Foreign direct investment is viewed as a major stimulus to economic growth in developing countries. (www.odi.org.uk) Foreign Direct Investment mainly deals with two major factors, namely, shortages of financial resources and technology and skills. Foreign direct Investment can be an attractive and viable option depending upon the industry sector and type of business. Attracting foreign direct investment (FDI) has become an increasingly important factor in promoting growth, upgrading the competitiveness of the national economy and increasing its integration into global production.
Foreign Direct Investment plays a vital role in the economic development of the country. Over the period of time foreign direct investment has helped the host country in economic development. FDI accelerates the speed of adoption of general purpose technologies (GPT) in the host countries; FDI is embedded with new technologies and know-how not available in the host countries. Foreign direct investment pumps in a lot of capital knowledge and technological resources into the economy of a host country. Normally, FDI from developed countries help developing countries to boost their financial condition. This financial assistance can be used into various sectors of the economy depending upon the requirements of the particular sector.
India, the largest democracy in the world, with its consistent growth/performance and abundant skilled manpower provides enormous opportunities for investment, both to domestic and foreign country (indianembassy.org). India's Industrial policy of 1991 allowed access to foreign companies, which led to accelerated growth of the country. Until the liberalization (India's industrial policy) of 1991, India was isolated from the world markets, to protect its economy and to achieve self-reliance. Since liberalization, the value of India's international trade has become more broad-based and has risen to Rs. 63,080,109 crores in 2003-04 from Rs.1,250 crores in 1950-51. India's major trading partners are China, the US, the UAE, the UK, Japan and the EU.(Datt, 2009) The exports during April 2007 were $12.31 billion up by 16% and import were $17.68 billion with an increase of 18.06% over the previous year.(INDIA'S FOREIGN TRADE, 2007) In 2006-07, major export commodities included engineering goods, petroleum products, chemicals and pharmaceuticals, gems and jewellery, textiles and garments, agricultural products, iron ore and other minerals. Major import commodities included crude oil and related products, machinery, electronic goods, gold and silver.
FOREIGN DIRECT INVESTMENT IN INDIA: -
In view of the economic crisis on the one hand, and the perceived importance of foreign capital in the economic development of the country on the other, the Government of India has been making continuous efforts to attract foreign capital during the post-liberalization period. Foreign Direct Investment has played a very crucial role in the economic development of India. FDI has helped India to focus on areas that may have needed economic attention, and helped to address the problematic areas in development. In view of the economic crisis on the one hand, and the perceived importance of foreign capital in the economic development of the country on the other, the Government of India started taking initiative towards attracting the FDI. Government started providing concession in taxes, announcing tax holidays and increasing the investment capital in various sectors of the Indian economy. GDP growth rate has crossed 9% due to boom in manufacturing and service industries. (economywatch, 2009)
Foreign direct investment (FDI) inflow to India was US$ 3.5 billion in July, 56 per cent higher than US$ 2.25 billion in the same month a year ago, according to the Commerce and Industry Minister. FDI equity inflows amounting to US$ 10.532 billion were received during April-July 2009. (Indian brand equity foundation, 2009). While the services sector comprising financial and non-financial services attracted US$ 1,855 million in April- June period of the current fiscal, computer software and hardware sector garnered about US$ 239 million in the said period. To strengthen higher overseas investment into cash-strapped micro and small enterprises (MSEs), the government has liberalised the FDI norms for the sector replacing the current 24 per cent ceiling on foreign holding with the sectoral caps. These industries will now be guided like other large enterprises as far as FDI is concerned.
High volume of FDI takes place in the service sector including information technology (IT), telecommunication, travel etc. It industry is one of the booming sector in India which makes India the leading country pertaining to the IT industry in Asia-pacific region. IT sector in India attracts 22% of overall fdi whereas agriculture sector attracts less than 1% of FDI. Agriculture is an important sector of the Indian economy; more than 70% of the India's population depends upon the agriculture. India has taken major steps to attract more and more FDI in agriculture sector like 100% FDI is allowed through the automatic route covering many for the agro and allied sectors, various funds are raised, etc. FDI incentives one of the most important incentives provided for FDI in India relates to taxation policy as tax rates in the country are sufficiently high. Domestic corporations are subject to tax at a basic rate of 35% and a 2.5% surcharge. Foreign corporations have a basic tax rate of 40% and a 2.5% surcharge. (Fritz B, 2004) 19 Tax incentives include tax holidays or reduction of corporate profit tax, accelerated depreciation allowance, and tax deduction of certain expenses (e.g. R&D expenses). For instance, India was able to attract much FDI into the IT industry by offering a 10-year tax holiday. Investment in the infrastructure sector, power distribution, certain telecom services, refining of mineral oil, R&D projects, food processing and some other activities enjoy special tax treatment and holidays as well. For example, infrastructure projects - road, highways, irrigation projects, sanitation and sewage projects, and solid waste management systems - receive 100% deduction of the profits for 10 years. (Investing in India: Foreign Direct Investment Policy and Procedures (2005) Government of India, Ministry of Commerce & Industry, Department for Industrial Policy and Promotion.) The government offers 5-years tax holidays for power projects and firms engaged in exports, other tax rebates are also provided for specific sectors and activities. (India Finance and Investment Guide, 2009)
Tax holidays are available in Special Economic Zones (SEZ) set up to create internationally competitive and favourable environment for exports. The SEZ regulations offer tax exemptions from 50 to 100% over a fifteen year period: 100% income tax exemption on export income for SEZ units is offered for the first 5 years, 50% for next 5 years thereafter and 50% of rein- vested export profits for next 5 years. In addition duty free import/domestic procurement of goods for development, operation and maintenance is granted for SEZ units.
India's liberalisation policy has made a very successful achievement in attracting the foreign investment. Still there are many ways India can attract more and more FDI. Foreign investors are targeting only selected sectors for investment which leads to uneven distribution of resources, to avoid this condition and for a better use of resources and development Indian government needs to take some important steps in attracting foreign investment. India is a developing country and still it aims to attract 50 billion dollars of FDI by 2012. If Indian government is successful in attracting foreign investment in those sectors where they feel development is require then it will be a bonus for Indian economy. India has already succeeded in attracting the FDI in service and telecommunication sectors, though less than 10% of population is depending on this industry. So it is very important for Indian government to develop those sectors where FDI is needed.
A substantial part of the total FDI into India is routed through Mauritius. The advantages of routing both direct and indirect investment into India through Mauritius have been acknowledged by a number of major fund managers and multinationals, which have already established their investment vehicles in Mauritius. Specifically, Mauritius' Double Taxation Agreement (DTA) with India has been widely used for routing investments into India with a substantially reduced withholding tax rate of 5% on dividends paid out of India. However, with the elimination of shareholders tax on dividends since 1997, there was no withholding tax on dividends and this type of tax treaty planning had ceased to be as attractive as it used to be.
Four BRIC economies together have attracted over $ 144.57 billion as recently as 2005, which was about 16% of the total FDI inflows in the world. (financialexpress, 2009). FDI flows, on the one hand, provide BRIC countries the much-needed access to financial capital, superior technology and global best-practice systems of marketing and corporate governance, employment, and, on the other, also reinforce the capacity of BRIC trans-national corporations (TNCs), that is essential for intra-and inter-BRIC FDI. Between 2000 and 2006, inward FDI stock in the four BRIC countries grew from $136.9bn (8% of global FDI stock) to $1.53tn (13%). This represents a compound annual growth rate of 41.3%, against a CAGR of 24.1% in the US (the single biggest recipient of FDI) and 32.7% in the EU (the largest regional destination).
CAUSES AND REASONS FOR LOW FDI
Though economic reforms welcoming foreign capital introduced in the early nineties it does not seem so far to be actually evident in our overall attitude. There is a slow awareness in abroad that foreign investors are still looked at with some suspicion. When a foreign investor considers making any new investment decision, it goes through four stages in the decision making process and action cycle, namely screening, planning, implementing and operating and expanding. The biggest barrier for India is at the first, screening stage itself in the action cycle. "Often India looses out at the screening stage itself" (BCG). This is primarily because we do not get across effectively to the decision-making "board room" levels of corporate entities where a final decision is taken. Our promotional effort is quite often of general nature and not corporate specific. India is, moreover, a multi-cultural society and a large number of multinational companies (MNC) do not understand the diversity and the multi-plural nature of the society and the different stakeholders in this country. Though in several cases, the foreign investor is discouraged even before he seriously considers a project, 220 of the Fortune 500 companies have some presence in India and several surveys (JBIC, 2009) show India as the most promising and profitable destination.
All investments, foreign and domestic are made under the expectation for future profits. The economy benefits if economic policy fosters competition, creates a well functioning modern regulatory system and discourages 'artificial' monopolies created by the government through entry barriers. A recognition and understanding of these facts can result in a more positive attitude towards FDI. (Foreign Investment, 2009).
Taxes levied on transportation of goods from state to state (such as octroi and entry tax) adversely impact the economic environment for export production. Such taxes impose both cost and time delays on movement of inputs used in production of export products as well as transport of the latter to the ports. Differential sale and excise taxes (state and centre) on small and large companies are found to be deterrent to FDI in sectors such as textiles (McKinsey 2009). Investment that could raise the productivity and quality of textiles and thus make them competitive in global markets remains unprofitable because they cannot overcome the tax advantage given to small products in the domestic market. Globally the service sector received 43% of total investment in emerging markets in 1997. As this is a state subject, the states have to take the lead in simplifying and modernising the policy and rules relating to this sector.
China has achieved most remarkable results in FDI attraction and foreign capital utilization. China has experienced that provision of incentives (e.g. tax exemption or reduction, financial subsidies, reduced import tariffs and etc.) coupled with the execution of macroeconomic policies that help foreign investors to conduct business without incurring unnecessary risk and these are the key factors in creating a favourable environment for FDI. To improve the investment climate the Indian government should ensure a stable macro-economic environment, speed up privatization, improve the business environment and increase certainty, and take measures to combat bureaucracy and corruption. Also, there should be a steady match between the FDI attraction policy and industrial policy. FDI Incentives should be elaborated based on the Indian Government's vision of the future industrial landscape, and with this principle in mind investors should be carefully targeted based on sector prospects and investment motives, as investors' priorities depend on the sector in which they are going to invest. Effective aftercare services that address problems that investors are facing can help foreign companies and make India more attractive for FDI. Such incentives as investment grants (employment, R&D, training and etc) can encourage Greenfield FDI or investment in regions.
To become one of the favourable destinations for FDI, India needs to consistently review its policies and necessary steps have to be taken. As it appears from the analysis, unlike in china, the expatriate Indians do not form a large segment of the target investors in India. Therefore, to compete with China and other countries in attracting FDI inflows, measures must be taken to attract increased volume of 'quality' FDI inflows from the MNCs into the country. For example, India can adopt policies to target the right type of FDI for enhancement of exports. The contribution of MNCs in the exports of India was only 3 percent in 2002 against 48 percent in the case of China. Also, India should identify the sectors where it has a comparative advantage and negotiate with the major players in those sectors for setting up plants. Together with this, there is also the necessity for India to create a favourable investment climate in the country to attract FDI from the multinational companies (Bajpai and Sachs, 2000). Perhaps, then, India can possibly withstand Chinese competition in the market for FDI inflows and achieve the benefits that FDI inflows bring in.
Foreign firms invest abroad if they obtain locational advantages arising from direct access to markets, raw materials and lower unit labour costs, reduced transportation and communication costs, and avoidance of tariffs and nontariff barriers. Based on that logic he identifies four basic motives for FDI: (a) resource-seeking enterprises want to acquire access to natural or specific resources, skilled or semi-skilled labour and technological capability at a cost lower than in home country; (b) market-seeking firms are interested in access to internal and export markets for their goods and services; (c) efficiency seekers wish to exploit economies of scale and gain from cost and quality of human and physical infrastructure resources; and (d) strategic asset-seeking enterprises are keen to acquire the assets of foreign corporations to promote their long-term strategic objectives and increase international competitiveness.
Host country determinants of FDI
Markets
Size; income levels; urbanization, stability and growth prospects;
Access to regional markets; distribution and demand patterns.
Economic Conditions
Resources
Natural resources; location.
Competitiveness
Labour availability, cost, skills, trainability; managerial techical skills;
Access to inputs; physical infrastructure; supplier base; technology support.
Macro policies
Management of crucial macro variables; ease of remittance;
Access to foreign exchange.
Private sector
Promotion of private ownership; clear and stable policies;
Host country policies
Easy entry/exit policies; efficient financial markets; other support.
Trade and industry
Trade strategy; regional integration and access to
Markets; ownership controls; competition policies; support for SMEs.
FDI policies
Ease of entry; ownership, incentives; access to inputs;
Transparent and stable policies.
Risk perception
Perceptions of country risk, based on political factors,
Macro management, labour markets, policy stability.
Foreign investors strategies
Location, sourcing,
Company strategies on location, sourcing of products/
integration transfer
inputs, integration of affiliates, strategic alliances, training, technology
RECOMMENDATION: -
Taking into account that the main objective of FDI is to serve long-term development goals and improve competitiveness it should be a quite reliable match between the foreign direct investment attraction policy and industrial policy. Therefore FDI incentives should be elaborated based on Indian Government vision of the future industrial landscape as investors' priorities depend on the sector they are going to invest. For example, according to Ernst&Young Investment attractiveness Survey companies operating in high-tech and business services tend to favour quality factors such as telecommunication infrastructure (very important to 61.5% business-to-business companies) and labour skill level (very important for 53% of them). Industrial companies are most focus on cost efficiency (labour cost are very important for 50% of tem), tax burdens, legal and regulatory factors. (Reinventing European Growth, Ernst & Young 2009 European Attractiveness Survey) Hence, investors should be carefully targeted based on sector forecast and investment motives, e.g. such policy measures as development of physical and technical infrastructure and promotion of clusters, development of human resources can effectively help to attract FDI at high value added sectors and benefit from it.
Regulatory reforms
Foreign Investment Law: -
The entire FDI policy and procedures, as notified by the Government from time to time, are duly incorporated under FEMA regulations. A legal group should be constituted to draft a new law that would have as its objectives, (i) the promotion of FDI and (ii) National treatment for FDI. This law could also deal with issues such as double taxation, making a provision for preferential treatment of FDI, where this is considered to be in the national/public interest and help overcome obstacles arising from hurdles created at the State level for infrastructure sectors that are on the Central list.
State Law Infrastructure: -
Infrastructure investment and exports can be key drivers of productivity change and economic growth. Both domestic private and foreign direct investment can play an important role in these areas, but FDI can potentially play a more than fair role because of the special features of these sectors.
Institutional Changes
Industry Department: -
With greater automaticity in foreign direct investment, very few cases require FIPB approval and its regulatory functions are getting reduced. The weight henceforth would be increasingly on the promotional aspects. There is, nonetheless, a need for a sound database. An FDI registration system can be useful in creating the necessary database for tracking speedy execution of FDI projects.
Planning and FDI sector Targets:-
If FDI flows of over US$ 8 billion is to be attained over the next five years all wings of government have to be made responsible and liable for increasing private investment in general and FDI in particular. Sector wise FDI targets could be set and sector ministries made responsible for achieving these targets.
Funds for Assistance to states: -
An investment facilitation fund can be set up to provide assistance to those States who need assistance in modifying policies and procedures for promoting foreign and domestic investment. This could have two components: technical assistance and financial assistance. The latter could be made contingent on State specific reforms. The investment facilitation fund should have an effective implementation agency to help States in capacity building in the areas of investment promotion and facilitation like construction of investment road maps, investment tracking system, on mirroring as closely as possible a single-window facility.
Non Governmental facilitation services: -
Some industry associations such as CII are already taking steps to help foreign direct investors in dealing with unfamiliar Indian procedures. This effort needs to be supported and expanded. A non-governmental Society or Council should be set up by industry associations with the help and encouragement of the government (DIPP), for assisting first time foreign investors. This organisation would operate on a non-profit basis and supply information, approval and clearance services to FDI investors.
Raising FDI Sectoral CAPS
National Security: -
As a general proposition all governments prefer vital defence industries to be controlled by their own resident nationals. There are however two dimensions of this issue that need to be considered in the Indian context. One is the boundary of the defence industry. There is absolutely no need to put equity restrictions on the production of civilian goods used by the defence forces. The second dimension that is important in determining FDI equity limits is the domestic production versus import decision. Most discussion of FDI limits is carried out on the presumption that the item will be produced in India no matter what and the only choice is the level of FDI equity or management control. The third dimension relates to bans imposed by developed countries on the import of defence and dual use goods and strategic technology.
Culture and Media: -
We should have no objection in principle to publications on culture, society and entertainment being published and sold in India as long as this is not at the expense of Indian culture, social norms and practices. One touchstone for deciding on foreign equity could be a criterion of true cultural globalisation.
Natural Monopolies: -
Natural monopolies arise in the case of some non-tradable infrastructure sectors. These sectors or natural monopoly segments need to be regulated by independent regulators whether they are government or private, domestic or foreign owned. Efficient and effective regulation requires professional skills and knowledge. Independent and autonomous regulatory systems must be built so that the public benefits rather than the owners and/or managers of such 'natural monopolies.'
Monopoly Power: -
In the case of tradable goods competition arises not just from domestic production but also from imports. A limited number of domestic producers need not denote monopoly power. Modern competition law emphasises control of the abuse of monopoly power rather than focussing on the number of producers in a narrowly defined sub-sector.
Natural resources: -
The ownership of natural resources such as the electromagnetic spectrum and sites for dams, harbours, vests in the people and their government. The resource rent is defined as the difference between market price and the efficient costs of exploitation of the particular resource at a particular time and place. The resource rent depends on scarcity of the resource and its quality.
Transition Costs: -
An important reason for encouraging FDI is the productivity gains that can accrue. But the flip side of this coin is the short-term transition costs that it imposes on existing less productive competitors. For instant FDI in food retailing (entry of food department store chain) would lead to more efficient supply chain management systems that can reduce the large gap between the price received by farmers and that paid by consumers.
CONCLUSION
Thus a meaningful alignment of FDI statistics in India could possibly help in attracting more FDI into the country. However, just aligning the FDI definition is unlikely to find help with foreign investors who still rate India high in terms of inconsistent investment policy, poor infrastructure, red tapism, bureaucratic over-interference, corruption and a slow moving legal system. India must therefore take active steps to attract much higher levels of FDI flows. The merit of FDI in generating economic growth and development, both directly and also through spill-over effects has been amply acknowledged by the Government of India.
