FDI

Foreign Direct Investments in India
INTRODUCTION
The world is slowly becoming smaller and smaller day by day. The ever growing
population and the literacy rate has slowly but surely ensured that the world is
progressing forward. All the countries in the world are trying to stay ahead from each
other technically and of course financially. Any country would like to be strong any
aspect so that the world stands and notices them. The country wants to progress ahead
of other countries and stay ahead of the competition. There are some countries that
are considered as considered as “super powers”. These countries are mainly countries
which are developed and are superior in any aspect than other developing countries.
The so called “super powers” capture the maximum share of the market in the
economy and hence rule the market. Ant upswing or downswing in these countries
causes a major concern for other countries. Countries like USA, China, Japan and
Russia are some of the major “super powers” of the world. The world has accepted
the dollar to be the primitive currency for any trade. Similarly Euro has a great
existence in the European markets. Due to the diverse conditions of trade and
different trade practices, every country is compelled to interact with each other in
exchanging thoughts and ideas. The developing and the least developed country have
to take the help of these counties to stand firm on their feet.
Let’s have a look at the World Economy in short:
In the year 2002-2003, growth in global output (gross world product) (GWP) fell
from 4.8% in 2000 to 2.2% in 2001 and 2.7% in 2002. Due to sluggishness in the EU
economy (21.7% of GWP) and in the US economy (21.1% of GWP); continued
stagnation in the Japanese economy (7.0% of GWP); and spillover effects in the less
developed regions of the world.
China, the second-largest national economy in the world (12% of GWP), proved an
exception, continuing its rapid annual growth, officially announced as 8% but
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estimated by some observers as perhaps two percentage points lower. India
maintained a growth rate of around 6%, and its economic liberalisation pushed it
forward into a modern economic superpower. Russia (2.6% of GWP), with 4%
growth, continued to make uneven progress, its GDP per capita still only one-third
that of the leading industrial nations.
Externally, the nation-state, as a bedrock economic-political institution, is steadily
losing control over international flows of people, goods, funds, and technology.
Internally, the central government often finds its control over resources slipping as
separatist regional movements - typically based on ethnicity - gain momentum, e.g.,
in many of the successor states of the former Soviet Union, in the former Yugoslavia,
in India, and in Indonesia.
The addition of 80 million people each year to an already overcrowded globe is
exacerbating the problems of pollution, desertification, underemployment, epidemics,
and famine. Because of their own internal problems and priorities, the industrialized
countries devote insufficient resources to deal effectively with the poorer areas of the
world, which, at least from the economic point of view, are becoming further
marginalized.
The euro as the common currency of much of Western Europe in January 1999, while
paving the way for an integrated economic powerhouse, poses economic risks
because of varying levels of income and cultural and political differences among the
participating nations.
The terrorist attacks on the US on 11 September 2001 accentuate a further growing
risk to global prosperity, illustrated, for example, by the reallocation of resources
away from investment to anti-terrorist programs. The opening of war in March 2003
between a US-led coalition and Iraq added new uncertainties to global economic
prospects.
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Since we are dealing in an Asian country here is the low-down on the Economy of
Asia, the largest continent of the world. Following are some facts and figures about
Asian Economy:
The Economy of Asia comprises more than 4 billion people (60% of the world
population), living in 46 different states. In addition to this there are six further states
that lie partly in Asia, but are considered to belong to another region economically
and politically.
As in all world regions, the wealth of Asia differs widely between, and within, states.
This is due to its vast size, meaning a huge range of differing cultures, environments,
historical ties and government systems. The largest economy in Asia in terms of GDP
is Japan, the Smallest East Timor, (although there is currently no reliable data for
either Iraq or North Korea). This demonstrates the huge disparity in wealth in Asia,
with Japan being the world's second largest economy, and North Korea being one of
the poorest.
Asia was relatively rich in the ancient times. China was a major economic power and
attracted many to the East and for many the legendary wealth and prosperity of the
ancient culture of India personified Asia, attracting European commerce, exploration
and colonialism. The accidental discovery of America by Columbus in search for
India demonstrates this deep fascination. The Silk Road became the main East-West
trading route in the Asian hither land while the Straits of Malacca stood as a major
sea route. In the Straits of Malacca, Malacca established itself as an important port in
Asia.
Prior to World War II, most of Asia was under colonial rule. Only relatively few
managed to stay independent in face of constant pressure from many European
powers. Japan in particular managed to develop its economy thanks to reformation
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done in the 19th century. The reformation was comprehensive and is today known as
the Meiji Restoration. The Japanese economy continued to grow well into the 20th
century. Their ever increasing economy created various shortages of resources
essential to the economic growth. As a result, the Japanese expansion began and a
great part of Korea and China were annexed and thus, allowing the Japanese to secure
strategic resources.
At the same time, Southeast Asia was prospering due to trade and the introduction of
various new technologies of that time. The volume of trade continued to increase with
the opening of the Suez Canal in the 1860s. Singapore, founded in 1819 rose to
prominence as trade between the east and the west increased at an incredible rate. The
British colony of Malaya, now part of Malaysia, was the world's largest producer of
tin and rubber. The Dutch East Indies, now Indonesia on the other hand was known
for its spices production. Both the British and the Dutch created their own trading
companies to manage their trade flow in Asia. The British created the British East
India Company while the Dutch formed Dutch East India Company. Both companies
maintained trade monopoly of their respective colonies.
In 1908, crude oil was first discovered in Persia, modern day Iran. Afterwards, many
oil fields were discovered and it was learnt later that the Mideast processes the
world's largest oil stock. This made the rulers of the Arab nations very rich though the
socioeconomic development in that region lagged behind.
In the early 1930s, the world underwent a global economic depression, today known
as the Great Depression. Asia was not spared and suffered the same pain as Europe
and the United States. The volume of trade decreased dramatically all around Asia
and indeed the world. With falling demand, prices of various goods starting to fall
and further impoverished the locals and foreigners alike. In 1941, Japan invaded
Malaya and hence, begun World War II in Asia.
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After the liberalization of the Indian Economy undertaken by the then Finance
Minister and current Prime Minister of India Dr. Manmohan Singh, the Indian
economy coupled with the Chinese economy which was already booming with the
wise economic measures undertaken by Jiang Zemin powered Asia to being one of
the hotspots for world trade. Currently, as these two economies are growing at well
over 6% per year, Asia has started showing its potential. One of the favorable (or
unfavorable, depending upon one's point of view) is the sheer size of the population
in this region.
Meanwhile, Thailand, Malaysia and Indonesia emerged as the new Asian tigers with
their GDP grew well above 7% per year in the 80s and the 90s. The economies were
mainly driven by growing exports. The Philippines began to open up its once-
stagnant economy in the early 1990's.
Throughout the 1990s, the manufacturing ability and cheap labor markets in Asian
developing nations allowed companies there to establish themselves in many of the
industries previously dominated by developed-nation companies. Asia became one of
the largest sources of automobiles, machinery, audio equipment and other electronics.
At the end of 1997, Thailand was hit by currency speculators and the value of baht
along with its annual growth rate fell dramatically. Soon after, the crisis spread to
Indonesia, Malaysia, South Korea, Singapore and many other Asian economies and
inflicted great economic damage to the affected countries. In fact, some of the
economies actually contracted. This later would be known as the Asian financial
crisis. By 1999, most countries have already recovered from the crisis.
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GLOBALISATION
The term Globalisation means the changes in societies and the world economy that
are the result of dramatically increased trade and cultural exchange. In specifically
economic contexts, it is often understood to refer almost exclusively to the effects of
trade, particularly trade liberalization or free trade. Between 1910 and 1950, a series
of political and economic upheavals dramatically reduced the volume and importance
of international trade flows. More specifically, beginning with WWI and until the end
of WWII, when the Bretton Woods institutions were created (i.e. the IMF and the
GATT), globalization trends reversed. In the post-World War II environment,
fostered by international economic institutions and rebuilding programs, international
trade dramatically expanded. With the 1970s, the effects of this trade became
increasingly visible, both in terms of the benefits and the disruptive effects.
In simple terms the word globalization means coming together of different countries’
cultures’ traditions and races. It’s like creating a global village where there is free
transfer of thoughts and practices. This global village has a culmination of elements
which are essential in creating a wholesome package for achieving the objective of
every organization or person obtaining maximum profit. Globalisation has brought in
new opportunities to developing countries. Greater access to developed country
markets and technology transfer hold out promise improved productivity and higher
living standard. But globalisation has also thrown up new challenges like growing
inequality across and within nations, volatility in financial market and environmental
deteriorations. Another negative aspect of globalisation is that a great majority of
developing countries remain removed from the process. Globalization also affects the
local market. Due to competition consumers want more at lesser prices. There are any
brands available in market today. Any consumers who want better quality at lower
prices will go for cheaper products which are of high quality. Globalisation has
opened doors for the world to market any products anywhere in the world any time at
any price. Due to the harsh step taken by the countries to allow foreign products to
enter the market has left any local dealers dissatisfied. The local dealers are not able
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to get the best rates for their products. There is increasing competition which reduces
the prices of the products further down leading to more losses for the producers.
Impact of Globalisation on India
India opened up the economy in the early nineties following a major crisis that led
by a foreign exchange crunch that dragged the economy close to defaulting on loans.
The response was a slew of Domestic and External sector policy measures partly
prompted by the immediate needs and partly by the demand of the multilateral
organisations. The new policy regime radically pushed forward in favour of amore
open and market oriented economy.
Major measures initiated as a part of the liberalisation and globalisation strategy in
the early nineties included scrapping of the industrial licensing regime, reduction in
the number of areas reserved for the public sector, amendment of the monopolies and
the restrictive trade practices act, start of the privatisation programme, reduction in
tariff rates and change over to market determined exchange rates.
Over the years there has been a steady liberalisation of the current account
transactions, more and more sectors opened up for foreign direct investments and
portfolio investments facilitating entry of foreign investors in telecom, roads, ports,
airports, insurance and other major sectors.
The Indian tariff rates reduced sharply over the decade from a weighted average of
72.5% in 1991-92 to 24.6 in 1996-97.Though tariff rates went up slowly in the late
nineties it touched 35.1% in 2001-02. India is committed to reduced tariff rates. Peak
tariff rates are to be reduced to be reduced to the minimum with a peak rate of 20%,
in another 2 years most non-tariff barriers have been dismantled by March 2002,
including almost all quantitative restrictions.
This is major improvement given that India is growth rate in the 1970’s was very low
at 3% and GDP growth in countries like Brazil, Indonesia, Korea, and Mexico was
more than twice that of India. Though India’s average annual growth rate almost
doubled in the Eighties to 5.9% it was still lower than the growth rate in China, Korea
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and Indonesia. The pick up in GDP growth has helped improve India’s global
position. Consequently India’s position in the global economy has improved from the
8th
position in 1991 to 4th
place in 2001, when GDP is calculated on a purchasing
power parity basis.
Consequences of globalisation on India
The implications of globalisation for a national economy are many. Globalisation has
intensified interdependence and competition between economies in the world market.
This is reflected in Interdependence in regard to trading in goods and services and in
movement of capital. As a result domestic economic developments are not
determined entirely by domestic policies and market conditions. Rather, they are
influenced by both domestic and international policies and economic conditions. It is
thus clear that a globalising economy, while formulating and evaluating its domestic
policy cannot afford to ignore the possible actions and reactions of policies and
developments in the rest of the world.
Where does India stand in terms of Global Integration?
India clearly lags in globalisation. Numbers of countries have a clear lead among
them China, large part of east and far east Asia and Eastern Europe. Let’s look at a
few indicators how much we lag.
• Over the past decade FDI flows into India have averaged around 0.5% of
GDP against 5% for China 5.5% for Brazil. Whereas FDI inflows into China
now exceeds US $ 50 billion annually. It is only US $ 4billion in the case of
India
• Consider global trade – India’s share of world merchandise exports increased
from .05% to .07% over the pat 20 years. Over the same period China’s share
has tripled to almost 4%.
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• India’s share of global trade is similar to that of the Philippines, an economy
6 times smaller according to IMF estimates. India under trades by 70-80%
given its size, proximity to markets and labour cost advantages.
• As Amartya Sen and many other have pointed out that India, as a
geographical, politico-cultural entity has been interacting with the outside
world throughout history and still continues to do so. It has to adapt,
assimilate and contribute. This goes without saying even as we move into
what is called a globalised world which is distinguished from previous eras
from by faster travel and communication, greater trade linkages, denting of
political and economic sovereignty and greater acceptance of democracy as a
way of life.
FOREIGN DIRECT INVESTMENT (FDI)
Definitions of FDI are contained in the Balance of Payments Manual: Fifth Edition
(BPM5) (Washington, D.C., International Monetary Fund, 1993) and the Detailed
Benchmark Definition of Foreign Direct Investment: Third Edition (BD3) (Paris,
Organization for Economic Co-operation and Development, 1996).
According to the BPM5, FDI refers to an investment made to acquire lasting interest
in enterprises operating outside of the economy of the investor. Further, in cases of
FDI, the investor’s purpose is to gain an effective voice in the management of the
enterprise. The foreign entity or group of associated entities that makes the
investment is termed the "direct investor". The unincorporated or incorporated
enterprise-a branch or subsidiary, respectively, in which direct investment is made-is
referred to as a "direct investment enterprise". Some degree of equity ownership is
almost always considered to be associated with an effective voice in the management
of an enterprise; the BPM5 suggests a threshold of 10 per cent of equity ownership to
qualify an investor as a foreign direct investor.
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Once a direct investment enterprise has been identified, it is necessary to define
which capital flows between the enterprise and entities in other economies should be
classified as FDI. Since the main feature of FDI is taken to be the lasting interest of a
direct investor in an enterprise, only capital that is provided by the direct investor
either directly or through other enterprises related to the investor should be classified
as FDI. The forms of investment by the direct investor, which are classified as FDI,
are equity capital, the reinvestment of earnings and the provision of long-term and
short-term intra-company loans (between parent and affiliate enterprises).
According to the BD3 of the OECD, a direct investment enterprise is an incorporated
or unincorporated enterprise in which a single foreign investor either owns 10 per
cent or more of the ordinary shares or voting power of an enterprise (unless it can be
proven that the 10 per cent ownership does not allow the investor an effective voice
in the management) or owns less than 10 per cent of the ordinary shares or voting
power of an enterprise, yet still maintains an effective voice in management. An
effective voice in management only implies that direct investors are able to influence
the management of an enterprise and does not imply that they have absolute control.
The most important characteristic of FDI, which distinguishes it from foreign
portfolio investment, is that it is undertaken with the intention of exercising control
over an enterprise.
FDI flows constitute capital provided by foreign investors, directly or indirectly, to
enterprises in another economy. The three main components of FDI are:
• Equity Capital, which involves purchase by the foreign investor of shares of an
enterprise in a country other than its own.
• Reinvested Earnings, which refer to the foreign investor’s share of earnings that
are not remitted to it by the affiliate as dividends, but are reinvested or ploughed back
into the affiliate enterprise in the host country.
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• Working capital, which involves short and long term borrowing and lending of
funds by the parent investors and their affiliate enterprises in the host country.
FDI can be classified on the basis of the mode of entry of the foreign investor into a
country. It can enter a country in the form of Greenfield investment or mergers and
acquisitions (M&As).
• A Greenfield investment involves the setting up of new units or facilities by foreign
firms. For example, Silicon Chip Company of Taiwan coming to India and setting up
an Indian subsidiary with new plants in order to manufacture silicon chips.
• Cross border M&As, on the other hand, involve taking over or merging with an
existing local firm. For example, Coca-Cola company taking over Thums-Up in India.
KEY BENEFITS OF FDI
1. Capital formation
FDI brings in financial capital, which is scarce in developing countries. It has
the potential to add to the productive capacity or capital formation of the host
country.
2. Improve balance of payments
Greater FDI into the export sector can improve the current account balance and
hence the overall balance of payments.
3. Growth in net domestic savings & investment
FDI can encourage domestic saving and investment by encouraging the setting
up of new enterprises in the host country. Foreign businesses can increase the
demand for domestically produced inputs, which could lead to expansion of
existing domestic units or setting up of new ones. Domestic units can also be set
up to for processing of semi-finished products produced by foreign corporations
or to engage in retailing, marketing etc.
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4. Transfer of inputs, technology and skills
FDI transfers technology and skills to developing countries. FDI brings in new
varieties of capital units and better quality of factors of production including
management, which improves productive efficiency in the host country.
5. Net job creation
FDI can involve investment in new sectors, or setting up and expanding
business in thriving sectors. This can lead to increased employment
opportunities in the host economy.
6. Environmental benefits
Transnational corporations often develop environmental-friendly technologies
at lower costs and can actually induce local firms to adopt good environmental
practices.
7. FDI assures considerable stability in foreign inflows of funds
FDI as compared to other international flows is stable. Hence it has the potential
of ensuring a stable flow of foreign funds into the developing economy.
8. FDI can lead to higher export growth
If the motive of the foreign investor is to tap the export market of the host
country then it can lead to higher export growth. For e.g., if FDI flows into the
garments export industry in India, it will bring in financial resources and high
technology production processes. By taking advantage of skilled labour in India
in this sector, it can make garments export of India more competitive.
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9. Access to international markets
FDI can improve the competitive efficiency of domestic exports and hence
improve market access of goods. International production networks offer market
access to end products produced in any economy.
COSTS ASSOCIATED WITH FDI
1. Limited addition to capital
FDI might not contribute to total capital accumulation, when it does not involve
the creation of new units/investment. Concerns are often raised when FDI enters
more in the form of Mergers and Acquisitions than as Greenfield investments.
M & As involves taking extensive control over the decision-making and
management over the merger. Lack of local representation might lead to
decisions being made without taking into account needs and conditions of
domestic economy and society. Repatriation of profits can lead to withdrawal of
capital from the host country.
2. Worsen balance of payments
FDI could have a negative impact on the balance of payments situation of the
host country through an increase in imports of inputs and through remittances of
royalties and dividends abroad by the subsidiaries. For example, 75 per cent of
profits made by US firms abroad returns to the US.
3. FDI can bring about a fall in net domestic investment
Foreign corporations often form monopolies in the domestic market. Due to
their sheer size, good quality and low cost products and extensive advertising of
their products they might drive out small-scale firms. FDI, which is expected to
contribute to growth in domestic investment, often fails to, due to the
withdrawal of investments. There have been several instances in India where
approved FDI proposals have failed to translate into actual investments, on
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account of foreign investors getting put off by long- drawn procedures involved,
lack of infrastructure facilities etc
4. Transfer pricing
Transfer pricing relates to the way in which prices are determined for
transactions between subsidiaries and parent companies. It involves subsidiaries
paying a higher price for imports from the parent company and then exporting
products to parent companies at a lower price than the competitive market price.
Such distortion in prices affects the free flow of resources between countries
and also has a negative impact on the balance of payments situation of the host
country.
5. The downside
Developing countries might not have the ability to absorb high technology
imparted by foreign firms. For example, domestic conditions such as poor
infrastructure, low levels of education, rigidities in labour legislation and other
regulations are obstacles facing the Indian economy. Some foreign corporations
can bring in technology that is not appropriate to suit the conditions of the host
developing country.
6. Net job loss
Job creation might only take place in already well-developed urban sectors
where the levels of education, training and infrastructure are high. Small scale
and rural businesses have a low capacity to attract FDI and as a result are left
out. They can often be forced out of business due to lack of financial resources
or be forced into using informal sources of financing.
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7. Environmental costs
Foreign investors can take advantage of weak environmental regulation in
developing countries, by using technologies that are cheap but harmful to the
environment.
8. FDI may contribute to financial instability
Given the capacities and constraints of developing countries, free capital
movements make them more vulnerable to both external and internal shocks.
Developing countries’ dependence on foreign finance to cover their current
account deficits also makes them more financially fragile.
9. FDI might not encourage export growth
If the FDI is aimed at capturing the domestic market, then it will not have much
impact on growth of exports. Licensing conditions in the host country may
restrict exports to some or all foreign markets.
10. No contribution to market access
If FDI comes into a country only to exploit domestic markets, it does not
contribute to greater market access for domestic country exports
We can see that FDI has both positive as well as negative implications.
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BALANCE OF PAYMENTS (BOP)
FDI is also shown in the Balance of Payments of any country. The Balance Of
Payments (BOP) is a measure of the payments that flow into and out from a particular
country from and to other countries. It is determined by a country's exports and
imports of goods, services, and financial capital, as well as financial transfers.
BOP is a indicative study showing the flows i.e. inflows or outflows of any country to
another country. If there is more money flowing into a country than there is flowing
out, that country has a positive balance of payments; if, on the other hand, more
money flows out than in, the balance of payments is negative. A country's
international transactions can be grouped into three categories:
(I) Current Account
• Exports
1. Merchandise (tangible goods)
2. Services (invisible trade, eg. legal, consulting, royalties, patents etc.)
3. Factor Income (interest, dividend or any other foreign investment
income)
• Imports
1. Merchandise
2. Services
3. Factor income
• Unilateral Transfers (one way "unrequitted" payments, eg.foreign aid,
grants, gifts etc.)
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(II) Capital Account
1. Foreign Direct Investment (FDI)
2. Portfolio Investment
o Equity Securities
o Debt Securities
3. Other Investment (transactions in currency, bank deposits, trade credits
etc.)
4. Statistical discrepancies
(III) Foreign Reserves
• Official Reserve account, includes gold, foreign exchanges, SDRs,
reserves in IMF
• Current account: records net flow of money into a country resulting from
trade in goods and services and transfer payments made from abroad. The
current
• account itself comprises of 3 accounts : trade account, income account and
transfers account. A trade deficit(surplus) arises when there is a
deficit(surplus) in the Merchandise trade within the current account
• Capital account: records net flow of money from purchases and sales of
assets such as stocks, bonds and land.
Money coming in (+), or leaving (−):
• + Exports
• − Imports
• − Increase of owned assets abroad
• + Increase of foreign-owned assets in the country
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An account may show a surplus or a deficit. For example, a trade surplus implies that
a country's exports are higher than its imports and hence there is a net flow of money
into the country. A trade deficit, on the other hand, implies that the country's imports
exceed its exports and hence there is a net flow of money out of the country.
For a country to have a zero balance of payments, a current account deficit must be
balanced by a capital account surplus. The US have been running a negative current
account for a long while, which is financed through a positive financial account. The
only way to buy more than you sell is to borrow money.
A country will have a negative balance of payments (i.e., there is to be a net flow of
money out of the country) if the net of the current account and the capital account is a
deficit. Similarly, there will be a positive balance of payments (i.e., a net flow of
money into a country) if the net of the current and the capital account results in a
surplus.
WHY ARE FOREIGN DIRECT INVESTMENTS MADE?
Developing countries, emerging economies and countries in transition have come
increasingly to see FDI as a source of economic development and modernisation,
income growth and employment. Countries have liberalised their FDI regimes and
pursued other policies to attract investment. They have addressed the issue of how
best to pursue domestic policies to maximise the benefits of foreign presence in the
domestic economy.
Given the appropriate host-country policies and a basic level of development, a
preponderance of studies shows that FDI triggers technology spillovers, assists
human capital formation, contributes to international trade integration, helps create a
more competitive business environment and enhances enterprise development. All of
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these contribute to higher economic growth, which is the most potent tool for
alleviating poverty in developing countries. Moreover, beyond the strictly economic
benefits, FDI may help improve environmental and social conditions in the host
country by, for example, transferring “cleaner” technologies and leading to more
socially responsible corporate policies. Some countries have a flexible policy to allow
FDI into their country. This FDI flows not only big in money but also bring a lot of
wealth in knowledge. The technology transfer is the most popular form of FDI into
any country. Most empirical studies conclude that FDI contributes to both factor
productivity and income growth in host countries, beyond what domestic investment
normally would trigger. It is more difficult, however, to assess the magnitude of this
impact, not least because large FDI inflows to developing countries often concur with
unusually high growth rates triggered by unrelated factors. Whether, as sometimes
asserted, the positive effects of FDI are mitigated by a partial “crowding out” of
domestic investment is far from clear. Some researchers have found evidence of
crowding out, while others conclude that FDI may actually serve to increase
Domestic investment. Regardless, even where crowding out does take place, the net
effect generally remains beneficial, not least as the replacement tends to result in the
release of scarce domestic funds for other investment purposes.
In the least developed economies, FDI seems to have a somewhat smaller effect on
growth, which has been attributed to the presence of “threshold externalities”.
Apparently, developing countries need to have reached a certain level of development
in education, technology, infrastructure and health before being able to benefit from a
foreign presence in their markets. Imperfect and underdeveloped financial markets
may also prevent a country from reaping the full benefits of FDI. Weak financial
intermediation hits domestic enterprises much harder than it does multinational
enterprises (MNEs). In some cases it may lead to a scarcity of financial resources that
precludes them from seizing the business opportunities arising from the foreign
presence. Foreign investors’ participation in physical infrastructure and in the
financial sectors (subject to adequate regulatory frameworks) can help on these two
grounds.
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As countries develop and approach industrialised- nation status, inward FDI
contributes to their further integration into the global economy by engendering and
boosting foreign trade flows. Apparently, several factors are at play. They include the
development and strengthening of international networks of related enterprises and an
increasing importance of foreign subsidiaries in MNEs’ strategies for distribution,
sales and marketing. In both cases, this leads to an important policy conclusion,
namely that a developing country’s ability to attract FDI is influenced significantly by
the entrant’s subsequent access to engage in importing and exporting activities. This,
in turn, implies that would-be host countries should consider a policy of openness to
international trade as central in their strategies to benefit from FDI, and that, by
restricting imports from developing countries, home countries effectively curtail these
countries’ ability to attract foreign direct investment. Host countries could consider a
strategy of attracting FDI through raising the size of the relevant market by pursuing
policies of regional trade liberalisation and integration.
ECONOMY OF INDIA
India has had robust economic growth since 1991 when the government reversed its
socialist-inspired policy of a large public sector with extensive controls on the private
sector and began to liberalize the economy. Liberalization has proceeded in fits and
starts since then, mainly due to political pressures, but the economy has responded
well by posting strong growth in many sectors. A certain amount of dissatisfaction is
expressed in the face of these changes in the Indian economy- some of which are that
a quarter of the population is still too poor to be able to afford an adequate diet,
electricity shortages still continue in many regions and the manufacturing sector has
slowed down at the expense of soft skills.
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With a GDP of 568 billion (B$) ($3.096 trillion (T$) at PPP) India has the world's
12th largest economy (and the 4th largest when adjusted for PPP). However, the large
population means that per capita income is quite low. In 2003 the World Bank ranked
India 143rd in PPP per capita income and 160th in real terms, among 208 countries
and territories.
About 60% of the population depends directly on agriculture. Industry and services
sectors are growing in importance and account for 25% and 51% of GDP,
respectively, while agriculture contributes about 25.6% of GDP. More than 25% of
the population lives below the poverty line, but a large and growing middle class of
300 million has disposable income for consumer goods.
India embarked on a series of economic reforms in 1991 in reaction to a severe
foreign exchange crisis. Those reforms have included liberalized foreign investment
and exchange regimes, significant reductions in tariffs and other trade barriers, reform
and modernization of the financial sector, and significant adjustments in government
monetary and fiscal policies. These economic reforms form an integral part in the
growth and development of India. These economic reforms are explained below in
detail.
FOREIGN INVESTMENT POLICY OF INDIA
The Government of India introduced many foreign policies to attract foreign direct
investors. The investment policy was made keeping in mind the growth pattern and
the problems associated while attracting capital from outside. The foreign policy on
investment can be traced from the period of independence to present day. Here is how
the different Governments of India at various times, political, economic and social
time frames made the foreign policy on investment to attract maximum foreign
wealth.
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1. “Cautious Welcome Policy” from Independence to the emergence of crisis in
the late 60’s (1948-1966).
2. “Selective and Restrictive Policy” from 1967 till the second oil crises in 1979.
3. “Partial Liberalisation Policy” from 1980 to 1990.
4. “Liberalisation and Open Door Policy” since 1991 onwards, signifying liberal
investment environment.
These were the different phases from which the foreign investment policy had to pass
through. Each of the phases is explained below:
1. “Cautious Welcome Policy”
India lacked a policy of its own on foreign capital before independence because it
derives its faith in total laissez faire from the British Government. Resultantly,
foreign enterprises found it convenient to export products to India and were
justified by local circumstances to setup branches or wholly owned subsidiaries.
Local entrepreneurs, which did not have many prospects for obtaining foreign
collaborations, setup industrial units without foreign collaborators as in case of
cotton textiles. Cement and paper or obtained the services of foreign consultants
as in the case of steel (TISCO).
The advent of Independence brought into focus the various issues involved in the
import of foreign capital and the expertise into the country, and the need for
defining a policy with respect to foreign investment. The new independent
government had specific views on industrialisation and role of foreign capital.
This was reflected in Industrial Policy Resolution of 1948.
The Industrial Policy Resolution of 1948 recognised that participation of foreign
capital and enterprise, particularly as regards of industrial techniques and
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knowledge would be of value for the rapid industrialisation of the country.
However, it was necessary that the conditions under which foreign capital could
participate in the Indian industry should be carefully regulated in the national
interest. As a rule, the major interest in ownership and effective control would be
normally in Indian hands though provision was made for special cases in a
manner calculated to serve the national interest.
It was stated by the Prime Minister Shri Jawaharlal Nehru in April, 1949 that once
foreign investment had been allowed to be made in the country, it would be given
a non-discriminatory treatment. Firms with foreign investment would be treated at
par with Indian firms. There was assurance for free remittance of profits,
dividends, and interest as well as repatriation of capital. In the event of
nationalisation, fair and equitable compensation was to be given to the foreign
investors.
In the mid-1950s when industrialisation got underway foreign capital ventured
into India primarily with technical collaborations. However, the foreign exchange
crisis of 1958 marked a change in foreign collaboration in India in two ways: a)
foreign enterprise began to take equity participation more frequently, b) more
technical collaborations started to accept equity participation in lieu of royalties
and fees. After 1958, Indian entrepreneurs were given provisional licenses
required to secure part or all of the foreign exchange by way of foreign
investment. The government extended the AID Investment Guarantee Program to
cover American private investment in India. It gave a number of tax concessions
to foreign enterprise. The licensing procedure was streamlined to avoid delays in
approvals of foreign collaboration. Double taxation avoidance agreements with
Finland, France, USA, Pakistan, Ceylon (Sri Lanka), Sweden, Norway, Denmark,
Japan and West Germany were signed.
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In 1963-64 the Government of India decided to give ‘letters of intent’ to foreign
companies to proceed with their capital projects, instead of making the foreign
company find a partner and then giving the ‘letter of intent’ to the Indian partner.
It was also decided to make the services of IDBI available for rupee financing
such undertakings.
The Finance Act, 1965 made provision for certain additional tax concessions. The
interests accruing in a Non-Resident Account on money transferred from abroad
through recognised banking channels and deposited in any bank was exempted
from tax. Also the tax exemption limit of 5 years allowed in respect of salaries of
foreign technicians was extended to 7 years. Tax rates on income assessable in
India of non-residents were brought down at par with those applicable to income
of residents. The rate of deduction of tax at source from non-residents income was
also lowered. The Act further provided for the refund of capital gains tax arising
out from the transfer of shares held by non-resident in an Indian company,
provided the sales proceeds were invested in India.
2. “Selective and Restrictive Policy”
Under the new industrial licensing policy, announced in February 1970, the larger
industrial houses and foreign enterprises were permitted to setup industries in the
core and heavy investments sectors expect industries reserved for public sector.
By notification dated July 25th
1970, they established undertakings and expanded
production in industries in others sectors provided they undertook specific export
commitments. However, in order to prevent a serious draft on their reserves, the
remittance facilities in respect of dividends declared by 100% foreign owned
companies were subject to some terms.
In 1972-73, though the Government Policy towards foreign investment continued
to attract foreign investment in India, the policy became highly selective. Foreign
Exchange Regulation Act (FEMA) was amended in 1973, to regulate the entry of
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foreign capital in the form of branches, non-resident Indians investment and
employment of foreigners in India. As per the amended rules all branches of
foreign companies in India and Indian Joint Stock Companies in which non-
resident interest was more than 40% were expected to bring down their non-
resident share holdings to 40% within a period of 2 years.
However, basic and core industries, export oriented industry or industries engaged
in manufacturing activities needing sophisticated technology or tea plantation
were allowed to carry on business with non-resident interest up to 74%. Such
companies were also exempted from taking permission from RBI to carry on
business provided they did not exceed the licensed capacity and undertook no
expansion or diversification of activities. Foreign shipping companies were given
permission to carry on business in India in October 1974.
With a view to encourage investment by non-resident Indians, in October 1975,
the government decided to permit non-residents and persons of Indian origin to
invest in the equity capital of permitted industries up to a maximum of 20% of
new issues of capital of new industries. Such investments were made by
remittances from abroad through approved banking channels or out of funds held
in Non-Resident Account. The investment could be in addition to any foreign
equity investment that could be permitted by the government in the company
concerned.
In October 1976, the scheme under which non-resident Indians were allowed to
start industrial units in India by bringing in imported machinery was liberalised to
permit equity investment upto 74% without any minimum limit in a number of
priority sector industries. The permission was also granted for investment in other
industries provided the investor undertook to export 60% of the output (75% in
the case of small scale industries). The scheme was applicable only to new units
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and to existing industrial undertaking seeking expansion and diversification.
Capital invested under the scheme was eligible for repatriation after the unit had
gone into commercial production subject to adherence to export obligation.
A statement on Industrial Policy was presented by the Government to Parliament
on December 23, 1977. Under this statement, foreign investment and acquisition
of technology necessary for India’s industrial development could be allowed
where they ere in national interest and on the terms determined by the
government. As a rule majority interest in ownership and effective control could
be in Indian hands expect in highly export oriented and sophisticated technology
areas and 100% export oriented areas. Where foreign investments had been
approved, there could be complete freedom of remittances of profits, royalties,
dividends and repatriation of capital subject to the usual regulations. The
government had made it clear that it would strictly enforce the provisions of
FERA, the companies which diluted their non-resident holdings to less than 40%
would be treated at par with Indian companies, expect in cases specifically
notified. Their future expansion would be guided by the same principles as those
applicable to Indian companies.
3. “Partial Liberalisation Policy”
In order to tap resources from oil exporting developing countries, the government
revised the foreign investment policy in October 1980 so that investment
proposals from these countries need not be associated with the transfer of
technology and that investment could be portfolio nature. However, a ban was
imposed by the government on financial and technical collaborations in 22
categories of industries such as cement, paper and consumer goods and several
other industries where indigenous technology within the country.
In the 1982-83, the government liberalised facilities with regard to bank deposits
and investments in equity shares of the corporate sector. These facilities were
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further liberalised in July-August, 1982 to cover preference shares and debentures
issued by Indian companies. The Reserve Bank of India also simplified the
exchange procedure formalities to facilitate such investments. The government
also decided to borrow from international capital markets to the extent that the
availability of the low cost unilateral and bilateral resources fell short of the
requirement of external resources. In line with this policy, Indian enterprises both
public and private companies had been selectively permitted to raise funds
abroad. However, the facilities available for deposits for deposits in non-resident
account and in shares of Indian companies were confined to non-resident
individuals of Indian nationality or origin. Liberalised facilities were extended to
overseas companies, partnership firms, trusts, societies and other corporate bodies
in which atleast 60% of ownership/beneficial interest was vested in non-resident
individuals of Indian origin or nationality.
It was specified that in the case of investment, with repatrability, by non-resident
Indians and overseas corporate bodies can make portfolio investments through
stock exchanges in India in equity/preference shares and convertible/non
convertible debentures without nay limit on the quantum or value. They could
also invest in the new issues of public or private limited companies in any
business activity (expect real estate business) upto 100% of the issued capital
without any obligation to associate resident Indian participation in the equity
capital at any time. Payment of purchases either through stock exchanges or for
direct investment in new issues could be made by the eligible investor either a) by
fresh remittances from abroad or b) out of the funds held in non-resident external
accounts designated in rupees or in foreign currencies and ordinary non-resident
share accounts.
In 1983-84 the government provided the incentives in the form of:
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• Taxation of investment income derived by a non-resident of Indian
nationality or Indian origin from the specified investments and long-term
capital gains arising out of transfer of these assets at a flat rate of 20%
plus surcharge of 121/2
% of such income tax,
• Exemption of long-term capital gains arising from the transfer of any
foreign exchange asset,
• Exemption from wealth tax of the value of foreign exchange assets
acquired and held by non-resident,
• Exemption from gift tax of gifts of foreign exchange assets by non-
residents Indian to their relatives in India,
• Additional interest of 1% on investments by NRIs in the 6-year NSCs
would be paid provided subscription for these certificates were received
in foreign exchange.
In May 1983, relaxations granted to NRIs investment were subjected to a specific
limit. An overall ceiling of:
• 5% of the value of the total paid up equity of the company concerned,
• 5% of the total paid up value of each series of convertible debentures was
fixed on purchases of equity stock exchanges on repatriation and non-
repatriation basis together.
In 1985-86, the government abolished the Estate Duty, which was considered as
major hurdles in the way of inward remittances to India by non-resident of Indian
origin or nationality. The surcharge on income tax was also abolished bringing
down the effective rate of tax on NRI income from 22.5% to 20%.
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During 1986-87, the government permitted NRIs to subscribe to the
Memorandum and Articles of Association of a new company and take up their
share up to the face value of Rs. 10,000 for the purpose of its incorporation. It
also permitted Indian companies with more than 40% non-resident interest to
acquire immovable properties in India. Further, NRIs were allowed to invest:
• Upto 100% of the equity capital in sick industrial units,
• In new issues of Indian shipping companies under the 40% scheme,
• In diagnostic centres in India under 40% or 74% scheme.
The government also decided to remove the quantitative ceiling of Rs. 40 lakhs
for making investment in India by NRIs in private limited companies under the
40% scheme. With a view to augmenting the inflows, the Foreign Currency (NR)
Account Scheme was extended to cover DM and Yen and a differential interest
rate scheme was introduced with effect from August 1, 1988
4. “Liberalisation and Open Door Policy”
As a part of the structural adjustment policies introduced in the Indian economy
by the government of India since July 1991, policies relating to foreign financial
participation in Indian companies and those relating to foreign technology
agreements had also undergone a radical change. Three tiers for approving
proposals for foreign direct investment in the country were introduced:
1. The Reserve Bank’s automatic approval system.
2. Secretariat for Industrial Approvals for considering proposals within the
general.
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3. Foreign Investment Promotion Board (FIPB) specially created to invite,
negotiate and facilitate substantial investment by international companies
that would provide access to high technology and work markets.
In case of investment with benefits of repatriation of capital and income NRIs and
OCBs were permitted to make investment in shares and debentures through stock
exchanges upto 1% of the paid up value of equity/preference and convertible
debentures of the company. No limit either on quantum or value was stipulated
with regard to purchases of non-convertible debentures. With the benefit of
repatriation, investments in new issues of non-convertible debentures were
allowed without any monetary limit. However, in case of new issue of shares and
convertible debentures through prospectus, they could invest upto 40% of the new
capital raised with repatriation benefit. They could also invest in the capital raised
other than through prospectus upto 40% of the new issue of shares and debentures
of any company (Public or Private) subject to a quantitative ceiling of Rs. 40
lakhs. The liberalised facility of direct investment by NRIs was confined only to
capital raised by Indian companies or setting up new industrial projects or
expansion/diversification of existing industrial undertaking. However, with the
abolition of the list of industries which were not open direct investment by non-
resident and with the addition of the hotel industry, the scope for investment by
NRIs had been widened.
NRIs and OCBs had also been permitted to invest 12%, 6 year NSCs and it was
exempted from wealth, income and gift taxes. The government of India permitted
equity share holding of foreign investors to be maintained at a level of 51% or
below. It was the same level of foreign equity, which the foreign majority
companies had been allowed under the FERA even when there was a likelihood
of its reduction as a result of exercise of convertibility clause option.
As per the new policy, fully owned foreign enterprises were allowed to setup
giant power projects without the requirement to balance dividend payments with
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export earnings. FERA companies (those having more than 40% foreign equity)
were treated at par with Indian companies. FERA companies were also given the
facility of 51% equity. Companies could use foreign brands names and
trademarks on goods for sale within the country. Expect the 22 industries in the
consumer goods sector, the earlier stipulation that dividend remittances of
companies receiving approval under the foreign equity upto 51% scheme must be
balanced by export earnings over a period of 7 years was scrapped in respect of
all foreign direct investment including NRIs and OCBs. The foreign private
equity in oil refineries was limited at 26%. Foreign Institutional Investors (FIIs)
were permitted to invest in all the securities traded on primary and secondary
markets. Portfolio investments in primary and secondary markets were subjected
to a ceiling of 24% of issued share capital for the total holdings of all registered
FIIs, in any company. The holding of a single FII in any company was subjected
to a ceiling of 5% of total issued capital. NRIs and OCBs could invest with full
repatriation benefits up to 100% in high priority industries and export oriented
industries and sick units, and power generation. In the context of such revisions,
the earlier 74% scheme has been discontinued.
During 1993-94 the tax rate on short term capital gains were reduced from 75% to
30%. An Electronic Hardware Technology Park (EHTP) scheme was setup to
allow 100% equity participation, duty free import of capital goods and a tax
holiday. The ceiling on foreign equity participation in Indian companies engaged
in mining activity was hiked to 50%. Disinvestment by foreign investors was
permitted on a near automatic basis on stock exchanges in India through a
registered merchant banker or a private stock broker or on a private basis. NRIs
(but not OCBs) were allowed to invest upto 100% on non-repatriation basis in any
partnership/sole proprietorship or in public/private limited companies (expect in
agricultural or plantation activities) without RBI’s approval.
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In 1994-95, the Reserve Bank of India decided to allow NRIs/OCBs and also FIIs,
to invest in all activities expect agriculture and plantation activities on a
repatriation basis. The aggregate allocation of shares/convertible debentures
qualifying for repatriation benefits to such non-residing investors could not
exceed 24% of the new issue. However, FIIs were not eligible to make investment
in unlisted/private companies under this scheme. The funds for such investment
could be received by way of remittance from abroad through normal banking
channels or by debit to NRI/FCNR Account of the non-residing investor. A
general permission was also granted to NRIs/OCBs to purchase the shares on
repatriation basis of Public Sector Enterprise (PSEs) disinvested by Central
Government subject to 1% of the paid up capital of the PSE concerned.
With effect from May 24, 1995 the permission was given to Euro issuing
companies to retain the Euro issue proceeds as foreign currency deposits with the
Bank’s and Public Financial Institutions in India, which could be converted into
Indian rupee only as and when expenditure for the approved end uses were
incurred. With effect from November 25, 1995 companies were permitted to remit
funds into India in anticipation of the use of funds for approved end uses.
Moreover the existing ceiling for the use of issue proceeds for general corporate
restructuring including working capital requirements were raised from 15% to
25% of the GDR issues.
During 1996-97 FIIs were allowed to invest up to 100% of their funds in debt
instruments of Indian companies effective January 15, 1997. With effect from
March 8, 1997, FIIs were allowed to invest in Government of India dated
securities upto 30%. Under the automatic route, the ceiling for lump sum payment
of technical know how fee had been increased from Rs. 1 crore to US $ 2 million
with effect from November 5, 1996. With effect from January 17, 1997, the
government allowed under the Automatic Approval route inclusion in Annexure-
III of the Statement of Industrial Policy 1991 the following:
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a) 3 categories of industries/items relating to mining activities for foreign
equity upto 50%.
b) 13 additional categories of industries/items for foreign equity upto 51%.
c) 9 categories of industries/items for foreign equity upto 74%.
During 1997-98 FDI was allowed in 16 non-banking financial services through
Foreign Investment Promotion Board. Expanding the scope of “automatic route”
for foreign FDI, the Government of India approved 13 additional categories of
industries/items under service sector for foreign equity participation upto 51% of
the equity. There were 3 items relating to mining activity upto 50% foreign equity
participation and 9 categories of industries/activities upto 74% foreign equity
participation.
As a part of the liberalised policy the RBI had decided to permit foreign banks to
operating in India to remit their profits or surplus to their head offices without the
approval of Reserve Bank. The Reserve Bank also allowed branches of foreign
companies operating in India to remit profits to their head offices without the
approval of Reserve Bank. Also the Authorized Dealers were permitted to provide
forward cover to FIIs in respect of their fresh investment in equity in India as well
as to cover the appreciation in the marked value of their existing investments in
India w.e.f. June 12, 1998. The Authorised Dealers were given the option of
extending the over fund-wise or FII-wise according to their operational feasibility.
The same facility was extended to NRIs/OCBs for their portfolio investments
w.e.f. June 16, 1998.
FOREIGN INVESTMENT PROMOTION BOARD (FIPB)
Introduction
The government of India has set up a special Board known as the Foreign Investment
Promotion Board. This specially empowered Board in the office of the Prime
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Minister is the only agency dealing with matters relating to FDI as well as promoting
investment into the country. It is chaired by Secretary Industry (Department of
Industrial Policy & Promotion).
Objective
Its objective is to promote FDI into India by undertaking investment promotion
activities in India and abroad by facilitating investment in the country through
international companies, non-resident Indians and other foreign investors.
Clearance of Proposals
Early clearance of proposals submitted to it through purposeful negotiation and
discussion with potential investors. Reviewing policy and put in place appropriate
institutional arrangements and transparent rules and procedures and guidelines for
investment promotion and approvals.
The FIPB is expected to meet every week to ensure quick disposal of the cases
pending before it. It endeavours to ensure that the Government's decisions on FDI
proposals are communicated to the applicant within six weeks. Foreign Investment
proposals received
by the board's secretariat should be put up to the Board within 15 days of receipt and
the Administrative Ministries must offer their comments either prior to and/or in the
meeting of the FIPB. It would function as a transparent effective and investor friendly
single window providing clearance for investment proposals.
Composition
The Board will comprise the core group of secretaries to Government and would have
the following composition:-
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i) Industry Secretary - Chairman, (Secretary Department of Industrial Policy and
Promotion), Government of India.
ii) Finance Secretary, Government of India.
iii) Commerce Secretary, Government of India.
iv) Secretary (Economic Relations), Ministry of External Affairs, Government of
India. The Board may opt other Secretaries to the Government of India and top
officials of financial institutions, banks and professional experts of Industry and
Commerce, as and when necessary.
Functions
The main functions of the Board will be as follows:
1. To ensure expeditious clearance of the proposals for foreign investment;
2. To review periodically the implementation of the proposals cleared by the
Board;
3. To review, on a continuous basis, the general and sectoral policy regimes
relating to FDI and in consultation with the Administrative Ministries and
other concerned agencies, evolve a set of transparent guidelines for facilitating
foreign investment in various sectors;
4. To undertake investment promotion activities including establishment of
contact with and inviting selected international companies to invest in India in
the appropriate projects;
5. To interact with the Industry Association/Bodies and other concerned
government and non-government agencies on relevant issues in order to
facilitate increased inflow of FDI;
6. To identify sectors into which investment may be sought keeping in view the
national priorities and also the specific regions of the world from which
investment may be invited through special efforts;
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7. To interact with the Foreign Investment Promotion Council (FIPC) being
constituted separately in the Ministry of Industry; and
8. To undertake all other activities for promoting and facilitating foreign direct
investment, as considered necessary from time to time. The Board will submit
its recommendations to the Government for suitable action.
Approval by FIPB
The recommendations of FIPB in respect of the project-proposals each involving a
total investment of Rs.600 crores or less would be considered and approved by the
Industry Minister.
The recommendations in respect of the projects each with a total investment of above
Rs 600 crores would be submitted to the Cabinet Committee on Foreign Investment
(CCFI) for decision. The CCFI would also consider the proposals which may be
referred to it or which have been rejected by the Industry Minister.
The approval letters in all cases will be issued by the Secretariat of FIPB. The FIPB
has accorded approval to the investments of a large number of corporations such as
McDonalds, General Electric, Coca-Cola and Fujitsu in the recent past. It normally
processes applications within 6 weeks.
FOREIGN EXCHANGE REGULATION ACT (FERA)
During the World War II September 1939, there was a shortage of foreign exchange
resources. A system of exchange control was first time introduced through a series of
rules under the Defence of India Act, 1939 on temporary basis. The foreign crisis
persisted for a long time and finally it got enacted in the statue under the title
"Foreign Exchange Regulation Act, 1947." This was meant to last for 10 years.
However, 10 years of economic development did not ease the foreign exchange
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constraint, it only made things worse. Thus, FERA permanently entered the statue
book in 1957.
Hon’ble Finance Minister then Shri Chidambaram’s Budget Speech announced the
setting up of a Reserve Bank of India committee to draft a Foreign Exchange
Management Act (FEMA), following guidelines laid down by the Sodhani
Committee (an RBI Committee) in 1993. Under the Hon’ble Prime Minister then Shri
Atal Bihari Vajpayee Government, the draft FEMA was approved by the Cabinet, and
Hon’ble Finance Minister then Shri Yashwant Sinha introduced a Bill in the Lok
Sabha on August 4, 1998. The mere fact that the number of sections has come down
from 81 sections in the 1973 FEMA Act to 19 in the new FEMA is symptomatic of
liberalisation.
In 1991 Budget speech, Hon’ble Finance Minister then Shri Dr. Manmohan Singh
remarked that India had accepted the Article VIII obligations of the IMF. But this did
not mean that the changes would be implemented overnight. There were four
different reasons why India was still short of complete current account convertibility
of 1994, Hon’ble Finance Minister then Shri Dr. .Manmohan Singh announced that
the rupee was going to be converted on the current account.
In 1997, the Reserve Bank of India appointed a Committee known as Tara pore
Committee to lay down road map for capital account convertibility. The Tara pore
committee recommended a phased transition to capital account convertibility in three
phases – 1997-98, 1998-99 and 1999-2000. This time frame was of course,
implausible. Before complete capital account convertibility, certain macroeconomic
conditions have been stated as prerequisites as per Article IV of IMF. However, the
South East Asian crisis compelled Government of India to put off the idea of capital
account convertibility.
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The FERA, which was known as the law to "Control", has been replaced by FEMA
the law to "Manage" foreign exchange transactions against 81 sections under FERA.
Out of 49 sections, 9 sections are substantive in nature, the rest being procedural and
administrative in nature. FERA is known as negative law whereas FEMA promises to
be positive law.
FOREIGN EXCHANGE MANAGEMENT ACT (FEMA)
The Foreign Exchange Management Act, 1999 (FEMA), as mentioned earlier, has
been in force with effect from 1.6.2000, thus replacing the old FERA, 1973. There is
a general misunderstanding among the NRIs that all restrictions and controls relating
to foreign exchange transactions have been abolished and that foreign exchange
dealings would be allowed to be freely made after the enactment of FEMA. This is
not so. It is, of course, true that there is a great change in the outlook of FEMA in
comparison with FERA but reasonable restrictions with regard to foreign exchange
transactions with a view to facilitate them in a regulated manner find a place in
FEMA, 1999 and connected rules and regulations. One of the special aspects of
FEMA is that various notifications and provisions of the RBI Exchange Control
Manual have been reframed in the form of separate regulations for different types of
exchange transactions with a view to making them available easily to NRIs and other
persons and also to provide
transparency to the RBI rules and regulations. For example, the various types of
accounts like NRI Account, FCNR account; NRO Account, etc. were regulated
through Exchange Control Manual and Notifications in this regard. Now, the FEMA
(Deposit) Regulations deal with the maintenance and operation of such accounts in a
clear cut manner. Similar is the case with reference to other various aspects of foreign
exchange. FEMA is a civil law, whereas the FERA was a criminal law.
Under the FEMA no prosecution would be launched for contravention of operating
provisions, likewise, arrest and imprisonment would not be resorted to except in the
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solitary case where the person, alleged to have contravened the provisions of the
FEMA, defiantly resolves not to pay the penalty imposed under Section 13 of the
FEMA. In the same manner unrestrained enormous powers of Directorate of
Enforcement have been slashed down to a considerable extent. Even the word
"offence" is conspicuous by its absence in the substantive provisions of FEMA. There
are 49 sections in all in FEMA. Of these, only seven sections, namely, Sections 3 to 9
deal with certain acts to be done or not to be done in connection with transactions
involving foreign exchange, foreign security, etc. There are various sections from 16
to 35 relating only to adjudication and appeal. Further, one of the most important and
distinguishing features of FEMA is that there is a provision for compounding of
penalty as contained in Section 15 of FEMA. This could not have been imagined
earlier under FERA. Thus, NRIs and residents will have much easier time under
FEMA.
NRIs under Income Tax Act and persons resident outside India come under FEMA.
The expression Non-resident Indian or an NRI is used both under the Income Tax Act
and FEMA. However, there is a great difference between the meanings of both the
expressions. Sometimes, a person may be NRI under the I.T. Act but he may not NRI
under the FEMA or vice versa. This is because NRI, i.e., an Indian Resident outside
India under FEMA is treated differently now than he used to be under FERA.
COMPARISON OF INDIA OVER OTHER ASIAN
COUNTRIES
The Asian countries are attracting a great amount of FDI ever since the marketers and
investors felt that the European Countries are saturated. These Asian countries not
only offer expertise but also cheap labour. If we have a look on the Asian countries
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which attract maximum FDI we can count countries like India, China, Japan, Vietnam
and to a extent Singapore and Indonesia. But, if we have a closer look, we can find
out that China and India attract the most FDI. These are the two most important and
sought after countries as regards FDI by outside agencies. Let’s have a look why
China is attracting FDI.
CHINA’S FOREIGN DIRECT INVESTMENT
Foreign direct investment (FDI) in China has undergone a rapid growth since 1992.
In both 1992 and 1993, actual investment more than doubled. In the peak year of
1993, contractual investment increased nine fold compared to 1991. Beginning in
1993, China emerged as the largest recipient of FDI among developing countries.
Though this rising trend slowed down after 1995, the momentum resumed in 2000.
China’s joining the WTO is providing a strong push to a new wave of foreign direct
investment to China.
Several factors can explain this important change in China’s economic landscape.
First, Deng Xiaoping’s South Tour in the summer of 1992 established the direction of
“socialist market economy” for China’s economic reform, which was officially
confirmed at the14th National Congress of the Chinese Communist Party of the same
year. This helped offer foreign investors a better-reformed investment environment.
Second, rapid expansion of foreign direct investment in 1992 took place at a quite
low level. In 1991,
actual investment was only US$ 4.366 billion. Third, the significant acceleration of
economic growth since 1992, combined with the political stability re-established,
strengthened foreign investor’s confidence of China’s investment environment and
led them make a strategic change in investment decision making. Fourth, the foreign
investment regime in China was significantly reformed. The early liberalization,
which applied to the four special economic zones, was further extended to broad
areas, especially, the developed Yangtze River Delta Area, and restrictions on FDI
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were relaxed in some important areas (domestic sale, equity control, market access,
etc.). There are two important aims underlying the change of the policy stance of the
Chinese government. One is to “exchange technology with market”, and the other is
to push the transformation of the inefficient big state- run industrial enterprises
through the means of joint ventures.
From the external perspective, broadly speaking, the recent rise of FDI in China is
part of the international capital movement in the developing world, which results
from the realignment in the location of production facilities and investment of
multinational corporations (MNCs). Obviously, some of the factors, which lead to the
dramatic increase of foreign direct investment in China, are only temporary; thus, the
gains are static in nature. It is of interest to know the basic forces and mechanisms,
which determine the long-run trends of foreign direct investment in China.
Foreign direct investment in China began in 1979. Until 1991, the amount of both
contractual and actual investment was small. Most of FDI came from small and
medium-sized enterprises in Hong Kong and were highly concentrated in Guangdong
province. Production of foreign-invested enterprises was overwhelmingly export-
oriented and had little link with the domestic economy .The “take-off” of FDI took
place in 1992. In the next 9 years, annual contractual investment increased from US$
11.977 billion in 1991 to US$ 62.380 billion in 2000, and annual actual investment
rose from US$ 4.366 billion in 1991 to US$ 40.715 billion in 2000. By 2000, the total
amount of cumulative contractual and actual investment reached US$ 676.097 billion
and US$ 348.349 billion respectively.
The effects of foreign direct investment became prominent in some important aspects.
The share in total exports contributed by foreign-invested enterprises increased from
16.75 percent in 1991 to 47.93 percent in 2000. The share of foreign- invested
enterprises in the total industrial output values increased from 5.29 percent in 1991 to
22.51 percent in 2000. One consequence of rapid growth of FDI since 1992 has
41

been that it has become the most important source of foreign capital inflow into
China. The share of actual FDI in total foreign capital inflows increased from less
than one half in 1991 to 80 percent in 2000.
The main factors which influence FDI into China are the technical expertise as well
as hard working population. China is considered as the hub of FDI in the world.
China being the second most populated country in the world enjoys a lot of benefits
like rich technology, easy approachable markets, huge opportunities for expansion
and the government policies which attract FDI a lot. As shown above the country has
a very open policy for FDI. It has that every ingredient which a corporate requires
from his investments. Hence we can see a lot of countries mainly the European
countries making a beeline of investments in China.
But India doesn’t remain behind in catching up the competition. There are many
articles comparing India and China as to which country is the best country for
investing.
COMPARISON BETWEEN INDIA AND CHINA IN FDI
It is practically an established fact that China’s track record in attracting foreign
direct investment (FDI) is far superior to that of India. India has been considered as
an “underachiever” in securing FDI. India fell eight spots to the 15th position in
2002 with 20 percent decline in attracting FDI, according to the FDI
Confidence Index, by A T Kearney, one of the world’s biggest business
strategy consultants. Communist China for the first time has overtaken the United
States to be the best destination for overseas investments. China scored 1.99 in a scale
from zero to three, while the United States ranked second with 1.89 and India scored
1.05 as per the results. The United States, Britain, Germany and France rounded out
the top five, with Brazil falling to 13th place in 2002 from third in the previous year.
42

China has also remained the most preferred destination for FDI among the
developing nations in the Asia and the Pacific. In terms of FDI performance index2 of
the United Nations Conference on Trade and Development (UNCTAD), China
ranked 47 in the world way above India, which ranked at 119 (UNCTAD, 2002).
In volume, FDI in China exceeds that in India many-fold. India lagged much
behind China in 2001, grabbing only 7.25% of the FDI dollars that its neighbour
received. With the annual FDI inflows of over $46 billions of China compared with
a trivial amount of $3.4 billion into India in 2001, it is virtually a settled fact that
India trails significantly behind China in attracting FDI in spite of its undying
competitive efforts in the market for FDI inflows. This ratio is an indicator of the
attractiveness of an economy to draw FDI. A country with a ratio of FDI to GDP that
is greater than unity is reckoned to have received more FDI than that implied by the
size of its economy. It indicates that the country may have a comparative advantage
in production or better growth prospects reflecting larger market size for the foreign
firm.
On the other hand, a country that has the ratio value of less than one may be more
protectionist and technologically backward, or may possess a political and social
regime that is not conducive for investments. The yawning gap between China and
India in attracting the non-debt creating FDI flows has indeed been a matter of
significant policy concern for India, because in the process India is supposed to be
losing a lot of markets and a lot of capital investment to China.
India has certain strength which China will require another revolution of the short to
attain. China will not be able to sustain economic growth if it insists on delaying
political reform. China is using authoritarianism as its strength where as India’s
strength lies with democracy. Although official FDI figures point to $47 billion
investment to China in 2001 with India only $3 billion, but the race could be actually
43

closer. According to the international Finance Corporation the whole issue of FDI in
China could be overestimated due to “round-tripping” where mainland funds leaving
China return as foreign investment to gain tax and other incentives. The World Bank
thinks that that as much as 50% of China’s FDI could actually be domestic cash
cutting its 2001 total to about 2% of the GDP. India according to the IFC,
underestimates FDI because of incomplete data and may have received up to $8
billion; 1.7 per cent of the GDP in 2001. (Far Eastern Economic Review, December
2002). Venture capitalism is leading the way investing serious money in India against
much hyped China.
So can India catch up with China? In terms of purchasing power parity, India is the
fourth largest economy, after the US, China and Japan, in that order; it recently
overtook Germany. By 2010, India is projected to overtake Japan. Many economic
observers believe that in the next 20 years India's real GDP can potentially grow at 10
per cent if it pursues reforms vigorously. This should reduce the percentage of the
population below the poverty line to less than 15 per cent. If India concentrates on
producing a significantly accelerated growth in agriculture, information technology,
and exports in these 20 years, it may get closer to China. Many Indian companies are
setting up shops in China to take advantage of the growth.
China and India have pursued radically different development strategies. India is not
outperforming China overall, but it is doing better in certain key areas. That success
may enable it to catch up with and perhaps even overtake China. Should that prove to
be the case, it will not only demonstrate the importance of home-grown
entrepreneurship to long-term economic development; but it will show the limits of
the foreign direct investment (FDI) dependent approach China is pursuing.
China’s exceptional growth is partly explained by its markets –based reforms that
started in 1978, well before India’s similar reforms began in 1991. These reforms
have enabled China to integrate with the global economy at phenomenal peace.
44

Today it is the largest recipient of foreign direct investment among developing
countries, with the annual investment rising from almost zero in 1978 to about $ 52
billion in 2002. (Nearly 5% of GDP). Foreign direct investment in India has also
increased significantly, though at much lower levels, growing from $129 million in
1991 to $ 4 billion in 2002 (Less than 1% of GDP). On the way to the new economy,
China is gradually becoming the world manufacturing centre of IT equipment and
products, while India has gained the leading position in software technology and has
become the second largest software country in the world. Since mid-1990s, trading
activities between the two countries greatly increased, economic cooperation, such as
labour, technical cooperation and inter- investment had been widely developed. Both
enjoy healthy rates of economic growth. But there are significant differences in their
FDI performance. FDI flows to China grew from $3.5 billion in 1990 to $52.7 billion
in 2002; if round-tripping is taken into account, China’s FDI inflows could fall to,
say, $40 billion Those to India rose from $ 0.4 billion to $5.5 billion during the same
time period. Even with these adjustments, China attracted seven times more FDI than
India in 2002, 3.2% of its GDP compared with 1.1% for India. In UNCTAD’s FDI
Performance Index, China ranked 54th and India 122nd in 1999-2001. FDI has also
contributed to the rapid growth of China’s merchandise exports, at an annual rate of
155 between 1989 and 2001. In 1989 foreign affiliates accounted for less than 9% of
total Chinese exports; by 2002 they provided half. In some high-tech industries
in 2002 the share of foreign affiliates in total exports was as high as 91% in
electronics circuits and 96% in mobile phones (WIPR-2002) About two-thirds of FDI
flows to China in 2000-2001 went to manufacturing. In India, by contrast, FDI has
been much less important in driving India’s export growth, except in information
technology. FDI in Indian manufacturing has been and remains domestic market
seeking. FDI accounted for only 3% of India’s exports in the early 1990s (WIPR,
2002).
45

Even today, FDI is estimated to account for less than 10% of India’s manufacturing
exports. For China the lion’s share of FDI inflows in 2000-2001 went to a
broad range of manufacturing industries. For India most went to services,
electronics and electrical equipment and engineering and computer industries. The
differential performance of India and China in attracting the FDI inflows has been the
subject of attention at the international level (UNCTAD, 2003). Further, the
difference in FDI inflows to India and China can be attributed partly to definitional
and conceptual issues. For instance, a part of the difference in FDI inflow to India and
China can be traced to data reporting. A sizable portion of the FDI in China is
investment made by the Chinese from foreign location-the so called “round tripping”-
and this takes place to a large extent due to special treatment extended by the Chinese
authorities towards foreign investors’ vis-à-vis domestic investors. The round tripping
is much smaller in India and takes place mainly through Mauritius for tax purposes.
Estimates suggest that as 30 percent of the reported FDI in china may in fact be a
result of round- tripping.
Another major factor could be the earlier initiation of reform measures in China
(1978) as compared to India (1991). Moreover, China’s manufacturing sector
productivity is 1.6 times that of India and, in some sectors, as much as five ties (Mc
Kinsey, 2001). Flexible labour laws, a better labour climate and entry and exit
procedures for business, business-oriented and more FDI–friendly policies also make
China an attractive destination. Investors underscore the predictability and stability of
the tax system as an important factor in determining investment decision. Higher
Import duties on raw materials in India result in higher prices of inputs, as most
domestic players resort to import parity pricing. China has a flat 17 per cent VAT
rate, while India’s indirect taxes range from 25 per cent to 30 per cent of the retail
price for most manufactured product. The emergence of China as a member of world
46

Trade Organization (WTO) in 2001 is a stabilizing anchor and has led to substantial
liberalization in the services sector (RBI 2004).It is also important to note that India
and China focused on different strategies for industrial development. India
encouraged FDI only in higher technology activities, whereas China favoured
export- oriented FDI concentrated in manufacturing sector.
China’s strategy is based on the premise that an increasing proportion of international
trade is inter-firm trade between multinational, and in such an environment there is no
alternative to attracting FDI for export. China’s FDI –driven merchandise exports
grew at an annual rate of 15 percent between 1969 and 2001. In 1989, foreign
affiliates accounted for less than nine percent of total Chinese exports; by 2002 these
accounted for half of the exports and in high-tech industries the proportion was much
higher (World Investment Report, 2003). In contrast, in India, given its product
reservation policy for Small Scale Industries (SSIs), FDI is not permitted in SSI
reserved products such as garments and toys, which has adverse implications for
export growth. In India, exports by FDI companies grew at an average of around 9%
during 1990-91 to 2001-02. A major factor in the growth of Chinese exports was the
relocation of labour intensive activities by TNCs to China. However, in India this has
happened mainly in the services sector. Almost all major U.S and European
information technology firms have presence in India now. Foreign companies
dominate India’s call centre industry, with a 60% share of the annual US$ 1.5 billion
turnover.
Despite large FDI flows, restrictions on the organizational forms of FDI entry are still
prevalent in China. For instance, in 31 industries the establishment of wholly foreign
– owned enterprises is not allowed and the Chinese partners must hold majority share
holdings or a dominant position in another 32 sectors (OECD, 2002). A view has
been expressed that China’s large absorption of FDI is not necessarily a sigh of the
strength of its economy; instead, it may be a sigh of some, rather substantial. It is
argued that FDI plays a major role in the Chinese economy due to systematic and
47

pervasive discrimination against efficient and entrepreneurial domestic firms.
Furthermore, unlike India, a vibrant private sector is absent in China and most of
the foreign investors must perform tie up with only state owned behemoths for joint
ventures.
Conclusion
Thus we can see that both the countries function differently but attract the most
foreign investment. But, inspite of all the problems associated with India, it can still
stand on its own feet and show the world that they are better than the Chinese.
WHY PEOPLE INVEST IN INDIA?
India and the Indians have undergone a paradigm shift. There have been fundamental
and irreversible changes in the economy, government policies, outlook of business
and industry, and in the mindset of the Indians in general. The following factors have
shown why people wish to invest in India:
1. From a shortage economy of food and foreign exchange, India has now
become a surplus one.
2. From an agro based economy it has emerged as a service oriented one.
From the low-growth of the past, the economy has become a high-growth one
in the long-term.
3. After having been an aid recipient, India is now joining the aid givers club.
4. Although India was late and slow in modernization of industry in general in
the past, it is now a front-runner in the emerging Knowledge based New
Economy.
48

5. The Government is continuing its reform and liberalization not out of
compulsion but out of conviction.
6. Indian companies are no longer afraid of Multinational Companies. They have
become globally competitive and some of them have started becoming MNC’s
themselves.
7. Fatalism and contentment of the Indian mindset have given way to optimism
and ambition.
8. Introvert and defensive approach have been replaced by outward-looking and
confident attitude.
9. In place of denial and sacrifice, the Indian value system has started
recognizing seeking of satisfaction and happiness
10. The Indian culture, which looked down upon wealth as a sin and believed in
simple living and high thinking, has started recognizing prosperity and
success as acceptable and necessary goals.
11. Graduates no longer queue up for safe government jobs. They prefer and
enjoy the challenges and risks of becoming entrepreneurs and global players.
Goldman Sachs Report of 1 October, 2003 "Dreaming with BRICs: The path to
2050" says the following about the future of Indian economy
1. India's GDP will reach $ 1 trillion by 2011, $ 2 trillion by 2020, $ 3 trillion by
2025, $ 6 trillion by 2032, $ 10 trillion by 2038, and $ 27 trillion by 2050,
becoming the third largest economy after USA and China.
2. In terms of GDP, India will overtake Italy by the year 2016, France by 2019,
UK by 2022, Germany by 2023, and Japan by 2032. Chinese GDP could
overtake Germany by 2007, Japan by 2016, and the US by 2041.
3. Among the BRIC group India alone has the potential to show the highest
growth (over 5 percent) over the next 50 years. The Chinese growth rate is
likely to reduce to 5% by 2020, 4% by 2029, and 3% by 2046.
49

The fundamentals of the Indian economy have become strong and sustainable. The
macro-economic indicators are at present the best in the history of independent India
with high growth, foreign exchange reserves, and foreign investment and robust
increase in exports and low inflation and interest rates. India is the second fastest
growing economy of the world at present. The GDP growth in 2003-04 is estimated
to be around 7%. The growth rate in the second quarter July-Sept.2003 reached 8.4%.
India has recorded one of the highest growth rates in the 1990s. The target of the 10th
Five Year Plan (2002-07) is 8%. While the agricultural and industrial sectors have
continued to grow, the services sector has grown at a significantly higher pace, and is
currently contributing to nearly half of the total GDP. India's services sector growth
of 7.9% over the period 1990-2001 is the second highest in the world.
A unique feature of the transition of the Indian economy has been high growth with
stability. The Indian economy has proved its strength and resilience when there have
been crises in other parts of the world including in Asia in recent years. The foreign
exchange reserves have reached a record level of US$ 100 billion as on 22nd
December 2003. India is the sixth largest foreign exchange holder in the world. This
is remarkable considering the fact that the Forex reserves went under US$ one billion
in 1991 before the economic reforms started. This comfortable situation has
facilitated further relaxation of foreign exchange restrictions and a gradual move
towards greater capital account convertibility. Given the large foreign exchange
reserves, the Government has made premature repayment of US$ 3 billion of 'high-
cost' loans to World Bank and Asian Development Bank and is considering further
premature payment of other loans.
The Government has decided to (i) discontinue receiving aid from other countries
except the following five: Japan, UK, Germany, USA, EU, and the Russian
Federation and (ii) to make pre-payment of all bilateral debt owed to all the countries
except the five mentioned above. Since July this year, India has become a net creditor
to IMF, after having been a borrower in the past. The Government has written off
50

debts of 30 million US dollars due from seven heavily indebted countries as part of
the "India Development Initiative" announced in this year's budget speech.
The external debt to GDP ratio has improved significantly from 38.7% in 1992 to
20% in 2003. This is one of the lowest among developing economies. External debt in
September, 2003 was 112.5 billion US dollars. Of this long-term NRI deposits is $ 27
billion, commercial borrowings $ 24 billion, multilateral debt $ 31 billion, and
bilateral debt $ 18 billion.
Some more facts:
1. Foreign direct investments in the period April - March, 2004 - 05 stood at
US$ 4.70 billion.
2. Foreign Direct Investment inflows more than doubled from US$ 434 million
in April-May 2004 to US$ 922 million in April-May 2005. However, there
was a net outflow of US$ 427 million of portfolio investments, which reduced
the total foreign investments in April-May 2005 to US$ 495 million as against
the inflows of US$ 993 million in April-May 2004. The non-resident deposits
with the scheduled commercial banks went up by US$ 88 million in April
2005 as against the addition of US$ 79 million in April 2004.
3. On the inward FDI front, Mauritius still tops the list, followed by the US and
the Netherlands. An encouraging note, during the last fiscal, was that the FDI
flows from Germany and Japan rose sharply. FDI flows were directed mainly
at the manufacturing sector, which received $924m, followed by computer
services at $372m and business services ($363m). Foreign portfolio flows at
$8.8bn were also buoyant during '04-05.
4. Sector-wise break-up of FDI is as follows: fuels -28.1%, telecom-16.7%,
transportation-8.4%, electrical equipments-6.7%, services-6.7% and
metallurgical industry-5.3%
51

5. Major FDI destinations are Maharashtra-17.4%, Delhi-12%, Tamil Nadu-
8.6%, Karnataka-8.2%, Gujarat-6.5%, and Andhra Pradesh- 4.6%.
6. MNCs, which have invested in India include GE, Dupont, Eli Lily, Monsanto,
Caterpillar, GM, Hewlett Packard, Motorola, Bell Labs, Daimler Chrysler,
Intel, Texas Instruments, Cummins, Microsoft, IBM, Toyota, Mitsubishi,
Samsung, LG, Novartis, Bayer, Nestle, Coca Cola and McDonalds.
7. FII investment during the period 2004 - 05 stood at US$ 9.4 billion.
8. Foreign institutional investors (FII) have pumped in $1.9 billion in July, the
highest ever in any calendar year. The total net FII investment in CY05 is now
more than $6.7 billion.
9. The current calendar saw a rise in the number of FIIs registered with SEBI.
According to SEBI, whopping 145 new foreign institutional investors (FII)
logged in to the country in CY05. The total number of registered FIIs as on
August 2, 2005 was 739, much higher than 637 as on December 31, 2004.
10. Many Japanese and European funds have also started eyeing India with an aim
to cash in on the rising equity markets. Registrations from non-traditional
countries like Denmark, Italy, Belgium, Canada, Sweden and Ireland went up
significantly in the fiscal 2004-05, according to the Securities and Exchange
Board of India (SEBI).
11. CALPERS (California Public Employees Retirement System), the world's
biggest pension fund with a base of US$ 165 billion has recently decided to
invest US$ 100 million in India thus adding India to their list of countries for
investment.
12. US$ 8.5 billion of FII funds in calendar year 2004 went into equities. The
cumulative FII inflow in equities in calendar 2005 (till 8 September 2005) has
already reached US$ 7.93 billion as compared to the whole of calendar year
2004, where the inflow aggregated US$ 8.5 billion.
52

13. FIIs have 50 percent stake in one third of the 30 companies which make up
the BSE-30 Index and hold about 10 percent of the stakes in public sector
undertakings.
HOW TO INVEST INTO INDIA?
Foreign direct investments in India are approved through two routes:
I. Automatic approval by RBI:
The Reserve Bank of India accords automatic approval within a period of two
weeks (provided certain parameters are met) to all proposals involving:
1) Foreign equity up to 50% in 3 categories relating to mining activities (List 2).
2) Foreign equity up to 51% in 48 specified industries (List 3).
3) Foreign equity up to 74% in 9 categories (List 4).
4) Where List 4 includes items also listed in List 3, 74% participation shall
apply.
5) 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.
II. The FIPB Route
53

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.
A foreign company planning to set up business operations in India has the following
options:
AS AN INCORPORATED ENTITY
By incorporating a company under the Companies Act, 1956 through
i. Joint Ventures; or
ii. Wholly Owned Subsidiaries
Foreign equity in such Indian companies can be up to 100% depending on the
requirements of the investor, subject to any equity caps prescribed in respect of the
area of activities under the Foreign Direct Investment (FDI) policy.
AS AN UNINCORPORATED ENTITY
As a foreign Company through:
i. Liaison Office/Representative Office
ii. Project Office
iii. Branch Office
54

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