1

CHAPTER 1
Introduction to Foreign Direct Investment (FDI)

1.0 INTRODUCTION

One of the most striking developments during the last two decades is the spectacular
growth of FDI in the global economic landscape. This unprecedented growth of global
FDI in 1990 around the world make FDI an important and vital component of
development strategy in both developed and developing nations and policies are designed
in order to stimulate inward flows. Infact, FDI provides a win win situation to the host
and the home countries. Both countries are directly interested in inviting FDI, because
they benefit a lot from such type of investment. The home countries want to take the
advantage of the vast markets opened by industrial growth. On the other hand the host
countries want to acquire technological and managerial skills and supplement domestic
savings and foreign exchange. Moreover, the paucity of all types of resources viz.
financial, capital, entrepreneurship, technological know- how, skills and practices, access
to markets- abroad- in their economic development, developing nations accepted FDI as a
sole visible panacea for all their scarcities. Further, the integration of global financial
markets paves ways to this explosive growth of FDI around the globe.

2
1.1 AN OVERALL VIEW

The historical background of FDI in India can be traced back with the establishment of
East India Company of Britain. British capital came to India during the colonial era of
Britain in India. However, researchers could not portray the complete history of FDI
pouring in India due to lack of abundant and authentic data. Before independence major
amount of FDI came from the British companies. British companies setup their units in
mining sector and in those sectors that suits their own economic and business interest.
After Second World War, Japanese companies entered Indian market and enhanced their
trade with India, yet U.K. remained the most dominant investor in India. Further, after
Independence issues relating to foreign capital, operations of MNCs, gained attention of
the policy makers. Keeping in mind the national interests the policy makers designed the
FDI policy which aims FDI as a medium for acquiring advanced technology and to
mobilize foreign exchange resources. The first Prime Minister of India considered foreign
investment as necessary not only to supplement domestic capital but also to secure
scientific, technical, and industrial knowledge and capital equipments. With time and as
per economic and political regimes there have been changes in the FDI policy too. The
industrial policy of 1965, allowed MNCs to venture through technical collaboration in
India. However, the country faced two severe crisis in the form of foreign exchange and
financial resource mobilization during the second five year plan (1956 -61). Therefore,
the government adopted a liberal attitude by allowing more frequent equity participation
to foreign enterprises, and to accept equity capital in technical collaborations. The
government also provides many incentives such as tax concessions, simplification of
licensing procedures and de- reserving some industries such as drugs, aluminium, heavy
electrical equipments, fertilizers, etc in order to further boost the FDI inflows in the
country. This liberal attitude of government towards foreign capital lures investors from

3
other advanced countries like USA, Japan, and Germany, etc. But due to significant
outflow of foreign reserves in the form of remittances of dividends, profits, royalties etc,
the government has to adopt stringent foreign policy in 1970s. During this period the
government adopted a selective and highly restrictive foreign policy as far as foreign
capital, type of FDI and ownerships of foreign companies was concerned.

Government setup Foreign Investment Board and enacted Foreign Exchange Regulation
Act in order to regulate flow of foreign capital and FDI flow to India. The soaring oil
prices continued low exports and deterioration in Balance of Payment position during
1980s forced the government to make necessary changes in the foreign policy. It is during
this period the government encourages FDI, allow MNCs to operate in India. Thus,
resulting in the partial liberalization of Indian Economy. The government introduces
reforms in the industrial sector, aimed at increasing competency, efficiency and growth in
industry through a stable, pragmatic and non-discriminatory policy for FDI flow.

Infact, in the early nineties, Indian economy faced severe Balance of payment
crisis. Exports began to experience serious difficulties. There was a marked increase in
petroleum prices because of the gulf war. The crippling external debts were debilitating
the economy. India was left with that much amount of foreign exchange reserves which
can finance its three weeks of imports. The outflowing of foreign currency which was
deposited by the Indian NRIs gave a further jolt to Indian economy. The overall Balance
of Payment reached at Rs.( -) 4471 crores. Inflation reached at its highest level of 13%.
Foreign reserves of the country stood at Rs.11416 crores. The continued political
uncertainty in the country during this period adds further to worsen the situation. As a
result, Indias credit rating fell in the international market for both short- term and longterm borrowing. All these developments put the economy at that time on the verge of
default in respect of external payments liability. In this critical face of Indian economy the
then finance Minister of India Dr. Manmohan Singh with the help of World Bank and

4
IMF introduced the macro economic stabilization and structural adjustment programm.
As a result of these reforms India open its door to FDI inflows and adopted a more liberal
foreign policy in order to restore the confidence of foreign investors.

Further, under the new foreign investment policy Government of India constituted
FIPB (Foreign Investment Promotion Board) whose main function was to invite and
facilitate foreign investment through single window system from the Prime Ministers
Office. The foreign equity cap was raised to 51 percent for the existing companies.
Government had allowed the use of foreign brand names for domestically produced
products which was restricted earlier. India also became the member of MIGA
(Multilateral Investment Guarantee Agency) for protection of foreign investments.
Government lifted restrictions on the operations of MNCs by revising the FERA Act
1973. New sectors such as mining, banking, telecommunications, highway construction
and management were open to foreign investors as well as to private sector.

Table-1.1
FDI INFLOWS IN INDIA
(from 1948-2010)
Amount

Mid

March

March

March

March

March

March

of FDI
In

1948
256

1964
565.5

1974
916

1980
933.2

1990
2705

2000
18486

2010
1,23,378

crores
Source: Kumar39 1995, various issues of SIA Publication.
There is a considerable decrease in the tariff rates on various importable goods.
Table 1.1 shows FDI inflows in India from 1948 2010.FDI inflows during 1991-92 to

5
March 2010 in India increased manifold as compared to during mid 1948 to march 1990
(Chart-1.1). The measures introduced by the government to liberalize provisions relating
to FDI in 1991 lure investors from every corner of the world. There were just few (U.K,
USA, Japan, Germany, etc.) major countries investing in India during the period mid
1948 to march 1990 and this number has increased to fifteen in 1991. India emerged as a
strong economic player on the global front after its first generation of economic reforms.
As a result of this, the list of investing countries to India reached to maximum number of
120 in 2008. Although, India is receiving FDI inflows from a number of sources but large
percentage of FDI inflows is vested with few major countries. Mauritius, USA, UK,
Japan, Singapore, Netherlands constitute 66 percent of the entire FDI inflows to India.
FDI inflows are welcomed in 63 sectors in 2008 as compared to 16 sectors in 1991.

6
Chart 1.1

crores

FDI Flow in India

(1948-2010)

140000
120000
100000 1995, various
Source:
Kumar
ssues
i of SIA Publication.
Amt.
in Rs.
80000
60000
40000
20000
0
March
March
March
March
1948
1964
1974
1980

amt. in crores
March
1990

March
2000

March
2010

Years

The FDI inflows in India during mid 1948 were Rs, 256 crores. It is almost double in
March 1964 and increases further to Rs. 916 crores. India received a cumulative FDI
inflow of Rs. 5,384.7 crores during mid 1948 to march 1990 as compared to Rs.1,41,864
crores during August 1991 to march 2010 (Table-1.1). It is observed from the (Chart
1.1) that there has been a steady flow of FDI in India after its independence. But there is a
sharp rise in FDI inflows from 1998 onwards. U.K. the prominent investor during the pre
and post independent era stands nowhere today as it holds a share of 6.1 percent of the
total FDI inflows to India.

7
1.2 FDI INFLOWS IN INDIA IN POST REFORM ERA

Indias economic reforms way back in 1991 has generated strong interest in
foreign investors and turning India into one of the favourite destinations for global FDI
flows. According to A.T. Kearney1, India ranks second in the World in terms of
attractiveness for FDI. A.T. Kearneys 2007 Global Services Locations Index ranks India
as the most preferred destination in terms of financial attractiveness, people and skills
availability and business environment. Similarly, UNCTADs76 World Investment Report,
2005 considers India the 2nd most attractive destination among the TNCS. The positive
perceptions among investors as a result of strong economic fundamentals driven by 18
years of reforms have helped FDI inflows grow significantly in India. The FDI inflows
grow at about 20 times since the opening up of the economy to foreign investment. India
received maximum amount of FDI from developing economies (Chart 1.2). Net FDI
flow in India was valued at US$ 33029.32 million in 2008. It is found that there is a huge
gap in FDI approved and FDI realized (Chart- 1.3). It is observed that the realization of
approved FDI into actual disbursements has been quite slow. The reason of this slow
realization may be the nature and type of investment projects involved. Beside this
increased FDI has stimulated both exports and imports, contributing to rising levels of
international trade. Indias merchandise trade turnover increased from US$ 95 bn in FY02
to US$391 bn in FY08 (CAGR of 27.8%).

8
s

FDI INFLOWS IN INDIA

60000

Source: compiled
from the vari
ous issuesof SIA Bulletin, Ministryof
50000and computed
1991-2008

40000

US$ million

30000
20000
10000
0
Developed Countries

Dev

eloping Countries

NRI's

Chart-1.2
Commerce, GOI

Chart-1.3

Commerce, GOI

Indias exports increased from US$ 44 bn in FY02 to US$ 163 bn in FY08 (CAGR of

9
24.5%). Indias imports increased from US$ 51 bn in FY02 to US$ 251 bn in FY08
(CAGR of 30.3%). India ranked at 26th in world merchandise exports in 2007 with a
share of 1.04 percent.

Further, the explosive growth of FDI gives opportunities to Indian industry for
technological upgradation, gaining access to global managerial skills and practices,
optimizing utilization of human and natural resources and competing internationally with
higher efficiency. Most importantly FDI is central for Indias integration into global
production chains which involves production by MNCs spread across locations all over
the world. (Economic Survey 2003-04).16

1.3 OBJECTIVES

The study covers the following objectives:

1. To study the trends and patterns of flow of FDI.

2. To assess the determinants of FDI inflows.
3. To evaluate the impact of FDI on the Economy.

1.4 HYPOTHESES

The study has been taken up for the period 1991-2008 with the following hypotheses:

10
1. Flow of FDI shows a positive trend over the period 1991-2008.

2. FDI has a positive impact on economic growth of the country.

1.5 RESEARCH METHODOLOGY

1.5.1 DATA COLLECTION

This study is based on secondary data. The required data have been collected from
various sources i.e. World Investment Reports, Asian Development Banks Reports,
various Bulletins of Reserve Bank of India, publications from Ministry of Commerce,
Govt. of India, Economic and Social Survey of Asia and the Pacific, United Nations,
Asian Development Outlook, Country Reports on Economic Policy and Trade PracticeBureau of Economic and Business Affairs, U.S. Department of State and from websites
of World Bank, IMF, WTO, RBI, UNCTAD, EXIM Bank etc.. It is a time series data and
the relevant data have been collected for the period 1991 to 2008.

1.5.2 ANALYTICAL TOOLS

In order to analyse the collected data the following mathematical tools were
used. To work out the trend analyses the following formula is used:

a.) Trend Analysis i.e. = a + b x

where = predicted value of the dependent variable
a = y axis intercept,
b = slope of the regression line (or the rate of change in y for a given change in x),

11
x = independent variable (which is time in this case).
b.) Annual Growth rate is worked out by using the following formula:
AGR = (X2- X1)/ X1
where X1 = first value of variable X
X2 = second value of variable X
c.) Compound Annual Growth Rate is worked out by using the following
formula:
CAGR (t0, tn) = (V(tn)/V(t0))1/tn t0 -1
where
V (t0): start value, V (tn): finish value, tn t0: number of years.
In order to analyse the collected data, various statistical and mathematical tools were
used.

1.5.3 MODEL BUILDING

Further, to study the impact of foreign direct investment on economic growth, two models
were framed and fitted. The foreign direct investment model shows the factors
influencing the foreign direct investment in India. The economic growth model depicts
the contribution of foreign direct investment to economic growth. The two model
equations are expressed below:

FDI = f [TRADEGDP, RESGDP, R&DGDP, FIN. Position, EXR.]

GDPG = f [FDIG]
where,
FDI= Foreign Direct Investment
GDP = Gross Domestic Product
FIN. Position = Financial Position
TRADEGDP= Total Trade as percentage of GDP.

12
RESGDP= Foreign Exchange Reserves as percentage of GDP.
R&DGDP= Research & development expenditure as percentage of GDP.
FIN. Position = Ratio of external debts to exports
EXR= Exchange rate
GDPG = level of Economic Growth
FDIG = Foreign Direct Investment Growth
Regression analysis (Simple & Multiple Regression) was carried out using relevant
econometric techniques. Simple regression method was used to measure the impact of
FDI flows on economic growth (proxied by GDP growth) in India. Further, multiple
regression analysis was used to identify the major variables which have impact on
foreign direct investment. Relevant econometric tests such as coefficient of
determination R2, Durbin Watson [D-W] statistic, Standard error of coefficients,
TStatistics and F- ratio were carried out in order to assess the relative significance,
desirability and reliability of model estimation parameters.

1.6 IMPORTANCE OF THE STUDY

It is apparent from the above discussion that FDI is a predominant and vital factor in
influencing the contemporary process of global economic development. The study
attempts to analyze the important dimensions of FDI in India. The study works out the
trends and patterns, main determinants and investment flows to India. The study also
examines the role of FDI on economic growth in India for the period 1991-2008. The
period under study is important for a variety of reasons. First of all, it was during July
1991 India opened its doors to private sector and liberalized its economy. Secondly, the
experiences of South-East Asian countries by liberalizing their economies in 1980s
became stars of economic growth and development in early 1990s. Thirdly, Indias
experience with its first generation economic reforms and the countrys economic growth
performance were considered safe havens for FDI which led to second generation of
economic reforms in India in first decade of this century. Fourthly, there is a considerable

13
change in the attitude of both the developing and developed countries towards FDI. They
both consider FDI as the most suitable form of external finance. Fifthly, increase in
competition for FDI inflows particularly among the developing nations.
The shift of the power center from the western countries to the Asia sub continent is yet
another reason to take up this study. FDI incentives, removal of restrictions, bilateral and
regional investment agreements among the Asian countries and emergence of Asia as an
economic powerhouse (with China and India emerging as the two most promising
economies of the world) develops new economics in the world of industralised nations.
The study is important from the view point of the macroeconomic variables included in
the study as no other study has included the explanatory variables which are included in
this study. The study is appropriate in understanding inflows during 1991- 2008.

1.7 LIMITATIONS OF THE STUDY

All the economic / scientific studies are faced with various limitations and this study is no
exception to the phenomena. The various limitations of the study are:

1. At various stages, the basic objective of the study is suffered due to inadequacy of
time series data from related agencies. There has also been a problem of sufficient
homogenous data from different sources. For example, the time series used for
different variables, the averages are used at certain occasions. Therefore, the trends,
growth rates and estimated regression coefficients may deviate from the true ones.
2. The assumption that FDI was the only cause for development of Indian economy in
the post liberalised period is debatable. No proper methods were available to
segregate the effect of FDI to support the validity of this assumption.

14
3. Above all, since it is a Ph.D. project and the research was faced with the problem of
various resources like time and money.

Chapter 2
General Conditions on FDI

2.1 Who Can Invest in India?

1. A non-resident entity can invest in India, subject to the FDI Policy except in those
sectors/activities which are prohibited. However, a citizen of Bangladesh or an entity
incorporated in Bangladesh can invest only under the Government route. Further, a
citizen of Pakistan or an entity incorporated in Pakistan can invest, only under the
Government route, in sectors/activities other than defence, space and atomic energy
and sectors/activities prohibited for foreign investment.
2. NRIs resident in Nepal and Bhutan as well as citizens of Nepal and Bhutan are
permitted to invest in the capital of Indian companies on repatriation basis, subject to
the condition that the amount of consideration for such investment shall be paid only
by way of inward remittance in free foreign exchange through normal banking
channels.

15
3. OCBs have been derecognized as a class of investors in India with effect from
September 16, 2003. Erstwhile OCBs which are incorporated outside India and are
not under the adverse notice of RBI can make fresh investments under FDI Policy as
incorporated non-resident entities, with the prior approval of Government of India if
the investment is through Government route; and with the prior approval of RBI if
the investment is through Automatic route.
(i) An FII/FPI may invest in the capital of an Indian company under the Portfolio
Investment Scheme which limits the individual holding of an FII/FPI below 10% of
the capital of the company and the aggregate limit for FII/FPI/QFI investment to
24% of the capital of the company. This aggregate limit of 24% can be increased to
the sectoral cap/statutory ceiling, as applicable, by the Indian company concerned
through a resolution by its Board.
(ii) An Indian company which has issued shares to FIIs/FPIs under the FDI
Policy for which the payment has been received directly into companys
account should report these figures separately under item no. 5 of Form FCGPR .
(iii) A daily statement in respect of all transactions (except derivative trade) has to
be submitted by the custodian bank in floppy/soft copy in the prescribed format
directly to RBI and also uploaded directly on the OFRS web site
4. Only registered FIIs/FPIs and NRIs as per Schedules 2, 2A and 3 respectively of
Foreign Exchange Management (Transfer or Issue of Security by a Person Resident
Outside India) Regulations, 2000, can invest/trade through a registered broker in the
capital of Indian Companies on recognised Indian Stock Exchanges.
5. A SEBI registered Foreign Venture Capital Investor (FVCI) may contribute up to
100% of the capital of an Indian Venture Capital Undertaking (IVCU) and may also
set up a domestic asset management company to manage the fund. All such
investments can be made under the automatic route in terms of Schedule 6 to
Notification No. FEMA 20. A SEBI registered FVCI can invest in a domestic
venture capital fund registered under the SEBI (Venture Capital Fund) Regulations,
1996. Such investments would also be subject to the extant FEMA regulations and
extant FDI policy including sectoral caps, etc. SEBI registered FVCIs are also

16
allowed to invest under the FDI Scheme, as non-resident entities, in other
companies, subject to FDI Policy and FEMA regulations.

Further, FVCIs are

allowed to invest in the eligible securities (equity, equity linked instruments, debt,
debt instruments, debentures of an IVCU or VCF, units of schemes/funds set up by a
VCF) by way of private arrangement/purchase from a third party also, subject to
terms and conditions as stipulated in Schedule 6 of Notification No. FEMA 20 /
2000 RB dated May 3, 2000 as amended from time to time. It is also being clarified
that SEBI registered FVCIs would also be allowed to invest in securities on a
recognized stock exchange subject to the provisions of the SEBI (FVCI)
Regulations, 2000, as amended from time to time, as well as the terms and
conditions stipulated therein.

2.1.1 Qualified Foreign Investors (QFls) investment in equity shares

QFls are permitted to invest through SEBI registered Depository Participants (DPs)
only in equity shares of listed Indian companies through recognized brokers on
recognized stock exchanges in India as well as in equity shares of Indian companies
which are offered to public in India in terms of the relevant and applicable SEBI
guidelines/regulations. QFls are also permitted to acquire equity shares by way of
right shares, bonus shares or equity shares on account of stock split/consolidation or
equity shares on account of amalgamation, demerger or such corporate actions
subject to the prescribed investment limits. QFIs are allowed to sell the equity shares

so acquired subject to the relevant SEBI guidelines.

The individual and aggregate investment limits for the QFls shall be 5% and 10%
respectively of the paid up capital of an Indian company. These limits shall be within
FPI aggregate limits. Further, wherever there are composite sectoral caps under the
extant FDI policy, these limits for QFI investment in equity shares shall also be
within such overall FDI sectoral caps.

17

Dividend payments on equity shares held by QFls can either be directly remitted to
the designated overseas bank accounts of the QFIs or credited to the single noninterest bearing Rupee account.

Entities into which FDI can be made

2.2

2.2.1 FDI in an Indian Company

Indian companies can issue capital against FDI.
2.2.2 FDI in Partnership Firm/Proprietary Concern
(i)

A Non-Resident Indian (NRI) or a Person of Indian Origin (PIO) resident outside

India can invest in the capital of a firm or a proprietary concern in India on nonrepatriation basis provided;
(a)

Amount is invested by inward remittance or out of NRE/FCNR(B)/NRO account

maintained with Authorized

Dealers/Authorized banks.
(b)

The firm or proprietary concern is not engaged in any agricultural/plantation or

real estate business or print media sector.

18
(c)

Amount invested shall not be eligible for repatriation outside India.

(ii)

Investments with repatriation option: NRIs/PIO may seek prior permission of

Reserve Bank for investment in sole proprietorship concerns/partnership firms with

repatriation option. The application will be decided in consultation with the Government
of India.
(iii)

Investment by non-residents other than NRIs/PIO: A person resident outside India

other than NRIs/PIO may make an application and seek prior approval of Reserve Bank
for making investment in the capital of a firm or a proprietorship concern or any
association of persons in India. The application will be decided in consultation with the
Government of India.
(iv)

Restrictions: An NRI or PIO is not allowed to invest in a firm or proprietorship

concern engaged in any agricultural/plantation activity or real estate business or print

media.

2.2.3 FDI in Venture Capital Fund (VCF)

FVCIs are allowed to invest in Indian Venture Capital Undertakings (IVCUs)/Venture
Capital Funds (VCFs)/other companies, as stated in paragraph 3.1.6 of this Circular. If a
domestic VCF is set up as a trust, a person resident outside India (non-resident
entity/individual including an NRI) can invest in such domestic VCF subject to approval
of the FIPB. However, if a domestic VCF is set-up as an incorporated company under the
Companies Act, as applicable, then a person resident outside India (non-resident
entity/individual including an NRI) can invest in such domestic VCF under the automatic
route of FDI Scheme, subject to the pricing guidelines, reporting requirements, mode of
payment, minimum capitalization norms, etc.

2.2.4 FDI in Trusts

FDI in Trusts other than VCF is not permitted.

19
2.2.5 FDI in Limited Liability Partnerships (LLPs)
FDI in LLPs is permitted, subject to the following conditions:
(a)

FDI will be allowed, through the Government approval route, only in LLPs

operating in sectors/activities where 100% FDI is allowed, through the automatic route
and there are no FDI-linked performance conditions (such as 'Non Banking Finance
Companies' or 'Development of Townships, Housing, Built-up infrastructure and
Construction-development projects' etc.).
(b)

LLPs with FDI will not be allowed to operate in agricultural/plantation activity,

print media or real estate business.

(c)

An Indian company, having FDI, will be permitted to make downstream

investment in an LLP only if both-the company, as well as the LLP- are operating in
sectors where 100% FDI is allowed, through the automatic route and there are no FDIlinked performance conditions.
(d)

LLPs with FDI will not be eligible to make any downstream investments.

(e)

Foreign Capital participation in LLPs will be allowed only by way of cash

consideration, received by inward remittance, through normal banking channels or by

debit to NRE/FCNR account of the person concerned, maintained with an authorized
dealer/authorized bank.
(f)

Investment in LLPs by Foreign Portfolio Investors (FPIs) and Foreign Venture

Capital Investors (FVCIs) will not be permitted. LLPs will also not be permitted to avail
External Commercial Borrowings (ECBs).
(g)

In case the LLP with FDI has a body corporate that is a designated partner or

nominates an individual to act as a designated partner in accordance with the provisions

of Section 7 of the LLP Act, 2008, such a body corporate should only be a company

20
registered in India under the Companies Act, as applicable and not any other body, such
as an LLP or a trust.
(h)

For such LLPs, the designated partner "resident in India", as defined under the

'Explanation' to Section 7(1) of the LLP Act, 2008, would also have to satisfy the
definition of "person resident in India", as prescribed under Section 2(v)(i) of the Foreign
Exchange Management Act, 1999.
(i)

The designated partners will be responsible for compliance with all the above

conditions and also liable for all penalties imposed on the LLP for their contravention, if
any.
(j)

Conversion of a company with FDI, into an LLP, will be allowed only if the

above stipulations (except clause 3.2.5(e) which would be optional in case of a company)
are met and with the prior approval of FIPB/Government.

2.2.6 FDI in other Entities

FDI in resident entities other than those mentioned above is not permitted.

2.3 Types of Instruments

1 Indian companies can issue equity shares, fully, compulsorily and mandatorily
convertible debentures and fully, compulsorily and mandatorily convertible preference
shares subject to pricing guidelines/valuation norms prescribed under FEMA Regulations.
The price/conversion formula of convertible capital instruments should be determined
upfront at the time of issue of the instruments. The price at the time of conversion should
not in any case be lower than the fair value worked out, at the time of issuance of such
instruments, in accordance with the extant FEMA regulations [as per any internationally
accepted pricing methodology on arms length basis for the unlisted companies and
valuation in terms of SEBI (ICDR) Regulations, for the listed companies].

21
2 Optionality clauses are allowed in equity shares, fully, compulsorily and mandatorily
convertible debentures and fully, compulsorily and mandatorily convertible preference
shares under FDI scheme, subject to the following conditions:
(a)

There is a minimum lock-in period of one year which shall be effective from the

date of allotment of such capital instruments.

(b)

After the lock-in period and subject to FDI Policy provisions, if any, the non-

resident investor exercising option/right shall be eligible to exit without any assured
return, as per pricing/valuation guidelines issued
by RBI from time to time.
3 Other types of Preference shares/Debentures i.e. non-convertible, optionally convertible
or partially convertible for issue of which funds have been received on or after May 1,
2007 are considered as debt. Accordingly all norms applicable for ECBs relating to
eligible borrowers, recognized lenders, amount and maturity, end-use stipulations, etc.
shall apply. Since these instruments would be denominated in rupees, the rupee interest
rate will be based on the swap equivalent of London Interbank Offered Rate (LIBOR)
plus the spread as permissible for ECBs of corresponding maturity.
4 The inward remittance received by the Indian company vide issuance of DRs and
FCCBs are treated as FDI and counted towards FDI.

2.3.1 Issue of Foreign Currency Convertible Bonds (FCCBs) and

Depository
Receipts(DRs)
a)

FCCBs/DRs may be issued in accordance with the Scheme for issue of Foreign

Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt

22
Mechanism) Scheme, 1993 and DR Scheme 2014 respectively, as per the guidelines
issued by the Government of India there under from time to time.
b)

DRs are foreign currency denominated instruments issued by a foreign Depository

in a permissible jurisdiction against a pool of permissible securities issued or transferred

to that foreign depository and deposited with a domestic custodian.
c)

In terms of Notification No. FEMA.20/2000-RB dated May 3, 2000 as amended

from time to time, a person will be eligible to issue or transfer eligible securities to a
foreign depository, for the purpose of converting the securities so purchased into
depository receipts in terms of Depository Receipts Scheme, 2014 and guidelines issued
by the Government of India thereunder from time to time.
d)

A person can issue DRs, if it is eligible to issue eligible instruments to person

resident outside India under Schedules 1, 2, 2A, 3, 5 and 8 of Notification No. FEMA
20/2000-RB dated May 3, 2000, as amended from time to time.
e)

The aggregate of eligible securities which may be issued or transferred to foreign

depositories, along with eligible securities already held by persons resident outside India,
shall not exceed the limit on foreign holding of such eligible securities under the relevant
regulations framed under FEMA, 1999.
f)

The pricing of eligible securities to be issued or transferred to a foreign depository

for the purpose of issuing depository receipts should not be at a price less than the price
applicable to a corresponding mode of issue or transfer of such securities to domestic
investors under the relevant regulations framed under FEMA, 1999.
g)

The issue of depository receipts as per DR Scheme 2014 shall be reported to the

Reserve Bank by the domestic custodian as per the reporting guidelines for DR Scheme
2014.
2.9.1 (i) Two-way Fungibility Scheme: A limited two-way Fungibility scheme has
been put in place by the Government of India for ADRs/GDRs. Under this Scheme, a
stock broker in India, registered with SEBI, can purchase shares of an Indian company

23
from the market for conversion into ADRs/GDRs based on instructions received from
overseas investors. Re-issuance of ADRs/GDRs would be permitted to the extent of
ADRs/GDRs which have been redeemed into underlying shares and sold in the Indian
market.
(ii) Sponsored ADR/GDR issue: An Indian company can also sponsor an issue of
ADR/GDR. Under this mechanism, the company offers its resident shareholders a choice
to submit their shares back to the company so that on the basis of such shares,
ADRs/GDRs can be issued abroad. The proceeds of the ADR/GDR issue are remitted
back to India and distributed among the resident investors who had offered their Rupee
denominated shares for conversion. These proceeds can be kept in Resident Foreign
Currency (Domestic) accounts in India by the resident shareholders who have tendered
such shares for conversion into ADRs/GDRs.

2.4 Issue/Transfer of Shares

1 The capital instruments should be issued within 180 days from the date of receipt of the
inward remittance received through normal banking channels including escrow account
opened and maintained for the purpose or by debit to the NRE/FCNR (B) account of the
non-resident investor. In case, the capital instruments are not issued within 180 days from
the date of receipt of the inward remittance or date of debit to the NRE/FCNR (B)
account, the amount of consideration so received should be refunded immediately to the
non-resident investor by outward remittance through normal banking channels or by
credit to the NRE/FCNR (B) account, as the case may be. Non-compliance with the
above provision would be reckoned as a contravention under FEMA and would attract
penal provisions. In exceptional cases, refund of the amount of consideration outstanding
beyond a period of 180 days from the date of receipt may be considered by the RBI, on
the merits of the case.

24
2.4.1 Issue price of shares
Price of shares issued to persons resident outside India under the FDI
Policy, shall not be less than a.

the price worked out in accordance with the SEBI guidelines, as applicable, where

the shares of the company are listed on any recognised stock exchange in India;
b.

the fair valuation of shares done by a SEBI registered Merchant Banker or a

Chartered Accountant as per any internationally accepted pricing methodology on arms

length basis, where the shares of the company are not listed on any recognised stock
exchange in India; and
c.

the price as applicable to transfer of shares from resident to non-resident as per

the pricing guidelines laid down by the Reserve Bank from time to time, where the issue
of shares is on preferential allotment.
However, where non-residents (including NRIs) are making investments in an Indian
company in compliance with the provisions of the Companies Act, as applicable, by way
of subscription to its Memorandum of Association, such investments may be made at face
value subject to their eligibility to invest under the FDI scheme.

2.4.2 Foreign Currency Account

Indian companies which are eligible to issue shares to persons resident outside India
under the FDI Policy may be allowed to retain the share subscription amount in a Foreign
Currency Account, with the prior approval of RBI.

2.4.3 Transfer of shares and convertible debentures

25
(i)

Subject to FDI sectoral policy (relating to sectoral caps and entry routes),

applicable laws and other conditionalities including security conditions, nonresident investors can also invest in Indian companies by purchasing/acquiring existing
shares from Indian shareholders or from other non-resident shareholders. General
permission has been granted to nonresidents/NRIs for acquisition of shares by way of
transfer subject to the following:
(a)

A person resident outside India (other than NRI and erstwhile OCB) may transfer

by way of sale or gift, the shares or convertible debentures to any person resident outside
India (including NRIs). Government approval is not required for transfer of shares in the
investee company from one non-resident to another non-resident in sectors which are
under automatic route. In addition, approval of Government will be required for transfer
of stake from one nonresident to another non-resident in sectors which are under
Government approval route.
(b)

NRIs may transfer by way of sale or gift the shares or convertible debentures held

by them to another NRI.

(c)

A person resident outside India can transfer any security to a person resident in

India by way of gift.

(d)

A person resident outside India can sell the shares and convertible debentures of

an Indian company on a recognized Stock Exchange in India through a stock broker

registered with stock exchange or a merchant banker registered with SEBI.
(e)

A person resident in India can transfer by way of sale, shares/ convertible

debentures (including transfer of subscribers shares), of an Indian company under

private arrangement to a person resident outside India, subject to the guidelines given in
para 3.4.5.2 and Annex-2.
(f)

General permission is also available for transfer of shares/convertible debentures,

by way of sale under private arrangement by a person resident outside India to a person
resident in India, subject to the guidelines given in para 3.4.5.2 and Annex-2.

26
(g)

The above General Permission also covers transfer by a resident to a non-resident

of shares/convertible debentures of an Indian company, engaged in an activity earlier

covered under the Government Route but now falling under Automatic Route, as well as
transfer of shares by a non-resident to an Indian company under buyback and/or capital
reduction scheme of the company.
(h)

The Form FC-TRS should be submitted to the AD Category-I Bank, within 60

days from the date of receipt of the amount of consideration. The onus of submission of
the Form FC-TRS within the given timeframe would be on the transferor/transferee,
resident in India. However, in cases where the NR investor, including an NRI, acquires
shares on the stock exchanges under the FDI scheme, the investee company would have
to file form FC-TRS with the AD Category-I bank.
(ii)

The sale consideration in respect of equity instruments purchased by a person

resident outside India, remitted into India through normal banking channels, shall be
subjected to a Know Your Customer (KYC) check by the remittance receiving AD
Category-I bank at the time of receipt of funds. In case, the remittance receiving AD
Category-I

bank is different from the AD Category-I bank handling the transfer

transaction, the KYC check should be carried out by the remittance receiving bank and
the KYC report be submitted by the customer to the AD Category-I bank carrying out the
transaction along with the Form FC-TRS.
(iii)

A person resident outside India including a Non-Resident Indian investor who has

already acquired and continues to hold the control in accordance with the SEBI
(Substantial Acquisition of Shares and Takeover) Regulations can acquire shares of a
listed Indian company on the stock exchange through a registered broker under FDI
scheme provided that the original and resultant investments are in line with the extant
FDI policy and FEMA regulations in respect of sectoral cap, entry route, mode of
payment, reporting requirement, documentation, etc.

27
(iv)

Escrow: AD Category-I banks have been given general permission to open

Escrow account and Special account of non-resident corporate for open offers/exit offers
and delisting of shares. The relevant SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations, 2011 (SAST) Regulations or any other applicable SEBI
Regulations/provisions of the Companies Act, as applicable will be applicable. AD
Category-I banks have also been permitted to open and maintain, without prior approval
of RBI, non-interest bearing Escrow accounts in Indian Rupees in India on behalf of
residents and/or non-residents, towards payment of share purchase consideration and/or
provide Escrow facilities for keeping securities to facilitate FDI transactions subject to
the terms and conditions specified by RBI. SEBI authorised Depository Participants have
also been permitted to open and maintain, without prior approval of RBI, Escrow
accounts for securities subject to the terms and conditions as specified by RBI. In both
cases, the Escrow agent shall necessarily be an AD Category-I bank or SEBI authorised
Depository Participant (in case of securities accounts). These facilities will be applicable
for both issue of fresh shares to the non- residents as well as transfer of shares from/to the
non- residents.

2.4.4 Prior permission of RBI in certain cases for transfer of capital instruments
1 Except cases mentioned in paragraph 3.4.5.2 below, the following cases require prior
approval of RBI:
(i)

Transfer of capital instruments from resident to non-residents by way of sale

where
(a)

Transfer is at a price which falls outside the pricing guidelines specified by the

Reserve Bank from time to time and the transaction does not fall under the exception
given in para 3.4.5.2.
(b)

Transfer of capital instruments by the non-resident acquirer involving deferment

of payment of the amount of consideration. Further, in case approval is granted for a

28
transaction, the same should be reported in Form FC-TRS, to an AD Category-I bank for
necessary due diligence, within 60 days from the date of receipt of the full and final
amount of consideration.
(ii)

Transfer of any capital instrument, by way of gift by a person resident in India to

a person resident outside India. While forwarding applications to Reserve Bank for
approval for transfer of capital instruments by way of gift, the documents mentioned in
Annex-3 should be enclosed. Reserve Bank considers the following factors while
processing such applications:
(a)

The proposed transferee (donee) is eligible to hold such capital instruments under

Schedules 1, 4 and 5 of Notification No. FEMA 20/2000-RB dated May 3, 2000, as

amended from time to time.
(b)

The gift does not exceed 5 per cent of the paid-up capital of the Indian

company/each series of debentures/each mutual fund scheme.

(c)

The applicable sectoral cap limit in the Indian company is not breached.

(d)

The transferor (donor) and the proposed transferee (donee) are close relatives as

defined in Section 2 (77) of Companies Act, 2013, as amended from time to time. The
current list is reproduced in Annex-4.
(e)

The value of capital instruments to be transferred together with any capital

instruments already transferred by the transferor, as gift, to any person residing outside
India does not exceed the rupee equivalent of USD 50,000 during the financial year.
(f)

Such other conditions as stipulated by Reserve Bank in public interest from time

to time.
(iii)

Transfer of shares from NRI to non-resident.

2.4.5 In the following cases, approval of RBI is not required:

29
A. Transfer of shares from a Non-Resident to Resident under the FDI scheme where
the pricing guidelines under FEMA, 1999 are not met provided that:
i.

The original and resultant investment are in line with the extant FDI policy and

FEMA regulations in terms of sectoral caps, conditionalities (such as minimum

capitalization, etc.), reporting requirements, documentation, etc.;
ii.

The pricing for the transaction is compliant with the specific/explicit, extant and

relevant SEBI regulations/guidelines (such as IPO, Book building, block deals, delisting,
exit, open offer/substantial acquisition/SEBI SAST, buy back); and
iii.

Chartered Accountants Certificate to the effect that compliance with the relevant

SEBI regulations/guidelines as indicated above is attached to the form FC-TRS to be

filed with the AD bank.
B.

Transfer of shares from Resident to Non-Resident:

i) where the transfer of shares requires the prior approval of the Government
conveyed through FIPB as per the extant FDI policy provided that:
a)

the requisite approval of the FIPB has been obtained; and

b)

the transfer of shares adheres with the pricing guidelines and documentation

requirements as specified by the Reserve Bank of India from time to time.

ii) where the transfer of shares attract SEBI (SAST) Regulations subject to the
adherence with the pricing guidelines and documentation requirements as specified by
Reserve Bank of India from time to time.

iii) where the transfer of shares does not meet the pricing guidelines under the
FEMA, 1999 provided that:

30
a)

The resultant FDI is in compliance with the extant FDI policy and FEMA

regulations in terms of sectoral caps, conditionalities (such as minimum capitalization,

etc.), reporting requirements, documentation etc.;
b)

The pricing for the transaction is compliant with the specific/explicit, extant and

relevant SEBI regulations/guidelines (such as IPO, Book building, block deals, delisting,
exit, open offer/substantial acquisition/SEBI SAST); and
c)

Chartered Accountants Certificate to the effect that compliance with the relevant

SEBI regulations/guidelines as indicated above is attached to the form FC-TRS to be

filed with the AD bank.

iv) where the investee company is in the financial sector provided that:
a)

Any fit and proper/due diligence requirements as regards the nonresident

investor as stipulated by the respective financial sector regulator, from time to time, have
been complied with; and
b)

The FDI policy and FEMA regulations in terms of sectoral caps, conditionalities

(such as minimum capitalization, pricing, etc.), reporting requirements, documentation

etc., are complied with.

2.4.6 Conversion of ECB/Lump sum Fee/Royalty etc. into Equity

(i)

Indian companies have been granted general permission for conversion of

External Commercial Borrowings (ECB) (excluding those deemed as ECB) in

convertible foreign currency into equity shares/fully compulsorily and mandatorily
convertible preference shares, subject to the following conditions and reporting
requirements:
(a)

The activity of the company is covered under the Automatic Route for FDI or the

company has obtained Government approval for foreign equity in the company;

31
(b)

The foreign equity after conversion of ECB into equity is within the sectoral cap,

if any;
(c)

Pricing of shares is as per the provision of para 3.4.2 above;

(d)

Compliance with the requirements prescribed under any other statute and

regulation in force; and

(e)

The conversion facility is available for ECBs availed under the Automatic or

Government Route and is applicable to ECBs, due for payment or not, as well as
secured/unsecured loans availed from nonresident collaborators.
(ii)

General permission is also available for issue of shares/preference shares against

lump sum technical know-how fee, royalty due for payment, subject to entry route,
sectoral cap and pricing guidelines (as per the provision of para 3.4.2 above) and
compliance with applicable tax laws. Further, issue of equity shares against any other
funds payable by the investee company, remittance of which does not require prior
permission of the Government of India or Reserve Bank of India under FEMA, 1999 or
any rules/ regulations framed or directions issued thereunder is permitted, provided that:
(I)

The equity shares shall be issued in accordance with the extant FDI guidelines on

sectoral caps, pricing guidelines etc. as amended by Reserve bank of India, from time to
time;
Explanation: Issue of shares/convertible debentures that require Government approval in
terms of paragraph 3 of Schedule 1 of FEMA 20 or import dues deemed as ECB or trade
credit or payable against import of second hand machinery shall continue to be dealt in
accordance with extant guidelines;
(II)The issue of equity shares under this provision shall be subject to tax laws as
applicable to the funds payable and the conversion to equity should be net of applicable
taxes.

32
(iii)

Issue of equity shares under the FDI policy is allowed under the Government

route for the following:

(I)

import of capital goods/ machinery/ equipment (excluding second-hand

machinery), subject to compliance with the following conditions: (a) Any import of
capital goods/machinery etc., made by a resident in India, has to be in accordance with
the Export/Import Policy issued by Government of India/as defined by DGFT/FEMA
provisions relating to imports.
(b)

The application clearly indicating the beneficial ownership and identity of the

Importer Company as well as overseas entity.

(c)

Applications complete in all respects, for conversions of import payables for

capital goods into FDI being made within 180 days from the date of shipment of goods.
(II)

pre-operative/pre-incorporation expenses (including payments of rent etc.),

subject to compliance with the following conditions:

(a)

Submission of FIRC for remittance of funds by the overseas promoters for the

expenditure incurred.
(b)

Verification and certification of the pre-incorporation/pre-operative expenses by

the statutory auditor.

(c)

Payments should be made by the foreign investor to the company directly or

through the bank account opened by the foreign investor as provided under FEMA
Regulations.
(d)

The applications, complete in all respects, for capitalization being made within

the period of 180 days from the date of incorporation of the company.
General conditions:
(i)

All requests for conversion should be accompanied by a special resolution of the

company.

33
(ii)

Governments approval would be subject to pricing guidelines of RBI and

appropriate tax clearance.

2.5 Specific Conditions in Certain Cases

2.5.1 Issue of Rights/Bonus Shares
FEMA provisions allow Indian companies to freely issue Rights/Bonus shares to existing
non-resident shareholders, subject to adherence to sectoral cap, if any. However, such
issue of bonus/rights shares has to be in accordance with other laws/statutes like the
Companies Act, as applicable, SEBI (Issue of Capital and Disclosure Requirements)
Regulations, 2009 (in case of listed companies), etc. The offer on right basis to the
persons resident outside India shall be:
(a)

in the case of shares of a company listed on a recognized stock exchange in India,

at a price as determined by the company;

(b)

in the case of shares of a company not listed on a recognized stock exchange in

India, at a price which is not less than the price at which the offer on right basis is made
to resident shareholders.

2.5.2 Prior permission of RBI for Rights issue to erstwhile OCBs

OCBs have been de-recognised as a class of investors from September 16, 2003.
Therefore companies desiring to issue rights share to such erstwhile OCBs will have to
take specific prior permission from RBI. As such, entitlement of rights share is not
automatically available to erstwhile OCBs. However bonus shares can be issued to
erstwhile OCBs without the approval of RBI.

2.5.3 Additional allocation of rights share by residents to non-residents

34
Existing non-resident shareholders are allowed to apply for issue of additional
shares/fully, compulsorily and mandatorily convertible debentures/fully, compulsorily
and mandatorily convertible preference shares over and above their rights share
entitlements. The investee company can allot the additional rights share out of
unsubscribed portion, subject to the condition that the overall issue of shares to nonresidents in the total paid-up capital of the company does not exceed the sectoral cap.

2.5.4 Acquisition of shares under Scheme of

Merger/Demerger/Amalgamation
Mergers/demergers/ amalgamations of companies in India are usually governed by an
order issued by a competent Court on the basis of the
Scheme submitted by the companies undergoing merger/demerger/amalgamation. Once
the scheme of merger or demerger or amalgamation of two or more Indian companies has
been approved by a Court in India, the transferee company or new company is allowed to
issue shares to the shareholders of the transferor company resident outside India, subject
to the conditions that:
(i)

the percentage of shareholding of persons resident outside India in the transferee

or new company does not exceed the sectoral cap, and

(ii)

the transferor company or the transferee or the new company is not engaged in

activities which are prohibited under the FDI policy.

Note: FIPB approval would not be required in case of mergers and acquisitions taking
place in sectors under automatic route.
2.5.4.1 Issue of Non convertible/redeemable bonus preference shares or debentures
Indian companies are allowed to issue non-convertible/redeemable preference shares or
debentures to non-resident shareholders, including the depositories that act as trustees for
the ADR/GDR holders, by way of distribution as bonus from its general reserves under a

35
Scheme of Arrangement approved by a Court in India under the provisions of the
Companies Act, as applicable, subject to no-objection from the Income Tax Authorities.

2.5.5 Issue of shares under Employees Stock Option Scheme (ESOPs)

(i)

Listed Indian companies are allowed to issue shares under the Employees Stock

Option Scheme (ESOPs), to its employees or employees of its joint venture or wholly
owned subsidiary abroad, who are resident outside India, other than to the citizens of
Pakistan. ESOPs can be issued to citizens of Bangladesh with the prior approval of FIPB.
Subject to this, Government approval is not required for issue of ESOPs in sectors under
automatic route. Shares under ESOPs can be issued directly or through a Trust subject to
the condition that:
(a)

The scheme has been drawn in terms of relevant regulations issued by the SEBI,

and
(b)

The face value of the shares to be allotted under the scheme to the non-resident

employees does not exceed 5 per cent of the paid-up capital of the issuing company.
(ii)

Unlisted companies have to follow the provisions of the Companies Act, as

applicable. The Indian company can issue ESOPs to employees who are resident outside
India, other than to the citizens of Pakistan. ESOPs can be issued to the citizens of
Bangladesh with the prior approval of the FIPB. Subject to this, Government approval is
not required for issue of ESOPs in sectors under automatic route.
(iii)

The issuing company is required to report (plain paper reporting) the details of

granting of stock options under the scheme to non-resident employees to the Regional
Office concerned of the Reserve Bank and thereafter the details of issue of shares
subsequent to the exercise of such stock options within 30 days from the date of issue of
shares in Form FCGPR.
2.5.6 Share Swap

36
In cases of investment by way of swap of shares, irrespective of the amount, valuation of
the shares will have to be made by a Merchant Banker registered with SEBI or an
Investment Banker outside India registered with the appropriate regulatory authority in
the host country. Approval of the Government conveyed through Foreign Investment
Promotion Board (FIPB) will also be a prerequisite for investment by swap of shares.

2.5.7 Pledge of Shares

(A)

A person being a promoter of a company registered in India (borrowing

company), which has raised external commercial borrowings, may pledge the shares of
the borrowing company or that of its associate resident companies for the purpose of
securing the ECB raised by the borrowing company, provided that a no objection for the
same is obtained from a bank which is an authorised dealer. The authorized dealer, shall
issue the no objection for such a pledge after having satisfied itself that the external
commercial borrowing is in line with the extant FEMA regulations for ECBs and that:
the loan agreement has been signed by both the lender and the borrower,
there exists a security clause in the Loan Agreement requiring the borrower to
create charge on financial securities, and
the borrower has obtained Loan Registration Number (LRN) from the Reserve
Bank:
and the said pledge would be subject to the following conditions:
o the period of such pledge shall be co-terminus with the maturity of the
underlying ECB;
o in case of invocation of pledge, transfer shall be in accordance with the
extant FDI Policy and directions issued by the Reserve Bank;
o the Statutory Auditor has certified that the borrowing company will
utilized/has utilized the proceeds of the ECB for the permitted end use/s
only.

37
(B)

Non-residents holding shares of an Indian company, can pledge these shares in

favour of the AD bank in India to secure credit facilities being extended to the resident
investee company for bonafide business purpose, subject to the following conditions:

in case of invocation of pledge, transfer of shares should be in accordance with

the FDI policy in vogue at the time of creation of pledge;

submission of a declaration/ annual certificate from the statutory auditor of the
investee company that the loan proceeds will be / have been utilized for the

declared purpose;
the Indian company has to follow the relevant SEBI disclosure norms; and
pledge of shares in favour of the lender (bank) would be subject to Section 19 of
the Banking Regulation Act, 1949.

(C)

Non-residents holding shares of an Indian company, can pledge these shares in

favour of an overseas bank to secure the credit facilities being extended to the nonresident investor/non-resident promoter of the Indian company or its overseas group
company, subject to the following:

loan is availed of only from an overseas bank;

loan is utilized for genuine business purposes overseas and not for any

investments either directly or indirectly in India;

overseas investment should not result in any capital inflow into India;
in case of invocation of pledge, transfer should be in accordance with the FDI

policy in vogue at the time of creation of pledge; and

submission of a declaration/annual certificate from a Chartered Accountant/
Certified Public Accountant of the non-resident borrower that the loan proceeds
will be / have been utilized for the declared purpose.

2.6 Entry Routes for Investment

38
3.6.1 Investments can be made by non-residents in the equity shares/fully, compulsorily
and mandatorily convertible debentures/fully, compulsorily and mandatorily convertible
preference shares of an Indian company, through the Automatic Route or the Government
Route. Under the Automatic Route, the non-resident investor or the Indian company does
not require any approval from Government of India for the investment. Under the
Government Route, prior approval of the Government of India is required. Proposals for
foreign investment under Government route, are considered by FIPB.

2.6.2 Guidelines for establishment of Indian companies/ transfer of ownership or

control of Indian companies, from resident Indian citizens to non-resident entities,
in sectors with caps
In sectors/activities with caps, including inter-alia defence production, air transport
services, ground handling services, asset reconstruction companies, private sector
banking, broadcasting, commodity exchanges, credit information companies, insurance,
print media, telecommunications and satellites, Government approval/FIPB approval
would be required in all cases where:
(i)

An Indian company is being established with foreign investment and is not owned

by a resident entity or
(ii)

An Indian company is being established with foreign investment and is not

controlled by a resident entity or

(iii)

The control of an existing Indian company, currently owned or controlled by

resident Indian citizens and Indian companies, which are owned or controlled by resident
Indian citizens, will be/is being transferred/passed on to a non-resident entity as a
consequence of transfer of shares and/or fresh issue of shares to non-resident entities
through amalgamation, merger/demerger, acquisition etc. or
(iv)

The ownership of an existing Indian company, currently owned or controlled by

resident Indian citizens and Indian companies, which are owned or controlled by resident

39
Indian citizens, will be/is being transferred/passed on to a non-resident entity as a
consequence of transfer of shares and/or fresh issue of shares to non-resident entities
through amalgamation, merger/demerger, acquisition etc.
(v)

It is clarified that these guidelines will not apply to sectors/activities where there

are no foreign investment caps, that is, 100% foreign investment is permitted under the
automatic route.
(vi)

It is also clarified that Foreign investment shall include all types of foreign

investments i.e. FDI, investment by FIIs, FPIs, QFIs, NRIs, ADRs, GDRs, Foreign
Currency Convertible Bonds (FCCB) and fully, mandatorily & compulsorily convertible
preference shares/debentures, regardless of whether the said investments have been made
under Schedule 1, 2, 2A, 3, 6 and 8 of FEMA (Transfer or Issue of Security by Persons
Resident Outside India) Regulations.

2.7 Caps on Investments

3.7.1 Investments can be made by non-residents in the capital of a resident entity only to
the extent of the percentage of the total capital as specified in the FDI policy. The caps in
various sector(s) are detailed in Chapter 6 of this Circular.

2.8 Entry Conditions on Investment

3.8.1 Investments by non-residents can be permitted in the capital of a resident entity in
certain sectors/activity with entry conditions. Such conditions may include norms for
minimum capitalization, lock-in period, etc. The entry conditions in various
sectors/activities are detailed in Chapter 6 of this Circular.

2.9 Other Conditions on Investment besides Entry Conditions

40
3.9.1 Besides the entry conditions on foreign investment, the investment/investors are
required to comply with all relevant sectoral laws, regulations, rules, security conditions,
and state/local laws/regulations.

2.10 Foreign Investment into/downstream Investment by Indian Companies

3.10.1 The Guidelines for calculation of total foreign investment, both direct and indirect
in an Indian company, at every stage of investment, including downstream investment,
have been detailed in Paragraph 4.1.
2.10.2 For the purpose of this chapter,
(i)

Downstream investment means indirect foreign investment, by one Indian

company, into another Indian company, by way of subscription or acquisition, in terms of

Paragraph 4.1. Paragraph 4.1.3 provides the guidelines for calculation of indirect foreign
investment, with conditions specified in paragraph 4.1.3 (v).
(ii)

Foreign Investment would have the same meaning as in Paragraph

4.1.

2.10.3 Foreign investment into an Indian company engaged only in the activity of
investing in the capital of other Indian company/ies (regardless of its ownership or
control):
3.10.3.1

Foreign investment into an Indian company, engaged only in the activity of

investing in the capital of other Indian company/ies, will require prior Government/FIPB
approval, regardless of the amount or extent of foreign investment. Foreign investment
into Non-Banking Finance Companies (NBFCs), carrying on activities approved for FDI,
will be subject to the conditions specified in paragraph 6.2.18.8 of this Circular.
3.10.3.2 Those companies, which are Core Investment Companies (CICs), will

41
have to additionally follow RBIs Regulatory Framework for CICs.
3.10.3.3 For infusion of foreign investment into an Indian company which does not have
any operations and also does not have any downstream investments, Government/FIPB
approval would be required, regardless of the amount or extent of foreign investment.
Further, as and when such a company commences business(s) or makes downstream
investment, it will have to comply with the relevant sectoral conditions on entry route,
conditionalities and caps.
Note: Foreign investment into other Indian companies would be in accordance/
compliance with the relevant sectoral conditions on entry route, conditionalities and caps.

2.10.4 Downstream investment by an Indian company which is not owned and/or

controlled by resident entity/ies
3.10.4.1 Downstream investment by an Indian company, which is not owned and/or
controlled by resident entity/ies, into another Indian company, would be in
accordance/compliance with the relevant sectoral conditions on entry route,
conditionalities and caps, with regard to the sectors in which the latter Indian company is
operating.
Note: Downstream investment/s made by a banking company, as defined in clause (c) of
Section 5 of the Banking Regulation Act, 1949, incorporated in India, which is owned
and/or controlled by non-residents/a non-resident entity/non-resident entities, under
Corporate Debt Restructuring (CDR), or other loan restructuring mechanism, or in
trading books, or for acquisition of shares due to defaults in loans, shall not count
towards indirect foreign investment. However, their 'strategic downstream investment'
shall count towards indirect foreign investment. For this purpose, 'strategic downstream
investments' would mean investment by these banking companies in their subsidiaries,
joint ventures and associates.

42
Downstream investments by Indian companies will be subject to the following
conditions:
(i)

Such a company is to notify SIA, DIPP and FIPB of its downstream investment in

the form available at http://www.fipbindia.com within 30 days of such investment, even

if capital instruments have not been allotted along with the modality of investment in
new/existing ventures (with/without expansion programme);
(ii)

Downstream investment by way of induction of foreign equity in an existing

Indian Company to be duly supported by a resolution of the Board of Directors as also a

shareholders agreement, if any;
(iii)

Issue/transfer/pricing/valuation of shares shall be in accordance with applicable

SEBI/RBI guidelines;
(iv)

For the purpose of downstream investment, the Indian companies making the

downstream investments would have to bring in requisite funds from abroad and not
leverage funds from the domestic market.

This would, however, not preclude

downstream companies, with operations, from raising debt in the domestic market.
Downstream investments through internal accruals are permissible, subject to the
provisions of paragraphs 3.10.3 and 3.10.4.1

43
Chapter 3
A Brief History of Foreign Direct Investment In India

Foreign Direct Investment in India: A Critical Analysis of FDI

3.1 Introduction
There is hardly a facet of the Indian psyche that the concept of foreign has not
permeated. This term, connoting modernization, international brands and acquisitions by
MNCs in popular imagination, has acquired renewed significance after the reforms
initiated by the Indian Government in 1991. Contrary to the grand narrative opening of
flood-gates idea of 1991, what took place was a gradual process of changes in policies
on investment in certain sub-sections of the Indian economy.
As a result of controversy surrounding Foreign Direct Investment owing to a lack of
understanding, it has become the eye of a political storm. The paper aims to present a
unique understanding of FDI in the context of liberalisation and the prevailing political
climate.

44
FDI eludes definition owing to the presence of many authorities: Organisation for
Economic Co-operation and Development (OCED), International Monetary Fund (IMF),
International Bank for Reconstruction and Development (IBRD) and United Nations
Conference on Trade and Development (UNCTAD). All these bodies attempt to illustrate
the nature of FDI with certain measuring methodologies.
Generally speaking FDI refers to capital inflows from abroad that invest in the production
capacity of the economy and are usually preferred over other forms of external finance
because they are non-debt creating, non-volatile and their returns depend on the
performance of the projects financed by the investors. FDI also facilitates international
trade and transfer of knowledge, skills and technology.
It is furthermore described as a source of economic development, modernization, and
employment generation, whereby the overall benefits (dependant on the policies of the
host government),triggers technology spillovers, assists human capital formation,
contributes to international trade integration and particularly exports, helps create a more
competitive business environment, enhances enterprise development, increases total
factor productivity and, more generally, improves the efficiency of resource use.
Changes in the national political climate have precipitated a marked trend towards greater
acceptability of FDI. The envisioned role of FDI has evolved from that of a tool to solve
the crisis under the license raj system to that of a modernising force that has been given
special agencies and extensive discourse. This evolution is illustrated by analysis of the
Economic policies of the Indian government from 1991 to 2005. The primary focus of
this analysis will be towards the industrial and infrastructural sectors which form the
beginning of the gradual liberalization process that was started in 1991. A complete
understanding of these two sectors will provide interesting statistics and information
regarding trends of FDI.

45
3.2 Uneven Beginning
In most narratives on Indias liberalization, 1991 has acquired a revolutionary status as a
time of change in the planning of Indias 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.At the time the focus for long term planning was
still inwards as efforts were on to solve the balance of payments crisis with Indias own
resources and ingenuity as self reliance presented itself as the only alternative. 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

46
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. 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. 7 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.8 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.

47

The following paragraph illustrates the importance.

The PM was also highly sensitive to the impact of reform on Indias 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 couldbe 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 Andhra Pradesh, 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 nations attention in their election manifestoes
presented their agenda (a mix of ideology and party advancement) that could be

48
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.13 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 selfreliance.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 governments capacity
to pursue the social goals of generating employment, removing poverty and promoting
equity16. 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 mischief17 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

49
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.18 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 Indias 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 Indias 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

50
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, but it was just the
reverse when it was seen from a practical point of view and the history of their stance
when it comes to the states where they are in power. Needless to say the policies were
theoretically seen as pro multinational and anti public sector and local industries.24 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 MNCs 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 mainly an
election issue. If nothing else the topic has sparked discussion as its future will affect the
welfare of the country.
Maintaining the Flow With the new government focus on FDI was evident in changes in
1996-97 that resulted in an increase in understanding and resources towards investment.
This included the setting up of the Foreign Investment Promotion Council along with the
Foreign Investment Promotion Board (FIPB) being streamlined and made more
transparent. The first ever guidelines were announced for consideration of foreign direct
investment proposals by the FIPB, which were not covered under the automatic route.26
The list of industries eligible for automatic approval of up to 51 per cent foreign equity
were expanded and there was a recognition that foreign direct investment flows
provided savings without adding to the country's external debt. The case of comparison

51
for numbers and example seem to be China and the Asian Tigers that were enjoying the
economic boom.
By now FDI trends are taken more serious and FDI flow had to be maintained for the
economy to grow. The government recognized that greater procedural simplifications
were still needed in the area of FDI. In 1998 when there was a decline in FDI the
government had to take greater technical measures in terms of liberalising investment
norms in bring in FDI. Though these were steps in the right direction the government was
not able to function as a central ruling body and elections had to be called that resulted
with a BJP government.

3.3 Another Beginning

By now after having been in power the BJP in 1998-1999, overhauled its previous
stance and in its party manifesto admitted that that the country cannot do without FDI
because besides capital stocks it brings with it technology, new market practises and most
importantly employment.27 However there is a clarification that FDI will be encouraged
in core areas so that it usefully supplements the national efforts and discourage FDI in
non priority areas.28 The Communist party while talking about land reforms also made a
recognition of foreign capital that is to be solicited to those areas for which clear cut
priorities are set.29 CPI (M) was not clear as the so called priorities were to be

52
themselves are to be determined by the need for developing new production capacities
and acquiring new technology. Meanwhile the Congress party (now was on a different
level than the other party) planned an increase both the level and productivity of
investment, both domestic and foreign, public and private, in infrastructure like power,
roads, ports, railways, coal, oil and gas, mining and telecommunications.
The trends now illustrated that while the facets of FDI were not completely understood
by all the parties it was a topic that was a major election and policy topic. The analysis
reveals that FDI at this point could not be blocked but the parliamentary parties through
their policy realized that its speed could be controlled to garner effective longevity for the
party while balancing the investment needs of the country.
The trends of FDI now resulted in policy formulation. For example in 1999-2000, when a
second year of decline continued a Foreign Investment Implementation Authority (FIIA)
was set up for providing a single point interface between foreign investors and the
government machinery, including state authorities. This body was also empowered to
give comprehensive approvals. After this point FDI has acquired an acceptable status and
the debate is on the levels that will be allowed.
By the next election in 2004, FDI had become a non-electable issue. There was
widespread acceptance of the topic among all the party lines and it was no longer will it
be allowed but how the polices would be designed for FDI.

3.4 Sector Analysis

When the reforms began in 1991 it was inevitable there would be a discrepancy as
various sectors have different characteristics and procedures. The reforms and polices on
FDI have trickled down to various sectors in different speed and effectiveness. Thus the
progress of FDI will be effectively analyzed by studying two sectors of the Indian
economy: Industry and Infrastructure. These sectors are an agglomeration of sub sectors
that when combined from the integral components of the economic growth.

3.5 Significant Change versus Struggling On

53
When initial reforms took place in 1991, Industry was one of the first to benefit from the
reforms as it resulted in changing the overall system. Firstly the new policy of July 1991
sought substantially to deregulate industry so as to promote the growth of a more efficient
and competitive industrial economy. During this process the procedures for investment in
non-priority industries were streamlined. On a central level the foreign Investment
Promotion Board (FIPB) was established to negotiate with large international firms and
to expedite the clearances required. The FIPB also considered individual cases involving
foreign equity participation over 51 percent.30 Furthermore for industry an important
step was the removal of the Mandatory Convertibility Clause. The government realised
that foreign investment had been traditionally tightly regulated in India and now the
government hand was lifting.
These changes while dramatic did not yield results immediately; though Foreign
Investment was liberalised in 1992, manufacturing declined. The widespread social
disturbances and economic uncertainties which prevailed during the year contributed to
this decline and to a weakening of investment demand as investment intentions suffered
from the uncertain conditions which prevailed. On a positive note by this time due to the
announcement of the new industrial policy in July 1991, a large number of
Governmentinduced restrictions, licensing requirements and controls on corporate
behaviour were eliminated.
The full impact of the events surrounding Ayodhaya in 1992 were felt a year later, as the
incident had disrupted industrial activity and had upset business plans and investment
decisions.33 It was in the years of 1995-1996 that Industry observed a change that has
become a staple of attracting FDI to India ever since. With state governments undertaking
procedural and policy reforms in line with liberalization taken by the centre, reforms
were initiated by most state governments for promoting foreign investment, thus
encouraging investment participation in industry.
While Industry had taken a stride forward, an examination of Infrastructure reveals a
policy and approach that differs significantly from Industry. From the onset the status of
infrastructure sector did not cause any state of panic, as overall the sector was not seen to

54
be performing too badly, and was seen as the stabilizing force of the economy. The sector
was seen as a bloc and in its components while the performance of coal and
telecommunications sectors fell short of the respective targets; simultaneously energy,
railways, and shipping exceeded their respective targets thus bringing up the overall
performance of the sector to positive growth.
This discrepancy was recognized in n 1992-1993 when the general review mentioned in
an overview that capital intensive infrastructure industries such as power, irrigation and
telecommunications, were handicapped by a number of constraints and where possible
these industries should eventually develop competitive market structures.35 Once again
the shipping, railways and telecommunications were able to meet targets while the
performances of coal and power have been below target. As a result the sector as a whole
was not liberalized but there were only suggestions that it was important to attract foreign
and private investment in the power sector to overcome the resource constraint.
1993-1994 followed the trend whereby instead of economic data the analysis offered was
the shortcomings on the Infrastructure sector such as its development largely in the public
sector and need for structural changes in the organization, operation and management of
the public sector enterprises.37 The call to induce greater efficiency and accountability by
replacing the monopolistic nature of these sectors with a competitive environment was
not followed by steps to make this dream a practicality.
1994-1995 follows in the same footsteps of the previous years but with recognition that
as governments ability to undertake investment in infrastructure is severely constrained
and it is necessary to induce much more private sector investment and participation in the
provision of infrastructure services.38 1995-1996 illustrates the great unevenness of the
growth that is taking place within sectors and between technologies. By the time
infrastructure is linked to FDI as the condition of infrastructure has a direct correlation to
international competitiveness and flow of FDI, the government has finished its tenure.

55

Explains the reason of practicing the present mode of ''development'' where common
people are expandable in order to grow infrastructure for free FDI inflow

3.6 Understanding FDI

The period of the next coalition government in 1996-1998 could be seen as a willingness
to understand FDI by placing policies that would result in an increase in FDI and further
liberalization. There was a greater understanding on the role of FDI in both the sectors.
Industry still lead the reforms whereby automatic approval of FDI was increased up to 74
per cent by the Reserve Bank of India in nine categories of industries, including
electricity generation and transmission, non-conventional energy generation and
distribution, construction and maintenance of roads, bridges, ports, harbours, runways,
waterways, tunnels, pipelines, industrial and power plants, pipeline transport except for
POL and gas, water transport, cold storage and warehousing for agricultural products,
mining services except for gold, silver and precious stones and exploration and
production of POL and gas, manufacture of iron ore pellets, pig iron, semi-finished iron
and steel and manufacture of navigational, meteorological, geophysical, oceanographic,
hydrological and ultrasonic sounding instruments and items based on solar energy. The
government also announced in January 1997 the first ever guidelines for FDI expeditious
approval in areas not covered under automatic approval.
This above trends illustrates the earlier point of the government recognizing and carrying
forth of the previous work done by the Rao government. While the advantage of FDI did

56
not reach the mindset of the common man the government seemed to show possibilities
of development through FDI. For example when Indian industry registered a modest
growth rate of 7.1 per cent in 1996-97, which was much lower than the 12.1 per cent
growth in 1995-96, there was research carried out which revealed this was partially
attributable to the mining and electricity generation sectors which recorded
meagre growth rates of 0.7 per cent and 3.9 per cent respectively. Thus the policy was
immediately rectified by expanding the list of industries eligible for foreign direct equity
investment under the automatic approval route by RBI in 1997-1998.
For infrastructure there was a realization that investments were, by their very nature, for
long-term return activities. This implies that there is a continuing mismatch between the
required debt maturities and the availability of funding. The focus of this government
shifted from Infrastructural direct investment to more towards equity investment. In terms
of specific cases there is only literature on two areas namely roads and ports in relation to
FDI. By 1997-1998 the most the term infrastructure was expanded to include telecom,
oil exploration and industrial parks to enable these sectors to avail of fiscal incentives
such as tax holidays and concessional duties. Liberalisation of foreign investment norms
in the road sector resulted in granting of automatic approvals for foreign equity
participation up to 74 per cent in the construction and maintenance of roads and bridges
and up to 51 per cent in supporting services to land transport like operation of highway
bridges, toll roads and vehicular tunnels.42 Civil Aviation also dealt with a new policy for
private investment that was announced allowing for 100 per cent NRI/OCB equity and 40
per cent foreign equity participation in domestic airlines.43 The development of the
Infrastructure sector for FDI was still haphazard as power, telecommunications, postal
services, railways, urban Infrastructure have no mention of FDI.
In a narrative of the governments it can be easily observed that a strong legacy of FDI
was inherited and the trend that continued were along the same fissures of development
whereby liberal polices advanced with certain modifications. The weak hold on power by

57
the government meant there could not be an overhaul by further increasing FDI at a
phenomenal level but slowly opened the economy by carrying on the reforms that the
Congress had started.

3.7 A Procedural Battle

In the next governments of the BJP, though the party ideology was initially formulated
with its own unique ways of FDI advancement, the prospect of advancing overall
development, and an established system by the last two governments resulted in
continuing the reforms in the economy along the same lines. In course of the year several
policy measures were announced for reviving industrial investment. These included
reduction of income and corporate tax rates, reduction in excise duties on intermediates
and customs duties on raw materials, reduction in bank rate and cash reserve ratio. By
now the government had liberalised investment norms in various sectors, further
simplified procedures, delicensed and de-reserved some of the key industries and stepped
up public investment in infrastructure industries.
For industry the period started with a decline whereby the total foreign investment (FDI
and portfolio) declined to $ 2312 million in 1998-99 from $ 5853 million in 1997-98, as a
result of a reduction of $ 1.8 billion portfolio flows and a 32 per cent reduction in FDI.
During 1998, the flows to developing countries declined by 3.8 percent, resulting in
Indias share in these flows falling sharply to 1.4 per cent. World FDI flows to developing
countries peaked in 1997 ($ 173 billion) when Indias share in these flows was 1.9 per
cent.44 Nationally this resulted in several measures taken for facilitating the inflow of
foreign investment in the economy. The scope of the automatic approval scheme of the

58
RBI was again significantly expanded. The Government decided to place all items under
the automatic route for Foreign Direct Investment/ NRI and OCB investment except for a
small negative list and set up a Group of Ministers for reviewing the existing sectoral
policies and caps. The Union Budget (1999-2000) permitted FDI up to 74 percent, under
the automatic route, in bulk drugs and pharmaceuticals. In 2000-2001 the time frame for
consideration of FDI proposals was reduced from 6 weeks to 30 days for communicating
Government decisions. The 2001-2002 years were not good for Industry due to an
industrial slowdown.
For Infrastructure by 1998-1999 the narrative is stabilizing to the same concept of broad
statements regarding the role of infrastructure and its importance to the government. In
terms of procedures automatic approval for foreign equity participation up to 100 percent
is permitted for electricity generation, transmission and distribution for foreign equity
investment not exceeding Rs.1500 crore (excluding atomic reactor power plants).
Once again in the outlook section the government realized the importance of
infrastructure but there are not concrete steps listed to achieve this. In 1999-2000 there is
talk of infrastructure growing in the year there is no data available on the role and amount
of foreign direct investment.
Breaking down into sub sectors for Infrastructure reveals that compared to Industry,
Infrastructure has had a large discrepancy in its sub-sectors. For example the power
sector performance during the period 1992-93 to 1999-2000 has been disappointing
despite significant reforms in the sector, such as setting up of a regulatory authority and
opening power generation to private investment, both domestic and foreign. For the
postal sector the emphasis on social objectives has outweighed other considerations and
user charges remained low. Therefore, notwithstanding the revision of tariff, the
postalservices continue to run into a deficit; in 1999-2000, the postal deficit was Rs.
1,596 crore.
One of the important conclusions of the above review of infrastructure development is
that the demand for infrastructure services continues to outpace supply. There is

59
recognition of the role of Infrastructure in the upcoming years, as it is a precondition to
rapid economic development but the policies have not brought the required change as
quickly as expected. For example in urban infrastructure 100 percent FDI has been
permitted on the development of integrated townships since 2001. However investments
did not materialize because of very rigid existing conditions relating to land procurement
especially in urban areas, where land revenue and reform legislation have precedence
over organization. Moreover there are problems relating to lack of clear titles, old
protective tenancy and rent control. The suggestion is that the system of maintenance of
land records needs to be improved through computerization.

3.8 FDI Redux

By 2002 FDI changes completely for India as it is given new importance in Ministry of
Finances Economic Survey in the form of a new subsection in Industry that exclusively
dealt with FDI and went to great lengths to define its role, and provides much more data
than in the previous years. There is also particular mention on how RBI is evaluating
some modifications in the way that Indian FDI is measured, which could lead somewhat
higher estimates for India. By now garnering FDI is a prized commodity in a competitive
global arena and is analysed in context as other countries are also improving policies and
institutions, to further increase their FDI flows. By 2003-2004 the non-comparability of
the Indian FDI statistics was addressed by a committee constituted in May 2002 by
Department of Industrial Policy & Promotion (DIPP), in order to bring the reporting
system of FDI data in India into alignment with international best practices.
For infrastructure from 2002-2003 (re formulation of FDI data) there is mention in sub
sectors for FDI and not for infrastructure as a whole. Telecom has been a major recipient
of FDI and during the period of August 1991 to June 2002, 831 proposals for FDI of Rs.
56,226 crore were approved and the actual flow of FDI during the above period was Rs.
9528 crore. In terms of approval of FDI, the telecom sector is the second largest after the

60
energy sector. In 2002, the increase of FDI inflow was of the order of Rs 1077 crore
during January to July 2002.
The FDI target for the Telecommunication sector is estimated at US $2.5 billion per
annum, by the Steering Group on FDI, Planning commission. By 2003-2004 literature on
Infrastructure talks about investments needed to bring infrastructure to world standards.
However there is no mention of details. Finally for 2004-2005 there is data for Telecom
but in general there is no data on FDI in the infrastructure sector as a whole. The analysis
of both the sectors and especially Infrastructure raises questions on the haphazard nature
of FDI taking place. While this trend may have been acceptable in the early 1990s, when
FDI was in its infancy the recognition and building of reforms by the successive
governments raises the questions on what part of FDI is the government attention shifted
in.

3.9 Sub sector: Telecommunications

Further narrowing of FDI in sub-sectors reveals more interesting trends. Research into
Telecommunications furthers the haphazard nature of FDI investment and policy making.
The current process for FDI in telecommunications can be attributed to two policies that
were undertaken by the government: National Telecom Policy of 1994 and New Telecom
Policy of 1999. Before the economic reforms teledensity was low, infrastructure growth
was slow, and the lack of reforms restricted investments and adoption of new
technologies. The existing legislative and regulatory environment needed major changes
to facilitate growth in the sector.
It was 1991 when the programme was undertaken to expand and upgrade Indias vast
telecom network. The programme included: complete freedom of telecom equipment
manufacturing, privatisation of services, liberal foreign investment and new regulation in
technology imports.47 Simultaneously, the government-managed Department of
Telecommunications (DoT) was restructured to remove its monopoly status as the service
provider.48 The government programme was formalised on a telecom policy statement

61
called National Telecom Policy 1994 on 12 May 1994. However the 1994 policy was not
sufficient to make the Indias telecommunications sector fully open and liberalised. The
incumbent monopoly (DoT) was indifferent in implementing the national telecom policy
effectively due to its lack of commitment and also due to the instability at the Centre
(frequent changes of governments) over 1994 and 1998. This paved the way for
designing a new policy framework for telecommunications which was called the New
Telecom Policy 1999 (NTP99) and was delivered by the new government led by BJP
coalitions.
The New Telecom Policy 1999 (NTP99) was developed at the backdrop of three major
events witnessed by the Indian economy after the reform process began in 1991. First,
although NTP94 was a right step to bring reform in the telecommunications industry, it
failed to achieve a desired goal until 1997. Second, the coalition government of the BJP
brought stability to the Central government and after assuming power; the BJP-led
government announced and followed through with further reform in telecommunications
to attain an effective and efficient communications sector.49 This policy is an example
that economics reforms and political systems coexist. In order to achieve the BJP-led
coalition government immediately formed a high powered committee to develop the
Internet Services Development Policy headed by than Kerala CM Chandrababu Naidu.
The committee and the interest of the government led to the new policy. As a result in
addition to the sectoral caps, the government policy played a major role in the
liberalization of the telecom sector. As a result a large number of private operators started
operating in the basic/mobile telephony and Internet domains. Teledensity has increased,
mobile telephony has established a large base, the number of Internet users has seen a
steep growth, and large bandwidth has been made available for software exports and ITenabled services, and the tariffs for international and domestic links have seen significant
reductions.

3.10 FDI Culture

62
Many economists in the country have now realized the advantages of FDI to India. While
the achievements of the Indian government are to be lauded, a willingness to attract FDI
has resulted in what could be termed an FDI Industry. While researching the economic
reforms on FDI, it was discovered that there exists a plethora of boards, committees, and
agencies that have been constituted to ease the flow of FDI. A call to one agency about
their mandate and scope usually results in the quintessential response to call someone
else. Reports from FICCI and the Planning Commission place investor confidence and
satisfaction at an all time high; citizens too deserve to be clued in on the government
bodies are doing.
According to the current policy FDI can come into India in two ways. Firstly FDI up to
100% is allowed under the automatic route in all activities/sectors except a small list that
require approval of the Government. FDI in sectors/activities under automatic route does
not require any prior approval either by the Government or RBI. The investors are
required to notify the Regional office concerned of RBI within 30 days of receipt of
inward remittances and file the required documents with that office within 30 days of
issue of shares to foreign investors.51 All proposals for foreign investment requiring
Government approval are considered by the Foreign Investment Promotion Board
(FIPB). The FIPB also grants composite approvals involving foreign investment/foreign
technical collaboration.52 As this clarity is useful for future investors, it has to be seen if
these bodies are effective. The Initial research revealed four major bodies that have been
constituted and could provide data pertaining to FDI1991 Foreign Investment Promotion Board FIPB
consider and recommend Foreign Direct Investment (FDI) proposals, which do not
come under the automatic route. It is chaired by Secretary Industry (Department of
Industrial Policy & Promotion).
1996 Foreign Investment Promotion Council FIPC

63
constituted under the chairmanship of Chairman ICICI, to undertake vigorous
investment promotion and marketing activities. The Presidents of the three apex business
associations such as ASSOCHAM, CII and FICCI are members of the Council.
1999 Foreign Investment Implementation Authority FIIA
functions for assisting the FDI approval holders in obtaining various approvals and
resolving their operational difficulties. FIIA has been interacting periodically with the
FDI approval holders and following up their difficulties for resolution with the concerned
Administrative Ministries and State Governments.
3.11 2004 Investment Commission
Headed by Ratan Tata, this commission seeks meetings and visits industrial groups and
houses in India and large companies abroad in sectors where there was dire need for
investment.
Attempting to research directives and results of the above bodies resulted in no direct
contact but instead a list of various other sub bodies.
Project Approval Board (PAB) for approving foreign technology transfer proposals not
falling under the automatic route.
Licensing Committee (LC) for considering and recommending proposals for grant of
industrial license.
In addition, concerned Ministries/ Departments issue various approvals as per the
allocation of business and various Acts being administered by them.
At the State level, State Investment Promotion Agency and, at the district level,
District Industries Centres, generally look after projects.
Concerned departments of the State Government handle sectoral projects.
Fast Track Committees (FTCs) have been set up in 30 Ministries/Departments for close
monitoring of projects with estimated investment of Rs. 100 crores and above and for
resolution of issues hampering implementation.

64
Investment Promotion and Infrastructure Development Cell gives further impetus to
facilitation and monitoring of investment, as well as for better coordination of
infrastructural requirements for industry
SIA has been set up by the Government of India in the Department of Industrial Policy
and Promotion in the Ministry of Commerce and Industry to provide a single window for
entrepreneurial assistance, investor facilitation, receiving and processing all applications
which require Government approval, conveying Government decisions on applications
filed, assisting entrepreneurs and investors in setting up projects, (including liaison with
other organizations and State Governments) and in monitoring implementation of
projects.
CCFI Cabinet Committee on Foreign Investment- meets at the ministerial level and is
guided by the prime Minister, considers foreign investment exceeding Rs 3 billion as
requiring special political attention.
Indian Missions Abroad- can also receive project proposal and will forward them the
institutions in New Delhi.
Indian Investment Centre- (This was supposed to be closed after the Planning
Commission was established but still continues to operate) established as an autonomous
organization in 1960 with the objective of doing promotional work abroad to attract
foreign private investment into India and establishment of joint ventures, technical
collaborations and third country ventures between Indian and foreign entrepreneurs.
The face of FDI usually resides with pamphlets and amalgamation of facts and figures
that are circulated through many conferences. From these it can be deciphered that
officially FDI policy is reviewed on an ongoing basis and measures for its further
liberalization are taken. The change in sectoral policy/ sectoral equity cap is notified from
time to time through Press Notes by the Secretariat for Industrial Assistance (SIA) in the
Department of Industrial Policy & Promotion. Policy announcement by SIA are
subsequently notified by Reserve Bank of India (RBI) under Foreign Exchange
Management Act (FEMA).

65
Thus while clear procedures have been established for FDI, government needs to
seriously evaluate how much resources and money is being poured to what is becoming
the FDI industry. The fluidity of bodies has resulted in the monetary value of FDI feeding
a makeshift industry that deals with dealing with the concept and procedures of FDI.

3.12 Conclusion
As evidenced by analysis and data the concept and material significance of FDI has
evolved from the shadows of shallow understanding to a proud show of force.
While it is accepted that the government was under compulsion to liberalize cautiously,
the understanding of foreign investment was lacking. It was because of the submissive
nature of the govt. that harnesses scope of FDI inflow. A sectoral analysis reveals that
while FDI shows a gradual increase and has become a staple for success for India, the
progress is hollow (Annexure 1 and 2). The Telecommunications and power sector are the
reasons for the success of Infrastructure. This is a throwback to 1991 when Infrastructure
reforms were not attempted as the sector was performing in the positive. FDI has become

66
a game of numbers where the justification for growth and progress is the money that
flows in and not the specific problems plaguing the individual sub sectors.
Political parties (Congress, BJP, CPI (M)) have changed their stance when in power and
when in opposition and opposition (as well as public debate) is driven by partisan
considerations rather that and effort to assess the merit of the policies. This is evident is
the public posturing of Hindu right, left and centrist political parties like the
Congress.The growing recognition of the importance of FDI resulted in a substantive
policy package but and also the delegation of the same to a set of eminently dispensable
bodies. This is indicative of a mood of promotion counterbalanced by a clear deference of
responsibility.
In the comparative studies the notion of Infrastructure as a sector has undergone a
definitional change. FDI in the sector is held up primarily by two sub sectors
(telecommunications and Power) and is not evenly distributed.The three major industrial
houses (CII, ASSOCHAM, FICCI), World Bank and the Planning Commission have
similar recommendations for FDI and yet despite their concurrence, a comprehensive
policy in this respect is still to be formulated after 15 years of Indias economic reforms.
The worship of FDI by the business class of India doesn't have any resemblance with the
falling rate of industrial growth and shifting of the labor class to a white collar technocrat
section based on outsourcing. The Swadeshi alternative has receded in public policy
debate.
Thus the impact of the reforms in India on the policy environment for Foreign Direct
Investment presents a mixed picture. The industrial reforms have gone shady, they are
supplemented by more infrastructure reforms and increase in service sector rather than
any significant industrial growth which is a critical missing link

67

CHAPTER-4
FDI AND INDIAN ECONOMY

4.0 INTRODUCTION
Nations progress and prosperity is reflected by the pace of its sustained economic growth
and development. Investment provides the base and pre-requisite for economic growth
and development. Apart from a nations foreign exchange reserves, exports, governments
revenue, financial position, available supply of domestic savings, magnitude and quality
of foreign investment is necessary for the well being of a country. Developing nations, in
particular, consider FDI as the safest type of international capital flows out of all the
available sources of external finance available to them. It is during 1990s that FDI
inflows rose faster than almost all other indicators of economic activity worldwide.
According to WTO83, the total world FDI outflows have increased nine fold during
1982 to 1993, world trade of merchandise and services has only doubled in the same.

68
Since 1990 virtually every country- developed or developing, large or small alike- have
sought FDI to facilitate their development process. Thus, a nation can improve its
economic fortunes by adopting liberal policies vis--vis by creating conditions conducive
to investment as these things positively influence the inputs and determinants of the
investment process. This chapter highlights the role of FDI on economic growth of the
country.

4.1 FDI AND INDIAN ECONOMY

Developed economies consider FDI as an engine of market access in developing and less
developed countries vis--vis for their own technological progress and in maintaining
their own economic growth and development. Developing nations looks at FDI as a
source of filling the savings, foreign exchange reserves, revenue, trade deficit,
management and technological gaps. FDI is considered as an instrument of international
economic integration as it brings a package of assets including capital, technology,
managerial skills and capacity and access to foreign markets. The impact of FDI depends
on the countrys domestic policy and foreign policy. As a result FDI has a wide range of
impact on the countrys economic policy. In order to study the impact of foreign direct
investment on economic growth, two models were framed and fitted. The foreign direct
investment model shows the factors influencing the foreign direct investment in India.
The economic growth model depicts the contribution of foreign direct investment to
economic growth.

4.2 Selection of Variables: Macroeconomic indicators of an economy are considered as

the major pull factors of FDI inflows to a country. The analysis of above theoretical
rationale and existing literature also provides a base in choosing the right combination of

69
explanatory variables that explains the variations in the flows of FDI in the country. In
order to have the best combination of explanatory variables for the determinants of FDI
inflows into India, different alternatives combination of variables were identified and
then estimated. The alternative combinations of variables included in the study are in tune
with the famous specifications given by United Nations Conference on Trade and
Development, (UNCTAD 2007)77. The study applies the simple and multiple regression
method to find out the explanatory variables of the FDI inflows in the country. The
regression analysis has been carried out in two steps. In the first step, all variables are
taken into consideration in the estimable model. In the second stage, the insignificant
variables are dropped to avoid the problem of multi-colinearity and thus the variables are
selected. However, after thorough analysis of the different combination of the
explanatory variables, the present study includes the following macroeconomic
indicators: total trade (TRADEGDP), research and development expenditure (R&DGDP),
financial position (FIN.Position), exchange rate (EXR), foreign exchange reserves
(RESERVESGDP), and foreign direct investment (FDI), foreign direct investment growth
rate (FDIG) and level of economic growth (GDPG). These macroeconomic
indicators are considered as the pull factors of FDI inflows in the country. In other words,
it is said that FDI inflows in India at aggregate level can be considered as the function of
these said macroeconomic indicators. Thus, these macroeconomic indicators can be put in
the following specifications:

MODEL-1
FDIt = a + b1TRADEGDPt + b2RESGDPt + b3R&DGDPt + b4FIN. Positiontt + b5EXRt +
e (4.1)
MODEL-2
GDPGt = a + bFDIGt + e.................. (4.2)
where,

70
FDI= Foreign Direct Investment
GDP = Gross Domestic Product
FIN. Position = Financial Position
TRADEGDP= Total Trade as percentage of GDP.
RESGDP= Foreign Exchange Reserves as percentage of GDP.
R&DGDP= Research & development expenditure as percentage of GDP.
FIN. Position = Ratio of external debts to exports
EXR= Exchange rate
GDPG = level of Economic Growth

FDIG

Foreign Direct Investment Growth

t

= time frame

4.2.1 FOREIGN DIRECT INVESTMENT (FDI): It refers to foreign direct investment.

Economic growth has a profound effect on the domestic market as countries with
expanding domestic markets should attract higher levels of FDI inflows. The generous
Table - 4.1

FDI FLOW IN INDIA

amount in Rs. crores
Years

FDI inflows in

1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00

India
409
1094
2018
4312
6916
9654
13548
12343
10311

71
2000-01
10368
2001-02
18486
2002-03
13711
2003-04
11789
2004-05
14653
2005-06
24613
2006-07
70630
2007-08
98664
2008-09
123025
Source: various issues of SIA Bulletin.

flow of FDI (Chart - 4.1 and Table - 4.1) is playing a significant and contributory role in
the economic growth of the country. In 2008-09, Indias FDI touched Rs. 123025 crores

up 56% against Rs. 98664 crores in 2007-08 and the countrys foreign exchange reserves
touched a new high of Rs.1283865 crores in 2009-10. As a result of Indias economic
reforms, the countrys annual growth rate has averaged 5.9% during 1992-93 to 2002-03.

Chart 4.1

72

Movement of FDI Flow in India

1500

amt. in Rs. 1000

crores
500
0
FDI00Flow01- 02- 03- 04- 05- 06- 07- 08
91- 92- 93- 94- 95- 96- 97- 98- 9992 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

years

Source: various issues of SIA Bulletin.

Notwithstanding some concerns about the large fiscal deficit, India represents a
promising macroeconomic story, with potential to sustain high economic growth rates.
According to a survey conducted by Ernst and Young 19 in June 2008 India has been rated
as the fourth most attractive investment destination in the world after China, Central
Europe and Western Europe. Similarly, UNCTADs World Investment Report 76 2005
considers India the 2nd most attractive investment destination among the Transnational
Corporations (TNCs). All this could be attributed to the rapid growth of the economy and
favourable investment process, liberal policy changes and procedural relaxation made by
the government from time to time.

4.2.2 GROSS DOMESTIC PRODUCT (GDP): Gross Domestic Product is used as one
of the independent variable. The tremendous growth in GDP (Chart-4.2, Table- 4.2) since

73
1991 put the economy in the elite group of 12 countries with trillion dollar economy.
India makes its presence felt by making remarkable progress in information technology,
high end services and knowledge process services. By achieving a growth rate of 9% in
three consecutive years opens new avenues to foreign investors from 2004 until 2010,
Indias GDP growth was 8.37 percent reaching an historical high of 10.10 percent in
2006.

Gross Domestic Product

4000000
amount Rs. in
3000000
crores

2000000
1000000various issues of RBI Bulletin
Source:

GDP

0
91- 92- 93- 94- 95- 96- 97- 98- 99- 00- 01- 02- 03- 04- 05- 06- 07- 08
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
years

Chart- 4.2
Table - 4.2

GROSS DOMESTIC PRODUCT

amount in Rs. crores

Years

GDP at factor cost

1991-92

1099072

1992-93

1158025

74
1993-94

1223816

1994-95

1302076

1995-96

1396974

1996-97

1508378

1997-98

1573263

1998-99

1678410

1999-00

1786525

2000-01

1864301

2001-02

1972606

2002-03

2048286

2003-04

2222758

2004-05

2388768

2005-06

2616101

2006-07

2871120

2007-08

3129717

2008-09

3339375

Source: various issues of RBI Bulletin

Indias diverse economy attracts high FDI inflows due to its huge market size, low wage
rate, large human capital (which has benefited immensely from outsourcing of work from
developed countries). In the present decade India has witnessed unprecedented levels of
economic expansion and also seen healthy growth of trade. GDP reflects the potential
market size of Indian economy. Potential market size of an economy can be measured
with two variables i.e. GDP (the gross domestic product) and GNP (the gross national
product).GNP refers to the final value of all the goods and services produced plus the net
factor income earned from abroad. The word gross is used to indicate the valuation of
the national product including depreciation. GDP is an unduplicated total of monetary
values of product generated in various kinds of economic activities during a given period,

75
i.e. one year. It is called as domestic product because it is the value of final goods and
services produced domestically within the country during a given period i.e. one year.
Hence in functional form GDP= GNP-Net factor income from abroad. In India GDP is
calculated at market price and at factor cost. GDP at market price is the sum of market
values of all the final goods and services produced in the domestic territory of a country
in a given year. Similarly, GDP at factor cost is equal to the GDP at market prices minus
indirect taxes plus subsidies. It is called GDP at factor cost because it is the summation of
the income of the factors of production

Further, GDP can be estimated with the help of either (a) Current prices or (b) constant
prices. If domestic product is estimated on the basis of market prices, it is known as GDP
at current prices. On the other hand, if it is calculated on the basis of base year prices
prevailing at some point of time, it is known as GDP at constant prices.
Infact, in a dynamic economy, prices are quite sensitive due to the fluctuations in the
domestic as well as international market. In order to isolate the fluctuations, the estimates
of domestic product at current prices need to be converted into the domestic product at
constant prices. Any increase in domestic product that takes place on account of increase
in prices cannot be called as the real increase in GDP. Real GDP is estimated by
converting the GDP at current prices into GDP at constant prices, with a fixed base year.
In this context, a GDP deflator is used to convert the GDP at current prices to GDP at
constant prices. The present study uses GDP at factor cost (GDPFC) with constant prices
as one of the explanatory variable to the FDI inflows into India for the aggregate analysis.

Gross Domestic Product at Factor cost (GDPFC) as the macroeconomic variable of the
Indian economy is one of the pull factors of FDI inflows into India at national level. It is
conventionally accepted as realistic indicator of the market size and the level of output.
There is direct relationship between the market size and FDI inflows. If market size of an
economy is large than it will attract higher FDI inflows and vice versa i.e. an economy
with higher GDPFC will attract more FDI inflows. The relevant data on GDPFC have

76
been collected from the various issues of Reserve bank of India (RBI) bulletin and
Economic Survey of India.

4.2.3 TOTAL TRADE (TRADEGDP): It refers to the total trade as percentage of GDP.
Total trade implies sum of total exports and total imports. Trade, another explanatory
variable in the study also affects the economic growth of the country. The values of
exports and imports are taken at constant prices. The relationship between trade, FDI and
growth is well known. FDI and trade are engines of growth as technological diffusion
through international trade and inward FDI stimulates economic growth. Knowledge and
technological spillovers (between firms, within industries and between industries etc.)
contributes to growth via increasing productivity level. Economic growth, whether in the
form of export promoting or import substituting strategy, can significantly affect trade
flows. Export led growth leads to expansion of exports which in turn promote economic
growth by expanding the market size for developing countries.

77

s
s. crore

ount in R

TradeGDP

am

Trade as % of GDP

70
60
50
40
30
20
10
0

91- 92- 93- 94- 95- 96- 97- 98- 99- 00- 01- 02- 03- 04- 05- 06- 07- 08
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
Years

Chart- 4.3
Source: various issues of RBI Bulletin
India prefers export stimulating FDI inflows, that is, FDI inflows which boost the
demand of export in the international market are preferred by the country as it nullifies
the gap between exports and imports.

Table - 4.3

TOTAL TRADE

amount in Rs. crores

Years

Total Trade

1991-92

91892

1992-93

117063

78
1993-94

142852

1994-95

172645

1995-96

229031

1996-97

257737

1997-98

284276

1998-99

318084

1999-00

374797

2000-01

434444

2001-02

454218

2002-03

552343

2003-04

652475

2004-05

876405

2005-06

1116827

2006-07

1412285

2007-08

1668176

2008-09(P)

2072438

Source: various issues of RBI Bulletin. (P) Provisional Since liberalization, the value
of Indias international trade (Chart-4.3) has risen to Rs. 2072438 crores in 2008-09 from
Rs. 91892 crores in 1991-92. As exports from the country have increased manifolds after
the initiation of economic reforms since 1991
(Table 4.3). Indias major trading partners are China, United States of America, United
Arab Emirates, United Kingdom, Japan, and European Union. Since 1991, Indias exports
have been consistently rising although India is still a net importer. In 2008-09 imports
were Rs. 1305503 crores and exports were Rs. 766935 crores. India accounted for 1.45
per cent of global merchandise trade and 2.8 per cent of global commercial services
export.

79
Economic growth and FDI are closely linked with international trade. Countries that are
more open are more likely to attract FDI inflows in many ways: Foreign investor brings
machines and equipment from outside the host country in order to reduce their cost of
production. This can increase exports of the host country. Growth and trade are mutually
dependent on one another. Trade is a complement to FDI, such that countries tending to
be more open to trade attract higher levels of FDI.

4.2.4 FOREIGN EXCHANGE RSERVES (RESGDP): RESGDP represents Foreign

Exchange Reserves as percentage of GDP. Indias foreign exchange reserves comprise
foreign currency assets (FCA), gold, special drawing rights (SDR) and Reserve Tranche
Position (RTP) in the International Monetary Fund. The emerging economic giants, the
BRIC (Brazil, Russian Federation, India, and China) countries, hold the largest foreign
exchange reserves globally and India is among the top 10 nations in the world in terms of
foreign exchange reserves. India is also the worlds 10 th largest gold holding country
(Economic Survey 2009-10)17. Stock of foreign exchange reserves shows a countrys
financial strength. Indias foreign exchange reserves have grown significantly since 1991
(Chart-4.4). The reserves, which stood at Rs. 23850 crores at end march 1991, increased
gradually to Rs. 361470 crores by the end of March 2002, after which rose steadily
reaching a level of Rs. 1237985 crores in March 2007. The reserves stood at Rs. 1283865
crores as on March 2008 (Table- 4.4).

Chart- 4.4

80
Source: various issues of RBI Bulletin

Further, an adequate FDI inflow adds foreign reserves by exchange reserves which put
the economy in better position in international market. It not only allows the Indian
government to manipulate exchange rates, commodity prices, credit risks, market risks,
liquidity risks and operational risks but it also helps the country to defend itself from
speculative attacks on the domestic currency. Adequate foreign reserves of India

Foreign Exchange Reserves as percentage of GDP

50
40
percentage
30
20
10
0

RESGDP

91- 92- 93- 94- 95- 96- 97- 98- 99- 00- 01- 02- 03- 04- 05- 06- 07- 08
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
years

Table - 4.4

FOREIGN EXCHNAGE RESERVES

amount in Rs. crores

Years

Foreign Exchange
Reserves

81
1991-92

23850

1992-93

30744

1993-94

60420

1994-95

79781

1995-96

74384

1996-97

94932

1997-98

115905

1998-99

138005

1999-00

165913

2000-01

197204

2001-02

264036

2002-03

361470

2003-04

490129

2004-05

619116

2005-06

676387

2006-07

868222

2007-08

1237985

2008-09

1283865

Source: various issues of RBI Bulletin.

indicates its ability to repay foreign debt which in turn increases the credit rating of India
in international market and this helps in attracting more FDI inflows in the country. An
analysis of the sources of reserves accretion during the entire reform period from 1991 on
wards reveals that increase in net FDI from Rs. 409 crores in 1991-92 to Rs. 1,23,378
crores by March 2010. NRI deposits increased from Rs.27400 crores in 1991-92 to
Rs.174623 by the end of March 2008. As at the end of March 2009, the outstanding NRI

82
deposits stood at Rs. 210118 crores. On the current account, Indias exports, which were
Rs. 44041 crore during 1991-92 increased to Rs. 766935 crores in 2007-08.

Indias imports which were Rs. 47851 crore in 1991-92 increased to Rs. 1305503 crores
in 2008-09. Indias current account balance which was in deficit at 3.0 percent of GDP in
1990-91 turned into a surplus during the period 2001-02 to 2003-04. However, this could
not be sustained in the subsequent years. In the aftermath of the global financial crisis,
the current account deficit increased from 1.3 percent of GDP in 2007-08 to 2.4 percent
of GDP in 2008-09 and further to 2.9 percent in 2009-10. Invisibles, such as private
remittances have also contributed significantly to the current account. Enough stocks of
foreign reserves enabled India in prepayment of certain high cost foreign currency
loans of Government of India from Asian Development Bank (ADB) and World Bank
(IBRD)

Infact, adequate foreign reserves are an important parameter of Indian economy in

gauging its ability to absorb external shocks. The import cover of reserves, which fell to a
low of three weeks of imports at the end of Dec 1990, reached a peak of 16.9 months of
imports at the end of March 2004. At the end of March 2010, the import cover stands at
11.2 months. The ratio of short term debt to the foreign exchange reserves declined
from 146.5 percent at the end of March 1991 to 12.5 percent as at the end of March 2005,
but increased slightly to 12.9 percent as at the end of March 2006. It further increased
from 14.8 percent at the end of March 2008 to 17.2 percent at the end of March 2009 and
18.8 percent by the end of March 2010. FDI helps in filling the gap between targeted
foreign exchange requirements and those derived from net export earnings plus net public
foreign aid. The basic argument behind this gap is that most developing countries face
either a shortage of domestic savings to match investment opportunities or a shortage of
foreign exchange reserves to finance needed imports of capital and intermediate goods.

83
4.2.5 RESEARCH & DEVELOPMENT EXPENDIYURE (R&DGDP): It refers to
the research and development expenditure as percentage of GDP (Chart-4.5). India has
large pool of human resources and human capital is known as the prime mover of
economic activity.

Chart-4.5

R&D expenditure as percentage of GDP

1
0.8
amt. in percentage
0.6
0.4
Source: various issues of RBI Bulletin
0.2
R&DGDP
0
91- 92- 93- 94- 95- 96- 97- 98- 99- 00- 01- 02- 03- 04- 05- 06- 07
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
Years

Table - 4.5

RESEARCH & DEVELOPMENT EXPENDITURE

amount in Rs. crores

84
Years

National Expenditure
on Research &
Development

1991-92

8363.31

1992-93

8526.18

1993-94

9408.79

1994-95

9340.94

1995-96

9656.11

1996-97

10662.41

1997-98

11921.83

1998-99

12967.51

1999-00

14397.6

2000-01

15683.37

2001-02

16007.14

2002-03

16353.72

2003-04

17575.41

2004-05

19991.64

2005-06

22963.91

2006-07

24821.63

2007-08

27213

Source: various issues of RBI Bulletin.

India has the third largest higher education system in the world and a tradition of over
5000 year old of science and technology. India can strengthen the quality and
affordability of its health care, education system, agriculture, trade, industry and services
by investing in R&D activities.

85
India has emerged as a global R&D hub since the last two decades. There has been a
significant rise in the expenditure of R&D activities (Table-4.5) as FDI flows in this
sector and in services sector is increasing in the present decade. R&D activities (in
combination with other high end services) generally known as Knowledge Process
Outsourcing or KPO are gaining much attention with services sector leading among all
sectors of Indian economy in receiving / attracting higher percentage of FDI flows. It is
clear from (Chart- 4.5) that the expenditure on R&D activities is rising significantly in
the present decade. India has been a centre for many research and development activities
by many TNCs. Today, companies like General Electric, Microsoft, Oracle, SAP and
IBM to name a few are all pursuing R&D in India. R&D activities in India demands huge
funds thus providing greater opportunities for foreign investors.

4.2.6 FINANCIAL POSITION (FIN. Position): FIN. Position stands for Financial
Position. Financial Position (Chart-4.6, Table- 4.6) is the ratio of external debts to
exports. It is a strong indicator of the soundness of any economy. It shows that external
debts are covered from the exports earning of a country.

86

Table - 4.6

FINANCIAL POSITION

amount in Rs. crores

Years

Exports

Debt

1991-92

44041

252910

1992-93

53688

280746

1993-94

69751

290418

1994-95

82674

311685

1995-96

106353

320728

1996-97

118817

335827

1997-98

130100

369682

1998-99

139752

411297

1999-00

159561

428550

2000-01

203571

472625

2001-02

209018

482328

2002-03

255137

498804

2003-04

293367

491078

2004-05

375340

581802

2005-06

456418

616144

87
2006-07

571779

746918

2007-08

655864

897955

2008-09

766935 (P)

1169575

Source: various issues of RBI Bulletin, (P) - Provisional

(Chart-4.6)
Financial Position
8
6
4
2
0
91- 92- 93- 94- 95- 96- 97- 98- 99- 00- 01- 02- 03- 04- 05- 06- 07- 08
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
Years
ratio of debt to exports

Source: various issues of RBI Bulletin

External debt of India refers to the total amount of external debts taken by India in a
particular year, its repayments as well as the outstanding debts amounts, if any. Indias
external debts, as of march 2008 was Rs. 897955, recording an increase of Rs.1169575
crores in march 2009 (Table 4.6) mainly due to the increase in trade credits. Among the
composition of external debt, the share of commercial borrowings was the highest at
27.3% on March 2009, followed by short term debt (21.5%), NRI deposits (18%) and
multilateral debt (17%).Due to arise in short term trade credits, the share of short term

88
debt in the total debt increased to 21.5% in march 2009, from 20.9% in march 2008. As a
result the short term debt accounted for 40.6% of the total external debt on March 2009.
In 2007 India was rated the 5th most indebted country (Table 4.6.1) according to an
international comparison of external debt of the twenty most indebted countries.

Table-4.6.1

INTERNATIONAL COMPARISON OF TOP TEN DEBTOR COUNTRIES, 2007

Country

External

Concessional Debt

External

Short

Forex

Debt

Debt/Total

Service

Debt to

term

reserves

stock,

Debt (%)

ratio

GNI (%)

debt/

to Total

Total

debt (%)

Total

(%)

debt

(US $ bn)
China

373.6

10.1

2.2

11.6

(%)
54.5

413.9

Russian

370.2

.4

9.1

29.4

21.4

129.1

Federation
Turkey

251.5

2.1

32.1

38.8

16.6

30.4

Brazil

237.5

1.0

27.8

18.7

16.5

75.9

India

224.6

19.7

4.8

19.0

20.9

137.9

Poland

195.4

.4

25.6

47.7

30.9

33.6

Mexico

178.1

.6

12.5

17.7

5.1

49

Indonesia

140.8

26.2

10.5

33.9

24.8

40.4

Argentina

127.8

1.3

13.0

49.7

29.8

36.1

89
Kazakhstan

96.1

1.0

49.6

103.7

12.2

18.4

The ratio of short term debt to foreign exchange reserves (Table-4.6.2) stood at 19.6%
in March 2009, higher than the 15.2% in the previous year. Indias foreign exchange
reserves provided a cover of 109.6% of the external debt stock at the end of March 2009,
as compared to 137.9% at the end of March 2008. An assessment of sustainability of
external debt is generally undertaken based on the trends in certain key ratios such as
debt to GDP ratio, debt service ratio, short term debt to total debt and total debt to
foreign exchange reserves. The ratio of external debt to GDP increased to 22% as at end
march 2009 from 19.0% as at end March 2008. The debt service ratio has declined
steadily over the year, and stood at 4.8 % as at the end of March 2009.

Table -4.6.2

Year

Debt Service Ratio (%)

Ratio of Foreign Exchange

to Debt

1991-92

35.3

0.15

1992-93

30.2

0.12

1993-94

27.5

0.22

1994-95

25.4

0.27

1995-96

25.9

0.24

1996-97

26.2

0.3

1997-98

23.0

0.35

1998-99

19.5

0.37

90
1999-00

18.7

0.4

2000-01

17.1

0.46

2001-02

16.6

0.56

2002-03

13.7

0.75

2003-04

16.0

0.98

2004-05

16.1

1.26

2005-06

5.9

1.16

2006-07

10.1

1.41

2007-08

4.7

1.66

2008-09

4.8

1.43

Source: various issues of RBI Bulletin

However, the share of concessional debt (Chatr-4.6.1) in total external debt declined to
18.2% in 2008-2009 from 19.7 % in 2007-2008.

crores
Concesional and Short - term Debt as % of Total Debt
50

Source: various
issues of RBI Bulletin
40

amount in 30
Rs.

Concessional Debt as % of Total Debt

20
10

Short - Term Debt as % of Total Debt

0
9192

9293

9394

9495

9596

9697

9798

9899

9900

0001

Years

(Chart-4.6.1)

0102

0203

0304

0405

0506

0607

0708

08
09

91
Large fiscal deficit has variety of adverse effects: reducing growth, lowering real
incomes, increasing the risks of financial and economic crises and in some circumstances
it can also leads to high inflation.

Recently the finance minister of India had promised to cut its budget deficit to 5.5% of
the GDP in 2010 from 6.9% of GDP in 2009. As a result the credit rating outlook was
raised to stable from negative by standard and poors based on the optimism that faster
growth in Asias third largest and world second fastest growing economy will help the
government cut its budget deficit. The government also plans to cut its debt to 68% of the
GDP by 2015, from its current levels of 80%. In order to reduce the ratio of debt to GDP
there must be either a primary surplus (i.e. revenue must exceed non interest outlays) or
the economy must grow faster than the rate of interest, or both, so that one must outweigh
the adverse effect of the other.
4.2.7 EXCHANGE RATES (EXR): It refers to the exchange rate variable. Exchange
rate is a key determinant of international finance as the world economies are globalised
ones.

Table - 4.7

EXCHANGE RATES
Years

Exchange Rates

1991-92

24.5

1992-93

30.6

1993-94

31.4

92
1994-95

31.4

1995-96

33.4

1996-97

35.5

1997-98

37.2

1998-99

42.1

1999-00

43.3

2000-01

45.7

2001-02

47.7

2002-03

48.4

2003-04

45.9

2004-05

44.9

2005-06

44.3

2006-07

42.3

2007-08

40.2

2008-09

45.9

Source: various issues of SIA Bulletin.

There are a number of factor which affect the exchange rate viz. government policy,
competitive advantages, market size, international trade, domestic financial market, rate
of inflation, interest rate etc. Exchange rate touched a high of Rs. 48.4 in 2002-03 (Table
-4.7).

Chart- 4.7

93
Movement in Exchange Rate
60
50
40
30
20
10
0
91- 92- 93- 94- 95- 96- 97- 98- 99- 00- 01- 02- 03- 04- 05- 06- 07- 08
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
Exchange Rate

Source: various issues of RBI Bulletin

Since 1991 Indian economy has gone through a sea change and that changes are reflected
on the Indian Industry too. There is high volatility in the value of INR/USD. There is
high appreciation in the value of INR from 2001-02 (Chart -4.7) which has swept away
huge chunk of profits of the companies.

4.2.8 GROSS DOMESTIC PRODUCT GROWTH (GDPG): It refers to the growth

rate of gross domestic product. Economic growth rate have an effect on the domestic
market, such that countries with expanding domestic markets should attract higher levels
of FDI. India is the 2nd fastest growing economy among the emerging nations of the
world. It has the third largest GDP in the continent of Asia. Since 1991 India has emerged
as one of the wealthiest economies in the developing world. During this period, the
economy has grown constantly and this has been accompanied by increase in life
expectancy, literacy rates, and food security. It is also the world most populous
democracy. The Indian middle class is large and growing; wages are low; many workers
are well educated and speak English. All these factors lure foreign investors to India.

94
India is also a major exporter of highly skilled workers in software and financial
services and provide an important back office destination for global outsourcing of
customer services and technical support. The Indian market is widely diverse. The
country has 17 official languages, 6 major religion and ethnic diversity. Thus, tastes and
preferences differ greatly among sections of consumers.

4.2.9 FOREIGN DIRECT INVESTMENT GROWTH (FDIG): In the last two decade
world has witnessed unprecedented growth of FDI. This growth of FDI provides new
avenues of economic expansion especially, to the developing countries. India due to its
huge market size, diversity, cheap labour and large human capital received substantial
amount of FDI inflows during 1991-2008. India received cumulative FDI inflows of Rs.
577108 crore during 1991 to march 2010. It received FDI inflows of Rs. 492303 crore
during 2000 to march 2010 as compared to Rs. 84806 crore during 1991 to march 99.
During 1994-95, FDI registered a 110% growth over the previous year and a 184% age
growth in 2007-08 over 2006-07. FDI as a percentage of gross total investment increased
to 7.4% in 2008 as against 2.6% in 2005. This increased level of FDI contributes towards
increased foreign reserves. The steady increase in foreign reserves provides a shield
against external debt. The growth in FDI also provides adequate security against any
possible currency crisis or monetary instability. It also helps in boosting the exports of the
country. It enhances economic growth by increasing the financial position of the country.
The growth in FDI contributes toward the sound performance of each sector (especially,
services, industry, manufacturing etc.) which ultimately leads to the overall robust
performance of the Indian economy.

95
4.3 ROLE OF FDI ON ECONOMIC GROWTH

In order to assess the role of FDI on economic growth, two models were used. The
estimation results of the two models are supported and further analysed by using the
relevant econometric techniques viz. Coefficient of determination, standard error, f- ratio,
t- statistics, D-W Statistics etc. In the foreign direct investment model (Model-1, Table4.8), the main determinants of FDI inflows to India are assessed. The study identified the
following macroeconomic variables: TradeGDP, R&DGDP, FIN.Position, EXR, and
ReservesGDP as the main determinants of FDI inflows into India. And the relation of
these variables with FDI is specified and analysed in equation 4.1. In order to study the
role of FDI on Indian economy it is imperative to assess the trend pattern of all the
variables used in the determinant analysis. It is observed that FDI inflows into India
shows a steady trend in early nineties but shows a sharp increase after 2005, though it had
fluctuated a bit in early 2000. However, Gross domestic product shows an increasing
trend pattern since 1991-92 to 2007-08 (Table 4.2 and Chart - 4.2). Another variable i.e.
tradeGDP maintained a steady trend pattern upto 2001-02, after that it shows a
continuous increasing pattern upto 2008-09. ReservesGDP, another explanatory variable
shows low trend pattern upto 2000-01 but gained momentum after 2001-02 and shows an
increasing trend. In addition to these trend patterns of the variables the study also used
the multiple regression analysis to further explain the variations in FDI inflows into India
due to the variations caused by these explanatory variables.

MODEL-1

FOREIGN DIRECT INVESTMENT MODEL

96
FDI = f [TRADEGDP, R&DGDP, EXR, RESGDP, FIN. Position]
Variable

Coefficient

Constant

26.25

.126

207*

TradeGDP

11.79

7.9

1.5*

ReservesGDP

1.44

3.8

.41

Exchange rate

7.06

9.9

.72**

Financial health 15.2

35

.45

R&DGDP

704

.83**

R2 = 0.623

-582.14

Standard Error

t- Statistic

Adjusted2R
= 0.466

Table-4.8
D-W Statistic = .98, F-ratio = 7.74
Note: * = Significant at 0.25, 0.10 levels; ** = Significant at 0.25 level.

In Foreign Direct Investment Model (Table 4.8), it is found that all variables are
statistically significant. Further the results of Foreign Direct Investment Model shows
that TradeGDP, R&DGDP, Financial Position (FIN.Position), exchange rate (EXR), and
ReservesGDP (RESGDP) are the important macroeconomic determinants of FDI inflows
in India. The regression results of (Table 4.8) shows that TradeGDP, ReservesGDP,
Financial Position, exchange rate are the pull factors for FDI inflows in the country
whereas R&DGDP acts as the deterrent force in attracting FDI flows in the country. As
the regression results reveal that R&DGDP exchange rate does not portray their
respective predicted signs. However, R&DGDP shows the unexpected negative sign
instead of positive sign and exchange rate shows positive sign instead of expected
negative sign. In other words, all variables included in the foreign direct investment

97
model shows their predicted signs (Table 4.9) except the two variables (i.e. Exchange
rate & R&DGDP) which deviate from their respective predicted signs. The reason for this
deviation is due to the appreciation of Indian Rupee in the international market and low
expenditure on R&D activities in the activities in the country.

Table 4.9

PREDICTED SIGNS OF VARIABLES

Variables

Predicted Sign

TradeGDP

ReservesGDP

Exchange Rate

Financial Position

R&DGDP

Unexpected Sign

It is observed from the results that the elasticity coefficient between FDI & TradeGDP is
11.79 which implies that one percent increase in Trade GDP causes 11.79 percentage
increase in FDI inflows in India. The TradeGDP shows that the predicted positive sign.
Hence, Trade GDP positively influences the flow of FDI into India. Further, it is seen
from the analysis that another important promotive factor of FDI inflows to the country is
ReservesGDP. The positive sign of ReservesGDP is in accordance with the predicted

98
sign. The elasticity coefficient between ReserveGDP and FDI inflows is 1.44. It implies
that one percent increase in ReserveGDP causes 1.44 percentage increases in FDI inflows
into India. The other factor which shows the predicted positive sign is FIN.Position
(financial position). The elasticity coefficient between financial position and FDI is 15.2
% which shows that one percent increase in financial position causes 15.2 percent of FDI
inflows to the country. India prefers FDI inflows in export led strategy in boosting its
exports.

Further, the analysis shows that the trend pattern of external debt to exports (i.e. FIN.
Position) has been decreasing continuously since 1991-92, indicating towards a strong
economy. This positive indication is a good fortune to the Indian economy as it helps in
attracting foreign investors to the country.

One remarkable fact observed from the regression results reveal that R&DGDP shows a
negative relationship with FDI inflows into India. The results show that the elasticity
coefficient between FDI and R&D GDP is -582.14. This implies that a percentage
increase in R&DGDP causes nearly 582 percent reductions in the FDI inflows. This may
be attributed to the low level of R&D activities in the country. This is also attributed to
the high interest rate in the country and also investments in Brownfield projects are more
as compared to investments in Greenfield projects. India requires more knowledge cities,
Special Economic Zones (SEZs), Economic Processing Zones (EPZs), Industrial clusters,
IT Parks, Highways, R&D hubs etc. so government must attract Greenfield investment.
Another variable which shows the negative relationship with FDI is exchange rate. The
elasticity coefficient between FDI and Exchange rate is 7.06 which show that one percent
increase in exchange rate leads to a reduction of 7.06 percentage of FDI inflows to the
country. The exchange rate shows a positive sign as expected of negative sign.
Conventionally, it is assumed that exchange rate is the negative determinant of FDI
inflows. This positive impact of exchange rate on the FDI inflows could be attributed to

99
the appreciation of the Indian rupee against US Dollar. This appreciation in the value of
Rupee helped the foreign firms in many ways. Firstly, it helped the foreign firms in
acquiring the firm specific assets cheaply. Secondly, it helped the foreign firms in
reducing the cost of firm specific assets (this is particularly done in case of Brownfield
projects). Thirdly, it ensures the foreign firm higher profit in the longrun (as the value of
the assets in appreciated Indian currency also appreciates). The results of foreign Direct
Investment Model also facilitates in adjudging the relative importance of the
determinants of FDI inflows from the absolute value of their elasticity coefficients. In this
regard it is observed from the regression results of Table - 4.8 that among the positive
determinants, FDI inflows into India are more elastic to FIN. Position than to TradeGDP
and ReservesGDP. It is also observable that FDI inflows are more sensitive to R&DGDP
than to exchange rate as the elasticity coefficient between FDI and exchange rate is least,
whereas the elasticity coefficient between FDI and R&DGDP is more. Further, to decide
the suitability and relevancy of the model results the study also relies on other
econometric techniques. The coefficient of determination i.e. R- squared shows that the
model has a good fit, as 62% of foreign direct investment is being explained by the
variables included in the model. In order to take care of autocorrelation problem, the
Durbin Watson (D-W statistics) test is used. The D-W Statistic is found to be .98 which
confirms that there is no autocorrelation problem in the analysis. Further the value of
adjusted R-square and F-ratio also confirms that the model used is a good
statistical fit.

MODEL-2

ECONOMIC GROWTH MODEL

100
GDPG = f [FDIG]

Table-4.10

Variable

Coefficient

Standard Error

t- Statistic

Constant

.060322925

0.00007393156391

815.92

FDIG

0.039174416

.020661633

1.8959

R2= 0.959

Adjusted R2= 0.956

D-W Statistic = 1.0128, F-ratio = 28.076

Note: * = Significant at 1%

In the Economic Growth Model (Table 4.10), estimated coefficient on foreign direct
investment has a positive relationship with Gross Domestic Product growth (GDPG). It is
revealed from the analysis that FDI is a significant factor influencing the level of
economic growth in India. The coefficient of determination, i.e. the value of R 2 explains
95.6% level of economic growth by foreign direct investment in India. The F-statistics
value also explains the significant relationship between the level of economic growth and
FDI inflows in India. D-W statistic value is found 1.0128 which confirms that there is no
autocorrelation problem in the analysis.

Thus, the findings of the economic growth model show that FDI is a vital and significant
factor influencing the level of growth in India.

101
4.4 CONCLUSIONS
It is observed from the results of above analysis that TradeGDP, ReservesGDP, Exchange
rate, FIN. Position, R&DGDP and FDIG are the main determinants of FDI inflows to the
country. In other words, these macroeconomic variables have a profound impact on the
inflows of FDI in India. The results of foreign Direct Investment Model reveal that
TradeGDP, ReservesGDP, and FIN. Position variables exhibit a positive relationship with
FDI while R&DGDP and Exchange rate variables exhibit a negative relationship with
FDI inflows. Hence, TradeGDP, ReservesGDP, and FIN. Position variables are the pull
factors for FDI inflows to the country and R&DGDP and Exchange rate are deterrent
forces for FDI inflows into the country. Thus, it is concluded that the above analysis is
successful in identifying those variables which are important in attracting FDI inflows to
the country. The study also reveals that FDI is a significant factor influencing the level of
economic growth in India. The results of Economic Growth Model and Foreign Direct
Investment Model show that FDI plays a crucial role in enhancing the level of economic
growth in the country. It helps in increasing the trade in the international market.
However, it has failed in raising the R&D and in stabilizing the exchange rates of the
economy.

The positive sign of exchange rate variables depicts the appreciation of Indian Rupee in
the international market. This appreciation in the value of Indian Rupee provides an
opportunity to the policy makers to attract FDI inflows in Greenfield projects rather than
attracting FDI inflows in Brownfield projects.

Further, the above analysis helps in identifying the major determinants of FDI in the
country. FDI plays a significant role in enhancing the level of economic growth of the
country. This analysis also helps the future aspirants of research scholars to identify the

102
main determinants of FDI at sectoral level because FDI is also a sector specific activity
of foreign firms vis--vis an aggregate activity at national level.

Finally, the study observes that FDI is a significant factor influencing the level of
economic growth in India. It provides a sound base for economic growth and
development by enhancing the financial position of the country. It also contributes to the
GDP and foreign exchange reserves of the country.