Evolution of FDI in India: Subject: Trade Finance

Evolution of FDI in India
Subject: Trade finance

Submitted By: 1. Ankita kodap 2. Astha Shiv 3. Ashwin Nakman 4. Raunaq Singh Warna 5. Nikhil Bhudhiraja 6. Saurabh Sharma

History of Foreign direct Investment Foreign direct investment (FDI) is now widely perceived as an important resource for expediting the industrial development of developing countries in view of the fact that it flows as a bundle of capital, technology, skills and sometimes even market access. Most of the developing countries, Therefore, offer a welcoming attitude to multinational enterprises (MNEs) that are usually associated with FDI. Indias case is a typical in this context. After following a somewhat restrictive policy towards FDI, India liberalized herFDI policy regime considerably since 1991. This liberalization has been accompanied by increasing inflows. The liberalization has also been accompanied by changes in the sectoral composition, sources and entry modes of FDI. The increasing recognition of Indias locational advantages in knowledge-based industries among MNEs has also led to increasing investments by them in software development and In global R&D centers set up in India to exploit these advantages The government adopted a more restrictive attitude towards FDI in the late 1960s as the local base of machinery manufacturing capability and local entrepreneurship developed and as the outflow on account of remittances of dividends, profits, royalties, and technical fees, etc, abroad on account of servicing of FDI and technology imports grew sharply From 1973 onwards the Further activities of foreign companies (along with those of local large industrial houses) were restricted to a select group of core or high priority industries. The Foreign Exchange Regulation Act, (FERA) of 1973 required all foreign companies operating in India to register under Indian corporate legislation with up to 40 per cent foreign equity. Exceptions from the general limit of 40 per cent were made only for companies operating in high priority or high technology sectors, tea plantations, or those producing predominantly for exports In the 1980s the attitude towards FDI began to change as a part of the strategy of modernization of industry with liberalized imports of capital goods and technology, exposing the Indian industry to foreign competition, and assigning a greater role to MNEs in the promotion of manufactured exports. The policy changes adopted in the 1980s covered liberalization of industrial licensing (approval) rules, a host of incentives, and exemption from foreign equity restrictions under FERA to 100 per cent export-oriented units and a degree of flexibility concerning foreign ownership. After pursuing a restrictive policy towards FDI over the four decades with a varying degree of selectivity, India changed tracks in 1990s and embarked on a broader process of reforms designed controls. The New Industrial Policy (NIP) announced on July 24, 1991 marked a major departure with respect to FDI policy with the abolition of industrial licensing system except where it is required for strategic or environmental grounds, creation of a system of automatic clearance of FDI proposals fulfilling the conditions laid down, such as the ownership levels of 50 per cent, 51 per cent, 74 per cent and 100 per cent foreign equity and opening of new sectors such as mining, banking, insurance, telecommunications, construction and management of ports, harbors, roads and highways, airlines, and defense equipment, to foreign-owned companies subject to sectoral caps. Foreign ownership up to 100 per cent is permitted in most manufacturing sectors in some sectors even on automatic basis except for defense equipment where it is limited to 26 per cent and for items reserved for production by small-scale industries where it is limited to 24 percent. The Foreign Exchange Regulation act (FERA) of 1973 which curtailed foreign investment to 40% in Indian companies. This had a very adverse impact and companies such as Coca-Cola and

IBM exited the country. The impact of this could be seen in the slow growth of the Indian economy as compared to its neighbors over a 30 year period. After getting independence in 1947, the government of India envisioned a socialist approach to developing the countrys economy broadly based on the USSR system. The government decided to adopt an economic agenda that would follow five year plans. Each five year plan was focused on certain sectors of the economy that the government felt needed to be developed for the countries progress. The government followed an interventionist policy and dictated most of the norms of running a business by favoring certain sectors and ignoring others.
Until 1991, India was primarily a closed economy. The industrial environment in India was highly regulated and a license system known as license raj - was in place to ensure compliance with the government regulations and directives. The government also adopted a policy of import substitution and the idea was to help the domestic industry improve in a safe environment until the local industries could compete internationally. This was implemented by levying extremely high tariffs or completely banning imported goods Due to the governments protection most of the industries failed to catch up with the technological innovations taking place around the world. As they were shielded from imports due to extremely high import tariffs the industries had no incentive to improve their operations. This led to a vicious circular logic where the tariffs were not reduced since domestic companies could not compete and the high tariffs prevented industries from innovating. Corruption and opaqueness of the system added to the difficulties and the situation became extremely complex.

The Balance of Payments Crisis Gulf war broke out in 1990 and the resulting oil shock was enough to trigger a serious balance of payment (BoP) crisis for India in 1991. The cost of oil imports went up to 10,820 crores from the estimated 6,400 crores1. Traditionally, India received lot of remittances from the expatriates working in the Gulf countries and this source also dried up as the migrant Indian workers were forced to return home due to the war. The problem was compounded due to an extremely high inflation of about 16% and a fiscal deficit of about 8.5%. The situation was so severe that India had foreign reserves of only around $1 Billion - barely enough to cover two weeks of its payment obligations. Indias credit rating was downgraded as its debt servicing capability was critically impaired and the government had to pledge its gold reserves to soothe creditors. Ostensibly, the trigger for the BoP crisis was the oil shock but the deeper issue was that the governments heavy hand in trying to regulate businesses and to move the country towards economic progress had failed to produce results and drastic measures were now called for.
Faced with these insurmountable problems, the Indian government turned to the IMF and thus began a series of far reaching reforms in the India economy which envisioned transforming the countrys economy from an interventionist and overly-regulated economy to a more market oriented one.
Historical trends in FDI in India Starting with the market reforms initiated in 1991, India gradually opened up its economy to FDI in a wide range of sectors. The license-raj system was dismantled in almost all the industries. The infrastructure sector which was in dire need of capital welcomed foreign equity. FDI was especially encouraged in ports, highways, oil and gas industries, power generation and telecommunication. Consumer goods and service sector which was once completely off-limits for foreign equity was also gradually opened up. The reserve bank of India set up an automatic approval system which allowed investments in slabs of 50, 51 or 74% depending on the priority of the industry, as defined by the government. The foreign investment limits were slowly raised and some sectors saw the limits raised to 100%. The reforms thus led to a gradual increase in FDI in India. Table 3 shows the FDI flow to India after the structural reforms began in 1991. As can be seen from the table, FDI increased from a non-existent value in the start to about $4 billion a year. It should be noted that till 2000, the figure of FDI reported actually underestimates the amount of FDI according to IMF definition. This is because the Indian government had its own definition of FDI and did not include heads like reinvested earnings, proceeds of foreign listings and foreign subordinated loans to domestic subsidiaries. But, the government recognized this problem and after a study undertaken in 2003, the standard definition of FDI as suggested by the IMF was adopted by the Indian government.
Policies A foreign company planning to set up business operations in India may:

Incorporate a company under the Companies Act, 1956, as a Joint Venture or a Wholly Owned Subsidiary. Set up a Liaison Office / Representative Office or a Project Office or a Branch Office of the foreign company which can undertake activities permitted under the Foreign Exchange Management (Establishment in India of Branch Office or Other Place of Business) Regulations, 2000.
An Indian company may receive Foreign Direct Investment under the two routes as given under:
Automatic Route
FDI up to 100 per cent is allowed under the automatic route in all activities/sectors except where the provisions of the consolidated FDI Policy Government Route
FDI in activities not covered under the automatic route requires prior approval of the Government which is considered by the Foreign Investment Promotion Board (FIPB), Department of Economic Affairs, and Ministry of Finance. DI is prohibited under the Government Route as well as the Automatic Route in the following sectors: i) Retail Trading (except single brand product retailing) ii) Atomic Energy iii) Lottery Business iv) Gambling and Betting v) Business of Chit Fund vi) Nidhi Company vii) Agricultural (excluding Floriculture, Horticulture, Development of seeds, Animal Husbandry, Pisciculture and cultivation of vegetables, mushrooms, etc. under controlled conditions and services related to agro and allied sectors) and Plantations activities (other than
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Tea Plantations) (cf. Notification No. FEMA 94/2003-RB dated June 18, 2003). viii) Housing and Real Estate business (except development of townships, construction of residential/commercial premises, roads or bridges to the extent specified in Notification No. FEMA 136/2005-RB dated July 19, 2005). ix) Trading in Transferable Development Rights (TDRs). x) Manufacture of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes.
1. Investment policy in India performance and perceptions, 2002, Dr Sanjib Pohit and Ms. Shalini Subramaniam, CUTS Centre for Competition, Investment & Economic Regulation
Some of the key highlights of the current procedures and policies of Investing in India are as follows2:
a) FDI of up to 100% is allowed in numerous sectors and activities which include most manufacturing activities, non-banking financial services, software development, hospital, private oil refineries, electricity generation (non-atomic) / transmission / distribution, roads & highways, ports & harbors, hotel & tourism, research and development etc. Only a have been limited to industrial licensing and a couple being total prohibited e.g. atomic energy, railway transport3 etc. Other places where 100% FDI is permitted are for setting up Special Economic Zone (SEZ) Units and 100% Export Oriented Units (EOU). b) There are multiple forms of entry for a corporation depending on its needs and requirements which include entry through setting up Joint Ventures, Wholly Owned Subsidiaries, Liaison / Representative Office, Project Office or Branch Office. c) Liberal foreign exchange regulations, under the rule of the Central Bank, namely the Reserve Bank of India e.g. all foreign investment and dividends declared thereon is freely repatriable unless otherwise specified under a particular scheme and through an authorized dealer.
d) Favorable policies for Foreign Institutional Investors (FIIs) looking to just invest and trade in as well as out of the Stock Exchange under the Portfolio Investment Scheme (PSI). They have the option of investing in both equity and debt instruments, the only catch being that the investment has to be split in the ratio of 70:30, and also the other option of declaring themselves purely interested in debt instruments and then becoming a 100% debt FII. e) A mature and favorable taxation system with low customs and excise duties and low corporate taxes. It caters for numerous tax holidays or rebates depending upon the sector of investment and geographical location e.g. there is a tax holiday of 10 years for foreign investment in infrastructure projects, various projects taken up in certain backward areas in the North Eastern States and Sikkim, units located in specified zones, projects which are 100% export oriented etc. Moreover India has already entered into a Double Taxation Avoidance Agreement (DTAA) with 65 other countries, under which the income generated in India will be taxed in India and then would not be re-taxed in the home country of the investor, only the difference in the tax rate between the home country and India would be payable. f) Keeping in mind the growing concern over intellectual property rights, India has been prompt to enact numerous rules and regulations e.g. The Patents Act, The Trademarks Act, The Geographical Indicators of Goods Act and The Designs Act. g) To assist in providing a prompt and smooth investment process the Indian Government has set up numerous independent institutions e.g. The establishment of Foreign Investment Implementation Authority (FIIA) to assist in the prompt implementation of FDI approvals, the formation of the Foreign Investment Promotion Board (FIPB) to assess various FDI proposals and to cater to the grievances and complaints of potential and current investors the appointment of a Business Ombudsperson and Grievances Officer-Cum-Joint Secretary in the Ministry of Commerce and Industry. h) Also, to ensure adequate and up-to-date information on current policies and procedures is available at all time to investors various points of call have been set up which can be easily accessed e.g. the Secretariat for Industrial Assistance (SIA) has been set up for this particular purpose. Other means are through the internet on various websites (e.g. http://dipp.nic.in), online chats, bulletin board services, frequent publications and monthly newsletters. i) Focusing in on more recent events in India and specifically in the Banking and Insurance Sector, in previous years the FDI limit in private sector banks was raised to 74% from the existing 49% and the insurance sector to be hiked from 26% to 49%4, but there was a caveat of only having 10% voting rights irrespective of the shareholding, which was seen as a major
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Budget 2004,

constraint. In 2005, a new regulation namely the Banking Regulation (Amendment) Bill 2005 has been proposed which will give private investors voting rights which will be in line with their current shareholding. Once this regulation is given the nod, it is likely to increase foreign investment significantly5. Foreign Direct Investment (FDI) is permitted as under the following forms of investments

Through financial collaborations. Through joint ventures and technical collaborations. Through capital markets via Euro issues. Through private placements or preferential allotments.
Forbidden Territories FDI is not permitted in the following industrial sectors:

Arms and ammunition. Atomic Energy. Railway Transport. Coal and lignite. Mining of iron, manganese, chrome, gypsum, sulphur, gold, diamonds, copper, zinc.
Foreign Investment through GDRs (Euro Issues) Indian companies are allowed to raise equity capital in the international market through the issue of Global Depository Receipt (GDRs). GDR investments are treated as FDI and are designated in dollars and are not subject to any ceilings on investment. An applicant company seeking Government's approval in this regard should have consistent track record for good performance (financial or otherwise) for a minimum period of 3 years. This condition would be relaxed for infrastructure projects such as power generation, telecommunication, petroleum exploration and refining, ports, airports and roads. 1. Clearance from FIPB There is no restriction on the number of Euro-issue to be floated by a company or a group of companies in the financial year. A company engaged in the manufacture of items covered under Annex-III of the New Industrial Policy whose direct foreign investment after a proposed Euro issue is likely to exceed 51% or which is implementing a project not contained in Annex-III, would need to obtain prior FIPB clearance before seeking final approval from Ministry of Finance.

2. Use of GDRs The proceeds of the GDRs can be used for financing capital goods imports, capital expenditure including domestic purchase/installation of plant, equipment and building and investment in software development, prepayment or scheduled repayment of earlier external borrowings, and equity investment in JV/WOSs in India.
3. Restrictions However, investment in stock markets and real estate will not be permitted. Companies may retain the proceeds abroad or may remit funds into India in anticipation of the use of funds for approved end uses. Any investment from a foreign firm into India requires the prior approval of the Government of India.
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Foreign direct investments in India are approved through two routes 1. Automatic approval by RBI The Reserve Bank of India accords automatic approval within a period of two weeks (subject to compliance of norms) to all proposals and permits foreign equity up to 24%; 50%; 51%; 74% and 100% is allowed depending on the category of industries and the sectoral caps applicable. The lists are comprehensive and cover most industries of interest to foreign companies. Investments in high-priority industries or for trading companies primarily engaged in exporting are given almost automatic approval by the RBI. 2. The FIPB Route Processing of non-automatic approval cases FIPB stands for Foreign Investment Promotion Board which approves all other cases where the parameters of automatic approval are not met. Normal processing time is 4 to 6 weeks. Its approach is liberal for all sectors and all types of proposals, and rejections are few. It is not necessary for foreign investors to have a local partner, even when the foreign investor wishes to hold less than the entire equity of the company. The portion of the equity not proposed to be held by the foreign investor can be offered to the public.
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Sectoral Caps/Limits on Investments by Persons Resident Outside India or Foreign Companies for each Industry
S. No. 1. 2.
Sector Private Sector Banking Non-Banking Financial Companies (NBFC) Insurance
Investment Cap 49% 100%
Description of Activity/Items/Conditions Subject to guidelines issued by RBI from time to time FDI/NRI investments allowed in the following 19 NBFC activities shall be as per the levels indicated below : FDI up to 26% in the Insurance sector is allowed on the automatic route subject to obtaining license from Insurance Regulatory and Development Authority (IRDA)
3.
26%
4. 5.
6. 8.
9.
Telecommunications (i)] Petroleum Refining (Private Sector) (ii) Petroleum Product Marketing (iii) Oil Exploration in both small and medium sized fields (iv) Petroleum Product Pipelines Housing and Real Estate Venture Capital Fund (VCF) and Venture Capital Company (VCC) Trading
49% 100% FDI permitted up to 100% in case of private Indian companies Subject to the existing sectoral policy and regulatory frame-work in the oil marketing sector
100% 100%
100% 100%
Subject to and under the Government Policy and Regulations thereof.]
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10. 11. 12. Power 100% Other than atomic reactor power plants.
Drugs & 100% Pharmaceuticals Road and highways, 100% Ports and harbors Hotel & Tourism 100%
In projects for construction and maintenance of roads, highways, vehicular bridges, toll roads, vehicular tunnels, ports and harbors.
13.
14.
Mining
74%
(i) For exploration and mining of diamonds and precious stones FDI is allowed up to 74% under automatic route,
100% (ii) For exploration and mining of gold and silver and minerals other than diamonds and precious stones, metallurgy and processing Advertising Sector FDI up to 100% allowed on the automatic route Film Sector (Film production, exhibition and distribution including related services/products) Govt. approval required beyond 74%
15. 16 17. 18. 19. 20.
Advertising Films Airports
100% 100% 74%
Mass Rapid 100% Transport Systems Pollution Control & 100% Management Special Economic 100% Zones
All manufacturing activities except Arms and ammunition, warships; Atomic substances, Narcotics and Psychotropic Substances and Hazardous Chemicals; Distillation and brewing of Alcoholic drinks, and Cigarette/cigars and manufactured tobacco substitutes.
21.
Any other 100% sector/activity (if not included in

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22. Annexure A) Air Transport Services (Domestic Airlines) Townships, housing, infrastructure, construction projects. 100% for No direct or indirect equity participation by foreign NRIs 49% for airlines is allowed. others 100% The investment shall be subject to the following guidelines
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Comparison with China
Top 3 business functions
Top 3 source countries Top 3 investors Beginning of FDI reforms
Research & development Manufacturing Sales marketing & support US, UK, Germany LG, General Electric, Intel Early 90s
Manufacturing Sales marketing & support Business services Japan, US, Germany Toyota, LG, Formosa Plastics Group Late 70s / Early 80s
Source: CIA World Fact Book 2005 (http://www.cia.gov/cia/publications/factbook/index.html), FDI Fact file 2005 (http://www.fdimagazine.com), UNCTAD, FDI Database On-Line (http://stats.unctad.org/fdi/eng/ReportFolders/Rfview/Explorerp.asp?CS_referer)
On comparing the key attributes between China and India9, China comes out more favorable in terms of market size and growth potential, access to export markets, higher government incentives, financial/economic/political/social stability, quality of life and Infrastructure availability whereas India comes out on top with respect to providing a highly educated workforce, management talent, rule of law, transparency, fewer cultural barriers and a relatively strong regulatory environment.
Based on these different attributes investors perceive China and India as two different markets for potential investment. India is identified as the upcoming business process and IT services provider and there are more investments in sectors and activities such as IT & software, business services and research & development. China is recognized as the fastest growing consumer market and the worlds leading manufacturer and is seem as an investment centre for sectors and activities such as manufacturing of chemicals, machinery & industrial goods and automobiles.
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Comparison with other developing countries
Comparative Growth Rates of Developing Economies Average Annual Rates 1960-88 Country Industrial GDP Production 1960-1980 1980-1988 1960-1980 South Korea 15.2 12.6 8.8 Taiwan 12.8 7.2 9.6 Singapore 12.1 4.5 9.2 Hong Kong 10.3 7.5 9.9 Thailand 10.3 6.6 7.4 Indonesia 8.9 5.1 5.9 Pakistan 8.0 7.2 4.4 Malaysia 9.6* 6.1 7.9* India 4.6 7.6 3.5 Bangladesh 6.1 4.9 5.8* Sri Lanka 5.3 4.4 5.2 Myanmar 4.2 7.3* 3.5 * - 1970-1980 Table 2
1980-1988 10.1 7.4 6.9 7.4 6.5 5.7 6.3 4.6 5.4 3.5 3.9 3.3*
Country Hungary Yugoslavia Argentina Morocco
Intermediate Goods 14.2 18.0 21.2 21.6
Capital Goods 15.0 20.7 25.0 18.1

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Consumer Goods 22.6 20.0 21.9 43.0
Manufactured Goods 20.9 19.0 22.9 27.3

Philippines Mexico Thailand Turkey Pakistan China Bangladesh India 21.8 25.5 27.8 29.4 75.0 78.9 97.9 146.4 24.5 23.5 24.8 54.9 73.8 62.5 80.5 107.3 39.0 32.2 8.5 55.3 127.3 130.7 116.1 140.9 28.0 24.7 33.6 37.1 89.8 91.2 100.8 137.7
Future of FDI
Chinas roaring success in past twenty years is on the back of Foreign Direct Investment (FDI). Chinese smartened up in 1980 and enacted rules and regulations to welcome it. India, belatedly, has to copy this concept. Initially FDI was thought to be Western economic imperialism in modern times. Leaders brought up with Nehruvian economic mould spurned upon it. Hence India missed the investment bus for almost 25 years. India needs FDI, and India needs it now. It needs it to boost the economic growth. Asian countries (with the exception of India) understood this change and devised rules and regulations to attract it. China and Asian Tigers (Thailand, Singapore, Malaysia, and South Korea etc.) were the net beneficiaries. The West did not care whether the recipients were a former enemy or a friend. Money saw no enemies or friend, instead it moved in the direction of minimum rules, pro-active government help, lower wages, low priced products and an understanding to deposit the proceeds of the export boom in American Banks or bonds. India and China not only survived the financial crisis over the course of the financial crisis their economies grew. This is the perfect time for India to attract much needed non-debt creating capital flows through foreign direct investment (FDI). The Indian Budget for 2010-11 has rightly proposed to simplify the FDI regime, maintaining FDI flows particularly by recognizing ownership and control issues and liberalizing the pricing and payment system for technology transfers, trademarks, and brand name and royalty payments. More importantly, the budget shows an intention to introduce user-friendly regulations and guidelines for FDI. But while India is macro-economically well placed to attract FDI inflows, merely showing an intention to introduce user-friendly regulations without addressing the core regulatory, institutional and policy issues affecting FDI may not be enough to attract the huge amounts of FDI the country needs. Economic surveys in last few years confirm time and again the need for concrete reforms to improve the Indian investment and business climate. While the 2009 Doing Business survey prepared by the World Bank showed that Indias indicators have gotten better, India still lags behind China overall. China beats India in crucial indicators such as: registering property, trading across borders, enforcing contracts and closing business (see the table below). In this context, the suggestion in the budget for simplified, user-friendly regulations and guidelines would be useful provided that after the budget institutions are designed to enforce commercial contracts, in order to reassure investors. In fact, it was expected that the budget
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would not only demonstrate an intention to simplify FDI rules and regulations, but also propose a proper framework of action for achieving this.
Indias high trade and transaction costs are mainly due to the countrys lack of quality infrastructure. This lack of infrastructure discourages resource-seeking and export-oriented FDI to use India as their base as they do with China. Chinas unmatched average growth rate of 10 per cent for more than a decade is due to consistent improvements in physical infrastructure. The 2010-11 Budgets does focus on infrastructure development, allocating substantial general funds, which constitute 46 per cent of the total plan allocation, and doubling plan allocation to power sector and improved allocation for renewable energy in particular. Moreover, some of the budgets announcementslike allocating coal blocks for captive mining and a proposal to set up a Coal Regulatory Authority to ensure greater transparencyare welcome steps. The public sector cannot cover the USD150 billion per annum required for the maintenance and creation of infrastructure. India invests around 5 to 6 per cent of GDP on infrastructure whereas China invests 14.4 per cent of GDP. The gap between infrastructure investments in China and India is widening not only as share of GDP, but also in absolute levels given that Indias GDP is only one third that of China. Hence, the private sector must participate substantially in infrastructure development in India. One way of improving the environment for infrastructure development is through public-private partnerships. These require a more stable and secure policy framework; particularly ensuring the protection of property rights and consistency in pricing and subsidy policies. Infrastructure projects need maximum clearances and approvals that sometimes run into innumerable disputes. Therefore, there should be an institutional mechanism for speedy dispute resolution. The politically acceptable cost-recovery based pricing is a must for attracting private investment into the infrastructure sector. Infrastructure projects are capital intensive. A special federal investment law should be formulated to consolidate the many sets of State laws, rules and regulations covering the infrastructure sector. Infrastructure also needs stable financing. Because of this the Rs 20,000 income tax exemption for investment on infrastructure bonds is a welcome step. But the government could do more by allowing financial intermediaries to invest in reasonably rated infrastructure projects and by giving a guarantee to use pension funds, insurance and FIIs to invest in infrastructure projects.
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The Budget 2010 intends to simplify and introduce user-friendly regulations and guidelines for FDI but these are mostly at the central government level. However, actual implementation of projects will take place at the state level. Bureaucratic hassles, mainly at the state level, are obstacles to the realization of FDI. Some of the major issues related to project implementation such as land acquisition, land use change, power connection, building plan approval are at the state level This division of political responsibility creates a delay in implementation. Therefore, a concerted effort is required for better co-ordination between the central and state governments on this issue. An institutional mechanism may be set up for getting clearances of FDI projects from both central and state governments within a stipulated time. Another way of attracting FDI is by following the Chinese special economic zone (SEZ) model. This is large with state of the art infrastructure facilities and proper infrastructure connectivity to the market. To attract FDI SEZs in India should be designed as Chinas are, with proper infrastructure connectivity to domestic and external markets. If necessary, the private sector should be encouraged to set up private airports and ports to service the SEZs through automatic routes and 100 per cent FDI equity. Since its hard to connect different kinds of transportation infrastructure in India, SEZs should be established in the coastal regions like in China to make transportation easier. The Budget 2010-11 should have addressed some of these measures to attract FDI much needed by the economy. While foreign equity participation has increased in most sectors, there are still sectors where there is huge potential for FDI inflows. Further increases in FDI ceilings in sectors such as telecom, civil aviation, power generation, food retailing, insurance, banking, investing companies and the real estate sector will be required to achieve this potential. Most of these sectors need to be opened up further with independent regulatory systems to control market distortions and allow fair competition. Though the budget recognizes the importance of ownership and control issues for FDI, no concrete steps have been announced or proposed. The investment climate can be improved through increasing foreign and private ownership in different sectors, simplifying rules and regulations and developing independent regulatory bodies. But India can only succeed in actually creating a conducive business environment and getting more investment both from private and foreign investors if it focuses on providing quality physical infrastructure. This union budget has done the right thing by allocating USD37 billion for infrastructure upgrades in both rural and urban areas. However, mere allocation is not enough as infrastructure projects are complicated and actual outcomes are quite different from the proposals. Private sector participation, both domestic and foreign, needs to be encouraged to enable infrastructure development. Though an emphasis on infrastructure development in the 2010-11 Budget would certainly help in achieving more FDI realization, we also need to work on other important issues related to labour laws, centre-state coordination, better SEZ schemes and proper institutional mechanisms to attract more FDI in future. Foreign direct investment (FDI), which is vital to Indias growth, has lacked a proper policy document and has been administered primarily through a series of press notes over many years. According to the critics, the 177 existing press
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notes have created new areas of ambiguity while trying to resolve the existing ones. Doing away with the press notes approach will go a long way in making Indias FDI policy transparent and friendly to investors. India is becoming increasingly attractive to foreign investors. The reforms proposed in this years Budget will simplify regulations and guidelines for FDI and make them more userfriendly, paving the way for a better investment climate and sustainable growth. But in India there is huge gap between proposals for reforms, and their implementation. Bipartisan cooperation will help to ensure that reforms are implemented, allowing India to attract FDI and progress toward double digit growth.
As explained above, India is definitely a lucrative place for FDI, but there are certainly some challenges and areas for improvement still present. Until, these areas are honed to perfection, India will not become the number one place for FDI. Some of the key areas are listed below6:
a) Political risk: Amongst the top items is the political instability of the country. On one hand the fact that India is the worlds largest democracy does add a sense of pride and security, but the hard reality is that there is insurmountable instability present. Just the fact that the past two governments have been based on coalitions between a few parties is reason enough to be skeptical. Moreover, each new government has certain policies which are different from the ruling government and if there is frequent change in government, this will lead to changes in policy and increased uncertainty. Just take the example of the last elections in 2004, where by a sudden change of event the Indian National Congress was able to come into power by forming a coalition government, by soliciting the vast majority of the poor people of the country, surprising the incumbent government which was relying heavily on a fast growing economy, increased privatization and a thriving middle class. b) Bureaucracy: Another very important factor that affects Indias competitiveness on the world standing is the Bureaucracy. Particularly in the FDI process the Indian Government has already invested a lot of time and effort but there is still a lot of room for improvement in the identification, approval and implementation process e.g. creating more canters for assistance, more user friendly processes, effective use of technology, being as clear as possible leaving no room for interpretation, assisting in identifying new areas for investment etc. c) Security risk: Another important factor that needs to be handled with care and worked upon is the ever present security risk. This risk includes the geopolitical risk with Pakistan and the
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ongoing dispute over the Kashmir issue, which on numerous occasions has brought these two countries armed with nuclear weapons to the brink of war. The other security risks would include incidences of domestic terrorism, not only in the Kashmir valley but also in Assam, Manipur and Nagaland, where numerous separatists group operate. d) Cost advantage: One of the attractions of India is the lower cost advantage as compared to most western economies. The Indian Government would have to work on creating an atmosphere where this advantage can be maintained else it might result in India not seem as attractive. One of the key drivers would be to try and control inflation because if there is increased level of inflation then there would be increased costs and reduced returns. Other factors which would act in similar respects would be increased tax incentives and reduced tariffs. e) Intellectual Property (IP) Rights & Piracy: With the increased instances of Piracy around the world and the extreme importance placed by Investors on maintaining their IP rights, this is definitely an area which needs improvement in India. India has begun instilling intellectual property rules and regulations into the country but there is still a long road ahead. The main area for improvement in this respect is the enforcement, which is the most crucial part but the weakest at present in the country. The enforcement of IP rights included the increased crackdown in the market on pirated and knock-downed good. f) Privatization and deregulation: Increased privatization of various sectors would definitely enhance the attractiveness of India as an FDI destination. India has already taken steps to privatize areas such as electricity, telecommunication etc. and increase the foreign holding capacity in sectors such as banking and insurance which is a first step.
g) Infrastructure: It definitely is an added bonus to the investor if there is adequate
infrastructure present in the country. In India there is substantial lack of robust infrastructure around the country, e.g. proper roads, highways, adequate supply of clean water, uninterruptible supply of electricity etc.
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EVOLVING ECONOMIES
The trajectory of inbound FDI in the BRIC countries reflects the evolving positions of the four economies in the global economy: China
WTO-mandated liberalization of Chinese foreign investment has stimulated FDI in financial services, real estate, construction, and other non-manufacturing sectors. Meanwhile, rising wages in Shanghai and other coastal regions have eroded Chinas cost advantages in labour-intensive production, precipitating a diversion of manufacturing-related FDI to Vietnam and other lower-cost locales. But manufacturing remains the centerpiece of Chinas foreign investment sector, accounting for nearly 70% of the countrys inbound FDI stock. Chinas large installed manufacturing base enables the country to bootstrap sequential investments in key industries (automotive, consumer durables, garments, microelectronics, and telecommunications); solidifying Chinas standing as the worlds manufacturing platform.
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Brazil
A number of leading multinational corporations have been active in Brazil for decades. The countrys size, resource endowment, industrial base and geographic locale offer huge rewards for foreign investors. But a variety of factors (high levels of corruption, acute income inequality and a long history of political-economic instability) has hindered Brazil from realizing its FDI potential. While Brazil is unlikely to attain Chinese FDI levels, recent developments bode well for the countrys ability to boost foreign direct investment. The Lula governments economic reform program has improved business conditions, while its privatization campaign has spurred crossborder mergers and acquisitions in financial services, telecommunications and other sectors. Brazils automotive, food and beverages and retail distribution sectors are receiving increasing amounts of FDI. The Brazilian biofuels industry, which has become a world leader amid growing demand for renewable energy products, is also garnering significant attention from the foreign investor community.
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Russia
The Russian Federation is a late mover in the foreign investment sphere. During the 1990s, Russia received lower amounts of FDI than the smaller and less well-endowed countries of East Central Europe. While Russia has now surpassed the CEE countries as an FDI host, the Russian business environment remains less attractive to foreign investors than the EU accession states that are converging toward Western-style legal/regulatory norms. Furthermore, the continued delay in Russias entry to the World Trade Organization has stalled the countrys adoption of intellectual property protections and related reforms critical to the foreign investor community. Moscows heavy-handed treatment of the dispute over Sakhalin-2 (which resulted in the transfer of majority ownership from Royal Dutch Shell to Gazprom) deepened anxieties over foreign investment conditions in Russias energy sector, the countrys primary FDI destination. But Russias centrality as an oil and gas supplier to Europe indicates growing inflows of hydrocarbon-related FDI. Meanwhile, Russias rising per capita income and expanding middle class are stimulating foreign investment in non-energy sectors, notably banking, consumer goods and real estate. Manufacturing-related investment in Russia remains small (about 7% of inbound FDI), but is likely to grow in the coming years as Russian manufacturers seek foreign investment to bridge the competitive gap with China, Brazil and East Central Europe.
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India
At $66bn, Indias inbound FDI stock is the smallest of the BRIC countries, and smaller than the FDI stocks of other, far less populous emerging economies like Chile, Czech Republic and Hungary. Indias weak performance in the FDI arena demonstrates several factors:
Indias belated opening to foreign investors, which didnt occur until 1990 and which enabled China to exploit first-mover advantages in manufacturing-related FDI The low FDI intensity of off-shored IT services, which have become the bulwark of Indias foreign investment sector A notoriously balky and inefficient bureaucracy, which raises entry costs for putative foreign investors A poorly developed infrastructure, which frustrates transportation, logistics and supply chain management by foreign manufacturers and distributors
The central challenge facing India is leveraging the countrys success in IT services to stimulate technology-intensive investment in manufacturing and other non-service sectors. To that end, the Indian government has accelerated privatization of state-owned companies, launched major investments in infrastructure and created special economic zones to attract export-oriented FDI. Indias locational assets (notably a rapidly expanding middle class and a huge supply of welltrained, English-speaking professionals) augur favorably for a steady if unspectacular expansion of foreign investment in coming years. SUSTAINING GROWTH The ability of Brazil, Russia, India and China to sustain robust growth rates and strong FDI inflows amid a slowing global economy lends credence to Goldman Sachs oft-cited prediction that the BRIC group will overtake the combined income of the developed countries by midcentury.
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To FDI or NOT
The debate on foreign direct investment in retail is heating up. Once again, the ruling Government and its allies are in sharp disagreement. Why does FDI in retail create so much animosity? One, we are afraid that the entry of large global retailers such as Wal-Mart would kill local shops and millions of jobs. The retail industry is about 10% of the GDP. India, with over 15 million retail outlets, has the highest retail density in the world, Over 95% of which is in the unorganized sector and provides employment to about 8% of the total workforce, roughly 40 million people. The livelihood of these people is at risk. The more vociferous elements, however, are the middlemen & traders. They stand to lose their livelihoods altogether. Two, the global retailers would collude and exercise monopolistic power to raise prices. Consider that Wal-Mart had sales of $ 405 billion in fiscal year 2010. Just this company alone has the bargaining muscle power while sourcing products, equal to 158% of the countrys total retail market estimated at Rs 12, 00,000 crores or $ 257 billion. Only the nave can believe that this bargaining power will not be used to squeeze suppliers or will not drive out smaller retailers with predatory prices. Global retail giants enjoy huge economies of scale and they have access to the cheapest goods (read Chinese) available so will cut prices which will bleed the kirana stores to death. Once competition is eliminated they will be free to raise prices. The best safeguard would be in permitting all global chains to set up shops. The competition among them (as has happened in the automobile industry) would ensure better prices for consumers and suppliers alike. Three, FDI In retail is a major bargaining tool which cannot be given away on a platter by a unilateral action. Markets in the developed world are saturated. Attracted by the huge growing Indian market, the sole objective of global retailers is to expand and create more profit opportunities. US & European Governments are putting pressure on us to open up the retail sector. In return we should make them accept our trade terms, i.e. free access to Indian goods and labour in their markets. If at all foreign countries are allowed to participate in the enormous potential of one of the largest markets in the world by establishing just a retail base, there must be a sound basis and a matching quid pro quo. What advantage do supporters of FDI see? One, Farmers & Consumers both would benefit. To the extent the large retailers establish a direct linkage with the farmers by cutting out many layers of middlemen, develop the processing facilities and export the products to meet their global requirements, farmers would get better prices and bigger markets while the consumers would benefit in terms of lower prices, better quality and greater variety. The resultant rural
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prosperity may open up markets for other industrial goods and help a more balanced regional development as also job creation in other sectors. Four - Reforms in Retail will push exports of Indian produce and add a few points to GDP growth The global retailers taken together buy about $60 billion of goods each year from China for exports. Contrast this with India where less than $1 billion of exports are accounted for by global retailers. Clearly, the scope of exports through the global retailers is enormous, indeed. Foreigners if they want to enter will have to take local partners to start with. Once the local partners and other local players learn by doing, the FDI cap can be raised gradually. Foreigners can be allowed to set up 100% foreign-owned retail chains only after the local players are able to muster enough capital, experience and expertise to compete with established global giants. They argue that with the right checks and balances, opening up of the retail sector are the need of the hour to give a push to the GDP growth rate. Five - Control inflation by reducing wastage India, unlike other parts of the world, suffers from huge wastage in the food chain. Researchers estimate avoidable supply chain costs (wastage, excess inventory and excess transportation costs) in Indian food and grocery sales to be about US$24 billion. One of the arguments in favor of FDI is that it will bring with it the technologies and expertise required to build robust food supply chains.
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Recent Development in FDI

FDI Policy with Regard to Retailing in India a) FDI up to 100% for cash and carry wholesale trading and export trading allowed under the automatic route. b) FDI up to 51 % with prior Government approval (i.e. FIPB) for retail trade of Single Brand products, subject to Press Note 3 (2006 Series) c) FDI is not permitted in Multi Brand Retailing in India.
FDI in Single Brand Retail In single-brand retail, FDI up to 51 per cent is allowed, subject to Foreign Investment Promotion Board (FIPB) approval and subject to the conditions mentioned in Press Note 3[8] that (a) Only single brand products would be sold (i.e., retail of goods of multi-brand even if produced by the same manufacturer would not be allowed), (b) Products should be sold under the same brand internationally, (c) Single-brand product retail would only cover products which are branded during manufacturing and (d) Any addition to product categories to be sold under single-brand would require fresh approval from the government.
FDI in Multi Brand Retail Currently FDI in Multi Brand Retail is not allowed. Concerns for the Government for only Partially Allowing FDI in Retail Sector A number of concerns were expressed with regard to partial opening of the retail sector for FDI. The Honble Department Related Parliamentary Standing Committee on Commerce, in its 90th Report, on Foreign and Domestic Investment in Retail Sector, laid in the Lok Sabha and the
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Rajya Sabha on 8 June, 2009, had made an in-depth study on the subject and identified a number of issues related to FDI in the retail sector. These included: It would lead to unfair competition and ultimately result in large-scale exit of domestic retailers, especially the small family managed outlets, leading to large scale displacement of persons employed in the retail sector. Further, as the manufacturing sector has not been growing fast enough, the persons displaced from the retail sector would not be absorbed there. Another concern is that the Indian retail sector, particularly organized retail, is still underdeveloped and in a nascent stage and that, therefore, it is important that the domestic retail sector is allowed to grow and consolidate first, before opening this sector to foreign investors. Antagonists of FDI in retail sector oppose the same on various grounds, like, that the entry of large global retailers such as Wal-Mart would kill local shops and millions of jobs, since the unorganized retail sector employs an enormous percentage of Indian population after the agriculture sector; secondly that the global retailers would conspire and exercise monopolistic power to raise prices and monopolistic (big buying) power to reduce the prices received by the suppliers; thirdly, it would lead to asymmetrical growth in cities, causing discontent and social tension elsewhere. Hence, both the consumers and the suppliers would lose, while the profit margins of such retail chains would go up
Recent Developments in FDI Retail. Government of India allowed FDI in retail in last week Of November, but due to opposition from the opposition party, some of the coalition members, the retailers of India and due to above concerns, Government had to withdraw the FDI in retail. Recent developments in FDI Civil Aviation. The Civil Aviation Ministry has proposed 24 per cent investment by foreign airlines. Foreign Direct Investment (FDI) up to 49 per cent is now allowed in domestic airlines, but the policy currently bars foreign airlines from investing in them primarily on security grounds. A 26 per cent cap would allow a foreign investor to have voting rights in the board of an Indian carrier which is not allowed if the cap is 24 per cent. DIPP feels that allowing foreign airlines to invest in domestic carriers would help them raise the much- needed equity; it does not find support among many Indian airlines which feel that fledgling carriers would be susceptible to hostile takeovers as they were passing through a difficult financial situation.
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PROs & CONs

Government argument * Huge investments in the retail sector will see gainful employment opportunities in agroprocessing, sorting, marketing, logistics management and front-end retail. * At least 10 million jobs will be created in the next three years in the retail sector. * FDI in retail will help farmers secure remunerative prices by eliminating exploitative middlemen. * Foreign retail majors will ensure supply chain efficiencies. * Policy mandates a minimum investment of $100 million with at least half the amount to be invested in back-end infrastructure, including cold chains, refrigeration, transportation, packing, sorting and processing. This is expected to considerably reduce post-harvest losses. *This will have a salutary impact on food inflation from efficiencies in supply chain. This is also because food, which perishes due to inadequate infrastructure, will not be wasted. * Sourcing of a minimum of 30% from Indian micro and small industry is mandatory. This will provide the scales to encourage domestic value addition and manufacturing, thereby creating a multiplier effect for employment, technology up gradation and income generation. * A strong legal framework in the form of the Competition Commission is available to deal with any anti-competitive practices, including predatory pricing. * There has been impressive growth in retail and wholesale trade after China approved 100% FDI in retail. Thailand has experienced tremendous growth in the agro-processing industry. * In Indonesia, even after several years of emergence of supermarkets, 90% of fresh food and 70% of all food is still controlled by traditional retailers. * In any case, organized retail through Indian corporate is permissible. Experience of the last decade shows small retailers have flourished in harmony with large outlets.
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Opposition's argument * Move will lead to large-scale job losses. International experience shows supermarkets invariably displace small retailers. Small retail has virtually been wiped out in developed countries like the US and in Europe. South East Asian countries had to impose stringent zoning and licensing regulations to restrict growth of supermarkets after small retailers were getting displaced. India has the highest shopping density in the world with 11 shops per 1,000 people. It has 1.2 crore shops employing over 4 crore people; 95% of these are small shops run by selfemployed people * Global retail giants will resort to predatory pricing to create monopoly/oligopoly. This can result in essentials, including food supplies, being controlled by foreign organizations. * Fragmented markets give larger options to consumers. Consolidated markets make the consumer captive. Allowing foreign players with deep pockets leads to consolidation. International retail does not create additional markets, it merely displaces existing markets. * Jobs in the manufacturing sector will be lost because structured international retail makes purchases internationally and not from domestic sources. This has been the experience of most countries which have allowed FDI in retail. * Argument that only foreign players can create the supply chain for farm produce is bogus. International retail players have no role in building roads or generating power. They are only required to create storage facilities and cold chains. This could be done by governments in India. * Comparison between India and China is misplaced. China is predominantly a manufacturing economy. It's the largest supplier to Wal-Mart and other international majors. It obviously cannot say no to these chains opening stores in China when it is a global supplier to them. India in contrast will lose both manufacturing and services jobs.
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Bottom line: FDI is a demon or an angel. Either it will eat us up or if we can ride it, it will fly us to the heavens Liberalization of trade policies during the last one and half decade has led India to become an investment friendly country. Foreign direct investment (FDI) in this country assumed critical importance in the context of this liberalization. Though India is the tenth most industrialized country in the world, it is well known that it is mainly agro-based with around 70% population engaged in the farm sector. However, in the initial stage of liberalization, FDI was centered on the urban manufacturing sectors because of its civic infrastructure, labour availability, flexible taxation mechanism etc. The success story of FDI in these sectors is known to us. For a long time there were efforts for FDI in the retail sector so that the trader can reap the benefit of FDI. Retail trade contributes around 10-11% of Indias GDP and currently employs over 4 crores of people. Recently, a great debate has cropped up against the government plans for FDI in the Indian retail sector. FDI in retail is fundamentally different from that in manufacturing. FDI in manufacturing basically enhances the productive employment in most cases; but FDI in retail trade may create job losses and displacement of traditional supply chain. One of the main features of rural India is disguised unemployment. Farmers, evicted from the agricultural sector, engage in small retail trades for livelihood. The main fear of FDI in retail trade is that it will certainly disrupt the livelihood of the poor people engaged in this trade. The opening of big markets or foreign-sponsored departmental outlets will not necessarily absorb them; rather they may try to establish the monopoly power in the country. However, so many positive factors are also there in favor of FDI in Indian retail service.
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Sources
http://www.rbi.org.in/scripts/FAQView.aspx?Id=26
http://ganga.iiml.ac.in/~devan/ecolib-sajm.pdf
Manual on Investing in India-Foreign Direct Investment- Policy and Procedures, Ministry of Commerce and Industry, Department of Industrial Policy and Promotion, http://dipp.nic.in/
Confederation of Indian Industry, http://www.ciionline.org/services/74/default.asp?Page=FDI%20in%20India.htm
http://economictimes.indiatimes.com/articleshow/1109923.cms
http://www.equitymaster.com/budget0405/sectors/banking.asp
FDI Confidence Index, The Global Business Policy Council, October 2004, Volume 7, A. T. Kearney Competing for Sen WMRC Country Report: India (Country Analysis and Forecast) 10 May 2005, World Markets Research Centre
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