Influence of FDI on Indian Economy

Capital is the important lifeline of every production and distribution activity, and it also plays an important role among all the factors of production. The need of capital remains at every span of the venture. However, capital when in short supply, it can be the limiting factor for starting, expansion and diversification of any venture. In the light of the continuing crisis and the ever increasing importance of the foreign capital, the Government of India has been making continuous efforts to attract FDI during the post-liberalization period. It includes providing concessions in taxes, announcing tax holidays and increasing the investment cap in various sectors of the Indian economy. Due to the continuous efforts by the Government of India, there has been steady rise in the inflow of foreign capital on the one hand, and overall progress in various sectors of the Indian economy on the other. According to the Reserve Bank of India (RBI), India has received total Foreign Direct Investment (FDI) inflows of $50.1 bn since 1991. There has been tremendous progress in the various sectors of the Indian economy due to the inflow of foreign capital. The GDP growth rate has crossed 9% due to boom in manufacturing and service industries. The foreign exchange reserves have crossed $204 bn at the beginning of May, 2007. In addition, there has been improvement in the employment position, standard of living, infrastructure development, health and hygiene, GDP and NDP due to FDI inflows in India.

Indian economy has made remarkable progress during the pre-liberalization period. The agricultural sector has progressed through green, yellow, white and blue revolutions. The industrial sector has grown annually by 6%-7%, and the tertiary sector has also contributed a lot to the growth of Indian economy. But, around 1990 there was a great setback in Indian economy due to economic crisis. The Indian economy suffered from low per capita income, chronic unemployment, low capital formation, increased trade deficit, low standard of living, low infrastructure development, low health and hygiene standard, low growth in GDP and NDP, etc., during the pre-liberalization period. The NRIs took away their deposits amounting to $1.4 bn. Further, the foreign exchange reserve was not enough to meet even a few weeks’ requirements and import of essential goods was inevitable to meet the needs of the growing population.

Cumulative FDI inflows reached just over US $129,656 million between August 1991 and July 2007. Since 2002, some sectors such as electrical equipment, services, drugs and pharmaceuticals, cement and gypsum products, metallurgical industries have also been doing very well in attracting FDI. The electrical equipment sector and the services sector in particular received the largest shares of total FDI inflows between August 1991 and July 2009. These were followed by the telecommunications, transportation, fuels, and chemicals sectors.The Department of Industrial Policy and Promotion has recently modified the classifications of the sectors and data released from August 2007 has been based on the new sectoral classifications. According to that classification, the top performers are the services and computer software & hardware sectors . Clearly, India has attracted significant overseas investment interest in services. It has been the main destination for off-shoring of most services as back-office processes, technical support and customer interaction. Indian services have also ventured into other territories such as reading medical X-rays, analyzing equities, and processing insurance claims. According to some reports, however, increasing competition is making it more difficult for Indian firms to attract and keep BPO employees with the necessary skills, leading to increasing wages and other cost

Economic Reforms in India

Major economic reforms in India have been associated with crises. For example, after nearly two decades of industry-oriented planning, India accorded due importance to the agricultural sector in the late 1960s, in response to massive food shortages. The consequence of this policy shift was the Green Revolution in the early 1970s. The balance of payments crisis of the early 1980s, together with the stagnation that had become known as the “Hindu” rate of growth, precipitated the “new” economic policy of 1984-85, in which lay the genesis for the economic reforms of the 1990s. The reforms process in the 1980s was aimed mostly at opening up the economy to import competition, and at streamlining the process of tax administration. The much discussed economic reforms of the 1990s, the first sustained effort at restructuring the economy, came in response to another balance of payments crisis in 1991, when India was left with two weeks’ import cover. The government reacted by ushering in sweeping macroeconomic and structural changes. Direct tax rates were reduced for both individuals and corporate entities, with the expectation that reduced tax rates would lead to greater compliance. Tariff rates too were reduced, and the peak tariff rate came down from 350 percent in 1990-91 to 35 percent in 2000-01. The structure of the other indirect taxes was rationalized, and a process was put in place to enable the introduction of value added tax in the foreseeable future. Licensing was eliminated, and firms in all but a few sectors were allowed to start operations without government approval. The impact of de-licensing was most evident in sectors like steel, automobiles, FMCG and consumer electronics which witnessed a surge in entry of new firms. Over time, capital account restrictions were eased to allow Indian companies to raise capital abroad, by way of Eurobonds and GDR/ADRs, and acquire firms in other countries. The domestic capital market was restructured with the Securities and Exchange Commission and the National Stock Exchange as the driving forces, and interest rates were liberalised. In brief, market forces were unleashed both in the product and, by and large, in the factor markets, and firms were given much more freedom to realize gains associated with allocational efficiency.

The government also made is easier for MNCs to invest in India. Today, India welcomes foreign investment in virtually all sectors except defence, railway transport and atomic energy. In sectors like road and port infrastructure, mining of gold and minerals, and pharmaceuticals, MNCs can own up to 100 percent of their Indian affiliates without government approval. In certain other lines of business like generation of power and development of integrated townships, 100 percent foreign ownership is possible with government approval. In activities like exploration for petroleum reserves, development of marketing infrastructure for petroleum products, and exploration and mining of coal, MNCs are allowed majority stake in the affiliates, usually varying between 51 percent and 74 percent. In most cases, however, their stakes in SOEs are restricted to 26 percent. Finally, in sectors like media and insurance, MNCs are restricted to minority stake, and are expected to obtain government approval prior to initiation of business.

All is not well with the business environment in India, however. Aside from continuing bureaucratization of many processes affecting business, the reforms process in India has three weak links. First, the policy of protecting small firms in some sectors has not completely been eliminated, thereby preventing ent ry of larger and more solvent firms, with greater economies of scale, to these sectors. This has had adverse impact on the competitiveness of firms in these sectors. Second, privatization in India has largely been a tame affair, despite some major privatization deals involving companies like the aluminum giant BALCO, the (former) telecom monopoly VSNL and the country’s flagship (automobile) product Maruti Suzuki. Successive governments have failed to meet privatization targets, and privatization of large and inefficient firms like Indian Airlines and Air India have repeatedly been postponed. Third, the labour code remains largely unchanged, and closure of bankrupt firms remains a difficult and tedious process.

Global Response to India’s Reforms

How has the rest of the world reacted to the width and depth of the Indian reforms? As measured by the quantum of FDI inflow, global response has been, by and large, positive. The annual flow of FDI rose from a paltry USD 0.1 billion in 1991 to USD 4.28 billion in 2001. FDI in 2001 accounted for 1 percent of GDP and 4.3 percent of domestic investment, the corresponding figures for 1991 being 0.07 and 0.12 respectively. However, the aggregate stock of FDI received by India during the 1990s stands at a low USD 18 billion, less than half of China’s annual flow of FDI. From the average policymaker’s perspective, more worrisome is the fact that an exponential growth in FDI inflow is not expected in the near future, despite the elimination of a large number of barriers to FDI during the last 10 years. In order to better understand the reason behind India’s sub-expectations performance, in so far as quantum of FDI is concerned, one has to probe at the sub- national level. Specifically, one has to understand the nature and ex post views of the MNCs investing India. Are they large MNCs, for example, who want to have a small exposure to India by way of a downstream affiliate or are they largely in sectors like financial services where there is a lot of scope for transfer of technology and knowhow but little scope for significant transfer of capital? Are the spillover effects of entry, by way of technology transfer, training of personnel and export growth, significant such that the inflow of relatively small quantum of capital is supplemented by significant intangible gains? Are they entering largely by way of JVs where the investment is split between MNCs and local firms, thereby reducing the MNCs contribution to capital? Given the possible relationship between entry mode choice and the aforementioned intangibles, what determines the choice of the entry mode? Are MNCs that are in operation in India meeting their expectations about performance,thereby signaling to others that investment in India is worthwhile? With the help of data collected from 152 MNC affiliates operating in India, this chapter aims at addressing these questions. The data was collected by way of stratified random sampling, to ensure that none of the sectors are over- or under-represented in the sample, relative to the population, and that there is no selection bias of any other kind. Firms belonging to the machines and equipment (26 percent), IT (20 percent) and the intermediate goods (16 percent) sectors account for most of the firms in the sample. The machines and equipment sector has been over-sampled, and the intermediate goods sector has been under-sampled. However, there is no selection bias at the 2-digit level of ISIC classification.

SECTOR WISE INFUENCE:

The Sector wise Analysis of FDI Inflow in India reveals that maximum FDI has taken place in the service sector including the telecommunication, information technology, travel and many others. The service sector is followed by the manufacturing sector in terms of FDI. High volumes of FDI take place in electronics and hardware, automobiles, pharmaceuticals, cement, metallurgical and other manufacturing industries.

The IT industry is one of the booming sectors in India. At present India is the leading country pertaining to the IT industry in the Asia -Pacific region. With more international companies entering the industry, the Foreign Direct Investments (FDI) has been phenomenon over the year. The rapid development of the telecommunication sector was due to the FDI inflows in form of international players entering the market and transfer of advanced technologies. The telecom industry is one of the fastest growing industries in India. With a growth rate of 45%, Indian telecom industry has the highest growth rate in the world.  

The FDI in Automobile Industry has experienced huge growth in the past few years. The increase in the demand for cars and other vehicles is powered by the increase in the levels of disposable income in India. The options have increased with quality products from foreign car manufacturers. The introduction of tailor made finance schemes, easy repayment schemes has also helped the growth of the automobile sector. For the past few years the Indian Pharmaceutical Industry is performing very well. The varied functions such as contract research and manufacturing, clinical research, research and development pertaining to vaccines are the strengths of the Pharma Industry in India. Multinational pharmaceutical corporations outsource these activities and help the growth of the sector. The Indian Pharmaceutical Industry has been experiencing a vast inflow of FDI.  

The FDI inflow in the Cement Industry in India has increased with some of the Indian cement giants merging with major cement manufacturers in the world such Holcim, Heidelberg, Italcementi, Lafarge, etc. The FDI in Semiconductor sector in India were crucial for the development of the IT and the ITES sector in India. Electronic hardware is the major component of several industries such as information technology, telecommunication, automobiles, electronic appliances and special medical equipments.

Harsh beginning

In most narratives on India’s liberalization, 1991 has acquired a revolutionary status as a time of change in the planning of India’s future. The appointment of Economist Manmohan Singh, considered a non-political figure, as finance minister signalled a different approach to economics; one that in itself was radical, but did not significantly permeate the economic imagination of the Nation or the State. Data from various individuals and agencies can lead to different conclusions all of which can be challenged on different grounds. The Ministry of Finance, however, forms my primary source of information for two main reasons: it has been the agency of and party to economic reform and has compiled data on the state of reforms for the entire duration of their history.

As early as the introductory chapter of the Ministry of Finance Economic Survey for 1991, the conclusion is that “compared to domestic investment the contribution of foreign investment is bound to remain minor”.3 At the time the focus for long term planning was still inwards as efforts were on to solve the balance of payments crisis with India’s own ‘resources and ingenuity’ as self reliance presented itself as the only alternative.4 Denying the imminence of reform at the time, the Indian government clung to the ‘self-reliance model’ and intended to reform only as much as was absolutely essential to arrest the crisis and revert to status quo. Unevenness in implementation of policy was due to opposition to economic reforms from several stakeholders. Owing to the likelihood of reforms challenging over manning and under productivity; the first major revolt from workers in the public sector, who for the preceding four decades enjoyed employment with a virtual permanence. A significant protest that took political roots began in the form of the Swadeshi Jagaran Manch (SJM) created by the RSS in the November of 1991; a few months after the new liberal economic policy. The ‘fight’ against globalisation and privatisation found its chief targets in multinational companies. FDI was seen to be a new form of ‘western imperialism’ which the Indian Nation was to combat through indigenous capabilities. The rhetoric aimed at exploiting the feeling of insecurity spawned by the liberalization of the economy and strengthening national identity which was held synonymous with Hindu consciousness by invoking the spectre of foreign domination. The tactic worked; many Indian capitalists accustomed to decades of protectionist policies, anxious about the impact of liberalization on their well being; got together to complain that foreign capital would drive them out of business.6 An argument of this nature came from the director of the Confederation of Indian Industry, a business lobby group, in an attack in April 1996 on the role of multinational corporations in India. He accused them of not being committed to India for the long term, of not bringing in state of the art technology, and of an over reliance on imported components rather than Indian made ones.

The population of rural India was barely affected and only remotely concerned with FDI but it formed the largest part of the Indian Nation and was swayed by anti- FDI rhetoric. Thus, in the interests of political expediency, P.V. Narasimha Rao, the then Prime Minister, could not and took care not to reform the economy too fast. Before announcing any reforms in contentious areas such as taxation, financial services and the public sector, the Prime Minister appointed committees to explore each issue, and make recommendations.9 These recommendations, almost identical to prescriptions made by the World Back and the IMF, were deemed more acceptable from Indian committees.Politics and political standpoints made a very large impact on the trajectory of reforms. The following paragraph illustrates the importance. The PM was also highly sensitive to the impact of reform on India’s voters; his instincts were driven by politics, not economics. A way to measure the popularity of the reforms can be done through the elections. The delinking in 1971 of state assembly polls from those to the national Parliament, some state or other is constantly going to the polls and as a result the central government face constant judgements at the tribunal of public opinion. Rao felt that an electoral setback even in one state could be interpreted as a verdict against the economic reforms nationwide; he therefore downplayed them as much as possible, and avoided making reforms that might have been politically costly in the short term, such as laying off public sector workers, privatizing or closing down inefficient factories, reducing subsidies, or taxing agricultural income. Despite this, when electoral defeats came in states like Karnataka, and AndhraPradesh, political stalwarts were quick to ascribe them to the reforms, alleging that the populous in general did not benefit from them. Election time manifestos of major political parties are an indicator of the standpoints of major political parties, and also tools to analyse the variance that liberalization could take. The party in power is concerned with self-perpetuation and cannot afford to alienate anyone. In an effort to broaden support bases, political parties often dilute their original agendas. An analysis of political party agendas is important as it forms the crux of the agenda once elected.

The political parties that vied for the nation’s attention in their election manifestoes presented their agenda (a mix of ideology and party advancement) that could be implemented in 1991. Of the three major political parties (Congress, BJP and Communist Party (Marxist) (CPI(M)) had already placed the state of the Indian economy by tracing it to the IMF loans that were taken in 1981 by one of the previous Congress government. The BJP talked about reversing current trends with the declaration that the country was corrupt and on the verge of bankruptcy.12 Their economic strategy required holding the price line and liberating the economy from bureaucratic controls and not excising duties on item of mass consumption for 5 years.In their tenure agriculture would have been given the first priority. The crux of the viewpoint can be summed by “we will make our economy truly Swadeshi by promoting native initiatives.”The above viewpoints were contrasted by the Congress Party that announced that foreign investment and technology collaboration would be permitted to obtain higher technology, to increase exports and to expand the production base. The Congress realized the importance of a change in the economic model but was also wary of domestic concerns. With their announcement for investment was a warning that “such foreign investment will not be at the cost of self-reliance”.15 The different approach of the Congress Party meant that if elected there could not be policies that alienated the segment of the population that followed or shared other party viewpoints. Even after Congress came to power and reforms began, FDI was not in anyway defined in 1991 nor was it considered a mechanism for development. In the context of the time the emphasis is placed on stabilizing the economy. The goals for the upcoming year were to consolidate gains, bring problems under control and restore “the government’s capacity to pursue the social goals of generating employment, removing poverty and promoting equity”16. What this illustrates is that while the new policy had brought in a dramatic increase in investment activity, there was no clear understanding of FDI as a proper mechanism for development or its future role.

This trend was visible through 1992-1993 where investment has increased but the role of the government emphasizes it role in ‘filmi’ terms as a protector of the weak and to “ensure peace, and prevent mischief”17 It is in 1993-1994 where there seems to be a realization on the importance of FDI. Reading the definition it seems that both literature and economics have come together as an ideal definition of this concept is given that seems to weave together knowledge, technology, and high rates of growth. It takes another year before the policy reforms properly percolate down to the level of state governments and state capitals; the actual benefits of new industrial investment can only accrue if investment approvals and intentions are translated into real investment, employment and production. The role of the state government is critical because resources for production such as land use, water, power generation, and distribution and roads come under the purview of state governments. The far reaching unanimity for FDI within came in 1995-1996 when the government began to showcase the progress made as a result of FDI along with defending the changes to critics. Statistics had been available for most years, but now FDI entered the mindset of the government. The future of India’s growth and output was seen to be connected to FDI and it was deemed necessary for promoting higher growth of output, exports and employment.20 Furthermore the government also defended FDI by stating that “fears of foreign investment swamping our domestic industry or creating unemployment are unfounded or grossly exaggerated”.

The acceptance of FDI was not shared by the opposition, as by the next elections the party positions show some level of variance but the general feelings were similar. The BJP stayed critical of the Congress Party and their so called “acceptance of IMF conditionalities” coupled with what they referred to as a radical different approach to Foreign Investment.The criticism delved into another level, as the party viewed that at some level the License Quota Permit Raj has remained intact. BJP believed in the Swadeshi approach, but recognized that foreign Investment would be required and encouraged for world class technology. The party was able to effectively change its stance by allowing for FDI but stating that it would “strive to minimize dependence of foreign saving” thus elaborating distinctions that would keep India’s economic sovereignty. The party elaborated that globalisation is not a synonym for the oliberation of national economic interest. The party was able to change its viewpoint by separating a progressive India open to new ideas, new technology and fresh capital but at the same time not a westernized India.

Meanwhile the Communist party stayed true to its previous stance and offered strong criticism of the general economic policy that unfolded since 1991. Needless to say the policies were seen as pro multinational and anti public sector and local industries.The issue of self reliance was still considered important and the policy of globalization and privatization were seen to strike a heavy blow at the self reliant path of development. The inclusion of FDI was analysed as MNC’s acquiring vital sectors of the economy. The most important observation by CPI (M) was policy evaluation; that the BJPs economic nationalism was a crude mixture of swadeshi demagogy and actual support to liberalization policy of the congress. The Communist party observed the trends from the state governments of BJP and was able to effectively summarize and offer criticism that the BJP party line had oscillated between extremes (perhaps to mobilize support) from denouncing Enron and threatening to throw it into the sea, to quickly striking a fresh deal with the same company Thus by 1996, though there was difference of opinion on FDI, term was slowly being worked into the party position as a debateable and election issue. If nothing else the topic has sparked discussion as its future will affect the welfare of the country.

Distribution of FDI within India

Mumbai and New Delhi have been the top performers, with the majority of FDI inflows within India being heavily concentrated around these two major cities. Chennai, Bangalore, Hyderabad and Ahmedabad are also drawing significant shares of FDI inflows. For statistical purposes, India’s Department of Industrial Policy and Promotion (DIPP) divides the country into 16 regional offices. The top 6 regions account for more than two-thirds of all FDI inflows to India between January 2000 and July 2009.The foregoing data is based on both Greenfield and Mergers and Acquisitions (M&As). However, a recent study that examines only Greenfield projects makes a largely similar set of points (USITC, 2007). That data shows that the 5 Indian states that received the largest number of Greenfield FDI projects in 2006, based on the total number of projects reported, were Maharashtra (20 percent, includes the city of Mumbai). The key sectors attracting FDI to the Mumbai-Maharashtra region are energy, transportation, services, telecommunications, and electrical equipment. Delhi attracts FDI inflows in sectors like telecommunications, transportation, electrical equipment (including software), and services. Karnataka (15 percent, includes the city of Bangalore), Tamil Nadu (13 percent, includes the city of Chennai), Delhi (9 percent, includes the city of New Delhi), and Andhra Pradesh (8 percent, includes the city of Hyderabad). The states of Uttar Pradesh and Haryana (especially those parts of the National Capital Region) have also performed really well in recent years. Due to its abundance of natural resources, Uttar Pradesh attracts FDI in chemicals, pharmaceuticals, and mining and minerals whereas Haryana attracts FDI in the electrical equipment, transportation, and food processing sectors. Tamil Nadu has done well in sectors related to automotive and auto components. Ford, Hyundai, and Mitsubishi have made major investments in Tamil Nadu. The state has attracted FDI in other sectors as well such as port infrastructure, ICT, and electronics. Andhra Pradesh and Karnataka have attracted FDI mainly in areas associated with software and, to a lesser extent, hardware for computers and telecom. Hyderabad and Bangalore are the cities which received the major share of the projects in these two states. Karnataka has done well in the automotive sector as well. India’s rural areas have also attracted some big projects. Orissa, for example, has secured some large Greenfield FDI projects in bauxite mining, aluminum smelting operations as well as in steel and automotive facilities. For example, Luxembourg based Arcelor-Mittal, the world’s largest steel maker, has also signed a memorandum of understanding with the Orissa state government to build an US$8.7 billion steel mill.

Review of literature

(Kulwindar Singh , 2005) states that the Concept of Foreign Direct Investment is now a part of India’s economic future but the term remains abstruse to many, even after it has the profound effects on economy. Despite of many studies on FDI, there has been little illumination forthcoming and it remains a debatable topic. The paper depicts the uneven beginnings of FDI, in India and examines the developments (economic and political) relating to the trends in two sectors: Industry and Infrastructure and sub sector Telecom, to illustrate that.

Ravi Subramanian .et.al states that the trends in India’s outward FDI over the last decade and then attempts to identify the driving factors for the same. The aim is to provide policy makers with insights regarding levers which would help in encouraging FDI outflows and to spur further research in foreign investment from emerging economies. The analysis is based on 287 instances of foreign investment from India by top Indian companies across 17 sectors. The paper draws on the “diverse” paradigm to study the impact of ownership, location and internalization variables on India’s foreign investment. A sector wise analysis of mode of entry, intent of entry and geographic concentration has been performed. At a cumulative level, it has been found that acquisitions have been the predominant mode of entry for Indian firms investing abroad and seeking new markets the primary intent of investment. A regression model was also devise to understand the impact and relative importance of ownership variables such as distribution system, need for resources, factor of production, post sales service requirement, presence of IP and brand on foreign investment from India.

Ramkishen S. and Et.al(April 2008) states the FDI impact on various sectors in INDIA. It tells us in which all states have FDIs invested. Its has given a detailed report on various sectors that FDIs have found useful and invested in also the time line of the investments , it provides a very detailed insight on the various FDI preferences in terms of location amount and time. This kind of analysis helps in understanding the behaviour and the patterns of investment and also gives a brief idea of how the future of investers will be shaped in the coming time.

Nidhiya Menon and Paroma Sanyal states about the patterns of foreign direct investment in India. Paper investigate how labor conflict, credit constraints, and indicators of a state’s economic health influence location decisions of foreign firms. It accounts for the possible endogeneity of labor conflict variables in modeling the location decisions of foreign firms. This is accomplished by using a state-specific fixed effects framework that captures the presence of unobservable, which may affects the investment decisions and labor unrest simultaneously. Results indicate that labor unrest is endogenous across the states of India, and has a strong negative impact on foreign investment.

Amar KJR Nayak, Xavier Institute of Management, Bhubaneswar states about the condition of FDI in India and took Suzuki motor corporation as the example to explain the phenomenon.

Even after a long history and experience of investment by several hundred foreign companies in India few companies have regular growth and profitability in India. Owing to conditions of an industrially developing host for foreign direct investment like India the direct investment pattern of Suzuki Motor Corporation is a model of one of it’s kind that has benefited the host and helped the company to grow in size, profitability and global presence through its operation in India. This paper, after a sampling of foreign companies in India during 1920s-1990s, selected the case of Suzuki Motors and studies the investment pattern of Suzuki Motor Corporation in India. It looks into the automobile industry scenario prior to Suzuki’s entry to India and analyses the nature, timing, and scope of investment adopted by Suzuki Motors. Based on the observations of the study, the paper suggests a suitable model of Foreign Direct Investment in emerging economies like India.

Anu Antony Lecturer, SCMS Cochin, Kerala, India state about the FDI investment in retail sector and came up with analysis that the major driver for the development in the retail sector is mainly due to consumers ‘choice preference’. Inc