Foreign investment

History • From 1951 ( first 5 year plan ) to 1991 • Growth rate 3.5 % • Population growing at 2.5 % • Poverty • Most plans fell short on their targets • Government loans from US, UK, Soviet Union • Other donor institutions like World Bank were stingy in providing assistance.

Contd. • Two major events • First , the US-China rapprochement and large-scale influx of capital from 1980 onwards placed China on a higher growth path • Second, in 1991 India ran out of money and had to mortgage its gold to borrow money to import the basics to keep even the dismal economy going. • During mid eighties, India started having balance of payments problems. Precipitated by the Gulf war , India’s oil import bill swelled, exports slumped, credit dried up and investors took their money out.Large fiscal deficits, over time, had a spill over effect on the trade deficit culminating in an external payments crisis. By the end of 1990, India was in serious economic trouble.

Contd. • The foreign exchange reserves had dried up to the point that India could barely finance three weeks worth of imports. • Noted economist and current Prime Minister Manmohan Singh’s services were requisitioned in 1992. As a Finance Minister, he further requisitioned the services of Montek Singh (another economist) and others. Together they set to put India’s finances in order.

Period 1991 to 1997 • An adjustment period for the Indian economy • China kept reaping the harvest of good governance with huge investment cash inflow. • GDP grew at 8% a year • The exports were priced low . • Allowed huge profits for the American businesses • As the population stayed employed and more money kept coming their way.

Contd. • India does not subscribe to the Chinese model. • Businesses in India have to operate to turn out a profit, pay taxes and employ people. • high taxation • restrictive trade practices and • political turmoil from time to time • This made India as an unattractive place for foreign investment

Post 1998 • The US and the West, needed English speaking, highly skilled IT and BPO consultants in large numbers. • India had this necessary resource; hence this sector was ripe for investment. • China was not in the running as it lacked the English speaking populace and the West did not wish to put all its eggs into one basket. • Small investment in India placed this sector on a rapid growth. The other sectors of economy felt the benefits of this sudden boom and prospered

Period 1998 to 2004 • The period of greatest improvement in the Indian economy and its perception abroad. • The economy grew at 6.5% with an occasional burst of 8% in 2003. • The foreign money managers started to look at India favorably. • Political instability diminished a bit.

Contd. • Constrictions to the growth were slowly removed or reduced. • That allowed the Foreign Direct Investment (FDI) to increase. • A total of about $3.5 Billion in FDI has reached India in 2004. • It compares unfavorably with China, which received $50 Billion, but it is three times higher than what India received in 1998.

Foreign Direct Investment (FDI) • Foreign direct investment (FDI) is investment directly into production in a country , by a company located in another country, either by buying a company in the target country or by expanding operations of an existing business in that country. • FDIs do not only provide an foreign capital and funds, but also provides domestic countries with an exchange of skill sets, information and expertise, job opportunities and improved productivity levels.

Contd. • Major driving force can be – • Cost advantage in the form of low labour cost & operating cost • Reduction of risk as different countries have different economic cycles • Penetration in foreign market & earn more than normal return • special investment privileges such as tax exemptions offered by the country

Contd. • Prior to 1991, FDI was allowed on a case to case basis with a normal ceiling of 40 % the total equity capital . • Higher % was permitted in certain industries If the technology is sophisticated & was not available in the country or If the venture was export oriented . • The industrial policy reforms have reduced industrial licensing requirements , removed restrictions on investment& expansion , facilitating easy access to foreign technology & FDI

Contd. • Now FDI is freely allowed in all the sectors including the service sector , except where the existing & notified sectoral policy does not permit the FDI beyond a ceiling . • Most items through Automatic route – powers delegated to RBI • Remaining through government approval – recommendations by FIPB ( foreign investment promotion board )

Determinants of Foreign Direct Investment • size as well as the growth prospects of the economy of the country • The population of a country, thus market size • high per capita income so reasonably good spending capabilities • status of the human resources in a country ex. China • natural resources eg. Saudi Arabia and other oil rich countries

Contd. • Inexpensive labor force ex. Indian BPO industry • Infrastructural factors like the status of telecommunications and railways • the transparency of the legal frameworks

Foreign institutional investors investment ( FII ) • The FII investment in the country is routed through the capital market / primary & secondary market securities , including the government securities . • FIIs include asset management companies, pension funds, mutual funds, investment trusts, incorporated/institutional portfolio managers or their power of attorney holders, university funds, endowment foundations, charitable trusts and charitable societies.

Contd. • FIIs are required to allocate their investment between equity and debt instruments in the ratio of 70:30. However, it is also possible for an FII to declare itself a 100% debt FII in which case it can make its entire investment in debt instruments. • There is a widespread notion that FII inflows are hot money — that it comes and goes, creating volatility in the stock market and exchange rates. While this might be true of individual funds, cumulatively, FII inflows have only provided net inflows of capital.

FDI or FII ? • FDI is preferred overFII investments since it is considered to be the most beneficial form of foreign investment for the economy as a whole. • Direct investment targets a specific enterprise, with the aim of increasing its capacity/productivity or changing its management control • In the case of FII investment that flows into the secondary market, the effect is to increase capital availability in general, rather than availability of capital to a particular enterprise

Contd. • FDI tends to be much more stable than FII inflows. Moreover, FDI brings not just capital but also better management and governance practices and, often, technology transfer. The know-how thus transferred along with FDI is often more crucial than the capital per se. • No such benefit accrues in the case of FII inflows, although the search by FIIs for credible investment options has tended to improve accounting and governance practices among listed Indian companies.

Contd. • The government allows greater freedom to FDI in various sectors as compared to FII investments. • However, there are peculiar cases like airlines where foreign investment, including FII investment, is allowed to the extent of 49%, but FDI from foreign airlines is not allowed.

Contd. • FDI is a bit of a permanent nature, the FII flies away at the shortest political or economical disturbance. • Once this money leaves, it leaves ruined economy and ruined lives behind. Hence FII is to be welcomed with strict political and economical discipline. • China receives mainly the FDI. They do not have instruments to receive the FII i.e. laws, institutions and political and judicial framework

External commercial borrowings ( ECB ) • Refers to commercial loans ( in the form of bank loans, securities instrument etc. ) availed from non resident lenders . • Minimum average maturity is 3 years . • Two options available • Automatic route- no RBI permission required or • Approval route – RBI permission required

Indian direct investment abroad • To encourage Indian firms & businesses to grow strong • For acquisitions abroad • Indian direct investment in joint ventures ( JV ) • And wholly owned subsidiaries ( WOSs) • JV means a foreign concern formed in which an Indian party makes direct investment , whether such investment amounts to majority or minority shareholding . • WOS means foreign concern formed with entire equity capital is owned by the Indian party .

Foreign investment