FDI

Submitted to

Prof. V. Muralidharan

Foreign Direct Investment

Definition:
FDI in its classic form is defined as a company from one country making a physical
investment into building a factory in another country. It is the establishment of an
enterprise by a foreigner.

Classification of Foreign Direct Investment

Foreign direct investment may be classified as Inward or Outward.
Investment is "the flow of funds from one destination to another" for any activity,
including industrial development, infrastructure, and manufacturing. When the
investment goes from the home country to another country, it is defined as 'investment
outflow' and when foreign investment comes in from other countries to the home country,
it is termed 'investment inflow'. Both inward and outward movements are encouraged in
the majority of countries across the world.

Importance
FDI represents foreign assets in domestic structures, equipments, and organizations. It
does not include foreign investment in stock markets. Foreign direct investment is useful
to a country if the focus is more on projects rather than investments in the equity of
companies.

Characteristics of FDI
 FDI is an activity by which an investor, who is a resident in one country, obtains a
lasting interest in, and is a significant influence on, the management of an entity in
another country.

 This may involve either creating an entirely new enterprise, a so-called "Greenfield"
investment, or more typically, changing the ownership of existing enterprises via
mergers and acquisitions.

Investment Patterns
 International Product Life Cycle - Reduces costs by 'shifting production to developing
countries. For instance, Essel Propack moved to China.

 Location - Specific advantages make FDI easier than exporting or licensing.

Mahindra tractors are manufactured in North America.

 Contract manufactures - Brings down the cost of manufacturing and also contributes
to consolidating competitive sourcing and competing in the world market. Honda
Motors manufactures its vehicles in Europe.

 Assured return on investment - R&D centers and futuristic projects enable the
investor to achieve great successes through high revenues

 Social effects: Countries with closed economies have started to liberalize their
economies through market reforms that are favorable to foreign investors through
privatization, property rights, and liberal labor policies.

Benefits of FDI for Host Country

 Capital: Multinational enterprises invest in long-term projects, taking risks and
repatriating profits only when the projects yield returns.

 Technology: The effects of technology emerge especially when the liberalization of

the investment flow drives a more rapid rate of technology development, diffusion,
and transfer. Such processes may involve the transfer of physical goods and/or the
transfer of knowledge. A vast majority of economic studies dealing with the
relationship between FDI and productivity and economic growth have found that the
transfer of technology through FDI has contributed positively to productivity and
economic growth in host countries.
 Market access: Investors can provide access to export markets. The growth of exports
themselves offers benefits, such as technological learning and competitive stimuli.
They can transform normal customers into intellectual customers.

 Increase in domestic investment: The increase in FDI inflow is associated with a

manifold increase in the investment by national investors.

 Export promotion: It seems that FDI could be related to export trade in goods, and the
host country can benefit from an FDI-led export growth.

 Generating employment: FDI leads to the generation of both direct and indirect
employment opportunities in the host country.

 Infrastructure: In order to facilitate and enable investors to perform well, the host
country studies other competitive destinations and enhances the level of infrastructure
in selected areas to match the requirements of the investors. India's Silver Valley in
Bangalore, Hitech City in Hyderabad, and Tidel Park in Chennai have revolutionized
the areas through connectivity.

 Social effects: Countries with closed economies have started to liberalize their
economies through market reforms that are favourable to foreign investors through
privatization, property rights, and liberal labour policies. Society at large benefits as
employment, infrastructure, literacy, and health care are bound to improve as an
impact of FDI inflow.

 Formation of Clusters: Groups of similar projects and manufacturing centres are

formed in a specific location by way of providing common production, R&D,
training, and pollution control systems to a group of competing companies. In Italy,
Brazil, and India, such clusters have worked wonders.
 Spin-offs: Statistical evidence exists across the world to prove that FDIs have a
number of spin-offs. Business history is replete with examples where individuals who
trained with companies started their own ventures and became successful leaders in
their respective fields. Silicon Valley in the U.S. provides many examples of such
spin-offs. Intel is a spin-off of Fairchild. The main competitor to Intel today is its own
spin-off. Even in India, the machine tool industries of Ludhiana and Bangalore are
spin-offs of yesteryears' popular companies, such as SKF, Bosch and MICO
.
Costs for the Host Country
 The investing companies may not serve the host country's interests.
 There is an outflow of earnings as they are repatriated 'to their home country.
 There is an import of substantial inputs from the investor's country.
 Companies will hire expatriate managers for management positions.
 The investing country has controlling technologies, for which it charges a huge
technology fee.
 FDI can even wipe out local firms. Infant industries and other home industries
 may suffer if they cannot compete. Home-country producers do not have money
power or the technology to withstand the onslaught of investors.

Benefits for Home Country

 Inward flow of earnings on a long term basis.
 High salaries for employees.
 Exposure to the foreign market.

Costs for the Home Country

 Initial capital outflow is extremely large.
 Exports may decrease.
 Imports may increase if FDI is intended to serve the home country.
 Employment will be lost to the home country population.
 Profits are repatriated abroad. They may not stay in the country for reinvestrnent.
 Major tax havens will enjoy the money at the cost of home country.

Motivations for FDI

 Exporting may not be feasible with high transportation costs and trade barriers.
 Companies with operations solely in the home country have a limited scope for
prosperity, and in order to grow more quickly, investing in fertile grounds outside is a
strategic move.
 Ownership advantages are used to benefit from global expansion.
 Location-specific advantages are important at the time of selecting the right
destination:
1. Availability of a low-cost labor force.
2. Abundant availability of natural resources that do not deplete.
3. The cost incurred in research and development can be recovered at the earliest by
identifying a suitable location.
4. The cost of transportation and logistics is low in the specific as well as neighboring
countries.

Strategies for Foreign Investors to invest in India

There are several strategies by which foreign enterprises could be lured to set up
operations in India. Broadly, entry strategies for such organizations may be classified into
three major categories:
1. A foreign investor may directly set up its operations in India through a branch
office, a representative office, a liaison office, or a project office to carry out
business.

2. A foreign investor may set up its operations through an Indian arm, i.e. through a
subsidiary company set up in India under Indian laws.

3. A foreign investor may invest in business units in Special Economic Zones

(SEZs) and Export Oriented Units (EOUs).
As Operations in India:
Foreign companies can set up their operations in India by opening liaison offices, project
offices and branch offices. Companies that wish to set up operation directly must register
themselves with the Registrar of Companies in New Delhi within 30 days of setting up
business in India.

As Indian company:
A foreign company can commence operations in India through the incorporation of a
com¬pany under the provisions of the Indian Companies Act, 1956. Foreign equity in
such Indian companies can be up to 100% depending on the business plan of the foreign
investor, subject to the prevailing investment policies of the Government and the receipt
of the requisite approvals. For registration and incorporation as an Indian company, an
application has to be filed with the Registrar of Companies. Once a company has been
duly registered and incorporated as an Indian company, it will be subject to the same
Indian laws and regulations that are applicable to other domestic Indian companies.

Wholly-owned subsidiary company:

The other investment option open to foreign investors is the setting up of a wholly-owned
subsidiary. This implies that the foreign company can own 100% of the shares of the
Indian company. All such cases are subject to prior approval from the Foreign Investment
Promotion Board (FIPB).
The FIPB considers cases on a flexible basis and grants permission for 100% ownership
based on the following criteria:
 Where only a "holding" operation is involved and all subsequent/downstream
investments to be carried out would require prior approval of the Government.
 Where proprietary technology is sought to be protected or sophisticated technology is
proposed to be brought in.
 Where at least 50% of the production is to be exported.
 Where the company offers proposals for consultancy services.
 Where the company offers proposals for power, roads, ports, and industrial model
towns/ industrial parks/estates/clusters.
 Where the company seeks to establish business units in SEZs, AEZs, Techno-Parks
and EODs.

Strategies for Indian Companies to raise funds

 Foreign Investment through GDRs (Global Depository Receipts), ADRs (American
Depository Receipts), and FCCBs (Foreign Currency Convertible Bonds) are
considered to be main methods to generate funds for Indian companies.

 Foreign investments through GDRs, ADRs, and FCCRs are treated as Foreign Direct
Investments. Indian companies are allowed to raise equity capital in the international
market through the issuance of GDRs, ADRs, and FCCBs. These are not subject to
any ceilings on investment. A company seeking the Government's approval in this
regard should have a consistent track record of good financial performance for a
minimum period of 3 years. This condition can be relaxed for infrastructure projects,
 such as power generation, telecommunication, petroleum exploration, and refining,
ports, airports, and roads.

 There is no restriction on the number of GDRs, ADRs, and FCCBs to be floated by a

company or a group of companies in a financial year. There are no end-use
restrictions on GDRs/ ADRs/issue proceeds, except a ban on investment in real estate
and stock markets. The FCCB issue proceeds need to conform to external commercial
borrowing end-use requirements. In addition, 25% of the FCCB proceeds can be used
for general corporate restructuring.

FDI POLICY:
The Government has put in place a liberal, transparent, and investor-friendly FDI policy,
wherein FDI up to 100% is allowed on the automatic route in most of the sectors, except
in:
 Activities that attract industrial licensing.
 Proposals where the foreign collaborator has previous/existing ventures in India.
 Proposals for the acquisition of shares in an existing Indian company in favour of
Non-residents.
 Activities where the automatic route is not available under the notified sectoral
policy.

Salient features of FDI Policy

In view of sectoral policies, security concerns, and other strategic considerations,
restrictions, such as equity cap, divestment condition, minimum capitalization, and lock-
in periods have been imposed on FDI in some sectors, including:
 Agriculture and ,plantations, excluding tea plantations.
 Real estate business, excluding integrated township development. However,
NRI/OCB investment is allowed for the real estate business.
 Retail trade in any form.
 Lottery, betting, and gambling activities.
 Security services.
 Atomic energy.

Non-Resident Indian Scheme

The general policy and facilities for Foreign Direct Investment as available to foreign
investors/companies are fully applicable to NRls as well. Additionally, the Government
has extended some concessions for NRIs and Overseas Corporate Bodies in which NRls
have invested more than 60%.
These include:
 NRI/OCB investment in the real estate and housing sectors up to 100%:
 NRI/OCB investment in the domestic airline sectors up to 100%;
 NRI/OBC investment in the banking sector up to 74%.

Since 2001, the investments of NRIs in India have grown 20% every year until 2007 due
to liberal policies, Some NRIs from the Middle East and Europe invest huge amounts in
real estate and SEZs. The confidence level towards India has increased amongst NRIs,
resulting huge investments in India.

FDI Policy Initiatives

The FDI policy is reviewed on an ongoing basis and suitable liberalization measures are
taken. Some of the main initiatives undertaken are mentioned below.
 The issuance of equity shares has been allowed against a one-time fee or royalty and
External Commercial Borrowings received in convertible foreign currency, subject to
meeting all tax liabilities and procedures.

 The policy governing the payment of royalties under a foreign-technology

collaboration has been further liberalized by allowing all companies that have entered
into foreign technology agreements to pay royalties on the automatic route to a limit
of 8% on exports and 5% on domestic sales without any restrictions on the duration
of the royalty payments. This is irrespective of the extent of foreign equity in the
shareholding.

 The foreign investment in the banking sector has been further liberalized by allowing
an FDI limit in private sector banks up to 74% under the automatic route including
investment by Foreign Institutional Investors (FIIs).

 The foreign banks regulated by a banking supervisory authority in the home country
and meeting the Reserve Bank's licensing criteria have been allowed to hold 100%
paid up capital to enable them to set up a wholly-owned subsidiary in India.

 An FDI up to 100% has been permitted in printing scientific and technical magazines,
periodicals, and journals, subject to compliance with all legalities and with the prior
approval of the Government.

 An FDI up to 100% has been permitted on the automatic route for the marketing of
petroleum products, subject to the existing sectoral policy and regulatory framework
in the oil marketing sector.

 An FDI up to 100% has been permitted on the automatic route in oil exploration in
both small- and medium-sized fields subject to and under the policy of the
Government on private participation in:
1. The exploration of oil.
2. The discovered fields of national companies.

 An FDI upto 100% has been permitted on the automatic route for petroleum product
pipelines subject to and permitted for Natural Gas/LNG pipelines with prior
Government approval.

 An FDI of 100% is permitted in any venture related to Special Economic Zones and
100% export oriented units, as a developer, unit holder, or service provider. The same
scheme is applicable to agricultural zones and technology parks.
Country-wise distribution of approvals
In terms of the quantum of investment
 Mauritius is the highest with 22.61% of total approvals.
 U.S.A. (12.62%)
 Netherlands (9.78%)
 U.K. (8.28%)
 Japan (5.68%)
 Singapore (3.59%)
 Germany (3.53%)
 Hong Kong (1.64%)
 Switzerland (1.39%)
 Belgium (1.27%) and
 Other countries constitute the remaining 29.61% of approvals.

Sectoral distribution of approvals

The drug and pharmaceutical sector holds a major share of the approvals, followed by the
services sector, both financial and non-financial; electrical equipment, including
computer software and electronics; the food processing industry; telecommunications;
and automobiles. All together, these account for 60% of approvals. Other sectors account
for the remaining 40% of approvals.

Country-wise distribution of approvals

In terms of the quantum: of investment, Mauritius is the highest with 24.10% of total
approvals, followed by the U.S.A. (12.53%), Singapore (11.95%), the U.K. (7.93%), and
the U.A.E. (3.52%). Other countries constitute the remaining 39.97% of approvals.

State-wise distribution of approvals

Maharashtra, Delhi, Tamil Nadu, Karnataka, Gujarat, Andhra Pradesh, Madhya Pradesh,
West Bengal, Orissa, and Uttar Pradesh accounted for a major portion of FDI investment
approvals during the cumulative period i.e. from August 1991 to March 2004.

FDI Promotion Initiatives

Several steps have been .initiated during the year to facilitate increased FDI inflows,
which include, inter alia, the following:
 On the policy front: While our FDI policy is already very liberal, it is being
further progressively liberalized. Equity caps in the banking sector, the petroleum
sector, and the printing of scientific/technical magazines, periodicals, and journals
have recently been raised as a measure of further liberalisation of the policy.

 On the investment promotion front: The Government-organized "Destination

Authority", which has been widely acknowledged as an effective problem-solving
platform has been actively involved to ensure the speedy resolution of investment
related problems.
 On the competitiveness front: The Government has received report~ regarding
various studies on the current potentials and risks involved in various business
activities in India. Different sectors with competitive advantages have been
enlisted to attract foreign investments.

 An exclusive website has been set up and hosted by the promotion authorities. It
is comprehensive and informative with online chat facilities. About 2000
investment related queries were replied to during the year.

 The Committee on Reforming Investment Approval and Implementation

Procedures submitted its reports on the simplification of investment procedures.
Steps have already been initiated to implement these recommendations. The
department is coordinating with other ministries to implement the same at all
levels in the Central Government.

 Every state government takes a major initiative, such as Vibrant Gujarat, to bring
in investors from around the world, showcase their advantages, and encourage
them to invest.

Criteria considered by investors prior to selecting a destination

 Political stability and a strong policy to protect investors.

 Safety and security for life, money, and output.
 Investment protection through legal provisions.
 Good governance as compared to other countries.
 Proactive government policies and implementing authorities and bureaucrats.
 Continuous infrastructural development.
 A banking system with up-to-date technology.
 A highly productive labour force and unhindered working conditions.
 Clear and simple tax procedures without any ambiguity.
 The availability of raw material, components, and consumables.
 A hospitable society, especially with a secular approach towards investors.
 A demand for the products the investor manufactures.
 Ample potential opportunities for products in neighbouring countries.

Why India was unable to attract an expected investment

The reasons are:
 A poor infrastructure, which does not match international standards.
 Political instability, which is no longer a major constraint.
 High levels of corruption, which are deep-rooted at all levels.
 Bureaucratic red tape, which the investor does not have to face in other
destinations in the world.
 A complex interpretation and implementation of policies.
 A heterogeneous society with different states, cultures, and languages.
 An inordinate delay in projects.
 A draconian labour legislation.
 A lack of transparency in regulatory bodies.
 High costs of production due to expensive power and other inputs, as well as
transportation.