MINOR PROJECT REPORT

ON

FDI AND ITS IMPLICATION IN INDIA

SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENT FOR THE AWARD FOR THE DEGREEE OF BACHELOR OF BUSINESS ADMINISTRATION (BANKING AND INSURANCE)

Submitted by:Bibin John 04219301810

Under the supervision of Mr. Pramod Rawat

BATCH(2010-2013) KASTURI RAM COLLEGE OF HIGHER EDUCATION NARELA DELHI-110040 (Affiliated To Guru Gobind Singh Indraprastha University , Delhi )

ACKNOWLEDGEMENT

Though words are not enough to express our indebtness and gratitude to all those who helped me directly or indirectly in conducting this project. I hereby acknowledge all those who, encouraged and inspired through the project. It is privilege to express my sincere and profound sense of gratitude to Mr. Pramod Rawat (project guide), his kind help , guidance and cooperation despite the time and work constraints with their able guidance, encouragement and valuable suggestion, this project would have been able to see the light of the day. In the last but not the least I would like to express sincere thanks to all faculty members who are not only the source of inspiration but a constant motivation.

Bibin John 04219301810 BBA(B&I)

Certificate
This is to certify that Bibin John has completed his project FDI And Its Implication In India under my supervision and guidance. He has submitted his project report in the partial fulfillment requirement for revival of degree of BBA(B&I) from guru gobind singh indrprasth university,Delhi. This work has not been submitted anywhere else for award degree all source of information have been duly mentioned.

Project Guide Mr.Pramod Rawat (Assistant Professor) KRCHE

Project Coordinator Ms.Vandana Gupta (Assistant Professor) KRCHE

CHAPTERIZATION

CHAPTER 1 1.0 INTRODUCTION

One of the most striking developments during the last two decades is the spectacular growth of FDI in the global economic landscape. This unprecedented growth of global FDI in 1990 around the world make FDI an important and vital component of development strategy in both developed and developing nations and policies are designed in order to stimulate inward flows. Infact, FDI provides a win win situation to the host and the home countries. Both countries are directly interested in inviting FDI, because they benefit a lot from such type of investment. The home countries want to take the advantage of the vast markets opened by industrial growth. On the other hand the host countries want to acquire technological and managerial skills and supplement domestic savings and foreign exchange. Moreover, the paucity of all types of resources viz. financial, capital, entrepreneurship, technological know- how, skills and practices, access to markets- abroad- in their economic development, developing nations accepted FDI as a sole visible panacea for all their scarcities. Further, the integration of global financial markets paves ways to this explosive growth of FDI around the globe.

1.1 AN OVERALL VIEW

The historical background of FDI in India can be traced back with the establishment of East India Company of Britain. British capital came to India during the colonial era of Britain in India. However, researchers could not portray the complete history of FDI pouring in India due to lack of abundant and authentic data. Before independence major amount of FDI came from the British companies. British companies setup their units in mining sector and in those sectors that suits their own economic and business interest. After Second World War, Japanese companies entered Indian market and enhanced their trade with India, yet U.K. remained the most dominant investor in India. Further, after Independence issues relating to foreign capital, operations of

MNCs, gained attention of the policy makers. Keeping in mind the national interests the policy makers designed the FDI policy which aims FDI as a medium for acquiring advanced technology and to mobilize foreign exchange resources. The first Prime Minister of India considered foreign investment as necessary not only to supplement domestic capital but also to secure scientific, technical, and industrial knowledge and capital equipments. With time and as per economic and political regimes there have been changes in the FDI policy too. The industrial policy of 1965, allowed MNCs to venture through technical collaboration in India. However, the country faced two severe crisis in the form of foreign exchange and financial resource mobilization during the second five year plan (1956 -61). Therefore, the government adopted a liberal attitude by allowing more frequent equity participation to foreign enterprises, and to accept equity capital in technical collaborations. The government also provides many incentives such as tax concessions, simplification of licensing procedures and dereserving some industries such as drugs, aluminium, heavy electrical equipments, fertilizers, etc in order to further boost the FDI inflows in the country. This liberal attitude of government towards foreign capital lures investors from other advanced countries like USA, Japan, and Germany, etc. But due to significant outflow of foreign reserves in the form of remittances of dividends, profits, royalties etc, the government has to adopt stringent foreign policy in 1970s. During this period the government adopted a selective and highly restrictive foreign policy as far as foreign capital, type of FDI and ownerships of foreign companies was concerned. Government setup Foreign Investment Board and enacted Foreign Exchange Regulation Act in order to regulate flow of foreign capital and FDI flow to India. The soaring oil prices continued low exports and deterioration in Balance of

Payment position during 1980s forced the government to make necessary changes in the foreign policy. It is during this period the government encourages FDI, allow MNCs to operate in India. Thus, resulting in the partial liberalization of Indian Economy. The government introduces reforms in the industrial sector, aimed at increasing competency, efficiency and growth in industry through a stable, pragmatic and non-discriminatory policy for FDI flow. Infact, in the early nineties, Indian economy faced severe Balance of payment crisis. Exports began to experience serious difficulties. There was a marked increase in petroleum prices because of the gulf war. The crippling external debts were debilitating the economy. India was left with that much amount of foreign exchange reserves which can finance its three weeks of imports. The outflowing of foreign currency which was deposited by the Indian NRIs gave a further jolt to Indian economy. The overall Balance of Payment reached at Rs.( -) 4471 crores. Inflation reached at its highest level of 13%. Foreign reserves of the country stood at Rs.11416 crores. The continued political uncertainty in the country during this period adds further to worsen the situation. As a result, Indias credit rating fell in the international market for both short- term and long term borrowing. All these developments put the economy at that time on the verge of default in respect of external payments liability. In this critical face of Indian economy the then finance Minister of India Dr. Manmohan Singh with the help of World Bank and IMF introduced the macro economic stabilization and structural adjustment programm. As a result of these reforms India open its door to FDI inflows and adopted a more liberal foreign policy in order to restore the confidence of foreign investors. Further, under the new foreign investment policy Government of India constituted FIPB (Foreign Investment Promotion Board) whose main function was to invite and facilitate foreign investment

through single window system from the Prime Ministers Office. The foreign equity cap was raised to 51 percent for the existing companies. Government had allowed the use of foreign brand names for domestically produced products which was restricted earlier. India also became the member of MIGA (Multilateral Investment Guarantee Agency) for protection of foreign investments. Government lifted restrictions on the operations of MNCs by revising the FERA Act 1973. New sectors such as mining, banking, telecommunications, highway construction and management were open to foreign investors as well as to private sector.

Amount FDI
In crores

of Mid March March March March March March

194 8 256 1964 1974 916 1980 1990 2705 2000 2010 565.5 933.2 18486 1,23,378

There is a considerable decrease in the tariff rates on various importable goods. Table 1.1 shows FDI inflows in India from 1948 2010.FDI inflows during 1991-92 to March 2010 in India increased manifold as compared to during mid 1948 to march 1990. The measures introduced by the government to liberalize provisions relating to FDI in 1991 lure investors from every corner of the world. There were just few (U.K, USA, Japan, Germany, etc.) major countries investing in India during the period mid 1948 to march 1990 and this number has increased to fifteen in 1991. India emerged as a strong economic player on the global front after its first generation of economic reforms.

As a result of this, the list of investing countries to India reached to maximum number of 120 in 2008. Although, India is receiving FDI inflows from a number of sources but large percentage of FDI inflows is vested with few major countries. Mauritius, USA, UK, Japan, Singapore, Netherlands constitute 66 percent of the entire FDI inflows to India. FDI inflows are welcomed in 63 sectors in 2008 as compared to 16 sectors in 1991.

1.2 FDI INFLOWS IN INDIA IN POST REFORM ERA

Indias economic reforms way back in 1991 has generated strong interest in foreign investors and turning India into one of the favourite destinations for global FDI flows. According to A.T. Kearney1, India ranks second in the World in terms of attractiveness for FDI. A.T. Kearneys 2007 Global Services Locations Index ranks India as the most preferred destination in terms of financial attractiveness, people and skills availability and business environment. Similarly, UNCTADs76 World Investment Report, 2005 considers India the 2nd most attractive destination among the TNCS. The positive perceptions among investors as a result of strong economic fundamentals driven by 18 years of reforms have helped FDI inflows grow significantly in India. The FDI inflows grow at about 20 times since the opening up of the economy to foreign investment. India received maximum amount of FDI from developing economies (Chart 1.2). Net FDI flow in India was valued at US$ 33029.32 million in 2008. It is found that there is a huge gap in FDI approved and FDI realized (Chart- 1.3). It is observed that the realization of approved FDI into actual disbursements has been quite slow. The reason of this slow realization may be the nature and type of investment projects involved. Beside this increased FDI has stimulated both exports and imports, contributing to rising levels of international trade. Indias merchandise trade turnover increased from US$ 95 bn in FY02 to US$391 bn in FY08 (CAGR of 27.8%).

Further, the explosive growth of FDI gives opportunities to Indian industry for technological upgradation, gaining access to global managerial skills and practices, optimizing utilization of human and natural resources and competing internationally with higher efficiency. Most importantly FDI is central for Indias integration into global production chains which involves production by MNCs spread across locations all over the world. (Economic Survey 2003-04).

CHAPTER 2 TRENDS AND PATTERN OF FDI 2.1 INTER COUNTRY STUDIES

Anatomy and Consequences of Exchange Control Regimes analyzed the impact of FDI on international trade. He concluded that countries actively pursuing export led growth strategy can reap enormous benefits from FDI. Determinant Factors of FDI Spillovers What Do We Rally Know? analyze the factors determining the existence, dimensions and sign of FDI spillovers. They identify that FDI spillovers depend on many factors like absorptive capacities of domestic firms and regions, the technological gap, or the export capacity. An International Economic Analysis of FDI and International Indebtedness developed a micro foundations framework of analysis of FDI and integrated it into a macro level analysis. They highlighted the importance of profit repatriation in generating different effects of FDI on net international debt, trade and real exchange rate in developed economies compared to less developed economies. The impact of exchange rate movements on Foreign Direct Investment: Market Oriented versus Cost Oriented, examine the impact of exchange rate movements on Foreign Direct Investment. Their empirical findings indicate that the exchange rate level and its volatility in addition to the relative wage rate have had a significant impact on

Taiwanese firms outward FDI into China. They concluded that the relationship between exchange rates and FDI is crucially dependent on the motives of the investing firms. The Determinants and Impact of Foreign Direct Investment on economic Growth in Developing Countries: A study of Nigeria examines the determinants and impact of Foreign Direct Investment on economic Growth in Developing Countries using Nigeria as a case study. The study observed that inflation, debt burden, and exchange rate significantly influence FDI flows into Nigeria. The study suggests the government to pursue prudent fiscal and monetary policies that will be geared towards attracting more FDI and enhancing overall domestic productivity, ensure improvements in infrastructural facilities and to put a stop to the incessant social unrest in the country. The study concluded that the contribution of FDI to economic growth in Nigeria was very low even though it was perceived to be a significant factor influencing the level of economic growth in Nigeria. Globalization, FDI and Employment in Vietnam, examines the impact of FDI on employment in Vietnam, a country that received considerable inflow of foreign capital in the 1990s as part of its increased integration with the global economy. The study shows that the indirect employment effects have been minimal and possibly even negative because of the limited linkages which foreign investors create and the possibility of crowding out of domestic investment. Thus, the study finds out that despite the significant share of foreign firms in industrial output and exports, the direct employment generated has been limited because of the high labour productivity and low ratio of value added to output of much of this investment. Foreign Direct Investment in a changing Political Environment compares Finnish Investment during the restrictive period in 1984- 1997, with the liberal period in 1998-2002. The study reveals that the political environment

of the firm in the host country may have a special role among the other parts of the firms environment because of the supremacy of the host government to use its political power in order to intervene in FDI. FDI and Currency Crisis: Currency Crisis and the inflow of Foreign Direct Investment analyse if there are any changes in the flow of FDI before, during and after a currency crisis. Found that no similarities in regions or year of occurrence of the currency crisis. The depth, length and structure of each currency crisis together with using the right definition of a currency crisis are two important factors relating to the outcomes. Developing Countries and Foreign Direct Investment analysed the pros and cons of FDI for developing countries and other interested parties. This thesis scrutinizes the regulation of FDI as a means to balance the interests of the concerned parties, giving an assessment of the balance of interests in some existing and potential FDI regulations. The study also highlights the case against the deregulation of FDI and its consequences for developing countries. The study concludes by formulating regulatory FDI guidelines for developing countries. Foreign Direct Investment and Economic Growth investigates the casual relationship between FDI and economic growth. The findings of this thesis are that bidirectional causality exist, between FDI and economic growth in Malaysia i.e. while growth in GDP attracts FDI, FDI also contributes to an increase in output. FDI has played a key role in the diversification of the Malaysian economy, as a result of which the economy is no longer precariously dependent on a few primarily commodities, with the manufacturing sector as the main engine of growth.

2.2 INTER INDUSTRY STUDIES

The FDI suggests suitable measures like need for setting up of national commission to study the problems of the retail sector and to evolve policies that will enable it to cope with FDI. The study concludes that the entry of FDI in Indias retailing sector is inevitable. However, with the instruments of public policy in its hands, the government can slow down the process. The government can try to ensure that the domestic and foreign players are more or less on an equal footing and that the domestic traders are not at a special disadvantage. The small retailers must be given the opportunity to provide more personalized service, so that their higher costs are taken advantage of by large supermarkets and hypermarkets. The key to promoting FDI inflows into India may lie in industries and products that are technology intensive and have economies of scale and significant domestic content. Need for Caution in Retail FDI examines the constraints faced by traditional retailers in the supply chain and give an emphasis on establishment of a package of safety nets as Thailand has done. India should also draw lessons from restrictions placed on the expansion of organized retailing, in terms of sourcing, capital requirement, zoning etc, in other Asian countries. The article comments on the retail FDI report that as commissioned by the Department of Consumer Affairs and suggests the need for a more comprehensive study. Effect of Foreign Direct Investment in the presence of sector specific unemployment extends the work done by Srinivasan68 (1983)International factor movements, commodity trade and commercial policy in a specific factor model, by making an analysis of the welfare effects of foreign investment. The study shows that if there are no distortions, foreign investment enhances the social uplift of the people. The study strongly favours import substitution

policies since such a strategy provides greater job opportunities to the people and consequently improves their standards of living. But the study finds that welfare effects of foreign Investment do not explain the pattern of trade in the economy. Thus, both Srinivasan (1983) and Gonzalez (1998) concluded that foreign direct investment and distortions of the labour market results in social uplift of the people. FDI in Higher Education: Official Vision Needs Corrections, examines the issues and financial compulsions presented in the consultation paper prepared by the Commerce Ministry, which is marked by Shoddy arguments, perverse logic and forced conclusions. This article raises four issues which need critical attention: the objectives of higher education, its contextual relevance, the prevailing financial situation and the viability of alternatives to FDI. The conclusion of the article is that higher education needs long term objectives and a broad vision in tune with the projected future of the country and the world. Higher education will require an investment of Rs. 20,000 to 25,000 crore over the next five or more years to expand capacity and improve access. For such a huge amount the paper argues, we can look to FDI. To sum up, it can be said that industrial clusters are playing a significant role in attracting FDI at Inter industry level. It is argued that industries and products that are technology intensive and have economies of scale and significant domestic content attract FDI at industrial level.

2.3 STUDIES IN INDIAN CONTEXT

Canadian Foreign Direct Investment in India: Some Observations, analyse the patterns and trends of Canadian FDI in India. He finds out that India does not figure very much in the investment

plans of Canadian firms. The reasons for the same is the indifferent attitude of Canadians towards India and lack of information of investment opportunities in India are the important contributing factor for such an unhealthy trends in economic relation between India and Canada. He suggested some measures such as publishing of regular documents like newsletter that would highlight opportunities in India and a detailed focus on Indias area of strength so that Canadian firms could come forward and discuss their areas of expertise would got long way in enhancing Canadian FDI in India. Does India need a lot more FDI compares the levels of FDI inflows in India and China, and found that FDI in India is one tenth of that of china. The paper also finds that India may not require increased FDI because of the structure and composition of Indias manufacturing, service sectors and her endowments of human capital. The requirements of managerial and organizational skills of these industries are much lower than that of labour intensive industries such as those in China. Also, India has a large pool of well Trained engineers and scientists capable of adapting and restructuring imported know how to suit local factor and product market condition all of these factors promote effective spillovers of technology and know- how from foreign firms to locally own firms. The optimum level of FDI, which generates substantial spillovers, enhances learning on the job, and contributes to the growth of productivity, is likely to be much lower in India than in other developing countries including China. The country may need much larger volumes of FDI than it currently attracts if it were to attain growth rates in excess of 10 per cent per annum. Finally, they conclude that the country is now in a position to unbundle the FDI package effectively and rely on sources other than FDI for its requirements of capital. Foreign Direct Investment in India in the 1990s: Trends and Issues discusses the trends in FDI in India in the 1990s and compare them with China. 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. Foreign Direct Investment from India: 1964-83 studied the features of Indian FDI and the nature and mode of control exercised by Indians and firms abroad, the causal factors that underlie Indian FDI and their specific

strengths and weaknesses using data from government files. To this effect, 14 case studies of firms in the textiles, paper, light machinery, consumer durables and oil industry in Kenya and South East Asia are presented. This study concludes that the indigenous private corporate sector is the major source of investments. The current regime of tariff and narrow export policy are other reasons that have motivated market seeking FDI. Resources seeking FDI has started to constitute a substantial portion of FDI from India. . The only truly general force is the inexorable push of capital to seek markets, whether through exports or when conditions at home put a brake on accumulation and condition abroad permit its continuation. Foreign Direct Investment in India: Issues and Problems, attempted to identify the issues and problems associated with Indias current FDI regimes, and more importantly the other associated factors responsible for Indias unattractiveness as an investment location. Despite India offering a large domestic market, rule of law, low labour costs, and a well working democracy, her performance in attracting FDI flows have been far from satisfactory. The conclusion of the study is that a restricted FDI regime, high import tariffs, exit barriers for firms, stringent labor laws, poor quality infrastructure, centralized decision making processes, and a very limited scale of export processing zones make India an unattractive investment location. Foreign Direct Investment in India: A Critical analysis of FDI from 19912005 explores the uneven beginnings of FDI, in India and examines the developments (economic and political) relating to the trends in two sectors: industry and infrastructure.The study concludes that the impact of the reforms in India on the policy environment for FDI presents a mixed picture. The industrial reforms have gone far, though they need to be supplemented by more infrastructure reforms, which are a critical missing link. Economic Reforms, FDI and its Economic Effects in India assess the growth implications of FDI in India by subjecting industry specific FDI and output data to Granger causality tests within a panel co -integration framework. It turns out that the growth effects of FDI vary widely across sectors. FDI stocks and output are mutually reinforcing in the manufacturing sector. In sharp contrast, any causal relationship is absent in the primary

sector. Most strikingly, the study finds only transitory effects of FDI on output in the service sector, which attracted the bulk of FDI in the post reform era. These differences in the FDI Growth relationship suggest that FDI is unlikely to work wonders in India if only remaining regulations were relaxed and still more industries opened up o FDI. Foreign Direct Investment in India: Emerging Horizon, intends to study the qualitative shift in the FDI inflows in India in depth in the last fourteen odd years as the bold new policy on economic front makes the country progress in both quantity and the way country attracted FDI. It reveals that the country is not only cost effective but also hot destination for R&D activities. The study also finds out that R&D as a significant determining factor for FDI inflows for most of the industries in India. The software industry is showing intensive R&D activity, which has to be channelized in the form of export promotion for penetration in the new markets. The study also reveals strong negative influence of corporate tax on FDI inflows. To sum up, it can be said that large domestic market, cheap labour, human capital, are the main determinants of FDI inflows to India, however, its stringent labour laws, poor quality infrastructure, centralize decision making processes, and a vary limited numbers of SEZs make India an unattractive investment location.

CHAPTER-3 TRENDS AND PATTERENS OF FDI INFLOWS

3.1TRENDS AND PATTERNS OF FDI FLOW IN THE WORLD The liberalization of trade, capital markets, breaking of business barriers, technological advancements, and the growing internationalization of goods, services, or ideas over the past two decades makes the world economies the globalised one. Consequently, with large domestic market, low labour costs, cheap and skilled labour, high returns to investment, developing countries now have a significant impact on the global economy, particularly in the economics of the industrialized states. Trends in World FDI flows (Table -3.1) depict that developing countries makes their presence felt by receiving a considerable chunk of FDI inflows.

Developing economies share in total FDI inflows rose from 26% in 1980 to 40% in 1997.
FDI INFLOWS IN THE WORLD
Years/ Countrie s World FDI Develop ed Economi es share in world FDI Developi ng Economi es share in world FDI 199 095 225. 3 64.4 96 97 98 99 200 0 149 2 82.2 01 02 03 04 05 06 07

386. 1 57.1

478. 1 56

694. 5 69.7

1088. 3 77.1

73 5.1 68. 4

71 6.1 76. 5

632. 6 69.9

648. 1 58.6

95 8.7 63. 8

14 11 66. 7

183 3.3 68

33

39.5

39.9

27

20.7

15.9

27. 9

21. 7

26.3

36

33

29. 3

27. 3

However, the share during 1998 to 2003 fell considerably but rose in 2004, again in 2006 and 2007 it reduces to 29% to 27% due to global economic meltdown. Specifically, developing Asia received 16 %, Latin America and the Caribbean 8.7 %, and Africa 2 %. On the other hand, developed economies show an increasing upward trend of FDI inflows, while developing economies show a downward trend of FDI inflows after 1995.

3.2 TRENDS AND PATTERNS OF FDI FLOW IN INDIA

Economic reforms taken by Indian government in 1991 makes the country as one of the prominent performer of global economies by placing the country as the 4th largest and the 2nd fastest growing economy in the world. India also ranks as the 11th largest economy in terms of industrial output and has the 3rd largest pool of scientific and technical manpower. Continued economic liberalization since

1991 and its overall direction remained the same over the years irrespective of the ruling party moved the economy towards a market based system from a closed economy characterized by extensive regulation, protectionism, public ownership which leads to pervasive corruption and slow growth from 1950s until 1990s. In fact, Indias economy has been growing at a rate of more than 9% for three running years and has seen a decade of 7 plus per cent growth. The exports in 2008 were $175.7 bn and imports were $287.5 bn. Indias export has been consistently rising, covering 81.3% of its imports in 2008, up from 66.2% in 1990-91. Since independence, Indias BOP on its current account has been negative. Since 1996-97, its overall BOP has been positive, largely on account of increased FDI and deposits from Non Resident Indians (NRIs), and commercial borrowings. The fiscal deficit has come down from 4.5 per cent in 2003-04 to 2.7 per cent in 2007-08 and revenue deficit from 3.6 per cent to 1.1 per cent in 2007-08. As a result, Indias foreign exchange reserves shot up 55 per cent in 2007-08 to close at US $309.16 billion an increase of nearly US $110 billion from US $199.18 billion at the end of 2006-07. Domestic saving ratio to GDP shot up from 29.8% in 2004-05 to 37.7% in 2007-08. For the first time Indias GDP crossed one trillion dollars mark in 2007. As a consequence of policy measures (taken way back in 1991) FDI in India has increased manifold since 1991 irrespective of the ruling party over the years, as there is a growing consensus and commitments among political parties to follow liberal foreign investment policy that invite steady flow of FDI in India so that sustained economic growth can be achieved. Further, in order to study the impact of economic reforms and FDI policy on the magnitude of FDI inflows, quantitative information is needed on broad dimensions of FDI and its distribution across sectors and regions.

3.3 SOURCES OF FDI IN INDIA

India has broadened the sources of FDI in the period of reforms. There were 120 countries investing in India in 2008 as compared to 15 countries in 1991. Thus the number of countries investing in India increased after reforms. After liberalization of economy Mauritius, South Korea, Malaysia, Cayman Islands and many more countries predominantly appears on the list of major investors apart from U.S., U.K., Germany, Japan, Italy, and France which are not only the major investor now but during

MAJOR SOURCES OF FDI IN INDIA

Mauriti us USA Singapo re UK Netherla nds Japa n Germa ny Cypr us Franc e Switzerla nd

39.9

8.8

7.2

6. 1

4.4

3.4

2.9

2.1

1.5

1.1

pre- liberalizations era also. The analysis in (Table-3.6) presents the major investing countries in India during 19912008. Mauritius (Chart- 3.11) is the largest investor in India during 1991-2008. FDI inflows from Mauritius constitute about 39.9% of the total FDI in India and enjoying the top position on Indias FDI map from 1995. This dominance of Mauritius is because of the Double Taxation Treaty i.e. DTAADouble Taxation Avoidance Agreement between the two countries, which favours routing of investment through this country. This (DTAA) type of taxation treaty has been made out with Singapore also.

3.5 DISTRIBUTION OF FDI WITHIN INDIA

FDI inflows in India are heavily concentrated around two cities, Mumbai (US$ 26899.57 million) and Delhi (US$ 12683.24 million). Bangalore, Ahmedabad and Chennai are also receiving significant amount of FDI inflows. These five cities together account for 69 per cent of total FDI inflows to India. Mumbai and Delhi together received 50 per cent of total FDI inflows to India during 2000 to 2008. Mumbai

received heavy investment from Mauritius (29%), apart from U.K. (17%), USA (10%), Singapore (9%) and Germany (4%).The key sectors attracting FDI inflows to Mumbai are services (30%), computer software and hardware (12%), power (7%), metallurgical industry (5%) and automobile industry (4%). Mumbai received 1371 numbers of technical collaborations during 1991-2008. Delhi received maximum investment from Mauritius (58%), apart from Japan (10%), Netherlands (9%), and UK (3%).While the key industries attracting FDI inflows to Delhi region are telecommunications (19%), services (18%), housing and real estate (11%), automobile industry (8%) and computer software and hardware (6%). As far as technical collaborations are concerned Delhi received 315 numbers of technical collaborations during 1991- 2008. Heavy investment in Bangalore came from Mauritius (40%) alone. The other major investing countries in Bangalore are USA (15%), Netherlands (10%), Germany (6%), and UK (5%). Top sectors reported the FDI inflows are computer software and hardware (22%), services (11%), housing and real estate (10%), telecommunications (5%), and fermentation industries (4%). Bangalore received 516 numbers of technical collaborations during 1991-2008. Chennai received FDI inflows from Mauritius (37%), Bermuda (14%), USA (13%), Singapore (9%) and Germany (4%). The key sectors attracting FDI inflows are construction activities (21%), telecommunications (10%), services (10%), computer software and hardware (7%), automobile industry (7%), As far as technical collaborations are concerned, Chennai received 660 numbers of technical collaborations during 1991-2008.

CHAPTER-4 FDI AND INDIAN ECONOMY

Nations progress and prosperity is reflected by the pace of its sustained economic growth and development. Investment provides the base and pre-requisite for economic growth and

development. Apart from a nations foreign exchange reserves, exports, governments revenue, financial position, available supply of domestic savings, magnitude and quality of foreign investment is necessary for the well being of a country. Developing nations, in particular, consider FDI as the safest type of international capital flows out of all the available sources of external finance available to them. It is during 1990s that FDI inflows rose faster than almost all other indicators of economic activity worldwide. According to WTO83, the total world FDI outflows have increased nine fold during 1982 to 1993, world trade of merchandise and services has only doubled in the same. Since 1990 virtually every country- developed or developing, large or small alikehave sought FDI to facilitate their development process. Thus, a nation can improve its economic fortunes by adopting liberal policies vis--vis by creating conditions conducive to investment as these things positively influence the inputs and determinants of the investment process. This chapter highlights the role of FDI on economic growth of the country. 4.1 FDI AND INDIAN ECONOMY Developed economies consider FDI as an engine of market access in developing and less developed countries vis--vis for their own technological progress and in maintaining their own economic growth and development. Developing nations looks at FDI as a source of filling the savings, foreign exchange reserves, revenue, trade deficit, management and technological gaps. FDI is considered as an instrument of international economic integration as it brings a package of assets including capital, technology, managerial skills and capacity and access to foreign markets. The impact of FDI depends on the countrys domestic policy and foreign policy. As a result FDI has a wide range of impact on the countrys economic policy. In order to study the impact of foreign direct investment on economic growth, two models were framed and fitted. The foreign direct investment model shows the factors influencing the foreign direct investment in India. The economic growth model depicts the contribution of foreign direct investment to economic growth. 4.2 Selection of Variables:

Macroeconomic indicators of an economy are considered as the major pull factors of FDI inflows to a country. The analysis of above theoretical rationale and existing literature also provides a base in choosing the right combination of explanatory variables that explains the variations in the flows of FDI in the country. In order to have the best combination of explanatory variables for the determinants of FDI inflows into India, different alternatives combination of variables were identified and then estimated. The alternative combinations of variables included in the study are in tune with the famous specifications given by United Nations Conference on Trade and Development, (UNCTAD 2007)77. The study applies the simple and multiple regression method to find out the explanatory variables of the FDI inflows in the country. The regression analysis has been carried out in two steps. In the first step, all variables are taken into consideration in the estimable model. In the second stage, the insignificant variables are dropped to avoid the problem of multi-colinearity and thus the variables are selected. However, after thorough analysis of the different combination of the explanatory variables, the present study includes the following macroeconomic indicators: total trade (TRADEGDP), research and development expenditure (R&DGDP), financial position (FIN.Position), exchange rate (EXR), foreign exchange reserves (RESERVESGDP), and foreign direct investment (FDI), foreign direct investment growth rate (FDIG) and level of economic growth (GDPG). These macroeconomic indicators are considered as the pull factors of FDI inflows in the country. In other words, it is said that FDI inflows in India at aggregate level can be considered as the function of these said macroeconomic indicators.

4.2 FOREIGN DIRECT INVESTMENT (FDI):

It refers to foreign direct investment. Economic growth has a profound effect on the domestic market as countries with expanding domestic markets should attract higher levels of FDI inflows. The generous flow of FDI (Chart - 4.1 and Table 4.1) is playing a significant and contributory role in the economic growth of the country. In 2008-09, Indias FDI touched Rs. 123025 crores up 56% against Rs. 98664 crores in 2007-08 and the countrys foreign exchange reserves touched a new high of Rs.1283865 crores in 2009-10. As a

result of Indias economic reforms, the countrys annual growth rate has averaged 5.9% during 1992-93 to 2002-03. Notwithstanding some concerns about the large fiscal deficit, India represents a promising macroeconomic story, with potential to sustain high economic growth rates. According to a survey conducted by Ernst and Young19 in June 2008 India has been rated as the fourth most attractive investment destination in the world after China, Central Europe and Western Europe. Similarly, UNCTADs World Investment Report76 2005 considers India the 2nd most attractive investment destination among the Transnational Corporations (TNCs). All this could be attributed to the rapid growth of the economy and favourable investment process, liberal policy changes and procedural relaxation made by the government from time to time.

4.3 GROSS DOMESTIC PRODUCT (GDP):

Gross Domestic Product is used as one of the independent variable. The tremendous growth in GDP (Chart-4.2, Table4.2) since 1991 put the economy in the elite group of 12 countries with trillion dollar economy. India makes its presence felt by making remarkable progress in information technology, high end services and knowledge process services. By achieving a growth rate of 9% in three consecutive years opens new avenues to foreign investors from 2004 until 2010, Indias GDP growth was 8.37 percent reaching an historical high of 10.10 percent in 2006. Indias diverse economy attracts high FDI inflows due to its huge market size, low wage rate, large human capital (which has benefited immensely from outsourcing of work from developed countries). In the present decade India has witnessed unprecedented levels of economic expansion and also seen healthy growth of trade. GDP reflects the potential market size of Indian economy. Potential market size of an economy can be measured with two variables i.e. GDP (the gross domestic product) and GNP (the gross national product).GNP refers to the final value of all the goods and

services produced plus the net factor income earned from abroad. The word gross is used to indicate the valuation of the national product including depreciation. GDP is an unduplicated total of monetary values of product generated in various kinds of economic activities during a given period, i.e. one year. It is called as domestic product because it is the value of final goods and services produced domestically within the country during a given period i.e. one year. Hence in functional form GDP= GNP-Net factor income from abroad. In India GDP is calculated at market price and at factor cost. GDP at market price is the sum of market values of all the final goods and services produced in the domestic territory of a country in a given year. Similarly, GDP at factor cost is equal to the GDP at market prices minus indirect taxes plus subsidies. It is called GDP at factor cost because it is the summation of the income of the factors of production Further, GDP can be estimated with the help of either (a) Current prices or (b) constant prices. If domestic product is estimated on the basis of market prices, it is known as GDP at current prices. On the other hand, if it is calculated on the basis of base year prices prevailing at some point of time, it is known as GDP at constant prices. Infact, in a dynamic economy, prices are quite sensitive due to the fluctuations in the domestic as well as international market. In order to isolate the fluctuations, the estimates of domestic product at current prices need to be converted into the domestic product at constant prices. Any increase in domestic product that takes place on account of increase in prices cannot be called as the real increase in GDP. Real GDP is estimated by converting the GDP at current prices into GDP at constant prices, with a fixed base year. In this context, a GDP deflator is used to convert the GDP at current prices to GDP at constant prices. The present study uses GDP at factor cost (GDPFC) with constant prices as one of the explanatory variable to the FDI inflows into India for the aggregate analysis.

Gross Domestic Product at Factor cost (GDPFC) as the macroeconomic variable of the Indian economy is one of the pull factors of FDI inflows into India at national level. It is conventionally accepted as realistic indicator of the market size and the level of output. There is direct relationship between the market size and FDI inflows. If market size of an economy is large than it will attract higher FDI inflows and vice versa i.e. an economy with higher GDPFC will attract more FDI inflows. The relevant data on GDPFC have been collected from the various issues of Reserve bank of India (RBI) bulletin and Economic Survey of India.

4.4 TOTAL TRADE (TRADEGDP): It refers to the total trade as percentage of GDP. Total trade implies sum of total exports and total imports. Trade, another explanatory variable in the study also affects the economic growth of the country. The values of exports and imports are taken at constant prices. The relationship between trade, FDI and growth is well known. FDI and trade are engines of growth as technological diffusion through international trade and inward FDI stimulates economic growth. Knowledge and technological spillovers (between firms, within industries and between industries etc.) contributes to growth via increasing productivity level. Economic growth, whether in the form of export promoting or import substituting strategy, can significantly affect trade flows. Export led growth leads to expansion of exports which in turn promote economic growth by expanding the market size for developing countries. India prefers export stimulating FDI inflows, that is, FDI inflows which boost the demand of export in the international market are preferred by the country as it nullifies the gap between exports and imports.

Since liberalization, the value of Indias international trade (Chart-4.3) has risen to Rs. 2072438 crores in 2008-09 from Rs. 91892 crores in 1991-92. As exports from the country have increased manifolds after the initiation of economic reforms since 1991 (Table 4.3). Indias major trading partners are China, United States of America, United Arab Emirates, United Kingdom, Japan, and European Union. Since 1991, Indias exports have been consistently rising although India is still a net importer. In 2008-09 imports were Rs. 1305503 crores and exports were Rs. 766935 crores. India accounted for 1.45 per cent of global merchandise trade and 2.8 per cent of global commercial services export. Economic growth and FDI are closely linked with international trade. Countries that are more open are more likely to attract FDI inflows in many ways: Foreign investor brings machines and equipment from outside the host country in order to reduce their cost of production. This can increase exports of the host country. Growth and trade are mutually dependent on one another. Trade is a complement to FDI, such that countries tending to be more open to trade attract higher levels of FDI

4.5 FOREIGN EXCHANGE RSERVES (RESGDP): RESGDP represents Foreign Exchange Reserves as percentage of GDP. Indias foreign exchange reserves comprise foreign currency assets (FCA), gold, special drawing rights (SDR) and Reserve Tranche Position (RTP) in the International Monetary Fund. The emerging economic giants, the BRIC (Brazil, Russian Federation, India, and China) countries, hold the largest foreign exchange reserves globally and India is among the top 10 nations in the world in terms of foreign exchange reserves. India is also the worlds 10th largest gold holding country (Economic Survey 200910)17. Stock of foreign exchange reserves shows a countrys financial strength. Indias foreign exchange reserves have grown significantly since 1991.

The reserves, which stood at Rs. 23850 crores at end march 1991, increased gradually to Rs. 361470 crores by the end of March 2002, after which rose steadily reaching a level of Rs. 1237985 crores in March 2007. The reserves stood at Rs. 1283865 crores as on March 2008. Further, an adequate FDI inflow adds foreign reserves by exchange reserves which put the economy in better position in international market. It not only allows the Indian government to manipulate exchange rates, commodity prices, credit risks, market risks, liquidity risks and operational risks but it also helps the country to defend itself from speculative attacks on the domestic currency. Adequate foreign reserves of India indicates its ability to repay foreign debt which in turn increases the credit rating of India in international market and this helps in attracting more FDI inflows in the country. An analysis of the sources of reserves accretion during the entire reform period from 1991 on wards reveals that increase in net FDI from Rs. 409 crores in 1991-92 to Rs. 1,23,378 crores by March 2010. NRI deposits increased from Rs.27400 crores in 1991-92 to Rs.174623 by the end of March 2008. As at the end of March 2009, the outstanding NRI deposits stood at Rs. 210118 crores. On the current account, Indias exports, which were Rs. 44041 crore during 1991-92 increased to Rs. 766935 crores in 2007-08. Indias imports which were Rs. 47851 crore in 1991-92 increased to Rs. 1305503 crores in 200809. Indias current account balance which was in deficit at 3.0 percent of GDP in 1990-91 turned into a surplus during the period 2001-02 to 2003-04. However, this could not be sustained in the subsequent years. In the aftermath of the global financial crisis, the current account deficit increased from 1.3 percent of GDP in 2007-08 to 2.4 percent of GDP in 2008-09 and further to 2.9 percent in 2009-10. Invisibles, such as private remittances have also contributed significantly to the current account. Enough stocks of foreign reserves enabled India in prepayment of certain high cost foreign currency loans of Government of India from Asian

Development Bank (ADB) and World Bank (IBRD) Infact, adequate foreign reserves are an important parameter of Indian economy in gauging its ability to absorb external shocks. The import cover of reserves, which fell to a low of three weeks of imports at the end of Dec 1990, reached a peak of 16.9 months of imports at the end of March 2004. At the end of March 2010, the import cover stands at 11.2 months. The ratio of short term debt to the foreign exchange reserves declined from 146.5 percent at the end of March 1991 to 12.5 percent as at the end of March 2005, but increased slightly to 12.9 percent as at the end of March 2006. It further increased from 14.8 percent at the end of March 2008 to 17.2 percent at the end of March 2009 and 18.8 percent by the end of March 2010. FDI helps in filling the gap between targeted foreign exchange requirements and those derived from net export earnings plus net public foreign aid. The basic argument behind this gap is that most developing countries face either a shortage of domestic savings to match investment opportunities or a shortage of foreign exchange reserves to finance needed imports of capital and intermediate goods.

4.6 FOREIGN DIRECT INVESTMENT GROWTH (FDIG):

In the last two decade world has witnessed unprecedented growth of FDI. This growth of FDI provides new avenues of economic expansion especially, to the developing countries. India due to its huge market size, diversity, cheap labour and large human capital received substantial amount of FDI inflows during 1991-2008. India received cumulative FDI inflows of Rs. 577108 crore during 1991 to march 2010. It received FDI inflows of Rs. 492303 crore during 2000 to march 2010 as compared to Rs. 84806 crore during 1991 to march 99. During 1994-95, FDI registered a 110% growth over the previous year and a 184% age growth in 2007-08 over 200607. FDI as a percentage of gross total investment increased to 7.4% in 2008 as against 2.6% in 2005. This increased level of FDI contributes towards increased foreign reserves.

The steady increase in foreign reserves provides a shield against external debt. The growth in FDI also provides adequate security against any possible currency crisis or monetary instability. It also helps in boosting the exports of the country. It enhances economic growth by increasing the financial position of the country. The growth in FDI contributes toward the sound performance of each sector (especially, services, industry, manufacturing etc.) which ultimately leads to the overall robust performance of the Indian economy.

4.7 ROLE OF FDI ON ECONOMIC GROWTH

In order to assess the role of FDI on economic growth, two models were used. The estimation results of the two models are supported and further analysed by using the relevant econometric techniques viz. Coefficient of determination, standard error, f- ratio, t- statistics, D-W Statistics etc. In the foreign direct investment model (Model-1, Table- 4.8), the main determinants of FDI inflows to India are assessed. The study identified the following macroeconomic variables: TradeGDP, R&DGDP, FIN.Position, EXR, and ReservesGDP as the main determinants of FDI inflows into India. And the relation of these variables with FDI is specified and analysed in equation 4.1. In order to study the role of FDI on Indian economy it is imperative to assess the trend pattern of all the variables used in the determinant analysis. It is observed that FDI inflows into India shows a steady trend in early nineties but shows a sharp increase after 2005, though it had fluctuated a bit in early 2000. However, Gross domestic product shows an increasing trend pattern since 1991-92 to 2007-08 (Table 4.2 and Chart - 4.2). Another variable i.e. tradeGDP maintained a steady trend pattern upto 2001-02, after that it shows a continuous increasing pattern upto 2008-09. ReservesGDP, another explanatory variable shows low trend pattern upto 2000-01 but gained momentum after 2001-02 and shows an increasing trend. In addition to these trend patterns of the variables the study also used the

multiple regression analysis to further explain the variations in FDI inflows into India due to the variations caused by these explanatory variables.