1

CHAPTER – 1

Introduction to Foreign Direct Investment (FDI)

1.0 INTRODUCTION

One of the most striking developments during the last two decades is the spectacular

growth of FDI in the global economic landscape. This unprecedented growth of global

FDI in 1990 around the world make FDI an important and vital component of

development strategy in both developed and developing nations and policies are designed

in order to stimulate inward flows. Infact, FDI provides a win – win situation to the host

and the home countries. Both countries are directly interested in inviting FDI, because

they benefit a lot from such type of investment. The ‘home’ countries want to take the

advantage of the vast markets opened by industrial growth. On the other hand the ‘host’

countries want to acquire technological and managerial skills and supplement domestic

savings and foreign exchange. Moreover, the paucity of all types of resources viz.

financial, capital, entrepreneurship, technological know- how, skills and practices, access

to markets- abroad- in their economic development, developing nations accepted FDI as a

sole visible panacea for all their scarcities. Further, the integration of global financial

markets paves ways to this explosive growth of FDI around the globe.

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1.1 AN OVERALL VIEW

The historical background of FDI in India can be traced back with the establishment of

East India Company of Britain. British capital came to India during the colonial era of

Britain in India. However, researchers could not portray the complete history of FDI

pouring in India due to lack of abundant and authentic data. Before independence major

amount of FDI came from the British companies. British companies setup their units in

mining sector and in those sectors that suits their own economic and business interest.

After Second World War, Japanese companies entered Indian market and enhanced their

trade with India, yet U.K. remained the most dominant investor in India. Further, after

Independence issues relating to foreign capital, operations of MNCs, gained attention of

the policy makers. Keeping in mind the national interests the policy makers designed the

FDI policy which aims FDI as a medium for acquiring advanced technology and to

mobilize foreign exchange resources. The first Prime Minister of India considered foreign

investment as “necessary” not only to supplement domestic capital but also to secure

scientific, technical, and industrial knowledge and capital equipments. With time and as

per economic and political regimes there have been changes in the FDI policy too. The

industrial policy of 1965, allowed MNCs to venture through technical collaboration in

India. However, the country faced two severe crisis in the form of foreign exchange and

financial resource mobilization during the second five year plan (1956 -61). Therefore,

the government adopted a liberal attitude by allowing more frequent equity participation

to foreign enterprises, and to accept equity capital in technical collaborations. The

government also provides many incentives such as tax concessions, simplification of

licensing procedures and de- reserving some industries such as drugs, aluminium, heavy

electrical equipments, fertilizers, etc in order to further boost the FDI inflows in the

country. This liberal attitude of government towards foreign capital lures investors from

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other advanced countries like USA, Japan, and Germany, etc. But due to significant

outflow of foreign reserves in the form of remittances of dividends, profits, royalties etc,

the government has to adopt stringent foreign policy in 1970s. During this period the

government adopted a selective and highly restrictive foreign policy as far as foreign

capital, type of FDI and ownerships of foreign companies was concerned.

Government setup Foreign Investment Board and enacted Foreign Exchange Regulation

Act in order to regulate flow of foreign capital and FDI flow to India. The soaring oil

prices continued low exports and deterioration in Balance of Payment position during

1980s forced the government to make necessary changes in the foreign policy. It is during

this period the government encourages FDI, allow MNCs to operate in India. Thus,

resulting in the partial liberalization of Indian Economy. The government introduces

reforms in the industrial sector, aimed at increasing competency, efficiency and growth in

industry through a stable, pragmatic and non-discriminatory policy for FDI flow.

Infact, in the early nineties, Indian economy faced severe Balance of payment

crisis. Exports began to experience serious difficulties. There was a marked increase in

petroleum prices because of the gulf war. The crippling external debts were debilitating

the economy. India was left with that much amount of foreign exchange reserves which

can finance its three weeks of imports. The outflowing of foreign currency which was

deposited by the Indian NRI’s gave a further jolt to Indian economy. The overall Balance

of Payment reached at Rs.( -) 4471 crores. Inflation reached at its highest level of 13%.

Foreign reserves of the country stood at Rs.11416 crores. The continued political

uncertainty in the country during this period adds further to worsen the situation. As a

result, India’s credit rating fell in the international market for both short- term and long-

term borrowing. All these developments put the economy at that time on the verge of

default in respect of external payments liability. In this critical face of Indian economy

the then finance Minister of India Dr. Manmohan Singh with the help of World Bank and

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IMF introduced the macro – economic stabilization and structural adjustment programm.

As a result of these reforms India open its door to FDI inflows and adopted a more liberal

foreign policy in order to restore the confidence of foreign investors.

Further, under the new foreign investment policy Government of India constituted

FIPB (Foreign Investment Promotion Board) whose main function was to invite and

facilitate foreign investment through single window system from the Prime Minister’s

Office. The foreign equity cap was raised to 51 percent for the existing companies.

Government had allowed the use of foreign brand names for domestically produced

products which was restricted earlier. India also became the member of MIGA

(Multilateral Investment Guarantee Agency) for protection of foreign investments.

Government lifted restrictions on the operations of MNCs by revising the FERA Act

1973. New sectors such as mining, banking, telecommunications, highway construction

and management were open to foreign investors as well as to private sector.

Table-1.1

FDI INFLOWS IN INDIA

(from 1948-2010)

Amount

of FDI

Mid

1948

March

1964

March

1974

March

1980

March

1990

March

2000

March

2010

In

crores

256 565.5 916 933.2 2705 18486 1,23,378

Source: Kumar39 1995, various issues of SIA Publication.

There is a considerable decrease in the tariff rates on various importable goods.

Table –1.1 shows FDI inflows in India from 1948 – 2010.FDI inflows during 1991-92 to

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March 2010 in India increased manifold as compared to during mid 1948 to march 1990

(Chart-1.1). The measures introduced by the government to liberalize provisions relating

to FDI in 1991 lure investors from every corner of the world. There were just few (U.K,

USA, Japan, Germany, etc.) major countries investing in India during the period mid

1948 to march 1990 and this number has increased to fifteen in 1991. India emerged as a

strong economic player on the global front after its first generation of economic reforms.

As a result of this, the list of investing countries to India reached to maximum number of

120 in 2008. Although, India is receiving FDI inflows from a number of sources but large

percentage of FDI inflows is vested with few major countries. Mauritius, USA, UK,

Japan, Singapore, Netherlands constitute 66 percent of the entire FDI inflows to India.

FDI inflows are welcomed in 63 sectors in 2008 as compared to 16 sectors in 1991.

Chart – 1.1

The FDI inflows in India during mid 1948 were Rs, 256 crores. It is almost double in

March 1964 and increases further to Rs. 916 crores. India received a cumulative FDI

ssues of SIA Publication. Source: Kumar 1995, various i

amt. in crores

crores

Amt. in Rs.

Years

2010 March

2000March

1990March

1980March

1974March

1964March

1948March

140000 120000 100000

80000 60000 40000 20000

0

(1948-2010) FDI Flow in India

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inflow of Rs. 5,384.7 crores during mid 1948 to march 1990 as compared to Rs.1,41,864

crores during August 1991 to march 2010 (Table-1.1). It is observed from the (Chart –

1.1) that there has been a steady flow of FDI in India after its independence. But there is a

sharp rise in FDI inflows from 1998 onwards. U.K. the prominent investor during the pre

and post independent era stands nowhere today as it holds a share of 6.1 percent of the

total FDI inflows to India.

1.2 FDI INFLOWS IN INDIA IN POST REFORM ERA

India’s economic reforms way back in 1991 has generated strong interest in

foreign investors and turning India into one of the favourite destinations for global FDI

flows. According to A.T. Kearney1, India ranks second in the World in terms of

attractiveness for FDI. A.T. Kearney’s 2007 Global Services Locations Index ranks India

as the most preferred destination in terms of financial attractiveness, people and skills

availability and business environment. Similarly, UNCTAD’s76 World Investment Report,

2005 considers India the 2nd most attractive destination among the TNCS. The positive

perceptions among investors as a result of strong economic fundamentals driven by 18

years of reforms have helped FDI inflows grow significantly in India. The FDI inflows

grow at about 20 times since the opening up of the economy to foreign investment. India

received maximum amount of FDI from developing economies (Chart – 1.2). Net FDI

flow in India was valued at US$ 33029.32 million in 2008. It is found that there is a huge

gap in FDI approved and FDI realized (Chart- 1.3). It is observed that the realization of

approved FDI into actual disbursements has been quite slow. The reason of this slow

realization may be the nature and type of investment projects involved. Beside this

increased FDI has stimulated both exports and imports, contributing to rising levels of

international trade. India’s merchandise trade turnover increased from US$ 95 bn in

FY02 to US$391 bn in FY08 (CAGR of 27.8%).

Chart-1.2

s US$ million

60000

50000

40000

30000

20000

10000

0

FDI INFLOWS IN INDIA

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Commerce, GOI

Chart-1.3

Commerce, GOI

India’s exports increased from US$ 44 bn in FY02 to US$ 163 bn in FY08 (CAGR of

24.5%). India’s imports increased from US$ 51 bn in FY02 to US$ 251 bn in FY08

(CAGR of 30.3%). India ranked at 26th in world merchandise exports in 2007 with a

share of 1.04 percent.

Further, the explosive growth of FDI gives opportunities to Indian industry for

technological upgradation, gaining access to global managerial skills and practices,

optimizing utilization of human and natural resources and competing internationally with

higher efficiency. Most importantly FDI is central for India’s integration into global

production chains which involves production by MNCs spread across locations all over

the world. (Economic Survey 2003-04).16

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1.3 OBJECTIVES

The study covers the following objectives:

1. To study the trends and patterns of flow of FDI.

2. To assess the determinants of FDI inflows.

3. To evaluate the impact of FDI on the Economy.

1.4 HYPOTHESES

The study has been taken up for the period 1991-2008 with the following hypotheses:

1. Flow of FDI shows a positive trend over the period 1991-2008.

2. FDI has a positive impact on economic growth of the country.

1.5 RESEARCH METHODOLOGY

1.5.1 DATA COLLECTION

This study is based on secondary data. The required data have been collected from

various sources i.e. World Investment Reports, Asian Development Bank’s Reports,

various Bulletins of Reserve Bank of India, publications from Ministry of Commerce,

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Govt. of India, Economic and Social Survey of Asia and the Pacific, United Nations,

Asian Development Outlook, Country Reports on Economic Policy and Trade Practice-

Bureau of Economic and Business Affairs, U.S. Department of State and from websites

of World Bank, IMF, WTO, RBI, UNCTAD, EXIM Bank etc.. It is a time series data and

the relevant data have been collected for the period 1991 to 2008.

1.5.2 ANALYTICAL TOOLS

In order to analyse the collected data the following mathematical tools were

used. To work out the trend analyses the following formula is used:

a.) Trend Analysis i.e. ŷ = a + b x

where ŷ = predicted value of the dependent variable

a = y – axis intercept,

b = slope of the regression line (or the rate of change in y for a given

change in x),

x = independent variable (which is time in this case).

b.) Annual Growth rate is worked out by using the following formula:

AGR = (X2- X1)/ X1

where X1 = first value of variable X

X2 = second value of variable X

c.) Compound Annual Growth Rate is worked out by using the following

formula:

CAGR (t0, tn) = (V(tn)/V(t0))1/tn – t0 -1

where

V (t0): start value, V (tn): finish value, tn − t0: number of years.

In order to analyse the collected data, various statistical and mathematical tools were

used.

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1.5.3 MODEL BUILDING

Further, to study the impact of foreign direct investment on economic growth, two

models were framed and fitted. The foreign direct investment model shows the factors

influencing the foreign direct investment in India. The economic growth model depicts

the contribution of foreign direct investment to economic growth. The two model

equations are expressed below:

1 FDI = f [TRADEGDP, RESGDP, R&DGDP, FIN. Position, EXR.]

2 GDPG = f [FDIG]

where,

FDI= Foreign Direct Investment

GDP = Gross Domestic Product

FIN. Position = Financial Position

TRADEGDP= Total Trade as percentage of GDP.

RESGDP= Foreign Exchange Reserves as percentage of GDP.

R&DGDP= Research & development expenditure as percentage of GDP.

FIN. Position = Ratio of external debts to exports

EXR= Exchange rate

GDPG = level of Economic Growth

FDIG = Foreign Direct Investment Growth

Regression analysis (Simple & Multiple Regression) was carried out using relevant

econometric techniques. Simple regression method was used to measure the impact of

FDI flows on economic growth (proxied by GDP growth) in India. Further, multiple

regression analysis was used to identify the major variables which have impact on

foreign direct investment. Relevant econometric tests such as coefficient of

determination R2, Durbin – Watson [D-W] statistic, Standard error of coefficients,

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TStatistics and F- ratio were carried out in order to assess the relative significance,

desirability and reliability of model estimation parameters.

1.6 IMPORTANCE OF THE STUDY

It is apparent from the above discussion that FDI is a predominant and vital factor in

influencing the contemporary process of global economic development. The study

attempts to analyze the important dimensions of FDI in India. The study works out the

trends and patterns, main determinants and investment flows to India. The study also

examines the role of FDI on economic growth in India for the period 1991-2008. The

period under study is important for a variety of reasons. First of all, it was during July

1991 India opened its doors to private sector and liberalized its economy. Secondly, the

experiences of South-East Asian countries by liberalizing their economies in 1980s

became stars of economic growth and development in early 1990s. Thirdly, India’s

experience with its first generation economic reforms and the country’s economic growth

performance were considered safe havens for FDI which led to second generation of

economic reforms in India in first decade of this century. Fourthly, there is a considerable

change in the attitude of both the developing and developed countries towards FDI. They

both consider FDI as the most suitable form of external finance. Fifthly, increase in

competition for FDI inflows particularly among the developing nations.

The shift of the power center from the western countries to the Asia sub – continent is

yet another reason to take up this study. FDI incentives, removal of restrictions, bilateral

and regional investment agreements among the Asian countries and emergence of Asia as

an economic powerhouse (with China and India emerging as the two most promising

economies of the world) develops new economics in the world of industralised nations.

The study is important from the view point of the macroeconomic variables included in

the study as no other study has included the explanatory variables which are included in

this study. The study is appropriate in understanding inflows during 1991- 2008.

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1.7 LIMITATIONS OF THE STUDY

All the economic / scientific studies are faced with various limitations and this study is no

exception to the phenomena. The various limitations of the study are:

1. At various stages, the basic objective of the study is suffered due to inadequacy of

time series data from related agencies. There has also been a problem of sufficient

homogenous data from different sources. For example, the time series used for

different variables, the averages are used at certain occasions. Therefore, the trends,

growth rates and estimated regression coefficients may deviate from the true ones.

2. The assumption that FDI was the only cause for development of Indian economy in

the post liberalised period is debatable. No proper methods were available to

segregate the effect of FDI to support the validity of this assumption.

3. Above all, since it is a Ph.D. project and the research was faced with the problem of

various resources like time and money.

Chapter 2

General Conditions on FDI

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2.1 Who Can Invest in India?

1. A non-resident entity can invest in India, subject to the FDI Policy except in those

sectors/activities which are prohibited. However, a citizen of Bangladesh or an entity

incorporated in Bangladesh can invest only under the Government route. Further, a

citizen of Pakistan or an entity incorporated in Pakistan can invest, only under the

Government route, in sectors/activities other than defence, space and atomic energy

and sectors/activities prohibited for foreign investment.

2. NRIs resident in Nepal and Bhutan as well as citizens of Nepal and Bhutan are

permitted to invest in the capital of Indian companies on repatriation basis, subject to

the condition that the amount of consideration for such investment shall be paid only

by way of inward remittance in free foreign exchange through normal banking

channels.

3. OCBs have been derecognized as a class of investors in India with effect from

September 16, 2003. Erstwhile OCBs which are incorporated outside India and are

not under the adverse notice of RBI can make fresh investments under FDI Policy as

incorporated non-resident entities, with the prior approval of Government of India if

the investment is through Government route; and with the prior approval of RBI if

the investment is through Automatic route.

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(i) An FII/FPI may invest in the capital of an Indian company under the Portfolio

Investment Scheme which limits the individual holding of an FII/FPI below 10% of

the capital of the company and the aggregate limit for FII/FPI/QFI investment to

24% of the capital of the company. This aggregate limit of 24% can be increased to

the sectoral cap/statutory ceiling, as applicable, by the Indian company concerned

through a resolution by its Board.

(ii) An Indian company which has issued shares to FIIs/FPIs under the FDI

Policy for which the payment has been received directly into company’s

account should report these figures separately under item no. 5 of Form FCGPR .

(iii) A daily statement in respect of all transactions (except derivative trade) has to

be submitted by the custodian bank in floppy/soft copy in the prescribed format

directly to RBI and also uploaded directly on the OFRS web site

4. Only registered FIIs/FPIs and NRIs as per Schedules 2, 2A and 3 respectively of

Foreign Exchange Management (Transfer or Issue of Security by a Person Resident

Outside India) Regulations, 2000, can invest/trade through a registered broker in the

capital of Indian Companies on recognised Indian Stock Exchanges.

5. A SEBI registered Foreign Venture Capital Investor (FVCI) may contribute up to

100% of the capital of an Indian Venture Capital Undertaking (IVCU) and may also

set up a domestic asset management company to manage the fund. All such

investments can be made under the automatic route in terms of Schedule 6 to

Notification No. FEMA 20. A SEBI registered FVCI can invest in a domestic

venture capital fund registered under the SEBI (Venture Capital Fund) Regulations,

1996. Such investments would also be subject to the extant FEMA regulations and

extant FDI policy including sectoral caps, etc. SEBI registered FVCIs are also

allowed to invest under the FDI Scheme, as non-resident entities, in other

companies, subject to FDI Policy and FEMA regulations. Further, FVCIs are

allowed to invest in the eligible securities (equity, equity linked instruments, debt,

debt instruments, debentures of an IVCU or VCF, units of schemes/funds set up by a

VCF) by way of private arrangement/purchase from a third party also, subject to

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terms and conditions as stipulated in Schedule 6 of Notification No. FEMA 20 /

2000 RB dated May 3, 2000 as amended from time to time. It is also being clarified

that SEBI registered FVCIs would also be allowed to invest in securities on a

recognized stock exchange subject to the provisions of the SEBI (FVCI)

Regulations, 2000, as amended from time to time, as well as the terms and

conditions stipulated therein.

2.1.1 Qualified Foreign Investors (QFls) investment in equity shares

QFls are permitted to invest through SEBI registered Depository Participants (DPs)

only in equity shares of listed Indian companies through recognized brokers on

recognized stock exchanges in India as well as in equity shares of Indian companies

which are offered to public in India in terms of the relevant and applicable SEBI

guidelines/regulations. QFls are also permitted to acquire equity shares by way of

right shares, bonus shares or equity shares on account of stock split/consolidation or

equity shares on account of amalgamation, demerger or such corporate actions

subject to the prescribed investment limits. QFIs are allowed to sell the equity shares

so acquired subject to the relevant SEBI guidelines.

The individual and aggregate investment limits for the QFls shall be 5% and 10%

respectively of the paid up capital of an Indian company. These limits shall be within

FPI aggregate limits. Further, wherever there are composite sectoral caps under the

extant FDI policy, these limits for QFI investment in equity shares shall also be

within such overall FDI sectoral caps.

Dividend payments on equity shares held by QFls can either be directly remitted to

the designated overseas bank accounts of the QFIs or credited to the single non-

interest bearing Rupee account.

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2.2 Entities into which FDI can be made

2.2.1 FDI in an Indian Company

Indian companies can issue capital against FDI.

2.2.2 FDI in Partnership Firm/Proprietary Concern

(i) A Non-Resident Indian (NRI) or a Person of Indian Origin (PIO) resident outside

India can invest in the capital of a firm or a proprietary concern in India on non-

repatriation basis provided;

(a) Amount is invested by inward remittance or out of NRE/FCNR(B)/NRO account

maintained with Authorized

Dealers/Authorized banks.

(b) The firm or proprietary concern is not engaged in any agricultural/plantation or

real estate business or print media sector.

(c) Amount invested shall not be eligible for repatriation outside India.

(ii) Investments with repatriation option: NRIs/PIO may seek prior permission of

Reserve Bank for investment in sole proprietorship concerns/partnership firms with

repatriation option. The application will be decided in consultation with the Government

of India.

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(iii) Investment by non-residents other than NRIs/PIO: A person resident outside India

other than NRIs/PIO may make an application and seek prior approval of Reserve Bank

for making investment in the capital of a firm or a proprietorship concern or any

association of persons in India. The application will be decided in consultation with the

Government of India.

(iv) Restrictions: An NRI or PIO is not allowed to invest in a firm or proprietorship

concern engaged in any agricultural/plantation activity or real estate business or print

media.

2.2.3 FDI in Venture Capital Fund (VCF)

FVCIs are allowed to invest in Indian Venture Capital Undertakings (IVCUs)/Venture

Capital Funds (VCFs)/other companies, as stated in paragraph 3.1.6 of this Circular. If a

domestic VCF is set up as a trust, a person resident outside India (non-resident

entity/individual including an NRI) can invest in such domestic VCF subject to approval

of the FIPB. However, if a domestic VCF is set-up as an incorporated company under the

Companies Act, as applicable, then a person resident outside India (non-resident

entity/individual including an NRI) can invest in such domestic VCF under the automatic

route of FDI Scheme, subject to the pricing guidelines, reporting requirements, mode of

payment, minimum capitalization norms, etc.

2.2.4 FDI in Trusts

FDI in Trusts other than VCF is not permitted.

2.2.5 FDI in Limited Liability Partnerships (LLPs)

FDI in LLPs is permitted, subject to the following conditions:

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(a) FDI will be allowed, through the Government approval route, only in LLPs

operating in sectors/activities where 100% FDI is allowed, through the automatic route

and there are no FDI-linked performance conditions (such as 'Non Banking Finance

Companies' or 'Development of Townships, Housing, Built-up infrastructure and

Construction-development projects' etc.).

(b) LLPs with FDI will not be allowed to operate in agricultural/plantation activity,

print media or real estate business.

(c) An Indian company, having FDI, will be permitted to make downstream

investment in an LLP only if both-the company, as well as the LLP- are operating in

sectors where 100% FDI is allowed, through the automatic route and there are no FDI-

linked performance conditions.

(d) LLPs with FDI will not be eligible to make any downstream investments.

(e) Foreign Capital participation in LLPs will be allowed only by way of cash

consideration, received by inward remittance, through normal banking channels or by

debit to NRE/FCNR account of the person concerned, maintained with an authorized

dealer/authorized bank.

(f) Investment in LLPs by Foreign Portfolio Investors (FPIs) and Foreign Venture

Capital Investors (FVCIs) will not be permitted. LLPs will also not be permitted to avail

External Commercial Borrowings (ECBs).

(g) In case the LLP with FDI has a body corporate that is a designated partner or

nominates an individual to act as a designated partner in accordance with the provisions

of Section 7 of the LLP Act, 2008, such a body corporate should only be a company

registered in India under the Companies Act, as applicable and not any other body, such

as an LLP or a trust.

(h) For such LLPs, the designated partner "resident in India", as defined under the

'Explanation' to Section 7(1) of the LLP Act, 2008, would also have to satisfy the

19

definition of "person resident in India", as prescribed under Section 2(v)(i) of the Foreign

Exchange Management Act, 1999.

(i) The designated partners will be responsible for compliance with all the above

conditions and also liable for all penalties imposed on the LLP for their contravention, if

any.

(j) Conversion of a company with FDI, into an LLP, will be allowed only if the

above stipulations (except clause 3.2.5(e) which would be optional in case of a company)

are met and with the prior approval of FIPB/Government.

2.2.6 FDI in other Entities

FDI in resident entities other than those mentioned above is not permitted.

2.3 Types of Instruments

1 Indian companies can issue equity shares, fully, compulsorily and mandatorily

convertible debentures and fully, compulsorily and mandatorily convertible preference

shares subject to pricing guidelines/valuation norms prescribed under FEMA

Regulations. The price/conversion formula of convertible capital instruments should be

determined upfront at the time of issue of the instruments. The price at the time of

conversion should not in any case be lower than the fair value worked out, at the time of

issuance of such instruments, in accordance with the extant FEMA regulations [as per

any internationally accepted pricing methodology on arm’s length basis for the unlisted

companies and valuation in terms of SEBI (ICDR) Regulations, for the listed companies].

2 Optionality clauses are allowed in equity shares, fully, compulsorily and mandatorily

convertible debentures and fully, compulsorily and mandatorily convertible preference

shares under FDI scheme, subject to the following conditions:

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(a) There is a minimum lock-in period of one year which shall be effective from the

date of allotment of such capital instruments.

(b) After the lock-in period and subject to FDI Policy provisions, if any, the non-

resident investor exercising option/right shall be eligible to exit without any assured

return, as per pricing/valuation guidelines issued

by RBI from time to time.

3 Other types of Preference shares/Debentures i.e. non-convertible, optionally convertible

or partially convertible for issue of which funds have been received on or after May 1,

2007 are considered as debt. Accordingly all norms applicable for ECBs relating to

eligible borrowers, recognized lenders, amount and maturity, end-use stipulations, etc.

shall apply. Since these instruments would be denominated in rupees, the rupee interest

rate will be based on the swap equivalent of London Interbank Offered Rate (LIBOR)

plus the spread as permissible for ECBs of corresponding maturity.

4 The inward remittance received by the Indian company vide issuance of DRs and

FCCBs are treated as FDI and counted towards FDI.

2.3.1 Issue of Foreign Currency Convertible Bonds (FCCBs) and

Depository

Receipts(DRs)

a) FCCBs/DRs may be issued in accordance with the Scheme for issue of Foreign

Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt

Mechanism) Scheme, 1993 and DR Scheme 2014 respectively, as per the guidelines

issued by the Government of India there under from time to time.

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b) DRs are foreign currency denominated instruments issued by a foreign Depository

in a permissible jurisdiction against a pool of permissible securities issued or transferred

to that foreign depository and deposited with a domestic custodian.

c) In terms of Notification No. FEMA.20/2000-RB dated May 3, 2000 as amended

from time to time, a person will be eligible to issue or transfer eligible securities to a

foreign depository, for the purpose of converting the securities so purchased into

depository receipts in terms of Depository Receipts Scheme, 2014 and guidelines issued

by the Government of India thereunder from time to time.

d) A person can issue DRs, if it is eligible to issue eligible instruments to person

resident outside India under Schedules 1, 2, 2A, 3, 5 and 8 of Notification No. FEMA

20/2000-RB dated May 3, 2000, as amended from time to time.

e) The aggregate of eligible securities which may be issued or transferred to foreign

depositories, along with eligible securities already held by persons resident outside India,

shall not exceed the limit on foreign holding of such eligible securities under the relevant

regulations framed under FEMA, 1999.

f) The pricing of eligible securities to be issued or transferred to a foreign depository

for the purpose of issuing depository receipts should not be at a price less than the price

applicable to a corresponding mode of issue or transfer of such securities to domestic

investors under the relevant regulations framed under FEMA, 1999.

g) The issue of depository receipts as per DR Scheme 2014 shall be reported to the

Reserve Bank by the domestic custodian as per the reporting guidelines for DR Scheme

2014.

2.9.1 (i) Two-way Fungibility Scheme: A limited two-way Fungibility scheme has

been put in place by the Government of India for ADRs/GDRs. Under this Scheme, a

stock broker in India, registered with SEBI, can purchase shares of an Indian company

from the market for conversion into ADRs/GDRs based on instructions received from

overseas investors. Re-issuance of ADRs/GDRs would be permitted to the extent of

22

ADRs/GDRs which have been redeemed into underlying shares and sold in the Indian

market.

(ii) Sponsored ADR/GDR issue: An Indian company can also sponsor an issue of

ADR/GDR. Under this mechanism, the company offers its resident shareholders a choice

to submit their shares back to the company so that on the basis of such shares,

ADRs/GDRs can be issued abroad. The proceeds of the ADR/GDR issue are remitted

back to India and distributed among the resident investors who had offered their Rupee

denominated shares for conversion. These proceeds can be kept in Resident Foreign

Currency (Domestic) accounts in India by the resident shareholders who have tendered

such shares for conversion into ADRs/GDRs.

2.4 Issue/Transfer of Shares

1 The capital instruments should be issued within 180 days from the date of receipt of the

inward remittance received through normal banking channels including escrow account

opened and maintained for the purpose or by debit to the NRE/FCNR (B) account of the

non-resident investor. In case, the capital instruments are not issued within 180 days from

the date of receipt of the inward remittance or date of debit to the NRE/FCNR (B)

account, the amount of consideration so received should be refunded immediately to the

non-resident investor by outward remittance through normal banking channels or by

credit to the NRE/FCNR (B) account, as the case may be. Non-compliance with the

above provision would be reckoned as a contravention under FEMA and would attract

penal provisions. In exceptional cases, refund of the amount of consideration outstanding

beyond a period of 180 days from the date of receipt may be considered by the RBI, on

the merits of the case.

2.4.1 Issue price of shares

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Price of shares issued to persons resident outside India under the FDI

Policy, shall not be less than -

a. the price worked out in accordance with the SEBI guidelines, as applicable, where

the shares of the company are listed on any recognised stock exchange in India;

b. the fair valuation of shares done by a SEBI registered Merchant Banker or a

Chartered Accountant as per any internationally accepted pricing methodology on arm’s

length basis, where the shares of the company are not listed on any recognised stock

exchange in India; and

c. the price as applicable to transfer of shares from resident to non-resident as per

the pricing guidelines laid down by the Reserve Bank from time to time, where the issue

of shares is on preferential allotment.

However, where non-residents (including NRIs) are making investments in an Indian

company in compliance with the provisions of the Companies Act, as applicable, by way

of subscription to its Memorandum of Association, such investments may be made at face

value subject to their eligibility to invest under the FDI scheme.

2.4.2 Foreign Currency Account

Indian companies which are eligible to issue shares to persons resident outside India

under the FDI Policy may be allowed to retain the share subscription amount in a Foreign

Currency Account, with the prior approval of RBI.

2.4.3 Transfer of shares and convertible debentures

(i) Subject to FDI sectoral policy (relating to sectoral caps and entry routes),

applicable laws and other conditionalities including security conditions, non-

24

resident investors can also invest in Indian companies by purchasing/acquiring existing

shares from Indian shareholders or from other non-resident shareholders. General

permission has been granted to nonresidents/NRIs for acquisition of shares by way of

transfer subject to the following:

(a) A person resident outside India (other than NRI and erstwhile OCB) may transfer

by way of sale or gift, the shares or convertible debentures to any person resident outside

India (including NRIs). Government approval is not required for transfer of shares in the

investee company from one non-resident to another non-resident in sectors which are

under automatic route. In addition, approval of Government will be required for transfer

of stake from one nonresident to another non-resident in sectors which are under

Government approval route.

(b) NRIs may transfer by way of sale or gift the shares or convertible debentures held

by them to another NRI.

(c) A person resident outside India can transfer any security to a person resident in

India by way of gift.

(d) A person resident outside India can sell the shares and convertible debentures of

an Indian company on a recognized Stock Exchange in India through a stock broker

registered with stock exchange or a merchant banker registered with SEBI.

(e) A person resident in India can transfer by way of sale, shares/ convertible

debentures (including transfer of subscriber’s shares), of an Indian company under

private arrangement to a person resident outside India, subject to the guidelines given in

para 3.4.5.2 and Annex-2.

(f) General permission is also available for transfer of shares/convertible debentures,

by way of sale under private arrangement by a person resident outside India to a person

resident in India, subject to the guidelines given in para 3.4.5.2 and Annex-2.

(g) The above General Permission also covers transfer by a resident to a non-resident

of shares/convertible debentures of an Indian company, engaged in an activity earlier

25

covered under the Government Route but now falling under Automatic Route, as well as

transfer of shares by a non-resident to an Indian company under buyback and/or capital

reduction scheme of the company.

(h) The Form FC-TRS should be submitted to the AD Category-I Bank, within 60

days from the date of receipt of the amount of consideration. The onus of submission of

the Form FC-TRS within the given timeframe would be on the transferor/transferee,

resident in India. However, in cases where the NR investor, including an NRI, acquires

shares on the stock exchanges under the FDI scheme, the investee company would have

to file form FC-TRS with the AD Category-I bank.

(ii) The sale consideration in respect of equity instruments purchased by a person

resident outside India, remitted into India through normal banking channels, shall be

subjected to a Know Your Customer (KYC) check by the remittance receiving AD

Category-I bank at the time of receipt of funds. In case, the remittance receiving AD

Category-I bank is different from the AD Category-I bank handling the transfer

transaction, the KYC check should be carried out by the remittance receiving bank and

the KYC report be submitted by the customer to the AD Category-I bank carrying out the

transaction along with the Form FC-TRS.

(iii) A person resident outside India including a Non-Resident Indian investor who has

already acquired and continues to hold the control in accordance with the SEBI

(Substantial Acquisition of Shares and Takeover) Regulations can acquire shares of a

listed Indian company on the stock exchange through a registered broker under FDI

scheme provided that the original and resultant investments are in line with the extant

FDI policy and FEMA regulations in respect of sectoral cap, entry route, mode of

payment, reporting requirement, documentation, etc.

(iv) Escrow: AD Category-I banks have been given general permission to open

Escrow account and Special account of non-resident corporate for open offers/exit offers

and delisting of shares. The relevant SEBI (Substantial Acquisition of Shares and

26

Takeovers) Regulations, 2011 (SAST) Regulations or any other applicable SEBI

Regulations/provisions of the Companies Act, as applicable will be applicable. AD

Category-I banks have also been permitted to open and maintain, without prior approval

of RBI, non-interest bearing Escrow accounts in Indian Rupees in India on behalf of

residents and/or non-residents, towards payment of share purchase consideration and/or

provide Escrow facilities for keeping securities to facilitate FDI transactions subject to

the terms and conditions specified by RBI. SEBI authorised Depository Participants have

also been permitted to open and maintain, without prior approval of RBI, Escrow

accounts for securities subject to the terms and conditions as specified by RBI. In both

cases, the Escrow agent shall necessarily be an AD Category-I bank or SEBI authorised

Depository Participant (in case of securities’ accounts). These facilities will be applicable

for both issue of fresh shares to the non- residents as well as transfer of shares from/to the

non- residents.

2.4.4 Prior permission of RBI in certain cases for transfer of capital instruments

1 Except cases mentioned in paragraph 3.4.5.2 below, the following cases require prior

approval of RBI:

(i) Transfer of capital instruments from resident to non-residents by way of sale

where

(a) Transfer is at a price which falls outside the pricing guidelines specified by the

Reserve Bank from time to time and the transaction does not fall under the exception

given in para 3.4.5.2.

(b) Transfer of capital instruments by the non-resident acquirer involving deferment

of payment of the amount of consideration. Further, in case approval is granted for a

transaction, the same should be reported in Form FC-TRS, to an AD Category-I bank for

necessary due diligence, within 60 days from the date of receipt of the full and final

amount of consideration.

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(ii) Transfer of any capital instrument, by way of gift by a person resident in India to

a person resident outside India. While forwarding applications to Reserve Bank for

approval for transfer of capital instruments by way of gift, the documents mentioned in

Annex-3 should be enclosed. Reserve Bank considers the following factors while

processing such applications:

(a) The proposed transferee (donee) is eligible to hold such capital instruments under

Schedules 1, 4 and 5 of Notification No. FEMA 20/2000-RB dated May 3, 2000, as

amended from time to time.

(b) The gift does not exceed 5 per cent of the paid-up capital of the Indian

company/each series of debentures/each mutual fund scheme.

(c) The applicable sectoral cap limit in the Indian company is not breached.

(d) The transferor (donor) and the proposed transferee (donee) are close relatives as

defined in Section 2 (77) of Companies Act, 2013, as amended from time to time. The

current list is reproduced in Annex-4.

(e) The value of capital instruments to be transferred together with any capital

instruments already transferred by the transferor, as gift, to any person residing outside

India does not exceed the rupee equivalent of USD 50,000 during the financial year.

(f) Such other conditions as stipulated by Reserve Bank in public interest from time

to time.

(iii) Transfer of shares from NRI to non-resident.

2.4.5 In the following cases, approval of RBI is not required:

A. Transfer of shares from a Non-Resident to Resident under the FDI scheme where

the pricing guidelines under FEMA, 1999 are not met provided that:

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i. The original and resultant investment are in line with the extant FDI policy and

FEMA regulations in terms of sectoral caps, conditionalities (such as minimum

capitalization, etc.), reporting requirements, documentation, etc.;

ii. The pricing for the transaction is compliant with the specific/explicit, extant and

relevant SEBI regulations/guidelines (such as IPO, Book building, block deals, delisting,

exit, open offer/substantial acquisition/SEBI SAST, buy back); and

iii. Chartered Accountants Certificate to the effect that compliance with the relevant

SEBI regulations/guidelines as indicated above is attached to the form FC-TRS to be

filed with the AD bank.

B. Transfer of shares from Resident to Non-Resident:

i) where the transfer of shares requires the prior approval of the Government

conveyed through FIPB as per the extant FDI policy provided that:

a) the requisite approval of the FIPB has been obtained; and

b) the transfer of shares adheres with the pricing guidelines and documentation

requirements as specified by the Reserve Bank of India from time to time.

ii) where the transfer of shares attract SEBI (SAST) Regulations subject to the

adherence with the pricing guidelines and documentation requirements as specified by

Reserve Bank of India from time to time.

iii) where the transfer of shares does not meet the pricing guidelines under the

FEMA, 1999 provided that:

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a) The resultant FDI is in compliance with the extant FDI policy and FEMA

regulations in terms of sectoral caps, conditionalities (such as minimum capitalization,

etc.), reporting requirements, documentation etc.;

b) The pricing for the transaction is compliant with the specific/explicit, extant and

relevant SEBI regulations/guidelines (such as IPO, Book building, block deals, delisting,

exit, open offer/substantial acquisition/SEBI SAST); and

c) Chartered Accountants Certificate to the effect that compliance with the relevant

SEBI regulations/guidelines as indicated above is attached to the form FC-TRS to be

filed with the AD bank.

iv) where the investee company is in the financial sector provided that:

a) Any ‘fit and proper/due diligence’ requirements as regards the nonresident

investor as stipulated by the respective financial sector regulator, from time to time, have

been complied with; and

b) The FDI policy and FEMA regulations in terms of sectoral caps, conditionalities

(such as minimum capitalization, pricing, etc.), reporting requirements, documentation

etc., are complied with.

2.4.6 Conversion of ECB/Lump sum Fee/Royalty etc. into Equity

(i) Indian companies have been granted general permission for conversion of

External Commercial Borrowings (ECB) (excluding those deemed as ECB) in

convertible foreign currency into equity shares/fully compulsorily and mandatorily

convertible preference shares, subject to the following conditions and reporting

requirements:

(a) The activity of the company is covered under the Automatic Route for FDI or the

company has obtained Government approval for foreign equity in the company;

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(b) The foreign equity after conversion of ECB into equity is within the sectoral cap,

if any;

(c) Pricing of shares is as per the provision of para 3.4.2 above;

(d) Compliance with the requirements prescribed under any other statute and

regulation in force; and

(e) The conversion facility is available for ECBs availed under the Automatic or

Government Route and is applicable to ECBs, due for payment or not, as well as

secured/unsecured loans availed from nonresident collaborators.

(ii) General permission is also available for issue of shares/preference shares against

lump sum technical know-how fee, royalty due for payment, subject to entry route,

sectoral cap and pricing guidelines (as per the provision of para 3.4.2 above) and

compliance with applicable tax laws. Further, issue of equity shares against any other

funds payable by the investee company, remittance of which does not require prior

permission of the Government of India or Reserve Bank of India under FEMA, 1999 or

any rules/ regulations framed or directions issued thereunder is permitted, provided that:

(I) The equity shares shall be issued in accordance with the extant FDI guidelines on

sectoral caps, pricing guidelines etc. as amended by Reserve bank of India, from time to

time;

Explanation: Issue of shares/convertible debentures that require Government approval in

terms of paragraph 3 of Schedule 1 of FEMA 20 or import dues deemed as ECB or trade

credit or payable against import of second hand machinery shall continue to be dealt in

accordance with extant guidelines;

(II)The issue of equity shares under this provision shall be subject to tax laws as

applicable to the funds payable and the conversion to equity should be net of applicable

taxes.

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(iii) Issue of equity shares under the FDI policy is allowed under the Government

route for the following:

(I) import of capital goods/ machinery/ equipment (excluding second-hand

machinery), subject to compliance with the following conditions: (a) Any import of

capital goods/machinery etc., made by a resident in India, has to be in accordance with

the Export/Import Policy issued by Government of India/as defined by DGFT/FEMA

provisions relating to imports.

(b) The application clearly indicating the beneficial ownership and identity of the

Importer Company as well as overseas entity.

(c) Applications complete in all respects, for conversions of import payables for

capital goods into FDI being made within 180 days from the date of shipment of goods.

(II) pre-operative/pre-incorporation expenses (including payments of rent etc.),

subject to compliance with the following conditions:

(a) Submission of FIRC for remittance of funds by the overseas promoters for the

expenditure incurred.

(b) Verification and certification of the pre-incorporation/pre-operative expenses by

the statutory auditor.

(c) Payments should be made by the foreign investor to the company directly or

through the bank account opened by the foreign investor as provided under FEMA

Regulations.

(d) The applications, complete in all respects, for capitalization being made within

the period of 180 days from the date of incorporation of the company.

General conditions:

(i) All requests for conversion should be accompanied by a special resolution of the

company.

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(ii) Government’s approval would be subject to pricing guidelines of RBI and

appropriate tax clearance.

2.5 Specific Conditions in Certain Cases

2.5.1 Issue of Rights/Bonus Shares

FEMA provisions allow Indian companies to freely issue Rights/Bonus shares to existing

non-resident shareholders, subject to adherence to sectoral cap, if any. However, such

issue of bonus/rights shares has to be in accordance with other laws/statutes like the

Companies Act, as applicable, SEBI (Issue of Capital and Disclosure Requirements)

Regulations, 2009 (in case of listed companies), etc. The offer on right basis to the

persons resident outside India shall be:

(a) in the case of shares of a company listed on a recognized stock exchange in India,

at a price as determined by the company;

(b) in the case of shares of a company not listed on a recognized stock exchange in

India, at a price which is not less than the price at which the offer on right basis is made

to resident shareholders.

2.5.2 Prior permission of RBI for Rights issue to erstwhile OCBs

OCBs have been de-recognised as a class of investors from September 16, 2003.

Therefore companies desiring to issue rights share to such erstwhile OCBs will have to

take specific prior permission from RBI. As such, entitlement of rights share is not

automatically available to erstwhile OCBs. However bonus shares can be issued to

erstwhile OCBs without the approval of RBI.

2.5.3 Additional allocation of rights share by residents to non-residents

33

Existing non-resident shareholders are allowed to apply for issue of additional

shares/fully, compulsorily and mandatorily convertible debentures/fully, compulsorily

and mandatorily convertible preference shares over and above their rights share

entitlements. The investee company can allot the additional rights share out of

unsubscribed portion, subject to the condition that the overall issue of shares to non-

residents in the total paid-up capital of the company does not exceed the sectoral cap.

2.5.4 Acquisition of shares under Scheme of

Merger/Demerger/Amalgamation

Mergers/demergers/ amalgamations of companies in India are usually governed by an

order issued by a competent Court on the basis of the

Scheme submitted by the companies undergoing merger/demerger/amalgamation. Once

the scheme of merger or demerger or amalgamation of two or more Indian companies has

been approved by a Court in India, the transferee company or new company is allowed to

issue shares to the shareholders of the transferor company resident outside India, subject

to the conditions that:

(i) the percentage of shareholding of persons resident outside India in the transferee

or new company does not exceed the sectoral cap, and

(ii) the transferor company or the transferee or the new company is not engaged in

activities which are prohibited under the FDI policy.

Note: FIPB approval would not be required in case of mergers and acquisitions taking

place in sectors under automatic route.

2.5.4.1 Issue of Non convertible/redeemable bonus preference shares or debentures

Indian companies are allowed to issue non-convertible/redeemable preference shares or

debentures to non-resident shareholders, including the depositories that act as trustees for

the ADR/GDR holders, by way of distribution as bonus from its general reserves under a

34

Scheme of Arrangement approved by a Court in India under the provisions of the

Companies Act, as applicable, subject to no-objection from the Income Tax Authorities.

2.5.5 Issue of shares under Employees Stock Option Scheme (ESOPs)

(i) Listed Indian companies are allowed to issue shares under the Employees Stock

Option Scheme (ESOPs), to its employees or employees of its joint venture or wholly

owned subsidiary abroad, who are resident outside India, other than to the citizens of

Pakistan. ESOPs can be issued to citizens of Bangladesh with the prior approval of FIPB.

Subject to this, Government approval is not required for issue of ESOPs in sectors under

automatic route. Shares under ESOPs can be issued directly or through a Trust subject to

the condition that:

(a) The scheme has been drawn in terms of relevant regulations issued by the SEBI,

and

(b) The face value of the shares to be allotted under the scheme to the non-resident

employees does not exceed 5 per cent of the paid-up capital of the issuing company.

(ii) Unlisted companies have to follow the provisions of the Companies Act, as

applicable. The Indian company can issue ESOPs to employees who are resident outside

India, other than to the citizens of Pakistan. ESOPs can be issued to the citizens of

Bangladesh with the prior approval of the FIPB. Subject to this, Government approval is

not required for issue of ESOPs in sectors under automatic route.

(iii) The issuing company is required to report (plain paper reporting) the details of

granting of stock options under the scheme to non-resident employees to the Regional

Office concerned of the Reserve Bank and thereafter the details of issue of shares

subsequent to the exercise of such stock options within 30 days from the date of issue of

shares in Form FCGPR.

2.5.6 Share Swap

35

In cases of investment by way of swap of shares, irrespective of the amount, valuation of

the shares will have to be made by a Merchant Banker registered with SEBI or an

Investment Banker outside India registered with the appropriate regulatory authority in

the host country. Approval of the Government conveyed through Foreign Investment

Promotion Board (FIPB) will also be a prerequisite for investment by swap of shares.

2.5.7 Pledge of Shares

(A) A person being a promoter of a company registered in India (borrowing

company), which has raised external commercial borrowings, may pledge the shares of

the borrowing company or that of its associate resident companies for the purpose of

securing the ECB raised by the borrowing company, provided that a no objection for the

same is obtained from a bank which is an authorised dealer. The authorized dealer, shall

issue the no objection for such a pledge after having satisfied itself that the external

commercial borrowing is in line with the extant FEMA regulations for ECBs and that:

the loan agreement has been signed by both the lender and the borrower,

there exists a security clause in the Loan Agreement requiring the borrower to

create charge on financial securities, and

the borrower has obtained Loan Registration Number (LRN) from the Reserve

Bank:

and the said pledge would be subject to the following conditions:

o the period of such pledge shall be co-terminus with the maturity of the

underlying ECB;

o in case of invocation of pledge, transfer shall be in accordance with the

extant FDI Policy and directions issued by the Reserve Bank;

o the Statutory Auditor has certified that the borrowing company will

utilized/has utilized the proceeds of the ECB for the permitted end use/s

only.

36

(B) Non-residents holding shares of an Indian company, can pledge these shares in

favour of the AD bank in India to secure credit facilities being extended to the resident

investee company for bonafide business purpose, subject to the following conditions:

in case of invocation of pledge, transfer of shares should be in accordance with

the FDI policy in vogue at the time of creation of pledge;

submission of a declaration/ annual certificate from the statutory auditor of the

investee company that the loan proceeds will be / have been utilized for the

declared purpose;

the Indian company has to follow the relevant SEBI disclosure norms; and

pledge of shares in favour of the lender (bank) would be subject to Section 19 of

the Banking Regulation Act, 1949.

(C) Non-residents holding shares of an Indian company, can pledge these shares in

favour of an overseas bank to secure the credit facilities being extended to the non-

resident investor/non-resident promoter of the Indian company or its overseas group

company, subject to the following:

loan is availed of only from an overseas bank;

loan is utilized for genuine business purposes overseas and not for any

investments either directly or indirectly in India;

overseas investment should not result in any capital inflow into India;

in case of invocation of pledge, transfer should be in accordance with the FDI

policy in vogue at the time of creation of pledge; and

submission of a declaration/annual certificate from a Chartered Accountant/

Certified Public Accountant of the non-resident borrower that the loan proceeds

will be / have been utilized for the declared purpose.

2.6 Entry Routes for Investment

37

3.6.1 Investments can be made by non-residents in the equity shares/fully, compulsorily

and mandatorily convertible debentures/fully, compulsorily and mandatorily convertible

preference shares of an Indian company, through the Automatic Route or the Government

Route. Under the Automatic Route, the non-resident investor or the Indian company does

not require any approval from Government of India for the investment. Under the

Government Route, prior approval of the Government of India is required. Proposals for

foreign investment under Government route, are considered by FIPB.

2.6.2 Guidelines for establishment of Indian companies/ transfer of ownership or

control of Indian companies, from resident Indian citizens to non-resident entities,

in sectors with caps

In sectors/activities with caps, including inter-alia defence production, air transport

services, ground handling services, asset reconstruction companies, private sector

banking, broadcasting, commodity exchanges, credit information companies, insurance,

print media, telecommunications and satellites, Government approval/FIPB approval

would be required in all cases where:

(i) An Indian company is being established with foreign investment and is not owned

by a resident entity or

(ii) An Indian company is being established with foreign investment and is not

controlled by a resident entity or

(iii) The control of an existing Indian company, currently owned or controlled by

resident Indian citizens and Indian companies, which are owned or controlled by resident

Indian citizens, will be/is being transferred/passed on to a non-resident entity as a

consequence of transfer of shares and/or fresh issue of shares to non-resident entities

through amalgamation, merger/demerger, acquisition etc. or

(iv) The ownership of an existing Indian company, currently owned or controlled by

resident Indian citizens and Indian companies, which are owned or controlled by resident

38

Indian citizens, will be/is being transferred/passed on to a non-resident entity as a

consequence of transfer of shares and/or fresh issue of shares to non-resident entities

through amalgamation, merger/demerger, acquisition etc.

(v) It is clarified that these guidelines will not apply to sectors/activities where there

are no foreign investment caps, that is, 100% foreign investment is permitted under the

automatic route.

(vi) It is also clarified that Foreign investment shall include all types of foreign

investments i.e. FDI, investment by FIIs, FPIs, QFIs, NRIs, ADRs, GDRs, Foreign

Currency Convertible Bonds (FCCB) and fully, mandatorily & compulsorily convertible

preference shares/debentures, regardless of whether the said investments have been made

under Schedule 1, 2, 2A, 3, 6 and 8 of FEMA (Transfer or Issue of Security by Persons

Resident Outside India) Regulations.

2.7 Caps on Investments

3.7.1 Investments can be made by non-residents in the capital of a resident entity only to

the extent of the percentage of the total capital as specified in the FDI policy. The caps in

various sector(s) are detailed in Chapter 6 of this Circular.

2.8 Entry Conditions on Investment

3.8.1 Investments by non-residents can be permitted in the capital of a resident entity in

certain sectors/activity with entry conditions. Such conditions may include norms for

minimum capitalization, lock-in period, etc. The entry conditions in various

sectors/activities are detailed in Chapter 6 of this Circular.

2.9 Other Conditions on Investment besides Entry Conditions

39

3.9.1 Besides the entry conditions on foreign investment, the investment/investors are

required to comply with all relevant sectoral laws, regulations, rules, security conditions,

and state/local laws/regulations.

2.10 Foreign Investment into/downstream Investment by Indian Companies

3.10.1 The Guidelines for calculation of total foreign investment, both direct and indirect

in an Indian company, at every stage of investment, including downstream investment,

have been detailed in Paragraph 4.1.

2.10.2 For the purpose of this chapter,

(i) ‘Downstream investment’ means indirect foreign investment, by one Indian

company, into another Indian company, by way of subscription or acquisition, in terms of

Paragraph 4.1. Paragraph 4.1.3 provides the guidelines for calculation of indirect foreign

investment, with conditions specified in paragraph 4.1.3 (v).

(ii) ‘Foreign Investment’ would have the same meaning as in Paragraph

4.1.

2.10.3 Foreign investment into an Indian company engaged only in the activity of

investing in the capital of other Indian company/ies (regardless of its ownership or

control):

3.10.3.1 Foreign investment into an Indian company, engaged only in the activity of

investing in the capital of other Indian company/ies, will require prior Government/FIPB

approval, regardless of the amount or extent of foreign investment. Foreign investment

into Non-Banking Finance Companies (NBFCs), carrying on activities approved for FDI,

will be subject to the conditions specified in paragraph 6.2.18.8 of this Circular.

3.10.3.2 Those companies, which are Core Investment Companies (CICs), will

40

have to additionally follow RBI’s Regulatory Framework for CICs.

3.10.3.3 For infusion of foreign investment into an Indian company which does not have

any operations and also does not have any downstream investments, Government/FIPB

approval would be required, regardless of the amount or extent of foreign investment.

Further, as and when such a company commences business(s) or makes downstream

investment, it will have to comply with the relevant sectoral conditions on entry route,

conditionalities and caps.

Note: Foreign investment into other Indian companies would be in accordance/

compliance with the relevant sectoral conditions on entry route, conditionalities and caps.

2.10.4 Downstream investment by an Indian company which is not owned and/or

controlled by resident entity/ies

3.10.4.1 Downstream investment by an Indian company, which is not owned and/or

controlled by resident entity/ies, into another Indian company, would be in

accordance/compliance with the relevant sectoral conditions on entry route,

conditionalities and caps, with regard to the sectors in which the latter Indian company is

operating.

Note: Downstream investment/s made by a banking company, as defined in clause (c) of

Section 5 of the Banking Regulation Act, 1949, incorporated in India, which is owned

and/or controlled by non-residents/a non-resident entity/non-resident entities, under

Corporate Debt Restructuring (CDR), or other loan restructuring mechanism, or in

trading books, or for acquisition of shares due to defaults in loans, shall not count

towards indirect foreign investment. However, their 'strategic downstream investment'

shall count towards indirect foreign investment. For this purpose, 'strategic downstream

investments' would mean investment by these banking companies in their subsidiaries,

joint ventures and associates.

41

Downstream investments by Indian companies will be subject to the following

conditions:

(i) Such a company is to notify SIA, DIPP and FIPB of its downstream investment in

the form available at http://www.fipbindia.com within 30 days of such investment, even

if capital instruments have not been allotted along with the modality of investment in

new/existing ventures (with/without expansion programme);

(ii) Downstream investment by way of induction of foreign equity in an existing

Indian Company to be duly supported by a resolution of the Board of Directors as also a

shareholders agreement, if any;

(iii) Issue/transfer/pricing/valuation of shares shall be in accordance with applicable

SEBI/RBI guidelines;

(iv) For the purpose of downstream investment, the Indian companies making the

downstream investments would have to bring in requisite funds from abroad and not

leverage funds from the domestic market. This would, however, not preclude

downstream companies, with operations, from raising debt in the domestic market.

Downstream investments through internal accruals are permissible, subject to the

provisions of paragraphs 3.10.3 and 3.10.4.1

42

Chapter 3

A Brief History of Foreign Direct Investment In India

Foreign Direct Investment in India: A Critical Analysis   of FDI      

3.1 Introduction

There is hardly a facet of the Indian psyche that the concept of ‘foreign’ has not

permeated. This term, connoting modernization, international brands and acquisitions by

MNCs in popular imagination, has acquired renewed significance after the reforms

initiated by the Indian Government in 1991. Contrary to the grand narrative ‘opening of

flood-gates idea’ of 1991, what took place was a gradual process of changes in policies

on investment in certain sub-sections of the Indian economy.

As a result of controversy surrounding Foreign Direct Investment owing to a lack of

understanding, it has become the eye of a political storm. The paper aims to present a

unique understanding of FDI in the context of liberalisation and the prevailing political

climate.

43

FDI eludes definition owing to the presence of many authorities: Organisation for

Economic Co-operation and Development (OCED), International Monetary Fund (IMF),

International Bank for Reconstruction and Development (IBRD) and United Nations

Conference on Trade and Development (UNCTAD). All these bodies attempt to illustrate

the nature of FDI with certain measuring methodologies.

Generally speaking FDI refers to capital inflows from abroad that invest in the production

capacity of the economy and 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. FDI also facilitates international

trade and transfer of knowledge, skills and technology.”

It is furthermore described as a source of economic development, modernization, and

employment generation, whereby the overall benefits (dependant on the policies of the

host government),triggers technology spillovers, assists human capital formation,

contributes to international trade integration and particularly exports, helps create a more

competitive business environment, enhances enterprise development, increases total

factor productivity and, more generally, improves the efficiency of resource use. 

Changes in the national political climate have precipitated a marked trend towards greater

acceptability of FDI. The envisioned role of FDI has evolved from that of a tool to solve

the crisis under the license raj system to that of a modernising force that has been given

special agencies and extensive discourse. This evolution is illustrated by analysis of the

Economic policies of the Indian government from 1991 to 2005. The primary focus of

this analysis will be towards the industrial and infrastructural sectors which form the

beginning of the gradual liberalization process that was started in 1991. A complete

understanding of these two sectors will provide interesting statistics and information

regarding trends of FDI.

44

3.2 Uneven Beginning

In most narratives on India’s liberalization, 1991 has acquired a revolutionary status as a

time of change in the planning of India’s future. The appointment of Economist

Manmohan Singh, considered a non-political figure, as finance minister signalled a

different approach to economics; one that in itself was radical, but did not significantly

permeate the economic imagination of the Nation or the State.

Data from various individuals and agencies can lead to different conclusions all of which

can be challenged on different grounds. The Ministry of Finance, however, forms my

primary source of information for two main reasons: it has been the agency of and party

to economic reform and has compiled data on the state of reforms for the entire duration

of their history.

As early as the introductory chapter of the Ministry of Finance Economic Survey for

1991, the conclusion is that “compared to domestic investment the contribution of

foreign investment is bound to remain minor”.At the time the focus for long term

planning was still inwards as efforts were on to solve the balance of payments crisis with

India’s own ‘resources and ingenuity’ as self reliance presented itself as the only

alternative. Denying the imminence of reform at the time, the Indian government clung to

the ‘self-reliance model’ and intended to reform only as much as was absolutely essential

to arrest the crisis and revert to status quo.

Unevenness in implementation of policy was due to opposition to economic reforms from

several stakeholders. Owing to the likelihood of reforms challenging over manning and

under productivity; the first major revolt from workers in the public sector, who for the

preceding four decades enjoyed employment with a virtual permanence.

A significant protest that took political roots began in the form of the Swadeshi Jagaran

Manch (SJM) created by the RSS in the November of 1991; a few months after the new

liberal economic policy. The ‘fight’ against globalisation and privatisation found its chief

targets in multinational companies. FDI was seen to be a new form of ‘western

45

imperialism’ which the Indian Nation was to combat through indigenous capabilities. The

rhetoric aimed at exploiting the feeling of insecurity spawned by the liberalization of the

economy and strengthening national identity which was held synonymous with Hindu

consciousness by invoking the spectre of foreign domination.

The tactic worked; many Indian capitalists accustomed to decades of protectionist

policies, anxious about the impact of liberalization on their well being; got together to

complain that foreign capital would drive them out of business. An argument of this

nature came from the director of the Confederation of Indian Industry, a business lobby

group, in an attack in April 1996 on the role of multinational corporations in India.

He accused them of not being committed to India for the long term, of not bringing in

state of the art technology, and of an over reliance on imported components rather than

Indian made ones. 7 The population of rural India was barely affected and only remotely

concerned with FDI but it formed the largest part of the Indian Nation and was swayed by

anti- FDI rhetoric.

Thus, in the interests of political expediency, P.V. Narasimha Rao, the then Prime

Minister, could not and took care not to reform the economy too fast.8 Before

announcing any reforms in contentious areas such as taxation, financial services and the

public sector, the Prime Minister appointed committees to explore each issue, and make

recommendations.9 These recommendations, almost identical to prescriptions made by

the World Back and the IMF, were deemed more acceptable from Indian committees.

Politics and political standpoints made a very large impact on the trajectory of reforms.

46

The following paragraph illustrates the importance.

The PM was also highly sensitive to the impact of reform on India’s voters; his instincts

were driven by politics, not economics. A way to measure the popularity of the reforms

can be done through the elections. The delinking in 1971 of state assembly polls from

those to the national Parliament, some state or other is constantly going to the polls and

as a result the central government face constant judgements at the tribunal of public

opinion. Rao felt that an electoral setback even in one state couldbe interpreted as a

verdict against the economic reforms nationwide; he therefore downplayed them as much

as possible, and avoided making reforms that might have been politically costly in the

short term, such as laying off public sector workers, privatizing or closing down

inefficient factories, reducing subsidies, or taxing agricultural income. Despite this, when

electoral defeats came in states like Karnataka, and Andhra Pradesh, political stalwarts

were quick to ascribe them to the reforms,alleging that the populous in general did not

benefit from them. 

Election time manifestos of major political parties are an indicator of the standpoints of

major political parties, and also tools to analyse the variance that liberalization could

take. The party in power is concerned with self-perpetuation and cannot afford to alienate

anyone. In an effort to broaden support bases, political parties often dilute their original

agendas. An analysis of political party agendas is important as it forms the crux of the

agenda once elected.

The political parties that vied for the nation’s attention in their election manifestoes

presented their agenda (a mix of ideology and party advancement) that could be

47

implemented in 1991. Of the three major political parties (Congress, BJP and Communist

Party (Marxist) (CPI(M)) had already placed the state of the Indian economy by tracing it

to the IMF loans that were taken in 1981 by one of the previous Congress government.

The BJP talked about reversing current trends with the declaration that the country was

corrupt and on the verge of bankruptcy.12 Their economic strategy required holding the

price line and liberating the economy from bureaucratic controls and not excising duties

on item of mass consumption for 5 years.13 In their tenure agriculture would have been

given the first priority. The crux of the viewpoint can be summed by “we will make our

economy truly Swadeshi by promoting native initiatives.” The above viewpoints were

contrasted by the Congress Party that announced that foreign investment and technology

collaboration would be permitted to obtain higher technology, to increase exports and to

expand the production base. The Congress realized the importance of a change in the

economic model but was also wary of domestic concerns. With their announcement for

investment was a warning that “such foreign investment will not be at the cost of self-

reliance”.15 The different approach of the Congress Party meant that if elected there

could not be policies that alienated the segment of the population that followed or shared

other party viewpoints.

Even after Congress came to power and reforms began, FDI was not in anyway defined

in 1991 nor was it considered a mechanism for development. In the context of the time

the emphasis is placed on stabilizing the economy. The goals for the upcoming year were

to consolidate gains, bring problems under control and restore “the government’s

capacity to pursue the social goals of generating employment, removing poverty and

promoting equity”16. What this illustrates is that while the new policy had brought in a

dramatic increase in investment activity, there was no clear understanding of FDI as a

proper mechanism for development or its future role.

This trend was visible through 1992-1993 where investment has increased but the role of

the government emphasizes it role in ‘filmi’ terms as a protector of the weak and to

“ensure peace, and prevent mischief”17 It is in 1993-1994 where there seems to be a

realization on the importance of FDI. Reading the definition it seems that both literature

48

and economics have come together as an ideal definition of this concept is given that

seems to weave together knowledge, technology, and high rates of growth.18 It takes

another year before the policy reforms properly percolate down to the level of state

governments and state capitals; the actual benefits of new industrial investment can only

accrue if investment approvals and intentions are translated into real investment,

employment and production. The role of the state government is critical because

resources for production such as land use, water, power generation, and distribution and

roads come under the purview of state governments. 

The far reaching unanimity for FDI within came in 1995-1996 when the government

began to showcase the progress made as a result of FDI along with defending the changes

to critics. Statistics had been available for most years, but now FDI entered the mindset

of the government. The future of India’s growth and output was seen to be connected to

FDI and it was deemed necessary for promoting higher growth of output,exports and

employment.20 Furthermore the government also defended FDI by stating that “fears of

foreign investment swamping our domestic industry or creating unemployment are

unfounded or grossly exaggerated”. 

The acceptance of FDI was not shared by the opposition, as by the next elections the

party positions show some level of variance but the general feelings were similar. The

BJP stayed critical of the Congress Party and their so called “acceptance of IMF

conditionalities” coupled with what they referred to as a radical different approach to

Foreign Investment. The criticism delved into another level, as the party viewed that at

some level the License Quota Permit Raj has remained intact. BJP believed in the

Swadeshi approach, but recognized that foreign Investment would be required

and encouraged for world class technology. The party was able to effectively change its

stance by allowing for FDI but stating that it would “strive to minimize dependence of

foreign saving” thus elaborating distinctions that would keep India’s economic

sovereignty. The party elaborated that globalisation is not a synonym for the oliberation

of national economic interest. The party was able to change its viewpoint by separating a

49

progressive India open to new ideas, new technology and fresh capital but at the same

time not a westernized India. 

Meanwhile the Communist party stayed true to its previous stance and offered strong

criticism of the general economic policy that unfolded since 1991, but it was just the

reverse when it was seen from a practical point of view and the history of their stance

when it comes to the states where they are in power.  Needless to say the policies were

theoretically seen as pro multinational and anti public sector and local industries.24 The

issue of self reliance was still considered important and the policy of globalization and

privatization were seen to strike a heavy blow at the self reliant path of development. The

inclusion of FDI was analysed as MNC’s acquiring vital sectors of the economy. The

most important observation by CPI (M) was policy evaluation; that the BJPs economic

nationalism was a crude mixture of swadeshi demagogy and actual support to

liberalization policy of the congress. The Communist party observed the trends from the

state governments of BJP and was able to effectively summarize and offer criticism that

the BJP party line had oscillated between extremes (perhaps to mobilize support) from

denouncing Enron and threatening to throw it into the sea, to quickly striking a fresh deal

with the same company. Thus by 1996, though there was difference of opinion on FDI,

term was slowly being worked into the party position as a debateable and mainly an

election issue. If nothing else the topic has sparked discussion as its future will affect the

welfare of the country.

Maintaining the Flow With the new government focus on FDI was evident in changes in

1996-97 that resulted in an increase in understanding and resources towards investment.

This included the setting up of the Foreign Investment Promotion Council along with the

Foreign Investment Promotion Board (FIPB) being streamlined and made more

transparent. The first ever guidelines were announced for consideration of foreign direct

investment proposals by the FIPB, which were not covered under the automatic route.26

The list of industries eligible for automatic approval of up to 51 per cent foreign equity

were expanded and there was a recognition that foreign direct investment flows

provided savings without adding to the country's external debt. The case of comparison

50

for numbers and example seem to be China and the Asian Tigers that were enjoying the

economic boom.

By now FDI trends are taken more serious and FDI flow had to be maintained for the

economy to grow. The government recognized that greater procedural simplifications

were still needed in the area of FDI. In 1998 when there was a decline in FDI the

government had to take greater technical measures in terms of liberalising investment

norms in bring in FDI. Though these were steps in the right direction the government was

not able to function as a central ruling body and elections had to be called that resulted

with a BJP government.

3.3 Another Beginning

By now after having been in power the BJP in 1998-1999, overhauled its previous

stance and in its party manifesto admitted that that “the country cannot do without FDI

because besides capital stocks it brings with it technology, new market practises and most

importantly employment”.27 However there is a clarification that FDI will be encouraged

in core areas so that it usefully supplements the national efforts and discourage FDI in

non priority areas.28 The Communist party while talking about land reforms also made a

recognition of foreign capital that is “to be solicited to those areas for which clear cut

priorities are set.”29 CPI (M) was not clear as the so called ‘priorities’ were to be

51

themselves are to be determined by the need for developing new production capacities

and acquiring new technology. Meanwhile the Congress party (now was on a different

level than the other party) planned an increase both the level and productivity of

investment, both domestic and foreign, public and private, in infrastructure like power,

roads, ports, railways, coal, oil and gas, mining and telecommunications.

The trends now illustrated that while the facets of FDI were not completely understood

by all the parties it was a topic that was a major election and policy topic. The analysis

reveals that FDI at this point could not be blocked but the parliamentary parties through

their policy realized that its speed could be controlled to garner effective longevity for the

party while balancing the investment needs of the country.

The trends of FDI now resulted in policy formulation. For example in 1999-2000, when a

second year of decline continued a Foreign Investment Implementation Authority (FIIA)

was set up for providing a single point interface between foreign investors and the

government machinery, including state authorities. This body was also empowered to

give comprehensive approvals. After this point FDI has acquired an acceptable status and

the debate is on the levels that will be allowed.

By the next election in 2004, FDI had become a non-electable issue. There was

widespread acceptance of the topic among all the party lines and it was no longer will it

be allowed but how the polices would be designed for FDI.

3.4 Sector Analysis

When the reforms began in 1991 it was inevitable there would be a discrepancy as

various sectors have different characteristics and procedures. The reforms and polices on

FDI have trickled down to various sectors in different speed and effectiveness. Thus the

progress of FDI will be effectively analyzed by studying two sectors of the Indian

economy: Industry and Infrastructure. These sectors are an agglomeration of sub sectors

that when combined from the integral components of the economic growth.

3.5 Significant Change versus Struggling On

52

When initial reforms took place in 1991, Industry was one of the first to benefit from the

reforms as it resulted in changing the overall system. Firstly the new policy of July 1991

sought substantially to deregulate industry so as to promote the growth of a more efficient

and competitive industrial economy. During this process the procedures for investment in

non-priority industries were streamlined. On a central level the foreign Investment

Promotion Board (FIPB) was established to negotiate with large international firms and

to expedite the clearances required. The FIPB also considered individual cases involving

foreign equity participation over 51 percent.30 Furthermore for industry an important

step was the removal of the Mandatory Convertibility Clause. The government realised

that foreign investment had been traditionally tightly regulated in India and now the

government hand was lifting.

These changes while dramatic did not yield results immediately; though Foreign

Investment was liberalised in 1992, manufacturing declined. The widespread social

disturbances and economic uncertainties which prevailed during the year contributed to

this decline and to a weakening of investment demand as investment intentions suffered

from the uncertain conditions which prevailed. On a positive note by this time due to the

announcement of the new industrial policy in July 1991, a large number of

Governmentinduced restrictions, licensing requirements and controls on corporate

behaviour were eliminated. 

The full impact of the events surrounding Ayodhaya in 1992 were felt a year later, as the

incident had disrupted industrial activity and had upset business plans and investment

decisions.33 It was in the years of 1995-1996 that Industry observed a change that has

become a staple of attracting FDI to India ever since. With state governments undertaking

procedural and policy reforms in line with liberalization taken by the centre, reforms

were initiated by most state governments for promoting foreign investment, thus

encouraging investment participation in industry.

While Industry had taken a stride forward, an examination of Infrastructure reveals a

policy and approach that differs significantly from Industry. From the onset the status of

infrastructure sector did not cause any state of panic, as overall the sector was not seen to

53

be performing too badly, and was seen as the stabilizing force of the economy. The sector

was seen as a bloc and in its components while the performance of coal and

telecommunications sectors fell short of the respective targets; simultaneously energy,

railways, and shipping exceeded their respective targets thus bringing up the overall

performance of the sector to positive growth. 

This discrepancy was recognized in n 1992-1993 when the general review mentioned in

an overview that capital intensive infrastructure industries such as power, irrigation and

telecommunications, were handicapped by a number of constraints and where possible

these industries should eventually develop competitive market structures.35 Once again

the shipping, railways and telecommunications were able to meet targets while the

performances of coal and power have been below target. As a result the sector as a whole

was not liberalized but there were only suggestions that it was important to attract foreign

and private investment in the power sector to overcome the resource constraint.

1993-1994 followed the trend whereby instead of economic data the analysis offered was

the shortcomings on the Infrastructure sector such as its development largely in the public

sector and need for structural changes in the organization, operation and management of

the public sector enterprises.37 The call to induce greater efficiency and accountability

by replacing the monopolistic nature of these sectors with a competitive environment was

not followed by steps to make this dream a practicality.

1994-1995 follows in the same footsteps of the previous years but with recognition that

as government’s ability to undertake investment in infrastructure is severely constrained

and it is necessary to induce much more private sector investment and participation in the

provision of infrastructure services.38 1995-1996 illustrates the great unevenness of the

growth that is taking place within sectors and between technologies. By the time

infrastructure is linked to FDI as the condition of infrastructure has a direct correlation to

international competitiveness and flow of FDI, the government has finished its tenure.

54

Explains the reason of practicing the present mode of ''development'' where common

people are expandable in order to grow infrastructure for free FDI inflow

3.6 Understanding FDI

The period of the next coalition government in 1996-1998 could be seen as a willingness

to understand FDI by placing policies that would result in an increase in FDI and further

liberalization. There was a greater understanding on the role of FDI in both the sectors.

Industry still lead the reforms whereby automatic approval of FDI was increased up to 74

per cent by the Reserve Bank of India in nine categories of industries, including

electricity generation and transmission, non-conventional energy generation and

distribution, construction and maintenance of roads, bridges, ports, harbours, runways,

waterways, tunnels, pipelines, industrial and power plants, pipeline transport except for

POL and gas, water transport, cold storage and warehousing for agricultural products,

mining services except for gold, silver and precious stones and exploration and

production of POL and gas, manufacture of iron ore pellets, pig iron, semi-finished iron

and steel and manufacture of navigational, meteorological, geophysical, oceanographic,

hydrological and ultrasonic sounding instruments and items based on solar energy. The

government also announced in January 1997 the first ever guidelines for FDI expeditious

approval in areas not covered under automatic approval.

This above trends illustrates the earlier point of the government recognizing and carrying

forth of the previous work done by the Rao government. While the advantage of FDI did

55

not reach the mindset of the common man the government seemed to show possibilities

of development through FDI. For example when Indian industry registered a modest

growth rate of 7.1 per cent in 1996-97, which was much lower than the 12.1 per cent

growth in 1995-96, there was research carried out which revealed this was partially

attributable to the mining and electricity generation sectors which recorded

meagre growth rates of 0.7 per cent and 3.9 per cent respectively. Thus the policy was

immediately rectified by expanding the list of industries eligible for foreign direct equity

investment under the automatic approval route by RBI in 1997-1998.

For infrastructure there was a realization that investments were, by their very nature, for

long-term return activities. This implies that there is a continuing mismatch between the

required debt maturities and the availability of funding. The focus of this government

shifted from Infrastructural direct investment to more towards equity investment. In terms

of specific cases there is only literature on two areas namely roads and ports in relation to

FDI. By 1997-1998 the most the term “infrastructure” was expanded to include telecom,

oil exploration and industrial parks to enable these sectors to avail of fiscal incentives

such as tax holidays and concessional duties. Liberalisation of foreign investment norms

in the road sector resulted in granting of automatic approvals for foreign equity

participation up to 74 per cent in the construction and maintenance of roads and bridges

and up to 51 per cent in supporting services to land transport like operation of highway

bridges, toll roads and vehicular tunnels.42 Civil Aviation also dealt with a new policy

for private investment that was announced allowing for 100 per cent NRI/OCB equity

and 40 per cent foreign equity participation in domestic airlines.43 The development of

the Infrastructure sector for FDI was still haphazard as power, telecommunications,

postal services, railways, urban Infrastructure have no mention of FDI.

In a narrative of the governments it can be easily observed that a strong legacy of FDI 

was inherited and the trend that continued were along the same fissures of development

whereby liberal polices advanced with certain modifications. The weak hold on power by

56

the government meant there could not be an overhaul by further increasing FDI at a

phenomenal level but slowly opened the economy by carrying on the reforms that the

Congress had started.

3.7 A Procedural Battle

In the next governments of the BJP, though the party ideology was initially formulated

with its own unique ways of FDI advancement, the prospect of advancing overall

development, and an established system by the last two governments resulted in

continuing the reforms in the economy along the same lines. In course of the year several

policy measures were announced for reviving industrial investment. These included

reduction of income and corporate tax rates, reduction in excise duties on intermediates

and customs duties on raw materials, reduction in bank rate and cash reserve ratio. By

now the government had liberalised investment norms in various sectors, further

simplified procedures, delicensed and de-reserved some of the key industries and stepped

up public investment in infrastructure industries.

For industry the period started with a decline whereby the total foreign investment (FDI

and portfolio) declined to $ 2312 million in 1998-99 from $ 5853 million in 1997-98, as a

result of a reduction of $ 1.8 billion portfolio flows and a 32 per cent reduction in FDI.

During 1998, the flows to developing countries declined by 3.8 percent, resulting in

India’s share in these flows falling sharply to 1.4 per cent. World FDI flows to

developing countries peaked in 1997 ($ 173 billion) when India’s share in these flows

was 1.9 per cent.44 Nationally this resulted in several measures taken for facilitating the

inflow of foreign investment in the economy. The scope of the automatic approval

57

scheme of the RBI was again significantly expanded. The Government decided to place

all items under the automatic route for Foreign Direct Investment/ NRI and OCB

investment except for a small negative list and set up a Group of Ministers for reviewing

the existing sectoral policies and caps. The Union Budget (1999-2000) permitted FDI up

to 74 percent, under the automatic route, in bulk drugs and pharmaceuticals. In 2000-

2001 the time frame for consideration of FDI proposals was reduced from 6 weeks to 30

days for communicating Government decisions. The 2001-2002 years were not good for

Industry due to an industrial slowdown.

For Infrastructure by 1998-1999 the narrative is stabilizing to the same concept of broad

statements regarding the role of infrastructure and its importance to the government. In

terms of procedures automatic approval for foreign equity participation up to 100 percent

is permitted for electricity generation, transmission and distribution for foreign equity

investment not exceeding Rs.1500 crore (excluding atomic reactor power plants).

Once again in the outlook section the government realized the importance of

infrastructure but there are not concrete steps listed to achieve this. In 1999-2000 there is

talk of infrastructure growing in the year there is no data available on the role and amount

of foreign direct investment.

Breaking down into sub sectors for Infrastructure reveals that compared to Industry,

Infrastructure has had a large discrepancy in its sub-sectors. For example the power

sector performance during the period 1992-93 to 1999-2000 has been disappointing

despite significant reforms in the sector, such as setting up of a regulatory authority and

opening power generation to private investment, both domestic and foreign. For the

postal sector the emphasis on social objectives has outweighed other considerations and

user charges remained low. Therefore, notwithstanding the revision of tariff, the

postalservices continue to run into a deficit; in 1999-2000, the postal deficit was Rs.

1,596 crore.

One of the important conclusions of the above review of infrastructure development is

that the demand for infrastructure services continues to outpace supply. There is

58

recognition of the role of Infrastructure in the upcoming years, as it is a ‘precondition to

rapid economic development’ but the policies have not brought the required change as

quickly as expected. For example in urban infrastructure 100 percent FDI has been

permitted on the development of integrated townships since 2001. However investments

did not materialize because of very rigid existing conditions relating to land procurement

especially in urban areas, where land revenue and reform legislation have precedence

over organization. Moreover there are problems relating to lack of clear titles, old

protective tenancy and rent control. The suggestion is that the system of maintenance of

land records needs to be improved through computerization.

3.8 FDI Redux

By 2002 FDI changes completely for India as it is given new importance in Ministry of

Finance’s Economic Survey in the form of a new subsection in Industry that exclusively

dealt with FDI and went to great lengths to define its role, and provides much more data

than in the previous years. There is also particular mention on how RBI is evaluating

some modifications in the way that Indian FDI is measured, which could lead somewhat

higher estimates for India. By now garnering FDI is a prized commodity in a competitive

global arena and is analysed in context as other countries are also improving policies and

institutions, to further increase their FDI flows. By 2003-2004 the non-comparability of

the Indian FDI statistics was addressed by a committee constituted in May 2002 by

Department of Industrial Policy & Promotion (DIPP), in order to bring the reporting

system of FDI data in India into alignment with international best practices.

For infrastructure from 2002-2003 (re formulation of FDI data) there is mention in sub

sectors for FDI and not for infrastructure as a whole. Telecom has been a major recipient

of FDI and during the period of August 1991 to June 2002, 831 proposals for FDI of Rs.

56,226 crore were approved and the actual flow of FDI during the above period was Rs.

9528 crore. In terms of approval of FDI, the telecom sector is the second largest after the

59

energy sector. In 2002, the increase of FDI inflow was of the order of Rs 1077 crore

during January to July 2002.

The FDI target for the Telecommunication sector is estimated at US $2.5 billion per

annum, by the Steering Group on FDI, Planning commission. By 2003-2004 literature on

Infrastructure talks about investments needed to bring infrastructure to world standards.

However there is no mention of details. Finally for 2004-2005 there is data for Telecom

but in general there is no data on FDI in the infrastructure sector as a whole. The analysis

of both the sectors and especially Infrastructure raises questions on the haphazard nature

of FDI taking place. While this trend may have been acceptable in the early 1990s, when

FDI was in its infancy the recognition and building of reforms by the successive

governments raises the questions on what part of FDI is the government attention shifted

in.

3.9 Sub sector: Telecommunications

Further narrowing of FDI in sub-sectors reveals more interesting trends. Research into

Telecommunications furthers the haphazard nature of FDI investment and policy making.

The current process for FDI in telecommunications can be attributed to two policies that

were undertaken by the government: National Telecom Policy of 1994 and New Telecom

Policy of 1999. Before the economic reforms ‘teledensity’ was low, infrastructure growth

was slow, and the lack of reforms restricted investments and adoption of new

technologies. The existing legislative and regulatory environment needed major changes

to facilitate growth in the sector.

It was 1991 when the programme was undertaken to expand and upgrade India’s vast

telecom network. The programme included: complete freedom of telecom equipment

manufacturing, privatisation of services, liberal foreign investment and new regulation in

technology imports.47 Simultaneously, the government-managed Department of

Telecommunications (DoT) was restructured to remove its monopoly status as the service

provider.48 The government programme was formalised on a telecom policy statement

60

called National Telecom Policy 1994 on 12 May 1994. However the 1994 policy was not

sufficient to make the India’s telecommunications sector fully open and liberalised. The

incumbent monopoly (DoT) was indifferent in implementing the national telecom policy

effectively due to its lack of commitment and also due to the instability at the Centre

(frequent changes of governments) over 1994 and 1998. This paved the way for

designing a new policy framework for telecommunications which was called the New

Telecom Policy 1999 (NTP99) and was delivered by the new government led by BJP

coalitions.

The New Telecom Policy 1999 (NTP99) was developed at the backdrop of three major

events witnessed by the Indian economy after the reform process began in 1991. First,

although NTP94 was a right step to bring reform in the telecommunications industry, it

failed to achieve a desired goal until 1997. Second, the coalition government of the BJP

brought stability to the Central government and after assuming power; the BJP-led

government announced and followed through with further reform in telecommunications

to attain an effective and efficient communications sector.49 This policy is an example

that economics reforms and political systems coexist. In order to achieve the BJP-led

coalition government immediately formed a high powered committee to develop the

Internet Services Development Policy headed by than Kerala CM Chandrababu Naidu.

The committee and the interest of the government led to the new policy. As a result in

addition to the sectoral caps, the government policy played a major role in the

liberalization of the telecom sector. As a result a large number of private operators started

operating in the basic/mobile telephony and Internet domains. Teledensity has increased,

mobile telephony has established a large base, the number of Internet users has seen a

steep growth, and large bandwidth has been made available for software exports and IT-

enabled services, and the tariffs for international and domestic links have seen significant

reductions.

3.10 FDI Culture

61

Many economists in the country have now realized the advantages of FDI to India. While

the achievements of the Indian government are to be lauded, a willingness to attract FDI

has resulted in what could be termed an “FDI Industry”. While researching the economic

reforms on FDI, it was discovered that there exists a plethora of boards, committees, and

agencies that have been constituted to ease the flow of FDI. A call to one agency about

their mandate and scope usually results in the quintessential response to call someone

else. Reports from FICCI and the Planning Commission place investor confidence and

satisfaction at an all time high; citizens too deserve to be clued in on the government

bodies are doing.

According to the current policy FDI can come into India in two ways. Firstly FDI up to

100% is allowed under the automatic route in all activities/sectors except a small list that

require approval of the Government. FDI in sectors/activities under automatic route does

not require any prior approval either by the Government or RBI. The investors are

required to notify the Regional office concerned of RBI within 30 days of receipt of

inward remittances and file the required documents with that office within 30 days of

issue of shares to foreign investors.51 All proposals for foreign investment requiring

Government approval are considered by the Foreign Investment Promotion Board

(FIPB). The FIPB also grants composite approvals involving foreign investment/foreign

technical collaboration.52 As this clarity is useful for future investors, it has to be seen if

these bodies are effective. The Initial research revealed four major bodies that have been

constituted and could provide data pertaining to FDI- 

1991 Foreign Investment Promotion Board FIPB

• consider and recommend Foreign Direct Investment (FDI) proposals, which do not

come under the automatic route. It is chaired by Secretary Industry (Department of

Industrial Policy & Promotion).

1996 Foreign Investment Promotion Council FIPC

62

• constituted under the chairmanship of Chairman ICICI, to undertake vigorous

investment promotion and marketing activities. The Presidents of the three apex business

associations such as ASSOCHAM, CII and FICCI are members of the Council.

1999 Foreign Investment Implementation Authority FIIA

• functions for assisting the FDI approval holders in obtaining various approvals and

resolving their operational difficulties. FIIA has been interacting periodically with the

FDI approval holders and following up their difficulties for resolution with the concerned

Administrative Ministries and State Governments.

3.11 2004 Investment Commission

• Headed by Ratan Tata, this commission seeks meetings and visits industrial groups and

houses in India and large companies abroad in sectors where there was dire need for

investment.

Attempting to research directives and results of the above bodies resulted in no direct

contact but instead a list of various other sub bodies.

• Project Approval Board (PAB) for approving foreign technology transfer proposals not

falling under the automatic route.

• Licensing Committee (LC) for considering and recommending proposals for grant of

industrial license.

• In addition, concerned Ministries/ Departments issue various approvals as per the

allocation of business and various Acts being administered by them.

• At the State level, State Investment Promotion Agency and, at the district level,

• District Industries Centres, generally look after projects.

• Concerned departments of the State Government handle sectoral projects.

• Fast Track Committees (FTCs) have been set up in 30 Ministries/Departments for close

monitoring of projects with estimated investment of Rs. 100 crores and above and for

resolution of issues hampering implementation.

63

• “Investment Promotion and Infrastructure Development Cell” gives further impetus to

facilitation and monitoring of investment, as well as for better coordination of

infrastructural requirements for industry

• SIA has been set up by the Government of India in the Department of Industrial Policy

and Promotion in the Ministry of Commerce and Industry to provide a single window for

entrepreneurial assistance, investor facilitation, receiving and processing all applications

which require Government approval, conveying Government decisions on applications

filed, assisting entrepreneurs and investors in setting up projects, (including liaison with

other organizations and State Governments) and in monitoring implementation of

projects.

• CCFI Cabinet Committee on Foreign Investment- meets at the ministerial level  and is

guided by the prime Minister, considers foreign investment exceeding Rs 3 billion as

requiring special political attention.

• Indian Missions Abroad- can also receive project proposal and will forward them the

institutions in New Delhi.

• Indian Investment Centre- (This was supposed to be closed after the Planning

Commission was established but still continues to operate) established as an autonomous

organization in 1960 with the objective of doing promotional work abroad to attract

foreign private investment into India and establishment of joint ventures, technical

collaborations and third country ventures between Indian and foreign entrepreneurs.

The face of FDI usually resides with pamphlets and amalgamation of facts and figures

that are circulated through many conferences. From these it can be deciphered that

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

liberalization are taken. The 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 Reserve Bank of India (RBI) under Foreign Exchange

Management Act (FEMA).

64

Thus while clear procedures have been established for FDI, government needs to

seriously evaluate how much resources and money is being poured to what is becoming

the FDI industry. The fluidity of bodies has resulted in the monetary value of FDI feeding

a makeshift industry that deals with dealing with the concept and procedures of FDI.

3.12 Conclusion

As evidenced by analysis and data the concept and material significance of FDI has

evolved from the shadows of shallow understanding to a proud show of force.

While it is accepted that the government was under compulsion to liberalize cautiously,

the understanding of foreign investment was lacking. It was because of the submissive

nature of the govt. that harnesses scope of FDI inflow.  A sectoral analysis reveals that

while FDI shows a gradual increase and has become a staple for success for India, the

progress is hollow (Annexure 1 and 2). The Telecommunications and power sector are

the reasons for the success of Infrastructure. This is a throwback to 1991 when

Infrastructure reforms were not attempted as the sector was performing in the positive.

65

FDI has become a game of numbers where the justification for growth and progress is the

money that flows in and not the specific problems plaguing the individual sub sectors.

Political parties (Congress, BJP, CPI (M)) have changed their stance when in power and

when in opposition and opposition (as well as public debate) is driven by partisan

considerations rather that and effort to assess the merit of the policies. This is evident is

the public posturing of Hindu right, left and centrist political parties like the

Congress.The growing recognition of the importance of FDI resulted in a substantive

policy package but and also the delegation of the same to a set of eminently dispensable

bodies. This is indicative of a mood of promotion counterbalanced by a clear deference of

responsibility.

In the comparative studies the notion of Infrastructure as a sector has undergone a

definitional change. FDI in the sector is held up primarily by two sub sectors

(telecommunications and Power) and is not evenly distributed.The three major industrial

houses (CII, ASSOCHAM, FICCI), World Bank and the Planning Commission have

similar recommendations for FDI and yet despite their concurrence, a comprehensive

policy in this respect is still to be formulated after 15 years of India’s economic reforms.

The worship of FDI by the business class of India doesn't have any resemblance with the

falling rate of industrial growth and shifting of the labor class to a white collar technocrat

section based on outsourcing. The Swadeshi alternative has receded in public policy

debate.

Thus the impact of the reforms in India on the policy environment for Foreign Direct

Investment presents a mixed picture. The industrial reforms have gone shady, they are

supplemented by more infrastructure reforms and increase in service sector rather than

any significant industrial growth  which is a critical missing link

66

CHAPTER-4

FDI AND INDIAN ECONOMY

4.0 INTRODUCTION

Nations’ progress and prosperity is reflected by the pace of its sustained economic

growth and development. Investment provides the base and pre-requisite for economic

growth and development. Apart from a nation’s foreign exchange reserves, exports,

government’s revenue, financial position, available supply of domestic savings,

magnitude and quality of foreign investment is necessary for the well being of a country.

Developing nations, in particular, consider FDI as the safest type of international capital

flows out of all the available sources of external finance available to them. It is during

1990s that FDI inflows rose faster than almost all other indicators of economic activity

worldwide. According to WTO83, the total world FDI outflows have increased nine – fold

67

during 1982 to 1993, world trade of merchandise and services has only doubled in the

same. Since 1990 virtually every country- developed or developing, large or small alike-

have sought FDI to facilitate their development process. Thus, a nation can improve its

economic fortunes by adopting liberal policies vis-à-vis by creating conditions conducive

to investment as these things positively influence the inputs and determinants of the

investment process. This chapter highlights the role of FDI on economic growth of the

country.

4.1 FDI AND INDIAN ECONOMY

Developed economies consider FDI as an engine of market access in developing and less

developed countries vis-à-vis for their own technological progress and in maintaining

their own economic growth and development. Developing nations looks at FDI as a

source of filling the savings, foreign exchange reserves, revenue, trade deficit,

management and technological gaps. FDI is considered as an instrument of international

economic integration as it brings a package of assets including capital, technology,

managerial skills and capacity and access to foreign markets. The impact of FDI depends

on the country’s domestic policy and foreign policy. As a result FDI has a wide range of

impact on the country’s economic policy. In order to study the impact of foreign direct

investment on economic growth, two models were framed and fitted. The foreign direct

investment model shows the factors influencing the foreign direct investment in India.

The economic growth model depicts the contribution of foreign direct investment to

economic growth.

4.2 Selection of Variables: Macroeconomic indicators of an economy are considered as

the major pull factors of FDI inflows to a country. The analysis of above theoretical

68

rationale and existing literature also provides a base in choosing the right combination of

explanatory variables that explains the variations in the flows of FDI in the country. In

order to have the best combination of explanatory variables for the determinants of FDI

inflows into India, different alternatives combination of variables were identified and

then estimated. The alternative combinations of variables included in the study are in tune

with the famous specifications given by United Nations Conference on Trade and

Development, (UNCTAD 2007)77. The study applies the simple and multiple regression

method to find out the explanatory variables of the FDI inflows in the country. The

regression analysis has been carried out in two steps. In the first step, all variables are

taken into consideration in the estimable model. In the second stage, the insignificant

variables are dropped to avoid the problem of multi-colinearity and thus the variables are

selected. However, after thorough analysis of the different combination of the

explanatory variables, the present study includes the following macroeconomic

indicators: total trade (TRADEGDP), research and development expenditure (R&DGDP),

financial position (FIN.Position), exchange rate (EXR), foreign exchange reserves

(RESERVESGDP), and foreign direct investment (FDI), foreign direct investment

growth rate (FDIG) and level of economic growth (GDPG). These macroeconomic

indicators are considered as the pull factors of FDI inflows in the country. In other words,

it is said that FDI inflows in India at aggregate level can be considered as the function of

these said macroeconomic indicators. Thus, these macroeconomic indicators can be put

in the following specifications:

MODEL-1

FDIt = a + b1TRADEGDPt + b2RESGDPt + b3R&DGDPt + b4FIN. Positiontt + b5EXRt +

e… (4.1)

69

MODEL-2

GDPGt = a + bFDIGt + e.................. (4.2)

where,

FDI= Foreign Direct Investment

GDP = Gross Domestic Product

FIN. Position = Financial Position

TRADEGDP= Total Trade as percentage of GDP.

RESGDP= Foreign Exchange Reserves as percentage of GDP.

R&DGDP= Research & development expenditure as percentage of GDP.

FIN. Position = Ratio of external debts to exports

EXR= Exchange rate

GDPG = level of Economic Growth FDIG =

Foreign Direct Investment Growth

t = time frame

4.2.1 FOREIGN DIRECT INVESTMENT (FDI): It refers to foreign direct investment.

Economic growth has a profound effect on the domestic market as countries with

expanding domestic markets should attract higher levels of FDI inflows. The generous

Table - 4.1

FDI FLOW IN INDIA

amount in Rs. crores

Years FDI inflows in

India

1991-92 409

1992-93 1094

1993-94 2018

70

1994-95 4312

1995-96 6916

1996-97 9654

1997-98 13548

1998-99 12343

1999-00 10311

2000-01 10368

2001-02 18486

2002-03 13711

2003-04 11789

2004-05 14653

2005-06 24613

2006-07 70630

2007-08 98664

2008-09 123025

Source: various issues of SIA Bulletin.

flow of FDI (Chart - 4.1 and Table - 4.1) is playing a significant and contributory role in

the economic growth of the country. In 2008-09, India’s FDI touched Rs. 123025 crores

up 56% against Rs. 98664 crores in 2007-08 and the country’s foreign exchange reserves

touched a new high of Rs.1283865 crores in 2009-10. As a result of India’s economic

reforms, the country’s annual growth rate has averaged 5.9% during 1992-93 to 2002-03.

Chart – 4.1

71

Source: various issues of SIA Bulletin.

Notwithstanding some concerns about the large fiscal deficit, India represents a

promising macroeconomic story, with potential to sustain high economic growth rates.

According to a survey conducted by Ernst and Young19 in June 2008 India has been rated

as the fourth most attractive investment destination in the world after China, Central

Europe and Western Europe. Similarly, UNCTAD’s World Investment Report76 2005

considers India the 2nd most attractive investment destination among the Transnational

Corporations (TNCs). All this could be attributed to the rapid growth of the economy and

favourable investment process, liberal policy changes and procedural relaxation made by

the government from time to time.

4.2.2 GROSS DOMESTIC PRODUCT (GDP): Gross Domestic Product is used as one

of the independent variable. The tremendous growth in GDP (Chart-4.2, Table- 4.2) since

1991 put the economy in the elite group of 12 countries with trillion dollar economy.

India makes its presence felt by making remarkable progress in information technology,

high end services and knowledge process services. By achieving a growth rate of 9% in

three consecutive years opens new avenues to foreign investors from 2004 until 2010,

FDI Flow

amt. in Rs. crores

years

09 08

0807-

0706-

0605-

0504-

0403-

0302-

0201-

0100-

0099-

9998-

9897-

9796-

9695-

9594-

9493-

9392-

9291-

1500

1000

500

0

Movement of FDI Flow in India

72

India’s GDP growth was 8.37 percent reaching an historical high of 10.10 percent in

2006.

Chart- 4.2

Table - 4.2

GROSS DOMESTIC PRODUCT

amount in Rs. crores

Years GDP at factor cost

1991-92 1099072

1992-93 1158025

1993-94 1223816

1994-95 1302076

Source: various issues of RBI Bulletin

GDP

amount Rs. in crores

years

09 08

0807-

0706-

0605-

0504-

0403-

0302-

0201-

0100-

0099-

9998-

9897-

9796-

9695-

9594-

9493-

9392-

9291-

4000000

3000000

2000000

1000000

0

Gross Domestic Product

73

1995-96 1396974

1996-97 1508378

1997-98 1573263

1998-99 1678410

1999-00 1786525

2000-01 1864301

2001-02 1972606

2002-03 2048286

2003-04 2222758

2004-05 2388768

2005-06 2616101

2006-07 2871120

2007-08 3129717

2008-09 3339375

Source: various issues of RBI Bulletin

India’s diverse economy attracts high FDI inflows due to its huge market size, low wage

rate, large human capital (which has benefited immensely from outsourcing of work from

developed countries). In the present decade India has witnessed unprecedented levels of

economic expansion and also seen healthy growth of trade. GDP reflects the potential

market size of Indian economy. Potential market size of an economy can be measured

with two variables i.e. GDP (the gross domestic product) and GNP (the gross national

product).GNP refers to the final value of all the goods and services produced plus the net

factor income earned from abroad. The word ‘gross’ is used to indicate the valuation of

the national product including depreciation. GDP is an unduplicated total of monetary

values of product generated in various kinds of economic activities during a given period,

i.e. one year. It is called as domestic product because it is the value of final goods and

services produced domestically within the country during a given period i.e. one year.

74

Hence in functional form GDP= GNP-Net factor income from abroad. In India GDP is

calculated at market price and at factor cost. GDP at market price is the sum of market

values of all the final goods and services produced in the domestic territory of a country

in a given year. Similarly, GDP at factor cost is equal to the GDP at market prices minus

indirect taxes plus subsidies. It is called GDP at factor cost because it is the summation of

the income of the factors of production

Further, GDP can be estimated with the help of either (a) Current prices or (b) constant

prices. If domestic product is estimated on the basis of market prices, it is known as GDP

at current prices. On the other hand, if it is calculated on the basis of base year prices

prevailing at some point of time, it is known as GDP at constant prices.

Infact, in a dynamic economy, prices are quite sensitive due to the fluctuations in the

domestic as well as international market. In order to isolate the fluctuations, the estimates

of domestic product at current prices need to be converted into the domestic product at

constant prices. Any increase in domestic product that takes place on account of increase

in prices cannot be called as the real increase in GDP. Real GDP is estimated by

converting the GDP at current prices into GDP at constant prices, with a fixed base year.

In this context, a GDP deflator is used to convert the GDP at current prices to GDP at

constant prices. The present study uses GDP at factor cost (GDPFC) with constant prices

as one of the explanatory variable to the FDI inflows into India for the aggregate analysis.

Gross Domestic Product at Factor cost (GDPFC) as the macroeconomic variable of the

Indian economy is one of the pull factors of FDI inflows into India at national level. It is

conventionally accepted as realistic indicator of the market size and the level of output.

There is direct relationship between the market size and FDI inflows. If market size of an

economy is large than it will attract higher FDI inflows and vice versa i.e. an economy

with higher GDPFC will attract more FDI inflows. The relevant data on GDPFC have

been collected from the various issues of Reserve bank of India (RBI) bulletin and

Economic Survey of India.

75

4.2.3 TOTAL TRADE (TRADEGDP): It refers to the total trade as percentage of GDP.

Total trade implies sum of total exports and total imports. Trade, another explanatory

variable in the study also affects the economic growth of the country. The values of

exports and imports are taken at constant prices. The relationship between trade, FDI and

growth is well known. FDI and trade are engines of growth as technological diffusion

through international trade and inward FDI stimulates economic growth. Knowledge and

technological spillovers (between firms, within industries and between industries etc.)

contributes to growth via increasing productivity level. Economic growth, whether in the

form of export promoting or import substituting strategy, can significantly affect trade

flows. Export led growth leads to expansion of exports which in turn promote economic

growth by expanding the market size for developing countries.

Chart- 4.3

Source: various issues of RBI Bulletin

Trade as % of GDP

s s.

ount in R

am

Years

09 08

0807-

0706-

0605-

0504-

0403-

0302-

0201-

0100-

0099-

9998-

9897-

9796-

9695-

9594-

9493-

9392-

9291-

70 60 50 40 30 20 10

0

TradeGDP

76

India prefers export stimulating FDI inflows, that is, FDI inflows which boost the

demand of export in the international market are preferred by the country as it nullifies

the gap between exports and imports.

Table - 4.3

TOTAL TRADE

amount in Rs. crores

Years Total Trade

1991-92 91892

1992-93 117063

1993-94 142852

1994-95 172645

1995-96 229031

1996-97 257737

1997-98 284276

1998-99 318084

1999-00 374797

2000-01 434444

2001-02 454218

2002-03 552343

2003-04 652475

2004-05 876405

77

2005-06 1116827

2006-07 1412285

2007-08 1668176

2008-09(P) 2072438

Source: various issues of RBI Bulletin. (P) Provisional Since liberalization, the value

of India’s international trade (Chart-4.3) has risen to Rs. 2072438 crores in 2008-09 from

Rs. 91892 crores in 1991-92. As exports from the country have increased manifolds after

the initiation of economic reforms since 1991

(Table – 4.3). India’s major trading partners are China, United States of America, United

Arab Emirates, United Kingdom, Japan, and European Union. Since 1991, India’s

exports have been consistently rising although India is still a net importer. In 2008-09

imports were Rs. 1305503 crores and exports were Rs. 766935 crores. India accounted

for 1.45 per cent of global merchandise trade and 2.8 per cent of global commercial

services export.

Economic growth and FDI are closely linked with international trade. Countries that are

more open are more likely to attract FDI inflows in many ways: Foreign investor brings

machines and equipment from outside the host country in order to reduce their cost of

production. This can increase exports of the host country. Growth and trade are mutually

dependent on one another. Trade is a complement to FDI, such that countries tending to

be more open to trade attract higher levels of FDI.

4.2.4 FOREIGN EXCHANGE RSERVES (RESGDP): RESGDP represents Foreign

Exchange Reserves as percentage of GDP. India’s foreign exchange reserves comprise

foreign currency assets (FCA), gold, special drawing rights (SDR) and Reserve Tranche

78

Position (RTP) in the International Monetary Fund. The emerging economic giants, the

BRIC (Brazil, Russian Federation, India, and China) countries, hold the largest foreign

exchange reserves globally and India is among the top 10 nations in the world in terms of

foreign exchange reserves. India is also the world’s 10th largest gold holding country

(Economic Survey 2009-10)17. Stock of foreign exchange reserves shows a country’s

financial strength. India’s foreign exchange reserves have grown significantly since 1991

(Chart-4.4). The reserves, which stood at Rs. 23850 crores at end march 1991, increased

gradually to Rs. 361470 crores by the end of March 2002, after which rose steadily

reaching a level of Rs. 1237985 crores in March 2007. The reserves stood at Rs. 1283865

crores as on March 2008 (Table- 4.4).

Chart- 4.4

Source: various issues of RBI Bulletin

Further, an adequate FDI inflow adds foreign reserves by exchange reserves which put

the economy in better position in international market. It not only allows the Indian

government to manipulate exchange rates, commodity prices, credit risks, market risks,

liquidity risks and operational risks but it also helps the country to defend itself from

speculative attacks on the domestic currency. Adequate foreign reserves of India

Table - 4.4

percentage

years

09 08

0807-

0706-

0605-

0504-

0403-

0302-

0201-

0100-

0099-

9998-

9897-

9796-

9695-

9594-

9493-

9392-

9291-

50 40 30 20 10

0

Foreign Exchange Reserves as percentage of GDP

79

FOREIGN EXCHNAGE RESERVES

amount in Rs. crores

Years Foreign Exchange

Reserves

1991-92 23850

1992-93 30744

1993-94 60420

1994-95 79781

1995-96 74384

1996-97 94932

1997-98 115905

1998-99 138005

1999-00 165913

2000-01 197204

2001-02 264036

2002-03 361470

2003-04 490129

2004-05 619116

2005-06 676387

2006-07 868222

2007-08 1237985

2008-09 1283865

80

Source: various issues of RBI Bulletin.

indicates its ability to repay foreign debt which in turn increases the credit rating of India

in international market and this helps in attracting more FDI inflows in the country. An

analysis of the sources of reserves accretion during the entire reform period from 1991 on

wards reveals that increase in net FDI from Rs. 409 crores in 1991-92 to Rs. 1,23,378

crores by March 2010. NRI deposits increased from Rs.27400 crores in 1991-92 to

Rs.174623 by the end of March 2008. As at the end of March 2009, the outstanding NRI

deposits stood at Rs. 210118 crores. On the current account, India’s exports, which were

Rs. 44041 crore during 1991-92 increased to Rs. 766935 crores in 2007-08.

India’s imports which were Rs. 47851 crore in 1991-92 increased to Rs. 1305503 crores

in 2008-09. India’s current account balance which was in deficit at 3.0 percent of GDP in

1990-91 turned into a surplus during the period 2001-02 to 2003-04. However, this could

not be sustained in the subsequent years. In the aftermath of the global financial crisis,

the current account deficit increased from 1.3 percent of GDP in 2007-08 to 2.4 percent

of GDP in 2008-09 and further to 2.9 percent in 2009-10. Invisibles, such as private

remittances have also contributed significantly to the current account. Enough stocks of

foreign reserves enabled India in prepayment of certain high – cost foreign currency

loans of Government of India from Asian Development Bank (ADB) and World Bank

(IBRD)

Infact, adequate foreign reserves are an important parameter of Indian economy in

gauging its ability to absorb external shocks. The import cover of reserves, which fell to a

low of three weeks of imports at the end of Dec 1990, reached a peak of 16.9 months of

imports at the end of March 2004. At the end of March 2010, the import cover stands at

11.2 months. The ratio of short – term debt to the foreign exchange reserves declined

from 146.5 percent at the end of March 1991 to 12.5 percent as at the end of March 2005,

but increased slightly to 12.9 percent as at the end of March 2006. It further increased

from 14.8 percent at the end of March 2008 to 17.2 percent at the end of March 2009 and

81

18.8 percent by the end of March 2010. FDI helps in filling the gap between targeted

foreign exchange requirements and those derived from net export earnings plus net public

foreign aid. The basic argument behind this gap is that most developing countries face

either a shortage of domestic savings to match investment opportunities or a shortage of

foreign exchange reserves to finance needed imports of capital and intermediate goods.

4.2.5 RESEARCH & DEVELOPMENT EXPENDIYURE (R&DGDP): It refers to

the research and development expenditure as percentage of GDP (Chart-4.5). India has

large pool of human resources and human capital is known as the prime mover of

economic activity.

Chart-4.5

Table - 4.5

Source: various issues of RBI Bulletin

R&DGDP

amt. in percentage

Years

08 07

0706-

0605-

0504-

0403-

0302-

0201-

0100-

0099-

9998-

9897-

9796-

9695-

9594-

9493-

9392-

9291-

1 0.8 0.6 0.4 0.2

0

R&D expenditure as percentage of GDP

82

RESEARCH & DEVELOPMENT EXPENDITURE

amount in Rs. crores

Years National Expenditure

on Research &

Development

1991-92 8363.31

1992-93 8526.18

1993-94 9408.79

1994-95 9340.94

1995-96 9656.11

1996-97 10662.41

1997-98 11921.83

1998-99 12967.51

1999-00 14397.6

2000-01 15683.37

2001-02 16007.14

2002-03 16353.72

2003-04 17575.41

2004-05 19991.64

2005-06 22963.91

2006-07 24821.63

2007-08 27213

83

Source: various issues of RBI Bulletin.

India has the third largest higher education system in the world and a tradition of over

5000 year old of science and technology. India can strengthen the quality and

affordability of its health care, education system, agriculture, trade, industry and services

by investing in R&D activities.

India has emerged as a global R&D hub since the last two decades. There has been a

significant rise in the expenditure of R&D activities (Table-4.5) as FDI flows in this

sector and in services sector is increasing in the present decade. R&D activities (in

combination with other high – end services) generally known as “Knowledge Process

Outsourcing” or KPO are gaining much attention with services sector leading among all

sectors of Indian economy in receiving / attracting higher percentage of FDI flows. It is

clear from (Chart- 4.5) that the expenditure on R&D activities is rising significantly in

the present decade. India has been a centre for many research and development activities

by many TNCs. Today, companies like General Electric, Microsoft, Oracle, SAP and

IBM to name a few are all pursuing R&D in India. R&D activities in India demands huge

funds thus providing greater opportunities for foreign investors.

4.2.6 FINANCIAL POSITION (FIN. Position): FIN. Position stands for Financial

Position. Financial Position (Chart-4.6, Table- 4.6) is the ratio of external debts to

exports. It is a strong indicator of the soundness of any economy. It shows that external

debts are covered from the exports earning of a country.

84

Table - 4.6

FINANCIAL POSITION

amount in Rs. crores

Years Exports

Debt

1991-92 44041 252910

1992-93 53688 280746

1993-94 69751 290418

1994-95 82674 311685

1995-96 106353 320728

1996-97 118817 335827

1997-98 130100 369682

1998-99 139752 411297

1999-00 159561 428550

85

2000-01 203571 472625

2001-02 209018 482328

2002-03 255137 498804

2003-04 293367 491078

2004-05 375340 581802

2005-06 456418 616144

2006-07 571779 746918

2007-08 655864 897955

2008-09 766935 (P) 1169575

Source: various issues of RBI Bulletin, (P) - Provisional

(Chart-4.6)

Source: various issues of RBI Bulletin

ratio of debt to exports

Years

09 08

0807-

0706-

0605-

0504-

0403-

0302-

0201-

0100-

0099-

9998-

9897-

9796-

9695-

9594-

9493-

9392-

9291-

8 6 4 2 0

Financial Position

86

External debt of India refers to the total amount of external debts taken by India in a

particular year, its repayments as well as the outstanding debts amounts, if any. India’s

external debts, as of march 2008 was Rs. 897955, recording an increase of Rs.1169575

crores in march 2009 (Table – 4.6) mainly due to the increase in trade credits. Among the

composition of external debt, the share of commercial borrowings was the highest at

27.3% on March 2009, followed by short – term debt (21.5%), NRI deposits (18%) and

multilateral debt (17%).Due to arise in short – term trade credits, the share of short – term

debt in the total debt increased to 21.5% in march 2009, from 20.9% in march 2008. As a

result the short – term debt accounted for 40.6% of the total external debt on March 2009.

In 2007 India was rated the 5th most indebted country (Table – 4.6.1) according to an

international comparison of external debt of the twenty most indebted countries.

Table-4.6.1

INTERNATIONAL COMPARISON OF TOP TEN DEBTOR COUNTRIES, 2007

Country External

Debt

stock,

Total

(US $ bn)

Concessional

Debt/Total

Debt (%)

Debt

Service

ratio

(%)

External

Debt to

GNI (%)

Short

term

debt/

Total

debt

(%)

Forex

reserves

to Total

debt (%)

China 373.6 10.1 2.2 11.6 54.5 413.9

Russian

Federation

370.2 .4 9.1 29.4 21.4 129.1

87

Turkey 251.5 2.1 32.1 38.8 16.6 30.4

Brazil 237.5 1.0 27.8 18.7 16.5 75.9

India 224.6 19.7 4.8 19.0 20.9 137.9

Poland 195.4 .4 25.6 47.7 30.9 33.6

Mexico 178.1 .6 12.5 17.7 5.1 49

Indonesia 140.8 26.2 10.5 33.9 24.8 40.4

Argentina 127.8 1.3 13.0 49.7 29.8 36.1

Kazakhstan 96.1 1.0 49.6 103.7 12.2 18.4

The ratio of short – term debt to foreign exchange reserves (Table-4.6.2) stood at 19.6%

in March 2009, higher than the 15.2% in the previous year. India’s foreign exchange

reserves provided a cover of 109.6% of the external debt stock at the end of March 2009,

as compared to 137.9% at the end of March 2008. An assessment of sustainability of

external debt is generally undertaken based on the trends in certain key ratios such as

debt to GDP ratio, debt service ratio, short – term debt to total debt and total debt to

foreign exchange reserves. The ratio of external debt to GDP increased to 22% as at end

march 2009 from 19.0% as at end – March 2008. The debt service ratio has declined

steadily over the year, and stood at 4.8 % as at the end of March 2009.

Table -4.6.2

Year Debt Service Ratio (%) Ratio of Foreign Exchange

to Debt

1991-92 35.3 0.15

88

1992-93 30.2 0.12

1993-94 27.5 0.22

1994-95 25.4 0.27

1995-96 25.9 0.24

1996-97 26.2 0.3

1997-98 23.0 0.35

1998-99 19.5 0.37

1999-00 18.7 0.4

2000-01 17.1 0.46

2001-02 16.6 0.56

2002-03 13.7 0.75

2003-04 16.0 0.98

2004-05 16.1 1.26

2005-06 5.9 1.16

2006-07 10.1 1.41

2007-08 4.7 1.66

2008-09 4.8 1.43

Source: various issues of RBI Bulletin

However, the share of concessional debt (Chatr-4.6.1) in total external debt declined to

18.2% in 2008-2009 from 19.7 % in 2007-2008.

89

(Chart-4.6.1)

Large fiscal deficit has variety of adverse effects: reducing growth, lowering real

incomes, increasing the risks of financial and economic crises and in some circumstances

it can also leads to high inflation.

Recently the finance minister of India had promised to cut its budget deficit to 5.5% of

the GDP in 2010 from 6.9% of GDP in 2009. As a result the credit – rating outlook was

raised to stable from negative by standard and poor’s based on the optimism that faster

growth in Asia’s third largest and world second fastest growing economy will help the

government cut its budget deficit. The government also plans to cut its debt to 68% of the

GDP by 2015, from its current levels of 80%. In order to reduce the ratio of debt to GDP

there must be either a primary surplus (i.e. revenue must exceed non interest outlays) or

the economy must grow faster than the rate of interest, or both, so that one must outweigh

the adverse effect of the other.

4.2.7 EXCHANGE RATES (EXR): It refers to the exchange rate variable. Exchange

rate is a key determinant of international finance as the world economies are globalised

ones.

Source: various issues of RBI Bulletin

Short - Term Debt as % of Total Debt Concessional Debt as % of Total Debt

crores

amount in Rs.

Years

09 08

0807-

0706-

0605-

0504-

0403-

0302-

0201-

0100-

0099-

9998-

9897-

9796-

9695-

9594-

9493-

9392-

9291-

50

40

30

20

10

0

Concesional and Short - term Debt as % of Total Debt

90

Table - 4.7

EXCHANGE RATES

Years Exchange Rates

1991-92 24.5

1992-93 30.6

1993-94 31.4

1994-95 31.4

1995-96 33.4

1996-97 35.5

1997-98 37.2

1998-99 42.1

1999-00 43.3

2000-01 45.7

2001-02 47.7

2002-03 48.4

2003-04 45.9

2004-05 44.9

2005-06 44.3

2006-07 42.3

2007-08 40.2

2008-09 45.9

91

Source: various issues of SIA Bulletin.

There are a number of factor which affect the exchange rate viz. government policy,

competitive advantages, market size, international trade, domestic financial market, rate

of inflation, interest rate etc. Exchange rate touched a high of Rs. 48.4 in 2002-03 (Table

-4.7).

Chart- 4.7

Since 1991 Indian economy has gone through a sea change and that changes are reflected

on the Indian Industry too. There is high volatility in the value of INR/USD. There is

high appreciation in the value of INR from 2001-02 (Chart -4.7) which has swept away

huge chunk of profits of the companies.

various issues of RBI BulletinSource:

Exchange Rate

09 08

0807-

0706-

0605-

0504-

0403-

0302-

0201-

0100-

0099-

9998-

9897-

9796-

9695-

9594-

9493-

9392-

9291-

60 50 40 30 20 10

0

Movement in Exchange Rate

92

4.2.8 GROSS DOMESTIC PRODUCT GROWTH (GDPG): It refers to the growth

rate of gross domestic product. Economic growth rate have an effect on the domestic

market, such that countries with expanding domestic markets should attract higher levels

of FDI. India is the 2nd fastest growing economy among the emerging nations of the

world. It has the third largest GDP in the continent of Asia. Since 1991 India has emerged

as one of the wealthiest economies in the developing world. During this period, the

economy has grown constantly and this has been accompanied by increase in life

expectancy, literacy rates, and food security. It is also the world most populous

democracy. The Indian middle class is large and growing; wages are low; many workers

are well educated and speak English. All these factors lure foreign investors to India.

India is also a major exporter of highly – skilled workers in software and financial

services and provide an important ‘back office destination’ for global outsourcing of

customer services and technical support. The Indian market is widely diverse. The

country has 17 official languages, 6 major religion and ethnic diversity. Thus, tastes and

preferences differ greatly among sections of consumers.

4.2.9 FOREIGN DIRECT INVESTMENT GROWTH (FDIG): In the last two decade

world has witnessed unprecedented growth of FDI. This growth of FDI provides new

avenues of economic expansion especially, to the developing countries. India due to its

huge market size, diversity, cheap labour and large human capital received substantial

amount of FDI inflows during 1991-2008. India received cumulative FDI inflows of Rs.

577108 crore during 1991 to march 2010. It received FDI inflows of Rs. 492303 crore

during 2000 to march 2010 as compared to Rs. 84806 crore during 1991 to march 99.

During 1994-95, FDI registered a 110% growth over the previous year and a 184% age

growth in 2007-08 over 2006-07. FDI as a percentage of gross total investment increased

to 7.4% in 2008 as against 2.6% in 2005. This increased level of FDI contributes towards

93

increased foreign reserves. The steady increase in foreign reserves provides a shield

against external debt. The growth in FDI also provides adequate security against any

possible currency crisis or monetary instability. It also helps in boosting the exports of

the country. It enhances economic growth by increasing the financial position of the

country. The growth in FDI contributes toward the sound performance of each sector

(especially, services, industry, manufacturing etc.) which ultimately leads to the overall

robust performance of the Indian economy.

4.3 ROLE OF FDI ON ECONOMIC GROWTH

In order to assess the role of FDI on economic growth, two models were used. The

estimation results of the two models are supported and further analysed by using the

relevant econometric techniques viz. Coefficient of determination, standard error, f- ratio,

t- statistics, D-W Statistics etc. In the foreign direct investment model (Model-1, Table-

4.8), the main determinants of FDI inflows to India are assessed. The study identified the

following macroeconomic variables: TradeGDP, R&DGDP, FIN.Position, EXR, and

ReservesGDP as the main determinants of FDI inflows into India. And the relation of

these variables with FDI is specified and analysed in equation 4.1. In order to study the

role of FDI on Indian economy it is imperative to assess the trend pattern of all the

variables used in the determinant analysis. It is observed that FDI inflows into India

shows a steady trend in early nineties but shows a sharp increase after 2005, though it had

fluctuated a bit in early 2000. However, Gross domestic product shows an increasing

trend pattern since 1991-92 to 2007-08 (Table 4.2 and Chart - 4.2). Another variable i.e.

tradeGDP maintained a steady trend pattern upto 2001-02, after that it shows a

continuous increasing pattern upto 2008-09. ReservesGDP, another explanatory variable

shows low trend pattern upto 2000-01 but gained momentum after 2001-02 and shows an

increasing trend. In addition to these trend patterns of the variables the study also used

94

the multiple regression analysis to further explain the variations in FDI inflows into India

due to the variations caused by these explanatory variables.

MODEL-1

FOREIGN DIRECT INVESTMENT MODEL

FDI = f [TRADEGDP, R&DGDP, EXR, RESGDP, FIN. Position]

Table-4.8

D-W Statistic = .98, F-ratio = 7.74

Note: * = Significant at 0.25, 0.10 levels; ** = Significant at 0.25 level.

0.466 =2Adjusted R = 0.623 2R

** .83 704 -582.14R&DGDP

.45 35 15.2Financial health

.72** 9.9 7.06 Exchange rate

.41 3.8 1.44ReservesGDP

1.5* 7.9 11.79 TradeGDP

* 207 .126 26.25Constant

t- Statistic Standard Error Coefficient Variable

95

In Foreign Direct Investment Model (Table 4.8), it is found that all variables are

statistically significant. Further the results of Foreign Direct Investment Model shows

that TradeGDP, R&DGDP, Financial Position (FIN.Position), exchange rate (EXR), and

ReservesGDP (RESGDP) are the important macroeconomic determinants of FDI inflows

in India. The regression results of (Table 4.8) shows that TradeGDP, ReservesGDP,

Financial Position, exchange rate are the pull factors for FDI inflows in the country

whereas R&DGDP acts as the deterrent force in attracting FDI flows in the country. As

the regression results reveal that R&DGDP exchange rate does not portray their

respective predicted signs. However, R&DGDP shows the unexpected negative sign

instead of positive sign and exchange rate shows positive sign instead of expected

negative sign. In other words, all variables included in the foreign direct investment

model shows their predicted signs (Table – 4.9) except the two variables (i.e. Exchange

rate & R&DGDP) which deviate from their respective predicted signs. The reason for this

deviation is due to the appreciation of Indian Rupee in the international market and low

expenditure on R&D activities in the activities in the country.

Table – 4.9

PREDICTED SIGNS OF VARIABLES

Variables Predicted Sign Unexpected Sign

96

TradeGDP +

ReservesGDP +

Exchange Rate - +

Financial Position +

R&DGDP + -

It is observed from the results that the elasticity coefficient between FDI & TradeGDP is

11.79 which implies that one percent increase in Trade GDP causes 11.79 percentage

increase in FDI inflows in India. The TradeGDP shows that the predicted positive sign.

Hence, Trade GDP positively influences the flow of FDI into India. Further, it is seen

from the analysis that another important promotive factor of FDI inflows to the country is

ReservesGDP. The positive sign of ReservesGDP is in accordance with the predicted

sign. The elasticity coefficient between ReserveGDP and FDI inflows is 1.44. It implies

that one percent increase in ReserveGDP causes 1.44 percentage increases in FDI inflows

into India. The other factor which shows the predicted positive sign is FIN.Position

(financial position). The elasticity coefficient between financial position and FDI is 15.2

% which shows that one percent increase in financial position causes 15.2 percent of FDI

inflows to the country. India prefers FDI inflows in export led strategy in boosting its

exports.

Further, the analysis shows that the trend pattern of external debt to exports (i.e. FIN.

Position) has been decreasing continuously since 1991-92, indicating towards a strong

economy. This positive indication is a good fortune to the Indian economy as it helps in

attracting foreign investors to the country.

One remarkable fact observed from the regression results reveal that R&DGDP shows a

negative relationship with FDI inflows into India. The results show that the elasticity

coefficient between FDI and R&D GDP is -582.14. This implies that a percentage

97

increase in R&DGDP causes nearly 582 percent reductions in the FDI inflows. This may

be attributed to the low level of R&D activities in the country. This is also attributed to

the high interest rate in the country and also investments in Brownfield projects are more

as compared to investments in Greenfield projects. India requires more knowledge cities,

Special Economic Zones (SEZs), Economic Processing Zones (EPZs), Industrial clusters,

IT Parks, Highways, R&D hubs etc. so government must attract Greenfield investment.

Another variable which shows the negative relationship with FDI is exchange rate. The

elasticity coefficient between FDI and Exchange rate is 7.06 which show that one percent

increase in exchange rate leads to a reduction of 7.06 percentage of FDI inflows to the

country. The exchange rate shows a positive sign as expected of negative sign.

Conventionally, it is assumed that exchange rate is the negative determinant of FDI

inflows. This positive impact of exchange rate on the FDI inflows could be attributed to

the appreciation of the Indian rupee against US Dollar. This appreciation in the value of

Rupee helped the foreign firms in many ways. Firstly, it helped the foreign firms in

acquiring the firm specific assets cheaply. Secondly, it helped the foreign firms in

reducing the cost of firm specific assets (this is particularly done in case of Brownfield

projects). Thirdly, it ensures the foreign firm higher profit in the longrun (as the value of

the assets in appreciated Indian currency also appreciates). The results of foreign Direct

Investment Model also facilitates in adjudging the relative importance of the

determinants of FDI inflows from the absolute value of their elasticity coefficients. In this

regard it is observed from the regression results of Table - 4.8 that among the positive

determinants, FDI inflows into India are more elastic to FIN. Position than to TradeGDP

and ReservesGDP. It is also observable that FDI inflows are more sensitive to R&DGDP

than to exchange rate as the elasticity coefficient between FDI and exchange rate is least,

whereas the elasticity coefficient between FDI and R&DGDP is more. Further, to decide

the suitability and relevancy of the model results the study also relies on other

econometric techniques. The coefficient of determination i.e. R- squared shows that the

model has a good fit, as 62% of foreign direct investment is being explained by the

variables included in the model. In order to take care of autocorrelation problem, the

98

Durbin – Watson (D-W statistics) test is used. The D-W Statistic is found to be .98 which

confirms that there is no autocorrelation problem in the analysis. Further the value of

adjusted R-square and F-ratio also confirms that the model used is a good

statistical fit.

MODEL-2

ECONOMIC GROWTH MODEL

GDPG = f [FDIG]

Table-4.10

Variable Coefficient Standard Error t- Statistic

Constant .060322925 0.00007393156391 815.92

FDIG 0.039174416 .020661633 1.8959

R2= 0.959 Adjusted R2= 0.956

D-W Statistic = 1.0128, F-ratio = 28.076

Note: * = Significant at 1%

99

In the Economic Growth Model (Table – 4.10), estimated coefficient on foreign direct

investment has a positive relationship with Gross Domestic Product growth (GDPG). It is

revealed from the analysis that FDI is a significant factor influencing the level of

economic growth in India. The coefficient of determination, i.e. the value of R 2 explains

95.6% level of economic growth by foreign direct investment in India. The F-statistics

value also explains the significant relationship between the level of economic growth and

FDI inflows in India. D-W statistic value is found 1.0128 which confirms that there is no

autocorrelation problem in the analysis.

Thus, the findings of the economic growth model show that FDI is a vital and significant

factor influencing the level of growth in India.

4.4 CONCLUSIONS

It is observed from the results of above analysis that TradeGDP, ReservesGDP, Exchange

rate, FIN. Position, R&DGDP and FDIG are the main determinants of FDI inflows to the

country. In other words, these macroeconomic variables have a profound impact on the

inflows of FDI in India. The results of foreign Direct Investment Model reveal that

TradeGDP, ReservesGDP, and FIN. Position variables exhibit a positive relationship

with FDI while R&DGDP and Exchange rate variables exhibit a negative relationship

with FDI inflows. Hence, TradeGDP, ReservesGDP, and FIN. Position variables are the

pull factors for FDI inflows to the country and R&DGDP and Exchange rate are deterrent

forces for FDI inflows into the country. Thus, it is concluded that the above analysis is

successful in identifying those variables which are important in attracting FDI inflows to

the country. The study also reveals that FDI is a significant factor influencing the level of

economic growth in India. The results of Economic Growth Model and Foreign Direct

Investment Model show that FDI plays a crucial role in enhancing the level of economic

100

growth in the country. It helps in increasing the trade in the international market.

However, it has failed in raising the R&D and in stabilizing the exchange rates of the

economy.

The positive sign of exchange rate variables depicts the appreciation of Indian Rupee in

the international market. This appreciation in the value of Indian Rupee provides an

opportunity to the policy makers to attract FDI inflows in Greenfield projects rather than

attracting FDI inflows in Brownfield projects.

Further, the above analysis helps in identifying the major determinants of FDI in the

country. FDI plays a significant role in enhancing the level of economic growth of the

country. This analysis also helps the future aspirants of research scholars to identify the

main determinants of FDI at sectoral level because FDI is also a sector – specific activity

of foreign firms’ vis-à-vis an aggregate activity at national level.

Finally, the study observes that FDI is a significant factor influencing the level of

economic growth in India. It provides a sound base for economic growth and

development by enhancing the financial position of the country. It also contributes to the

GDP and foreign exchange reserves of the country.