The Concept of Foreign Direct Investment is now a part of India's economic future but the term remains vague to many, despite the profound effects on the economy. Despite the extensive studies on FDI, there has been little illumination forthcoming and it remains a contentious topic.
India has made impressive strides in building a policy environment to encourage both domestic and foreign investment, in particular to attract foreign direct investment (FDI) and facilitate outward investment. This progress is an integral part of the market-oriented reforms which have since 1991 set the scene for a shift to a consistently higher rate of real annual GDP growth than the country has experienced in its recent history.
Economic policymakers in most countries go out of their way to attract foreign direct investment (FDI). A high level of FDI inflows is an affirmation of the economic policies that the policymakers have been implementing as well as a stamp of approval of the future economic health of that particular country. This paper tells more about the FDI In India.
Introduction
India has made tremendous progress in building a policy environment to encourage investment. As a result, the country's economy is growing more rapidly and FDI inflows have accelerated impressively. However, investment remains insufficient to meet India's needs, particularly in infrastructure. Current efforts to strengthen and liberalise the regulatory framework for investment need to be intensified and India's well-developed economic legislation implemented at an accelerated pace both at national level and right across India's states and union territories.
According to UNCTAD (2007), India has emerged as the second most attractive destination for FDI after China and ahead of the US, Russia and Brazil. While India has experienced a marked rise in FDI inflows in the last few years (doubling from an average of US$5-6 billion the previous three years to around US$ 19 billion in 2006-07) (Figure 1), it still receives far less FDI flows than China or much smaller economies in Asia like Hong Kong and Singapore was ahead of India (Figure 2). Not surprisingly India's growth strategy has depended predominantly on domestic enterprises and domestic demand as opposed to FDI and export demand.
India, with its relatively well developed financial sector, strong industrial base and critical mass of well educated workers, appears to be well placed to reap the benefits of FDI In view of this, it is appropriate that Indian policy makers continue to make concerted efforts to make India an attractive destination for FDI.
FDI In India
With the pace at which India Inc is expanding its footprint abroad, the country's outward foreign direct investment (FDI) may very well catch up with inward FDI. In '04-05, Indian direct investment abroad aggregated $1.54bn on the back of a drive by manufacturing companies to expand abroad. On the other hand, total FDI into the country totalled $2.32bn. According to the RBI annual report, the phase of acquiring foreign companies, which kicked off in the information technology and related services sector, has now spread to other areas. Apart from manufacturing, the non-financial services segment accounted for outward FDI of $230.1m, followed by trading at $175.5m and financial services with $6.9m. In '00-01, India's outward FDI was just $708.3m.
The best known example of Indian corporates making strategic investments abroad include Tata Steel buying Corus Inc and Aditya Birla group wrapping-up the aluminium major Novelis Inc. Of course, the latter has been for long the well-known Indian multinational. There have also been acquisitions abroad by medium-sized Indian companies such as Godrej and Marico.
All these point to the growing competitiveness of the Indian corporate sector, a newfound sense of confidence and of course, vaulting ambition to be a global player. So, the two-way flow of FDI means that not only is the world taking note of India's market potential, Indian companies too are constantly on the lookout for synergistic acquisitions overseas. While it may make commercial sense for Indian corporates to invest abroad, it is also an indication of the perceived inadequacy of natural resources within the country and the policy-roadblocks that stymie their exploitation. Lack of transparency and absence of long-term policies deter free flow of investments.
The increasing competitiveness of Indian firms and their interest to expand globally, particularly in IT-related services and pharmaceuticals, are driving its outward FDI growth. Indian outward FDI is expected to grow, in particular in IT and software services. India's membership in various regional integration arrangements also provides Indian firms with a favourable platform to strengthen their presence in these partner economies. Not least, the encouragement and the significant liberalization of policies by the government of India will continue to play an instrumental role in the expansion of Indian firms abroad.
FDI Inflows by Sector
Cumulative FDI inflows reached just over US$60 billion between August 1991 and July 2007. Since 2002, some sectors such as electrical equipment, services, drugs and pharmaceuticals, cement and gypsum products, metallurgical industries have also been doing very well in attracting FDI. The electrical equipment sector and the services sector in particular received the largest shares of total FDI inflows between August 1991 and July 2007. These were followed by the telecommunications, transportation, fuels, and chemicals sectors (Figure 3).
The Department of Industrial Policy and Promotion has recently modified the classifications of the sectors and data released from August 2007 has been based on the new sectoral classifications. According to that classification, the top performers are the services and computer software & hardware sectors (Figure 4). Clearly, India has attracted significant overseas investment interest in services. It has been the main destination for off-shoring of most services as back-office processes, customer interaction and technical support (UNCTAD, 2007). Indian services have also ventured into other territories such as reading medical X-rays, analyzing equities, and processing insurance claims. According to some reports, however, increasing competition is making it more difficult for Indian firms to attract and keep BPO employees with the necessary skills, leading to increasing wages and other costs.
Country Sources of FDI
Among countries, Mauritius has been the largest direct investor in India. Firms based in Mauritius invested over US$20 billion in India between August 1991 and July 2007 or over two-fifth of total FDI inflows during that period (Table 1). However, this data is rather misleading. Mauritius has low rates of taxation and an agreement with India on double tax avoidance regime. To take advantage of that situation, many companies have set up dummy companies in Mauritius before investing to India. Also, a major part of the investments from Mauritius to India are actually round-tripping by Indian firms, not unlike that between Mainland China and Hong Kong.
The United States (US) is the second largest investor in India. The total capital flows from the US was around US$6. billion between August 1991 and July 2007, which accounted for 12 percent of the FDI inflows. Most of the US investments were directed to the fuels, telecom, electrical equipment, food processing, and services sectors.
Distribution of FDI within India
Mumbai and New Delhi have been the top performers, with the majority of FDI inflows within India being heavily concentrated around these two major cities. Chennai, Bangalore, Hyderabad and Ahmedabad are also drawing significant shares of FDI inflows. For statistical purposes, India's Department of Industrial Policy and Promotion (DIPP) divides the country into 16 regional offices. The top 6 regions account for more than two-thirds of all FDI inflows to India between January 2000 and July 2007 (Table 2).
(http://dipp.nic.in/manual/manual_03_05.pdf - Department of Industrial Policy and Promotion. 2005. Foreign Direct Investment-Policy & Procedures. New Delhi: Government of India.)
India Lags as a FDI Destination for Manufacturing
Two major problems that are often highlighted in India have been the poor state of the country's infrastructure as well as the acute labour market rigidities. This is not to say that infrastructure in urban areas is any good. Urban infrastructure in the country remains woeful. The fact is that they are terrible in absolute terms and not just in comparison to any Western city. The other problem is power. It is very common for towns and villages to face daily blackouts averaging more than 8 hours a day. The other infrastructure issues are the ports, airports, both which are either too small or bad when compared to world-class ports or airports.
Added to the acute infrastructure woes are the rigidities in Indian labour markets which makes it practically impossible to shed excess labour or get rid of nonperformers. Looking beyond these two constraints, a number of studies and reports have highlighted other weaknesses that hinder India's development as a major export oriented manufacturing base.
Doing Business in India - A Study by World Bank
The World Bank conducts an annual study on "Doing Business in India". The latest report available is Doing Business 2008 and in this report, India is ranked a rather inglorious 120 out of 178 economies. The report is based on a "series of annual reports investigating the regulations that enhance business activity and those that constrain it. Doing Business presents quantitative indicators on business regulations and the protection of property rights that can be compared across 178 economies-from Afghanistan to Zimbabwe-and over time." The report considers 10 indicators and they are fairly self-explanatory. These indicators are; starting a business, dealing with licenses, employing workers, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts and closing a business.
India fairs "decently" in only two areas, viz. getting credit and protecting investors' categories. Perhaps the truly embarrassing rank is for the "enforcing contracts" category in which India is ranked a dismal 177 out of 178 countries. According to the report, it takes 1420 days to enforce a contract and the cost to enforce that contract is almost two-fifths of the claim. This is a key concern for businesses.
Improvements in FDI statistics
Current official statistics provide much detail on the origin and application of FDI in India and improvements continue to be implemented. However, there is still no consistent reporting and publication of FDI inflows to the states and union territories. As detailed in this report, FDI inflows are recorded at 16 Reserve Bank of India (RBI) regional offices, but there is no record of the final destination. The FDI inflows to each state are therefore not effectively recorded by the RBI. Many states keep their own records of FDI inflows, but there is no guarantee that the methodology used is consistent across states, and some states may not have the capacity to maintain a regular reporting system for FDI inflows, so the available data for cross-state comparisons are likely to be incomplete and of variable quality. Thus, Improvements in FDI statistics can support effective regional analysis and informed policy decisions.
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. The government while serious in its efforts to induce growth in the economy and country started with foreign investment in a haphazard manner. While it is accepted that the government was under compulsion to liberalize cautiously, the understanding of foreign investment was lacking. A sectoral analysis reveals that while FDI shows a gradual increase and has become a staple for success for India.
The decisions governing FDI have been spread over many areas and agencies that have to be streamlined or an overarching regulatory body and practical policy has to be developed. 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 far, though they need to be supplemented by more infrastructure reforms, which are a critical missing link.
While many policy barriers have been removed on FDI in India, results have at times been disappointing due to administrative barriers at the state level as well as lack of coordination between the central and state governments. There need to be greater coordination between the centre and states to ensure that the substantial foreign interest in investing in India gets translated into actual investment flows to the state.
