Essay on Foreign Direct

Investment (FDI)
Read this essay to learn about Foreign Direct Investment
(FDI). After reading this essay you will learn about: 1.
Introduction to FDI 2. Concept of FDI 3. Foreign Portfolio
Investment 4. Raison d’etre 5. Benefits 6. Selection 7.
Negative Impact 8. Types 9. Theories 10. Patterns 11.
Policy Framework 12. Promotion 13. FDI Trends in India.
Contents:
1. Essay on the Introduction to FDI
2. Essay on the Concept of FDI
3. Essay on Foreign Portfolio Investment in comparison to FDI
4. Essay on Raison d’etre for FDI
5. Essay on the Benefits of FDI
6. Essay on the Selection of FDI Destinations
7. Essay on the Negative Impact of Foreign Direct Investment
8. Essay on the Types of Foreign Direct Investment (FDI)
9. Essay on the Theories of Foreign Direct Investment
10. Essay on the Patterns of FDI
11. Essay on the Policy Framework to Promote Foreign Direct
Investment (FDI)
12. Essay on the Promotion of Foreign Direct Investment in
India(FDI)
13. Essay on FDI Trends in India

Essay # 1. Introduction to FDI:

International trade and foreign direct investment (FDI) are the two
most important international economic activities integrating the
world economy. With the increase in the mobility of factors of
production across countries, FDI has become an integral part of a
firm’s strategy to expand international business.
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FDI is the largest source of external finance for developing

countries. At present, inward stock of FDI amounts to about one-
third of the developing countries’ gross domestic product (GDP),
compared to merely 10 per cent in 1980.

FDI plays a crucial role in the development process of host

economies. It also has a significant role in enhancing exports of the
host country. It is estimated that the sales from foreign-owned
facilities are about double the value of world trade.

FDI not only serves as a source of capital inflow into host

economies, but also helps to enhance the competitiveness of the
domestic economy through transferring technology, strengthening
infrastructure, raising productivity, and generating new
employment opportunities.

FDI has often been viewed as a threat by host countries due to the
capacity of transnational investing firms to influence economic and
political affairs. Many developing countries often fear FDI as a
modern form of economic colonialism and exploitation, similar to
their previous unpleasant experiences with colonial powers.

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Yet, FDI flows are generally preferred to other forms of external

finance because these are non-debt creating, non-volatile, and the
returns depend on the performance of the project financed by the
investors.
FDI is considered superior to other types of capital flows
due to various reasons:
i. Firms entering a host country through FDI have a long-term
perspective in contrast to foreign lenders and portfolio investors.
Therefore, FDI flows are less volatile and easier to sustain at the
time of economic crisis.

ii. Debt inflows may finance consumption whereas FDI is more

likely to be used to improve productivity.

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iii. Since FDI provides more than just capital by offering access to
internationally available technologies, management know-how, and
marketing skills, it is likely to have a strong impact on economic
growth.

A firm has to evaluate various options to cater to foreign markets

and select the most appropriate mode of international business
expansion.

Geographical distances of markets or resources, especially for low-

value products, make it more attractive to get into manufacturing
operations overseas. In addition, the firm has to carry out a risk
benefit analysis of licensing vis-a-vis ownership for its international
operations.

A foreign firm investing in India should understand the institutional

and regulatory framework for investment promotion in India.
Essay # 2. Concept of FDI:
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In simple terms, FDI means acquiring ownership in an overseas

business entity. It is the movement of capital across national
frontiers, which gives the investor control over the assets acquired.
FDI occurs when an investor based in one country (the home
country) acquires an asset in another country (the host country)
with the intent to manage it.

It is the management dimension that distinguishes FDI from

portfolio investment in foreign stocks and other financial
instruments. Conceptually, a firm becomes a multinational
corporation (MNC) by way of FDI as its operations extend to
multiple countries.

FDI is defined as an investment involving a long-term relationship

and reflecting a lasting interest and control by a resident enterprise
(foreign direct investor or parent enterprise) in one economy in an
enterprise (FDI enterprise or affiliate enterprise or foreign affiliate)
resident in an economy other than that of the foreign direct
investor.’

For acquiring substantial controlling interest, generally 10 per cent

or more equity is to be acquired in the foreign firm. The ‘lasting
interest’ implies the existence of a long- term relationship between
the direct investor and the enterprise wherein a significant degree of
influence is exerted by the investor in the management of the direct
investment enterprise.

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Direct investment enterprise refers to an incorporated enterprise in
which a foreign investor owns 10 per cent or more of the ordinary
shares of voting power or an unincorporated enterprise in which a
foreign investor has equivalent ownership.

Ownership of 10 per cent of the ordinary shares or voting stock is

the criterion for determining the existence of a direct investment
relationship. These are either directly or indirectly owned by the
direct investor. The definition of direct investment enterprise
extends to the branches and subsidiaries of the direct investor.

FDI is characterized by decreased sensitivity to fluctuations in

foreign exchange rates. Since FDI is the result of a long-term
perspective by the investor, it is much less volatile than foreign
portfolio investment. It has been reported that most FDI (i.e., more
than 90%) leads to intra-corporate trade at international level.

The returns of FDI are generally in form of profit, i.e., retained

earnings, profits, dividends, royalty payments, management fees,
etc.

Essay # 3. Foreign Portfolio Investment in

comparison to FDI:
Foreign portfolio investment (FPI) is defined as an investment by
individuals, firms, or a public body in foreign financial instruments,
such as foreign stocks, government bonds, etc. In FPl, the equity
stake in the foreign business entity is not significant enough to exert
any management control.
Thus, FPI is the passive holding of securities and other financial
assets by a foreign firm, which does not entail management control
of the issuing firm. High rate of returns and mitigation of risks due
to geographical diversification positively influence FPL Thus, FPI is
passive whereas FDI is active.

The returns in the case of FPI are generally in the form of non-
voting dividends or interest payments. Portfolio investment, like
FDI, is part of the capital account of balance of payment (BoP)
statistics.

Essay # 4. Raison d’etre for FDI:

It is important to understand why a firm takes a decision to invest
in foreign countries when low-risk alternatives to cater to foreign
markets, such as exporting and licensing, are already available. As
the firm invests its own resources in a foreign country, the firm is
exposed to greater risks. Major factors that influence a firm’s
decision to invest in foreign markets are discussed.

Cost of transportation:
Higher costs of transportation between the production facilities and
geographically distant markets make it economically unviable for
firms to compete or enter such markets. Substantial costs of
transportation have to be incurred for marketing products in
countries located at larger geographical distances.

For a product with low unit value, i.e., value to weight ratio, such as
steel, fast food, cement, etc., the cost of transportation has much
larger impact on its competitiveness in foreign markets compared to
a high-unit value product, such as watches, jewellery, computer
processors, hard-disks, etc.

Therefore, for low-unit value products, it becomes more attractive

to manufacture the products in the foreign country itself either by
way of licensing or FDI.

Liability of foreignness:
A firm’s unfamiliarity with the host country and lack of adaptation
of business practices in a foreign country often result in a
competitive disadvantage vis-a-vis indigenous firms. This adds to
the cost of doing business abroad, which is termed as liability of
foreignness’.

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For instance, Kellogg’s unfamiliarity with Indian breakfast habits

led to faulty positioning of its cornflakes as a substitute to the
traditional Indian breakfast and has been a classic marketing
blunder.

It took several years for Kellogg’s to understand the centrality of its

traditional food in India’s lifestyle before repositioning its
cornflakes as a complementary rather than a substitute to the
Indian breakfast. In another instance, Disneyland failed miserably
in its French venture primarily due to lack of product adaptation in
view of significant differences in customers’ preferences in Europe
vis-a-vis the US market.

It has to arrive at a trade-off between scale benefits from

concentrating production at a single location and exporting or
benefits of FDI, such as proximity of production locations, higher
level of control, and gaining better access to the market.

Essay # 5. Benefits of FDI:

Potential benefits of FDI to host countries include the
following:
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Access to superior technology:

Foreign firms bring superior technology to the host countries while
investing. The extent of benefits depends upon the technology spill-
over to other firms based in the host country.

Increased competition:
The investing foreign firm increases industry output, resulting in
overall reduction in domestic prices, improved product or services
quality, and greater availability. This intensifies competition in host
economies, resulting in net improvement in consumer welfare.

Increase in domestic investment:

It is found that capital inflows in the form of FDI increase domestic
investment so as to survive and effectively respond to the increased
competition.

Bridging host countries foreign exchange gaps:

In most developing countries, the levels of domestic savings are
often insufficient to support capital accumulation to achieve growth
targets. Besides, the level of foreign exchange may be insufficient to
purchase imported inputs. Under such situations, the FDI helps in
making available foreign exchange for imports.

Essay # 6. Selection of FDI Destinations:

A firm has to evaluate various countries as investment destinations
and select the most appropriate one for investment.

Briefly, the factors influencing net profit of an MNE’s

operations in a host country include the following:
Cost of capital input:
Cost includes interest rate and financial capital employed for setting
up of plant or the rent.

Wage rate:
Wage rate is highly significant for the manufacture of labour-
intensive products.

Taxation regime:
The prevailing taxation rates of the host country are of prime
importance while making an investment decision. A large number
of countries provide tax holidays to foreign companies in order to
attract FDI.

Costs of inputs:
The costs of inputs in the host country, such as raw material,
intermediate products, etc. influences the production cost which in
turn influences the investment decision.

Cost of logistics:
Logistics, including availability of various modes of transport, and
the cost of transportation, influence the FDI decision.

Market demand:
Demand of a product in the host country market, including
consumer preferences and their income levels, significantly affects
the investment decisions. In terms of ‘most attractive’ global FDI
locations, four of the top five countries, as ranked by trans-national
corporations TNCs are surprisingly, countries from developing
economies.

China is considered the most attractive investment location by 52

per cent of respondents followed by India with 41 per cent (Fig.
12.1).

India’s high ranking is considered to be even more remarkable

given the fact that FDI inflows to India have been modest until
recently. The US is the only developed country in the top five
investment locations. Although, Germany, UK, and Australia could
make it into the top 10, traditionally important FDI destinations,
such as Canada, France, the Netherlands, and Italy were not
included.

This implies that TNCs expect investors to move away from

established FDI locations, which often have saturated markets and
high production costs, towards emerging economies that are often
more dynamic. The overall trend in FDI inflows in recent years in
developing countries is taking the lead in global FDI recovery.

As indicated in Exhibit 12.1, India has emerged as a hot investment

destination. Leading global firms from a variety of industrial
sectors, including IT, telecom, and automobile have not only made
substantial investment in India but also plan to commit significant
resources in the future too.
Essay # 7. Negative Impact of Foreign Direct
Investment (FDI):
In most countries, public opinion towards foreign enterprises is not
very favourable and FDI is feared due to its impact on domestic
firms, the economy, and culture.

The major concerns about the negative aspects of FDI are

as follows:
(i) Market monopoly:
Multinational enterprises (MNEs) are far more advanced than
domestic companies, owing to their large size and financial power.
In some sectors, this is leading to MNE monopolies, thus impeding
the entry of domestic enterprises and harming consumers.

MNEs’ ability to operate at a large scale and invest heavily in

marketing and advertising and R&D activities differentiate their
products and makes entry of new firms far more difficult as they are
unable to make similar investments in R&D and marketing
strategies.

(ii) Crowding-out and unemployment effects:

FDI tends to discourage entry and stimulates exit of domestic
entrepreneurs, often termed as the crowding-out effect. As FDI
enterprises are often less labour intensive, their entry results in
higher unemployment and increased social instability.

(iii) Technology dependence:

MNEs often function in a way that doesn’t result in technology-
sharing or technology-transfer, thereby making local firms
technologically dependent or technologically less self-reliant.
(iv) Profit outflow:
Foreign investors import their inputs and use the host country as a
processing base, with little value-added earnings in the host
country. A large proportion of their profits may be repatriated.

(v) Corruption:
Large foreign investors often bribe government officials and distort
market forces.

(vi) National security:

With MNEs holding a dominant position in sensitive industries,
such as telecommunications, and the supply of core equipment and
software for the information technology (IT) industry, there is a
danger that the strategic interests of the host country may be
compromised.

Essay # 8. Types of Foreign Direct Investment (FDI):

Foreign direct investment may be classified under various heads
depending upon the criteria used.

Major types of FDI are discussed here:

(i) On the Basis of Direction of Investment:
Inward FDI:
Foreign firms taking control over domestic assets is termed as
inward FDI. From an Indian perspective, direct investments made
by foreign firms, such as Suzuki, Honda, LG, Samsung, General
Motors, Electrolux, etc., in India are examples of inward FDI.

Outward FDI:
Domestic firms investing overseas and taking control over foreign
assets is known as outward FDI. Such outward FDI is also known as
Direct Investment Abroad (DIA). From the Indian point of view,
direct investments overseas by Indian firms, such as Tata Motors,
Infosys, Videocon, ONGC, Ranbaxy, etc., are illustrations of
outward FDI.

(ii) On the Basis of Types of Activity:

Horizontal FDI:
When a firm invests in a foreign country in similar production
activity as carried out in home country, it is termed as horizontal
FDI. Thus, horizontal FDI occurs when the multinational
undertakes the same production activities in multiple countries.

Horizontal FDI enables the investing firm to exploit its competitive

advantage in the host country. Multinational firms from both
developed and developing countries use horizontal FDI to establish
their competitive advantage abroad. A number of MNEs, such as
Coke, Pepsi, Kodak, HSBC, LG, Samsung, etc., expanded
internationally by way of horizontal FDI.

Vertical FDI:
Direct investment in industries abroad so as to either provide inputs
for the firm’s domestic operations or sell its domestic outputs
overseas is termed as vertical FDI. Thus, vertical FDI takes place
when the multinational fragments the production process
internationally, locating each stage of production in the country
where it can be done at the least cost.
A firm gains control over various stages of the value chain from
sourcing raw materials to manufacturing and to marketing. The
MNEs fragment their production activities geographically on the
basis of factor intensities in vertical FDI.

Backward vertical FDI:

Direct investment overseas aimed at providing inputs for the firm’s
production processes in the home country is termed as backward
vertical FDI (Exhibit 12.2). Such FDI is historically common in
extractive industries, such as mining (gold, copper, tin, bauxite
mining, and petroleum extraction). Companies like British
Petroleum and Shell have expanded their international business by
backward vertical FDI.

Forward vertical FDI:

Direct investment in a foreign country aimed to sell the output of
the firm’s domestic production processes is referred to as forward
vertical FDI. Setting up a marketing network, assembly, or mixing
operations overseas are illustrations of forward vertical FDI.

Conglomerate FDI:
Direct investment overseas aimed at manufacturing products not
manufactured by the firm in the home country is termed as
conglomerate FDI.

(iii) On the Basis of Investment Objectives:

Resource-seeking FDI:
In order to gain privileged access to resources vis-a-vis competitors,
MNEs invest in countries with availability of natural resources. This
ensures the MNE of stability of raw material supply at right prices.

The major economic determinants for resource seeking

FDI include:
i. Availability of raw material

ii. Complementary factors of production

iii. Physical infrastructure

When resource-abundant countries lack capital and necessary

technical skills for resource extractions, such FDI is favored. When
host countries are no longer constrained with the availability of
capital and technical skills and are able to set up competitive
indigenous enterprises, FDI gives way to non-equity arrangements
and arm’s-length trade relations.

Historically, resource-seeking FDI has been very important but its

significance has declined considerably over time. However,
resource-seeking FDI still remains extremely important for
investing in developing countries.

Such types of MNEs are common in sectors, such as oil, agro-

processing, metals like steel, copper, bauxite, etc. Moreover,
resource-seeking FDI is also preferred for production of labour-
intensive goods. For instance, naturally occurring soda ash in Kenya
reduces the cost of production by half for chemical industries.

Cheap gas in Trinidad and Tobago considerably brings down the

cost of steel production. Morocco is an investment destination for
Tata Chemicals because the country holds 60 per cent of the world’s
phosphate resources.

Market-seeking FDI:
MNEs invest in countries with sizeable market and growth
opportunities in order to protect existing markets, counteract
competitors, and to preclude rivals or potential rivals from gaining
new markets. Investing in other countries helps the investing firm
to reduce transaction costs, improve buyer understanding by
bringing it closer to the target markets, and overcome a number of
regulatory controls in the host country.

The major economic determinants of market-seeking FDI

include:
i. Market size

ii. Market growth

iii. Regional integration

Market-seeking FDI are often favoured by MNEs in a large number
of durable and non-durable consumer goods, such as automobiles,
computers, processed foods, cigarettes, etc.

Efficiency-seeking FDI:
A firm may strategically opt for efficiency-seeking FDI as a part of
regional or global product rationalization and/or to gain advantages
of process specialization.

Efficiency-seeking FDI provides the investing firm not only access

to markets but also economies of scope, geographical
diversification, and international sourcing of inputs.

The major economic determinants of efficiency seeking

FDI include:
i. Productivity adjusted labour costs

ii. Availability of skilled labour

iii. Availability of business related services

iv. Trade policy

Efficiency-seeking FDI are often favoured in product categories,

such as motor vehicles, electrical appliances, business services, etc.,
besides, in process involving production of consumer electronics,
textiles and clothing, and pharmaceuticals.

(iv) On the Basis of Entry Modes:

On the basis of entry modes, foreign direct investment
may be of the following two types:
Greenfield investments:
Investing in creation of new facilities or expansion of existing
facilities is termed as Greenfield investment. Firms often enter
international markets by way of Greenfield investments in
industries where technological skills and production technology are
the key.

Further, the selection of FDI mode is influenced by:

i. Institutional factors

ii. Cultural factors

iii. Transactional cost factors

Particularly, the attitude towards takeovers, conditions in capital

markets, liberalization policies, privatization, regional integration,
current sales, and the role played by intermediaries, such as
investment bankers affect the mode of direct investment abroad.

Investment promotion by host countries aims at investment in new

greenfield ventures as it is viewed to generate economic benefits. In
developing countries where the right types of companies are not
available for acquisition, Greenfield operations are the preferred
mode of FDI.

Mergers and acquisitions:

For establishing overseas production facilities, mergers and
acquisitions (M&As) are crucial tools for a firm’s
internationalization strategy. M&As have become an increasingly
popular mode of investment among firms worldwide in order to
enhance their competitiveness so as to consolidate, protect, and
advance their position by acquiring companies internationally.
It is estimated that about 70-80 per cent of FDI are in the form of
M&As.

In developed countries with large number of competing firms,

M&As serve as principal source of FDI. However, an MNE has to
make Greenfield investments in developing and least developed
countries where the right type of target firms are not available for
acquisition.

The value of India’s total cross-border deals, both inbound and

outbound, increased significantly by 409 per cent from US$9.5
billion in 2005 to US$48 billion in 2007 but declined to US$25.63
billion in 2008.

The value of inbound deals increased by 200 per cent from US$5.1
billion in 2005 to US$15.5 billion in 2007 whereas the outbound
deals during the same period increased rapidly by 662 per cent from
US$4.3 billion to US$32.8 billion. However, both inbound and
outbound deals declined^ to US$12.48 billion and US$13.15 billion,
respectively in 2008.

The major foreign MNEs acquiring Indian firms during 2005 to

2007 included Vodafone, Maxis Communication and Apollo,
Vendanta Resources, Mylan Laboratories, Mittal Investments,
Citigroup, Oracle, Holcim and Matsushita Electric Works Ltd (Table
12.1) whereas major overseas acquisitions by Indian firms included
that of Tata Steel, Hindalco, Suzlon, Essar Steel Holdings, Great
Offshore, United Spirits, Tata Power, Tata Chemicals, J SW Steel
Limited, Wipro Technologies, Dr. Reddy’s Laboratories, and Suzlon
Energy (Table 12.2).
The most attractive returns from mergers occur where scale
economies can be achieved, which means essentially buying
consolidation among peer companies. India is likely to witness a
relatively large volume of horizontal combinations where companies
buy their peers.

An acquisition may be termed as a ‘hostile takeover’ when it is

resisted by the target firm’s management and board of directors.
Such takeover attempts are strongly resisted by the target firm. In
order to prevent the acquiring firm from such takeovers the target
firm often resorts to use of ‘poison pills’ by increasing the cost of
negative items as a strategic option, as discussed in Exhibit 12.3.
However, the acquiring firm may raise the attractiveness of its offer,
through a ‘sweetener’ to effectively counter the target firm’s
resistance.
(v) On the Basis of Sector:
Industrial FDI:
Investment by foreign firms in the manufacturing sector is termed
as industrial FDI.

Major objectives of FDI in the manufacturing sector

include:
i. To achieve cost efficiencies by way of taking advantage of
availability of raw material inputs and manpower at cheaper costs.
Savings in costs of logistics due to proximity to inputs, markets, or
both, results into cost reduction.

ii. To bypass trade barriers such as high import tariffs and other
import restrictions.

iii. To be closer to the markets and serve them more efficiently.

iv. To have physical presence due to strategic reasons.

Non-industrial FDI:
Investment by a foreign firm in services sector is termed as non-
industrial FDI.

The major reasons for non-industrial FDI are:

i. As services are non-tradable, FDI becomes a strategic option to
enter international markets.

ii. To overcome regulatory obstacles.

iii. To create regular contact with the customer.

(vi) On the Basis of Strategic Modes:

Export replacement:
In response to trade barriers of the host country, such as import
restrictions and prohibitive tariff structure, FDI is made a substitute
for exports. It is aimed to serve the target market and its
surroundings effectively. Entry mode for such types of FDI is
typically through M&As. Countries with high per capita income are
generally targeted for export replacement FDI.

Export platforms:
In order to minimize a firm’s cost of production and distribution,
FDI is made so as to utilize the target country to serve the global
markets. The competitive advantage and the incentives offered by
the host country plays a crucial role in attracting such FDI.
Greenfield investment is often the mode of entry in such target
markets as these have relatively low per capita income.

Domestic substitution:
Firms invest in foreign countries so as to use the target as a base to
serve investors’ home country. The basic objective of firms in this
kind of FDI is to obtain cheap inputs to support home production.
Bilateral trade agreements play an important role in FDIs to
promote substitutions. Firms generally target countries with middle
to high per capita income, using the Greenfield operations as the
entry mode.

Essay # 9. Theories of Foreign Direct Investment:

Most trade theories fail to explain why a firm invests in foreign
countries in unfamiliar environments, making its operations much
more complex, difficult to manage and, therefore, running
additional risks.
An FDI theory should help one conceptualize answers to
typical ‘W and ‘H’ questions such as:
Who is the investor?
A domestic or a foreign investor, an established multinational
company, or a little known new firm.

What kind of investment is to be made?

Whether it is Greenfield or merger or acquisition? Whether the
investment is first-time or sequential?

Why should the firm go abroad?

Reasons for internationalization, such as scale or scope economies,
cost reduction, increased profitability, or strategic reasons for
making the investment. The firm has to carry out analysis of socio-
cultural, political, and economic factors before deciding upon the
selection of host country for investment.

When to invest?
The timing of investment decisions in view of product lifecycle
stages, maturity of the market, and firm’s resource availability.

How to internationalize?
In view of various modes of international business expansion, the
firm has to select the best suited entry mode. Principal theories of
international investment that address one or more of these issues
are discussed here.
(i) Capital Arbitrage Theory:
The earlier theories were based on the belief that FDI takes place
due to differences in the rates of return on capital across countries.
Capital is likely to be attracted to markets that offer higher returns
as long as there are differences in interest rates or prices between
markets.

These theories were based on the assumption that markets were

perfectly competitive and firms invest overseas as a form of factor
movement to benefit from differential profits.

The theory of capital arbitrage is more suitable for foreign portfolio

investments where the returns on capital are crucial in the short
term. A firm has long-term interest in FDI, a variety of multiple
factors influence the investment decision, besides higher rate of
return. Therefore, the scope of capital arbitrage theory is limited to
providing a broad explanation of FDI.

(ii) Market Imperfection Theory:

Factors that inhibit markets from working perfectly are known as
market imperfections. Government policies, including import
restrictions and quotas, incentives on exports and FDI, tax regimes,
restrictions on FDI, and government’s participation in trade are
some of the examples of government intervention that create
market imperfections.

The basic objective of such restrictive measures is to promote a

country’s industrial development and manage the balance of trade.
Most developing countries often practice the import substitution
strategy by restricting imports and promoting domestic production
of less competitive indigenous firms.

However, developed countries are in no way behind in protecting

their domestic industries by providing huge subsidies and
incentives to domestic producers, besides using a variety of ever-
evolving non- tariff barriers to restrict entry to their markets. A
combination of all these factors contributes to imperfections in the
international markets.

Such market imperfections make exporting both restrictive and

expensive. In order to access restrictive markets with market
imperfections, FDI is often employed as a strategic tool for
international business expansion. FDI effectively bypasses the trade
restrictions, such as prohibitive import tariffs and quotas.

MNEs tend to exploit market imperfections created by the host

country governments by direct investment overseas. Such
protectionist measures decreased profitability of exporting
automobiles from Japan to Europe and increased profitability of
FDI to cater to the market. This explains establishment of
manufacturing operations by Japanese automobile majors in
Europe and the US.

It is important to understand that it is the mobility of capital and

immobility of low- cost labour that makes FDI a preferred tool to
access foreign markets. Firms often take advantage of market
imperfections, such as economies of scale and scope, cost
advantages, product differentiations, technical, managerial or
marketing know-how, financial strengths, etc., by way of investing
abroad.

(iii) Internalization Theory:

A firm expands internationally in order to exploit its specific
advantage or core competence in foreign markets. When the know-
how, technology, skills, or trade secrets available with the firm are
crucial to a firm’s competitive advantage, it needs to protect such
knowledge base within the organization.

Since arm’s-length collaborative strategies, such as management

contract and licensing do not provide complete protection to the
specific know-how possessed by the firm, internalization is often
preferred so that trade secrets remain within the organization.
Therefore, a firm expands into international markets by way of
investing in a foreign country in order to have control over its
overseas operations.

(iv) Monopolistic Advantage Theory:

An MNE is believed to possess monopolistic advantage, which
enables it to operate overseas more profitably and compete with
local firms. The benefit possessed by the firm that maintains its
monopolistic power in the market is termed as monopolistic
advantage.

For a firm to invest in physical resources overseas, the

following conditions are required:
i. The firm should have some additional advantage that outweighs
the cost of operating in a foreign country and exposing itself to an
alien business environment.

ii. The firm can exploit such specific advantage only through control
of foreign operations by ownership rather than other low-risk
means of market access requiring less commitment of resources
such as exporting and licensing.

Such an advantage specific to the investing firm is also known as

firm specific advantage (FSA). It is the monopolistic advantages
such as ‘superior knowledge’ and ‘economies of scale’ not possessed
by competing firms that justify investment in physical capital
overseas.

(v) International Product Life Cycle Theory:

The international product life cycle (IPLC) theory developed by
Raymond Vernon provides an explanation as to why production
locations are shifted across countries. Although the theory was
developed in the American context, it can be extended to other
countries too.

A firm gains monopolistic advantage by innovation of a product or

process technology and markets the product domestically or in
overseas markets through exports.

The product is initially manufactured in the country of innovation

even though the cost of production in other countries may be lower.
Subsequently, in the growth phase of the product life cycle, when
the product becomes standardized, the innovating firm takes
advantage of lower cost of manufacturing abroad, and starts
investing in other countries to create its own manufacturing
facilities.

The theory suggests that an MNE prefers those countries for

investment as manufacturing locations that have market size large
enough to support local production. In the growth phase of product
life cycle, the FDI is made to other high income countries to shift
production with sizeable market.

In the maturity stage, technology becomes available to the

competitors, the competition intensifies, and the innovating firm
shifts production from the country of initial FDI to other lower-cost
locations.

As a result, the products manufactured in overseas locations

become more cost-competitive vis-a-vis those manufactured in the
home country and the foreign-based subsidiaries become not only
more competitive to serve overseas markets but their production is
also imported into the innovating country even to serve its domestic
market.

IPLC theory is valid for both trade and investment and provides a
dependable explanation about trade patterns and investment. The
theory explains why firms undertake FDI in countries with low
production costs and considerable demand to support local
production.

However, the IPLC theory does not touch upon the reasons for
undertaking international investment rather than exporting or
licensing, which are low cost alternatives for international business
expansion. The theory applies mainly to industrial FDI in
manufacturing sector.

It is generally relevant to large firms with innovating capabilities.

The IPLC theory ignores revenue as it is too cost-oriented. Further,
it does not discuss opportunities when FDI is more profitable.

(vi) Eclectic Theory:

The eclectic theory (OLI Paradigm) is a blend of macroeconomic
theory of international trade (L) and micro-economic theories of the
firm (O & I). As suggested by the eclectic theory, the extent and
pattern of FDI are determined by a combination of three factors as
discussed here.

The ownership (O) factor:

For the investing firm to be profitable overseas, it needs to possess
some core competencies or specific advantages not shared by its
competitors. Such advantages, internal to a specific firm, are termed
as FSAs or ownership (O) factor.

Such advantages should enable the firm either to have a lower

marginal cost or higher marginal returns vis-a-vis its competitors so
as to enable it to reap more profits from overseas investment.

An MNE possesses firm-specific advantages, such as:

i. Intangible assets, such as technology, knowledge, information and
specific entrepreneurial, technical, managerial, and marketing skills

ii. Tangible assets, such as natural resources, capital, and manpower

iii. Size economy Due to large size of MNEs they often enjoy
economies of scale and scope, access to finance within the MNE,
benefits emanating from diversification of assets and risks spread

iv. Monopolistic advantage An MNE may benefit from its

monopolistic ownership of scarce natural endowments, privileged
access to raw materials, ownership of patent rights, and other
inputs.

Since an MNE is required to have its operations in foreign

countries, it has to incur additional costs due to:
i. Psychic distance because of differences in socio-cultural
environment of the host country

ii. Unfamiliarity with the host country’s market conditions

iii. Differences in legal, political, economic environment, and

institutional framework

iv. Increased expenses of operation and communication in a foreign

country due to geographical difference

As the indigenous firm in the host country is not required to incur

the above costs, the ‘costs of foreignness’ are specific to foreign
firms. Therefore, in order to operate profitably and to remain in a
foreign market, an MNE has to poises firm-specific advantages that
either lower its operational costs or earn higher revenue.

The location factor:

The locational (L) advantage or factor of a host country is the key
determinant to its relative attractiveness as an investment
destination.

The major country-specific advantages can be as follows:

Economic:
Availability of factor endowments, availability of raw materials and
other inputs, productivity and costs of inputs, market size and its
growth, cost of logistics, efficacy, and cost of communication
channels

Socio-cultural:
Familiarity of operational environment, socio-cultural similarity,
language, low psychic distance between the firm’s home country
and the host country

Political:
The host country government’s attitudes and policies towards
foreign firms and investment, incentives to promote FDI, continuity
of economic policies, and the stability of the government.

An MNE would, therefore, typically prefer countries with large

market size and high rate of market growth, adequate and low cost
availability of raw material, inputs and manpower, socio-cultural
proximity, economic and political stability.

The internalization factor:

The internalization (I) factor explains the entry mode used by an
MNE to access international markets. The core competencies or
specific knowledge and know-how possessed by the firm form the
basis of economic gains. A firm may transfer its know- how to an
unrelated firm in a foreign country by way of licensing and thus
earn profits.

A firm attempts to internalize its operations:

i. To protect its proprietary knowledge from competitors

ii. To create and maintain monopolistic or oligopolistic power in the

market by placing entry barriers to its competitors, forming cartels,
predatory pricing, cross- subsidizing among its international
operations, etc.

iii. To protect itself against market uncertainties

Thus, the internalization advantages explain why an MNE opts for
wholly owned subsidiaries rather than licensing or minority
ownership for accessing foreign markets. Internalization helps a
firm lessen the incidences of market failure.

The eclectic framework distinguishes between two types of

market failures:
Endemic market failure:
Such market failure occurs due to natural market imperfections,
such as unfamiliarity with markets or lack of market knowledge, the
incidence of transaction costs in external markets, interdependence
on demand and supply, uncertainty and risks, etc.

Structural market failure:

Endogenous market imperfections created by an MNE so as to
exploit its oligopolistic power are termed as structural market
failures. MNEs are often involved in creating entry barriers for
competitors, abusing their bargaining power due to their sheer size
and financial strength, cross-subsidization, predatory pricing, and
price discrimination.

Besides, MNEs indulge in arbitraging government-imposed market

regulations, such as tariffs and non-tariff barriers, differentiation in
taxation regimes, etc., that create exogenous market imperfections.

MNEs are often criticized for adopting unfair practices, such as

transfer pricing and under-invoicing, through their affiliates for
their own advantage so as to bypass high tariffs and the taxation
differences among various countries.
Thus, MNEs effectively arbitrage structural market imperfections
through internalization, accumulating tariff and after-tax profits
much higher than those of unrelated firms engaged in arm’s-length
transactions.

While enjoying these benefits of internalization, an MNE has to

incur various costs too—those of running large-scale vertically and
horizontally integrated international businesses. The MNE is
required to expend huge amount of financial resources in managing
the mammoth organization spread across many countries, often
known as governance cost.

Multinational firms are often required to invest substantial

resources in acquiring know-how or technological competence
while entering into unrelated lines of business.

The eclectic theory provides the most comprehensive explanation of

FDI, integrating firm-specific (O), location-specific (L), and
internalization (I) advantages. It logically examines the reasons for
investing overseas, the selection of country location for investment,
and the cost-benefit analysis for selecting the mode of international
expansion in a holistic manner.

In the past decade, the US software firms have increasingly utilized

the low-cost IT labour force in India. Companies wishing to capture
the benefits of outsourcing can engage in contracting (hiring an
Indian contracting company to perform the service) or foreign
direct investment (opening an Indian subsidiary and hiring Indian
employees).
Modern FDI theories predict that Indian software outsourcing
should occur primarily in the form of FDI.

However, contrary to FDI theories, many US and European

companies are hiring Indian software contracting companies in
order to use the low-cost Indian IT labour force. Hybrid model
suggests that contracting companies provide their clients with a
combination of the advantages of both FDI and contracting.

Essay # 10. Patterns of FDI:

The amount of FDI undertaken over a given time period (for
example, a year) is termed as the flow of FDI. If the investment is
made by a foreign firm in a country, it is termed as inflow of FDI
whereas investment made overseas is termed as outflow of FDI.

The total accumulated value of foreign owned assets at a given time

is termed as stock of FDI. FDI comprises equity capital and re
invested earnings as per IMF norms. Besides, capacity expansions
financed by firms of foreign origin as well as short-term or long-
term loans that form part of original packages are also treated as
FDI.

There has been significant growth in FDI over the years. Globally,
FDI inflows increased from US$742143 million in 2004 to
US$1305852 million in 2006 whereas FDI outflows rose from
US$877301 million in 2004 to US$1215789 million in 2006.
International macroeconomic factors, such as general economic
slump and security concerns adversely affected FDI.
This growth reflected increased flows to developing countries as
well as to South East Europe and the Commonwealth of
Independent States (CIS) which more than offset the decline in
flows to developed countries.

Between 2006 and 2007, FDI inflow’ to Netherlands exhibited the

highest growth by 2285 per cent from US$4.4 billion in 2006 to
US$104.2 in 2007 followed by the US (30.3%), Czech Republic
(27.3%), and the UK (22.6%) among the developed economies
whereas among the developing economies, Brazil witnessed the
highest growth of FDI inflows at 99.3 per cent, followed by Mexico
(92.9%), Chile (92.2%), and Singapore (52.6%) (Table 12.3).

The Russian Federation witnessed an impressive FDI inflow growth

of 70.3 per cent whereas FDI declined by 9.4 per cent for India and
3.1 per cent for China.
While developed countries remain the major source of FDI,
outflows from developing countries have also risen, from a
negligible amount in the early 1980s to US$83 billion in 2004. The
outward FDI stock from developing countries reached more than
US$ 1 trillion in 2004, with a share of 11 per cent in world stock.

Developing countries are beginning to recognize the significance of

foreign investment in order to achieve their firms’ competitiveness
and for enhancing their economic growth.

It is important to understand that the government policies in

developing countries were restrictive and paid little attention to
outward investment. Moreover, the ratio of FDI outflows to gross
capital formation was 25 per cent for Singapore in 2002-04
compared to 8 per cent for the US. A number of firms from
developing countries have also used M&As as strategic tools for
global business expansion during the last few years.

The global FDI increased faster than world trade and world output.
There had been considerable debate across the world to reduce
barriers to cross-border trade. Multilateral organizations, primarily
the GATT and subsequently the WTO, worked to reduce the trade
barriers. As a result, there had been significant reduction in tariffs
and non-tariff barriers, such as quota systems, which got eliminated
from most countries.

However, countries do exercise innovative barriers and firms often

use FDI as a tool to circumvent protectionist measures. FDI by
Japanese automobile companies in Europe, the US, and some other
countries was primarily aimed to circumvent their trade
protectionist measures. Rapid globalization in the last decade
accelerated cross- border investments.

Modes of FDI Entry:

Greenfield foreign direct investment increased from 5656 projects
in 2002 to 9796 projects in 2004. Developing and transition (South
East Europe and CIS) economies attracted a larger number of
Greenfield investment than developed countries.

Greenfield investment is the key driver behind the FDI recovery

during the recent years. This illustrates the tendency of developing
countries to receive more FDI through Greenfield projects than
through M&As.

China and India attracted significant number of Greenfield FDI

projects, together accounting for nearly half of the total number in
the developing countries. Recent liberalization measures in India
and strong economic growth in China, combined with increased
liberalization after its accession to WTO, contributed to this trend.
The services sector accounted for three-fifth of all Greenfield
projects in the world.

However, the FDI surge in 2005 is mainly attributed to increase in

cross-border M&As. Global M&As increased by 40 per cent to
US$2.9 trillion whereas Greenfield projects marginally dropped in
2005. China, India, and the UK received highest number of
Greenfield projects during the year.

It has been observed that:

i. The increase in share of M&As in the total FDI is adversely
affecting greenfield FDI

ii. The growing trend of M&As is leading to creation of oligopolistic

world, especially in case of strategic industries

iii. M&As severely affects survival of indigenous firms and

industries from developing countries and they need to be more
watchful

Components of FDI Flows:

FDI is mainly financed by MNEs through:
Equity capital:
The foreign direct investor’s purchase of share of an enterprise in a
country other than its own.

Intra-company loans:
Short- or long-term borrowings and lending of funds between direct
investors, i.e., parent enterprises and affiliate enterprises.

Reinvested earnings:
The direct investor’s share (in proportion to direct equity
participation) of earnings not distributed as dividends by affiliates,
or earnings not remitted to the direct investor. Such retained profits
by affiliates are reinvested.

Among various FDI financing options, equity capital is the largest

component. Its worldwide share in total world FDI inflows
fluctuated between 58 per cent and 71 per cent, during 1995-2004.
The intra-company loans accounted for 23 per cent and re-invested
earnings for 12 per cent of the world FDI inflows during the same
period.

The later two components are also much less s. In 2001, the share of
reinvested earnings in FDI financing reached a low of 2 per cent of
worldwide FDI whereas the equity capital registered a higher share.
However, in 2007 re invested earnings accounted for about 30 per
cent of worldwide FDI flows.

FDI Performance Indices:

For carrying out cross-country comparison of FDI performance and
FDI potential, the UNCTAD’s FDI performance and potential
indices serve as useful tools.

Inward FDI performance index:

It is a measure of the extent to which a host economy receives
inward FDI compared to the relative size of its economy. It is
calculated as the ratio of a country’s share in global FDI inflows to
its share in global GDP.

INDi = FDIi/FDIw/GDPi/GDPw
Where,

INDi = The inward FDI performance index of the i th country

FDIi = The FDI inflows in the i th country
FDIw = World FDI inflows
GDPi = GDP in the i th country
GDPw = World GDP
A value greater than ‘one’ indicates that the country receives more
FDI compared to its relative economic size, a value below one that it
receives less, a negative value means that foreign investors disinvest
in that period.

Thus, the index captures the influence of FDI on factors other than
market size, assuming that, other things being equal, size is the
‘baseline’ for attracting investments.

These other factors can be diverse, ranging from the business

climate, economic, and political stability, the presence of natural
resources, infrastructure, skills, and technologies, to opportunities
for participating in privatization or the effectiveness of FDI
promotion.

The countries with top inward FDI Performance Index in 2006

included Luxembourg, Hong Kong, China, Suriname, Iceland,
Singapore Malta, Bulgaria, Jordan, Estonia, and Belgium. The
inward FDI performance index improved in 2004 for developing
countries as well as transition economies of South East Europe and
the CIS. The improvement had been remarkable in South, East, and
Southeast Asia.

However, it worsened in developed countries compared to 2003.

For instance, the US where the FDI inflows rose by 69 per cent in
2004 had a lower performance index and ranked 114th out of 140
countries of the world due to its lower FDI flows in 2002-03.

India’s ranking for inward FDI index declined considerably from

98th in 1990 to 120th in 2000. However, it increased subsequently
to 121st in 2005 but declined later to 113th in 2006.

Outward FDI performance index:

Performance in FDI outflows relating to the size of economies is
measured by outward FDI performance index. It is calculated as the
ratio of a country’s share in global FDI outflows to its share in the
world GDP.

ONDi = (FDIi/FDIw)/(GDPi/GDPw)
Where,

ONDi = The outward FDI performance index of the i th country

FDIi = The FDI outflows in the i th country
FDIw = World FDI outflows
GDPi = GDP in the i th country
GDPw = World GDP
The differences in the index values among countries
reflect differences in these two sets of factors determining
outward FDI by Trans-national Companies (TNCs)
headquartered in different countries:
i. ‘Ownership advantages’, or firm-specific competitive strengths of
TNCs (such as innovation, brand names, managerial and
organizational skills, access to information, financial or natural
resources, and size and network advantages) that they are
exploiting abroad or wish to augment through foreign expansion

ii. ‘Location factors’, which reflect primarily economic factors

conducive to the production of different goods and services in home
and host economies, such as relative market size, production or
transport costs, skills, supply chains, infrastructure, and technology
supply.

Driven by the competitive pressures of globalization of world

economy, both these factors work together and lead a firm to invest
abroad by establishing foreign affiliates. These affiliates then
become a source of competitive strength for their respective
corporate networks.

The leading investor economies, in term of outward FDI

performance index include Iceland, Hong Kong, China,
Luxembourg, Switzerland, Belgium, Netherlands, Panama, Ireland,
Azerbaijan, and Bahrain. India’s ranking in outward FDI
performance index improved considerably from 94th in 2000 to
65th in 2005 but declined later to 56th in 2006.

Inward FDI potential index:

The inward FDI potential index reflects the stability of structure
variables comprising the index. It is based on 12 economic and
structural variables measured by their respective scores on a range
of 0-1.
It is the un-weighted average of scores based on:
a. GDP per capita

b. The rate of growth of GDP

c. The share of exports in GDP

d. Telecom infrastructure

e. Commercial energy use per capita

f. The share of R&D expenditures in gross national income

g. The share of tertiary students in the population

h. Country risk

i. Exports of natural resources as a percentage of the world total

j. Imports of parts and components of electronics and automobiles

as a percentage of the world total

k. Exports in services as a percentage of the world total

l. Inward FDI stock as a percentage of the world total

The top economies by inward FDI potential index in 2006 include

the US, Singapore, the UK, Canada, Luxembourg, Germany, Qatar,
Sweden, Norway, and Hong Kong (China).

Cross-country comparison of FDI performance vs.

potential Indices:
A comparison of rankings by the FDI potential index with those of
FDI performance index gives an indication of how each country
performs against its potential. Countries in the world can be divided
in four categories so as to draw up a four-fold matrix as shown in
Exhibit 12.4.

Front-runners:
Countries with high FDI potential and performance

Above potential:
Countries with low FDI potential but strong FDI performance

Below potential:
Countries with high FDI potential but low FDI performance

Under performers:
Countries with both low FDI potential and performance. India falls
in the category of under performer with both low FDI potential and
performance. Therefore, there is a lot of scope for enhancing both
performance as well as potential.

The concern for below potential countries is how they could raise
their FDI performance to match their potential whereas the above
potential countries need to continuously strive so as to sustain their
FDI performance at levels comparable with those of past while
addressing their structural problems.

Essay # 11. Policy Framework to Promote Foreign

Direct Investment (FDI):
Attracting foreign direct investment has become a key part of
national development strategies for most countries. Such
investments are often viewed to augment domestic capital,
employment, and productivity, leading to economic growth.

Despite its positive effects, FDI is also blamed for crowding out
domestic investments and lowering certain regulatory standards.
The impact of FDI depends on many conditions. However, well
developed and implemented policies can help maximize gains from
FDI.

Investment Promotion:
Although FDI is believed to play a positive role in achieving
sustainable development, it does not, however, automatically lead
to environmentally and socially beneficial outcomes. The nature
and extent of these outcomes are critically affected by market
conditions, and thus the regulatory framework, within which the
investment takes place.
Investment promotion by host countries is broadly made
through three different ‘generation’ policies, which are
discussed as follows:
First generation policies the liberalization of FDI flows and the
opening up of sectors to foreign investors

Second generation policies the marketing of countries as locations

for FDI and the setting up of national investment promotion
agencies

Third generation policies the targeting of foreign investors at the

level of industries and clusters, and the marketing of regions and
clusters with the aim of matching the locational advantages of
countries with the needs of foreign investors.

Major regulatory and incentives measures for FDI may be

summarized as:
i. Screening, admission, and establishment:
a. Closure of certain sectors, industries, or activities to FDI

b. Minimum capital requirements

c. Restrictions on modes of entry

d. Eligibility for bidding on privatization

e. Establishment of special zones (such as EPZs/SEZs) for FDI with

legislation distinct from that governing the rest of the country

ii. Fiscal incentives:

a. Reduction in standard corporate income tax rates o Tax holidays
b. Reductions in social security contributions

c. Accelerated depreciation allowances

d. Duty exemptions and drawbacks

e. Export tax exemptions

f. Reduced taxes for expatriates

iii. Financial incentives:

a. Investment grants

b. Subsidized credits

c. Credit guarantees

iv. Other incentives

a. Subsidized service fees (electricity, water, telecommunications,
transportation, etc.)

b. Subsidized designated infrastructure such as, commercial

buildings

c. Preferential access to government contracts

d. Closure of the market to further entry or granting of monopoly

rights

v. Performance requirements:
a. Protection from import competition

b. Local content requirements (value added)

c. Minimum export shares

d. Trade balancing

e. Technology transfer

f. Local equity participation

g. Employment targets

h. R&D requirements

More generally, countries typically have a mix of both resource-

seeking and efficiency-seeking FDI, reflecting partial reform of their
trade regimes, and the political economy of dispensing patronage.
Consequently, most countries follow dual policy regimes.

On the basis of cross-country analysis of FDI regimes of

six major Asian countries, i.e., India, People’s Republic of
China (PRC), Republic of Korea, Malaysia, Thailand, and
Vietnam, the following observations may be made:
i. FDI policy may differ between regions. Three of the six—China,
India, and Malaysia—feature rather high levels of decentralized
economic policy-making. Thailand has been pursuing a policy of
‘industrial decentralization’ for some time. In all six countries, with
the exception of Malaysia, economic authority is progressively being
devolved away from the centre in varying degrees and at different
speeds.

ii. There are large inter-industry differences in the degree of

protection, and thus difference in incentive, in all the six countries.
iii. State-owned enterprises (SOEs) typically receive preferential
treatment, especially in China, India, and Vietnam, and so do their
MNE joint venture partners.

iv. Most countries offer some sort of fiscal or financial incentive to

foreign investors. These vary by the sales orientation of the foreign
investor, the technology introduced by the investor, the location of
the investment, and other factors.

v. The regulatory regime frequently offers more than one entry

option for potential foreign investors, especially in recently
reformed economies.

A critical evaluation of FDI and economic development in India and

China, as given in Exhibit 12.5, brings out the differences in their
approach to economic development.
Essay # 12. Promotion of Foreign Direct Investment
in India(FDI):
Institutional framework:
The Department of Industrial Policy and Promotion is responsible
for facilitating and promoting FDI inflows into the country. It plays
an active role in investment promotion through dissemination of
information on investment climate and opportunities in India.

The department also advises potential investors about investment

policies, procedures, and opportunities. It also helps resolve
problems faced by foreign investors in the implementation of their
projects through the Foreign Investment Implementation Authority
(FIIA) which interacts directly with the investors.

In addition, a number of government departments, such as

Ministries of Finance, External Affairs, Labour, Environment and
Forests, etc., are also involved in the investment process. Exhibit
12.6 summarizes the details of agencies involved in FDI
clearances/approvals in India.

Policy framework:
The policy framework of FDI in India evolved in a phased manner,
from the strategy of import substitution soon after independence to
progressive liberalization that began in the early 1990s. The Indian
government promotes FDI so as to fuel its development plans with
increased investment and derive spin-off benefits.

FDI inflows in the development of infrastructure, setting up of

Special Economic Zones (SEZs), and technological up gradation of
Indian industry through Greenfield operation investments in
manufacturing and in projects with high employment potential are
encouraged. The FDI policy in India may be summarized as

FDI prohibited:
i. Retail trading (except single brand product retailing)

ii. Atomic energy

iii. Lottery business

iv. Gambling and betting sector

v. Business of chit fund and Nidhi Company

vi. Plantation except tea

vii. Trading in Transferable Development Rights (TDR)

viii. Activity/sector not opened to private sector investment

FDI up to 24 per cent allowed:

i. Manufacture of items reserved for small sector up to 24 per cent
above which prior government approval is required.

FDI up to 26 per cent allowed:

i. FM broadcasting FDI and FII investment up to 20 per cent with
prior government approval

ii. Up-linking a news and current affairs TV channels with prior

government approval

iii. Defence production with prior government approval

iv. Insurance FDI and FII under the automatic route

v. Publishing of news papers and periodicals: with prior government

approval

FDI up to 49 per cent allowed:

i. Broadcasting

a. Setting up hardware facilities, FDI and FII equity with prior

government approval

b. Cable network FDI and FII with prior government approval

c. Direct to Home (DTH) FDI and FII with prior government
approval. FDI cannot exceed 20 per cent

ii. Scheduled air transport services under the automatic route

iii. Commodity exchanges with prior government approval

iv. Credit information companies with prior government approval

v. Refining in case of PSUs with prior government approval

vi. Asset reconstruction companies with prior government approval

FDI up to 51 per cent allowed:

i. Single brand product retailing subject to prior approval

FDI up to 74 per cent allowed:

i. ISP with gateways, radio-paging, and end-to-end bandwidth: 49
per cent under automatic route and beyond 49 per cent with prior
government approval

ii. Establishment and operation of satellites: with prior government

approval

iii. Private sector banking: FDI and FII under the automatic route

iv. Telecommunications services: Basic, cellular, unified access

services, global mobile personal communication services, and other
value added telecom services with 49 per cent under the automatic
route and beyond 49 per cent with prior government approval

v. Non-scheduled air transport services, ground handling services

under the automatic route
Foreign direct investment up to 100 per cent allowed with
prior government approval subject to conditions:
i. Trading

a. Items from small scale sector

b. Test marketing of items approved for manufacture

ii. Courier services

iii. Tea sector, including tea plantation subject to divestment of 26

per cent equity in favour of Indian partner/public within five years

iv. ISP without gateway, infrastructure provider, electronic mail,

and voice mail: FDI up to 49 per cent under the automatic route
and beyond 49 per cent with prior government approval

v. Mining and mineral separation of titanium bearing minerals and

ores, its value addition and integrated activities

vi. Cigars and cigarettes manufacture

vii. Airports-existing projects with prior government approval

beyond 74 per cent

viii. Up-linking of a non-news and current affairs TV channel

ix. Investing companies in infrastructure/ services sector (except

telecom sector)

x. Publishing of scientific magazines, specialty journals and

periodicals
Foreign direct investment allowed up to 100 per cent
under automatic route:
i. Agriculture sector:
a) Floriculture

b) Horticulture

c) Development of seeds

d) Animal husbandry

e) Pisciculture

f) Aquaculture

g) Services related to agro and allied sectors

ii. Industrial sectors:

(a) Mining:
(a) Covering exploration and mining of diamonds and precious
stones, gold, silver, and minerals

(b) Coal and lignite for captive consumption

(b) Manufacturing activities:

(a) Alcohol distillation and brewing

(b) Coffee and rubber processing and warehousing

(c) Hazardous chemicals

(d) Industrial explosive—manufacture

(e) Drugs and pharmaceuticals

(f) Manufacture of telecom equipment

(c) Petroleum sector:

(a) Petroleum sector other than refining including market study and
formulation; investment/financing; setting-up infrastructure for
marketing.

(b) Petroleum refining for private companies

(d) Power:
(a) Generation (except atomic energy), transmission, distribution,
and power trading

i. Special Economic Zones and Free Trade Warehousing Zones

ii. Industrial Parks

iii. Construction development projects

(e) Services:
(a) Civil aviation

i. Airports Greenfield projects

ii. Helicopter/seaplane services

iii. Maintenance and repair organizations, flying and technical

training institutes

iv. Air transport services for NRI investment

v. Ground handling services for NRI investment

(b) Non-banking finance companies

(c) Trading

i. Wholesale/cash & carry trading

ii. Trading for exports

In sectors/activities not listed above, FDI is permitted up to 100 per

cent through automatic route subject to prevailing rules and
regulations applicable.

Essay # 13. FDI Trends in India:

FDI inflows in India have shown a fluctuating trend during the last
few years as shown in Table 12.4 and Fig. 12.2. It increased from
US$4029 million in 2000-01 to US$6130 million in 2001-02.
However, the FDI inflows declined to US$4322 million in 2003-04
but subsequently exhibited a rising trend to US$8,961 million in
2005-06 and thereafter jumped to US$22,079 million 2006-07 and
US$29,893 million in 2007-08.
The equity capital accounted for 74.8 per cent, whereas re-invested
earnings were 21.8 per cent, and other capital for 3.4 per cent of the
total FDI inflows in India, as shown in Fig. 12.3 during April 2000
to May 2008.
Sector-wise composition of FDI inflows as shown in Fig. 12.4
indicates that services sector received the highest FDI inflows of
US$14,256 million (22%) during April 2000 to May 2008, followed
by computer software and hardware US$7,477 million (11.5%),
construction activities US$4325 million (6.7%),
telecommunications US$4074 million (6.3%), housing and real
estate US$3745 million (5.8%), power US$2643 million (4.1%),
automobile industry US$2582 million (4.0%), metallurgical
industries US$2377 million (3.70/0), petroleum and natural gas
US$2007 (3.1%), chemicals US$1519 million (2.3o/o), and others
US$19800.3 million (30.6%).
Mauritius has been the top investor in India with US$28493 million
(40.6%) as shown in Fig. 12.5. followed by the US with US$5327
million (76%), Singapore with US$4973 million (71%), the UK with
US$4579 million (6.5%), Netherlands with US$2791 million (4.0%),
Japan with US$2151 million (3.1%), Germany with US$1637 million
(2.3%), Cyprus with US$1162 million (1.7%), France with US$997
million (1.4%), UAE with US$802 million (1.1%), and others with
US$17279 million (24.6%) during April 2000 to May 2008.

Foreign Direct investment in Retail Sector:

India is the second largest market in the world after China and it
fascinates global retailers to invest. Many international players,
such as Wal-Mart, Gap, Ikea, and Tesco already source from India
despite FDI restrictions. Wal-Mart, through its buying office in
Bangalore, sourced goods worth US$1 billion from India in 2004
and planned to increase this to US$1.5 billion in 2005.

The major pros and cons of opening up FDI in the retail sector are
discussed here.

Pros:
i. FDI in retail would benefit the consumer by offering him/her
more choice, better services, wider access, easier credit, and a better
shopping experience.

ii. Modern retailing will benefit local retailing by forcing it to re-

invent as has been the case in China.

iii. It will lead to higher standards of quality, introduce best

practices, provide more skilled employment, and improve tax
collection.

iv. Foreign direct investment in retail would lead to less wastage of

agri-produce due to improved food processing techniques and cold
storage facilities.

v. FDI would involve up gradation of infrastructure, logistics, and

support services.

vi. It would help Indian products get global recognition.

vii. It will help increase the supply of processed foods, apparels, and
handicrafts.

viii. Elimination of multiple middlemen would reduce transaction

costs related to inventory, delivery, and handling.

Cons:
i. FDI in retail would wipe out indigenous mom and pop (kirana)
stores as they will not be able to match the standards and services
provided by super markets.
ii. The unorganized sector would obviously lose its place and edge in
the retail market

iii. Retail FDI would also introduce competitive pricing, forcing a lot
of domestic players out of the game.

iv. It would reduce employment opportunities by displacing smaller

retailers in the unorganized sector, like what has happened in
Thailand.

v. It would mean legalizing the predatory practices of the MNC

retail chains.

vi. Retail-FDI will promote a ‘standardized’ form of global foreign

culture.

vii. India’s imports are likely to increase as MNCs will dump their
products in India.

viii. Since very little investment is required in retailing, foreign

players would end up remitting their profits.

Allowing FDI in retail sector will considerably affect the market

structure and the consumers. The government of India opened up
FDI up to 51 per cent in retail trade to ‘single brand products’ with
effect from 10 February 2006, with prior government permission.

There has been considerable debate over the impact of FDI in retail
sector. Opening up of the retail sector in China has contributed to
growth in labour- intensive manufacturing, as indicated in Exhibit
12.7.
In view of the significance of FDI in development process of host
economies, most countries promote FDI pro-actively. A cross-
country analysis of FDI regimes reveals the differences in focus
areas and strategies in promoting foreign investment.