FOREIGN CAPITAL

Rama Mittal Assistant Professor

Meaning of FDI

Foreign direct investment (FDI) in its classic form is defined as a company from one country making a physical investment into building a factory in another country. It is the establishment of an enterprise by a foreigner. It is the movement of capital across national frontiers in a manner that grants the investor control over the acquired asset

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Its definition can be extended to include investments made to acquire lasting interest in enterprises operating outside of the economy of the investor. The FDI relationship consists of a parent enterprise and a foreign affiliate which together form an international business or a multinational corporation (MNC). In order to qualify as FDI the investment must afford the parent enterprise control over its foreign affiliate.

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Type of Foreign Direct Investors

A foreign direct investor may be classified in any sector of the economy and could be any one of the following; An individual; A group of related individuals; An incorporated or unincorporated entity; A public company or private company; A group of related enterprises; A government body; or Any combination of the above.

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Classification of FDI
FDI

Inward

Outward
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Inward FDI

Foreign direct investment, which is inward, is a typical form of what is termed as 'inward investment'. Here, investment of foreign capital occurs in local resources. The factors propelling the growth of Inward FDI comprises tax breaks, relaxation of existent regulations, loans on low rates of interest and specific grants. The idea behind this is that, the long run gains from such a funding far outweighs the disadvantage of the income loss incurred in the short run. Flow of Inward FDI may face restrictions from factors like restraint on ownership and disparity in the performance standard

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Outward FDI

Foreign direct investment, which is outward, is also referred to as direct investment abroad. In this case it is the local capital, which is being invested in some foreign resource. It may also find use in the import and export dealings with a foreign country.

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Some other forms of FDI

Horizontal FDI : FDI in the same industry abroad as that in which a firm operates at home
Vertical FDI:

When a multinational operates in some other related fields

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Advantages of FDI

Bringing infrastructure into the country Bring advanced technology into the country which can be used later on in the economy Generates healthy competition in the recipient country Creates more industrial units in the country Creates more employment in the economy
Eg- Hyundai (South Korean company) has established its new car manufacturing plant at Chennai in India because of low wages rates, guaranteed power supply, cheap land and providing employment in India.
Note:- It is estimated that very dollar of FDI increases domestic investment by 80% of the amount of FDI.

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Disadvantages of FDI

Inflation may increase slightly Breeds bribery and corruption Domestic firms may suffer if they are relatively uncompetitive Small and marginal firms are made to exit May lead to social and cultural disruption Too much dependency may arise and cause problems

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FDI Flow in India

Amount ($ bn)
45 40

35

30

25 Amount ($ bn)

20

15

10

0 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

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Sources: Department of Industrial policy and promotion

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SECTORS ATTRACTING HIGHEST FDI EQUITY INFLOWS

2% 4% 5%
Energy

1%

6%

31%

Telecommunication
Electrical Equipment

8%

Transportation Service Sector Metallurgical Industry

9%

Chemicals Food & food processing Hotels & Tourism

11%

23%

Texiles

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FDI POLICY IN INDIA

FDI has helped the Indian economy grow, and the government continues to encourage more investments of this sort - but with $5.3 billion in FDI in 2004 India gets less than 10% of the FDI of China.

FDI has allowed India to focus on the areas that may have needed economic attention, and address the various problems that continue to challenge the country. India has continually sought to attract FDI from the worlds major investors. In 1998 and 1999, the Indian national government announced a number of reforms designed to encourage FDI and present a favorable scenario for investors.

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Foreign Direct Investment Incentives

Low corporate tax and income tax rates Tax holidays Other types of tax concessions Preferential tariffs Special economic zones Investment financial subsidies Soft loan or loan guarantees Free land or land subsidies Relocation & expatriation subsidies Job training & employment subsidies Infrastructure subsidies R&D support.
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Main Sectors with FDI Equity/Route Limit

FDI equity limitautomatic Route

FDI requiring prior approval

Defense production 26% FM Broadcasting - foreign equity 20% News and current affairs- 26% Broadcasting- cable, DTH, uplinking foreign equity 49% Trading- wholesale cash and carry, export trading, etc., 100% Tea plantation 100% Development of airports- 100% Courier Services-100% Cigars & cigarettes manufacture100%
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Insurance 49% Domestic airlines 49% (74%) Telecom services- Foreign equity 74% Private sector banks- 74% Mining of coal and lignite for captive consumption- 100% Coffee and rubber processing-100% Civil Aviation-100% Manufacture of Telecom Equipment100% Non Banking Finance Companies100%

Foreign portfolio investment (FII)

It is the passive holding of securities such as foreign stocks, bonds, or other financial assets ,none of which entails active management or control of the securities issues by the investor,

Starting up

In 1992, India opened up its economy and allowed foreign portfolio investment in its domestic stock market Since then ,FII has emerged as a major source of private capital inflow in this country

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Factors affecting Portfolio Investment

Tax rates on interest or dividends

Interest rates Exchange rates

Note: FII is the part of capital account on BOP

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How FII flow can help an economy?

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Regulations regarding Portfolio Investment by FIIs

RBI has granted permission to SEBI registered (FIIs) invest in India under Portfolio investment scheme.
All FIIs and their sub-accounts taken together cannot acquire more than24% of the paid up capital of an Indian economy
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Regulations regarding Portfolio Investments by NRIs/PIOs

NRIs/PIOs can purchase/ sell shares / convertible debentures of Indian companies on stock exchanges. An NRI or PIO can purchase shares upto5% of the paid up capital of Indian company. All NRIs/PIOs taken together cannot purchase more than 10% of the paid up value of the company.
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Difference Between FDI & FII

Basis Stands for Sell off: FDI Foreign Direct Investment It is more difficult to sell off or pull out. FII Foreign Institutional Investment It is fairly easy to sell securities and pull out because they are liquid.

Comes from

Tends to be undertaken by Multinational Comes from more diverse sources e.g.a small organisations company's pension fund or through mutual funds held by individuals; investment via equity instruments (stocks) or debt (bonds) of a foreign enterprise. Involves the transfer of non-financial assets e.g.technology and intellectual capital, in addition to financial assets. Only investment of financial assets.

What is invested

Volatility Management Involvement - direct or indirect:

Having smaller in net inflows Projects are efficiently managed

Having larger net inflows Projects are less efficiently managed

Involved in management and ownership No active involvement in management. control; long-term interest Investment instruments that are more easily traded, less permanent and do not represent a controlling stake in an enterprise.
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