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CHAPTER II
CONCEPTS AND REVIEW OF LITERATURE
In any research work, certain concepts are repeatedly used.
The scholar must be familiar with the concepts related with the area
of her interest. Going through related literature gives an idea of the
basic concepts used in the study area. In this chapter an attempt is
made to review some of the studies already made in related area.
This chapter begins with definitions of important concepts used in this
study.
CONCEPTS
Some of the important concepts used in the present study are
defined here.
Foreign Capital Inflow Foreign capital inflow is defined as a movement of capital into
a country in the form of securities trading, the acquisition of
companies and loans by foreign companies.1
Foreign Investment
Foreign investment is the investment in the domestic economy
by foreign individuals or companies. Foreign investment takes the
26
form of either direct investment in productive enterprises or
investment in financial instruments, such as a portfolio of shares.2
Foreign Direct Investment (FDI) Foreign Direct Investment is defined as a form of long-term
international capital movement made for the purpose of productive
activity and accompanied by the intention of managerial control or
participation in the management of a foreign firm.3
Foreign Investment Promotion Board (FIPB)
The Government of India has set up a special Board known as
the Foreign Investment Promotion Board. This specially empowered
Board in the office of the Prime Minister, is the only agency dealing
with matters relating to foreign direct investment as well as promoting
investment into the country.4
Reserve Bank of India (RBI)
The Reserve Bank of India is the central banking system of
India and it acts as the bank of the national and state governments.
This institution was established on 1 April 1935 during the British-Raj
in accordance with the provisions of the Reserve Bank of India Act,
1934. It formulates, implements and monitors the Monetary Policy.5
27
Non – Resident Indian (NRI) Deposits Non-Resident Indian (NRI) deposits are a major source of
capital inflow into India. Indian nationals and persons of Indian origin,
residing abroad can open bank accounts in India freely out of funds
remitted from abroad or foreign exchange brought in India or out of
funds legitimately due to them in India.6
Equity Capital Equity capital covers equity in branches, shares in subsidiaries
and associates and other capital contributions that constitute a part of
the capital of direct investment enterprise. Equity capital also covers
the acquisition by a direct investment enterprise of shares in its direct
investor.7
Reinvested Earnings Reinvested earnings comprise the direct investor’s share (in
proportion to direct equity participation) of earnings not distributed as
dividends by affiliates or earnings not remitted to the direct investors.
Reinvested earnings are considered to be additional capital of the
direct investment enterprises.8
Other Capital Other capital covers the borrowing and lending of funds,
including debt securities and trade credits, between direct investors
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and direct investment enterprises, and between two direct investment
enterprises resident in different countries that share the same direct
investment.9
Limited Liability Partnerships (LLPs)
Limited Liability Partnerships is a business set up that
combines the benefits of limited liability while retaining the flexibility in
operations of a partnership firm.10
Repatriation
Repatriation means return of financial assets deposited in a
foreign bank or foreign branch of a domestic bank to a home country.
Repatriation of assets denominated in a foreign currency may be
impeded by exchange controls limiting the ability of residents of
another country to transfer assets.11
Foreign Portfolio Investment Foreign portfolio investments are purely financial assets, such
as bonds, denominated in national currency. With bonds, the investor
simply lends capital to get fixed payouts or a return at regular
intervals and then receives the face value of the bond at a pre-
specified date.12
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Foreign Portfolio Investment is the entry of funds into a country
where and foreigners make purchases in the country’s stock and
bond markets, usually for speculation.13
Global Depository Receipts (GDRs)
Global Depository Receipt (GDR) is a certificate issued by
International Bank, which can be subject of worldwide circulation on
capital markets. GDRs are issued by banks, which purchase shares
of foreign companies and deposit it on the accounts. Global
Depository Receipt facilitates trade of shares, especially those from
emerging markets. Prices of GDR's are often close to values of
related shares.14
American Depositary Receipts (ADRs) American Depository Receipts popularly known as ADRs were
introduced in the American market in 1927. ADR is a security issued
by a company outside the U.S. which physically remains in the
country of issue, usually in the custody of a bank, but is traded on
U.S. Stock Exchanges. In other words, ADR is a stock that is traded
in the United States but represents a specified number of shares in a
foreign corporation.15
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Foreign Institutional Investor (FII) Foreign institutional investor is an investor or investment fund
that is registered in a country outside the one in which it is currently
investing. Institutional investors include hedge funds, insurance
companies and mutual funds.16
Offshore Funds An offshore fund is a collective investment scheme domiciled in
an offshore financial centre and typically sold exclusively to foreign
investors.17
Overseas Corporate Body (OCB)
Overseas Corporate Body (OCB) means a company,
partnership firm, society and other corporate body owned directly or
indirectly to the extent of at least 60 per cent by Non Resident Indians
and includes overseas trust in which not less than 60 per cent
beneficial interest is held by Non Resident Indians directly or
indirectly but irrevocably.18
External Commercial Borrowing (ECB) External Commercial Borrowing refer to the loans floated by
the financial institutions and the public sector undertakings in the
external commercial market. Thus, external commercial borrowing
are defined to include loans from commercial banks and other
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financial institutions, suppliers, credits, bonds and loans from semi-
government export credit agencies, IFC, DEG Germany, CDC and
U.K. These loans are procured at the market rate of interest.19
Commercial Bank Loans
A basic commercial bank loan is called a bank term loan. A
bank term loan has a particular term or length of maturity and usually
a fixed interest rate. The repayment of the principal of bank term
loans are usually amortised, which means that the principal and
interest are set up as periodic payments designed to pay-off the loan
in a certain period of time.20
Foreign Currency Convertible Bonds (FCCBs)
FCCB is a foreign currency denominated quasi-debt instrument
which can be converted into equity in accordance with a pre-
determined formula or may be retained as a bond as per the
investor’s choice.21
Self-Liquidating Loans It is a loan used to finance the purchase of assets intended to
be sold within a short period of time. For example, a company may
use a self-liquidating loan to pay for its inventory, which it intends to
sell quickly. It is called a self-liquidating loan because the proceeds
32
from the sale of the assets provide the capital with which the debtor
may repay the loan.22
External Assistance
It refers to the assistance to foreign nations ranging from the
sale of military equipment to donations of food and medical supplies
to aid survivors of natural and man made disasters. US assistance
takes three forms development assistance, humanitarian assistance
and security assistance.23
Loans
A loan is a type of debt. Like all debt instruments, a loan entails
the redistribution of financial assets over time, between the lender
and the borrower. In a loan, the borrower initially receives or borrows
an amount of money, called the principal, from the lender, and is
obligated to pay back or repay an equal amount of money to the
lender at a later time. Typically, the money is paid back in regular
installments or partial repayments.24
Grants The grants are defined as ‘something for nothing’ to the
recipient country.25
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Foreign Aid Foreign aid refers to the transfer of resources at concessional
terms and conditions from the donor countries and multilateral
institutions to the recipient under developed countries.26
Debt Service Payments The series of payments of interest and principal required on a
debt over a given period of time is termed as debt service
payments.27
Amortisation
Amortisation is the distribution of a loan repayment into
multiple cash flow installments, as determined by an amortisation
schedule. Unlike other repayment models, each repayment
installment consists of both principal and interest. Amortisation is
chiefly used in loan repayments and in sinking funds. Payments are
divided into equal amounts for the duration of the loan, making it the
simplest repayment model. A greater amount of the payment is
applied to interest at the beginning of the amortisation schedule,
while more money is applied to principal at the end.28
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Review of Literature A researcher must update knowledge about the studies related
to her own problem already made by others. For any worthwhile
study the researcher needs an adequate familiarity with the library
and its resources.
A survey of related literature not only forms one of the early
chapters of the thesis, but also serves other useful purposes. A brief
summary of the previous research and writings of recognised experts
provides evidence that the researcher is familiar with what is already
known and with what is still unknown and untested. This step helps to
eliminate the duplication of what has been done and provides
suggestions for significant investigation. The literature in any field
forms the foundation upon which all future work will be built.
The key to the vast store house of published literature may
open doors to sources of significant problem and explanatory
hypothesis and provide helpful orientation for definition of the
problem, the background for selection procedure and comparative
data for interpretation of results. The review of literature is a crucial
aspect of the planning of the study. The review of some studies on
the area of interest of the scholar is presented in this chapter.
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Foreign Capital Suresh K. Chadha (2000)29 indicates that, foreign capital is the
engine of economic development and this statement is gaining
importance in recent times. Traditionally, the various sources of
capital for developing countries were either the demand for their
output by industrial countries, or foreign aid, or loans from foreign
banks, or foreign direct investment. This is considered to be the major
source of fund which may contribute considerably to growth rate of
the developing countries. Trans National Corporations (TNCs)
account for two-thirds of the world trade in services and goods. The
government policy since 1991 has been aimed at encouraging
foreign investment particularly, in core and infrastructure sectors and
in other wide ranging activities, such as chemicals, food processing
industries, metallurgical industries, etc. In order to provide a level
playing field to the domestic industry and to protect national interests,
several measures have been initiated to attract foreign investment in
the form of dividend balancing, foreign equity neutrality, foreign equity
capital etc. based on sectorial sensitivities.
Veena Pailwar (2001)30 states that, capital formation plays an
important role in the process of development. However, in the initial
stages of development, developing countries are unable to generate
36
sufficient resources over and above their consumption requirement
and therefore the level of investment remains low in these countries.
To overcome the vicious circle of low capital formation and low
growth, developing countries seek to look for help from external
sources. Foreign capital, by supplementing internal resources fills the
resource gap of developing countries. However, even when internal
resources are sufficient for the development needs of a country,
foreign capital is essential as improved machinery and technology
and imported raw-material can only be bought by paying in terms of
foreign exchange. Thus besides filling the resource gap, foreign
capital fills the foreign exchange gap of developing countries.
Renu Kohil (2003)31 reveals that, the last decade has
witnessed a tremendous increase in international capital mobility.
Cross-country trends in capital flows reveal that private capital flows
now dominate the official capital. It has tilted the composition of
international capital flows towards short-term investments, exposing
individual countries to enhanced volatility and sudden withdrawal
risks. These trends have been driven by globalisation, which has
enabled pursuit of higher returns and portfolio diversification, as well
as market-oriented reforms in many countries, which have liberalised
access to financial market.
37
Foreign Investment
Kutty Krishnan Nambiar (2005)32 mentions that, foreign
investment implies the flow of investment funds, from countries where
the capital is relatively abundant, to countries where capital is
relatively scarce. In other words, it moves from countries with low
marginal productivity of capital to countries where marginal
productivity of capital is high.
Foreign Direct Investment (FDI) Bhalla, V.K., (2003)33 states that, foreign direct investment is
one of the most dynamic resources to the developing countries.
Foreign direct investment flows are particularly important because
foreign direct investment is a package of tangible and intangible
asset.
Ruddar Datt (2003)34 reveals that, foreign direct investment
flows are usually preferred over other forms of external finance
because they are non-debt creating, non-volatile and their returns
depend on the performance of the projects financed by the investors.
Bhatt, P.R., (2008)35 points out that, foreign direct investment
is an investment involving a long-term relationship and reflecting a
lasting interest and control by a resident entity in one country (foreign
direct investor or parent enterprise) in an enterprise resident in an
38
economy other than that of the foreign direct investor (FDI enterprise
or affiliate enterprise or foreign affiliate). Foreign direct investment
implies that the investor exerts a significant degree of influence on
the management of the enterprise in the other country.
Kamaraj, C., (2009)36 states that, foreign direct investment is
any form of investment that earns interest in enterprises which
functions outside the domestic territory of the investor. Foreign direct
investment requires a business relationship between a parent
company and its foreign subsidiary. For an investment to be regarded
as foreign direct investment, the parent firm needs to have at least 10
per cent of the ordinary shares of its foreign affiliates. The investing
firm may also qualify for an foreign direct investment if it owns voting
power in a business enterprise operating in a foreign country.
Foreign Portfolio Investment (FPI) Parthapratimpal (1998)37 points out that, during the late 1980s,
foreign portfolio investment to developing countries was perceived as
a symbiosis that benefited everyone. Less developed countries were
eager to welcome any kind of foreign capital inflow because after the
debt crisis of early 1980s, they were facing a shortage of both foreign
capital and invisible resources. The low correlation between
movements in developed and developing countrys’ stock markets,
39
the deceleration in industrial countrys’ markets and the high growth
prospects of the less developed markets made them an attractive
option for portfolio diversification. The most important benefit from
foreign portfolio investment is that it gives an upward thrust to the
domestic stock market prices. Foreign Institutional Investors (FIIs) are
the primary source of portfolio investment in India. FIIs can invest in
all the listed and unlisted securities traded on the primary and
secondary markets, including the equity and other securities-
instruments of companies. These would include shares, debentures,
warrants and schemes floated by domestic mutual funds.
Bhalla, V.K., (1999)38 indicates that, portfolio investment in
India takes a variety of forms such as investment by Foreign
Institutional Investors (FIIs), issue of Global Depository Receipts
(GDRs), abating of off shore funds by Indian Corporates aboard and
those under special investment schemes designed for Non-Resident
Indians. Portfolio investments have favourable implication for overall
market discipline and monitoring of economic fundamentals by both
the authorities and market players. These factors play a catalytic role
in attracting foreign portfolio investment.
Sanjay K. Hansda and Partha Ray (2002)39 are of the opinion
that, among the significant measures of integration, portfolio
40
investment by Foreign Institutional Investors (FIIs) allowed since
September 1992, has undoubtedly been the turning point for the
Indian stock market. Now FIIs are allowed to invest in all categories
of securities traded in the primary and secondary segments including
unlisted ones. FIIs are also allowed from June 1998 to trade in
exchange-traded derivatives and take forward exchange cover for
equity investment. While there is no restriction on the volume of FIIs
investment or any lock-in-period, preferential allotment to FIIs is
restricted to a maximum of 15 per cent equity of a company.
External Commercial Borrowing (ECB) Kalpana Rajaram (2004)40 states that, external commercial
borrowings are non-concessional borrowings at market rates with the
obligation of payment of the interest as well as the principal. A
number of changes were announced in June 1996 in ECB guidelines
governing the maximum borrowing limits and end-use restrictions.
External commercial borrowings act as window for resources
mobilisation
NRI Investments
Haja Shareeff, K.S.G., (1989)41 indicates that, the Government
of India has initiated a number of steps to augment inflow of
investment from Non-Resident Indians. To establish a continuous
41
dialogue with the NRI community, a committee on NRI matters has
been constituted in the Department of Economic Affairs. The
committee has representatives from government, trade and industry
and NRIs representing all the continents. This has so far held a
number of meetings with Non-Resident Indians both in India and
abroad. In order to provide prompt escort services to NRI
entrepreneurs, nodal officers have been designated in most of the
central ministries and also at state government level for NRI work.
Quarterly meetings of nodal officers are held to review problems in
implementation of industrial projects taken up by NRIs.
Sumanjeet (2009)42 states that, the NRIs are permitted to
acquire immoveable property (other than agricultural land, plantations
and farm houses) easily. There are no restrictions regarding the
number of such properties to be acquired. The only restriction is that
where the property is acquired out of inward remittances, the
repatriation is restricted to principal amount for two residential
properties. There is no such restriction in respect of commercial
property. NRIs are also permitted to avail housing loans for acquiring
property in India and repayment of such loans by close relatives.
42
Foreign Aid Kalpana Rajaram (2004)43 states that, the public bilateral/
multilateral development assistance is called foreign aid. It is different
from other private flows which are prompted by commercial
considerations of profits and rate of return. Foreign aid as any flow of
foreign capital to an underdeveloped country should be non-
commercial from the point of view of the donor, and the interest rate
and repayment period for borrowed capital should be softer than
commercial terms.
Foreign Loans Pragati Kapoor (2002)44 states that, getting loans from relatives
abroad is made easier by the Reserve Bank of India. The RBI has
also liberalized rules to enable residents to get foreign exchange for
medical treatment abroad without much loss of time. Earlier, Indian
residents had general permission to borrow up to $250,00 from their
close relatives living outside India provided the loan was interest free
and was not repayable before seven years. The seven years
moratorium was obviously a hurdle in obtaining loans from relatives
abroad. Following due representations, RBI has decided to reduce
the minimum period, after which such loans can be repaid in one
year. According to RBI’s spokesperson, Killawala, residents are now
43
able to borrow up to $ 250,000 from their close relatives residing
abroad.
Foreign Direct Investment and GDP Rajan Bharti Mittal (2010),45 President of the Federation of
Indian Chambers of Commerce and Industry (FICCI), stressed the
need to allow greater foreign direct investment in the country to
achieve 10 per cent GDP growth. He further stressed upon the need
to open up retail sector to more foreign direct investment. A retail
sector is a huge employment generator and it is a sector that needs
more foreign investment. He also states that Federation of Indian
Chambers of Commerce and Industry will focus on making India the
global investment destination with a target of US $75 billion FDI by
the year 2015. To reach this target FICCI will also undertake efforts
and advocate policy issues and changes needed therein to improve
the policy framework.
Determinants of Foreign Investment
Agarwal, R.N., (1997)46 indicates that, inflation rate, real
exchange rate, index of economic activity and the share of domestic
capital market in the world stock market capitalization are the four
statistically significant determinants of foreign portfolio investment.
44
Gopinath,T., (1997)47 indicates that, market size is the
important determinant of foreign capital inflow. Positive relationship is
postulated between the market size variable and the flow of foreign
investment. The high level of foreign exchange reserves in terms of
the import cover reflects the strength of the external payment position
and helps to improve the confidence of the prospective investors.
Negative relationship has been hypothesised between the rate of
inflation and the flow of foreign investment. It is postulated that Gross
Fiscal Deficit (GFD) and Debt Service Ratio (DBR) also have a
negative relationship with the flow of foreign investment.
Purna Chandra Dash (2000-2001)48 states that, the major
determinant of foreign direct investment in the host country is the FDI
policies which consists of rules and regulations governing the entry
and operations of foreign investors, the standard of treatment
accorded to them and the functioning of the markets within which
they operate. The other economic determinants of foreign direct
investment are availability of raw materials, low cost unskilled labour
and skilled labour, technological innovatory and other created assets
and physical infrastructure such as ports, roads, power and
telecommunication, income of the population, market growth, access
to regional and global markets, country-specific consumer
preferences and structure of market.
45
Arindam Banik, Pradip K. Bhaumik and Sunday O. Iyer
(2004)49 point out that, foreign direct investment flows are generally
believed to be influenced by indicators like market size, export
intensity, institutions etc. irrespective of the source and the
destination. This study looks at foreign direct investment inflows in an
alternative approach based on the concepts of neighbourhood and
extended neighbourhood. The study shows that the neighbourhood
concepts are widely applicable in different contexts-particularly for
China and India. Foreign direct investment inflow in the extended
intermediate neighbourhood has been facilitated significantly by
financial markets. The process of global financial integration has
been fuelled primarily by the liberalisation of markets. Capital inflows
to the extended intermediate neighbourhood has also been benefitted
from technological progress that improves the timeliness, accuracy
and analysis of information. Improved information and communication
technology have played major role in financial integration. Foreign
direct investment inflows to both the original and intermediate
neighbourhoods attained their peak at the end of the 1980s.
Jongsoo Park (2004)50 indicates that, in developing countries,
there has been a remarkable shift in attitude towards many aspects
of foreign investment. The Indian Government’s attitude towards
46
foreign investment has been changing in the Post-Independence
period. Industrial clusters are playing an important role in economic
activity. The key to promoting foreign direct investment inflows into
India may lie in industries and products that are technology-intensive
and have economies of scale and significant domestic content.
Investors in India
Rahulsen, Mukul G. Asher and Ramkishen S. Rajan (2004)51
reveal that, investment relation between ASEAN and India have until
now remained rather limited. Among the ASEAN countries, Malaysia
and Singapore have been the major investors in India. The findings of
a recent survey based on interviews with firms from Malaysia and
Singapore have suggested that ASEAN investors developed
relatively more positive attitude towards investing in India in the mid-
1990s. The survey indicated a high level of satisfaction among those
firms that decided to invest in India and many of them were
considering expansion or diversification of investment in India. This
emphasises the point that those who are able to change the mindset
and overcome their negative bias towards India will have positive
experience and more importantly, profitability of their Indian
operations.
47
Maathai K. Mathiyazhagan and Dukhabandhu Sahoo (2008)52
find out that, total foreign direct investment inflows into India reached
Rs.706.30 billion (US$15.73 billion) in 2006-2007, with the largest
share coming from Mauritius, followed by the United States, the
United Kingdom, the Netherlands and Singapore. The sectors that
received the largest share of total foreign direct investment inflows
between August 1991 and March 2007 were electrical equipment and
the service sector, accounting for 18.77 per cent and 17.84 per cent
of total foreign direct investment respectively.
Liberalisation and Foreign Capital
Radhakrishnan, K.G., and Jaya Prakash Pradhan (2000)53
point out that, the liberalisation policy of 1991 had a distinct impact in
boosting up the flow of foreign direct investment into the country.
Service sector attracts more amount of foreign direct investment.
There has been a continuous diversification of foreign direct
investment inflows and that indicates the expedited globalisation of
economy.
Prabha Shastri Ranade (2001)54 indicates that, after economic
liberalisation, India has been able to attract foreign capital in a bigger
way. The issues such as size, composition and determinant of foreign
capital inflows have developed considerable interest among scholars.
48
India aims at accelerating and strengthening industrial development
and attracting more foreign capital.
Nalini Praba Tripathi (2002)55 explains that, rapid development
of the capital market and financial liberalisation have brought a
profound change in perception of entrants in the capital market. The
large sum of foreign direct investment in the country is an obvious
outcome of India’s commitment to the process of liberalisation. India
has emerged as one of the most attractive investment markets in the
world. The Global Depositary Receipts issues of Indian companies
received an overwhelming response abroad.
Sahana Joshi and R.V. Dadibhavi (2008)56 state that, since
1991, the role of foreign direct investment in Indian economy is
increasing due to a number of measures undertaken to liberalise the
FDI policy and expand many economic areas to foreign capital which
were earlier closed. Following economic reforms, governments at the
state level are initiating measures to attract more financial resources
into the states. To attract foreign investors in their states, many of
them are offering incentive packages in the form of various tax
concessions, capital and interest subsidies, reduced power tariff etc.
49
Government Measures towards Foreign Capital
Sarda, D.P., (1998)57 points out that, in line with the industrial
policy announced by the Government of India on 24th July 1991,
several steps have been taken to encourage foreign investments. As
a result of the new policy, a large amount of foreign investment is
flowing into the country to finance new projects as well as
expansion/diversification/modernisation/rehabilitation projects of
existing companies. A wide range of facilities for making investments
in India have been provided to individuals of Indian nationality or
origin staying abroad (NRIs) and Overseas Corporate Bodies (OCBs)
predominantly owned by NRIs. Foreign Institutional Investors (FIIs)
are also permitted to invest in securities in primary and secondary
markets in India. Certain Indian companies have been allowed to
issue Global Depository Receipts (GDRs) and Foreign Currency
Convertible Bonds (FCCBs) in the international market.
Radhakrishnan, K.G., and Jaya Prakash Pradhan (2000)58
mention that, the Government of India has been taking several
measures to attract foreign direct investment into India. The
Government has set up a separate body. Foreign Investment
Promotion Board (FIPB) is created for the sole purpose of attracting
foreign direct investment into the nation. Its prime duty is to check the
process of applications for foreign direct investment which are not
50
covered in automatic route. Many other measures have also been
taken to facilitate foreign investment.
Veena Pailwar (2001)59 states that, for speedy approval of
various foreign direct investment proposals, Foreign Investment
Promotion Board (FIPB) has been set up. For reducing the time lag
between approval and implementation of these projects, Foreign
Investment Implementation Authority (FIIA) has been set up. Apart
from the various structural reform measures and regulatory changes,
the government is continuously evolving and implementing foreign
direct investment promotion measures. As part of these measures,
the government has opened up all sectors of the economy except
agriculture and plantation for foreign investors. Government of India
is following a more systematic export promotion approach in the
aftermath of balance of payment crisis of 1991-1992. The thrust
areas of the export promotion policies in the post 1991 period have
been exchange rate management, reduction in tariff and non-tariff
barriers, direct export incentives such as duty exemption scheme,
export promotion of capital goods scheme, special import licenses,
setting up of various types of technology parks, Export Processing
Zones and Special Economic Zones with special incentives to units in
these zones and various tax exemption schemes. The Ministry of
Commerce has also come out with the Medium Term Export Strategy
51
Document in 1997. Establishment of Export Processing Zones was
supposed to increase the inflow of foreign direct investment in these
areas and boost the export of the country.
Pulak Mishra and Ramakanta Prusty (2002)60 point out that, the
New Industrial Policy (NIP) of 1991 accords a much liberal attitude
towards foreign direct investment to exploit the opportunities for
promoting foreign investment in the form of simplification of
procedural rules and regulations and removal of entry barriers. These
measures have created a favourable environment for the foreign
investors. The new policy framework not only permits the firm to have
higher equity participation in their ventures in India, but also opens up
many new sectors to them that were earlier reserved exclusively for
the domestic firms.
Siddharthan, N.S., (2004)61 explains that, realising the benefits
of foreign direct investment flow in the development process of the
country the Government of India has adopted various structural
reform measures and made changes in the regulatory framework to
promote the flow of foreign direct investment to the country. Foreign
direct investment companies are also suffering from declining export
intensity of sales and increasing import intensity of exports. One of
the major challenges facing the country is to devise the mechanism to
52
improve export intensity of sales in general and foreign direct
investment companies in particular.
Ajit Kumar Sinha (2005)62 mentions that, the Government of
India has initiated major structural changes in its economic policy
since July 1991. The main aim of the policy is to make Indian industry
more competitive. These changes include some critical reforms in its
industrial policy, trade policy, policy towards financial markets and
institutions and towards foreign direct investment. The role of foreign
direct investment has been clearly mentioned in the process of
economic development of India. India has taken active steps for the
reduction of administrative and regulatory barriers to foreign direct
investment, providing various fiscal incentives and other measures
aimed at improving the climate for foreign direct investment.
Foreign Investment and Capital Formation
Nagaraj, R., (2003)63 indicates that, India followed a fairly
restrictive foreign private investment policy until 1991. After
liberalisation foreign investment is seen as a source of scarce capital,
technology and managerial skills. India not only permits foreign direct
investment but also foreign portfolio investment in almost all sectors
of the economy. The flow of foreign investment reflects in capital
formation, formation of new firms and factories and increase in
53
foreign equity holding in the existing firms. Foreign investment
creates tangible assets in host country.
Foreign Investment and Economic Growth
Pami Dua and Aneesa I. Rashid (1998)64 indicate that, foreign
investment have positive effects on growth in the host country. It is an
important vehicle for the transfer of technology and knowledge.
Foreign investment also have long-run effects on growth by
generating increasing returns in production via externalities and
productivity spillovers. It contributes more to growth than domestic
investment when there is sufficient absorptive capacity available in
the host country. Foreign investment lead to higher growth by
incorporating new inputs and techniques. It is also an important
source of human capital augmentation and provides specific
productivity increasing labour training and skill acquisition through
knowledge transfers.
Pulak Mishra and Ramakanta Prusty (2002)65 state that, inflow
of foreign direct investment for an economy in transition like India can
never be ignored, as the foreign direct investment inflow not only
integrates the host country, but also acts as a capital, technology,
managerial and marketing knowhow and market access required for
sustained economic growth and development. Besides, a large and
54
quality inward foreign direct investment can make the relationship
between the domestic and foreign enterprises more dynamic in terms
of both technology and environment, which is very urgent particularly
in the present era of globalisation and competition compared to the
earlier restrictive.
Ramakrishnan S. Rajan (2004)66 reveals that, foreign direct
investment is attracted into countries for different reasons. Foreign
direct investment brings in much needed capital, technical know-how,
organisational, managerial and marketing practices and global
production networks, thus facilitating the process of economic growth
and development in host countries.
Suresh K. Chadha (2004)67 states that, foreign investment has
been instrumental in the economic growth of the developed countries.
This has inspired the developing countries to reform their economic
policies to attract foreign investment. Since 1991, the Government of
India has been laying down the road map for foreign direct
investment reforms to encompass relaxation of procedural as well as
investment norms. Foreign direct investment provides financial
resources for investment in the host country and thereby augments
the domestic savings efforts to achieve sustained economic growth.
The investment saving gap can be bridged by attracting foreign direct
55
investment. Foreign direct investment facilitates technology
upgradation and introduction of modern production and management
practices. Thus it is anticipated that with the economic reforms and
adequate supplies of capital, India can come out of the vicious circle
of poverty and help creating more jobs.
Arabi, U., (2005)68 states that, foreign direct investment is an
important channel for accessing resources for economic
development. Foreign direct investment represents transfer of a
bundle of assets like capital, technology and access to export
markets, skills and management techniques and modern environment
management system.
Neera Verma (2007)69 indicates that, foreign direct investment
has emerged as the most important external resource flow to
developing countries. Foreign direct investment can be expected to
contribute to growth more than proportionately compared to domestic
investments in the host country. Foreign direct investment is also
viewed as a way of increasing the efficiency with which the world’s
scarce resources are used. Most of the countries have experienced
positive spillovers from foreign direct investment.
Smitha Francis (2010)70 reveals that, the principal contribution
to a host country are the financial capital invested by foreign firms,
56
the export market access provided by them and the faster technology
development. Foreign investment helps the host country to achieve
faster industrial growth and contribute to the host country’s economic
growth and development.
Foreign Investment and Foreign Exchange
Bishwanath Goldar and Esturo Ishigami (1999)71 state that,
foreign direct investment is the important source of external finance
for developing countries. Foreign direct investment provides the
needed foreign exchange to bridge the balance of trade deficit.
Foreign investment helps to improve the export performances. It
makes a positive impact on the host country’s export competitiveness
by raising the level of efficiency and the standard of product quality
and contributes to the growth of the host economies by relaxing
demand side constraints on growth.
Foreign Investment and Technological Knowledge
Bernard Tao Khium Mien (1999)72 reveals that, foreign firms
brought with them not only capital and foreign exchange but also
technological knowledge, production techniques, marketing,
managerial and administration skills. Other benefits of foreign
investment are the generation of employment opportunities,
contribution of taxes and royalties and creation of external
economies.
57
Foreign Investment and Balance of Payment Kutty Krishnan Nambiar (2005)73 indicates that, foreign capital
brings in enormous social benefits such as transferring production
technology, skills, innovative capacity, organizational and managerial
practices that are vital for open competitive economies. They can
access external markets by sourcing manufactured goods and
services from domestic firms thus boosting exports and easing the
balance of payment problems. Foreign capital also contributes more
to domestic savings, foreign exchange and to the exchequer by way
of corporate tax.
Foreign Investment and Employment
Manash Ranjan Gupta (1999)74 points out that, foreign capital
inflow creates additional employment opportunities in the economies
suffering from unemployment. Inflow of foreign capital does not affect
the domestic factor income. Technology transfer in the domestic sub-
sectors of the economy takes place through foreign capital.
Jaya Prakash Pradhan (2006)75 states that, inward foreign
capital is an important contributing factor in changing the patterns of
employment in a host country. Foreign firms are more productive,
more capital intensive, employ more skilled workers and pay higher
wages.
58
Foreign Investment and Trade
Siddharthan, N.S. and Hirashima, S., (1999)76 reveal that,
foreign direct investment has been instrumental in changing the
structure of the manufacturing and trade sectors. It plays an important
role in promoting trade and changing the industrial structure through
transfer of technology and management. Foreign direct investment
helps in the expansion of domestic market.
Bernard Tao Khium Mien (1999)77 indicates that, the industrial
and trade structure of a country is determined by both endogenous
and exogenous factors. Endogenous factors comprise industrial and
trade policies that are implemented and factor endowment of a
country. Exogenous factors encompass external influences which are
beyond the control of a country, including impacts from foreign
investments. Different forms of foreign investment determines the
industrial and trade structure of the economy. The manufacturing
sector is driven strongly by foreign investment.
Impediment to Foreign Capital
Siddharthan, N.S., (2004)78 points out that, the main constraint
for investing in India seem to be corruption, infrastructure bottlenecks
and policy instability. These three are directly related to government
infrastructure that turns out to be a crucial factor influencing
59
investments in India. While the role of government in tackling
corruption and policy instability is obvious, its role in transport
infrastructure is less obvious. For instance Indian road transport is
plagued by delays. Commercial vehicles in India run only about 250
km per day compared to about 600 km in several other countries. The
poor mileage in India could not be only due to bad roads but also,
due to delays in road check posts, toll gates etc. Corruption and
unpredictability or frequent changes in policies are the two most
important factors that adversely affect investment.
Nagson, D.S.V., (2004)79 indicates that, the lack of clear cut
policy and complicated legal procedures lead the international
investors into confusion. Political instability due to coalition
government may be another problem to the international investors.
However, this will not make changes in India’s economic policies.
This is evident from the commitment shown by all the successive
political parties in power for continuing the reforms towards
liberalisation since 1991. During the recent interactions with CEO of
European Companies Hon. Prime Minister of India said that “Several
parties across the political spectrum have been in government at the
centre and the state level and there has been continuity in policy . . . .
there is a broad base consensus on the direction of a economic
policy liberalisation with a human face has come to stay.” Extreme
60
north eastern part of India and Kashmir insurgence activities of
terrorist create an unsecured situation to international investors and
create risk.
Majumdar, S., (2004)80 is of the opinion that, India lags several
countries in the matter of attracting foreign investment. The main
reason for the low foreign investment inflow into India is the
bureaucratic tangle.
61
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