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 CONTENTS

1. Advantages of FDI
2. Types of FDI
3. Host country policies
4. Home country policies
5. FDI regime in India
6. FDI in services production,
investment and trade
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Ô ðeport of the UNCTAD Ad-Hoc Working
Group on Non-debt Creating Financial Flows
1993-1995 (Author was a member of the WG).
Ô Study on Foreign Investment, Technology
Transfer and Growth Nexus in Asian Economies,
by the author as Consultant to UN-ESCAP,1999.
Ô Study on Globalisation and Industrial
Diversification in Asian Countries, by the author
as Consultant to UN-ESCAP, 2002.
Ô Studies on Foreign Investment by ICðIEð
and IIFT during 1995-1999 (Author was a
Member of the Advisory Committees).
Ô Other studies on FDI by the author.
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Ô FDI facilitates global integration, industrial
diversification, privatization, infrastructure deve-
lopment, technology upgradation, and acts as
an engine of external trade and overall growth.
Ô Unlike other capital flows, FDI is a package
that embodies capital along with technology and
managerial, marketing and technical skills.
Ô Presence of multinationals promotes greater
efficiency and dynamism in the domestic sector
and widens external trade.
Ô Training gained by local employees and their
exposure to modern organizational system and
international best practices are valuable assets
for the host country .
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 1.3 Advantages of FDI
Ô FDI is a non-debt creating financial flow and
is preferred to other forms of capital flows.
Ô External debt has attendant problems of
repayment of principal and payment of interest
charges, which may create problems in case the
project becomes non-viable due to market risk.
Ô Example: East Asian crisis in 1998-1999.
Ô Foreign institutional investment is also
volatile and can be withdrawn in the case of
economic, financial, foreign exchange crisis.
Ô FDI does not face any such problems, there
is repatriation of dividends only when the
project is profitable.
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 1.4 Types of capital flows
Ô Ñonds
Ô External Loans from commercial banks
Ô Financial derivatives- commercial papers and
note issuance, interest rate and exchange rate
swaps, options and futures etc.
Ô Foreign direct investment- equity sharing
and participation in management
Ô Portfolio investment- buying of shares
Ô Quasi equity investment- joint ventures,
licensing agreements, franchising, management
contracts, turnkey contracts, production sharing
and international subcontracting.
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—odes of Expected ðisk- —anagerial

capital flow Cost Sharing Participation
___________________________________
Ñond Lending Low Low Low
Ñank loans High Low Low
Derivatives Low Low Low
FDI Low —edium High
Portfolio —edium High —edium
Quasi-Equity —edium High —edium
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! FDI is a non-debt creating financial flow and
does not have the attendant obligation for
debt servicing (repayment of principal and
payment of interest charges) as in the case of
external debt.
ƥ Only indirect cost in the form of increasing
dividend remittances and import intensity,
which are much less than debt service
charges.

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ƥ Consumer Ñenefits
- Price, quality and variety
- FDI players are better equipped to invest in
difficult and remote markets and develop
products and services better adapted to
consumers
- —ore and more countries can hope to
develop comparative advantages in new
sectors. As FDI currently is more market
seeking than efficiency seeking , offereing
opportunities to any country willing to open
its market or integrate with its neighbours.

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 2.1 Types of FDI
Ô —arket seeking- to take advantage of huge
domestic markets in host countries
Ô ðesource exploiting- driven by availability of
mineral and other resources
Ô Export enhancing- to shift production base to
take advantage of low wage rates but technical
manpower and availability of resources
Ô Efficiency enhancing through technology
transfer and infrastructure development

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 2.1 Host Country Policies
Ô FDI inflows are determined by a complex set
of economic, political and social factors.
Ô Foreign investors look beyond the array of
fiscal incentives offered by the host country.
Ô FDI is attracted by sound macro-economic
policies, stable economic systems, sustained
high growth,liberalisation of trade, investment
and industry, particularly by liberal FDI regimes.
Ô Full currency convertibility, free repatriation,
less performance criteria, tax holidays and other
incentives, abolition of screening requirements,
relaxation of sectoral limits on foreign equity.
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2.2 Other Factors Attracting FDI
Ô Domestic market potentials
Ô Low wage rates
Ô Low transactions costs
Ô High rates of return
Ô Labour mobility
Ô —atured capital market
Ô —odern financial system
Ô Efficient infrastructure
Ô Established legal and institutional set-up
Ô Transparent rules and regulations
Ô Administrative speed and efficiency
Ô Special economic zones, EPZs etc.
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 2.3 Other Factors Attracting FDI
‰National treatment to foreign investors
‰—ost favored nation treatment (—FN)
‰Free transfer of profits and dividends
‰International standards for laws
‰International arbitration in the case of disputes
‰Protection of intellectual property rights (IPð
‰ðight to employ management of its choice
‰The formation of regional trading blocks such
as NAFTA, ASEAN, APEC, SAAðC etc. had also
an important impact on the FDI pattern
‰In future, countries outside the regional blocks
might have disadvantages in attracting FDI.
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2.4 Foreign Investors Dislike —ost
Ô Any screening of investment except for
national security, public health, individual
safety, and environmental protection.
Ô Performance requirements such as export
orientation, local content, value addition, foreign
exchange, as these distort international trade
and investment flows, and result in diminished
returns to both home and host countries.
Ô Since 1980, countries that guaranteed full
repatriation of profits attracted 95% of foreign
investment, countries adhering to Convention of
Settlement of Investment Disputes attracted
90% of foreign investment from USA.
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Ô Fiscal and other incentives remain an
important part of a countryƞs investment
promotion package, and can tilt the balance in
investorsƞ location choices, particularly for
Ơfootloose industriesơ such as automobiles and
food processing industries.
Ô Incentives play, however, only a minor role
for FDI and attract only those Ơfly-by-nightơ
firms, which exist on exploitation of incentives.
Ô As incentives represent substantial economic
costs, a rational, efficient, equitable and
internationally competitive tax system is more
conducive to FDI than fiscal incentives.
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Ô Few developing countries have paid
due attention to outward FDI policies by
liberalizing outward capital flows.
Ô There is a need to liberalize further
capital markets and foreign exchange
regulations to move towards full capital
account convertibility.
Ô Liberalisation of policies for
institutional investors such as insurance,
pension and provident funds could lead to
a multiple increase of foreign investment.
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 4.1 FDI ðegime in India

Ô Since 1991 India adopted an open door policy

and welcomed FDI in most areas.
Ô Foreign investment is not allowed in:
- Chit fund
- Nidhi company
- Agriculture and plantation
- ðeal estate or construction of farm houses
- Trading in Transferable Development ðights

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   :
ƥðetail trading
ƥAtomic energy
ƥLottery business
ƥGambling and betting
ƥHousing and real estate
ƥAgriculture (except floriculture, develop-
ment of seeds, animal husbandry,
pisiculture and cultivation of vegetables
and mushrooms etc. and Plantations
(except tea plantations .

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 4.3 Factors affecting
FDI Inflows in India
ƥ Fourth largest economy in terms of PPP
adjusted GDP after USA, China and Japan
ƥ One of ten fastest economies of the world
ƥ Largest pool of technical manpower
ƥ Demographic dividend- youngest workforce
ƥ ðich in mineral and natural resources
ƥ —ajor country in agrl and industrial products
ƥ Fiscal incentives and investment environment
ƥ Low wage rates and low production costs
ƥ High ðeturn and Huge domestic market
ƥ Well developed banking and capital markets
ƥ Dynamic private sector
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ƥ Various incentives by Centre and
States. These are equally applicable to
both domestic and foreign companies.
ƥ Tax holidays up to 15 years for
backward regions and infrastructure.
ƥ Incentives for exporters, ð
D, SEZs,
EPZs, Science and Technology Parks.
ƥ States provide capital subsidy, tax
breaks or deferment, concessional
land, power and utility tariffs.
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ƥ Nationality treatment
ƥ —FN Treatment
ƥ No expropriation of capital
ƥ Free expatriation of foreign equity
ƥ ðupee fully convertible on current account
ƥ Fully convertible on capital account for
foreign investors.
ƥ FEðA replaced by FE—A.
ƥ Foreign companies can own real estate,
and use their trade marks and brand names
for domestic sales.
ƥ India is a member of the —ultilateral
Investment Guarantee Agency (—IGA and
has signed comprehensive treaties for
avoidance of double taxation with 66
countries, and FTA with many countries.
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4.8 Share of Indian States in FDI in 1991-2003
 
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1. —aharashtra 17.3
2. Delhi 12.0
3. Tamil Nadu 8.6
4. Karnataka 8.3
5. Gujarat 6.5
6. Andhra Pradesh 4.6
7. —adhya Pradesh 3.2
8. West Ñengal 3.2
9. Orissa 2.9
10. Uttar Pradesh 1.7
11. ðajasthan 1.0

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 4.9 FDI Inflows as % of World FDI
Country 1990 1995 2000
India 0.1 0.7 0.2
China 1.7 10.9 3.2
Hong Kong 0.9 2.7 5.1
Korea, ðep. 0.4 0.5 0.8
—alaysia 1.1 1.3 0.4
Philippines 0.3 0.4 0.1
Singapore 2.7 2.2 0.4
Thailand 1.2 0.6 0.4

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 4.10-A FDI Inflows as % of GDI

 
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- FDI inflows are more of tariff jumping
and market seeking rather than
efficiency seeking or export driven
- 40 percent of FDI inflows went into
acquisition of gross fixed assets such as
plant and machienery.
Increase in Exports
- Export as a proportion of sales among
a sample of 450-odd ^FDI controlled
firms in India was just 11.6 percent.

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ƥ Infrastructure and technology transfer
- —ore through merger and acquisition ^—
A
route to increase its share in the Indian
market rather than greenfield investment to
establsh new industrial and service units.
- A study by Nagesh Kumar of ðIS states that
40 percent of FDI in India came through
—
A route to take over Indian companies,
increase control in existing subsidiaries by
issuing shares at low cost or buy back shares
and de-list from stock exchanges.
ƥ Less or limited ripple effect of the technology
transfer that the FDI is supposed to bring
across a large economy.
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- Increased productive and managerial
efficiency due to competition from multilateral
subsidiaries.
- Studies of Clive Harris^2003 and —cKinsey
Global Institute^2003 indicated that FDI has
a significant positive impact on productivity
and coverage of services, particularly financial
and telecommunications.
- In sectors like automotive, telecom and
financial services, increased competition and
investments have resulted in an increase in
output and employment, fall of prices, wide
range of products and rise of quality.

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 6.1 Policy Issues for Foreign Investment
ƥ Liberalisation of labour laws and labour
markets to enhance labour mobility
ƥ Simplification of land laws and regulations
ƥ Unbundling and sharing of risks
ƥ ðationalisation of user charges
ƥ Strengthening of capital markets
ƥ Development of municipal bonds
ƥ Strengthening ðegulatory, legal and
institutional set up
ƥ Strengthening of Public-Private Partnership
ƥ Improvement of model ÑOT legislation
ƥ Separation of policy makers, regulators and
operators
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 6.2 Sectoral Policies and ðegulation

ƥ Locational, safety and environmental

regulations are necessary for the efficient
functioning of industry.
ƥ Simplification of excessively detailed,
outdated and complicated regulations for
utilities, petroleum sector, banking and
insurance, transport and telecommunications.
ƥ ðeduction, simplification, and greater
transparency of the rules and procedures and
further reduction of the bureaucratic
intervention are needed to attract more
foreign investment.
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 6.3 —inerals including oil and gas
ƥ —ineral industries, including petroleum and
gas, create particular problems for private
investment because resource rents have to
be divided between local landowners, the
States and the central governments.
ƥ Private firms also seek a share of such rents
to compensate for the risk of mineral
exploration
subsequent mine development.
ƥ The efficient and equitable apportioning of
mineral rents is thus an important aspect of
the economic policy framework for attracting
private investment including FDI.
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 6.4 —inerals including oil and gas

ƥ Indian states impose cess and royalties on

minerals to raise resources.
ƥ—inerals and power have also environmental
aspects that should be taken into account while
allowing private investment.
ƥIndonesia and —alaysia have been among
world leaders in dealing with foreign investment
in petroleum, gas and other minerals.

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 6.5 Agriculture and plantation
ƥ Agriculture and real estate present difficulties
for foreign investment because of
complexities of landownership, rules and
taxes regarding tenancy, sale, purchase,
transfer, lease or mortgage.
ƥ Ñecause of these problems, India like many
countries, does not allow foreign investment
in agriculture and real estate.
ƥ However, in the case of plantation, foreign
investment in nucleus estates and processing
facilities can provide a market for farmers
and at the same time enable them to improve
their productivity.
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 6.6 Water supply and sanitation
ƥ Water is a merit good with many positive health
and environmental spillovers.
ƥ Under UN-—illennium Development Goals,
Government is committed to provide universal
access to the minimum daily requirement of safe
water, but this may require subsidies.
ƥ Water distribution pipes are a monopoly network
of the local government and many water and
sanitation systems are buried.
ƥ These factors complicate the transfer of water
distribution to private sector.

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 6.7 Water supply and sanitation
ƥ Scope of unbundling the water sector is not
clear with limited potential for competition
amongst bulk water service providers because
the main water sources in municipalities are
location specific and limited in number.
ƥ Operational costs of providing the raw resource
are relatively low compared with sunk capital
costs in pipes, dams and treatment stations.
ƥ Efficiency gains in water supply come from
increased trade amongst water users and
reduced distribution losses rather than
competition amongst suppliers.
ƥ In the case of water supply, organizational
restructuring, corporatization and unbundling of
risks should precede full private participation.
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 6.8 Water supply and sanitation
ƥ ðesource management functions such as
catchment planning should be separated from
commercial functions of service delivery.
Government should be responsible for the former
while private operators can compete for the latter.
ƥ Govt. should own water pipe and sewerage
network while private operators lease long-term
rights to use pipelines and collect revenues from
service delivery.
ƥ Private operators have incentives to reduce water
losses and costs, expand consumer connections
and to improve services to the consumers.

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 6.9 Water supply and sanitation
ƥ It is necessary to develop private property
rights and commercial law, to establish clear
accounting and environmental standards,
transparent legal and regulatory system, and
introduce specific ÑOT legislation for private
investment in utilities.
ƥ Tariff reform is equally fundamental to
improve utility efficiency and delivery.
ƥ While private operators should bear
construction, commercial and operation costs
and risks, government should bear the
sovereign risks.
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 7. Concluding ðemarks
ƥ As the first generation reforms take root
and second generation reforms unfold,
India is emerging as a favourite
destination for foreign investment, and
a land of immense opportunity for all.
ƥ India should maintain its open door
policy in goods and services production,
investment and trade.
ƥ Carried to their logical ends, reforms
would make India as one of the most
dynamic and fastest growing economies
of the by 2010.
ƥ India is an economic miracle waiting to
happen.
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 º% #1

1. What are the special advantages of Foreign
Direct Investment ^FDI over other forms of
external capital flows?
2. ^a Discuss broad types of FDI.
^b Which one is the dominant type of FDI
flows to India and what are main reasons
for that?
^c Indicate the major sources of FDI
inflows to India.
^d Which are the major sectors attracting
FDI to India?
3. ^a Discuss the general host country and
home country policies attracting foreign
investment.
^b discuss relative merits and demerits of
fiscal incentives for attracting FDI.
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4. ^a Discuss policies, strategy and regulatory
regime for foreign investment of India.
^b What has been their impact on he Indian
economy?
5. ^a Discuss the strengths and weaknesses of
the Indian economy for attracting FDI.
^b Discuss special problems for attracting
FDI in agriculture and plantation, minerals
including oil and gas, power generation,
water supply and sanitation.

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