FOREIGN CAPITAL

Rama Mittal

Assistant Professor

Meaning of FDI

Foreign direct investment (FDI) in its classic form is defined as a company from one country making a physical investment into building a factory in another country. It is the establishment of an enterprise by a foreigner. It is the movement of capital across national frontiers in a manner that grants the investor control over the acquired asset

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Its definition can be extended to include investments made to acquire lasting interest in enterprises operating outside of the economy of the investor. The FDI relationship consists of a parent enterprise and a foreign affiliate which together form an international business or a multinational corporation (MNC). In order to qualify as FDI the investment must afford the parent enterprise control over its foreign affiliate.

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Type of Foreign Direct Investors

A foreign direct investor may be classified in any sector of the economy and could be any one of the following;

An individual;

A group of related individuals;

An incorporated or unincorporated entity;

A public company or private company;

A group of related enterprises;

A government body; or

Any combination of the above.

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RAMA MITTAL, Assistant Professor

RAMA MITTAL, Assistant Professor

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Classification of FDI

FDI

Inward

Outward

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Foreign direct investment, which is inward, is a typical form of what is termed as 'inward investment'. Here, investment of foreign capital occurs in local resources.The factors propelling the growth of Inward FDI comprises tax breaks, relaxation of existent regulations, loans on low rates of interest and specific grants. The idea behind this is that, the long run gains from such a funding far outweighs the disadvantage of the income loss incurred in the short run. Flow of Inward FDI may face restrictions from factors like restraint on ownership and disparity in the performance standard

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Inward FDI

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Foreign direct investment, which is outward, is also referred to as direct investment abroad. In this case it is the local capital, which is being invested in some foreign resource.It may also find use in the import and export dealings with a foreign country.

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Outward FDI

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Horizontal FDI :

FDI in the same industry abroad as that in which a firm operates at home

Vertical FDI:

When a multinational operates in some other related fields

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Some other forms of FDI

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Bringing infrastructure into the countryBring advanced technology into the country which can be used later on in the economyGenerates healthy competition in the recipient countryCreates more industrial units in the countryCreates more employment in the economyEg- Hyundai (South Korean company) has established its new car manufacturing plant at Chennai in India because of low wages rates, guaranteed power supply, cheap land and providing employment in India.

Note:- It is estimated that very dollar of FDI increases domestic investment by 80% of the amount of FDI.

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Advantages of FDI

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Inflation may increase slightly

Breeds bribery and corruption

Domestic firms may suffer if they are relatively uncompetitive

Small and marginal firms are made to exit

May lead to social and cultural disruption

Too much dependency may arise and cause problems

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Disadvantages of FDI

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FDI Flow in India

Sources: Department of Industrial policy and promotion

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SECTORS ATTRACTING HIGHEST

FDI EQUITY INFLOWS

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RAMA MITTAL, Assistant Professor

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RAMA MITTAL, Assistant Professor

FDI POLICY IN INDIA

FDI has helped the Indian economy grow, and the government continues to encourage more investments of this sort - but with $5.3 billion in FDI in 2004 India gets less than 10% of the FDI of China. FDI has allowed India to focus on the areas that may have needed economic attention, and address the various problems that continue to challenge the country. India has continually sought to attract FDI from the worlds major investors. In 1998 and 1999, the Indian national government announced a number of reforms designed to encourage FDI and present a favorable scenario for investors.

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Policy regarding Foreign Capital

Industrial Policy 1991 announced by the Govt. accepted the fact that foreign investment is essential for modernization, technology upgradation and industrial development of India. The main points of policy were:

Approval will be given for direct foreign investment up to 51% foreign equity in high priority industries.

The payment of dividend would be monitored through the RBI.

Automatic permission would be given for foreign technology agreements in high priority industries up to a lump sum payment of Rs. 1crore, 55 royalty for domestic sales and 8% for foreign sales over a period of 10 years.

Foreign Investment Inflows

After the announcement of Industrial Policy 1991, there has been an acceleration in the flow of foreign capital in India.During 1991-92 to 2012-13 total foreign investment flows were $456.9 billion, out of which about $270.2 billion (59.1%) were in the form of FDI and the remaining (40.9%) were in the form of portfolio investment.

Region wise Breakup of FDI
(From April 2000 to March 2013)

Source: Department of Industrial policy and promotion, March 2013.

RegionShare % Maharashtra (Mumbai)33%Delhi-NCR19%Tamil Nadu and Pondicherry(Chennai)6%Karnataka(Bengaluru) 6%Gujarat(Ahmadabad)4%Andhra Pradesh(Hyderabad)4%Others28.6

6 destinations comprising of Mumbai, Delhi, Chennai, Bengaluru, Ahmedabad and Hyderabad had a total 71.4% FDI inflow.In other words, there was heavy concentration of FDI inflows in these 6 regions.

Foreign Direct Investment Incentives

Low corporate tax and income tax ratesTax holidaysOther types of tax concessionsPreferential tariffsSpecial economic zonesInvestment financial subsidiesSoft loan or loan guaranteesFree land or land subsidiesRelocation & expatriation subsidiesJob training & employment subsidiesInfrastructure subsidiesR&D support.

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Main Sectors with FDI Equity/Route Limit

FDI equity limit-automatic Route

Insurance 49%Domestic airlines 49% (74%)Telecom services- Foreign equity 74%Private sector banks- 74%Mining of coal and lignite for captive consumption- 100%Coffee and rubber processing-100%Civil Aviation-100%Manufacture of Telecom Equipment-100%Non Banking Finance Companies-100%

FDI requiring prior approval

Defense production 26%FM Broadcasting - foreign equity 20%News and current affairs- 26%Broadcasting- cable, DTH, up-linking foreign equity 49%Trading- wholesale cash and carry, export trading, etc., 100%Tea plantation 100%Development of airports- 100%Courier Services-100%Cigars & cigarettes manufacture-100%

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It is the passive holding of securities such as foreign stocks, bonds, or other financial assets ,none of which entails active management or control of the securities issues by the investor. It is also called Foreign Institutional Investment (FIIs).It represent movement of financial resources and do not have much effect on productive capacity and employment.

Foreign portfolio investment (FPI)

In 1992, India opened up its economy and allowed foreign portfolio investment in its domestic stock market Since then ,FPI has emerged as a major source of private capital inflow in this country

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Starting up

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Tax rates on interest or dividends Interest rates Exchange rates

Note: FII is the part of capital account of BOP

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Factors affecting Institutional Investment

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How FPI flow can help an economy?

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RBI has granted permission to SEBI registered (FIIs) invest in India under Portfolio investment scheme.All FIIs and their sub-accounts taken together cannot acquire more than24% of the paid up capital of an Indian economy

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Regulations regarding Investment
by FIIs

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NRIs/PIOs can purchase/ sell shares / convertible debentures of Indian companies on stock exchanges.An NRI or PIO can purchase shares upto5% of the paid up capital of Indian company.All NRIs/PIOs taken together cannot purchase more than 10% of the paid up value of the company.

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Regulations regarding Portfolio Investments by NRIs/PIOs

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Difference Between FDI & FII

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BasisFDIFIIStands forForeign Direct InvestmentForeign Institutional InvestmentSell off:It is more difficult to sell off or pull out.It is fairly easy to sell securities and pull out because they are liquid.Comes fromTends to be undertaken by Multinational organisationsComes from more diverse sources e.g.a small company's pension fund or through mutual funds held by individuals; investment via equity instruments (stocks) or debt (bonds) of a foreign enterprise.What is investedInvolves the transfer of non-financial assets e.g.technology and intellectual capital, in addition to financial assets.Only investment of financial assets.VolatilityHaving smaller in net inflowsHaving larger net inflowsManagementProjects are efficiently managedProjects are less efficiently managedInvolvement - direct or indirect:Involved in management and ownership control; long-term interestNo active involvement in management. Investment instruments that are more easily traded, less permanent and do not represent a controlling stake in an enterprise.

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