FDI

Foreign Direct Investments in India

INTRODUCTION

The world is slowly becoming smaller and smaller day by day. The ever growing

population and the literacy rate has slowly but surely ensured that the world is

progressing forward. All the countries in the world are trying to stay ahead from each

other technically and of course financially. Any country would like to be strong any

aspect so that the world stands and notices them. The country wants to progress ahead

of other countries and stay ahead of the competition. There are some countries that

are considered as considered as “super powers”. These countries are mainly countries

which are developed and are superior in any aspect than other developing countries.

The so called “super powers” capture the maximum share of the market in the

economy and hence rule the market. Ant upswing or downswing in these countries

causes a major concern for other countries. Countries like USA, China, Japan and

Russia are some of the major “super powers” of the world. The world has accepted

the dollar to be the primitive currency for any trade. Similarly Euro has a great

existence in the European markets. Due to the diverse conditions of trade and

different trade practices, every country is compelled to interact with each other in

exchanging thoughts and ideas. The developing and the least developed country have

to take the help of these counties to stand firm on their feet.

Let’s have a look at the World Economy in short:

In the year 2002-2003, growth in global output (gross world product) (GWP) fell

from 4.8% in 2000 to 2.2% in 2001 and 2.7% in 2002. Due to sluggishness in the EU

economy (21.7% of GWP) and in the US economy (21.1% of GWP); continued

stagnation in the Japanese economy (7.0% of GWP); and spillover effects in the less

developed regions of the world.

China, the second-largest national economy in the world (12% of GWP), proved an

exception, continuing its rapid annual growth, officially announced as 8% but

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estimated by some observers as perhaps two percentage points lower. India

maintained a growth rate of around 6%, and its economic liberalisation pushed it

forward into a modern economic superpower. Russia (2.6% of GWP), with 4%

growth, continued to make uneven progress, its GDP per capita still only one-third

that of the leading industrial nations.

Externally, the nation-state, as a bedrock economic-political institution, is steadily

losing control over international flows of people, goods, funds, and technology.

Internally, the central government often finds its control over resources slipping as

separatist regional movements - typically based on ethnicity - gain momentum, e.g.,

in many of the successor states of the former Soviet Union, in the former Yugoslavia,

in India, and in Indonesia.

The addition of 80 million people each year to an already overcrowded globe is

exacerbating the problems of pollution, desertification, underemployment, epidemics,

and famine. Because of their own internal problems and priorities, the industrialized

countries devote insufficient resources to deal effectively with the poorer areas of the

world, which, at least from the economic point of view, are becoming further

marginalized.

The euro as the common currency of much of Western Europe in January 1999, while

paving the way for an integrated economic powerhouse, poses economic risks

because of varying levels of income and cultural and political differences among the

participating nations.

The terrorist attacks on the US on 11 September 2001 accentuate a further growing

risk to global prosperity, illustrated, for example, by the reallocation of resources

away from investment to anti-terrorist programs. The opening of war in March 2003

between a US-led coalition and Iraq added new uncertainties to global economic

prospects.

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Since we are dealing in an Asian country here is the low-down on the Economy of

Asia, the largest continent of the world. Following are some facts and figures about

Asian Economy:

The Economy of Asia comprises more than 4 billion people (60% of the world

population), living in 46 different states. In addition to this there are six further states

that lie partly in Asia, but are considered to belong to another region economically

and politically.

As in all world regions, the wealth of Asia differs widely between, and within, states.

This is due to its vast size, meaning a huge range of differing cultures, environments,

historical ties and government systems. The largest economy in Asia in terms of GDP

is Japan, the Smallest East Timor, (although there is currently no reliable data for

either Iraq or North Korea). This demonstrates the huge disparity in wealth in Asia,

with Japan being the world's second largest economy, and North Korea being one of

the poorest.

Asia was relatively rich in the ancient times. China was a major economic power and

attracted many to the East and for many the legendary wealth and prosperity of the

ancient culture of India personified Asia, attracting European commerce, exploration

and colonialism. The accidental discovery of America by Columbus in search for

India demonstrates this deep fascination. The Silk Road became the main East-West

trading route in the Asian hither land while the Straits of Malacca stood as a major

sea route. In the Straits of Malacca, Malacca established itself as an important port in

Asia.

Prior to World War II, most of Asia was under colonial rule. Only relatively few

managed to stay independent in face of constant pressure from many European

powers. Japan in particular managed to develop its economy thanks to reformation

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done in the 19th century. The reformation was comprehensive and is today known as

the Meiji Restoration. The Japanese economy continued to grow well into the 20th

century. Their ever increasing economy created various shortages of resources

essential to the economic growth. As a result, the Japanese expansion began and a

great part of Korea and China were annexed and thus, allowing the Japanese to secure

strategic resources.

At the same time, Southeast Asia was prospering due to trade and the introduction of

various new technologies of that time. The volume of trade continued to increase with

the opening of the Suez Canal in the 1860s. Singapore, founded in 1819 rose to

prominence as trade between the east and the west increased at an incredible rate. The

British colony of Malaya, now part of Malaysia, was the world's largest producer of

tin and rubber. The Dutch East Indies, now Indonesia on the other hand was known

for its spices production. Both the British and the Dutch created their own trading

companies to manage their trade flow in Asia. The British created the British East

India Company while the Dutch formed Dutch East India Company. Both companies

maintained trade monopoly of their respective colonies.

In 1908, crude oil was first discovered in Persia, modern day Iran. Afterwards, many

oil fields were discovered and it was learnt later that the Mideast processes the

world's largest oil stock. This made the rulers of the Arab nations very rich though the

socioeconomic development in that region lagged behind.

In the early 1930s, the world underwent a global economic depression, today known

as the Great Depression. Asia was not spared and suffered the same pain as Europe

and the United States. The volume of trade decreased dramatically all around Asia

and indeed the world. With falling demand, prices of various goods starting to fall

and further impoverished the locals and foreigners alike. In 1941, Japan invaded

Malaya and hence, begun World War II in Asia.

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After the liberalization of the Indian Economy undertaken by the then Finance

Minister and current Prime Minister of India Dr. Manmohan Singh, the Indian

economy coupled with the Chinese economy which was already booming with the

wise economic measures undertaken by Jiang Zemin powered Asia to being one of

the hotspots for world trade. Currently, as these two economies are growing at well

over 6% per year, Asia has started showing its potential. One of the favorable (or

unfavorable, depending upon one's point of view) is the sheer size of the population

in this region.

Meanwhile, Thailand, Malaysia and Indonesia emerged as the new Asian tigers with

their GDP grew well above 7% per year in the 80s and the 90s. The economies were

mainly driven by growing exports. The Philippines began to open up its once-

stagnant economy in the early 1990's.

Throughout the 1990s, the manufacturing ability and cheap labor markets in Asian

developing nations allowed companies there to establish themselves in many of the

industries previously dominated by developed-nation companies. Asia became one of

the largest sources of automobiles, machinery, audio equipment and other electronics.

At the end of 1997, Thailand was hit by currency speculators and the value of baht

along with its annual growth rate fell dramatically. Soon after, the crisis spread to

Indonesia, Malaysia, South Korea, Singapore and many other Asian economies and

inflicted great economic damage to the affected countries. In fact, some of the

economies actually contracted. This later would be known as the Asian financial

crisis. By 1999, most countries have already recovered from the crisis.

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GLOBALISATION

The term Globalisation means the changes in societies and the world economy that

are the result of dramatically increased trade and cultural exchange. In specifically

economic contexts, it is often understood to refer almost exclusively to the effects of

trade, particularly trade liberalization or free trade. Between 1910 and 1950, a series

of political and economic upheavals dramatically reduced the volume and importance

of international trade flows. More specifically, beginning with WWI and until the end

of WWII, when the Bretton Woods institutions were created (i.e. the IMF and the

GATT), globalization trends reversed. In the post-World War II environment,

fostered by international economic institutions and rebuilding programs, international

trade dramatically expanded. With the 1970s, the effects of this trade became

increasingly visible, both in terms of the benefits and the disruptive effects.

In simple terms the word globalization means coming together of different countries’

cultures’ traditions and races. It’s like creating a global village where there is free

transfer of thoughts and practices. This global village has a culmination of elements

which are essential in creating a wholesome package for achieving the objective of

every organization or person obtaining maximum profit. Globalisation has brought in

new opportunities to developing countries. Greater access to developed country

markets and technology transfer hold out promise improved productivity and higher

living standard. But globalisation has also thrown up new challenges like growing

inequality across and within nations, volatility in financial market and environmental

deteriorations. Another negative aspect of globalisation is that a great majority of

developing countries remain removed from the process. Globalization also affects the

local market. Due to competition consumers want more at lesser prices. There are any

brands available in market today. Any consumers who want better quality at lower

prices will go for cheaper products which are of high quality. Globalisation has

opened doors for the world to market any products anywhere in the world any time at

any price. Due to the harsh step taken by the countries to allow foreign products to

enter the market has left any local dealers dissatisfied. The local dealers are not able

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to get the best rates for their products. There is increasing competition which reduces

the prices of the products further down leading to more losses for the producers.

Impact of Globalisation on India

India opened up the economy in the early nineties following a major crisis that led

by a foreign exchange crunch that dragged the economy close to defaulting on loans.

The response was a slew of Domestic and External sector policy measures partly

prompted by the immediate needs and partly by the demand of the multilateral

organisations. The new policy regime radically pushed forward in favour of amore

open and market oriented economy.

Major measures initiated as a part of the liberalisation and globalisation strategy in

the early nineties included scrapping of the industrial licensing regime, reduction in

the number of areas reserved for the public sector, amendment of the monopolies and

the restrictive trade practices act, start of the privatisation programme, reduction in

tariff rates and change over to market determined exchange rates.

Over the years there has been a steady liberalisation of the current account

transactions, more and more sectors opened up for foreign direct investments and

portfolio investments facilitating entry of foreign investors in telecom, roads, ports,

airports, insurance and other major sectors.

The Indian tariff rates reduced sharply over the decade from a weighted average of

72.5% in 1991-92 to 24.6 in 1996-97.Though tariff rates went up slowly in the late

nineties it touched 35.1% in 2001-02. India is committed to reduced tariff rates. Peak

tariff rates are to be reduced to be reduced to the minimum with a peak rate of 20%,

in another 2 years most non-tariff barriers have been dismantled by March 2002,

including almost all quantitative restrictions.

This is major improvement given that India is growth rate in the 1970’s was very low

at 3% and GDP growth in countries like Brazil, Indonesia, Korea, and Mexico was

more than twice that of India. Though India’s average annual growth rate almost

doubled in the Eighties to 5.9% it was still lower than the growth rate in China, Korea

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and Indonesia. The pick up in GDP growth has helped improve India’s global

position. Consequently India’s position in the global economy has improved from the

8th position in 1991 to 4th place in 2001, when GDP is calculated on a purchasing

power parity basis.

Consequences of globalisation on India

The implications of globalisation for a national economy are many. Globalisation has

intensified interdependence and competition between economies in the world market.

This is reflected in Interdependence in regard to trading in goods and services and in

movement of capital. As a result domestic economic developments are not

determined entirely by domestic policies and market conditions. Rather, they are

influenced by both domestic and international policies and economic conditions. It is

thus clear that a globalising economy, while formulating and evaluating its domestic

policy cannot afford to ignore the possible actions and reactions of policies and

developments in the rest of the world.

Where does India stand in terms of Global Integration?

India clearly lags in globalisation. Numbers of countries have a clear lead among

them China, large part of east and far east Asia and Eastern Europe. Let’s look at a

few indicators how much we lag.

Over the past decade FDI flows into India have averaged around 0.5% of

GDP against 5% for China 5.5% for Brazil. Whereas FDI inflows into China

now exceeds US $ 50 billion annually. It is only US $ 4billion in the case of

India

Consider global trade – India’s share of world merchandise exports increased

from .05% to .07% over the pat 20 years. Over the same period China’s share

has tripled to almost 4%.

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India’s share of global trade is similar to that of the Philippines, an economy

6 times smaller according to IMF estimates. India under trades by 70-80%

given its size, proximity to markets and labour cost advantages.

As Amartya Sen and many other have pointed out that India, as a

geographical, politico-cultural entity has been interacting with the outside

world throughout history and still continues to do so. It has to adapt,

assimilate and contribute. This goes without saying even as we move into

what is called a globalised world which is distinguished from previous eras

from by faster travel and communication, greater trade linkages, denting of

political and economic sovereignty and greater acceptance of democracy as a

way of life.

FOREIGN DIRECT INVESTMENT (FDI)

Definitions of FDI are contained in the Balance of Payments Manual: Fifth Edition

(BPM5) (Washington, D.C., International Monetary Fund, 1993) and the Detailed

Benchmark Definition of Foreign Direct Investment: Third Edition (BD3) (Paris,

Organization for Economic Co-operation and Development, 1996).

According to the BPM5, FDI refers to an investment made to acquire lasting interest

in enterprises operating outside of the economy of the investor. Further, in cases of

FDI, the investor’s purpose is to gain an effective voice in the management of the

enterprise. The foreign entity or group of associated entities that makes the

investment is termed the "direct investor". The unincorporated or incorporated

enterprise-a branch or subsidiary, respectively, in which direct investment is made-is

referred to as a "direct investment enterprise". Some degree of equity ownership is

almost always considered to be associated with an effective voice in the management

of an enterprise; the BPM5 suggests a threshold of 10 per cent of equity ownership to

qualify an investor as a foreign direct investor.

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Once a direct investment enterprise has been identified, it is necessary to define

which capital flows between the enterprise and entities in other economies should be

classified as FDI. Since the main feature of FDI is taken to be the lasting interest of a

direct investor in an enterprise, only capital that is provided by the direct investor

either directly or through other enterprises related to the investor should be classified

as FDI. The forms of investment by the direct investor, which are classified as FDI,

are equity capital, the reinvestment of earnings and the provision of long-term and

short-term intra-company loans (between parent and affiliate enterprises).

According to the BD3 of the OECD, a direct investment enterprise is an incorporated

or unincorporated enterprise in which a single foreign investor either owns 10 per

cent or more of the ordinary shares or voting power of an enterprise (unless it can be

proven that the 10 per cent ownership does not allow the investor an effective voice

in the management) or owns less than 10 per cent of the ordinary shares or voting

power of an enterprise, yet still maintains an effective voice in management. An

effective voice in management only implies that direct investors are able to influence

the management of an enterprise and does not imply that they have absolute control.

The most important characteristic of FDI, which distinguishes it from foreign

portfolio investment, is that it is undertaken with the intention of exercising control

over an enterprise.

FDI flows constitute capital provided by foreign investors, directly or indirectly, to

enterprises in another economy. The three main components of FDI are:

• Equity Capital, which involves purchase by the foreign investor of shares of an

enterprise in a country other than its own.

• Reinvested Earnings, which refer to the foreign investor’s share of earnings that

are not remitted to it by the affiliate as dividends, but are reinvested or ploughed back

into the affiliate enterprise in the host country.

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• Working capital, which involves short and long term borrowing and lending of

funds by the parent investors and their affiliate enterprises in the host country.

FDI can be classified on the basis of the mode of entry of the foreign investor into a

country. It can enter a country in the form of Greenfield investment or mergers and

acquisitions (M&As).

• A Greenfield investment involves the setting up of new units or facilities by foreign

firms. For example, Silicon Chip Company of Taiwan coming to India and setting up

an Indian subsidiary with new plants in order to manufacture silicon chips.

• Cross border M&As, on the other hand, involve taking over or merging with an

existing local firm. For example, Coca-Cola company taking over Thums-Up in India.

KEY BENEFITS OF FDI

1. Capital formation

FDI brings in financial capital, which is scarce in developing countries. It has

the potential to add to the productive capacity or capital formation of the host

country.

2. Improve balance of payments

Greater FDI into the export sector can improve the current account balance and

hence the overall balance of payments.

3. Growth in net domestic savings & investment

FDI can encourage domestic saving and investment by encouraging the setting

up of new enterprises in the host country. Foreign businesses can increase the

demand for domestically produced inputs, which could lead to expansion of

existing domestic units or setting up of new ones. Domestic units can also be set

up to for processing of semi-finished products produced by foreign corporations

or to engage in retailing, marketing etc.

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4. Transfer of inputs, technology and skills

FDI transfers technology and skills to developing countries. FDI brings in new

varieties of capital units and better quality of factors of production including

management, which improves productive efficiency in the host country.

5. Net job creation

FDI can involve investment in new sectors, or setting up and expanding

business in thriving sectors. This can lead to increased employment

opportunities in the host economy.

6. Environmental benefits

Transnational corporations often develop environmental-friendly technologies

at lower costs and can actually induce local firms to adopt good environmental

practices.

7. FDI assures considerable stability in foreign inflows of funds

FDI as compared to other international flows is stable. Hence it has the potential

of ensuring a stable flow of foreign funds into the developing economy.

8. FDI can lead to higher export growth

If the motive of the foreign investor is to tap the export market of the host

country then it can lead to higher export growth. For e.g., if FDI flows into the

garments export industry in India, it will bring in financial resources and high

technology production processes. By taking advantage of skilled labour in India

in this sector, it can make garments export of India more competitive.

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9. Access to international markets

FDI can improve the competitive efficiency of domestic exports and hence

improve market access of goods. International production networks offer market

access to end products produced in any economy.

COSTS ASSOCIATED WITH FDI

1. Limited addition to capital

FDI might not contribute to total capital accumulation, when it does not involve

the creation of new units/investment. Concerns are often raised when FDI enters

more in the form of Mergers and Acquisitions than as Greenfield investments.

M & As involves taking extensive control over the decision-making and

management over the merger. Lack of local representation might lead to

decisions being made without taking into account needs and conditions of

domestic economy and society. Repatriation of profits can lead to withdrawal of

capital from the host country.

2. Worsen balance of payments

FDI could have a negative impact on the balance of payments situation of the

host country through an increase in imports of inputs and through remittances of

royalties and dividends abroad by the subsidiaries. For example, 75 per cent of

profits made by US firms abroad returns to the US.

3. FDI can bring about a fall in net domestic investment

Foreign corporations often form monopolies in the domestic market. Due to

their sheer size, good quality and low cost products and extensive advertising of

their products they might drive out small-scale firms. FDI, which is expected to

contribute to growth in domestic investment, often fails to, due to the

withdrawal of investments. There have been several instances in India where

approved FDI proposals have failed to translate into actual investments, on

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account of foreign investors getting put off by long- drawn procedures involved,

lack of infrastructure facilities etc

4. Transfer pricing

Transfer pricing relates to the way in which prices are determined for

transactions between subsidiaries and parent companies. It involves subsidiaries

paying a higher price for imports from the parent company and then exporting

products to parent companies at a lower price than the competitive market price.

Such distortion in prices affects the free flow of resources between countries

and also has a negative impact on the balance of payments situation of the host

country.

5. The downside

Developing countries might not have the ability to absorb high technology

imparted by foreign firms. For example, domestic conditions such as poor

infrastructure, low levels of education, rigidities in labour legislation and other

regulations are obstacles facing the Indian economy. Some foreign corporations

can bring in technology that is not appropriate to suit the conditions of the host

developing country.

6. Net job loss

Job creation might only take place in already well-developed urban sectors

where the levels of education, training and infrastructure are high. Small scale

and rural businesses have a low capacity to attract FDI and as a result are left

out. They can often be forced out of business due to lack of financial resources

or be forced into using informal sources of financing.

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7. Environmental costs

Foreign investors can take advantage of weak environmental regulation in

developing countries, by using technologies that are cheap but harmful to the

environment.

8. FDI may contribute to financial instability

Given the capacities and constraints of developing countries, free capital

movements make them more vulnerable to both external and internal shocks.

Developing countries’ dependence on foreign finance to cover their current

account deficits also makes them more financially fragile.

9. FDI might not encourage export growth

If the FDI is aimed at capturing the domestic market, then it will not have much

impact on growth of exports. Licensing conditions in the host country may

restrict exports to some or all foreign markets.

10. No contribution to market access

If FDI comes into a country only to exploit domestic markets, it does not

contribute to greater market access for domestic country exports

We can see that FDI has both positive as well as negative implications.

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BALANCE OF PAYMENTS (BOP)

FDI is also shown in the Balance of Payments of any country. The Balance Of

Payments (BOP) is a measure of the payments that flow into and out from a particular

country from and to other countries. It is determined by a country's exports and

imports of goods, services, and financial capital, as well as financial transfers.

BOP is a indicative study showing the flows i.e. inflows or outflows of any country to

another country. If there is more money flowing into a country than there is flowing

out, that country has a positive balance of payments; if, on the other hand, more

money flows out than in, the balance of payments is negative. A country's

international transactions can be grouped into three categories:

(I) Current Account

Exports

1. Merchandise (tangible goods)

2. Services (invisible trade, eg. legal, consulting, royalties, patents etc.)

3. Factor Income (interest, dividend or any other foreign investment

income)

Imports

1. Merchandise

2. Services

3. Factor income

Unilateral Transfers (one way "unrequitted" payments, eg.foreign aid,

grants, gifts etc.)

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(II) Capital Account

1. Foreign Direct Investment (FDI)

2. Portfolio Investment

o Equity Securities

o Debt Securities

3. Other Investment (transactions in currency, bank deposits, trade credits

etc.)

4. Statistical discrepancies

(III) Foreign Reserves

Official Reserve account, includes gold, foreign exchanges, SDRs,

reserves in IMF

Current account: records net flow of money into a country resulting from

trade in goods and services and transfer payments made from abroad. The

current

account itself comprises of 3 accounts : trade account, income account and

transfers account. A trade deficit(surplus) arises when there is a

deficit(surplus) in the Merchandise trade within the current account

Capital account: records net flow of money from purchases and sales of

assets such as stocks, bonds and land.

Money coming in (+), or leaving (−):

+ Exports

− Imports

− Increase of owned assets abroad

+ Increase of foreign-owned assets in the country

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An account may show a surplus or a deficit. For example, a trade surplus implies that

a country's exports are higher than its imports and hence there is a net flow of money

into the country. A trade deficit, on the other hand, implies that the country's imports

exceed its exports and hence there is a net flow of money out of the country.

For a country to have a zero balance of payments, a current account deficit must be

balanced by a capital account surplus. The US have been running a negative current

account for a long while, which is financed through a positive financial account. The

only way to buy more than you sell is to borrow money.

A country will have a negative balance of payments (i.e., there is to be a net flow of

money out of the country) if the net of the current account and the capital account is a

deficit. Similarly, there will be a positive balance of payments (i.e., a net flow of

money into a country) if the net of the current and the capital account results in a

surplus.

WHY ARE FOREIGN DIRECT INVESTMENTS MADE?

Developing countries, emerging economies and countries in transition have come

increasingly to see FDI as a source of economic development and modernisation,

income growth and employment. Countries have liberalised their FDI regimes and

pursued other policies to attract investment. They have addressed the issue of how

best to pursue domestic policies to maximise the benefits of foreign presence in the

domestic economy.

Given the appropriate host-country policies and a basic level of development, a

preponderance of studies shows 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 of

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these contribute to higher economic growth, which is the most potent tool for

alleviating poverty in developing countries. Moreover, beyond the strictly economic

benefits, FDI may help improve environmental and social conditions in the host

country by, for example, transferring “cleaner” technologies and leading to more

socially responsible corporate policies. Some countries have a flexible policy to allow

FDI into their country. This FDI flows not only big in money but also bring a lot of

wealth in knowledge. The technology transfer is the most popular form of FDI into

any country. Most empirical studies conclude that FDI contributes to both factor

productivity and income growth in host countries, beyond what domestic investment

normally would trigger. It is more difficult, however, to assess the magnitude of this

impact, not least because large FDI inflows to developing countries often concur with

unusually high growth rates triggered by unrelated factors. Whether, as sometimes

asserted, the positive effects of FDI are mitigated by a partial “crowding out” of

domestic investment is far from clear. Some researchers have found evidence of

crowding out, while others conclude that FDI may actually serve to increase

Domestic investment. Regardless, even where crowding out does take place, the net

effect generally remains beneficial, not least as the replacement tends to result in the

release of scarce domestic funds for other investment purposes.

In the least developed economies, FDI seems to have a somewhat smaller effect on

growth, which has been attributed to the presence of “threshold externalities”.

Apparently, developing countries need to have reached a certain level of development

in education, technology, infrastructure and health before being able to benefit from a

foreign presence in their markets. Imperfect and underdeveloped financial markets

may also prevent a country from reaping the full benefits of FDI. Weak financial

intermediation hits domestic enterprises much harder than it does multinational

enterprises (MNEs). In some cases it may lead to a scarcity of financial resources that

precludes them from seizing the business opportunities arising from the foreign

presence. Foreign investors’ participation in physical infrastructure and in the

financial sectors (subject to adequate regulatory frameworks) can help on these two

grounds.

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As countries develop and approach industrialised- nation status, inward FDI

contributes to their further integration into the global economy by engendering and

boosting foreign trade flows. Apparently, several factors are at play. They include the

development and strengthening of international networks of related enterprises and an

increasing importance of foreign subsidiaries in MNEs’ strategies for distribution,

sales and marketing. In both cases, this leads to an important policy conclusion,

namely that a developing country’s ability to attract FDI is influenced significantly by

the entrant’s subsequent access to engage in importing and exporting activities. This,

in turn, implies that would-be host countries should consider a policy of openness to

international trade as central in their strategies to benefit from FDI, and that, by

restricting imports from developing countries, home countries effectively curtail these

countries’ ability to attract foreign direct investment. Host countries could consider a

strategy of attracting FDI through raising the size of the relevant market by pursuing

policies of regional trade liberalisation and integration.

ECONOMY OF INDIA

India has had robust economic growth since 1991 when the government reversed its

socialist-inspired policy of a large public sector with extensive controls on the private

sector and began to liberalize the economy. Liberalization has proceeded in fits and

starts since then, mainly due to political pressures, but the economy has responded

well by posting strong growth in many sectors. A certain amount of dissatisfaction is

expressed in the face of these changes in the Indian economy- some of which are that

a quarter of the population is still too poor to be able to afford an adequate diet,

electricity shortages still continue in many regions and the manufacturing sector has

slowed down at the expense of soft skills.

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With a GDP of 568 billion (B$) ($3.096 trillion (T$) at PPP) India has the world's

12th largest economy (and the 4th largest when adjusted for PPP). However, the large

population means that per capita income is quite low. In 2003 the World Bank ranked

India 143rd in PPP per capita income and 160th in real terms, among 208 countries

and territories.

About 60% of the population depends directly on agriculture. Industry and services

sectors are growing in importance and account for 25% and 51% of GDP,

respectively, while agriculture contributes about 25.6% of GDP. More than 25% of

the population lives below the poverty line, but a large and growing middle class of

300 million has disposable income for consumer goods.

India embarked on a series of economic reforms in 1991 in reaction to a severe

foreign exchange crisis. Those reforms have included liberalized foreign investment

and exchange regimes, significant reductions in tariffs and other trade barriers, reform

and modernization of the financial sector, and significant adjustments in government

monetary and fiscal policies. These economic reforms form an integral part in the

growth and development of India. These economic reforms are explained below in

detail.

FOREIGN INVESTMENT POLICY OF INDIA

The Government of India introduced many foreign policies to attract foreign direct

investors. The investment policy was made keeping in mind the growth pattern and

the problems associated while attracting capital from outside. The foreign policy on

investment can be traced from the period of independence to present day. Here is how

the different Governments of India at various times, political, economic and social

time frames made the foreign policy on investment to attract maximum foreign

wealth.

21


1. “Cautious Welcome Policy” from Independence to the emergence of crisis in

the late 60’s (1948-1966).

2. “Selective and Restrictive Policy” from 1967 till the second oil crises in 1979.

3. “Partial Liberalisation Policy” from 1980 to 1990.

4. “Liberalisation and Open Door Policy” since 1991 onwards, signifying liberal

investment environment.

These were the different phases from which the foreign investment policy had to pass

through. Each of the phases is explained below:

1. “Cautious Welcome Policy”

India lacked a policy of its own on foreign capital before independence because it

derives its faith in total laissez faire from the British Government. Resultantly,

foreign enterprises found it convenient to export products to India and were

justified by local circumstances to setup branches or wholly owned subsidiaries.

Local entrepreneurs, which did not have many prospects for obtaining foreign

collaborations, setup industrial units without foreign collaborators as in case of

cotton textiles. Cement and paper or obtained the services of foreign consultants

as in the case of steel (TISCO).

The advent of Independence brought into focus the various issues involved in the

import of foreign capital and the expertise into the country, and the need for

defining a policy with respect to foreign investment. The new independent

government had specific views on industrialisation and role of foreign capital.

This was reflected in Industrial Policy Resolution of 1948.

The Industrial Policy Resolution of 1948 recognised that participation of foreign

capital and enterprise, particularly as regards of industrial techniques and

22


knowledge would be of value for the rapid industrialisation of the country.

However, it was necessary that the conditions under which foreign capital could

participate in the Indian industry should be carefully regulated in the national

interest. As a rule, the major interest in ownership and effective control would be

normally in Indian hands though provision was made for special cases in a

manner calculated to serve the national interest.

It was stated by the Prime Minister Shri Jawaharlal Nehru in April, 1949 that once

foreign investment had been allowed to be made in the country, it would be given

a non-discriminatory treatment. Firms with foreign investment would be treated at

par with Indian firms. There was assurance for free remittance of profits,

dividends, and interest as well as repatriation of capital. In the event of

nationalisation, fair and equitable compensation was to be given to the foreign

investors.

In the mid-1950s when industrialisation got underway foreign capital ventured

into India primarily with technical collaborations. However, the foreign exchange

crisis of 1958 marked a change in foreign collaboration in India in two ways: a)

foreign enterprise began to take equity participation more frequently, b) more

technical collaborations started to accept equity participation in lieu of royalties

and fees. After 1958, Indian entrepreneurs were given provisional licenses

required to secure part or all of the foreign exchange by way of foreign

investment. The government extended the AID Investment Guarantee Program to

cover American private investment in India. It gave a number of tax concessions

to foreign enterprise. The licensing procedure was streamlined to avoid delays in

approvals of foreign collaboration. Double taxation avoidance agreements with

Finland, France, USA, Pakistan, Ceylon (Sri Lanka), Sweden, Norway, Denmark,

Japan and West Germany were signed.

23


In 1963-64 the Government of India decided to give ‘letters of intent’ to foreign

companies to proceed with their capital projects, instead of making the foreign

company find a partner and then giving the ‘letter of intent’ to the Indian partner.

It was also decided to make the services of IDBI available for rupee financing

such undertakings.

The Finance Act, 1965 made provision for certain additional tax concessions. The

interests accruing in a Non-Resident Account on money transferred from abroad

through recognised banking channels and deposited in any bank was exempted

from tax. Also the tax exemption limit of 5 years allowed in respect of salaries of

foreign technicians was extended to 7 years. Tax rates on income assessable in

India of non-residents were brought down at par with those applicable to income

of residents. The rate of deduction of tax at source from non-residents income was

also lowered. The Act further provided for the refund of capital gains tax arising

out from the transfer of shares held by non-resident in an Indian company,

provided the sales proceeds were invested in India.

2. “Selective and Restrictive Policy”

Under the new industrial licensing policy, announced in February 1970, the larger

industrial houses and foreign enterprises were permitted to setup industries in the

core and heavy investments sectors expect industries reserved for public sector.

By notification dated July 25th 1970, they established undertakings and expanded

production in industries in others sectors provided they undertook specific export

commitments. However, in order to prevent a serious draft on their reserves, the

remittance facilities in respect of dividends declared by 100% foreign owned

companies were subject to some terms.

In 1972-73, though the Government Policy towards foreign investment continued

to attract foreign investment in India, the policy became highly selective. Foreign

Exchange Regulation Act (FEMA) was amended in 1973, to regulate the entry of

24


foreign capital in the form of branches, non-resident Indians investment and

employment of foreigners in India. As per the amended rules all branches of

foreign companies in India and Indian Joint Stock Companies in which non-

resident interest was more than 40% were expected to bring down their non-

resident share holdings to 40% within a period of 2 years.

However, basic and core industries, export oriented industry or industries engaged

in manufacturing activities needing sophisticated technology or tea plantation

were allowed to carry on business with non-resident interest up to 74%. Such

companies were also exempted from taking permission from RBI to carry on

business provided they did not exceed the licensed capacity and undertook no

expansion or diversification of activities. Foreign shipping companies were given

permission to carry on business in India in October 1974.

With a view to encourage investment by non-resident Indians, in October 1975,

the government decided to permit non-residents and persons of Indian origin to

invest in the equity capital of permitted industries up to a maximum of 20% of

new issues of capital of new industries. Such investments were made by

remittances from abroad through approved banking channels or out of funds held

in Non-Resident Account. The investment could be in addition to any foreign

equity investment that could be permitted by the government in the company

concerned.

In October 1976, the scheme under which non-resident Indians were allowed to

start industrial units in India by bringing in imported machinery was liberalised to

permit equity investment upto 74% without any minimum limit in a number of

priority sector industries. The permission was also granted for investment in other

industries provided the investor undertook to export 60% of the output (75% in

the case of small scale industries). The scheme was applicable only to new units

25


and to existing industrial undertaking seeking expansion and diversification.

Capital invested under the scheme was eligible for repatriation after the unit had

gone into commercial production subject to adherence to export obligation.

A statement on Industrial Policy was presented by the Government to Parliament

on December 23, 1977. Under this statement, foreign investment and acquisition

of technology necessary for India’s industrial development could be allowed

where they ere in national interest and on the terms determined by the

government. As a rule majority interest in ownership and effective control could

be in Indian hands expect in highly export oriented and sophisticated technology

areas and 100% export oriented areas. Where foreign investments had been

approved, there could be complete freedom of remittances of profits, royalties,

dividends and repatriation of capital subject to the usual regulations. The

government had made it clear that it would strictly enforce the provisions of

FERA, the companies which diluted their non-resident holdings to less than 40%

would be treated at par with Indian companies, expect in cases specifically

notified. Their future expansion would be guided by the same principles as those

applicable to Indian companies.

3. “Partial Liberalisation Policy”

In order to tap resources from oil exporting developing countries, the government

revised the foreign investment policy in October 1980 so that investment

proposals from these countries need not be associated with the transfer of

technology and that investment could be portfolio nature. However, a ban was

imposed by the government on financial and technical collaborations in 22

categories of industries such as cement, paper and consumer goods and several

other industries where indigenous technology within the country.

In the 1982-83, the government liberalised facilities with regard to bank deposits

and investments in equity shares of the corporate sector. These facilities were

26


further liberalised in July-August, 1982 to cover preference shares and debentures

issued by Indian companies. The Reserve Bank of India also simplified the

exchange procedure formalities to facilitate such investments. The government

also decided to borrow from international capital markets to the extent that the

availability of the low cost unilateral and bilateral resources fell short of the

requirement of external resources. In line with this policy, Indian enterprises both

public and private companies had been selectively permitted to raise funds

abroad. However, the facilities available for deposits for deposits in non-resident

account and in shares of Indian companies were confined to non-resident

individuals of Indian nationality or origin. Liberalised facilities were extended to

overseas companies, partnership firms, trusts, societies and other corporate bodies

in which atleast 60% of ownership/beneficial interest was vested in non-resident

individuals of Indian origin or nationality.

It was specified that in the case of investment, with repatrability, by non-resident

Indians and overseas corporate bodies can make portfolio investments through

stock exchanges in India in equity/preference shares and convertible/non

convertible debentures without nay limit on the quantum or value. They could

also invest in the new issues of public or private limited companies in any

business activity (expect real estate business) upto 100% of the issued capital

without any obligation to associate resident Indian participation in the equity

capital at any time. Payment of purchases either through stock exchanges or for

direct investment in new issues could be made by the eligible investor either a) by

fresh remittances from abroad or b) out of the funds held in non-resident external

accounts designated in rupees or in foreign currencies and ordinary non-resident

share accounts.

In 1983-84 the government provided the incentives in the form of:

27


Taxation of investment income derived by a non-resident of Indian

nationality or Indian origin from the specified investments and long-term

capital gains arising out of transfer of these assets at a flat rate of 20%

plus surcharge of 121/2% of such income tax,

Exemption of long-term capital gains arising from the transfer of any

foreign exchange asset,

Exemption from wealth tax of the value of foreign exchange assets

acquired and held by non-resident,

Exemption from gift tax of gifts of foreign exchange assets by non-

residents Indian to their relatives in India,

Additional interest of 1% on investments by NRIs in the 6-year NSCs

would be paid provided subscription for these certificates were received

in foreign exchange.

In May 1983, relaxations granted to NRIs investment were subjected to a specific

limit. An overall ceiling of:

5% of the value of the total paid up equity of the company concerned,

5% of the total paid up value of each series of convertible debentures was

fixed on purchases of equity stock exchanges on repatriation and non-

repatriation basis together.

In 1985-86, the government abolished the Estate Duty, which was considered as

major hurdles in the way of inward remittances to India by non-resident of Indian

origin or nationality. The surcharge on income tax was also abolished bringing

down the effective rate of tax on NRI income from 22.5% to 20%.

During 1986-87, the government permitted NRIs to subscribe to the

Memorandum and Articles of Association of a new company and take up their

28


share up to the face value of Rs. 10,000 for the purpose of its incorporation. It

also permitted Indian companies with more than 40% non-resident interest to

acquire immovable properties in India. Further, NRIs were allowed to invest:

Upto 100% of the equity capital in sick industrial units,

In new issues of Indian shipping companies under the 40% scheme,

In diagnostic centres in India under 40% or 74% scheme.

The government also decided to remove the quantitative ceiling of Rs. 40 lakhs

for making investment in India by NRIs in private limited companies under the

40% scheme. With a view to augmenting the inflows, the Foreign Currency (NR)

Account Scheme was extended to cover DM and Yen and a differential interest

rate scheme was introduced with effect from August 1, 1988

4. “Liberalisation and Open Door Policy”

As a part of the structural adjustment policies introduced in the Indian economy

by the government of India since July 1991, policies relating to foreign financial

participation in Indian companies and those relating to foreign technology

agreements had also undergone a radical change. Three tiers for approving

proposals for foreign direct investment in the country were introduced:

1. The Reserve Bank’s automatic approval system.

2. Secretariat for Industrial Approvals for considering proposals within the

general.

3. Foreign Investment Promotion Board (FIPB) specially created to invite,

negotiate and facilitate substantial investment by international companies

that would provide access to high technology and work markets.

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In case of investment with benefits of repatriation of capital and income NRIs and

OCBs were permitted to make investment in shares and debentures through stock

exchanges upto 1% of the paid up value of equity/preference and convertible

debentures of the company. No limit either on quantum or value was stipulated

with regard to purchases of non-convertible debentures. With the benefit of

repatriation, investments in new issues of non-convertible debentures were

allowed without any monetary limit. However, in case of new issue of shares and

convertible debentures through prospectus, they could invest upto 40% of the new

capital raised with repatriation benefit. They could also invest in the capital raised

other than through prospectus upto 40% of the new issue of shares and debentures

of any company (Public or Private) subject to a quantitative ceiling of Rs. 40

lakhs. The liberalised facility of direct investment by NRIs was confined only to

capital raised by Indian companies or setting up new industrial projects or

expansion/diversification of existing industrial undertaking. However, with the

abolition of the list of industries which were not open direct investment by non-

resident and with the addition of the hotel industry, the scope for investment by

NRIs had been widened.

NRIs and OCBs had also been permitted to invest 12%, 6 year NSCs and it was

exempted from wealth, income and gift taxes. The government of India permitted

equity share holding of foreign investors to be maintained at a level of 51% or

below. It was the same level of foreign equity, which the foreign majority

companies had been allowed under the FERA even when there was a likelihood

of its reduction as a result of exercise of convertibility clause option.

As per the new policy, fully owned foreign enterprises were allowed to setup

giant power projects without the requirement to balance dividend payments with

export earnings. FERA companies (those having more than 40% foreign equity)

were treated at par with Indian companies. FERA companies were also given the

facility of 51% equity. Companies could use foreign brands names and

30


trademarks on goods for sale within the country. Expect the 22 industries in the

consumer goods sector, the earlier stipulation that dividend remittances of

companies receiving approval under the foreign equity upto 51% scheme must be

balanced by export earnings over a period of 7 years was scrapped in respect of

all foreign direct investment including NRIs and OCBs. The foreign private

equity in oil refineries was limited at 26%. Foreign Institutional Investors (FIIs)

were permitted to invest in all the securities traded on primary and secondary

markets. Portfolio investments in primary and secondary markets were subjected

to a ceiling of 24% of issued share capital for the total holdings of all registered

FIIs, in any company. The holding of a single FII in any company was subjected

to a ceiling of 5% of total issued capital. NRIs and OCBs could invest with full

repatriation benefits up to 100% in high priority industries and export oriented

industries and sick units, and power generation. In the context of such revisions,

the earlier 74% scheme has been discontinued.

During 1993-94 the tax rate on short term capital gains were reduced from 75% to

30%. An Electronic Hardware Technology Park (EHTP) scheme was setup to

allow 100% equity participation, duty free import of capital goods and a tax

holiday. The ceiling on foreign equity participation in Indian companies engaged

in mining activity was hiked to 50%. Disinvestment by foreign investors was

permitted on a near automatic basis on stock exchanges in India through a

registered merchant banker or a private stock broker or on a private basis. NRIs

(but not OCBs) were allowed to invest upto 100% on non-repatriation basis in any

partnership/sole proprietorship or in public/private limited companies (expect in

agricultural or plantation activities) without RBI’s approval.

In 1994-95, the Reserve Bank of India decided to allow NRIs/OCBs and also FIIs,

to invest in all activities expect agriculture and plantation activities on a

repatriation basis. The aggregate allocation of shares/convertible debentures

qualifying for repatriation benefits to such non-residing investors could not

31


exceed 24% of the new issue. However, FIIs were not eligible to make investment

in unlisted/private companies under this scheme. The funds for such investment

could be received by way of remittance from abroad through normal banking

channels or by debit to NRI/FCNR Account of the non-residing investor. A

general permission was also granted to NRIs/OCBs to purchase the shares on

repatriation basis of Public Sector Enterprise (PSEs) disinvested by Central

Government subject to 1% of the paid up capital of the PSE concerned.

With effect from May 24, 1995 the permission was given to Euro issuing

companies to retain the Euro issue proceeds as foreign currency deposits with the

Bank’s and Public Financial Institutions in India, which could be converted into

Indian rupee only as and when expenditure for the approved end uses were

incurred. With effect from November 25, 1995 companies were permitted to remit

funds into India in anticipation of the use of funds for approved end uses.

Moreover the existing ceiling for the use of issue proceeds for general corporate

restructuring including working capital requirements were raised from 15% to

25% of the GDR issues.

During 1996-97 FIIs were allowed to invest up to 100% of their funds in debt

instruments of Indian companies effective January 15, 1997. With effect from

March 8, 1997, FIIs were allowed to invest in Government of India dated

securities upto 30%. Under the automatic route, the ceiling for lump sum payment

of technical know how fee had been increased from Rs. 1 crore to US $ 2 million

with effect from November 5, 1996. With effect from January 17, 1997, the

government allowed under the Automatic Approval route inclusion in Annexure-

III of the Statement of Industrial Policy 1991 the following:

a) 3 categories of industries/items relating to mining activities for foreign

equity upto 50%.

b) 13 additional categories of industries/items for foreign equity upto 51%.

c) 9 categories of industries/items for foreign equity upto 74%.

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During 1997-98 FDI was allowed in 16 non-banking financial services through

Foreign Investment Promotion Board. Expanding the scope of “automatic route”

for foreign FDI, the Government of India approved 13 additional categories of

industries/items under service sector for foreign equity participation upto 51% of

the equity. There were 3 items relating to mining activity upto 50% foreign equity

participation and 9 categories of industries/activities upto 74% foreign equity

participation.

As a part of the liberalised policy the RBI had decided to permit foreign banks to

operating in India to remit their profits or surplus to their head offices without the

approval of Reserve Bank. The Reserve Bank also allowed branches of foreign

companies operating in India to remit profits to their head offices without the

approval of Reserve Bank. Also the Authorized Dealers were permitted to provide

forward cover to FIIs in respect of their fresh investment in equity in India as well

as to cover the appreciation in the marked value of their existing investments in

India w.e.f. June 12, 1998. The Authorised Dealers were given the option of

extending the over fund-wise or FII-wise according to their operational feasibility.

The same facility was extended to NRIs/OCBs for their portfolio investments

w.e.f. June 16, 1998.

FOREIGN INVESTMENT PROMOTION BOARD (FIPB)

Introduction

The government of India has set up a special Board known as the Foreign Investment

Promotion Board. 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).

33


Objective

Its objective is to promote 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.

Clearance of Proposals

Early clearance of proposals submitted to it through purposeful negotiation and

discussion with potential investors. Reviewing policy and put in place appropriate

institutional arrangements and transparent rules and procedures and guidelines for

investment promotion and approvals.

The FIPB is expected to meet every week to ensure quick disposal of the cases

pending before it. It endeavours to ensure that the Government's decisions on FDI

proposals are communicated to the applicant within six weeks. Foreign Investment

proposals received

by the board's secretariat should be put up to the Board within 15 days of receipt and

the Administrative Ministries must offer their comments either prior to and/or in the

meeting of the FIPB. It would function as a transparent effective and investor friendly

single window providing clearance for investment proposals.

Composition

The Board will comprise the core group of secretaries to Government and would have

the following composition:-

i) Industry Secretary - Chairman, (Secretary Department of Industrial Policy and

Promotion), Government of India.

ii) Finance Secretary, Government of India.

iii) Commerce Secretary, Government of India.

34


iv) Secretary (Economic Relations), Ministry of External Affairs, Government of

India. The Board may opt other Secretaries to the Government of India and top

officials of financial institutions, banks and professional experts of Industry and

Commerce, as and when necessary.

Functions

The main functions of the Board will be as follows:

1. To ensure expeditious clearance of the proposals for foreign investment;

2. To review periodically the implementation of the proposals cleared by the

Board;

3. To review, on a continuous basis, the general and sectoral policy regimes

relating to FDI and in consultation with the Administrative Ministries and

other concerned agencies, evolve a set of transparent guidelines for facilitating

foreign investment in various sectors;

4. To undertake investment promotion activities including establishment of

contact with and inviting selected international companies to invest in India in

the appropriate projects;

5. To interact with the Industry Association/Bodies and other concerned

government and non-government agencies on relevant issues in order to

facilitate increased inflow of FDI;

6. To identify sectors into which investment may be sought keeping in view the

national priorities and also the specific regions of the world from which

investment may be invited through special efforts;

7. To interact with the Foreign Investment Promotion Council (FIPC) being

constituted separately in the Ministry of Industry; and

8. To undertake all other activities for promoting and facilitating foreign direct

investment, as considered necessary from time to time. The Board will submit

its recommendations to the Government for suitable action.

35


Approval by FIPB

The recommendations of FIPB in respect of the project-proposals each involving a

total investment of Rs.600 crores or less would be considered and approved by the

Industry Minister.

The recommendations in respect of the projects each with a total investment of above

Rs 600 crores would be submitted to the Cabinet Committee on Foreign Investment

(CCFI) for decision. The CCFI would also consider the proposals which may be

referred to it or which have been rejected by the Industry Minister.

The approval letters in all cases will be issued by the Secretariat of FIPB. The FIPB

has accorded approval to the investments of a large number of corporations such as

McDonalds, General Electric, Coca-Cola and Fujitsu in the recent past. It normally

processes applications within 6 weeks.

FOREIGN EXCHANGE REGULATION ACT (FERA)

During the World War II September 1939, there was a shortage of foreign exchange

resources. A system of exchange control was first time introduced through a series of

rules under the Defence of India Act, 1939 on temporary basis. The foreign crisis

persisted for a long time and finally it got enacted in the statue under the title

"Foreign Exchange Regulation Act, 1947." This was meant to last for 10 years.

However, 10 years of economic development did not ease the foreign exchange

constraint, it only made things worse. Thus, FERA permanently entered the statue

book in 1957.

Hon’ble Finance Minister then Shri Chidambaram’s Budget Speech announced the

setting up of a Reserve Bank of India committee to draft a Foreign Exchange

36


Management Act (FEMA), following guidelines laid down by the Sodhani

Committee (an RBI Committee) in 1993. Under the Hon’ble Prime Minister then Shri

Atal Bihari Vajpayee Government, the draft FEMA was approved by the Cabinet, and

Hon’ble Finance Minister then Shri Yashwant Sinha introduced a Bill in the Lok

Sabha on August 4, 1998. The mere fact that the number of sections has come down

from 81 sections in the 1973 FEMA Act to 19 in the new FEMA is symptomatic of

liberalisation.

In 1991 Budget speech, Hon’ble Finance Minister then Shri Dr. Manmohan Singh

remarked that India had accepted the Article VIII obligations of the IMF. But this did

not mean that the changes would be implemented overnight. There were four

different reasons why India was still short of complete current account convertibility

of 1994, Hon’ble Finance Minister then Shri Dr. .Manmohan Singh announced that

the rupee was going to be converted on the current account.

In 1997, the Reserve Bank of India appointed a Committee known as Tara pore

Committee to lay down road map for capital account convertibility. The Tara pore

committee recommended a phased transition to capital account convertibility in three

phases – 1997-98, 1998-99 and 1999-2000. This time frame was of course,

implausible. Before complete capital account convertibility, certain macroeconomic

conditions have been stated as prerequisites as per Article IV of IMF. However, the

South East Asian crisis compelled Government of India to put off the idea of capital

account convertibility.

The FERA, which was known as the law to "Control", has been replaced by FEMA

the law to "Manage" foreign exchange transactions against 81 sections under FERA.

Out of 49 sections, 9 sections are substantive in nature, the rest being procedural and

administrative in nature. FERA is known as negative law whereas FEMA promises to

be positive law.

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FOREIGN EXCHANGE MANAGEMENT ACT (FEMA)

The Foreign Exchange Management Act, 1999 (FEMA), as mentioned earlier, has

been in force with effect from 1.6.2000, thus replacing the old FERA, 1973. There is

a general misunderstanding among the NRIs that all restrictions and controls relating

to foreign exchange transactions have been abolished and that foreign exchange

dealings would be allowed to be freely made after the enactment of FEMA. This is

not so. It is, of course, true that there is a great change in the outlook of FEMA in

comparison with FERA but reasonable restrictions with regard to foreign exchange

transactions with a view to facilitate them in a regulated manner find a place in

FEMA, 1999 and connected rules and regulations. One of the special aspects of

FEMA is that various notifications and provisions of the RBI Exchange Control

Manual have been reframed in the form of separate regulations for different types of

exchange transactions with a view to making them available easily to NRIs and other

persons and also to provide

transparency to the RBI rules and regulations. For example, the various types of

accounts like NRI Account, FCNR account; NRO Account, etc. were regulated

through Exchange Control Manual and Notifications in this regard. Now, the FEMA

(Deposit) Regulations deal with the maintenance and operation of such accounts in a

clear cut manner. Similar is the case with reference to other various aspects of foreign

exchange. FEMA is a civil law, whereas the FERA was a criminal law.

Under the FEMA no prosecution would be launched for contravention of operating

provisions, likewise, arrest and imprisonment would not be resorted to except in the

solitary case where the person, alleged to have contravened the provisions of the

FEMA, defiantly resolves not to pay the penalty imposed under Section 13 of the

FEMA. In the same manner unrestrained enormous powers of Directorate of

Enforcement have been slashed down to a considerable extent. Even the word

"offence" is conspicuous by its absence in the substantive provisions of FEMA. There

38


are 49 sections in all in FEMA. Of these, only seven sections, namely, Sections 3 to 9

deal with certain acts to be done or not to be done in connection with transactions

involving foreign exchange, foreign security, etc. There are various sections from 16

to 35 relating only to adjudication and appeal. Further, one of the most important and

distinguishing features of FEMA is that there is a provision for compounding of

penalty as contained in Section 15 of FEMA. This could not have been imagined

earlier under FERA. Thus, NRIs and residents will have much easier time under

FEMA.

NRIs under Income Tax Act and persons resident outside India come under FEMA.

The expression Non-resident Indian or an NRI is used both under the Income Tax Act

and FEMA. However, there is a great difference between the meanings of both the

expressions. Sometimes, a person may be NRI under the I.T. Act but he may not NRI

under the FEMA or vice versa. This is because NRI, i.e., an Indian Resident outside

India under FEMA is treated differently now than he used to be under FERA.

COMPARISON OF INDIA OVER OTHER ASIAN

COUNTRIES

The Asian countries are attracting a great amount of FDI ever since the marketers and

investors felt that the European Countries are saturated. These Asian countries not

only offer expertise but also cheap labour. If we have a look on the Asian countries

which attract maximum FDI we can count countries like India, China, Japan, Vietnam

and to a extent Singapore and Indonesia. But, if we have a closer look, we can find

out that China and India attract the most FDI. These are the two most important and

sought after countries as regards FDI by outside agencies. Let’s have a look why

China is attracting FDI.

39


CHINA’S FOREIGN DIRECT INVESTMENT

Foreign direct investment (FDI) in China has undergone a rapid growth since 1992.

In both 1992 and 1993, actual investment more than doubled. In the peak year of

1993, contractual investment increased nine fold compared to 1991. Beginning in

1993, China emerged as the largest recipient of FDI among developing countries.

Though this rising trend slowed down after 1995, the momentum resumed in 2000.

China’s joining the WTO is providing a strong push to a new wave of foreign direct

investment to China.

Several factors can explain this important change in China’s economic landscape.

First, Deng Xiaoping’s South Tour in the summer of 1992 established the direction of

“socialist market economy” for China’s economic reform, which was officially

confirmed at the14th National Congress of the Chinese Communist Party of the same

year. This helped offer foreign investors a better-reformed investment environment.

Second, rapid expansion of foreign direct investment in 1992 took place at a quite

low level. In 1991,

actual investment was only US$ 4.366 billion. Third, the significant acceleration of

economic growth since 1992, combined with the political stability re-established,

strengthened foreign investor’s confidence of China’s investment environment and

led them make a strategic change in investment decision making. Fourth, the foreign

investment regime in China was significantly reformed. The early liberalization,

which applied to the four special economic zones, was further extended to broad

areas, especially, the developed Yangtze River Delta Area, and restrictions on FDI

were relaxed in some important areas (domestic sale, equity control, market access,

etc.). There are two important aims underlying the change of the policy stance of the

Chinese government. One is to “exchange technology with market”, and the other is

to push the transformation of the inefficient big state- run industrial enterprises

through the means of joint ventures.

40


From the external perspective, broadly speaking, the recent rise of FDI in China is

part of the international capital movement in the developing world, which results

from the realignment in the location of production facilities and investment of

multinational corporations (MNCs). Obviously, some of the factors, which lead to the

dramatic increase of foreign direct investment in China, are only temporary; thus, the

gains are static in nature. It is of interest to know the basic forces and mechanisms,

which determine the long-run trends of foreign direct investment in China.

Foreign direct investment in China began in 1979. Until 1991, the amount of both

contractual and actual investment was small. Most of FDI came from small and

medium-sized enterprises in Hong Kong and were highly concentrated in Guangdong

province. Production of foreign-invested enterprises was overwhelmingly export-

oriented and had little link with the domestic economy .The “take-off” of FDI took

place in 1992. In the next 9 years, annual contractual investment increased from US$

11.977 billion in 1991 to US$ 62.380 billion in 2000, and annual actual investment

rose from US$ 4.366 billion in 1991 to US$ 40.715 billion in 2000. By 2000, the total

amount of cumulative contractual and actual investment reached US$ 676.097 billion

and US$ 348.349 billion respectively.

The effects of foreign direct investment became prominent in some important aspects.

The share in total exports contributed by foreign-invested enterprises increased from

16.75 percent in 1991 to 47.93 percent in 2000. The share of foreign- invested

enterprises in the total industrial output values increased from 5.29 percent in 1991 to

22.51 percent in 2000. One consequence of rapid growth of FDI since 1992 has

been that it has become the most important source of foreign capital inflow into

China. The share of actual FDI in total foreign capital inflows increased from less

than one half in 1991 to 80 percent in 2000.

41


The main factors which influence FDI into China are the technical expertise as well

as hard working population. China is considered as the hub of FDI in the world.

China being the second most populated country in the world enjoys a lot of benefits

like rich technology, easy approachable markets, huge opportunities for expansion

and the government policies which attract FDI a lot. As shown above the country has

a very open policy for FDI. It has that every ingredient which a corporate requires

from his investments. Hence we can see a lot of countries mainly the European

countries making a beeline of investments in China.

But India doesn’t remain behind in catching up the competition. There are many

articles comparing India and China as to which country is the best country for

investing.

COMPARISON BETWEEN INDIA AND CHINA IN FDI

It is practically an established fact that China’s track record in attracting foreign

direct investment (FDI) is far superior to that of India. India has been considered as

an “underachiever” in securing FDI. India fell eight spots to the 15th position in

2002 with 20 percent decline in attracting FDI, according to the FDI

Confidence Index, by A T Kearney, one of the world’s biggest business

strategy consultants. Communist China for the first time has overtaken the United

States to be the best destination for overseas investments. China scored 1.99 in a scale

from zero to three, while the United States ranked second with 1.89 and India scored

1.05 as per the results. The United States, Britain, Germany and France rounded out

the top five, with Brazil falling to 13th place in 2002 from third in the previous year.

China has also remained the most preferred destination for FDI among the

developing nations in the Asia and the Pacific. In terms of FDI performance index2 of

42


the United Nations Conference on Trade and Development (UNCTAD), China

ranked 47 in the world way above India, which ranked at 119 (UNCTAD, 2002).

In volume, FDI in China exceeds that in India many-fold. India lagged much

behind China in 2001, grabbing only 7.25% of the FDI dollars that its neighbour

received. With the annual FDI inflows of over $46 billions of China compared with

a trivial amount of $3.4 billion into India in 2001, it is virtually a settled fact that

India trails significantly behind China in attracting FDI in spite of its undying

competitive efforts in the market for FDI inflows. This ratio is an indicator of the

attractiveness of an economy to draw FDI. A country with a ratio of FDI to GDP that

is greater than unity is reckoned to have received more FDI than that implied by the

size of its economy. It indicates that the country may have a comparative advantage

in production or better growth prospects reflecting larger market size for the foreign

firm.

On the other hand, a country that has the ratio value of less than one may be more

protectionist and technologically backward, or may possess a political and social

regime that is not conducive for investments. The yawning gap between China and

India in attracting the non-debt creating FDI flows has indeed been a matter of

significant policy concern for India, because in the process India is supposed to be

losing a lot of markets and a lot of capital investment to China.

India has certain strength which China will require another revolution of the short to

attain. China will not be able to sustain economic growth if it insists on delaying

political reform. China is using authoritarianism as its strength where as India’s

strength lies with democracy. Although official FDI figures point to $47 billion

investment to China in 2001 with India only $3 billion, but the race could be actually

closer. According to the international Finance Corporation the whole issue of FDI in

China could be overestimated due to “round-tripping” where mainland funds leaving

China return as foreign investment to gain tax and other incentives. The World Bank

43


thinks that that as much as 50% of China’s FDI could actually be domestic cash

cutting its 2001 total to about 2% of the GDP. India according to the IFC,

underestimates FDI because of incomplete data and may have received up to $8

billion; 1.7 per cent of the GDP in 2001. (Far Eastern Economic Review, December

2002). Venture capitalism is leading the way investing serious money in India against

much hyped China.

So can India catch up with China? In terms of purchasing power parity, India is the

fourth largest economy, after the US, China and Japan, in that order; it recently

overtook Germany. By 2010, India is projected to overtake Japan. Many economic

observers believe that in the next 20 years India's real GDP can potentially grow at 10

per cent if it pursues reforms vigorously. This should reduce the percentage of the

population below the poverty line to less than 15 per cent. If India concentrates on

producing a significantly accelerated growth in agriculture, information technology,

and exports in these 20 years, it may get closer to China. Many Indian companies are

setting up shops in China to take advantage of the growth.

China and India have pursued radically different development strategies. India is not

outperforming China overall, but it is doing better in certain key areas. That success

may enable it to catch up with and perhaps even overtake China. Should that prove to

be the case, it will not only demonstrate the importance of home-grown

entrepreneurship to long-term economic development; but it will show the limits of

the foreign direct investment (FDI) dependent approach China is pursuing.

China’s exceptional growth is partly explained by its markets –based reforms that

started in 1978, well before India’s similar reforms began in 1991. These reforms

have enabled China to integrate with the global economy at phenomenal peace.

Today it is the largest recipient of foreign direct investment among developing

countries, with the annual investment rising from almost zero in 1978 to about $ 52

billion in 2002. (Nearly 5% of GDP). Foreign direct investment in India has also

44


increased significantly, though at much lower levels, growing from $129 million in

1991 to $ 4 billion in 2002 (Less than 1% of GDP). On the way to the new economy,

China is gradually becoming the world manufacturing centre of IT equipment and

products, while India has gained the leading position in software technology and has

become the second largest software country in the world. Since mid-1990s, trading

activities between the two countries greatly increased, economic cooperation, such as

labour, technical cooperation and inter- investment had been widely developed. Both

enjoy healthy rates of economic growth. But there are significant differences in their

FDI performance. FDI flows to China grew from $3.5 billion in 1990 to $52.7 billion

in 2002; if round-tripping is taken into account, China’s FDI inflows could fall to,

say, $40 billion Those to India rose from $ 0.4 billion to $5.5 billion during the same

time period. Even with these adjustments, China attracted seven times more FDI than

India in 2002, 3.2% of its GDP compared with 1.1% for India. In UNCTAD’s FDI

Performance Index, China ranked 54th and India 122nd in 1999-2001. FDI has also

contributed to the rapid growth of China’s merchandise exports, at an annual rate of

155 between 1989 and 2001. In 1989 foreign affiliates accounted for less than 9% of

total Chinese exports; by 2002 they provided half. In some high-tech industries

in 2002 the share of foreign affiliates in total exports was as high as 91% in

electronics circuits and 96% in mobile phones (WIPR-2002) About two-thirds of FDI

flows to China in 2000-2001 went to manufacturing. In India, by contrast, FDI has

been much less important in driving India’s export growth, except in information

technology. FDI in Indian manufacturing has been and remains domestic market

seeking. FDI accounted for only 3% of India’s exports in the early 1990s (WIPR,

2002).

Even today, FDI is estimated to account for less than 10% of India’s manufacturing

exports. For China the lion’s share of FDI inflows in 2000-2001 went to a

broad range of manufacturing industries. For India most went to services,

electronics and electrical equipment and engineering and computer industries. The

45


differential performance of India and China in attracting the FDI inflows has been the

subject of attention at the international level (UNCTAD, 2003). Further, the

difference in FDI inflows to India and China can be attributed partly to definitional

and conceptual issues. For instance, a part of the difference in FDI inflow to India and

China can be traced to data reporting. A sizable portion of the FDI in China is

investment made by the Chinese from foreign location-the so called “round tripping”-

and this takes place to a large extent due to special treatment extended by the Chinese

authorities towards foreign investors’ vis-à-vis domestic investors. The round tripping

is much smaller in India and takes place mainly through Mauritius for tax purposes.

Estimates suggest that as 30 percent of the reported FDI in china may in fact be a

result of round- tripping.

Another major factor could be the earlier initiation of reform measures in China

(1978) as compared to India (1991). Moreover, China’s manufacturing sector

productivity is 1.6 times that of India and, in some sectors, as much as five ties (Mc

Kinsey, 2001). Flexible labour laws, a better labour climate and entry and exit

procedures for business, business-oriented and more FDI–friendly policies also make

China an attractive destination. Investors underscore the predictability and stability of

the tax system as an important factor in determining investment decision. Higher

Import duties on raw materials in India result in higher prices of inputs, as most

domestic players resort to import parity pricing. China has a flat 17 per cent VAT

rate, while India’s indirect taxes range from 25 per cent to 30 per cent of the retail

price for most manufactured product. The emergence of China as a member of world

Trade Organization (WTO) in 2001 is a stabilizing anchor and has led to substantial

liberalization in the services sector (RBI 2004).It is also important to note that India

and China focused on different strategies for industrial development. India

46


encouraged FDI only in higher technology activities, whereas China favoured

export- oriented FDI concentrated in manufacturing sector.

China’s strategy is based on the premise that an increasing proportion of international

trade is inter-firm trade between multinational, and in such an environment there is no

alternative to attracting FDI for export. China’s FDI –driven merchandise exports

grew at an annual rate of 15 percent between 1969 and 2001. In 1989, foreign

affiliates accounted for less than nine percent of total Chinese exports; by 2002 these

accounted for half of the exports and in high-tech industries the proportion was much

higher (World Investment Report, 2003). In contrast, in India, given its product

reservation policy for Small Scale Industries (SSIs), FDI is not permitted in SSI

reserved products such as garments and toys, which has adverse implications for

export growth. In India, exports by FDI companies grew at an average of around 9%

during 1990-91 to 2001-02. A major factor in the growth of Chinese exports was the

relocation of labour intensive activities by TNCs to China. However, in India this has

happened mainly in the services sector. Almost all major U.S and European

information technology firms have presence in India now. Foreign companies

dominate India’s call centre industry, with a 60% share of the annual US$ 1.5 billion

turnover.

Despite large FDI flows, restrictions on the organizational forms of FDI entry are still

prevalent in China. For instance, in 31 industries the establishment of wholly foreign

– owned enterprises is not allowed and the Chinese partners must hold majority share

holdings or a dominant position in another 32 sectors (OECD, 2002). A view has

been expressed that China’s large absorption of FDI is not necessarily a sigh of the

strength of its economy; instead, it may be a sigh of some, rather substantial. It is

argued that FDI plays a major role in the Chinese economy due to systematic and

pervasive discrimination against efficient and entrepreneurial domestic firms.

Furthermore, unlike India, a vibrant private sector is absent in China and most of

47


the foreign investors must perform tie up with only state owned behemoths for joint

ventures.

Conclusion

Thus we can see that both the countries function differently but attract the most

foreign investment. But, inspite of all the problems associated with India, it can still

stand on its own feet and show the world that they are better than the Chinese.

WHY PEOPLE INVEST IN INDIA?

India and the Indians have undergone a paradigm shift. There have been fundamental

and irreversible changes in the economy, government policies, outlook of business

and industry, and in the mindset of the Indians in general. The following factors have

shown why people wish to invest in India:

1. From a shortage economy of food and foreign exchange, India has now

become a surplus one.

2. From an agro based economy it has emerged as a service oriented one.

From the low-growth of the past, the economy has become a high-growth one

in the long-term.

3. After having been an aid recipient, India is now joining the aid givers club.

4. Although India was late and slow in modernization of industry in general in

the past, it is now a front-runner in the emerging Knowledge based New

Economy.

5. The Government is continuing its reform and liberalization not out of

compulsion but out of conviction.

48


6. Indian companies are no longer afraid of Multinational Companies. They have

become globally competitive and some of them have started becoming MNC’s

themselves.

7. Fatalism and contentment of the Indian mindset have given way to optimism

and ambition.

8. Introvert and defensive approach have been replaced by outward-looking and

confident attitude.

9. In place of denial and sacrifice, the Indian value system has started

recognizing seeking of satisfaction and happiness

10. The Indian culture, which looked down upon wealth as a sin and believed in

simple living and high thinking, has started recognizing prosperity and

success as acceptable and necessary goals.

11. Graduates no longer queue up for safe government jobs. They prefer and

enjoy the challenges and risks of becoming entrepreneurs and global players.

Goldman Sachs Report of 1 October, 2003 "Dreaming with BRICs: The path to

2050" says the following about the future of Indian economy

1. India's GDP will reach $ 1 trillion by 2011, $ 2 trillion by 2020, $ 3 trillion by

2025, $ 6 trillion by 2032, $ 10 trillion by 2038, and $ 27 trillion by 2050,

becoming the third largest economy after USA and China.

2. In terms of GDP, India will overtake Italy by the year 2016, France by 2019,

UK by 2022, Germany by 2023, and Japan by 2032. Chinese GDP could

overtake Germany by 2007, Japan by 2016, and the US by 2041.

3. Among the BRIC group India alone has the potential to show the highest

growth (over 5 percent) over the next 50 years. The Chinese growth rate is

likely to reduce to 5% by 2020, 4% by 2029, and 3% by 2046.

The fundamentals of the Indian economy have become strong and sustainable. The

macro-economic indicators are at present the best in the history of independent India

49


with high growth, foreign exchange reserves, and foreign investment and robust

increase in exports and low inflation and interest rates. India is the second fastest

growing economy of the world at present. The GDP growth in 2003-04 is estimated

to be around 7%. The growth rate in the second quarter July-Sept.2003 reached 8.4%.

India has recorded one of the highest growth rates in the 1990s. The target of the 10th

Five Year Plan (2002-07) is 8%. While the agricultural and industrial sectors have

continued to grow, the services sector has grown at a significantly higher pace, and is

currently contributing to nearly half of the total GDP. India's services sector growth

of 7.9% over the period 1990-2001 is the second highest in the world.

A unique feature of the transition of the Indian economy has been high growth with

stability. The Indian economy has proved its strength and resilience when there have

been crises in other parts of the world including in Asia in recent years. The foreign

exchange reserves have reached a record level of US$ 100 billion as on 22nd

December 2003. India is the sixth largest foreign exchange holder in the world. This

is remarkable considering the fact that the Forex reserves went under US$ one billion

in 1991 before the economic reforms started. This comfortable situation has

facilitated further relaxation of foreign exchange restrictions and a gradual move

towards greater capital account convertibility. Given the large foreign exchange

reserves, the Government has made premature repayment of US$ 3 billion of 'high-

cost' loans to World Bank and Asian Development Bank and is considering further

premature payment of other loans.

The Government has decided to (i) discontinue receiving aid from other countries

except the following five: Japan, UK, Germany, USA, EU, and the Russian

Federation and (ii) to make pre-payment of all bilateral debt owed to all the countries

except the five mentioned above. Since July this year, India has become a net creditor

to IMF, after having been a borrower in the past. The Government has written off

debts of 30 million US dollars due from seven heavily indebted countries as part of

the "India Development Initiative" announced in this year's budget speech.

50


The external debt to GDP ratio has improved significantly from 38.7% in 1992 to

20% in 2003. This is one of the lowest among developing economies. External debt in

September, 2003 was 112.5 billion US dollars. Of this long-term NRI deposits is $ 27

billion, commercial borrowings $ 24 billion, multilateral debt $ 31 billion, and

bilateral debt $ 18 billion.

Some more facts:

1. Foreign direct investments in the period April - March, 2004 - 05 stood at

US$ 4.70 billion.

2. Foreign Direct Investment inflows more than doubled from US$ 434 million

in April-May 2004 to US$ 922 million in April-May 2005. However, there

was a net outflow of US$ 427 million of portfolio investments, which reduced

the total foreign investments in April-May 2005 to US$ 495 million as against

the inflows of US$ 993 million in April-May 2004. The non-resident deposits

with the scheduled commercial banks went up by US$ 88 million in April

2005 as against the addition of US$ 79 million in April 2004.

3. On the inward FDI front, Mauritius still tops the list, followed by the US and

the Netherlands. An encouraging note, during the last fiscal, was that the FDI

flows from Germany and Japan rose sharply. FDI flows were directed mainly

at the manufacturing sector, which received $924m, followed by computer

services at $372m and business services ($363m). Foreign portfolio flows at

$8.8bn were also buoyant during '04-05.

4. Sector-wise break-up of FDI is as follows: fuels -28.1%, telecom-16.7%,

transportation-8.4%, electrical equipments-6.7%, services-6.7% and

metallurgical industry-5.3%

5. Major FDI destinations are Maharashtra-17.4%, Delhi-12%, Tamil Nadu-

8.6%, Karnataka-8.2%, Gujarat-6.5%, and Andhra Pradesh- 4.6%.

51


6. MNCs, which have invested in India include GE, Dupont, Eli Lily, Monsanto,

Caterpillar, GM, Hewlett Packard, Motorola, Bell Labs, Daimler Chrysler,

Intel, Texas Instruments, Cummins, Microsoft, IBM, Toyota, Mitsubishi,

Samsung, LG, Novartis, Bayer, Nestle, Coca Cola and McDonalds.

7. FII investment during the period 2004 - 05 stood at US$ 9.4 billion.

8. Foreign institutional investors (FII) have pumped in $1.9 billion in July, the

highest ever in any calendar year. The total net FII investment in CY05 is now

more than $6.7 billion.

9. The current calendar saw a rise in the number of FIIs registered with SEBI.

According to SEBI, whopping 145 new foreign institutional investors (FII)

logged in to the country in CY05. The total number of registered FIIs as on

August 2, 2005 was 739, much higher than 637 as on December 31, 2004.

10. Many Japanese and European funds have also started eyeing India with an aim

to cash in on the rising equity markets. Registrations from non-traditional

countries like Denmark, Italy, Belgium, Canada, Sweden and Ireland went up

significantly in the fiscal 2004-05, according to the Securities and Exchange

Board of India (SEBI).

11. CALPERS (California Public Employees Retirement System), the world's

biggest pension fund with a base of US$ 165 billion has recently decided to

invest US$ 100 million in India thus adding India to their list of countries for

investment.

12. US$ 8.5 billion of FII funds in calendar year 2004 went into equities. The

cumulative FII inflow in equities in calendar 2005 (till 8 September 2005) has

already reached US$ 7.93 billion as compared to the whole of calendar year

2004, where the inflow aggregated US$ 8.5 billion.

13. FIIs have 50 percent stake in one third of the 30 companies which make up

the BSE-30 Index and hold about 10 percent of the stakes in public sector

undertakings.

52


HOW TO INVEST INTO INDIA?

Foreign direct investments in India are approved through two routes:

I. 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:

1) Foreign equity up to 50% in 3 categories relating to mining activities (List 2).

2) Foreign equity up to 51% in 48 specified industries (List 3).

3) Foreign equity up to 74% in 9 categories (List 4).

4) Where List 4 includes items also listed in List 3, 74% participation shall

apply.

5) The lists are comprehensive and cover most industries of interest to foreign

companies. Investments in high-priority industries or for trading companies

primarily engaged in exporting are given almost automatic approval by the

RBI.

II. The FIPB Route

Processing of non-automatic approval cases: FIPB stands for Foreign Investment

Promotion Board which approves all other cases where the parameters of

automatic approval are not met. Normal processing time is 4 to 6 weeks. Its

approach is liberal for all sectors and all types of proposals, and rejections are

few. It is not necessary for foreign investors to have a local partner, even when

53


the foreign investor wishes to hold less than the entire equity of the company. The

portion of the equity not proposed to be held by the foreign investor can be

offered to the public.

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

options:

AS AN INCORPORATED ENTITY

By incorporating a company under the Companies Act, 1956 through

i. Joint Ventures; or

ii. Wholly Owned Subsidiaries

Foreign equity in such Indian companies can be up to 100% depending on the

requirements of the investor, subject to any equity caps prescribed in respect of the

area of activities under the Foreign Direct Investment (FDI) policy.

AS AN UNINCORPORATED ENTITY

As a foreign Company through:

i. Liaison Office/Representative Office

ii. Project Office

iii. Branch Office

Such offices can undertake activities permitted under the Foreign Exchange

Management (Establishment in India of Branch Office of other place of business)

Regulations, 2000.

INCORPORATION OF COMPANY

For registration and incorporation, an application has to be filed with Registrar of

Companies (ROC). Once a company has been duly registered and incorporated as an

54


Indian company, it is subject to Indian laws and regulations as applicable to other

domestic Indian companies.

LIAISON OFFICE / REPRESENTATIVE OFFICE

The role of liaison office is limited to collecting information about possible market

opportunities and providing information about the company and its products to

prospective Indian customers. It can promote export/import from/to India and also

facilitate technical/ financial collaboration between parent company and companies in

India. Liaison office can not undertake any commercial activity directly or indirectly

and can not, therefore, earn any income in India. Approval for establishing a liaison

office in India is granted by Reserve Bank of India (RBI).

PROJECT OFFICES

Foreign Companies planning to execute specific projects in India can set up

temporary project/site offices in India. RBI has now granted general permission to

foreign entities to establish Project Offices subject to specified conditions. Such

offices can not undertake or carry on any activity other than the activity relating and

incidental to execution of the project. Project Offices may remit outside India the

surplus of the project on its completion, general permission for which has been

granted by the RBI.

BRANCH OFFICE

Foreign companies engaged in manufacturing and trading activities abroad are

allowed to set up Branch Offices in India for the following purposes:

i. Export/Import of goods

ii. Rendering professional or consultancy services

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

55


iv. Promoting technical or financial collaborations between Indian

companies and parent or overseas group company.

v. Representing the parent company in India and acting as buying /

selling agents in India.

vi. Rendering services in Information Technology and development of

software in India.

vii. Rendering technical support to the products supplied by the parent/

group companies.

viii. Foreign airline/shipping Company.

Branch Offices established with the approval of RBI may remit outside India profit of

the branch, net of applicable Indian taxes and subject to RBI guidelines. Permission

for setting up branch offices is granted by the Reserve Bank of India (RBI).

BRANCH OFFICE ON “STAND ALONE BASIS” IN SEZ

Such Branch Offices would be isolated and restricted to Special Economic Zone

(SEZ) alone and no business activity/ transaction will be allowed outside the SEZs in

India, which include branches/subsidiaries of its parent office in India.

No approval shall be necessary from RBI for a company to establish a branch/unit in

SEZs to undertake manufacturing and service activities subject to the following

conditions:

i. Such units are functioning in those sectors where 100% FDI is

permitted,

ii. Such units comply with part XI of the Company’s Act (Section 592 to

602),

iii. Such units function on a stand-alone basis,

iv. In the event of winding up of business and for remittance of winding-

up proceeds, the branch shall approach an authorized dealer in foreign

exchange with the documents required as per FEMA.

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SECTORS OPENED UP FOR FDI IN INDIA

India has opened up many sectors for FDI. All the sectors have either some entry

barriers or a limit. India is the land where there is a lot of opportunity for foreign

investment. But, the government has to support the local companies as well. So there

are restrictions/limits for investing in sectors in India. Let’s have a look as to which

sector is really opened up for foreign investment.

First of all starting with the sectors where in FDI is prohibited:

1. Retail trading

2. Lottery business

3. Gambling and betting sector

4. Housing and real-estate business except development of integrated townships.

5. Agriculture (excluding Floriculture, Horticulture, Development of Seeds,

Animal Husbandry, Pisiculture and cultivation of vegetables, mushrooms, etc.

under controlled conditions and services related to agro and allied sectors) and

Plantation (excluding Tea Plantations).

6. Retail sector (not decided as still).

SECTORS WHERE FDI IS ALLOWED

Sr. no.

Sector Specific Guidelines and Limitations

57


1. Airports Up to 100% with FDI, beyond 74% requiring

Government approval.

2. Atomic Energy The following three activities are permitted to

receive FDI/NRI investments through FIPB (as

per detailed guidelines issued by Department

of Atomic Energy vide Resolution No. 8/1

(1) / 97-PSU /1422 dated 6.10.98):

a. Mining and mineral separation

b. Value addition per se to the products of

(a) above

c. Integrated activities [comprising of

both (a) and (b) above

The following FDI participation is permitted:

a. Up to 74% in both pure value addition

and integrated projects

b. For pure value addition projects as well

as integrated projects with value

addition up to any intermediate stage,

FDI is permitted up to 74% through

joint venture companies with Central/

State PSUs in which equity holding of

at least one PSU is not less than 26%.

c. In exceptional cases, FDI beyond 74%

will be permitted subject to clearance

of the Atomic Energy Commission

before FIPB approval.

3. Agriculture (Including Plantation) No FDI/NRI investment is permitted other

than Tea sector, where FDI permitted up to

100% in Tea sector, including tea plantations,

with prior Government approval and subject to

58


following conditions:

a. Compulsory divestment of 26% equity

in favour of Indian partner/Indian

public within a period of five years,

b. Prior State government approval

required in case of any future land use

change.

4. BroadcastingBroadcasting

TV Software Production

a) 100% foreign investment allowed subject to:

I. all future laws on broadcasting and no

claim of any privilege or protection by

virtue of approval accorded, and

II. not undertaking any broadcasting from

Indian soil without Government

approval

b) Setting up hardware facilities, such as

uplinking, HUB, etc.

Private companies incorporated in India with

permissible FII/NRI/PIO equity within the

limits (as in the case of telecom sector FDI

limit up to 49% inclusive of both FDI and

portfolio investment) to set up uplinking hub

(teleports) for leasing or hiring out their

facilities to broadcasters

c) Cable Network

Foreign investment allowed up to 49%

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(inclusive of both FDI and portfolio

investment) of paid up share capital.

Companies with minimum 51% of paid up

share capital held by Indian citizens are

eligible under the Cable Television Network

Rules (1994) to provide cable TV services

d) Direct-to-Home

Company with a maximum of foreign equity

including FDI/NRI/FII of 49% would be

eligible to obtain DTH License. Within the

foreign equity, the FDI component not to

exceed 20%

e) Terrestrial Broadcasting FM

The licensee shall be a company registered in

India under the Companies Act. All share

holding should be held by Indians except for

the limited portfolio investment by

FII/NRI/PIO/ OCB subject to such ceiling as

may be decided from time to time. Company

shall have no direct investment by foreign

entities, NRIs and OCBs. As of now, the

foreign investment is permissible to the extent

of 20% portfolio investment

f) Terrestrial TV

No private operator is allowed in terrestrial TV

transmission.

5. Coal & Lignite (i) Private Indian companies setting up or

operating power projects as well as coal or

60


lignite mines for captive consumption are

allowed FDI up to 100%.

(ii) 100% FDI is allowed for setting up coal

processing plants subject to the condition that

the company shall not do coal mining and shall

not sell washed coal or sized coal from its coal

processing plants in the open market and shall

supply the washed or sized coal to those

parties who are supplying raw coal to coal

processing plants for washing or sizing

(iii) FDI up to 74% is allowed for exploration

or mining of coal or lignite for captive

consumption.

(iv) In all the above cases, FDI is allowed up

to 50% under the automatic route subject to the

condition that such investment shall not exceed

49% of the equity of a PSU.

6. Domestic Airlines In the domestic Airlines:

i) FDI up to 49% permitted under automatic

route.

ii) 100% investment by NRIs permitted under

automatic route subject to no direct or indirect

equity participation by foreign airlines

7. Defence and Strategic Industries

Foreign Direct Investment, including NRI

investment, is permitted up to 26% with prior

Government approval subject to licensing and

security requirements.

8. Establishment and FDI up to 74% is permitted with prior

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Operation of Satellite Government approval.

9. Housing & Real Estate

NRIs are allowed to invest in the following

activities:

a) Development of serviced plots and

construction of built up residential

premises

b) Investment in real estate covering

construction of residential and

commercial premises including

business centres and offices

c) Development of townships

d) City and regional level urban

infrastructure facilities, including both

roads and bridges

e) Investment in manufacture of building

materials, which is also open to FDI

f) Investment in participatory ventures in

(a) to (e) above

g) Investment in housing finance

institutions, which is also open to FDI

as an NBFC.

10. Investing Companies in

Infrastructure/Service Sector

In respect of the companies in

infrastructure/service sector, where there is a

prescribed cap for foreign investment, only the

direct investment will be considered for the

prescribed cap and foreign investment in an

investing company will not be set off against

this cap provided the foreign direct investment

in such investing company does not exceed

49% and the management of the investing

company is with the Indian owners. The

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automatic route is not available.

11. Insurance FDI up to 26% in the Insurance sector is

allowed on the automatic route subject to

obtaining licence from Insurance Regulatory &

Development Authority (IRDA).

12. Mining (i) For exploration and mining of diamonds

and precious stones FDI is allowed up to 74%

under automatic route

(ii) For exploration and mining of gold and

silver and minerals other than diamonds and

precious stones, metallurgy and processing,

FDI is allowed up to 100% under automatic

route

(iii) Press Note No. 18 (1998 series) dated

14.12.98 and Press Note No 1 of 2005 dated

12.01.2005 would not be applicable for setting

up 100% owned subsidiaries in so far as the

mining sector is concerned, subject to a

declaration from the applicant that he has no

existing joint venture for the same area and / or

the particular mineral.

13. Non-Banking Financial

(a) FDI/NRI investments allowed in the

following 19 NBFC activities shall be as per

levels indicated Companies below:

i) Merchant banking

ii) Underwriting

iii) Portfolio Management Services

iv) Investment Advisory Services

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v) Financial Consultancy

vi) Stock Broking

vii) Asset Management

viii) Venture Capital

ix) Custodial Services

x) Factoring

xi) Credit Reference Agencies

xii) Credit rating Agencies

xiii) Leasing & Finance

xiv) Housing Finance

xv) Forex Broking

xvi) Credit card business

xvii) Money changing Business

xviii) Micro Credit

xix) Rural Credit

(b) Minimum Capitalisation Norms for fund

based NBFCs:

i) For FDI up to 51% - US$ 0.5 million to be

brought upfront

ii) For FDI above 51% and up to 75% - US $ 5

million to be brought upfront

iii) For FDI above 75% and up to 100% - US $

50 million out of 24 months

(c) Minimum capitalisation norms for non-

fund based activities:

Minimum capitalisation norm of US $ 0.5

million is applicable in respect of all permitted

non- fund based NBFCs with foreign

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investment

(d) Foreign investors can set up 100%

operating subsidiaries without the condition to

disinvest a minimum of 25% of its equity to

Indian entities, subject to bringing in US$ 50

million as at (b) (iii) above (without any

restriction on number of operating subsidiaries

without bringing in additional capital)

(e) Joint Venture operating NBFC’s that have

75% or less than 75% foreign investment will

also be allowed to set up subsidiaries for

undertaking other NBFC activities, subject to

the subsidiaries also complying with the

applicable minimum capital inflow i.e. (b)(i)

and (b)(ii) above

(f) FDI in the NBFC sector is put on automatic

route subject to compliance with guidelines of

the Reserve Bank of India. RBI would issue

appropriate guidelines in this regard.

14. Petroleum (Other than Refining)

a) FDI is permitted up to 100% on

automatic route in petroleum products

marketing. FDI in this sector would be

permissible subject to the existing

sectoral policy and regulatory

framework in the oil marketing sector.

b) FDI up to 100% is allowed in on the

automatic route in oil exploration in

both small and medium sized fields

65


Petroleum (Refining)

subject to and under the policy of the

Government on private participation in

(i) exploration of oil and (ii) the

discovered fields of national oil

companies.

c) FDI up to 100% is permitted on the

automatic route for petroleum products

pipeline subject to and under the

Government policy and regulations

thereof.

d) FDI upto 100% is permitted for Natural

Gas/LNG Pipelines with prior

Government approval.

e) 100% Wholly owned Subsidiary (WoS)

is permitted for the purpose of market

study and formulation

f) 100% wholly owned subsidiary (WOS)

is permitted for investment/Financing

g) For actual trading and marketing,

minimum 26% Indian equity is

required over 5 years.

a) FDI is permitted up to 26% in case of

public sector units (PSUs). PSUs will

hold 26% (Refining) and balance 48%

by public. Automatic route is not

available

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b) In case of private Indian companies,

FDI is permitted up to100% under

automatic route.

15. Postal Services FDI up to 100% is permitted in courier

services with prior Government approval

excluding distribution of letters, which is

reserved exclusively for the state.

16. Print Media The following FDI participation in Indian

entities publishing News Papers and

periodicals is permitted:

(a)FDI up to 100% in publishing/printing

scientific & technical magazines, periodicals &

journals.

(b)FDI up to 26% in publishing News Papers

and Periodicals dealing in News and Current

Affairs subject to verification of antecedents of

foreign investor, keeping editorial and

management control in the hands of resident

Indians and ensuring against dispersal of

Indian equity.

17. Private Sector Banking

74% from all sources on the automatic route

subject to guidelines issued by RBI from time

to time.

18. Telecommunication i) Basic, cellular, value added services and

global mobile personal communications by

satellite, FDI is limited to 74% subject to

licensing and security requirements and

adherence by the companies (who are

investing and the companies in which the

investment is being made) to the licence

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conditions for foreign equity cap and lock- in

period for transfer and addition of equity and

other licence provisions

ii) In ISPs with gateways, radio-paging and

end-to-end bandwidth, FDI is permitted up to

74% with FDI, beyond 49% requiring

Government approval. These services would

be subject to licensing and security

requirements

iii) No equity cap is applicable to

manufacturing activities

iv) FDI up to 100% is allowed for the following activities in the telecom sector:

a) ISPs not providing gateways (both for

satellite and submarine cables).

b) Infrastructure Providers providing dark

fibre (IP Category I).

c) Electronic Mail; and

d) Voice Mail

The above services would be subject to the

following conditions:

1. FDI up to 100% is allowed subject to

the condition that such companies

would divest 26% of their equity in

favour of Indian public in 5 years, if

these companies are listed in other

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parts of the world

2. The above services would be subject to

licensing and security requirements,

wherever required

3. Proposals for FDI beyond 49% shall be

considered by FIPB on case to case

basis.

19. Trading Trading is permitted under automatic route

with FDI up to 51% provided it is primarily

export activities, and the undertaking is an

export house/trading house/super trading

house/star trading house. However, under the

FIPB route:-

I. 100% FDI is permitted in case of

trading companies for the following

activities:

a) Exports

b) Bulk imports with ex-port/ex-bonded

warehouse sales c) cash and carry

wholesale trading.

d) Other import of goods or services provided

at least 75% is for procurement and sale of

goods and services among the companies of

the same group and for third party use or

onward transfer/distribution/sales.

II. The following kinds of trading are also

permitted, subject to provisions of

Foreign Trade Policy:

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a) Companies for providing after sales services

(that is not trading per se).

b) Domestic trading of products of JVs is

permitted at the wholesale level for such

trading companies who wish to market

manufactured products on behalf of their joint

ventures in which they have equity

participation in India.

c) Trading of hi-tech items/items requiring

specialised after sales service.

d) Trading of items for social sector.

e) Trading of hi-tech, medical and diagnostic

items.

f) Trading of items sourced from the small

scale sector under which, based on technology

provided and laid down quality specifications,

a company can market that item under its

brand name.

g) Domestic sourcing of products for exports.

h) Test marketing of such items for which a

company has approval for manufacture

provided such test marketing facility will be

for a period of two years, and investment in

70


setting up manufacturing facilities commences

simultaneously with test marketing.

i) FDI up to 100% permitted for e-commerce

activities subject to the condition that such

companies would divest 26% of their equity in

favour of the Indian public in five years, if

these companies are listed in other parts of the

world. Such companies would engage only in

business to business (B2B) e-commerce and

not in retail trading. FDI is not permitted in

retail trading activity.

20. Township Development

FDI upto 100% is allowed under the automatic

route in townships, housing, built-up

infrastructure and construction-development

projects which would include, but not

restricted to, housing, commercial, premises,

hotels, resorts, hospitals, educational

institutions, recreational facilities, city and

regional level infrastructure) subject to

conditions and guidelines

21. Venture Capital As per Schedule VI under FEMA Regulation,

a registered Foreign Venture Capital Investor

(FVCI) may invest in Indian Venture Capital

Undertakings (IVCU) or in a VCF after

approval from RBI.

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In a nutshell we can have the following inferences:

FDI Prohibited

1) Retail trading

2) Atomic energy

3) Lottery business

4) Gambling and betting sector

5) Housing and real-estate business except development of integrated townships.

6) Agriculture (excluding Floriculture, Horticulture, Development of Seeds,

Animal Husbandry, Pisiculture and cultivation of vegetables, mushrooms, etc.

under controlled conditions and services related to agro and allied sectors) and

Plantation (excluding Tea Plantations)

FDI up to 26 % allowed

1) FM Broadcasting – Only portfolio investment up to 20% with prior

Government approval

2) Print media: Publishing newspaper and periodicals dealing with news and

current affairs - FDI up to 26% with prior Government approval

3) Defence industries - FDI up to 26% with prior Government approval

4) Insurance - Foreign equity (FDI+FII) up to 26% under the automatic route

FDI up to 49 % allowed

1) Broadcasting

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a) Setting up hardware facilities such as up-linking, HUB, etc.- FDI+FII

equity up to 49% with prior Government approval

b) Cable network- Foreign equity (FDI+FII) up to 49% with prior

Government approval

c) DTH - Foreign equity (FDI+FII) up to 49% with prior Government

approval. FDI can not exceed 20%.

2) Domestic airlines - FDI up to 49% under the automatic route with no direct or

indirect participation of foreign airlines

3) Telecommunication services: basic and cellular - FDI up to 49%. However,

under license conditions foreign equity (FDI+FII) up to 49% is allowed. The

decision to raise foreign equity limit to 74% has not been notified so far

4) Investing companies in infrastructure/service sector – FDI up to 49% with

prior Government approval

FDI up to 74% allowed

1) Development of Airports- up to 74% under the automatic route; prior

Government approval beyond 74%

2) ISP with gateways, radio-paging, end-to-end bandwidth – FDI up to 74% with

FDI beyond 49% requiring prior Government approval

3) Establishment and operation of satellites - FDI up to 74% with prior

Government approval

4) Atomic minerals - FDI up to 74% with prior Government approval

5) Exploration and mining of coal and lignite for captive consumption – FDI up

to 74% with FDI above 50% requiring prior Government approval

6) Mining of diamonds and precious stones- FDI up to 74% under the automatic

route

7) Private sector banks - Foreign equity (FDI + FII) up to 74% under the

automatic route

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FDI up to 100 % allowed subject to conditions

1) Development of Airports - FDI beyond 74% requires Government approval

2) Petroleum sector: NG/LPG pipelines with prior Government approval

3) Petroleum sector: market study and formulation, investment /financing with

prior Government approval. Minimum 26% Indian equity within 5 years for

actual trading and marketing.

4) Trading: wholesale cash and carry; exports, trading of hi-tech items with prior

Government approval. In Export trading – FDI up to 49% permitted under the

automatic route.

5) B2B e-commerce subject to divestment of 26% equity within 5 years if the

company is listed in other parts of the world

6) Courier services- prior Government approval

7) Tea Sector, including tea plantation – prior Government approval subject to

divestment of 26% equity within five years

8) Non Banking Finance Companies – FDI up to 100% under the automatic route

subject to minimum capitalization norms

9) ISP without gateway, infrastructure provider providing dark fibre, electronic

mail and voice mail – FDI up to 100% allowed subject to divestment of 26%

equity in 5 years if the investing companies are listed in other parts of the

world.

10) Domestic airlines – NRI investment up to 100% permitted under the

automatic route with no direct or indirect participation of foreign airlines.

Now some of the sectors which are in news for their latest happenings:

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Retail Sector

There is a lot of news about FDI in retail. The government of India wants FDI in

retail. But not all the corporate retailing companies support this move.

Current Indian FDI Regime

FDI not permitted in retail trade sector, except in:

Private labels

Hi-Tech items / items requiring specialized after sales service

Medical and diagnostic items

Items sourced from the Indian small sector (manufactured with technology

provided by the foreign collaborator)

For 2 year test marketing (simultaneous commencement of investment in

manufacturing facility required)

Current FDI

For example, the Metro Group of Germany. It has Cash-and-carry wholesale trading.

But the proposal faced strong opposition

Entities established prior to 1997

Allowed to continue with their existing foreign equity components.

No FDI restrictions in the retail sector pre-1997

Example: Food World, 51:49 JV between RPG and Dairy Farm International, it is the leading food retailer in India now

Example: McDonald’s

Franchise

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International company gives name and technology to local partner. Gets

royalty in return

In case master franchise is appointed for region or country, he has right to

appoint local franchisees

Nike, Pizza Hut, Tommy Hilfiger, Marks and Spencer, Mango all function

through these franchisees.

Manufacturing

Company sets up Indian arm for production. For example, Bata India. It also has right

to retail in India

Distribution International company sets up local distribution office

Supply products to Indian retailers to sell

Also set up franchised outlets for brand

Example: Swarovski, Hugo Boss

Wholesale trading Cash and Carry operations

100% FDI permitted

Example: Metro Cash n Carry

The government is planning to introduce FDI in retail very soon since it sees this

sector as the sector which can bring laurels to Indian economy. There are a no. of

companies (foreign) who are desperate to enter the Indian market. But they still have

to wait till the stand on FDI in retail is cleared. A no. of retail biggies are suggesting

the government to have the following plan of action:

FDI should be allowed in stages:

Initial stages: 26% FDI

Establishment Phase: 49% FDI

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Mature Phase: 100% FDI

FDI policy for Retail.

No incentives needed to attract FDI

Market size and potential are sufficient inducers

No need for costly tax breaks, import duty exemptions, land and power

subsidies, and other enticements

This is what the government had decide on FDI in Retail

1. 49% FDI.

2. Foreign companies can control a Joint Venture with Indian partner.

3. A foreign retailer can open stores only in 10 metros subject to only 3 stores

per metro.

4. MNC’s may be given tax rebates.

5. Per MNC should operate only 1 store per metro.

Some of the international companies who are trying hard to invest in Retail in India are:

1. Starbucks.

2. Wal-Mart.

Oppositions to FDI in Retail- a case of Wal-Mart

The moot point is that FDI in retail sector shall harm and not help the

economic interest of the country. There cannot be any justification in allowing FDI in

retail business in our country. Retail markets in our country are dominated by small

business. The entry of Wal-Mart will have bull-dozing effect on our retail market.

The vast numbers of self-employed small owners run retails shops shall be perished.

Lakhs and lakhs of people connected with retails business shall be rendered jobless.

77


FM

The information and broadcasting ministry has cleared a proposal for 20% FDI in the

FM radio sector, but will maintain the ban on news and current affairs programmes.

Currently, FII investment up to 20% of the equity capital is allowed, but FDI is

strictly not permitted. Telecom Regulatory Authority of India (TRAI) had earlier

recommended allowing FDI in the private FM radio sector.

Real Estate

The Indian Government has allowed FDI for several industries in the recent past. FDI

in Real estate is being permitted since January 2002. Despite the fact that it is almost

a year, since the FDI was allowed in Real Estate, the response is not encouraging.

EXISTING POLICY GUIDELINES FOR FDI IN REAL ESTATE

The minimum capitalization norm will be $10 million for a wholly owned

subsidiary and $5 million for joint ventures with Indian partners.

The minimum area to be developed by a company will have to be 100 acres.

A minimum lock-in period of 3 years from completion of minimum

capitalization shall apply before repatriation of original investment is

permitted.

A minimum of 50% of the integrated project development must be completed

within a period of 5 years from the date of possession of the land.

The company must be registered as an Indian company under the Companies

Act 1956 and will be allowed to take up land aggregation and development.

FIPB under the Ministry of Urban Development & Poverty Alleviation will

process all FDI cases and set guidelines for the companies.

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BENEFITS OF FDI IN REAL ESTATE

FDI in real estate can create major inflows of funds that can enhance domestic

investment to achieve a higher level of real estate development. FDI can

certainly bring in the funds at reasonably cheaper rates, besides new ideas and

technologies, which would enhance the efficiency of the Indian construction

industry.

A major part of the cumbersome procedures of the government and RBI are

simplified with the FDI policy. So, the impact on the real estate industry can

be significant, leading to increased competition levels among the local

developers, in terms of price, quality and timing. The potential of growth and

contribution of the real estate industry to the GDP is tremendous in India, as

compared to other countries.

INTERNATIONAL REACTIONS TO FDI FLOWS INTO

INDIA

The world is getting up and taking notice of India. It was not a long time ago that

India was still considered just a small developing country. But now all the top firms

on the world are making a beeline of FDI into India. The recent surge of the

benchmark indices of India’s premier stock exchanges i.e. the Bombay Stock

Exchange (BSE) have shown that India is the best place to invest. It has also

overtaken the major countries like USA, China, Japan who are the first preferences

for any company for placing their investments.

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The investment advisory company Goldman Sachs is very bullish on India. It has

predicted the following for India:

1. India's GDP will reach $ 1 trillion by 2011, $ 2 trillion by 2020, $ 3 trillion by

2025, $ 6 trillion by 2032, $ 10 trillion by 2038, and $ 27 trillion by 2050,

becoming the third largest economy after USA and China.

2. In terms of GDP, India will overtake Italy by the year 2016, France by 2019,

UK by 2022, Germany by 2023, and Japan by 2032. Chinese GDP could

overtake Germany by 2007, Japan by 2016, and the US by 2041.

3. Among the BRIC group India alone has the potential to show the highest

growth (over 5 percent) over the next 50 years. The Chinese growth rate is

likely to reduce to 5% by 2020, 4% by 2029, and 3% by 2046.

AT Kearney, a leading management consulting firm, carries out the FDI Confidence

Index survey, which tracks the impact of likely political, economic and regulatory

changes on the foreign direct investment intentions and preferences of the leaders of

the world’s leading companies.

Findings on India (2003)

1. India has been upgraded from 15th in 2002 to 6th most attractive FDI destination

worldwide in 2003.

a) U.S. and British investors have ranked India 3rd, and Canadian investors have

placed it 4th most attractive globally.

b) Overall, European and Asian investors have ranked India 10th and 11th most

attractive, respectively.

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c) One in 10 global investors committing FDI to new markets plan to enter the

d) Indian market over the next three years.

2. India chosen as the prime offshore location for low- and high-tech activities.

a) Manufacturing investors rank India among the top six most

preferred investment locations and nearly one-third are bullish on the Indian

market.

b) Services sector investors ranked India as the fourth most attractive

destination in 2003, up from 14th in 2002.

c) India received investments from GE Capital, American Express,

Citibank, Conseco, British Airways, Dell Computers and Reuters. Oracle and

Microsoft have announced plans to expand their software development

operations in India.

3. However, in comparison with China and Brazil, FDI remains significantly lower.

a) India received only about 2% of the total FDI flow to the developing world in

2002. China received a mammoth 28% and Brazil 9%, followed by 7% by

Mexico.

b) Investors complained about a highly bureaucratic business climate as well as

ceilings on foreign ownership in India.

c) Many companies hence prefer to outsource by hiring Indian firms to manage

business processes without making direct investments.

d) It is reported that the recent delays in tax reform, protests against

privatisation of state-owned industries, and the slowdown in privatisation

could limit India from achieving significant FDI increases.

4. Attributes influencing FDI decisions

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a) Amongst the attributes influencing FDI decisions, India failed to capture the

top spot in any attribute except for its highly educated work force.

b) However, it took second place behind China with regard to market growth and

potential, and unit costs.

c) India (along with Poland) dominated the education category, which along with

market size and potential appear to be India’s overriding differentiating

factors for global investors.

d) It has been reported that the perceived weak infrastructure in India is also

turning investors toward other emerging markets.

Following where the above attributes:

a) Market Size

b) Market growth and potential

c) Production and labour costs

d) Access to export markets

e) Competitor Presence

f) Availability of M&A targets

g) Financial and economic stability

h) Political and social ability

i) Tax regime

j) Infrastructure

k) Transparency

l) Highly educated workforce

m) Quality of life

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FUTURE PROSPECTS

The future of India is very bright, thanks to the FDI inflows in India. But the present

coalition government must introduce more and more effective schemes so that India

can shine on the world map and indeed be a “SUPER POWER”. There are some

problems in India which when solved can bring laurels to Indian economy and help

India to reach the pinnacle of success.

The government can open up more sectors for FDI such as more limits in Retail, Fm,

Pharma and other allied industries. Also there is a great potential in airports and

airline services. The government can also open up the skies for private and foreign

investors.

CONCLUSION

FDI investments are very essential for any country. It gives them not only better

products and services but also equally high returns. FDI may be into many criticisms

and flaws, but it is essential for any developing country.

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BIBLIOGRAPHY

1. Indian Economy in 21st Century- Prospects and Challenges by Indian Tax

Foundation.

2. Foreign Direct Investment- Global & Indian Aspects by Niti Sury.

3. Foreign Investment in India- Liberalisation & the WTO, the Emerging

Scenario by Chanchal Chopra.

4. Reports on Investment Approval in India & FDI India by EconomicaIndia

Info Services.

5. www.google.co.in

6. www.unctad.com

7. www.ibef.org/economy/fdi.aspx

8. www. atkearney.com/main.taf?p=1,5,1,151

9. www.finance.indiamart.com/investment_in_india/fdi.html

10. www.indiaonestop.com/economy-fdi.htm

11. www.indiainbusiness.nic.in/faq/faqs-fdi.htm

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