EXECUTIVE SUMMARY

International trade and financeA study on foreign direct investment in IndiaSubmitted by:-

Snehlata

BMS 2nd year

13MG4553

Submitted to:- Dr. Rakesh KumarDEEN DAYAL UPADHAYA COLLEGE OF DELHI UNIVERSITY

Acknowledgement

I,SNEHLATA, student of Bachelor of Management Studies (4th semester), in Deen Dayal Upadhyaya College, University of Delhi, hereby declare that I have made this academic project titled A study on foreign direct investment in India as a part of the internal assessment for the subject International trade and finance, for academic year 2013-14. The project is submitted for the first time and here only and the information submitted therein is true to the best of my knowledge.I sincerely thanks Dr rakesh kumar sir and my friends for the help extended by them for the successful completion of the project report.

Signature:-.Indexs.no particular

1.introduction

2.Types of Foreign Direct Investment

3.Methods of Foreign Direct Investments

4.HISTORY OF FDI IN INDIA

5FOREIGN DIRECT INVESTMENT POLICY IN INDIA

6

Merits of FDI

7

Demerits of FDI

8

Reference

EXECUTIVE SUMMARY

Foreign direct investment (FDI) has played an important role in the process of globalisation during the past two decades. The rapid expansion in FDI by multinational enterprises since the mid-eighties may be attributed to significant changes in technologies, greater liberalisation of trade and investment regimes, and deregulation and privatisation of markets in developing countries like India.

The title of the empirical study is FDI inflows and its impact in India during 2007 to 2011. The present study aims at providing detailed information about FDI inflows in India during the subsequent years. The analysis is fully based on secondary data collected through different website and journals.

The project aims at providing information of present FDI policy, year wise FDI inflows, sector wise FDI inflows, countries contribution to maximum of FDI inflows, state wise FDI inflows, trends and patterns of FDI inflows in different sector, FDI comparison between India and China and so on.

From the study it has been found out that total FDI inflows are estimated at US$19.43 billion during April 2010 to March 2011 and cumulative FDI inflows from 1991-2011 was $146319 million. The services sector, computer hardware & software, telecommunications, real estate, construction received maximum FDI inflows in India and Mauritius is the main source followed by Singapore, the US, the UK, the Netherlands and Japan for FDI inflows in India. From the hypothesis it has been found out that there is a positive relationship between FDI and economy growth of India.

And thus different suggestion and recommendation are given to improve the present condition of FDI in India.

INTRODUCITON TO FDI

Foreign Direct Investment (FDI) is capital provided by a foreign direct investor, either directly or through other related enterprises, where the foreign investor is directly involved in the management of the enterprise. Development of a new business or acquisition of at least 10% interest in a domestic company or a tangible assets, (purchase of bond & stock). "Foreign direct investment is the transfer by a multinational firm of capital, managerial, and technical assets from its home country to a host country".

FDI has three components: equity capital, reinvested earnings and intra-company loans. FDI flows are recorded on a net basis (capital account credits less debits between direct investors and their foreign affiliates) in a particular year. Outflows of FDI in the reporting economy comprise capital provided (either directly or through other related enterprises) by a company resident in the economy (foreign direct investor) to an enterprise resident in another country (FDI enterprise). Inflows of FDI in the reporting economy comprise capital provided (either directly or through other related enterprises) by a foreign direct investor to an enterprise resident in the economy (called FDI enterprise).

Foreign direct investment (FDI) includes significant investments by foreign companies, such as construction of production facilities or ownership stakes taken in U.S. companies. FDI not only creates new jobs, it can also lead to an infusion of innovative technologies, management strategies, and workforce practices. 'The ultimate flow of foreign involvement is direct ownership of foreign- based assembly or manufacturing facilities. The foreign company can buy part or full interest in a local company or build its own facilities. If the foreign market appears large enough, foreign promotion facilities offer distinct advantages. First, the firm secures cost economies in the form of cheaper labor or raw material, foreign government incentives, and freight savings. Second, the firm strengthens its image in the host country because it creates jobs. Third, the firm develops the recent relationship with the government, customers, local suppliers, and distributors, enabling it to adapt its product better to the local environment. Forth, the firm retains full retain over its investment and therefore can develop manufacturing and marketing policies that serve its long-term international objectives. Fifth, the firm assures itself access to the market in case the host country starts insisting that locally purchased goods have domestic content."

Types of Foreign Direct Investment Multinational CorporationA country that maintains significant operation in multiple countries but manages them from the base in the home country.The MNC's are playing an important role in economic development of developing countries. First, the investment made by MNC's help in filling the saving investment gap. Secondly, it fills the foreign exchange or trade gap. Thirdly, the govt. of the developing countries is able to fill up the reserves gap by taxing the profits of MNC's. Fourthly, MNC's fill the gaps in management entrepreneurship, technology and skills in the developing countries. Transnational CorporationA country that maintains the significant operation in more than one country but decentralize management to the local country. Strategic allianceAn approach to going global that involves partnerships between an organization and a foreign company in which both share knowledge & resources in developing new products or building production facilities. t is an agreement typically between a large company with established products & channel of distribution and an emerging technology company with a promising research and development program in areas of interest to the larger company. In exchange for its financial support, the larger established company obtains a stake in the technology being developed by the emerging company. Today, strategic alliance is common place in the biotechnology, information technology & the software industries Joint ventureAn approach going global that is a specific type of strategic alliance in which the partners agree to form an independent organization for some business purpose.They can be of two types: A contractual joint venture between firms is usually for a specific project, such as manufacturing a component or other product for a fixed period of time. In equity joint venture is when firms hold an equity stake in the setting up of a joint subsidiary, again to produce a good or a service, for example Toyota and General Motors formed the subsidiary NUMMI to manufacture cars in the United States.

The percent of sales method for preparing pro forma financial statement are fairly simple. Basically this method assumes that the future relationship between various elements of costs to sales will be similar to their historical relationship. When using this method, a decision has to be taken about which historical cost ratios to be used.Neoclassical Economic Theory of FDI Neoclassical economic theory propounds that FDI contributes positively to the economic development of the host country and increases the level of social wellbeing [Bergten, et al. (1978)]. The reason behind this argument is that the foreign investors are usually bringing capital in to the host country, thereby influencing the quality and quantity of capital formation in the host country. The inflow of capital and reinvestment of profits increases the total savings of the country. Government revenue increases via tax and other payments [Seid (2002)]. Moreover, the infusion of foreign capital in the host country reduces the balance of payments pressures of the host country.

The other argument favouring the neoclassical theory is that FDI replaces the inferior production technology in developing countries by a superior one from advanced industrialised countries through the transfer of technology, managerial and marketing skills, market information, organisational experience, and the training of workers.

The MNCs through their foreign affiliates can serve as primary channel for the transfer of technology from developed to developing countries. The welfare gain of adopting new technologies for developing countries depends on the extent to which these innovations are diffused locally.

The proponents of neoclassical theory further argue that FDI raises competition in an industry with a likely improvement in productivity; Bureau of Industry Economics. Rise in competition can lead to reallocation of resources to more productive activities, efficient utilization of capital and removal of poor management practices. FDI can also widen the market for host producers by linking the industry of host country more closely to the world markets, which leads to even greater competition and opportunity to technology transfer

It is also argued that FDI generates employment, influences incomes distribution and generates foreign exchange, thereby easing balance of payments constraints of the host country; Sornarajah; Bergten, et al.. Furthermore, infrastructure facilities would be built and upgraded by foreign investors. The facilities would be the general benefit of the economy.

The Guidelines on the Treatment of Foreign Direct Investment incorporates the neoclassical theory when it recognises:. that a greater flow of direct investment brings substantial benefits to bear on the world economy and on the economies of the developing countries in particular, in terms of improving the long-term efficiency of the host country through greater competition, transfer of capital, technology and managerial skills and enhancement of market access and in terms of the expansion of international trade.

Kennedy (1992) has noted that host countries became more confident in their abilities to gain greater economic benefits from FDI without resorting to nationalization, as the administrative, technical and managerial capabilities of the host countries increased.

Types of FDIsBy direction

1. outward-bound

FDI is backed by the government against all types of associated risks. This form of FDI is subject to tax incentives as well as disincentives of various forms. Risk coverage provided to the domestic industries and subsidies granted to the local firms stand in the way of outward FDIs, which are also known as 'direct investments abroad.'

2. Inward FDIs:

Different economic factors encourage inward FDIs. These include interest loans, tax breaks, subsidies, and the removal of restrictions and limitations. Factors detrimental to the growth of FDIs include necessities of differential performance and limitations related with ownership patterns.

Horizontal FDI- Investment in the same industry abroad as a firm operates in at home.3. Vertical FDI

Backward Vertical FDI: Where an industry abroad provides inputs for a firm's domestic production process.

Forward Vertical FDI: Where an industry abroad sells the outputs of a firm's domestic production.BY TARGET

Greenfield investment:

Direct investment in new facilities or the expansion of existing facilities. Greenfield investments are the primary target of a host nations promotional efforts because they create new production capacity and jobs, transfer technology and know-how, and can lead to linkages to the global marketplace. The Organization for International Investment cites the benefits of Greenfield investment (or in sourcing) for regional and national economies to include increased employment (often at higher wages than domestic firms); investments in research and development; and additional capital investments. Disadvantage of Greenfield investments include the loss of market share for competing domestic firms. Another criticism of Greenfield investment is that profits are perceived to bypass local economies, and instead flow back entirely to the multinational's home economy. Critics contrast this to local industries whose profits are seen to flow back entirely into the domestic economy.

Mergers and Acquisitions

Transfers of existing assets from local firms to foreign firm takes place; the primary type of FDI. Cross-border mergers occur when the assets and operation of firms from different countries are combined to establish a new legal entity. Cross-border acquisitions occur when the control of assets and operations is transferred from a local to a foreign company, with the local company becoming an affiliate of the foreign company. Nevertheless, mergers and acquisitions are a significant form of FDI and until around 1997, accounted for nearly 90% of the FDI flow into the United States. Mergers are the most common way for multinationals to do FDI.

BY MOTIVE

FDI can also be categorized based on the motive behind the investment from the perspective of the investing firm:

1. Resource-Seeking

Investments which seek to acquire factors of production those are more efficient than those obtainable in the home economy of the firm. In some cases, these resources may not be available in the home economy at all. For example seeking natural resources in the Middle East and Africa, or cheap labour in Southeast Asia and Eastern Europe.

2. Market-Seeking

Investments which aim at either penetrating new markets or maintaining existing ones.FDI of this kind may also be employed as defensive strategy; it is argued that businesses are more likely to be pushed towards this type of investment out of fear of losing a market rather than discovering a new one. This type of FDI can be characterized by the foreign Mergers and Acquisitions in the 1980s Accounting, Advertising and Law firms.

3. Efficiency-Seeking

Investments which firms hope will increase their efficiency by exploiting the benefits of economies of scale and scope, and also those of common ownership. It is suggested that this type of FDI comes after either resource or market seeking investments have been realized, with the expectation that it further increases the profitability of the firmMethods of Foreign Direct Investments

The foreign direct investor may acquire 10% or more of the voting power of an enterprise in an economy through any of the following methods:

By incorporating a wholly owned subsidiary or company

By acquiring shares in an associated enterprise

Through a merger or an acquisition of an unrelated enterprise

Participating in an equity joint venture with another investor or enterprise

Foreign direct investment incentives may take the following forms:

Low corporate tax and income tax rates

Tax holidays

Preferential tariffs

Special economic zones

Investment financial subsidies

Soft loan or loan guarantees

Free land or land subsidies

Relocation & expatriation subsidies

Job training & employment subsidies

Infrastructure subsidies

R&D support

HISTORY OF FDI IN INDIAIndia intent to open its markets to foreign investment can be traced back to the economic reforms adopted during two prime periods- pre- independence and post independence.

Pre- independence, India was the supplier of foodstuff and raw materials to the industrialised economies of the world and was the exporter of finished products- the economy lacked the skill and means to convert raw materials to finished products. Post independence with the advent of economic planning and reforms in 1951, the traditional role played changes and there was remarkable economic growth and development. International trade grew with the establishment of the WTO. India is now a part of the global economy. Every sector of the Indian economy is now linked with the world outside either through direct involvement in international trade or through direct linkages with export and import.

Development pattern during the 1950-1980 periods was characterised by strong centralised planning, government ownership of basic and key industries, excessive regulation and control of private enterprise, trade protectionism through tariff and non-tariff barriers and a cautious and selective approach towards foreign capital. It was a quota, permit, licence regime which was guided and controlled by a bureaucracy trained in colonial style. This inward thinking, import substitution strategy of economic development and growth was widely questioned in the 1980s. Indias economic policy makers started realising the drawbacks of this strategy which inhibited competitiveness and efficiency and produced a much lower growth rate that was expected.

Consequently economic reforms were introduced initially on a moderate scale and controls on industries were substantially reduced by 1985 industrial policy. This set the trend for more innovative economic reforms and they got a boost with the announcement of the landmark economic reforms in 1991. After nearly five decades of insulation from world markets, state controls and slow growth, India in 1991 embarked on an accelerated process of liberalization. The 1991 reforms ensured that the way for India to progress will be through globalization, privatisation, and liberalisation. In this new regime, the government is now assuming the role of a promoter, facilitator and catalyst agent instead of the regulator and

India has a number of advantages which make it an attractive market for foreign capital namely, political stability in democratic polity, steady and sustained economic growth and development, significantly huge domestic market, access to skilled and technical manpower at competitive rates, fairly well developed infrastructure. FDI has attained the status of being of global importance because of its beneficial use as an instrument for global economic integration.

Pre-Independence Reforms:

Under the British colonial rule, the Indian economy suffered a major set-back. An economy with rich natural resources was left plundered and exploited to the hilt under the English regime. India is originally an agrarian economy. Indias cottage industries and trade were abused and exploited as means to pave the way for European manufactured goods. Under the British rule the economy stagnated and on the eve of independence India was left with a poor economy and the textile industry as the only life support of the industrial economy.

Post-Independence Reforms:

Indias struggle post independence has been an excruciating financial battle with a slow economic growth and development which were largely due to the political climate and impact of the economic reforms. The country began it transformation from a native agrarian to industrial to commercial and open economy in the post independence era. India in the post independence era followed what can be best called as a trial and error path. During the post independence era, the Indian Economy geared up in favour of central planning and resource allocation. The government tailored policies that focussed a great deal on achieving overall economic self-reliance in each state and at the same time exploit its natural resource. In order to augment trade and investments, the government sought to play the role of custodian and trustee by intervening in the practice of crucial sectors such as aviation, telecommunication, banking, energy mainly electricity, petrol and gas.

The policy of central planning adopted by the government sought to ensure that the government laid down marked goals to be achieved by the economy thereby establishing a regime of checks and balances. The government also encouraged self sufficiency with the intent to encourage the domestic industries and enterprises, thereby reducing the dependence on foreign trade. Although, initially these policies were extremely successful as the economy did have a steady economic growth and development, they werent sustained. In the early, 1970s, India had achieved self sufficiency in food production. During the 1970s, the government still continued to retain and wield a significant spectre of control over keyIn the Early 1980s-Macro-Economic Policies were conservative. Government control of industries continued. There was marginal economic growth & development courtesy of the development projects funded by foreign loans. The financial crisis of 1991 compelled drafting and implementation of economic reforms. The government approached the World Bank and the IMF for funding. In keeping with their policies there was expectation of devaluation of the rupee. This lead to a lack of confidence in the investors and foreign exchange reserves declined. There was a withdrawal of loans by Non Resident Indians.

Economic reforms of 1991:

India has been having a robust economic growth since 1991 when the government of India decided to reverse its socially inspired policy of a retaining a larger public sector with comprehensive controls on the private sector and eventually treaded on the path of liberalization, privatisation and globalisation.

During early 1991, the government realised that the sole path to India enjoying any status on the global map was by only reducing the intensity of government control and progressively retreating from any sort of intervention in the economy thereby promoting free market and a capitalist regime which will ensure the entry of foreign players in the market leading to progressive encouragement of competition and efficiency in the private sector. In this process, the government reduced its control and stake in nationalized and state owned industries and enterprises, while simultaneously lowered and deescalated the import tariffs. All of the reforms addressed macroeconomic policies and affected balance of payments. There was fiscal consolidation of the central and state governments which lead to the country viewing its finances as a whole. There were limited tax reforms which favoured industrial growth. There was a removal of controls on industrial investments and imports, reduction in import tariffs. All of this created a favourable environment for foreign capital investment. As a result of economic reforms of 1991, trade increased by leaps and bounds. India has become an attractive destination for foreign direct and portfolio investment.Government Approvals for Foreign Companies Doing Business in IndiaGovernment Approvals for Foreign Companies Doing Business in India or Investment Routes for Investing in India, Entry Strategies for Foreign Investors India's foreign trade policy has been formulated with a view to invite and encourage FDI in India. The Reserve Bank of India has prescribed the administrative and compliance aspects of FDI. A foreign company planning to set up business operations in India has the following options:1. Automatic approval by RBI:

The Reserve Bank of India accords automatic approval within a period of two weeks (subject to compliance of norms) to all proposals and permits foreign equity up to 24%; 50%; 51%; 74% and 100% is allowed depending on the category of industries and the sectoral caps applicable. The lists are comprehensive and cover most industries of interest to foreign companies. Investments in high-priority industries or for trading companies primarily engaged in exporting are given almost automatic approval by the RBI.

2. The FIPB Route Processing of non-automatic approval cases:FIPB stands for Foreign Investment Promotion Board which approves all other cases where the parameters of automatic approval are not met. Normal processing time is 4 to 6 weeks. Its approach is liberal for all sectors and all types of proposals, and rejections are few. It is not necessary for foreign investors to have a local partner, even when the foreign investor wishes to hold less than the entire equity of the company. The portion of the equity not proposed to be held by the foreign investor can be offered to the public.

FOREIGN DIRECT INVESTMENT POLICY IN INDIA

FDI is prohibited in sectors like(a) Retail Trading (except single brand product retailing) (b) Lottery Business including Government /private lottery, online lotteries, etc.

(c) Gambling and Betting including casinos etc.

(d) Chit funds

(e) Nidhi Company

(f) Trading in Transferable Development Rights (TDRs)

(g) Real Estate Business or Construction of Farm Houses

(h) Manufacturing of Cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes

(i) Activities / sectors not open to private sector investment e.g. Atomic Energy and Railway Transport (other than Mass Rapid Transport Systems).

Foreign technology collaboration in any form including licensing for franchise, trademark, brand name, management contract is also prohibited for Lottery Business and Gambling and Betting activities. Conditions to be fulfilled by foreign countries to enter Indian marketsThere are some basic requirements which must be fulfilled by the foreign companies to enter Indian retail market which are as follows

1) Amount of investmentIf any foreign company wants to enter into the Indian market the very first condition which it has to satisfy is that such foreign company must invest at least100 million dollarsor more into the Indian market. No foreign company whose investment is less than 100 million dollars will be allowed to enter Indian retail sector.

2) Places of opening storesAnother condition which these foreign companies have to satisfy is that they can't open their stores at any place in India where they want rather such companies can open their stores only in those cities the population of which is1 million or more.

3) Other conditionsApart from this there are certain other conditions which must be satisfied by these foreign companies to enter Indian markets like at least 50 % of their investment should be in back-end infrastructure like warehouses etc. & they have to take permission to the concerned state government where they want to establish their chains. Merits of FDI

FDI has lot to advantages to its favour which can be summarized as below More consumer savingsOne of the biggest advantage of FDI is that it will increase the savings of Indian consumer as he will get good quality products at much cheaper rates. Consumer savings are likely to increase 5 to 10% from FDI.

Higher remuneration for farmersAnother advantage of FDI is that it will help a lot in improving the miserable condition of Indian farmers who are committing suicides on daily basis because of lesser return from their agricultural produce. But FDI will certain help a lot in improving their conditions as the farmers are going to get 10 to 30 %higher remuneration because of FDI.

Increase in employment opportunitiesFDI is certainly going to increase the employment opportunities in India by providing around 3 to 4 million new jobs. Not only this another 4 to 6 million jobs will be created in logistics, labour etc. because of FDI. Increase in government revenueGovernment revenues are certainly going to increase a lot because of FDI. Government revenues will increase by 25 to 30 billion dollars which is a really big amount. This government revenue can help a lot in the development of Indian economy.

Demerits of FDI

Although FDI brings with it lot of advantages but it is not free from disadvantages as well. Following are some of its demerits

Destruction of small entrepreneursThe biggest fear from FDI is that it is likely to destroy the small entrepreneurs or small kirana shops as they will not be able to withstand the tough competition of big entrepreneurs as these entrepreneurs are going to provide all the goods to the consumers at much lesser prices.

Shrinking of jobsMany critics of FDI are of the view that entry of big foreign chains like Wal-Mart, Carrefour etc. are not going to generate any jobs in reality in India. At best the jobs will move from unorganized sector to organized sector while their number will remain the same or lesser but not more.

No real benefit to farmersCritics of FDI are also of the view that it is a fallacy that the farmers are going to benefit in any way because of the entry of foreign chains in India rather it will make the Indian farmers a slave of these big chains & the farmers will entirely be on their mercy. Thus, FDI is only going to deteriorate the already miserable conditions of Indian farmers.

Conclusion

After taking into consideration both pros & cons of FDI one can safely say that although there are certain apprehensions about FDI in India but all these fears are unfounded. There is hardly any truth in the fact that it would destroy the small entrepreneurs in India rather it will be beneficial for both the consumers & farmers of India. So, the future of India lies in FDI & the government must proceed in that direction if it wants to make the Indian economy a developed economy.Reference

Financial Management Prasanna ChandraManagement Accounting M.Y. Khan and P.K. JainAdvanced Accountancy S.M. ShuklaFinancial Statements Royal Classic Groupwww.wikipedia.orgwww.rcg.in

http://www.indiastudychannel.com/resources/147116-FDI-or-Foreign-Direct-Investment-India.aspx