FOREIGN CAPITAL AND FOREIGN INVESTMENT IN INDIA

Almost every developed country of the world in its initial stages of development had made use of foreign capital to make up the deficiency of domestic saving. In the seventeenth and eighteenth century, England borrowed from Holland and in the nineteenth and twentieth century England gave loans to many countries. United States of America, the richest country of the world, had borrowed heavily in the nineteenth century and now, in the twentieth century, USA has become the biggest lender country of the world. Foreign capital has played an important role in economic development of India. Foreign capital had started flowing in India since the times of East India Company. However, the policy relating to foreign capital pursued by the British government was favorable to the foreign capitalists but against the interests of India. After independence, foreign capital was used as a tool for promoting economic development and to make balance of payments favorable.

Meaning of Foreign Capital

Foreign Capital refers to the investment of capital by a foreign government, institution, private individual, and international organization in a country. Foreign Capital includes foreign aid, commercial borrowing and foreign investment. Foreign aid includes foreign grants, concessional loans, etc. Foreign Capital is invested in the form of foreign currency, foreign machines and foreign technical know-how. Foreign Capital has many forms, that is foreign collaborations, loan in the form of foreign currency, investment in equity capital, etc. Many foreign institutions and governments give grants. The main difference between foreign grants and loans is that loans are repaid with interest, whereas grants are not repaid.

Classification of foreign capital

Foreign Capital is classified as under: (1) Foreign Aid (2) Commercial Borrowings (3) Foreign Investment- Participation in Equity Capital/Bonds/Debentures

Foreign Aid
Foreign Capital may come to a country in the form of foreign aid. Foreign aid refers to concessional loans and grants received from abroad. The rate of interest on such loans is normally below the market rate of interest. The period repayment is usually long, sometimes extending over decades. Foreign aid is given by foreign government and institutions like IMF, World Bank, International Development Association (I.D.A) etc. Foreign aid is of following types:
(1) Grants: Apart of foreign aid is received in the form of grants. It involves no repayment

obligation on the part of recipient nation, neither by way of payment of interest nor return of capital.
(2) Concessional Loans: The rate of interest on such loans is lower than the market rate of

interest. The repayment period of these loans is long. These loans are given to the developing countries for development projects and for meeting balance of payment deficit. These loans are:

(i) Loans from Foreign Government: In this case, government of one country loans to government of another country. These loans can be of following types: (a) Soft Loans: These are long term loans with low rate of interest. (a) Project loans: These are given for completion of specific projects. (b) Non-Project Loans: These loans are not meant for any particular project. These loans can be used for any purpose. (ii) Loans from International Institutions: International Financial Institutions like World Bank International Monetary Fund (I.M.F), Asian Development Bank, etc. also provide loans in the form of foreign capital. These institutions provide loans both to private as well as public sectors. These loans may be Soft loans, Project loans or Non Project loans.

Commercial Borrowings
These loans are raised from foreign banks at market rate of interest. Rate of interest on commercial borrowing is higher than on loans as foreign aid. Repayment period of commercial borrowing is shorter than loan as foreign aid. Commercial borrowings include: (1) Loans from Foreign Banks: Many a time, Government of India has raised loans from the foreign banks such as U.S Exim Bank, Japanese Exim Bank, ECGC (Export Credit Guarantee Corporation of U.K) etc. (2) Deposits of NRIs: Another important source of commercial borrowing in India is the inflow of Non-Resident Indian (NRI) deposits. Non-resident deposit have been considered a major component of countrys foreign inflows during the past decade. This amount is deposited by NRIs in Indian bank accounts and Indian banks provide interests on these deposits. Their rate of interest is usually equal to the market rate of interest.

Foreign Investment
Foreign investment refers to the investment by foreign investors in shares, debentures, bonds of Indian companies. Foreign aid has contributed to the development of our economy, but its availability has shrunk in recent times. We have reduced our dependence on commercial borrowings because commercial borrowings are raised at the market rate of interest. It created a problem of debt servicing (interest payment). Because of this, our government has start encouraging the entry of foreign capital from foreign private sector. Foreign private sector investment is made by individuals or companies of foreign country in the private or public sector in India. This type of investment is mainly in the form of equity capital, which has no fixes interest burden. It can be classified as under:

(1) Foreign Direct Investment (FDI): Foreign direct investment by foreign companies in
order to establish wholly owned companies in other countries and to manage them or to purchase shares of companies in another country for the purpose of managing such companies. The main characteristics of foreign direct investment are that native companies are managed by the foreign companies or new companies are setup in India by foreign companies. In this type of investment, it is the foreign investor, who takes risk and is solely responsible for profit/loss of such company. It also includes foreign collaborations, which mean setting up of an enterprise, jointly by the foreign and native entrepreneurs. It may be of following types: (i) Collaborations between Indian and Foreign private companies. (ii) Collaborations between Indian Government and private companies. (iii) Collaborations between Indian Government and Foreign Government.

(2) Portfolio Investment: Under this type of investment, foreign companies/ foreign
institutional investors (FII) buy shares/ debentures of native companies, however management and control remain vested with the native companies themselves. In the case of investment in debentures, a fixed rate of interest is guaranteed, while in the case of investment in shares, no fixed dividend is guaranteed. Another type of portfolio investment is raising foreign capital by Indian companies from the foreign capital markets by issuing Global Depository Receipts (GDRs), American Depository Receipts (ADRs) and Foreign Currency Convertible Bonds (FCCBs). Main difference between foreign direct investment and portfolio investment is that in the case of FDI, foreign investor also manages the enterprise, in which it makes

investment. While in the case of portfolio investment it simply makes investment but doesnot manage the enterprise.

Need/Objective of Foreign Capital/ Foreign Investment in India

Foreign investment is not considered only as a stock of capital but as something that provides modern technology, managerial expertise, employment opportunities and a new market for products produced in India. Moreover it is essential as we have a gap between our savings and investment requirements. The gap can be filled by foreign direct investment. Foreign investment is needed due to following reasons for overall economic development of India: (1) To increase the level of investment by supplementing the domestic investment. (2) To develop basic industries in India. (3) To develop infrastructure. (4) To remove the shortage of foreign exchange, because of deficit balance of payment. (5) To improve managerial and entrepreneur ability (6) To exploit natural resources. (7) To set-up risky and capital intensive projects. (8) To improve technology. (9) To increase employment opportunities.

Foreign Capital Policy 1991/ New Foreign Investment Policy

Foreign Investment Policy of 1991, was very liberal and it lifted the ceilings on inflow of foreign investment. Earlier, foreign equity participation was restricted up to 40%, but now 100% equity participation is allowed. Earlier all foreign investment and technological agreements needed prior permissions but now the new policy has allowed the foreign capital with automatic approval in many industries. Moreover huge incentives and concessions are granted for the flow of foreign capital in the country. Followings are the main features of new foreign investment policy.

(1) Liberal Approach: Present approach towards foreign capital is to welcome its
inflow. The entry of foreign capital has been permitted in consumer goods and capital goods including high priority industries. Foreign Investment approval for various investment projects is automatic. The share of foreign equity capital in Indian industries has been allowed to 100%. The approach of the government towards FDI is liberal and investors friendly.

(2) Various forms of Foreign Capital: Earlier foreign capital was raised mainly
through foreign aid and commercial borrowings. But now it is raised in various forms, such as: (i) Foreign collaboration (ii) Foreign Equity Participation (iii) Investments by Foreign Institutional Investors, Non resident Indians and other Foreign Investors (iv) Raising of funds by Indian Corporate Sectors in Foreign Markets

(3) Tax Concessions to NRIs: To attract foreign capital from Non-Resident Indians,
government in recent years, announced a number of tax concessions, tax holidays for a certain period on profits of new industrial undertakings, lowering tax rates on short term and long term capital gains for NRIs.

(4) Technological Collaborations: For promoting the inflow of modern technology,

new foreign investment policy granted various concessions to technical collaboration agreements. Under the new policy. No approval will be needed to make payment in foreign currency to foreign technical experts or for getting indigenously developed techniques tested abroad.

(5) Organisation of Boards: The new policy provides for the organization of boards for
direct foreign capital investment in selected areas. These boards will negotiate with MNCs for setting up their enterprises in India. These boards will function under a special programme so that foreign capital is attracted on a large-scale, foreign technical knowhow can be obtained and Indian exports may have access to world markets.

(6) Foreign Investment in Small Industries: Under new small industrial policy,
foreign entrepreneur can have 24% share capital in small industries without any prior approval.

(7) Joint Ventures: The conditions for establishing joint ventures have been made
simpler and liberal from January 1997. the foreign investors can own even more than 51% share capital in joint ventures.

(8) Wholly owned Foreign Enterprises: According to new Foreign Capital Policy,
the MNCs have been given freedom to establish their wholly owned subsidiaries in India.

(9) Foreign Capital for Infrastructural Development: The government is

providing many concessions and facilities to invite foreign investment for the development of infrastructure like roads, power, telecommunications, ports etc. they will be allowed to transfer their earnings in foreign currency. The maximum limit of foreign participation in these joint ventures has been fixed. It is 100% for power, oil exploration, roads, ports, airports, and 74% for banking and telecommunication.

(10)Foreign Investment Implementation Authority (FIIA): This authority has

been established in August 1999 within the Ministry of Industry. It will ensure the approval for foreign investments are quickly translated into actual inflows. It has also so see that the foreign investment actually leads to the establishment of projects.

Other features of the New Foreign Investment Policy are: High Technology and High Priority Industries Export Promotion Disinvestment of equity by Foreign Investors Foreign Institutional Investors Investment Commission

 Fair treatment to Foreign Investments Benefits of Repatriation Issue of Global Depository Receipts (GDRs), American Depository Receipts (ADRs) and Foreign Currency Convertible Bonds (FCCBs) by the Indian Companies. Clearance for Foreign Investment
In short the new foreign investment policy is more liberal and encouraging for foreign investors. It aims at encouraging more and more foreign investment in India. Indias share in global foreign direct investment in the year 2004 was just 0.82%. in order to increase it, the procedure for making foreign investment should be simplified and efforts should be made to win the confidence of foreign investors.

Shortcoming or limitation of foreign capital

The main disadvantages of foreign capital/foreign investment are as follow:

(1)Hindrance in Adopting Independent Economic Policy: A country like India that

receives foreign aid has got to accept the conditions of the donor countries and institutions. The recipient countrys monetary, fiscal, industrial and commercial policies must adhere to the conditions imposed by the donor country. Consequently, it becomes difficult for India to adopt an independent economic policy.

(2) Increase in Foreign Dependence: Foreign capital and aid increase dependence on
foreign countries. The machines, raw material, technical know-how etc. Which are imposed from abroad increases the dependence of the receiving country in those countries, from whom these capital goods have been imported for the subsequent supply of spare parts, accessories, technicians, etc.

(3) More burden of External Debt: Burden of external debt is always more than the
burden of internal debt. The reason being that the debtor country has to transfer foreign exchange resources to the creditor country. The debtor country has to manage the foreign exchange to discharge its debt liability. But many a time, because of shortage of foreign exchange, it becomes difficult to repay the foreign debt with interest.

(4) Insufficient Development of Internal Financial Resources: Foreign capital has

an adverse effect on the development of internal financial resources. If foreign capital or loans are easily available, then efforts are not made to increase the savings within the country. In the initial years of planning, the rate of internal savings was very low. It was because of easy access to foreign aid.

(5)Uncertainty : The element of uncertainty is large in respect of foreign capital and aid .
It may be repatriated at any time. Hence, foreign capital can never be a permanent part of an economy. At the time of crisis when capital is needed the most, its availability becomes scarce.

(6) Harmful for Domestic Producers: Domestic producers stand to suffer because of
the establishment of industries financed by foreign capital. They are enable to compete with foreign enterprises. Their profits decline. It has an adverse effect on their development. Many a time, they have to stop production.

(7) Unbalanced development: In India, foreign capital has been invested in high profit
industries. Consequently, basic and key industries could not develop properly. Industrial development of the country, therefore is not balanced one.

(8) Hindrance in the Development of Indian Technology: Foreign technology

accompanies foreign capital. It has an adverse effect on the development of Indian technology and research. Those Indian firms which are operating in collaboration with foreign firms have not only to depend upon them for technical know-how bur for future technological improvement and repairs also. As a result development of domestic technology is hindered.

(9) More Project Aid: Foreign aid is of two kinds: (i)Tied Aid
(ii) Untied Aid. Tied Aid can be used only for a particular project and for importing goods from a particular country. It not only restricts the freedom of the country but it has also to buy goods at high prices. As against it, untied aid is used at the discretion of the borrower country. There is no restriction imposed on its utilization. Of the total foreign aid received in India. 66% is tied aid and remaining 34% is untied aid. Consequently, India does not get freedom to use the foreign aid. Most of the foreign trade is not utilized at its discretion.

(10) Problem of Debt Servicing: Foreign loans give rise to the problem of debt
servicing. It implies repayment of the principal and payment of interest at the expiry of debt period. The burden of debt servicing on Indian economy has been rising. Increased burden of debt servicing has an adverse effect on the long-tern balance of payments problems.

Suggestion to overcome limitation or shortcoming of foreign capital

For optimum utilization of foreign capital following suggestions are given:

(1)Untied Aid: Optimum use of foreign aid requires that it should be untied. India can
make use of the untied aid as desired by it. Thus, foreign capital can be utilized to get maximum benefits.

(2) Long-Term Loans: Agreement regarding foreign loan should be long-term. As a result
of it, there will be less element of uncertainty and pre-planning of schemes regarding economic development would become possible. It will help to invest foreign capital in long term key projects like dams, irrigation projects, ports, airports, etc.

(3) Use for Productive Projects: Foreign capital should be utilized for productive
purposes so that there is rapid growth of the economy. The income generated by the productive projects can be used for repaying loans. Thus, the foreign capital will become selfliquidating and its burden on the economy will go on diminishing.

(4) More Aid for International Institutions: India should receive more aid from
international institutions like International Development Association, International Monetary Fund, World Bank etc., as against commercial borrowings. These institutions can provide untied liberal aid on a large scale. Moreover, it will involve less political pressure on the country.

(5) Foreign Capital Linked with Exports: India should encourage such foreign capital
investment as in likely to increase exports. If foreign capital is invested in export oriented industries it will reduce the burden of foreign capital and increase the availability of foreign exchange in the country.

(6) Reduction in the Burden of the Debt Servicing: Attempts should be made to
bring down the burden of debt servicing. As far as possible , concessional loans should be encouraged. Debt relief aid should be procured from international organizations. Efforts should be made to repay old debt.

(7) More preference to Equity Capital Investment: Foreign capital should be

invited more in the form of equity than loans. Equity capital undertakes the risk of enterprise. There is no fixed interest burden in equity investment. So private foreign equity investment is better than foreign debts. In short, we can conclude with words of Dr. Malcom Adisehiah, The economy needs more investment both domestic and foreign. While domestic investment is responding ti these needs, foreign investment is also beginning to increase. Every effort should be made to increase foreign investment, while taking necessary safeguards against their ill effects and misuse as has been done by the East Asian economies including China which are attracting large amounts of foreign investment but under conditions in which governments supervision and countrys safeguards are ensured.