foreign direct investment in india-opportunities and challenges
TRANSCRIPT
Volume-1 Number-1 Date: March-August 2011 ISSN: 2231-4539
Introduction:
Foreign Direct Investment (FDI) is considered to be the
lifeblood for economic development as far as the developing
nations are concerned. Since the liberalization of the Indian
economy inflows of foreign direct investment has greatly
increased. As far as forting direct investment is concerned,
its flow in India is very small as compared not only to China
but also to India's potential. Economic Survey for 2005-06
points out that India has potential to absorb $150 billion
FDI in the infrastructure sectors alone by 2010.Most of the
FDI inflows come from a few countries. Between 1991 and
2005, investments of 10 countries accounted for 71 percent
of FDI, the main investor countries being the USA, the
Netherlands, Japan, and the United Kingdom. With regard
to FDI, U.S. is one of the largest foreign direct investors in
India. India is becoming an attractive location for global
business on account to its buoyant economy, its increasing
consumption market, and its needs in infrastructure and in
the engineering sector. Opening and FDI have really created
new opportunities for India's development and boosted the
performances of local firms as well as the globalization of
some of them. Such a trend has undeniably raised Indian's
stature among developing countries.
Foreign direct investment (FDI) inflows in India is a defining
feature of free market, liberalisation and globalization. The
important aspect is that how and through what channels
impact of FDI inflows affects the performance of companies
in developing countries. One major channel through which
inflows of foreign capital, of foreign direct investment (FDI)
in particular, affect labour markets in developing countries
is economic growth. If capital inflows enable the recipient
developing countries to increase the investment rate
beyond what they could sustain with their domestic savings,
they should achieve accelerated economic growth with
favourable consequences for employment, wages and
labour productivity. Emerging markets possess a lot of
potential for foreign direct investment (FDI). FDI in India is
on the increase but the country has not experienced a rapid
growth of FDI inflow. Theories of FDI suggest that firm size,
profitability, trade, interest rates, economy and inflation
wield significant influence in attracting FDI. This study
explores the factors that contribute to the explanation of
FDI in India and tests whether the variables do really
influence the flow of FDI into India.
Abstract
With the advent of globalization,
developing countries, particularly
those in Asia, have been witnessing a
massive surge of FDI inflows during
the past two decades. Even though
India has been a latecomer to the FDI
scene compared to other East Asian
countries, its significant market
potential and a liberalized policy
regime has sustained its attraction as
a favorable destination for foreign
investors. This article aims to examine
the impact of inward FDI on the Indian
economy, particularly after a decade
of economic reforms, and analyzes the
challenges to position itself favourably
in the global competition for FDI. In
this context, the article further
investigates the likely impact on FDI
inflows to India as a result of
increasing competition from another
major emerging market economy, i.e.,
China, in the wake of its accession to
the WTO and the opportunities and
challenges present before it.
Rahul Singh Asstt. Professor,
School of Business Management
Indus International University,una(H.P)
Foreign Direct
Investment in India -
Opportunities and
Challenges
Volume-1 Number-1 Date: March-August 2011 ISSN: 2231-4539 Review of Literature
A brief review of literature on FDI and related aspects is provided below Hymer (1960), Caves
(1996), Dunning (1993) found that MNEs have both tangible and intangible resources, or explicit and
tacit knowledge, in the form of technologies, managerial skill, international networks, capital, and
brand names and goodwill (Hymer 1960, Caves 1996, Dunning 1993).Teece (1977) stated that the
MNEs can supply these resources to local firms in equity joint ventures (intra-firm), in non-equity
strategic alliances, or in arm’s-length transactions through the external market. The transfer
mechanism through the market or intra-firm depends on transaction costs (Teece 1977). Lucas
(1990) has also analyzed the issue by examining the question of why capital does not flow from rich
to poor countries and critically explored some candidate answers that are based on human capital
and capital market imperfections. With regard to human capital, he shows that the rich country’s
optimal policy is to retard capital flows so as to maintain real wages at artificially low levels in the
poor country. As far as capital market imperfections are concerned, Lucas’s paper analyzes a
borrowing contract between poor and rich countries. In this paper, the focus is on linkages and on
the rational behavior of different foreign investors in the face of reform uncertainty.
Cheng, (1993) noted the growing importance of cross-border R & D activities and suggested that
additional research on FDI should be done on why firms internationalize their R & D.
Anand and Delios (1996) documented that the relatively slow growth of FDI from Japanese MNCs in
India as compared to China is attributed to the desire to gain only market access in India.
Garg, et al. (1996) documented that along with the regulation of product prices, since 1986 the
Indian government has limited the profits pharmaceutical companies can earn to approximately 6
percent of sales turnover. From 1970 through the early 1990s, industry pre-tax profitability as a
percent of sales declined consistently, one reason for which was the rate of return constraint.
Indeed, in 1977- 1978 industry profitability 11.7 percent. In 1982-1983 this dropped to 7.5 percent,
further declining to 3.5 percent in 1987-1988. Since 1992, industry profitability has been rising, and
by 1996 it had reached approximately 10 percent of sales .
Lee and Mansfield (1996) found that the developing country technology polices have often favored
the objective of national self-determination at the expense of foreign technology transfer. In
particular, host country policies of weak intellectual property protection and forced licensing of
technology, although intended to facilitate technology spillovers, are more likely to discourage FDI
and the transfer of leadingedge technologies by MNCs (Lee and Mansfield, 1996).
Dijkstra (2000), Tybout (2000) and Vachani (1997) found that investment policy liberalisations have
major impacts on firms in less developed countries (LDCs) where the pre-liberalisation level of
protection was high. Not all firms are affected equally; some will be losers while others will be
winners, depending on their characteristics
Feinberg & Majumdar (2001) found that Liberalisation of FDI policies offers opportunities for firms as
well as threats. If FDI (and trade) liberalisation results in faster growing national economies, then
firms face larger, faster-growing markets domestically.
The studies of FDI in the US, Japan and Europe have been prevalent, similar research on FDI in India
is however limited. Restricted policy environment towards FDI and weak property protection rights
have been described to cause significant R&D spillovers in Indian pharmaceutical sector [Feinberg
and Majumdar 2001].
Volume-1 Number-1 Date: March-August 2011 ISSN: 2231-4539 Aditya K.R. Bajaj and Swastik Nigam (2007) in this work made an attempt to analyze and study the
impact of globalization in the pharmaceutical industry and FDI spillovers in various forms to the
domestic pharmaceutical industry in terms of domestic productivity and competitiveness etc. The
analysis of the study reveals thathe spillover effects have had a manifold impact on the Indian
pharmaceutical industry, with the new WTO patent regime introduced in 2005, the foreign players
have found greater security in operating in India and due to the spillover effects of a competitive
environment, the domestic players have substantially increased their productivity, probability and
hence compete on stranger footing with the incoming pharma firms.
Jaya Gupta(2007) in his paper made an attempt to review the change in sectoral trends in India due
to FDI Inflows since liberalization. This paper also examines the changed policy implications on
sectoral growth and economic development of India as a whole.
Jayashree Bose(2007) in his book studied the sectoral experiences faced by India and China in
connection with FDI inflows. This bookprovides information on FDI in India and China, emerging
issues, globalization, foreign factors, trends and issues in FDI inflows, FDI inflows in selected sectors.
A comparative study has also been conducted on FDI outflows from India and China. This book also
revealed the potential and opportunities in various sectors in India that would surpass FDI inflows in
India as compared to China.
Sudershan K (2007) in his thesis made an attempt to examine the impact of FDI inflows on financial
performance and export performance of select pharmaceutical companies and the financing pattern
of FDI and Non-FDI based select pharmaceutical companies. The study is conducted for a period of
15 years i.e. from 1991 to 2005 and the data analysis is done using both traditional methodologies,
such as common size statements, trend analysis and ratio analysis and econometric modeling such
as pooled cross section time series analysis or panel data analysis. Based on the results, the study
reveals that higher proportion of FDI will result into better performance of companies. As far as
export performance is concerned, the performance of FDI based pharmaceutical companies in India.
Tanay Kumar Nandi and Ritankar Saher (2007) in their work made an attempt to study the Foreign
Direct Investment In India with a special focus on Retail Trade. This paper stresses the need of FDI
in India in retail sector and uses the augment that FDI is allowed in multiple sectors and the effects
have been quite good without harming the domestic economy. The study also suggests that FDI in
retail sector must be allowed.
The review of literature reveals that on a particular sector FDI has a direct impact and on a particular
sector it has an indirect impact. A study on the impact of FDI on manufacturing sector reveals that
FDI inflows in chemicals, electrical and electronics shows direct impact and FDI inflow in drugs and
pharmaceutical sectors shows indirect impact (spillover effects). (Rajit Kumar Sahoo, 2005)
India Perspective
India is the second largest country in the world, with a population of over 1 billion people. As a
developing country, India’s economy is characterized by wage rates that are significantly lower than
those in most developed countries. These two traits combine to make India a natural destination for
FDI and foreign institutional investment (FII). Until recently, however, India has attracted only a
small share of global FDI and FII primarily due to government restrictions on foreign involvement in
the economy. But beginning in 1991 and accelerating rapidly since 2000, India has liberalized its
Volume-1 Number-1 Date: March-August 2011 ISSN: 2231-4539 investment regulations and actively encouraged new foreign investment, a sharp reversal from decades of discouraging economic integration with the global economy.
India attracted FDI equity inflows of US$ 2,014 million in December 2010. The cumulative amount of
FDI equity inflows from April 2000 to December 2010 stood at US$ 186.79 billion, according to the
data released by the Department of Industrial Policy and Promotion (DIPP).
The services sector comprising financial and non-financial services attracted 21 per cent of the total
FDI equity inflow into India, with FDI worth US$ 2,853 million during April-December 2010, while
telecommunications including radio paging, cellular mobile and basic telephone services attracted
second largest amount of FDI worth US$ 1,327 million during the same period. Automobile industry
was the third highest sector attracting FDI worth US$ 1,066 million followed by power sector which
garnered US$ 1,028 million during the financial year April-December 2010. The Housing and Real Estate sector received FDI worth US$ 1,024 million.
During April-December 2010, Mauritius has led investors into India with US$ 5,746 million worth of
FDI comprising 42 per cent of the total FDI equity inflows into the country. The FDI equity inflows in
Mauritius is followed by Singapore at US$ 1,449 million and the US with US$ 1,055 million, according to data released by DIPP.
Opportunities
India has been ranked at the second place in global foreign direct investments in 2010 and will
continue to remain among the top five attractive destinations for international investors during 2010-
12 period, according to United Nations Conference on Trade and Development (UNCTAD) in a report
on world investment prospects titled, 'World Investment Prospects Survey 2009-2012'.
The 2010 survey of the Japan Bank for International Cooperation released in December 2010,
conducted among Japanese investors, continues to rank India as the second most promising country for overseas business operations.
A report released in February 2010 by Leeds University Business School, commissioned by UK Trade
& Investment (UKTI), ranks India among the top three countries where British companies can do
better business during 2012-14.
According to Ernst and Young's 2010 European Attractiveness Survey, India is ranked as the 4th
most attractive foreign direct investment (FDI) destination in 2010. However, it is ranked the 2nd most attractive destination following China in the next three years.
The wave of M and A’s as a driving force for FDI will continue, particularly in crucial sectors such as
IT, telecom, financial and pharmaceuticals. These might be aided by trade liberalization, investment
in capital markets, deregulation and the fiercer competitive pressures resulting from globalization and technological changes.
The Unctad study notes: ``Expanding firm size and managing a portfolio of locational assets
becomes more important for firms, enabling them to take advantage of resources and markets
worldwide. The search for size is also driven by the search for financial, managerial and operational
synergies, as well as economies of scale. Finally, size puts firms in a better position to keep pace
with an uncertain and rapidly-evolving technological environment, a crucial requirement in an increasingly knowledge-intensive world economy, and to face soaring research costs.
A contributing factor for the increased flow of foreign investment in the 1990s has been the
extensive reform by host governments, removal of restrictive policies governing FDI flows and
permitting free flows of capital. Approval procedures were simplified and rationalized either by
Volume-1 Number-1 Date: March-August 2011 ISSN: 2231-4539 removing licensing requirements or keeping it to the bare minimum. A survey, by the European
Round Table of Industrialists, of the improvements of conditions for investment in 25 developing
countries including India, in the wake of liberalization, noted that more companies were willing to
invest in the developing world for strategic considerations and to realize the long-term economic
potential of these markets. Towards that goal, regulatory efficiency, as opposed to simple
deregulation, should be the policy focus. Improved conditions for investment are not automatically,
or always, identical with deregulation, much less efficient regulatory framework. The demand for a
competition policy and an open investment regime as demanded at the WTO has its genesis in this premise.
Challenges
However, some important issues can be identified. To what extent can foreign investment serve the
overall socio-economic goals in an open regime? Income disparities, employment generation,
technology flows, environmental costs of industrial development, commitment to exports are some of
the key issues.
There could be a crowding-out effect in the face of competition for scarce resources and markets.
The pattern of investment and the routes FDI flows might take may undergo a significant change.
For instance, M and A’s may become more common. There could b e takeovers of local firms in a few
cases with implications for domestic brands. Takeovers per se are not to be frowned upon. But the
ground rules for transparency and prevention of insider-trading practices must be enforced vigorously under SEBI guidelines. Today, this is a weak area in Indian corporate mergers.
Improving the country's negotiating power with MNCs needs attention. Information of cost and the
status of technology offered and the global strategies of firms are vital to strengthen the bargaining
capability.
There is likely to be an increasing role of the MNC home countries in controlling the flow of critical or
dual technology on so called `security grounds' which issue must be discussed to evolve suitable international standards.
With particular reference to portfolio investments and profit repatriation, Government must evolve suitable financial policies and instruments to prevent capital market volatility.
As in Budget 2000-01, raising the level of investment by the FIIs which essentially operate in the
capital market might have both advantages and disadvantages. The advantage is that this step
might integrate India's financial market with the rest of the world. But there is a price: Market
volatility could have a destabilizing effect and bearish and bullish trends can be managed at will by
large investors as it can be seen in the high volatility shown by stock market in 2008 due to USA
financial crisis.
This might also be true when more Indian companies have their stocks listed in world capital markets
where the volumes traded are high as is the velocity. The solution is not to argue against these
measures if we want globalization but to encourage industrialization and improve corporate
performance to international standards. Also, the number of good scrips must increase as should the
volumes traded.
The regulatory framework of the capital market must also improve with the professionalization of
brokerage firms, and the enforcement of strict dealing and settlement standards. Increasingly,
trading velocity will be much higher, and scripless trading, with networked stock markets to rope in more investors, will be necessary.
Volume-1 Number-1 Date: March-August 2011 ISSN: 2231-4539 The Malaysian example of placing an embargo on capital repatriation at a time of crisis is not to be
emulated. However, to the extent to maintain a globally competitive regime movement of capital
cannot have a totally disruptive effect. Otherwise, the experience of East Asian countries and Japan
may be repeated.
With increased investment by MNCs, there should be effective tools in our tax system and the
administrative machinery needs to be adequately adjusted to address the question of transfer pricing.
Lastly, evolving good corporate governance and proper internal checks and balances through
independent audit committees is a must. So far, this area has been only a talking point among
corporate with some leading chambers of commerce even treating this issue as a voluntary measure.
Conclusion
The Concept of Foreign Direct Investment is now a part of India’s economic future but the term
remains vague to many, despite the profound effects on the economy. Despite the extensive studies
on FDI, there has been little illumination forthcoming and it remains a contentious topic. The
experience of successful ASEAN countries amply demonstrates how FDI can play a leading role in
bringing about rapid, export-led growth. Rapidly rising exports have fuelled the world’s fastest
growth rates in some of these economies which, until recently, had made them the envy of the
developing world. But economic development is more than growth, as the crisis in these countries
has made abundantly clear. The ASEAN countries have not always managed to translate economic
growth through FDI into something more durable which builds on existing indigenous capabilities
which Indian policymakers should also keep in mind. As evidenced by analysis and data the concept
and material significance of FDI ha evolved from the shadows of shallow understanding to a proud
show of force. The government while serious in its efforts to induce growth in the economy and
country started with foreign investment in a haphazard manner. While it is accepted that the
government was under compulsion to liberalize cautiously, the understanding of foreign investment
was lacking. A sectoral analysis reveals that while FDI shows a gradual increase and has become a
staple for success for India, the progress is hollow. The Telecommunications and power sector are
the reasons for the success of Infrastructure. This is a throwback to 1991 when Infrastructure
reforms were not attempted as the sector was performing in the positive. FDI has become a game of
numbers where the justification for growth and progress is the money that flows in and not the
specific problems plaguing the individual sub sectors.
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