“Foreign Direct Investment (FDI) is increasingly important in economic

development because f its close links in trade, financial flows and technology
transfer” Explain the above statement and examine the policy of the government
regarding promoting foreign capital in India.
Ans. Foreign capital refers to that part of total capital stock of a country whose ownership
belongs to the foreigners. In other words this represents the foreign investments in a
country in its various spheres of economy. Since these investments are made by the
foreigners in their private capacity (as against the loans and grants given by the foreign
Governments), it is called Private Foreign Capital. And further, these investments are
made directly in various business activities, industry or trade, this is also known as Direct
Business Investment.

Advantages of Foreign Capital. Foreign capital confers certain. distinct important

benefits on the receiving country. Firstly, we know that the rate of growth of an economy
depends crucially on the growth rate of capital accumulation. Thus for economic and
industrial development the country must possess adequate supply of capital. But
unfortunately, the domestic sources cannot provide all the capital requirements required
for the planned growth of the less developed countries. Consequently there is a gap of
capital resources, which must somehow be filled up if the economy has to achieve the
planned rate of growth. Foreign capital can be used to fill up this gap ; by
supplementing the enables the underdeveloped countries to plan and achieve a higher
growth rate of the economy.
Secondly, foreign capital ensures the best possible use of foreign funds. The private
profit motive of the foreigners guide them to make investments in such a manner as to
assure the maximum possible rate of return. The self interest of the foreign investors thus
prevents the flow of capital into unproductive and wasteful activities. This, in turn, leads
to optimum growth of the industrial and other sectors of the economy where foreign
investments are being made.
Thirdly, as we know that in the less developed countries, there are many unexplored
fields and unexploited resources. Investments in these areas may be risky ; they may
yield fruit or not. Drilling for oil is one such example where many of the wells where
drilling is made turn out to be unprofitable, use of scarce domestic capital resources in
such fields may be full of risks. However, if foreign capital is used in these sectors, the
risk is entirely borne by the foreigners and the country has nothing to lose.
Fourthly, foreign capital also helps in development and adoption of modern
technology and efficient management techniques. Foreigners not only bring their capital,
but also along with it, their techniques, engineers and technicians, management personnel
and other specialists in various branches of business. Working with them, the natives too
learn new techniques, better ways of organisation, new knowledge, modern work ethics,
all of which can then be fruitfully utilised in other various spheres of industry and trade.

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 Lastly, perhaps the biggest advantage of foreign capital is that this type of
investment does not pose any problems that are associated with foreign loans viz.
repayment of loans and the interest on them. This is because this capital has been
invested by the foreigners voluntarily and at their own risk. It is not a borrowed money
which has to be paid back with interest. This foreign capital does not create BALANCE
OF PAYMENTs difficulties. Rather, such investments, by creating larger productive
capacity, can help in raising country's ex orts and thus help in overcoming BALANCE
OF PAYMENTs difficulties.

Policy Regarding Foreign Investment (1991)

The Congress (I) Government in 1991 announced a new Industrial Policy. This
policy recognized the fact that foreign investment is essential for modernisation,
technology upgradation and industrial development of India. The highlights of the policy
are:
(1) Approval will be given for direct foreign investment upto 51% foreign
equity in high priority industries. Clearance will be available if foreign
equity covers the foreign exchange requirement for imported capital
goods.
(2) Other foreign equity proposals, including proposals involving 51 per
cent foreign equity which do not need the above said criteria, will
continue to need prior clearance.
(3) Prior to 1991, the Government generally discouraged foreign equity
participation in service industries other than hotels. The new policy
permits foreign equity holding upto 51 per cent in trading companies
primarily engaged in export activities.
(4) A Special Empowered Board would be constituted to negotiate with a
number of large international firms and approve direct foreign
investment in select areas.
(5) The policy permits automatic approval for foreign technology
agreement in respect of 34 high priority industries (Annexure III) upto a
lump sum payment of Rs. 1 crore, 5 per cent royalty for domestic sales
and 8 per cent for exports, subject to total payment of 8 per cent of sales
over a 10 year period from the date of agreement or 7 years from the
commencement of production.
(6) In respect of industries other than those in Annexure III, automatic
permission will be given, subject to the same guidelines as above, if no
free foreign exchange is required for any payments.
(7) Hiring of foreign technicians and testing of indigenously developed
technologies abroad require no permission.
The Government of India liberalised its policy in 1991 to permit automatic
approval for foreign investment upto 51 per cent equity in 34 industries.
Additional Measures Taken During 1992-93
To encourage direct foreign investment, portfolio investment, NRI investment,
the following additional measures were taken:

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 (1) NRIs and OCBs predominately owned by them are also permitted to invest
upto 100 per cent equity in high priority industries with repartiability of
capital and income. NRI investment upto 100 per cent of equity is also
allowed in export houses, trading houses, star trading houses, hospitals,
EOUs, sick industries, hotels and tourism related industries and without the
right of repatriation in the previously excluded areas of real estate, housing
and infrastructure.
(2) India signed Multilateral Investment Guarantee Agency Protocol (MICA) for
the protection of foreign investors on 13th April. 1992.
(3) Foreign companies have been allowed to use their trade marks on domestic
sales.
(4) Provisions of the Foreign Exchange Regulation Act (FERA) have been
liberalised as result of which companies with more than 40 per cent of equity
are also now treated at par with fully Indian-owned companies.
(5) Disinvestment of equity by foreign investors has been allowed at market
price on stock exchanges from 15th September, 1992 with permission to
repatriate the proceeds of such disinvestment.
(6) Existing companies with foreign equity can it raise to 51 per cent subject to
certain prescribed guidelines.
Changes in Foreign Investment Policy During the Year 1994-95
The following important measures have been undertaken in 1994-95:
(1) Non-resident Indians and Overseas Corporate Bodies (OCBs) and
foreign institutional investors were allowed to invest in all activities
(except agricultural and plantation) including hire-purchase, leasing,
trading, other services, etc. subject to the condition that there share did
not exceed 24 per cent of the issue.
(2) NRIs/OCBs were granted general permission to purchase shares of
public sector enterprises (PSEs) disinvested by Government of India
with a condition that there holding should not exceed 1 per cent of the
total paid-up capital of the concerned enterprise. -
(3) Foreign investment in bulk drugs, their intermediaries and
formulations were brought under atomic approval.
(4) A working group was set up to examine the existing schemes and
incentives available to NRIs in India and to make recommendations for
larger NRI investments.

Changes Made with Regard to Foreign Investment in 1996-97

The significant changes were:
(1) The list of industries eligible for automatic approval upto 51 per cent foreign
equity was expanded to 48.
(2) Foreign equity participation upto 74% was allowed in respect of nine
priority sectors.
(3) To facilitate the foreign investment, the Foreign Investment Promotion
Council was set up to prepare projects in Thrust areas.

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 (4) The Foreign Investment Promotion Board (FIPB) was revamped for
making rules and regulations to make foreign investment more
transparent.
(5) Foreign Institutional Investors (FIls) have been permitted to make equity
investment in unlisted companies and the limit of investment of 5 per
cent of total equities in a single company by an individual FII has been
increased to 10 per cent.
(6) The Government announced the first ever guidelines in 1997 for
expeditious approval of FDI's direct investment in areas not covered
under automatic approval.
The salient features of the guidelines are:
(i) 100 per cent foreign equity will be allowed in those cases where the
foreign company could not find a suitable Indian joint venture partner
with a condition that within 3-5 years, the foreign investor would
disinvest at least 26 per cent of its equity in favour of Indian parties.
(ii) Priority areas for FDI as per the guidelines include infrastructure, export
potential, large scale employment potential, particularly for rural areas,
items linked with farm sector, social sector projects like hospitals, health
care and medicines, and proposals that lead to induction and infusion of
capital.
(iii) FDI approvals are subject to sectoral limits: 20 per cent (40 per cent for
NRIs) in the banking sector; 51 per cent in non-banking financial
companies; 100 per cent in power, road, ports, tourism and venture capital
funds; 49 per cent in tele-communications; 40 per cent (100 per cent for
NRIs) in domestic air taxi operations airlines; 24 per cent in small-scale
industries; 51 per cent in drugs/ pharmaceutical industries for bulk drugs;
100 per cent in petroleum; and 50 per cent in mining except for gold,
silver, diamond and precious stones.

Recommendations of Steering Committee on FDI

Recommendations of Steering Committee on FDI set up by the Planning
Commission in August 2001 has submitted its report, which is currently being
considered by the government. The main recommendations of the Committee are:
(1) Enactment of a Foreign Investment Promotion Law incorporating and
integrating relevant aspects for promoting FDI
(2) Urge States to enact a special investment law relating to infrastructure for
expediting investment in infrastructure and removing hurdles to production
in infrastructure.
(3) Empower the Foreign Investment Promotion Board (FIPB) for granting
initial Central-level registrations and approvals wherever possible, for
speeding up the implementation process.
(4) Empower the Foreign Investment Implementation Authority (FIIA) for
expediting administrative and policy approvals.
(5) Disaggregating FDI targets for the 10th Plan in terms of sectors, and
relevant administrative ministries/departments, for increasing
accountability.

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 (6) Reduction of Sectoral FDI caps to the minimum and elimination of entry
barriers. Caps can be taken off for all manufacturing and mining activities
(except defence), eliminated in advertising, private banks, and real estate,
and hiked in telecom, civil aviation, broadcasting, insurance and plantations
(other than tea).
(7) Overhauling the existing FDI strategy by shifting from a broader macro-
emphasis to a targeted sector-specific approach.
(8) Informational aspects of the FDI strategy require refinement in the light of
India's strengths and weaknesses as an investment destination and should
use information technology and modern marketing technique.
(9) The Special Economic Zones (SEZs) should be developed as internationally
competitive destinations for export - oriented FDI, by simplifying laws, rules,
and procedures and reducing bureaucratic rigmarole on the lines of China.
(10) Domestic Policy reforms in power, urban infrastructure, and real estate, and
de-control / de-licensing should be expedited for attracting more FDI.
Revised FDI Definition
A committee was constituted by the DIPP (Department of Industrial Policy and
Promotion) in May, 2002 to bring the reporting system of FDI data in India into
alignment with international best practices. The revised definition includes three
categories of capital flows under FDI: equity capital, reinvested earnings and other
direct capital. Accordingly, the RBI has recently revised data on FDI flows from the
year 2000-01 onward by adopting a new definition of FDI. The international best
practice systems have focused on recording of FDI data in BALANCE OF
PAYMENTs statistics in terms of 3 main categories as mentioned below:
(1) Equity Flows (equity in branches, shares in subsidiaries and other capital
contributions),
(2) Reinvested Earnings (Retained earnings of foreign subsidiaries and
affiliates), and
(3) Inter-company Debt Transactions (inter-corporate debt transactions
between associated corporate entities).
Table I. Foreign Investment Inflows
(in US$
Million)
Year FDI (Net) FIN Euro Equities Total
and
1990-91 97 00 06 103
1996-97 2651 1926 1386 5963
1997-98 3525 979 849 5353
1998-99 2380 - 390 322 2312
1999-2000 2093 2135 889 5117
2000-01 3272 1677 913 5862