Foreign Direct Investment in India

A DECADE (1991-2000) OF ECONOMIC REFORMS AND FOREIGN DIRECT INVESTMENT IN INDIA DISSERTATION SUBMITTED TO VINAYAKA MISSIONS UNIVERSITY IN PARTIAL FULFILLMENT FOR THE AWARD OF MASTER OF PHILOSOPHY IN ECONOMICS BY GEETA RANI REG NO. A7PJ035M1040121 UNDER THE GUIDANCE OF MRS. GURCHARAN KAUR BATRA (LECTURER IN ECONOMICS) HEAD OF THE DEPARTMENT OF ECONOMICS N.J.S.A. GOVT. COLLEGE, KAPURTHALA (PUNJAB)

VINAYAKA MISSIONS UNIVERSITY SALEM, TAMILNADU, INDIA

1

JULY 2008

2

DECLARATION I Geeta Rani, hereby declare the Dissertation entitled “A decade” (1991-2000) of economic reforms and foreign direct investment in India submitted to the directorate of distance education, Vinayaka Missions University in partial fulfillment for the awards of the degree of Master of Philosophy in Economics is my original research work and that the dissertation has not previously formed the basis for the award of any other degree diploma, Associateship fellowship or any other title.

Place:Date:

Signature of the

Candidate

3

CERTIFICATE This is to certify that the Dissertation entitled “A Decade (1991-2000

of

Economic

Reforms

and

investment in India is a bonafide record research

work

done

by

Geeta

foreign

direct

of independent Rani

(Reg.

No.A7PJ035M1040121) under my supervision during 2007-08 submitted to the Directorate of distance Education, Vinayaka Missions university in Partial Fulfillment for the award of the degree of master of philosophy in Economics and that the Dissertation has not previously award

of

any

other

formed the basis for the

degree,

Diploma,

Associateship,

Fellowship or other title.

Signature of the supervisor (with Seal)

4

ACKNOWLEDGMENT With immense pleasure and deep sense of gratitude , I wish to express my Sincerest thanks to my esteemed supervisor Mrs. Gurcharan Kaur Batra (Lect. In Economics Govt. College, Kapurthala) for her Valuable Guidance, Suggestions and constructive criticism throughout this, work, inspite of her busy schedule. I also extend my thanks to my Parents for their cooperation for their help and moral support at every step.

Date

Geeta Rani

5

INDEX Sr. No 1. 2. 3. 4. 5. 6. 7.

Particulars

Page No. 2 3 4 5 6-7 8 9-10

1. 2. 3. 4.

Declaration Certificate Acknowledgment Index LIST of Table List of Figures Abbreviations CHAPTER TITLE Introduction Review of Literature Data Base and Methodology Foreign Direct Investment and Foreign

11-25 26-37 38-42 43-51

5.

Portfolio Investment-A comparative study Structural changes in Foreign Direct

52-96

6.

Investment during Economic Reforms. Impact of Foreign Direct Investment on

97-118

Growth in India (1991-2000) – A comparative Study Appendix:- A Statistical Analysis of FDI growth rate and GDP growth rate during 7.

1991-2000. Summary and Conclusions Bibliography

6

119-127 128-133

LIST OF TABLES S. No. 4.1 Foreign Investment Inflows In India (1990-2000) 4.2 Percentage Variation in FDI and Portfolio Investment in India 5.1 Composition Of Net Capital Flows In India 5.2 Net Long Term Flows to Developing

Countries, 1990-

2000 5.3 Net Capital Flows to Emerging Markets 5.4 Net Capital Flows to Crisis Economics 5.5 FDI Inflows to Asia 5.6 Foreign Direct Investment in Selected Asian Developing Countries. 5.7 Foreign Direct Investment: Actual Flows Vs Approvals. 5.8 FDI Inflows to India During Reform Period: 1991-1992 to 2005-2006 5.9 FDI Data as Per International Practices (August 1991February 2006) 5.10 Foreign Direct Investment Approvals and Inflows 5.11 Sectors Attracting Highest FDI Inflows

7

5.12 Share of Top Investing Countries in FDI Inflows from August 1991 to November 2004) 5.13 State-Wise FDI Approvals (From August 1991-No. 2004) 6.1 Foreign Trade on GDP ( in % for Selected Countries, in 2001) 6.2 FDI in India and in Other Asian Economies in 2000 6.3 FDI by Sectors (in %) 6.4 FDI Overview –India and China 6.5 FDI Overview – India and China 6.6 FDI and Portfolio Inflows and Relative GDP Per Capita

8

LIST OF FIGURES S. No 1. Comparative Analysis of FDI and FPI in India:1990-2000 2. Stages of FDI Policy Liberalization in India : 1991-2001 3. FDI inflows, 1971-2005( in Million USD) 4. FDI in India Real Estate 5. The opening up of Indian Economy, 1980-2000(in %) 6. FDI flows (net); 1997-98 to 2003-04

9

ABBREVIATIONS ARC – Asset Reconstruction Companies ASSOCHAM-Associated Chambers of Commerce and Industry DIPP- Department of Industrial Policy and Promotion EOUs – Export Oriented Units FDI – Foreign Direct Investment FERA – Foreign Exchange Regulation Act FIIs – Foreign Institutional Investors FICCI – Federation of India Chambers of Commerce and Industry FIPB – Foreign Investment Promotion Boards GDP- Gross Domestic Product ICICI- Industrial Credit and Investment Corporation of India IDBI- Industrial Development Bank of India IMF – International Monetary Fund MNC – Multinational Corporations NPAs – Non performing Assets NRI – Non- Resident Indians OCB – Overseas Corporate Bodies RBI – Reserve Bank of India 10

SBI- State Bank of India UNCTAD- United Nation Conference On Trade And Development

11

CHAPTER -1 INTRODUCTION

12

The economic reawakening in the 90’s has sought to put the country on a firm growth development strategy followed

path the inward looking hither

with extensive

government intervention helped the country to overcome the massive illiteracy and poverty that prevailed before independence

but this also isolated the country from the

rest of the world in terms of trade, technology and productivity with adverse implications snowballing

effects

of

macroeconomic polices

the

structural

for growth. The weaknesses

in

on current account and fiscal

balances culminated in the 1990-91 crisis. To some extent the balance of payment crisis was diffused by short terms measures such as correcting the exchange rate and liberalising investment and trade regimes, with immediate result too (SARMA) Foreign investment is considered

as one of the very

important source of capital in a capital scarce

developing

countries like India. It is the flow of foreign capital in the economy and has important implications for the economy. International capital flows have been marked by a sharp

13

expansion in net and gross capital flows and a substantial increase in the participation

of foreign institutions

in the

financial markets of developing countries (World Bank 1997) The capital flows are generally

welcome in a developing

economy. They leads to the appreciation of real exchange rate also gives upward thrust to the economy. They ease the external constraints and help to achieve higher investment and growth of the economy. Such flows also serve as vehicles for the transfer of technology and management skills. The Capital inflows may be in the form of foreign portfolio investment and foreign direct investment. Foreign portfolio

investment is the important form of

foreign investment. The fastest growing component been the portfolio investment

has

in the form of bonds and

portfolio equity flows. Portfolio flows accounted for 32.% of net development financing to developing countries during 1993-96 as against 11% during 1989-92. it comprises both debt

and equity

components. The debt portion includes

mainly the bonds, certificate of deposits and

14

commercial

papers

issued

by

developing

country

borrowers

in

international market. The equity component of investment is through emerging market mutual funds, country funds and direct purchase of foreigners of equity in developing country stock market through

foreign institutional investors.

The

latter component represents the most dynamic and growing segment of portfolio equity investment. Foreign foreign

portfolio investment

institutional

investment

can be made through (FII’s), global depository

ratio and euro equity. Foreign Institutional includes institutions such as pension

Investors

funds, investment

trusts, asset management companies, nominee companies and

incorporated

institutional

portfolio

managers.

The

securities includes shares, debentures, warrants and the schemes floated by domestic mutual funds. The most important benefit from foreign portfolio investment is that it gives an upward thrust to the domestic stock exchange prices. This has an impact on the price earning ratios of the firm. A higher price earning ratio leads to lower cost of finance, which in turns lead to a higher

15

amount

of investment. The lower cost of capital and a

booming share market can encourage new equity issue. Foreign institutional

investor

also has the virtue

of

stimulating the development of the domestic stock market. The catalyst

for this

development is competition

from

foreign financial institutions. The competition necessitates the importation of more sophisticated financial technology, adaption of

technology to local environment and greater

investment in information processing and financial services. The result are greater efficiencies in allocating capital, risk sharing

and

monitoring

the

issue

of

capital.

This

enhancement of efficiency due to internationalization makes the market

more liquid, which leads to a lower cost of

capital. The cost of foreign capital also tend to be lower because the foreign portfolio

investment can be more

diversified across the national boundaries and therefore be more efficient in reducing country specific risks, resulting in a lower risk premium (Parthapratimpal 1998) The recent shows

experience of some developing countries

that huge capital inflows have created peculiar

16

problems. Firstly they may be of a short term duration which could lead to instability in inflation rate and instability in balance of payment. Sudden deterioration in any country’s political environment and changes in tax rates on the returns from these inflows may also create a situation where foreign investors may sell the domestic

stocks held by them and

take their money out of the country. All this can effect the stock prices of host country, on the other hand, if the conditions are favourable and portfolio investment continue to come in heavily, this may lead to an increase in stock prices, fall in domestic interest rates and cause exchange rates

to

appreciate

up

to

a

depreciation compensates foreign

point

where

investors

expected

for the lower

expected return they may demand, (Shashikant 1996) The second

form of foreign

investment

is foreign

direct investment. Foreign direct investment is particularly attractive channel for the less developed countries because to them it transfers not only capital but also some scarce managerial, technical and marketing skills which cannot be supplied through aid mechanism of foreign trade.

17

Foreign direct investment is the control of a company in one country by an individual or organization of another country. Foreign direct investment of a particular country includes the shares of investment of the particular country in all those foreign business

enterprises in which that

country’s resident, person, organization or affiliated group owns as 25 percent either in voting stock of a foreign corporation

or

an

equivalent

ownership

in

a

non-

incorporated foreign enterprise (Anthony 1967) Inflows in the form of direct foreign generally considered more permanent

investment are

in character. They

also have an immediate favourable impact on the real sector of the economy including investment though

and output even

not all foreign direct investment result directly an

increase in capital formation. FDI flows into developing countries are now running at $100 billion a year, compared with under $ 20 billion in the early 1980s, mainly into china and the countries of South – East Asia. FDI raises the investment

ratio above the domestic

savings ratio, which is good for growth if nothing adverse

18

happens to the productivity of the investment.

The

investment brings with itself the knowledge, technology and management skills, which can have positive externalities on the rest of the economy. Foreign investment can often be a catalyst

for domestic investment

in the same or related

fields. It requires the training of labour, which is another positive externality. Finally, a great deal of FDI goes into the tradeable goods sector of the receipient countries

which

improves the export performance of these countries and earns them valuable foreign exchange. MNC’s locate in urban areas. They widen the income gap between the urban and rural sectors, thus perpetuating dualism. They encourage and manipulate consumption. They may introduce inappropriate

technology

and retard the

development of an indigenous capital –goods industry. FDI has the potential disadvantage even compared with loan finance, that there may be an outflow of profits that lasts much longer than the outflow of debt-service payments on a loan of equivalent amount. While a loan only creates obligation for a definite number of years, FDI may involve an

19

unending commitment. This has serious implications for the balance of payment and for domestic resource utilization of foreign exchange is a scarce resource. The cost of foreign investors may also manifest in the form of refusal of foreign firms to transfer latest technology and the refusal to train local manpower. They might realize excessive profits due to higher protection

and

prices as a result of tariff

might refuse to reinvest

them in less

developed countries and demand repatriation of the same to other countries thus draining of the national reserves. The host country might even feel balance of payment pressure if there is a significant difference in inflows and outflow of funds. Many amendments have been made in developing countries from time to time about the regulation of foreign investment. investors

Many

concessions

were

given

to

foreign

to attract more foreign investment. As a result

there has been a dramatic increase in capital flows to developing countries. According to world bank aggregates net long term resources flows to developing countries went

20

up from U.S $ 10.6 billion in 1990 to an estimated $284.6 billion in 1996. Net Private Flows as a share of receipient gross national product for some of countries were Malaysia – 14.8%, China – 6.8%, Indonesia – 6.2%, Mexico – 4.3%, Argentina – 3.6 %, Brazil – 2.9% and India 1.1% for the year 1996 and in presented in following diagram. Net Private inflows as a share of GNP year 1996

india 3%

Brazil 7% Argentina 9%

Malaysia 37%

Mexico 11%

india Brazil Argentina Mexico Indonesia

China 17%

Indonesia 16%

21

China Malaysia

Total flows touched a record of $ 571 billion in 2006, having risen by 19% on top of an average growth of 40% during the three previous years. Relative to the GDP of developing countries, total flows, at 5.1% are at levels they touched at the time of the east Asian financial crisis in 1997 (World bank 2007). Since

independence,

in

line

with

development

establishment thinking new foreign investment has been rigidly

controlled. Existing

foreign- controlled enterprises

were discriminated against and compelled or persuaded to exit or relinquish control. New investments

are mostly

restricted to industries where it was felt that the acquisition of foreign technology was important, or where the promise of export was convincing. The Foreign Exchange Regulation Act. of 1973 (FERA) was a landmark. In most industries, foreign shareholding of 40% and

operations by subsidiary

branches of foreign registered

companies were largely

eliminated. The attitude towards

foreign investment

began to

change in 1985, as part of Rajiv Gandhi’s drive for advanced

22

technology.

But

major

changes

awaited

the

reforms

1991/92. The limit of 40% was raised to 51 percent for a wide range

of industries,

deemed

to

be

of national

importance and where high technology was thought to be needed. In these industries approval of foreign investment was ‘automatic’. Proposals of up to 100 percent ownership would be considered by a Foreign Investment Promotion Board which was intended also to be a forum for quick decision-

making.

Restriction

such

as

the

tying

of

remittances to exports have been removed. There has been some response. Foreign direct investment rose from $ 150 million in 1991/1992 to $ 756 million in 1994/95. In the post reform

period, progressively

liberal

economic policies of the government have led to increasing inflows of foreign investment in the country, both in term of foreign

direct investment as well as foreign

portfolio

investment. Annual aggregate foreign investment inflows in the country varied between US$ 4 to 6 billion during 199394

to

2001-02.

The

average

volume

of

the

foreign

investment inflows during the same period estimated to be

23

roughly US $ 4.9billion (excluding 1998-99 when it was US $ 5.2 billion). Inflows during April –October 2002 was around 53 percent of that during corresponding period of 2001. The reduced

volume of foreign investment

was attributed to

heavy outflow of portfolio investment during 2002-03. FDI inflows are an indicator of the foreign investor community’s long –term stakes in the host economy. Among developing economies of Asia, China has been the largest recipient of FDI inflows. Its share in the total of FDI of these economies increased from 43 percent in 1996 to almost 46 percent in 2001. India is way behind China in FDI inflows. However, it has marginally improved its share in total FDI inflows of developing economies of Asia from 2.7% in 1996 to 3.3 percent in 2001. In 2001-02, the FDI inflows in India was US $ 3,904 million as against US $ 2339 million in 2000-01. The spurt in FDI inflows was remarkable for several reasons. In term of overall trends in FDI inflows into emerging markets of developing Asia, the year 2001 was hardly

24

encouraging. Even then FDI inflows in the Post reforms period, surpassing the previous high of 1997-98. The major part of the year 2001-02 was characterized by synchromised slow down in the global economy, which dampened investors sentiments and tightened international capital

markets. But India received higher FDI inflows not

with standing the rigidities in global financial markets. Finally, grappling

the year

2001

with exogenous

saw

the

shocks

Indian

economy

like the Gujrat

earthquake (January 2001) and the terrorist attack on the Indian parliament

(December 2001), apart from the

calamitous developments on Sept. 11, 2001. The ability of the economy to overcome these shocks and attract record FDI inflows points to the increasing attractiveness of India’s country – specific attributes (e.g. strong macro-economic fundamentals, expanding market, large pool of human resources etc.) in securing FDI. Thus performance of FDI in India has been improving gradually. And it makes a sense to examine the impact of economic reforms on the growth and structure of foreign

25

direct investment, also the foreign direct investment policy adopted in India Since 1991. SPECIFICALLY THIS STUDY AIMS AT: 1. To study the foreign investment

India before the New economic

Policy

followed in

Policy of 1991 and

during the era of Liberalization, Privatisation

and

Globalization. 2. To

examine the relative comparison between the

foreign direct investment and portfolio investment in India. 3. Present structure of foreign direct investment. 4. To make a comparative

analysis of the impact of

foreign direct investment on growth in India and viceversa. PLAN OF THE STUDY •

The study has been divided into six chapters including the present one.

• Chapter II reviews the Literature related to the problem •

Data and methodology are described in chapter III.

•

A comparative study of Foreign Direct investment and foreign portfolio investment is made in chapter IV.

26

•

Structural changes in foreign direct investment during economic reforms forms the subject matter of chapter V

• Impact of foreign Direct investment (FDI) on growth in India (1991-2000) is examined in chapter VI • Summary and Conclusions are presented in chapter VII.

27

CHAPTER – II REVIEW OF LITERATURE

28

This chapter presents the review of the work done in the sphere of foreign investment

direct investment

and portfolio

and its effect on Indian economy. In recent

years, the study of foreign investment has become very important from the point of view of positive or negative impact on overall development of the economy. To be able to formulate the problem precisely and to pinpoint a rationale for its undertakings

it thus seems logical to

present a brief review of the literature which is related directly or indirectly to the problem. Though this review is not exhaustive but efforts has been made to review the major work done in this direction. The brief review of some

important

studies

is

presented

below

in

chronological order. Wider (1990) in his study explained that the developing countries want to attract foreign capital in non-debt creating forms because they wish to foster their emerging equity market. He analysed the role of foreign investors with in the context of general desirability of the growth

of

equity

markets

29

for

domestic

resource

mobilization as well as for tapping foreign savings and know how on market organization and technology. The motivation, range and scope of foreign investors interest is the economic and market conditions of the country . To attract more foreign direct investment portfolio

investment government

restriction on foreign should be taken to

investors.

and foreign

should reduce the Adequate measures

promote market growth and the

supply of suitable stock should be increased. In a study Vittorio

and Hernandes (1993) have

analyzed (1993) have analyzed recent experience of few countries which have applied direct and indirect method to deal with some of the potential

macroeconomic

problems caused by such capital flows. They indicates three types of problem i.e. an increase in monetization and inflation, exchange rate appreciation and lower effectiveness of monetary policy. Gooptu (1994) studied that there is competition between developing countries

for portfolio investment

from abroad. Although portfolio investment has increased

30

in recent years it still remains a small share of the asset portfolio of international institutional investor. The capital flow in developing countries has been

primarily

in the

form of foreign portfolio investment and foreign direct investment. To attract more private flows the policy makers must continue to provide the right signal to foreign institutional investors in terms of economic and domestic

institutional reforms that attract for portfolio

investment from abroad. There is a need to continue the increasing

pace of reforms

in any given emerging

market in order to maintain the steady portfolio flows to developing countries. Sau(1994) in his study explained that foreign capital comes in two forms foreign direct investment and foreign portfolio

investment

if we see the stability of

inflow of foreign capital we find that the equilibrium is most likely direct

to be stable if interest elasticity

investment

investment

is

high

and

foreign

of foreign portfolio

is low. The experience of India however

indicated that situation

is just reverse that implies the

31

possibility of instability. Government of India has also offered various incentives to foreign direct investment. Foreign direct investment

is a long term commitment

where as foreign portfolio

investment

is more flexible.

The immediate impact of foreign direct investment is on the good market where as foreign portfolio investment is felt strongly on the asset market. Both

of them are

qualitatively different. Kumar(1995) examines that Indian government liberalised its policy regime in 1991 with respect to both inward and outward foreign direct investment as a part of reforms

undertaken

competitiveness

of

to

Indian

increase

the

enterprises.

international The

sectoral

pattern of foreign direct investment in India reveals a shift favour more technology and skill intensive industries as the country industrialized itself. The Indian Government policies

appear to have played and important role in

shaping the pattern. The recent liberalized policy has not yet succeeded in attracting export-oriented foreign direct investment

in

a

considerable

32

manner.

The

study

concludes that in the current environment of intense competition among developing countries to attract foreign direct investment, just liberalization of polices may not be adequate. Sen (1995) has argued

that foreign

direct

investment should not be treated as a short run balance of payment management device. The real benefit of foreign direct investment lies in augmenting the level of investment in the economy and thereby contributing to output

expansion and growth. The choices available to

the government for achieving planned

this are (a) increased

foreign borrowing (b) implement appropriate

macro-economic adjustment (c) ensure that the foreign investors remit sufficient foreign exchange as equity to cover not only his direct

import but also the additional

imports. Selected inflow of foreign portfolio investment should

be permitted to cover the short run foreign

exchange outflow arising from foreign direct investment. Blomstreams

and Arikokko (1997) argued that

foreign direct investment

may promote the economic

33

development by contributing to productivity growth and export in the host countries. However the exact nature of the relation between foreign multinational corporate sector and their host countries seems to vary between industries and countries. Economy’s industrial and policy environment are important determinants of the net benefits of foreign direct investment. The various studies makes it evident that multinationals enters mainly where barriers are high and they invest in industries which satisfy their own goal and innovation and technical changes can be done. There is direct effect of foreign direct as well portfolio investment on factor rewards, employment and capital flows. Taylor (1997) in his study explained that the international capital flow have recently been marked by a sharp expansion in capital flow and increase

in the

participation of foreign institutional investors. The recent features of capital flow to developing countries is that private flows are increasing

as a crucial source of

financing. The fundamental determinants of international

34

capital flows are factors such as investment opportunities, expected returns, preferences attitude toward increased

of consumer and their

risk. The process of globalization has

efficiency

and

volatility

which

leads

to

generation of portfolio flow which are potentially more stable. Kumar (1998) examines the emerging trend and patterns in foreign direct investment inflows to India. A major objective is to evaluate the role of policy of liberalization has played in shaping these patterns. This is done with an analysis of change in the source of capital flow in India. The magnitude of inflows is still at a small level as compared to country’s potential. The policy reforms have enabled the country to widen the sectoral as well as source country composition of foreign

direct

investment inflows. The liberalization policy has not yet helped India to improve her share in foreign

direct

investment inflows. There is lack of efficient outflow in the country. India should take advantage of her resources

35

more effectively

to attract a greater proportion of

outflow. Majumdar & Chibber (1998) observed that after the economic policy of 1991 there have been moves towards a market based regime in which foreign capital both

on

the

current

account

and

via

the

foreign

investment is expected to play a big part. In the Indian case, the liberal trade policies Since economic policy

is absolutely necessary.

making in India seems to be

entirely based on ad hocism and intution and not on the necessary vital facts. For the policy maker in India these results indicate

that if the full benefits of foreign

ownership are to be reaped then full foreign control over firms be permitted. According to Rangarajan (2000), the importance of capital

inflows

to

developing

understood. Financial markets

economies

around

is

well

the world are

getting integrated. This process has been helped by deregulation, information technology and increasing role of institutional

investors to invest

36

internationally. The

major benefit of the capital flows is the more efficient allocation of global savings among countries. Inflows which take the form of foreign direct investment are generally more permanent

in character. They have an

immediate favouravle impact on the economy. While foreign direct investment

have remained

steady,

portfolio investment and banking have fluctuated. The process of capital account liberalization

should be in

stages. India as a country must take full advantage of the global changes in the capital flows and attract not only more but also high quality investment which has strong links to the domestic economy, export orientation and advanced technology. According to Kohli (2001 a) Composition of flows make a significant difference both in terms of impact and smooth management. Portfolio flows because of their short- term

nature can cause uneven expansion and

contraction in domestic liquidity and thus have a greater impact upon stock markets and expansion in money supply, and domestic credit. Foreign direct investment are

37

less volatile because of their long term nature. The distribution of capital flows between portfolio and foreign direct investment flows into India tilts distinctly towards the foreign portfolio investment in most of the years after liberalization. Foreign direct investment does not reveal a stable trend

so far. India

is gradually liberalizing its

capital account and the issue of free

capital outflow is

controversial. Kohli (2001 b) Explained that capital inflows impact domestic money supply through accumulation of net foreign currency assets

with the central bank. The

interaction between capital flows and domestic money supply

however needs to be formally investigated in

depth as a monetary expansion implies inflation. In India the

monetary

reserve’s

accumulation

primarily through reserve

requirement

is

neutralized changes on

commercial bank’s liabilities. There are some constraints of fiscal led monetary expansion in India, which raises the aggregate demand and aggravates

38

the inflationary

impact of capital inflows. These pressures complicate macroeconomic management. BalaKrishnan 2004, Virmani 2004, Acharya 2002Economists held a sceptical view of India’s long run potential growth until the 1990s. In some quarters, it was viewed that the average growth if Indian economy during the 1990’s was not significantly different from the 1980’s despite a plethora of reform and liberalization measures which were taken in 1991-92 in the wake of balance of payment

crisis. Real GDP growth increased by 0.5

percentage points to an average of 6.1 percent growth between 1992-93 and 1999-2000 compared to 5.6 percent during the 1980’s

39

CHAPTER III DATA BASE AND METHODOLOGY

40

This chapter seeks to explain

the nature, source and

methodology used in present study entitled “A Decade (1991-2000) of Economic

reforms and foreign direct

investment in India”. The nature of study is such that secondary data has been used. Study covers the period from 1991-2001, the latest year for which data was available. 3.1 Data Source:For empirical investigations this study exclusively relies on secondary data

which have been obtained

from

various sources like: * Economic surveys (Various issues), Govt. of India * Reports of planning commission * Various RBI bulletins * Five year plan documents. 3.2 Methodology:Many simple and sophisticated statistical techniques were used to analyze the data. Techniques used in the study discussed are below:

41

3.2.1 Tabular Analysis:Suitable use of tables has been made in order to present data systemically. Tabular analysis was undertaken for comparative

analysis of foreign

direct and portfolio

investment in India 3.3.2 Graphic Analysis:Graphs and charts (Bar Graphs) were also prepared for the variables to show the tends in FII’s investment and foreign direct investment from 1990-2000 3.3.3 Time series Analysis: Trend line is used to show the overall trend of foreign direct investment inflows (net) from 1997 – 98 to 2003-04. 3.3.4 Standard Deviation:Standard deviations were also calculated to measure the variations in the foreign direct investment and foreign portfolio investment for the purpose of calculation.

42

ΣX2

Standard Deviation of X =

N ΣY2

Standard Deviation of Y =

N Where x = X-X and X =

ΣX N

y = Y – Y and Y=

Σy N

Here N is the number of years X shows the foreign direct investment and Y shows the foreign Portfolio investment 3.3.5 Correlation and Regression Analysis:Simple correlation is used to determine the relationship between two variables by following Karl Pearson’s Short – cut method. r=

NΣdxdy – (Σdx) (Σdy) NΣdx2 –(Σdx)2

NΣdy2 – (Σdy)2

X is Foreign direct investment and Y is Gross Domestic Product r is Correlation coefficient

43

dx is deviation in X Variable from Assumed mean dy is deviation in y variable from Assumed mean N is number of items or years. Simple regression equations were fitted by regressing dependent variables on the independent variables. The Regression equation is Y- Y = byx (X- X) Where byx=

N ΣdxΣdy – Σdx. Σdy NΣdx2

- (Σdx)2

Where Y is dependent variable which is FDI growth rate in our equation and X is Independent variable which is GDP growth rate. X is the mean value of X Y is the mean value of Y byx is regression coefficient of y on x equation N is Number of items dx is deviation in X variable from assumed mean dy is deviation in Y variable from assumed mean

44

Given the level of GDP growth rate, we can estimate the level of foreign direct investment growth rate and viceversa.

CHAPTER IV FOREIGN DIRECT INVESTMENT AND FOREIGN PORTFOLIO INVESTMENT – A COMPARATIVE STUDY.

45

The composition of foreign investment flows makes a significant difference, both in terms of impact and smooth management of the economy. Portfolio flows are more volatile than direct investment flows and are of short-term nature. They can cause uneven expansion and contraction in domestic liquidity and thus have a greater impact upon stock markets and expansion in money supply and domestic credit. Direct investment flows , on the other hand are of long term nature and for that reason less volatile. Being visibly foreign

embedded

in investment in plant and equipment,

direct investment

withdrawls

is less susceptible

to sudden

out of the country and leads to productive uses

of capital and consequent economic growth. It is significant that the distribution of capital flows between portfolio and foreign direct investment flows into India tilts distinctly towards the former in most years after liberalization

foreign

direct investment does not reveal a

stable trend so far. Portfolio investment flows exceed direct investment in the early

years of liberalization. The former

46

accelerates

peaking in 1995 and falling therafter Global financial markets had changed substantially

by the 1990’s with

portfolio capital flows registering a sharp rise. While foreign direct investment discretionary

procedures remained complicated

investment via the

financial

and

market route

was much faster and simpler. This might have tilted

the

composition of flows in favour of portfolio investment. The

jump

in

foreign

inward

capital

that

India

experienced after liberalization as well as the composition of these inflows gets changed. The foreign investment flow to India and the share of foreign direct investment and foreign portfolio investment in total flow of foreign investment is presented in table 4.1

47

Table 4.1 Foreign investment inflows in India 1990-2000 US.$ Million 199091

199192

199293

199394

199495

199596

199697

199798

199899

19992000

97

129

315

586

1314

2144

2821

3557

2462

2155

94.2 % 6

96.9 % 4

56.4 % 244

14.2 % 3567

25.5 % 3824

43.8 % 2748

46.0 % 3312

66.1 % 1828

102.5 % -61

41.5 % 3026

5.8%

3.1%

-

-

85.8 % 1520

74.5 % 2082

56.2 % 683

54.0 % 1366

33.9 % 645

-

GDR’s/ADR’s

43.6 % 240

270

58.5 % 768

FII

-

-

1

1665

1503

2009

1926

979

-390

2135

-

-

0.2%

4

3

29.2 % 239

41.1 % 56

31.4 % 20

18.1 % 204

-

6

40.1 % 382

59

12.3 % -

103

133

559

4153

5138

4892

6133

5385

2401

5181

Direct investment Portfolio investment

Offeshore funds & other Total

Source: Reserve Bank of India From the table 4.1 it is clear that proportion of foreign direct investment as a percentage of total investment is declining year after year and the proportion of portfolio investment by FIIs and through GDRs and ECBs is increasing upto 199394. The share of portfolio

investment

was 85.8 percent

where as that of foreign direct investment was 14.2 percent in the year 1993-94. In the year 1994-95 the share of foreign

48

direct investment marginally increased to 25.5 percent with portfolio investment at 74.5 percent. There was a upward rise in direct investment from 1995-96 till 1997 to 1998. In the year 1998-99 there were disinvestments withdrawls from portfolio investment investment

was in the form of foreign

or net

and all foreign direct investment.

This decline in portfolio investment is mainly attributable to the contagion from the East Asian crisis,

which adversely

affected capital flows to all emerging markets. Though in the year 1998-99 and 1999-2000 there was fall in the direct investment as compared to previous year. In the year 19992000 when foreign institutional investors again invested in the Indian stock exchange , the share of foreign investment

direct

fell to 41.5 percent and thus was less-than

portfolio investment which was 58.5 percent. Mauritius was the dominant source of FDI inflows in 1997-98. U.S.A. and S. Korea were, respectively, the second and third largest source

of FDI. The Striking feature was that South Korea

increased its flow of investment in India from a meagre U.S.

49

& 6.3 million is 1996- 97 (0.2 percent of total FDI) to U.S. $ 333.1 million in 1997-98(10.4 percent share.) On the sectoral side, although the engineering industry witnessed a decline in inflows in 1997-98 , it remained an attractive area for FDI, being the second largest recipient after electronics & electrical equipment. Now the percentage variation of both foreign direct investment

and foreign portfolio investment and foreign

portfolio investment is shown in table 4.2 from this table it is evident that

foreign

direct investment shows a stable

trend and there is less variation in foreign direct investment as compared to foreign portfolio investment . It is seen from the table that foreign direct investment varied positively between 26 percent to 144 percent annually from 1991-92 to 1997 – 98 where as it fell in the year 1998-99 and 19992000. There are wide variations in the foreign portfolio investment

thus

showing

volatility.

Foreign

Portfolio

investment varied between 6000 percent and -103 percent annually during this period. From this table it is clear that

50

percentage variation in foreign direct investment was less than percentage variation in foreign portfolio investment.

51

Table 4.2 Percentage Variation in Foreign Direct and Portfolio investment in India Years

Direct investmen t

1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-2000

97 129 315 586 1314 2144 2821 3557 2462 2155

% variation from previous year 32% 144% 86% 124% 63% 31% 26% -30.00% 12.40%

Portfolio investmen t 6 4 244 3567 3824 2748 3312 1828 -61 3026

% variation from previous year -33% 6000% 1362% 7% -28% 20% -45% -103% 5060%

The graphic representation of foreign direct and portfolio investment along with the actual magnitude for the period 1990-1991 to 1992-2000 is shown in figure 1. It is clear from the figure that except for the year 1997-98 and 1998-99 foreign portfolio investment constituted the large part of foreign investment in the years after opening of economy to the foreign investment in the era of liberalization. The composition of foreign capital makes a difference in its impact on the economy. Portfolio capital which is 52

subjected to sudden reversal and is therefore more volatile renders the recipient country extremely vulnerable. Above analysis of trends in portfolio investment in case of India support this hypothesis that portfolio flows are more volatile than foreign direct investment. This hypothesis is supported by the result of standard deviation of two series i.e. foreign direct investment and foreign portfolio investment between 1990 – 2000 comes out to be 1446.53 and for foreign direct investment is 1176.18 which is smaller than that of foreign portfolio investment. Thus supporting that there are more variation in foreign portfolio investment than that of foreign direct investment. Comparative Analysis of FDI and FPI in India:1990-2000 4500 4000

3824

3567

3312

3500 2748

3000 2500

2144

2000

3026

2821 2462

2455

1828

1314

1500 1000 500

3557

97 6

129 4

315244

586

0 -500

-61 1999-2000 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 Foreign Direct InvestmentForeign Portfolio Investment

Figure: - 1

53

Portfolio investment

also renders the stock market

volatile through increased linkages between the local and foreign financial

market. The nature of capital flow is

important in assessing the impact and foreign direct investment are always considered permanent in character. They also have an immediate favorable impact on the real sector of the economy including

investment, output and

employment, even though not all foreign direct investment increase capital formation. The fact that capital mobility is two

way phenomenon is best seen in the portfolio flows

which by their very nature are reversible in character. They are contingent upon the returns available on the different assets classes and the perceived stability of a market or an economy. India as a country must take full advantage of the global changes in capital

flows and attract not only more

but also high quality investment which has strong links to the domestic economy, export orientation and advanced technology.

54

CHAPTER-V STRUCTURAL CHANGES IN FOREIGN DIRECT INVESTMENT DURING ECONOMIC REFORMS

55

Foreign direct investment is thought to be more useful to a country than investment in the equity of its companies because

equity investments are potentially “hot money”

which can leave at the first sign of trouble, whereas FDI is durable

and generally useful whether things go

well or

badly. Developing countries, emerging economies and countries in transition increasingly see foreign direct investment (FDI) as a source of economic development, modernization and employment

generation and have liberalized their

FDI

regims to attract investment. The overall benefits of FDI for developing economies are well documented. Given the appropriate host-country policies and a basic level of development, the preponderance of studies shows that FDI triggers

technology

spillovers,

formation, contributes

assists

human

capital

to international trade integration,

helps to create a more competitive business environment and enhances enterprise development. All these contribute to higher economic economic

stimulus

growth. Beyond the initial macro macro economics stimulus

56

for actual

investment FDI influences growth by increasing total factor productivity and more generally, the efficiency of resource use in the receipient economy. Technology transfers through FDI generate positive externalities in the host country. Many economists in the country have now realized the advantage of FDI to India. While the achievements of the India government are to be applauded, a willingness to attract FDI has resulted in what could be tumed as “FDI Industry”. While researching the economics reforms on FDI, it was discovered that there exist a plethora of boards, committees and agencies that have been constituted to ease the flow of FDI. A call to one agency about their mandate and scope usually results in the quintessential response to call someone else. Reports from the planning commission place investor confidence and satisfaction at an all high, citizens too deserve to be included in on what the government bodies are doing. During the nineties there was a spurt in capital flows into India as into other emerging economies in Asia and America. However the magnitude of capital inflows in India

57

(Which peaked at 3.5% of GDP in 1994-95) remained much smaller than in most other countries. The composition of capital flows into India change significantly in the nineties compared to the eightees as depicted in table 5.1 Table 5.1 Composition of Net Capital flows in India

Percent of total net capital flows

198 5 198 9 199 0 199 1 199 2 199 3 199 4 199 5 199 6 199 7 199 8 199

Foreign Externa Investmen l aid t

Commercia NRI l deposi borrowings t

Other s

0

30.3

21.1

16.3

32.3

Bn US $ Capital flows 1.37

0

26.5

25.4

34.4

13.7

1.86

1.38

30.7

31.3

21.4

15.22

7.19

3.5

77.7

40.0

10.6

-31.8

3.78

14.2

48.4

-9.2

51.3

-4.7

2.94

43.6

19.6

6.3

12.4

18.1

9.7

53.7

16.7

11.3

1.9

16.4

9.16

104.3

21.5

29.2

24.5

-79.5

4.69

53.6

9.9

24.7

29.4

-17.6

11.41

54.8

9.2

40.6

11.4

-16.0

9.844

28.6

9.7

51.7

11.4

-1.4

8.43

49.7

8.6

3.0

14.7

24.0

10.44

58

9 200 0

56.5

4.7

44.5

25.7

-31.4

9.02

Source: Kohli 2001, RBI 2001 The contribution of aid declined steadily increase

and

sharp

in private capital flows took place as it is also

observed in other emerging economies. Its economic and trade liberalization allowed India to take part in the global trend of capital flows and to attract both FDI and portfolio investment. Net long term flow to developing countries, for the time period

1990 to 2000 has been depicted in table 5.2

indicating that there is regular increment in private flows from 43.2% in 1990 to 87% in 2000. Out which debt flows are declining. And equity

flows and FDI are overall

increasing. Table 5.2

Net long –term flows to developing countries, 1999-2000 Total (Billion $) Official flows

1990 98.5

1991 123

1992 155.8

1993 220.4

1994 223.7

1995 261.2

1996 311.2

1997 342.6

1998 334.9

1999 264.5

2000 295.8

56.8%

49.5%

36.3%

24.3%

21.5%

21.1%

10.3%

12.5%

16.3%

17.1%

13.0 %

59

Private flows of which Debt flows Equity flows FDI

13.2%

50.5%

63.7%

75.7%

78.5%

78.9%

89.7%

87.5%

83.7%

82.9%

87.0 %

36.9%

30.3%

38.4%

29.5%

28.7%

30.6%

35.3%

32.4%

31.4%

-0.3%

6.6%

12.2%

14.2%

30.6%

20.0%

17.5%

17.6%

10.1%

5.6%

15.7%

56.6%

57.5%

47.4%

39.9%

51.2%

51.9%

47.1%

57.6%

63.1%

84.6%

12.2 % 18.6 % 69.2 %

Source:- Global Development Finance 2000, world Bank. Thus total long –term capital flows to developing countries increased from $ 98 billion in 1990 to over US $ 295 billion in 2000. Large private capital flows to emerging market are a phenomenon of the nineties. Prior to the nineties developing countries

received

capital flows primarily through official

aid. Net capital flows to Emerging markets

and to crisis

economies are shown in the table 5.3 and 5.4 respectively. Table 5.3

Net Capital Flows to Emerging Markets (Billion US Dollars) 1992 112. 6

Net Private capital Flows Net direct 35.4 investmen t Net 56.1

1993 172. 1

1994 136. 3

1995 226. 9

1996 215. 9

1997 147. 6

1998 75.1

1999 80.5

59.4

84.0

92.9

113. 2

138. 6

143. 3

149. 8

84.4

109.

36.9

77.8

52.9

8.5

23.3

60

portfolio investmen t Other bet 21.0 investmen t Net official 21.2 flows Total 133. 8

6 28.3

-57.3 97.4

24.9

-43.9 76.7

-92.5

17.2

3.4

11.7

0.4

23.5

44.7

3.0

189. 3

139. 7

238. 6

216. 3

171. 1

119. 8

83.5

Source : World Economics Outlook, May 2000, International Monetary fund.

61

Table:- 5.4 Net Capital Flows to Crisis Economies (billion US Dollars) Net Private capital Flows Net direct investment Net portfolio investment Other bet investment Net official flows Total

1992 29.0

1993 31.8

1994 36.1

1995 74.2

1996 65.8

1997 1998 1999 -20.4 -25.6 -24.6

7.3

7.6

8.8

7.5

8.4

10.3

8.6

10.2

6.4

17.2

9.9

17.4

20.3

12.9

-6.0

6.3

15.3

7.0

17.4

49.2

37.1

-43.6 -28.2 -41.1

2.0

0.6

0.3

0.7

-0.4

17.9

19.7

-4.7

31.0

32.4

36.4

74.9

65.4

2.5

5.9

-29.3

Source : World Economics Outlook, May 2000, International Monetary fund. It is clear from the table 5.3 that net private capital flows to emerging markets increased from $112 billion in 1992 to $216 billion in 1996, the year preceding the East Asian crisis. During this period net official flows came down from around $21 billion to almost a negligible figure in 1996. Net FDI flows increased from $35 billion in 1992 to $113 billion in 1996 and further $139 billion in 1997. There was a sharp drop in portfolio flows. However, portfolio flows increases

62

strongly again in 1996, as emerging markets including Mexico regained access in international capital markets. The East Asian crisis burst on the world scene almost like a bolt from the blue. The crisis hit hard five countries – South

Korea,

Malaysia,

Thailand,

Indonesia,

and

the

Philippines (the asia-5) In case of Asia-5, capital inflows increased from $29 billion in 1992 to $74.2 billion in 1995 and declined slightly to $65.8 billion in 1996 as shown in table 5.4 Net direct investment increased from $7.3 billion in 1992 to $8.4 billion in 1996 while net portfolio investment increased from $6.4 billion to $20.3 billion. Banking flows showed the strongest rise from $15.3 billion to $ 37.1 billion. Now table 5.5 shows the FDI inflows to Asia in US $ million from the period 1994 to 1999.

63

Table- 5.5: FDI Inflows to Asia (US$ million)

Source:- World Investment Report, 2000

Region / Economy South, east and SouthEast Asia of which Bangladesh Brunei Darussala m Cambodia China Hong Kong India Indonesia Korea, Republic of Lao Peopies democratic Republic Macau, China Malaysia Maldives Mongolia Myanmar Nepal Pakistan Philippines Singapore Sri lanka Taiwan Thailand Vietnam

1994

1995

1996

1997

1998

1999

65954

71654

87952

93518

87158

96148

11 6

2 13

14 11

141 5

308 4

150 5

69 33/87 7828 973 2109 991

151 35849 6213 2144 4346 1357

294 40180 10460 2426 6194 2308

168 44236 11368 3577 4677 3068

121 43751 14776 2635 -356 5215

135 40400 23068 2168 -3270 10340

59

88

128

86

45

70

4

2

6

3

-

1

4581 9 7 128 7 419 1591 8550 166 1375 1343 1936

5816 7 10 277 8 719 1459 7206 65 1559 2000 2349

7296 9 16 310 19 918 1520 8984 133 1864 2405 2455

6513 11 24 387 23 713 1249 8085 435 2248 3732 2745

2700 12 19 315 12 507 152 5493 206 222 7449 1972

3632 10 30 300 132 531 737 6984 202 2926 6078 1609

64

It is interesting to note that FDI inflows into India are very small as compared with many other countries. While the total foreign direct investment over the entire 90’s in India has been of the order of $15 billion. The foreign direct investment that has come to India has gone into areas which are of critical significance to India. Investors are showing their growing confidence in the immediate and medium term prospects of the Indian economy. A recent confidence survey by global consultancy AT Kearney rated India as the third most favoured FDI destination, next only to china and United States. Moreover, for the first time manufacturing investors surveyed by AT Kearney considered India as a superior manufacturing location than even the US. According to the World Investment Report, 2004 of United Nations Conference On Trade and Development (UNCTAD), global FDI inflows have declined significantly from the peak of US $1.4 trillion in 2000 to US $ 560 billion in 2003. FDI inflows to India, on the contrary has shown a rise,

65

particularly in 2003, to reach US $ 4.27 billion as shown in table 5.6 Table 5.6 Foreign

Direct

Investment

in

selected

Asian

developing countries ( Billions of US $) Country

Foreign Direct2001 46.88(5.7) 23.78(2.9) 3.40(0.4) -2.98(-0.4) 3.68(0.5) 0.55(0.1) 0.98(0.1) 15.04(1.8) 0.08(0.0) 3.81(0.5) 219.72(26.9)

Investment 2002 52.74(7.8) 9.68(1.4) 3.45(0.5) 0.15(6.0) 2.94(0.4) 3.20(0.5) 1.79(0.3) 5.73(0.8) 0.20(0.0) 1.07(0.2) 157.61(23.2)

Inflows 2003

China 53.51(9.6) Hongkong 13.56(2.4) India 4.27(0.8) Indonesia -0.60(-0.1) Korea 3.75(0.7) Malaysia 2.47(0.4) Philippines 0.32(0.1) Singapore 11.41(2.0) Srilanka 0.23(0.0) Thailand 1.80(0.3) Developing 172.03(30.7) economics World 817.57) 678.75 559.58 Source: World Investment Report 2004, UNCTAD Note: Figures in bracket are percent share to world total. After the announcement of New Industrial policy, 1991 and the current policies of liberalization, India has been experiencing acceleration in the flow of foreign investment into the country.

66

The main policy of concessions provided in this policy includes: (a)

Approving direct Foreign investment up to51 percent foreign equity in high priority areas.

(b)

Monitoring of payment of dividends through RBI to ensure that the outflows through dividend payment are balanced with export earning.

(c)

In order to provide access to international markets, most of the foreign equity holding up to 51 percent equity will now be permitted for trading companies mostly engaged in export activities.

(d)

To permit automatic approval for foreign investment up to 51 % equity in 34 industries.

(e)

To

constitute

a

special

empowered

board

for

negotiating with various large international firms and approving direct foreign investment in select areas. (f)

To have foreign technicians and allowing the testing of indigenously developed technology in foreign countries without any prior permission.

67

The foreign investment promotion Board (FIPB) was also set up to process applications in cases not covered by automatic approval. The FIPB also considered individual cases involving Foreign equity participation over 51 percent. Further more for industry an important step was the removal of the Mandatory convertibility clause. These changes while dramatic did not yield results immediately; though foreign investment was liberalized in 1992, manufacturing declined. On a positive not by this time due to the announcement of the new industrial policy in July 1991, a large number of government induced restrictions, licensing requirement and controls on corporate behaviour were eliminated. During 1992-93 several additional measures were taken by the government to encourage investment flows; direct foreign investment, portfolio investment, NRI investment and deposit and investment in global depository receipts. Some of these measures are given below:

68

1. The dividend – balancing

to foreign investment

condition earlier applicable

upto

51 percent equity

is no

longer applied except for consumer goods industries. 2. Existing companies with foreign

51 percent

equity can raise it to

subject to certain prescribed guidelines,

foreign direct investment

has also been allowed

exploration , production and refining marketing of

in

of oil and

gas. Captive coal mines can also be

owned and run by private investor in power. 3. NRIs

and

overseas

corporate

bodies

predominantly owned by them are also

(OCBs)

permitted to

invest upto 100 percent equity in high

priority

industries with repatriability of capital and income. NRI investment upto 100 percent of equity is also allowed in export houses, trading houses hospitals, EOUs, Sick industries, hotels and tourism related industries. 4. Disinvestment of equity by foreign investors no longer

needs to be at prices determined by the Reserve Bank. It has been allowed

at market rates on stock

69

exchanges from 15 September, 1992 will permission to repatriate the proceeds of such investment. 5. India has signed the Multilateral Investment Guarantee

Agency

protocol

for the protection of foreign

investment in 13 April, 1992. 6. Provision of foreign

exchange Regulation Act (FERA)

have been liberalized through

an ordinance dated 9

January 1993, as a result of which companies with more than 40 percent foreign equity are also now treated at par with fully Indian owned companies. 7. Foreign companies

have been allowed

to use their

trade marks on domestic sales 14 may, 1992. The result of new policy is quite encouraging. In the period August 1991 to December 1993, the Government approved 3467 foreign collaboration proposals including 1565 cases with foreign equity participation. The total value of equity in foreign investment proposals approved is Rs. 122.9 billion which is more than ten times of the Rs. 12.7 billion of foreign investment approved in the last decade (1981-90). About 80 percent of the approvals are in priority sector.

70

There have been sharp increases in approvals of direct investment proposals, the value of which rising to $ 15.7 billion (Rs. 57149 Crores) in 1997 from $ 325 million (Rs 739 Crore) in 1991. The total Foreign direct Investment (FDI) proposals approved Since 1991 to 1998 amounts to $ 54.26 billion (Rs. 189968 Crore), against just under $1.0 billion (Rs 1274 Crore)

approved during the whole of the previous

period (1981-90), But actual inflows of FDI during the period 1991 to 1998 stood at $ 11.8 billion (Rs. 41490 Crore) Which accounts for 21.7 percent of total approvals.

71

Table5.7 Foreign Direct Investment: Actual Flows VS Approvals. Heads Approvals in Rs. Crores Approvals in US$ Million Actual inflows in Rs. Crores Actual inflows in US $ Million Actual Inflows as %age ofApproval s in US$ terms

1991 1992 1993 739 5256 11189

1994 13590

1995 37489

1996 3945 3

1997 5714 9

1998* Total 2510 18996 3 8

325

1781 3559

4332

11245

1114 2

1575 2

6132

54268

351

675

1786

3009

6720

8431

1208 5

8433

41490

155

233

574

958

2100

2383

3330

2073

11806

47.7

13.1

16.1

22.1

18.7

21.4

21.1

33.8

21.7

* : Up to September, 1998. figures are provisional Source: Reserve Bank of India Note: The approval and actual inflows figures include NRIs direct investment approve by RBI. Table 5.7 reveals the trends in approvals of FDIs and actual flows in India

since 1991. Approvals for FDI in 1991 were

only US $325 million which gradually increased to $ 3.56 billion in 1993, $ 15.75 billion in 1997 and then to about US $6.97 billion during 1998. Again gradually

the actual flows of FDI

increased from US $ 154.5 million (Rs. 351.4

Crore) in 1991 to US $ 573.8 million (Rs. 1786 Crore) in 1993 72

and then to US $ 3330 million in (Rs. 12085 Crore) in 1997 and finally to US $ 2.23 billion (Rs. 9116 Crore) during 1998.Actual inflows as percent of approvals which was 48 percent in 1991 gradually declined to 13 percent in 1992 and than it increased to 22 percent and 19 percent and 32 percent in 1994, 1995 and 1998 respectively. Again during the period 1991 to 1998 total actual inflows of FDI was $ 11.9 billion as compared to that of total approvals of US $ 55.1 billion

which accounts for only 21.7 percent of total

approvals. Foreign direct investment (FDI) flow, after reaching a peak of US $ 3.56 billion in 1997-98 receded gradually to US $ 2.16 billion in 1999-2000. FDI inflows rose only marginally to US $ 2.34 billion in 2000-01. Figure: 2 shows

liberalization measures

during 1991-2001 in India

73

in FDI Policy

Stages of FDI policy liberalization in India:1991-2001

Allows selectively up to 40%

Pre 1991

Up to 51% under Auto-matic Route for 34 high-priority Sectors

1991/1992

Up to 50/51/74% in 111 sectors under Automatic Route and 100% in some sectors

1997/1998

Up to 100% under Automatic Route in all sectors. Except for a small negative list

2000/2001

Figure-2 FDI inflows to India: 1991-2005:With the changes

in Indian FDI policy, there has been a

steady rise in the average annual amount of FDI during 1991-2005. In particular, it is visible in comparison previous periods. Figure 3 shows average inwards

to

FDI to

India in five year periods during 1971-2005. In the period 1986-1990 average inward FDI was 910 min USD, in 19911995 it was about five times more 4.7 bn USD, in 1996-2000 it was 14.9 bn, and in 2001-2005 it was 19.3 bn.

74

FDI Inflows, 1971-2005 (in million USD) 25000 19294

20000

14882

15000

Series1

10000 5000

4729 245

161

295

910

19711976

19761980

19811986

19861990

0 19911996

19962000

20012006

Figure:-3 Source: Indian FDI fact sheet- May 2006, Department of Industrial policy $ Promotion- Ministry of Commerce and Industry (years: 1991-2005) Table 5.8 shows detailed data about

the annual average

inward FDI to India during 1991-2005 and yearly percent changes. The dynamics of annual growth was changing within this period. Last years were optimize for India because in the years 2004/2005 and 2005/2006 there was over forty percent increase in FDI inflows.

75

Table 5.8 FDI inflows to India during reforms period 1991/1992-2005/2006 min INR min USD Fiscal year Amount of Yearly Amount Yearly inflows changes of change inflows 1991-1992 4090 -----167 1992-1993 10940 167% 393 135% 1993-1994 20180 84% 654 66% 1994-1995 43120 114% 1374 110% 1995-1996 69160 60% 2141 56% 1996-1997 96540 40% 2770 39% 1997-1998 135480 40% 3682 33% 1998-1999 123430 -9% 3083 -16% 1999-2000 103110 -16% 2439 -21% 2000-2001 126450 23% 2908 19% 2001-2002 193610 53% 4222 45% 2002-2003 14932 -23% 3134 -26% 2003-2004 12117 -19% 2634 -16% 2004-2005 17138 41% 3755 43% 2005-2006 24613 44% 5549 48% Total 161411 38905 Source: India FDI fact sheet – May 2006, Dept. of Industrial policy and PromotionMinistry of Commerce and Industry. At the beginning of the new century, India introduced a new method of collecting and presenting

FDI data. The

changes were necessary because in previous periods Indian had different

definition of FDI than IMF and UNCTAD and

76

data weren’t comparable to other countries. Prior to that, FDI data in India had only one component: “equity capital” under FIPB route, RBI automatic route and NRI route. Equity capital of unincorporated bodies (liaison/ Branch/ Project office),

reinvested

borrowings) were

earnings

and

other

capitals

(e.g.

missing. Those new components were

introduced to data statistics in fiscal year 2000/2001. Table 5.9 shows FDI data as per international practices for the period 2000/2001 to 2005/2006. It is visible that new components are important part FDI inflows to India.

77

Table 5.9 FDI data as per International practices (August 1991-February 2006) Financial Year 08.199103.2000 20002001 20012002 20022003 20032004 20042005 04.200502-2006 Total

Equity FIPB route/RBI Equity capital Reinveste Other automatic unincorporate d earning capita route/Acquisition d bodies l rout 15483 2339

61

3904

135

279

4029

191

1645

390

6130

2574

190

1833

438

5035

2197

32

1460

633

4322

3251

527

1508

367

5653

4300

210

1257

203

5970

34048

1211

9053

2,31

46622

Source:- India fact sheet-May 2006, Department of Industrial Policy & Promotion- Ministry of Commerce and Industry. After the year

Total FDI inflow s 15483

1991 the structure

of FDI inflows has

undergone globalization. However there is some surprise in inflows structure, because a substantial part of the total FDI inward into India is routed through Mauritius. The 78

advantages

of routing FDI into India through this country

have been acknowledged managers

and

by a number

multinationals,

which

of major fund have

already

established their subsidiaries in Mauritius. SECTOR ANALYSIS:When the reforms

began

in 1991 it was inevitable there

would be a discrepancy as various sectors have different characteristics and procedures. The reforms and policies on FDI have trickled down to various sectors in different speed and effectiveness. Thus the progress of FDI will be effectively analyzed by studying two sectors of the Indian economy: industry

and

infrastructure.

These

sector

are

an

agglomeration of sub sectors that when combined from the integral components of the economic growth. While industry had taken a stride forward, an examination of infrastructure significantly

reveals a policy and approach

that differs

from industry. From the onset the

status of

infrastructure sector did not cause any state of panic, as overall the sector was net seen to be performing too badly, and was seen as the stabilizing force of the economy. The

79

sector was seen as a bloc and in its components while the performance short

of coal and

telecommunication sectors

of the respective targets, simultaneously

railways and shipping exceeded

their

fell

energy,

respective targets

thus bringing up the overall performance of the sector to positive growth. This discrepancy general

review

was recognized mentioned

in 1992-93 when the

in an overview

that capital

intensive infrastructure industries such as power, irrigation and telecommunications, were handicapped by a number of constraints

and where possible

these industries should

eventually develop competitive market structures. Once again the shipping, railways and telecommunication were able to meet targets while the performance of coal and power have been below the target. As a result the sector as a whole was not liberalized but there were only suggestions that it was important to attract foreign

and

private investment in the power sector to overcome the resource constraint.

80

1993-1994 followed

the trend

whereby

instead of

economic data the analysis offered was the shortcomings on the infrastructure sector such as its development largely in the public sector and need for structural changes in the organization, operation and management of the public sector enterprises. The call to induce greater efficiency and account ability by replacing the monopolistic nature of these sectors with a competitive environment was not followed by steps to make this dream a practically. 1994-1995 follows in the same footsteps

of the

previous of the previous years but with recognition that as government’s

ability

to

undertake

investment

in

infrastructure is severely constrained and it is necessary to induce much

more private sector

investment

and

participation in the provision of infrastructure services. 1995-96 illustrates the great unevenness of the growth that

is

taking

place

with

in

sectors

and

between

technologies. Infrastructure is linked to FDI as the condition

81

of infrastructure

has a direct correlation to international

competitiveness and flow of FDI. In the period

between 1996-98 there was greater

understanding on the role of FDI in both the sectors. Industry still lead the reforms whereby automatic was increased

upto 74 percent

approval of FDI

by the Reserve

Bank of

India in nine categories of industries, including electricity generation

and

transmission,

non-conventional

energy

generation and distribution, construction and maintenance of roads, bridges,

ports, harbours, runways, waterways,

tunnels, pipelines, industrial transport

except

and power plants, pipeline

for POL and gas, water transport, cold

storage and warehousing for agricultural products, mining services except for gold

silver and precious

stones and

exploration and production of POL and gas, manufacture of iron are pellets, pig iron, semi-finished iron and steel and manufacture

of navigational, meteorological, geophysical,

oceanographic,

hydrological

and

ultrasonic

instruments and items based on solar energy.

82

sounding

By 1997-1998 the most term “ infrastructure” was expanded to include telecom, oil exploration and industrial parks to enable these sectors to avail of fiscal incentives such

as

tax

holidays

and

concessional

development of the infrastructure sector

duties.

The

for FDI was still

haphazard as power, telecommunication, postal services, railways, urban infrastructure have no mention of FDI. For industry the period started with a decline whereby the total foreign

investment (FDI and Portfolio) declined to $

2312 million in 1998-99 from $ 5853 million in 1997-98

SUB SECTOR : TELECOMMUNICATIONS : For infrastructure for 2002 -2003 (reformulation of FDI data) there is mention in sub sector for FDI and not for infrastructure as a whole. Telecom has been a major recipient of FDI during the period of August-1991 to june2002, 831 proposals for FDI of Rs 56,226 crore

were

approved and the actual flow of FDI during the above period was Rs 9528 crore. In terms of approval of FDI ,the telecom sector is the second largest after the energy sector. In 2002

83

the increase of FDI inflow was of the order of Rs. 1077 crore during Jan to July 2002.

RECENT CHANGES IN FDI SECTOR ; The Foreign Direct Investment in india have recorded on phenomenal growth. FDI inflows have increased in the first eight months of the year 2004-2005 reaching US $2.5 bn which is more than double compared to the corresponding period last year and is very near to the total FDI inflows in 2003-2004. These trends are shown in table 5.10. It represents the latest foreign direct investment (FDI) approval and inflows in india.

84

Table 5.10: Foreign direct investment approval and inflows. Sr. No .

Financial year

Amount in Rupees in crore Approvals

1 2 3 4 5 6 7 8 9 1 0 1 1 1 2 1 3 1

19911992 # 1992-1993 1993-1994 1994-1995 1995-1996 1996-1997 1997-1998 1998-1999 1999-2000 2000-2001

Amount in US $ in million Inflows

Approval Inflows 165

1.345

408

527

5.546 7.469 9.971 36.608 40.206 40.033 30.324 17.976 25.207

1.094 2.018 4.312 6.916 9.654 13.548 12.343 10.311 12.645

1.976 2.428 3.178 11.439 11.484 10.984 7.532 4.266 5.754

393 654 1.374 2.141 2.770 3.682 3.083 2.439 2.908

2001-2002 14.465

19.361

3.160

4.222

2002-2003 7.904

14.932

3.134

2003-2004 6.224

12.117

1.6541.35 3 1.353

20042005

11.726

1.475

2.549

6.784

85

2.776

4

* Total

250,062

131,385 67,210

32,290

Notes 1. # Aug.-March, *Up to November 2004 2. As most of the sectors / activities have been placed under automatic route in recent years, which do not require any approval, the FDI approvals statistics are not a true reflection of the FDI approved. Source: Govt. of India, Economic survey 2004-2005

SECTOR WISE FDI INFLOWS: Sector wise inflows from August-1991 until September -2006 are shown in table 5.11. Among sectors attracting high cummulative FDI's, electrical equipments retained the first spot, followed by the services

and

telecommunications.

Services

and

telecommunications dislodged transportation industry to the fourth spot to the second spot held by it last year.

86

87

Table 5.11 Sectors Attracting highest FDI inflows (Amount in Rupees crore and in US$ in million in parentheses) Rank

Sectors

2003-04

2004-05

2005-06

2006-07 April – Sep)

1

Electrical Equipments (including computer software and electronics) Services Sector (financial $ nonfinancial) Telecommunication

2,449(532)

3,281(721)

6,499(1451

3,601(778 )

1,235(269)

2,106(469)

2,565(581)

532(116)

588(129)

3,023(680)

Transportations Industries Fuels (Power & Oil Reifinery) Chemicals (other than fertilizers) Food Processing industries Drugs and Pharmaceuticals Metallurgical Industries Cement and Gypsum Products

1,417(308)

815(179)

983(222)

521(113)

759(166)

94(20)

2 3 4 5 6 7 8 9 10

Cumulative inflows FDI (from Aug.1991-Sep 2006 27,311(6,272)

Share of inflows (in percent)

6,955(1,50 9)

19,759(4,600)

12.69

16,172(3,776)

10.39

14,502(3,436)

9.31

416(94)

3,835(405 ) 1,187(259 ) 632(138)

11,608(2,720)

7.45

909(198)

1979(447)

439(95)

9,019(2,238)

5.79

511(111)

174(38)

183(42)

150(33)

4,852(1,212)

3.12

502(109)

1,3431(292)

760(172)

219(48)

4,531(1,055)

2.91

146(32)

881(192)

681(153)

511(111)

3,328(766)

2.14

44(10)

1(0)

1,970(452)

96(21)

3,327(768)

2.14

Source: FDI data cell, Ministry of Commerce.

88

17.54

COUNTRY WISE FDI INFLOWS TO INDIA: Table 5.12 represents country wise , FDI inflows to india. Country wise FDI inflows to India are dominated by Mauritius (34.49%) followed by the United states (17.08%) and Japan (7.33%). These aggregate figures are related to the time period from August -1991 to November -2004.

Table 5.12: 89

Share of top investing countries in FDI inflows (from August 1991 to November 2004) Amount in Rupees crore (million of US $) Rank Country Aug. 20002001- 2002- 2003- 2004Total %age 1991 to 01 02 03 04 05(up Inflows of total Mar. to inflows 2000 Nov.) 1 Mauritius 13,272 4.111 10.063 3.766 2,609 3,730 37,551 34.49 (3,608) (942) (2,182) (788) (567) (811) (8,898) 2 USA 8,956 1.544 1.748 1.504 1,658 2,401 17,811 17.08 (2.450) (356) (382) (319) (360) (522) (4,389) 3 Japan 3,314 977 809 1,971 360 466 7,897 7.33 (898) (224) (178) (412) (78) (101) (1,891) 4 Netherland 2,260 706 890 836 2,247 906 7,845 7.16 s (628) (162) (196) (176) (489) (197) (1,847) 5 UK 2,286 303 1.673 1,617 769 361 7,009 6.56 (670) (70) (366) (340) (167) (78) (1,692) 6 Germany 2,396 540 519 684 373 553 5,066 4.86 (672) (123) (113) (144) (81) (120) (1,254) 7 France 1.002 455 499 534 176 165 2,822 2.63 (280) (104) (108) (112) (38) (36) (679) 8 South 2,094 90 5(1) 188 110 115 2,601 2.64 Korea (572) (21) (39) (24) (25) (682) 9 Singapore 1.244 502 251(54) 180 172 225 2,573 2.48 (344) (117) (38) (37) (49) (639) 10 Switzerland 948 71 180(40) 437 207 287 2,130 2.04 (269) (16) (93) (45) (62) (525) Total FDI 60.604 12,645 19.361 14,932 12,117 11.726 1,31,38 Inflows* (16.701) (2,908) (4,222) (3,134) (2,634) (2,549) 5 (32,290) Source:- SIA, FDI data cell, Ministry of Commerce

& Industry,

Department of Industrial Policy and Promotion. Note:- *Includes inflows under NRI Schemes of RBI, Stock swapped and advances pending issue of shares.

90

State wise FDI approvals in India Table 5.13 represents top five states of India receiving FDI approvals. Five states / union territory- Maharashtra , Delhi, Tamilnadu, Karnataka and Gujrat- which were the top receipients of FDI approvals, secure more than 48% of such approvals in the country. Table 5.13: State wise FDI approvals (from August 1991 to November 2004) Rank State

Approvals

Amount of FDI approved

Tech. Financial Rs. In US$ in crore million 1 Maharashtra 5,03 1,31 3,719 37,02 9,621 7 8 0 2 Delhi 2.81 307 2,503 30,51 8,445 0 9 3 Tamil Nadu 2,68 618 2,063 22,64 5,894 1 2 4 Karnataka 2,63 502 2,137 17,07 4,833 9 5 5 Gujarat 1,23 568 668 12.43 3,273 6 7 Note:-RBI provides regional office wise information based on the intimation of investment received from investors under the automatic

Percentag e of total FDI approved

Total

91

14.80 12.20 9.05 7.63 4.97

route.Consequently,above table may not necessarily indicate state-wise information intentions of investors.

In January 2004, guidelines on equity cap on FDI, including investment by NRIs and overseas corporate bodies (OCBS) were revised as under:•

FDI upto 100% is permitted in printing scientific and technical

magazines

and

periodicals

and

journals

subject to compliance with legal framework and with the prior approval of the government •

FDI upto 100% is permitted through automatic route for petroleum product marketing , subject to existing sectoral policy and regulatory framework.

•

FDI upto 100% is permitted through automatic route in oil exploration in both small and medium sized field subject to and and under the policy of the government on private participation in explotraion of oil fields and the discovered fields of national oil companies.

•

FDI upto 100% is permitted through automatic route for petroleum products pipelines subject to and under the 92

government policy and regulation thereof. •

FDI upto

100%

is

permitted

for

naural

gas/LNG

pipelines with prior government approval. Most sectors have been put on automatic route with industrial licensing being limited to: •

Industries reserved for public sector,

•

Industries of strategic, social or environmental concern,

•

Manufacture of items reserved for the small scale sector by non small scale industry units or units in which foreign equity is more than 24%.

•

All

other

industries

are

exempt

from

industrial

licencing, subject to certain restrictions in metropolitan areas. List of industries for which industrial licensing is compulsory: •

Distillation and brewing of alcoholic drinks.

•

Cigars and cigarettes of tobacco and manufactured tobacco substitutes.

•

Electronic aero space and defence equipments; all types.

93

•

Industrial explosives including detonating fuses , safety fuses, gun powder, nitrocellulose and matches

•

Hazardous Chemicals

•

Drugs and pharmaceuticals

FDI is not permitted in the following industrial sector: Automatic energy and railway transport. Insurance sector An Indian company with foreign equity held by entities other than its foreign partners in its insurance joint venture can now breathe easy. As such equity will not be counted while calculating the foreign investment cap of 26%. •

It implies that cumulative foreign holdings in a joint venture can now climb beyond 50% but management control

will

remain

in

Insurance

Regulatory

and

Development Authority (IRDA). •

The ruling of the IRDA is expected to affect the fate of most private insurance companies as international players hold 26% stake in his ventures.

94

•

This will also help Indian promoters to infuse capital in insurance companies. The move is likely to help nonresident Indians, overseas commercial banks with investment in FIIs mutual funds and Indian insurance companies.

FDI IN REAL ESTATE:The Goverment of India in march 2005 amended existing norms to allow 100% FDI in the construction business. The liberalization act cleared the path for foreign investment to meet the demand into development of the commercial and residential real estate sectors. Indian Real Estate is on the high growth path. From figure 4, it is evident in 2003-2004, India received total FDI inflows of US 2.70 billion of which only 4.5% was committed to real estate sector. In 2004-05, this increased to US $ 3.75 billion of which, the real estate share was 10.6% . However in 2005-06, while total FDIs in India were estimated at US $ 5.46 bn. the real estate share in them was around 16%.

95

FDI IN INDIAN REAL ESTATE

INCREASE IN FDI

7 6 5

FDI Inflow (in US $ billion)

4 3

FDI in Real Estate(In US $ billions)

2 1 0 2003-04

2004-05

2005-06

FDI OVER THE YEARS

FIGURE 4

Source:- ASSOCHAM Report Guidelines for FDI application in Indian Real Estate: •

Minimum area to be developeed under each project has been reduces to 25 acres.

•

Earlier requirement of minimum 2000 dewelling units for service housing plots changed to a minimum built up area of 50000 sq. mtr.

•

Minimum $10 mn capital investment for wholly owned subsidiaries.

•

Minimum $ 5 mn capital investment for joint ventures.

•

Original investment cannot be repatriated before 3

96

years. •

Sale of under developed land barred to present speculation in real estate.

•

The funds would have to be brought in within 6 months of commencement of the business.

TELECOME SECTOR The ceiling of FDI has been increased to 74 % from 49%. This can come directly or indirectly into the operation or through a holding company. The condition is that the remaining 26 % equity will be held by resident Indian citizens or an "Indian Company" which is defined as one in which FDI does not exceed 49%. The proportionate FDI components of such an Indian company will also be counted towards the overall ceiling of 74%. Certain conditions have also been put in place to safe guard our national interest. The companies will have to ensure that the majority of directors on the board, including the chairman, the managing director and CEO are resident Indians. FDI in Non-News Publication: The cap on foreign investment in Non-News Publication has

97

been removed. The existing investment limit allowing maximum of 74% foreign equity in Indian entities publishing scientific, technical , speciality magazines and periodicals and journals has been scrapped and upto 100 % equity has been permitted. •

In case where both FDI and portfolio investment by foreign institutional investor’s investment is envisaged. The investor would have to approach the foreign investment board and the

Reserve Bank of India

respectively for clearance after obtaining the NoObjection Certificate (NOC) from the

Ministry of

Information and Broadcasting. •

In

case

involving

only

portfolio

investment,

the

applicant may approach the RBI for further clearance, if any , after obtaining NOC from the Information and Broadcasting Minstry. •

Guidelines of the Ministry of the finance of FDI and portfolio investment will apply.

•

Title verification shall continue to be done by the registrar of the news papers for India as per the

98

existing procedure.

FDI IN ASSET RECONSTRUCTION COMPANIES (ARC) The government has permitted 49% FDI in the equity capital of

asset

reconstruction

companies

through

the

non

automatic route. This means prior approval of FIPB( Foreign Investment Promotion Board) will be necessary for FDI investment in ARC. An ARC acquires bad loans, better known as NPAs ( Non- Performing Assets) at a steep discounts from banks. If an ARC controls 75% of the bad debt of defaulting firm, it can use the security enforcement low to take management control of the company something which bank can't. The Dutch financial services group, ING , Private equity player Actis and British banking group, StanChart are some of

the

foreign

players

who

had

shown

interest

in

participating in an ARC. There entry into bad-loan business will certainly help to clean up the balance-sheets of ARCs. The government, however will not allow FIIs to pick up stakes in ARCs. Currently, Arcil is the only functional ARC in the country in which

SBI, ICICI bank and IDBI are the

99

principal sponsors.

More about FDI •

Civil Aviation:-

FDI cap in airlines is 49% while the

airports can attract 100%, though government approval is required for FDI beyond 74%. •

Petroleun, natural gas:- The government revises the FDI cap in government refining firms from 26% to 49%.

•

Commodity exchanges:- New policy allowed FDI upto 26%, FII upto 23% , subject to no single investor holding over 5%. The inflows of FDI on Jan 7, 2008 increased 5 folds

in the past three years from 2.2 $ bn in 2003-2004 to $15.7 bn in 2006-2007. Progessive delicencing of various sectors coupled with ease in doing business for global companies has led to this increase as per the year end review by the Department of Industrial Policy and Promotion(DIPP) under the commerce and industry ministry. To conclude, the FDI policy in India is considered as one of the most liberal, with very few barriers. The Global

100

Competitiveness Report 2003-2004 by the world economic forum ranks India at 41st place on barriers to foreign ownership against 67th for Malaysia, 75th for Thailand and 81st for China.

101

CHAPTER -VI IMPACT OF FOREIGN DIRECT INVESTMENT(FDI) ON GROWTH IN INDIA (1991-2000)

102

There has been an accelarated shift from the policy of self reliance to reliance on foreign direct investment in India. The shift in policy is reflected in the industrial policy issued on May 31, 1990. The policy seeks to promote joint ventures with MNCs (Multi National Corporations). In respect of technology transfer, if the import of technology is considered necessary by the local entrepreneur he can conclude an agreement with the collaborator without obtaining any clearance from the government provided that royalty payments do not exceed 5% on domestic sales and 8% on exports. Further 40% of equity will be allowed automatic basis keeping in view the need to attract effective inflow of technology. A

number

of

additional

measures

are

suggested

for

attracting foreign direct investment (FDI) including a larger share of foreign equity beyond 40%; for reduction of import levis

on

imported

raw

materials,

capital

goods

and

components; for a positive exchange rate policy and depreciation of the rupee to improve trade. The poilicy shifts are justified on a number of other

103

grounds besides the gap filling arguments. •

They are said to contribute the competitiveness of Indian industry and also to a reduction of the rent seeking role of domestic capitalists.

•

Nearly all of the world's patents are registered in the developed countries and most of them are in the hands of multinationals. The shift in policy, it is said, will create an opportunity for the developing countries to have access to the technology of the developed countries.

•

Besides the much publicised invitations of the socialist countries to multinationals have given respectability to the shift in policy.

The reform process of the 90's has brought about significant changes in the exchange rate and trade policy frame work. At the end of 90's by Indian Standard, the trade regime is more outward looking, with new foreign equipment and technologies becoming more available through imports as well as FDI. The degree of openness of Indian economy has significantly

104

risen since the mid 1980's as shown in figure 5. The share of imports in GDP has started to increase in 1991 , showing clearly the effect of import liberalization. It rose from 7% in 1991 to 9.5% in 2000 with a peak to 10% in 1995-1996. The ratio of exports to GDP has begun rising steadily since the mid 1980's from a low of 4% to 9% in 2000. The impact of trade liberalization on exports has been less marked than on imports.

The Opening of the Indian Economy, 1980-2000 (in %) M/GDP

X/GDP

15 10 5 0 1975

1980

1985

1990

1995

2000

2005

Figure- 5 Source :- CPEII, CHELEM data base. However, Indian liberalization is still anemic compared to the standards of Asia. Amongst other Asian economies, India is by far the one in which foreign trade plays the smallest part. The share of exports and imports in GDP is more than twice 105

lower than it is in China and well below the share of Pakistan as shown in table 6.1 Table 6.1 Foreign Trade on GDP (in % for Selected Countries, in 2001) Countries Foreign Trade on GDP*, in % Malaysia 86.6 Singapore 86.2 Asian NIE 2 62.2 Philippines 50.8 Thailand 50.5 Asian NIE 1 37.0 Taiwan 34.7 Southkorea 32.6 Indonesia 32.4 Hongkong 26.8 China People’s Rep 21.6 Pakistan 16.4 India 9.8 Countries are ranked according to the share of foreign trade in GDP, descending order. Source:- CEPII, CHELEM data base. *{(X+M)/2}/GDP* 100 The total amount of foreign investment in India ($ 47 bn) was

almost 10 times smaller than the amount of FDI

actually in China ($420 bn). Comparison with Asian countries shows that FDI plays a limited part in the Indian economy. The importance of FDI in the domestic economy topped in 106

1997 , when inflows represented almost 1% of GDP and 3.7% of Gross Capital Formation. These shares have declined since to respectively 0.4% and 2%. The share of FDI stocks in GDP (3.6%) is lower only in Bangladesh (1.5%) in 1999. Table 6.2 gives the current statistics regarding the FDI inflow as percentage of GDP in 2000. Table 6.2: FDI in India and in other Asian Economies in 2000 Heads FDI Stocks /GDP FDI flows /GFCF Malaysia 58.8 16.5 Indonesia 39.6 -12.2 China 32.3 10.5 Thailand 20.0 10.4 Pakistan 11.2 3.9 Philippines 16.6 9.2 Taiwan 9.0 6.8 South Korea 13.7 7.1 Indian 4.1 2.3 Bangladesh 2.1 2.7 South East and 36.4 14.0 South-East Asia Developing 30.9 13.4 Countries Note: Countries are ranked according to the share of FDI stocks in GDP, descending order. GFCF is Gross Fixed Capital Formation Source:- World Investment Report, 2001. Impact on the Economy:-

107

Since 1997, more than half of FDI has been directed to manufacturing industry ( RBI, 2001) Electrical and Electronic equipment has become the most important sector for FDI ahead of engineering and chemicals (Table 6.3). The impact of FDI on Indian Industry has remained small, due to the limited size of foreign capital. FDI in Industry has not had a significant impact on export performance

(Sharma,

2000).

Analysing

the

export

performance of a sample of listed firms 1996 to 2000, Aggarwal (2001) found that the evidence of a better performance of multinational affiliates was not strong enough to suggest that India had attracted efficiency seeking, outward oriented FDI. Foreign affiliates perform better than domestic firms in low-tech industry but not in high-tech exports. This suggest that up to now, India has attracted foreign investment aimed at its large domestic market but has not been considered as a good outsourcing base by foreign investors.

108

Table-6.3:FDI by Sectors (in%) Heads

199798 9.8

Chemicals & Pharmaceutical s Engineering 19.6 Electric 25.6 &Electronic equipment Food 10.9 Finance 5.0 Service 10.9 Other 24.4 Total 100 Source:- RBI 2001

199899 20.2

199900 11.0

200001 10.4

199701 12.6

21.4 16.7

20.6 17.1

14.3 27.2

19.0 22.3

1.0 9.3 18.4 13.1 100

7.7 1.3 7.3 35.0 100

3.9 2.1 11.8 30.3 100

6.3 4.7 12.2 25.0 100

Aggregate FDI inflows into India were somewhat lower during 2003-2004 as compared to that during 2002-03. The reduction is attributable to a small decline (US $379million) in fresh equity capital inflows in 2003-04. FDI flows into India, on BOP basis, after rising sharply from 1999-2000, have been showing a decline since 2001-2002 as shown in figure 6. A free hand trend line is drawn in figure 6 to show the over all trend in FDI flows (net) from 1997-98 to 200304.Trend line indicates that on the whole, FDI is increasing as a result of economic reforms. 109

FDI Flows (Net):1997-98 to 2003-04

US $ million

7000 6000 5000 4000 3000 2000 1000 0

FDI Flows (Net) Trend Line

1997- 1998- 1999- 2000- 2001- 2002- 200398 99 2000 2001 2002 2003 2004 Years

FIGURE - 6

Empirical studies on FDI in India endorse the proposition that the productive efficiency and spillovers from FDI tend to be relatively high in science oriented groups of firms and industries. Kathuria's (2001) carefully crafted econometric study of the impact of FDI on productivity of Indian industry , based on data for 487 firms in 24 industry groups ,for the period 1989-90 to1996-97 reports that •

Following the economic liberalisation policies instituted in 1991 ,productive efficiency increased in the case of both foreign owned and domestically owned firms but the growth in efficiency was relatively high in case of foreign firms;

•

Only those domestic firms with a threshold levels of

110

research and development(R and D) gained from the presence of foreign firms; •

In

the

scientific

sub

group,

or

science

oriented

industries, the presence of foreign firms exerted a strong learning effect i.e. domestic firms in this group experienced technology spillovers from the presence of foreign firms; and. •

In the non-science oriented industry groups, only those locally owned firms with an R and D base experienced spillovers in the presence of foreign firms.

Another study on the impact of domestic R and D imported technology on the productivity of Indian Industry (Basant and Fikkert 1996) also concludes that in the absence of domestic R and D, locally owned firms would not experience any spillovers of technology from the presence of FDI, This study also finds that imported know how through technology licencing

agreements

has

much

stronger

impact

on

productivity growth than domestic R and D. In one of its report on external financing for developing countries, the world bank observed that most of

111

the FDI flows to India have been concentrated in power and fuel and more recently in communication and infrastructure. The report observed that the net private capital flow to India amounted to 2.1 billion dollars in 1990, 1.9 billion dollars in 1991, 2.0 billion dollars in 1992, 3.5 billion dollars in 1993, 5.5 billion dollars in 1994 and 4.4 billion dollars in 1995. But the flows of FDI in India is in way comparable to China which obtains a much higher amount. The World Bank Report 2000 observed that FDI flows in India is no comparison with China. It is found that FDI in India is onetenth of that in China, but given the structure, composition and

factor

endowments

of

her

economy

which

are

significantly different from that of China, India may not need large volumes of FDI, in any case not on the scale that China attracts. Table 6.4 and 6.5 gives the FDI overview in India and China stating that ratio of FDI to GDP in India and China can be seen as an indicator of the productivity of FDI in two countries -a rough measure of the capital-output ratio. It can be viewed that a unit of FDI is much more productive in India than in China. Though it needs detailed statistical verification

112

yet another explanation for the observed differences in the volume of FDI in the two countries. It is that India may not require as large a volume of FDI as China harbours. Table:- 6.4:FDI Overview – India and China Years

India FDI Inflows (million US$) 452

FDI inflow as per Cent of GFKF 1.9

China FDI inflows FDI Inflow (millions as percent US$) of GFKF

1985-1995 11,715 (annual average) 2001-2002 3,403 3.2 46,878 2002-2003 3,449 3.0 52,743 2003-2004 4,269 3.2 53,505 2004-2005 5,335 3.4 60,630 Note: Gross Fixed Capital Formation (GFKF) Source: UNCTAD World Investment Report, 2006

6.0 10.5 10.4 8.6 8.2

Table 6.5 FDI Overview – India and China India China years FDI Stock FDI as FDI Stock FDI as (million per Cent (millions percent of US$) of GDP US$) GDP 1980-1981 452 0.2 1,074 0.5 1990-1991 1,657 05 20,691 5.8 2000-2001 17,517 3.7 193,348 17.9 2002-2003 30,827 5.2 228,371 16.2 2004-2005 38,676 5.9 245,467 14.9 Note:- Gross Domestic Product (GDP) Source:- UNCTAD, World Investment Report, 2006.

113

Performance of foreign direct investors (FDI) in India has been

improving

gradually.

In

2001,FDI

performed

satisfactorily with 36% of the FDI investment units making profits and 25% of the FDI units have reached break even point. this has been revealed from the "FDI survey 2002 " conducted

by

the

Federation

of

Indian

Chambers

of

Commerce and Industry (FICCI) . The survey report observed that nearly 66% of investors feel the Indian market offers good to average

profitability. The survey shows that the

state level handling of approvals still needs improvement, with 38% of the investors ranking it poor. The U.N. Conference on Trade and Development (UNCTAD) in its latest report has termed the India's performance as remarkable. Due to the efforts of the Government of India to attract FDI, including investment from overseas investors, investment into the country surged by 34 percent. The country has also become an attractive FDI location for Asian transnational companies. The pace of investment from the Republic of Korea into the country has far outstripped even that of the USA and the UK.

114

However the Indian Government, target of raising annual flows amounting to $ 10 billion still remain a far cry. Thus the impact of the reforms in India on the policy environment for FDI presents a mixed picture. The industrial reforms

have

gone

far,

though

they

need

to

be

supplemented by more infrastructure reforms, which are a critical missing link. FDI and GROWTH The impact of FDI on the capital receiving country is not easy to explain. Infact, the benefits from FDI do not accrue automatically and evenly across countries and sectors . In order to reap the maximum benefits from FDI, there is need to establish a transparent, broad and effective enabling policy environment for investment and to put in place appropriate framework for their implementation. Under this heading, an attempt has been made to workout the relation between FDI and growth rate and also between growth rate and FDI. Analysis was undertaken to find out whether there exist any dependence of Gross Domestic Product (GDP) on Foreign Direct Investment (FDI).

115

There exists positive relation between FDI and growth of GDP. It has been estimated by Borensztein, de Gregorio and Lee (1995) that a one percentage point increase in the ratio of FDI to GDP in Developing countries over the period 1971-89 was associated with a 0.4-0.7 percentage point increase in the growth of per capita GDP, with the impact varying

positively

with

educational

attainment

as

an

indicator of country's ability to absorb technology. But there is also evidence of bidirectional causality (see de Mello, 1997) . FDI affects growth positively, at least above a certain threshold, but growth also affects FDI positively; another example of virtuous circle. Table 6.6 represents flows of FDI and Portfolio investment for time period 2000 to 2007 and relative GDP per capita and GDP at current market prices.

116

Table 5.6

FDI and Portfolio Inflows and Relative GDP per capita Years

FDI in India (net) (US $ million)

Portfolio Investmen t (US$ Million)

GDP(Rs.) Per Capita (current prices)

2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07

4031 6125 5036 4322 5987 9801 21991

2760 2021 979 11356 9311 12494 7004

20,632 21,976 23,299 25,773 28,684 32,224 36,950

Source: Various RBI bulletin

117

GDP at current market price (Rs.Crore) 21,02,375 22,81,058 24,58,084 27,65,491 31,26,596 35,67,177 41,45,810

APPENDIX : A STATISTICAL ANALYSIS OF FDI GROWTH RATE AND GDP GROWTH RATE DURING 1991-2000 1. Correlation Analysis between FDI growth Rate and the GDP growth rate :Years

FDI Growth Rate (%) 1991-92 2.86 1992-93 -41.8 1993-94 -74.5 1994-95 79.6 1995-96 71.7 1996-97 5.02 1997-98 43.7 1998-99 55.0 1999-00 -59.5 2000-01 42.9 Source:- Various RBI Bulletin

FDP Growth rate (%) 1.3 5.1 5.9 7.3 7.3 7.8 4.8 6.5 6.1 4.0

We apply the Karl Pearson's formula to obtain the coefficient of correlation between FDI growth rate and GDP growth rate Co-efficiently of correlation (r) = N. Σdxdy - Σdx. Σdy (Σdy)2

NΣdx2 – (Σdx)2

118

NΣdy2 –

Years 199192 199293 199394 199495 199596 199697 199798 199899 199900 200001 N=10

X

Dx2

Dx= XA(A=5 0)

Y

Dy= AA(A=5 9)

Dy2

Dxdy

28

-32

1024

13

-46

2116

1472

-418

-468

219024

51

-8

64

3744

-745

-795

632025

59

0

0

0

796

746

556516

73

14

196

10444

717

667

444889

73

14

196

9338

50

0

0

78

19

361

0

437

387

149769

48

-11

121

-4257

550

500

250000

65

6

36

3000

-595

-645

416025

61

2

4

-1290

429

379

143641

40

-19

361

-7201

Σdx=73 9

Σdx2= 28,12,91 3

Σdy=-29

Σdy2 = 3455

Σdxdy = 15,250

By Putting the values in the fiven formula we obtain r=0.18 It shows that there is low positive correlation between the FDI growth rate and GDP growth rate during the period 1991-2000 2. Regression Analysis

of trends in GDP growth and the

growth rate of FDI (Foreign Direct Investment)

119

Year

1991 -92 1992 -93 1993 -94 1994 -95 1995 -96 1996 -97 1997 -98 1998 -99 1999 -00 2000 -01 N=10

GDP growth rate (%) (x) 1.3

Dx= XA(A=5. 9)

Dx2

Dy= ADy2 A(A=5.0)

Dxdy

21.16

FDI growth rate (%) Y 2.8

-4.6

-3.2

10.24

14.72

5.1

-0.8

0.64

-41.8

-46.8

2190.24

37.44

5.9

0

0

-74.5

-79.5

6320.25

0

7.3

1.4

1.96

79.6

74.6

5565.16

104.44

7.3

1.4

1.96

71.7

66.7

4448.89

93.38

7.8

1.9

3.61

5.0

0

0

0

4.8

-1.1

1.21

43.7

38.7

1497.69

-42.57

6.5

0.6

0.36

55.0

50

2500

30

6.1

0.2

0.04

-59.5

-64.5

4160.25

-12.90

4.0

-1.9

3.61

42.9

37.9

1436.41

-72.01

Σdx2 =34.5 5

ΣY=124. 9 Y=12.49

Σdy=73. 9

Σdy2 =28,129.1 3

Σdxdy=152. 5

ΣX=56. Σdx= 1 -2.9 X =5.61

Take growth rate of FDI as a dependent variable

(Y) and

GDP growth rate as the independent variable (X), we make an attempt to fit the trend line with the help of regression analysis. The relevant regression equation is Y-Y = byx (X-X) Where byx = N Σdxdy – Σdx. Σdy

120

N Σdx2

- (Σdx)2

By putting the values in the given regression equation, we derive the following trend line: Y = -16.4+5.15x From this equation we can derive the expected growth rate of foreign direct investment, given the growth rate of GDP.

If we consider the 11th five year plan (2007-12) with its target of achieving 10% growth rate of GDP, we can estimate the growth rate of FDI. As for 10% growth rate of GDP, the estimated growth rate of FDI for (2007-12) is 35.1%. The value is obtained by putting the value of X in trend line equation as stated above. Now take GDP growth rate as dependent variable (X) and growth rate of FDI as independent variable (Y). The relevant regression equation is X-X = bxy (Y-Y) Where , bxy = N Σdxdy – Σdx. Σdy N Σdy2

- (Σdy)2 121

By putting the values in the given regression equation, we derive the following trend line: X = 5.53 + 0.0063Y From this equation we can derive the expected GDP growth rate, given the growth rate of FDI. Thus relation between GDP growth rate and FDI growth rate is

r=

bxy x byx

=

0.0063x5.15

=

0.18

It shows that there is positive relationship between the growth rate of GDP and growth rate of FDI. But the degree of positive relationship is low. This is so because of the fact that FDI is one of the several factors which contribute to growth. FDI is not a panacea for the development problem, it is a catalyst in the growth process. It enhances the efficiency of other inputs in the growth process through its well known role as supplier of technology 122

and know-how. Also there is a suggestion that it is not FDI which promotes growth but it is growth which attracts foreign firms. This may be so but the strong argument is that FDI can accelerate the growth process in progress.

123

CHAPTER VII SUMMARY AND CONCLUSIONS

124

In this chapter an attempt have been made to summaries the main findings of the study entitled " A decade (19912000) of Economic Reforms and foreign Direct Investment in India." The study was undertaken with the following objectives: •

To study the foreign investment policy followed in India before the new economic policy of 1991 and during the era of liberalization, privatization and globalization.

•

To examine the relative comparison between the foreign

direct

investment

and

foreign

Portfolio

investment in India. •

To study the present structure of Foreign Direct Investment (FDI)

•

To make a comparative analysis of the impact of economic reforms on the growth and structure of foreign direct investment (FDI) in India.

The study has been divided into six chapters including the present one. Chapter 1 introduces the problem. The literature related to the problem has been reviewed in Chapter II. Data base and methodology and discussed in 125

Chapter III. Policy and structural changes in foreign direct investment and comparative analysis of foreign direct investment with foreign portfolio investment is discussed in Chapter IV. Impact of economic reforms on the foreign direct investment and growth in India formed the subject matter of study of Chapter V. The nature of study was such that secondary data has been used. Study covered the period from 1991 to 2001, the latest year for which the data was available. The data regarding the FDI flows to India was collected from various sources like various issues of Economic Survey, Govt of India, Various RBI Bulletins, Reports of Planning commission etc. Tables were prepared to show the trend and share of foreign direct investment in India and the ratio of FDI to GDP. Standard deviations were also calculated for the comparative

analysis

of

foreign

direct

and

portfolio

investment. Coefficient of correlation is used to find out the relationship between growth rate of FDI and growth rate of GDP.

126

Regression equation was fitted by regressing foreign direct investment FDI on growth rate of GDP.

Main findings of the study 1. There has been an accelerated shift from the policy of

self- reliance to reliance on foreign direct investment in India. As a result FDI in India have recorded on phenomenal growth , FDI inflows are improved. The inflow of FDI on Jan 7, 2008 increased five folds in the past three years. 2. Study found that highest share of FDI inflows have gone

to

the

data-processing

software

and

consultancy

services, followed by pharmaceuticals and automobile industry.

FDI

inflows

to

India

are

dominated

by

Mauritius, U.S.A, and Japan. And top five states of India -Maharashtra,

Delhi, Tamilnadu, Karnataka and

Gujarat are the recipient of the FDI approvals more than 48% in the country. 3. The FDI policy in India is considered as one of the most

liberal, with very few barriers. India is at 41st place on

127

barriers to foreign ownership against 67th for Malaysia, 75th for Thailand and 81st for China.

4. Study

found

that

composition

of

flow

makes

a

significant difference both in terms of impact and smooth management. portfolio flows are more volatile than direct investment because of their short term nature.

They

can

cause

uneven

expansion

and

contraction in domestic liquidity and thus have a greater impact upon stock markets and expansion in money supply and domestic credit. Foreign direct investment, on the other hand, are long term in nature and for that reason less volatile and is less suspectible to sudden withdrawls out of a country and leads to productive uses of capital and consequent economic growth. 5. Study also found that in India we have witnessed large private capital flows to equity market. While Foreign direct investment has remained steady foreign portfolio investment have fluctuated. India as a country must

128

take full advantage of the global changes in capital flows and attract not only more but also high quality investment

which

has

strong

links

to

domestic

economy, export orientation and advanced technology. 6. Standard deviation of portfolio investment between

1999-2000 comes out to be more than that of foreign direct investment and thus supporting that there are more variations in foreign portfolio investment than that of foreign direct investment during the study period. 7. There is positive correlation between growth rate of FDI

and growth rate of GDP but the degree of relation is quite low because of the fact that FDI is one of the several factors which contribute to growth. It is a catalyst in the growth process. It enhances the efficiency of other inputs in the growth process through its well known role as supplier of technology and knowhow. 8. When

compairing

the

levels

of

foreign

direct

investment in India and China, it is found that FDI in

129

India is one-tenth of that in China. But given the structure , composition and factor endowments of her economy which are significantly different from that of China , India may not need larger volumes of FDI as China harbours. Also a unit of FDI is much more productive in India than in China. But the amount which India attracts now may not be adequate for generating a 10% rate of growth aspired for by India's planners but the optimum level of FDI the country needs may not be much higher than the present inflows of FDI. 9. It is observed that nearly 66% of investors feel the

Indian market offers good to average profitability. 93% of the respondents says that handling of approvals at the centre is in the range of good to average. However, at the state level handling of approvals still needs improvement , with 38% of the investors ranking it poor. 10. Results

of

the

regression

analysis

shows

that

regressions coefficient of FDI growth rate on GDP growth rate turns out to be positive thus showing a

130

positive relationship. Indicating that it is growth which attract foreign firms. However, the reverse relationship has also its significant that FDI is a catalyst in the growth process that could accelerate the growth process in progress. Thus foreign direct investment is thought to be more useful to a country than investments in the equity of its companies because equity investments are potentially" hot money" which can leave at the first sign of trouble, whereas FDI is durable and generally useful whether things go well or badly . Foreign direct investment is highly conducive for optimum utilisation of human and natural resources and competing

globally

with

higher

efficiency.

FDI

has

a

significant role in integration of Indian economy with global production chains which involve production by multinational corporations spread across locations the entire world over. The achievements of the Indian government are to be aplauded , a willingness to attract FDI has resulted in what could be termed as "FDI Industry ". In the post- liberalisation

131

era , policy oriented distortions are likely to be low and long years of investment in tertiary education have endowed India with the sort of technology absorptive capacity or skills required to assimilate, adapt and restructure imported technologies and know-how. To sum up , we can conclude that foreign direct investment is conducive to the growth process as compared to portfolio investment of foreign institutional investors FIIs who have potential to destabilize the emerging equity market and to drain the surplus from it by manipulating the equity market with their vast resources . Efforts should be made to get more foreign direct investment which will be ultimately in the interest of the economy for its growth. In order that the benefits of liberalisation reaches the poorest of the poor, foreign direct investment should be encouraged so that more employment can be generated. Thus there is need to establish a transparent, broad and effective enabling policy environment for investment and to put in place appropriate framework for their

132

implementation to reap the maximum benefits from FDI.

133

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