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.
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. India has experienced a 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). India's growth strategy has depended predominantly on domestic enterprises and domestic demand as opposed to FDI and export demand. For instance, India's FDI as a share of GDP in 2007 represented only about 1.7 percent compared to 2.8 percent in China and even below Pakistan, and its share of gross fixed investment is 5.2 percent compared to 7.0 in China and 16.7 percent in Pakistan.
Going back in history, we find that after Independence, India continued with its receptive attitude towards FDI for about a decade after it gained independence in 1947. This was because of limited availability of resources like technology, skills and entrepreneurship. During this period, foreign investors were assured of free remittances of profits and dividends, fair compensation in the event of acquisition, and were promised national treatment. However, the second five-year plan (1956-61) laid emphasis on self-reliant economic development and therefore adopted a restrictive attitude towards FDI. Further in 1973, the Foreign Exchange Regulation Act (FERA) came into force which prescribed a ceiling of 40 percent in equity by foreigners in Indian companies. This resulted in many foreign companies leaving India in the late 1970s.
However, there was a policy reversal during 1980s. The liberalisation of industrial and trade policies during this decade was accompanied by an increasingly receptive attitude towards FDI and foreign collaborations. In order to modernise the Indian industry, greater role was sought to be given to trans-national corporations (TNCs). Further, exceptions from the general ceiling of 40 percent on foreign equity were allowed on the merits of individual investment proposals.
Further, full-scale liberalisation was initiated in 1990s with a view to aligning the Indian economy with the world economy. The policy allowed automatic approval system for priority industries. For granting automatic approvals, three slabs of foreign ownerships were defined viz., up to 50 percent, up to 51 percent and up to 74 percent, and such limits were relaxed year after year.
Foreign Investment Promotion Board (FIPB) was set up to process applications for cases not covered by automatic approval. Replacement of FERA by Foreign Exchange Management Act (FEMA) removed shareholding and business restrictions on TNCs. Further policies relating to foreign technology purchase and licensing were liberalised to improve access to foreign technology. Finally, outward investments by Indian enterprises were liberalised and proposals satisfying certain specified norms were given automatic approval. These changes in national FDI policies were complemented by bilateral investment treaties (BITs) and double taxation avoidance treaties (DTATs), many of which have been signed by India in recent years. Foreign investment started pouring in after India launched its liberalisation programme in 1991.
The factors that determine "location decision" of the TNCs, which make most of FDI may be tax structure, special programmes and schemes, competition regime, entry and establishment requirements, investment protection, technology transfer, natural resources and skill levels, incentives and institutional mechanism.
WHAT FACTORS ARE CONSIDERED CONDUCIVE FOR FDI ?
Market-related factors.
Most TNCs, including the biggest ones, are still very concentrated on their home market in terms of sales. They intend to keep expanding their sales abroad to take advantage of the opportunities offered by the world market.
• Size of the local market.
• Growth of the local market.
• Access to the regional market.
Resource-related factors.
Access to various kinds of resources - skills, natural resources or financial markets is becoming an increasingly important motive for companies' internationalization
Access to skilled labour is the most important among the various types of resource-seeking motivations. An increasing number of companies now consider access to qualified and creative manpower as an important determinant of competitiveness. Consequently, a large share of FDI is influenced by the search for qualified manpower. The most striking example is the ongoing internationalization of corporate R&D through the establishment or acquisition of research centres abroad.
Access to natural resources is also considered as a major location. It is a major feature of the attractiveness of sub-Saharan African countries, Australia, Latin America and West Asia.
Access to capital markets and financial services is also considered a major location criterion.
As per the World Investment Prospects Survey 2007-2009 conducted by UNCTAD, South, East and South-East Asia include the two leading host countries for FDI location until 2009: China and India. Almost two thirds of the companies that participated in the survey stated that they had plans to invest in either or both of these two economies. While, in the view of investors, they share the same advantages in terms of labour costs and size/growth of market, India ranks higher in terms of skilled labour. Location experts for the UNCTAD survey also expressed optimism for investment prospects in these countries, stressing the fact that India and China are among the few developing countries in the world where it is possible to find three major kinds of locational advantages (low costs, markets and technological capabilities). The experts thus consider an increase in FDI projects as the most probable scenario, including in medium-technology manufacturing in China and in high-value-added services in India. Moreover, these projects could be increasingly oriented towards new regions in these countries (e.g. Central China, mid-sized towns in India), as costs are rising in established locations such as Bangalore (India) and Shenzen or Shanghai (China). On the other hand, according to investors, these countries still present constraints in terms of their investment environment, government effectiveness and access to capital markets. Location experts confirmed the existence of some negative elements, such as the lack of protection of intellectual rights in China or the high turnover of manpower in some areas in India.
ASSESSMENT OF INDIA'S POSITION IN THE WORLD ECONOMIC MAP
Through its reports and activities, the Centre for Global Competitiveness and Performance of the World Economic Forum identifies impediments to growth and thereby helps stimulate the development of relevant strategies to achieve sustained economic progress. The team's flagship publication is The Global Competitiveness Report (GCR). It is the most comprehensive and authoritative assessment of the comparative strengths and weaknesses of national economies. The GCI provides a methodological framework to assess "the set of institutions, policies and factors that determine the level of productivity of a country." It comprises a large number of drivers of competitiveness organized in 12 categories. India ranks 49th out of 133 economies in the GCI (Global Competitiveness Index) 2009-2010, up one rank from the previous edition. India has a developed financial system (16th) with a particularly sound banking sector (25th). Another competitive advantage is the size of its market (4th overall). The Indian goods market is also fairly efficient (48th) thanks to fierce competition and despite the presence of important barriers to entry. India's showing in the two most complex areas of competitiveness, Business Sophistication (27th) and Innovation (30th), is truly remarkable. This reflects, to a large extent, the brisk development of India's private sector and of a few industries in particular. As per the report,, India possesses a number of competitive advantages in several areas, namely Institutions, Financial Market Sophistication, Market Size, Business Sophistication and Innovation. India has come a long way since 1991 to become one of the world's fastest growing economies. There are several factors favouring India's competitiveness. These include the relatively inexpensive and skilled labour force, the availability of key raw materials and a large and fast growing domestic market. India's rise in global competitiveness is widely associated with its services sector, which is forecast to represent over 90% of economic growth in 2010.
As per the figures provided by the Economist Intelligence Unit, the emergence of India as the preferred hub for Foreign Investment is borne out by the fact that FDI as a percentage of GDP increased from 0.7% in 2003 to 2.1% in 2010 in India, while during the same period, it decreased from 2.9% to 1.6%. Moreover, in the period 2003 - 2010, FDI as a percentage of gross investment increased from 2.9% to 6% in India, while it reduced to almost half from 7.3% to 3.8% in China.
It would therefore not be an exaggeration to say that India has been able to create the right atmosphere to attract the TNC's to invest in this country and presents a huge potential in terms of infrastructure and market.
Sources & References:
Economist Intelligence Unit (2007)
UNCTAD's World Investment Report
World Economic Forum (Global Competitiveness Index)
FDI in India - CII Snapshot
Report of Department of Industrial Policy and Promotion
