new college of corparate sec ate rio ship

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NEW COLLEGE OF CORPARATE SECATERIOSHIP

CHAPTER-1:INTRODUCTIONThe last two decade of the 20

thcentury witnessed a dramatic

world-wide increas e in foreign direct investm ent (FDI),acc om panied by a mark ed change in the attitude of most

developing countries towards inward FDI. As against a highly

suspicious attitude of these countries towards inward FDI in the past,

most countries now regard FDI as beneficial for their development

efforts and compete with each other to attract it. Such shift in attitude

lies in the changes in political and economic systems that have occurredduring the closing years of the last century.

The wave of liberalisation and globalization sweeping across the world

has opened many national markets for international business.

Global private in ves tm ent , i n mos t pa r t , i s n ow ma de b ymu lt in at io na l c or po ra t i on s(MNCs). Clearly these

corporations play a major role in world trade and investments

because of their demonstrated management skills, technology, financialresources and related advantages. Recent developments in global

markets are indicative of the rapidly growing international business. The

end of the 20th

century has already marked a tremendous growth in

international investments, trade and financial transactions along with

the integration and openness of international markets.

FDI is a subject of topical interest . Countries of th e world, part icularly developing economies, are vying with each other to

attract foreign capital



boost their domestic rates of investment and also to acquire new

technology and managerial skills. Intense competition is

taking place among the fund

s t a r ve d l e s s de ve l ope d c oun t r i e s t o l u r e f o r e i gn

inve to r s b y o f f e r in g repatriation facilities, tax concessions

and other incentives. However, FDI is not an unmixed

blessing. Governments in developing countries have to be

very careful while deciding the magnitude, pattern and

conditions of private foreign investment. In the 1980s, FDI

was concentrated within the Triad(EU, Japan and

US).However, in the 1990s, the FDI flows to developedcountries declined, while those to developing countr ie s

increas ed in response to rapid growth and fewer

restrictions. Most FDI flows continue still to be concentrated in

10 to15 host countries overwhelmingly in Asia and Latin

America. South, East and Southeas t Asi a has

experi enced the fastest economic gro wth in the world,

and emerged as the largest host region. China is now the largesthost country in the developing world. However, small markets

with low growth rates, poor infrastructure, and high

i nde b t e dne s s, s l ow p r og r e s s i n i n t r oduc i ng m a r ke

t an d p r i vat e- se ct o r oriented economic reforms and

low levels of technological capabilities are not attractive to

foreign investors. The remarkable expansion of FDI flows to

developing countries had belied the fear that the opening of

central and Eastern Europe and the efforts of the countries of that region to attract such investment would divert

investment



f l o w s f r o m d e v e l o p i n g c o u n t r i e s . T h e m o s t i m p o r t a n t

f a c t o r s m a k i n g

developing countries at tract ive to foreign investors are rapid economic gro wt h ,

p r i v a t i z a t i o n p r o g r a m m e s o p e n t o f o r e i g n i n v e s t o r s a nd t h e liberalisation of the FDI regulatory frame work. In India, prior

to economic reforms initiated in1991, FDI was discouraged by

Imposing severe limits on equity holdings by foreigners and

Restricting FDI to the production of only a few reserved items.

The Foreign Exchange Regulation Act (FERA), 1973 (nowrep laced by Foreign Exchange Management Act [FEMA]), prescribed

the detailed rules in this regard and the firms belonging to thisgroup were known as FERA firms. All foreign investors were

virtually driven out from Indian industries by FERA. Technology

transfer was possible only through the purchase of foreign

technology. However, due to severe limits on royalty payments

to

foreigners to reduce foreign exchange use, this option was

ineffec t ive . Ho wev er ,t h e g o v e r n m e n t g r a n t e d l i b e r a l t a x i n c e n t i v e s t o e n c o

urage indigenous generation of technology by domestic firms.In the absence

of f o r e i g n t e c h n o l o g y , I n d i a n i n d u s t r y s u f f e r e d b o t h i

n t e rm s o f c os t o f production and quality. The initial policy stimulus to foreign direct investment in India in came

July1991 when the new industrial policy provided, inter alia, automatic

approval for project with foreign equity participation up to 51 percent inhigh priority



Eareas. In recent years, the government has initiated the

second generationre forms under which measures ha ve

been taken to further faci lit ate and broaden the base of

foreign direct investment in India. The policy for FDIallows freedom of location, choice of technology,

repatriation of capital anddividends. As a result of these

measures, there has been a strong surge of international

interest in the Indian economy. The rate at which FDI

inflowhas grown during the post-liberalisation period is a clear

indication that

I n d i a i s f a s t e m e r g i n g a s a n a t t r a c t i v e d e s t i n a t io n fo r o v e r s e a s i n v e s t o r s . Encouragement of

foreign investment, particularly for FDI, is an integral part

of ongoing economic reforms in India.Though India has one

of the most tr ansparent and liberal FDI r egimesamong

the developing countries with strong macro-economic

fundamentals,its share in FDI inflows i s d ismally lo w.

The country still suffers fromweaknesses and

constraints, in terms of policy and regulatory

framework,which restricts the inflow of FDI.Foreign

investment policies in the post-reforms period have

emphasizedgreater encouragement and mobali sation of

non-debt creating privateinflows for reducing reliance

on debt flows. Progressively liberal policieshave led

to increasing inflows of foreign investment in the country.



VIVEK COLLEGE OF COMMERCE

CHAPTER-2:WHAT IS FOREIGN DIRECT

INVESTMENT?

FDI is the process whereby residents of one country (the

home country)acquire ownership of assets for the purpose

of controlling the

production,dis t r i bu t io n and oth er ac t iv i t i es of a f i r

m i n an ot he r c ou nt ry ( t he ho stcountry)

.IMF Definition

According to the BPM5, FDI is the category of internationalinvestment thatreflects the objective of obtaining a lasting

interest by a resident entity inone economy in an

enterprise resident in another economy. The

lastinginterest implies the existence of a long-term relationship

between the directinvestor and the en terprise and a

signi ficant d egree o f influence by th einvestor on the

management of the enterprise

.UNCTAD Definition

T h e W I R 0 2 d e f i n e s F D I a s µ a n i n v e s t m e n t

i n v o l v i n g a l o n g - t e r m relationship and reflecting a

lasting interest and control by a resident entityin one economy

(foreign direct investor or parent enterprise) in an

enterpriseres id en t i n an eco no my ot he r th an th at o f

t he F D I e n t e r p r i s e, a f f i l i a t e e n te r p r i s e o r f o r e i gn

a f f i l i a t e . FDI impl i e s t ha t t he i nv es to r exe r t s a significant degree of influence on the management of the enterprise

residentin the other economy. Such investment involves both the

initial transaction between the two entities and all subsequent

transaction between them among



foreign affiliates, both incorporated and unincorporated. Individuals as

wellas business entities may undertake FDI.Flows of FDI comprise

capital provided (either directly or through other re la tedenterprises) by a foreign direct in vestor to an FDI

enterprise, or capital received from an FDI enterprise by a foreigndirect investor. FDI

hast h re e c omp one n t s , v i z . , e qu i t y c a p i t a l , r e i n ve s t e d e

arnings and intra-company loans.

Equity capital is the foreign direct investor¶s purchase of share of

anenterprise in a country other than its own.

Reinvested earnings comprise the direct investors share (in proportionto

direct equity participation) of earnings not distributed as dividends byaffi l iates, or earnings not remitted to the direct investor.

Suchretained profits by affiliates are reinvested.

Intra-company loans or intra-company debt transactions refer to shortor

long term borrowing and lending of funds between direct

investors(parent enterprises) and affiliate enterprises.OECD Benchmark Definition of Foreign Direct Investm

ent (ThirdEdition)

FDI reflects the objective of obtaining a lasting interest by a resident

entityin one economy (direct investor) in an entity resident in an

economy other than that of the investor (direct investment

enterprise). The lasting interestimplies the existence of a long

term relationship between the direct investor



And the enterprise and a significant degree of influence on the

managementof the ent erpr ise. Dir ect inv estmen t involve s b ot

h the in iti al tr an sac tion between the two entities and allsubsequent capital transactions

betweent h e m a n d a m o n g a f f i l i a t e d e n t e r p r i s e s, b o t h i n c o r p o r a t e d a n d unincorporated.A s i s e v i d e n

t f r o m t h e a b o v e d e f i n i t i o n s , t h e r e i s a l a r g e d e g r

e e o f commonality between the IMF, UNCTAD and OECD

definitions of FDI.The IMF definition is followed internationally



CHAPTER-3:FOREIGN DIRECT INVESTMENT

(FDI): THEORITICALSETTINGS

Most of the present day underdeveloped countries of the world have setout

a p l a n n e d p r o g r a m m e f o r a c c e l e r a t i n g t h e p a c e

o f t h e i r e c o n o m i c d evelop men t. In a cou nt ry p la nn in g

for in du st ri al izat ion an d ai ming toachieve a target rate of

growth, there is a need for resources. The resourcescan be mobilized

through domestic as well as foreign sources. So far as, thedomestic

sources are concerned, they may not be sufficient to acquire

thefixed rate of growth. Generally domestic savings are less thanthe requiredamount of investment. Also the very process of

industrializat ion calls for import of capital goods which can not be

locally produced. Hence comes theneed for foreign sources. They

not only supplement the domestic savings buta l so p r ov i d e t h e r e c i p i e n t c oun t ry w i t h e x t r a f o r e i g

n exc h a n g e t o b u yimports essential for filling the saving

investment gap and foreign exchangegap.The means of getting foreignresources available to a developing country aremainly

three:1.Through export of

goods and services2 . E x t e r n a l a i d 3 . Fore i gn inv es tm ent



Export of goods and services do contribute to foreign resources but they

canmeet only a small part of the total demand for foreignresources.External Aid from foreign governments and

international institutions, byincreasing the rate of home savings andremoving the foreign gap allows theutilization of previously under

utilized resources and capacity. But generallythe aid is tied and distorts

the allocation of resources. So its use has been onthe decline.Foreign

investment is of following two types.1.Foreign Direct Investment

(FDI) and2.Portfolio Investment.

Foreign Direct versus Portfolio InvestmentBy Foreign Direct Investment (FDI) we mean any investment in

a foreigncountry where the investing party (corporation, firm)

retains control over investment. A direct investment typicallytakes the form of a foreign firmstarting a subsidiary or taking over

control of an existing firm in the countryi n q u es t i o n . F D I

c o n s i s t s o f e q u i t y c a p i t a l , t e c h n i c a l a n dma na ge ri a l services , capi ta l equipment and intermedia te

inputs and legal rights to patented or secret products, processes or

trade marks. It is the direct type of forei gn invest men t wh ich isassocia ted with m ult ina tional cor por ati ons because most of

FDI is transferred through firms and remains outside of ordinary,

functioning markets.



FDI can be done in the following ways1.In order to participate in the

management of the concerned enterprise, thestocks of the existing

foreign enterprise can be acquired.2.The existing enterprise and

factories can be taken over.3.A new subsidiary with 100%ownership can be established abroad.4.It is possible to

participate in a joint venture through stock holdings.5.Newforeign branches, offices and factories can be

established.6.Existing foreign branches and factories can be

e x p a n d e d . 7 . M i n o r i t y s t o c k a c q u i s i t i o n , i f t h e

o b j e c t i v e i s t o p a r t i c i p a t e i n t h e management of the

enterprise.8.Long term lending, particularly by a parent

company to i ts subsidiary, when the objective is to participate inthe management of the enterprise.Portfolio investment, on the other

hand, does not seek management control, but is motivated by

profi t . Portfolio investment occurs whenindividuali n v e s t o r s i n v e s t , m o s t l y t h r o u g h

s t o c k b r o k e r s , i n s t o c k s o f f o r e i g n companies in foreign

land in search of profit opportunities.FDI flows are usually preferredover other forms of external finance becausethey a re non-debt

creating, non-volat i le and their returns depend on

th e performance of the projects financed by the investors. FDIalso facilitatesinternational trade and transfer of knowledge,

skills and technology. In awo r ld of in cr ea s ed co mp et i t i on

an d ra p i d te ch n ol og ic a l ch a n ge , t h ei r complimentary and

catalytic role can be very valuable.



Superiority of FDI over Other Forms of Capital Inflows

F D I i s p e r c e i v e d s u p e r i o r t o o t h e r t y p e s o f c a p i t a l

in f l ow s fo r s ev er a l reasons:1.

In contrast to foreign lenders and portfolio investors,fo re ign di rect investors typically have a longer-term perspective

when engaging in ahost country. Hence, FDI inflows are less volatile

and easier to sustain attimes of crisis.2 .Wh ile deb t inflows may

finance consumption rather than investment inthe host

country, FDI is more likely to be used productively.3.FDI is expected

to have relatively strong effects on economic growth, asF D I p r o v i d e s f o r m o r e t h a n j u s t c a p i t a l . F D I

o f f e r s a c c e s s t o internationally available technologies and

management know-how, andmay render it easier to penetrate wordmarkets.A recent United Nations report has revealed that FDI flows are

less volatilethan port fol io flows . To quote , ³ FD I f low s t o

dev elopi ng and transi tioneconomies in 1998 declined by about5 percent from the peak in 1997, amodest reduction in relation to

the effects on the other capital flows of thesp read of th e Asi an

fin anc ial cr isi s to gl oba l prop ort ions. FD I flo ws ar egenerallymuch less volatile than portfolio flows. The decline was modest inall

regions, even in the Asian economies most affected by the

financialcrisis.´FDI is the appropriate form of external financing for

developing countries,wh i c h h a ve l es s c a p a c i t y t h a n h i gh l y

d ev e l op ed e c o n o m i e s t o a b s o r b external shocks. Likewise, the

evidence supports the predominant view that



F D I i s m o r e s t a b l e t h a n o t h e r t y p e s o f c a p i t a l

i n fl o ws . M o r eo v er , th evolati li ty of FDI remained

exceptionally low in the 1990s, when severalemerging economieswere hit by financial crisis.FDI is wi del y con sider ed an

ess ent ia l elem ent fo r achi eving sust ainab ledevelopment. Evenformer critics of MNCs expect FDI to provide a stronger st imulus to

income growth in host countries than other types of

c a p i t a l i n f l ow s . Espe c i a l l y a f t e r t he r e c e n t f i na nc i a l

crisis in Asia and LatinAmerica, developing countries are

strongly advised to rely primarily on FDI,in order to supplement

national savings by capital inflows and promoteeconomicdevelopment.

Macro-economic and Micro-economic Aspects of FDI

I n j u d g i n g t h e s i g n i f i c a n c e o f F D I , e s p e c i a l l y f r o mthe view point of developing countr ies , i t i s useful to

make a di st inct ion be twe en ma cro-economic and micro-

economic effects. The former is connected with issuesof domesticcapital formation, balance of payments, and taking advantage

of external markets for achieving faster growth, while the latter

is connectedwith the issues of c ost reduc tion, produ ctqual i ty impro vem en t, makingchanges in industrial structure and

developing global inter-firm linkages.In this context, it needs to be

recognized that FDI is an aggregate entity, thesum total of the

investments made by many diverse multinationals, eachwith its

o w n c o r p o r a t e s t r a t e g y . T h e m i c r o - e c o n o m i c e f f e c t s

o f t h e



investment made by one multinational may be quite different

from that of another multinational even if the investments are made in

the same industry.Also, what benefits the local economy will depend onthe capabilities of thehost country in regard to technology transfer and

industrial restructuring.Resource-seeking and Market-seeking FDI

Two major types of FDI are typically differentiated: resource-

seeking FDIand market-seeking FDI.Resource-seeking FDI is

motivated by the availability of natural resources inthe host countries.

This type of FDI was historically important and remains arelevant

source of FDI for various d eveloping countries. However,on aworld-wide scale, the relat ive importance of resource-

seeking FDI hasdecreased significantly.The relative importance of

market-seeking FDI is rather difficult to assess. Itis almost impossible totell whether this type of FDI has already become lessimportant due to

economic globalization. Regarding the history of FDI

indeveloping countries, various empirical studies have shown that thesize andgro wth o f ho s t cou n t ry mark e t s wer e a mon g t he

m os t i m p or t a n t F D Ideterminants. It is debatable, however,

whether this is still true with ongoingglobalization.



G l o b a l i s a t i o n e s s e n t i a l l y m e a n s t h a t

g e o g r a p h i c a l l y d i s p e r s e d manufacturing, slicing upthe value chain and the combination of marketsand resources

through FDI and trade are becoming major characteristics of the world

economy. Efficiency-seeking FDI, i.e. FDI motivated by creatingnewsources of competitiveness for firms and strengthening existing

ones,may then em erge as the m ost imp ortant t ype of FDI.

Accordingly, t hecom pe t i t i on fo r FD I wou ld b e bas ed

i n c r ea s i n g l y on c o s t d i f f e r e n c es between locations, thequality of infrastructure and business-related services,the ease of

doing business and the availabil i ty of skil ls . Obviously,

th is scenario involves major challenges for developing countries,

ranging fromhuman capital formation to the provision of business-

related services such asefficient communication and distribution

systems.

Nature of FDI

A l m o s t a l l m o d e r n ( F D I ) i s c a r r i e d o u t b yc o r p o r a t i o n s r a t h e r t h a n i nd ivi du als . Som ewh at li ke

port foli o in vestm ent, the flows o f FD I hav ehistorically been

highly concentrated, both in terms of geography and byindustryand at both the investor and receptor poles. Geographically,

theownership of global stocks of FDI is highly skewed

towards on ly a fewla r ge , h igh in come cou n t r i e s . Ea ch

i n ve s t i n g c o u n t r y h a s , wh et h er b yaccident or design , tended

to direct the major part of its FDI to only a veryfew receiving countries;in fact the pattern of global distribution of FDI have been highly similar

to historical relationships based on colonial ties or other forms of

political hegemony.



Viewed industrially, for any given country, FDI generally comes from

lessthan four or five out of twenty or so major industry groups and

inflows intothose same industries in the receptor country.Generalattribute of FDI is that it has evoked by type over time. Prior to

FirstWorld War, a crude but valid generalization would that a large part

of FDIwas i n se rvic e sec tor of t he host econ omy(par t icu la r ly t ranspor ta t ion , power , communica t ion and

t ra d i ng) whi l e m os t o f th e re s t wa s o f t he ³backward

vertical integration´ type. During the inter-war period, most

of the currently largest manufacturing mult inationalcorpora tions (MNCs)made th e i r i n i t i a l f o re i gn

inves tments , but these hor izonta l or marke textens ion

types of investments have now become major category.Th e f ou r t h

r e c o g n i z e d c h a r a c t e r i s t i c o f m a n u f a c t u r i n g F D I i s

t h a t i t originates in industries that are technologically intensive, ³skill

oriented´ or pr og r es si ve . I n a dd i t io n, th e FD I pr on e

industries are typically moreconcentrated, have higher

advertising outlays per unit of sales and exhibitabove averageexport propensit ies. Industries from which FDI tends

tooriginate display many characteristics associated with

oligopoly.A n o t h e r u n i v e r s a l p r o p e r t y o f F D I i s t h a ti t i s r e a l l y a p a c k a g e o f comp lem en ta ry i np ut s, a

collective flow of both tangible and intangibleassets &

services



FDI in Developing Countries

F D I i s n o w i n c r e a s i n g l y r e c o g n i z e d a s a n i m p o r t a n tc on t r i b u t o r t o a d e v e l o p i n g c o u n t r y ¶ s e c o n o m i c

p e r f o r m a n c e a n d i n t e r n a t i o n a l competitiveness.A f t e r

t h e d e b t - c r i s i s t h a t h i t t h e d e v e l o p i n g w o r l d i n e a r l y1 9 8 0 s , t h econventional wisdom quickly became that it had been

unwise for countriesto borrow so heavily from international banks or

international bond markets.Ra th er count ri es sh ou ld tr y to at tr ac t

non-debt-creating private inflows(DFI). The financialadva nta ge is tha t su ch c apit al in flows need not berepaid and

that outflow of funds (remittance of profits) would fluctuate withthe

cycle of the economy. It has also been widely observed that the

structuraladjustment efforts of the 1980s failed to lead to new

patterns of sustainedgrowth in developing countries. In particular,

structural adjustment programsfailed to restore private investment to

desirable levels. Again it is hoped thatFDI could play an important role;

the World Bank observes that FDI can bean important complement tothe adjustment effort, especially in countrieshaving difficulty in

increasing domestic savings.Against this background of balance of

payments problems and low level of private investment, it is probablynot surprising that attitudes in developingcountries towards FDI have

shifted. In the 1960s and 1970s many countriesmaintained a rather

cautious, and sometimes an outright negative positionwith

respect to FDI. In the 1980s, however the attitudes shifted

radically

new college of corparate sec ate rio ship

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