ECONOMICS

FINAL DRAFT

India’s Foreign Investment Policy Since 1991

SUBMITTED TO: - SUBMITTED BY:-

Prof.(Dr.) Madhuri Srivastava Aditi Mangal

Roll no. 11

IIIrd Semester

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Table of Contents

Acknowledgement.....................................................................................................3

Introduction...............................................................................................................4

Objective of Study:....................................................................................................5

Research Methodology:.............................................................................................5

Review of Literature:.................................................................................................5

Post 1991 Measures to Attract Foreign Investment..................................................6

Other Developments after 1991.................................................................................8

Five Year Plans on Foreign Investment..................................................................10

Eighth Five Year Plan (1992-93 to 1996-97):......................................................10

Ninth Five Year Plan (997-98 to 2001-02):.........................................................11

Tenth Five Year Plan (2002-03 to 2006-07):.......................................................12

Impact on Indian Economy.....................................................................................13

Conclusion...............................................................................................................15

Bibliography............................................................................................................16

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Acknowledgement

Firstly, I would like to thank my Economics Teacher, Prof. Madhuri Srivastava for having

provided me with the inspiration and guidance for this project. Without her help this project

wouldn’t have been possible. I would also wish to thank our Vice-Chancellor who constantly

exhorts us to deliver our best at every level. I would also express my gratitude towards my

seniors who were a source of constant support and inspiration. Lastly, yet equally importantly, I

am grateful to my family and my friends for supporting me all the way through the making of

this project.

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Introduction

Foreign Investment in India is subject to the same Industrial Policy as all other business ventures,

in addition to some other policies and rules specially governing foreign collaboration.

Government’s policy towards foreign capital has passed through four phases, the last one being

the area of prime concern in this paper.

India’s approach to foreign investment during the 1950s and 1960s was carefully restricted. It

was ensured that ownership and enterprise control remained primarily with resident investors.

Foreign capital was recognized as an important supplement to domestic savings for facilitating

national economic and technological progress. Foreign investment proposals, however, were

sanctioned only after careful scrutiny which was necessary because of India’s fragile balance of

payments and scarce foreign exchange reserves.

The year 1991 marked a key transition in India’s foreign investment policy.The Economic Policy

of 1991 can be rightly said to have brought about a minor revolution in the area of foreign

investment. Till 1990, India’s Foreign Investment Policy was very restrictive and allowed

foreign investment only in a handful of high technology industry. But the 1991 policy was liberal

as it included reduction of foreign investment controls and simplification of procedures. Many

initiatives were taken after 1991 to attract foreign investment. The industrial policy allowed

foreign investment in thirty five high-priority industries while removing several procedural

controls on inflow of FDI.1

Liberalization of foreign investment policy has been a central component of economic reform in

India, introduced in 1991. The first step was to remove the age-old limit of 40 per cent foreign

equity and allow automatic clearance up to 51 per cent foreign equity. Subsequently/ a series of

steps have been taken, encompassing policy as well as procedures, to create an environment for

free flow of foreign capital. Liberalization of foreign investment policy has been of an on-going

nature, and the process is continuing even today.

1 ‘Statement on Industrial Policy', July 24, 1991, paragraph 1.25 as reproduced in Handbook of Industrial Policy and Statistics (2006-2007), Office of Economic Adviser, Ministry of Commerce and Industry, Government of India; p. 6; available at: http://eaindustry.nic.in/2008_handout.htm

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Objective of Study:

The objective of the study is to:

1. List the post-1991 initiatives and measures to attract foreign investment.

2. Study the relevant parts of Five Year Plans related to foreign investment.

3. Explain the important rules and regulations governing foreign investments in India.

4. Study its impact on the Indian Economy.

Research Methodology:

In developing this research paper, analytical method has been used and references from text have

been taken to strengthen the analysis. The doctrinal mode of research has been followed.

Research has also been done in the library to get the required data. Various secondary sources of

data have been used which include various books, journals, newspaper articles, committee

reports etc.

Review of Literature:

Many books and articles have discussed the topic of foreign investment at length. Some of the

important ones that have been consulted are:

“Foreign Investment in India: 1947-48 to 2007-08” by Niti Bhasin: The book traces

the evolution of various phases of policies of India related to foreign investment and

analyses the same.

“Indian Economics for Law Students” by Dr. S.R. Munerjee: This book briefly talks

about the foreign policy regimes of India.

“Economic Development and Planning in India” by I.C. Dhingra and V.K. Garg:

This book has discussed the response to the policy and has critically appraised the policy

“Indian Economy” by S.K. Misra and V.K. Puri: Here, the authors have listed the pros

and cons of the new policy adopted by government.

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Post 1991 Measures to Attract Foreign Investment

The year 1991 marked a key transition in India’s foreign investment policy. The transformation

was induced by the government’s decision to encourage stable non-debt creating long- term

capital flows as a major source of funds for supplementing domestic savings. This was a

significant departure from the overt reliance on debt-creating flows during the 1970s and 1980s.

Such reliance was instrumental in creating structural imbalances in the economy that manifested

in a serious balance of payments crisis in 1991. The crisis precipitated a paradigmatic shift in the

policy perspective on future development of the country resulting in reforms aiming to move

away from a rigidly controlled, inward-looking, state dominated economic framework to a

decontrolled, outward-oriented and market-friendly system. The positive outlook towards FDI

was a key part of this shift.

Since 1991, the Government of India has sought to move towards liberalization and globalization

and to bring about rapid and substantial economic growth. The new policies have therefore

substantially relaxed restrictions on foreign investment and foreign capital. Capital market has

been opened to foreign investment and banking controls have been relaxed. Some of the features

of new economic regime are:

The industrial policy allowed foreign investment in thirty five high-priority industries

while removing several procedural controls on inflow of FDI. 2 The policy introduced the

‘automatic’ route for FDI. Sectors opened to FDI included almost the entire gamut of

machineries (e.g. rubber, printing, electrical, industrial and agricultural), processed food,

oil extraction, cement, metallurgical industries, chemical, ceramics, paper, fiber,

pharmaceuticals, fertilizers, automobiles & auto components, electrical equipment, hotels

& tourism and software.3 The thrust was clearly on attracting foreign capital and

technology in large segments of manufacturing with FDI in services remaining restricted

to tourism and software.

2 ‘Statement on Industrial Policy', July 24, 1991, paragraph 1.25 as reproduced in Handbook of Industrial Policy and Statistics (2006-2007), Office of Economic Adviser, Ministry of Commerce and Industry, Government of India; p. 6; available at: http://eaindustry.nic.in/2008_handout.htm [Accessed on June 2, 2009].3 Press Note No. 10 (1992 series), DIPP, Government of India; pp. 60-81; Available at: http://siadipp.nic.in/policy/changes.htm [Accessed on June 2, 2009].

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Easy entry of foreign capital in notified industries was accompanied by some limiting

restrictions. Foreign ownership was capped at a maximum of 51 percent of enterprise

capital. Automatic approval was contingent upon the proposed foreign equity covering

the foreign exchange requirement for imported capital goods. Furthermore, companies

receiving automatic approval for FDI up to 51 percent were required to ‘balance’ their

dividend payments by export earnings over a period of seven years.

Entry of foreign investment was streamlined in two distinct channels. Apart from the

automatic route, an empowered Board was set up for negotiating with investors and

approving investments in select areas. This board –the Foreign Investment Promotion

Board FIPB) – administers the government channel of foreign investments.4 Subsequent

developments in FDI policy have focused on altering the scale and scope of foreign

investment between these two routes.

4 Duce, M. and Espana, B. ‘Definitions of Foreign Direct Investment: A Methodological Note’ (2003) 55

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Other Developments after 1991

Since 1991, FDI policies and procedures have been progressively relaxed at different points in

time. A major policy revamp occurred in February 2000. The automatic route was significantly

expanded to make FDI in all items/activities eligible for the route except a well-defined ‘negative

list’. The latter included industries requiring licenses under the Industries (Development and

Regulation) Act of 1951 and in terms of locational policy requirements of the Industrial Policy of

1991, proposals involving FDI higher than24 percent of equity in small-scale enterprises,

instances where foreign collaborator had previous venture/tie-up in India, cases relating to

acquisition of shares in resident Indian companies in favor of foreign/NRI/OCB investors and all

proposals falling outside notified sectoral policy/caps relating to the automatic route, or in

sectors where FDI was not permitted. The ‘negative list’ proposals were to be examined by

FIPB.

The Industrial Policy of 1991 limited public sector monopoly to only eight activities while

freeing up the rest. Subsequently state monopoly has been cramped to only sectors of strategic

importance such as atomic energy. Private initiative and foreign investment has been allowed in

most of the erstwhile domain of the public sector including ‘sensitive’ segments such as defense,

insurance, petroleum & natural gas.

The Industrial Policy of 1991 confined mandatory licensing to 18 manufacturing industries.

These included minerals and natural resource-based products, chemicals, alcoholic beverages,

tobacco and consumer durables. Licensing continued even in some high-priority industries made

eligible for FDI up to 51 percent through automatic route (e.g. pharmaceuticals and

automobiles). These were, however, freed soon after. While automobiles were de-licensed in

April 1993, most bulk drugs and formulations were freed from licensing in 1994.

Over time India’s foreign investment policy has steadily enlarged the scope of foreign ownership

in resident enterprises. Foreign equity remained capped at 51 percent for quite a few years and it

was only in January 1997 that nine industries were allowed to increase FDI to 74 percent under

the automatic route. The bulk of the expanded list comprised services including mining,

electricity generation and transmission, non-conventional energy generation and distribution,

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construction, land transport, water transport, storage and warehousing. Only two industries –

basic metals & alloys and other manufacturing industries – were manufacturing.

In a significant move, 100 percent foreign ownership under automatic route was allowed in

electricity generation, transmission, and distribution in June 1998. However, the projects were

capped at a maximum of Rs 15 billion (approximately US$300 million @1USD= Rs 50). Within

less than a year in January 1999, projects for construction and maintenance of roads, highways,

vehicular bridges, toll roads, vehicular tunnels, ports and harbours were permitted 100 percent

FDI under automatic route subject to same limitations on size. Permission of full foreign

ownership underlined the urgency of inviting funds in India’s infrastructure. Since then, almost

all manufacturing activities and several services have been allowed to access 100 percent FDI

under automatic route.

The scopes of the Negative List and intervention by FIPB have narrowed over time. A key step

in this respect has been simplification of rules relating to foreign investment in instances where

the investor had a previous tie-up with a local partner. Foreign investors with previous tie-ups

were required to justify why the new venture will not be injurious to the existing collaboration.

The FIPB is also no longer required to decide on proposals pertaining to transfer and acquisition

of resident shares by nonresidents with the process now being delegated to the automatic route.

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Five Year Plans on Foreign Investment

Eighth Five Year Plan (1992-93 to 1996-97):The overall strategy in Eighth Plan was to reduce dependency on external commercial

borrowings and more on Foreign Direct Investment to correct the current account deficit. The

Foreign Exchange and Regulation Act was also amended.

The Plan Document observed as follows, “As a part of the package of recent trade policy

reforms, the Government has liberalized capital inflows in the form of foreign direct investment.

Specific measures in this direction are:

1. Automatic approval of foreign technology collaboration as well as foreign equity

participation up to 51 per cent in about 31 areas;

2. Delinking technology transfer from equity investment to impart flexibility in sourcing of

technology imports;

3. Automatic clearance for import of capital goods in cases where foreign exchange flows

through foreign equity. More recently FERA has been amended to place FERA

companies on par with Indian Companies for all operational purposes. Foreign

Companies are now Permitted to use their trade-marks, accept appointment as agents, or

technical or management advisors. They are also allowed to borrow and accept deposits

from the public and acquire and sell immovable property.

These relaxations of foreign investment are in the right direction. Yet, if India were to attract

significant flows of foreign investment and technology in an increasingly independent world,

the Government should continuously monitor the progress on this front, compare our policies

on foreign investment with those of other developing countries and make swift changes in

them if required. After all, our share of world capital flows will not just depend on our set of

policies, but on our policies in relation in those of other developing countries. Overall, our

strategy during the Eighth Plan should be of one of relying less on external commercial

borrowings and more on foreign direct investment for financing the current account deficit. It

should be possible to increase the flow of direct foreign investment to about $1 billion per

year by the end of the Plan period. This would still be a modest amount given the size of the

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economy. This would require a continuous watch on our foreign investment policy and

strong initiatives from our side.”5

Ninth Five Year Plan (997-98 to 2001-02):Under this plan, the prime emphasis was on continuing the process of cautious liberalization the

financial sector with particular caution on the buildup of short term debt. Another very

important step was taken by replacing FERA with FEMA (Foreign Exchange Management Act).

The plan observed, “Foreign investment provide external resources which help to finance the

balance of payment deficit without adding to the country’s financial debt. In this respect, the

ability to attract foreign investment promotes the objective of self-reliance by helping to avoid a

build-up of external debt which adds to our vulnerability. Apart from providing support for our

Balance of Payments, foreign investment also provide critical access to technology and other

types of know-how, and also provides potential linkage to world markets. In a world where trade

is increasingly dominated by transnational corporations, it is important to encourage foreign

investment as part of the process of modernizing our industry and developing our linkages with

the rest of the world. Many Indian companies are seeking foreign investment in joint ventures a s

a part of their plan for technological upgradation and modernization and these efforts should be

encouraged. As the second largest developing economy in Asia, India can be a major destination

for foreign investment and policies in the Ninth plan should be made to take advantage of this

policy. Foreign investment was re-oriented in the Eighth Plan period to encourage a larger flow

of foreign investment into the economy, especially into the infrastructure sectors where a rapid

expansion in capacity is urgently needed. Foreign direct Investment increased form US $ 0.1

billion in 1990-91 to US $ 3.2 billion in 1997-98. This level can be raised threefold by the end of

the Ninth Plan period.

An aspect of external economic policy which needs careful consideration is the pace of

liberalization of the capital account. Globalisation has meant an explosion of financial

integration in world markets, with large volumes of capital moving freely across national

boundaries. External policies should continue the process of cautious liberalization in the

financial sector with particular caution on the buildup of short term debt.”6

5 Niti Bhasin, Foreign Investment in India (1st, New Century Publications, New Delhi 2008) 88, 896 Niti Bhasin, Foreign Investment in India (1st, New Century Publications, New Delhi 2008) 89, 90

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Tenth Five Year Plan (2002-03 to 2006-07): The plan document lays no extra measures or changes in the Government’s Foreign Policy. It

just briefly reviews the existing policy.

It observed, “In developing countries like India, FDI is seen as a means to supplement domestic

investment for achieving s higher level of economic growth. FDI benefits the domestic industry

as well as the consumers by providing opportunities for technological upgradation, access to

global managerial skills and practices. Optimal utilisation of human and natural resources,

opening up export markets and access to international quality goods and services. Towards this

end, the FDI policy has been constantly reviewed and necessary steps taken to make India a most

favourable destination for foreign investors.

FDI inflows depend upon a number of factors like the assurance of safe recovery of capital,

regular repatriation of dividends, overall climate, exchange rate and price stability, availability of

raw materials and other inputs, skilled manpower, infrastructural facilities and the existence of

domestic and export markets. The government policy on FDI since 1991 has aimed at

encouraging foreign investment, particularly in the core and infrastructure sectors. The

government has permitted access to the automatic route for FDI in most sectors, except for a

small negative list.”7

7 Niti Bhasin, Foreign Investment in India (1st, New Century Publications, New Delhi 2008) 92

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Impact on Indian Economy

The reforms of 1991 had both negative and positive impacts on the economy of India. The same

have been listed below:

The immediate impact of these policies was an increase in the growth rate of the GDP,

during the eighties the average growth rate was about 5.6 percent. The primary,

secondary and tertiary sectors grew at rates of 3.5, 7.0 and 6.7 percent respectively,

between 1980 and 1991. However, this growth was accompanied by two problems, one,

the government was increasingly relying on deficit financing and secondly, the influx of

imports was being financed by increased private sector borrowing.

The reforms helped India to be a part of the competitive trade setup in the globalized

world. Earlier, India was left out when other developing countries like China were

already following market oriented policies. It was singled out as virtually a closed

economy. The new reforms brought India apace with such countries.

Ever since there was a change in policy in favour of higher foreign equity participation,

significant developments have taken place in India's corporate world. There was, first, a

steady growth in joint ventures. The Indian corporates did globe-trotting to forge

partnerships. The foreign partners were not difficult to locate and a large number of joint

ventures came into existence.

It was thought that higher foreign equity would help in forging long-term partnerships,

enable access to latest technologies, develop export capabilities in high value-added

items, and foster healthy competition. Instead, it was found that the Indian companies

were increasingly losing control over their enterprises and joint ventures had started

falling apart. It was also observed that the new FDI policy was not creating much of new

capital assets, but was giving rise to de-stabilization and uncertainty.

This kind of development that gave rise to serious concern about the growth prospect of

indigenous industry. This, in brief, is the genesis of 'swadeshi' sentiment that favours

protection to indigenous industry. Given the long experience of colonial rule and the cult

of self-reliance cultivated since the beginning of economic planning, the spirit of

swadeshi goes well with the Indian psyche.

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The direction of flow of foreign investment has also been questioned. foreign investors

were found to be interested mainly in low-tech consumer goods such as potato chips,

bubble gums, cornflakes, soaps and toiletries, and were not keen on exposing India to the

world of high technology. India does not need foreign investment in the field of mass

consumption goods. What it needs is investment in 'micro' chips and other state-of-the-art

technologies.

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Conclusion

The objective is to frame a result oriented and appropriate foreign investment policy. But the

challenge is to reconstruct foreign investment policies in such a manner that we should be able to

fulfill multilateral obligations while still promoting the cause of the national economy and

industry. But, this needs serious deliberation at the policy-making levels.

While India has an overall market-friendly and liberal policy towards foreign investment, foreign

capital still does not enjoy equally porous access in all parts of the economy. India has been able

to provide an enabling environment to foreign investors in several respects. Deep reforms in

capital markets aided by an efficient regulatory architecture have facilitated portfolio

investments. Transfer and acquisition of shares are taking place according to investor-friendly

guidelines. Foreign exchange regulations have been aligned to global standards courtesy FEMA.

But these facilitations need to be matched by a more open foreign investment policy for

increasing FDI inflows to a level higher than their current share of only 3 percent of India’s

GDP.

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Bibliography

Books:

“Foreign Investment in India: 1947-48 to 2007-08” by Niti Bhasin

“Indian Economics for Law Students” by Dr. S.R. Munerjee

“Economic Development and Planning in India” by I.C. Dhingra and V.K. Garg

“Indian Economy” by S.K. Misra and V.K. Puri

“Liberalization of Foreign Investment Policy in India: Some Observations” by Tarun

Das.

“Definitions of Foreign Direct Investment: A Methodological Note” by M. Duce and B.

Espana

Websites:

http://siadipp.nic.in/policy/changes.htm

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