FOREIGN DIRECT INVESTMENT

&

IT’S IMPACT ON INDIAN ECONOMY

Presented By
Akshay Mehta 08005

Aniket Vakharia 08012

Hemal Shah 8044

Hetal Shah 8046

Krutika Trivedi 08065

Rachita Ruia 08105

 INTRODUCTION
FOREIGN DIRECT INVESTMENT (FDI) is defined as "investment made to acquire
lasting interest in enterprises operating outside of the economy of the investor.” The foreign
direct investment provides for investment in Indian companies/setting up of wholly owned
subsidiary in areas which are otherwise not reserved exclusively for the public sector or which
are otherwise not under the prohibited categories such as real estate, insurance, agriculture and
plantation.

A parent business enterprise and its foreign affiliate are the two sides of the FDI relationship.
Together they form a Transnational corporation (TNC). The parent enterprise through its foreign
direct investment effort seeks to exercise substantial control over the foreign affiliate company.
'Control' as defined by the UN, is ownership of greater than or equal to 10% of ordinary shares or
access to voting rights in an incorporated firm. For an unincorporated firm one needs to consider
an equivalent criterion.
Ownership share amounting to less than that stated above is termed as PORTFOLIO
INVESTMENT and is not categorized as FDI.

FDI (Foreign direct investment) has become a key component of national development
strategies for almost all the countries over the Globe. FDI is considered to be an essential tool for
jump-starting economic growth through its bolstering of domestic capital, productivity and
employment. Dependence on FDI is rising heavily due to its all round contributions to the
economy. The important effect of FDI is its contributions to the growth of the economy. FDI has
an impact on country's trade balance, Increasing labour standards and skills, Transfer of new
technology and innovative ideas, Improving infrastructure, skills and the general business
climate.

FDI (Foreign direct investment) is considered to be the lifeblood for economic development as
far as the developing nations are concerned. FDI to developing countries in the 1990s was the
leading source of external financing. The rise in FDI volume was accompanied by a marked
change in its composition. That is investment taking the form of acquisition of existing assets
(mergers and acquisitions) grew much more rapidly than investment in new assets particularly in
countries undertaking extensive privatization of public enterprises. The role of Foreign Direct
Investment in the present world is noteworthy. It acts as the lifeblood in the growth of the
developing nations. Flow of the FDI to the countries of the world truly reflects their respective
potentiality in the global scenario. Flow of FDI truly reflects the country's both economic and
political scenario. Though the services sector in India constitutes the largest share in the Gross
Domestic Product, still it has failed to some extent in attracting more funds in the forms of
investments.
 FORMS OF FDI

BY DIRECTION:
 INWARD
Inward foreign direct investment is when foreign capital is invested in local resources.
Inward FDI is encouraged by:
> Tax breaks, subsidies, low interest loans, grants, lifting of certain restrictions
> The thought is that the long term gain is worth short term loss of income
Inward FDI is restricted by:
> Ownership restraints or limits
> Differential performance requirements

 OUTWARD
Outward foreign direct investment, sometimes called "direct investment abroad", is when
local capital is invested in foreign resources. Yet it can also be used to invest in imports and
exports from a foreign commodity country.
Outward FDI is encouraged by:
> Government-backed insurance to cover risk
Outward FDI is restricted by:
> Tax incentives or disincentives on firms that invest outside of the home country or on
repatriated profits
> Subsidies for local businesses
Leftist government policies that support the nationalization of industries (or at least a modicum
of government control) Self-interested lobby groups and societal sectors who are supported by
inward FDI or state investment, for example labour markets and agriculture. Security industries
are often kept safe from outwards FDI to ensure the localized state control of the military
industrial cytye6omplex

BY TARGET:
 GREENFIELD INVESTMENT
 Direct investment in new facilities or the expansion of existing facilities. Greenfield
investments are the primary target of a host nation’s promotional efforts because they create new
production capacity and jobs, transfer technology and know-how, and can lead to linkages to the
global marketplace. The Organization for International Investment cites the benefits of
Greenfield investment (or insourcing) for regional and national economies to include increased
employment (often at higher wages than domestic firms); investments in research and
development; and additional capital investments. Criticism of the efficiencies obtained from
Greenfield investments includes the loss of market share for competing domestic firms. Another
criticism of Greenfield investment is that profits are perceived to bypass local economies, and
instead flow back entirely to the multinational's home economy. Critics contrast this to local
industries whose profits are seen to flow back entirely into the domestic economy.

 MERGERS AND ACQUISITIONS

Transfers of existing assets from local firms to foreign firms takes place; the primary type
of FDI. Cross-border mergers occur when the assets and operation of firms from different
countries are combined to establish a new legal entity. Cross-border acquisitions occur when the
control of assets and operations is transferred from a local to a foreign company, with the local
company becoming an affiliate of the foreign company. Unlike greenfield investment,
acquisitions provide no long term benefits to the local economy-- even in most deals the owners
of the local firm are paid in stock from the acquiring firm, meaning that the money from the sale
could never reach the local economy. Nevertheless, mergers and acquisitions are a significant
form of FDI and until around 1997, accounted for nearly 90% of the FDI flow into the United
States. Mergers are the most common way for multinationals to do FDI.

 HORIZONTAL FDI
Investment in the same industry abroad as a firm operates in at home.

 VERTICAL FDI
Where an industry abroad provides inputs and outputs for a firm's domestic production
process.

IMPACT OF FDI
POSITIVES
1. Can contribute to growth, higher incomes, and reduced poverty - Perhaps the most
you could hope for any economic activity in a developing country is that it contributes to
 economic growth. This is the heart of the matter, but as with many economic phenomena,
there is not conclusive evidence here one way or another. But the empirical evidence is
good that FDI often, though definitely not always, contributes to economic growth. To the
extent that FDI contributes to economic growth, the evidence is indeed good than
economic growth usually leads to reduced poverty, though not necessarily to a more
equitable distribution of income.

2. Incentive structure leads to productive investment - Because FDI is generally done by

Multi-National Corporations, those companies are usually concerned with making
investments that will create profits. Therefore, the investments are usually well-targeted
towards setting up a business that will make money and create jobs. This contrasts
especially with aid and loans to governments, which have often been squandered through
corruption or spent inefficiently on unneeded infrastructure or other “vanity” projects.

3. Less volatile than other capital flows - Because FDI is generally spent on “hard assets”
such as plant and equipment, the capital embodied in FDI cannot flee a country in times
of crisis as easily as debt capital. A company can’t sell off a factory and pull out of the
country as quickly as a bank can sell off the country’s bonds, or refuse to roll over short-
term loans. Even in instances where the FDI is in a service-related industry such as
banking or advertising, substantial effort and time is spent to develop an ongoing
business, and owners will not easily pull the plug. Thus FDI is said to be much less likely
than debt capital to exacerbate a crisis situation, as happened in the Asian crisis in the late
90's. Experience through the nineties showed FDI to be much less variable than debt
flows.

4. Can lead to increased tax revenues -- A successful foreign-owned firm should generate
profits, and hence generate tax revenue for the host country. Those taxes can then be
spent on needed infrastructure, social programs, education, etc. This is a strong incentive
for government encouragement of FDI. However, in some cases the tax benefits can be
disappointing. One risk is that the government may provide too great a tax amnesty as an
incentive. Also, if the foreign-owned entity produces intermediate goods purchased by its
parent company, such as car parts that are shipped to an assembly plant in another
country, then profits can be affected by transfer price manipulation. That is what happens
when the subsidiary sells its product at an artificially cheap price to the parent company,
so that it can pay lower taxes.

5. Can lead to “technology transfer” and “management skills transfer” -- These are
components of “positive spillover”, or the positive effect on local firms that is often cited
as a key advantage of FDI. Because MNCs typically have greater technological and
management expertise than local firms, such expertise can be transferred to other parts of
the economy. This appears to happen most clearly when the MNC has close ties to local
partners, suppliers and customers. But even in cases where the MNC is not tightly
integrated with local firms, there is evidence that technology and skill transfer takes
 place, most likely through labor mobility, professional contacts, or a general raising of
competitive pressure.

6. Can improve skill and wages of labor force - FDI is often encouraged because MNCs
are thought to provide training and better employment opportunities for development of
the labor force. Evidence is strong that MNCs pay better and train employees more
thoroughly than domestic firms in developing economies. It is also claimed that the
presence of MNCs in the labor market provides incentive to local firms to improve
conditions and wages of workers. Note that from the perspective of local firms this can be
a negative -- if MNCs “skim” the local workforce of skilled workers, labor costs for local
firms can increase.

7. May improve access to export markets - MNCs almost by definition require substantial
skill in importing and exporting. Many economists and policy-makers believe that a key
benefit of FDI is that the presence of export-oriented foreign firms in a country can help
improve efforts by local firms to sell overseas. There is good evidence that this is the case.
One way this happens is through improvements in shipping and logistics infrastructure -
e.g. increased presence of international shipping firms and agents. There is probably also
some knowledge transfer, where managers of local firms learn from the example of the
MNC how to open new export markets.

8. Can provide additional demand for output of local producers - Another key component
of “positive spillover” is the increased demand for inputs from local suppliers that a new
MNC can create, which can lead to increased revenue and profits for local firms. Some
studies have suggested that a key determinant of the benefits to national income from FDI
is the extent to which the foreign enterprise sources locally, rather than importing its
inputs.

9. Can provide lower-cost inputs for local suppliers - Similar to the previous benefit, if the
MNC creates a product previously imported by local producers or otherwise in short
supply, the FDI can lead to a decrease in production costs for local firms and
correspondingly higher productivity and profits.

10. Can improve the balance of payments and capital account - Because exports will
typically bring in hard currency, an export-oriented foreign-owned entity can improve the
balance of payments and capital account of a nation. This balance of payment benefit is
reduced, however, by the extent to which the firm imports its production inputs. In
addition, the initial FDI investment itself can also be an important source of hard currency,
since the MNCs will typically need to convert hard currency to the local currency to either
purchase a local entity or contract for work and equipment in setting up a new entity. Note
also that MNCs will eventually repatriate profits and retained earnings periodically, which
causes a reduction in hard currency reserves.
 The Indian Advantage to FDI:
 Stable democratic environment over 60 years of independence
 Large and growing market
 World class scientific, technical and managerial manpower

Surveys by leading organizations rate India among the top three investment hot spots
and one of the fastest growing economies in the world
 NEGATIVES

1. If foreign ownership becomes too extensive, “decapitalization” can occur -- As

foreign-owned firms become established and profitable, they begin to repatriate earnings to
the home country of the owner. In so doing, local currency is converted to the home
country currency, and capital leaves the country. If the base of foreign-owned companies is
large enough, this can lead to a serious capital drain. This is especially a concern if in times
of crisis foreign-owned companies repatriate retained earnings suddenly. The effect of this
can be similar to the effect of foreign lenders refusing to roll over short term loans -- the
country can be starved of capital, and a bad economic situation can be made dramatically
worse. This is sometimes cited as one of the primary risks of a country becoming too
reliant on FDI.

2. May create damaging competition for local firms - This is often cited as a primary
“negative spillover” from FDI. Because MNCs often have skill, technology and capital that
local firms cannot match, FDI can create damaging competition for local firms. This is
noted as one of the most significant risks, but it is a complex one to evaluate. It is certainly
true that local firms can be damaged, even put out of business, and that unemployment can
result. But it is also true that in many instances competition from more efficient foreign-
owned producers can be seen as a benefit to the economy as a whole, improving overall
productivity, and forcing local firms to modernize and improve efficiency. The question to
ask here may be whether local firms will be able to improve enough to compete, or will
they just be decimated by the competition from the MNC. If it is the latter, then the FDI
may deserve additional scrutiny.

3. Can lead to market dominance by MNC -- Utilizing deep pockets and advanced
technical and management expertise, MNCs can possibly force all local competitors out of
business. Once such monopoly power is obtained, the MNC can then raise prices,
extracting excessive profits, potentially eliminating any overall benefit of the FDI.
Monopoly power, however gained, appears to be a risk associated with FDI, one that
should be closely scrutinized in most cases.

4. Social protest and disorder can occur -- When MNCs are seen as exerting too much
power, especially monopoly power over something considered a “public good” - e.g.
water, electricity, phone service - then public resentment and protest can occur. This can
lead to a hostile business environment, social disorder, and in the worst case political
instability. This happened dramatically in Cochabamba, Bolivia in 2000, when local water
service was taken over by a multinational conglomerate led by Bechtel, which immediately
doubled prices, precipitating a general strike and transportation shut-down. In this case the
Bolivian government reversed the privatization and Bechtel was forced to exit the country.
A counter-example is phone service in several countries around the world, including
Mexico, Brazil, and India, where foreign entry into the industry previously controlled by
the government dramatically reduced cost and improved service for phone service.
 However, in each of these cases, it is probably the introduction of competition, rather than
the introduction of foreign capital per se, that lad to such dramatic service improvements.

5. New production facilities may lead to environmental degradation -- A frequent

argument against FDI is that MNCs attempt to locate polluting facilities where
environmental controls are the weakest. It is true that most developing countries have
fewer environmental regulations, and less ability to enforce those that they do have, than
developed countries. However, while there may be some instances of terrible accidents and
great environmental harm being caused by MNC’s (e.g. the Bhopal chemical disaster, oil-
related pollution in southern Nigeria), for the most part there is not good evidence of
MNCs being more likely to pollute than domestic firms. Evidence may actually point the
other way, because MNCs, due to their higher profile, may be more sensitive to
environmental issues than local firms.

6. The foreign exchange FDI effects are much more negative than the idealized view of
FDI – The foreign exchange FDI positive effects arise only where new productive capacity
is created in the export sector, or in very strongly import-substituting sectors. If FDI takes
the form of purchase of existing capacity, even in the export sector it will have a negative
foreign exchange effect even if export production goes up, unless the productivity of
capital increases enough to offset the other increased foreign exchange costs. At lower
levels of import substitution, the effects of "Greenfield" FDI on new capacity are much
more ambiguous, and may be negative.

7. It may be misleading to assume that FDI necessarily contributes to increased

employment -- In fact, the employment effect will depend on a whole range of variables,
including the balance between Greenfield FDI and the purchase of existing assets; the
Labour intensity of new productive capacities or new organizational techniques; the extent
to which FDI-based production substitutes for existing production and their relative Labour
intensities, and so on. In general, therefore, it is not the case that FDI creates much more
net employment unless it is really very large in scale and heavily involved in Greenfield
activities, and even in such cases it need not be more employment-intensive.

8. Large-scale flows of FDI also have effects on other domestic economic policies -- To
begin with, reliance on such flows imposes severe constraints on domestic government
policy because of the fear of withdrawal, and of course the potential impact of
disinvestment increases as the FDI stock grows. Further, FDI is embodied in the presence
of multinational corporations (MNCs) which tend to be large and powerful lobbies in the
matter of domestic policies. And then, of course, the very competition to attract more FDI
by governments with over-optimistic expectations regarding such investment means that
all sorts of concessions are offered, which may turn out to be very expensive for the
economy in the medium or long term. Such FDI promotion tends to focus heavily on the
demand side, in terms of requirements imposed on host countries which involve changing
their own policies in order to make them more attractive. Such unilateral concessions are
increasingly sought to be entrenched through international agreements.
9. FDI can contribute to the underlying fragility of an economy and make it more
susceptible to balance of payments crises – There are several ways in which this can
happen. First, as rapidly growing stocks of inward FDI generate similarly growing profits
that form part of the foreign exchange outflow. Secondly, when FDI fuels an increase in
imports, such as capital goods for investment projects and other such payments. Thirdly,
because current foreign exchange costs of MNCs typically exceed the foreign exchange
they tend to earn through exports of import substitution. Fourthly, through the role played
by foreign affiliates, including those involved in retailing, in changing patterns of
consumption through advertising and brand promotion. For these and other reasons, FDI
can contribute to large current account deficits, which tend to precede financial crises.
They can also add to both the economic shocks preceding crises and to the process of
contagion. There are a number of examples like the East Asian economies and of Mexico
prior to their respective financial crises.