UNIT 2 FOREIGN INVESTMENT

2.0 Objectives
2.1 Introduction
2.2 Capital Transfer and Economic Growth
2.3. Functions of Foreign Capital
2. 4 Sources of Foreign Capital
2.4.1. Foreign Aid
2.4.2. External Commercial Borrowings
2.4.3. Foreign Investment
2.5 Recent Trends in Foreign Investment
2.6 Multinational Corporations
2.6.1. Significance of Multinational Corporations
2.6.2. Regulation of Multinational Corporations
2.7. Government Policy towards Foreign Capital
2.7.1. New Economic Policy and 1991-2022 Policy Changes
2.7.2. 2018 Reforms Push
2.7.3. Suggestions
2.8. Foreign Institutional Investors
2.9. India’s Overseas Investments
2.10. Start-Up India
2.11. Let Us Sum Up
Key Words
Terminal Questions
Select References

2.0 OBJECTIVES
After you have studied well this unit, you will be able to:
1. Elaborate the concept of foreign capital.
2. Discuss the role and significance of foreign capital in the development process of an economy
3. Identify the different types and sources of foreign capital.
4. Differentiate between direct investment and portfolio investment.
5. Analyse the process in which MNCs operate and make their contribution
6. Examine their positive and negative role in growth process.
7. Discuss the need to regulate the operations of MNCs

1
8. Describe the contribution made by foreign institutional investors in the growth process.
9. Analyse the dimensions of Start - Ups programme in India

2.1. INTRODUCTION
As stated earlier in unit 1 flows of goods, invisibles and capital regularly and continuously recur
in an economy and make their contribution to the growth process. In that unit we have examined
different dimensions of these flows. We proceed further and examine the nature and significance
of capital flows in the present unit.
In this unit, you will learn about the capital transfer and economic growth, Sources of foreign
capital, multinational corporations and government policy towards foreign capital. You will be
further familiarized with the foreign institutional investors, India’s overseas investment and start
up India.
2. 2. CAPITAL TRANSFER AND ECONOMIC GROWTH
There are four sorts of forex inflows. The most stable, desirable sort is foreign direct investment
(FDI). Foreign-owned factories and power stations cannot exit in a panic.
The second most stable inflow is into equities. If foreign investors try to exit en masse in a
panic, stock prices and the exchange rate plummet. Equity investors may exit at a steep loss. This
was demonstrated in the Asian Financial Crisis and Great Recession.
The third most stable—or second most unstable— inflow is into medium or long-term rupee
bonds. Here too, any mass exit will depress the price and exchange rate too. But bonds are far
less volatile than stocks, and so carry a much lower exit penalty.
The fourth, worst sort of inflow is dollar- denominated debt, which on maturity is repaid in
full without any exit penalty. Long-term dollar debt takes time to mature, and is not so hot. But
short-term dollar debt matures very quickly and is the hottest-of- hotflows. Rupee-denominated
short-term debt is not quite so bad, since it carries some currency risks (which are, however,
limited because of the short maturity).
These facts should guide the strategy of the government and of the RBI. Priority should be
given to raising productivity and, thus, reducing the current account deficit. As for inflows, FDI
is the best. Inflow into equities is also desirable. Dollar-denominated debt should not be
encouraged. Foreign investment in short-term debt, whether in rupees or dollars, must be
strongly discouraged. Hot money must not be allowed to make exports uncompetitive.
2.3 FUNCTIONS OF FOREIGN CAPITAL
Foreign capital can perform three gap-filling functions.

1. Savings Gap: The key to the development problem lies in raising the rate of capital formation.
Such a raise envisages a much higher level of investment than is warranted by the present level
of savings in the EEs. The scope for a sharp rise in domestic savings is limited by the prevailing
low level of income, slow rates of growth and rising consumption needs in these economies. The
gap between investment requirements and domestic savings can be filled in by foreign capital.

2
A little simple algebra will show why.
In national income accounting an excess of investment over domestic saving is equivalent to a
surplus of imports over exports. The national income equation can be written from the
expenditure side as
Income = Consumption + Investment + Exports - Imports
Since saving is equal to income minus consumption, we
S = I + X-M
Or I-S=M-X
A surplus of imports over exports financed by foreign borrowings allows a country to spend more than
it produces or to invest more than it serves

The availability of foreign capital increases the availability of total resources in the economy.
The increase in total resources helps an EE primarily in two ways:
(i) It influences investment decisions. It makes possible construction of many projects which
would not have been possible otherwise. Certain programmes of development can give the
optimum results if all the components of the programme are undertaken simultaneously in
a phased manner. The availability of foreign capital makes this type of investment
possible.
(ii) Establishment of bigger projects and projects with a high investment component open up
new opportunities of investment and thus encourage domestic entrepreneurs and savers to
supply their services and savings. The addition to the total volume of resources generated
thereby exceeds the addition made by foreign resources.

2. Trade Gap or Foreign Exchange Gap

An EE is faced with two structural constraints: (i) a minimum requirement of inputs to sustain a
given rate of growth of GNP, and (ii) an actual or potential ceiling on export earnings which are
insufficient to finance the required imports.
In either of the above two situations, the availability of foreign exchange can save an economy
from the position of an impasse in which it may find otherwise. It may provide place at her
disposal high quality factors such as improved machinery, technical know-how and qualified
foreign technicians which may have a beneficial effect on her development by, what Harrod
called, "fertilising the productivity of common labour".

3. Technological and Management Gap

The EEs do not have access to advanced technology. But they have the "advantages of
latecomers". They have not to invent the wheel themselves. Instead they can borrow/receive
technology from the developed world and thus improve their resource use and efficiency.
Analogous to technology gap is a gap in management, entrepreneurship and skill. Foreign
capital can supply a "package" of needed resources that can be transferred to their local
counterparts by means of training programmes and the process of learning by doing.
To sum up, foreign capital touches three sensitive areas, crucial in the development strategy of
an EE. However, there is no definite answer in this to the proposition that foreign capital is a

3
must for growth. "The West has poured $2 trillion into Africa in the past fifty years. Yet, the
proportion of Africans living in poverty has risen from 10 per cent in 1970 to 50 percent now.

Check Your Progress 1

1. What is Savings gap
2. What is Foreign exchange gap
3. What is Technology gap
………………………………………………………………………………………………….
………………………………………………………………………………………………….
………………………………………………………………………………………………….

2. 4 SOURCES OF FOREIGN CAPITAL

We have been getting aid from various multilateral and bilateral external agencies, as also
various individual countries. About 60 per cent of the total aid received has been in the form of
multilateral aid. About 90 per cent of the total multilateral assistance has come from the World
Bank. Bilateral aid has accounted for 40 per cent of the total external assistance; during the past
five years, taken together, Japan has led the group of India's bilateral donors having accounted
for 22.5 per cent of bilateral aid utilised by India.

2.4.1 Foreign Aid

Countries and multilateral aid agencies are increasingly looking to channel their funding into
impact —investing projects that generate some commercial returns with social benefit—by the
private sector. The emergent impact economy, centred on input investing, recognised the
limitations of traditional government and NGO approaches to development challenges in health-
care, water and sanitation, agriculture or infrastructure development.
The concept was introduced by the Rockfeller Foundation around 2007. Presently, it is
finding takers even among mainstream investors like J. P. Morgan, City Bank and Deutsche
Bank.

Impact of Aid
India's experience with FA has been a mixed one. While on the one hand, FA has helped India
raise its productive capacity in all the sectors of the economy, it has also inflicted heavy costs,
both direct and indirect.
Nevertheless, compared with many other EEs, India has been relatively successful in avoiding
the problems associated with drawing from a multiplicity of aid donors by avoiding the use of a
number of domestic agencies for that purpose.
(a) All aid is negotiated through a single department, the Department of Economic Affairs,
which keeps account of the recurrent cost and foreign exchange implication of all the
country's aid transactions.
(b) Government's control of foreign exchange and financial institutions ensures that the aid
pattern does not distort the structure of national plan expenditure.

4
2. 4.2 External Commercial Borrowings (ECBs)
During the mid-1980s concessional aid to India from varied sources almost reached a plateau,
and indeed was on a reverse track. When the foreign exchange shortage began to work as a
constraint on India's developmental efforts, India was forced to borrow from private foreign
sources, i.e., from the international credit market. Such loans are known as 'external commercial
borrowings' (ECBs).
ECBs are defined to include loans from commercial banks and other financial institutions,
suppliers' credits, bonds, FRN and loans from semi- governmental export agencies, IFC (W),
DEG Germany, CDC U.K., and Nordic Investment Bank. The major source of ECB, presently, is
'Eurodollar' or 'Eurocurrency' market. The market for dollar (or any other currency) denominated
loans located anywhere can be termed as Eurodollar (Eurocurrency) market, and would not be
subject to US (the country's) domestic banking regulations like reserve requirements on the
liabilities, interest rate restrictions and exchange control restrictions.
More than 90% of the total approvals have taken place under the automatic approval route of
the RBI. The bulk of the (75% to 80%) borrowings have been by public sector units like the
ONGC, NTPC, BHEL, MUL, etc. The maturities have varied from 3 to 10 years generally and
interest charges between 12 and 16 per cent; the spreads have been 0.5-0.75 per cent LIBOR
(London inter-bank offer rate, the benchmark rate at which banks loan money to one another).

2. 4.3 Foreign Investment

(a) Equity Capital: It is the value of the MNC's investment in shares of an enterprise in a
foreign country. An equity capital stake of 10 per cent or more of the ordinary shares or
voting power in an incorporated enterprise, or its equivalent in an unincorporated
enterprise, is normally considered as a threshold for the control of assets. This category
includes both mergers and acquisitions and ‘greenfield investments' (the creation of new
facilities).
(b) Private Equity: It has emerged as an important source of FDI in more recent years.
(c) Reinvested Earnings: These are the MNC's share of affiliate earnings not distributed as
dividends or remitted to the MNC. Such retained profits by affiliates are assumed to be
reinvested in the affiliate.
(d) Other Capital. It refers to short- or long-term borrowing and lending of funds between the
MNC and the affiliate.
Investment and Collaboration: Although foreign investment and collaboration with foreign
parties are very closely interrelated, they are not one and the same thing. Foreign investment may
take place without foreign collaboration and vice versa. Capital participation refers to the foreign
partner's stake in the capital of the recipient country's company while technical collaboration
refers to such facilities provided by the foreign partner as technical services, licensing, franchise,
trade marks and patents (against which he gets lump sum fee or royalty payments for a specified
period).

5
FDI can be Horizontal or Vertical
Horizontal FDI constitutes a situation in which multi-plant firms duplicate roughly the same
activities in multiple countries.
Vertical FDI constitutes a situation in which firms locate different stages of production in
different countries.
Vertical FDI in turn can be of two types:
(a) Upstream vertical FDI: If Peugeot (the French automaker) only assembles cars and does
not manufacture components in France, but in the UK, it can be said that Peugeot enters
into components manufacturing through FDI.
(b) Downstream vertical FDI: If a Volkswagen (the German automaker) does not engage in
car distribution in Germany and instead invests in car dealerships in Saudi Arabia (a
downstream activity), it can be said that Volkswagen is engaged in "downstream vertical
FDI."
Types of FDI
Looked at from the point of view of the investors, the FDI inflows can be classified into three
groups:
(i) Market-seeking: These are attracted by the size of the local market, which depends on the
income of the country and its growth rate.
(ii) Efficiency-seeking: In EEs where capital is relatively scarce the marginal efficiency of
capital (MEC) tends to be higher than in the developed world where it is abundant.
Assuming that interest rates broadly reflect MECs, it follows that lending rates in Western
financial centres are below MEC in EEs. Hence, economic efficiency — and commercial
logic— dictate that capital should flow from the relatively less-profitable developed world to
the relatively more profitable EEs.
(iii) ‘Other location' advantages: These include the technological status of a country, brand
name and goodwill enjoyed by the local firms, openness of the economy, trade and macro
policies pursued by the government and intellectual property protection granted by the
government.

FDI is essentially long-term investment and is associated with investment in capital assets and
creating employment while FII is inherently short-term investment linked to the financial market.
FDI by its very nature has a high multiplier effect on the economy than FII. Entry and exit
decisions invariably take longer for FDI as compared with FII. The nimbleness of FII flows has
implications for money supply, forex reserves and interest rates.

Recent Trends in Foreign Investment

Table 2.1: Foreign Investment Inflows

Year
Gross Repatriation/ Direct FDI by Net Net Total

inflows/ Disinvestmen Invest India Foreign Portfolio

Gross t ment to Direct Investment
Investments India Investment
US $ Million US $ Million US $ US $ US $ Million US $ Million US $

6
 Million Million Million

2000-01 4031 0 4031 759 3272 2590 5862

2001-02 6130 5 6125 1391 4734 1952 6686

2002-03 5095 59 5036 1819 3217 944 4161

2003-04 4322 0 4322 1934 2388 11356 13744

2004-05 6052 65 5987 2274 3713 9287 13000

2005-06 8962 61 8901 5867 3034 12494 15528

2006-07 22826 87 22739 15046 7693 7060 14753

2007-08 34844 116 34729 18835 15893 27433 43326

2008-09 41903 166 41738 19365 22372 -14030 8342

2009-10 37746 4637 33109 15143 17966 32396 50362

2010-11 36047 7018 29029 17195 11834 30293 42127

2011-12 46552 13599 32952 10892 22061 17170 39231

2012-13 34298 7345 26953 7134 19819 26891 46711

2013-14 36047 5284 30763 9199 21564 4822 26386

2014-15 45147 9864 35283 4031 31251 42205 73456

2015-16 55559 10652 44907 8886 36021 -4130 31891

2016-17 60220 18005 42215 6603 35612 7612 43224

2017-18 60974 21544 39431 9144 30286 22115 52401

2018-19 62001 18699 43302 12590 30712 -618 30094

2019-20 74390 18384 56006 12993 43013 1403 44417

2020-21 81973 27046 54927 10972 43955 36137 80092

2021-22 84835 28605 56231 17644 38587 -16777 21809

Notes: 1. Data for 2021-22 are provisional.
2. Data on FDI have been revised since 2000-01 with expanded coverage to approach international best practices.
3. Negative (-) sign indicates outflow (except in case of FDI by India).
4. Direct Investment data for 2006-07 include swap of shares of $3.1 billion.
Source: Reserve Bank of India.

Look at Table 2.1, it shows the details of the foreign investment inflows from the year 2000-21
to 2021-22. In the year 2000-21, the total figure was at 5862 US $ Million. After a decade in
2010-11, the figure was 42127 US $ Million. Gradually, it accelerated and in 2020-21 and
reached to 80092 US $ Million. In the year 2021-22, due to the negative figure of Portfolio
Investment (-16777), the total foreign investment inflows stands at 21809 US $ Million.

Table 2.2: Foreign Direct Investment Flows to India:Country-Wise

(US$ billion)
Countries 2017-18 2018- 2019- 2020- 2021-
19 20 21 22 (P)

7
Singapore 12.2 16.2 14.7 17.4 15.9
US 2.1 3.1 4.1 13.8 10.5
Mauritius 15.9 8.1 8.2 5.6 9.4
Netherlands 2.8 3.9 6.5 2.8 4.6
Switzerland 0.5 0.3 0.2 0.2 4.3
Cayman Islands 1.2 1.0 3.7 2.8 3.8
UK 0.8 1.4 1.3 2.0 1.6
Japan 1.6 3.0 3.2 1.9 1.5
UAE 1.0 0.9 0.3 4.2 1.0
Germany 1.1 0.9 0.5 0.7 0.7
Canada 0.3 0.6 0.2 0.0 0.5
Luxembourg 0.3 0.3 0.3 0.3 0.5
Thailand 0.1 0.1 0.0 0.1 0.5
France 0.5 0.4 1.9 1.3 0.3
Denmark 0.0 0.1 0.0 0.1 0.3
Others 4.2 4.2 4.7 6.3 3.1
Total FDI 44.9 44.4 50 59.6 58.8
P: Provisional.
Note: Includes FDI through approval, automatic and acquisition of existing shares routes.
Source: RBI.
Look at table 2.2, it shows the country-wise details of the Foreign Direct Investment Flows to
India. In the year 2021-22 highest inflows were received from Singapore (15.9 US$ billion)
followed by US (10.5 US $ billion), Mauritius (9.4 US$ billion), Netherlands (4.6 US$ billion),
Switzerland (4.3 US$ billion), Cayman Islands (3.8 US$ billion), UK (1.6 US$ billion), Japan
(1.5 US$ billion) and UAE (1.0 US$ billion).

Table 2.3: Foreign Direct Investment Flows to India: Industry-Wise

(US$ billion)

Industries 2017-18 2018- 2019- 2020- 2021-22

19 20 21 (P)
Manufacturing 9.0 9.6 9.6 9.3 16.3
Computer Services 3.4 3.7 5.1 23.8 9.0
Communication Services 9.1 6.5 7.8 2.9 6.4
Retail & Wholesale Trade 4.6 4.9 5.1 3.9 5.1

8
Financial Services 4.6 7.2 5.7 3.5 4.7
Education, Research & Development 0.4 0.9 0.8 1.3 3.6
Transport 2.5 1.2 2.4 7.9 3.3
Construction 2.8 2.3 2.0 1.8 3.2
Business services 3.3 2.8 3.8 1.8 2.5
Electricity and other energy Generation, 2.8 2.6 2.8 1.3 2.2
Distribution & Transmission
Miscellaneous Services 0.9 1.4 1.1 0.9 1.0
Restaurants and Hotels 0.5 0.8 2.7 0.3 0.7
Mining 0.1 0.3 0.3 0.2 0.4
Real Estate Activities 0.5 0.2 0.6 0.4 0.1
Trading 0.0 0.0 0.0 0.0 0.0
Others 0.3 0.1 0.2 0.2 0.4
Total FDI 44.9 44.4 50 59.6 58.8
P: Provisional.
Note: Includes FDI through approval, automatic and acquisition of existing shares routes.
Source: RBI.

Look at table 2.3, it shows the industry-wise details of the Foreign Direct Investment Flows to
India. In the year 2021-22 highest inflows were received by manufacturing sector (16.3 US$
billion) followed by computer services (9.0) Communication Services (6.4), Retail &
Wholesale Trade (5.1), Financial Services (4.7), Education, Research & Development (3.6),
Transport (3.3), Construction (3.2), Business services (2.5), Electricity and other energy
Generation, Distribution & Transmission (2.2) and Miscellaneous Services (1.0).

Need to Regulate Capital Inflows

The global financial integration and free flow of capital does improve the resource allocation and
hence growth prospects but can also be a source of macroeconomic instability. Occasional
restrictions on capital inflows may therefore be necessary. This is not inconsistent with the
overall objective of liberalisation/financial globalisation and stability. While the pace of global
flows may moderate in the coming years, India as one of the fastest growing economies will
keep attracting foreign capital and will remain vulnerable to unpredictable capital inflows and
outflows. In this scenario, the broad policy thrust should be to strengthen the domestic
institutions, develop deep and efficient financial markets and improve risk management practices
to raise the capacity of the economy to deal with capital flows.

2.6 MULTINATIONAL CORPORATIONS

An MNC is one which undertakes FDI, i.e., it owns or controls income generation assets in
more than one country, and in so doing produces goods or services outside its country of origin,

9
i.e., engages in international production. The MNCs are multiprocess, multi-product and multi-
national composite enterprises.
These are also known as Transnational Corporations, (TNCs), although there are certain fundamental
differences between the two. The most important difference is that an MNC, wherever it is, is controlled
from its national headquarters with globally standardised operating procedures laid down in a universally
applicable policy manual. A TNC, on the other hand, favours foreign semi- autonomous units with only
reports and income repatriation flowing back to base.
New Phase of Operations by MNCs
Operations of MNCs have been changing over the past two decades, and this change has
become a dominant pattern of their behaviour during the past decade. Instead of making mega-
sized investments in host economies, MNCs have been sub-contracting various parts of the value
chains by establishing joint ventures with local enterprises in a number of countries, thus
establishing global value chains (GVCs). This fragmentation of production has twin advantages
for these conglomerates. They are able to diversify their risk by collaborating with local
enterprises, especially in the emerging economies, but perhaps more importantly, they are able to
pick the more dynamic enterprises in their partner countries to improve their overall bottom
lines.
Advantages of GVCs have been seen in India's neighbourhood. South-East Asian countries
have long been involved in these GVCs that were first triggered when Japanese firms moved
away from their home country in search of more cost-efficient locations. In the past decade,
firms located in China have brought these countries closer in the production networks, a
phenomenon that has also contributed to deepening of economic integration within the South
Asian region. The growing share of trade in intermediate goods in the total non-fuel trade
between these countries provides the evidence of greater regional integration.

2.6.1 Significance of Multinational Corporations

The retreat of socialism, and failure of aid as an instrument of economic development, there
has been a greater realisation of the capacity of MNCs to deliver an efficient package of
practices. In the 1970s MNCs were characterised by alarmists as something of an evil monster—
almost like muggers on a dusk night waiting to pounce on the innocent passerby. MNCs were
seen as pariahs, not saviours— objects of harm, not instruments for good. These attitudes have
changed in the last few years. Today they constitute a powerful force in the world economy.
They are being increasingly credited with dramatic and industry transforming innovations that
are taking place today faster and faster.
Table 2.4: Potential Benefits from MNC Operations
Impact Area Potential Benefits
• Imitation Adoption of new production methods. Adoption of new
management practices.
• Skills acquisition Increased productivity of complementary labour. Tacit
knowledge.
• Competition Reduction in X-inefficiency. Faster adoption of new

10
 technology.
• Capital Provision of scarce capital resources
— Internally generated

— Externally generated (privileged access to global capital

markets)
• Technology Provision of sophisticated technology and other technology not
available in the host country.
• Exports and balance of Access to superior global distribution and marketing systems.
payments —MNCs may increase exports and create positive balance of
payments effects
• Diversification MNCs command technology and skills required for
diversification of the industrial base and for the creation of
backward and forward linkages.
— Based on the host countries factor endowement.

The Case for Multinational Corporations

The case for MNCs revolves around the potential benefits that an EE can hope to get from MNC
operations. These benefits are summarised in Table 2.4 above.
A recent study on the subject concludes that in today's world of global capitalism foreign
investment is the only instrument that can reduce the inequalities between nations.
The Case Against Multinational Corporations in actual operations, in the past half a-century or
so, the experience of EEs with MNCs has been none- too-happy. Main points of criticism can be
summarised as in Table 2.5.
Table 23.5: Actual Impact of MNC Operations
• Capital Insignificant net inflow
— The MNCs raise most of the investment capital in domestic
capital market, pre-empt scarce local capital resources and crowd
out domestic borrowers.
• Remittances Large dividend remittances
Large technical payments
Progressive fall of foreign participation in corporate capital
formation.
• Technology Transitory reluctance followed by
increased inflow
May be costly 'over-import'
Problems with advanced technology and
updating
Problems with technical support
• Export Export performance on par with domestic companies
Higher import propensity than domestic companies
Some import substitution but negative BOP effects.
• Diversification MNCs do contribute: reallocation in favour of manufacturing and
technology-intensive sectors.

11
 There may be preemption of growth opportunities and
substitution of domestic capital in several promising areas
Increased foreign influence in key sectors.

In a partial response to the above propositions it may be stated that many of the old myths are no
longer valid. Present-day Third World Governments are not exactly powerless like those of
yesteryears, nor are the modern MNCs mere' white profiteers who would turn into predators,
unscrupulous, insensitive and interventionist. They are not like large trading firms of the 19th
century, such as the East India Company 1 or the Royal African Company which “were like
dinosaurs, large in bulk but small in brain, feeding on the lush vegetations of the new worlds".
They have transformed themselves into modem MNCs which acknowledge their responsibility to
the concerns and interests of the host countries and basically operate on the basis of mutuality of
interests of both. MNCs are increasingly losing the sense of loyalty to their home country to
provide employment. They are in search of bases where they can produce their products most
competitively. The chosen model of growth is being defined as 'micro-multinational', i.e., a
company that from its very inception is based in a developed country but maintains a less-costly
skill workforce abroad. The slogans 'Thinkglobal, act local' and ‘multidomestic' are a working
reality with most multinationals today. In fact, in present times international capital has no
loyalty towards any nationality. MNCs realise they cannot be oriented toward the state of their
origin. They have to be the citizens of the country they are in. If they are not, they do not
succeed.
In view of these, there has been a perceptible change in the attitude of the EEs towards the
MNCs.

2.6.2 Regulation of Multinational Corporations

In view of the fact that MNCs do possess a potential that can be gainfully exploited, most of the
EEs have chosen to regulate their activities rather than to dispense with them altogether—an
effort to separate the gold from the dross.
(i) Threat of nationalisation is an effective tool of regulation. Although nationalisation should
be resorted to only in the extreme situations, the very fact that it can be exercised makes the
corporations act in a disciplined manner.
(ii) The Government may allow collaboration in certain selected industries or certain selected
regions where the operation of MNC is felt highly suitable. Similarly, the government may
deny permission in specific cases.
(iii) MNCs may be allowed to invest for specific periods. Thus, after a certain period of time
restrictions may be imposed on foreign holdings, or there may be provision for gradual
disinvestment.
(iv) A multi-tax system may be followed by the Government. The MNCs may be taxed at a
higher rate.
(v) The host country may lay down certain export criteria.
(vi) Large domestic market can be used as sweetener, if not a bait, to get new technologies in
areas such as agriculture, bio-technology, infrastructure and export-oriented industries.
These areas would be of more lasting benefits to host country than soaps, detergents or fried

12
 chicken.
(vii) MNCs may be asked to carry out a minimum fixed share of their total research and develo-
pment activities within the host countries.

2.7. GOVERNMENT POLICY TOWARDS FOREIGN CAPITAL

Foreign investment in India is subject to the same Industrial Policy as all other business ventures,
plus some additional policies and rules specially governing foreign collaborations.
Beginning with the First Plan in 1951, five distinct phases can be marked:
• First phase lasted till 1965. As the domestic base of 'created' assets, viz., technology, skills,
entrepreneurship was quite limited. The policy was characterised by a liberal attitude towards
foreign capital. Many concessions and incentives were given to foreign capital participation in
the industrial development of the country.
• In the second phase, beginning with the mid- 1960s, the liberal attitude of the State yielded
place to strict controls and the broad policy was to restrict the area of operation of foreign
capital.
• In the third phase, beginning towards the end of the decade of 1970s, the policy was marked
by a certain liberalisation. The changes eased the restrictions on FDI inflows.
• Fourth phase, beginning with the adoption of economic reforms programme since July 1991,
has adopted a liberal attitude towards foreign capital and has aimed at attracting a free flow of
direct foreign investment.
• Fifth phase. In late 2012 the RBI softened its stand on foreign direct investments that have in-
built options, settling for a one-year lock-in on such investments as opposed to three years it
wanted earlier. The compromise solution will help government put in place a policy that
should address concerns of potential overseas investors, and end the uncertainty over the
investment proposals that the RBI had refused to clear.

2.7. 1. New Economic Policy and 1991-2022 Policy Changes

The New Industrial Policy, 1991 can be described as a minor revolution as far as decisions
concerning foreign investment and foreign technology agreements are concerned.
The various changes in the policy can be broadly classified into four categories:
1. Choice of Product. The number of products in which foreign investment is freely
permitted has been significantly increased.
2. Choice of Market. The foreign investors are now free to compete with the domestic
producers in the Indian market.
3. Choice of Ownership Structure. In most cases, the foreign investor is free to own a
majority share in equity.
4. Simplification of Procedures.

India has opened two routes for FDI inflows. First, the RBI route (or the Bombay route). This is
transparent in the sense that the guidelines are clear. If projects satisfy the guidelines, the approvals are
practically automatic.
FDI proposals which fall under the automatic route are listed in Annexure III of the industires list; it
consists of 42 industries.
The second route is the FIPB route (or the Delhi route). Foreigners are welcome to make proposals that

13
do not fit into the first category. Such proposals are considered case by case, in all manufacturing
activities in Special Economic Zones except those subject to licensing, or public sector monopoly. The
Government has also set up Foreign Investment Implementation Authority (FIIA), independent of the
Foreign Investment Promotion Board (FIPB), to act as a single point interface between the investor and
government agencies.

Centre approves New Definition of 'Control' in FDI

The government has changed the definition of 'control' in the context of foreign direct investment
(FDI) policy. The new definition will empower the shareholders' agreement or voting agreements
and will be with prospective effect.
Control will be defined as "the right to appoint a majority of the directors or to control the
management or policy decisions including by virtue of their shareholding or management rights
or shareholder agreements or voting agreements. This was done in order to bring parity with the
definitions that are given under the guidelines of Securities and Exchange Board of India and
Companies Bill 2012.
Further, the government has allowed 100 per cent FDI in contract manufacturing and in coal
mining and related activities such as washery, handling and separation. This easing of
restrictions on foreign investment, which sends a positive signal to the international community,
should be seen as a continuation of the measures to prop up the economy.

2.7.2 2018 Reforms Push

In early January 2018 the government unveiled a fresh round of liberalisation of the foreign
direct investment (FDI) policy.
These changes are pointers to the fact that, lately, the Government is keen to attract more of
foreign investment. It seems it has come to be believed that:
(i) It is better to allow equity than to go out to borrow. For one thing, dividend remittance on
equity will start only when the unit starts producing.
(ii) Capital is generally never repatriated. Profit also is normally re-invested. The company
meanwhile makes a substantial contribution to GNP and domestic market becomes
competitive.
(iii) Direct foreign investment brings technology. This technology spills over into other
sectors which supply components and inputs.

Also when FDI firms produce cheaper and better capital goods or intermediate products, the
competitiveness of sectors which use these improves. The competitive edge will spur
development and accelerate the growth process. And, above all, the following message seems to
have been clearly driven home to us: "The piper playing his tune on past borrowings can only be
paid without an external drain of capital from the economy if the nation is successful in
attracting a new flow of investment."

2.7.3 Suggestions
(i) State infrastructure is a major constraint and things can worsen if quick action is not taken to
match the quality and size of all infrastructure components. For examples; transport,
14
 communication and energy, comparable with that in other countries competing for the same
capital.
(ii) Attention need be paid to restructuring education, training and skills. The process must begin
at the level of primary education upwards with emphasis on absorption of appropriate skills
and through upgradation.
(iii) India should promote quality standards. The present mindset favouring cheapness at the cost
of quality needs a change.
(iv) The existing framework of legislation and practices related to industrial action should be
reorganised so as to make it conducive to the promotion of productivity-oriented measures.
(v) The operating environment need to be made 'investor-friendly'. For this purpose, following
suggestions can be made:
- At the entry level, there are two alternative routes viz., the Automatic Approval Route
(AA) of RBI and the Foreign Investment Promotion Board (FIPB). The policy
framework should be liberalised to make the AA route more effective. An increased
share of the AA route in the FDI approvals will concurrently reduce the pressures on the
FIPB system.
During the last couple of years, much of the FDI was directed to the real estate sector,
with comparatively little going into manufacturing or services.
- The efficiency of the state-level frontline bureaucracy is absolutely critical to keep up
investor's confidence to prevent cost and time overruns which. This should be prevented,
otherwise will have adverse effect not only on individual investors but also on the
economy as a whole.
We are at the bottom of the Brie league on three key parameters: absence of corruption,
order and security and access to civil justice.
Our poor ranking is a contributory factor for the dwindling funds flow into India in
recent. On the face of it, this is bad news. If our image as a country where there is little
respect for the rule of law gains currency, it is only a matter of time before this trend
gets entrenched. And that is bad news for a country that despite the high domestic
savings rate, desperately needs foreign capital to meet its huge infrastructure
requirements.
(vi) We need more clarity on foreign ownership. There are far too many grey areas—sectoral
limits, automatic route, FIPB, direct/indirect preference capital, convertible debt—that have
unnecessarily complicated the foreign investment regime. We need quickly to move to 100%
FDI policy regime in non-strategic sectors. It would check bureaucratic/political discretion
and, thereby, impart more predictability in administrative outcome. Likewise, for award of
contracts and projects, we need to have more sound bid documents particularly in terms of
eligibility conditions and better evaluation of bids. Courts, too, need to be more circumspect
in staying proceedings when unsuccessful bidders allege lacunae in bidding process or
appraisal mechanism after participating in the bidding under the very terms.
(vii) We need to be tough with MNCs. But the real way to be tough with MNCs is to make
the domestic market a ruthlessly competitive place by doing away with discretionary
FDI approvals. Otherwise, corporates would be back at the old game of maximising
gains by taking advantage of opportunities to politically manage the market place.

15
 India has entered into Bilateral Investment and Protection Agreement with a number of
countries. This agreement provides protection to private investment from abroad in India.
(viii) A last word, direct foreign investment may actually be harmful to the recipient country
if the economy is highly protected and foreign investment takes place behind high tariff
walls. This type of investment is generally referred to as the ‘tariff jumping' variety of
foreign investment, whose primary objective is to take advantage of the protected
markets in the host country. The longer the government shields its home market with
tariffs the more will the foreigner come in to exploit that protected market, and more
acute will be the conflict between him and the domestic entrepreneur. In view of this,
an appropriate policy framework must respond to two conflicting objectives. First, the
need to liberalise rules governing such investment in view of the growing integration of
the world economy. The Second, the need to ensure that such investment has positive
effects on the country's economy and does not lead to negative welfare effects. We do
not need a 'rent- a-womb' type of investment.
Keep it Simple
Define a negative list where foreign investment is unwanted, lift caps on the rest.
The government should formulate a small, negative list of activities like the media where it
desires little or no foreign investment. Even countries like the US rope off some activities from
foreign funding. In all other sectors, it should allow full foreign investment, without limits. That
and a transparent, rule-based regime will encourage overseas investors to enter India and do
business with confidence.
We need to take a lesson from China. China is presented as the mightiest example of the
virtues of international 'coupling'. During late 2007, China made a 180-degree turn and
substantially cut down on its globalisation thrust. It eliminated tax breaks for foreign
investments, limited merger deals, withdrawn many of the support schemes for export-
oriented enterprises and clamped down on foreign investment in many sectors. These
measures came in the wake of an increasing concern that the country was falling into the
hands of powerful MNCs that left little for its people. With the new measures, China intends
to use foreign investment rather than be used by foreign investors. India is also sailing in the
same boat and should draft its policy accordingly.
India has much to offer the foreign investor. It must ensure that the benefits also flow the
other way round.
A Question of Control
FDI Policy Defines ‘Control’ Narrowly
An entity is said to control another if it can appoint a majority of its directors. It does not
consider indirect control via shareholder agreements & quasi-equity instruments.
This Allows Foreign Cos to Avoid Curbs
Foreign owned or controlled Indian entities are considered foreign companies
They face same restrictions on downstream investments as any other foreign company
They cannot invest in prohibited sensitive sectors
A foreign investor can exercise indirect control over an Indian company to get around

16
restrictions.
Indian companies having foreign stakes will now face a much closer scrutiny of their
management and decision-making structures as the government decides to tighten the rules to
determine who controls them.
As brought out clearly in a recent Supreme Court Judgement (Vodafone case), it is important to
have clear tax laws incorporated in the treaties and in the laws so as to avoid conflicting views.
Foreign investors should know where they stand. It also helps the tax administration in enforcing
the provisions of the existing laws.

2.8. FOREIGN INSTITUTIONAL INVESTORS

Foreign institutional investors (Fils), described as New Bulls on Indian bourses, include pension
funds, mutual funds, asset management companies, investment trusts, nominee companies and
corporate or institutional portfolio managers, university funds, endowments, foundations and
charitable trusts.
FII inflows are divided into two groups, (/) Regular sources, and (ii) others. Regular sources
refer to global emerging market and Asia funds. The other category includes global funds.
Wedge funds and sector-specific and sovereign wealth funds.
These can directly invest money raised from clients (firms, individuals and pension funds) or
through sub accounts created for those who are not eligible to invest directly. The most popular
channel for investment till 2007 was the (PN). A PN is a contract note where the funds accrue
from overseas investors but the transactions are via the proprietory accounts of registered Fils.
(In case of both PNs and subaccounts, the regulators do not have knowledge of the source of the
money).
At present, over 9,000 Fils are registered in India; they operate sub-accounts; such accounts
typically belong to large overseas wealth funds. Fils contribute an estimated 80% of the equity
volume in India.

Benefits
Since their entry into Indian markets in the early 1990s, FIIs have invested cumulatively about $
450 billion. Their annual level of operations on both the purchase and sale sides account for just
7.5 per cent of the turnover on our exchanges but their operations decisively impact the
movement in stock prices. Fils bring with them certain advantages that help markets to save on
time as the learning process is quicker, (i) They have deep pockets and can invest in large
numbers as institutions, which other domestic entities may not be willing to do. (ii) They have
considerable knowledge on global markets and developments taking place that would add a lot of
value to the Indian markets too. Their global research teams provide valuable advice on world
developments, (tn) They bring in the global best practices to the floor which help to strengthen
the system.

17
Limitations
It is time we take a close look at this development. There are two aspects to it: One, its macro
impact on overall policy framework; and two, its micro impacts on capital market, individual
shareholdes, etc.
Macro Impact
Capital inflows in the form of portfolio investment have two negative, mutually reinforcing,
effects.
1. Portfolio investors may become the ultimate arbiters of national macro-economic policy to
the determinant of economically vulnerable groups. Fils account for 45% of the free float.
Investors' veto power is expressed through the mechanism of portfolio reallocation. An eco-
nomic crisis that threatens portfolio investors is likely to induce assistance from foreign
governments and/or multilateral institutions. Those providing assistance may do so with the
provision that they be given substantive influence over policy making.
2. Under floating exchange rates, a withdrawal of portfolio investment may trigger a nominal
and real depreciation of the domestic currency. This may be because the government may
not have forex reserves sufficient to stabilise the currency value. In such circumstances,
problems of increased risk potential and constrained autonomy may be mutually reinforcing
as measures undertaken to stem the crisis may further constrain autonomy.
3. Foreign investors have been found to break free of investment caps imposed by the RBI. To
counter one such move the RBI, asked custodian bank to ensure foreign investor holding
dues not exceed the cap.
Micro Impact
Among these the following may be noted:
1. It cannot be said with certainty how long Fils will hold on to their investments, that is,
when they will sell for profit and repatriate the earnings in foreign currency.
Worldwide they are branded as notoriously fickle investors; the slightest whiff of
danger and they are gone.
2. Foreigners currently have a bigger stake in the biggest companies listed on the BSE
than that of Indians, minus all promoters, foreign or Indian. FII investment in financial
assets has exceeded foreign direct investment under liberalisation. This type of foreign
investment is making little difference to the real economy.
3. With increasing equity acquisition, Fils are unlikely to remain passive investors for
long. (Fils now own about one-fourth of Indian equities.) They are allowed to acquire
any amount of a company's equity—against 10 per cent in South Korea and Taiwan—
enough to pressurise or dislodge controlling interests of most companies. The predators
may, in the first instance, replace domestic components with imported ones, as is
happening in consumer electronics. Import dependence will increase with a decline in
domestic capability.
4. There is no knowing how much of the FII inflow represents the return of capital
outflow of the past two decades. (The illegal outflow from India, unofficially estimated
and generally accepted, was of the order of $ 1.5 billion a year.) Less certain is the
impact of the financial flows on the real economy.

18
Suggestions
With little bit of deftness, the government can ensure that the entry of Fils will continue to
benefit foreigners, but not at the cost of Indians. It could, for example, charge Fils a hefty fee for
getting registered in India. And it could insist on having tax laws which would treat foreigners at
par with Indians; no better, and no worse. The Mauritius route should be brought under tax
network. Above all, the government will have to move fast to improve the functioning of stock
markets and the regulatory system which can curb undesirable speculation and ensure an orderly
functioning of the markets during crisis situation. It is very necessary that we take steps to ensure
that our entire financial system does not sway with every whim and fancy of Fils as it is starting
to do now.
The real 800-pound gorilla in the room is financial globalization. Financial globalization is the
consequence of the naive extension of the belief that if finance was essential for economic
growth, lots of it would ensure faster growth. After three decades of the pursuit of financial
globalization, global economies are left with too much finance, too much debt and the prospect
of too little growth. Dani Rodrik, in a recent commentary, elaborates more on the harmful
consequences of financial globalization and reckons that the answer lies in striking the right
balance between the real economy and finance.
Financial globalization has left policymakers in the developing world with few meaningful
options. Few years ago, Rodrik coined the phrase, "inescapable tri-lemma" to make the argument
that deep economic integration, democratic politics and nation-states are incompatible. One of
the three has to give. He might as well have replaced "deep economic integration" with "financial
globalization" because that is what he had in mind when he coined the phrase. The "inescapable
trilemma" has reduced the well-known "impossible trinity" in economics to one of impossible
policy autonomy. That is, countries cannot have independent monetary policy in a world of
unrestricted capital flows regardless of whether they have fixed or floating exchange rates.
Therefore, given the reality of financial globalization, market-distorting responses from
emerging policymakers may well be inevitable. However, the real worry is that even these
second-best options may not be available to them.
Check your Progress 2
1. State two sources of external assistance.
………………………………………………………………………………………………….
………………………………………………………………………………………………….

2.What are external commercial borrowings?

………………………………………………………………………………………………….
………………………………………………………………………………………………….
3. What do you mean by foreign direct investment ?
………………………………………………………………………………………………….
………………………………………………………………………………………………….

2.9. INDIA’S OVERSEAS INVESTMENTS

19
A large number of Indian companies have been reaching out for overseas destinations in order to
access high-growth markets, technology and knowledge, attain economies of size and scale of
operations, to tap global natural resource banks and leverage international brand names for their
own brand building. India's overseas investments have taken the form of wholly-owned
subsidiaries (WOS) and Joint Ventures (JVs).
Joint ventures (JVs) include commercial and industrial enterprises in which two or more parties
from two or more countries share the responsibility for operation by providing risk capital,
goodwill, know-how and management, natural resources, and access to national markets in an
agreed manner. Controlling partner is one who is the major decisionmaker in the JV.

Government Policy
The Indian policy framework has been highly supportive of direct investment abroad.

Growth and Nature

FDI emanating from India has been growing by leaps and bounds over the past 10 years, and has
often been close to $ 20 billion a year of late. The gap between inbound and outbound FDI has
been narrowing, although India continues to be a net importer of capital because of its current
account deficit. Four phases with respect to sectors, magnitudes, entry modes and destination can
be differentiated.
In the first phase until 1990, largely Indian companies operated small operations as joint
ventures in poorer countries in Asia and Africa seeking markets based on adapted and scaled
down technologies in relatively low technology sectors. The entry mode was green field.
The second phase began with the onset of reforms. With greater freedom to invest abroad, Indian
companies made outward investments in other countries to support their exports with local
presence. Hence, they began to be concentrated in developed and developing countries where the
markets for Indian products and services existed. These investments were concentrated by select
industries such as pharmaceuticals and IT software in which Indian companies developed some
cost effective processes. The entry mode was largely green field.
The third phase in the evolution of Indian enterprises has been ushered in by the Tata-Tetlay deal
in 2000. Hence, it is largely directed at acquiring strategic assets such as brand names and global
footprints, established marketing networks, access to customers, or access to clients, or
technology, or to secure access to raw materials. The scales and magnitudes involved are large
and the entry mode is acquisition.
In the current phase, post-2005, overseas investment began to slow down. During the last couple
of years these have picked up some small momentum despite the government liberalizing policy.
Potential Sectors
A recent study on the subject identifies the following sectors in which India can make a mark.
(i) Agricultural products: In products like tea, basmati rice, alphonso mangoes, Nagpur
oranges and even staple cotton and gold the Indian origin can provide extra value and make
the products and brands desirable. This could be a good platform given that the world is
moving towards organic and natural products. Of course, much needs to be done in farming
and packaging to make this a reality.
(ii) Food and fashion: India has strong associations in these areas in the developed world. In
food, India has a wide range of sweetmeats to add to the already familiar tandoori chicken,

20
 Hyderabadi biryani and spicy samosas. In fashion, Indian fabrics and colours give it a
distinct edge. These products, suitably adapted to local tastes and branded, could be made to
reach a larger consumer group.
(iii) Hospitality: Hotels and restaurants provide India an opportunity to leverage its traditional
values of warmth and friendliness to serve a larger world. Most Indians subscribe to the
concept of "Atithi Devo Bhava" (Guest is God).
(iv) Entertainment: Whether it is movies or soaps, entertainment in India has developed a
distinct character and DNA. In an increasingly stressful world where people are seeking to
escape all the time, the "nonsensical and masala mix" Bollywood and "melodramatic"
television serials provide alternative entertainment to the more serious and thought-
provoking Western celluloid. India's rich story-telling culture adds to this.
(v) Spirituality: India can formally brand and sell it in the form of yoga, ayurveda, homeopathy,
vaastu and so on. India has a rich heritage of holistic arts and sciences that intrigues and
interests many in the world.
(vi) Mass marketing: It is a big weapon to enter the global markets. In the past 70 years after
Independence, India's philosophy of balancing socialism with capitalism has provoked
marketers to think of value with volume and urban with rural. Thus, the average Indian
business mind has developed the core competence of creating products and mixes to reach
the less privileged. The Nano, the sachet and products with cheaper ingredients are
examples of this expertise. Brand India can leverage this to move a step ahead of traditional
global marketing giants in the less developed world.
(vii) Education: There is something powerful in the traditional gurukul system of education that
can be re-engineered to suit contemporary times to open a new "school" of education.
Clearly, there is much that Brand India can explore beyond IT and business outsourcing for
the world to look towards it as a global business powerhouse. However, remember that the
opportunities are accompanied by challenges.

Suggestions
For successful operation of JVs it would be essential to consider different aspects of these
ventures when promoters from India submit their proposals to the government.
1. Line of activities chosen for this purpose, the country in which such ventures are sought to
be established and the foreign collaborators identified along with such important details as
their growth ratings, reputation, capacities for investment, etc.
2. Government-to-government understanding about the conditionalities that such ventures
should respect in the creation of both implementation and operation of these ventures.
3. Feasibility studies and project reports prepared for this purpose detailing all important
aspects of these enterprises.
4. Political and economic climate in the country of operation so that at any stage the ventures
do not come under a cloud of uncertainty.
5. Preference should be given to export of Indian capital goods and also the initial
requirements of other inputs while emphasis would remain on exploitation of local raw
materials and marketing products in the local markets at the first instance and then exporting
to India and other countries. Exporting to India becomes relevant in cases where such
products are in short supply, on the one hand, and are much costlier in the case of imports

21
 from other countries, on the other.
6. It appears that adhocism and so-called 'on- merit' considerations still rule the roost, spelling
undesirable uncertainties which affect the degree of confidence of Indian entrepreneurs
seeking to sail in foreign waters.
Taking a cue from China, which backs its enterprises hunting for raw materials, the Indian
government is throwing its weight behind its companies. The government has directed its
missions across the globe to provide vital inputs to the PSUs eyeing acquisitions overseas.
Further in a major policy shift the government has formulated a plan, wherein it will assist Indian
corporate sector to acquire companies oversees, especially in South East Asia, eastern Europe
and Africa.
In terms of policy, the quest for financial stability has a couple of implications. First, central
banks need to use macro-prudential norms (things like getting banks to build capital buffers
during a business upswing) to ensure that the financial system is in good fettle. Second, they
need to have a set of tools at their disposal to smooth out the impact of a server jolt to the
financial system. Mere rate cuts, for instance, turned out to be far from adequate in restoring
some degree of order to the American and European inter-bank markets. The Fed and the
European Central Bank had to resort to the untested quantitative easing, which has now become
part of central banks' standard toolkit. The use of some of these tools (massive liquidity infusion,
for instance) could seem to work against the objective of price stability and confuse the markets.
It is the job of a central bank to make sure that its policy actions are interpreted correctly.

2.10. START-UP INDIA

Under the purview of Make in India, the government has introduced the initiative of Start-up
India with the ambition to set forth:
"Inspiration and strength to the younger generation of India which is talented and intends to do
new things for humanity as well as the nation”.
This initiative directs towards creating a platform where the promising entrepreneurs achieve the
ability to establish themselves smoothly into the market and receive funding support as well as
incentives in the fields which deal with law and simplification of the whole business of start up.
The consolidated policy of FDI has come into effect from August 2017. This is for the first time
that start ups have been included amongst the policies of FDI. According to the rules, startups
have been given the ability to raise up to complete 100% of funds from Foreign Venture Capital
Investor (FVCI). Earlier, they could only issue equity or instruments linked to equity or debt
instruments to FVCI against the receipt of foreign payment but now, a start up can issue
convertible notes to the foreign investors. By this, the startup company can issue the
corroboration receipt of money which was initially taken as debt as now to an asset which is
repayable at the recourse of the holder. Or allows conversion into equity shares of the start up
company, within the time limit of five years. The year starts on the date of the issue of the
convertible note. So basically, the balance of loan taken can automatically be converted to such
number of equity shares at that particular moment which is usually after the valuation of a
funding ground that takes place later on. This entire task is aimed at providing the investors a
friendly environment who are foreign contenders and in turn it is expected to attract more FDI.
The FDI will consequently provide more job opportunities and boost our economic development.

22
The policy has also intended to simplify the denotation of 'venture capital funds' simply as the
funds which are registered under the Securities and Exchange Board of India or SEBI (Venture
Capital Funds) Regulations 1996. Earlier the foreign contenders had to maintain a 51% stake in
the respective company where they invest but now, start ups have been permitted to take forward
losses till the extent where the promoters have the capacity to retain their holding in the venture
or company.

Intent and Objectives of Policy

The main aim of the consolidated policy is to ensure more ease at doing business in India and to
provide with a friendly atmosphere to the foreign investor in order to pull more FDI in the
country. However, the policy specifically mentions two objectives:
1. Upgrade and attract foreign direct investment so as to supplement domestic capital, skills
and technology to direct acceleration towards the wholesome economic growth of the
country. The document also states the difference between this from portfolio investment
which is dependent upon–lasting interest (in form of a resident) than merely as an
investor in the venture.
2. To issue a regular circular which talks about the consolidated policies of FDI in form of
press releases/notes, regulations, clarifications, etc. so as to maintain transparency and
predictability. Thus, it becomes easier for the foreign company to comprehend the rules.

Benefits of the Policy

Firstly, due to investment by foreign companies in our start ups, new and better technology is
carried along with the capital resources that they provide us. This leads to innovative products
with increase deficiency which gives more choices to the consumer in the Indian market. Thus,
the consumer can evaluate the opportunity cost of the products and purchase them accordingly.
Secondly, better production leads to increase in the Gross Domestic Product (GDP) of the nation.
GDP is the market value of all final services and commodities within a nation during a particular
period of time. It measures the total income of everybody in the economy (Fig. 2.2).

Fig. 2.3: Increase in the Gross Domestic Product (GDP) of the Nation
Thirdly, more inflow of FDI gives the opportunity to the Indian rupee to rise in the market as
shown in the Figure 2.4.

23
Fig. 2.4: Appreciation of the Indian Rupee
The investors invest in the market with a belief that they will get good returns through their
investment on the Indian Rupee. There is a purchase of corporate and government bonds and
these bonds are bought against the foreign currency. Consequently, all of this results in an
increase in the INR. Thus, FDI indirectly results in the appreciation of the Indian Rupee.

How can implementation be made more effective

First and foremost, the government should focus upon providing a better infrastructure. Our one
of the biggest issues as to why do the foreign investors hesitate to invest into the start up
industries or factories is due to the lack of adequate supply of electricity because the already built
business ventures have enough finance to avoid this error of lack of electricity. A start up just
cannot work without electric supply and power cuts are one of the major cruxes of problem as to
why there is less investment, especially in the rural areas. Secondly, a decrease in the rate of
corruption would lead to better investment as well as start up opportunities. It is easier for a start
up to sustain with FDI in a nation such as Singapore or Hong Kong because of the less
corruption rate as compared to India. Thirdly, although corporate tax rates avoid unnecessary
liberty to the foreign investors but high corporate tax rate can be a major disincentive to the
foreign corporate investment. This is why it is difficult to invest in a start up which is based in
UAE and easier for a start up based in Europe. Lastly, there has to be uniformity in the policies.
24
Investors necessarily take less interest to invest in such a place where there is political instability
because one government may favor one policy and once the government changes, the new one
may bring a policy completely opposite of the one existing. Hence, if there is more evenness then
it becomes less risky for the investor to invest.
Check your Progress 3

1. Distinguish between foreign direct investment and foreign portfolio investment.

………………………………………………………………………………………………….
………………………………………………………………………………………………….
2. What was the RBI Route for FDI inflows?
………………………………………………………………………………………………….
………………………………………………………………………………………………….

3. What are floating exchange rates ?

………………………………………………………………………………………………….
………………………………………………………………………………………………….

2.11. LET US SUM UP

International capital relations have been promoted globally to derive advantages of international
division of labour. Different countries possess different resource endowments and hence
differing efficiencies in different activities. International division of labour accumulates these
comparative advantages so as to produce goods and services at a lower cost. Lower cost of
production makes it possible to offer these goods at lower prices all over the globe, there by
widening the market. Thus, both producers and consumers gain. International supply chains are
set up. This involves the flows of capital across nations. Multinational corporations and foreign
institutional investors undertake this task , and promote welfare globally.

2. 12. Terminal Questions

1. There is a view which emphasises that the efficiency of foreign aid flow may be jeopardised if
the aid is tied, whether to projects or to maintenance imports". Do you agree? Justify your
answer.
2. "Is it true that the Indian economy is such that domestic savings alone may not be sufficient

for planned investment, and an import of foreign capital is needed for that purpose"? Elaborate
your arguments.
3. "An open foreign trade policy and an open external sector have created more problems for

domestic economy than it has solved". Do you agree? Justify your answer.
4. "The new foreign investment policy can be described as a minor revolution as far as decisions

concerning foreign capital are concerned". Elaborate. What has been the impact of the new
policy? Discuss with example.

25
5. Examine the need for foreign capital in the Indian economy and discuss critically the
Government policy on foreign direct investment.
6. "Foreign direct investment is not an unmixed blessing". Comment.

7. Review the reforms in the trade, exchange rate and foreign investment policies after the 1991

crisis. What has been the impact of these reforms on trade and foreign investment flows?
8. Discuss the trend and pattern of FDI inflow to India since 1991. Do you agree with the view

that if India were to shed its inhibitions about FDI and follow in the footsteps of China, we
would be in a position to realise our full potential. Explain.

2.13. KEY WORDS

ECBs: Loans contracted from private sources in international capital market.
External assistance: Loans contracted from govts of other countries or from international
institutions.
Foreign direct investment: Investments by foreigners in production sector of the host country.
Foreign portfolio investment: Amount of foreign exchange spent by foreigners on purchase of
equity in host country.
MNCs: Those corporates who operate in more than one country and cultivate economic interests.
Single-brand retail: 100% FDI now through automatic route. Norms for 30% sourcing from
India eased.
Real estate: Broking services can get 100% FDI without seeking government nod.
Security clearance: FDI from “countries of concern” under automatic route to be processed by
industry department, not by home ministry.

SELECT REFERENCES
1 Reserve Bank of india Annual Report
2.Government of India, Economic Survey Annual
3. UNCTAD, WORLD INVESTMENT REPORT ANNUAL
4. WORLD BANK . WORLD DEVELOPMENT REPORT

26