SUBMITTED TO: N.R VAID

FOSTIIMA BUISNESS SCHOOL

REPORT ON FOEIGN DIRECT

INVESTMENT

Saket Kumar, MBA SECOND YEAR.

ROLL NO : PGP091149

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INDEX

S.No TOPIC PAGE NO

1. What is Foreign Direct Investment 3.

2. Types of FDI 4

3. METHODS OF FOREIGN DIRECT INVESTMENT 7

4. Foreign direct investment incentives 7

5. ENTRY MODE 8

6. Policy 12

7. Determinants of FDI 16

8. Advantage & Disadvantage of FDI 17

9. Why India Gets Limited FDI 18

10. Conclusion 20

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What is Foreign Direct Investment?

Foreign direct investment (FDI) refers to long term participation by country A into

country B. It usually involves participation in management, joint-venture, transfer of

technology and expertise. There are three types of FDI: inward foreign

direct investment and outward foreign direct investment, resulting in

a net FDI inflow (positive or negative) and "stock of foreign direct investment", which is

the cumulative number for a given period. Direct investment excludes investment

through purchase of shares.

It is the policy of the Government of India to attract and promote productive FDI from

nonresidents in activities which significantly contribute to industrialization and socio-

economic development. FDI supplements the domestic capital and technology.

India has one of the most transparent and liberal FDI regimes among the emerging and

developing economies. By FDI regime we mean those restrictions that apply to foreign

nationals and entities but not to Indian nationals and Indian owned entities. The

differential treatment is limited to a few entry rules, spelling out the proportion of equity

that the foreign entrant can hold in an Indian (registered) company or business.

Foreign direct investment (FDI) has become an integral part of national development

strategies for almost all the countries globally. Its global popularity and positive output in

augmenting of domestic capital, productivity and employment; has made it an

indispensable tool for initiating economic growth for nations.

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India is evolving as one of the ‘most favored destination’ for FDI in Asia and the Pacific

(APAC). It has displaced US as the second-most favored destination for foreign direct

investment (FDI) in the world after China according to an AT Kearney's FDI

Confidence Index. FDI in India has contributed effectively to the overall growth of the

economy in the recent times. FDI inflow has an impact on India's transfer of new

technology and innovative ideas; improving infrastructure, a competitive business

environment.

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BY DIRECTION

Inward FDI

Here, investment of foreign capital occurs in local resources. 

The factors propelling the growth of Inward FDI comprises tax breaks, relaxation of

existent regulations, loans on low rates of interest and specific grants. The idea behind

this is that, the long run gains from such a funding far outweighs the disadvantage of

the income loss incurred in the short run. Flow of Inward FDI may face restrictions from

factors like restraint on ownership and disparity in the performance standard.

Outward FDI

Foreign direct investment, which is outward, is also referred to as “direct investment

abroad”. In this case it is the local capital, which is being invested in some foreign

resource. Outward FDI may also find use in the import and export dealings with a

foreign country. Outward FDI flourishes under government backed insurance at risk

coverage. 

BY TARGET

Greenfield FDI

Greenfield investments involve the flow of FDI for either building up of new production

capacities in the host nation or for expansion of the existent production facilities of the

host country. The plus points of this come in form of increased employment

opportunities, relatively high wages, R&D activities and capacity enhancement.

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The flip side comes in the form of declining market   share  for the domestic firm and

repatriation of profits made to a foreign country, which if retained within the country of

origin could have led

To considerable capital accumulation for the nation.

Horizontal FDI  

Horizontal FDI is an investment made by a multinational company in different nations.

The investment is made for conducting the similar business operations as already

operated by the company. For example, if a soft drink manufacturing   company  makes

its plant outside its national borders then it is horizontal FDI. Horizontal FDI results in

expansion of the parent company and brings FDI in the other economy.

Vertical FDI

There are two types of vertical direct investment. The first type of foreign   investment is

called foreign vertical direct investment which invests in the industry of foreign country.

Historically most backward vertical foreign direct investment has been in

extractive industries like oil extraction, bauxite mining, tin mining and copper mining.

The objective has been to provide inputs into a firm's downstream operations for

example oil refining, aluminum smelting and fabrication. Firms such as Royal

Dutch/Shell, British Petroleum, RTZ and Alcoa are among the classic examples. 

The second type of the foreign direct investment included forward vertical foreign direct

investment in which an industry abroad sells the outputs of a firm's domestic production

process. Forward vertical foreign direct investment is less common than backward

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vertical foreign direct investment. For example when Volkswagen entered

the United   States  market it acquired a large number of dealers rather than distribute

its cars through independent United States dealers. 

METHODS OF FOREIGN DIRECT INVESTMENT

The foreign direct investor may acquire 10% or more of the voting power of an

enterprise in an economy through any of the following methods:

by incorporating a wholly owned subsidiary or company

by acquiring shares in an associated enterprise

through a merger or an acquisition of an unrelated enterprise

participating in an equity joint venture with another investor or enterprise

Foreign direct investment incentives may take the following forms:

low corporate tax and income tax rates

tax holidays

other types of tax concessions

preferential tariffs

special economic zones

EPZ  - Export Processing Zones

Bonded Warehouses

investment financial subsidies

soft loan  or loan guarantees

free land or land subsidies

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relocation & expatriation subsidies

job training & employment subsidies

infrastructure  subsidies

R&D support

derogation from regulations (usually for very large projects)

ENTRY MODE

A foreign company planning to set up business operations in India has the following

options:

1) As an Indian Company

A foreign company can commence operations in India by incorporating a company

under the Companies Act, 1956 through

Joint Ventures; or

Wholly Owned Subsidiaries

Foreign equity in such Indian companies can be up to 100% depending on the

requirements of the investor, subject to equity caps in respect of the area of activities

under the Foreign Direct Investment (FDI) policy. Details of the FDI policy, sectoral

equity caps & procedures can be obtained from Department of Industrial Policy &

Promotion, Government of India.

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Joint Venture with an Indian Partner

Foreign Companies can set up their operations in India by forging strategic alliances

with Indian partners.

Joint Venture may entail the following advantages for a foreign investor:

Established distribution/ marketing set up of the Indian partner

Available financial resource of the Indian partners

Established contacts of the Indian partners which help smoothen the process of

setting up of operations

Wholly Owned Subsidiary Company

Foreign companies can also to set up wholly owned subsidiary in sectors where 100%

foreign direct investment is permitted under the FDI policy.

Incorporation of Company

For registration and incorporation, an application has to be filed with Registrar of

Companies (ROC). Once a company has been duly registered and incorporated as an

Indian company, it is subject to Indian laws and regulations as applicable to other

domestic Indian companies.

2) As a Foreign Company

Foreign Companies can set up their operations in India through

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Liaison Office/Representative Office 

Project Office 

Branch Office

Such offices can undertake any permitted activities. Companies have to register

themselves with Registrar of Companies (ROC) within 30 days of setting up a place of

business in India.

Liaison office/ Representative office

Liaison office acts as a channel of communication between the principal place of

business or head office and entities in India. Liaison office cannot undertake any

commercial activity directly or indirectly and cannot, therefore, earn any income in India.

Its role is limited to collecting information about possible market opportunities and

providing information about the company and its products to prospective Indian

customers. It can promote export/import from/to India and also facilitate

technical/financial collaboration between parent company and companies in India.

The approval for establishing a liaison office in India is granted by the Reserve Bank of

India (RBI).

Project Office

Foreign Companies planning to execute specific projects in India can set up temporary

project/site offices in India. RBI has now granted general permission to foreign entities

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to establish Project Offices subject to specified conditions. Such offices cannot

undertake or carry on any activity other than the activity relating and incidental to

execution of the project. Project Offices may remit outside India the surplus of the

project on its completion, general permission for which has been granted by the RBI.

Branch Office

Foreign companies engaged in manufacturing and trading activities abroad are allowed

to set up Branch Offices in India for the following purposes:

Export/Import of goods

Rendering professional or consultancy services

Carrying out research work, in which the parent company is engaged.

Promoting technical or financial collaborations between Indian companies and

parent or overseas group company.

Representing the parent company in India and acting as buying/selling agents in

India.

Rendering services in Information Technology and development of software in

India.

Rendering technical support to the products supplied by the parent/ group

companies.

Foreign Airline/shipping Company.

A branch office is not allowed to carry out manufacturing activities on its own but is

permitted to subcontract these to an Indian manufacturer. Branch Offices established

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with the approval of RBI may remit outside India profit of the branch, net of applicable

Indian taxes and subject to RBI guidelines Permission for setting up branch offices is

granted by the Reserve Bank of India (RBI). 

Branch Office on "Stand Alone Basis"

Such Branch Offices would be isolated and restricted to the Special Economic zone

(SEZ) alone and no business activity/transaction will be allowed outside the SEZs in

India, which include branches/subsidiaries of its parent office in India. No approval shall

be necessary from RBI for a company to establish a branch/unit in SEZs to undertake

manufacturing and service activities subject to specified conditions.

Policy

FDI up to 100% is allowed under the automatic route in all activities/sectors except the

following which will require approval of the Government:

• Activities/items that require an Industrial License;

• Proposals in which the foreign collaborator has a previous/existing venture/tie up in

India in the same. Prior Government approval for new proposals would be required

only in cases where the foreign investor has an existing joint venture, technology

transfer, trade mark agreement in the same field. With the amendment of the Press

Note 18, joint ventures formed with foreign investment before December 12, 2004

would be considered as “existing JVs” which will fall under the ambit of Press Note

18. The foreign partner in such JV has to obtain a No Objection Certificate (NOC)

from the Indian partner for starting new venture in India in the “same” field of activity.

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• All proposals relating to acquisition of shares in an existing Indian company by a

foreign/NRI investor.

• All proposals falling outside notified sectoral policy/caps or under sectors in which FDI

is not permitted.

FDI policy is reviewed on an ongoing basis and measures for its further liberalization

are taken. Change in sectoral policy/sectoral equity cap is notified from time to time

through Press Notes by the Secretariat for Industrial Assistance (SIA) in the Department

of Industrial Policy & Promotion. Policy announcement by SIA are subsequently notified

by RBI under FEMA.

Automatic Route

FDI Policy permits FDI up to 100 % from foreign/NRI investor without prior approval in

most of the sectors including the services sector under automatic route. FDI in

sectors/activities under automatic route does not require any prior approval either by the

Government or the RBI. The investors are required to notify the Regional office

concerned of RBI of receipt of inward remittances within 30 days of such receipt and will

have to file the required documents with that office within 30 days after issue of shares

to foreign investors.

The present Automatic Route allows Indian companies engaged in all industries except

for certain select industries/sectors to issue shares to foreign investors up to 100% of

their paid up capital in Indian companies. There are also some areas where though

Automatic Route is available, foreign investors cannot invest beyond a certain

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percentage of the paid up capital of the Indian companies or where investment is

subject to some other conditions.

Foreign investors have to, however, keep in mind that they may invest freely under the

Automatic Route described above but where such investment does not conform to

policies of Government of India, a specific approval from Government must be sought.

For example, there are Government guidelines on location of industrial units, or there

are certain items like explosives or liquor that need an industrial license.

Government approval route

All activities which are not covered under the automatic route, prior Government

approval for FDI/NRI shall be necessary. Areas/sectors/activities hitherto not open to

FDI/NRI investment shall continue to be so unless otherwise decided and notified by

Government.

An investor can make an application for prior Government approval even when the

proposed activity is under the automatic route.

Proposals requiring Govt’s Approval

Application for proposals requiring prior Govt’s approval should be submitted to FIPB in

FC-IL form. Plain paper applications carrying all relevant details are also accepted. No

fee is payable. The following information should form part of the proposals submitted to

FIPB: -

(a) Whether the applicant has had or has any previous/existing financial/technical

collaboration or trade mark agreement in India in the same or allied field for which

approval has been sought; and

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(b) If so, details thereof and the justification for proposing the new venture/technical

collaboration (including trade marks).

(c) Applications can also be submitted with Indian Missions abroad who will forward

them to the Department of Economic Affairs for further processing.

(d) Foreign investment proposals received in the DEA are placed before the Foreign

Investment Promotion Board (FIPB) within 15 days of receipt. The decision of the

Government in all cases is usually conveyed by the DEA within 30 days.

FDI Prohibited

FDI is not permissible in the following cases

i. Gambling and Betting, or

ii. Lottery Business, or

iii. Business of chit fund

iv. Nidhi Company

v. Housing and Real Estate business (to a certain extent has been opened. For details

please see note on Construction)

vi. Trading in Transferable Development Rights (TDRs)

vii. Retail Trading (discussions are being held to open this area-B2B and Cash & Carry

are permitted)

viii. Atomic Energy

ix. Agricultural or plantation activities or Agriculture (excluding Floriculture, Horticulture,

Development of Seeds, Animal Husbandry, Pisiculture and Cultivation of

Vegetables, Mushrooms etc. under controlled conditions and services related to

agro and allied sectors) and Plantations(other than Tea plantations)

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Determinants of Foreign Direct Investment

One of the most important determinants of foreign direct investment is the size as well

as the growth prospects of the economy of the country where the foreign direct

investment is being made.

It is normally assumed that if the country has a big market, it can grow quickly from

an economic point of view and it is concluded that the investors would be able to make

the most of theory investment in that country.

 The population of a country plays an important role in attracting foreign direct

investors to a country. In such cases the investors are lured by the prospects of a huge

customer base.

If the country has a high per capita income or if the citizens have reasonably good

spending capabilities then it would offer the foreign direct investors with the scope of

excellent performances. 

The status of the human resources in a country also helps in attracting direct

investment from overseas.

If a country has plenty of natural resources it always finds investors willing to put their

money in them.

Inexpensive labour force is also an important determinant of attracting foreign direct

investment.

Infrastructural factors like the status of telecommunication and railways play an

important role in having the foreign direct investors come into a particular country.

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Advantage of FDI

Causes a flow of money into the economy which stimulates economic activity 

Employment will increase 

long run aggregate supply will shift outwards 

Aggregate demand will also shift outwards as investment is a component of

aggregate demand 

It may give domestic producers an incentive to become more efficient 

The government of the country experiencing increasing levels of FDI will have a

greater voice at international summits as their country will have more

stakeholders in it.

Disadvantages   of FDI

FDI has adverse effects on competition.

FDI will be make the host country lost the control over domestic policy.

Certain foreign policies are adopted that are not appreciated by the workers of

the recipient country

Another disadvantage of foreign direct investment is that there is a chance that a

company may lose out on its ownership to an overseas company.

Local market is affected badly

If there is a lot of FDI into one industry e.g. the automotive industry then a

country can become too dependent on it and it may turn into a risk that is why

countries like the Czech Republic are "seeking to attract high value-added

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Problems of Foreign Capital or why .Too services such as research and

development (e.g.) biotechnology)" 

Why India Gets Limited FDI

Image and Attitude: There is a perception among investors that foreign businesses are

still treated with suspicion and distrust in India.

Domestic Policy: While the FDI policy is quite straightforward and getting increasingly

liberalized for most sectors, once an investor establishes his presence, “national”

treatment means that this investor is subject to domestic regulations, which are

perceived as being excessive.

Procedures. Although approval for investment is given quite readily, actual setting up

requires a long series of further approvals from central, state and local authorities. This

introduces substantial implementation lags.

Quality of infrastructure. Foreign investors are concerned about a number of

problems with the infrastructure sector – in particular, electricity and transport. Irregular

and undependable supply complicates problems for foreign investors.

State government level obstacles. This issue is tied up with one of the most pressing

agenda items for reform. At the level of actual investment the practices of state (and

often lower levels) governments become important. There is widespread agreement

among most observers that state government practices in issues such as land records,

utility (power, water etc.) connections, providing clearances of various sorts may make

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an important difference in the time it takes to get a plant up and running. Differences in

state practices in such matters partly explain the disproportionate flow of FDI to some

states in the peninsular region of India. In addition, there are some fiscal barriers to

unimpeded flow of goods and services within the country, although the level of such

barriers has come down in recent times.

Delays in legal process. Despite a highly structured legal system, dispute settlement

and contract enforcement are time consuming activities in India. Such apprehensions

deter the rapid flow of foreign investment.

Conclusion

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FDI provides India with stability in inflow of funds, access to international markets,

export growth, transfer of technology and skills and improves balance of payments.

More FDI does not necessarily guarantee high growth rates. The relative emphasis

must shift from a broad (scatter shot) approach to one of targeting specific companies in

specific sectors. Socially responsible FDI should be encouraged through the

development of national and international investment guidelines and regulations.

FDI is beneficial to India’s growth and India’s growth is beneficial for FDI. India needs to

create a talent pool suitable for the investors and it needs to develop infrastructure that

will encourage the investors. These steps taken by India to bring FDI will also help India

to grow on its own. FDI if monitored and nurtured in such a way that it will bring more

skills and resources to India will be mutually beneficial.

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