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Special articles

Foreign Direct Investment

in India in the 1990s
Trends and Issues
This paper documents the trends in foreign direct investment in India in the 1990s,
and compares them with those in China. Noting the data limitations, the study raises some
issues on the effects of the recent investments on the domestic economy. Based on
the analytical discussion and comparative experience, the study concludes by
suggesting a realistic foreign investment policy.

Introduction the passenger car industry that produced obsolete (and fuel-
inefficient) models of the 1950s at very high costs in small
C omparedto most industrialisingeconomies, India fol- numbers.
lowed a fairly restrictive foreign private investment policy Without denying some of these arguments and evidence, others
until 1991 - relying more on bilateral and multilateral have shown that the regulation reduced costs of technology
loans with long maturities.Inwardforeign direct investment (FDI, imports [Subramaniam1991], and promoted export of goods with
or foreign investment, or foreign capital hereafter) was perceived relatively stable technologies where domestic firms had the
essentially as a means of acquiring industrial technology that was opportunityof 'learningby doing' by cateringto the large domestic
unavailablethroughlicensing agreementsandcapitalgoods import. market - as illustrated by successful firms like TELCO (com-
Technology imports were preferred to financial and technical mercial vehicles) and BHEL (heavy electrical equipment) [Lall
collaborations. Even for technology licensing agreements, there 1982]. The recent international achievements of some Indian
were restrictions on the rates of royalty payment and technical pharmaceuticalfirms (Cipla, Ranbaxy, Dr Reddy's Laboratories,
fees. Development banks largely met the external financial needs for instance) is also attributedto the regulatory and promotional
for importing capital equipment. However, foreign investment policies, and the patent laws [Chaudhari 1999] that sought to
was permitted in designated industries, subject to varying con- encourage domestic production to reduce drug prices.
ditions on setting up joint ventures with domestic partners,local However, the 1980s witnessed a gradual relaxation of the
content clauses, export obligations, promotion of local R and D foreign investment rules - perhaps best symbolised by the setting
and so on - broadly similar to those followed in many rapidly up of Maruti,a central governmentjoint venture small car project
industrialising Asian economies. with Japan's Suzuki Motors in 1982. It was followed by Pepsi's
ForeignExchange and Regulation Act (FERA), 1974 stipulated entry in the second half of the decade, to primarily export
foreign firms to have equity holding only up to 40 per cent, processed food products from Punjab, and also to bottle its well
exemptions were at the government's discretion. Setting up of known beverages for the domestic market.
branchplants was usually disallowed; foreign subsidiaries were
induced to gradually dilute their equity holding to less than 40 Reforms in the 1990s
per cent in the domestic capital market. The law also prohibited
the use of foreign brands, but promoted hybrid domestic brands All this changed since 1991. Foreign investment is now seen
(Hero-Honda, for instance). However, pragmatism prevailed to as a source of scarce capital, technology and managerial skills
ensure stable domestic supply at reasonable prices. that were considered necessary in an open, competitive, world
Such a restrictive policy is believed to have retardeddomestic economy. India sought to consciously 'benchmark' its policies
technical capability (as reflected in the poor quality of Indian against those of the rapidly growing south-east Asian economies
goods); it also meant a loss of export opportunity of labour- to attract a greater share of the world FDI inflows. Over the
intensive manufactures - in contrast to many successful east decade, India not only permitted foreign investment in almost
Asian economies. Moreover, such a policy is said to have all sectors of the economy (barringagriculture,and, until recently,
encouraged 'rent seeking' by domestic partners on imported real estate), but also allowed foreign portfolio investment - thus
technology - with little efforts to improve product quality, practically divorcing foreign investment from the ersts hile
undertake innovation, and seek export markets [Ahluwalia technology acquisition effort. Further, laws were changed to
1985]. This popular perception was perhaps best illustrated by provide foreign firms the same standing as the domestic ones.1

Economic and Political Weekly April 26, 2003 1701

Economic and Political Weekly, Vol. 38, No. 17 (Apr. 26 - May 2, 2003), pp. 1701-1712
What are the trends in the quantum and composition of the strength of the foreign firms vis-a-vis the domestic firms (and
FDI inflow; and what are their benefits and costs to the economy? the host government). While the foreign firms' advantages lie
This paper seeks to provide a preliminary answer for these in their size, control over technology and marketing strength
questions. To do so, we first discuss, very briefly, the recent worldwide, the host country can use its domestic market, access
literature on foreign investment and economic development to cheap labour, location and quality of infrastructure (all of
(Section I). The limitations of the available data to test the which go to reduce the cost of production to service the inter-
propositions following from the analytical literatureare discussed national market) to bargain with the foreign firms.
in Section II. As a first step in our assessment, Section IIIdescribes Thus, a social cost benefit approach is perhaps a meaningful
the trends in FDI in the 1990s. Section IV contains a brief method to assess the potential effects of FDI. If such a view is
comparison of foreign investment in India and China - an issue valid, then what countries should do is perhaps not to maximise
that has a bearing on the current policy discussion. Based on foreign investment inflow per se, but to channel it in the desired
the available, limited and preliminary, information, Section V directions to maximise long-term returns to the economy. From
makes an initial assessment of foreign investment by raising some the development economics perspective, the questions one asks
issues for furtherwork. Section VI suggests a more realistic policy could get even deeper. In a world with unequal resources and
on the basis of the analytical discussion and comparative expe- technological capabilities (including brand names), how does
rience. Section VII concludes by summarising the study's main FDI affect the ownership and control of industrial firms? In the
findings. marketfor industrialtechnologies that is invariably oligopolistic,
does foreign capital inflow augment or reduce access to techno-
logy and domestic R and D efforts? Does foreign capital improve
A BriefAnalyticalReview exports (and export capability) from the host country? What is
the cost of FDI over a long period; is it necessarily lower than
Much of the currentlyheld perceptions of foreign investment's that of external debt [Helleiner 1989]?5
role essentially take a macroeconomic view: it is a source of It is perhaps worth reiterating that markets for industrial tech-
additionalexternal finance (and of risk capital), augmenting fixed nologies continue to be imperfect and probably have got accen-
investment, potential output and employment.2 Such a positive tuated with the recent international agreements like the TRIPS.
view gained currency mainly after the crises in Latin America Moreover, the experience of the last half a centuryclearly suggests
in the early 1980s, more recently in east Asia, when other forms that countries with liberal FDI and technology import policy are
of capital inflows quickly dried up (or reversed), accentuating not necessarily the examples of successful industrialisation[Bruton
the macroeconomic vulnerability of these economies. As against 1989]. They may have become either outposts of foreign firms
portfolio investment, FDI is also seen as a source of technology servicing regional markets (like Singapore), or partners in the
and managerial skills, creating tangible (and intangible) assets international division of labour with limited mastery over pro-
in the host economy. Foreign firms seek not only the domestic duction technology and generation of domestic brand names
market, but also provide access to external markets by sourcing (Brazilian automobile industry, for example).
manufactured products (and services) from domestic firms. In the development literature, well reflected in the Indian
The crux of the policy, therefore, is how the benefits of such discourse, there is a wide consensus that regulation reduces costs
investments are distributed between the foreign firms and the of imported technology [Lall 1989]. One of the ways to acquire
host country, as also between the various factors of production the disembodied technology is to 'unbundle' the package that
within the host country. In other words, the real question is the foreign firms offer, and to buy the technology outright, while
cost of foreign capital to the host economy: is it too high, providing for capital investment by the domestic financial system.
compared to the alternative sources of external finance and This has been the time-tested method of all the successful late
technology, in the short and the long run? industrialising economies [Amsden 2001].6
However, in a microeconomic perspective, a different set of
questions is usually asked: What does FDI do to the working II
of the domestic markets, and their effect on output and produc- Dataon FDIandTheirLimitations
tivity growth [Caves 1996]. If, as is often the case, the entry of
a foreign firm results in the creation of a domestic monopoly, To understand how the recent changes in foreign investment
then the benefits of such investment may be limited, unless policy have influenced the economy, quantitative information is
accompanied by a sound anti-trust law (or competition policy). needed on broad dimensions of the investment (and its distri-
Similarly, if FDI inflow results in the displacement of domestic bution) across industries, regions and by size of projects; firm
monopolies with the foreign ones, then again, social benefits of and industry level production accounts, and audited financial
such investments may be marginal (if any), as any monopolist, statements. However, such information is scarce. The most easily
regardless of its origin, would maximise profits either by varying available (and widely used) data in India are on FDI approvals
price or output (or both). Moreover, the host government may (contracted), by broad industry group (1-digit ISIC), by country
have considerable difficulty in enforcing domestic laws ad- of origin, and by states (regions) of destination. This represents
equately, as foreign firms often seek protection under compli- mere intentions of investment. The actual (or realised) foreign
cated legal structures.3 investment is not available by the same classification, but ac-
In industrialorganisation literature,from a variety of analytical cording to the administrative and institutional channels of the
perspectives, foreign firms are seen as having firm-specific inflow. Therefore, it is not possible to compare the realised
advantages - including significant market power that they seek with the intentions, in any meaningful manner. Apparently,
to exploit in many countries.4 Availability and costs of these even the concerned official agency does not seem to know - let
resources for the host economy depend on the relative bargaining alone monitor - how the actual inflows are translatedinto capital

1702 Economic and Political Weekly April 26, 2003

Figure 1: FDIinto India, 1992-2000 and 2000, in dollar terms, is about $ 67bn - -at an average exchange
60000 -80 rate of Rs 40 to a dollar. A fifth of it is from the US (Table 1).
50000 -- 60 Mauritius is the second largest source; reportedly a conduit for
40000 8 many US based firms, as India has a tax avoidance treaty with
o 30000 40 . it since 1982. In Asia, South Korea has emerged as a new source
a: 20000- 40 of foreign investment.10 A quarter of the approved FDI is for
0 -
I i i 00 power generation (Table 2), followed by telecommunications
1992 1993 1994 1995 1996 1997 1998 1999 2000 (mobile phone firms) at 18.5 per cent, and electrical equipment
(mainly software) at 10 per cent. While the proportionof projects
Year with investment up to Rs 5 crore is high, their share is less than
FDI realised r FDIapproved *- Realised to approvedratio
5 per cent in value. At the other end of the distribution, larger
projects with Rs 100 crore and above account for over two-thirds
formation, transfer of assets or change in managerial control. of the total value of approvals (Table 3). Evidently, very little
The actual FDI inflow is recorded under five broad heads: of the FDI has gone to augment exports that are mostly from
(i) Reserve Bank of India's (RBI) automatic approval route for labour-intensive unregistered manufacturing. The economically
equity holding up to 51 per cent, (ii) Foreign Investment Board's advanced states of Maharashtra,Delhi, Kamataka, Tamil Nadu
discretionaryapprovalroutefor largerprojectswith equity holding and Gujarat have attracted one-half of the approved foreign
greater than 51 per cent, (iii) acquisition of shares route (since investment (Table 4).
1996), (iv) RBI's non-resident Indian (NRI) schemes, and Table 5 provides the actual FDI inflow as estimated by four
(v) external commercial borrowings (ADR/GDR route). Report- different agencies, for 1991 to 2000. IMF's and the World
edly, the Indian definition of FDI differs from that of the IMF, Investment Report's estimates of the cumulative inflow during
as well as of the UN's WorldInvestmentReport. IMF's definition the 1990s are roughly the same - at about $17bn. The Economic
includes external commercial borrowings, reinvested earnings Survey estimate is about $ 22bn, while that by RBI is $17.3bn.
andsubordinateddebt, while the WorldInvestmentReportexcludes The difference between the last two estimates is mainly on
external commercial borrowings.7 account of ADR/GDR inflows. While the Economic Survey
Ideally, FDI inflow should get reflected in (i) capital formation classifies them as FDI, RBI records them under foreign portfolio
(ii) formation of new firms and factories, (iii) increase in foreign investment.
equity holding in the existing firms, and (iv) mergers and ac- As there has been a gradual improvement in the actual inflow
quisitions of existing firms and factories (or parts of them). from a low base, and a slow down in the approvals after 1997,
However, the availability of information on them depends on
Table 1: Top 10 Investing Countries in India, 1991-2000
their legal status. We know very little about those registered
outside the country, and in tax shelters, like Mauritius. For Country/Region Share (in Per Cent)
instance, Enron's Dabhol Power Company - the largest foreign US 20.4
investment project yet - is incorporated in India as an unlimited Mauritius 11.9
UK 6.4
liability company. But it is a shell company that Enron controls 4.0
through at least six holding companies registered in various off- South Korea 3.9
shore locations [Mehta 1999].8 Germany 3.4
Similarly, fully owned private limited companies of foreign Australia 2.7
firms (or branch plants) reveal very little information about their Malaysia 2.3
France 2.1
investmentandoutput.An increasingly large proportionof foreign Netherlands 1.9
firms have set up fully owned subsidiaries that have become
manufacturers (and distributors) by acquiring domestic firms. Note: Inadditionto the countries,externalcommercialborrowingsand non-
resident Indians(NRIs)contributed17.2 and 3.9 per cent of the FDI
They provide very little audited financial information to assess approvals.
the impact of the firms on the industry, and the corporate sector.9 Source:Handbookof IndustrialPolicyand Statistics,2001.
Considering these legal problems, many of their operations do
not seem to get recorded in the RBI's survey of financial per- Table 2: Sectoral Distribution of FDIApprovals, 1991-2000
formance of foreign controlled companies - a valuable data Sector No of ApprovedInvest- Share
source in the earlier times. Approvals ment(Rs Billion) (inPer Cent)
Therefore, the assessment of foreign investment reported in Powerand fuel 541 634531.2 25.7
this study remains preliminary. However, based on the preceding Telecommunications 579 458845.0 18.5
discussion, the issues raised below can perhaps be taken as Servicessector 790 152389.0 6.2
Chemicals(otherthanfertilisers) 809 123016.2 5.0
working hypotheses for further research. Foodprocessing 648 87574.9 3.5
Transportsector 722 184467.6 7.5
III industries
Metallurgical 304 143796.8 5.8
Elecequipment(inclsoftware) 2491 245791.5 10.0
The Trends Textiles 548 33617.8 1.4
Paperand paperproducts 111 31580.6 1.3
FDIApprovals and Its Composition Industrial
machinery 530 22438.5 0.9
Others 2404 348976.2 14.2
Total 11965 2467025.3 100.0
Approved FDI rose from about Rs 500 crore in 1992 to about
Rs 55 thousand crore in 1997 [Economic Survey, 2001-02] Note:Data is forthe period,August 1991 to March1998.
(Figure 1). Cumulative approved foreign investment during 1991 Source: Handbookof IndustrialPolicyand Statistics,2001.

Economic and Political Weekly April 26, 2003 1703

Figure 2: India's Share in World FDI About40 per cent of the inflow seems to have been used for
2.5 ......... acquiringexistingindustrialassets,andtheirmanagerialcontrol
(Table7 (i)); and,thereseems to be a gradualincreasein such
1.5 - mergerand acquisitionsin the 1990s (Table 7 (ii)). Further,
Table8 providesan illustrativelist of plants(anddivisions)of
Indiancontrolledfirms acquiredby foreignfirms in the 1990s.
0.5 - This is also evidentfromthe fact thatforeignfirmsseem to use
a largerproportionof theirtotalfundsfor such acquisitionthan
1992 1993 1994 1995 1996 1997 for capitalformation,comparedto Indianowned firms in the
privatecorporatesector,the ratioof fixed capitalformationto
- India's share in world FDI total uses of funds by foreign firms is lower than that by the
domestic companies[Nagaraj1997].
Figure 3: Actual FDIby Different Routes Predominanceof acquisitionsin India as a route to FDI is
80 similarto thetrendsin manydevelopingeconomies.Forinstance,
70 in Brazil, the ratio is as high as 70 per cent, mainlyfueled by
60 '
~ 50SOT - -/ - - -- - -- - -- - -- - - - -- -
privatisationdrive in the 1990s.11Foreignfirms seem to find
-~'7 - --- - it a quick and cheaperrouteto entera new market,and secure
a sizeable marketshare.
ro20- _____2 r . ,/ Of late,takingadvantageof thechangesin therulesgoverning
o10 the stock marketlisting, in a situationof low sharepricelevel,
manyexistingforeignfirmsarere-purchasing theirequityto exit
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Year Table 3: Distribution of FDI by Size of Investment, 1991-97
--- FIPB ---- RBI route -- Share acquisition
Investment No of FDIApprovals Quantumof FDIApproved
-- NRI route -*- ADRs/GDRs (Rs Crore) Number Share (inPer Cent) Amount Share(inPer Cent)
0-1 3040 49.2 919.4 0.9
there is an increase in the ratio of the actual-to-approved FDI 1-5 1686 27.3 3800.8 3.6
in the last few years. On average, it is a little over one-third in 5-25 906 14.7 10046.0 9.5
25-50 212 3.4 7503.5 7.1
the 1990s (Figure 1). India's share in world foreign investment 50-100 128 2.1 8828.4 8.4
increased from 0.5 per cent in 1992, to 2.2 per cent in 1997 100-500 173 2.8 38699.0 36.6
(Figure 2). Over500 38 0.6 35992.4 34.0
Figure 3 describes the actual inflow by various routes discussed Note:This distributionis forthe approvalsduringAugust1991 and May1997.
in the previous section. The FIPB route - representing larger Source: Rao and Murthy(1999).
projects requiring the government's discretionary approval -
accounts for the bulk of the inflow, though its share is somewhat Table 4: Top Five Destinations of Approved FDI
declining. Automatic approval route via RBI meant for smaller among the Indian States
sized investments received modest inflow; and the NRI route's State No of Financial ApprovedFDI Share
share has declined sharply. Proportion of the inflow to acquire CollaborationsApproved ($ Million) (in Per Cent)
shares in the domestic firms, and flotation of ADRs/GDRs have Maharashtra 2015 11135.9 16.9
gained in prominence in the second half of the 1990s. Delhi 1226 9226.7 13.1
Karnataka 1078 5247.1 8.1
TamilNadu 1223 5073.8 7.7
Interpreting the Trends Gujarat 458 3129.6 4.5
State not indicated 3119 19476.4 27.9
Though it is not possible to compare the actual with the
Source: Handbookof IndustrialPolicyand Statistics,2001.
approved FDI for the reasons discussed earlier, some broad
generalisation can perhaps be made based on the available quali- Table 5: Alternative Estimates of the Actual FDI, 1991-2000
tative information. While the bulk of the approvals is for infra- Year Economic RBI International WorldInvestment
structure, the actual inflow seems to be largely in registered Survey (Rs Crore) FinancialStatistics Report
manufacturing- more precisely, in consumer durable goods and (Rs crore) (Million
$) (Million
automotive industries; very little of it has gone into capital goods 1991 351 316 155
industries. The inflow in telecommunication industry is probably 1992 675 965 276.5 261
to get licences for mobile phone operations,not for manufacturing 1993 1787 1836 550.1 586
1994 3289 4126 973.3 947
equipment. The investments in electrical machinery industry are 1995 6820 7172 2143.6 2144
apparently to set up local offices to produce computer software. 1996 10389 10015 2426.1 2591
Much of the realised FDI has also come in as fully owned 1997 16425 13220 3577.3 3613
subsidiaries (or branch plants) of their parents abroad. Table 6 1998 13340 10358 2634.7 2614
1999 16868 9338 2168.6 2154
provides an illustrative list of such foreign entities. Most of them 2000 19342 10686 2315.1 2315
have not issued IPOs in the domestic bourses, hence are not Tota! 89286 68034 17065.3 17080
quoted companies. Quite contrary to the earlier period, the Sources: EconomicSurvey,variousissues; RBI'sHandbookof Statistics on
government has so far not insisted on enforcing its policy in this IndianEconomy,2001; IMF'sInternationalFinancialStatisticsCD-
respect (more about this later). ROM;UN's WorldInvestmentReport,variousissues.

1704 Economic and Political Weekly April 26, 2003

Figure 4: FDIin Selected Asian Economies, 1991-2000 as comparedto China.
90- However,it is well recognisedthata largeshareof the invest-
mentinflow in Chinarepresents'roundtripping'- recyclingof
u)60- the domesticsaving via Hong Kong to take advantageof tax,
D 50
tariffsand otherbenefitsofferedto non-residentChinese.This
3300 is estimatedto be in the rangeof 40-50 percent of the totalFDI
(IFC, Global Financial Report, 2002).
Further,abouta quarterof the inflow in Chinais investedin
I?4?t 'B" t t realestate[TsengandZebregs2002]. Someof theChinesecoastal
15000 citieshaveattractedconsiderablespeculativecapitalin thissector
in the 1990s after the collapse of the propertyprices in Hong
o1990 1992 194 1996 18 2 Kong. It is widely accepted, especially after the east Asian
financialcrisis,thatforeigninvestmentin realestateis inherently
Figure 5: FDIin India and China problematic,asthissectorcaneasilygive risetofinancialbubbles,
200 *00 * --- with potentiallyadversemacroeconomicconsequences.
China Of the remaining,only a small fractionhas gone into large-
40000 India in t scale manufacturingthat can potentially augment domestic
35000 capabilityandexports.Infact,FDIfromtheadvancedeconomies
30000 thatcould bringin newer technologyand managerialpractices
25000 are limited, as the Chinese still seem to have a fairly strict
20000 / regulationon such inflows. Reportedly,in 31 industriesChina
does not allow wholly foreign owned enterprises;and in 32
others,Chinese partnersmust hold majorityshareholding.15
Basedontheforegoing,theInternational FinanceCorporation's
studyof businessenvironment,in fact, places Indiamarginally
1990 1992 1994 1996 1998 2000 2001 aheadof China- from the viewpointof foreigninvestors[IFC
2002]. The studyalso foundthatthe quantumof FDI inflow in
from the domestic bourses. Table 9 provides an illustrative list China and India, as proportionsof their respective GDP, is
of such firms. This represents a reversal of the positive effect roughlycomparable. Thus,thewidelyheldviewof China'sability
that the foreign firms' domestic listing has had on the develop- to attractenormous foreign capital needs to be taken with
ment of the primary stock market since the late 1970s [Nagaraj considerablecircumspection.
1996]. Do countriesthat attractlargerFDI inflow necessarilygrow
faster?In otherwords, is there a positive associationbetween
IV foreigninvestmentinflowandGDPgrowth?Evidenceis farfrom
A Comparisonof FDIin Indiaand China unambiguous.If China'sexceptionalperformanceis believedto
be largelyon accountof the foreigncapitalinflow,thenone also
Though the actual FDI inflow in India in the 1990s increased has to contendwith the recentBrazilianexperiencethatproves
significantly over the past, it is modest compared to many Asian the contrary.It has probablyattractedthe largestFDI fromthe
economies (Figure 4); and, it palesinto insignificance in compari- industrialisedeconomiessince 1994. As notedearlier,muchof
son to China (Figure 5).12,s3 UNCTAD's ranking of countries it has gone to acquiredomestic assets that were privatisedon
in termsof foreign investment (relative to the size of the economy) a large scale. But neitherBrazil's growthor its exportperfor-
for the period 1998-2000 is 119 for India, and 47 for China. The mance improvedin the recent years.
rankinga decade ago was 121 and 61 respectively (The New York Firmlevel studiesalso do not show any evidencethatforeign
Times, August 28, 2002). It shows that even at the start of the investmentsimprove output and productivitygrowth [Caves
reforms,China's rankingwas way ahead of India's; China moved 1996].Thereare,however,numerouscross-countrystudiesthat
up in the ranking much faster than India did in the 1990s. provideconflictingevidenceon this issue. But,they often suffer
These statistics are widely seen as an evidence of the failure fromseriousmethodologicalproblems.A recentstudythatseeks
of India's reforms, since greater inflow of foreign capital in China to addressmanyof the concernsassociatedwith suchexercises,
is believed to be largely responsible for its exceptional growth
and export performance. As this perception is much discussed Table 6: IllustrativeList of Foreign Firms Not Listed in the
in the current policy discourse, we examine the quality of the Domestic Stock Market
Indian and the Chinese estimates, and the evidence on the role ProductGroup ForeignFirms
of FDI on economic performance in the recent years. Automobilesandallied GM,Ford,MercedesBenz, Honda,Hyundai,Fiat,
According to IFC (2002), India does not follow the standard products Toyota,Volvo,Yamaha,Cummins,Goodyear
IMFdefinition as it excludes (i) external commercial borrowings, Foodandbeverages Coca-cola, Cadbury Schweppes, Kellogg, Heinz,
that is ADRs/GDRs, (ii) reinvested profits and (iii) subordinated Seagram, HiramWaker, United Distillers,Perfitti,
debt.14 IFC is probably right, but only partially. As noted earlier, Wrigley,KFC,McDonalds
the Economic Survey estimates include external commercial Consumerdurablegoods Daewoo, Samsung, Sony, General Electric, LG
Electronics,Blackand Decker,Kimberley
borrowings,but not the remaining two items. Thus, notwithstand-
ing the underestimation of FDI in the Indian statistics, there is Personalcare products Revlon,L'Oreal,Cussons, Unilevers
littledoubtthatforeigninvestmentinflow in Indiais negligible Source:Rao, Murthyand Ranganathan(1999).

Economicand PoliticalWeekly April 26, 2003 1705

Figure 6: Decline in Technical Collaborations Agreements are only a few.17 Further,contrary to many early apprehensions,
1200r -80 bulk of the domestic firms (and brand names) have not been
displaced from the market.Dominant domestic firms have sought
to protect their market shares by expanding capacity and distri-
bution networks, contributing, among other factors, to the boom
-" in fixed investment in registered manufacturing in the 1990s
^iYear [Nagaraj 2002].
Though foreign firms have acquired a visible presence in
~~2 ~ .101 consumer durablegoods industries, by and large, it has apparently
not been an easy entry for them. While, again, no definitive
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Year estimates are available, popular reports suggest many of them
I I FTAs - Share of FTAs in total overestimated the size (and the growth) of the domestic market,
and the appeal of internationalbrands, and thus now suffer from
seems to find no evidence of a positive association between FDI excess capacity and poor profits (Financial Times, April 25,
inflow and output growth [Carkovic and Levine 2002].16 2002). Foreign firms seem to have realised the smallness of the
Thus, the quantum of FDI inflow into China, and its positive domestic market, and price sensitivity of its consumers.18
effect on the economy are perhaps overstated. Without getting Reportedly, a few foreign firms have left India, while many others
into simplistic comparisons, what we need to appreciate from have staggered their investment and expansion plans.19
the Chinese experience is perhaps how to take advantage of the However, realising the narrowness of the domestic market,
openness to investment and trade, to expand domestic capability many foreign firms are discovering the way out is to indigenise
and get access to external markets for its labour intensive production to reduce costs and secure economies of scale.
manufactures. Moreover, there seems to be a growing appreciation of the cost
advantage of domestic manufacturing for exports. For instance,
V discovering that their car was too expensive for the domestic
A Preliminary
Assessment market,Ford has now found it profitable to use its Indianfacilities
for the external market. Reportedly, it has exported 30,000 CKD
Focus on Domestic Market kits to ChinaandSouth Africa last year [Business World,December
2, 2002]. Samsonite is apparentlyexpanding its Indianoperations
As notedearlier,India's seemingly large (andgrowing) domestic for exports, while closing down its Europe plants. There are
market is probably the main attraction for foreign firms. For similar reports from ABB (electrical equipment manufacturer)
instance, internationalsoft drinks producers and fast food chains and Cummnis (Diesel engine manufacturer) as well. If such a
that were unknown a decade ago have acquired a visible presence tendency gathers momentum, India could possibly emerge as a
in the metropolitan cities, though their quantitative significance competitive manufacturingbase in these firms' global production
may yet be marginal. These firms have brought with them the networks.
oligopolistic market structuresand firm rivalries that are evident
in the developed economies. While such market structures may Problems with Infrastructure Investment
have some desirable properties, if they lead to tacit collusion to
bar new entry, then it may not be a positive development in the Foreign investment in power generation that attracted the
long run. largest approved FDI was predicated on securing a high and
Similarly, almost all majorinternationalautomobile companies assured rate of returnon invested capital - modeled after Enron's
have set up assembly and manufacturing facilities in varying DPC. It was the first of its kind, offering exchange rateguaranteed
extent. The same probably holds true for washing machines,
Table 7 (i): Share of M and A as in FDIInflows in India
refrigerators, and entertainment electronics. Such large-scale
entry of firms has resulted in increased price and non-price Year FDIInflow Mand A Fund Share of Mand A Fund
competition, leading to a greaterchoice and quality improvement ($ Million) ($ Million) in FDIInflow(Per Cent)
- a desirable outcome for consumers. 1997 3200 1300 40.6
Initially, there were considerable apprehensions that interna- 1998 2900 1000 34.5
tional firms with their superior technology, marketing skills and 1999 (Jan-Mar) 1400 2800 39.4
financial strength would wipe out domestic firms (and brand Source: Kumar(2000: 2852).
names) in many of these industries.To some extent this has indeed
Table 7 (ii): Foreign Firms Related M and A in India
happened - in the aerated drink market, for instance. The same
is partly true in the automotive industry as well: Fiat gradually Year Mergers Acquisitions Total
acquired Premier Auto (its erstwhile licensee); Hindustan 1993-94 4 9 13
Motors (an erstwhile GM licensee) has largely become a sub- 1994-95 - 7 7
contractor for GM and Ford, producing engines and trans- 1995-96 - 12 12
mission equipment. 1996-97 2 46 48
1997-98 4 61 65
But many technologically strong and financially sound domes- 1998-99 2 30 32
tic firms seem to have withstood the growing competition - at 1999-2000
least so far. In some cases, domestic firms have severed their (Upto Jan 2000) 5 74 79
Total 17 239 256
ties with their foreign collaborators to assert their managerial
independenceaftersome yearsof association,thoughsuchcases Source:Kumar(2002: 2852).

1706 Economic and Political Weekly April 26, 2003

16 per cent rate of return on investment on power purchase by initiatives of the earlier period. Foreign firms were quick to seize
the MaharashtraState Electricity Board. The agreement was not the opportunity to issue large equity to themselves at a fraction
based on competitive bidding, violating many established norms of the market prices (when the stock market was booming). This
of investment planning for a project of that size and scope. This meant, in principle, a substantial FDI inflow in the book of
was apparentlydone in the early years of the reforms to signal accounts during 1991-94, but in reality it was simply a book
India's eagerness to invite foreign investment. transferwithout any fresh capital inflow. With a largerproportion
Most of these power projects did not fructify, as they were of equity held by the parent firms, it is now possible for them
based on unrealistic assumptions regarding the profitability and to take out an ever-larger share of surplus in perpetuity.21 Table
the marketsize. Moreover, as the Enron's Indian saga unraveled, 10 provides an illustrative list of the foreign firms that followed
most foreign firms discovered the state governments' inability such a practice, and their gains due to the discount on the issue
to ensure the guaranteedreturn,hence cancelled their investment price of the fresh equity.
plans. The speed and secrecy, with which the Enron project was It only goes to show how sensitive foreign firms are about the
launched, ignoring the checks and balances in public decision- managerial control. In the absence of suitable regulations, they
making, invoked considerable debate in the press, parliamentand would like to retain an absolute control that may not be desirable
academia. In retrospect, many of the criticisms seem valid, for the host country. However, it is often argued that majority
denting foreign investment's popular image (and the credibility equity holding is necessary for international firms to be assured
of its exponents). enough to bring in the latest technology that could potentially
However, there are probably other reasons as well. Much of have positive spillover in the host economy. This view seems
the projecteddemand for power that formed the basis for inviting suspect. There is some evidence to show it is not the majority
such a large FDI in this sector was apparently inflated.20 After control, but the market structure that determines innovation and
the industrialslow down since the mid- 1990s, the demand-supply the introductionof new technology. Mani (1983), in a case study,
gap was found to be relatively modest [Nagaraj2002]. Moreover, showed that in the 1970s when the world's leading firms
cost of production of the thermal power plants of many state dominated the Indian automotive tyre industry, it was the new
electricity boards using domestic raw material and capital equip- Indian entrants like Apollo and Vikrant Tyres that introduced
ment were found to be lower than that of the proposed FDI innovations, and not the incumbent firms. Faced with such a
(invariably using imported feedstock). With hindsight - consis- threat, foreign firms quickly followed suit to protect their market
tent with much of what the critics maintained - the problem with shares.
the power sector was not so much the inefficiency of generation,
but pricing and recovery of the user charges. Despite the much Technology Spillovers
publicised reforms in the 1990s, the average revenue-to-cost ratio
in the power sector has not improved. As noted earlier, one of the arguments in favour of FDI is
the potential positive externality of technology into the host
Net Foreign Exchange Inflow economy. However, in reality, the process may not be that
simple. We have seen, that foreign investment does not neces-
For long it has been held that foreign firms bring in limited sarily lead to fixed capital formation; moreover, technical spill-
net resources in the host economy, as they usually take a large overs depend on the extent of value addition that is carried out
surplus out of the country as dividends and royalties [Chandra in the host economy. For instance, assembly operations or pro-
1991]. This, to some extent, is probably true of what happened duction of simple consumer products is likely to have marginal
in India in the early 1990s, though it may be hard to substantiate. externality.
One of the earliest changes in the foreign investment rules after For instance, most automobile firms - barring Hyundai and
the reforms was to remove the restriction on the foreign equity to a less extent Ford - have essentially set up minimal facility
holding in the existing foreign firms - reversing the policy to assemble and paint their imported CKD kits, leading to a

Table 8: Illustrative List of Units/Divisions Transferred to Foreign Firms

Unitsto be Transferred/Transferred Remark
AparLightingDivision Transferredto the joint-venture(JV)GE-AparLtd
Compressorunitof KirloskarBrothers Transferredto KirloskarCopeland
Compressorunitof SIELand Kelvinator Takenover by Tecumseh Venture
Enginevalve divisionof KirloskarOil Engines Proposed to be transferredto a JV withMWP,subsidiaryof MahelGermany.
HalolPlantof HindMotors Transferredto a JV withGM,of the US
HinditronComputers Acquiredby DigitalEquipmentCorp
IndiaLinoleum Transferredto a JV withDLWof Germany
PremierAuto Takenover by Fiat
LuxarPen Transferredto a JV withGillette
Electricmetersof VXLLtd Transferredto VXLLandysGys Ltd
Motorcycle divisionof Escorts Transferredto EscortsYamahaLtd
OralCareDivisionof Parle Acquiredby Gillette
Refrigeratordivisionof Godrej&Boyce Transferredto Godrej-GEappliances
Specialtychemicalsdiv of MaxIndia Transferredto Max-Atotech
Stabiliserdivisionof Jan Auto Takenover by NHKJai suspensions Ltd
Sugarmachinerydiv of KCPLtd Transferredto FCB-KCPLtd
Ceat'sTwo-and three-wheelertyre plant Transferredto South Asia Tyres Ltd withGoodyear
Source:Rao, Murthyand Ranganathan(1999)

Economic and Political Weekly April 26, 2003 1707

proliferation of firms and models with modest rise in domestic in building such assets before 'exporting' them. India followed
production and technological capability.22'23 a prudent policy in this respect up to the 1980s. However, in
In other durable goods industries too, foreign firms have the 1990s, as mentioned earlier, in soft drink industry, Coca Cola
acquired dormant domestic firms and/or resorted to contract bought rival brand Thumps Up; Gold Spot and Limca; Pepsi
manufacturing with the existing firms rather than set up green purchased Mongola, Dukes and so on. The foreign firms de-
field plants.24 While these may be efficient strategies for the stroyed many of the purchased brands that competed with their
firms concerned, the social benefit of such arrangements may international ones. Coca Cola "killed" all competing brands
remain modest. Ourcontention is consistent with RichardCaves's except Thums Up, as it was too uneconomical to do so. Report-
observation: edly, even now, this cola drink sells four times as much as the
from subsidiaries to local worldwide brand of Coke. It only seems to show how 'path
...While productivityspillovers foreign
firms are apparentlywidespread,they are neither ubiquitousnor dependent' brand loyalty can be in consumer goods. Therefore
there seems to be considerable merit in promoting indigenous
independentof firms' marketambientstructure.... Spilloversmay
be a justificationfor LDC governmentpolicies to encourageflow brands that have the potential to compete in the world market.
of foreign direct investment. ... Justificationis likely to be con- Such hasty policy changes could prove a costly mistake in the
ditional on the country's state of development and the structure long run for India, as consumer goods are nothing but their brand
of particularindustriesin which foreign subsidiariesmight alight names.26
[Caves 1999: 17].
Loss of Bargaining Power in the Technology Market
Decline in Competition
It is well accepted that dominant international firms have
FDI, in principle, brings in greater market discipline on the substantial market power, and many developed countries widely
incumbentfirms by increasing competition. But, as we have seen, intervene in the technology market to protect and promote in-
foreign firms often acquired dominant positions by taking over terests of their firms.27 Indian policy, after the reforms, prac-
domestic firms (and brands). This, again, is best illustrated by tically ceased to intervene in the technology market,significantly
Coca Cola's acquisition of the dominant domestic competitor, weakening domestic firms' bargaining position.
ThumsUp; and HindustanLever's-Indian subsidiaryof Unilever With the increasing role of financial collaborations, foreign
- acquisition of its largest domestic rival, and the second largest technical agreements as a source of technology have steadily
firm in the industry, TOMCO, and the largest cosmetics firm,
Lakme. Table 9: An Illustrative List of Foreign Firms Moving to De-List
In principle, in a well functioning market economy such from Domestic Bourses
acquisitions would have attracted the provisions of the compe- SI Company Current OfferPrice
Acquirer's Post-offerHolding
tition law. But they went unchallenged in India as the MRTP No Holding(PerCent) (Rs) (PerCent)
Act - the anti-trust law - was practically abolished as part of
1 Cabot 60 100 92
the economic reforms. Further,the government ignored the public 2 Cadbury 51 500 90
and academic criticisms of such acquisitions, as it was keen to 3 CarrierAircon 51 100 86
signal a positive outlook towards FDI. Thus, our examples show, 4 CentakChemicals 75 200 93
5 Hoganas 51 100 85
the widely held view of foreign investment per se leading to 6 Otis 69 280 79
greater competition needs to be taken with caution. 7 Philips 51 105 83
8 Reckitt&Colman 51 250 Yetto open
9 Sandvik 73 850 89
Foreign Exchange Earnings
Source: Business India,April1-14, 2002: 118.
One of the common apprehensions against foreign investment
is the net drain of foreign exchange in the host countries. Many Table 10: An Illustrative List of Foreign Companies that Issued
countries seek to overcome this problem by imposing foreign to Themselves Shares at a Concession

exchange neutrality clauses. Reportedly even the UK applied Sl Company Noof Shares PreferentialMarketPrice Gainto the
such a clause while permitting Japanese automotive firms in the No Allotted Issue Price on Allotment Company(in
(inmillion) (inrupees) Date (rupees)millionrupees)
early years of conservative reforms in late 1970s and the early
1980s. Many states in the US apply conditions of job creation 1 Colgate 11.3 60 700 7227.5
while offering incentives for Japanese automotive firms. Though 2 Castrol 3.5 110 1050 3325.7
3 Sesa Goa 3.3 120 1025 2968.4
we do not have data to examine net foreign exchange outgo on 4 Asea BrownBoveri 4.8 60 325 1260.0
account of foreign firms that came into India in the 1990s, the 5 Bata 4.7 35 325 936.7
government, reportedly, has been lax in enforcing this clause or 6 CoatsViyelia 7.5 65 260 1444.7
has diluted it.25 This could be a serious matter, especially with 7 AlfaLavel 3.4 73 290 738.8
8 Nestle 4.8 70 285 1021.6
many automotive firms that have set up are largely limited 9 Glaxo 4.5 75 255 808.0
assembly plants. 10 Hoechst 2.2 70 370 645.3
11 Lipton 3.5 105 380 972.4
12 Proctor&Gamble 4.8 70 285 1021.6
Brand Names 13 Proctor&Gamble 1.9 225 340 223.1
14 Philips 7.7 40 205 340.0
In consumer goods industries intangible assets like brand 15 Reckitt&Colman 3.0 100 380 848.4
names matter most; and, it takes a long time and effort to create Totalgainto the foreignfirms 24737.0
them. A large home marketis widely accepted to be advantageous Source:Jain (2001: 219).

1708 Economic and Political Weekly April 26, 2003

dwindledin the 1990s - both in absolute and relative terms foreigninfrastructure investmentfromtheUS in the 1930s,only
(Figure6) [EconomicSurvey,2001-02]. Evidently,foreignfirms to leave withthe bitterexperienceof nationalisations in a couple
do notwantto partwiththeirtechnology,as they can now come of decades. It bears repetitionthat infrastructure is inherently
into Indiawithouta domestic partner. capitalintensivewith long gestationlags, and low (but stable)
Consideringtheir superiorfinancialand technicalstrengths, returnsovera longperiod.Marketfailuresareubiquitousin these
manyforeignfirmsin the capitalgoods industryseem to have industries,with considerablenetwork economies necessarily
wrestedmanagerialcontrolin the existingjoint venturesin the invitingwide anddeep stateintervention.In a worldconsisting
1990s.Forexample,Caterpillarboughtout Birla'sstakein their of politically independentnations with a growing numberof
jointventuremanufacturing earthmovingequipmentalthoughthe democracies,thepricingof infrastructure is boundto be a political
firmwasdoingwell inthemarket.Manyautomotivefirmsstarted decision.Foreignfirms with shortpay back periodsinvariably
as joint ventures,but graduallyforeignpartnersincreasedtheir findit hardto stayon, as it conflictswiththe goals of developing
financialstakebybuyingoutdomesticpartners,asIndianpartners economiescaughtin anincreasinglyuncertainworldeconomy.28
wereunableto bringin the resourcesto makeup for the losses There are also perhapssome India specific factors for the
in the early years of the firms' operations.This happenedat a relativelysmallforeigncapitalinflow.It seems worthreiterating
time when the domestic interest rates were higher than the that India is still largely an agrarianeconomy, with land pro-
international rates.Foreignpartnersfoundit an inexpensiveway ductivitybeinga thirdof China's,wherethe averagedisposable
to acquirea greatermanagerialcontrol,especiallyas thecurrency income aftermeetingfood and clothing (wage goods) require-
was steadilydepreciating. mentis stillrelativelysmall.Price-income-ratio of mostconsumer
For instance,Hondaboughtout the Sriramgroup,and Ford goods thatforeign firms usuallysell is high by domesticstan-
acquiredMahindras'sstake in theirjoint venturecar projects. dards, accentuatedperhaps by cultural factors and regional
However,more recently, there are instancesof the converse, heterogeneityof markets[Financial Times,April 25, 2002].
whereIndianfirmshave boughtout theirforeignerpartners;for In infrastructure industries,the rupeecost of electricitysupply
instanceTVS Motorsand Suzuki, Kinetic motorsand Honda. by foreign firms seems high. Given India's fairly diversified
and LML and Piaggio. But such instancesseem far fewer. industrialcapability,andlow labourcosts, foreignfirmsmaynot
Arguably,theaboveexamplesillustratethevirtuesof a market have a cost advantageover the domesticproducers- especially
drivenprocessfor corporatecontrolthatis best left to it. Such withthe currencydepreciatingin nominalterms.This is perhaps
a benignview may not necessarilyfavourdevelopingcountries bestillustrated,again,by theEnron'sDPC.Withimportedcapital
and theirconsumersin the long run. For instance,the demise goodsandfuel,andhighoperatingcostdueto international norms
of Spanishautomotivefirmswith its integrationin theEuropean of costing, Enron'scost of productionwas found to be higher
Union, and the lack of technologicaland marketdynamismin thanthecomparablenewplantsusingdomesticcapitalequipment
the Brazilianautoindustry- despitesubstantialinvestmentand [Morris1996].
outputgrowth- probablysuggeststhatstrategicinterventionto At thesametime,Hyundai'slargeinvestmentwithconsciously
supportdomesticfirms and industryare not incompatiblewith built-in high domestic content secured througheconomies of
securingdynamiccomparativeadvantageand exportcompeti- scale has succeededin producinga small car that seems com-
tiveness. petitivebothin priceandquality.Reportedly,Hyundaiproposes
In sum, while the entryof foreign firms has increasedcom- to use its Indianplant as a global hub for its small car [The
petitionandimprovedthevarietyandqualityof consumergoods, EconomicTimes,January2, 2003]. Thus, the key to increasing
thereare some disturbingsignals. Foreigninvestmentin infra- FDIinflowseemsto lie in industries(andproducts)withrelatively
structureis a failure.Gradualloss of managerialcontrolin many high technologythat have large economiesof scale, with sub-
industrialfirms, decline in competition in some industries, stantialdomestic content.
extinctionof some leading domesticbrandnames and limited However,the foregoingreasoningstill does not explainwhy
improvement in domesticproductioncapabilityseem to be signs foreigninvestmentdoes not come to use cheaplabourandskills
of concern. for exportof labourintensivemanufactures - as it has happened
in China.We areinclinedto believe thatthe foreigninvestment
VI policy lacks a clearfocus. Unlike China,Indiahas not invested
Towardsa RealisticFDIPolicy in exportinfrastructure. In fact, as is widely acceptednow, the
share of infrastructure in fixed capitalformationhas declined
It is widelybelievedthatIndiahas not done enoughof policy sharplyfor nearly one and half decade now [Nagaraj1997].
reformsto attractsubstantiallymoreforeigninvestment.More- Further,what is needed is perhapsnot large investmentbut
over,it is not the financialincentivesbut the lack of adequate suitableinducementto internationalmarketers- tradinghouses
infrastructure,bureaucraticdelaysandaboveall, the rigidindus- andretailchains- to set uppurchaseoffices andtestingfacilities
triallabourlaws thathave come in the way of attractingmore to tapthepotentialof the domesticmanufacturers.29 It is widely
investments[Sachsand Bajpai2001]. This view seems to have acknowledgedthat China'sexportsuccess largely lies in mar-
manylimitations.Forinstance,thereis no evidenceof a positive ryingits low cost manufacturing capabilityin Town andVillage
associationbetweenthe extent of marketorientedreformsand Enterprises (TVEs) with HongKong'shighlydevelopedtrading
FDI inflows across developing economies [Easterly 2001]. houses and other long-establishedcommercial organisations
Moreover,as discussedearlier,greaterforeigninvestmentinflow cateringto internationaltrade.While it is out of questionfor
doesnotnecessarilymeanfasteroutputandexportgrowth.What, Indiato replicatethe locationalandhistoricaladvantageof Hong
then, shouldguide India's foreign investmentpolicy? Kong for China,investmentin exportinfrastructure in strategic
If historyis any guide,foreigninvestmentin infrastructureis locationsandcarefullytailoredincentivesto international trading
potentiallyproblematic.Latin America witnessed a wave of houses (and retailers)merit a serious consideration.Similarly

Economicand PoliticalWeekly April 26, 2003 1709

suchinvestmentsareperhapsequallynecessaryto tapthegrowing thatin India,in relationto its domesticoutput.Contraryto the
potentialfor usingIndia'slabourcost advantagefor doing back popularbelief, China'sforeigninvestmentregimeis said to be
office jobs - businessprocessesoutsourcing- for international more restrictivethan India's. Therefore,what Indiashould be
firms [The Economist, May 5, 2001]. concernedabout is not so much the absolutequantumof the
Realistically, is it that India expectsfrom foreigninvest- inflow, but how effectively it uses its external openness to
ment, and how to secure it? In principle,openness to foreign augmentthe domesticcapability,andaccess foreignmarketsfor
investmentshouldbe strategic,notpassive(orunilateral).History its labourintensivemanufactures.
does not seem to supportsuch an uncriticalinternationalinte- For a careful economic analysis of the effects of foreign
grationas a provenrouteto growthandefficiency.If the recent investment,considerabledetailedstatisticalinformationis re-
experienceis any guide, foreign capital is far from a major quired- both at the aggregateand at the firm or industrylevel.
providerof externalsavings for rapid industrialisationof any In their absence,much of our analysis is indicativein nature,
largeeconomy.It can only supplementthe domesticresources, raisingquestionsfor furtherenquiry.
whereverthey necessarilycome bundledwith technology,and As the 1990s' experienceshows, quitecontraryto the popular
accessto international productionanddistributionnetworks.The perception,thesize of India'sdomesticmarketis relativelysmall,
termsof foreigninvestmentwill dependon therelativebargaining giventhelow levels of percapitaincome.Aftermeetingtheneeds
powerof the foreignfirm vis-a-vis domesticfirms, backedby of food andclothing(wage goods), incomeleft for spendingon
thestate.Indianadvantages aretheavailabilityof skilledworkforce, productsthatmost foreignfirmsoffer seems small;theirprice-
cheaplabour,andthesize of thedomesticmarket,whichit should income ratio too high for Indianconsumers.Therefore,many
leverageasmostsuccessfulcountrieshavedone.A tellinginstance of them seem to be makingefforts to indigeniseproductionto
of it is perhapsKorea'sbig leap in semiconductorand telecom reducecostsandsecureeconomiesof scale.Inthisprocess,many
equipmentmanufacturing in the recentyears,as it seemsto have foreignfirmsarediscoveringthe potentialof low cost of manu-
tied liberalisationof domesticmarketto sharingof production facturingfor exports.
technology. Much of the approvedFDI in infrastructure did not fructify,
If thisviewhasanyvalue,thenhow shouldwe go aboutinviting as the rupeecost of electricitysupplyby foreignfirmsis much
FDI thatis consistentwith the economy's long-terminterests? too high for Indianconsumers.This seems truefor two reasons:
Foreigninvestmentshouldbe allowedmainlyin manufacturing one, pricesof goods like electricityare widely subsidised,and
to acquiretechnology, and to establish internationaltrading cannotbe increasedwithoutinvitingpublicopposition;second,
channelsfor promotinglabourintensive exports.

Summary Conclusion
Endingits long held restrictiveforeign investmentpolicy in
1991,Indiasoughtto competewith the successfulAsianecono-
mies to get a greatershare of the world's FDI. Cumulative
approvedforeigninvestmentsince then is about$67bn,but the
realisedamountis abouta thirdof it - the ratioroughlycom- Prepublication
offerof VanRheede's
parableto China's.While the foreigninvestmentinflow repre- HORTUS
sents a substantialjump over the 1980s, it is modestcompared
to manyrapidlygrowingAsian economies,andminisculecom- English Edition in 12 volumes
pared to China. While the bulk of the approvedFDI is for
infrastructure,the realisedinvestmentis largelyin manufacture With annotationsand modem
of consumerdurablegoods andthe automotiveindustryseeking nomenclature
by Prof. K S Manilal,
India'sseeminglylargeand growingdomesticmarket.Foreign ProfessorEmeritus,CalicutUniversity.
investmentin telecom and software industrieshas also been Tis Edof HortuMalubai
rfit eerEnglirsh
significant.ApprovedFDI has largelygone to a few developed wil beanassettoanyleadinglibrary.
states- similartoitsconcentration
in China. A sizable part of the foreign investmentseems to ORDER NOW AND SAVERs 5000/!
representa gradualincrease in foreign firms' equity holding Original price Rs 20,000/
(hencemanagerialcontrol)in the existingfirms,andacquisition Pre-publication Price Rs. 15000/
of industrialassets (and brandnames).
China's ability to attracta phenomenalamountof foreign
investmentis a puzzleformany.About40-50 percentof China's
To order your copies, write to the Director of
FDIrepresentsitsdomesticsavingrecycledas foreigninvestment
Publications, University of Kerala,
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popularlycalled the "roundtripping".Another25 per cent or crossed Demand Draft for Rs.15000/ in favour
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1710 Economic and Political Weekly April 26, 2003

Indiaproducesmuch of these services at lower cost using domestic domestic investment,while no such association was found with respect
raw material and capital equipment. to foreign portfolio investment.
3 For a long time developing countries have complained about foreign
Foreign investment in consumer goods industries has increased firms, as they seemed to hide their trueoperationsfrom the host country
domestic competition, resulting in greater choice and quality rules. But in the recent years undereasier capital flow regime the same
improvement. While FDI inflow displaced some domestic firms legal maze seems to have begun to hurttax compliance in the developed
(and brandnames), the bulk of them have - at least yet - largely countries as well. Recently a report in the New YorkTimes sought to
been able to withstand the competition by making large capital unveil the legal maze of such operations [Johnston 2002].
investment, and in expanding distribution networks. 4 Though largely ignored in the mainstreameconomic writings, much of
the literatureon the behaviourof internationalfirms builds on Stephen
However, in industrial goods there have probably been
sizable acquisitions of domestic firms (and factories) whose Hymer's (1976) original contribution that focused on firm specific
characteristic,including their market power.
details are not known. There are many instances of foreign firms 5 It has long been held in the development literaturethat while short run
gradually acquiring controlling interests, edging out domestic cost of foreign debt is high, the long-term costs of FDI could be even
partners. Whether these firm-level changes get reflected in higher [Lewis 1953]. In fact, it is such a view that prevailed in the
industrial efficiency in the aggregate - as many expected - is successful industrialisationefforts of Japan, Korea and Taiwan that
a moot point. carefully regulated foreign investment inflow.
6 However, some recent literaturein mainstreameconomics has argued
What should be done to increase foreign investment? It is that while the state may have succeeded in steering these economies
popularly believed that a more liberal policy regime, industrial in the past, thereis little guaranteethat in the developing countriestoday
labourmarketreforms, and infrastructureinvestment are needed. the state has similar capability to repeat the performance[World Bank
While infrastructureimprovement surely merits a close attention, 1993].
one is not so sure if the extent of the reforms and the quantum 7 "Flowof FDI comprisescapitalprovided(eitherdirectlyor throughother
of foreign investment inflow are positively related. Moreover, enterprises)by a foreign direct investor to an FDI enterpriseor, capital
received from an FDI enterpriseby a foreign direct investor. There are
there is little evidence that greater FDI inflow ensures faster
three components in FDI: equity capital, reinvestedearnings,and intra-
output and export growth. Such simplistic associations, usually company loans." (World InvestmentReport, 2001: 275).
based on cross-country analysis, seem to have support neither 8 Apparently,there is a discrepancy in Enron's declarationof its equity
in principle nor in comparative experience. holding in the Indianentity. To the US bankruptcycourt it has declared
What is needed is a strategic view of foreign investment as that it holds 50 per cent, but here it has declared that it owns 65 per
a means of enhancing domestic production and technological cent equity.
9 The law requiresall closely held (private limited) companies to submit
capability, and as also to access the external market for labour their annualauditedaccounts to the departmentof company affairs that
intensive manufactures - as China has precisely done. It seems are, in principle, available to the public. But practice seems different
valuable to reiterate what K N Raj, a perceptive observer of as the law enforcement seems poor.
comparative economic development, noted early on in China's 10 Korean firms have aggressively moved in to India, since they perceive
liberalisation drive, "It is certainly not without good reason that it as their only chance to get into the last unexplored market, to beat
China has chosen to be hospitable even to multinationals with their established corporate rival from Japan and the US.
world-wide ramifications like IBM, evidently in the expectation 11 Assessing the Brazilian reforms, Rocha (2002) said, "Mergers and
of securing the know-how for building up semi-conductor in- acquisitionsof privatefirms have been equallycentralto the restructuring
of the Brazilianeconomy...A recent study shows thatbetween 1995 and
dustry of its own. Those who do not realise the implications of 1999 there were 1,233 mergersand acquisitionsin which multinational
all this for India are living in a dream world of their own..." corporationsacquired control or participationin Brazilian industries-
[Raj 1985]. the devaluationof the real since 1999 making such purchasescheaper.
Such interventions need selectivity, and strategic intent. A KPMG survey reveals that 70 per cent of all acquisitions in Brazil
Comparative experience seems to clearly favour such a policy during the same period were undertakenby multinationals,to the tune
of some $50 billion of FDI inflows" [Rocha 2002: 23].
stance. [1 12 Data for this graph is from the various issues of the UN's World
Investment Report.
Addressfor correspondence: 13 Figure 5 is from IFC (2002). In this graph,x-axis representsyears, and
nagaraj@igidr.ac.in y-axis measures FDI in million US dollar.
14 I am grateful to CherianSamuel for providing this unpublishedstudy.
15 Quoting an OECD study, China in the World Economy, Srinivasan
Notes (2002) reportsthatmajorityChinese equity holding is mandatoryin coal
mining, design and manufactureof aircraft,oil and gas, printing and
[This is a revised version of a paperpresentedat the Conferenceon Foreign publishing,agriculturalproductionin grains,cottonandoil seeds, domestic
Direct Investment- Opportunitiesand Challenges for Cambodia,Laos and commerce, foreign trade, medical instrumentsand repairs, design and
Vietnam organised by the State Bank of Vietnam and the IMF in Hanoi manufactureof ships.
in August 2002. Following the usual disclaimers, the author gratefully 16 I am grateful to Edward Graham for this unpublished paper.
acknowledgesthe comments and suggestions that he received on this study 17 For instance, in the two-wheeler industry,TVS, Kinetic and LML have
from K V Ramaswamy,C RammanoharReddy and M H Suryanarayana. terminatedtheir technical and/or financial collaboration with Suzuki,
The authoris also indebtedto PradyumnaKaul for sparing time to discuss Honda and Piaggio respectively to introduce indigenously developed
some issues on foreign infrastructureinvestment.] motorcycle/scooter models that have been well received in the
market.Bajajhas stopped making motorcycles in joint brandname with
1 Fora chronologicalaccountof the policy reforms,see appendixof Bajpai Kawasaki for the domestic market, to introduce its own brand of
andSachs (2001). For detailedofficial statementson the policy changes, motorcycles. In consumer products, Godrej, a leading domestic firm,
refer to the ministry of industry's annual publication, Handbook of terminatedits comprehensive ties with Proctor and Gamble, and re-
Industrial Statistics. promotedown brands to regain its lost market share. In wristwatch
2 There is some evidence to supportthis view. For instance, using cross- industry,Titan industriesceased its collaborationwith Timex to expand
section data for 58 developing countries during 1978-95, Bosworth and internationally.
Collins (1999) show that a dollar of FDI translatesinto an equivalent 18 Externalliberalisationwas predicatedon the propositionthat India has

Economic and Political Weekly April 26, 2003 1711

a core of about 200 million consumers with purchasingpower close to of Economics, HarvardUniversity.
that in the developed economies. After a decade's experience, many - (1996): Multinational Enterprise and Economic Analysis, 2nd Edition,
marketresearchagencies have reportedlyprunedthe estimateto a quarter CambridgeUniversity Press, London.
of the original. Chandra,Nirmal (1991): 'Growth of Foreign Capital and importance in
19 For instance, BMW (motorcycles), Piaggio (scooters), Nine Gold Indian Manufacturing', Economic and Political Weekly, Vol 26,
(broadcasting), Kokna and Haier (Chinese electronics firms), Roche, Nos 11-12.
Merck (pharmaceuticals),Blue Bunnies (ice cream) and so on have left
Chaudhuri, Sudip (1999): 'Growth and Structural Change in the
India (Business Standard, October 28, 2002). PharmaceuticalIndustryin India',IndianInstituteof ManagementCalcutta
20 During the earlierpolicy regime, the CentralElectricity Authority- an WP No 356/99.
autonomousbody- was responsiblefor looking into the techno-economicDatta Chaudhuri,M K (1981): 'Industrialisationand Foreign Trade: The
feasibility keeping in view the networkexternalityof power generation DevelopmentExperiencesof South Koreaand Philippines'in E Lee led)
and distributionsystem. Apparentlyafter the deregulation,such official Export Led Industrialisation and Development, ILO, Geneva.
scrutinywas largely ignored in the belief that, 'marketsknow the best'.
Easterly,William(2001): 'TheLostDecades:DevelopingCountriesStagnation
Hence, based on power demand projections drawn up by private in spite of Policy Reforms 1980-1998', Journal of Economic Growth,
consultants,large numbers of projects were approved. Vol 6, June.
21 Admittedly,the shareof foreign controlledfirms in the privatecorporate
Guha Thakurta,Paranjoy (2002): 'Coke: Arrogance of a Multinational',
sectoris, by mostreckoning,small. However,theyaccountfora substantial www.rediff.com, July 20.
share of total profits and dividend in this sector. Helleiner, G K (1989): 'TransnationalCorporationsand Direct Foreign
22 Infact,consideringthe fragmentednatureof the market,manyautomotive Investment' in Handbookof Development Economics, Vol 2, edited by
firms view their Indian operations as mainly distributionand 'brand H Chenery and T N Srinivasan, Elsevier Science Publishers B V.
building'exercises, ratherthan manufacturingones. Therefore,it is hard
Hymer, Stephen (1976): The International Operations of National Firms:
to expect such operations to have significant positive spillovers. A Study of Direct Foreign Investment,MIT Press, Massachusetts.
23 According to knowledgeable sources, the Indian auto industrynow is International Finance Corporation (2002): 'Business Environment and
as fragmentedas the Brazilianindustrywas when it liberalisedits industry
Surveys', (mimeo), Washington DC.
some 30 years ago. While Brazil failed to climb up the technology ladder,
Jain, Virendra (2001): Investors Beware, Macmillan India, Delhi.
it was strategic technology importing countries like Japan and Korea
Johnston, David Cay (2002): 'Tax Treaties with Small Nations Turn into
thatproducedworld-class automotivemanufactures.If the presenttrend a New Shield for Profit', The New York Times, April 16.
persists it seems likely that India will follow the Brazilian path, rather
Kumar,Nagesh (2000): 'Mergersand Acquisitions by MNEs: Patternsand
than the Japanese a':: !i-e Korean one. Implications', Economic and Political Weekly, August 5.
24 To illustrate,Hydra-i:,d Allwyn, acquiredby Voltas, afterprivatisation,
Lall, Sanjaya (1989): Learning to Industrialise, Macmillan, London.
has beenengaged in contractmanufacturingfor the Koreanfirm Samsung - (1982): Developing Countries as Exporters of Technology, Macmillan,
[BusilnessStandard, November 11, 2002]. London.
25 Reportedly,Coca Cola has repeatedlyrefused to comply with the law Lewis, W Arthur(1953): Aspects of Industrialiation,Bank of Egypt, Cairo.
in dilutingits equity in the domestic capital marketfor the past six years
Mani, Sunil (1983): Industrial Concentration and Economic Behaviour:
[Guha 2002]. Case Study of Indian Tyre Industry, Centre for Development Studies,
26 Apparently,the US tax laws providetax creditfor promotionof American Trivandrum.
brands abroad. We do not have evidence to substantiatethis claim. Mehta, Abhy (1999): Power Play: A Study of the Enron Project, Orient
27 The US protectionof the super computers manufacturer,Cray, despite Longman, Hyderabad.
competing productsby Japan's Hitachi and Fijitsu being much cheaperMorris, Sebastian (1996): 'Political Economy of Electric Power in India',
is a well knowncase. Recently when, for the firsttime, the US department
Economic and Political Weekly, Vol 31, No 21, May 25.
of agriculturebought a Fujitsu super computer, The New YorkTimes Nagaraj R (2002): 'Performanceof India's ManufacturingSector in the
considered the decision news worthy to report it (June 14, 2002). 1990s: Some Tentative Findings' in Shuji Uchikawa (ed) Economic
28 Writing at the height of the foreign infrastructureinvestment boom in Reforms and Industrial Structure in India, Manohar, Delhi.
the 'emerging markets' in the mid-1990s, Wells and Gleason (1995) - (1997): 'Whathas HappenedSince 1991? Assessment of India'sEconomic
cautionedtheAmericanbusinessmanagainstrushingintosuchinvestment Reforms', Economic and Political Weekly, Vol 32, No 44-45.
precisely on the above arguments. - (1996): 'India'sCapitalMarketGrowth:Trends,ExplanationsandEvidence',
29 In fact, it was MrinalDattaChaudhuri(1981) who long ago emphasised Economic and Political Weekly,Vol 31, Nos 35-37 (Special Number),
the role of large domestic and internationaltrading houses as market 1996.
institutionsin promotingmanufacturedexports from Koreaand Taiwan. Rao, K S Chalapati,Murthy,M R and Ranganathan,K V K (1999): 'Foreign
Direct Investment in the Post-Liberalisation Period: An Overview',
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1712 Economic and Political Weekly April 26, 2003