TOPIC: FDI Inflows and Economic Growth: A Study In India

UNDER THE GUIDANCE OF: PROFFESOR R.K RAUL

BY: SUBRATA SARMACHARJEE ROLL-040911 NO-0603451 REGISTRATION NO- 10102737 OF 2006-2007

CONCEPT

Foreign direct investment refers to an investment in a foreign country where the investors retain control over the investment. It typically takes the form of starting a subsidiary, acquiring a stake in an existing firm or starting a joint venture in a foreign country. According to IMF, FDI is an investment involving a long term relationship and reflecting a lasting interest and control of resident entity in one economy in an enterprise resident in another economy other than that of foreign direct investor. FDI may be undertaken by individuals as well as business entities. FDI flows comprises of two distinct form: equity and non-equity

THEORIES OF FDI

MacDougall-Kemp Hypothesis One of the earliest theories was developed by G.D.A. MacDougall (1958) and subsequently elaborated by M.C. Kemp (1964). Assuming a twocountry model one being the investing country and the other being the host country and the price of capital being equal to its marginal productivity, they explain that capital moves freely from a capital abundant country to a capital scarce country and in this way the marginal productivity of capital tends to equalize between the two countries.

Industrial Organization Theory The industrial organization theory is based on an oligopolistic or imperfect market in which the investing firm operates. Market imperfections arise in many cases, such as product differentiation, marketing skills, proprietary technology, managerial skills, better access to capital, economies of scale, governmentimposed market distortions, and so on. Such advantages confer on MNCs an edge over their competitors in foreign locations and thus, help compensate the additional cost of operating in an unfamiliar environment. Location-specific Theory Hood and Young (1979) stress upon the location-specific advantages. They argue that since real wage cost varies among countries, firms with low cost technology move to low wage countries. Again, in some countries, trade barriers are created to restrict import. MNCs invest in such countries in order to start manufacturing there and evade trade barriers. Sometimes it is the availability of cheap and abundant raw material that encourages the MNCs to invest in the county with abundant raw material.

Product Cycle Theory

Reymond Vernons theory is known as the product cycle theory. Vernon feels that most products follow a life cycle that is divided into three stages. The first is known as the innovation stage. The second stage is known as maturing product state. In the final or standardized product stage, a standardized product and its production techniques are no longer the exclusive possession of the innovating firm, rival firms from the home country itself, or from some other developed countries, put stiff competition.

Internalization Approach
Buckley and Casson (1976) too assume market imperfection, but imperfection, in their view, is related to the transaction cost that is involved in the intra-firm transfer of intermediate products such as knowledge or expertise. In an international firm, technology developed at one unit is normally passed on to other units free of charge. This means that the transaction cost in respect of intra-firm transfer of technology is almost zero, whereas such costs in respect of technology transfer to other firms are usually exorbitantly high putting those firms at a disadvantage. Coase (1937) too believes that MNCs bypass the regular market and use internal prices to overcome the excessive transaction cost of an outside market. Thus, it is the internationalization benefit manifesting in cost-free intra-firm flow of technology or any other knowledge that motivates a firm to go international.

Eclectic Paradigm
Dunnings eclectic paradigm is a combination of the major imperfect market-based theories of FDI, that is, industrial organization theory, internalization theory and location theory. It postulates that, at any given time, the stock of foreign assets owned by a multinational firm is determined by a combination of firm specific or ownership advantage (O), the extent of location bound endowments (L), and the extent to which these advantages are marketed within the various units of the firm (I). Dunning is conscious that configuration of the O-L-I advantages varies from one country to the other and from one activity to the other. Foreign investment will be greater where the configuration is more pronounced.

Currency based Approaches

The currency based theories are normally based on imperfect foreign exchange and capital market. One such theory has been developed by Aliber (1971). He postulates that internationalization of firms can best be explained in terms of the relative strength of different currencies. Firms from a strong-currency country move out to a weak-currency country. In a weak-currency country, the income stream is fraught with greater exchange risk. As a result, the income of a strong-currency country firm is capitalized at a higher rate. In other words, such a firm is able to acquire a large segment of income generation in the weak-currency country corporate sector.

Politico-economic Theories The politico-economic theories concentrate on political risk. Political stability in the host countries leads to foreign investment therein (Fatehi-Sedah and Safizedah, 1989). Similarly, political instability in the home country encourages investment in foreign countries (Tallman, 1988).

Modified Theories for Third World Firms The theories discussed above also apply to international firms headquartered in developing countries, but they need some modifications. These firms have long been importing technology from industrialized countries. But since imported technology is mainly designed to cope with a large market, firms export a part of their output after meeting the domestic demand. The products become gradually mature and then the firms set up units in the product importing countries.

BENEFITS TO THE HOST COUNTRY

 Availability of Scarce Factors of Production  Improvement in the Balance of Payments  Building of Economic and Social Infrastructure  Fostering of Economic Linkages  Strengthening of Government Budget

BENEFITS FOR HOME COUNTRY

 The country gets the supply of necessary raw material if the investor makes investments in the exploration of a particular raw material.  The balance of payments improves insofar as the parent company gets dividend, technical service fees, and other payments  Moreover, the government of the home country generates revenue by taxing the dividend and other earnings of the parent company.  It helps develop a closer political tie between the home country and the host country, which is beneficial for both countries.

COST TO THE HOST COUNTRY

 It is a fact that the inflow of foreign investment helps improve the balance of payments, but the outflow on account of import and the payments of dividend, technical service fees, royalty and so on deteriorates the balance of payments.  Raw materials are exploited keeping in view the interest on the home country, which sometimes mars the interest of the host country.  As far as employment of the locals is concerned, MNCs normally show reluctance to train local people. Technology is normally capital intensive, which does not assure larger employment.  Sometimes, manufacturing by the foreign investors does not abide by the pollution norms, the norms regarding optimal use of natural resources, or the norms regarding location of industries. All this goes against the interest of the host country.

COST TO THE HOST COUNTRY

 Foreign investors are generally more powerful. Domestic industrialists do not compare with then, with the result that the domestic industry fails to grow.  Higher prices hamper the interest of the consumers as well as lead to inflationary pressure. Foreign companies infuse foreign culture into the industrial set-up and also in the society. Sometimes, they are so powerful that they are able to subvert the government.

COST TO HOME COUNTRY

 The cost accruing to the home country is only little. However, it cannot be denied that an investment abroad takes away capital, skilled manpower, and managerial professionals from the country. Sometimes the outflow of these factors of production is so large that it hampers the home countrys interest.

 The MNCs operate in different countries in order to maximize their overall profit. To this end, they adopt various techniques that may not be in the interest of the host country. This leads to a tussle between the host government and the home government, leading to deterioration bilateral relations.

ROUTE OF FDI TO INDIA

 INVESTMENT UNDER AUTOMATIC ROUTE FDI in sectors/activities to the extent permitted under automatic route does not require any prior approval either by the govt. or RBI. The investors are only required to notify the Regional Office concerned of RBI within 30 days of receipt of inward remittances and file the required documents with that office within 30 days of issue of shares to foreign investors.

Foreign Direct Investment in India is allowed on automatic route in almost all sectors except  Proposals that require an industrial license and cases where foreign investment is more than 24% in the equity capital of units manufacturing items reserved for the small scale industries.  Proposals in which the foreign collaborator has a previous venture/tie-up in India.  Proposals relating to acquisition of shares in an existing Indian company in favour of a Foreign/Non-Resident Indian (NRI)/Overseas Corporate Body (OCB) investor; and  Proposals falling outside notified sectoral policy/caps or under sectors in which FDI is not permitted and/or whenever any investor chooses to make an application to the Foreign Investment Promotion Board and not to avail of the automatic route.

SECTORS AIRPORTS Existing Greenfield Air transport services Non-resident Indians other Alcohol distillation and brewing Banking (private sector) Coal and lignite mining (specified) Coffee, rubber processing and warehousing Construction and development(specified projects) Floriculture, horticulture and animal husbandry Specified hazardous chemicals Industrial explosives manufacturing Insurance Mining (precious metals, diamonds and stones) Non-banking finance companies(conditional) Petroleum and natural gas Refining (private companies) other areas Power generation, transmission, distribution Trading Wholesale cash and carry Trading of export SEZs and free trade warehousing zones Telecommunication Basic and cellular services ISP with gateways, radio paging, end-end bandwidth ISP without gateway (specified) Manufacture of telecom equipment

CAPS

74% 100% 100% 49% 100% 74% 100% 100% 100% 100% 100% 100% 26% 100% 100%

100% 100% 100% 100% 100% 100% 49% 49% 49% 100%

INVESTMENT THROUGH PRIOR APPROVAL OF GOVERNMENT OR FIPB ROUTE

FDI in activities not covered under the automatic route, requires prior government approval and are considered by the Foreign Investment Promotion Board (FIPB) which gives clearance on a case by case basis. Once the proposal is put forward to FIPB, it consults the concerned administrative ministry and depending on the quantum of investment and other detail of the project, clearance is given. The Secretariat of Industrial Approval (SIA) is the servicing agent of the FIPB which coordinates with the apex body while processing proposals.

SECTORS

CAPS

New investment by a foreign investor in a field in which the investor already has an existing joint venture or collaboration with another Indian partner New investment sought to be made in manufacture of items reserved for small scale industries Existing airports Asset reconstruction companies Atomic minerals Broadcasting FM Radio Cable network Direct- to-home (DTH) Setting up hardware facilities Up linking news and current affairs Up linking non- news, and current affairs TV channel 74% to 100% 49% 74% 20% 49% 49% 49% 26% 100%

Cigarette manufacturing Courier services other than those under the ambit of Post Office Act, 1898 Defense production Investment companies in infrastructure/service sector (except telecom) Petroleum and natural gas refining Tea sector- including tea plantation Trading items sourced from small scale sector Test marketing for equipment for which company has approval for manufacture Single brand retailing Satellite establishment and operations Print media Newspaper and periodicals dealing with news and current affairs Publishing of scientific magazines / specialty journals periodicals

100% 100% 26% 49% 26% 100% 100% 100% 51% 74% 26% 100%

Telecommunications Basic and unified access services ISP with gateways, radio paging, end to end bandwidth ISP with gateway (specified)

49% to 74% 49% to 74% 49% to 100%

NEED OF FDI

SUSTAINING A HIGH LEVEL OF INVESTMENT: THE TECHNOLOGICAL GAP PROPER UTILIZATION OF NATURAL RESOURCES UNDERTAKING THE INITIAL RISK DEVELOPMENT OF BASIC INFRASTRUCTURE

SIGNIFICANCE OF FDI

 FDI involves the transfer of technology, financial capital, and other skills, which are very much essential for any developing or underdeveloped nation.  It boosts overall growth in the host country through technology diffusion and transfer of capital.

 FDI leads to improvement in the capital account of the host country.  FDI can lead to increase in employment opportunities in the host country by setting up new production facilities.  It shifts the risk of investment from domestic country to foreign investors.

NEED OF THE STUDY:

There was tremendous change in the Indian economy after 1991 due to the adoption of Liberalization, globalization, and privatization policy known as LPG policy also. This policy was responsible among other factors for the growth of the country. It became very beneficial for the developing countries like India. The policy makers could forecast the need of taking up this policy which would open the road for foreign direct investment that will act as a tonic for the growth of the country. This study has been undertaken to know the worlds reaction on this step of our country along with the success of the policy and its impact on the country

OBJECTIVES

1: To study the FDI inflows since post liberalization. 2: To analyze the sector-wise inflow of FDI. 3: To study the significance of FDI flows and its impact on various macroeconomic fundamentals

RESEARCH METHODOLOGY

TYPE OF RESEARCH: It is a descriptive and Analytical type of research. Data type: It is based on secondary data Data source: RBI bulletin, FICCI reports, Dept. of Industrial Policy and Promotion Reports. HYPOTHESES: : There is no significant impact of FDI on GDP. : There is no significant difference in the growth FDI and FOREX. : There is no significant impact of FDI on GDCF. : There is no significant impact of FDI on IIP : There is no significant impact of FDI on INFLATION

ANALYSIS AND INTERPRETATION

Objective 1: To study the FDI inflows since post liberalization.

YEAR 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

FDI (CRORES) 316 965 1838 4126 7172 10015 13220 10358 9338 18406 29235 24367 19860 27188 39674 103367 140180 161536 176304

PERCENTAGE (%) GROWTH OVER THE PREVIOUS YEAR.

205% 90% 124% 74% 40% 32% -22% -10% 97% 59% -17% -18% 37% 46% 161% 36% 15% 9%

200000

180000

160000

140000

120000

100000 Series1 80000

60000

40000

20000

COUNTRIES MAURITIUS U.S.A. U.K. SINGAPORE JAPAN GERMANY NETHERLAND FRANCE SOUTH KOREA

FDI INFLOW 206962 57727 38799 24071 22194 20650 20571 9941 9918

PERCENTAGE OF SHARE 36% 10% 7% 4% 4% 4% 4% 2%

2% 8513 SWITZERLAND 1%

FDI INFLOW
FRANCE NETHERLAND GERMANY SOUTH KOREA SWITZERLAND

JAPAN MAURITIUS

SINGAPORE

U.K.

U.S.A.

Cumulative Inflows Serial no. RBIs - Regional office State covered MAHARASHTRA, DADRA& NAGAR HAVELI, DAMAN &DIU DELHI, PART OF UP & HARYANA KARNATAKA GUJARAT TAMIL NADU, PONDICHERRY ANDHRA PRADESH WEST BENGAL, SIKKIM, ANDAMAN & NICOBAR ISLAND CHANDIGARH, PUNJAB, HARYANA, HIMACHAL PRADESH GOA MADHYA PRADESH, CHATTISGARH RAJASTHAN KERALA, LAKSHADWEEP ORISSA UTTAR PRADESH, UTTARANCHAL ASSAM, ARUNACHAL PRADESH, MANIPUR, MEGHALAYA,MIZORAM,NAGALAND & TRIPURA BIHAR, JHARKHAND

%age to total inflows (in terms of US$)

1 MUMBAI 2 NEW DELHI 3 BANGALORE 4 AHMEDABAD 5 CHENNAI 6 HYDERABAD

1,99,322 1,11,937 36,139 30,969 29,914 25,605

35 19 6 5 5 5

7 KOLKATA

6,339

8 CHANDIGARH` 9 PANAJI 10 BHOPAL 11 JAIPUR 12 KOCHI 13 BHUBANESHWAR 14 KANPUR

4,223 3,316 2,961 2,421 1,633 1,196 744

1 1 0.5 0.4 0.3 0.2 0.1

15 GUWAHATI 16 PATNA 17 REGION NOT INDICTED sub total

280 27 1,13,079 5,70,105 533 _ 5,70,638 _

0.1 0 20 100

18 RBIS-NRI SCHEMES (frm 2000-2002) grand total

RANK SECTORS
2ND Electrical Equipments (including computer software and electronics) 4TH Transportation Industry 1ST 3RD Telecommunications ( radio paging, cellular mobile, basic telephone services) 7TH Fuels (Power + Oil Refinery) 5TH Chemicals (other than fertilizers) 10TH 6TH 8TH Cement and Gypsum Products 9TH Metallurgical Industries 101 222 44 146 1 881 1,970 681 1,020 573 3,136 2503 Food Processing Industries Drugs & Pharmaceuticals 611 177 192 94 511 502 909 174 1,343 1979 183 760 913 222 988 4506 1,267 3785 551 521 759 416 1,050 3,297 Services Sector (financial & nonfinancial) 2173 1,551 1,417 1,235 815 2,106 983 2,585 1989 20,348 7377 27,825

2002

2003

2004

2005

2006

TOTAL

3,075

2,449

3,281

6499

11,983

27,287

1058

532

588

3023

2338

7539

OBJECTIVE 2: TO ANALYSE THE SECTOR-WISE INFLOW OF FDI

25,000

Electrical Equipments (including computer software and electronics) Transportation Industry

20,000 Services Sector (financial & non- financial) 15,000 Fuels (Power + Oil Refinery)

10,000

Chemicals (other than fertilizers) Food Processing Industries

5,000 Drugs & Pharmaceuticals

0 2002 2003 2004 2005 2006

Cement and Gypsum Products

SECTORS Services Sector (financial & non- financial) COMPUTER SOFTWARE & hardware Telecommunications ( radio paging, cellular mobile, basic telephone services) HOUSING & REAL ESTATE CONSTRUCTION ACTIVITIES (including roads and highways) POWER AUTOMOBILE INDUSTRY METALLURGICAL INDUSTRIES PETROLEUM & NATURAL GAS CHEMICALS

2007 26589 5623 5103 8749 6989 3875 2697 4686 5729 920

2008 28,516 7,329 11,727 12,621 8,792 4,382 5,212 4,157 1,931 3,427

2009

2010

TOT AL 87766 19920 34130 39525 33059 19656 16062 15180 11409 7292

20,776 11,885 4,351 2,617 12,338 4,962 13,586 4,569 13,516 3,762 6,908 4,491 5,754 2,399 1,935 4,402 1,328 2,421 1,707 1,238

30000

Services Sector (financial & nonfinancial) 25000 COMPUTER SOFTWARE & hardware Telecommunications ( radio paging, cellular mobile,basic telephone services) HOUSING & REAL ESTATE

20000

15000

CONSTRUCTION ACTIVITIES (includin roads and highways) POWER

AUTOMOBILE INDUSTRY 10000 METALLURGICAL INDUSTRIES

5000

PETROLEUM & NATURAL GAS

CHEMICALS

0 2007 2008 2009 2010

OBJECTIVE 3: TO STUDY THE SIGNIFICANCE OF FDI FLOWS AND ITS IMPACT ON VARIOUS MACROECONOMIC FUNDAMENTALS
Year 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 FDI 174 316 965 1838 4126 7172 10015 13220 10358 9338 18406 29235 24367 19860 27188 39674 103367 140180 IIP 7 0 3 6 9 12 7 4 4 5 6 3 7 7 10 9 13 9 Inflation 9 14 12 6 10 10 9 7 13 5 4 4 4 4 4 4 6 6 GDP 1099072 1158025 1223816 1302076 1396974 1508378 1573263 1678410 1786525 1864301 1972606 2048286 2222758 2388768 2967599 3249130 3564627 3893457 4154973 FOREX 23850 30744 60420 79780 74384 94932 115905 138005 165913 197204 264036 361470 490129 619116 676387 868222 1237965 1283865 1259665 GDCF 246099 269647 286305 349266 375888 374006 419378 419885 506244 488658 474449 554044 651346 1057618 1212585 1388239 1622226 1557757 -

1. THERE IS NO SIGNIFICANT IMPACT OF FDI ON GROSS DOMESTIC PRODUCT. FDI-GDP

From the above analysis we find that the Sig. F change is 0.00 which is less than 0.05 and implies that there is a significant impact of FDI on GDP. So we reject the null hypothesis and accept the alternative hypothesis which says that there is a significant impact of FDI on GDP.

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2. THERE IS NO SIGNIFICANT IMPACT OF FDI ON FOREX. FDI-FOREX

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From the above analysis we find that the Sig. F change is 0.00 which is less than 0.05 and implies that there is a significant impact of FDI on FOREX. So we reject the null hypothesis and accept the alternative hypothesis which says that there is a significant impact of FDI on FOREX.

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3. THERE IS NO SIGNIFICANT IMPACT OF FDI ON GROSS DOMESTIC CAPITAL FORMATION. FDI-GDCF

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From the above analysis we find that the Sig. F change is 0.00 which is less than 0.05 and implies that there is a significant impact of FDI on GDFC. So we reject the null hypothesis and accept the alternative hypothesis which says that there is a significant impact of FDI on GDFC.

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4. THERE IS NO SIGNIFICANT IMPACT OF FDI ON INDUSTRIAL INDEX OF PRODUCTION (IIP) FDI-IIP

From the above analysis we find that the Sig. F change is 0.045 which is less than 0.05 and implies that there is a significant impact of FDI on IIP. So we reject the null hypothesis and accept the alternative hypothesis which says that there is a significant impact of FDI on IIP.

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5. THERE IS NO SIGNIFICANT IMPACT OF FDI ON CONSUMER PRICE INDEX (CPI) FDI-Inflation (CPI)

From the above analysis we find that the Sig. F change is 0.159 which is more than 0.05 and implies that there is no significant impact of FDI on CPI. So we accept the null hypothesis and rejects the alternative hypothesis which says that there is a significant impact of FDI on CPI.

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FINDINGS

 FDI is an important stimulus for the economic growth of India.  It has been observed that with the adoption of liberalization policy in the year 1991, the FDI inflow in India has experienced steady growth barring a few occasions sudden drop in the amount of inflows. But, the most remarkable growth of 160.54% was observed in the year 2005-2006.  The different countries of the world have taken the opportunity to invest in India since it was liberalized in the year 1991. These countries have started investing in various sectors since 1991.

The top contributor of FDI in India is Mauritius with a contribution of 36.2%. Other countries leading the list are USA, UK with a contribution of 10.11% and 6.79% respectively. The reason attributable to Mauritius being the top contributor can be given to the Double Taxation Treaty that India has with Mauritius.

On observing the sector wise inflow it was found that the major industries attracting FDI are service sector, transportation sector, electrical equipment, telecommunication, real estate, construction, power, automobiles, etc. Remarkable growth was observed in the service sector attracting an amount of Rs. 27825 Crores.

FDI create high perks jobs for skilled employee in Indian service sector.

On analyzing the state wise distribution of FDI in India it was found that Maharashtra, Dadra& Nagar Haveli, Daman &Diu top the list with 34.29%. Other states in the list are Delhi, Gujarat, and Karnataka. States like Assam, Arunachal Pradesh, Mizoram, Manipur, Nagaland, Meghalaya, Tripura, Bihar, Jharkhand Uttaranchal.

After analyzing the relationship between FDI and the Macro-economic fundamentals like IIP, GDP, GDFC, FOREX and INFLATION, it was found that FDI has significant impact on the above fundamentals except one which is INFLATION. Thus, whenever FDI inflow increases or decreases there is subsequent impact on the macro economic variables of the country

SUGGESTIONS:

 FDI can be instrumental in developing rural economy. There is abundant opportunity in Greenfield Projects. But the issue of land acquisition and steps taken to protect local interests by the various state governments are not encouraging. MOU Arecelor-Mittal controversy is one of the best examples of such disputes.  India has a huge pool of working population. However, due to poor quality primary education and higher there is still an acute shortage of talent. This factor has negative repercussion on domestic and foreign business. FDI in Education Sector is less than 1%. Given the status of primary and higher education in the country, FDI in this sector must be encouraged. However, appropriate measure must be taken to ensure quality. The issues of commercialization of education, regional gap and structural gap have to be addressed on priority.

India has a well-developed equity market but does not have a welldeveloped debt market. Steps should be taken to improve the depth and liquidity of debt market as many companies may prefer leveraged investment rather than investing their own cash. Looking for debt funds in their own country invites exchange rate risk. In order to improve technological competitiveness of India, FDI into R&D should be promoted. Various issues pending relating to Intellectual Property Rights, Copy Rights and Patents need to be addressed on priority. Special package can be also instrumental in mobilizing FDI in R&D. India has a well-developed equity market but does not have a welldeveloped debt market. Steps should be taken to improve the depth and liquidity of debt market as many companies may prefer leveraged investment rather than investing their own cash. Looking for debt funds in their own country invites exchange rate risk.

In order to improve technological competitiveness of India, FDI into R&D should be promoted. Various issues pending relating to Intellectual Property Rights, Copy Rights and Patents need to be addressed on priority. Special package can be also instrumental in mobilizing FDI in R&D.

Though service sector is one of the major sources of mobilizing FDI to India, plenty of scope exists. Still we find the financial inclusion is missing. Large part of population still doesnt have bank accounts, insurance of any kind, under insurance etc. These problems could be addressed by making service sector more competitive. Removal of sectoral cap in insurance is still awaited.

LIMITATIONS OF THE STUDY

Following are some of the limitations faced while undertaking the study:  The study is completely based on secondary data, so there is very little scope left to verify the true fact.  Availability of recent figures is quite difficult as most of the recent figures are represented as projected data.  The factors considered for the purpose of the study are limited, thus the findings may not depict the complete and true picture.  Dependability in regards to collection of data also hampers the flow of the study.

THANK YOU