ECONOMICS – II Final Project Report

Foreign Direct Investment and Its Impact on India

Submitted to

Prof. Sanjay Singh

Submitted By

Section B Sarin (PGP25090)

Shivkumar (PGP25099) Shreyas (PGP25100) Soumen (PGP25101) Souvick (PGP25102)

TABLE OF CONTENTS

1. FDI in India ................................................................................................................................................................... 3

1.1. What is foreign investment? ...................................................................................................................... 3

1.2. Entry Options for Foreign Investors ...................................................................................................... 3

1.3. What is the difference between FDI and FII? .................................................................................... 3

1.4. Different TYPES of FDI in India: ............................................................................................................... 4

1.5. Current inflows for FDI in India ............................................................................................................... 4

1.6. Country contribution List of FDI in India............................................................................................ 4

2. Relationship of Foreign Investment with Macro Economic Factors ............................................. 5

2.1. Foreign investment and GDP of india ................................................................................................... 5

2.2. FDI and Indian Currency .............................................................................................................................. 5

2.3. Foreign investment and employment growth ................................................................................. 5

2.4. FDI and INFLATION (WPI) ........................................................................................................................... 5

2.5. Foreign Investment And IIP ....................................................................................................................... 5

3. Time Series Analysis of Foreign investment and FDI in India ......................................................... 6

4. Political footprints on FDI in India .................................................................................................................. 6

5. How does government attracts and monitors FDI? ............................................................................... 7

6. What determines the FDI in the economy? ................................................................................................ 8

7. Annexure .................................................................................................................................................................... 10

1. FDI IN INDIA

1.1. WHAT IS FOREIGN INVESTMENT?

Any investment flowing from one country to another country is foreign investment. The management of a business enterprise in a foreign country is foreign investment.

Indian Government classifies foreign investment in the following form: Foreign direct investment (FDI) Foreign institutional investment (FII) Non-resident Indian (NRI) investment

1.2. ENTRY OPTIONS FOR FOREIGN INVESTORS

A foreign company planning to set up business operations in India has the following options:

Incorporate a company under the Companies Act, 1956 through: Joint Venture or Wholly owned Subsidiary

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 sector/area of activities under the FDI policy.

Enter as a Foreign Company through: o Liaison Office/Representative Office o Project Office o Branch Office

Such offices can undertake activities permitted under the Foreign Exchange Management Regulations, 2000 (Establishment in India of branch or office of other place of business).

1.3. WHAT IS THE DIFFERENCE BETWEEN FDI AND FII?

Foreign direct investment (FDI) is defined as "investment made to acquire lasting interest in enterprises operating outside of the economy of the investor."The FDI relationship consists of a parent enterprise and a foreign affiliate which together form a Multinational corporation (MNC). In order to qualify as FDI the investment must afford the parent enterprise control over its foreign affiliate. The UN defines control in this case as owning 10% or more of the ordinary shares or voting power of an incorporated firm or its equivalent for an unincorporated firm; lower ownership shares are known as

portfolio investment. The definition of FDI originally meant that the investing corporation gained a significant number of shares (10 percent or more) of the new venture. In recent years, however, companies have been able to make a foreign direct investment that is actually long-term management control as opposed to direct investment in buildings and equipment. FDI growth has been a key factor in the “international” nature of business that many are familiar with in the 21st century. This growth has been facilitated by changes in regulations both in the originating country and in the country where the new installation is to be built. FII generally means portfolio investment by foreign institutions in a market which is not their home country. These institutions are generally Mutual Funds, Investment Companies, Pension Funds, and Insurance Houses. Their investments are in the stock market whereas FDI is generally a long term commitment to a particular company in a sector in terms of equity investment by some foreign entity. FII funding is a paramount maker of stock markets and there selling or buying moves the stock in a day. FDI have long term commitment and hence we see flight of capital in terms of FII outflows but not generally in FDIs. 1.4. DIFFERENT TYPES OF FDI IN INDIA:

Foreign direct investment (FDI) is permitted in India as under the following form: Financial collaborations Joint ventures and technical collaborations Capital markets via Euro issues Private placements or preferential allotments

1.5. CURRENT INFLOWS FOR FDI IN INDIA

CUMULATIVE FDI EQUITY INFLOWS

Rs Crores US$ Million

Cumulative FDI inflows (From April 2000 to March 2009)

393,126 89,840

FDI inflows during 2009-10 (From April to Sep 2009)

74378 15312

Cumulative amount of FDI Inflows (Up to Sep 2009)

467,504 105152

SOURCE: DIPP, Federal Ministry of Commerce & Industry, Government of India

1.6. COUNTRY CONTRIBUTION LIST OF FDI IN INDIA

The major countries contributing to the FDI inflow in India are Mauritius, USA, UK, Singapore etc. Mauritius is the largest contributor in the cumulative FDI flow during the period of 2000-2009. For detailed break up please refer to section ‘C’ of the Annexure.

2. RELATIONSHIP OF FOREIGN INVESTMENT WITH MACRO ECONOMIC FACTORS

2.1. FOREIGN INVESTMENT AND GDP OF INDIA

Foreign investment shows a strong correlation (polynomial) with GDP in the last decade (1998-2008). The R2 value for the same is 0.881. Please refer to section ‘A.1’ of the Annexure for detailed data. FDI shows a strong linear correlation with the GDP of India. R2 value of 0.904 shows the strength of the correlation between the two parameters. For detailed data analysis, please refer to the section ‘A.2’ of Annexure.

2.2. FDI AND INDIAN CURRENCY

A trend analysis of the FDI inflows to India and the exchange rates prevailing in the financial year 2008-09 shows a trend which doesn’t depict a very strong correlation between the two chosen parameters. The best and strongest fit function for the trend was given by the 6-degree polynomial function with a R^2 value of 0.461. The exchange rate taken is taken with respect to US dollar. Please refer to section ‘A.3’ of Annexure for further details.

2.3. FOREIGN INVESTMENT AND EMPLOYMENT GROWTH

The R^2 value is 0.174 for the 5-degree polynomial correlation between foreign investment in India and employment. FDI shows a 4-degree polynomial correlation with employment with an R^2 value of 0.264. For detailed data analysis, please refer to section ‘A.4’ of the Annexure.

2.4. FDI AND INFLATION (WPI)

The correlation derived between Wholesale Price Index (WPI) and FDI based on the monthly data available for the financial year 2008-09 shows a trend which is not as strong as seen in the previous sections. The R^2 value for the correlation between the two parameters is only 0.075. Please refer to section ‘A.5’ of the Annexure for further reference.

2.5. FOREIGN INVESTMENT AND IIP

The correlation derived between Foreign Investment and Index for Industrial Production (IIP) shows strong relationship with R^2 value of 0.91 for a linear correlation. The R^2 value is 0.95 for a 2-degree polynomial correlation of FDI with IIP which again shows a very strong relationship. Please refer to section ‘A.6’ of the Annexure for further reference.

3. TIME SERIES ANALYSIS OF FOREIGN INVESTMENT AND FDI IN INDIA

The best fit equation derived from the time series analysis of foreign investment in India is given by the following 2-degree polynomial equation: – y = 355.5x2 - 1E+06x + 1E+09

Where, x represents time (year) and y represents the foreign investment made in US $millions

The R2 value obtained for the above equation is 0.945. The best fit equation derived from the time series analysis of FDI in India is given by the following 3-degree polynomial equation: y = 61.01x3 - 36592x2 + 7E+08x - 5E+11

Where, x represents time (year) and y represents FDI in US $millions.

The R2 value obtained for the above equation is 0.870. For details and graphs corresponding to the analysis please refer to the section ‘A.7’ of Annexure.

4. POLITICAL FOOTPRINTS ON FDI IN INDIA

Year Political Impact on FDI in India

1991 BJP: “We will make our economy truly Swadeshi by promoting native initiatives".

Congress: "Foreign investment will not be at the cost of self-reliance". 1993-94 The government realized the importance of FDI. 1995-96 The FDI Mindset sets into the Government but opposition were critical of

FDI and the Government's acceptance to IMF conditionality. 1996-97 United Front Government: Increase in understanding towards Foreign

Investment. Foreign Investment Promotion Council Setup.

1997 The first ever guidelines were announced for consideration of foreign direct investment proposals by the FIPB, which were not covered under the automatic route.

The list of industries eligible for automatic approval of up to 51 per cent foreign equity was expanded.

1998 When there was a decline in FDI the government had to take greater technical measures in terms of liberalizing investment norms in bring in FDI.

1998-99 BJP admitted in its manifesto that “the country cannot do without FDI, because besides capital stocks it brings with it technology, new market practices and most importantly employment”.

However BJP clarified that FDI will be encouraged in core areas so that it usefully supplements the national efforts and it discouraged FDI in non

priority areas.” 1999 When a second year of decline continued a Foreign Investment

Implementation Authority (FIIA) was set up for providing a single point interface between foreign investors and the government machinery.

2004 FDI had become a non-electable issue as there was widespread acceptance of the topic among all the party lines

2006 "FDI will continue to be encouraged and actively sought, particularly in areas of infrastructure, high technology and exports and where local assets are created on a significant scale. The country needs and can easily absorb at least two to three times the present level of FDI inflows” – basis of CMP

5. HOW DOES GOVERNMENT ATTRACTS AND MONITORS FDI?

Foreign Investment Promotion Board FIPB: This specially empowered Board in the office of the Prime Minister is the only agency dealing with matters relating to FDI as well as promoting investment into the country. It is chaired by Secretary Industry (Department of Industrial Policy & Promotion). It promotes FDI into India by undertaking investment promotion activities in India and abroad by facilitating investment in the country through international companies, non-resident Indians and other foreign investors. Foreign Investment Promotion Council FIPC: The Government has constituted a Foreign Investment Promotion Council (FIPC) under the chairmanship of Chairman ICICI, to undertake vigorous investment promotion and marketing activities. The Presidents of the three apex business associations such as ASSOCHAM, CII and FICCI will be members of the Council. Ministry of Industry personnel will be Member-Secretary. Foreign Investment Implementation Authority FIIA: Foreign Investment Implementation Authority (FIIA) has been set up by the government of India in order to encourage the implementation of the proposals for FDI in the country. By doing this, Foreign Investment Implementation Authority (FIIA) has given a major boost to the Indian economy. Role of Foreign Investment Implementation Authority (FIIA):

To understand and solve the problems of the investors To understand and solve the problems of the approving authorities To refer the cases that have not been resolved at the level of FIA to the agencies at the higher levels To start consultations with multiple agencies

Investment Commission: The Investment commission of India is a three-member commission set up in the Ministry of Finance in December 2004 by the Government of India. Mr. Ratan Tata is Chairman and Mr. Deepak Parekh and Dr. Ashok Ganguly are members. The Investment Commission has been set up to enhance and facilitate investment in India. The Commission makes recommendations to the Government of India on policies and

procedures to facilitate investment, recommends projects and investment proposals that should be fast tracked/mentored and promotes India as an investment destination

6. WHAT DETERMINES THE FDI IN THE ECONOMY?

Growth of the economy: o The growth rate of the home economy is an important determinant

of FDI into the country.

Size of the economy: o The FDI flows also depend on the size of the home economy.

Real exchange rate: o Any depreciation in the currency of India will make our country

more favorable for foreign investments.

Degree of openness of the economy: o Any FDI investment into a country depends upon how ‘open’ the

economy is towards foreign trade (both imports and exports). We have captured the ‘openness’ of the economy through the proxy variable, DO (Degree of Openness) where it is given by DO = (Imports+Exports)/GDP

An open-market operation where the RBI decides to buy government bonds from the public will result in the expansion of the money supply. From the above graph, we can see that the increase in the money supply decreases the interest rate from i1 to i2. The decrease in the interest rate increases the exchange rate (as the demand for foreign currency > supply of foreign currency). As a result, the FDI increases in the host country. Also, the decrease in the interest rate means the cost of capital decreases since national income identity suggests that an increase in domestic investment will positively impact on domestic output.(Y = C + I + G + X – M). Open-market operations are likely to do a better job in attracting more flows of FDI than other type of monetary policy. The reason is because they impact on two determinants of FDI inflows - exchange rate and GDP.

Incorporating all these factors as determinants of FDI, we get the following model:

FDIt = a +b ∆GDPt + c GDPt + d DOt+ e REERt+ ut

Where, FDIt = Foreign Direct Investment in Period t GDPt = Gross Domestic Product in Period t ∆GDPt = GDPt -GDPt-1 DOt = Degree of Openness in Period t and is equal to ratio of Sum of Exports and Imports to GDPt

REERt = Real Effective Exchange Rate in Period t ut = Error Term

Using the time series data, we ran a multi-variate regression of the above equation to estimate the values of the coefficients and to check their significance levels. We obtained an adjusted R square value of .783 which shows that the model explains more than 70% of the data.

FDIt = -83110 + .011 ∆GDPt + .02 GDPt + 66970 DOt+ 633.5 REERt

Also, we note that all the coefficients are positive which is as expected and the t statistic values indicate that all coefficients are significant.

7. ANNEXURE

FDI, FI, GDP, WPI, Unemployment and Currency statistics are taken from RBI’s Indian Statistics Handbook 2009 mentioned below

http://www.rbi.org.in/scripts/AnnualPublications.aspx?head=Handbook%20of%20Statistics%20on%20Indian%20Economy

A.1) Foreign investment in India and India’s GDP:

Year Foreign Investment ('000 US $ millions) GDP ('00000 In Rs Crore)

1998-99 2.401 17.86525

1999-2000 5.181 19.25017

2000-01 6.789 20.97726

2001-02 8.151 22.61415

2002-03 6.014 25.38171

2003-04 15.699 28.77706

2004-05 15.366 23.82068

2005-06 21.453 27.46928

2006-07 29.082 43.03654

2007-2008 34.36 50.234

A.2) FDI in India and India’s GDP:

Year FDI ('000 US $ millions) GDP ('00000 In Rs Crore)

1998-99 2.462 17.86525

1999-2000 2.155 19.25017

2000-01 4.029 20.97726

2001-02 6.13 22.61415

2002-03 5.035 25.38171

2003-04 4.322 28.77706

2004-05 6.051 23.82068

2005-06 8.961 27.46928

2006-07 22.07 43.04

2007-2008 34.36 47.234

A.3) Foreign Investment and Indian Currency

Month - Year RBI REFERENCE RATE WITH RESPECT TO USD FDI ('00 in US $ Million)

Sep-08 45.5635 25.62

Oct-08 48.6555 14.97

Nov-08 48.9994 10.83

Dec-08 48.6345 13.62

Jan-09 48.8338 27.33

Feb-09 49.2611 14.88

Mar-09 51.2287 19.56

Apr-09 50.0619 23.39

May-09 48.5330 20.95

Jun-09 47.7714 25.82

Jul-09 48.4783 35.16

Aug-09 48.5348 32.68

Sep-09 49.4697 15.12

A.4) Foreign Investment and Indian Employment

Year Public Sector

Private Sector

Total (Public + Private) in millions

FDI in US $ millions

FI in US $ millions

1995-96 19.43 8.51 37.43

2144 4892

1996-97 19.56 8.69 39.14

2821 6133

1997-98 19.42 8.75 40.09

3557 5385

1998-99 19.41 8.70 40.37

2462 2401

1999-2000

19.31 8.65 41.34

2155 5181

2000-01 19.14 8.65 42.00

4029 6789

2001-02 18.77 8.43 41.17

6130 8151

2002-03 18.58 8.42 41.39

5035 6014

2003-04 18.20 8.25 40.46

4322 15699

2004-05 18.01 8.45 39.35

6051 15366

2005-06 18.19 8.77 41.47

8961 21453

A.5) Foreign Investment and Wholesale Price Index

Month -Year Wholesale Price Index FDI (’00 US $ Millions)

Sep-08 241.5 25.62

Oct-08 239 14.97

Nov-08 234.2 10.83

Dec-08 229.7 13.62

Jan-09 228.9 27.33

Feb-09 227.6 14.88

Mar-09 228.2 19.56

Apr-09 231.5 23.39

May-09 234.3 20.95

Jun-09 235 25.82

Jul-09 238.4 35.16

Aug-09 240.8 32.68

Sep-09 242.7 15.12

WPI figures from http://www.eaindustry.nic.in/asp2/list_d.asp

FDI inflows figures from http://dipp.nic.in/fdi_statistics/india_FDI_September2009.pdf

A.6) Foreign Investment and Index for Industrial Production (IIP)

Annual Average IIP (Apr-Mar) Indices

Year Basic Goods

Capital Goods

Intermediate Goods Total Durables

Non Durables

General Index

1995-96 121.4 115.0 125.7 126.5 146.2 122.1 123.3

1996-97 125.0 128.2 135.9 134.3 152.9 130.2 130.8

1997-98 133.6 135.6 146.8 141.7 164.9 136.5 139.5

1998-99 135.8 152.7 155.8 144.8 174.1 138.1 145.2

1999-00 143.3 163.3 169.5 153.0 198.7 142.5 154.9

2000-01 148.6 166.2 177.4 165.2 227.6 150.8 162.6

2001-02 152.5 160.6 180.1 175.1 253.7 157.0 167.0

2002-03 159.9 177.4 187.1 187.5 237.8 175.9 176.6

2003-04 168.6 201.5 199.0 200.9 265.4 186.1 189.0

2004-05 177.9 229.6 211.1 224.4 303.5 206.2 204.8

2005-06 189.8 265.8 216.4 251.4 349.9 228.8 221.5

2006-07 209.3 314.2 242.4 276.8 382.0 252.6 247.1

2007-08 223.9 370.8 264.1 293.6 378.0 274.2 268.0

IIP data flows from http://mospi.nic.in/iip_table4.htm

Year FDI in US $ millions Foreign Investment US $ millions

1995-96 2144 4892

1996-97 2821 6133

1997-98 3557 5385

1998-99 2462 2401

1999-2000 2155 5181

2000-01 4029 6789

2001-02 6130 8151

2002-03 5035 6014

2003-04 4322 15699

2004-05 6051 15366

2005-06 8961 21453

2006-07 22826 29082

2007-08 34362 34360

FDI and FI figures are taken from RBI website mentioned below

http://www.rbi.org.in/scripts/AnnualPublications.aspx?head=Handbook%20of%20Statistics%20on%20Indian%20Economy

A.7) Time series analysis of foreign investment in India

Year Foreign Investment

1995-96 4892

1996-97 6133

1997-98 5385

1998-99 2401

1999-2000 5181

2000-01 6789

2001-02 8151

2002-03 6014

2003-04 15699

2004-05 15366

2005-06 21453

2006-07 29082

Time series analysis for foreign investment in India

Year FDI (in US $ millions)

1995-96 2144

1996-97 2821

1997-98 3557

1998-99 2462

1999-2000 2155

2000-01 4029

2001-02 6130

2002-03 5035

2003-04 4322

2004-05 6051

2005-06 8961

2006-07 22079

Time series analysis of FDI in India

B) Sector wise FDI Inflows:

Ranks Sector 2006-07

(April-March)

2007-08

(April-

March)

2008-09

(April-March)

2009-10

(April- Sept.

‘09)

Cumulative

Inflows

(April ’00 to

Sept. ‘09)

% age to

total

Inflows

(In terms of

rupees)

1. SERVICES

SECTOR

(financial & non-

financial)

21,047

(4,664)

26,589

(6,615)

28,411

(6,116)

12,782

(2,627)

97,235

(21,876)

22 %

2. COMPUTER

SOFTWARE &

HARDWARE

11,786

(2,614)

5,623

(1,410)

7,329

(1,677)

2,107

(434)

41,603

(9,388)

9 %

3. TELECOMMUNI 2,155 5,103 11,727 9,815 38,182 9 %

CATIONS

(radio paging,

cellular mobile,

basic telephone

services)

(478) (1,261) (2,558) (2,010) (8,386)

4. HOUSING &

REAL ESTATE

2,121

(467)

8,749

(2,179)

12,621

(2,801)

9,193

(1,894)

32,975

(7,407)

7 %

5. CONSTRUCTIO

N ACTIVITIES

(including roads

& highways)

4,424

(985)

6,989

(1,743)

8,792

(2,028)

4,814

(991)

26,991

(6,182)

6 %

6. POWER 713

(157)

3,875

(967)

4,382

(985)

5,805

(1,197)

19,816

(4,387)

4 %

7. AUTOMOBILE

INDUSTRY

1,254

(276)

2,697

(675)

5,212

(1,152)

4,029

(833)

19,096

(4,222)

4 %

8. METALLURGIC

AL

INDUSTRIES

7,866

(173)

4,686

(1,177)

4,157

(961)

1,273

(263)

12,778

(2,987)

3 %

9. PETROLEUM &

NATURAL GAS

401

(89)

5,729

(1,427)

1,931

(412)

1,019

(205)

11,196

(2,598)

3 %

10. CEHMICALS

(other than

fertilizers)

930

(205)

920

(229)

3,427

(749)

617

(127)

10,185

(2,261)

2 %

C) Country wise break up of FDI inflow:

Top ten investing (FDI Equity) countries (In Rs. Crore)

Rank

s

Country 2006-07

(April-

March)

2007-08

(April-

March)

2008-09

(April-

March)

2009-10

(April-

Sept. ‘09)

Cumulative

Inflows

(April ‘00 to

Sept. ‘09)

%age to total

Inflows

(in terms of

rupees)

1. MAURITIUS 28,759

(6,363)

44,483

(11,096)

50,794

(11,208)

31,761

(6,520)

193,034

(43,385)

44 %

2. SINGAPORE 2,662

(578)

12,319

(3,073)

15,727

(3,454)

5,763

(1,187)

39,615

(8,998)

9 %

3. U.S.A. 3,861

(856)

4,377

(1,089)

8,002

(1,802)

5,991

(1,244)

33,951

(7,579)

8 %

4. U.K. 8,389

(1,878)

4,690

(1,176)

3,840

(864)

1,364

(282)

24,268

(5,508)

5 %

5. NETHERLANDS 2,905

(644)

2,780

(695)

3,922

(883)

2,761

(571)

18,614

(4,161)

4 %

6. JAPAN 382

(85)

3,336

(815)

1,889

(405)

3,857

(793)

15,082

(3,324)

3 %

7. CYPRUS 266

(58)

3,385

(834)

5,983

(1,287)

3,871

(794)

13,920

(3,067)

3 %

8. GERMANY 540

(120)

2,075

(514)

2,750

(629)

1,815

(375)

11,304

(2,548)

3 %

9. FRANCE 528

(117)

583

(145)

2,098

(467)

891

(185)

6,373

(1,412)

1 %

10. U.A.E. 1,174

(260)

1,039

(258)

1,133

(257)

2,344

(484)

6,350

(1,404)

1 %

TOTAL FDI INFLOWS 70,630

(15,726)

98,664

(24,579)

122,919

(27,329)

74,378

(15,312)

467,504

(105,153)

-

D) FDI Inflows month wise for 2009-2010

SOURCE: DIPP, Federal Ministry of Commerce and Industry, Government of India

Figures in bracket are in US$ million

FDI Inflows for 2009-2010

(In Rs. Crore) (In US$ mn)

1. April 2009 11,708 2,339

2. May 2009 10,168 2,095

3. June 2009 12,335 2,582

4. July 2009 17,045 3,516

5. August 2009 15,796 3,268

6. September 2009 7,326 1,512

2009-10 (Up to September 2009) 74,378 15,312

2008-09 (Up to September 2008) 73,111 17,211

%age growth over last year ( + ) 02 % ( - ) 11 %