Foreign the year 1991 when India’s economy was

Foreign
Direct Investment

Foreign direct investment (FDI) is a type of an investment made by a
company or individual of a country interested in another country’s business, in
the form of either having business operations or acquiring business assets in
the other country, such as ownership or controlling interest in a foreign
company.

We Will Write a Custom Essay Specifically
For You For Only $13.90/page!


order now

Foreign direct investments are made in many different ways, like

·        
Investor can open a
subsidiary or associate
company in a foreign country

·        
Investor can
acquire controlling interest in an existing foreign company

·        
 Merger or joint venture with a foreign company.

According to the
guidelines of Organization of Economic Cooperation and Development (OECD), the cusp
for FDI that establishes a controlling interest, is a minimum 10% ownership
stake in a foreign-based company, typically represented for the investor
acquiring 10% or more of the ordinary shares or voting shares
of a foreign company. Though, in some instances the effective controlling
interest in a firm can be established with less than 10% of the company’s
voting shares.

FDI is allowed through two different routes
namely, Automatic and the Government route. In the government route,
investments can be made only after the prior approval of the government. In the automatic route, prior approval of the
government is not needed by the foreign entities to invest. However, they have
to inform the RBI about the amount of investment within a given time period

FDI started in India in the year 1991 when India’s economy was very low
and this is when Indian government introduced Liberalisation, Privatisation and
Globalisation. Thus, India opened its doors to Foreign Investments. From 1991
there are many changes made in FDI policy till now. The recent significant
changes are-:

·        
FDI norms in
various sectors such as commodity exchanges, credit information, and aircraft
maintenance were relaxed.

·        
100% foreign direct
investments in Maintenance, Repair and Overhauling, (MRO) was allowed.

·        
100% FDI was permitted
in mining of titanium bearing minerals.

·        
There was a hike in
the ceilings on public sector oil refineries.

·        
Foreign investors
were exempted from minimum capitalization and a three-year lock-in period

·        
The present FDI
regime in banking sector permits 49% FDI participation in the equity of a
company under the automatic route. FDI above 49% is permitted through
government approval on a case-to-case basis. 

·        
FDI in defence
and teleports have also been hiked to 100%

·        
In pharmaceutical FDI of 74% is allowed under automatic route.

·        
Foreign airlines have been allowed to
invest up to 49% under approval route in Air India

·        
FIIs/FPIs have been allowed to invest
in Power Exchanges through primary market.

·        
FDI in LLPs: The
Erstwhile FDI Policy was silent with respect to conversion of an FDI funded
Limited Liability Partnership (LLP) into a company and vice versa. The New FDI
Policy allows conversion of an FDI funded LLP operating in sectors/activities
where (i) 100% FDI is allowed through the automatic route; and (ii) there
are no FDI linked performance conditions, into a company, under the automatic
route. Similarly, conversion of an FDI funded company operating in
sectors/activities where (i) 100% FDI is allowed through the automatic route;
and (ii) there are no FDI linked performance conditions, into an LLP, is
permitted under the automatic route.

·        
RBI also decided
to broaden non—resident centralised treasuries of multinational companies to
hedge the rupee (INR) risk on current account transactions of their Indian
subsidiaries. “This is expected to facilitate internationalisation of the rupee
by encouraging rupee invoicing of trade transactions while also encouraging
non—residents to hedge INR risks onshore,” it said.

 

Impact

These recent changes
to India’s trading rules has opened the door for fund managers to increase
their holdings of derivatives in the country, loosening restrictions that had
stifled trading. FDI has brought
better technology and management, marketing networks and offers competition,
the latter helping Indian companies improve, quite apart from being good for
consumers. Changes have led to larger FDI inflows contributing to growth of
investment, income and employment. The following graph depicts FDI flow before
and after policy changes.

 

Trends for the period of last 3 years (2014-15 to
2016-17)

·        
The FDI equity inflow during the last three financial years is US$
114.41 billion. It shows an increase of 40% compared to previous period of
three financial years (2011-12 to 2013-14) (US $ 81.84 billion).

·        
The overall
manufacturing sectors have witnessed a growth of 4% in comparison to previous
three financial years (i.e. from US$ 48.03 billion to US$ 50.09 billion).

·        
The total FDI
inflow during last three years grew by 38%.

Trends in the Financial Year 2016-17

·        
The FDI equity inflow received during the F.Y. 2016-17 is US$ 43.48
billion. It shows an increase of 9% compared to previous F.Y. 2015-16 (US $
40.00 billion). It is the highest ever for a particular financial year.

·        
The FDI equity inflow received through approval route during F.Y.
2016-17 amounts to US$ 5.90 billion, which is 65% higher than the previous year
(US $ 3.57 billion).

·        
The overall
manufacturing sectors have witnessed a tremendous growth of 52% in comparison
to previous F.Y. 2015-16 (i.e. from US$ 13.35 billion to US$ 20.26 billion).

·        
The total FDI inflow grew by 8%, i.e. US $ 60.08 billion in 2016-17 in
comparison to US $ 55.56 billion of the previous year. It is the highest ever
for a particular financial year. Prior to this, the highest FDI inflow was
reported in the F.Y. (2015-16).

·        
FDI has lowered the risk of individual
investors. It has diversified their holdings outside of the country, industry
or political system. Diversification always increases return without increasing
risk.

·        
FDI offsets the volatility created by “hot money.” As a result
short-term lenders and currency traders are creating an asset bubble. They invest lots of money all at once, then sell their
investments just as fast.

·        
High competitiveness has increased our
efficiency thus increasing foreign bank entry across financial system.
Declining cost and increasing productivity is seen in banking market after
foreign bank entry.

Increase in FDI has increased the GDP
with a significant amount. If we consider last 9 years GDP and FDI we can see a
positive correlation of 0.5052 between both which clearly depicts that increase
in FDI has raised the GDP of our country.

GDP of India for last 9 years

 

Increase in FDI has an effect on
Indian stock market also. If we analyse last 15 years data we can see a
correlation of 0.867 with CNX Nifty and 0.843 with NSE Sensex. We see a high
rise in Sensex from the year 2016, there is a growth of 52.1%.

Sensex Trend in last 9 years

 

 

Comparison with other countries

USA

If we compare these statistics with
the FDI stats of US we can see that US is the largest recipient of global FDI.
It had a FDI inflow of $2.9 trillion on historical cost basis in 2014. Its
inflow in 2015 alone was $348 billion, compared to 2014 ($172 billion).

·        
Majority of US FDI comes from
economies like United Kingdom, Japan and Germany while for India it is
Mauritus, Singapore, Japan. Japan contributing just 7% of the total FDI inflow.

·        
US has upheld an open investment
policy. Access to market has significantly affected the decisions of
multinationals to locate in the US. On the other hand, if we look at India it
has recently changed its policies to 100% FDI limit in various sectors and
after this change India has rose to 9th position in total FDI inflows.

China

Some of the best practices of China
were

·        
Encouragement to FDI has been an
integral part of the China’s economic reform process. It has gradually opened
up its economy for foreign businesses and has attracted large amount of direct
foreign investment.

·        
It changed its policies and increased
FDI flow by setting new regulations to permit joint ventures using foreign
capital and setting up Special Economic Zones (SEZs) and Open Cities.

·        
Foreign joint
ventures were provided with preferential tax treatment, hey provided the freedom
to import inputs such as materials and equipment, the right to retain and swap
foreign exchange with each other, and simpler licensing procedures in 1986.
Additional tax benefits were offered to export-oriented joint ventures and
those employing advanced technology.

·        
Priority was given to different
sectors like agriculture, basic raw materials, energy, telecommunications,
transportation, and high-technology industries, and FDI projects which could
take advantage of the rich natural resources and relatively low labour costs in
the central and northwest regions.

·        
China’s policies toward FDI have had
three stages: gradual and limited opening, active promoting through
preferential treatment, and promoting FDI in accordance with domestic
industrial objectives. These changes in policy priorities greatly affected the
FDI inflows in China.

·        
With these policies and an objective
of moving from traditional agriculture to industrialisation FDI in has been
increasing significantly. It has increased by 7.9% year-on-year to CNY 877.56
billion in 2017.

 

Challenges of implementing FDI in India

·        
Earlier India had put a ceiling of 25%
of FDI for small-scale industries while countries like China had floor ceiling
of 25% which could go to 100%. FDI in TVE’s have brought great technological
advancements and innovation of new products by contributing to 65% of China’s
export.

·        
Weak legal enforcement eroded the
competitive edge of India for FDI. A stricter implementation of Intellectual
Property Rights (IPR) could have boosted confidence in investors to invest. As
a weak IPR makes the host country less reliable and attractive to invest.

·        
Tax competition in FDI is one of the
major problem as the investors compares tax burdens in different locations
across countries which are demographically similar. India had high corporate
taxes (30% for domestic company and 40% for foreign company excluding surcharge
and education cess). This affected the flow of foreign direct investment
significantly. However, the corporate tax in other developing countries was much
lower than that in India. Hong Kong’s corporate tax is at 16.5%, Singapore’s
17% and Malaysia’s 25% this has helped them attaining high FDI inflow.

Alongside opening
up of the FDI regime, steps have been taken to allow foreign portfolio
investments(FPI) into the Indian stock market through the foreign institutional
investors. The objective was not only to unclog nondebt creating foreign
capital inflows but also to develop the stock market in India, lower the cost
of capital for Indian enterprises and indirectly improve corporate governance
structures. On their part, large Indian companies have been allowed to raise
capital directly from international capital markets through commercial
borrowings and depository receipts having underlying Indian equity. As on Aug 2017, 111310 FIIs are registered.

FIIs have played a
very important role in building up India’s forex reserves, which have

enabled a host of
economic reforms. Secondly, FIIs are now important investors in the

country’s economic
growth despite slow domestic outlook. FII strongly influence short-term market
movements during bear markets. However, the correlation between market returns
and FII inflows has reduced during bull markets as other market participants
raise their involvement reducing the influence of FIIs. Research by Morgan
Stanley shows that there is correlation between foreign inflows and market
returns. Market return is high during bear and weakens with strengthening
equity prices due to an increment in the participation by other players.
Exchange rate also has a significant impact on index volatility

The Securities and
Exchange Board of India has increased the combined futures and options trading
limit by removing some caps on contracts and on the market value of positions
held. The changes mean an average increase in allowed holdings of 550 per cent
on futures contracts traded at venues operated by NSE. The move has
boosted foreign investor sentiment toward India, which has recently been soured
by uncertainties over the tax rules facing offshore firms. The change will
enable global investors to raise exposure to Indian derivatives manifold as
they won’t refrain from investing due to smaller limits,”

 

BREXIT

Brexit is associate abbreviation for
“British exit,” relating
the UK’s call during a St John’s Eve, 2016 vote
to depart the European Union (EU). The vote’s
result defied expectations and roiled international
markets, inflicting the British pound to fall to its
lowest level against the greenback
in thirty years.

 

Impact

·        
India exports to
both EU and UK, its exports to the UK have been around 3% of the total exports
and to the European Union are around 17% of total exports. India’s exports to both
UK and Europe have been on a downtrend in the past two years because of restrained
demand led by a frail and scattered recovery in the region. Post Brexit there are
high chances of this trend being amplified for the coming years because of the
probable disturbances in currencies and UK facing a further slowdown in growth.
However, some safeguards are expected to be put in place to deal with the
volatility in currency in the UK.

·        
It is expected
that this decision would impact the confidence level of the business and the
investor community and there might be a temporary pause in outbound investments
from India to the UK until we get more clarity on the working framework between
the EU and UK. However, after the recent policy changes the Government has
liberalised the FDI regime in the country and an increase in FDI inflows has
been noticed over the last two years. This trend is expected to continue. With
the policy changes in June 2016, India has opened up almost all sectors for
foreign investors barring a very small negative list. India has once again
strengthened its position on the investment radar and the growth prospects in
the country remain strong. India is expected to get continued attention from
the investors including investments from the UK. UK is third largest investor
in India and accounts for about 8.0% of the total FDI inflows in the country.
In fact, several British companies have exhibited interests in India post
launch of the Make in India campaign.

·        
India
is one of the major Foreign Direct Investment (FDI) source for the UK as many
of the Indian firms have used it as a gateway to Europe. If UK moves out of EU,
it might not be as attractive to Indian firms as before. It is expected that the
UK government would not like to miss out Indian investment and will thus try to
attract Indian firms by offering more incentives such as tax breaks, easy
regulations and opening up markets which would be an advantage for Indian
market.

·        
UK’s currency has
become weaker so it is an advantage for us as exports would be cheaper.

·        
There could be a
decline in the demand of Indian goods as post Brexit there is a slowdown in
UK’s growth.

·        
In 2016, the
rupee gained 0.9%, while the yuan, euro and pound lost 1.1%, 1.7% and 13.2%, respectively,
against the dollar. The rupee has become relatively stronger vis-a-vis the
dollar compared to the yuan by 2%, euro 2.6%, and pound by over 14%. That would
adversely affect India’s export competitiveness in price-elastic items such as
textiles and clothing.

·        
Due to weakening
of the pound and euro it would be expensive for European tourists to visit
India and this would hurt India’s forex income from travel and tourism. 

 

In the financial
year 2016-17 after Brexit, imports from UK were Rs. 24,583.53 crores and
exports were Rs. 57,386.98 crores. Total trade being 81,970.51 and trade
balance being 32,803.46. We can see a fall in trade balance in the graph below.

 

 

It would take some time to know more pronounced
effects of Brexit on India but , till date India has not been at a major
advantage or disadvantage due to this policy of UK to get separated from EU.