INTERNATIONAL TRADE LAWA STUDY ON THE WTO RULES ON FDI-with special focus on the Indian experience

TEJASWI MALLIPEDDI201132, 6th SEMESTER

MARCH,2014

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Table of Contents

INTRODUCTION 3

OBJECT 5

RESEARCH QUESTIONS 5

1. What are the FDI polices, the positive and negative incentives related to it?

2. The relation between FDI and growth in India.

3. Factors which influence the flow of FDI.

HYPOTHESIS: 5

POSITIVE INCENTIVES 5

NEGATIVE INCENTIVES 5

RESEARCH METHODOLOGY 7

LITERARY REVIEW 7

CHAPTER 1 - WTO Agreements 9

CHAPTER 2 - IMPACT OF WTO ON INDIA 10

CHAPTER 3 - CRTICISIM 11

CONCLUSION 13

BIBLIOGRAPHY 14

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INTRODUCTION

The World Trade Organization is a living and growing organism. The functioning of

WTO affects the economic life of all countries around the globe. It is not concerned only

with international trade law-meaning exports and imports of goods and services in the

traditional sense-but with “international business” in general, and that includes foreign

direct investment (FDI). Foreign direct investment (FDI) is a direct investment into

production or business in a country by an individual or company of another country,

either by buying a company in the target country or by expanding operations of an

existing business in that country. The provisions on FDI in the WTO framework are

contained in two agreements: the General Agreement on Trade in Services (GATS) and

the Agreement on Trade-Related Investment Measures (TRIMs) in relation to trade in

goods. All forms of FDI come under the jurisdiction of WTO. The period from 1967 to

1980 may be referred to an era of severe restriction. The infamous Foreign Exchange

Regulation Act (FERA) came into existence in 1973. Foreign equity was restricted to 40

percent, in the sense that:

A. If the joint venture was to be treated without discrimination vis-a-vis domestic firms,

the foreign equity share must not exceed this limit.

B. The condition under which the foreign equity share could exceed 40 percent were

quite stringent and the decision as to whether such a venture would be allowed (even if it

met all conditions) was left to the discretion of the government.

Policies were eased in the 1980s. In the wake of the oil price shocks it was probably

realized that the country needed to increase its exports considerably and for various

reasons, domestic firm alone would not be up to the task FERA restrictions were relaxed

for 100 percent export-oriented units. In 1986, the tax rate on royalty payments was

brought down from 40 percent to 30 percent. FDI regulations continued to fall at a

gradual rate throughout the 1980s.

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An FDI proposal requires approval. There are two approval bodies: the Reserve Bank of

India and the Secretariat for Industrial Assistance and Foreign Investment Promotion

Board. The RBI gives automatic approval to proposals in high-priority sectors where

foreign equity does not exceed 51 percent and in the mining sector as long as it does not

exceed 50 percent. SIA/FIPB deals with other proposals, such as where foreign equity

exceed 51 percent the industry is not on the list of high-priority sectors, or foreign equity

does not cover the import of capital goods. Unlike the RBI, SIA/FIPB can initiate and

carry on detailed negotiations with foreign firns.

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OBJECT:

The object of my project is to depict the beneficiaries gained by Indian markets through

FDI. The policies and strategies picked up the parent and the host countries will be

discussed vividly. The last chapter of the project deals with criticizing the FDI

regulations.

RESEARCH QUESTIONS

1. What are the FDI polices, the positive and negative incentives related to it?

2. The relation between FDI and growth in India.

3. Factors which influence the flow of FDI.

HYPOTHESIS:

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POSITIVE INCENTIVES

1. Guarantee against nationalization

2. Tax holidays

3. Tax treaties to avoid double

taxation

4. Exemptions on import duties on

capital goods and intermediate

goods

5. Other exemptions or relaxation of

rules in priority Sectors.

6. Subsidized loans, reduced rent for

land use accelerated depreciation.

7. Special promotion of exports, for

example through export processing

zones.

NEGATIVE INCENTIVES

1. Nationalization or appropriation

2. Double taxation

3. Domestic content requirement in

terms of intermediates

4. Domestic employment restriction

5. Exports requirements and foreign

currency earning targets

6. General foreign equity

limitsSectoral foreign equity limits

7. Land ownership restrictions

8. Division of management within a

joint venture

9. Restrictions on remittance of profits

10. Transfer of shares

11. Restrictions on liquidation of The

company

2. Development economists state that effects of FDI are significant on economic growth.

The gains from FDI inflows are unquestionable because it contributes to economic

growth through an increase in productivity by providing new investment, better

technologies and managerial skills to the host countries. However, the effect of FDI on

domestic investment is an issue of concern because there is a possibility of displacement

of domestic capital due to competition from foreign investors with their superior

technologies and skills. Thus, the ultimate impact of FDI on economic growth depends on

the degree of capacity of the host country to use FDI as efficiently as possible. Similarly,

trade liberalisation may facilitate economic growth through efficiency in production by

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utilising the abundant factors of production more effectively and absorbing better

technologies from advanced countries. Indian economy was also concerned with issues

pertaining to foreign private capital inflows and trade liberalisation initially. However, it

later moved to liberalize its trade and investment policies to include various investment

incentives, particularly for foreign investors. Along with this it had maintained high and

steady economic growth, single-digit inflation rate; it has a growing domestic market, a

large number of skilled personnel and a more favourable investment market. FDI inflows

into India had grown sizably during the period from 2000 to 2007. The value of FDI

inflows has rose from 3.9 billions to US$ in 200 and touched the highest level of 23

billions of US$ in 2007. The average value of FDI inflows and annual growth in this

period works out to 9.4 billions of US$ and 77.17% per year respectively.1

3. There are numerous "pull" factors that can influence inflows of FDI.2 Current

economic performance represents the current governmental regime’s ability to handle the

state’s economy as well as other societal factors. Investors will seek out countries that

have had recent enonomic success, hoping that the trend will carry on in the long-run.

Investors will have more confidence in that nation that has done well in the past will aslo

do well in the future. In addition to macroeconomic stability, the consistency of exchange

rates is also important. The foreign investment of an MNC many times is used to

supplement the firm in the host country. As a result consistent exchange rates are

necessary for an MNC to repatriate fractions of its FDI profit to the home country. Lastly,

the human capital of a country is an important factor for an MNC when considering to

invest. When investing for the long term in another country, an MNC will most likely

have to utilize the labor in the host country.3

1 Robert M. Stern, India and the WTO, World bank Publication.2Trade and Investment: from bilateral to multilateral treaties? http://www.wto.org/english/thewto_e/minist_e/min03_e/brief_e/brief07_e.htm accessed on 1st March 2014.3 Michael Gestrin, Alan Rugman, Rules for Foreign Direct Investment at the WTO: Building on Regional Trade Agreements, http://link.springer.com/chapter/10.1007%2F0-387-22688-5_50 accessed on 1st March 2014.

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RESEARCH METHODOLOGY

I have followed the doctrinal method of research. The first part of my project deals with

the history of flow of FDI and the definitions. The second part of my project deals with

information about FDI policies taken from various articles. Information from books has

also been taken.

LITERARY REVIEW

1. There are various types of FDI:

Horizontal FDI arises when a firm duplicates its home country-based activities at the

same value chain stage in a host country through FDI.

Platform FDI Foreign direct investment from a source country into a destination country

for the purpose of exporting to a third country.

Vertical FDI takes place when a firm through FDI moves upstream or downstream in

different value chains i.e., when firms perform value-adding activities stage by stage in a

vertical fashion in a host country.

Despite the global meltdown and its effect on the economy, India's engagement with the

world continued to widen and deepen. India is one of the fastest growing economies

among the large economies of the world.[ According to the IMF's World Economic

Outlook, April 2011, India had the highest growth rate of 10.4% in 2010, followed by

China at 10.3%, while world output grew at 5%. For 2011, the IMF has estimated India's

growth at 8.2%, while global growth is projected at 4.4%.] In terms of purchasing power

parity (PPP), the Indian economy is the fourth largest after the United States, China and

Japan.[ World Bank: World Development Indicators Database; April 2011.] India's

share in world GDP (PPP) has increased from 4.3% in 1991 to 5.3% in 2009.4

4 World Bank: World Development Indicators Database; 1 March 2014

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2. Non transparency can be a barrier to the inflow of FDI. There are five origins of it.

First, economic policy – making will be seen as non-transparent if it is subject to

corruption and bribery. The second important element of non-transparency arises in the

area of property rights and their protection within a given country. The lack of copy right

protection, the existence of patent infringement and lack of enforcement of contracts are

all examples of what constitutes poor protection of property rights. The third and fourth

aspects of non-transparency relate to the level of bureaucratic inefficiency within the

government and poor enforcement of the rule of law. These two factors can pose severe

barriers to business. If the quality of government service is unpredictable, companies'

exposure to additional risks is increased. Moreover, their ability to cover against these

risk impeded due to the unpredictable nature of government service. OECD (1997b), for

example, shows that bureaucratic inefficiency and weak rule of law impede economic

activities by imposing additional costs on economic agents. Delays in licensing, the

inability of the courts to enforce contracts and the capricious and arbitrary enforcement of

rules and regulations all reduce economic efficiency and effectiveness. Finally, the fifth

origin of non-transparent economic policies has a great deal to do with the conduct of

economic policies per se. Economic policies are likely to be treated as non-transparent if

they are subject to unpredictable policy reversals. These policy reversal are particularly

damaging in privatization deals and whenever foreign investors are involved. Consider,

for example, the case of privatization in country X in which the government summarily

cancels decisions of the previous government to privatize the country's industry. The

reaction of foreign investors to the policy reversal is likely to put the country concerned

"off-limits" for foreign investors.5

CHAPTER 1 - WTO Agreements

The General Agreement on Trade in Services (GATS) is a treaty of the World Trade

Organization (WTO) that entered into force in January 1995 as a result of the Uruguay

Round negotiations. The treaty was created to extend the multilateral trading system to

5 Taken from his speech at the 24the Annual Conference of the International Organization of Securities Commission in Lisbon, on May 25, 1999. Also reported in IMF Survey, June 7, 1999.

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service sector, in the same way the General Agreement on Tariffs and Trade (GATT)

provides such a system for merchandise trade. While the overall goal of GATS is to

remove barriers to trade, members are free to choose which sectors are to be

progressively "liberalised", i.e. marketised and privatised, which mode of supply would

apply to a particular sector, and to what extent liberalisation will occur over a given

period of time. Members' commitments are governed by a "ratchet effect", meaning that

commitments are one-way and are not to be wound back once entered into. The reason

for this rule is to create a stable trading climate. However, Article XXI does allow

Members to withdraw commitments. For countries that like to attract trade and

investment, GATS adds a measure of transparency and legal predictability. Legal

obstacles to services trade can have legitimate policy reasons, but can also be an effective

tool for large scale corruption.

The Agreement on Trade Related Investment Measures (TRIMs) are rules that apply to

the domestic regulations a country applies to foreign investors, often as part of an

industrial policy. In the late 1980s, there was a significant increase in foreign direct

investment throughout the world. However, some of the countries receiving foreign

investment imposed numerous restrictions on that investment designed to protect and

foster domestic industries, and to prevent the outflow of foreign exchange reserves.

Examples of these restrictions include local content requirements (which require that

locally-produced goods be purchased or used), manufacturing requirements (which

require the domestic manufacturing of certain components), trade balancing

requirements, domestic sales requirements, technology transfer requirements, export

performance requirements (which require the export of a specified percentage of

production volume), local equity restrictions, foreign exchange restrictions, remittance

restrictions, licensing requirements, and employment restrictions. These measures can

also be used in connection with fiscal incentives as opposed to requirement. There are

eight types of TRIMs:

1. Local content requirements

2. Trade balancing requirements

3. Foreign exchange restrictions

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4. Export performance requirements

5. Local production requirements

6. Mandatory technology transfers

7. Production mandates

8. Limits on foreign equity and remittances

CHAPTER 2 - IMPACT OF WTO ON INDIA

Increase in export earnings: Increase in export earnings can be viewed from growth in

merchandise exports and growth in service exports:

Growth in merchandise exports: The establishment of the WTO has increased the exports

of developing countries because of reduction in tariff and non-tariff trade barriers. India’s

merchandise exports have increased from 32 billion us $ (1995) to 185 billion u $ (2008-

09).

Growth in service exports: The WTO introduced the GATS (general Agreement on Trade

in Services ) that proved beneficial for countries like India. India’s service exports

increased from 5 billion us $ (1995) to 102 billion us $ (2008-09) (software services

accounted) for 45% of India’s service exports)

2. Agricultural exports: Reduction of trade barriers and domestic subsidies raise the

price of agricultural products in international market, India hopes to benefit from this in

the form of higher export earnings from agriculture

3. Textiles and Clothing: The phasing out of the MFA will largely benefit the textiles

sector. It will help the developing countries like India to increase the export of textiles

and clothing.

4. Foreign Direct Investment: As per the TRIMs agreement, restrictions on foreign

investment have been withdrawn by the member nations of the WTO. This has benefited

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developing countries by way of foreign direct investment, euro equities and portfolio

investment. In 2008-09, the net foreign direct investment in India was 35 billion us $.

5. Multi-lateral rules and discipline: It is expected that fair trade conditions will be

created, due to rules and discipline related to practices like anti-dumping, subsidies and

countervailing measure, safeguards and dispute settlements. Such conditions will benefit

India in its attempt to globalise its economy.

CHAPTER 3 - CRTICISIM

1. TRIPs: Protection of intellectual property rights has been one of the major concerns

of the WTO. As a member of the WTO, India has to comply with the TRIPs standards.

However, the agreement on TRIPs goes against the Indian patent act, 1970, in the

following ways:

Pharmaceutical sector: Under the Indian Patent act, 1970, only process patents are

granted to chemicals, drugs and medicines. Thus, a company can legally manufacture

once it had the product patent. So Indian pharmaceutical companies could sell good

quality products (medicines) at low prices. However under TRIPs agreement, product

patents will also be granted that will raise the prices of medicines, thus keeping them out

of reach of the poor people, fortunately, most of drugs manufactured in India are off –

patents and so will be less affected.

Agriculture: Since the agreement on TRIPs extends to agriculture as well, it will have

considerable implication’s on Indian agriculture. The MNG, with their huge financial

resources, may also take over seed production and will eventually control food

production. Since a large majority of Indian population depends on agriculture for their

divelihood, these developments will have serious consequences.

Micro-organisms: Under TRIPs Agreement, patenting has been extended to micro-

organisms as well. This mill largely benefit MNCs and not developing countries like

India.

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2. TRIMs: The Agreement on TRIMs also favours developed nations as there are no

rules in the agreement to formulate international rules for controlling business practices

of foreign investors. Also, complying with the TRIMs agreement will contradict our

objective of self – reliant growth based on locally available technology and resources.

3. GATS: The Agreement on GATS will also favour the developed nations more. Thus,

the rapidly growing service sector in India will now have to compete with giant foreign

firms. Moreover, since foreign firms are allowed to remit their profits, dividends and

royalties to their parent company, it will cause foreign exchange burden for India.

4. TARIFF Barriers and NON-TARIFF Barriers: Reduction of trade and non-tariff

barriers has adversely affected the exports of various developing nations. Various Indian

products have been hit by. Non- tariff barriers. These include textiles, marine products,

floriculture, pharmaceuticals, basmati rice, carpets, leather goods etc.

5. LDC exports: Many member nations have agreed to provide duty – frce and quota –

frce market access to all products originating from least developed countries. India will

have to now bear the adverse effect of competing with cheap LDC exports

internationally. Moreover, LDC exports will also come to the Indian market and thus

compete with domestically produced goods.

CONCLUSION

Despite the difficulties associated with the measurement of the efficiency-enhancing

effects induced by FDI, let alone with the assessment of the specific channels by which a

transfer of technology affects local productivity, the empirical literature offers some

important conclusions. First, there appears to be a wide consensus that FDI is an

important, perhaps even the most important, channel through which advanced technology

is transferred to developing countries. Second, there also seems to be a consensus that

FDI leads to higher productivity in locally owned firms, particularly in the manufacturing

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sector. Third, there is evidence that the amount of technology transferred through FDI is

influenced by various host industry and host country characteristics. More competitive

conditions, higher levels of local investment in fixed capital and education, and less

restrictive conditions imposed on affiliates appear to increase the extent of technology

transfers. the present network of international agreements in the investment area provides

little protection against discrimination vis-à-vis non-participating countries. Genuinely

multilateral rules would enable bilateral and regional initiatives to be drafted and function

within a framework which protects the interests of third parties. A related concern is that

current work on investment-related issues tends to focus more on those countries which

are already receiving significant inflows of foreign investment, to the neglect of those

whose needs may be greater. Nor does it always provide for the effective participation, in

the formulation of new rules, of all those who may be affected by them. In the face of

these growing economic, institutional and legal interlinkages between trade and FDI,

WTO members are confronted with a basic policy choice: do they continue to approach

the FDI issue as they have until now, that is bilaterally, regionally and plurilaterally, and

on an ad hoc basis in sectoral and other specific WTO agreements; or do they seek to

integrate such arrangements into a comprehensive and global framework that recognizes

the close linkages between trade and investment, assures the compatibility of investment

and trade rules and, most of all, takes into account in a balanced way the interests of all

the members of the WTO - developed, developing and least-developed alike. Only a

multilateral negotiation in the WTO, when appropriate, can provide such a global and

balanced framework. Their decision will have an important impact on the efficiency with

which scarce supplies of capital and technology will be employed in the next decade and

beyond. It will also have an impact on the strength, coherence and relevance of efforts to

integrate all developing countries into the multilateral trading system.

BIBLIOGRAPHY

Books referred

Robert M. Sem, India and the WTO, World bank Publication.

Websites

http://wto.org.

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http://link.springer.com/

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