International Business

Foreign Direct Investment

Prof Bharat Nadkarni

International Business : Prof Bharat Nadkarni

One of the most interesting phenomena in the contemporary world economy is the explosive growth of foreign direct investment. Regional integration typically leads to reductions in tariffs and other barriers to trade between the member states and this liberalisation has a number of effects on both trade and an FDI. To the extent that firms increase their investment in response to a larger market or rationalise their production to lower cost locations within and across the block , then there will be benefits of efficiency and welfare. The removal of restrictions on the movement of factors of production should facilitate both intra block FDI and FDI from third countries. FDI should also be stimulated by the relaxation of ownership and entry requirements and other liberalising measures to open markets to greater competition.

International Business : Prof Bharat Nadkarni

The firms are motivated to invest overseas for a variety of reasons such as access to factors of production, cheaper factors of production, access to products, access to markets and customers, present and future.

Foreign Direct Investment (FDI) Direct investment represents acquisition of some amount of permanent interest in the enterprise, implying a degree of control over the management of the company in which the investment is made. FDI involves the ownership and control of a foreign company in a foreign country. In exchange, for this ownership, the investing country usually transfers some of its financial, technical, managerial trademark and other resources to the foreign country.

International Business : Prof Bharat Nadkarni Foreign Direct Investment (FDI) has been defined to include investment in : 1. Indian companies which were subsidiaries of foreign companies. 2. Indian companies in which 40 percent or more of the equity capital was held outside India in any one country. 3. Indian companies in which 25 percent or more of the equity capital was held by a single investor abroad. The objective criteria for identifying FDI from 1992 was fixed at 10 percent ownership of ordinary share capital for a single investor in keeping with the IMF guidelines. Portfolio investment is the most popular form of FDI in India. This is followed by direct investment and foreign institutional investment. This refers to the participation of a foreign undertaking in the risk capital of a existing or a new undertaking. The most common system of FDI flow is through participation in risk capital and gaining control in management of the host country enterprise.

International Business : Prof Bharat Nadkarni

Foreign Investment policy in India The Indian Governments attitude towards foreign direct investment can be divided into two phases. The first phase is the period from independence to the late 1980s where gradual liberation of attitude towards FDI and the second phase is the period from 1980s onwards where a liberal policy towards FDI was accepted, with independence, India became host to a large body of foreign capital. As a result of the policy changes in 1991 and active promotion of India as a destination, the amount of FDI approved and received has increased sharply. The foreign investment policy was revised in 1980 in order to encourage direct and portfolio investment by NRIs and Overseas Commercial Borrowings OCBs and investors on Oil Exporting Development countries to invest their money in India.

International Business : Prof Bharat Nadkarni

The following Foreign Direct Investment Schemes were introduced : 1. 40 percent equity on repatriation basis for investment in new issues of new or existing companies in manufacturing sectors. 2. 100 percent equity participation in housing and real estate development with a lock-in period of 3 years and a ceiling of 16 percent on remittable profit. 3. Sick unit scheme in which NRIs and OCBs are allowed to make investment on repatriation basis upto 100 percent subject to certain conditions like lock in period of 5 years and the shares of the company should be quoted below par for 2 years. 4. 100 percent equity participation by NRIs on repatriation basis under the air taxi scheme.

International Business : Prof Bharat Nadkarni

5. 40 percent participation on repatriation basis in private banks. 6. 100 percent equity on repatriation basis in any company, proprietary or partnership concerns engaged in any industrial, commercial or trading activities.

Similarly the following schemes were introduced for portfolio Investment: 1. Non-Resident Indians or OCB were allowed to acquire up to 1 percent of paid up capital of an Indian company with an aggregate ceiling of 5 percent for all NRIs/ OCBs. 2. Portfolio investment from OECDs were allowed in new companies engaged in exports, manufacturing activities, hotels, hospitals and shipping. Thus, 1980s witnessed a gradual sign of easing of restrictions on foreign investment inflows in India.

International Business : Prof Bharat Nadkarni

The policy relating to foreign investments was radically changed in 1991 with the introduction of structural changes in the economy. A three-tier systems for approvals for foreign investments was introduced i.e. (a) Reserve Bank of India. (b) Secretariat for industrial approvals (SIA) and (c) Foreign Investment Promotion Board (FIPB). The existing companies in India with foreign equity participation wishing to increase 51% will be granted automatic approvals provided that the expansion programme is in the high priority industries and the cost of import of capital goods is covered by foreign equity. The proposals for foreign investment within the general policy framework but outside the powers delegated to the RBI would be considered by the SIA. FIPB was specifically created to invite, negotiate and facilitate substantially large investment by international companies which would provide access to high technology and world markets. Foreign Institutional investors such as Mutual funds,

International Business : Prof Bharat Nadkarni

pension funds were permitted to invest in Indian Stock Markets. However, such investment would be subject to a ceiling of 24% of the issued share capital of a company for all FIIs put together. An individual FII can invest up to 10 percent of the issued capital. In 1995, a working group was set up to examine the existing schemes and incentives available to NRIs for investment in India and make recommendations for attracting larger NRI investment. The group made various recommendations, some of which have been implemented are as follows: 1. OCBs are allowed to sell, transfer shares, bonds, debentures of Indian companies required with repatriation benefits through stock exchange under portfolio investment scheme.

International Business : Prof Bharat Nadkarni

2. Foreign investors are allowed to disinvest equity shares through stock exchanges in India. 3. Permission is also granted to foreign investors for disinvestments of listed equity shares through private placement subject to certain conditions. 4. Restrictions relating to 5 years lock-in period for issue of equity shares on preferential basis are removed except in these cases where preferential issue of securities is in favour of promoters.

International Business : Prof Bharat Nadkarni

Advantages of Foreign Direct Investment 1. Economic Development 2. Transfer of Technologies 3. Human Capital Resources 4. Employment Creation 5. Research & Development 6. Income Generation 7. Beneficial for SMEs (Small & Medium level Enterprises)

International Business : Prof Bharat Nadkarni

International Investment Theories 1. Ownership Advantage Theory

2. Internalisation Theory 3. Dunnings Electic Theory

4. Factor Mobility Theory

5. Product Life Cycle Theory

International Business : Prof Bharat Nadkarni

International Investment Theories 1. Ownership Advantage Theory The firms having competitive advantage domestically derived from its domain knowledge and valuable assets like technology, brand names and large scale economies extend their operations to foreign markets through FDI. ex. Dr Reddys Lab, Caterpillar. 2. Internalisation Theory ex. Licensing, franchising, exporting loses advantage. 3. Dunnings Electic Theory ex. Locational advantage, advantage from factors of productions.

International Business : Prof Bharat Nadkarni

4. Factor mobility theory ex. The capital flow from developed to LDCs, Petrodollars. 5. Product life cycle theory ex. Nike Waterfall approach Factors influencing FDI 1. Supply factors 2. Demand factors 3. Political factors

International Business : Prof Bharat Nadkarni

Supply Factors 1. Production Costs 2. Logistics 3. Resource availability 4. Access to technology Demand Factors 1. Customer access 2. Marketing advantage 3. Exploitation of competitive advantage 4. Customer mobility Political Factors 1. Avoidance of trade barriers 2. Economic development incentives 3. Bureaucracy

International Business

Disadvantages of FDI s coming through MNCs 1. Although the initial impact of MNC investment is to improve the foreign exchange position of the recipient nation, its longrun impact may reduce foreign exchange earnings on both current and capital accounts. The current account may deteriorate as a result of substantial importation of intermediate and capital goods while the capital account may worsen because of the overseas repatriation of profits, interest, royalties, etc. 2. While MNCs do contribute to public revenue in the form of corporate taxes, their contribution is considerably less than it should be as a result of liberal tax concessions, excessive investment allowances, subsidies and tariff protection provided by the host country government. 3. The management, entrepreneurial skills, technology, and overseas contacts provided by the MNCs may have

International Business

4.

5.

little impact on developing local skills and resources. In fact, the development of these local skills may be inhibited by the MNCs by stifling the growth of indigenous entrepreneurship as a result of the MNCs dominance of local markets. MNCs impact on development is very uneven. In many situations MNC activities reinforce dualistic economic structures and widen income inequalities. They tend to promote the interests of some few modern-sector workers only. They also divert resources away from the production of consumer goods by producing luxurious goods demanded by the local elites. MNCs typically produce non-essential products and stimulate inappropriate consumption patterns through advertising and their monopolistic market power. Production is done with capital-intensive technique

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6.

7.

which is not useful for labour surplus economies. This would aggravate the unemployment problem in the host country. MNCs often use their economic power to influence government policies in directions unfavourable to development. The host government has to provide them special economic and political concessions in the form of excessive protection, lower tax, subsidised inputs, and cheap provision of factory sites. As a result, the private profits of MNCs may exceed social benefits. MNCs may damage the host countries by suppressing domestic entrepreneurship through their superior knowledge, worldwide contacts, and advertising skills. They tend to drive out local competitors and inhibit the emergence of small-scale enterprises.

International Business

8.

They exploit the economy of the host nation by paying low wages to workers, by exporting scarce natural resources or by adversely interfering with the development of local businesses. Workers in major industrialised nations argue that building a plant abroad takes away jobs at home.

F D I in India
Foreign direct investment approvals will, however, be subject to sectoral caps: (as on 31.03.2010)
20 percent (40'per cent for NRIs} in the banking sector; 51 per cent in non-banking financial companies; 100 per cent in power, roads, ports, tourism and venture capital funds; 49 per cent in telecommunications;

40 per cent (100 per cent for NRIs) in domestic air taxi operations/airlines;
24 per cent in small-scale industries; 51 per cent in drugs/pharma industry for bulk drugs; 100 per cent in petroleum; and 50 per cent in mining ~ except for gold. silver, diamonds and precious stones

International Capital Markets

Prof Bharat Nadkarni

International Business

Obstacles to International Investments 1. Information Barriers 2. Political & Capital control risks

3. Foreign exchange risk

4. Restrictions on foreign investments and control

5. Taxation

International Business

Foreign Direct Investment Definition: FDI occurs when an entity/investor from one country(home country, e.g. USA) obtains or acquires the controlling interest in an entity in another country (host country,e.g. India) and then operates and manages that entity and its assets as part of the multinational business of the investing entity. Foreign Portfolio Investment (FPI) Definition: FPI is a category of investment instruments that are more easily traded, may be less permanent, and do not represent a controlling stake in an enterprise. These include investment via equity instruments (Stocks) or debt (Bonds) of a foreign enterprise which does not necessarily represent a long-term interest.

International Business

The difference between FDI & FPI

FDI Motive To acquire controlling interest in a foreign entity or set up an entity with controlling interest. FPI To make capital gains from investments. There is no intention to control the entity. FPI investment come from investors, mutual funds, portfolio management companies, and corporate with pure motive of investment gains. FPI is highly volatile. Comes mainly through stock markets. Sole criteria and motive is gains on investments.

Source

FDI investments come from MNCs and corporate so as to derive benefit of new market, cheaper resources (labour), efficiency and skills, strategic asset seeking (oil fields) and time geography (BPOTranscriptions).

Duration More enduring and has longer time stability. Form Purpose Generally comes as subsidiary or joint venture. Made with core thought of business philosophy of diversification, integration, consolidation, expansion and/or core business formation. Calculation of gain is always prime criteria but never the sole criteria.

International Business

FDI in India are approved through two routes: 1. Automatic approval by RBI: The RBI accords automatic approval within a period of two weeks (provided certain parameters are met) to all proposals involving : Foreign equity up to 50% in 3 categories relating to mining activities. Foreign equity up to 51% in 48 specified industries. Foreign equity up to 74% in 9 categories.

The category lists are comprehensive and cover most industries of interest to foreign companies. Investments in high priority industries or for trading companies primarily engaged in exporting are given almost automatic approval by the RBI.

International Business

2. The Foreign Investment Promotion Board (FIPB) Route. FIPB approves all other cases where the parameters of automatic approval are not met. Normal processing time is 4 to 6 weeks. Its approach is liberal for all sectors and all types of proposals, and rejections are few. It is not necessary for foreign investors to have a local partner, even when the foreign investor wishes to hold less than the entire equity of the company. The portion of the equity not proposed to be held by the foreign investor can be offered to general public. FDI is permitted as under the following forms of investments: 1. Through financial collaborations. 2. Through joint ventures and technical collaborations. 3. Through capital markets via Euro issues. 4. Through private placements or preferential allotments.

International Business

Forbidden Territories: FDI is not permitted in following industrial sectors: 1. 2. 3. 4. 5. Arms and ammunition Atomic energy Railway transport Coal and lignite Mining of iron, manganese, chrome, gypsum, sulphur, gold, diamonds, copper, zinc.

International Business : Prof Bharat Nadkarni

Global Depository Receipts (GDRs) A depository receipt is basically a negotiable certificate, denominated in US dollars, that represents a non-US companys publicly traded local currency (Indian Rupee) equity shares. DRs are created when the local currency shares of an Indian company, for example, are delivered to the depositorys local custodian bank, against which the depository bank, such as Bank of New York, issues DRs in US dollars. The depository Receipts may trade freely in the overseas markets like any other dollar denominated security, either on a foreign stock exchange, or in the over-the-counter market, or among a restricted group such as qualified institutional buyers. Companys with good track record of three years may avail of Euro-issues for approved purposes. According to the revised guidelines issued in November 1995 companies investing in infrastructure projects, including power, petroleum exploration and refining, telecommunications, ports, roads and airports are

International Business : Prof Bharat Nadkarni

Exempted from the condition of three-year track record. It is expected to help companies in above sectors to access cheap overseas funds.