Global Services-10!11!12 Prof. Tarun Das

8/9/2019 Global Services-10!11!12 Prof. Tarun Das

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Global Services- Lectures 10-11-12Foreign Direct Investment inIndia - Policies and Prospects

Presented by

Prof. Tarun Das, IILM, New Delhi.Formerly, Economic Adviser, Ministry of Finance


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FDI Policies - Tarun Das 2

CONTENTS

1. Advantages of FDI

2. Types of FDI

3. Host country policies

4. Home country policies

5. FDI regime in India6. FDI in services production,investment and trade


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1.1 Summary Results of Studies

Report of the UNCTAD Ad-Hoc Working

Group on Non-debt Creating Financial Flows1993-1995 (Author was a member of the WG).

Study on Foreign Investment, TechnologyTransfer and Growth Nexus in Asian Economies,

by the author as Consultant to UN-ESCAP,1999. Study on Globalisation and IndustrialDiversification in Asian Countries, by the authoras Consultant to UN-ESCAP, 2002.

Studies on Foreign Investment by ICRIERand IIFT during 1995-1999 (Author was aMember of the Advisory Committees).

Other studies on FDI by the author.


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1.2 Advantages of FDI

FDI facilitates global integration, industrial

diversification, privatization, infrastructure deve-lopment, technology upgradation, and acts asan engine of external trade and overall growth.

Unlike other capital flows, FDI is a package

that embodies capital along with technology andmanagerial, marketing and technical skills.

Presence of multinationals promotes greaterefficiency and dynamism in the domestic sector

and widens external trade. Training gained by local employees and theirexposure to modern organizational system andinternational best practices are valuable assetsfor the host country.


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1.3 Advantages of FDI FDI is a non-debt creating financial flow and

is preferred to other forms of capital flows. External debt has attendant problems of repayment of principal and payment of interestcharges, which may create problems in case the

project becomes non-viable due to market risk. Example: East Asian crisis in 1998-1999.

Foreign institutional investment is alsovolatile and can be withdrawn in the case of

economic, financial, foreign exchange crisis. FDI does not face any such problems, thereis repatriation of dividends only when theproject is profitable.


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1.4 Types of capital flows Bonds

External Loans from commercial banks Financial derivatives- commercial papers andnote issuance, interest rate and exchange rateswaps, options and futures etc.

Foreign direct investment- equity sharingand participation in management

Portfolio investment- buying of shares

Quasi equity investment- joint ventures,licensing agreements, franchising, managementcontracts, turnkey contracts, production sharingand international subcontracting.


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1.5 Costs and Risks in different typesof capital flows

Modes of Expected Risk- Managerialcapital flow Cost Sharing Participation

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Bond Lending Low Low LowBank loans High Low Low

Derivatives Low Low Low

FDI Low Medium High

Portfolio Medium High Medium

Quasi-Equity Medium High Medium

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1.6 Advantages of FDIover other capital flows

FDI is a non-debt creating financial flow anddoes not have the attendant obligation fordebt servicing (repayment of principal andpayment of interest charges) as in the case ofexternal debt.

Only indirect cost in the form of increasingdividend remittances and import intensity,

which are much less than debt servicecharges.


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Consumer Benefits

- Price, quality and variety- FDI players are better equipped to invest in

difficult and remote markets and developproducts and services better adapted to

consumers- More and more countries can hope todevelop comparative advantages in newsectors. As FDI currently is more marketseeking than efficiency seeking , offereing

opportunities to any country willing to openits market or integrate with its neighbours.


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2.1 Types of FDI Market seeking- to take advantage of hugedomestic markets in host countries

Resource exploiting- driven by availability ofmineral and other resources

Export enhancing- to shift production base totake advantage of low wage rates but technicalmanpower and availability of resources

Efficiency enhancing through technology

transfer and infrastructure development


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2.1 Host Country Policies FDI inflows are determined by a complex setof economic, political and social factors.

Foreign investors look beyond the array offiscal incentives offered by the host country.

FDI is attracted by sound macro-economicpolicies, stable economic systems, sustainedhigh growth,liberalisation of trade, investmentand industry, particularly by liberal FDI regimes.

Full currency convertibility, free repatriation,less performance criteria, tax holidays and otherincentives, abolition of screening requirements,relaxation of sectoral limits on foreign equity.


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2.2 Other Factors Attracting FDI Domestic market potentials

Low wage rates Low transactions costs

High rates of return

Labour mobility

Matured capital market Modern financial system

Efficient infrastructure

Established legal and institutional set-up Transparent rules and regulations

Administrative speed and efficiency

Special economic zones, EPZs etc.


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2.3 Other Factors Attracting FDINational treatment to foreign investors

Most favored nation treatment (MFN)Free transfer of profits and dividends

International standards for laws

International arbitration in the case of disputesProtection of intellectual property rights (IPR)

Right to employ management of its choice

The formation of regional trading blocks such

as NAFTA, ASEAN, APEC, SAARC etc. had alsoan important impact on the FDI pattern

In future, countries outside the regional blocksmight have disadvantages in attracting FDI.


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2.4 Foreign Investors Dislike Most Any screening of investment except fornational security, public health, individualsafety, and environmental protection.

Performance requirements such as exportorientation, local content, value addition, foreign

exchange, as these distort international tradeand investment flows, and result in diminishedreturns to both home and host countries.

Since 1980, countries that guaranteed full

repatriation of profits attracted 95% of foreigninvestment, countries adhering to Convention ofSettlement of Investment Disputes attracted90% of foreign investment from USA.


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2.5 Role of Fiscal Incentives Fiscal and other incentives remain an

important part of a countrys investment promotion package, and can tilt the balance ininvestors location choices, particularly for

footloose industries such as automobiles andfood processing industries.

Incentives play, however, only a minor rolefor FDI and attract only those fly-by-nightfirms, which exist on exploitation of incentives.

As incentives represent substantial economiccosts, a rational, efficient, equitable andinternationally competitive tax system is moreconducive to FDI than fiscal incentives.


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3.1 Home Country Policies Few developing countries have paid

due attention to outward FDI policies byliberalizing outward capital flows.

There is a need to liberalize furthercapital markets and foreign exchangeregulations to move towards full capitalaccount convertibility.

Liberalisation of policies for

institutional investors such as insurance,pension and provident funds could lead toa multiple increase of foreign investment.


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4.1 FDI Regime in India

Since 1991 India adopted an open door policyand welcomed FDI in most areas.

Foreign investment is not allowed in:

- Chit fund

- Nidhi company

- Agriculture and plantation

- Real estate or construction of farm houses- Trading in Transferable DevelopmentRights


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4.2 FDI is not permissible in Indiain the following activities:

Retail tradingAtomic energyLottery businessGambling and betting

Housing and real estateAgriculture (except floriculture, develop-ment of seeds, animal husbandry,pisiculture and cultivation of vegetablesand mushrooms etc.) and Plantations(except tea plantations).


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4.3 Factors affectingFDI Inflows in India

Fourth largest economy in terms of PPPadjusted GDP after USA, China and Japan One of ten fastest economies of the world Largest pool of technical manpower

Demographic dividend- youngest workforce Rich in mineral and natural resources Major country in agrl and industrial products Fiscal incentives and investment environment

Low wage rates and low production costs High Return and Huge domestic market Well developed banking and capital markets Dynamic private sector


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4.4 Incentives for Investment

Various incentives by Centre and

States. These are equally applicable toboth domestic and foreign companies.

Tax holidays up to 15 years for

backward regions and infrastructure. Incentives for exporters, R&D, SEZs,

EPZs, Science and Technology Parks.

States provide capital subsidy, taxbreaks or deferment, concessionalland, power and utility tariffs.


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4.5 Incentives for FDI Nationality treatment MFN Treatment

No expropriation of capital Free expatriation of foreign equity Rupee fully convertible on current account Fully convertible on capital account for

foreign investors. FERA replaced by FEMA. Foreign companies can own real estate,

and use their trade marks and brand namesfor domestic sales.

India is a member of the MultilateralInvestment Guarantee Agency (MIGA) andhas signed comprehensive treaties foravoidance of double taxation with 66countries, and FTA with many countries.


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4.6 Sectoral Distribution of FDI (%)Sectors FDI outstanding at end

March 1990

FDI approvals during

Aug 1991- Aug 2003

1. Plantation & agriculture 9.5 1.4

2. Mining 0.3 0.13. Power 0.1 16.5

4. Manufacturing 84.9 50.4

y Petroleum 0.1 10.5

y Food processing 6.0 3.3

y Textiles 3.4 1.2

y Transport equipment 10.5 5.6

y Machinery & machine tools 13.1 2.6

y Metals and its products 5.2 5.4

y Electrical goods 10.9 9.9

y Chemicals & allied products 28.4 8.4

y Others 7.5 3.5

5. Services 5.2 32.4

(a) Financial services & real estate na 6.4(b) Telecommunications na 19.8

(c) Transport na 1.9

(d) Hotels and retail trade na 2.7

(e) Consultancy services & others na 1.6

Total 100 100


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4.8 Share of Indian States in FDI in 1991-2003States Percentage share1. Maharashtra 17.32. Delhi 12.03. Tamil Nadu 8.64. Karnataka 8.3

5. Gujarat 6.56. Andhra Pradesh 4.67. Madhya Pradesh 3.28. West Bengal 3.2

9. Orissa 2.910. Uttar Pradesh 1.711. Rajasthan 1.0


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4.9 FDI Inflows as % of World FDI

Country 1990 1995 2000India 0.1 0.7 0.2China 1.7 10.9 3.2Hong Kong 0.9 2.7 5.1Korea, Rep. 0.4 0.5 0.8Malaysia 1.1 1.3 0.4Philippines 0.3 0.4 0.1

Singapore 2.7 2.2 0.4Thailand 1.2 0.6 0.4


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4.10-A FDI Inflows as % of GDI

Country 1984-1989 1990 2004

India 0.1 0.1 3.4China 1.8 2.6 8.2Hong Kong 12.2 8.5 92.1

Indonesia 1.6 2.8 1.9

Korea, Rep. 1.4 0.8 3.8Malaysia 8.8 23.8 23.4Philippines 5.1 5.2 3.3

Singapore 28.3 47.1 62.7Taiwan 3.3 3.8 3.1

Thailand 4.4 7.1 2.5


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4.10-B FDI Outflows as % of GDI

Country 2002 2003 2004

India 1.0 0.7 1.4China 0.5 - 0.2Hong Kong 47.6 15.9 107.6

Indonesia 0.5 - 0.2

Korea, Rep. 1.6 1.9 2.4Malaysia 8.6 6.0 8.5Philippines 0.4 1.5 2.9




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4.11-A FDI Inward Stock as % of GDP

Country 1980 1990 2004

India 0.7 0.6 5.9China 3 7 14.9Hong Kong 487 218 277.6

Indonesia 14 34 4.4Korea, Rep. 2 2 8.1Malaysia 21 24 39.3

Philippines 4 7 14.9

Singapore 53 77 150.2Taiwan 6 6 12.8

Thailand 3 10 29.7


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4.11-B FDI Outward Stock as % of GDP

Country 1990 2000 2004

India 0.0 0.4 1.0China 1.3 2.6 2.4Hong Kong 15.9 234.9 246.5

Indonesia 0.1 4.6 0Korea, Rep. 0.9 5.8 5.8Malaysia 6.1 23.6 11.7

Philippines 0.3 2.1 1.9




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5.1 Impact of FDI on Indian Economy

- FDI inflows are more of tariff jumpingand market seeking rather thanefficiency seeking or export driven

- 40 percent of FDI inflows went into

acquisition of gross fixed assets such asplant and machienery.Increase in Exports

- Export as a proportion of sales amonga sample of 450-odd (FDI) controlledfirms in India was just 11.6 percent.


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Infrastructure and technology transfer- More through merger and acquisition (M&A)route to increase its share in the Indianmarket rather than greenfield investment toestablsh new industrial and service units.

- A study by Nagesh Kumar ofRIS states that40 percent of FDI in India came throughM&A route to take over Indian companies,increase control in existing subsidiaries byissuing shares at low cost or buy back sharesand de-list from stock exchanges.

Less or limited ripple effect of the technologytransfer that the FDI is supposed to bringacross a large economy.


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- Increased productive and managerial

efficiency due to competition from multilateralsubsidiaries.

- Studies of Clive Harris(2003) and McKinseyGlobal Institute(2003) indicated that FDI has

a significant positive impact on productivityand coverage of services, particularly financialand telecommunications.

- In sectors like automotive, telecom andfinancial services, increased competition and

investments have resulted in an increase inoutput and employment, fall of prices, widerange of products and rise of quality.


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6.1 Policy Issues for Foreign Investment

Liberalisation of labour laws and labourmarkets to enhance labour mobility

Simplification of land laws and regulations Unbundling and sharing of risks Rationalisation of user charges

Strengthening of capital markets Development of municipal bonds Strengthening Regulatory, legal and

institutional set up

Strengthening of Public-Private Partnership Improvement of model BOT legislation Separation of policy makers, regulators and

operators


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6.2 Sectoral Policies and Regulation

Locational, safety and environmentalregulations are necessary for the efficientfunctioning of industry.

Simplification of excessively detailed,

outdated and complicated regulations forutilities, petroleum sector, banking andinsurance, transport and telecommunications.

Reduction, simplification, and greatertransparency of the rules and procedures andfurther reduction of the bureaucraticintervention are needed to attract moreforeign investment.


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6.3 Minerals including oil and gas

Mineral industries, including petroleum andgas, create particular problems for privateinvestment because resource rents have tobe divided between local landowners, theStates and the central governments.

Private firms also seek a share of such rentsto compensate for the risk of mineralexploration & subsequent mine development.

The efficient and equitable apportioning of

mineral rents is thus an important aspect ofthe economic policy framework for attractingprivate investment including FDI.


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6.4 Minerals including oil and gas

Indian states impose cess and royalties onminerals to raise resources.

Minerals and power have also environmental

aspects that should be taken into account whileallowing private investment.

Indonesia and Malaysia have been amongworld leaders in dealing with foreign investment

in petroleum, gas and other minerals.


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6.5 Agriculture and plantation

Agriculture and real estate present difficulties

for foreign investment because ofcomplexities of landownership, rules andtaxes regarding tenancy, sale, purchase,transfer, lease or mortgage.

Because of these problems, India like manycountries, does not allow foreign investmentin agriculture and real estate.

However, in the case of plantation, foreigninvestment in nucleus estates and processing

facilities can provide a market for farmersand at the same time enable them to improvetheir productivity.


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6.6 Water supply and sanitation

Water is a merit good with many positive health

and environmental spillovers. Under UN-Millennium Development Goals,

Government is committed to provide universalaccess to the minimum daily requirement of safe

water, but this may require subsidies. Water distribution pipes are a monopoly networkof the local government and many water andsanitation systems are buried.

These factors complicate the transfer of water

distribution to private sector.


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Scope of unbundling the water sector is notclear with limited potential for competitionamongst bulk water service providers becausethe main water sources in municipalities arelocation specific and limited in number.

Operational costs of providing the raw resource

are relatively low compared with sunk capitalcosts in pipes, dams and treatment stations. Efficiency gains in water supply come from

increased trade amongst water users andreduced distribution losses rather than

competition amongst suppliers. In the case of water supply, organizational

restructuring, corporatization and unbundling ofrisks should precede full private participation.


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Resource management functions such ascatchment planning should be separated fromcommercial functions of service delivery.Government should be responsible for the formerwhile private operators can compete for the latter.

Govt. should own water pipe and sewerage

network while private operators lease long-termrights to use pipelines and collect revenues fromservice delivery.

Private operators have incentives to reduce water

losses and costs, expand consumer connectionsand to improve services to the consumers.


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6.9 Water supply and sanitation It is necessary to develop private property

rights and commercial law, to establish clearaccounting and environmental standards,transparent legal and regulatory system, andintroduce specific BOT legislation for private

investment in utilities. Tariff reform is equally fundamental to

improve utility efficiency and delivery.

While private operators should bearconstruction, commercial and operation costsand risks, government should bear thesovereign risks.


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7. Concluding Remarks As the first generation reforms take root

and second generation reforms unfold,India is emerging as a favouritedestination for foreign investment, anda land of immense opportunity for all.

India should maintain its open doorpolicy in goods and services production,investment and trade.

Carried to their logical ends, reformswould make India as one of the most

dynamic and fastest growing economiesof the by 2010.

India is an economic miracle waiting tohappen.


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8.1 Review Questions1. What are the special advantages of Foreign

Direct Investment(FDI) over other forms ofexternal capital flows?

2. (a) Discuss broad types of FDI.(b) Which one is the dominant type of FDIflows to India and what are main reasons

for that?(c) Indicate the major sources of FDIinflows to India.(d) Which are the major sectors attractingFDI to India?

3. (a) Discuss the general host country andhome country policies attracting foreigninvestment.(b) discuss relative merits and demerits offiscal incentives for attracting FDI.


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8.1 Review Questions

4. (a) Discuss policies, strategy and regulatoryregime for foreign investment of India.(b) What has been their impact on he Indianeconomy?

5. (a) Discuss the strengths and weaknesses of

the Indian economy for attracting FDI.(b) Discuss special problems for attractingFDI in agriculture and plantation, mineralsincluding oil and gas, power generation,water supply and sanitation.


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Thank you

Have a Good Day

Global Services-10!11!12 Prof. Tarun Das

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