foreign direct investment in india
TRANSCRIPT
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 foreign direct
investment in India is a bonafide record of independent
research work done by Geeta 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 formed the basis for the
award of any other 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
Particulars Page
No.
1. Declaration 2
2. Certificate 3
3. Acknowledgment 4
4. Index 5
5. LIST of Table 6-7
6. List of Figures 8
7. Abbreviations 9-10
CHAPTER TITLE
1. Introduction 11-25
2. Review of Literature 26-37
3. Data Base and Methodology 38-42
4. Foreign Direct Investment and Foreign
Portfolio Investment-A comparative study
43-51
5. Structural changes in Foreign Direct
Investment during Economic Reforms.
52-96
6. Impact of Foreign Direct Investment on
Growth in India (1991-2000) – A
comparative Study
Appendix:- A Statistical Analysis of FDI
growth rate and GDP growth rate during
1991-2000.
97-118
7. Summary and Conclusions 119-127
Bibliography 128-133
6
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 1991-
February 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 path the inward looking
development strategy followed 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 for growth. The
snowballing effects of the structural weaknesses in
macroeconomic polices 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 has
been the portfolio investment 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 commercial
14
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 portfolio investment can be made through
foreign institutional investment (FII’s), global depository
ratio and euro equity. Foreign Institutional Investors
includes institutions such as pension 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 experience of some developing countries
shows 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 point where expected
depreciation compensates foreign investors 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 investment are
generally considered more permanent in character. They
also have an immediate favourable impact on the real sector
of the economy including investment and output even
though 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 prices as a result of tariff
protection and 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. Many concessions were given to foreign
investors 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
india3%
Brazil7%
Argentina9%
Mexico 11%
Indonesia16%China
17%
Malaysia37%
india
Brazil
Argentina
Mexico
Indonesia
China
Malaysia
21
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 1993-
94 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, the year 2001 saw the Indian economy
grappling with exogenous shocks 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 Policy followed in
India before the New economic 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 vice-
versa.
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 direct investment and portfolio
investment 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 for domestic resource
29
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 and foreign
portfolio investment government should reduce the
restriction on foreign investors. Adequate measures
should be taken to 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 to be stable if interest elasticity of foreign
direct investment is high and foreign portfolio
investment 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 to increase the international
competitiveness of Indian enterprises. 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 manner. The study
32
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 this are (a) increased
planned 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 of consumer and their
attitude toward risk. The process of globalization has
increased 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 is absolutely necessary.
Since economic policy 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 economies is well
understood. Financial markets around the world are
getting integrated. This process has been helped by
deregulation, information technology and increasing role
of institutional investors to invest internationally. The
36
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 is neutralized
primarily through reserve requirement changes on
commercial bank’s liabilities. There are some constraints
of fiscal led monetary expansion in India, which raises
the aggregate demand and aggravates the inflationary
38
impact of capital inflows. These pressures complicate
macroeconomic management.
BalaKrishnan 2004, Virmani 2004, Acharya 2002-
Economists 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
Standard Deviation of X = ΣX2
N
Standard Deviation of Y = ΣY2
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 vice-
versa.
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 embedded in investment in plant and equipment,
foreign direct investment is less susceptible to sudden
withdrawls 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 accelerates
46
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 procedures remained complicated and
discretionary investment via the financial 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
1990-91
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-2000
Direct investment
97 129 315 586 1314 2144 2821 3557 2462 2155
94.2%
96.9%
56.4%
14.2%
25.5%
43.8%
46.0%
66.1%
102.5%
41.5%
Portfolio investment
6 4 244 3567 3824 2748 3312 1828 -61 3026
5.8% 3.1% 43.6%
85.8%
74.5%
56.2%
54.0%
33.9%
- 58.5%
GDR’s/ADR’s - - 240 1520 2082 683 1366 645 270 768
FII - - 1 1665 1503 2009 1926 979 -390 2135
- - 0.2% 40.1%
29.2%
41.1%
31.4%
18.1%
- 12.3%
Offeshore funds &
other
6 4 3 382 239 56 20 204 59 -
Total 103 133 559 4153 5138 4892 6133 5385 2401 5181
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 1993-
94. 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 or net
withdrawls from portfolio investment and all foreign
investment was in the form of 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 1999-
2000 when foreign institutional investors again invested in
the Indian stock exchange , the share of foreign direct
investment 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 1999-
2000. 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 investment
% variation from previous year
Portfolio investment
% variation from previous year
1990-91 97 - 6 -1991-92 129 32% 4 -33%1992-93 315 144% 244 6000%1993-94 586 86% 3567 1362%1994-95 1314 124% 3824 7%1995-96 2144 63% 2748 -28%1996-97 2821 31% 3312 20%1997-98 3557 26% 1828 -45%1998-99 2462 -30.00% -61 -103%1999-2000 2155 12.40% 3026 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.
Figure: - 1
Comparative Analysis of FDI and FPI in India:1990-2000
97 129 315586
1314
2144
2821
3557
2462 2455
6 4244
35673824
2748
3312
1828
-61
3026
-500
0
500
1000
1500
2000
2500
3000
3500
4000
4500
1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-2000
Foreign Direct InvestmentForeign Portfolio Investment
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, assists human capital
formation, contributes to international trade integration,
helps to create a more competitive business environment
and enhances enterprise development. All these contribute
to higher economic growth. Beyond the initial macro
economic stimulus macro economics stimulus for actual
56
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
Foreign Investment
External aid
Commercial borrowings
NRI deposit
Others
Bn US $ Capital flows
1985
0 30.3 21.1 16.3 32.3 1.37
1989
0 26.5 25.4 34.4 13.7 1.86
1990
1.38 30.7 31.3 21.4 15.22 7.19
1991
3.5 77.7 40.0 10.6 -31.8 3.78
1992
14.2 48.4 -9.2 51.3 -4.7 2.94
1993
43.6 19.6 6.3 12.4 18.1 9.7
1994
53.7 16.7 11.3 1.9 16.4 9.16
1995
104.3 21.5 29.2 24.5 -79.5 4.69
1996
53.6 9.9 24.7 29.4 -17.6 11.41
1997
54.8 9.2 40.6 11.4 -16.0 9.844
1998
28.6 9.7 51.7 11.4 -1.4 8.43
199 49.7 8.6 3.0 14.7 24.0 10.44
58
92000
56.5 4.7 44.5 25.7 -31.4 9.02
Source: Kohli 2001, RBI 2001
The contribution of aid declined steadily and sharp
increase 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
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000Total (Billion $)
98.5 123 155.8 220.4 223.7 261.2 311.2 342.6 334.9 264.5 295.8
Official flows
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
13.2% 50.5% 63.7% 75.7% 78.5% 78.9% 89.7% 87.5% 83.7% 82.9% 87.0%
Debt flows
36.9% 30.3% 38.4% 29.5% 28.7% 30.6% 35.3% 32.4% 31.4% -0.3% 12.2%
Equity flows
6.6% 12.2% 14.2% 30.6% 20.0% 17.5% 17.6% 10.1% 5.6% 15.7% 18.6%
FDI 56.6% 57.5% 47.4% 39.9% 51.2% 51.9% 47.1% 57.6% 63.1% 84.6% 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 1993 1994 1995 1996 1997 1998 1999Net Private capital Flows
112.6
172.1
136.3
226.9
215.9
147.6
75.1 80.5
Net direct investment
35.4 59.4 84.0 92.9 113.2
138.6
143.3
149.8
Net 56.1 84.4 109. 36.9 77.8 52.9 8.5 23.3
60
portfolio investment
6
Other bet investment
21.0 28.3 -57.3 97.4 24.9 -43.9 76.7 -92.5
Net official flows
21.2 17.2 3.4 11.7 0.4 23.5 44.7 3.0
Total 133.8
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)
1992 1993 1994 1995 1996 1997 1998 1999Net Private capital Flows
29.0 31.8 36.1 74.2 65.8 -20.4 -25.6 -24.6
Net direct investment
7.3 7.6 8.8 7.5 8.4 10.3 8.6 10.2
Net portfolio investment
6.4 17.2 9.9 17.4 20.3 12.9 -6.0 6.3
Other bet investment
15.3 7.0 17.4 49.2 37.1 -43.6 -28.2 -41.1
Net official flows
2.0 0.6 0.3 0.7 -0.4 17.9 19.7 -4.7
Total 31.0 32.4 36.4 74.9 65.4 2.5 5.9 -29.3Source : 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)
Region / Economy
1994 1995 1996 1997 1998 1999
South, east and South-East Asia of which
65954 71654 87952 93518 87158 96148
Bangladesh 11 2 14 141 308 150Brunei Darussalam
6 13 11 5 4 5
Cambodia 69 151 294 168 121 135China 33/87 35849 40180 44236 43751 40400Hong Kong 7828 6213 10460 11368 14776 23068India 973 2144 2426 3577 2635 2168Indonesia 2109 4346 6194 4677 -356 -3270Korea, Republic of
991 1357 2308 3068 5215 10340
Lao Peopies democratic Republic
59 88 128 86 45 70
Macau, China
4 2 6 3 - 1
Malaysia 4581 5816 7296 6513 2700 3632Maldives 9 7 9 11 12 10Mongolia 7 10 16 24 19 30Myanmar 128 277 310 387 315 300Nepal 7 8 19 23 12 132Pakistan 419 719 918 713 507 531Philippines 1591 1459 1520 1249 152 737Singapore 8550 7206 8984 8085 5493 6984Sri lanka 166 65 133 435 206 202Taiwan 1375 1559 1864 2248 222 2926Thailand 1343 2000 2405 3732 7449 6078Vietnam 1936 2349 2455 2745 1972 1609
Source:- World Investment Report, 2000
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
Investment 2002
Inflows 2003
China 46.88(5.7) 52.74(7.8) 53.51(9.6)Hongkong 23.78(2.9) 9.68(1.4) 13.56(2.4)India 3.40(0.4) 3.45(0.5) 4.27(0.8)Indonesia -2.98(-0.4) 0.15(6.0) -0.60(-0.1)Korea 3.68(0.5) 2.94(0.4) 3.75(0.7)Malaysia 0.55(0.1) 3.20(0.5) 2.47(0.4)Philippines 0.98(0.1) 1.79(0.3) 0.32(0.1)Singapore 15.04(1.8) 5.73(0.8) 11.41(2.0)Srilanka 0.08(0.0) 0.20(0.0) 0.23(0.0)Thailand 3.81(0.5) 1.07(0.2) 1.80(0.3)Developing economics
219.72(26.9) 157.61(23.2) 172.03(30.7)
World 817.57) 678.75 559.58Source: World Investment Report 2004, UNCTADNote: 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 condition earlier applicable
to foreign investment upto 51 percent equity is no
longer applied except for consumer goods industries.
2. Existing companies with foreign equity can raise it to
51 percent subject to certain prescribed guidelines,
foreign direct investment has also been allowed in
exploration , production and refining of oil and
marketing of gas. Captive coal mines can also be
owned and run by private investor in power.
3. NRIs and overseas corporate bodies (OCBs)
predominantly owned by them are also 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 1991 1992 1993 1994 1995 1996 1997 1998* Total Approvals in Rs. Crores
739 5256 11189 13590 37489 39453
57149
25103
189968
Approvals in US$ Million
325 1781 3559 4332 11245 11142
15752
6132 54268
Actual inflows in Rs. Crores
351 675 1786 3009 6720 8431 12085
8433 41490
Actual inflows in US $ Million
155 233 574 958 2100 2383 3330 2073 11806
Actual Inflows as %age ofApprovals in US$ terms
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 the actual flows of FDI
gradually 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 in FDI Policy
during 1991-2001 in India
73
Stages of FDI policy liberalization in India:1991-2001
Pre 1991 1991/1992 1997/1998 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 to
previous periods. Figure 3 shows average inwards FDI to
India in five year periods during 1971-2005. In the period
1986-1990 average inward FDI was 910 min USD, in 1991-
1995 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
Allows selectively up
to 40%
Up to 51% under Auto-matic Route for 34 high-priority Sectors
Up to 50/51/74% in 111 sectors under Automatic Route and 100% in some sectors
Up to 100% under Automatic Route in all sectors. Except for a small negative list
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.
FDI Inflows, 1971-2005 (in million USD)
245 161 295 910
4729
14882
19294
0
5000
10000
15000
20000
25000
1971-1976
1976-1980
1981-1986
1986-1990
1991-1996
1996-2000
2001-2006
Series1
75
Table 5.8
FDI inflows to India during reforms period
1991/1992-2005/2006
min INR min USDFiscal year Amount of
inflows Yearly changes
Amount of inflows
Yearly change
1991-1992 4090 ------ 1671992-1993 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 Promotion- Ministry 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 earnings and other capitals (e.g.
borrowings) were 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)
EquityFinancial Year
FIPB route/RBI automatic
route/Acquisition rout
Equity capital unincorporate
d bodies
Reinvested earning
Other capital
Total FDI inflows
08.1991-03.2000
15483 15483
2000-2001
2339 61 135 279 4029
2001-2002
3904 191 1645 390 6130
2002-2003
2574 190 1833 438 5035
2003-2004
2197 32 1460 633 4322
2004-2005
3251 527 1508 367 5653
04.2005-02-2006
4300 210 1257 203 5970
Total 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 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 by a number of major fund
managers and multinationals, which 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 reveals a policy and approach that differs
significantly 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 of coal and telecommunication sectors fell
short of the respective targets, simultaneously energy,
railways and shipping exceeded their respective targets
thus bringing up the overall performance of the sector to
positive growth.
This discrepancy was recognized in 1992-93 when the
general review mentioned 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 approval of FDI
was increased upto 74 percent 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 and power plants, pipeline
transport except 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 sounding
instruments and items based on solar energy.
82
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 duties. The
development of the infrastructure sector 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 june-
2002, 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
Amount in US $ in million
Approvals Inflows Approval Inflows
1 19911992#
1.345 408 527 165
2 1992-1993 5.546 1.094 1.976 3933 1993-1994 7.469 2.018 2.428 6544 1994-1995 9.971 4.312 3.178 1.3745 1995-1996 36.608 6.916 11.439 2.1416 1996-1997 40.206 9.654 11.484 2.7707 1997-1998 40.033 13.548 10.984 3.6828 1998-1999 30.324 12.343 7.532 3.0839 1999-2000 17.976 10.311 4.266 2.43910
2000-2001 25.207 12.645 5.754 2.908
11
2001-2002 14.465 19.361 3.160 4.222
12
2002-2003 7.904 14.932 1.6541.353
3.134
13
2003-2004 6.224 12.117 1.353 2.776
1 20042005 6.784 11.726 1.475 2.549
85
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)
Cumulative inflows FDI
(from Aug.1991-Sep
2006
Share of inflows
(in percent)
1 Electrical Equipments (including
computer software and electronics)
2,449(532) 3,281(721) 6,499(1451 3,601(778) 27,311(6,272) 17.54
2 Services Sector (financial $ non-
financial)
1,235(269) 2,106(469) 2,565(581) 6,955(1,509)
19,759(4,600) 12.69
3 Telecommunication 532(116) 588(129) 3,023(680) 3,835(405) 16,172(3,776) 10.394 Transportations
Industries1,417(308) 815(179) 983(222) 1,187(259) 14,502(3,436) 9.31
5 Fuels (Power & Oil Reifinery)
521(113) 759(166) 416(94) 632(138) 11,608(2,720) 7.45
6 Chemicals (other than fertilizers)
94(20) 909(198) 1979(447) 439(95) 9,019(2,238) 5.79
7 Food Processing industries
511(111) 174(38) 183(42) 150(33) 4,852(1,212) 3.12
8 Drugs and Pharmaceuticals
502(109) 1,3431(292) 760(172) 219(48) 4,531(1,055) 2.91
9 Metallurgical Industries
146(32) 881(192) 681(153) 511(111) 3,328(766) 2.14
10 Cement and Gypsum Products
44(10) 1(0) 1,970(452) 96(21) 3,327(768) 2.14
Source: FDI data cell, Ministry of Commerce.
88
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 $) Rank Country Aug.
1991 to Mar. 2000
2000-01
2001-02
2002-03
2003-04
2004-05(up
to Nov.)
Total Inflows
%age of total inflows
1 Mauritius 13,272(3,608)
4.111(942)
10.063(2,182)
3.766(788)
2,609(567)
3,730(811)
37,551(8,898)
34.49
2 USA 8,956(2.450)
1.544(356)
1.748(382)
1.504(319)
1,658(360)
2,401(522)
17,811(4,389)
17.08
3 Japan 3,314(898)
977(224)
809(178)
1,971(412)
360(78)
466(101)
7,897(1,891)
7.33
4 Netherlands 2,260(628)
706(162)
890(196)
836(176)
2,247(489)
906(197)
7,845(1,847)
7.16
5 UK 2,286(670)
303(70)
1.673(366)
1,617(340)
769(167)
361(78)
7,009(1,692)
6.56
6 Germany 2,396(672)
540(123)
519(113)
684(144)
373(81)
553(120)
5,066(1,254)
4.86
7 France 1.002(280)
455(104)
499(108)
534(112)
176(38)
165(36)
2,822(679)
2.63
8 South Korea
2,094(572)
90(21)
5(1) 188(39)
110(24)
115(25)
2,601(682)
2.64
9 Singapore 1.244(344)
502(117)
251(54) 180(38)
172(37)
225(49)
2,573(639)
2.48
10 Switzerland 948(269)
71(16)
180(40) 437(93)
207(45)
287(62)
2,130(525)
2.04
Total FDI Inflows*
60.604(16.701)
12,645(2,908)
19.361(4,222)
14,932(3,134)
12,117(2,634)
11.726(2,549)
1,31,385(32,290)
Source:- SIA, FDI data cell, Ministry of Commerce & Industry,
Department of Industrial Policy and Promotion.
Note:- *Includes inflows under NRI Schemes of RBI, Stock swapped
and advances pending issue of shares.
90
State wise FDI approvals in India
Table 5.13 represents top five states of India receiving FDI
approvals.
Five states / union territory- Maharashtra , Delhi, Tamilnadu,
Karnataka and Gujrat- which were the top receipients of FDI
approvals, secure more than 48% of such approvals in the
country.
Table 5.13:
State wise FDI approvals
(from August 1991 to November 2004)
Rank State Approvals Amount of FDI approved
Percentage of total FDI approved
Total Tech. Financial Rs. In crore
US$ in million
1 Maharashtra 5,037
1,318
3,719 37,020
9,621 14.80
2 Delhi 2.810
307 2,503 30,519
8,445 12.20
3 Tamil Nadu 2,681
618 2,063 22,642
5,894 9.05
4 Karnataka 2,639
502 2,137 17,075
4,833 7.63
5 Gujarat 1,236
568 668 12.437
3,273 4.97
Note:-RBI provides regional office wise information based on the intimation of investment received from investors under the automatic
91
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 non-
resident 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
0
1
2
3
4
5
6
7
2003-04 2004-05 2005-06
FDI OVER THE YEARS
INC
RE
AS
E IN
FD
I
FDI Inflow (in US $billion)
FDI in Real Estate(InUS $ billions)
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 No-
Objection 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 %)
0
5
10
15
1975 1980 1985 1990 1995 2000 2005
M/GDP X/GDP
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 86.2Asian NIE 2 62.2Philippines 50.8Thailand 50.5
Asian NIE 1 37.0Taiwan 34.7
Southkorea 32.6Indonesia 32.4Hongkong 26.8
China People’s Rep 21.6Pakistan 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 /GFCFMalaysia 58.8 16.5Indonesia 39.6 -12.2
China 32.3 10.5Thailand 20.0 10.4Pakistan 11.2 3.9
Philippines 16.6 9.2Taiwan 9.0 6.8
South Korea 13.7 7.1Indian 4.1 2.3
Bangladesh 2.1 2.7South East and South-East Asia
36.4 14.0
Developing Countries
30.9 13.4
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 1997-98
1998-99
1999-00
2000-01
1997-01
Chemicals & Pharmaceuticals
9.8 20.2 11.0 10.4 12.6
Engineering 19.6 21.4 20.6 14.3 19.0Electric &Electronic equipment
25.6 16.7 17.1 27.2 22.3
Food 10.9 1.0 7.7 3.9 6.3Finance 5.0 9.3 1.3 2.1 4.7Service 10.9 18.4 7.3 11.8 12.2Other 24.4 13.1 35.0 30.3 25.0Total 100 100 100 100 100Source:- RBI 2001
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 2003-
04.Trend line indicates that on the whole, FDI is increasing
as a result of economic reforms.
109
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
FDI Flows (Net):1997-98 to 2003-04
01000200030004000500060007000
1997-98
1998-99
1999-2000
2000-2001
2001-2002
2002-2003
2003-2004
Years
FDI Flows (Net)
Trend Line
US
$ m
illion
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 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
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
India ChinaYears FDI
Inflows (million
US$)
FDI inflow as per Cent of GFKF
FDI inflows (millions
US$)
FDI Inflow as percent
of GFKF
1985-1995 (annual
average)
452 1.9 11,715 6.0
2001-2002 3,403 3.2 46,878 10.52002-2003 3,449 3.0 52,743 10.42003-2004 4,269 3.2 53,505 8.62004-2005 5,335 3.4 60,630 8.2
Note: Gross Fixed Capital Formation (GFKF)Source: UNCTAD World Investment Report, 2006
Table 6.5FDI Overview – India and China
India Chinayears FDI Stock
(million US$)
FDI as per Cent of GDP
FDI Stock (millions
US$)
FDI as percent of
GDP1980-1981 452 0.2 1,074 0.51990-1991 1,657 05 20,691 5.82000-2001 17,517 3.7 193,348 17.92002-2003 30,827 5.2 228,371 16.22004-2005 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)
GDP at current market price
(Rs.Crore)2000-01 4031 2760 20,632 21,02,3752001-02 6125 2021 21,976 22,81,0582002-03 5036 979 23,299 24,58,0842003-04 4322 11356 25,773 27,65,4912004-05 5987 9311 28,684 31,26,5962005-06 9801 12494 32,224 35,67,1772006-07 21991 7004 36,950 41,45,810
Source: Various RBI bulletin
117
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 (%)
FDP Growth rate (%)
1991-92 2.86 1.31992-93 -41.8 5.11993-94 -74.5 5.91994-95 79.6 7.31995-96 71.7 7.31996-97 5.02 7.81997-98 43.7 4.81998-99 55.0 6.51999-00 -59.5 6.12000-01 42.9 4.0
Source:- Various RBI Bulletin
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
NΣdx2 – (Σdx)2 NΣdy2 –(Σdy)2
118
Years X Dx= X-
A(A=50)
Dx2 Y Dy= A-A(A=5
9)
Dy2 Dxdy
1991-92
28 -32 1024 13 -46 2116 1472
1992-93
-418 -468 219024 51 -8 64 3744
1993-94
-745 -795 632025 59 0 0 0
1994-95
796 746 556516 73 14 196 10444
1995-96
717 667 444889 73 14 196 9338
1996-97
50 0 0 78 19 361 0
1997-98
437 387 149769 48 -11 121 -4257
1998-99
550 500 250000 65 6 36 3000
1999-00
-595 -645 416025 61 2 4 -1290
2000-01
429 379 143641 40 -19 361 -7201
N=10 Σdx=739
Σdx2= 28,12,913
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 GDP growth rate (%) (x)
Dx= X-A(A=5.9)
Dx2 FDI growth rate (%) Y
Dy= A-A(A=5.0)
Dy2 Dxdy
1991-92
1.3 -4.6 21.16 2.8 -3.2 10.24 14.72
1992-93
5.1 -0.8 0.64 -41.8 -46.8 2190.24 37.44
1993-94
5.9 0 0 -74.5 -79.5 6320.25 0
1994-95
7.3 1.4 1.96 79.6 74.6 5565.16 104.44
1995-96
7.3 1.4 1.96 71.7 66.7 4448.89 93.38
1996-97
7.8 1.9 3.61 5.0 0 0 0
1997-98
4.8 -1.1 1.21 43.7 38.7 1497.69 -42.57
1998-99
6.5 0.6 0.36 55.0 50 2500 30
1999-00
6.1 0.2 0.04 -59.5 -64.5 4160.25 -12.90
2000-01
4.0 -1.9 3.61 42.9 37.9 1436.41 -72.01
N=10 ΣX=56.1X =5.61
Σdx=-2.9
Σdx2
=34.55
ΣY=124.9Y=12.49
Σdy=73.9
Σdy2
=28,129.13
Σdxdy=152.5
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 (1991-
2000) 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 know-
how.
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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