International trade and

finance
A study on foreign
direct investment in
India
Submitted by:Snehlata
BMS 2nd year
13MG4553
Submitted to:Dr. Rakesh Kumar

DEEN DAYAL UPADHAYA

COLLEGE OF DELHI
UNIVERSITY

Acknowledgement
I,SNEHLATA, student of Bachelor of Management Studies (4 th
semester), in Deen Dayal Upadhyaya College, University of
Delhi, hereby declare that I have made this academic project titled
A study on foreign direct investment in India
as a part of the internal assessment for the subject International
trade and finance, for academic year 2013-14. The project is
submitted for the first time and here only and the information
submitted therein is true to the best of my knowledge.
I sincerely thanks Dr rakesh kumar sir and my friends for the
help extended by them for the successful completion of the
project report.

Signature:-.

Index
s.no

particular

1.

introduction

2.

Types of Foreign Direct Investment

3.

Methods of Foreign Direct Investments

4.

HISTORY OF FDI IN INDIA

FOREIGN DIRECT INVESTMENT POLICY IN INDIA

Merits of FDI

Demerits of FDI

Reference

EXECUTIVE SUMMARY
Foreign direct investment (FDI) has played an important role in the process of
globalisation during the past two decades. The rapid expansion in FDI by
multinational enterprises since the mid-eighties may be attributed to
significant changes in technologies, greater liberalisation of trade and
investment regimes, and deregulation and privatisation of markets in
developing countries like India.
The title of the empirical study is FDI inflows
and its impact in India during 2007 to 2011. The present study aims at
providing detailed information about FDI inflows in India during the
subsequent years. The analysis is fully based on secondary data collected
through different website and journals.
The project aims at providing information of present FDI policy, year wise
FDI inflows, sector wise FDI inflows, countries contribution to maximum of
FDI inflows, state wise FDI inflows, trends and patterns of FDI inflows in
different sector, FDI comparison between India and China and so on.
From the study it has been found out that total
FDI inflows are estimated at US$19.43 billion during April 2010 to March
2011 and cumulative FDI inflows from 1991-2011 was $146319 million. The
services sector, computer hardware & software, telecommunications, real
estate, construction received maximum FDI inflows in India and Mauritius is
the main source followed by Singapore, the US, the UK, the Netherlands and
Japan for FDI inflows in India. From the hypothesis it has been found out that
there is a positive relationship between FDI and economy growth of India.
And thus different suggestion and recommendation are given to improve the
present condition of FDI in India.

INTRODUCITON TO FDI
Foreign Direct Investment (FDI) is capital provided by a foreign direct
investor, either directly or through other related enterprises, where the foreign
investor is directly involved in the management of the enterprise.
Development of a new business or acquisition of at least 10% interest in a
domestic company or a tangible assets, (purchase of bond & stock). "Foreign
direct investment is the transfer by a multinational firm of capital, managerial,
and technical assets from its home country to a host country".
FDI has three components: equity capital, reinvested earnings and intracompany loans. FDI flows are recorded on a net basis (capital account credits
less debits between direct investors and their foreign affiliates) in a particular
year. Outflows of FDI in the reporting economy comprise capital provided
(either directly or through other related enterprises) by a company resident in
the economy (foreign direct investor) to an enterprise resident in another
country (FDI enterprise). Inflows of FDI in the reporting economy comprise
capital provided (either directly or through other related enterprises) by a
foreign direct investor to an enterprise resident in the economy (called FDI
enterprise).
Foreign direct investment (FDI) includes significant investments by foreign
companies, such as construction of production facilities or ownership stakes
taken in U.S. companies. FDI not only creates new jobs, it can also lead to an
infusion of innovative technologies, management strategies, and workforce
practices. 'The ultimate flow of foreign involvement is direct ownership of
foreign- based assembly or manufacturing facilities. The foreign company can
buy part or full interest in a local company or build its own facilities. If the
foreign market appears large enough, foreign promotion facilities offer distinct
advantages. First, the firm secures cost economies in the form of cheaper labor
or raw material, foreign government incentives, and freight savings. Second,
the firm strengthens its image in the host country because it creates jobs.
Third, the firm develops the recent relationship with the government,
customers, local suppliers, and distributors, enabling it to adapt its product
better to the local environment. Forth, the firm retains full retain over its
investment and therefore can develop manufacturing and marketing policies
that serve its long-term international objectives. Fifth, the firm assures itself
access to the market in case the host country starts insisting that locally
purchased goods have domestic content."

Types of Foreign Direct Investment

Multinational Corporation

A country that maintains significant operation in multiple countries but

manages them from the base in the home country.The MNC's are playing an
important role in economic development of developing countries. First, the
investment made by MNC's help in filling the saving investment gap. Secondly,
it fills the foreign exchange or trade gap. Thirdly, the govt. of the developing
countries is able to fill up the reserves gap by taxing the profits of MNC's.
Fourthly, MNC's fill the gaps in management entrepreneurship, technology and
skills in the developing countries.

Transnational Corporation
A country that maintains the significant operation in more than one country but
decentralize management to the local country.

Strategic alliance
An approach to going global that involves partnerships between an organization
and a foreign company in which both share knowledge & resources in
developing new products or building production facilities. t is an agreement
typically between a large company with established products & channel of
distribution and an emerging technology company with a promising research
and development program in areas of interest to the larger company. In
exchange for its financial support, the larger established company obtains a
stake in the technology being developed by the emerging company. Today,
strategic alliance is common place in the biotechnology, information technology
& the software industries

Joint venture
An approach going global that is a specific type of strategic alliance in which
the partners agree to form an independent organization for some business
purpose.

They can be of two types:

A contractual joint venture between firms is usually for a specific project,
such as manufacturing a component or other product for a fixed period of
time. In equity joint venture is when firms hold an equity stake in the setting
up of a joint subsidiary, again to produce a good or a service, for example
Toyota and General Motors formed the subsidiary NUMMI to manufacture
cars in the United States.

 The percent of sales method for preparing pro forma financial statement are
fairly simple. Basically this method assumes that the future relationship
between various elements of costs to sales will be similar to their historical
relationship. When using this method, a decision has to be taken about
which historical cost ratios to be used.

Neoclassical Economic Theory of FDI

Neoclassical economic theory propounds that FDI contributes positively to the
economic development of the host country and increases the level of social
wellbeing [Bergten, et al. (1978)]. The reason behind this argument is that the
foreign investors are usually bringing capital in to the host country, thereby
influencing the quality and quantity of capital formation in the host country.
The inflow of capital and reinvestment of profits increases the total savings of
the country. Government revenue increases via tax and other payments [Seid
(2002)]. Moreover, the infusion of foreign capital in the host country reduces
the balance of payments pressures of the host country.
The other argument favouring the neoclassical theory is that FDI replaces the
inferior production technology in developing countries by a superior one from
advanced industrialised countries through the transfer of technology, managerial
and marketing skills, market information, organisational experience, and the
training of workers.
The MNCs through their foreign affiliates can serve as primary channel for the
transfer of technology from developed to developing countries. The welfare
gain of adopting new technologies for developing countries depends on the
extent to which these innovations are diffused locally.
The proponents of neoclassical theory further argue that FDI raises competition
in an industry with a likely improvement in productivity; Bureau of Industry
Economics. Rise in competition can lead to reallocation of resources to more
productive activities, efficient utilization of capital and removal of poor
management practices. FDI can also widen the market for host producers by
linking the industry of host country more closely to the world markets, which
leads to even greater competition and opportunity to technology transfer
It is also argued that FDI generates employment, influences incomes
distribution and generates foreign exchange, thereby easing balance of
payments constraints of the host country; Sornarajah; Bergten, et al..
Furthermore, infrastructure facilities would be built and upgraded by foreign
investors. The facilities would be the general benefit of the economy.
The Guidelines on the Treatment of Foreign Direct Investment incorporates the
neoclassical theory when it recognises:. that a greater flow of direct investment
brings substantial benefits to bear on the world economy and on the economies
of the developing countries in particular, in terms of improving the long-term
efficiency of the host country through greater competition, transfer of capital,
technology and managerial skills and enhancement of market access and in
terms of the expansion of international trade.

 Kennedy (1992) has noted that host countries became more confident in their
abilities to gain greater economic benefits from FDI without resorting to
nationalization, as the administrative, technical and managerial capabilities of
the host countries increased.

Types of FDIs
By direction
1. outward-bound
FDI is backed by the government against all types of associated risks. This
form of FDI is subject to tax incentives as well as disincentives of various
forms. Risk coverage provided to the domestic industries and subsidies
granted to the local firms stand in the way of outward FDIs, which are also
known as 'direct investments abroad.'
2.

Inward FDIs:

Different economic factors encourage inward FDIs. These include interest

loans, tax breaks, subsidies, and the removal of restrictions and limitations.
Factors detrimental to the growth of FDIs include necessities of differential
performance and limitations related with ownership patterns.
Horizontal FDI- Investment in the same industry abroad as a firm operates in
at home.
3. Vertical FDI
Backward Vertical FDI: Where an industry abroad provides inputs for a
firm's domestic production process.
Forward Vertical FDI: Where an industry abroad sells the outputs of a
firm's domestic production.

BY TARGET
Greenfield investment:
Direct investment in new facilities or the expansion of existing facilities.
Greenfield investments are the primary target of a host nations 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 in sourcing) 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.
Disadvantage of Greenfield investments include 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 firm 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. 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.

BY MOTIVE
FDI can also be categorized based on the motive behind the investment from
the perspective of the investing firm:

1. Resource-Seeking
Investments which seek to acquire factors of production those are more
efficient than those obtainable in the home economy of the firm. In some
cases, these resources may not be available in the home economy at all. For
example seeking natural resources in the Middle East and Africa, or cheap
labour in Southeast Asia and Eastern Europe.

2. Market-Seeking
Investments which aim at either penetrating new markets or maintaining
existing ones.FDI of this kind may also be employed as defensive strategy; it
is argued that businesses are more likely to be pushed towards this type of
investment out of fear of losing a market rather than discovering a new one.
This type of FDI can be characterized by the foreign Mergers and Acquisitions
in the 1980s Accounting, Advertising and Law firms.

3. Efficiency-Seeking
Investments which firms hope will increase their efficiency by exploiting the
benefits of economies of scale and scope, and also those of common
ownership. It is suggested that this type of FDI comes after either resource or
market seeking investments have been realized, with the expectation that it
further increases the profitability of the firm

Methods of Foreign Direct Investments

The foreign direct investor may acquire 10% or more of the voting
power of an enterprise in an economy through any of the following
methods:
By incorporating a wholly owned subsidiary or company
By acquiring shares in an associated enterprise
Through a merger or an acquisition of an unrelated enterprise
Participating in an equity joint venture with another investor or
enterprise
Foreign direct investment incentives may take the following forms:
Low corporate tax and income tax rates
Tax holidays
Preferential tariffs
Special economic zones
Investment financial subsidies
Soft loan or loan guarantees
Free land or land subsidies
Relocation & expatriation subsidies
Job training & employment subsidies
Infrastructure subsidies
R&D support

HISTORY OF FDI IN INDIA

India intent to open its markets to foreign investment can be traced back to the
economic reforms adopted during two prime periods- pre- independence and
post independence.
Pre- independence, India was the supplier of foodstuff and raw materials to
the industrialised economies of the world and was the exporter of finished
products- the economy lacked the skill and means to convert raw materials to
finished products. Post independence with the advent of economic planning
and reforms in 1951, the traditional role played changes and there was
remarkable economic growth and development. International trade grew with
the establishment of the WTO. India is now a part of the global economy.
Every sector of the Indian economy is now linked with the world outside
either through direct involvement in international trade or through direct
linkages with export and import.
Development pattern during the 1950-1980 periods was characterised by
strong centralised planning, government ownership of basic and key
industries, excessive regulation and control of private enterprise, trade
protectionism through tariff and non-tariff barriers and a cautious and
selective approach towards foreign capital. It was a quota, permit, licence
regime which was guided and controlled by a bureaucracy trained in colonial
style. This inward thinking, import substitution strategy of economic
development and growth was widely questioned in the 1980s. Indias
economic policy makers started realising the drawbacks of this strategy which
inhibited competitiveness and efficiency and produced a much lower growth
rate that was expected.
Consequently economic reforms were
introduced initially on a moderate scale and controls on industries were
substantially reduced by 1985 industrial policy. This set the trend for more
innovative economic reforms and they got a boost with the announcement of
the landmark economic reforms in 1991. After nearly five decades of
insulation from world markets, state controls and slow growth, India in 1991
embarked on an accelerated process of liberalization. The 1991 reforms
ensured that the way for India to progress will be through globalization,
privatisation, and liberalisation. In this new regime, the government is now
assuming the role of a promoter, facilitator and catalyst agent instead of the
regulator and

India has a number of advantages which make it an attractive market for

foreign capital namely, political stability in democratic polity, steady and
sustained economic growth and development, significantly huge domestic
market, access to skilled and technical manpower at competitive rates, fairly
well developed infrastructure. FDI has attained the status of being of global
importance because of its beneficial use as an instrument for global economic
integration.

Pre-Independence Reforms:
Under the British colonial rule, the Indian economy suffered a major set-back.
An economy with rich natural resources was left plundered and exploited to
the hilt under the English regime. India is originally an agrarian economy.
Indias cottage industries and trade were abused and exploited as means to
pave the way for European manufactured goods. Under the British rule the
economy stagnated and on the eve of independence India was left with a poor
economy and the textile industry as the only life support of the industrial
economy.

Post-Independence Reforms:
Indias struggle post independence has been an excruciating financial battle
with a slow economic growth and development which were largely due to the
political climate and impact of the economic reforms. The country began it
transformation from a native agrarian to industrial to commercial and open
economy in the post independence era. India in the post independence era
followed what can be best called as a trial and error path. During the post
independence era, the Indian Economy geared up in favour of central planning
and resource allocation. The government tailored policies that focussed a great
deal on achieving overall economic self-reliance in each state and at the same
time exploit its natural resource. In order to augment trade and investments,
the government sought to play the role of custodian and trustee by intervening
in the practice of crucial sectors such as aviation, telecommunication, banking,
energy mainly electricity, petrol and gas.
The policy of central planning adopted by the government sought to ensure
that the government laid down marked goals to be achieved by the economy
thereby establishing a regime of checks and balances. The government also
encouraged self sufficiency with the intent to encourage the domestic
industries and enterprises, thereby reducing the dependence on foreign trade.
Although, initially these policies were extremely successful as the economy
did have a steady economic growth and development, they werent sustained.
In the early, 1970s, India had achieved self sufficiency in food production.
During the 1970s, the government still continued to retain and wield a
significant spectre of control over key

In the Early 1980s-Macro-Economic Policies were conservative. Government

control of industries continued. There was marginal economic growth &
development courtesy of the development projects funded by foreign loans.
The financial crisis of 1991 compelled drafting and implementation of
economic reforms. The government approached the World Bank and the IMF
for funding. In keeping with their policies there was expectation of
devaluation of the rupee. This lead to a lack of confidence in the investors and
foreign exchange reserves declined. There was a withdrawal of loans by Non
Resident Indians.
Economic reforms of 1991:
India has been having a robust economic growth since 1991 when the
government of India decided to reverse its socially inspired policy of a
retaining a larger public sector with comprehensive controls on the private
sector and eventually treaded on the path of liberalization, privatisation and
globalisation.
During early 1991, the government realised that the sole path to India
enjoying any status on the global map was by only reducing the intensity of
government control and progressively retreating from any sort of intervention
in the economy thereby promoting free market and a capitalist regime which
will ensure the entry of foreign players in the market leading to progressive
encouragement of competition and efficiency in the private sector. In this
process, the government reduced its control and stake in nationalized and state
owned industries and enterprises, while simultaneously lowered and
deescalated the import tariffs. All of the reforms addressed macroeconomic
policies and affected balance of payments. There was fiscal consolidation of
the central and state governments which lead to the country viewing its
finances as a whole. There were limited tax reforms which favoured industrial
growth. There was a removal of controls on industrial investments and
imports, reduction in import tariffs. All of this created a favourable
environment for foreign capital investment. As a result of economic reforms of
1991, trade increased by leaps and bounds. India has become an attractive
destination for foreign direct and portfolio investment.

Government Approvals for Foreign Companies

Doing Business in India
Government Approvals for Foreign Companies Doing Business in India or
Investment Routes for Investing in India, Entry Strategies for Foreign
Investors India's foreign trade policy has been formulated with a view to invite
and encourage FDI in India. The Reserve Bank of India has prescribed the
administrative and compliance aspects of FDI. A foreign company planning to
set up business operations in India has the following options:
1. Automatic

approval by RBI:

The Reserve Bank of India accords automatic approval within a period of two
weeks (subject to compliance of norms) to all proposals and permits foreign
equity up to 24%; 50%; 51%; 74% and 100% is allowed depending on the
category of industries and the sectoral caps applicable. The lists are
comprehensive and cover most industries of interest to foreign companies.
Investments in high-priority industries or for trading companies primarily
engaged in exporting are given almost automatic approval by the RBI.
2. The FIPB Route Processing of non-automatic approval cases:
FIPB stands for Foreign Investment Promotion Board which approves all
other cases where the parameters of automatic approval are not met. Normal
processing time is 4 to 6 weeks. Its approach is liberal for all sectors and all
types of proposals, and rejections are few. It is not necessary for foreign
investors to have a local partner, even when the foreign investor wishes to
hold less than the entire equity of the company. The portion of the equity not
proposed to be held by the foreign investor can be offered to the public.

FOREIGN DIRECT INVESTMENT POLICY IN INDIA

FDI is prohibited in sectors like
(a) Retail Trading (except single brand product retailing)
(b) Lottery Business including Government /private lottery, online lotteries,
etc.
(c) Gambling and Betting including casinos etc.
(d) Chit funds
(e) Nidhi Company
(f) Trading in Transferable Development Rights (TDRs)
(g) Real Estate Business or Construction of Farm Houses
(h) Manufacturing of Cigars, cheroots, cigarillos and cigarettes, of tobacco or
of tobacco substitutes
(i) Activities / sectors not open to private sector investment e.g. Atomic
Energy and Railway Transport (other than Mass Rapid Transport Systems).
Foreign technology collaboration in any form including licensing for
franchise, trademark, brand name, management contract is also prohibited for
Lottery Business and Gambling and Betting activities.

Conditions to be fulfilled by foreign

countries to enter Indian markets
There are some basic requirements which must be fulfilled by the foreign
companies to enter Indian retail market which are as follows
1) Amount of investment
If any foreign company wants to enter into the Indian market the very first
condition which it has to satisfy is that such foreign company must invest at
least 100 million dollars or more into the Indian market. No foreign company
whose investment is less than 100 million dollars will be allowed to enter
Indian retail sector.
2) Places of opening stores
Another condition which these foreign companies have to satisfy is that they
can't open their stores at any place in India where they want rather such
companies can open their stores only in those cities the population of which
is 1 million or more.
3) Other conditions
Apart from this there are certain other conditions which must
be satisfied by these foreign companies to enter Indian
markets like at least 50 % of their investment should be in
back-end infrastructure like warehouses etc. & they have to
take permission to the concerned state government where
they want to establish their chains.

Merits of FDI
FDI has lot to advantages to its favour which can be summarized as below
More consumer savings
One of the biggest advantage of FDI is that it will increase the savings of
Indian consumer as he will get good quality products at much cheaper
rates. Consumer savings are likely to increase 5 to 10% from FDI.
Higher remuneration for farmers
Another advantage of FDI is that it will help a lot in improving the
miserable condition of Indian farmers who are committing suicides on
daily basis because of lesser return from their agricultural produce. But
FDI will certain help a lot in improving their conditions as the farmers are
going to get 10 to 30 %higher remuneration because of FDI.
Increase in employment opportunities
FDI is certainly going to increase the employment opportunities in India by
providing around 3 to 4 million new jobs. Not only this another 4 to 6
million jobs will be created in logistics, labour etc. because of FDI.
Increase in government revenue
Government revenues are certainly going to increase a lot
because of FDI. Government revenues will increase by 25 to
30 billion dollars which is a really big amount. This
government revenue can help a lot in the development of
Indian economy.

Demerits of FDI
Although FDI brings with it lot of advantages but it is not free from
disadvantages as well. Following are some of its demerits
Destruction of small entrepreneurs
The biggest fear from FDI is that it is likely to destroy the small
entrepreneurs or small kirana shops as they will not be able to withstand
the tough competition of big entrepreneurs as these entrepreneurs are going
to provide all the goods to the consumers at much lesser prices.
Shrinking of jobs
Many critics of FDI are of the view that entry of big foreign chains like
Wal-Mart, Carrefour etc. are not going to generate any jobs in reality in
India. At best the jobs will move from unorganized sector to organized
sector while their number will remain the same or lesser but not more.
No real benefit to farmers
Critics of FDI are also of the view that it is a fallacy that the
farmers are going to benefit in any way because of the
entry of foreign chains in India rather it will make the Indian
farmers a slave of these big chains & the farmers will
entirely be on their mercy. Thus, FDI is only going to
deteriorate the already miserable conditions of Indian
farmers.

Conclusion
After taking into consideration both pros & cons of FDI one can
safely say that although there are certain apprehensions
about FDI in India but all these fears are unfounded. There is
hardly any truth in the fact that it would destroy the small
entrepreneurs in India rather it will be beneficial for both the
consumers & farmers of India. So, the future of India lies in FDI
& the government must proceed in that direction if it wants to
make the Indian economy a developed economy.

Reference
Financial Management Prasanna Chandra
Management Accounting M.Y. Khan and P.K. Jain
Advanced Accountancy S.M. Shukla
Financial Statements Royal Classic Group
www.wikipedia.org
www.rcg.in
http://www.indiastudychannel.com/resources/147116-FDI-or-Foreign-DirectInvestment-India.aspx