FDI Trends in India and China: An Analysis
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Chapter 1: Aim and Objectives
All nations need a vision for future which stirs the thoughts and motivates different segments of society to a greater effort and thus inclines them to work toward the common cause that is economy growth of the individual nation. The market oriented policies normally have exclusionary impact which needs to be prevented through articulate response of the policy makers. India is the third-largest economy in the world in PPP (purchasing power parity) terms foreign direct investments (FDI), But China is currently a favourite nation and is more successful in attracting FDI over India Ballabh (2008). Hence, this thesis strives to analyse the past trend of FDI in India and China, its types, its critical analysis with regards to host country and investing firm, important factors of globalisation and foreign direct investments (FDI) strategies to be adopted, Finally, Its comparison with China's FDI and empirical evidences would help us cover aim of our thesis which is among India and China, Why is China more successful in attracting FDI than India and is favoured over India?
Therefore this paper has been divided in seven sections. It starts with brief introduction to FDI and its types in section 1. Section 2 covers background information and literature review that gives us a picture of the FDI policies in the past, Its trends and impact on MNCs in context to India and China, FDI's role on host economy and MNCs, , Its critical analysis based on Moran's model, and finally investment strategies adopted by MNCs where to invest and what to invest. This would give us greater insight into the chosen topic by discussion of various forms of FDI, its impact on MNCs, on host economy and presenting an argument on discussion. Section three; presents the discussion on methodology to be used for the data collection and analysis. Section four is our data analysis and discussion section that is further divided into two sections, first half covers China's FDI spread-its Sectoral & regional trends, the figures from the data sorted to analyse the growth in FDI over years and in different sectors, FDI distributions and opportunity sector that is playing increasingly important role by embracing FDI growth. The other half covers India's FDI Spread-Sectoral and Country wise distribution. Again we use graphs and charts to analyse the trend.
Comparative analysis of China with India would act as an indispensable step in structuring a consensus on a broad national development strategy to attract foreign investors that encompasses the roles and responsibilities of different agents in the economy, like Central, the private corporate sector, State and local government. Therefore finally presenting a logical explanation why China is a favourable nation over India and is highly successful in attracting FDI, hence the same is to be discussed in section five. Section Six is about building a feasible policy framework toward attracting FDI for the interest of the MNCs and host economy with reference to China's successful strategy in attracting FDI and summary of the literature followed by the concluding remarks are presented in the last section.
The Concept of FDI is now an integral part of every nation's economic prospect but the term remains vague to many, despite the thoughtful effects on the host economy and MNCs, despite the extensive studies on FDI, there has been little illumination forthcoming and it remains a contentious topic. The research findings will throw up a range of interesting possibilities in two countries, critical issues and crucial decision-points for government and private bodies to decide upon investment for future action in the favoured country. Therefore, the paper would explores the uneven beginnings of FDI in two countries, examine and present many important theoretical and empirical evidences on FDI and its impact on economy and MNCs, and would find reasons why China is more successful in FDI over India develop a feasible policy framework towards FDI in particular sector in India or China and making most out of it.
Chapter 2: Introduction
Foreign direct investment has multiple effects on the investing firm and on the economy of a host country. FDI influences the production, employment, income, prices, exports, imports, balance of payments, economic growth, and general welfare of the receiving economy Maniam (1998). Hence this section covers definition and types of Foreign Direct Investment, FDI's role been so far based on background information, discussion of resources and finally the theoretical aspect of why and where firms decide to invest abroad for benefits with special reference to India and China alongside host country's motive to attract FDI.
Definition of FDI
Bergman (2006) defined FDI as a direct or portfolio investment. A direct investment is an acquisition or construction of physical capital by a firm from one source country into another (host) country. The FDI is an investment that involves a long-term relationship and control by a resident entity of one country, in a firm located in a country other than that of the investing firm. There is more involved in the direct investment than only money capital, for instance, managerial or technical guidance. FDI is generally defined as resident firms with at least 10% of foreign participation (UNCTAD, 2002).
Types of FDI
MNCs have various options to enter into a foreign market. FDI's Different types have different levels of control and risks. For example, 'Green field investment' is when a firm establishes a subsidiary in a new country and starts its own production. In this type of investment a new plant is constructed rather than the purchase of an existing plant or firm. For this reason, there is large risk and has high set up costs because the foreign firm most likely does not have enough legislation knowledge, nor it has an existing distribution network and neither a local management skills. But still, the foreign firm has more control.
On the contrary, 'Brown field investment' is FDI that involves the purchase of an existing plant or firm, rather than building of a new plant. Joint venture is an equity and management partnership between the foreign firm and a local firm in the host market. Most host countries prefer the formation of joint ventures, as a way to build international co-operation, and to secure technology transfer (Samli & Hill, 1998). In This type of investment the foreign partner's contribute toward technology or products, the financial resources, and at the same time the local partner provides the manpower, skills and knowledge required for managing a firm in the host country (Bergman 2006). On UNCTAD's website we can have a comprehensive understanding of it and its types. It defines FDI as an investment that involves a long-term relationship and reflects a permanent interest of a resident entity in one economy (direct investor) in an entity resident in an economy other than of the investor. The direct investor's idea is to put forth a significant degree of influence on the management of the enterprise resident in the other economy. FDI covers both the opening and subsequent transaction between the two entities and among affiliated enterprises, both incorporated and unincorporated. FDI may be undertaken by individuals, as well as business entities. It further is classified as follows:
FDI Stock: it is the value of the share (For associate and subsidiary enterprises,) of their capital and reserves (including the retained profits) attributable to the parent enterprise (this is equal to the total assets minus total liabilities), plus the net indebtedness of associate or subsidiary to the parent firm. For branches, it is value of fixed assets and the value of current assets and investments, excluding amounts due from parent, less liabilities to third parties.
Reinvested Earnings: The part of an affiliates earnings accruing to the foreign investor that is reinvested in that enterprise.
FDI Flows: FDI flows (For associate and subsidiary enterprises) consists of the net sales of shares and loans (including non-cash acquisitions made against equipment, manufacturing rights, etc.) to the parent company plus the parent firm's share of the affiliate's reinvested earnings plus total net intra-company loans (short- and long-term) provided by the parent company. And, for branches, FDI flows consist of the increase in reinvested earnings plus the net increase in funds received from the foreign direct investor.
Equity Capital: The foreign direct investor's net purchase of the shares and loans of an enterprise in a country other than its own.
Other Capital: Short- or long-term loans from parent firms to affiliate enterprises or vice versa. Also included are trade credits, bonds and money market instruments, financial leases and financial derivatives.
Chapter 3: Background Information and Literature Review
History of FDI in India
India's foreign trade and investment regime has been identified in two different phases- Pre-1991 reforms phase and the post-1991 phase. Pre-1991 reforms phase that stretched over to four decades is worth reviewing in some detail as although the regime was marked by extensive regulation of trade and investment, it did not shun foreign enterprise participation in the economy and the nature of the regulatory framework was mostly complex and cumbersome. This has been extensively analysed by Kidron (1965) & Kumar (1994). The specification of sectors in which both foreign financial and technical participation were allowed, those in which only technical collaboration was permitted, and those in which neither technical and nor financial participation was allowed, reflects the desire to restrict foreign ownership and control to sectors of the economy in which its contribution was deemed to be essential. A preference to technical collaboration agreements instead of foreign equity ownership reflects the desire to promote the twin objectives of preserving freedom from foreign control over operations and simultaneously gaining access to foreign technology and know-how. The Foreign Exchange Regulation Act (FERA) of 1973 under Prime Minister Indira Gandhi was considered a hostile act. The FERA required foreign firms to dilute their equity holdings to less than 40% or export a substantial share of their total output. This resulted to closure of renowned MNCs like IBM and Coca Cola to shut their operations in India.1967-79, the number of collaborations agreements per year reached an all-time low of 242.
The Mid- 1980s saw a considerable though not a radical relaxation of the dirigiste trade and investment regime, with a relatively benign attitude towards foreign enterprise participation. The major crucial change during this period was a significant change in the pattern of foreign investment in India away from plantations, minerals and petroleum toward the manufacturing sector. By the end of decade of eighties manufacturing accounted for nearly 85% out of total stock of FDI of about Rupees 28 billion. Inflows of private capital remained meagre in the 1980s: they averaged less than $0.2 billion per year from 1985 to 1990 (Kapur & Athreye 1999).
In the year 1991, India too liberalised its highly regulated FDI regime, in place for more than three decades. Arguably Balasubramanyam (2004) in his book stated that, it took an economic crisis for India to liberalise its trade and FDI regime rather than a fundamental change in attitude towards the role of FDI in development process. Nonetheless, the 1991 reforms marked a major break from the earlier dirigiste regime with its regulation of the spheres of foreign enterprise participation on its mode of operation. And the policy framework was opaque with the implementation of policy based on bureaucratic consideration of each case on its merits. Hence the 1991 reforms were to change all this: The abolition of the industrial licensing system, controls over foreign trade and foreign investment were considerable relaxed, including the removal of ceilings on equity ownership by foreign firms. The reforms did result in increased inflows of FDI during the decades of the nineties as it considerable relaxed the dirigiste regime that prevailed for more than four decades (Balasubramanyam & Mahambare 2004). Hence with the liberalisation of the economy, fresh foreign investment was invited in a range of industries. Inflows to India rose steadily through the 1990s, exceeding $6 billion in 1996-97. The fresh inflows were primarily as portfolio capital in the early years (that is, diversified equity holdings not associated with managerial control), but increasingly, they have come as foreign direct investment (equity investment associated with managerial control). This was further supported by historically low interest rates in the US that encouraged global investment funds to diversify their portfolios by investing in emerging markets. International flows of direct investment, which had averaged $142 bn per year over 1985-90, more than doubled to $350 billion in 1996, with the developing countries receiving $130 billion (Kapur & Athreye 1999).
1996-1998, the period of the coalition government has been an imperative period in our study; Singh (2005) classified this as a period when government has shown willingness to understand FDI by placing policies that would result in an increase in FDI and further liberalization for the common cause. There was an increased understanding on the role of FDI in all sectors. Industries still lead the reforms whereby automatic approval of FDI was increased up to 74% by the Reserve Bank of India (RBI) in nine categories of industries, including electricity generation and transmission, non-conventional energy generation and distribution, construction and maintenance of roads, bridges, ports, harbours, runways, waterways, tunnels, pipelines, industrial and power plants, pipeline transport , water transport, cold storage and warehousing for agricultural products, mining services including silver and precious stones, manufacture of iron ore pellets, pig iron, semi-finished iron and steel and manufacture of navigational, meteorological, geophysical, oceanographic, hydrological and ultrasonic sounding instruments and items based on solar energy (indiabudget.nic.in).
January 1997, Government announced the first ever guidelines for FDI speedy approval in areas that are not covered under automatic approval. Above trends illustrates the earlier point of the government recognizing and carrying forth of the previous work done by the Rao government. While the advantage of FDI did not reach the mindset of the common man but government seemed to show possibilities of overall development through FDI. For example when Indian industry registered a modest growth rate of 7.1% in 1996-97, which was much lower than the 12.1% in 1995-96, there was research carried out which revealed this was partially attributable to the mining and electricity generation sectors which recorded very low growth rates of 0.7 % and 3.9 % respectively. Hence, the policy was immediately rectified and re-enforced by expanding the list of industries eligible for foreign direct equity investment under the automatic approval route by RBI in 1997-1998 (indiabudget.nic.in).
2004-05, embraced FDI for being an integral part of national development strategies. Its global popularity along with positive output in augmenting of domestic capital, productivity and employment; has made it an essential tool for initiating economic growth for nations. During this phase, India evolved as one of the most favoured destination for FDI in Asia. It has displaced US as the second-most favoured destination for FDI in the world after China. According to an AT Kearney's FDI Confidence Index, India attracted more than three times foreign investment at US$ 7.96 bn during the first half of 2005-06 fiscal, as against US$ 2.38 bn during the corresponding period of 2004-05. FDI in India has contributed effectively to the overall growth of the economy in the recent times. FDI inflow has an impact on India's transfer of new technology and innovative ideas, improving infrastructure, a competitive business environment (Indianground.com).
Ballabh (2008) in his article mentioned about the Balance of payments (BOP) since independence, India's BOP on its current account has been negative. Since liberalisation in the 1990s (precipitated by a BOP crisis), India's exports have been consistently rising, covering 80.3% of its imports in 2002-03, up from 66.2% in 1990-91. Although India is still a net importer, since 1996-97, its overall BOP (including the capital account balance), has been positive, largely on account of increased FDI and deposits from NRIs; until this time, the overall balance was only occasionally positive on account of external assistance and commercial borrowings. As a result, India's foreign currency reserves stood at $141bn in 2005-06. India's recently liberalised FDI policy (2005) allows up to a 100% FDI stake inventures. Industrial policy reforms have significantly reduced industrial licensing requirements, removed restrictions on expansion and facilitated easy access to foreign technology and foreign direct investment FDI.
History of FDI in China
FDI's main source in China from 1950s had been Soviet Union. However, it was after 1978 that China began to open up itself to the rest of the world for FDI inflows. From the start of 1978 China witnessed its exit from its self-dependent strategies since Mao's era with the country announcing a remarkable program to reform its economic system by opening itself up to the outside world. From the beginning of 1978, FDI in China became desirable and began to add in the development of the Chinese economy. In general, the development of FDI in China can be divided into following five stages.
Experiment Stage (1979 - 1983)
China started from an experimental approach, which they called "crossing the river by feeling the stones under the water." FDI was permitted into China in a step-by-step manner. One key action of the first step was the establishment of four Special Economic Zones (SEZs), namely Shen Zhen, Shan Tou, Zhu Hai and Xia Men, in July 1981. These SEZs were chosen for the absorption and utilization of foreign Investment. These provided foreign investors with preferential treatment for their Businesses. As China's "window to the world", these zones succeeded in attracting FDI. Meanwhile, China was putting up effort to complete its legislative system. First to come was, the Equity Joint Venture Law (the Law of People's Republic of China on Joint Ventures Using Chinese and Foreign Investment) that was enacted in July 1979. The legislation validated the existence of FDI in China and guaranteed the right and benefits of foreign investors. Second important policy taken at this stage included Regulation for the Implementation of the Law of the People's Republic of china on Chinese -foreign Equity Joint Ventures (1983).
Growth Stage (1984 - 1991)
Until 1984 there were flaws in China's handling FDI. China's restraints on FDI outside the SEZs remained rigid. Laws and regulations limited foreign ownership. FDI projects often encountered a long approval process even though they provided sufficient materials and explanation. This was simplified gradually between 1983 and 1985. Following is the list of new laws and regulations at this stage year on year basis.
- Wholly Owned Subsidiaries (WOS) Law (1986)
- Provision for the FDI Encouragement (1986)
- Constitutional Status of Foreign invested Enterprises in Chinese Civil Law (1986)
- Adoption of Interim provision on guiding FDI (1987)
- Delegation on approval of selected FDI projects to more local governments (1988)
- Laws of cooperative joint ventures (1988)
- Revision of equity joint venture law (1990)
- Rules for implementation of WOS law (1990)
- Income tax law and its rules for implementation (1991)
1984 witnessed two historic activities. First was when Deng Xiaoping remarked that China needed to open wider instead of checking upon the opening process (Zheng, 1984). Second was when Chinese government announced the decision on reform of the economic structure, and called for the building of a socialist commodity economy by assigning a larger role to the market in the domestic economic. Besides SEZs, Chinese government took a further step to give FDI access to other parts of the country. Fourteen coastal cities were announced to be opened to the outside world. They are Dalian, Qinhuangdao, Tianjin, Yantai, Qingdao, Lianyungang, Nantong, Shanghai, Ningbo, Wenzhou, Fuzhou, Guangzhou, Zhanjiang and Beihai. The local government from these cities could approve FDI projects with capital investment up to certain level. For example, Shanghai could approve all FDI projects under 30 million USD (Yuan, 2006). They were also given the right to spend foreign exchange yielded by local FDI for their own growth. The approval procedures for FDI projects were eased. The Law of People's Republic of China on Wholly Foreign-owned Enterprises (WFOEs) of 1986, was laid to protect the profits and interest of foreign investors. In addition to this series of other laws and regulations further relaxed China's restriction in promoting FDI with measures for enterprise autonomy, profit remittances, labour recruitment and land use.
In December 1990, the central government promulgated Detailed Rules and Regulations for the Implementation of the People's Republic of China Concerning Joint Ventures with Chinese and Foreign Investment. The regulation aimed to encourage joint ventures that adopted sophisticated technology or equipments, saved energy and raw materials and upgraded products.
Peak Stage (1992 - 1993)
This stage has witnessed the rise of Shanghai as China's economic hub. The Chinese government wanted to develop Shanghai into an international hub for finance, economy and trade. Their intention was to carry out the experiment of new policies and apply successful practices within the rest of Shanghai and across the country. Shanghai's location in Southeast China drew attention of Chinese government's in shifting emphasis to the area to avoid overly concentration of FDI. Hi-tech enterprises, established manufacturers and financial companies were encouraged to set up their China operation at Pudong with various preferential treatments from central and local government. With the implementation of a new framework for further opening up the economy, the Chinese government showed great effort to encourage FDI. A number of new Sectors were also opened up to foreign investors, including banking and insurance, accounting and information consultancy, wholesaling and retailing at the same time, governmental procedures were simplified in terms of FDI administration.
The year of 1992 witnessed the remarkable growth of FDI in China. In the same year, the Chinese government announced its intention to adopt the strategy of "socialist market economy" and improve the economic framework for standard market Operations. Following are the series of laws and regulations related to market operations were passed during 1992 and 1993, which included:
- Adoption of Trade Union Law (1992)
- Company Law (1993)
- Provision regulations of value-added tax, consumption tax, business tax and Enterprise income tax (1993)
Adjustment Stage (1994 - 2000)
After 1994, the growth rate of FDI in China went down to a steady level from the relatively high rate in past two years, which indicated that a new stage had arrived.
1995s Provisional Guidelines for Foreign Investment Projects provided preferential treatment to various enterprises in various industries. The directory of the Guidelines categorized all the FDI projects into four types: encouraged, restricted, prohibited and permitted (Yuan, 2006).
The projects in infrastructure or underdeveloped agriculture and with advanced technology or manufacturing under-supplied new equipment to satisfy market demand fell into the 'encouraged' category. Those whose production exceeded domestic demand and those who engaged in the exploration of rare and valuable resources were put into restricted. The 'prohibited' category included projects that would risk national security or public interest, or those endangering military facilities.. The last one is classified as permitted. Annual utilization of FDI reached to its peak in 1997 and 1998 but then moved downward in the following two years.
Post-WTO Stage (2001 - present)
November 11, 2001, saw China's admission as an official member of the World Trade Organization (WTO), after a 15-year negotiation. It was after accession to WTO, China started to fulfil its obligation such as basic principles of non-discrimination, pro-trade and pro-competition. This historic event had significant Impact on FDI inflows to China. This gave incentives to more export-oriented FDI. China's export market becomes larger and more predictable. Also, China's domestic market attracts FDI in industries where there is large market potential. Usually, these industries used to be dominated by relatively inefficient state-owned enterprises, such as telecommunication, banking and insurance. Foreign investors, especially large multinational companies (MNCs), have now growing interest in these industries. Becoming a WTO member, China had to restructure its legal framework. This, in consequence, improves China's business environment and helps attract more foreign investment.
Yuan (2006), in his literature has revealed, throughout the years, China has steadily reduced its industrial tariffs in a wide range of sectors. Foreign firms are granted direct trading rights for the first time, which means they can import and export themselves without going through a Chinese state-owned trading firm. Clearly, China's acquiring WTO membership boosts investors' confidence the Chinese economy and its market and thus attracts more FDI inflows.
FDI's: Critical Analysis
FDI's in other countries are now been continuously studied. There are numerous factors and studies motivating this type of investment for the benefit of source and host countries. There has been a substantial change in policies and attitudes towards FDI on the part of most developing countries in recent years. Disbelief and suspicion of FDI's in the past now appears to have given place to a new found faith in its ability to encourage growth and development for the investing firm and host countries. This perception is due to number of factors: steep fall in alternative sources of finance such as bank credit in the wake of the debt crisis, the self-evident success of Asian countries like India and China, and growth in Knowledge and understanding of the nature and operations of multinational enterprises (Balasubramanyam & Mahambare, 2004). In regards to stability aspect of FDI toward the growth of investing firm and host countries, empirical studies have found FDI to be more stable than other forms of capital (UNCTAD, 1998, World Investment Report, Geneva). Examination of a variety of capital flows in developing countries during East Asian financial crisis revealed FDI was more stable than other capital flows past studies analysis that FDI is the result of certain competitive advantage. Paul et al. (2002), revealed in their book; many developing countries like India favour FDI over other capital inflows and there is a substantial benefit that such investment benefit the host country and thereby attracting more foreign firms for investment as the benefits in this form of investment is both ways. Knowing the benefits of FDI in host countries would make the legislation system clear and simple and would enable foreign firm for investment based on long-term profits. Swamy (2000) in his book has done calculation the rate of return of FDI in India. His results revealed the rate of return on FDI in India higher than the rate of return obtained on global outward FDI. To quote from his studies," FDI Enterprises were able to earn relatively higher profit rates in India, despite higher level of taxation and tariffs etc. Thus the low level of FDI Inflows until the end of 1980s seems to have been caused restrictive policy environment rather than profitability considerations". Pradhan (2000) has scrutinised the various aspects of FDI from source as well as Host countries' point of view, with a focus on the risk from the firm's perspective and on the strategies to attract FDI to be adopted by host countries. His study thereby revealed that the higher rate of return for an MNC comes with FDI is, in fact, the result of existing market opportunities combined with the host countries policies towards FDI. Thereby, Indicating strong signals of overall growth of Host countries (developing) in conjunction with FDI and higher rate of return for MNCs.
Lensink & Morrissey (2001), literature suggests that FDI by MNCs is one of the major channels in providing LDCs (least developed countries) with access to advanced technologies and generating high revenue for MNCs involved in investment for them. The underlying theory differs illustrates the benefits of FDI for MNCs and host countries.
The 'imitation channel' is based on the view that domestic firms may become more Productive by imitating the more advanced technologies or managerial practices of Foreign firms for foreign firms and at the same time adding to GDP for their own country. Also, the competition channel emphasises that the entrance of more foreign firms from abroad intensifies competition in the domestic market, thereby encouraging domestic firms to become more efficient and productive by upgrading their technology base.
The 'linkages' channel stresses that foreign firms may relocate new technology to Domestic firms through transactions, and would develop buyer-seller relationship. This would necessities Training from the foreign firm to the domestic firm. Hence the training channel needs to be enforced on new technologies. This can only be adopted when the labour force feels comfortable to work with their foreign partner and when embraced works for the benefits of foreign firms as well.
Beside these studies, in some of the literature the contribution of FDI to foreign firm and host countries economic growth has been debated quite extensively. Findings reveals that FDI has both benevolent and a dangerous impact. Empirical evidence that FDI generates positive spillovers for firms is mixed. Few studies have found positive spillover effects, few finds no effects and few even conclude that there are negative effects (see Aitken and Harrison, 1999). The conventional argument is that an inflow of FDI positively contributes as; it brings technology, know-how and management techniques. It integrate the operation of local firms into the networks of foreign investors, it helps to place local production on international markets and integrates the national economies into worldwide production and distribution systems. Hence, concluding that FDI can contribute positively and increase the export activity of the host economy (Adam 2002). On the other hand, some of the recent literature points to the role of FDI as a channel of international technology transfer. It can deliver rather controversial effects. Foreign firms can out-compete local producers, reduce local production capacities close down research and development units, break up traditional subcontractor relationships and substitute them with imported goods, and repatriate profits thus deteriorating the balance of payments position of the host economy. Sometimes, could lead to absolute shut-down of foreign firms when opposed by local people of host countries. For example Coca-Cola Company had shut down bottling plant in India during a community-led campaign that demanded the closure of the Coca-Cola bottling plant because of indiscriminate pollution as well as illegal occupation of land (asia-pacific-action.org).
An overwhelming level of foreign ownership can distort the economic and social structure and, by weakening local resources (Adam 2002) thereby making it more difficult for foreign firms to invest. Other studies have argued that the contribution of FDI to growth is strongly dependent on the circumstances in host countries. In a paper, Borensztein et al. (1998) suggest that the efficacy of FDI depends on the stock of manpower in the host country. Only in countries where manpower is above a certain threshold does FDI positively contribute to growth.
To clarify this further, Adam (2002) commented on this argument in his report using the following two Models.
The Benign Model of FDI, that is referred as positive approach, This considers FDI as an appropriate tool for cutting the vicious circles of poverty-laden economic equilibrium, in which low levels of productivity lead to low wages, which lead to low levels of saving, which lead to low levels of investment, which disseminate low levels of productivity for the firm. FDI breaks the negative circle by delivering management and marketing expertise, technological innovation and integration into international production and distribution networks. Due to the diffusion of these skills and practices, the whole national production system, including locally-owned companies as well, realises considerable gains Moran (1998).
Farkas (1997) believes FDI as, the main benefit able vehicle for transferring technology and expertise to less developed countries like India and China in an integrating world economy. Explaining this view, in his thesis, he has highlighted the assumption of a gradual and comparatively steady diffusion of technical expertise. Now the question is beside these theoretical aspects Does Foreign Direct Investment really help emerging economies? And the matter of fact is yes (to much extent). Kumar (2007) in his article quoted China and India as two emerging economic giants that have some most attractive markets that would be discussed in later part of this thesis. According to him China and India has been positively affected by FDI Influx. China's FDI shot up from $3.5 bn in 1990 to $60 bn in 2004, while India's rose from a paltry $236 million to $5.3 billion. Hence, resulting China's economy growth by an unexpectedly strong 9.8 percent in 2005 and Indian growth hits 9.4% in 2007 (FT.COM).
3.3.2 The Malign Model of FDI by Adam (2002) elaborates the negative effects of FDI; it is elaborated broadly in analyses of Latin American growth paths. The experience of FDI in Latin American, in contrast to that of Southeast Asia, is considered as mainly a negative one. Foreign investments in Latin America have been described as being enclave-type economic islands, failing to contribute to the overall long-term socio-economic development. In line with Moran's "malign model", have contributed to:
"Lower domestic savings and investment by extracting rents and siphoning off capital through preferred access to local capital markets and local supplies of foreign exchange. Instead of closing the gap between investment and foreign exchange, they might drive domestic producers out of business and substitute imported inputs." Moran (1998), p. 21.
This is surely not to say that Moran condemns Latin American FDI projects in general, indeed in my thesis, It merely been used as a description of the negative effects of FDI. To further support this model, if we move east and Far East; it is evident that FDI in Russia has so far played a very limited role that too is mainly concentrated on the extraction of natural resources Farkas (1998), p. 37. Another 'non-recipient' country, Slovenia, has been, interestingly, the richest one in the whole CEE (Central & Eastern Europe) region. It had an FDI stock of $2.6 bn at the end of 1998, but most of this capital had landed in the Slovenian territories by 1990, when Slovenia was considered as the most eye-catching Yugoslav republic in the eyes of foreign investors. Capital inflows in the 1990s were rather low, because of lack of strategic investors in most enterprises, employee and management buy-outs. Furthermore, It (Slovenia) could not afford to take in FDI, because of the advanced level and relatively small size of their economy Adam (2002).
Foreign investment strategies of the MNCs
Beside all the arguments, MNCs have shown increasing interest in investment in European and Asian markets. India and China is a centre of attraction in present scenario. Therefore our thesis would emphasise three main elements which guide the foreign investment strategy of firms. Dunning (1973) precisely amalgamated these elements in the well-known eclectic paradigm or the OLI Explanation of FDI. According to this, For foreign firms to Invest in abroad successfully, it must possess advantages which no other firm possess (O), The country it wishes to invest in should offer location (L), and it must be capable of internalising operations (I).Internalisation is synonymous with the ability of firms to exercise control over operations essential for the exploitation of ownership and location advantages. It is the location advantage that form core of much of the discussion on the FDI strategies in India and China. Dunning's (1973, 1981) analysis set in train a number of econometric studies designed to identify the main investment decision on FDI (Agarwal, 1980; Root and Ahmed, 1979; Levis, 1979; Balasubramanyam and Salisu, 1991). The main conclusion of these studies is been briefly summarised Balasubramanyam & Mahambare (2004),
- Host countries with sizeable domestic markets, measured by GDP per capita, and sustained growth, measured by growth rates of GDP, is a factor for attracting FDI.
- Resources of the host countries including natural resources and human resources are a factor of importance in the investment decision process of foreign firms.
- Infrastructure facilities including transportation and communication net works are important determinants of FDI.
- Macroeconomic stability, signified by stable exchange rates and low rates of inflation is a significant factor in FDI decision of firms.
- Political Stability in the host country does play a vital role.
- A stable and transparent policy framework towards FDI is an attractive sign to Investors.
- Fiscal and monetary incentives in the form of tax concessions do play a role in attracting FDI, but these are of little significance in the absence of a stable economic environment.
India stands well on these attributes to market size and growth. Its growth rate of 6% per annum since 1990s has been substantial, and it its macroeconomic stability is superior to that of most of other developing countries including China, and judged by the criterion of the stability of policies it has displayed a relatively high degree of political stability. (Balasubramanyam & Mahambare 2004).
Hence, inculcating the arguments based on empirical evidences, it can be acknowledged that FDI and MNCs are inextricably linked. Discussion in our report is focussed on the Past and current trends on FDI with reference to specific developing country like India and China, and its impact. Now the questions are, why do firms go abroad? Why do they choose to invest in specific locations or sectors? The literature on these issues emphasises on some interesting parameters to be discussed in later section. Beside this, it covers the exhaustive analysis of sectoral FDI distribution and their contribution followed by the comparative analysis of FDI in India with china, and finally developing a policy framework towards FDI's in favourable country.
Chapter 4: Methodology
Numerous research techniques could be used for data collection of this topic, which could either be the field or desk research. These techniques aids in sorting the data, and are then divided into primary research and secondary research data. Primary research means field research and it involves the collection of data that doesn't exist. This method of research is mostly used as the first technique, this can then lead on to Field research. The term is extensively used in market research. The primary data is largely collected through surveys and Questionnaires that are open ended and close ended and are made out purposely to meet the objectives of the research. This further involves two approaches which are Quantitative research that is a scientific investigation and employs mathematical models, hypotheses, theories, and eventually data analysis and evaluation using SPSS, which is comprehensive statistical Software that is widely used for analytical purposes. Hence Quantitative methods are research methods dealing with numbers and anything that is measurable. They are therefore to be distinguished from Qualitative research that involved the in-depth understanding of human behaviours and the reason governing human behaviour. Unlike Quantitative, Qualitative relies on reasons behind various aspects of behaviour and this mainly involves in-depth interviews (Baldwin, 2007).
The research work in my thesis mainly involves the secondary research which is collection of genuine official data that already exists. There are number of sources of data on FDI and for this study data has been drawn from a variety of sources. As discussed, secondary Data in practice normally means desk or library research, or information from diverse computerised databases, associations, government agencies & different published sources such as libraries and newspapers. It can also be obtained from historical information and census data. In general, it is comparatively easy to acquire Secondary Data and is often a free source of information. But at the same time, large amount of data available sometime make it complicated to identify relevant information. Good knowledge on the methodologies of data collection is essential for the type of the data required. The most reliable series on FDI are provided by UNCTAD's World Investment Reports that covers the widest coverage and is the basic published source for cross-country data. The host countries' reports of inflows of investment are the other source of genuine information, or compiled surveys of investment activities are also useful for research purpose. These data's are better suited to country case studies. Data for FDI flows into India and China comes primarily from official government sources, and reflects actual FDI from cross-border equity flows, where available. Literature on two countries comes from worldwide popular economist reports/articles on websites. Additionally, data on FDI is extracted from World Bank data, UNCTAD's World Investment Reports, and books on FDI's, and Ministry of finance annual reports, as this provides wide coverage for a reasonably long period (1975-08). For better understanding of benefits of FDI, This data is further supported by U.S. data where added details on U.S FDI flows are required. The Information is also taken from publicly available reports from international financial institutions, press reports, commercial sources, and interviews articles on news websites with industry representatives.
On the contrary, few authors believe the secondary data is not accurate or reliable. Bloodgood (2007) in her Journal article mentioned, since the databases are compiled from press reports, and while they cover majority of FDI transactions, it is not guaranteed that data on all transactions would have been included, or that transactions have not been included more than once. Several transactions in reports do not cover data for the value of the transaction. Moreover, the data compiled from are always not in line with the official FDI data. Reported transaction figures in the databases do not account for how much of the capital is transferred in a given fiscal year, and non cash transactions such as equity swaps may not appear in official BOP statistics. Equally, FDI approvals are only an indicator of MNCs willingness in investment as many approved projects are never initiated, or are significantly modified between approval and implementation. For these many reasons, data compiled from these databases should be considered illustrative, rather than comprehensive.
In context to FDI, extensive studies already exist, but there has been little illumination on FDI in India and China and thereby picking a favourable country. Hence, the paper explores the secondary research mechanism in analysing and identifying the favourable country for investment.
Chapter: 5 Data Analysis and Discussion
In order to understand FDI in two countries and deciding upon favoured country for investment, it requires analyse the sector-wise current investments and countries of foreign influx, it requires the profitable sectoral analysis of FDI in India and China and then picking up most attractive sector of investment.
China's FDI spread: Sectoral & regional trends
In the first half of this year China's FDI fell by 17.9% year-on-year (y-o-y) to US$43.1 bn (Refer Chart 1), in contrast to a rapid growth recorded over the past five years. This is possibly because of the global economic and financial crisis that started in late 2007 - which dried up global liquidity as well as severely undermined investor's confidence. Comparatively, on an international basis, however, the rate of fall of FDI in China was relatively moderate and much slower than the 54% y-o-y drop in FDI around the globe during the six-month period. This leads us to believe that China remains the most attractive destination or at least one of the most attractive destinations in the world for FDI. It is evident from the report of Qun (2009) that China has witnessed a slower pace of FDI decline, at 6.8% y-o-y, in June 2009. The recent economic data, suggests that the global economy will recover in the second half of this year. On that basis, it can be realistically expected that the extent of decline in China's FDI will continue to ease in the second half of 2009.Furthermore, the Sectoral and regional patterns of China's FDI during the global financial and Economic crisis have also exhibited some special features from the past, with the Services sector and central and western areas registering sharper declines than the manufacturing sector and the eastern area, respectively. However these changes are temporary. As the global economy recovers and the international Investment market normalises, these Sectoral and regional patterns will revert to trends dictated by China's economic fundamentals and the central government's policy orientation Qun (2009).
Shifting Pattern- low value-added to high value-added sectors
Over the past decade Sectoral pattern of China's FDI has been steadily shifting from low Value-added sectors to high value-added sectors, which is in line with the country's accelerated industrialisation and modernisation process. As shown in Chart 2 and 3, the share of finance and insurance in China's total FDI has grown up from almost zero in 2000 to 14% in 2008, while over the same period, the share of manufacturing has gone down from 71% to 54%. These figures extracted from Qun (2009) further reveal that within the manufacturing sector, the market shares of high value-added industries such as telecom equipment, computers, electronics, electric machinery, chemicals and advanced equipment manufacturing have increased while those of relatively low value-added ones including textile and garments, toys, shoes and hats, furniture, and food have all declined. This trend is reflective of the present stage of development in the Chinese economy. This trend has gone strong in the aftermath of the global financial and economic crisis, the impact of which has severely hurt China's low-end and labour-intensive export industries and warned of the risks of economic reliance on such industries. Such a trend is expected to continue in the foreseeable future Qun (2009).
Current Sectoral Opportunities
China's central government's passed series of economic stimulus efforts since late 2008 to combat the global financial tsunami. It has created Sectoral opportunities for China's FDI. Qun (2009), report provides us vital information on infrastructural investment. The China's infrastructure sector-focused RMB4 trillion stimulus packages and has given rise to a huge number of massive projects covering transportation, power, new energy, environmental protection, machinery and building materials sectors. Besides, the consumption-boosting measures have led to new room for growth in the pharmaceuticals industries, electrical appliances and automobiles industries. The top 10 industry-specific stimulus packages for industries namely steel, automobiles, shipbuilding, petrochemicals, textiles, light, equipment manufacturing, non-ferrous, electronics and logistics, will encourage technological transformation in these industries and would result in numerous technology-upgrading projects. Although these projects may not be high-yielding, but they should be low-risk and can generate a reasonable return for MNCs. These policy-led new Sectoral developments in China's investment market and has created plenty of new investment opportunities for foreign investors Qun (2009).
Regional Opportunities: Eastern Area
According to Qun (2009) report again, China's eastern area has been the main destination for FDI over the past three decades, it has been attracting over 75% of the investment dollars ( for percentage distribution refer Chart 4 and 5). This is because; it has been the centre of the country's economic development and reforms over the past few periods. Its position is unlikely to be shaken in the foreseeable future, and hence would strengthen its economic and financial roles in the country. The three major growth engines - Yangtze River Delta, Pearl River Delta and Pan- Bohai Rim - are all located within this area. They are likely to continue their growth momentum and generate return for foreign investors. Shanghai is now on a grand mission to become an international financial centre. In line with such developments, foreign investments in the eastern area are set to continue to grow and would remain eye catching regions.
Regional Opportunities: Central and Western areas
In recent years, the central and western areas have also attracted more and more foreign investors. This is evident in the increase of their market shares in China's FDI from 9.3% and 3% in 2000 to 18.7% and 6.2% in 2008, respectively. This trend will go on and is a positive sign for foreign investors as the two areas has gained growing importance in the country's economic development. It is worth mentioning the three likely targets for foreign investors in the central and western areas. Firstly, the regional centres will be the priority targets: Xian for the north-western region, Wuhan for the central region, and Chongqing-Chengdu for the south-western region, given their roles as the regional economic centres as well as their relatively developed infrastructure and market mechanism. Secondly, the cities that are taking
Over the relocated industries from the eastern area, particularly those in Hunan, Jiangxi, Guangxi and Anhui provinces, should be the new targets for foreign investors engaging in the relatively traditional industries. The global financial and economic crisis is set to speed up the industry-relocation process, and hence these cities are likely to become new hot spots for foreign investments in the future. Thirdly, noting that resources in China are mostly located in the vast central and western areas, those locations with special minerals, tourism, ecological and agricultural resources should also be attractive to some foreign investors and hence an opportunity for MNCs to make most out of it Qun (2009).
India FDI Spread: Sectoral and Country wise distribution
Confederation of Indian Industry report on FDI (2008) Stated, The strong macro economic fundamentals, growing economy & improved investment environment has fascinated global corporations to invest in India. India's strategy aimed at opening up the economy, for the benefit of the economy and embracing globalization has led to remarkable increase in Foreign Direct investment inflows into India. According to AT Kearney's report, India ranks second in the world in terms of attractiveness of FDI. AT Kearney's 2007 Global Services Location Index ranks India as the most favourite destination in terms of financial attractiveness, people and skills availability. Similarly, The United Nations Conference on Trade and Environment 's (UNCTAD) World Investment Report, 2005 considers India the 2nd most attractive investment destination among the Transnational Corporations (TNCs). The positive perception as a result of strong economic fundamentals driven by 16 years of reforms has helped FDI inflows grow at about 20 times(as revealed in Chart 6.) since the opening up of the economy to foreign investment since August 1991.
Chart 7 reveals different sector shares in FDI Inflows from 1991 to 2007. Manufacturing industries, Financial and Business Services Sectors are main attractions for FDI. During the year 2006-07, the major recipient of FDI was Financial and business services (US $ 4.4 billion during 2006-07. Manufacturing was the next largest recipient of FDI at US $ 1.6 billion. This shows us the increased importance of the indigenous steel and automobile industries for the world markets.
According to Reuter.com (Fri May 2, 2008), in a press conference held by Trade Minister of India mentioned that India is aiming at FDI inflows of $35 billion in the year to March 2009, with relaxation of norms in more sectors. "A FDI equity inflow for 2007/08 has surpassed the previous year's inflows and reached $24.57 billion, Reinvested earnings of foreign firms in India amounted to $5.5 billion and we are aiming at $35 billion in 2008/09", Kamal Nath (trade minister) told to news conference. "Japanese and Chinese firms have poured more money into India. Lot of investment is expected to flow into petroleum, manufacturing and electronic hardware sectors", Nath added. Policymakers estimate that India will need massive investment in the five year period to March 2012, including $500 billion in infrastructure, to attract foreign investor and to sustain high growth rates. To attain this, In January, India already raised FDI limits in petroleum refinery, aviation, commodity exchanges, credit information companies and mining of some precious metals to attract more capital by foreign investors and in return generate returns to MNCs so as to eye a long term relationship with their foreign partners.
The sources of FDI in India are through both the equity route, which accounted for 82 % of the total FDI inflows in India, The Reinvested earnings of FDI companies accounted for 15 % of the total Direct Investment while acquisitions accounted for 32% of total FDI. Chart 8 predicts, Mauritius being the major route for FDI inflows into India due to the Mauritius's stature with India as a tax haven and most volume of FDI inflows through Mauritius has been from the USA and the major investor (FDI) in India for the last 16 years has been USA. Thus, playing a vital role for global recognition.
Chapter 6: Comparative Analysis of FDI attraction in India with China
Foreign investors now are extremely prudent when it comes to decide where to invest and on what to invest. Hence, it is imperative for them to analyse past, present and future FDI influx. The following discussion covers which country has succeeded India or China? In attracting FDI and why?
Looking into the above analysis on sector-wise FDI and its Impact on host economy as-well as MNCs, can we say that India has done well in attracting foreign investment and using FDI to develop the kinds of export industry that drove the growth of economy? According to Lall (2004), the answer to this is 'No'. India has been left behind in most industries especially in manufacturing where it is been found so week, despite the size, depth and diversity of its manufacturing sector. The key reasons are technological lags, aggravation by poor infrastructure, cumbersome labour practices, and excessive bureaucratic interference and a trade regime that still favours the domestic market.
In Sum, 'business cost' are still too high in India to attract export-oriented FDI by MNCs. Despite Foreign Investors interest in investment the internal deterrents are too many for them to make decision. Hence, Indian policy makers acknowledge much of this. Take into Consideration FDI per capita as a point of reference. China with a bigger population, receives FDI of $30 per capita whilst India gets less that $4. An added measure is the share of FDI in gross domestic investment. In India it has jumped up from 0.1% to about 2.5%. But at the same time in China, at the end of the year 2000 it was around 11%. Lall (2004), further calculated a revealed comparative advantage index for FDI for UNCTAD's World Investment Report 2002.This was a simple measure, a country's share in global FDI inflows divided by its share in global GDP: India's index value was 0.1 in 1990 and 0.2 in 2000, while for china the index values were 0.9 and 1.2, respectively. Kowalski (2007), mentioned China's trade and investment a reason for creating an attractive business environment and therefore has had a significant impact on FDI inflows. FDI grew from essentially zero in 1979 to USD 636 million in 1983, to USD 60.3 billion in 2005 (Greene et al., 2006) , as compared to India's FDI of USD 16bn 2006-2007, Although there is a growth of around 185% in comparison to 2005- 2006 (Business.com). Chart 9 shows the FDI growth of China compared to India; it thus pales into insignificance in comparison to China.
Chart 9: FDI in India and China
X-axis represents years, and y-axis measures FDI in million US dollar.
The UNCTAD's ranking of countries in terms of foreign investment (relative to the size of the economy) for the period 1998-2000 was 119 (Currently at 113 as per UNCTAD's report) for India, and 47 for China. The ranking a decade ago was 121 and 61 respectively. Hence enlightening the fact that China moved up in the ranking much faster than India in the 1990s. Hence, even at the start of the reforms, China's ranking was way ahead of India's, Nagraj (2003) stated. As per Kowalski (2007); Currently, China is the 3rd largest recipient of FDI after US and the UK. However, it is vital to note that China's FDI performance must be viewed in an international perspective. Interestingly, In terms of FDI inflows per capita, China ranks lower than all OECD countries, and it even ranks relatively low among developing countries OECD (2003). Chart 10 reveals that China's Growth rate at 10% annually during 1990-2006; a rate at which income more than doubles every seven years. However, at the same time, India's performance was less spectacular than China's with an approximate rate of growth of 6% annually. Besides, there are some concerns about the quality of these investment flows; much of China's FDI is relatively short-term, in labour intensive manufacturing, foreign investment in high-tech and the services sectors are still lagging behind (UNCTAD, 2005).
Chart 10: Annual GDP Growth Rate 1990-2006
Why China does so much better?
Consequently, It is certainly difficult to avoid the conclusion that India under-performs grossly in attracting FDI. But it would be interesting and relevant to discuss why China does so much better? Balasubramanyam & Mahambare (2004) has listed numerous explanations and 'round tripping' is one of it, though it is not enough in scale to explain the difference with India. Foreign Investment by Chinese Diaspora is another investment and this does account for a significant part of FDI in China, Comparatively India does not have dynamic economies offshore populated by its people who are willing to invest home for low wages. He has also pointed on different composition of FDI in two countries, with FDI in India concentrated mainly in high end technology industries. Lall (2004) doesn't agree to it, As per him Balasubramanyam correctly argues, that part of this is due to India's capital intensive industrialisation process over the years, But he understate the complexity of China's industry and FDI Structure. Currently, China is the world's largest exporter of the low-tech products and has also now developing world's largest exporter of high technology products. Its export structure has upgraded very swiftly over time and rapidly conquered the world market shares. Therefore in China, FDI has played a significant role in this process, not only by final assembly of imported components but also by setting up advanced manufacturing facilities in industries like telecommunication to serve domestic and international markets. In other words, China is wisely exploiting its comparative advantage over India in cheap labour and simultaneously moving beyond this by raising R&D Facilities. Sanjay Lall and his team visited Motorola factory in Tianjin for their research work and found that a huge R&D centre would be set up for the company at highest quality standards. In addition to this, low levels of skills in India are found another deterrent. This undeniably is surprising as India is now regarded as well capable with skills. But when compared the years of schooling and enrolment rates, China is seen far ahead and India seems to be missing on strategies that would make competitive quickly. India grossly missed the FDI driven industrialisation, the fragmentation of the global production system that has dynamised South East Asia. Not to ignore another fact which is India's main export industries, textiles and clothing, had been mostly neglected. India would have done better had allowed FDI in these industries. Hence, surely this explains why China is still a favourite destination for foreign investors and is doing so much better in FDI compared to India (Balasubramanyam & Mahambare 2004).
However situation is likely to change in years to come for MNCs that are eying long term investments. There are potential sectors in India that could be of great interest for MNCs and they still have not been fully exploited because internal restraints like manufacturing sectors. India might not have seen a rapid growth in FDI but have seen somewhat steady growth. Its democratic form of government is been very careful in implementing Investment legislation as they have a cordial relations with its western partners and would want be tied in long term relations for two way profits. Commerce and Industry Union Minister Kamal Nath on Indian Reality News (December 28, 2006) said "Needless to say, FDI has to be embraced with both hands as it plays an important role to add to the economic growth of the country. Since the time India stepped into a liberal mode from a restrictive regime, India's manufacturing sector has witnessed a growth rate of 23.4 % in the year 2005-06 which is the highest among the past three years' records. Industrial production has grown by leaps and bounds during April-October 2006. Investments in the manufacturing industry is considered as the 'first mile investments' and are expected to be followed by more funds to finance the projects. Likewise, Software industry and financial services are likely to see great cooperation from the potential foreign investors in the next coming years and would equally add to the further growth", added Nath (IndianRealityNews.com). Chakraborty & Nunnenkam (2006) in his book stated, in the late 1990s, under some unfavourable external factors, India embarked on a some what higher growth path compared to other Asian nations, hence an evidence of an economy that is capable to perform even under hostile conditions. He revealed, output growth in the primary sector, was on a declining trend and this trend was not even stopped by the relatively strong increase in FDI in 1991-1995.Not just this, growth acceleration was seen in manufacturing sector after reforms in 1991 when FDI stocks doubled. But output growth in manufacturing weakened in 1995-2000, even though FDI stocks continued to rise and this is because the patterns within the manufacturing sector are too diverse that it can not
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