INTRODUCITON TO FDI

Foreign Direct Investment (FDI) broadly encompasses any long-term investments by an

entity that is not a resident of the host country. Typically, the investment is over a long
duration of time and the idea is to make an initial investment and then subsequently keep
investing to leverage the host countrys advantages which could be in the form of access to
better (and cheaper) resources, access to a consumer market or access to talent specific to the
host country - which results in the enhancement of efficiency. This long-term relationship
benefits both the investor as well as the host country. The investor benefits in getting higher
returns for his investment than he would have gotten for the same investment in his country
and the host country can benefit by the increased know how or technology transfer to its
workers, increased pressure on its domestic industry to compete with the foreign entity thus
making the industry improve as a whole or by having a demonstration effect on other entities
thinking about investing in the host country.
FDI growth has been a key factor in the international nature of business that many are
familiar with in the 21st century. This growth has been facilitated by changes in regulations
both in the originating country and in the country where the new installation is to be built.
Corporations from some of the countries that lead the worlds economy have found fertile soil
for FDI in nations where commercial development was limited, if it existed at all. The dollars
invested in such developing-country projects increased 40 times over in less than 30 years.
The financial strength of the investing corporations has sometimes meant failure for smaller
competitors in the target country. One of the reasons is that foreign direct investment in
buildings and equipment still accounts for a vast majority of FDI activity. Corporations from
the originating country gain a significant financial foothold in the host country. Even with
this factor, host countries may welcome FDI because of the positive impact it has on the
smaller economy.
Foreign direct investment (FDI) is a measure of foreign ownership of productive assets, such
as factories, mines and land. Increasing foreign investment can be used as one measure of
growing economic globalization. Figure below shows net inflows of foreign direct investment
as a percentage of gross domestic product (GDP). The largest flows of foreign investment
occur between the industrialized countries (North America, Western Europe and Japan).But
flows to non-industrialized countries are increasing sharply. Foreign direct investment (FDI)
refers to long term participation by country A into country B.

It usually involves participation in management, joint-venture, transfer of technology and

expertise. There are two types of FDI: inward foreign direct investment and outward foreign
direct investment, resulting in a net FDI inflow (positive or negative) .Foreign direct
investment reflects the objective of obtaining a lasting interest by a resident entity in one
economy (direct investor) in an entity resident in an economy other than that of the
investor

(direct investment enterprise).The lasting interest implies the existence of a

long-term relationship between the direct investor and the enterprise and a significant degree
of influence on the management of the enterprise. Direct investment involves both the initial
transaction between the two entities and all subsequent capital transactions between them and
among affiliated enterprises, both incorporated and unincorporated.

Meaning:These three letters stand for foreign direct investment. The simplest explanation of FDI
would be a direct investment by a corporation in a commercial venture in another country. A
key to separating this action from involvement in other ventures in a foreign country is that
the business enterprise operates completely outside the economy of the corporations home
country. The investing corporation must control 10 percent or more of the voting power of the
new venture.
According to history the United States was the leader in the FDI activity dating back as far as
the end of World War II. Businesses from other nations have taken up the flag of FDI,
including many who were not in a financial position to do so just a few years ago.
The practice has grown significantly in the last couple of decades, to the point that FDI has
generated quite a bit of opposition from groups such as labor unions. These organizations
have expressed concern that investing at such a level in another country eliminates jobs.
Legislation was introduced in the early 1970s that would have put an end to the tax incentives
of FDI. But members of the Nixon administration, Congress and business interests rallied to
make sure that this attack on their expansion plans was not successful. One key to
understanding FDI is to get a mental picture of the global scale of corporations able to make
such investment. A carefully planned FDI can provide a huge new market for the company,
perhaps introducing products and services to an area where they have never been available.
Not only that, but such an investment may also be more profitable if construction costs and
labor costs are less in the host country.

Definition:Foreign direct investment is that investment, which is made to serve the business interests of
the investor in a company, which is in a different nation distinct from the investor's country of
origin. A parent business enterprise and its foreign affiliate are the two sides of the FDI
relationship. Together they comprise an MNC.
The parent enterprise through its foreign direct investment effort seeks to exercise substantial
control over the foreign affiliate company. 'Control' as defined by the UN, is ownership of
greater than or equal to 10% of ordinary shares or access to voting rights in an incorporated
firm. For an unincorporated firm one needs to consider an equivalent criterion. Ownership
share amounting to less than that stated above is termed as portfolio investment and is not
categorized as FDI.
The definition of FDI originally meant that the investing corporation gained a significant
number of shares (10 percent or more) of the new venture. In recent years, however,
companies have been able to make a foreign direct investment that is actually long-term
management control as opposed to direct investment in buildings and equipment.
Foreign Direct Investment when a firm invests directly in production or other
facilities, over which it has effective control, in a foreign country.
Manufacturing FDI requires the establishment of production facilities.
Service FDI requires building service facilities or an investment foothold via capital
contributions or building office facilities.
Foreign subsidiaries overseas units or entities.
Host country the country in which a foreign subsidiary operates.
Flow of FDI the amount of FDI undertaken over a given time.
Stock of FDI total accumulated value of foreign-owned assets.
Outflows/Inflows of FDI the flow of FDI out of or into a country.
Foreign Portfolio Investment the investment by individuals, firms, or public bodies in
foreign financial instruments.
Stocks, bonds, other forms of debt.
Differs from FDI, which is the investment in physical assets.

By Direction
Outward FDI:
An outward-bound FDI is backed by the government against all types of associated risks.
This form of FDI is subject to tax incentives as well as disincentives of various forms. Risk
coverage provided to the domestic industries and subsidies granted to the local firms stand in
the way of outward FDIs, which are also known as 'direct investments abroad.'
Inward FDIs:
Different economic factors encourage inward FDIs. These include interest loans, tax breaks,
subsidies, and the removal of restrictions and limitations. Factors detrimental to the growth of
FDIs include necessities of differential performance and limitations related with ownership
patterns.

BY Target:Greenfield investment: Direct investment in new facilities or the expansion of existing facilities. Greenfield
investments are the primary target of a host nations promotional efforts because they create
new production capacity and jobs, transfer technology and know-how, and can lead to
linkages to the global marketplace. The Organization for International Investment cites the

benefits of Greenfield investment (or in sourcing) for regional and national economies to
include increased employment (often at higher wages than domestic firms); investments in
research and development; and additional capital investments. Disadvantage of Greenfield
investments include the loss of market share for competing domestic firms. Another criticism
of Greenfield investment is that profits are perceived to bypass local economies, and instead
flow back entirely to the multinational's home economy. Critics contrast this to local
industries whose profits are seen to flow back entirely into the domestic economy.
Horizontal FDI- Investment in the same industry abroad as a firm operates in at home.
Vertical FDI

Backward Vertical FDI: Where an industry abroad provides inputs for a firm's

domestic production process.

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

production.

Mergers and Acquisitions

Transfers of existing assets from local firms to foreign firm takes place; the primary type of
FDI. Cross-border mergers occur when the assets and operation of firms from different
countries are combined to establish a new legal entity. Cross-border acquisitions occur when
the control of assets and operations is transferred from a local to a foreign company, with the
local company becoming an affiliate of the foreign company. Nevertheless, mergers and
acquisitions are a significant form of FDI and until around 1997, accounted for nearly 90% of
the FDI flow into the United States. Mergers are the most common way for multinationals to
do FDI.
BY MOTIVE
FDI can also be categorized based on the motive behind the investment from the perspective
of the investing firm
Resource-Seeking
Investments which seek to acquire factors of production those are more efficient than those
obtainable in the home economy of the firm. In some cases, these resources may not be
available in the home economy at all. For example seeking natural resources in the Middle
East and Africa, or cheap labour in Southeast Asia and Eastern Europe.

 Market-Seeking
Investments which aim at either penetrating new markets or maintaining existing ones.FDI of
this kind may also be employed as defensive strategy; it is argued that businesses are more
likely to be pushed towards this type of investment out of fear of losing a market rather than
discovering a new one. This type of FDI can be characterized by the foreign Mergers and
Acquisitions in the 1980s Accounting, Advertising and Law firms.
Efficiency-Seeking
Investments which firms hope will increase their efficiency by exploiting the benefits of
economies of scale and scope, and also those of common ownership. It is suggested that this
type of FDI comes after either resource or market seeking investments have been realized,
with the expectation that it further increases the profitability of the firm.

Foreign Direct investor

A foreign direct investor is an individual, an incorporated or unincorporated public or private
enterprise, a government, a group of related individuals, or a group of related incorporated
and/or unincorporated enterprises which has a direct investment enterprise that is, a
subsidiary, associate or branch operating in a country other than the country or countries of
residence of the foreign direct Investor or investors.

Methods of Foreign Direct Investments

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

By incorporating a wholly owned subsidiary or company

By acquiring shares in an associated enterprise
Through a merger or an acquisition of an unrelated enterprise
Participating in an equity joint venture with another investor or enterprise

Foreign direct investment incentives may take the following forms:

Low corporate tax and income tax rates

Tax holidays

Preferential tariffs

Special economic zones

Investment financial subsidies

Soft loan or loan guarantees

Free land or land subsidies

Relocation & expatriation subsidies

Job training & employment subsidies

Infrastructure subsidies

R&D support

History of FDI in India:India intent to open its markets to foreign investment can be traced back to the economic
reforms adopted during two prime periods- pre- independence and post-independence.
Pre- independence, India was the supplier of foodstuff and raw materials to the industrialised
economies of the world and was the exporter of finished products- the economy lacked the
skill and means to convert raw materials to finished products. Post-independence with the
advent of economic planning and reforms in 1951, the traditional role played changes and
there was remarkable economic growth and development. International trade grew with the
establishment of the WTO. India is now a part of the global economy. Every sector of the
Indian economy is now linked with the world outside either through direct involvement in
international trade or through direct linkages with export and import.
Development pattern during the 1950-1980 periods was characterised by strong centralised
planning, government ownership of basic and key industries, excessive regulation and control
of private enterprise, trade protectionism through tariff and non-tariff barriers and a cautious
and selective approach towards foreign capital. It was a quota, permit, licence regime which
was guided and controlled by a bureaucracy trained in colonial style. This inward thinking,
import substitution strategy of economic development and growth was widely questioned in
the 1980s. Indias economic policy makers started realising the drawbacks of this strategy
which inhibited competitiveness and efficiency and produced a much lower growth rate that
was expected.
Consequently economic reforms were introduced initially on a moderate scale and controls
on industries were substantially reduced by 1985 industrial policy. This set the trend for more
innovative economic reforms and they got a boost with the announcement of the landmark
economic reforms in 1991. After nearly five decades of insulation from world markets, state

controls and slow growth, India in 1991 embarked on an accelerated process of liberalization.
The 1991 reforms ensured that the way for India to progress will be through globalization,
privatisation, and liberalisation. In this new regime, the government is now assuming the role
of a promoter, facilitator and catalyst agent instead of the regulator and
India has a number of advantages which make it an attractive market for foreign capital
namely, political stability in democratic polity, steady and sustained economic growth and
development, significantly huge domestic market, access to skilled and technical manpower
at competitive rates, fairly well developed infrastructure. FDI has attained the status of being
of global importance because of its beneficial use as an instrument for global economic
integration.
Pre-Independence Reforms:
Under the British colonial rule, the Indian economy suffered a major set-back. An economy
with rich natural resources was left plundered and exploited to the hilt under the English
regime. India is originally an agrarian economy. Indias cottage industries and trade were
abused and exploited as means to pave the way for European manufactured goods. Under the
British rule the economy stagnated and on the eve of independence India was left with a poor
economy and the textile industry as the only life support of the industrial economy.
Post-Independence Reforms:
Indias struggle post-independence has been an excruciating financial battle with a slow
economic growth and development which were largely due to the political climate and impact
of the economic reforms. The country began it transformation from a native agrarian to
industrial to commercial and open economy in the post-independence era. India in the postindependence era followed what can be best called as a trial and error path. During the postindependence era, the Indian Economy geared up in favour of central planning and resource
allocation. The government tailored policies that focussed a great deal on achieving overall
economic self-reliance in each state and at the same time exploit its natural resource. In order
to augment trade and investments, the government sought to play the role of custodian and
trustee by intervening in the practice of crucial sectors such as aviation, telecommunication,
banking, energy mainly electricity, petrol and gas.
The policy of central planning adopted by the government sought to ensure that the
government laid down marked goals to be achieved by the economy thereby establishing a
regime of checks and balances. The government also encouraged self-sufficiency with the

intent to encourage the domestic industries and enterprises, thereby reducing the dependence
on foreign trade. Although, initially these policies were extremely successful as the economy
did have a steady economic growth and development, they werent sustained. In the early,
1970s, India had achieved self-sufficiency in food production. During the 1970s, the
government still continued to retain and wield a significant spectre of control over key
In the Early 1980s-Macro-Economic Policies were conservative. Government control of
industries continued. There was marginal economic growth & development courtesy of the
development projects funded by foreign loans. The financial crisis of 1991 compelled
drafting and implementation of economic reforms. The government approached the World
Bank and the IMF for funding. In keeping with their policies there was expectation of
devaluation of the rupee. This lead to a lack of confidence in the investors and foreign
exchange reserves declined. There was a withdrawal of loans by Non Resident Indians.
Economic reforms of 1991:
India has been having a robust economic growth since 1991 when the government of India
decided to reverse its socially inspired policy of a retaining a larger public sector with
comprehensive controls on the private sector and eventually treaded on the path of
liberalization, privatisation and globalisation.
During early 1991, the government realised that the sole path to India enjoying any status on
the global map was by only reducing the intensity of government control and progressively
retreating from any sort of intervention in the economy thereby promoting free market and
a capitalist regime which will ensure the entry of foreign players in the market leading to
progressive encouragement of competition and efficiency in the private sector. In this
process, the government reduced its control and stake in nationalized and state owned
industries and enterprises, while simultaneously lowered and deescalated the import tariffs.
All of the reforms addressed macroeconomic policies and affected balance of payments.
There was fiscal consolidation of the central and state governments which lead to the country
viewing its finances as a whole. There were limited tax reforms which favoured industrial
growth. There was a removal of controls on industrial investments and imports, reduction in
import tariffs. All of this created a favourable environment for foreign capital investment. As
a result of economic reforms of 1991, trade increased by leaps and bounds. India has become
an attractive destination for foreign direct and portfolio investment.

Entry Mode
The manner in which a firm chooses to enter a foreign market through FDI.
a. International franchising
b. Branches
c. Contractual alliances
d. Equity joint ventures
e. Wholly foreign-owned subsidiaries

Investment approaches:
a. Greenfield investment (building a new facility)
b. Cross-border mergers
c. Cross-border acquisitions
d. Sharing existing facilities

Objective of the study: To know the flow of investment in India

To know how can India Grow by Investment.
To examine the trends and patterns in the FDI across different sectors and from
different countries in India.
To know in which sector we can get more foreign currency in terms of investment in
India.
Influence of FII on movement of Indian stock exchange
To understand the FII & FDI policy in India.

Government Approvals for Foreign Companies Doing Business in India

Government Approvals for Foreign Companies Doing Business in India or Investment Routes
for Investing in India, Entry Strategies for Foreign Investors India's foreign trade policy has
been formulated with a view to invite and encourage FDI in India. The Reserve Bank of India
has prescribed the administrative and compliance aspects of FDI. A foreign company
planning to set up business operations in India has the following options
1. Automatic approval by RBI:
The Reserve Bank of India accords automatic approval within a period of two weeks (subject
to compliance of norms) to all proposals and permits foreign equity up to 24%; 50%; 51%;

74% and 100% is allowed depending on the category of industries and the sectoral caps
applicable. The lists are comprehensive and cover most industries of interest to foreign
companies. Investments in high-priority industries or for trading companies primarily
engaged in exporting are given almost automatic approval by the RBI.
2. The FIPB Route Processing of non-automatic approval cases:
FIPB stands for Foreign Investment Promotion Board which approves all other cases where
the parameters of automatic approval are not met. Normal processing time is 4 to 6 weeks. Its
approach is liberal for all sectors and all types of proposals, and rejections are few. It is not
necessary for foreign investors to have a local partner, even when the foreign investor wishes
to hold less than the entire equity of the company. The portion of the equity not proposed to
be held by the foreign investor can be offered to the public.

FOREIGN DIRECT INVESTMENT POLICY IN INDIA

FDI policy is reviewed on an ongoing basis and measures for its further liberalization are
taken. 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 announcement by SIA are subsequently notified by RBI under FEMA. All Press Notes
are available at the website of Department of Industrial Policy & Promotion. FDI Policy
permits FDI up to 100 % from foreign/NRI investor without prior approval in most of the
sectors including the services sector under automatic route. FDI in sectors/activities under
automatic route does not require any prior approval either by the Government or the RBI. The
investors are required to notify the Regional office concerned of RBI of receipt of inward
remittances within 30 days of such receipt and will have to file the required documents with
that office within 30 days after issue of shares to foreign investors.
The Foreign direct investment scheme and strategy depends on the respective FDI norms and
policies in India. The FDI policy of India has imposed certain foreign direct investment
regulations as per the FDI theory of the Government of India.
1. Foreign direct investment in India in infrastructure development projects excluding
arms and ammunitions, atomic energy sector, railways system , extraction of coal and
lignite and mining industry is allowed upto 100% equity participation with the
capping amount as Rs. 1500 crores.
2. FDI figures in equity contribution in the finance sector cannot exceed more than 40%
in banking services including credit card operations and in insurance sector only in
joint ventures with local insurance companies.

3. FDI limit of maximum 49% in telecom industry especially in the GSM services
FDI is prohibited in sectors like
(a) Retail Trading (except single brand product retailing)
(b) Lottery Business including Government /private lottery, online lotteries, etc.
(c) Gambling and Betting including casinos etc.
(d) Chit funds
(e) Nidhi Company
(f) Trading in Transferable Development Rights (TDRs)
(g) Real Estate Business or Construction of Farm Houses
(h) Manufacturing of Cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco
substitutes
(i) Activities / sectors not open to private sector investment e.g. Atomic Energy and Railway
Transport (other than Mass Rapid Transport Systems).
Foreign technology collaboration in any form including licensing for franchise, trademark,
brand name, management contract is also prohibited for Lottery Business and Gambling and
Betting activities.

Permitted Sectors:In the following sectors/activities, FDI up to the limit indicated against each sector/activity is
allowed, subject to applicable laws/ regulations; security and other conditionalitys.

In

sectors/activities not listed below, FDI is permitted up to 100% on the automatic route,
subject to applicable laws/ regulations; security and other conditionalitys.
Wherever there is a requirement of minimum capitalization, it shall include share premium
received along with the face value of the share, only when it is received by the company upon
issue of the shares to the non-resident investor. Amount paid by the transferee during postissue transfer of shares beyond the issue price of the share, cannot be taken into account
while calculating minimum capitalization requirement.

FDI promotion initiatives: On the policy front, the FDI policy is already very liberal & it is being further
progressively rationalized, on the basis of an exercise initiated for integration of all prior
regulations on FDI, contained in FEMA, RBI circulars, various Press Notes etc., into one
consolidated document, so as to reflect the current regulatory framework. The latest

consolidated FDI policy document has been launched by Department of Industrial Policy
& Promotion on 30.09.2010, which is available at DIPPs website (www.dipp.nic.in) for
public domain.
On the investment promotion front, the Department organises Destination India and
Invest India events in association with CII and FICCI.
DIPP has been undertaking concerted efforts for improving the business environment in
the country. The business reforms aimed at improving the business environment include
setting up of single windows, online registrations, computerization of information,
simplification of taxes and payments, reduction of documents through developing single
forms for various licences/permissions and reduction of inspections etc.
As a step towards promoting an online single window at the national level for business
users, the Department has undertaking e-Biz project, which is one of Mission Mode
Projects (MMPs) under the National eGovernance Plan (NeGP). The objectives of setting
up of the e-Biz Portal are to provide a number of services to business users covering the
entire life cycle on their operations. The project aims at enhancing Indias business
competitiveness through a service oriented, event-driven G2B interaction.
The National Manufacturing Competitiveness Council (NMCC) has been set up to
provide a continuing forum for policy dialogue to energise and sustain the growth of
manufacturing industries.
The Department has regular interaction with foreign investors. Such interactions have
been held in bilateral/regional/international meets such as Indo-ASEAN, Indo-EU, IndoJapan, etc. Meetings with individual investors were also held on a regular basis.
The Department website (www.dipp.nic.in) has been made both comprehensive and
informative, with an online chat facility.

FDI and Economic Development:FDI is considered to be the lifeblood and an important vehicle of for economic development
as far as the developing nations are concerned. The important effect of FDI is its contribution
to the growth of the economy.
FDI has an important impact on countrys trade balance, increasing labour standards and
skills, transfer of technology and innovative ideas, skills and the general business climate.
FDI also provides opportunity for technological transfer and up gradation, access to global
managerial skills and practices, optimal utilization of human capabilities and natural
resources, making industry internationally competitive, opening up export markets, access to
international quality goods and services and augmenting employment opportunities.

Top sectors that attracted FDI:

Metallurgical industries
Chemicals (other than fertilizers)
Trading
Industrial machinery and
Computer software & hardware

Agriculture:Agriculture is another factor of economic comparison between India and China. It forms a
major economic sector in both the countries. However, the agricultural sector of China is
more developed than that of India. Unlike India, where farmers still use the traditional and
old methods of cultivation, the agricultural techniques used in China are very much
developed. This leads to better quality and high yield of crops which can be exported.
IT/BPO:One of the sectors where Indi enjoys an upper hand over China is the IT/BPO industry.
India's earnings from the BPO sector alone in 2010 are $49.7 billion while China earned
$35.76 billion. Seven Indian cites are ranked as the world's top ten BPO's while only one city
from China features on the list.
Liberalization of the market:In spite of being a Socialist country, China started towards the liberalization of its market
economy much before India. This strengthened the economy to a great extent. On the other
hand, India was a little slow in embracing globalization and open market economies. While
India's liberalization policies started in the 1990s, China welcomed foreign direct investment
and private investment in the mid-1980s. This made a significant change in its economy and
the GDP increased considerably.
Difference in infrastructure and other aspects of economic growth:Compared to India, China has a much well developed infrastructure. Some of the important
factors that have created a stark difference between the economies of the two countries are
manpower and labour development, water management, health care facilities and services,
communication, civic amenities and so on. All these aspects are well developed in China
which has put a positive impact in its economy to make it one of the best in the world.
Although India has become much developed than before, it is still plagued by problems such
as poverty, unemployment, lack of civic amenities and so on. In fact unlike India, China is

still investing in huge amounts towards manpower development and strengthening of

infrastructure.
Company Development
Tax incentives are one area where China is lagging behind India. The Chinese capital market
lags behind the Indian capital market in terms of predictability and transparency. The Indian
capital or stock market is both transparent and predictable. India has Asia's oldest stock
exchange which is the BSE or the Bombay Stock Exchange. Whereas China is home to two
stock exchanges, namely the Shenzhen and Shanghai stock exchange. As far as capitalization
is concerned the Shanghai Stock Exchange is larger than the BSE since the SSE has US$1.7
trillion with 849 listed companies and the BSE has US$1 trillion with 4,833 listed companies.
But more than the size what makes both these stock exchanges different is that the BSE is run
on the principles of international guidelines and is more stable due to the quality of the listed
companies. In addition to this the Chinese government is the major stake holder of most of its
State-owned organizations hence the listed firms have to run according to the rules and
regulations lay down by the government. Hence India is ahead of China in matters of
financial transparency.
Company Management Capabilities:It is said that Indians have great managerial skills. India also leaves China behind as far as
management abilities are concerned. As compared to China India has better managed
companies. One of the major reasons for this is that management reform training in China
began 30 years ago and sadly the subject has still not picked up as a matter of interest by the
citizens of the country. Another important factor behind China not doing well in the business
forefront is that most of the countries came to China and manufactured their goods. It was not
Chinas exports that drove the economy instead it were the export products of outsiders. Even
in the case of mergers and acquisitions China still has not managed to do too well. On the
other hand Indian companies are rapidly expanding mergers and acquisitions. Some of the
recent examples include; Tata Steel's $13.6 Billion Acquisition of Corus, Tata Tea's purchase
of a controlling stake in Britain's Tetley for US$407 million, Indian Pharmaceutical giant
Ranbaxy's acquisition of Romania's Terapia etc.

Advantages of FDI:-

Enhancing Efficiency from Location Advantages

Location advantages - defined as the benefits arising from a host countrys comparative
advantages. - Better access to resources

Lower real cost from operating in a host country

Labor cost differentials

Transportation costs, tariff and non-tariff barriers

Governmental policies

Improving Performance from Structural Discrepancies

Structural discrepancies are the differences in industry structure attributes between

home and host countries.

Examples include areas where:

Competition is less intense

Products are in different stages of their life cycle
Market demand is unsaturated
There are differences in market sophistication
Increasing Return from Ownership Advantages
Ownership Advantages come from the application of proprietary tangible and intangible
assets in the host country.
(a) Reputation, brand image, distribution channels
(b) Technological expertise, organizational skills, experience
Core competence skills within the firm that competitors cannot easily imitate or match.
Ensuring Growth from Organizational Learning

MNEs exposed to multiple stimuli, developing:

(a) Diversity capabilities

(b) Broader learning opportunities

(c) Employment opportunities

Exposed to:
New markets
New practices
New ideas
New cultures

New competition
The Impact of FDI on the Host Country
Employment
Firms attempt to capitalize on abundant and inexpensive labour.
Host countries seek to have firms develop labour skills and sophistication.
Host countries often feel like least desirable jobs are transplanted from home
countries.
Home countries often face the loss of employment as jobs move.

FDI Impact on Domestic Enterprises

Foreign invested companies are likely more productive than local competitors.
The result is uneven competition in the short run, and competency building efforts in
the longer term.
It is likely that FDI developed enterprises will gradually develop local supporting
industries, supplier relationships in the host country.

Investment Risk:-

Sovereign Risk
India is an effervescent parliamentary democracy since its political freedom from British rule
more than 50 years ago. The country does not face any real threat of a serious revolutionary
movement which might lead to a collapse of state machinery. Sovereign risk in India is hence
nil for both "foreign direct investment" and "foreign portfolio investment." Many Industrial
and Business houses have restrained themselves from investing in the North-Eastern part of
the country due to unstable conditions. Nonetheless investing in these parts is lucrative due to
the rich mineral reserves here and high level of literacy. Kashmir on the northern tip is a
militancy affected area and hence investment in the state of Kashmir are restricted by law
Political Risk
India has enjoyed successive years of elected representative government at the Union as well
as federal level. India suffered political instability for a few years in the sense there was no
single party which won clear majority and hence it led to the formation of coalition
governments. However, political stability has firmly returned since the general elections in
1999, with strong and healthy coalition governments emerging. Nonetheless, political
instability did not change India's bright economic course though it delayed certain decisions
relating to the economy. Economic liberalization which mostly interested foreign investors
has been accepted as essential by all political parties including the Communist Party of India
Though there are bleak chances of political instability in the future, even if such a situation
arises the economic policy of India would hardly be affected.. Being a strong democratic
nation the chances of an army coup or foreign dictatorship are minimal. Hence, political risk
in India is practically absent.
Commercial Risk
Commercial risk exists in any business ventures of a country. Not each and every product or
service is profitably accepted in the market. Hence it is advisable to study the demand /
supply condition for a particular product or service before making any major investment. In
India one can avail the facilities of a large number of market research firms in exchange for a
professional fee to study the state of demand / supply for any product. As it is, entering the
consumer market involves some kind of gamble and hence involves commercial risk

Risk Due To Terrorism

In the recent past, India has witnessed several terrorist attacks on its soil which could have a
negative impact on investor confidence. Not only business environment and return on
investment, but also the overall security conditions in a nation have an effect on FDI's.
Though some of the financial experts think otherwise. They believe the negative impact of
terrorist attacks would be a short term phenomenon. In the long run, it is the micro and
macro-economic conditions of the Indian economy that would decide the flow of foreign
investment and in this regard India would continue to be a favourable investment destination.

FOREIGN INSTITUTIONAL INVESTMENT

Introduction to FII
Since 1990-91, the Government of India embarked on liberalization and economic reforms
with a view of bringing about rapid and substantial economic growth and move towards
globalization of the economy. As a part of the reforms process, the Government under its
New Industrial Policy revamped its foreign investment policy recognizing the growing
importance of foreign direct investment as an instrument of technology transfer,
augmentation of foreign exchange reserves and globalization of the Indian economy.
Simultaneously, the Government, for the first time, permitted portfolio investments from
abroad by foreign institutional investors in the Indian capital market. The entry of FIIs seems
to be a follow up of the recommendation of the Narsimhan Committee Report on Financial
System. While recommending their entry, the Committee, however did not elaborate on the
objectives of the suggested policy. The committee only suggested that the capital market
should be gradually opened up to foreign portfolio investments.
From September 14, 1992 with suitable restrictions, FIIs were permitted to invest in all the
securities traded on the primary and secondary markets, including shares, debentures and
warrants issued by companies which were listed or were to be listed on the Stock Exchanges
in India. While presenting the Budget for 1992-93, the then Finance Minister Dr. Manmohan
Singh had announced a proposal to allow reputed foreign investors, such as Pension Funds
etc., to invest in Indian capital market.

Market design in India for foreign institutional investors:Foreign Institutional Investors means an institution established or incorporated outside India
which proposes to make investment in India in securities. A Working Group for Streamlining
of the Procedures relating to FIIs, constituted in April, 2003, inter alia, recommended
streamlining of SEBI registration procedure, and suggested that dual approval process of
SEBI and RBI be changed to a single approval process of SEBI. Currently, entities eligible to
invest under the FII route are as follows:
1. As FII: Overseas pension funds, mutual funds, investment trust, asset management
company, nominee company, bank, institutional portfolio manager, university funds,
endowments, foundations, charitable trusts, charitable societies, a trustee or power of
attorney holder incorporated or established outside India proposing to make proprietary
investments or with no single investor holding more than 10 per cent of the shares or
units of the fund.
2. As Sub-accounts: The sub account is generally the underlying fund on whose behalf the
FII invests. The following entities are eligible to be registered as sub-accounts, viz.
partnership firms, private company, public company, pension fund, investment trust, and
individuals.
FIIs registered with SEBI fall under the following categories:
a) Regular FIIs- those who are required to invest not less than 70 % of their investment in
equity-related instruments and 30 % in non-equity instruments.
b) 100 % debt-fund FIIs- those who are permitted to invest only in debt instruments.
The Government guidelines for FII of 1992 allowed, inter-alia, entities such as asset
management companies, nominee companies and incorporated/institutional portfolio
managers or their power of attorney holders (providing discretionary and non-discretionary
portfolio management services) to be registered as FIIs. While the guidelines did not have a
specific provision regarding clients, in the application form the details of clients on whose
behalf investments were being made were sought.
While granting registration to the FII, permission was also granted for making investments in
the names of such clients. Asset management companies/portfolio managers are basically in
the business of managing funds and investing them on behalf of their funds/clients. Hence,

the intention of the guidelines was to allow these categories of investors to invest funds in
India on behalf of their 'clients'. These 'clients' later came to be known as sub-accounts. The
broad strategy consisted of having a wide variety of clients, including individuals,
intermediated through institutional investors, who would be registered as FIIs in India. FIIs
are eligible to purchase shares and convertible debentures issued by Indian companies under
the Portfolio Investment Scheme.
3.

Prohibitions on Investments: FIIs are not permitted to invest in equity issued by an

Asset Reconstruction Company. They are also not allowed to invest in any company
which is engaged or proposes to engage in the following activities:

1) Business of chit fund

2) Nidhi Company
3) Agricultural or plantation activities
4) Real estate business or construction of farm houses (real estate business does not include
development of townships, construction of residential/commercial premises, roads or
bridges).
5) Trading in Transferable Development Rights (TDRs).
4. Trends of Foreign Institutional Investments in India.
Portfolio investments in India include investments in American Depository Receipts (ADRs)/
Global Depository Receipts (GDRs), Foreign Institutional Investments and investments in
offshore funds. Before 1992, only Non-Resident Indians (NRIs) and Overseas Corporate
Bodies were allowed to undertake portfolio investments in India. Thereafter, the Indian stock
markets were opened up for direct participation by FIIs. They were allowed to invest in all
the securities traded on the primary and the secondary market including the equity and other
securities/instruments of companies listed/to be listed on stock exchanges in India. It can be
observed from the table below that India is one of the preferred investment destinations for
FIIs over the years. As of March 2009, there were 1609 FIIs registered with SEBI.

Difference between FDI and FII

FDI v/s FII

Both FDI and FII is related to investment in a foreign country. FDI or Foreign Direct
Investment is an investment that a parent company makes in a foreign country. On the
contrary, FII or Foreign Institutional Investor is an investment made by an investor in the
markets of a foreign nation. In FII, the companies only need to get registered in the stock
exchange to make investments. But FDI is quite different from it as they invest in a foreign
nation. The Foreign Institutional Investor is also known as hot money as the investors have
the liberty to sell it and take it back. But in Foreign Direct Investment, this is not possible. In
simple words, FII can enter the stock market easily and also withdraw from it easily. But FDI
cannot enter and exit that easily. This difference is what makes nations to choose FDIs more
than then FIIs.
FDI is more preferred to the FII as they are considered to be the most beneficial kind of
foreign investment for the whole economy. Specific enterprise. It aims to increase the
enterprises capacity or productivity or change its management control. In an FDI, the capital
inflow is translated into additional production. The FII investment flows only into the
secondary market. It helps in increasing capital availability in general rather than enhancing
the capital of a specific enterprise. The Foreign Direct Investment is considered to be more
stable than Foreign Institutional Investor. FDI not only brings in capital but also helps in good
governance practices and better management skills and even technology transfer. Though the
Foreign Institutional Investor helps in promoting good governance and improving
accounting, it does not come out with any other benefits of the FDI. While the FDI flows into
the primary market, the FII flows into secondary market. While FIIs are short-term
investments, the FDIs are long term.
1. FDI is an investment that a parent company makes in a foreign country. On the contrary,
FII is an investment made by an investor in the markets of a foreign nation.
2. FII can enter the stock market easily and also withdraw from it easily. But FDI cannot
enter and exit easily.
3. Foreign Direct Investment targets a specific enterprise. The FII increasing capital
availability in general.
4. The Foreign Direct Investment is considered to be more stable than Foreign Institutional
Investor.

Foreign Investment through GDRs (Euro Issues)

Indian companies are allowed to raise equity capital in the international market through the
issue of Global Depository Receipt (GDRs). GDR investments are treated as FDI and are
designated in dollars and are not subject to any ceilings on investment. An applicant company
seeking Government's approval in this regard should have consistent track record for good
performance (financial or otherwise) for a minimum period of 3 years. This condition would
be relaxed for infrastructure projects such as power generation, telecommunication,
petroleum exploration and refining, ports, airports and roads.
1. Clearance from FIPB
There is no restriction on the number of Euro-issue to be floated by a company or a group of
companies in the financial year. A company engaged in the manufacture of items covered
under Annex-III of the New Industrial Policy whose direct foreign investment after a
proposed Euro issue is likely to exceed 51% or which is implementing a project not contained
in Annex-III, would need to obtain prior FIPB clearance before seeking final approval from
Ministry of Finance.
2. Use of GDRs
The proceeds of the GDRs can be used for financing capital goods imports, capital
expenditure including domestic purchase/installation of plant, equipment and building and
investment in software development, prepayment or scheduled repayment of earlier external
borrowings, and equity investment in JV/WOSs in India.
Forbidden Territories:

Arms and ammunition

Atomic Energy

Coal and lignite

Rail Transport

Mining of metals like iron, manganese, chrome, gypsum, sulphur, gold, diamonds,
copper, zinc.

India Further Opens up Key Sectors for Foreign Investment

India has liberalized foreign investment regulations in key sectors, opening up commodity
exchanges, credit information services and aircraft maintenance operations. The foreign
investment limit in Public Sector Units (PSU) refineries has been raised from 26% to 49%.
An additional sweetener is that the mandatory disinvestment clause within five years has
been done away with. FDI in Civil aviation up to 74% will now be allowed through the
automatic route for non-scheduled and cargo airlines, as also for ground handling activities.
100% FDI in aircraft maintenance and repair operations has also been allowed.
But the big one, allowing foreign airlines to pick up a stake in domestic carriers has been
given a miss again. India has decided to allow 26% FDI and 23% FII investments in
commodity exchanges, subject to the proviso that no single entity will hold more than 5% of
the stake.
Sectors like credit information companies, industrial parks and construction and development
projects have also been opened up to more foreign investment. Also keeping India's civilian
nuclear ambitions in mind, India has also allowed 100% FDI in mining of titanium, a mineral
which is abundant in India.
Sources say the government wants to send out a signal that it is not done with reforms yet. At
the same time, critics say contentious issues like FDI and multi-brand retail are out of the
policy radar because of political compulsions.

Monopolistic Advantage Theory

An MNE has and/or creates monopolistic advantages that enable it to operate subsidiaries
abroad more profitably than local competitors.
Monopolistic Advantage comes from:

Superior knowledge production technologies, managerial skills, industrial organization,

knowledge of product.

Economies of scale through horizontal or vertical FDI

Internationalization Theory
When external markets for supplies, production, or distribution fails to provide efficiency,
companies can invest FDI to create their own supply, production, or distribution streams.
Comparison of FDI between India and China
China has been receiving substantial FDI compared to India. Although prior to 1980s India
received higher FDI than China but because of the liberalization policy adopted by China in
1978, turned the tables in favour of China. Since late eighties and throughout nineties China
has been in forefront of the developing world in terms of FDI inflows and hence economic
development.

Advantages
Avoid search and negotiating costs
Avoid costs of moral hazard (hidden detrimental action by external partners)
Avoid cost of violated contracts and litigation
Capture economies of interdependent activities
Avoid government intervention
Control supplies
Control market outlets
Better apply cross-subsidization, predatory pricing and transfer pricing.
Disadvantages: Destruction of small entrepreneurs
Shrinking of jobs
No real benefit to farmers

 Huge competition

CONCLUSION:A large number of changes that were introduced in the countrys regulatory economic policies
heralded the liberalization era of the FDI policy regime in India and brought about a
structural breakthrough in the volume of the FDI inflows into the economy maintained a
fluctuating and unsteady trend during the study period. It might be of interest to note that
more than 50% of the total FDI inflows received by India, came from Mauritius, Singapore
and the USA.
The main reason for higher levels of investment from Mauritius was that the fact that India
entered into a double taxation avoidance agreement (DTAA) with Mauritius were protected
from taxation in India. Among the different sectors, the service sector had received the larger
proportion followed by computer software and hardware sector and telecommunication
sector.
According to findings and results, we have concluded that FII did have significant impact on
Sensex but there is less co-relation with Banker and IT. One of the reasons for high degree of
any linear relation can also be due to the sample data. The data was taken on monthly basis.
The data on daily basis can give more positive results (may be). Also FII is not the only factor
affecting the stock indices. There are other major factors that influence the bourses in the
stock market.