Current scenario of FDI in India & Its effects on Indian economy

Contents
1. Introduction 2. Meaning & Types of FDI 3. Determinants of FDI 4. Effect of FDI on a country 5. FDI policy in India 6. Current Scenario of FDI in India 7. Whether Global recession affected FDI? 8. Impact of FDI on Indian economy 9. Analysis of FDI inflows 10. Recent changes to FDI policy 11. Latest changes in some sectors of the economy 12. SEZs in India 13. Comparison with China 14. What India can learn from China? 15. Recommendations on overall FDI policy of India 16. FDI in Multi-brand retail sector 17. Details of the retail issue with Example of Wal-Mart 18. Analysis & Recommendations on retail issue 19. Conclusion 20. References

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Introduction
Most of the present day developing countries of the world have set out a planned programme for accelerating the pace of their economic development. In a country planning for industrialization & aiming to achieve a target rate of growth, there is a need for resources. The resources can be mobilized through domestic as well as foreign sources. So far as the domestic sources are concerned, they may not be sufficient to achieve the fixed rate of growth. Generally, domestic savings are less than the required amount of investment. Also the very process of industrialization calls for import of capital good which cannot be locally produced. Hence there is a need for foreign resources or Foreign Direct Investment. They not only supplement the domestic savings but also provide the recipient country with extra foreign exchange to buy imports essential for development of economy. Thus foreign resources are craved for filling the saving investment gap. There are various means available for a developing country to obtain Foreign Resources such as Foreign Investment, export of goods & services etc. Export of goods & services do contribute to the foreign resources but can only meet small part of the total demand for foreign resources. External aid from foreign governments and international institutions, by increasing the rate of home savings and removing the foreign gap allows the utilization of previously underutilized resources and capacity. But the aid generally comes with conditions which distorts the allocation of resources. So its use has been on the decline.

Meaning
Foreign Direct Investment (FDI) is generally defined as A form of long term international capital movement, made for the purpose of productive activity accompanied by the intention of operational control or participation in the management of foreign firm. In the Indian context the definition of FDI is given by DIPP as FDI means investment by non-resident entity/person resident outside India in the capital of the Indian company under Schedule 1 of FEMA (Transfer or Issue of Security by a Person Resident outside India) Regulations 2000.

TYPES OF FDI Basically FDI can be a mere monetary investment or it can be a technological agreement. Greenfield investment: A form of foreign direct investment where a parent company starts a new venture in a foreign country by constructing new operational facilities. In addition to building new facilities, most parent companies also create new longterm jobs in the foreign country by hiring new employees. It is the principal mode of investing in developing countries like India. 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. Mergers and Acquisition: Cross-border mergers occur when the assets and operation of firms from different countries are combined to undertake business activities. Companies enter into mergers usually for technological and financial purposes. Horizontal Foreign Direct Investment: Investment in foreign country in the same type of business activity, as the firm has in home country. Vertical Foreign Direct Investment: Takes two forms:

4 1) Backward vertical FDI: where an industry abroad provides inputs for a firm's domestic production process. 2) Forward vertical FDI: in which an industry abroad sells the outputs of a firm's domestic production FDI can be in the form of: In order to participate in the management of the concerned enterprise, the stock of the existing foreign enterprise can be acquired i.e. the existing enterprise and factories can be taken over. A new subsidiary with 100 per cent ownership can be established abroad. New foreign branches, offices and factories can be expanded It is possible to participate in a joint venture through stock holdings. Minority stock acquisition, if the objective is to participate in the management of the enterprise. FDI v/s PIS Both FDI and PIS (Portfolio Investment Scheme) are 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, Investments through PIS or Portfolio Investment Scheme are made by an investor in the stock exchanges of a foreign nation. The PIS Investment is also known as volatile money as this investment can fluctuate quickly on the basis of economic conditions in the international market. But in Foreign Direct Investment, this is not possible. In simple words, PIS can enter the stock markets easily and also can be withdraw from it easily. But FDI cannot enter and exit that easily. FDI is more preferred to the PIS as it is considered to be the most beneficial kind of foreign investment for the whole economy. Foreign Direct Investment only targets a 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

5 additional production. The PIS flows only into the secondary market. It helps in increasing capital availability in general rather than enhancing the capital of a specific enterprise. FDI not only brings in capital but also helps in good governance practices and better management skills, improving exports and even technology transfer. Though the Portfolio Investment helps in increases flow of capital & foreign currency in the host country, it does not come out with any other benefits of the FDI. FDI v/s External Loans Foreign Investment, particularly foreign direct investment has significant advantages over external loans & other forms of financing the resource gap. In the normal circumstances, the repayment of foreign direct investment is cheaper in comparison to loans and commercial borrowings. For instance, FDI takes the form of repatriation of certain percentage of earnings in the form of dividend of an enterprise only when it reaches at the stage of commercial profitability. Practically, it happens normally after five years to seven years after the establishment of the concern. By the time, foreign investment already unpacks its various components like capital, technical know-how, exports, marketing & managerial skill etc. That is why, in certain cases, FDI is considered to be much more productive than commercial borrowings where repayment starts normally from 2nd year, further which is at high rate of interest. Developing countries like India need substantial foreign inflows to achieve the required investment to accelerate economic growth and development. It can act as a catalyst for domestic industrial development. A country, attracting an inflow of FDI strengthens the connection to world trade networks and finances its development path. However, unilateral massive FDI to a country can make it dependent on the external pressure that foreign owners might exert on it.

Determinants of FDI
At investor's level, a firm can decide to make a foreign investment because of many factors, including: Diversification, by purchasing a firm doing somewhat different activities than the purchaser, to seize new opportunities. A firm already exporting to a market can decide to make a FDI and build there a productive unit to reduce the transport cost and avoid tariff barriers. Also, FDI is the chosen vehicle used by a foreign firm having a monopolistic advantage in comparison with other firms in the market. Host country conditions are favourable in such a way that it enables the generation of economic profits, higher than the expected profit to be gained from selling done in the home country. E.g. lower taxes, cheap availability of factors of production. Inflow of Foreign Direct Investments increases with the attractiveness of the country, due to the following factors in different proportions depending on the industry and the country: Higher future growth expected large market potential skilled work-force & low labour cost and wages low taxation encouraging business environment favourable laws and incentives Sound political stability It should be noted that on a sub-national level, FDI usually concentrates in the richest part of the country, because there the investor can find a better infrastructure and easier logistical accessibility from abroad. This weakens the argument that FDI go hand in hand with the overall economic development of a nation.

Effect of FDI
A. Financial variables As an inflow of capital, FDI changes the balance of payments. Other things equal, FDI increases the official reserves of foreign currency. B. External trade and industrial variables A particularly strong FDI concentrated in a short period of time can lead to a re-valuation of the currency exchange rate. If the good produced in the host country is sold there, consumption composition will change, possibly with a loss in market shares of local producers and of foreign producers based abroad. In the latter case, FDI is crowding out imports. If the product is new for the host country, it fills a gap and increases the variety of available goods, thus opening the path to higher productivity for industrial users and higher satisfaction for consumers. For instance, a FDI in an electricity generation plant will allow more firms to operate in the region and wider availability of energy for inhabitants. If, instead, the production is exported, FDI boosts exports of the host country, providing it with foreign currency. If FDI is targeted to green-field investment, employment will rise, possibly involving an increase in income and consumption and aggregate demand. If FDI is targeted to an acquisition of a large inefficient firm, the priority of profits will possibly lead, in the short run, to waves of dismissals and a rise of unemployment. Wages are usually higher in foreign affiliates than in local firms, sometimes it causes the crowding out of the local firms on the labour market (i.e. they do not find any more workers at the previous level of wage and they are not economical at the new level). Even the reputation & ambience of foreign firms may sometime be able to cause brain drain from host country companies.

8 C. Knowledge and entrepreneurial variables Usually, foreign firms have higher productivity than local ones, since the foreign ownership prompts managers to use non-locally available knowledge, both incorporated and not-incorporated in machines, which often constitute an innovation. The local workforce is put into contact with that knowledge and, more in general, with the foreigners' mentality. All this might generate knowledge spillovers to workers, as well as to local providers (e.g. forced to adopt ISO certification or specific methods of production) and to local competitors (who could imitate the foreign firm). Thus, a mid-term effect of FDI can be the mushrooming of new businesses formed in the same industry by competitors and key workers who have left the foreign company. In parallel, the presence of a big foreign investor can re-orient the education & training courses offered in the region, giving rise to a "pool" of specialized skills, which in turn become a competitive advantage for the investor as well as an incentive for other international firm to locate there. D. Political variables Far-sighted politicians can use FDI for their country to catch up with world standards in certain industries, prompting a fast development of the economy, by attracting and selecting the investors. However, large and concentrated FDI can exert external pressure to obtain a preferential treatment against the local firms, giving rise to political conflicts between the two groups. The external pressure can take the form of funds for corruption of bureaucrats and politicians. Foreign-owned managers risk to exhibit a radical "ignorance of law", since the law is not well known to them and they have no experience with it. In this case, the management may behave as it wants, leaving to lawyers and bribery the task to make the activity "In line with" with the regulation.

9 Technology spillover from FDI The proponents of FDI have argued that local firms can observe and adopt the technology brought from abroad and hence improve productivity. This spillover of technology thus creates an externality justifying policies encouraging FDI. The technology diffusion from FDI is more likely directed to local suppliers than to local competitors, as a strategy to build efficient supply chains from multinationals overseas operations. By transferring the technology to local suppliers, multinationals may be able to improve the quality & lower the price of non-labour inputs. How might the social benefits develop? The primary motivation for multinationals to transfer technology to suppliers is to enable higher-quality inputs at lower prices. Only one problem with this strategy is that if the enabling technology is transferred to one upstream supplier, then the multinational is vulnerable to delay in supply or unsatisfactory quality. To reduce these risks, the multinational could diffuse the technology widely-either by direct transfer to additional firms or by encouraging spillover from the original recipient. The technologys wide diffusion would then encourage entry in the supplier market, thereby increasing competition and lowering the prices. However, the multinational cannot prevent the upstream suppliers from also selling to the multinationals competitors in the downstream market. The lower input prices may induce entry and more competition in the downstream market, thereby lowering prices and increasing the output.

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Final Sector 1 Foreig Local n Firm Firm 1 1

Final Sector 2 Foreig Local n Firm Firm 2 2

Technology transfer Local Increased productivity Supply Entry and competition 1 Lower prices Increased output and Value added Local Supply 2

Lower final sector prices Increased output and value added

Lower Supply prices

Supply Sector

FDI policy in India

Foreign Direct Investment (FDI) in India is governed by the FDI Policy announced by the Government of India and the provisions of the Foreign Exchange Management Act (FEMA), 1999. Entry routes for investments in India Foreign Direct Investment is freely permitted in almost all sectors. Under the Foreign Direct Investments (FDI) Scheme, investments can be made by non-residents in the equity shares, mandatorily convertible debentures / preference shares of an Indian company, through two routes - the Automatic Route and the Government Route. Under the Automatic Route, the foreign investor or the Indian company does not require any approval from the Reserve Bank or Government of India for the investment. Under the Government Route, prior approval of the Government of India, Ministry of Finance, and Foreign Investment Promotion Board (FIPB) is required.

11 India has the most liberal and transparent policies on FDI among the emerging economies. FDI up to 100% is allowed under the automatic route in all the sectors except the following, which require prior approval of Government: Sectors prohibited for FDI. Activities that require industrial license. Proposals in which the foreign collaborator has an existing financial/technical collaboration in India in the same field. Proposals for acquisition of shares in an existing Indian Company in financial service sector and where SEBI regulations, 1997 is attracted. Review of FDI Policy The Government of India (GOI) has been selective in opening various sectors for FDI. Gradually different sectors were opened for foreign investment (except from Pakistan & only after permission from FIPB in case of Bangladesh) with varying rates of sectoral caps. Government of India is trying best to introduce simple and transparent FDI policy. The policy seems to reduce regional disparities, protect the interest of small retailers and health hazard of its citizens due to foreign investment. The areas which are of strategic importance are not opened for FDI under automatic route. However, the GOI has taken number of measures to boost FDI inflow. FDI up to 100 per cert is allowed under automatic route in many sectors and no approval is required either from government or RBI. Investors are only required to notify within 30 days to concerned regional RBI office about the inflow received through inward remittances only. The government has also broadened list of sector for automatic route. In the New Industrial Policy, all industrial undertakings are exempt from licensing except for Atomic Energy, Railway transport, distillation and brewing of alcoholic drinks, cigars and cigarettes, manufactured tobacco substitutes, Industrial explosives hazardous, chemicals, drugs and pharmaceuticals and those reserved for the small scale sector.

12 Following sectors are prohibited under FDI I. Retail Trading (except single brand product retailing) II. Atomic Energy III. Lottery Business including Government / private lottery, online lotteries etc. IV. Gambling and Betting including casinos etc. V. Business of chit fund VI. Nidhi Company VII. Trading in Transferable Development Rights (TDRs) VIII. Activities/sector not opened to private sector investment IX. Agriculture (excluding Floriculture, Horticulture, Development of seeds, Animal Husbandry, Pisciculture and cultivation of vegetables, mushrooms etc. under controlled conditions and services related to agro and allied sectors) and Plantations (Other than Tea Plantations) X. Real estate business or construction of farm houses. XI. Manufacturing of Cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco or of tobacco substitutes. Foreign Investment through equity shares, fully & mandatorily convertible debentures, preference shares, GDRs/ADRs, Foreign Currency Convertible Bonds (FCCBs) etc. are all treated as FDI.

Current scenario of FDI in India

Despite the opening up of its economy in 1991, India received only $5-6 billion FDI till 2004-05 due to a fairly restrictive FDI policy. But the policy regime changed in February 2006 and FDI inflow into India has accelerated since. Opening the economy to FDI and allowing foreign ownership is a necessary but not sufficient condition to attract FDI. If a liberal FDI policy is all that is important then the Eastern European and Central Asian countries, which have the most open policies towards foreign investors, should be attracting huge volumes of FDI. However, East Asian countries have a better track record in attracting FDI than the Eastern European and

13 Central Asian countries. The effectiveness of an FDI policy depends, to a large extent, on the environment within which it operates. A liberal FDI policy in a poor investment climate with high transaction costs is most likely to be ineffective. Therefore, factors like market size, infrastructure quality, the law of the land, well functioning institutions, macroeconomic stability, growth potential, etc, play an equally important role in attracting FDI. Clearly, investor confidence on some of these factors with respect to India has eroded lately and may perhaps be the reason for the drop in FDI this fiscal. China by keeping the spotlight on a low-cost manufacturing base for exports and development of related infrastructure and facilitation followed a focused approach to attract FDI. Not having an export focus in India also meant that FDI into the manufacturing sector in has mostly not been of an export-oriented variety. Since the business rationale of FDI into India has largely been driven by the desire to profit from Indias domestic market and its rising middle class, a large proportion of FDI into manufacturing in India till lately has been of setting up manufacturing facilities in India mainly to avoid high Indian import tariffs. This, nevertheless, expanded the range of products available to Indian domestic consumers. Also the FDI policy pursued so far does not appear to indicate that investment incentives given to FDI are different from what the government offers to its own residents. India, in fact charges 40% income tax to the foreign companies which is 10% higher than what it charges to domestic corporates. Wholly owned subsidiaries of foreign companies are charged with 30% tax in India & this still is higher than all the developed nations like UK, China, and US etc. But still India is considered as one of the top 5 destinations for FDI. It has been observed that if policies are over-friendly to FDI while the transaction costs (including tax and regulatory) of investments are high for domestic firms, then it can prove to be counter-productive, leading to round-tripping (i.e., where domestic investors route their investment

14 through a foreign country to avail the policy benefits of FDI). Both India and China have witnessed sizeable FDI inflows that can be classified as round-tripping. A significant proportion of FDI coming from Mauritius to India is of the round-tripping variety due to a treaty on avoidance of double taxation between India and Mauritius. According to the world investment report of UNCTAD, round-tripping accounts for nearly 20-30% of the total FDI in India & China. Clearly, evidence of round-tripping is an indication of shortcomings in the FDI policy sphere. After recording an average growth of 73.86% between FY05-FY08, the growth in FDI moderated to around 1% during 2008-09. The global trade had been affected due to the global economic slowdown.

Whether the Global recession had any effect on Indian FDI?

The global crisis has shown the power of finance channel. The impact of turmoil in one economys financial markets is not merely transmitted to other markets, the quantum and direction of the movement is also more or less similar (decline in equity markets, rise in corporate bond spreads and depreciation in currency). This is because cross border financial linkages have increased substantially over the years. Given the severity of the crisis it was felt there will be little FDI investment. However, in case of India, FDI inflows remained positive throughout the crisis. The FDI inflows actually helped keep maintain capital account when all other categories showed sharp decline.

15 Month FDI inflows (In billion) Jan-Mar 2008 11.8 FDI inflows USD billion) 2009 6.2 (Major Crisis Apr-June Jul-Sep Oct-Dec 10.1 7.1 3.9 (Major Crisis period) period) 7.0 8.3 5.3

USD (In

Source: DIPP Foreign investment through Portfolio Investment Scheme (PIS): Unlike FDI, it is difficult to pinpoint the origin of PIS investment. However, the linkage here is pretty direct. With turmoil in global financial markets, PIS inflows will decline. We have a large number of global financial firms which operate across the world and in case of a decline in one major market; there is a pull out from other markets as well. Month PIS (In billion) Jan-Mar 2008 -3.7 PIS USD (In billion) 2009 -2.7 (Major Crisis Apr-June Jul-Sep Oct-Dec -4.2 -1.3 -5.8 (Major Crisis period) period) 8.3 9.7 5.7 USD

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Source: SEBI

Remittances and NRI deposits: Another important flow is NRI deposits and Remittances. Former shows whether NRI depositors withdrew funds in wake of crisis and latter shows whether Indians living abroad stopped sending funds to their homes again because of the crisis. Its an interesting trend in the case of NRI deposits. The deposits increase in the crisis periods Oct-Dec 2008 and Jan- Mar 2009 and decline thereafter. It could be that NRI preferred to invest higher proceeds in India seeing crisis in their own economies. In case of remittances, we see a decline in crisis period Oct 08 Mar 09 but see improvements as crisis eases. There were huge concerns of remittances collapsing because of the crisis. In some countries they did collapse worsening poverty status. In India, despite the decline it manages to remain in positive. NRI Deposits NRI Remittances

17 Month NRI deposits (USD billion) Jan-Mar 2008 1.1 NRI deposits (USD billion) 2009 2.2 (Major Crisis Apr0.8 period) 1.8 1.0 0.6 AprJune JulSep OctDec 11.6 13.0 10.0 (Major Crisis period) With the gradual recovery in the global economic arena, the FDI JanMar Month NRI remittances (USD billion) 2008 13.4 NRI remittances (USD billion) 2009 9.5 (Major Crisis period) 12.9 13.8 12.8

June Jul-Sep 0.3 Oct-Dec 1.0 (Major Crisis period)

inflows in India showed some signs of improvement and grew by around 5.69% during FY10. However, despite improving global economic prospects and robust recovery of the Indian economy, the FDI inflows have largely remained muted during the course of the current fiscal. In fact, FDI inflows had recorded a significant decline of 23.3% during FY11 (Apr-Dec 10) as compared to the corresponding period of the last fiscal. A confluence of factors such as the recent spurt in corruption cases, procedural delays, environmental policy issues, comparatively higher inflation might have affected the FDI investment into the country during the current fiscal. While in general, the global economic prospect seems to have improved in the recent past, the emergence of issues such as debt crisis in the European region is likely to have impacted the investor's sentiment during some parts of the year. This, coupled with the issues prevalent domestically, might affect the long-term FDI flows in India. From a sectoral perspective, while the FDI inflows in services sector (financial & non-financial) recorded a decline of as much as 24%, as sectors such automobile, metallurgical industries, petroleum and natural

18 gas, chemicals, computer software and hardware witnessed an increase in FDI inflows during Apr-Dec 2010 as compared to the corresponding period of the previous year. The positive outlook regarding robust domestic demand from the long term perspective, large pool of skilled manpower, government policies such as deregulation of petroleum prices, bidding for oil blocks et c. all have been playing an instrumental role in attracting FDI in sectors such as automobile, petroleum and natural gas as well as computer software. The recent licensing issues in the telecom space and series of corruption cases in real estate financing is likely to have impacted investor's sentiment, thereby limiting the FDI inflows in these sectors. FDI inflows in the real estate and telecom sector registered a decline of 60% and 47% respectively during Apr-Dec 2010 as compared to Apr-Dec 2009. Another important factor that might have weighed down the investor's sentiment in the recent past could be the environment-sensitive policies pursued causing delays to the projects as evident in the recent episodes in the mining sector, integrated township projects, infrastructure projects etc. Moreover, the long standing issues such as lack of adequate infrastructure, land acquisition issues mostly in case of SEZs and persistent procedural delays continue to limit the FDI inflows in the country. Besides all these factors, foreign investors planning to enter the retail space as well as banking in India or increasing their stake in insurance ventures are still awaiting the required policy changes. The recent reduction in FDI inflows seems to have gained significant attention amongst the policy markers. As the Prime Minister's Economic Advisory Council highlighted the issue in the recent past, the RBI has taken steps towards examining the issue and articulating solutions thereon by proposing to set up a special committee. Moreover, some of the recent steps such as consolidating all prior regulations and guidelines

19 into one comprehensive document, granting clearance to 24 foreign investment proposals, worth $ 304.7 mn are steps in the right direction and would enhance clarity and predictability of our FDI policy to foreign investors.

Impact of FDI on Indian economy

YEAR
2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

Year-wise FDI inflows, GDP, GDP growth rates in India FDI Inflow GDP FDI as a percentage of GDP (%) [In USD billion] [USD billion]
2.91 4.22 3.13 2.63 3.76 5.55 15.73 24.59 27.33 25.83 19.43 460 478 507 599 722 834 951 1242 1216 1377 1383 0.87 1.28 0.99 0.72 0.84 1.07 2.40 2.77 2.89 2.74 1.81

Year-wise FDI inflows, GDP, GDP growth rates in China YEAR

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

FDI Inflow [USD billion]

42.1 46.8 52.74 53.51 60.63 72.41 72.72 83.52 92.43 90.00 105.71

GDP [In USD billion]

1,198 1,325 1,454 1,641 1,932 2,257 2,713 3,494 4,522 4,985 5,881

FDI as a percentage of GDP (%)

8.35 3.53 3.63 3.26 3.14 3.21 2.68 2.39 2.04 1.81 1.80

Source: World Bank, World development Indicators, DIPP & ministry of commerce, China Though FDI in both India & China has been very small in relation with the GDP of the countries, still it has helped the countries in creating employment & giving an economic boost in critical sectors & ultimately in

20 maintaining high positive growth rates. In the year 2006-07 the FDI inflow of India showed a huge growth by reaching to 22.83 USD bn from 8.96 USD bn, hence in the following year Indias GDP rose by almost 33% which is the highest rise in the recent years. Both the countries have posted relatively lower growth rates in 2008-09 due to global financial crisis. Indias growth rate came down from 9.8% to 4.9% & in case of China growth rate came down from 14.2% to 9.6%. In spite of lower performance in GDP growth rates, FDI inflows in both India & China were not much affected. This surely must have helped the countries to recover from the crisis & that is evident from the subsequent years figures. By 2010 India & China have posted GDP growth rates of 8.5 & 10.3 respectively. FDI in the form of Greenfield projects have been very useful for India especially in service sectors. After allowing FDI India became known as hub for IT, ITES & telecom services. The share of different sectors of the economy in Indias GDP in 2010 was as follows: Agriculture-18 percent, Industry-28 percent and Services 54 percent. The fact that the service sector accounted for more than half the GDP shows that FDI has been playing a crucial role in growth of service sector because in past India was considered as an agrarian economy. As we can see in the graph, after 2008 FDI projects in services are reducing sharply in India. The main reason for the decline in FDI in the services sector in 2009-10 was the global credit crunch caused due to US recession & euro crisis. The financial services sector was affected the most. As the euro zone crisis subdued investment from UK, Netherlands, Germany and France which used to be the major investors in India. As a result of recent corruption cases in telecom & realty sectors, in 2011, both FDI in service sector & total FDI decreased by almost 25%.

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Source: Ernst & Young Report on India attractiveness Survey, 2011 For many developing countries, attracting foreign direct investment (FDI) has been a key aspect of their outward-oriented development strategy, as investment is considered a crucial element for output growth and employment generation. FDI has been successful in creating many employment opportunities in India. But due to recent decrease in FDI inflows & FDI projects, less employment is being created.

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India has been experiencing clear positive trends in numbers of FDI projects and jobs created. On average, between 2003 and 2010, the number of FDI projects increased by 7% and the number of jobs created by FDI increased by 4% annually. As a result, job intensity per project has fallen over the period. This is due to a fall in the share of projects in the most job-intensive activities. These activities include shared service centers, customer contact centers, technical support centers, design and development. Foreign investors are focusing increasingly on business services, sales, marketing and support. These sectors require investment in less labor-intensive projects. But in all we can say that FDI has been really helpful for generating job opportunities in our country.

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Analysis of FDI in India

Various studies have projected India among the top 5 favoured destination for FDI. Cumulative FDI equity inflows have been USD 194.81 billion for the period 1991-2011. This is attributed to contribution from service sector, computer software, telecommunication, real estate etc. Indias 80% of cumulative FDI is contributed by nine countries while remaining 20% by rest of the world. Country-wise, FDI inflows to India are dominated by Mauritius (42 percent), followed by the Singapore (9 per cent), United States (7 percent) and UK (5 percent) [Table]. Countries like Singapore, USA, and UK etc. invest in India mainly in service, power, telecommunication, fuels, electric equipments, food processing sector. Diagram 1-Table: Share of top investing countries FDI Inflows

Source: Department of Industrial Policy and Promotion.

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(Amounts in US $ million) Diagram 3:

Geographical Distribution of FDI Inflows: April 2000 to March 2011 (Cumulative)

Maharashtra Delhi Karnataka Gujarat Tamil Nadu Andhra Pradesh Others

Balanced geographical distribution of FDI inflows could have been instrumental in achieving sustainable growth. However, there seems to wide concentration of FDI inflows around Maharashtra Region (35%) followed by New Delhi Region (19%), Karnataka (6%), Gujarat (6 %), Tamil Nadu (5%) and Andhra Pradesh (5%). It is alarming that these regions receive 76% of FDI equity inflow while rest of India accounts for only 24%.

25 Lack of infrastructure causes the disparities of foreign investments. Diagram 4: Geographical Distribution of foreign Technology Transfer April 2000 to March 2011

Maharashtra Region (17%) attracts FDI in energy, transportation, services, telecommunication and electrical equipment. Gujarat (7%) attracts FDI inflows Oil and gas, Infrastructure, Food processing industries. While Haryana (5%) emerged as a preferred destination for electrical equipment, transportation and food processing. Tamil Nadu (8%) has been successful in attracting FDI in automotive related and auto components sector. Andhra Pradesh (7%) and Karnataka (7%) emerged as a popular destination for software, computer hardware and telecommunication.

26 Orissa has also been successful in attracting FDI in securing large Greenfields FDI projects in bauxite, mining, aluminum and automotive facilities.

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Recent changes to FDI Policy

The Department of Industrial Policy and Promotion (DIPP), Government of India recently released its new edition of the Consolidated FDI Policy, Circular 1 of 2011 that comes into effect April 1, 2011. This is part of the bi-annual review process that the DIPP commenced last year so as to ensure that the policy is in tune with dynamics in the economy and industry. The recent round of review has introduced a number of changes, t a broad level, the changes appear to be investor friendly as they seek to remove several obstacles that have long held back foreign investment in crucial sectors. In fact, this round represents one of the more progressive sets of changes made to FDI policy in recent times. Neither the substance of the policy nor its timing are surprising, given recent reports appearing in the press about a steady drop in the FDI flows into India in recent times. Clearly, the effort seems to be to arrest the slide. 1) The changes relating to pricing of convertible instruments: The DIPP has done well to recognise this problem regarding companies issuing shares below the fair value & giving more number of shares to attract more FDI. DIPP has addressed this by amending the relevant clause in the new policy (Circular No. 1 of 2011) as follows: 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

28 issuance of such instruments, in accordance with the extant FEMA regulations [the DCF method of valuation for the unlisted companies and valuation in terms of SEBI (ICDR) Regulations, for the listed companies]. These amendments carry several positive implications. 1. It has asked the issuers to set the conversion price upfront and to agree upon a pricing formula with the consent of all parties. It should be noted that the earlier policy required fixing the absolute price, and did not entertain a formula as such. This change brings the use of convertible instruments in India in line with normal market practice. 2. The minimum regulatory pricing norms (DCF, or SEBI, as the case may be) will be applicable with reference to the date of issue of the convertible instruments. Hence, parties are free to set any formula for conversion as long as the price so arrived at is not less than the regulatory minimum pricing as of issue date. The minimum pricing as of issue date will effectively operate as the floor price, as the conversion cannot result in issue of shares at a discount to such price. On the whole, these changes to the FDI policy makes convertible instruments assume their usual character, without being constrained by pricing restrictions. This may likely increase the use of such instruments while investing into India. 2) New FDI rules for expansion for the foreign partners in Joint

Venture The Indian government has eased foreign direct investment rules for overseas ventures looking to expand in the country. Under the revised FDI policy effective from April 2011, existing foreign joint venture partners will no longer require the permission of their local collaborator to set up a wholly-owned subsidiary in the same field of business.

29 Immediately after the policy has been announced, in Mumbai, telecom major Vodafone announced that it was buying up the Essar Group's 33% stake in Vodafone Essar for US$5 billion. In Delhi, two-wheeler manufacturer Hero Honda reported to the stock exchange that two representatives of Japanese partner Honda had stepped down from its board. The Hero Group and Honda have parted ways, after 26 years with Hero in the process of buying Honda Motor's 26% stake for US$851 million. And in Chennai, Swiss company Rieter said it was selling its entire 50% stake in Rieter-LMW Machinery to its JV partner Lakshmi Machine Works (LMW). This policy will be helpful for increasing FDI in India. But it may so happen that foreign companies start the joint ventures & immediately break it to form a new wholly-owned subsidiary. But still the strategically important joint ventures will remain unaffected. 3) Companies have now been classified simply into two categories companies owned or controlled by foreign investors and companies owned and controlled by Indian residents. The earlier categorisations of investing companies, operating companies and investing-cum-operating companies have been done away with to simplify the distinctions. Between April 2010 and February 2011, FDI inflows into India declined by 25 per cent to $18.3 billion. These changes were deemed essential to arrest this downward trend. 4) The new consolidated policy also allows Indian companies to issue equity in return for capital goods and pre-operational expenses such as rent. Only So far, the government recognised the flow of foreign cash as FDI. This measure, which liberalises the conditions for converting non-cash items into equity, is expected to significantly boost the prospects for foreign companies doing business in India

30 5) In the agriculture sector, FDI will now be permitted in the development and production of seeds and planting material without the stipulation of having to do so under controlled conditions

31

Recent changes in some of the sectors

FDI in Indias Tourism Industry The Indian tourism industry is interwoven with the countrys monetary development. As GDP continues to mature, it increases deals in fundamental infrastructure like transportation systems, which is necessary to support the tourism industry. The hotel industry is directly connected to the tourism industry in India. As new destinations extend the tourist entry is likely to rise. Numerous procedures have been taken in infrastructure, which will shine Indian hospitality for overseas guests. Under the automatic path, 100 percent FDI is allowed in hotels and tourism. Travel and tourism is a US$32 billion business in India with an input to 5.3 percent of Indian GDP. The hotel and tourism industries have been growing rapidly in recent years, bringing in huge revenues through overseas as well as domestic tourists in many parts of India. FDI in tourism With a view to stimulate domestic and international investments in this sector, the government has permitted 100 percent FDI in the automatic route allowing full FDI into all construction development projects including construction of hotels and resorts, recreational facilities, and city and regional level infrastructure. 100 percent FDI is now allowed in all airport expansion projects subject to the condition that FDI for up gradation of existing airports requires Foreign Investment Promotion Board (FIPB) approval beyond 74 percent. A five year tax holiday has been given to organizations that set up hotels, resorts and convention centers at specific destinations, subject to fulfillment with the agreed conditions. Some international hospitality majors such as Hilton, Accor, Marriott International and InterContinental Hotels group have already announced major venture plans in India in

32 recent years. It is expected that the hospitality division is expected to see an additional US$11.41 billion in inbound investments over the next two years. (Source: International Tourism Development Corporation) There are several types of tourism in India such as Medical tourism, Spiritual tourism, rural tourism, Adventure tourism, Ecotourism which will be experiencing a lot of investment & growth in coming future. FDI in pharmaceutical sector At present 100% foreign direct investment is allowed in the pharmaceuticals sector through the automatic route. The DIPP, the nodal policy making body for foreign direct investment, had put out a discussion paper suggesting to shift foreign investment in pharma to the government route so that proposals for mergers and acquisitions in this sector could be scrutinized by the Foreign Investment Promotion Board. The move was prompted by some recent big ticket takeovers of Indian pharma companies by global drugs majors. The countrys largest drugs producer Ranbaxy was acquired by Japanese Daiichi Sankyo for $ 4.6 billion in 2008.Piramal Health Cares chemical solution business was recently acquired by US-based Abbot Laboratories for $3.7 billion. India, with its high-tech processing and low-cost manpower, is considered an attractive base for production for pharmaceuticals. Domestic companies are thus seen as lucrative buyout targets by MNCs seeking to expand capacity. The large-scale sell-out to MNC drug companies has created an apprehension that this could undermine the generics industry, affecting the availability of cheap drugs. The Indian Drug Manufacturers association has pitched for allowing foreign investment to only 74% and making FIPB approval mandatory. However, such a move would adversely impact the image of India as an

33 attractive destination for inbound FDI. The DIPP should shift FDI in pharma from automatic to government approval without reducing the 100% cap FDI in Limited Liability Partnerships The current inflow of foreign direct investment (FDI) to the country may get a boost because the Cabinet Committee on Economic Affairs (CCEA) has allowed FDI in limited liability partnership (LLP) firms, according to a government statement released on May 11, 2011. With this approval, the LLPs will have the opportunity to choose among domestic and foreign investors, thus creating a more competitive environment. The initiative is also expected to encourage more partner firms to get converted to LLPs. Although the new initiative may usher in more foreign funding, it will be implemented only in a calibrated manner and only in sectors like mining, power, roads & highways, manufacturing and pharmaceuticals where 100 per cent FDI is allowed for companies through the automatic route and there are no FDI-linked performance-related conditions. However, LLPs involved in agricultural and plantation activities, print media or real estate business will not be allowed to have FDI. LLPs will not be permitted to avail of external commercial borrowings; neither can they make any downstream investment. The Cabinet has further decided that foreign institutional investors and foreign venture capital investors will not be permitted to invest in LLPs. These restrictions are effective measures on the governments part to prevent LLPs from turning into new investment vehicles.

SEZ in India SEZ Policy was drafted with an intention to bring an overall boost to the Indian economy attracting the foreign investment & to give a very strong message to the investors worldwide about the strong desire to give them

34 a friendly business environment & policies free from the clutches of bureaucracy. The incentives and facilities offered to the units in SEZs for attracting investments into the SEZs, including foreign investment are as follows:

Duty free import/domestic procurement of goods for development, operation and maintenance of SEZ units 100% Income Tax exemption on export income for SEZ units under Section 10AA of the Income Tax Act for first 5 years, 50% for next 5 years thereafter and 50% of the ploughed back export profit for next 5 years.

Exemption from minimum alternate tax under section 115JB of the Income Tax Act. (In the Union Budget 2010-11, there is no more exemption on SEZ developers and SEZ units.)

External Commercial Borrowing by SEZ units up to US $ 500 million in a year without any maturity restriction through recognized banking channels.

Exemption from Central Sales Tax. Exemption from Service Tax. Exemption from State sales tax and other levies as extended by the respective State Governments.

Despite having so many incentives, SEZ in India contribute very less to Foreign Direct Investment unlike China, where the SEZs contribute to more than 20 percent of the total FDI. The SEZ model was also successfully implemented in Poland and Philippines. In Poland the SEZs contribute to almost 35 percent of the FDI inflows. Indian SEZ has attracted FDI inflows of mere $1.2bn in 2007-08, whereas the total FDI inflows in that year were around $24 bn. The contribution from SEZ further reduced during the period 2008-2011. In the span of 3 years SEZ has only attracted $2.42 bn while total FDI inflows were around $72.59 bn.

35 One of the largest Chinese SEZ, Tianjin has attracted USD 10.8 billion in 2010. In 2009, Shenzhen SEZ generated a GDP of USD 120 billion and utilized USD 4.16 billion in Foreign Direct Investment (FDI). 162 of the top 500 companies in the world have locations there. Shenzhen is the leading city in China for electronics manufacturing. It is a hub for Electronic Manufacturing Suppliers (EMS) and Original Equipment Manufacturers (OEM). This allows companies to cut costs by accessing a full supply chain in one location. Shenzhens skilled workforce is fed by the province of Guangdongs 100 universities, enrolling over 874,000 students in the regional area. There can be many reasons for Indian SEZs low performance such as India has more number of SEZs, if compared to China. India has 114 SEZs (as of October 2010). But SEZs in India are smaller in size. The average land area of an SEZ in India is 130.13 hectares. So the small SEZs could not make full use of the economies of Scale which is the whole idea behind development of SEZs. Infrastructure in SEZs in India is still lagging behind other nations. Unlike, Indian Government, the Chinese government itself develops SEZs instead of giving the contracts to private constructors. Government can move a lot of resources easily as compared to private cos. India can count on PPP (Public private placements) in this case. Most of the Chinese SEZs are restricted in costal parts & some specified parts in the country from where raw materials and products can be easily mobilized. In India there are not many specifications. Chinese Labour laws are way more liberal by manufacturers point of view. Recent tax issue such as: In the proposed Direct tax code (DTC), the government has proposed to levy Minimum Alternate Tax (MAT) of 18.5% on the book profits of Special Economic Zone (SEZ) developers

36 and units. The imposition of MAT on SEZ developers and units will negatively affect investors as it seeks to impose tax on income received from investments made with a commitment of tax exemption. The government has also proposed to impose dividend distribution tax on SEZ developers. Having poor performance in FDI, SEZs in India have been posting good results in case of exports though. Exports from SEZs: Rs. 22,840 crore in 2005-06 to Rs. 2,20,711 crore in 2009-10. India earned Rs 3.15 lakh crore by way of exports from the special economic zones (SEZs) during the last fiscal. It shows that Indian SEZs have enough potential to perform better; then it is a sign of concern as to why FDI coming in SEZs is low & if India wants to attract more FDI, reforms should be brought. Low in number but larger size SEZs, improvement in infrastructure, efficient resource mobility will be really helpful for augmenting FDI in SEZs.

37

Comparison with China

Creating friendly business climate for attracting FDI China, The leader in attracting FDI in an emerging market creates congenial business climate in its economic market environment. Their Model of attractiveness has three underpinnings: structural changes and strategic infrastructure. Structural changes in the economy include improving physical infrastructure. Availability of road network, water, electricity, telecommunications, and other resources provides opportunity for TNCs to produce, move goods and services efficiently, and minimize costs to that they can compete globally on a cost advantage. The strategic infrastructure includes location decisions like it should have connectivity with the vicinity to obtain continuous supply of cheap labor from backward areas. The specified area should be self contained and have world class infrastructure such as hotels, airports, banks, stock markets, retail stores, educational institutes, recreational facilities, etc. The infrastructure can be strategic if it has proximity to the largest global markets and has connectivity with the global shipping network. Such economic clusters are strategic in every sense of the system for merit term. FDI-PIS (India-china) Indian scenario is characterised by strong portfolio inflows and much weaker foreign direct investment (FDI), with China, where the situation is the reverse. The difference to the opening of the capital market can be the cause. There is another factor thats just as critical, if not more. Ease of entry and exit.

38 Today, it is relatively effortless for Portfolio Investments (PIS) to enter the capital market. A Sebi registration, preceded by a fairly regular carefulness, is all it takes before PIS can enter the Indian stock market and commence trading. Exit is equally simple. For FDI, however, both entry and exit are far more difficult. No wonder portfolio inflows into India far exceed direct investment flows. Its just the reverse in China. FDI is in the range of $100 billion, while portfolio flows are much lower, in the range of $10-15 billion. Part of the reason is that equity markets are far less open than in India. The market is segregated between resident and non-resident investors and there are strict controls.

FDI Inflows-INDIA v/s CHINA A comparative analysis shows that India has a more liberal FDI regime than China. Yet, China attracts considerably more FDI than India. One of the important reasons for this abnormality is that India continues to be one of the highest transaction cost economies in the world. Here again, if one compares the ease of setting up a business by a foreign entity, then India scores over China. According to the World Bank study Investing across Boarders 2010, while it takes 18 procedures and 99 days to set up a foreign-owned limited liability company in China, it takes 16 procedures and only 46 days to do the same in India. Also, the Chinese approval process is not an easy one and includes both national and regional approval. While in China, both national and regional approval is one process, in India federal approval and state/local approval are two different processes and this often leads to projects getting bogged down in red tape and bureaucracy, leading to higher transaction costs. Separate clearances are needed to be taken.

39 E.g. one of the largest FDI into India: the $9.6 billion deal between London-listed Vedanta and British-owned Cairn India. Vedanta has been waiting for nine months to acquire Cairn's oil fields, but has been held up because an Indian state-owned enterprise's interests are on the line. The major port projects stuck due to environmental clearance include the Rs 3,600-crore container terminal project at Chennai, Rs 400-crore coal terminal at Marmagao Port (Goa), Rs 721-crore project for iron ore export at Marmagao port that is being built as a public-private partnership projects and projects worth Rs 1,000 crore at Paradip (Orissa). In Gujarat, Kandla Port, too, has one project worth 1,000 crore awaiting environmental clearance. (Source: Green hurdles cost port sector Rs10,000-crore- An article in India Urban infrastructure review) As matters stand, many of the proposed steel projects are facing seemingly intractable problems, mostly surrounding socio-economic issues like acquisition of land, forest and environment clearances, rehabilitation and resettlement of the project-affected people, Naxalite menace in Chhattisgarh, Jharkhand, Orissa and West Bengal, nonallocation of adequate captive mines, and supply of raw materials. To cite a recent example, the fate of South Korean company Posco's five-year old project to set up a 12-million tonne-per annum, integrated steel plant in Orissa worsened further after a key committee in the environment ministry recommended the withdrawal of forest clearance to the Rs 54,000-crore project, the single-largest foreign direct investment in India to date As a consequence due to these delays, India actually receives much less FDI than what it approves.

FDI development in China:

40 China is an example of a country that has created conducive business climate, attracted FDI over last twenty five years, and grown into being a $2.2 trillion dollar economy, the third largest economy in the world, and the fastest growing economy in the world. In 2010 FDI inflows to China were $101 billion as opposed to $25 billion for India. Chinas achievements and comparison with India demonstrate the success of the congenial business climate adopted by China. In 1978, India ($136 b) was not much far behind China ($148.1 b) in terms of GDP. Chinese government initiated reforms in 1978 and carried them forward in 1992. In 2010, Indias GDP is $ 1.32 trillion as against Chinas $ 5.88 trillion. China followed an export-import oriented growth pattern as opposed to an Indian import-substitution pattern. Chinese government made structural changes in the economy, provided strategic infrastructure in form of SEZs, and took strategic policy initiatives to provide freedom, openness in trade and made flexible labour laws to attract efficient labor in the manufacturing sector. All these factors attracted TNCs to set up manufacturing units in the SEZs and export the produce to different parts of the globe. Structural changes made in the economy can be demonstrated though the development of Shanghai and its modern infrastructure. Shanghai was a backward small place some fifteen years back. The government initiated the change process that brought about significant improvements. Modern Shanghai attracts 180 million people, has a GDP of $110 billion and has attained a growth rate of 10% for last ten years. Comparing Shanghai with India it seems strange that in some cases the achievements of the city are as good as that of our country India. Shanghai received $60 b in FDI as opposed to $58 b for India in 2006, in 2010, Shagnhai has received 17 billion US$ against Indias 25 billion US$.

41 Indias foreign trade was 30% less than Shanghais $241 b in 2005, Shanghai worlds largest port handled 443 million tones cargo against 423 million tones handled by 12 ports of India in 2010. Nearly 40,000 foreign invested companies have opened office in Shanghai. Strategic policy initiatives taken by Chinese government were providing economic freedom and creating openness during the period 1978-2005. Government intervention reduced over time and in 2005 85% of the manufacturing was outside non-state sector. Government allowed joint ventures between foreign and local firms, gave incentives, tax holidays, promoted exports, and wages were kept low due to allowing free competition. Lease and ownership rights were provided to foreigners. Tax exemption on importing machinery, free movement of goods between SEZ designated areas, rebates on export duty, liberal entry and exit policies were adopted. Foreign currency transactions were allowed in SEZ designated areas. Visa norms and zoning laws were simplified for foreigners. Foreign firms could form Wholly Foreign Owned Enterprise (WFOE) in China from 1986 onwards. Bilateral tax treaty has also helped in attracting investment. Flexible labor Laws were created in 1979, Labor housing was freed and free movement of labor in economic zones was permitted. Initially 20 million people were unemployed but with the growth in industrial activity unemployment rate dropped.

What India can learn from China?

Based on the Indian FDI model and findings from Chinese FDI model policy recommendations are made for creating a Congenial Business Climate in emerging market. India has to make structural changes in the economy.

42 Expressways have to connect all parts of the country. In the telecommunications field, mobile telephony has been highly successful in India and its penetration should continue to benefit farmers and rural poor people. Trailing Indian states of Bihar, Madhya Pradesh, Orissa, Uttaranchal, Uttar Pradesh, Chhattisgarh, and Jharkhand have to experience this favourable business climate growth. Power and electricity reform is another area where India needs to take immediate steps. Power sector has given -26% returns on government equity employed. India has to overcome the current service sector myopia. Service sector growth should be supported with manufacturing growth as well. Rural population may not be easily converted into computer literate call center executives. India has to diversify from developing service sector based core competence being currently followed to developing dynamic capabilities to augment current services growth with manufacturing growth. Even if we take a look at FDI inflows its the service sector that has been enjoying major FDI inflows.

Sectors attracting highest FDI inflows [Source: DIPP]

43

Paradigm shift in Indian manufacturing is required. India has to move towards skill-neutral mass manufacturing.

44

Despite manufacturing growth of 9% in last three years, current manufacturing pattern has created a job-less growth. Backward states do not have majority of educated people so a skill neutral massmanufacturing will help employ large number of unemployed youth. China has areas-wise advantage over India as China is the 2nd largest country in world by land area which is more than double when compared to India. India is developing 100s of SEZs that are small in size. Chinese SEZs are large-Hainan SEZ for example is of the size of Kerala. The right strategy for India might be rapid formation and showcasing of large but few SEZs on east coast. Most approved applications are either in landlocked areas or are in the developed states. Indian ports are congested and plagued with management which is not up to the mark. No major ports are there in west Bengal & there is Only 1 major port in Orissa .Creating large ports in open spaces from scratch in a state like west Bengal, Andhra & Orissa will help in developing state-of the art ports that can handle large ships directly. Port to be developed should have deep bed port facility. India has lagged behind due to its focus on services and specialized skill based relatively small manufacturing model in contrast to China. Indian growth model has been based on IT, ITES, and skilled manufacturing which is dependent on the availability of human skill and capital in an emerging market. India can learn lessons from China and create congenial

45 business climate in the country to catch up with China. If India can create structural changes at a faster pace it might attract more FDI and grow rapidly.

46

Recommendation regarding FDI

First of all India should try to increase the saving rate in India by way of stopping corruption, black money & controlling inflation. Only attracting more & more FDI should not be the objective of our country but the aim should be using FDI only in areas where it is really required. We should try to be self-sufficient in areas where we can & allow more FDI to flow in technological fields. India also requires FDI for nullifying the negative balance of trade or current account deficit. Recent figures show that Indias current account deficit is 2.7% of GDP, an amount of about $53 billion. And Indias budget deficit is around 5% of GDP. But thats not the right reason for attracting more & more FDI. One of the main reasons for attracting FDI in India is to fill the gap between savings & investment. It is agreed that Indias savings are lower than its investment requirements but the illegal flight of capital (Black money) from our country to outside countries can be one of the problems which if solved can seriously reduce the need for FDI. If this black money, otherwise, would have been available, India can do wonders with such a huge quantum of funds. India should immediately take some serious steps against the illicit flight of funds. FDI in Industry & manufacturing sector should be given preference. Only 15-20% of the total FDI is coming in industrial sector. A lot of scope & opportunity is available in areas of technologically engineered goods, metallurgical, oil & natural gas sectors, small scale industries, chemicals etc. Like China, India should also formulate some norms regarding mandatory exports to be done by foreign companies which will add to

47 the requirement of essential foreign exchange. At the same time India should build conducive business environment to lower the procedural costs & give them incentives, so that the foreign firm will be motivated to increase their exports. India's exports Year 200102 200203 200304 200405 200506 200607 200708 200809 200910 201011 Source: Department of Commerce, Government of India. From the above data it can be observed, that exports & FDI in case of India are not much positively co-related. Exports of India have been growing no matter what has happened to FDI in India. 2002-03 FDI inflows fell by almost 25%, still the exports showed 20% growth. Similarly in 2006-07 Indias FDI has augmented 3 times i.e. 300% but exports grew by 25% in that year & by 20% in next fiscal year. Exports (US $ million) 43,826 52,719 63,842 83,535 1,03,090 1,26,414 1,63,132 1,85,295 1,78,751 2,75,087 FDI (US $ million) 4,222 3,134 2,634 3,755 5,558 15,732 24,588 27,330 25,834 19,427

48 Indias exports in the fiscal year 2010-11 touched 275 billion, from $178 billion last year. India's merchandise exports rose an annual 37.5 percent in the last fiscal year, surpassing the initial target of $200 billion, as demand soared for engineering goods, oil products and gems. This is an interesting thing because our FDI has decreased by almost 25% in this fiscal still our exports are not much affected. Hence, it can be said that FDI in India is not helpful for exports. India has failed to evolve as inward FDI manufacturing destination which is most essential of all sources of FDI. Manufacturing investment has potentiality to develop ancillary industries also. There is a wide spread disguised unemployment in agriculture. Manufacturing sector has greater scope of low end, labour intensive manufacturing jobs for unskilled population when compared with service sector. There are a lot of obstacles in achieving friendly business environment in India where we should improve significantly; these factors are corruption, regional disparity in infrastructure, Illiteracy, lack of training in rural labours, acute labour market rigidities, and lack of world class ports, airports, and road and on an average 6-7 hours of power cuts. The issues of geographical disparities of FDI in India need to address on priority. Even the state like West Bengal which was once called Manchester of India attracts only 1.2% of FDI inflow in the country. West Bengal, Bihar, Jharkhand, Chhattisgarh are endowed with rich minerals but proper initiatives is required by governments of these states, they fail to attract FDI. India is striving hard to achieve a growth rate of 10%. Improving the level of productivity can be instrumental in achieving this target as growth rate is positively related to rates of return. Mauritius contributes about 44% of FDI inflow in the country. Such a high level of FDI contributed by a low tax country like Mauritius indicates that all is not well. Mauritius has agreement with India on

49 avoidance of double taxation. The corporate tax rate of Mauritius is 15% & there is no tax on capital gains & branch profit tax in Mauritius. Hence, it is likely that many MNCs may be first dummy companies in Mauritius before investing in India. This is not good for financial stability of the country and is also a reason for loss to state exchequers. Inflation is also affecting badly to Indian economy, as inflation reduces growth prospects in future there by affecting the psychology of foreign investors such as PIS & FDI. RBI is taking the adequate steps to curb the inflation problem & India surely can see a rise in FDI after the inflation is under control. FDI can be instrumental in developing rural economy. But proper care should be taken before allowing Greenfield projects. No land acquisitions should be allowed in case of fertile lands, like in ArecelorMittal case in Orissa. Also, proper consultation & study should be done before accepting any green field project in environmentally critical areas. In some cases rather than having more FDI, government should take initiative itself, or should support Indian firms. E.g. India is well known for its natural beauty, tourist places & its well diversified & well enriched culture. So instead of handing this huge opportunity in tourism sector to foreigners, government should develop the sector by itself. This sector, if expanded, will help the rural people as a source of earning & well-being. India has a huge pool of working population. However, due to poor quality primary education and higher there is still an acute shortage of talent. This factor has negative consequence on domestic and foreign business. Given the status of primary and higher education in the

50 country. The issues of regional gap in education have to be addressed on priority. In order to improve technological competitiveness of India, FDI into R&D should be promoted. Various issues pending relating to Intellectual Property Rights, Copy Rights and Patents need to be addressed on priority.

51

FDI in Multi-brand retail sector

Currently India allows 51% FDI in single-brand retail and 100% FDI in cash-and-carry stores who can only sell to other retailers and business concerns and not to individual consumers who shop for home consumption. The main driver for this policy seems to be the recognition that the Indian economy faces serious supply-side constraints, particularly in the food-related retail chains. The government would like to improve back-end infrastructure, and ultimately reduce post-harvest losses and other wastage. There is also a general concern, highlighted by the persistence of food inflation, that intermediaries obtain a disproportionate share of value in this chain and farmers receive only 15% of the end consumer price. FDI in Retail has always been a very sensitive issue in India. Supporters of FDI have been highlighting positivity it will bring to Indian economy like greater efficiency, raising the employment & thereby improvement of living standards and of course benefit for consumers by way of price reduction. But at the same time, people opposing it feels that it is a labor displacing act and will endanger unorganized and small retailers of India as well as Indian Retail Players. They believe it will affect balance of our economy when these foreign investors will draw billions of rupees as profit out of our consumer spending. Undoubtedly, as some people say that lower prices psychologically propel buyers to spend more than they otherwise would. The resulting growth in private consumption creates jobs. But, what we must avoid is a situation similar to the one in the US, where increased consumption does take place, but actually creates jobs in China. If we can ensure that recruitment of employees from large-format retail takes place within India, it may have a beneficial impact on jobs.

52 If we see many other developing nations like China, Malaysia, Thailand etc., have opened up there Retail Sector without much problems. But one must also not forget how these countries that opened their retail sector to FDI in the recent past, have been forced to enact new laws to check the radical expansion of the new foreign malls and hypermarkets. Even it is obvious that many economical, political, social aspects are not the same in case of India as they are in case of China or Thailand. Some of the features of Indian retail industry: 1) A simple glance at the employment numbers is enough to paint a good picture of the relative sizes of the two forms of trade in India Organized & unorganized 2) Organized trade employs roughly 10 lakh people whereas the unorganized retail trade employs nearly 3.95 crores. Unorganized sector is still predominant in the retail sector in India, the unorganized retail sector account for 98% of total trade, while organized trade accounts for only 2% held. 3) With about 11 million retail outlets operating in the country and only 4% of them are larger than 500 square feet in size. Compare this with the figure of just 0.9 million retail outlets in US, yet catering to more than 13 times of the Indian retail market size.

Detail look into the issue, with an example of Walmart

Walmart is the worlds largest company by turnover & worlds biggest Multi-brand retail company. Walmart is a US based company having 8,500 stores in 15 countries, under 55 different names & has an annual turnover of USD 421.849 billion worldwide (i.e. 26% of Indias GDP). In November 2006, the company announced a joint venture with Bharti Enterprises to open retail stores in India. As foreign corporations are not allowed to

53 directly enter the retail sector in India, Walmart will operate through franchises and handle the wholesale end. Bharti will manage the front end involving opening of retail outlets, while Walmart will take care of the back end, such as cold chains and logistics. Mr. Joe Menzer of Walmart recently met Prime-Minister Dr. Manmohan Singh for discussions regarding FDI in Multi-brand retailing. Implications of Entry of Wal-Mart Let alone the average Indian retailer in the unorganized sector, no Indian retailer in the organised sector will be able to meet the onslaught from a firm such as Wal-Mart when it comes. With its incredibly deep pockets Wal-Mart will be able to sustain losses for many years till its immediate competition is wiped out. This supermarket will typically sell everything, from vegetables to the latest electronic gadgets, at extremely low prices that will most likely undercut those in nearby local stores selling similar goods. Wal- Mart would be more likely to source its raw materials from abroad, and procure goods like vegetables and fruits directly from farmers at preordained quantities and specifications. This means a foreign company will buy big from India and abroad and be able to sell low severely undercutting the small retailers. Once a monopoly situation is created, this will then turn into buying low and selling high. The proponents of FDI in Retail argue as to how FDI in Retail will transform the supply chain benefiting farmers and small producers. They also argue that once the likes of Wal-Mart are established in India, exports will grow. The volume that the Wal-Mart sourcing from China, which is now in excess of US $20 billion annually. The suggestion therefore being that Wal-Mart will do likewise in India. But we cant ignore the other side of the argument, which says Wal-Mart is committed to buying the best goods at the cheapest prices to give its customers the best value for money. . That is why it sources so heavily in

54 China. Wal-Mart sourcing from China is now in excess of US $20 billion annually If Wal-Mart were a country it would have been Chinas sixth largest export market and eighth largest trading partner. The argument is that even if Wal-Mart were not operating its retail business in China it would still continue to source heavily from there. One had nothing to do with the other. Lets consider the opposite side to that, Wal-Mart also has a sourcing operation based in Bangalore and its Indian exports are less than 5% of what it procures from China. The reasons should be obvious. Its about getting value for money. The Government of Indias Department of Consumer affairs in collaboration with the Indian Council for Research on International Relations (ICRIER) has published FDI in Retail Sector INDIA in June 2005. The study strongly advocates that foreign direct investment should be allowed in retailing since it would speed up the growth of organized formats. It further states, In the initial stage FDI up to 49% should be allowed which can be raised to 100% in 3 to 5 years depending on the growth of the sector. FDI cap below 49% (i.e. 26%) would not bring in the desired foreign investment. It admits Foreign Retailers have pointed out that setting up of manufacturing base in India is difficult since the infrastructure is poor, labor laws are unfriendly, etc. If this absurd argument is carried to its logical limit, the retailers seem to be persuasive for unrestricted imports of all sorts of goods for consumption through a well-developed, single point-sourcing channel. (Source: FDI in Retail - II Inviting more Trouble? By Mohan Guruswamy, Kamal Sharma, and Centre for Policy Alternatives) The hyper marts and superstores of the foreign retail giants fed by manufacturing nodes in ASEAN and China could then swamp the retail space in India edging out not only the traditional distributors and retailers but also putting out organized retailers, the SSI and medium scale manufacturers in India. India with a current total domestic retail market of over Rs.100, 000 crores, and with organized (large format) retail of only Rs.3500 crores is the most wanted destination for these retail giants.

55 If Wal-Mart has accepted a secondary role within India in which Bharti interfaces with one billion potential consumers and does not display the global behemoths name on its exhibitions, then its interests and profits lie in furthering its monopsonist procurement. India will provide a new market for selling Wal-Marts monopsonistically procured goods. Bharti will then only be a thin cover for Wal-Marts profit making objectives and will help them greatly in spreading their operation in India. This at a time when we still have not got around to facilitating lower cost and more efficient manufacturing in India through enabling legislation and regulation will be destructive to our economy. The contribution of industry to GDP in 2010 was 28.6% for India there to manufacturing only accounted for while for China over roughly the same period it was 46.8%. Even when China allowed & opened FDI in multi-brand retail, the contribution of industry to GDP in 1992 and 1994 China was 42% and 47%. Indian industries contribute a mere 28% to GDP. Before allowing FDI in retail we need to know that the efficiency of the giant retailers arises from their ability to procure from the cheapest global source and its overwhelming power to force prices down because of its enormous volumes of purchase of any single item. When China allowed FDI, there were liberal or in some cases inhuman labour laws. Earlier Chinese labours were not allowed to form unions, participate in collective bargaining, and take recourse to strikes. Usually work consists of 12 hours a day with a regular overtime. Working age was 14-25 years. Any worker can be fired without giving official 1 months notice. Few benefits, poor working conditions were offered to workers & even female employees were not allowed to get pregnant otherwise they used to be retrenched.

56 The case of the Taiwan-owned Wintek factory, which makes electronic components for Apple, is not unusual. Last year, an audit of factories Apple contracts with in China showed that more than half of the factories were not paying valid overtime rates for those that qualified. In addition, 23 of the 83 surveyed factories weren't even paying their workers minimum wage. Apple is not alone in this respect. In 2008 labor groups claimed that Chinese factory workers lose or break about 40,000 fingers a year on the job, as well as accusing factories in the Pearl River Delta of unfair labor practices, using child labor and failing to pay wages. These factories supply multinational corporations such as Wal-Mart, Disney and Dell. The average industrial wage in China still compares poorly with that in India, a country whose per capita income is only a third of it. Chinese authorities have begun some trade union activity recently; even Wal-Mart was forced to accept unions in China. But still the labour laws are in favour of manufacturers & hence cheap labour is available. It is obvious that India cannot adopt the cheap labour strategy used by China. India, being a democratic country, simply can not have such labour laws. And Indian economy is still not developed in manufacturing sector & infrastructure. It is also recognized that Chinese exports are aggressively subsidized by the state. Hence, definitely even after opening the retail shops in India, foreign giants will like to borrow the products from china. About food products the contract farming imposed on farmers by MNCs require strict adherence to quality and schedule. It is difficult for our small tomato or onion farmers cope with the weather problems, and the infrastructural constraints to fulfill their legal contracts. India can follow the Chinese model of caution and vigilant approach. China allowed FDI in retail in 1992 but the cap was at 26%. After 10 years the

57 cap was raised to 49% when local chains had sufficiently entrenched themselves. Further, foreign chains were initially permitted to set up stores only in a few select cities. Local retailers were officially encouraged to become big by mergers and acquisitions so that they would be in a position to compete with big global players. In other words, China provided infant industry protection to domestic retailers, which was gradually reduced as the local players gathered strength. And then 100% FDI in retail was permitted only in 2004 after the infant retailing industry had acquired some muscle. Even in as liberal an economy as Japan, large-scale retail location law of 2000 stringently regulates factors such as garbage removal, parking, noise and traffic. Recently Carrefour (The 2nd largest multi-brand retailers in the world) decided to exit Japan by selling off its eight struggling outlets after four years as the extremely cumbersome Japanese regulations blatantly favor its own homegrown retail firms.

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Analysis & Recommendations:

There is huge potential in retail market, then why not promote a PPP (public Pvt. Partnership) in retail market sector or just give boost to already existing Indian companies. Why to allow International players when these things can be taken care of by Indian companies only. Considering the current scenario India should develop its Manufacturing hub well before allowing FDI in multi-brand retailing. If foreign retailers are going to be allowed in future, the huge demand which will be generated can be met by developed Indian manufacturers rather than importing it. Even a developed manufacturing sector will take care of unemployment caused due to removal of middlemen in supply chains. Arrival of big retailers has had an impact on small grocers; small stores are still growing their sales, although at a much lower rate than modern trade, according to data from market research firm The Nielsen Company. Since 2006, when most big retailers either entered the retail space or began expanding their network, sales in local kiranas have grown in the low single digits even less than the GDP growth rate, while modern trade has grown in strong double digits. For instance, sales at modern stores grew 34% in 2006 and 29.3% in 2010. Traditional stores could increase sales only 1.5% in 2006, but improved the growth rate to 6.2% last year (see graph) Growth rates

59 (Source: Modern retail outgrowing kirana stores in India- An article printed Economic Times dated 15th June 2011). Having this situation, bringing in large foreign retailers wont be a clever decision. A National Commission must be established to study the problems of the retail sector and to evolve policies that will enable it to cope with FDI as and when it comes. It will also regulate the whole retail sector which has become a very delicate issue The conditionals must be aimed at encouraging the purchase of goods in the domestic market, state the minimum space, size and specify details like, construction and storage standards, the ratio of floor space to parking space etc. Giant shopping centres must not add to our existing urban problems. The argument that Large Foreign Retail giants will not crowd-out small retailers should be reviewed as even the modern Indian retail sector had an effect on small kirana stores.

Implications in Food Retail sector It is widely agreed that the supply chain that links the Indian producer to the domestic consumer is primitive, outmoded and wasteful. Many studies exist that detail the extent of wastage. We will readily concede that large format retailing with its capacity for bulk procurement and capital investment, even if it accounts for a fraction of the retail trade in the sector, might be able to make some development in modernizing the supply chain. But this does not make FDI imperative. Entry of Multinationals in the Food-retail sector aims at cutting out many layers of middlemen, and establishing a direct linkage with the farmers. They may also develop the processing facilities and export the products to meet their global requirements, farmers would get better prices and

60 bigger markets while the consumers would benefit in terms of lower prices, better quality and greater variety. But farmers can face problems related to specifications of MNCs, delayed payments and lack of credit and insurance. The emergence of such problems in India, especially in the context of the deep crisis that has engulfed the agrarian economy, is entirely avoidable. The MNCs will deal with only the large-growers, & only few farmers will benefit. MNCs will fix prices in advance & can easily mislead farmers. MNCs will offer good prices to farmers at the beginning and after they develop the monopoly they may exploit the farmers by offering lower prices. Recommendations for the Food Retail Sector: India should itself develop its Agricultural infrastructure rather than looking for FDI. Provision of training in handling, storing, transporting, grading, sorting, maintaining hygiene standards, upkeep of refrigeration equipment, packing, etc. is an area where ITI (Industrial Training Institute) and SISI (Small Industrials Service Institute) can play a proactive role. It should give boost to the setting-up of co-operatives like Amul. It can be seen that Amul has been very successful with its unique supply chain & has got immense success in handling a quick perishable product like Milk. Amul is managed by a cooperative organization (Gujarat Co-operative Milk Marketing Federation Ltd.) & the milk suppliers are its shareholders. The owners decide what they should pay themselves for the raw material they supply. A unique situation where the owners of the company are also its largest vendors. In the Amul system milk is collected at the collection centres. These collection centres are in the village, where the milk quantity is measured, the quality is checked

61 and payment is made. The milk is then transported by vans to a chilling centre within 2 hours. At the chilling centre the milk is pasteurized and then packed. Some surplus milk is sent to a factory to be converted to other milk products. A simple hub and effective system. The miracle is that all this was done 40 years back, when road and infrastructure was primitive. Then there is no reason why it cannot be done today. For the fruit and vegetable supply chain to be successful, the farmers need to organize themselves into cooperatives. That way they will have the bargaining power with the buyers and transporters. Instead of multitudes of cooperatives, there should 1 per district or state. Next, the cooperatives would have to invest in Cold Storages. The collection of fruits and vegetables has to be organized. The onward distribution of the fruits and vegetables to cities, retail stores can then be organized by trucks or railway parcel vans. A Commission should be set up for Agricultural Perishable Produce to ensure that procurement prices for perishable commodities are fair to farmers and that they are not distorted with relation to market prices. Creation of infrastructure for retailing at mandis, warehouses, transport systems, community welfare centers and government and private colonies with a focus on easier logistics will enable greater employment and higher rollover of products.

While allowing the FDI in multi food-retail following norms can be kept for foreign companies like Fixing quota of Indian make products in their offerings in India. Say for example if they are offering Rs. 100 values of products, than Rs. 80 worth products should be made in India. This would increase demands of Indian Products and will boost Manufacturing sector too. Above clause will encourage them to get

62 manufactured some goods in India. If cost of manufacturing is controlled, retailer may also export these products to their outlets in other countries boosting Indias export. Govt. can impose that 100% of Fruits & Vegetables they are offering are produced in India. This will encourage contract farming by these Retailers in agreement with farmers ensuring high quality produce and better earnings to poor farmers of India. Further Govt. needs to monitor Prices in order to ensure that price efficiency of these retailers is not killing small Indian players. Some part of the total FDI say 50% should go for back-end infrastructure. MNCs will be allowed only in metropolitan cities with the specified floor area for their establishments. 26% FDI should be allowed at first & cautious approach should be taken while raising the limit after some years.

Conclusion
FDI as we have seen can complement local development by boosting export competitiveness, employment generation and strengthening skills, transfer-diffusion-generation of technology and enhanced financial resources for development. Recently Global investors have ranked India as the second top-priority destination for FDI in coming years, after China. India is attracting a low level of FDI largely due to poor business environment, lack of infrastructure & corruption issues prevailing in the country. The investment climate in India has become much friendlier today than previous decades. Investors are showing their growing confidence in the immediate and medium term prospects of Indian Economy.

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With the efforts of government & RBI, the FDI inflows are again showing a robust growth in 1st quarter of f. y. 2011-12. It is definitely a great sign of recovery of FDI inflows & strengthening of foreign investors confidence in our country. The new policy changes that had been brought in surely have played an important role in this rise. However, a lot is to be done if we want to reap full benefits out of FDI inflows & emerge as the greatest economy. FDI might be one of the important sources of financing the economic development. However, one should not forget that FDI alone is not a solution for poverty eradication, unemployment and other economic ills. Our aim should not only be increasing our GDP, posting double digit growth rates, improving FDI inflows but also to redirect the benefits of these achievements to all sections of the society by reducing poverty, inequality & raising the standard of living. Economical, political & social needs should go hand in hand & with all this falling in line we will be able to say ourselves A truly developed nation. Economical, political & social needs should go hand in hand & with all this falling in line we will be able to say ourselves A truly developed nation.

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References
Consolidated FDI Policy (Effective from April 1, 2011) Department of Industrial Policy and Promotion Ministry of Commerce and Industry Government of India RBIs Master Circular No.13/2010-11 July 01, 2010 RBI/2010-11/13 Fact sheet on foreign direct investment (FDI), March 2011www.DIPP.nic.in/ Foreign Direct Investment in India - 1947-200- a book by Kamlesh Gakhar. Does Foreign Direct Investment Promote Development?- A book by T. H. Moran Role of FDI in Economic Development of India: Sectoral Analysis-Ila Chaturvedi-30/3/2011 Indias Foreign Direct Investment: Current Status, Issues & Policy Recommendations by Mohd. Shamim Ansari, Mukesh Ranga-27/6/2010 Comparative analysis of FDI in India & China: Can laggards learn from leaders? A research project by Swapna S. Sinha. Determinants of FDI in China: Shaukat Ali and Wei Guo Issue of discussion paper over Foreign Direct Investment in Retail trading-DIPP Foreign Direct Investment by Valentino Piana (2005) FDI in Indias Tourism Industry Posted on February 14, 2011 by India Briefing By Ankit Shrivastava, Dezan Shira & Associates Indias FDI inflows: Trends & Concepts K.S. Chalapati Rao & Biswajit Dhar, ISID Working paper February 2011 How European crisis could impact India? Understanding the linkages An article By Amol Agrawal. What Walmart can learn from AMUL?-An article Dr. Verghese KurienNovember 15,2009 WalMarts supply chain management practices- ICFAI Demystifying Compulsorily Convertible Preference Shares- Finance Mortem Blog

65 SEZs as growth engines - India Vs Chin- An article by Pradeep Nema, Social Science Research Network FDI in Retail: More Bad than Good? FDI in Retail II Inviting more Trouble? and FDI in Retail-III: Implications of Walmart's Backdoor Entry By Mohan Guruswamy, Kamal Sharma, Central for policy Alternatives (CPAS) www.wikipedia.org www.economictimes.com www.financialexpress.com www.timesofindia.com www.unctad.org www.dipp.nic.in www.fdi.gov.cn www.mapsofindia.com