FDI

1.Definition
Foreign direct investment (FDI) plays an extraordinary and growing role in global business. It can provide a firm with new markets and marketing channels, cheaper production facilities, access to new technology, products, skills and financing. For a host country or the foreign firm which receives the investment, it can provide a source of new technologies, capital, processes, products, organizational technologies and management skills, and as such can provide a strong impetus to economic development. Foreign direct investment, in its classic definition, is defined as a company from one country making a physical investment into building a factory in another country. The direct investment in buildings, machinery and equipment is in contrast with making a portfolio investment, which is considered an indirect investment. In recent years, given rapid growth and change in global investment patterns, the definition has been broadened to include the acquisition of a lasting management interest in a company or enterprise outside the investing firms home country. As such, it may take many forms, such as a direct acquisition of a foreign firm, construction of a facility, or investment in a joint venture or strategic alliance with a local firm with attendant input of technology, licensing of intellectual property, In the past decade, FDI has come to play a major role in the internationalization of business. Reacting to changes in technology, growing liberalization of the national regulatory framework governing investment in enterprises, and changes in capital markets profound changes have occurred in the size, scope and methods of FDI. New information technology systems, decline in global communication costs have made management of foreign investments far easier than in the past. The sea change in trade and investment policies and the regulatory environment globally in the past decade, including trade policy and tariff liberalization, easing of restrictions on foreign investment and acquisition in many nations, and the deregulation and privitazation of many industries, has probably been been the most significant catalyst for FDIs expanded role.

The most profound effect has been seen in developing countries, where yearly foreign direct investment flows have increased from an average of less than $10 billion in the 1970s to a yearly average of less than $20 billion in the 1980s, to explode in the 1990s from $26.7billion in 1990 to $179 billion in 1998 and $208 billion in 1999 and now comprise a large portion of global FDI.. Driven by mergers and acquisitions and internationalization of production in a range of industries, FDI into developed countries last year rose to $636 billion, from $481 billion in 1998 (Source: UNCTAD) Proponents of foreign investment point out that the exchange of investment flows benefits both the home country (the country from which the investment originates) and the host country (the destination of the investment). For small and medium sized companies, FDI represents an opportunity to become more actively involved in international business activities. In the past 15 years, the classic definition of FDI as noted above has changed considerably. This notion of a change in the classic definition, however, must be kept in the proper context. Very clearly, over 2/3 of direct foreign investment is still made in the form of fixtures, machinery, equipment and buildings. Moreover, larger multinational corporations and conglomerates still make the overwhelming percentage of FDI. But, with the advent of the Internet, the increasing role of technology, loosening of direct investment restrictions in many markets and decreasing communication costs means that newer, non-traditional forms of investment will play an important role in the future. Many governments, especially in industrialized and developed nations, pay very close attention to foreign direct investment because the investment flows into and out of their economies can and does have a significant impact.

2.How Has FDI Changed in the Past Decade?

As mentioned above, the overwhelming majority of foreign direct investment is made in the form of fixtures, machinery, equipment and buildings. This investment is achieved or accomplished mostly via mergers & acquisitions. In the case of traditional manufacturing, this has been the primary mechanism for investment and it has been heretofore very efficient. Within the

past decade, however, there has been a dramatic increase in the number of technology startups and this, together with the rise in prominence of Internet usage, has fostered increasing changes in foreign investment patterns. Many of these high tech startups are very small companies that have grown out of research & development projects often affiliated with major universities and with some government sponsorship. Unlike traditional manufacturers, many of these companies do not require huge manufacturing plants and immense warehouses to store inventory. Another factor to consider is the number of companies whose primary product is an intellectual property right such as a software program or a software-based technology or process. Companies such as these can be housed almost anywhere and therefore making a capital investment in them does not require huge outlays for fixtures, machinery and plants. In many cases, large companies still play a dominant role in investment activities in small, high tech oriented companies. However, unlike in the past, these larger companies are not necessarily acquiring smaller companies outright. There are several reasons for this, but the most important one is most likely the risk associated with such high tech ventures. In the case of mature industries, the products are well defined. The manufacturer usually wants to get closer to its foreign market or wants to circumvent some trade barrier by making a direct foreign investment. The major risk here is that you do not sell enough of the product that you manufactured. However, you have added additional capacity and in the case of multinational corporations this capacity can be used in a variety of ways. High tech ventures tend to have longer incubation periods. That is, the product tends to require significant development time. In the case of software and other intellectual property type products, the product is constantly changing even before it hits the marketplace. Therefore, the expanded role of technology and intellectual property has changed the foreign direct investment playing field.

3.Why is FDI important for any consideration of going global?

The simple answer is that making a direct foreign investment allows companies to accomplish several tasks:

Avoiding foreign government pressure for local production. Circumventing trade barriers, hidden and otherwise. Making the move from domestic export sales to a locally-based national sales office. Capability to increase total production capacity. Opportunities for co-production, joint ventures with local partners, joint marketing arrangements, licensing, etc; A more complete response might address the issue of global business partnering in very general terms. While it is nice that many business writers like the expression, think globally, act locally The phrase does have significant connotations for multinational corporations. The simple explanation for this is the difference in perspective between executives of multinational corporations and small and medium sized companies. Multinational corporations are almost always concerned with worldwide manufacturing capacity and proximity to major markets. Small and medium sized companies tend to be more concerned with selling their products in overseas markets. The advent of the Internet has ushered in a new and very different mindset that tends to focus more on access issues. SMEs in particular are now focusing on access to markets, access to expertise and most of all access to technology.

What would be some of the basic requirements for companies considering a foreign investment?
Depending on the industry sector and type of business, a foreign direct investment may be an attractive and viable option. With rapid globalization of many industries and vertical integration rapidly taking place on a global level, at a minimum a firm needs to keep abreast of global trends in their industry. From a competitive standpoint, it is important to be aware of whether a companys competitors are expanding into a foreign market and how they are doing that. At the same time, it also becomes important to monitor how globalization is affecting domestic clients. Often, it becomes imperative to follow the expansion of key clients overseas if an active business relationship is to be maintained.

New market access is also another major reason to invest in a foreign country. At some stage, export of product or service reaches a critical mass of amount and cost where foreign production or location begins to be more cost effective. Any decision on investing is thus a combination of a number of key factors including: assessment of internal resources, competitiveness, market analysis market expectations.

4.FDI AND INDIAN ECONOMY

There have been significant changes in the growth models of developing economies during the past two decades. Many of these economies, including India, have moved away from inward-oriented import substitution policies to outward orient and marketdetermined export-oriented strategies. The skepticism about the role of FDI in reinforcing domestic growth has given way to greater openness to FDI, with a view to supporting investment and productivity of the host countries. While developing countries have started accepting FDI inflows with some caution, which is obvious, the developed countries have moved their investments to foreign locations, subject to safety and profitability of their business operations in foreign lands. With strong governmental support, FDI has helped the Indian economy grow tremendously. But with $34 billion in FDI in 2007, India gets only about 25% of the FDI in China. Foreign direct investment (FDI) in India has played an important role in the development of the Indian economy. FDI in India has in a lot of ways enabled India to achieve a certain degree of financial stability, growth and development. This money has allowed India to focus on the areas that needed a boost and economic attention, and address the various problems that continue to challenge the country.

India has continually sought to attract FDI from the worlds major investors. In 1998 and 1999, the Indian national government announced a number of reforms designed to encourage and promote a favourable business environment for investors. FDIs are permitted through financial collaborations, through private equity or preferential allotments, by way of capital markets through euro issues, and in joint ventures. FDI is not permitted in the arms, nuclear, railway, coal or mining industries. A number of projects have been implemented in areas such as electricity generation, distribution and transmission, as well as the development of roads and highways, with opportunities for foreign investors. The Indian national government also granted permission for FDIs to provide up to 100% of the financing required for the construction of bridges and tunnels, but with a limit on foreign equity of INR 1,500 crores, approximately $352.5 million. Currently, FDI is allowed in financial services, including the growing credit card business. These also include the non-banking financial services sector. Foreign investors can buy up to 40% of the equity in private banks, although there is condition that these banks must be multilateral financial organizations. Up to 45% of the shares of companies in the global mobile personal communication by satellite services (GMPCSS) sector can also be purchased. In 2007, India received $34 billion in FDI, a huge growth compared to the previous years, but significantly less than the $134 billion that flowed into China. Although the Chinese approval process is complex, China continues to outshine India as a choice destination for foreign investors. Why does India, a country with resources and a skilled workforce, lag so far behind China in FDI amounts? Physical infrastructure is the biggest hurdle that India currently faces, to the extent that regional differences in infrastructure concentrates FDI to only a few specific regions. While many of the issues that plague India in the aspects of telecommunications, highways and ports have been identified and remedied, the slow development and improvement of railways, water and sanitation continue to deter major investors.

Foreign investment is seen as a slow and inefficient way of doing business, especially in a paperwork system that is shrouded in red tape.

Trends in Foreign Direct Investment (FDI)

Historically, FDI has been directed at developing nations as firms from advanced economies invested in other markets, with the US capturing most of the FDI inflows. While developed countries still account for the largest share of FDI inflows, data shows that the stock and flow ofFDI has increased and is moving towards developing nations, especially in the emerging economies around the world. Aside from using FDIs as investment channel and a method to reduce operating costs, many companies and organizations are now looking at FDI was a way to internationalize. FDIs allow companies to avoid governmental pressure on local production and cope with protectionist measures by circumventing trade barriers. The move into local markets also ensures that companies are closer to their consumer market, especially if companies set up locally-based (national) sales offices.

RECENT TRENDS IN FDI

Foreign direct investment (FDI) refers to cross-border investment made by a resident in one economy (the direct investor) with the objective of establishing a lasting interest in an enterprise (the direct investment enterprise) that is resident in a country other than that of the direct investor .The motivation of the direct investor is strategic lasting interest in the management of the direct investment enterprise with at least 10 per cent voting power in decision making. The year 2007 posted 30 per cent growth in global FDI inflows, which touched $1,833 billion, i.e., about $400 billion above the previous record in the year 2000 (Figure 2.1). About two-third of the inflows ($1,248 billion) was received by developed economies, while developing economies received about $500 billion FDI inflows a 21 per cent increase over the year 2006. $500 billion FDI

inflows into developing countries included about $13 billion for the least developed countries (LDCs). India received $23 billion of FDI inflows in 2007, up from $20 billion in 2006. India has inward FDI stock worth $76.2 billion (compared with $327.1 billion in China) and outward FDI stock of $29.4 billion (compared with $95.8 billion of China). The FDI inflows received by India accounted for 3 per cent of gross fixed capital formation (GFCF) in 2005, 6.6 per cent in 2006 and 5.8 per cent in 2007. The corresponding figures for China are 7.7, 6.4 and 5.9 per cent, respectively. Thus, the share of FDI in GFCF for India in 2007 was almost the same as that of China. The share of inward FDI stock of India was 0.5 per cent of GDP in 1990, 3.7 per cent in 2000 and 6.7 per cent in 2007. The corresponding figures are much higher for China, viz., 5.1, 16.2 and 10.1 per cent, respectively. FDI Policy Framework Prior to 1991, the FDI policy framework in India was highly regulated. The government aimed at exercising control over foreign exchange transactions. All dealings in foreign exchange were regulated under the Foreign Exchange Regulation Act (FERA), 1973, the violation of which was a criminal offence. FDI-related Institutions There are three primary institutions in India that handle FDIrelated issues: the Foreign Investment Promotion Board (FIPB), the Secretariat for Industrial Assistance (SIA), and Foreign Investment Implementation Authority (FIIA). -Foreign Investment Promotion Board (FIPB) The Foreign Investment Promotion Board (FIPB), Department of Economic Affairs (DEA), Ministry of Finance is the nodal singlewindow agency for all matters relating to FDI as well as promoting investment in the country. It is chaired by the Secretary, Industry (Department of Industrial Promotion and Policy). Its objective is to promote FDI in India: i) by undertaking investment promotion activities in India and abroad;

ii) by facilitating investment in the country by international companies, non-resident Indians and other foreign investors; iii) through purposeful negotiations/discussions with potential investors; iv) through early clearance of proposals submitted to it; and v) by reviewing policies and putting in place appropriate institutional arrangements, transparent rules and procedures and guidelines for investment promotion and approvals.

-Secretariat for Industrial Assistance (SIA) The Secretariat for Industrial Assistance (SIA) has been set up by the Government of India in the Department of Industrial Policy and Promotion, Ministry of Commerce & Industry to provide a single-window service for entrepreneurial assistance, investor facilitation, receiving and processing all applications which require government approval, conveying government decisions on applications filed, assisting entrepreneurs and investors in setting up projects (including liaison with other organisations and state governments) and monitoring the implementation of projects. It also notifies all government policy decisions relating to investment and technology, and collects and publishes monthly production data for select industry groups. Foreign Investment Implementation Authority (FIIA) The Government of India has set up the Foreign Investment Implementation Authority (FIIA) to facilitate quick translation of Foreign Direct Investment (FDI) approvals into implementation, and to provide a pro-active one-stop after-care service to foreign investors by helping them obtain necessary approvals, sort out operational problems and meet with various government agencies to find solutions to their problems.

FDI IN RETAIL SECTOR

In recent years the destination sectors in FDI have become more varied. FDI inflows have shifted from infrastructure, natural

resources and export driven manufacturing to other areas such as retailing, tourism, construction and off shore services. A World Bank study showed that cumulative FDI inflows to the retail sector in the 20 largest developing countries amounted to US$ 45 billion in 1998-2002 (about 7 per cent of the total of these countries). The study showed that after liberalization; countries such as Brazil, Poland and Thailand have received significant FDI in retailing. After the waves of globalisation, liberalisation and privatisation marketing scenario particularly retailing has changed radically. These changes have resulted in emergence of new environment for buyers behaviour and purchasing habits. The upper and upper middle strata of the society now prefers to purchase well established branded goods from standard showrooms and it has transformed the entire picture and perception not only in the metro cities but almost in all big cities of our country. Why Global Retailers are Interested in India? More specifically the global players are interested in India due to following reasons: I)Strategic Location & Geography: India enjoys unique geographical advantage. It is strategically located in Asia with access to all leading markets of the World. With total area of 32, 87,590 Sq. Km, Coastline of 7000 Km and borders with six countries India becomes most promising destination for the foreign direct investment. II) Versatile Demographics: Demographically with a population of more than 1.1 billion and diverse culture, India is a land of all seasons. India presents a real cosmopolitan population with diverse religions and culture. Hinduism, Buddhism, Jainism, Sikhism, Christianity and Islam are the main religions of India. This variety of religions provides India with a diverse culture. Besides, India has versatile population of urban and rural nature. This versatility of population makes India a ready made market for foreign retailers. III)Vast growing Economy: On economic front, India the largest democracy of the world, have a stable Govt. with robust programme of economic reforms. India with a foreign exchange reserve of more than US $120 billion, FDI of more than US $9.9 billion ,average GDP growth of more than 7% per annum, rupee appreciation Vs. U.S dollar of more than 2% in last two years and with a rapidly growing investment in infrastructure has all the

ingredients of a emerging economic super power. India is tipped to be third largest economy in terms of GDP by the year 2050 IV) Retailing: The Emerging Revolution: Retailing is the largest private industry in India and second largest employer after agriculture. The sector contributes to around 10 percent of GDP. With over 12 million retail outlets, India has the highest retail outlets density in the world. This sector witnessed significant development in the past 10 years from small unorganized family owned retail formats to organized retailing. Liberalization of the economy, rise in per capita income and growing consumerism has encouraged large business and venture capitalist in investing in retail infrastructure. The importance of retail sector in India can be judged from following facts (a) Retail sector is the largest contributor to the Indian GDP (b) The retail Sector provides 15% employment (c) India has world largest retail network with 12 million outlets (d) Total market size of retailing in India Is U.S $ 180 billion (e) Current Share of Organized Retailing is just 2% which comes around to $3.6 trillion (f) Organized retail sector is growing @ 28% per annum. V)Indian Retailing: Opportunities Unexplored: India is sometimes referred to as the nation of shopkeepers. This is because the country has the highest density of retail outlets - over 12 million. However, unlike most developed and developing countries, Indian retail sector is highly fragmented and bulk of the business is in the unorganized sector. As compared to China (Table 2) the presence of global players in India is very less Arguments in favour of FDI in Retailing FDI in retailing is favoured on following grounds: (1) The global retailers have advanced management know how in merchandising and inventory management and have adopted new technologies which can significantly improve productivity and efficiency in retailing. (2) Entry of large low-cost retailers and adoption of integrated supply chain management by them is likely to lower down the prices. (3) FDI in retailing can easily assure the quality of product, better shopping experience and customer services. (4) They promote the linkage of local suppliers, farmers and manufacturers, no doubt only those who can meet the quality and

safety standards, to global market and this will ensure a reliable and profitable market to these local players. (5) As multinational players are spreading their operation, regional players are also developing their supply chain differentiating their strategies and improving their operations to counter the size of international players. This all will encourage the investment and employment in supply chain management. (6) Joint ventures would ease capital constraints of existing organised retailers and (7) FDI would lead to development of different retail formats and modernisation of the sector. Arguments against FDI in Retailing Many trading associations, political parties and industrial associations have argued against FDI in retailing due to following reasons: (1) Indian retailers have yet to consolidate their position. The existing retailing scenario is characterized by the presence of a large number of fragmented family owned businesses, who would not be able to survive the competition from global players. (2) The examples of south east Asian countries show that after allowing FDI, the domestic retailers were marginalised and this led to unemployment. (3)FDI in retailing can upset the import balance, as large international retailers may prefer to source majority of their products globally rather than investing in local products. (4)Global retailers might resort to predatory pricing. Due to their financial clout, they often sell below cost in the new markets. Once the domestic players are wiped out of the market foreign players enjoy a monopoly position which allows them to increase prices and earn profits. (5)Indian retailers have argued that since lending rates are much higher in India, Indian retailers, especially small retailers, are at a disadvantageous position compared to foreign retailers who have access to International funds at lower interest rates. High cost of borrowing forces the domestic players to charge higher prices for the products.

(6)FDI in retail trade would not attract large inflows of foreign investment since very little investment is required to conduct retail business. Goods are bought on credit and sales are made on cash basis. Hence, the working capital requirement is negligible. On the contrary; after making initial investment on basic infrastructure, the multinational retailers may remit the higher amount of profits earned in India to their own country.