenues of corporate taxes of the recipient country. Foreign direct investment helps in the creation of new jobs in a particular country. It also helps in increasing the salaries of the workers.
This enables them to get access to a better lifestyle and more facilities in life. It has normally been observed that foreign direct investment allows for the development of the manufacturing sector of the recipient country. Foreign direct investment can also bring in advanced technology and skill set in a country. There is also some scope for new research activities being undertaken. Foreign direct investment assists in increasing the income that is generated through revenues realized through taxation. It also plays a crucial role in the context of rise in the productivity of the host countries. In case of countries that make foreign direct investment in other countries this process has positive impact as well.
The companies get an opportunity to explore newer markets and thereby generate more income and profits. It also opens up the export window that allows these countries the opportunity to cash in on their superior technological resources. It has also been observed that as a result of receiving foreign direct investment from other countries, it has been possible for the recipient countries to keep their rates of interest at a lower level. It becomes easier for the business entities to borrow finance at lesser rates of interest. The biggest beneficiaries of these facilities are the small and medium-sized business enterprises. 2. 4. Disadvantages of Foreign Direct Investment
The disadvantages of foreign direct investment occur mostly in case of matters related to operation, distribution of the profits made on the investment and the personnel. One of the most indirect disadvantages of foreign direct investment is that the economically backward section of the host country is always inconvenienced when the stream of foreign direct investment is negatively affected. It is normally the responsibility of the host country to limit the extent of impact that may be made by the foreign direct investment. They should be making sure that the entities that are making the foreign direct investment in their country adhere to the environmental, governance and social regulations that have been laid down in the country.
The various disadvantages of foreign direct investment are understood where the host country has some sort of national secret – something that is not meant to be disclosed to the rest of the world. It has been observed that the defense of a country has faced risks as a result of the foreign direct investment in the country. At times it has been observed that certain foreign policies are adopted that are not appreciated by the workers of the recipient country. Foreign direct investment, at times, is also disadvantageous for the ones who are making the investment themselves. Foreign direct investment may entail high travel and communications expenses. The differences of language and culture that exist between the country of the investor and the host country could also pose problems in case of foreign direct investment.
Yet another major disadvantage of foreign direct investment is that there is a chance that a company may lose out on its ownership to an overseas company. This has often caused many companies to approach foreign direct investment with a certain amount of caution. At times it has been observed that there is considerable instability in a particular geographical region. This causes a lot of inconvenience to the investor. The size of the market, as well as, the condition of the host country could be important factors in the case of the foreign direct investment. In case the host country is not well connected with their more advanced neighbors, it poses a lot of challenge for the investors.
At times it has been observed that the governments of the host country are facing problems with foreign direct investment. It has less control over the functioning of the company that is functioning as the wholly owned subsidiary of an overseas company. Even in view of the various disadvantages of foreign direct investment it may be said that foreign direct investment has played an important role in shaping the economic fortunes of a number of countries around the world. 2. 5. How to attract FDI? Promotional efforts to attract foreign direct investment (FDI) have become the important point of competition among developed and developing countries.
This competition is also maintained when countries are adopting economic integration at another level. There are several trends, which are reinforcing traditional impulses for foreign direct investment that is access to natural resources, markets, and low-cost labor. With the rise of globalization technological progress allows for the separation of production into more discrete phases across national barriers. Expansion in Information and communication technologies, Improvement in logistics necessarily allow production to be close to markets while taking advantage of the specific characteristic of individual production locations. Countries have adopted their respective policies for attracting more investment.
Some countries rely on targeted financial concessions like tax concessions, cash grants and specific subsidies. Some countries focus on improving the infrastructure and skill parameter and creating a base meet the demands and expectations of foreign investors. Others try to improve the general business climate of a country by changing the administrative barriers and red tapism. Many governments have created state agencies to help investors through this administrative paperwork. Finally most of the countries have entered into international governing arrangements to increase their attractiveness for more investment. “Better Investment Climate” Need of the Hour. Sound investment climate is crucial for economic growth.
Microeconomic reforms aimed at simplifying business regulations, strengthening property rights, improving labor market flexibility, and increasing firms’ access to finance are necessary for raising living standards and reducing poverty in a country. Reform is necessary for creating an investment-oriented climate. Reform management matters as investment climate reforms are done politically. They often favor unorganized over organized groups and the benefits tend to accrue only in the long term, while costs are felt up front. Political decisions play a significant role in this context. Each and every countries over the globe are stepping forward to change the climate for attracting more investment. Opening up of doors by most of the nations have compelled them for adopting reforms. 3. Foreign Institutional Investment
Foreign institutional investor means an entity established or incorporated outside India which proposes to make investment in India. Positive tidings about the Indian economy combined with a fast-growing market have made India an attractive destination for foreign institutional investors. A foreign company planning to set up business operations in India has the following options: Incorporated Entity By incorporating a company under the Companies Act, 1956 through Foreign equity in such Indian companies can be up to 100% depending on the requirements of the investor, subject to equity caps in respect of the area of activities under the Foreign Direct Investment (FDI) policy. Unincorporated Entity As a foreign Company through
Any investment flowing from one country into another is foreign investment. A simple and commonly used definition says financial investment by which a person or an entity acquires a lasting interest in, and a degree of influence over, the management of a business enterprise in a foreign country is foreign investment. Globally, various types of technical definitions including those from IMF and OECD are used to define foreign investment. FDI is preferred over FII as it is considered to be the most beneficial form of foreign investment for the economy as a whole. Direct investment targets a specific enterprise, with the aim of increasing its capacity or changing its management control.
Direct investment to create or augment capacity ensures that the capital inflow translates into additional production. In case of FII investment that flows into the secondary market, the effect is to increase capital availability, rather than availability of capital to a particular enterprise. Translating an FII inflow into additional production depends on production decisions by someone other than the foreign investor some local investor has to draw upon the additional capital made available via FII inflows to augment production. In case of FDI that flows in for the purpose of acquiring an existing asset, no addition to production capacity takes place as a direct result of FDI inflow.
Just like in case of FII inflows, in this case too, addition to production capacity does not result from the action of the foreign investor the domestic seller has to invest the proceeds of the sale in a manner that augments capacity for the foreign capital inflow to boost domestic production. There is widespread notion that FII inflows are hot money that creates volatility in the stock market and exchange rates. FDI tends to be more stable than FII inflows. Moreover, FDI brings not just capital but also better management and governance practices and, often, technology transfer. The know-how transferred along with FDI is often more crucial than capital per se. No such benefit accrues in case of FII inflows, although the search by FIIs for credible investment options has tended to improve accounting and governance practices among listed companies.
According to the government’s definition, FIIs include asset management companies, pension funds, mutual funds, investment trusts as nominee companies, incorporated/institutional portfolio managers or their power of attorney holders, university funds, endowment foundations, charitable trusts and charitable societies. FIIs are required to allocate their investment between equity and debt instruments in the ratio of 70:30. However, it is also possible for an FII to declare itself a 100 per cent debt FII in which case it can make its entire investment in debt instruments. There are peculiar cases like airlines where foreign investment, including FII, is allowed to the extent of 49 per cent, but FDI from foreign airlines is not allowed. In addition, the government also introduces new regulations from time to time to ensure that FII investments are in order. For example, investment through participatory notes (PNs) was curbed by SEBI recently.
Today, it is relatively effortless for a foreign institutional investor (FII) to enter the capital market. A SEBI registration, preceded by a fairly perfunctory due diligence, is all it takes before an FII can enter the Indian stock market and commence trading. Exit is equally simple. For FDI, however, both entry and exit are far more difficult. Even in sectors opened to FDI on paper, problems remain at the grassroots. There are innumerable clearances that need to be obtained at the state and district levels. There are also a number of practical hurdles, such as infrastructure bottlenecks, all of which make entry difficult. Exit is more complicated. [pic] Fig 3: Net FII inflows in India Year |Net FII inflows(US $ million) | |1994 |1665 | |1995 |1503 | |1996 |2009 | |1997 |1926 | |1998 |979 | |1999 |-390 | |2000 |2135 | |2001 |1847 | |2002 |1505 | |2003 |377 | |2004 |10918 | |2005 |8686 | |2006 |9926 | |2007 |3225 | |2008 |20328 | | | | Table 3: Net FII inflows in India 4. Impact of FDI on Indian economic growth
Government of India accepts the key role of Foreign Direct Investment (FDI) in economic development not only as an addition to domestic capital but also as an important source of technology and global best practices. The Government of India has put in place a liberal and Transparent FDI policy. In recent times and in response to the need to provide investor-friendly environment so as not to be left behind in the new wave of global integration, the attitude of many developing countries has changed significantly. They have become more willing to offer numerous financial and non-financial incentives to multinational corporations in order to encourage them to increase direct investment flows.
Given the open door policies, and some external factors in the developed world such as low interest rates and the cycle of economic growth, the flow of FDI to developing countries has witnessed a rising trend in the last decade. India was one of the lowest recipients of FDI among developing countries until 1970s. During 1970s cumulative inflows of FDI was about US$454 million or 0. 20% of gross domestic investment. India has opened up its market since the beginning of the last decade (especially from July, 1991) by lowering tariff and non-tariff barriers (NTBs), and liberalizing investment policy. FDI up to 100% is allowed under the automatic route in most sectors/activities. FDI policy in India is reckoned to be among the most liberal in emerging economies.
FDI Policy permits FDI up to 100 % from foreign/NRI investor without prior approval in most of the sectors including the services sector under automatic route. FDI in sectors/activities under automatic route does not require any prior approval either by the Government or the RBI. Foreign direct investment (FDI) has become an integral part of national development strategies for almost all the nations globally. Its global popularity and positive output in augmenting of domestic capital, productivity and employment; has made it an indispensable tool for initiating economic growth for countries. India is evolving as one of the ‘most favored destination’ for FDI in Asia and the Pacific.
It has displaced US as the second-most favored destination for FDI in the world after China according to an AT Kearney’s FDI Confidence Index. India attracted more than three times foreign investment at US$ 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. Foreign direct investment has a major role to play in the economic development of the host country.
Over the years, foreign direct investment has helped the economies of the host countries to obtain a launching pad from where they can make further improvements. This trend has manifested itself in the last twenty years. Any form of foreign direct investment pumps in a lot of capital knowledge and technological resources into the economy of a country. This helps in taking the particular host economy ahead. The fact that the foreign direct investors have been able to play an important role vis-a-vis the economic development of the recipient countries has been due to the fact that these countries have changed their economic stances and have allowed the foreign direct investors to come in and improve their economies.
It has often been observed that the economically developing as well as underdeveloped countries are dependent on the economically developed countries for financial assistance that would help them to achieve some amount of economical stability. The economically developed countries, on their part, can help these countries financially by investing in these countries. This financial assistance can be channelized into various sectors of the economy. The channelization is normally done on the basis of the requirements of particular sectors. It has been observed that the foreign direct investment has been able to improve the infrastructural condition of a country. There is ample scope of technological development of a country as well.
The standard of living of the general public of the host country could be improved as a result of the foreign direct investment made in a country. The health sector of many a recipient country has been benefited by the foreign direct investment. Thus it may be said that foreign direct investment plays an important role in the overall economic and social development of a country. It has been observed that the private sector companies are not always interested in undertaking activities that help in improving the infrastructure of the country. This is because the gains form these infrastructural activities are made only in the long term; there are no short-term benefits as such. At times foreign direct investment could be provided in form of technology.
Else, the money that comes in a country through the foreign direct investment can be utilized to buy or import technology from other countries. This is an indirect way in which foreign direct investment plays an important part in the context of economic development. Foreign direct investment can also be helpful in assisting the host countries to set up mass educational programs that help them to educate the disadvantaged sections of the society. Such assistance is often provided by the non-governmental organizations in the form of subsidies. The developing countries can also tackle a number of healthcare issues with the help of the foreign direct investment. Communication infrastructure is an important area where the foreign direct investment can come in handy.
The money that is invested in a country by overseas entities can be used for the construction of roads, railways and bridges. These facilities are used for establishing connections with the remote areas of a country and for transporting important services to these parts like medicines and aids at times of floods or other natural disasters. A lot of construction groups are taking active interest in developing the communicational infrastructure of other countries. Foreign direct investment is also used for the purpose of educating the unskilled labor force that is present in a country. In India during the later stages of 80s and 90s there was a situation whereby there was a huge labor force but it was mostly unskilled and was employed in the unorganized sector.
It was possible with the help of the financial assistance from the overseas direct investors to train these people so that they may be capable of being recruited into the industry. Foreign direct investment is also useful for executing mass educational programs that can educate those people who remain out of the bounds of conventional and institutional education as they are not able to afford it or it may not be available in their areas. Flow of Foreign Direct Investment has grown faster over recent past. Higher flow of Foreign Direct Investment over the world always reflects a better economic environment in the presence of economic reforms and investment-oriented policies. Global flow of foreign direct investment reached at a record level of $ 1,306 billions in the year 2006.
Increase in FDI was largely fuelled by cross boarder mergers and acquisitions (M&As). FDI in 2006 increased by 38% than the previous year. Most of the developing and least developed countries worldwide equally participated in the process of direct investment activities. The following diagram shows the annual Growth of FDI inflows over the world: [pic] Fig 4: Annual Growth of FDI Higher inflows of FDI to a country largely generate employment in the nation. FDI in manufacturing sector creates more employment opportunities than to any other sectors. Over recent years most of the countries over the world have made their business environment investment friendly for absorbing lobal opportunities by attracting more investable funds to the country. 5. Impact of FII on Indian economic growth The year 2008 has seen the biggest ever FIIs sell-off for the Indian markets. FIIs were allowed to invest since 1991 when the economy opened up. FIIs sell-off of USD 13. 16 billion or Rs 53,000 crores has accounted for a 20% sell-off of the total FII’s equity investment since 1991. FIIs have invested USD 53. 16 billion or Rs 2. 3 lakh crores. The number of registered FIIs have increased from 1,219 in 2007 to 1,595 in 2008. In 2008, there were negative FIIs’ flows seen for 10 months, and the longest selling streak was seen from May to November.
Since 1999, there have been 32 months of negative FIIs flows as against 88 months of positive flows. Since 2003, there have been 19 months of negative FIIs’ flows as against 53 months of positive flows. October and January were two carnage months, where USD 3. 8 billion and UDS 3. 2 billion, respectively, were sold. The depreciation by 23% in rupee and the 51% sell-off in the markets has resulted in the Defty falling 61%, making India one of the worst emerging market performers for 2008. On the other hand, mutual funds have been the net buyers to the tune of Rs 13,075 crore. Mutual funds have been the sellers for five months in 2008 and buyers for seven months. The biggest sell-off was seen in March, when the FIIs sold Rs 1,881 crore.
In January, a correction bought the most at Rs 7,702 crore follwed by Rs 3,179 crore in June. In the BSE 500 basket, IVRCL Infrastructure, Aurobindo Pharma, Suzlon Energy, NIIT, Tata Motors, and Jet Airways were among stocks which saw the highest declines in FII holdings between September 30 and December 31. For these and other scrips where FIIs significantly reduced their holdings, prices plummeted more than the benchmark index. IVRCL Infrastructure, which was trading at Rs 143 in end-December, has lost 23 per cent till date and last closed at Rs 110. Suzlon Energy, where FIIs reduced their holdings from 21 per cent to 13 per over the quarter, saw its stock plummet by 34 per cent.
Though FIIs lightened exposures across a range of sectors, quite a few infrastructure names were present in the list of stocks which FIIs exited. IVRCL Infrastructure, Tata Steel, GVK Power and Infrastructure, Nagarjuna Construction, UltraTech Cement and Jindal Steel saw FII holdings reducing by 3 per cent or more in the past quarter. Sugar stocks proved an exception to this trend. Balrampur Chini Mills, which saw FIIs reduce their holdings from 20. 5 per cent to 14. 7 per cent over the quarter, has actually posted a 6-per cent increase in stock prices in 2009. Shree Renuka Sugars saw a 12 per cent increase in price despite a 3 per cent fall in FII holdings.
Domestic institutions such as mutual funds have been adding exposure to select sugar stocks on expectation that a sharp decline in sugar output next year would help their earnings. Though 30 new FIIs and 104 new sub-accounts have registered so far in 2009, FIIs continue to remain net sellers in the market. 5. 1. India is seen as a profitable destination FII money is coming back to India. Barring January, every month February through April 2008, we have witnessed FIIs as net buyers of Indian equities. Thus, the pivotal question is, or rather what should follow is, will FII money continue to flow into India? To answer this, a different question may provide a better perspective of the likely scenario. Are there many other options available to FIIs and worldwide fund managers to invest their money profitably?
The power equation is changing worldwide in the wake of global integration and better use of Asian manpower due to faster dissemination of information and better usage of technology. As evident, a slowdown in the US runs parallel with an increasing resilience of Asian countries such as India and China. At this point in time, it is pertinent to note that India apart from China and a few of the emerging economies is growing at a nominal 13%, and that too amidst the likelihood of a global economic slowdown. Further, if one compares India and China from an investment viewpoint, then, as a democratic country, India stands to gain in the final analysis.
As a democracy, information on corporations is more accessible and subsequently, it is easier to invest in democratic countries. Moreover, information technology, which garnered global recognition for India, is progressively and dynamically spreading across the value chain, and bringing high-end international jobs and lucrative opportunities to India, and thus attracting more money. Many are concerned about rising oil prices. These will have lesser impact in the near future as our country will only be less dependent on oil than it is now as we have discovered large resources of natural gas. Thus, India is progressively moving towards its target of self-sufficiency in the energy segment.
These factors will enable us to enjoy a virtuous cycle of prosperity culminating in strong market performance. Hence the belief about the sustainability of positive FIIis money flow into our country. 5. 2. We are getting only a nominal portion FIIs have played prominent role not only in bringing long-term capital flows into India but also in making our systems more refined and sustainable. While these portfolio flows can technically reverse at any time, given that the surfeit of international capital chase growth, as long as the host country follows sensible economic policies, consistent healthy GDP growth and strong corporate financials, this risk is not as high as it is frequently made out to be.
FIIs sold close to $4 billion in January 2008, and after that they have been marginal net buyers. However, if the FIIs want to exit, their very attempt to sell will drive down prices so fast that exiting will be more costly than staying on. Indian capital markets remained over dependent on FII flows for the past many years. The trend is now reversing as domestic mutual funds and insurance companies are also becoming dominant players in Indian equity markets. In the last financial year Indian MFs and insurance companies together pumped in more than $25 billion, which is around 1. 5 times the FII flows. FIIs remain integral part of Indian capital markets. India has seen blistering average economic growth of 9% between 2005 and 2007.
Even if we consider moderation in economy due to US slowdown, high inflation and restrained demand, economic growth for few years is likely to stay above 7. 5% in the most pessimistic scenario. This is still higher than the average growth of 3. 5% in 1980s or 6% in 1990s. Though the growth looks impressive, inflation would remain a big challenge, and it is more due to global supply side problem which may not fall below 6% during current year unless there is a major meltdown in commodities including oil and food, which is nowhere near in sight. India is getting only a nominal portion of the global inflows, although FIIs have more than $260 billion invested here.
One may also see incremental flow of pension funds from the US and the developed world, as the rapid ageing of population would stimulate growth of privately funded pensions. These funds, in search of higher yields would need to invest in markets such as India. Long-term FII inflows are here to stay as they are betting on the next 10 years structural transformation India story. India’s exceptional growth story and its booming economy have made the country a favourite destination with foreign institutional investors (FIIs). FIIs showed huge interest in 2007, pumping in the highest ever net investment of US$ 17. 23 billion in the equity markets and were instrumental n the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) clocking record index levels of over 20,000 and 6,000, respectively. In fact, during the year, FIIs were net buyers in 10 out of 12 months, turning net sellers in the rest, primarily to make up the losses on account of the sub-prime crisis in the US. This surge in FII investment has led to the cumulative net investments by FIIs into Indian equities to total US$ 52. 76 billion by the end of November 2008, since December 1993, when FIIs were allowed to enter India. As of November 28, 2008, 1581 FIIs and 4824 sub-accounts were registered with the Securities and Exchange Board of India (SEBI).
Though in 2008, thanks to the global meltdown, FIIs were mostly net sellers, they reinstated their confidence in the Indian stock market in the first week of December. As per data available with the Bombay Stock Exchange, on December 4, 2008, FIIs invested US$ 61. 83 million in equities showing confidence in the Indian stock market. Simultaneously, the upgradation of India’s sovereign ratings combined with the improvement in the macro-economic situation and growth fundamentals has led to a significant increase in FII investments in the debt market. Total investment in the country’s debt market till November 2008 amounted to US$ 6. 38 billion as against US$ 2. 80 billion by the end of November 2007. 5. 3. Impact of FII on stock market Buying/ Selling by FIIs: Clutching the highest number of votes (45. %), FII activity was seen as the key driver that could impact the Indian markets over the longer term. Higher FII inflows have been an important parameter determining the movement of the stock markets. In 2007, when FII invested US$ 17. 2 bn, stock markets notched 46% gains. The Indian economy grew over 8% for the third consecutive year and the prospects looked good for 2008. However in the following year, global financial crisis clouted the world markets, with India being no exception. This led to the FIIs turn into net sellers. The total FII disinvestment in 2008 was to the tune of US$ 13 bn. In the same period, the benchmark BSE Sensex lost 52% of its market capitalisation. This clearly indicates that the FIIs play a critical role.
Having said that, it would interest investors to know that while the FIIs have shied away, investments through the FDI (foreign direct investment) route have stupendously shot up in the past few months, given the attractive valuations. This is expected to hold good for India’s long term growth story. Stock Markets are on a roll following the Government’s move to restart the process of disinvestments in oil PSUs. The three-month moratorium that the Union Cabinet had imposed on progress in the disinvestments programme had inflicted heavy damage on the markets. The delay was seen as a setback to the entire economic reforms process and led to a halt in fresh investment inflows in Indian markets. Investments from FIIs were particularly hit by the delay as international rating agencies downgraded Indian credit rating.
The Morgan Stanley Report highlights two major issues. First, that the $14. 5 billion net FII flows since 1993 have contributed to almost 30 per cent of the accretion to forex reserves of the country. And, second that almost one-third of the free-float in the market available for investment is owned by the FIIs. The implications of the findings are worth considering. FIIs have played a very important role in building up India’s forex reserves, which have enabled a host of economic reforms and also given the country a respectable place in the global community. Secondly, FIIs are now important investors in the country’s economic growth despite sluggish domestic sentiment.
At a time when domestic investors have been shy of putting capital into Indian industry, FIIs have invested substantially in top Indian companies. India will soon have massive competition from China even in the area of attracting FII funds. Recently China opened up its huge domestic capital market, with shares designated in local currency and called A list, for investments by FIIs. This is a major concession for FIIs to invest in China’s hitherto protected companies. With such competitive pressures building up, Indian markets have to look closer at the means of maintaining positive fund flows from overseas markets. 5. 4. FII influence in Bull Markets The Morgan Stanley report notes that FII strongly influence short-term market movements during bear markets.
However, the correlation between returns and flows reduces during bull markets as other market participants raise their involvement reducing the influence of FIIs. Research by Morgan Stanley shows that the correlation between foreign inflows and market returns is high during bear and weakens with strengthening equity prices due to increased participation by other players. We should note that in the current stock market rally, the correlation with FII inflows has been low. The markets have gone up even on the days when there was selling by FIIs and indices have fallen even when there was net buying by FIIs. This suggests that the number of participants have now increased in the market. 6. Recent issues regarding FDI and FII 6. 1. Rs. 16 crore FDI proposals cleared The Central Government recently approved 29 Foreign Direct Investment (FDI) proposals worth Rs. 616. 08 crore, out of which nearly 60 per cent of the proposed foreign exchange inflow is accounted for by a Singapore-based company for entering the hotel business in India. The Government has permitted AAPC Singapore Pte Ltd. to invest Rs. 365. 78 crore in an Indian company for constructing, developing, owning and managing low-budget hotels in the country. Among the other major proposals was that of cargo-handling company ABG Bulk Handling which has been allowed to bring in Rs. 90 crore through FDI for making downstream investments.
Likewise, Cinema Capital Ventures Fund — the country’s first regulated venture fund in the media and entertainment sector — has been permitted to fetch Rs. 50 crore in foreign exchange for investment in the fund. In the telecom sector, global leader Telcordia Technologies of the U. S. has received consent to bring in Rs. 45 crore to buy equity in Indian companies for carrying out mobile number portability solutions. Alongside, the proposal by furniture design company Poltrona Frau to go in for single-brand retail trading with an investment of Rs. 21. 50 crore has also been cleared. Among a number of proposals involving no fresh inflow of FDI, Astra Microwave Products has got the go-ahead to tie up with a company for the manufacture of licensed defence items.
Similarly, a proposal by ‘What’s on India Media’ for holding a TV channel licence for uplinking a non-news and current affairs TV channel from India was also approved. The Government, however, deferred decisions on 19 other FDI proposals which include ventures by Hiranandani Realtors, Yamaha Motor India, BNP Paribas Securities Services and Quippo Telecom. 6. 2. Foreign funds may get direct public offer invite Companies in sectors with foreign direct investment (FDI) limits could soon be exempted from taking prior approvals for participation by foreign funds in their share issues, as per new rules being considered by the government to attract more overseas investments.
A committee of top government officials will soon consider a proposal that seeks to explicitly do away with the Foreign Investment Promotion Board’s (FIPB) approval for investments by foreign institutional investors (FIIs) in public offers of companies that operate in sectors with such FDI limits, a government official said. The proposal, mooted by the Department of Industrial Policy and Promotion, is likely to be taken up by the committee of secretaries. This move will remove all ambiguity in the policy over whether FIPB permission is needed for such investments and could benefit companies in sectors such as single brand retail, aviation and telecom, all of which have strict foreign investment limits.
At present, the government’s foreign investment policies are silent on whether such investments need FIPB approval, but companies as a practice take its approval for their public offers due to lack of clarity. Recently, Oil India Ltd and National Hydel Power Corporation sought FIPB approval for raising foreign capital in their planned initial public offerings, though both the oil and power sectors come under the automatic route where such approvals are not needed. “There is a lack of uniformity and clarity in the existing policy as far as treatment of FII investments vis-a-vis constituents of a sectoral cap is concerned,”. The secretaries’ panel will also consider a separate proposal to just prescribe a single composite cap on foreign investment, doing away with sub-limits on portfolio investments by foreign funds and FDI.
Sectors such as commodity exchanges, credit information companies, stock exchanges and direct-to-home broadcasters have sub-caps for FDI and portfolio holdings by foreign funds. Foreign investment in a company could be through any route so long as it remained within the stipulated composite ceiling. The committee of secretaries will also consider proposals for easing various restrictions for foreign investment in the real estate and aviation sectors. The proposal for aviation includes allowing up to 49% FDI in aviation through the automatic route. For real estate, the restrictions mainly pertain to minimum area and capitalisation requirements.
The proposal will seek to reduce the minimum area criteria to 10,000 square meters for commercial developments and 10 acres for residential projects. At present, no FDI is permitted in the sector below 50,000 square meters for commercial projects and 10 hectares for housing developments. 6. 3. Why FIIs prefer India to China India’s attractiveness as a destination for foreign investment is a relatively recent phenomenon, barely a few years old. As a result of the global economic recession and the consequent shrinking of the developed economies of North America, Western Europe and Japan during 2009, the inflows of foreign direct investment (FDI) to this country are almost certainly going to come down in the immediate future, as would investments in shares.
The terror attack on Mumbai, India’s financial and commercial capital, is also likely to exacerbate the downtrend in the short run. But there is reason to be optimistic about the medium-term future if the economy starts reviving by around the end of 2009, India will start attracting foreign investment again. The overall rate of growth of the country’s economy would slow down significantly in 2009-10, from an estimated 6. 5-7 per cent in the current fiscal year ending March 2009 to perhaps 5. 5-6 per cent. That would indeed be a sharp deceleration in comparison to the near-nine per cent growth that characterised the Indian economy for four years in a row from 2003-04 onwards.
Despite the slowdown, India will remain one of the fastest growing economies in the world with a large internal market, making it an attractive destination for FDI as well as for foreign institutional investors (FIIs) after the capital markets revive, hopefully in the not-too-distant future. It is often pointed out that China has attracted foreign investment inflows that are at least five times higher that those of India. This proportion could be higher. But the official figures of FDI put out by the Chinese government are not strictly comparable with the statistics compiled by Indian authorities. A study conducted by the International Monetary Fund in 2004 indicated that the manner in which China compiled its figures of foreign investment was not in tune with “international best practices”.
Though considerably higher than India, the IMF calculated that total inflow of FDI to China in 2003 comprised two per cent of that country’s gross domestic product against 1. 7 per cent in the case of India — a comparison that is quite flattering when one considers the fact that the Indian economy was considered particularly insular till the early-1990s. Well after economic liberalisation started in 1991, FDI and FII inflows did not pick up for nearly a decade. The government’s department of industrial policy and promotion estimates the cumulative total inflow of FDI in the form of equity capital to be under $100 billion between August 1991 and September 2008 — $96. 43 billion to be precise. Of this amount, two-thirds ($62. 1 billion) had flowed in between April 2000 and March 2008. Between April and September 2008, the inflow of FDI in the form of equity capital stood at $17. 21 billion, a jump of 137 per cent over the inflow of $7. 25 billion witnessed during the corresponding six months of 2007. It is more or less certain that the second half of 2008-09 (October to March) will see a sharp fall in FDI inflows on account of the worldwide recession. But the overall climate for FDI in India is currently far better than what it was till even a couple of years ago. The total annual inflow of FDI had varied between $4 billion and $6 billion between 2000-01 and 2004-05.
The following year, 2006-07, there was a surge in the inflow of FDI by nearly 150 per cent to over $22 billion. This figure jumped by nearly 50 per cent the next year, 2007-08, to touch a record high of almost $32. 5 billion. This amount would have been exceeded had it not been for the meltdown on Wall Street that unleashed a financial tsunami across the globe from September. But there’s a silver lining amid the dark clouds of recession as far as India is concerned. FDI inflows are unlikely to slow down to the extent FII inflows have. Portfolio investments are more often than not “hot” money that goes out as fast as it comes into the country.
During the calendar year 2007, FIIs had jumped in over $18 billion into India’s stock exchanges. These same investors scooted as their principals got swept away by the US financial crisis — they had pulled out around $15 billion from the country between the middle of January and the end of November 2008. Consequently, the exchange rate of the rupee has plummeted by around a quarter. Speculators in the share market may not return in a hurry. Their fingers have been badly burnt. Thankfully, the FDI story is far from calamitous. Unlike FII money that rushes in and out, FDI inflows are in the form of assets that remain in the country (even when the money has been used to purchase existing shares in companies) for quite a while.
In a recent issue, London’s Economist (December 13-19, 2008), which has never exactly been a great admirer of India, observed that in “two respects… India has big advantage over China in coping with an economic slowdown”. India has “all-too-extensive experience and it has a political system that can cope with disgruntlement without existential doubts,” the publication editorialised, before patronisingly adding that “India pays an economic price for its democracy”. For foreign investors, that’s precisely why India will continue to remain attractive, despite terrorism, inequality and anarchy. That’s the good news in an otherwise gloomy economic environment. 7. Conclusion Indian economy has reached in the orbit of high rate of economic growth.
It is being widely acclaimed and recognized as an emerging global economic power. The structural change based on sect oral income shares showed a rapid economic transformation of the Indian economy from predominantly agrarian to the service oriented. Policy endeavor of the government of India is to attract foreign investment for the removal of such constraints along with making domestic agents of production to become more competitive and efficient so that scarce resources can be use