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In the post-liberalization era, Indian economy has been growing at a phenomenal rate registering GDP growth of around 9% consistently during 2003-2008. It even managed GDP growth close to 7.5% during deep recession in 2008-09. Among all factors of production that contribute to the growth of economy, capital acts as the lifeblood and when in short supply, can be the limiting factor for starting, expansion and diversification of a venture. India economy faced a similar situation around 1990 when it suffered from low per capita income, chronic unemployment, increased trade deficit, low growth in GDP, minimal foreign exchange reserve etc. So India faced double jeopardy where it had to sustain and grow the economy but it had shortage of capital to invest. Since then there has been continuous effort by the Government in attracting foreign capital that can contribute to the economic development of the country.
Foreign direct investment is the acquisition of assets in a country by a foreign entity for the purpose of control. FDI implies ownership of at least 10% of a business. FDI flows are the sum of three basic components: equity capital, reinvested earnings, and intercompany loans. But Indian FDI calculation used to include the equity capital only which led to an underestimation of FDI inflows. But this has been revised since 2000 to include all components.
Table-I shows the FDI inflows into India over last few years. FDI inflows have increased substantially over last few years mainly due to the initiatives taken by the Government.
Among the countries contributing FDI inflows into India, Mauritius is leading with almost 40% contribution of India’s total FDI inflow. This could be attributed to the double taxation treaty that India has signed with Mauritius and also because of the reason that most US investment into India is being routed through Mauritius.
Over the years, a radical change has occurred in the sector wise FDI inflows. While in initial years, electrical equipment & transportation industry attracted most of the investment, in last few years, service industry has attracted maximum FDI fund. This is not surprising considering the fact that service sector contributes to almost 60% India’s GDP currently.
Advantages & Disadvantages of FDI Investment in Indian Economy
There are many positives which are attached with the increasing FDI limits. Increased FDI directly leads to increase in domestic employment for the country. The total number of people employed in FDI plants is about 15,64,920 (2008 figures).This amounts to a share of between 4 and 5 per cent of the total labour force in the formal sector. More than 50 per cent of the total employment in the FDI manufacturing sectors originates in small cities. Also important is to assess returns to labour in these firms. Employee cost can be taken as a proxy for payment to workers. The ratio of employee cost to net fixed capital turns out to be 19 paisa per rupee for FDI firms; the corresponding ratio is 15 paisa for domestic firms.
Increasing the limits and thereby attracting more foreign investments has a positive influence on the country’s Balance of Payments. Due to the technological expertise brought by the foreign investments, productivity of labor and capital increases in the country. Output to capital ratio is an indicator of production per unit of capital. FDI firms produce Rs. 3.55 worth of output per rupee of net fixed capital, compared with Rs. 2.92 for domestic firms. Also at the same time FDI has led to growth of new industry and new products. It has encouraged domestic investment indirectly by creating new markets, demand for products. FDI firms account for 13 per cent of the total sales turnover and 12 per cent of export by all firms, both domestic and FDI. For the economy as a whole, increasing the limits helps in increasing competition which makes the market efficient.
But at the same time, increasing the FDI limits has certain drawbacks too. Financial inflows raise the exchange rate thereby making exports unattractive. FDI’s cherry pick certain sectors where they find better returns. FDI’s crowd out domestic investment as it adopts predatory pricing. There is also a cultural aspect as people have to go through cultural change with infusion of foreign business practices and foreign culture. Also in certain sectors, as recently debated, foreign technology is too capital intensive and it might lead to reduction in jobs and thereby increasing unemployment. One of the most indirect disadvantages of foreign direct investment is that the economically backward section of the country will be inconvenienced when the stream of foreign direct investment is negatively affected and the situations in countries like Ireland, Singapore, Chile and China corroborate such an opinion.
FDI Caps in Various Sectors of Indian Economy
In order to protect domestic economy from the threat of FDI takeover, Government has fixed caps on maximum FDI investment in various sectors of economy (Table-II).
Of late, India has been opening up key sectors for FDI and increasing FDI limits. It has opened up commodity exchanges, credit information services and aircraft maintenance operations. The foreign investment limit in Public Sector Units (PSU) refineries has been raised from 26% to 49%. Even the disinvestment clause within 5 years has been removed.
FDI in Civil aviation up to 74% will now be allowed through the automatic route for non-scheduled and cargo airlines, as also for ground handling activities. 100% FDI in aircraft maintenance and repair operations has also been allowed. India has decided to allow 26% FDI and 23% FII investments in commodity exchanges, subject to the provision that no single entity will hold more than 5% of the stake.
Credit information companies, industrial parks and construction and development projects have also been opened up to more foreign investment. Also India has allowed 100% FDI in mining of titanium.
Government has also proposed relaxing FDI rules governing JVs. Under the present dispensation, a foreign player who entered India before January 12, 2005 has had to take government approval and show that the fresh investment in the same field would not affect interest of his domestic joint venture partner. DIPP has suggested abolishing this rule..
Also ASSOCHAM very recently proposed FDI cap hike in media, entertainment suggesting the FDI ceiling in FM radio to go up to 49 percent from the existing 20 percent.
Scopes & Limitations of Increasing FDI Limits
Currently huge debate is going on relaxing FDI limits in certain sectors like retailing, defence, FM, DTH, etc. which needs to be analyzed in greater detail.
Unorganized retailing is the dominant form of trade in India constituting 98% of total trade, while organised trade accounts for remaining 2%. It accounts for 12% of India’s GDP and provides employment to a massive 8% of total working population. Currently FDI investment in retail sector is limited to 10% only and there has been demand from various sectors of economy to relax the FDI limit in retail sector. The major argument is that how ultimately the consumer is benefited by both price reductions and improved selection, brought about by the technology and know-how of foreign players in the market. This can lead to greater output and domestic consumption. But the counter argument is that FDI driven “modern retailing” is labour displacing and it can only expand by destroying the traditional retail sector as players like Wal-Mart have deeper pockets and they can reduce prices to wipe out traditional retail business. India is already struggling with huge scale unemployment or disguised employment and these people kicked out of retailing job will create additional trouble for government. Hence till we are not in a position to create jobs on a large scale in manufacturing, it would make eminent sense not to relax FDI cap in retail sector so as to prevent entry of foreign players.
Similarly the current FDI cap in defence sector is 26% and there has been a demand to increase it upto 49%. If the FDI policy is properly leveraged, we can revive our Defence PSUs and Ordinance Factories by making them collaborate with foreign players and make them relevant to the process of modernization of Armed Forces. On the flip side, FDI could lead to ownership and control of firms operating in a highly sensitive industry like defence being passed on to foreign hands. This could lead to an increased dependence on foreign investment and raises concerns relating to availability or reliability of supplies in times of war.
Thus, as we can see that there has been a gradual increase in the FDI limits in India in various sectors to promote foreign investment and thereby derive benefits which accrue to FDI. But at the same time, increases in FDI limits in certain sectors have been highly contested owing to the issues created. Therefore, on one hand though increasing FDI limits leads to more productivity and economic growth, it is highly sector specific and therefore a prudent decision should be taken by the government analyzing the sector requirements and thereby deciding on raising FDI limits.
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