International Investment and Finance

International Investment
and Finance
320
International business has been propelled by large cross-border flows of finance. While the
private financial flows are, invariably, commercial in nature, financial flows related to
Official Development Assistance (ODA) have also implications for business.
Official Development Assistance refers to grants and soft loans from official sources,
with the objective of promoting economic development and social welfare. There are two
channels of aid flows: (i) between governments and government agencies (bilateral flows),
and (ii) through multilateral institutions like the World Bank and Regional Development
Banks like the Asian Development Bank (multilateral flows). The poor countries are not able
to raise much money on commercial terms. ODA or Aid is, therefore, very important for
them. Investments resulting from ODA also provide opportunities for private business,
besides the general economic improvements such investments may promote.
As explained in the preceding chapter, countries facing Balance of Payments problems
may take financial assistance from the IMF.
The economic liberalisations that swept across the world, particularly since the late
1980s, have very significantly changed the environment for international private financial
flows. At the same time, the surging international capital flows, in its turn, are substantially
impacting the business environment.
C H A P T E R
To understand the types of foreign investment.
To get an idea of the theories of FDI and factors influencing FDI.
To examine the effects and consequences of FDI.
To get a picture of the trends in FDI.
To get an idea of foreign investment in India.
LEARNING OBJECTIVES
International Investment and Finance 321
TYPES OF FOREIGN PRIVATE INVESTMENT
Broadly, there are two types of foreign investment, namely,
foreign direct investment (FDI) and portfolio investment.
Foreign Direct Investment (FDI)
FDI refers to investment in a foreign country where the investor retains control over the
investment. It typically takes the form of starting a subsidiary, acquiring a stake in an
existing firm or starting a joint venture in the foreign country. Direct investment and
management of the firms concerned normally go together.
UNCTADs World Investment Report defines foreign direct investment (FDI) as an
investment involving a long-term relationship and reflecting a
lasting interest and control by a resident entity in one economy
(foreign direct investor or parent enterprise) in an enterprise
resident in an economy other than that of the foreign direct
investor (FDI enterprise or affiliate enterprise or foreign affiliate). FDI implies that the
investor exerts a significant degree of influence on the management of the enterprise resident
in the other economy. Such investment involves both the initial transaction between the two
entities and all subsequent transactions between them and among foreign affiliates, both
incorporated and unincorporated, FDI may be undertaken by individuals as well as business
entities. Flows of FDI comprise capital provided (either directly or through other related
enterprises) by a foreign direct investor to an FDI enterprise, or capital received from an
FDI enterprise by a foreign direct investor. FDI has three components: equity capital,
reinvested earnings and intra-company loans. It may be noted that the Government of India
used to exclude reinvested earnings from the estimation of FDI in India. Government
sources have, however, indicated that Government would redefine FDI including reinvested
earnings also. Box 9.1 shows the growing role of Foreign Investment.
BOX 9.1 The Growing Role of Foreign Investment
The expansion of international investment, facilitated by the almost universal liberali-
sation, (see Box 1.6, Chapter 1), has resulted in a substantial increase in their role in
global production, employment generation and trade. The ratio of world FDI inflows to
global gross domestic capital formation increased more than seven-fold between 1980
(2 per cent) now. Similarly, the ratio of world FDI stock to world GDP witnessed a spurt. In
2002 the inward FDI stock of developing countries was about a third of their GDP, almost
twice the 19 per cent for developed countries. Back in 1980 the respective ratios were
13 per cent and 5 per centthe growth of FDI stock exceeded GDP growth in both
groups of countries.
The massive FDI flows and the steep increase in the FDI stock have been significantly
accelerating the integration of global production activity. In 2002 the world FDI stock
stood at $ 7.1 trillion, up more than 10 times since 1980. Ebbs and flow in the yearly
value of FDI, while important, augment the stock of FDI as long as they are positive. So
the stock of FDI matters more than flowsfor the structure of global specialisation, for
deepening global integration through production networks, and for generating the
FDI is akin to promoters
investment and portfolio
investment is akin to
stock market investment.
In case of FDI, equity
stake and management
control of the enterprise
go hand in hand.
322 I nternational Business: Text and Cases
benefits associated with FDI and international production. It also matters for new FDI
capital flows through the reinvestment of earnings and sequential flows to FDI. In 2002
the estimated value added of foreign affiliates, at $ 3.4 trillion, accounted for about a
tenth of world GDP, or twice the share in 1982. The world stock of FDI generated sales by
foreign affiliates of an estimated $ 18 trillion, compared with world exports of less than
$ 8 trillion. Nearly a third of world exports of goods and non-factor services takes place
within the networks of foreign affiliates, but that has not changed much since 1982.
Employment by foreign affiliates reached an estimated 53 million workers in 2002, two and
half times the number in 1982.
Source: UNCTAD, World Investment Report, 2000, 2003 and 2004.
FDIs are governed by long-term considerations because these investments cannot be
easily liquidated. Hence factors like long-term political stability, government policy,
industrial and economic prospects, etc. influence the FDI decision. However, portfolio
investments, which can be liquidated fairly easily, are influenced by short-term gains.
Portfolio investments are generally much more sensitive than FDIs. Direct investors have
direct responsibility with the promotion and management of the enterprise. Portfolio
investors do not have such direct involvement with the promotion and management.
Foreign Portfolio Investment (FPI)
If the investor has only a sort of property interest in investing the capital in buying equities,
bonds, or other securities abroad, it is referred to as portfolio
investment. That is, in the case of portfolio investments, the
investor uses his capital in order to get a return on it, but has no
much control over the use of the capital. There are mainly two
routes of portfolio investments in India, viz., by Foreign Institutional Investors (FIIs) like
mutual funds and through Global Depository Receipts (GDRs), American Depository
Receipts (ADRs) and Foreign Currency Convertible Bonds (FCCBs).
GDRs/ADRs and FCCBs are instruments issued by Indian companies in the foreign
markets for mobilising foreign capital by facilitating portfolio investment by foreigners in
Indian securities. Since 1992, Indian companies, satisfying certain conditions, are allowed to
access foreign capital markets by Euro issues.
Since the economic liberalisation of 1991, there has been a substantial increase in
foreign investments in India.
With reference to foreign investment in India, foreign investment may be classified as
shown in Figure 9.1.
Foreign Investment
Direct investment Portfolio investment
Wholly
owned
subsidiary
Joint
venture
Acquisition
Investments
by FIIs
Investment in
GDRs, ADRs,
FCCBs, etc.
FIGURE 9.1 Types of Foreign Investment.
FPI is lured by the
attractiveness of investible
securities.
As Peter Drucker in his Managing for the Future observes, ...increasingly world
investment rather than world trade will be driving the international economy. Exchange
rates, taxes, and legal rules will become more important than wage rates and tariffs.
1
THEORIES OF INTERNATIONAL INVESTMENT
A number of attempts have been made to formulate a theory to
explain the international investment. A brief outline of the
important attempts in this direction is given below.
Theory of Capital Movements
The earliest theoreticians, who assumed, in the classical tradition, the existence of a perfectly
competitive market, considered foreign investments as a form of factor movement to take
advantage of the differential profit.
The validity of this theory is clear from the observation of the noted economist
Charles Kindleberger that under perfect competition, foreign direct investment would not
occur and that would be unlikely to occur in a world wherein the conditions were even
approximately competitive.
2
Market Imperfections Theory
One of the important market imperfections approach to the explanation of the foreign
investments is the Monopolistic Advantage Theory propounded by Stephen in 1960.
According to this theory, foreign direct investment occurred largely in oligopolistic
industries rather than in industries operating under near perfect competition. Hymer
suggested that the decision of a firm to invest in foreign markets was based on certain
advantages the firm possessed over the local firms (in the foreign country) such as
economies of scale, superior technology or skills in the fields of management, production,
marketing and finance.
Kindleberger also argued that market imperfections were the basis of foreign
investment.
The Market Imperfections Theory does not answer several questions related to foreign
investment. For example, why does a firm prefer foreign investment to other alternative
market entry modes like exporting, licensing, franchising, etc.?
Internalisation Theory
According to the Internationalisation Theory, which is an extension of the Market
Imperfections theory, foreign investment results from the decision of a firm to internalise a
superior knowledge (i.e., keeping the knowledge within the firm to maintain the competitive
edge). For example, if a firm decides to externalise its know-how by licensing a foreign
firm, the firm (the licensor) does not make any foreign investment in this respect but, on
Theoretical explanations
of FDI include location-
specific advantage, firm-
specific advantage, inter-
nationalisation advantage
and competitive strategies.
the other hand, if the firm decides to internalise, it may invest abroad in production
facilities.
Methods of internalisation include formal ways like patents and copy rights and
informal ways like secrecy and family networks.
Appropriability Theory
According to the Appropriability Theory, a firm should be able to appropriate (to keep for
its exclusive use) the benefits resulting from a technology it has generated. If this condition
is not satisfied, the firm would not be able to bear the cost of technology generation and,
therefore, would have no incentive for research and development. MNCs tend to specialise
in developing new technologies which are transmitted efficiently through their internal
channels.
It is obvious that the Appropriability Theory is similar to the internalisation theory in
terms of creating an internal market (internal channels) for exploiting the firm specific
advantages.
Location Specific Advantage Theory
The Location Specific Advantage Theory suggests that foreign investment is pulled by
certain location specific advantages.
According to Hood and Young, there are four factors which are pertinent to the
Location Specific Theory. They are:
1. Labour costs.
2. Marketing factors (like market size, market growth, stages of development and
local competition).
3. Trade barriers.
4. Government policy.
The above factors have, of course, a very important bearing on foreign investment.
However, there are also other factors like cultural factors which influence foreign
investment. Further, it is the total cost, and not labour cost alone, that is important.
International Product Life Cycle Theory
According to the Product Life Cycle Theory developed by Raymond Vernon and Lewis T.
Wells, the production of a product shifts to different categories of countries through the
different stages of the product life cycle.
According to this theory, a new product is first manufactured and marketed in a
developed country like the US (because of favourable factors like large domestic market,
entrepreneurship and ease of organising production). It is then exported to other developed
markets. As competition increases in these markets, manufacturing facilities are established
there to cater to these markets and also to export to the developing countries. As the product
becomes standardised and competition further intensifies, manufacturing facilities are
established in developing countries to lower production costs and due to other reasons. The
developed country markets may also be serviced by exports from the production units in the
developing countries [see the chapter on International Product Decisions for further
elaboration and diagrammatic presentation of the international product life cycle].
The International Product Life Cycle model is true of several products like television
sets, as is illustrated by the case on the Television Receiver Industry.
Eclectic Theory
John Dunning has attempted to formulate a general theory of international production by
combining the postulates of some of the other theories. According to Dunning, foreign
investment by MNCs results from three comparative advantages which they enjoy, viz.,
1. Firm specific advantages
2. Internalisation advantages
3. Location specific advantages
Firm specific advantages result from the tangible and intangible resources held
exclusively, at least temporarily, by the firm and which provide the firm a comparative
advantage over other firms.
The firm specific advantages would not result in foreign investments unless the firm
internalises these advantages.
Even when a firm internalises its exclusive resources, it may be able to serve a foreign
market without foreign investment (for example by exporting). Therefore, for the
production to take place in the foreign country there should be some location specific
advantages. One important drawback of the Eclectic theory is that it does not explain
the foreign investment for acquisitions which have become a very important route to
internationalisation.
Other Theories
According to Knickerbockers theory of Oligopolistic Reaction and Multinational Enterprise,
when one firm, especially the leader in an oligopolistic industry, entered a market, other
firms in the industry followed as a defensive strategy i.e., to defend their market share from
being taken away by the initial investor with the advantage of local production.
Graham noted that there was a tendency for across investment by European and
American firms in certain oligopolistic industries. When American firms invested in Europe,
the European firms retaliated by investing in America and vice versa. This was mostly a
retaliatory strategy.
There are also other reasons for investment like following the customer (for example
the Japanese automobile ancillary firms to foreign markets) and seeking knowledge (for
example, Japanese and European investment in Silicon Valley).
These theories at best explain the reasons for some of the
foreign investments only.
The theories provide only
a partial explanation of
the reasons for FDI.
SIGNIFICANCE OF FOREIGN INVESTMENT
Foreign investment is playing an increasing role in economic development. Economic
reforms and the far-reaching political changes have resulted in very substantial changes in
the international capital flows. FDI now contributes to a significant share of the domestic
investment, employment generation, exports, etc. in a number of economies. China is a
classic example, where, in 1997, FDI contributed about 15 per cent of domestic investment,
41 per cent of total exports, 19 per cent of industrial output, 13 per cent of tax revenue and
18 million employment.
The changes in the composition of the capital flows and the substantial increase in
the magnitude of some of the flows, like FDI, have remarkably changed the balance of
payments and foreign exchange reserves position of several countries. The debt creating
flows as a percentage of total flows in the BOP of India averaged as much as 97 per cent
during the Seventh Plan (198590) but declined to less than 20 per cent by the mid-1990s.
Eventually, India began to experience a surplus on the BOP and a very remarkable
improvement in the reserves position.
Foreign investment has assisted and is assisting the economic growth of many
countries. As a World Bank report points out, for the developing countries FDI has the
following advantages over the official development assistance (ODA):
3
FDI shifts the burden of risk of an investment from
domestic to foreign investors.
Repayments are linked to profitability of the underlying
investment, whereas under debt financing the borrowed
funds must be serviced regardless of the project costs.
Further, it has also been observed that FDI is the only capital inflow that has been
strongly associated with higher GDP growth since 1970.
The contribution of FDI to economic growth is highlighted by the fact that the ratio of
FDI flow to domestic investment (gross capital formation) rose for most developed and
developing countries in the past. Although the bulk of the FDI goes to developed countries,
its share in their Gross Fixed Capital Formation (GFCF) is only about half of that in
developing countries because of the massiveness of their GFCF.
Apart from potential gains through technology transfer, FDI has generated large
employment opportunities in a number of countries.
Given the limitations of domestic savings, many developing countries will have to rely
on foreign investment to accelerate economic growth. It may be noted that China has been
able to maintain a high GDP growth-rate for a long time because of a high savings rate and
huge inflow of FDI.
Addressing a session on infrastructure at the seminar on moving to the market:
sustaining reforms in India and Asia, organised by the Confederation of Indian Industry
(CII) and Asian Society, in New Delhi on March 9, 1997, M. Gordon Wu has observed that
foreign investment brings four Esefficiency, equity, experience and expertise. In return,
there is a fifth Eexpatriation of profits.
FDI helps fill the savings,
technological, managerial
and foreign exchange
gaps.
TABLE 9.1 Backward Linkages and Other Relationships between Foreign Affiliates and
Local Enterprise and Organisations*
Form
*Source: UNCTAD, reproduced in World Investment Report, 2001.
Backward
(sourcing)
Forward
(distribution)
Horizontal
(cooperation
in production)
Relationship of
foreign affiliate
to non-business
institution
Relationship of foreign affiliate to local enterprise
Pure
market
transaction
Short-term
linkage
Longer-term
linkage
Equity
relationship
Spillover
Off-the-shelf
purchases
Once-for-all or
intermittent pur-
chases (on contract)
Longer-term
(contractual)
arrangement for the
procurement of
inputs for further
processing
Subcontracting of
the production of
final or inter-
mediate products
Joint venture with
supplier
Establishment of
new supplier-
affiliate (by existing
foreign affiliate)
Off-the shelf
sales
Once-for-all or
intermittent sales
(on contract)
Longer-term
(contractual)
relationship with
local distributor
or end-customer
Outsourcing from
domestic firms to
foreign affiliates
Joint venture
with distributor
or end-customer
Establishment of
new distribution
affiliate (by
existing foreign
affiliate)
Joint projects
with competing
domestic firm
Horizontal joint
venture
Establishment of
new affiliate (by
existing foreign
affiliate) for the
production of
same goods and
services as it
produces
R&D contracts
with local insti-
tutions such as
universities and
research centres
Training pro-
grammes for firms
by universities
Traineeships for
students in firms
Joint public-private
R&D centres/
training centres/
universities
Demonstration effects in unrelated firms
Spillover on processes (including technology)
Spillover on product design
Spillover on formal and on tacit skills (shopfloor and managerial)
Effects due to mobility of trained human resources
Enterprise spin-offs
Competition effects
FDI AND PRODUCTION LINKAGES
The contribution of FDI to sustainable economic development of
the host countries depends to a large extent on the production
linkages between foreign affiliates and domestic firms. Such
linkages can take the form of backward, forward or horizontal.
The contribution of FDI
to development of host
country also depends on
the linkages it generates.
Backward linkages exist when foreign affiliates acquire goods or services from
domestic firms, and forward linkages when foreign affiliates sell goods or services to
domestic firms. Horizontal linkages involve interactions with domestic firms engaged in
competing activities. Linkages, broadly defined, can also involve non-business entities like
universities, training centres, research and technology institutes, export promotion agencies
and other official or private institutions.
4
These are depicted in Table 9.1.
The extent to which foreign affiliates establish backward linkages with domestic
suppliers is usually measured by the local content of production or local sourcing by foreign
affiliates, although, for many reasons, however, these measures may not accurately reflect
the magnitude of backward linkages with domestic firms (see Box 9.2).
BOX 9.2 Cooperation between Foreign Affiliates and Local Suppliers:
The Case of LG Electronics in India
Some foreign affiliates use advanced and systematic techniques for transferring technology
and information to linked enterprises, based on their experience elsewhere. For instance
the Indian affiliate of the Korean TNC, LG Electronics, uses techniques for supplier
development such as early supplier involvement to implement the Six Sigma system of
statistical analysis for quality and productivity improvement. It helps them with process
re-design and re-engineering and direct on-line supply. It provides them with global cost
benchmark; data not easily available to local counterparts. Suppliers are provided with
assistance in factory innovation to improve quality and profits. Some are helped to set up
facilities close to the buyer to improve logistics. Selected vendor employees are sent
to overseas plants, invited to regular meetings and presented with awards. They can
participate in LGs training programmes and are instructed in e-commerce techniques. By
being exposed to global quality and cost standards, they can meet export market demands
directly; LG helps them to enter export markets.
Source: UNCTAD, based on Kalyankar, S.V., Cooperation between SMEs and MNCs,
presentation prepared by LG Electronics India Ltd., for the World Association for Small and
Medium Enterprises (Noida, India, WASME), October 10, 2000, reproduced in World
Investment Report, 2001.
Studies show that in selected developed host countries, affiliates source between 10 and
20 per cent of their inputs locally (i.e., supplied by domestic or foreign-owned suppliers). In
developing countries, the share of locally-sourced inputs by foreign affiliates varies by
industry and region.
5
Some of the important conclusions arrived at by the UNCTAD, after surveying various
studies are the following.
6
A number of TNCs take various steps to develop linkages
between their foreign-affiliates and suppliers in host developing countries or economies in
transition. Some affiliates provide assistance in a broad range of areas, whereas others may
only support suppliers on an ad hoc basis, if at all. The most intense relationships are those
affecting the technological status of suppliers and their ability to meet the scale, quality and
cost needs of the buyer. Meanwhile, it is clear that it has become more difficult for
domestic firms in host developing countries to qualify as suppliers to foreign affiliates, in
particular to affiliates that are a part of integrated international production systems. In such
cases, TNCs tend to focus their supplier development efforts on key suppliers providing the
most important inputs. On the other hand, when TNCs have a strong self-interest in
developing their supplier base in a host country, foreign affiliates can extend considerable
support to enhance the competitiveness of their domestic suppliers.
The transfer of information on technical specifications and production requirements is,
of course, a necessary part of all linkages; beyond this, there are generally considerable
flows of advice, information, assistance and support from buyers to suppliers. The shape that
linkages take varies by location, activity, firm, the state of domestic and other local firms,
the nature of activities, the duration and closeness of the buyer-seller-relationship and the
costs and risks involved. The general picture is, however, clear: TNCs invest in linkages if
and when they are expected to yield a positive (and competitive) return. Indeed, a survey of
84 companies in Japan, the Republic of Korea, United Kingdom and United States in a wide
range of industries showed that most, but not all, buying firms found that supplier develop-
ment activities did improve suppliers cost, quality, delivery performance and cycle time.
TRADE AND INVESTMENT
Foreign trade and foreign direct investment (FDI) are mutually
influential.
FDI in the natural resource sectors, including plantations, in developing countries
increase trade. FDIs in several other sectors also increase international trade.
While on the one hand investment increases trade, as stated above, on the other,
foreign production by FDI substitutes foreign trade in many cases. Due to factors like
foreign exchange problems, desire to industrialise fast, etc. the policies of many developing
countries prefer foreign investment (for import substitution) to imports. As pointed out in
Box 9.1, the sales of firms established by FDI far exceed the world exports. A part of this
represents substitution of foreign production for trade and a part of this generates trade
about one-third of the world trade in manufactures is intra-company trade.
Due to the protectionism and some other factors, large amounts of FDI have been
taking place in the developed countries leading to substitution of foreign production for
foreign trade. The regional integration schemes also tend to increase such investments to
substitute production for trade. For example, many foreign companies have been setting up
manufacturing and assembly facilities in the European Community to overcome the fortress
EC-92.
It may also be pointed out that, to a considerable extent, such investments are made
possible by the past trade; the funds generated by trade are ploughed back to investment in
the foreign markets. The massive foreign investments made by the Japanese companies since
the mid-1980s deserve a special mention in this context.
While the international investment replaces international trade in certain products,
it may generate trade in some other products. Drucker, who observes that although
traditionally investment has followed trade, trade is increasingly becoming dependent on
investment, points out that US exports in the years of the over-valued dollar would have
been even lower had the European subsidiaries of American companies and American joint
ventures in Japan not continued to buy machinery, chemicals, and parts from the US.
While some of the FDIs
increase international
trade, some decrease trade.
Similarly, the foreign subsidiaries of Americas financial institutions, such as the major
banks, accounted for something like one half of US service income during those dismal
years.
7
Foreign investment has been significantly contributing to the export performance of
some countries. The case of China deserves a special mention here.
FACTORS AFFECTING INTERNATIONAL INVESTMENT
International investments are influenced by a number of factors given in Box 9.3.
BOX 9.3 12 Commandments of Foreign Direct Investment
1. Stable, predictable macro economic policy. Companies must have the confidence that
the economy in which they make an investment will be managed in a competent and
predictable way. Simply stated, investors must believe that the rules of the game will
not change in the middle of a contest.
2. An effective and honest government. An investor must be able to rely upon the
integrity of the host government and its ability to maintain law and order.
3. A large and growing market. The size and potential for growth of a countrys
domestic market, especially the purchasing power of its customers, are key. Companies
do not seek to invest in a market where there is little potential to make a profit.
4. Freedom of activity in the market. The strength of the competition, as well as the
degree of government (theirs and ours) interference to entering a countrys market,
are important factors. The freer the market, the more attractive it becomes as an
investment site for international investors.
5. Minimal government regulation. The cost of government regulation and intervention
in the affairsand profitsof private companies must be kept to a minimum.
6. Property rights and protection. Private property must be protected. The likelihood that
a companys real or intangible (patents, copy-rights, etc.) property will be stolen
must be avoided.
7. Reliable infrastructure. The ability to consummate transactions and get products and
services to market is also critical. Whether it be reliable transportation, power
generation, insurance and accounting services, a competent financial system or other
basic factors, investments cannot yield a sufficient or reliable financial return without
them.
8. Availability of high-quality factors of production. While the investor brings capital,
technology and management to the table, the quality of the indigenous work force
and the availability of local raw materials are also key ingredients in the recipe for
success.
9. A strong local currency. The local currency must retain its value. If you make an
investment in dollars and then the local assets (valued in the local currency) are
devalued, you have lost partor possibly allof your original dollar-based
investment.
10. The ability to remit profits, dividends and interest. If you cannot get your money out
of the country, why invest?
11. A favourable tax climate. Although tax incentives geared to attract initial investments
are important, a companys final investment decision is usually based on how a
countrys taxation will affect the normal operating environment once the venture is
off the ground.
12. Freedom to operate between markets. A company must be able to source goods and
services from its operating unit in one market in order to serve other markets or to
maximize its global efficiency by trading among its operating entities in different
countries to round out its product lines.
Courtesy: John D. Sullivan, Prospering in the Global Economy, Economic Reforms Today,
No. 1, 2000.
Host Country Economic Determinants
Traditionally, the economic determinants of inward FDI have been grouped, for analytical
convenience, into three clusters, each of them reflecting the principal motivations of
investing in foreign countries: resources seeking, market seeking and efficiency seeking.
Resources
Historically, the most important motivation of FDI has been the exploitation of natural
resources. Dunning points out that in the nineteenth century,
much of the FDI by European, United States and Japanese firms
were promoted by the need to secure an economic and reliable
source of minerals, primary products for the investing industrial-
ising nations of Europe and North America. Up to the eve of the Second World War, about
60 per cent of the world stock of FDI was in natural resources. The post-war period,
particularly since the 1960s and 1970s, witnessed a decline in the share of natural resources
in the FDI. Besides the decline in the importance of the primary sector in world output, this
decline was caused by factors such as the development of the indigenous enterprises in this
sector. In a number of developing economies, the public sector came to play an important
role in the resources based industries. Public sector efforts also included equity or technical
collaborations with MNCs.
8
Although, the share of the primary sector in FDI has declined, there has been
a substantial increase of the FDI in this sector in absolute terms. The FDI stock in the
primary sector of developed countries increased more than five fold between 19751990,
while in the developing countries it increased more than six fold. According to the World
Investment Report 1998, though declining in importance, the availability of natural resources
is still a determinant of FDI and continues to offer important possibilities for inward
investment in resourcerich countries. Natural resources still explain much of the inward
FDI in a number of countries, developing (e.g. countries in sub-Sahara, Africa), developed
(e.g. Australia) and countries in transition (Azerbaijan, Kiazakhistan and Russian
Federation).
9
Markets
Another important traditional determinant of FDI has been market seeking. Markets
protected from international competition by high tariffs or quotas triggered tariff jumping
FDI. Dunning points out that market access became the predeterminant motive for investing
in the manufacturing sector of developed countries between the two world wars and of
The exploitation of natural
resources has been an
important motive of FDI.
developing countries in the 1960s and 1970s, during the heyday of import substitution
industrialisation. This motive was paramount, for example, in the wave of United States
investments in Europe, especially in the United Kingdom, during the early post-war period
and in Japanese investments in the United States after the mid-1980s, following voluntary
export restrictions and the possibility of further protectionist measures in the automobile
industry.
10
It is very relevant to note here that the largest markets in the world, USA and China,
are among the largest recipient of FDI. As UNCTAD points out,
some of the largest national markets remain unmatched in size
by the largest regional markets or even by entire continents. For
example, the market of the European Union during most of its
existence has been smaller than the United States market; the market of the African
continent (without South Africa) is smaller than that of Republic of Korea; and the
combined markets of the 14 Central and Eastern European countries are smaller than the
market of Brazil.
11
The lions share of FDI flow to the developing countries goes to the larger markets
with comparatively good infrastructure and political stability in general.
The growing importance of the service sector has also been resulting in increasing FDI
because of the fact that most services are not tradable and, therefore, the only way to deliver
them to foreign markets is through establishment abroad. However, the highly regulated
nature of the services sector has been a deterrent to the FDI flow in its full potential.
Efficiency
Another important motivation of FDI is efficiency seeking. Low cost of production,
deriving mostly from cheap labour, is the driving force of many FDIs in developing
countries. Export processing zones have been developed by developing countries mostly to
take advantage of the efficiency seeking FDI flows.
It may be noted that the presence of any of the three determinants mentioned before
alone need not attract FDI. For example, even if a country has natural resources or
abundance of cheap labour, FDI would not take place in the absence of required
infrastructural facilities to develop the industry or trade. Besides, several other factors such
as political environment, government policies, bureaucratic culture, social climate, etc. are
also important determinants of FDI. Figure 9.2 shows the economic determinants of FDI.
BOX 9.4 China and IndiaWhat Explains the Different FDI Performance?
There are significant differences in the FDI performance of China and India. The World
investment Report, 2003, citing several studies, makes the following observations.
FDI in Indian manufacturing has been and remains domestic market-seeking. FDI in China,
in contrast, has been market-seeking, efficiency seeking and resource seeking.
The above difference in the motives of FDI is reflected in the contribution of the FDI to
export performance of both the countries. FDI has contributed to the rapid growth of
Chinas merchandise exports, at an annual rate of 15 per cent between 1989 and 2001. In
1989, foreign affiliates accounted for less than 9 per cent of total Chinese exports; by
The motive of exploita-
tion of markets has been
a major driver of FDI.
2002 they provided half. In some high-tech industries in 2000 the share of foreign
affiliates in total exports was as high as 91 per cent in electronics circuits and 96 per
cent in mobile phones. In contrast, FDI has been much less important in driving Indias
export growth, except in information technology. FDI accounted for only 3 per cent of
Indias exports in the early 1990s. Even today, FDI is estimated to account for less than
10 per cent of Indias manufacturing exports.
On the basic economic determinants of inward FDI, China does better than India. Chinas
total and per capita GDP are higher, making it more attractive for market-seeking FDI.
Rapid growth in China has increased the local demand for consumer durables and
nondurables, such as home appliances, electronics equipment, automobiles, housing and
leisure. This rapid growth in local demand, as well as competitive business environment
and infrastructure, have attracted many market-seeking investors. It has also encouraged
the growth of many local indigenous firms that support manufacturing.
Its higher literacy and education rates suggest that its labour is more skilled, making it
more attractive to efficiency-seeking investors. In addition, Chinas physical infrastructure
is more competitive, particularly in the coastal areas.
India may have an advantage in technical manpower, particularly in information
technology. It also has better English language skills.
Some of the differences in competitive advantages of the two countries are illustrated by
the composition of their inward FDI flows. In information and communication technology,
China has become a key centre for hardware design and manufacturing by a number of
well-known companies across the world. India specialises in IT services, call centres,
business back-office operations and R&D.
Item Country 1990 2000 2001 2002
FDI inflows China 3,487 40,772 46,846 52,700
(Million dollars) India 379 4,029 6,131 5,518
Inward FDI stock China 24.762 348.346 395.192 447.892
(Million dollars) India 1,961 29,876 36,007 41,525
Growth of FDI inflows China 2.8 1.1 14.9 12.5
(annual, %) India 6.1 16.1 52.2 10.0
FDI stock as percentage China 7.0 32.3 33.2 36.2
of GDP (%) India 0.6 6.5 7.4 8.3
FDI flows as percentage of China 3.5 10.3 10.5
gross fixed capital formation (%) India 0.5 4.0 5.8
FDI flows per capita China 3.0 32.0 36.5 40.7
(Dollars) India 0.4 4.0 6.0 5.3
Share of foreign affiliates China 12.6 47.9 50.0
in total exports (%) India 4.5
GDP (billion dollars) China 388 1,080 1,159.1 1,237.2
India 311 463 484 502
Real GDP growth China 3.8 8.0 7.3 8.0
(%) India 6.0 5.4 4.2 4.9
As per the information available in 2001, nearly 80 per cent of all Fortune 500 companies
are in China, while 37 per cent of the Fortune 500 outsource from India.
FDI in China is very broad-based whereas in India the FDI destinations are relatively
narrow. For example, in 20002001 the lions share of FDI inflows to China went to a
broad range of manufacturing industries. For India most went to services, electronics and
electrical equipment and engineering and computer industries.
Other determinants related to FDI attitudes, policies and procedures also explain why
China does better in attracting FDI. China has more business-oriented and more FDI-
friendly policies than India. Chinas FDI procedures are easier, and decisions can be taken
rapidly. China has more flexible labour laws, a better labour climate and better entry and
exit procedures for business.
A recent business environment survey has indicated that China is more attractive than
India in the macroeconomic environment, market opportunities and policy towards FDI.
India scored better on the political environment, taxes and financing. A confidence
tracking survey in 2002 indicated that China was the top FDI destination, displacing the
United States for the first time in the investment plans of the TNCs surveyed; India came
15th. A Federation of Indian Chambers of Commerce and Industry (FICCI) survey suggests
that China has a better FDI policy framework, market growth, consumer purchasing power,
rate of return, labour laws and tax regime than India.
The different FDI performance of the two countries is also related to the timing, progress
and content of FDI liberalisation in the two countries and the development strategies
pursued by them. China opened its doors to FDI in 1979 and has been progressively
liberalizing its investment regime. India allowed FDI long before that but did not take
comprehensive steps towards liberalisation until 1991.
Chinas accession to the WTO in 2001 has led to the introduction of more favourable FDI
measures. With further liberalisation in the services sector, Chinas investment environment
may be further enhanced. For instance, China will allow 100 per cent foreign equity
ownership in such industries as leasing, storage and warehousing, wholesale and retail
trade, advertising, multimodal transport services, insurance brokerage, and transportation
of goods (railroad).
In retail trade, China has already opened and attracted FDI from nearly all the big-name
department stores and supermarkets such as Auchan, Carrefour, Diary Farm, Ito Yokado,
Jusco, Makro, Metro, Pricesmart, 7-Eleven and Wal-Mart. It may be noted that in India the
Government has not yet formed clear view and policy in respect of foreign investment in
several of these areas.
In addition to economic and policy-related factors, an important explanation for Chinas
larger FDI flows lies in its position as the destination of choice for FDI by Chinese
businesses and individuals overseas, especially in Asia. The role of the Chinese business
networks abroad and their significant investment in mainland China contrasts with the
much smaller Indian overseas networks and investment in India. Why? Overseas Chinese are
more in number, tend to be more entrepreneurial, enjoy family connections (guanxi) in
China and have the interest and financial capability to invest in Chinaand when they
do, they receive red-carpet treatment. Overseas Indians are fewer, more of a professional
group and, unlike the Chinese, often lack the family network connections and financial
resources to invest in India.
Both China and India are good candidates for the relocation of labour-intensive activities
by TNCs, a major factor in the growth of Chinese exports. In India, however, this has been
primarily in services, notably information and communication technology. Indeed, almost
all major United States and European information technology firms are in India.
The prospects for FDI flows to China and India are promising, assuming that both
countries want to accord FDI a role in their development processa sovereign decision.
The large market size and potential, the skilled labour force and the low wage cost will
remain key attractions. China will continue to be a magnet of FDI flows and Indias
biggest competitor. But, FDI flows to India are set to risehelped by a vibrant domestic
enterprise sector and if policy reforms continue and the Government is committed to the
objective of attracting FDI flows to the country.
FIGURE 9.2 Host Country Determinants of FDI
(Reproduced from UNCTAD, World Investment Report, 2002).
Economic Determinants
Policy framework for FDI
Economic, political and social stability
Rules regarding entry and operations
Standards of treatment of foreign affiliates
Policies on functioning and structure of
markets (especially competition and M&A
policies)
International agreements on FDI
Privatisation policy
Trade policy (tariffs and NTBs) and coherence
of FDI and trade policies
Tax policy
Market-seeking FDI
Market size and per
capita income
Market growth
Access to regional and
global markets
Country-specific consumer
preferences
Structure of markets
Business facilitation
Investment promotion (including image-
building and investmentgenerating activities
and investmentfacilitation services)
Investment incentives
Hassle costs (related to corruption,
administrative efficiency, etc.)
Social amenities (bilingual schools, quality of
life, etc.)
Afterinvestment services
Host Country Determinants of FDI
Resource/Asset-seeking FDI
Raw materials
Low-cost unskilled labour
Skilled labour
Technological, innovatory and
other created assets (e.g.
brand names), including as
embodied in individuals, firms
and clusters
Physical infrastructure (ports,
roads, power,
telecommunication)
Efficiency-seeking FDI
Cost of resources and assets
listed under resource/asset
seeking FDI, adjusted for
productivity for labour
resources
Other input costs, e.g. transport
and communication costs to/
from and within host economy
and costs of other intermediate
products
Membership of a regional
integration agreement
conductive to the establishment
of regional corporate networks
LIMITATIONS AND DANGERS OF FOREIGN CAPITAL
Foreign capital, both private and official (governmental and institutional), have certain
limitations. Certain additional risks are associated with private foreign capital.
One of the important limitations to utilise the foreign capital is the absorptive capacity
of the recipient country, i.e., the capacity of the country to utilise
the foreign capital effectively. Lack of infrastructural facilities,
technical know-how, personnel, inputs, market, feasible projects,
inefficiency or inadequacy of administrative machinery, etc. are
important factors that affect the absorptive capacity.
Sometimes strings are attached to the official assistancethe recipient country may
be pressurised to fall in line with the ideology or direction of the donor.
The following criticisms are levelled against foreign capital:
1. Private foreign capital tends to flow to the high profit areas rather than to the
priority sectors.
2. The technologies brought in by the foreign investor may not be adapted to the
consumption needs, size of the domestic market, resource availabilities, stages of
development of the economy, etc.
3. Through their power and flexibility, the multinational corporations can evade or
undermine national economic autonomy and control, and their activities may be
inimical to the national interests of particular countries.
4. Foreign investments, sometimes, have unfavourable effect on the Balance of
Payments of a country such as when the drain of foreign exchange by way
of royalty, dividend, etc., is more than the investment made by the foreign concern.
5. Foreign capital sometimes interferes in the national politics.
6. Foreign investors sometimes engage in unfair and unethical trade practices.
7. Foreign investment in some cases leads to the destruction or weakening of small
and traditional enterprises.
8. Sometimes foreign investment can result in the dangerous situation of minimising/
eliminating competition and the creation of monopolies or oligopolistic structures.
9. FDI can also potentially displace domestic producers by preempting their invest-
ment opportunities.
10. The evolution of private capital flows, characterised by fluctuations (which are
sometimes violent), suggests that they are not a reliable source of
financing for development, partly because portfolio equity flows
are very volatile and because financial liberalisation has led to an
increase in short-term speculative flows. Moreover, private capital flows, including
FDI, are concentrated in a small number of emerging-market economies, while
most low-income and least developed countries, which are the most dependent on
external financing, receive no or very small amounts of such flows.
12
11. Often, several costs are associated with encouraging foreign investment. Meier
observes
13
that these costs may arise from special concessions offered by the host
country, adverse effects on domestic saving, deterioration in the terms of trade, and
problems of balance of payments adjustment.
Capital absorptive capacity
is a constraint of FDI
inflow.
FDI has several risks and
costs.
(a) The incentives (including tax concessions), services and facilities which the
governments of the host countries offer to encourage foreign investment have
opportunity cost and the opportunity cost tends to be very high in developing
countries. The competition between countries and provinces to woo foreign
investment makes matters worse.
(b) Although foreign investment may have an income effect that will lead to
a higher level of domestic savings, this effect may be offset, however, by a
redistribution of income away from capital if the foreign investment reduces
profits in domestic industries (because of factors such as increased competition).
The consequent reduction in home savings would then be another indirect cost
of foreign investment. But it is unlikely to be of much consequence in practice
because of the favourable effects of the foreign investment.
(c) Foreign investment might also affect the recipient countrys commodity terms
of trade through structural changes associated with the pattern of development
that results from the capital inflow. If the foreign capital causes an increase in
the exportables to such an extent of resulting in a deterioration in the terms of
trade, the rise in real income of the country will be less than that in output,
and the worsening terms of trade may be considered another indirect cost of
the foreign investment. Whether the terms of trade will turn against the
capital-receiving country is problematical depending on various possible
changes at home and abroad in the supply and demand for exports, import
substitutes, and domestic commodities. It is unlikely, however, that private
foreign investment would cause any substantial deterioration in the terms of
trade. In fact, private foreign investment can help bring about a favourable
structural change in the countries foreign trade.
(d) The servicing of foreign debt capital, both public and private, can cause
balance of payments problems. Further, as has already been indicated above,
repatriation of profits can also cause problems.
GROWTH OF FDI
As Table 9.2 clearly shows, there has been a surge in foreign investment, supported by the
sweeping changes in the economic policy in many countries (see Box 9.1).
Although foreign direct investment flows had their ups and downs, the stock of FDI
has increased tremendously over time. Between 1982 and 2000, Foreign Direct Investment
(FDI) inflows and outflows increased from $ 59 billion and $ 27 billion respectively to
$ 1271 billion and $ 1150 billion respectively. After reaching its peak in 2000, the FDI
inflows experienced a decline in the next three years. However, after declining in 2001 and
2002, outflows increased slightly in 2003. In 2003, the FDI flows were less than half of the
peak levels of 2000. The 2001 decline was the first drop in inflows since 1991 and outflows
since 1992. The dramatic increases in cross-border M&As led to record flows in 1999 and
2000.
10
Cross-border M&As made its contribution to the decline in the FDI too. The FDI
flows again reached a record level in 2007, but declined in 2008 and 2009.
Some cyclical pattern is observed in the foreign investment flows. The decline in FDI
flows in 2001 followed rapid increases during the late 1990s. As
the World Investment Reports point out, there was a similar
pattern during the late 1980s and early 1990s, and in 19821983.
Thus, this is the third downward cycle in FDI, each punctuating a
long upward trend in FDI every ten years or so. These swings reflect changes in several
factors. The main ones are business cycles, stock market sentiment and M&As. These short-
term factors (including factors such as the terrorist attack of September 11, 2000) work in
tandem with longer-term factors, sometimes offsetting and at other times reinforcing them.
There is, on the other hand, a stable and positive relationship between global FDI flows and
the level and growth of world GDP. Technological change, shrinking economic distance and
new management methods favour international production. Their impact is, however,
countered by cyclical fluctuations in income and growth. The decline in FDI in 2001
reflected a slow down in the world economy. More than a dozen countriesincluding the
worlds three largest economiesfell into recession. On the supply side, FDI is affected by
the availability of investible funds from corporate profits or loans, which in turn is affected
TABLE 9.2 Selected Indicators of FDI and International Production, 19822005
Items
1982 1990 2003 2007 1986 1991 1996 2001 2002 2003 2007
1990 1995 2000
FDI inflows 59 208 633 1,833 22.8 21.2 39.7 40.9 13.3 11.7 29.9
FDI outflows 27 239 617 1,997 25.4 16.4 36.3 40.0 12.3 5.4 50.9
FDI inward stock 628 1,769 7,987 15,211 16.9 9.5 17.3 7.1 8.2 19.1 22.0
FDI outward stock 601 1,785 8,731 15,602 18.0 9.1 17.4 6.8 11.0 19.8 22.3
Cross-border M&As 151 297 1,637 25.9 24.0 51.5 48.1 37.8 19.6 46.4
Sales of foreign
affiliates 2,765 5,727 16,963 31,197 15.9 10.6 8.7 3.0 14.6 18.8 20.7
Gross product of
foreign affiliates 647 1,476 3,573 6,029 17.4 5.3 7.7 7.1 5.7 28.4 19.4
Total assets of
foreign affiliates 2,113 5,937 32,186 68,716 18.1 12.2 19.4 5.7 41.1 3.0 23.1
Exports of foreign
affiliates 730 1,498 3,073 5,714 22.1 7.1 4.8 3.3 4.9 16.1 15.4
Employment of
foreign affiliates
(thousands) 19,579 24,471 53,196 81,615 5.4 2.3 9.4 3.1 10.89 11.1 16.6
GDP (in current
prices) 11,758 22,610 36,327 54,568 10.1 5.2 1.3 0.8 3.9 12.1 11.5
Gross fixed capital
formation 2,398 4,905 7,853 12,356 12.6 5.6 1.6 3.0 0.5 12.9 13.1
Royalties and
licence fee receipts 9 30 93 164 21.2 14.3 8.0 2.9 7.5 12.4 15.4
Exports of goods
and non-factor
services 2,247 4,261 9,216 17,138 12.7 8.7 3.6 3.3 4.9 16.1 15.4
Source: UNCTAD, World Investment Report, 2005 and 2007.
Value at current prices
(Billions of dollars)
Annual growth rate
(Per cent)
FDI flows, cyclical in
nature, show a robust
growth trend.
by domestic economic conditions. On the demand side, growing overseas markets lead TNCs
to invest, while depressed markets inhibit them. The more interdependent host and home
economies become, and the more widely a recession or upswing spreads, the greater are the
corresponding movements in global FDI.
Data for 19802001 show that a bulge in global FDI accompanies high economic
growth, and a trough accompanies low growth. However, the relationship between GDP
growth and FDI is not uniform across groups of economies. They go together in developed
but not in developing countries. One explanation for the different patterns of FDI flows is
that business cycles spread much faster across developed countries than others. A
supplementary explanation may be that some countries (as in CEE) had been cut off from
substantial FDI flows for so long that they have a lot of catching up to doshort-term
cycles do not affect their attractiveness.
The economic liberalisation in many countries, including the erstwhile communist
countries and countries which still claim to be communist or socialist like the Peoples
Republic of China, should be expected to enlarge the FDI flows in future.
DISPERSION OF FDI
Concentration of FDI
A small number of countries account for the major chunk of the FDI. FDI outflow shows
more concentration than inflow.
The major chunk of the FDI flows takes place between the developed countries. For
nearly three decades till the early 1990s, about three-quarters of
the FDI have gone to the developed countries. Now nearly two-
thirds of the flows take place between the countries of the
Triadthe US, the European Community and Japan.
FDI is concentrated in a handful of countries. For instance, ten countries received
74 per cent of global FDI flows in 1999. Just ten developing countries received 80 per cent
of total FDI flows to the developing world. More importantly, there are no signs that the
concentration of international production across countries has been declining over time.
FDI in Developing Countries
The share of the FDI going to the developing countries declined substantially from 25 per
cent during 198085 to 17 per cent during 198690. There was, however, an increase in the
absolute amount of FDI flows to the developing countries. The economic liberalisations in
the developing countries have helped increase the FDI to them (see Tables 9.3 and 9.4).
TABLE 9.3 Distribution of Annual FDI Inflow by Category of Economies, 19932007 (Percentage)
Category of economies 199398 1999 2000 2001 2002 2003 200507
Developed economies 63.8 77.7 81.2 72.2 76.5 69.9 66.6
Developing economies 34.6 21.3 18.1 26.4 21.7 26.3 29.2
South East Europe and CIS 1.6 1.0 0.6 1.4 1.8 3.8 4.1
A small number of
countries receive the lions
share of FDI flows.
TABLE 9.4 Distribution of Annual FDI Outflow by Category of Economies, 19932007 (Percentage)
Category of economies 19931998 1999 2000 2001 2002 2003 200507
Developed economies 85.9 91.8 88.2 89.1 92.0 93.6 84.0
Developing economies 13.8 8.0 11.6 10.6 7.3 4.7 13.8
South East Europe and CIS 0.3 0.2 0.3 0.4 0.7 1.7 2.1
FDI in developing countries has been larger than official
inflows for every year since 1993. It was 10 times larger than
bilateral official development assistance (ODA) in 2000; this
contrasts with the latter half of the 1980s, when the two were
about equal.
Within the group of the developing countries, the relatively developed among them
get the lions share of the FDI. Very little FDI has taken place
in low income economies leaving exceptions like China and
India. In most cases, this has been due to the small size of the
domestic market and other adverse factors such as poor infra-
structure, lack of skilled labour.
The lions share of the FDI flows to the developing countries has been cornered by
two regions, viz., East Asia and the Pacific and Latin America while Sub-Saharan/Africa,
and Middle East and North Africa got very low shares. In 2001, the five largest recipients
attracted more than 60 per cent of the total inflows to the developing countries. South
Asias share has been very dismal. The least developed countries (numbering 50) get only
about half a per cent of the world FDI flows.
However, in many least developed countries that have received only small amounts of
FDI, such investment is important vis-a-vis the size of domestic investment. What remains a
challenge for these countries is the ability to attract not only more, but also higher quality
FDIbroadly defined as investment with strong links to the domestic economy, export
orientation, advanced technology and skill or spillover effects.
One traditional attraction of foreign investment, viz., cheap labour, is becoming less
important. Foreign investment today is not merely for exploitation of local resources.
Foreign companies today evaluate the market potential and production and related facilities
and their efficiencies, inter alia, for investment decision making. Countries with large and
growing markets, fairly developed infrastructures and efficient input supplies, conducive
trade policies, favourable political environment, required type of manpower supplies, etc.
rank high for investment. An encouraging government policy alone is not sufficient. China
has been able to attract huge FDI because its economic growth for quite some time now has
been very good, it is one of the largest potential markets in the world, because of the statist
policy until recently it is virtually a virgin market for many products, the labour force is
disciplined by the State and China has favourable political and bureaucratic environment.
Although India is not as attractive as China in terms of the aforementioned factors, its
potential is enormous. FDI flows to India have, however, been discouraged by such factors
as confusing political environment, agitation against certain multinationals etc. and
FDI is the largest source
of external finance for
developing countries.
FDI flows to developing
countries are mostly
directed to the relatively
developed among them.
bureaucratic problems (see Boxes 9.4 and 9.5). Countries which are at very low levels of
development would not be attractive to foreign investors due to factors such as constraints of
domestic markets and absence of infrastructural and other input supplies of the quantity and
quality needed to make the enterprises competitive.
BOX 9.5 Sources and Destinations of FDI
The developed world hosts two-thirds of world inward FDI stock and accounts for nine-
tenths of the outward stock. The most striking change is that the EU has become by far
the largest source. In 1980 the outward stocks of the EU and the United States were
almost equal at around $ 215 billion. But by 2002, the EUs stock (including intra-EU
stock) reached $ 3.4 trillion, more than twice that of the United States ($ 1.5 trillion).
Japan has been stable relative to the EU, with its outward stock about a tenth that of the
EU.
In 1980 the FDI stock originating from developing countries (at $ 65 billion) accounted for
11 per cent of the global outward FDI stock; by 2002 the corresponding share was
12 per cent. South, East and South-East Asia is the most important developing region for
outward FDI stock, with its stock exceeding Japans for the first time in 1997 and
becoming almost twice Japans by 2002. The Latin America and Caribbean region registered
a threefold increase in its outward FDI stock between 1980 and 2002. The concentration
of FDI within the Triad (EU, Japan and the United States) remained high between 1985
and 2002 (at around 80 per cent for the worlds outward stock and 5060 per cent for
the worlds inward stock).
Clusters of non-Triad countries have strong FDI links to each Triad member.
This pattern reveals the emergence of FDI blocks, each comprising one Triad country and
several associate partner countries. They overlap somewhat with trade blocks, each
comprising a Triad member and a cluster of trading partners with strong trade links to it.
The FDI block pattern is also roughly mirrored inand supported byinternational
investment agreements (IIAs)agreements that, at least in part, address FDI issues. To
improve the investment climate in their partners, associate partners and Triad members
have been concluding DTTs and BITs with them.
Courtesy: UNCTAD, World Investment Report, 2004.
Outward FDI from developing countries
FDI outflows from developing economies have been significantly increasing, reflecting the
recognition of firms that in a globalising world economy, they need a portfolio of locational
assets to be competitive internationally. In fact, countries like Malaysia, the Republic of the
Korea and Singapore already have an established track record and some others such as Chile,
Mexico and South Africa have become players relatively recently. Countries like Brazil,
China and India are at the take-off stage. Their investments span all sectors and country
groups and involve complex as well as simple industries. Annual FDI outflows from
developing countries have grown faster than those from developed countries in the 15 years
prior to 2003. Negligible until the beginning of the 1990s, outward FDI from developing
countries accounted for over 15 per cent of the world total stock in 2009.
14
FDI flows between developing countries seem to be growing faster than from
developing countries to developed countries. The growing importance of South-South FDI
indicates that developing countries are more financially integrated with one another than was
previously believed. Thus, a typical developing country has access to more sources of
investment than before. This is particularly important for small economies, as TNCs from
the South, because of their comparative advantages, tend to invest in countries with similar
or lower levels of development than their home countries.
15
Regional pattern
An examination of the investment pattern of the major sources of FDI shows that they,
generally, had a regional bias in their investment in the developing countries. The US
investments were largely in Latin America. Japans investments went mostly to the Asian
neighbours. There has, however, been some significant changes in the Japanese investments
recently. Much of the United Kingdoms investment has gone to the Commonwealth nations,
and France had a favour for countries with past colonial ties, mainly Africa.
Mega blocks of FDI flows appear to be emerging, with clusters of developing
countries linked to a triad country (see Box 9.5).
It has also been observed that direct investment is concentrated in particular economic
sectors. For instance, investment by UK and German firms has been mainly in manufactur-
ing while US and Japanese investment, although more evenly spread over the major econo-
mic sectors, has a bias towards manufacturing and primary industries; within manufacturing
direct investment has been made mainly in transportation equipment, chemicals and
machinery (which includes electronics).
The vast expansion of the investment opportunities across the world should be expected
to encourage some changes in the directional pattern of the foreign investment flows.
Sectoral trends
Although FDI has grown over time in all three economic
sectorsprimary, manufacturing and servicesthe sectoral
composition has undergone significant changes with marked shift
towards services.
16
The primary sectors share in world FDI stock decreased from 9 per cent in 1990 to
6 per cent in 2002. However, in the case of FDI flows between 19891991 and 20012002,
the share of the primary sector did not decline: it rose from 7 per cent to 9 per cent. While
nearly all FDI in the sector continues to originate from developed countries, developing
countriesmany of them rich in natural resources, but lacking internationally competitive
national firmsattract considerable FDI (32 per cent of total primary-sector FDI in 2002).
Within the primary sector, mining, quarrying and petroleum dominate: the primary sector
FDI with over 90 per cent of inward FDI stock.
The share of manufacturing in global FDI stock worldwide fell from 42 per cent in
1990 to 34 per cent in 2002. Manufacturing FDI is increasingly geared to more capital and
knowledge-intensive activities because of two developments. There has been a decline in
labour-intensive manufacturing in general, and the share of traditional manufacturing
employment has also steadily declined. Technological changes leading to increasing
The share of services in
FDI increased substantially
while those of primary
and manufacturing sectors
declined.
replacement of labour by capital and knowledge have been a key element in the decline of
labour-intensive FDI in manufacturing. Secondly, firms in more and more countries,
especially developing countries, have developed their own ownership-specific advantages
based on different factor endowments, particularly low-cost labour, vis--vis developed
countries.
During the period 19902002, while the global FDI stock in the primary sector nearly
doubled and in the manufacturing sector increased nearly threefold, in the services sector it
is more than quadrupled. As a result of more rapid growth in this sector than in the other
sectors, services accounted for about 60 per cent of the global stock of inward FDI in 2002,
compared to less than one-half in 1990 and only one-quarter in the early 1970s. In 2009,
services sector continued to receive an increasing share of FDI.
CROSS-BORDER M&As
A very significant aspect of the recent FDI surge is that it is
triggered to a large extent by cross border M&As. For instance,
in some of the recent years cross-border M&As accounted for
three-fourths of the value of global FDI (see Table 9.5).
TABLE 9.5 Cross-border M&As with Values of over $1 billion, 19872007
Year Number of deals Percentage of total Value ($ billion) Percentage of total
1987 14 1.6 30.0 40.3
1988 22 1.5 49.6 42.9
1989 26 1.2 59.5 42.4
1990 33 1.3 60.9 40.4
1991 7 0.2 20.4 25.2
1992 10 0.4 21.3 26.8
1993 14 0.5 23.5 28.3
1994 24 0.7 50.9 40.1
1995 36 0.8 80.4 43.1
1996 43 0.9 94.0 41.4
1997 64 1.3 129.2 42.4
1998 86 1.5 329.7 62.0
1999 114 1.6 522.0 68.1
2000 175 2.2 866.2 75.7
2001 113 1.9 378.1 63.7
2002 81 1.8 213.9 57.8
2003 56 1.2 141.1 47.5
2006 215 2.4 711.2 63.6
2007 300 3.0 1161.0 70.9
Cross-border mergers and acquisitions (M&As) involve FDI in a host country by
merging with or acquiring an existing local firm. In the latter case, the acquisition involves
an equity stake of 10 per cent or more. The share of FDI accounted for by cross-border
M&As is difficult to determine, since data sets are not directly comparable. First, the value
Cross-border mergers and
acquisitions (M&As) have
been the key driver of
global FDI since the late
1980s.
of cross-border M&As includes funds raised in local and international financial markets.
Secondly, FDI data are reported on a net basis, using the balance-of-payments concept, while
data on cross-border M&As purchases or sales report only the total value of the transaction.
Finally, payments for cross-border M&As are not necessarily made in a single year but may
be spread over a longer period.
17
As an UN report points out, one recent feature is that M&As among large or dominant
TNCs, resulting in even larger TNCs, seem to impel other major TNCs to move towards
restructuring or making similar deals with other TNCs. The pharmaceutical, automobile,
telecommunications and financial industries are typical examples of industries in which such
concentration can be observed. This trend significantly changes the industry structure. In the
automobile industry, for example, the total number of major automobile makers may well
decline to 510 by 2010, from the 1998 figure of 15. In the pharmaceutical industry, many
markets are now controlled by a small number of firms. In both these industries, there have
been a string of M&As. Major M&As in the pharmaceuticals include Glaxo-SmithKline
Beecham, Pfizer Warner Lambert and HoechstRhone.
The trend towards M&As is also accelerating the sale of non-core operations or
affiliates by firms and the acquisition of similar operations from other firms (of divisions or
affiliates, or firms that have similar businesses). This indicates a strategic shift by TNCs to
focus on their core activities. Unlike in the 1980s, there were fewer deals among unrelated
businesses. In addition to strategic considerations of firms, liberalisation and deregulation are
the other main factors behind the dramatic increases in M&As in both developed and
Developed countries account for the lions share of the mega mergers (nearly 90 per
cent of the total). However, an upward trend in M&As sales by developing countries and
countries in transition is noticeable. Among developing countries, majority M&As, sales in
South, East and SouthEast Asia have been increasing recently, in particular after the 1997
financial crisis. Latin America and Central and Eastern Europe also recorded significant
increases in M&A sales.
There has been a substantial shift towards services in cross-border M&As as it became
a widely used mode of TNC entry in such service industries as banking, telecommunications
and water. While in the late 1980s services accounted for some 40 per cent of global cross-
border M&As, their share rose to more than 60 per cent by the end of the 1990s.
The liberalisation and deregulation of several vital industries in many countries across
the world have given an impetus to cross-border M&As in both developed and developing
countries. Increasing M&As in the service sector in general and financial industries in
particular reflect the impact of liberalisation. Privatisation has been a very important
stimulant to M&As. Banking, finance, insurance and telecommunication industries have been
witnessing a spate of M&As.
The Indian Scene
The liberalisationthe privatisation, delicensing, liberalisation of foreign investment policy,
scrapping of MRTP restrictions on M&A, et al.and the SEBI Takeover Code have opened
the doors for cross-border M&As in India.
The FDI inflow to India on account of acquisition of shares increased from $ 11
million in 199596 to $ 916 million in 200203.
Foreign MNCs have been using M&A as a market entry strategy and competitive
strategy. The soft drink industry witnessed the use of M&A to increase market share and
shrink competition. The Indian cement industry, which has witnessed a number of domestic
M&As and resultant consolidation, has also witnessed the entry and expansion of global
cement majors by M&As. The French cement major, Lafarge, which made a market entry
with the acquisition of Tiscos cement unit for Rs. 550 crore has moved on to strengthen its
position by acquiring Raymonds cement unit for Rs. 785 crore. It then eyed Madras
Cements, a leading player in South India. Italcementi, the Italian cement major, through
its group company Ciments Francais, opened its door to India by the acquisition of the
K.K. Birla groups Zuari Cements. Other global majors like Cemex of Mexico, Holder Bank
of Switzerland and Blue Circle of UK have been reported to be interested in India.
Several MNCs have acquired the partners stake in their joint ventures or have hiked
the stake in the joint ventures and subsidiaries.
Acquisitions by India Inc Strategic M&As have been finding favour with corporate India
too. M&As by Indian companies involving foreign firms fall into three categories, viz.,
Acquisition of firms in foreign countries.
Acquisition of MNC affiliates in India.
Acquisition of foreign brands.
Acquisition of foreign firms by Indian companies is not something new. Acquisition
of foreign firms has been an important element of the inter-
nationalisation strategy of a number of Indian firms. Several
pharmaceutical companies, for example, have done it. A very
important foreign acquisition has been the $ 271 billion (Rs. 1870
crore) leveraged buyout of Tetley by Tata Tea. With this, Tata
Tea, the largest integrated tea producer in the world, got
possession of the second largest global tea marketer which has a
variety of tea products and number one position in some of the advanced markets. Other
Tata companies like Tata Steel and Tata Motors have also been expanding globally by
acquisitions. The acquisition of the Canadian aluminium major Alcans stake in its Indian
subsidiary, Indal, by the A.V. Birla Groups Hindalco for Rs. 1008 crore, was the largest
all-cash acquisition in the history of corporate India. Acquisition has been an important
globalisation strategy of Indian pharma and IT firms too.
Some Indian companies have acquired certain foreign brands. For example, the
Nicholas Piramal India has acquired the Indian rights for three anti-infective brands from
the US firm Eli Lilly which gave Piramal a strategic entry into this generation of antibiotic.
The acquisition of the $ 4 million generics business of Bayer AG has given Ranbaxy an
entry into Germany, the third largest generics market in the world. Sun Pharmaceuticals
acquisition of Caraco Pharma Labs, which has a FDA approved formulations manufacturing
plant, gave it a strategic entry into the US generics market with lightening speed. It may
be viewed in the light of the fact that 178 molecules valued at $ 43 billion is going off
In some of the recent
years, acquisitions of
foreign firms by Indian
companies exceeded the
value of acquisitions of
Indian firms by foreign
companies.
patent by 2003 in the US. Similarly, the acquisition of MJPL gave it an entry to the European
generics market.
The acquisition of Madura Garments, the ready-made garments business of Madura
Coats, a subsidiary of the UK based Coats Viyella, for nearly Rs. 236 crores by the Indian
Rayon of the A.V. Birla group gave it some overseas brand rights too.
Liberalisation, privatisation and growing competition have been stimulating restructur-
ing industries globally and cross-border M&A has become a necessitating and facilitating
force (see Table 9.6). The Takeover Code put in place by the SEBI has imparted clarity and
order to the acquisition scene in India.
TABLE 9.6 Cross-border M&AsIndia ($ million)
Period Sales Purchases
199095 (annual average) 159 72
1997 1520 1287
1998 361 11
1999 1044 126
2000 1219 910
2001 1037 2195
2002 1698 270
2003 949 1362
2006 6716 4740
2007 18830 11256
Source: UNCTAD.
PORTFOLIO INVESTMENTS
Portfolio equity flows to developing countries was conspicuous by their absence prior to
1982. The average annual portfolio flows to developing countries, which was $ 1.3 billion
during 19831990, shot up substantially in the 1990s. The portfolio inflows are likely to
significantly increase in future, supported by such factors as further capital market
liberalisation and reforms in developing countries, growth in global financial assets, growth
in developing countries exports and capacity to service foreign liabilities, industrial and
general economic growth in developing countries, increased diversification of investor
portfolios, growing resources of the investors and faster equity market capitalisation in
The fact that this very small share of the total investment by the developed country
portfolio investment would amount to large chunk of investment in the developing country
markets has serious implications because of the high sensitivity and volatility of the portfolio
investments. The Mexican crisis and the South-East Asian crisis may be remembered here.
Further, large foreign portfolio investment in companies could have other implications.
FOREIGN INVESTMENT IN INDIA
The flow of direct foreign investment to India has been comparatively limited because of
the type of industrial development strategy and the very cautious foreign investment policy
followed by the nation.
Direct foreign investment (private) in India was adversely affected by the following
factors:
1. The public sector was assigned a monopoly or dominant position in the most
important industries and, therefore, the scope of private investment, both domestic
and foreign, was limited.
2. When the public sector enterprises needed foreign
technology or investment, there was a marked preference for the
foreign government sources.
3. Government policy towards foreign capital was very selective. Foreign investment
was normally permitted only in high technology industries in priority areas and in
export oriented industries.
4. Foreign equity participation was normally subject to a ceiling of 40 per cent,
although exceptions were allowed on merit.
5. Payment of dividends abroad, repatriation of capital, etc., as well as inward
remittances were subject to stringent laws like the Foreign Exchange Regulation
Act (FERA), 1973. These discouraged foreign investment.
6. Corporate taxation was high and tax laws and procedures were complex.
These factors either limited the scope of or discouraged the foreign investment in
India.
Government Policy
The following paragraphs give a very brief account of Government of Indias policy
towards foreign capital and technology. First, the salient features of the policy followed till
the economic liberalisation introduced in July 1991 are given. This is followed by an
account of the new policy.
India was following a very restrictive policy towards foreign capital and technology.
Foreign collaboration was permitted only in fields of high priority and in areas where the
import of foreign technology was considered necessary. In other areas, import of technology
was considered on merits if substantial exports were guaranteed over a period of 5 to 10
years and if there were reasonable proposals for such exports. The government had issued
lists of industries where:
(a) (i) Foreign investment may be permitted.
(ii) Only foreign technical collaboration (but no foreign investment) may be
permitted.
(b) No foreign collaboration (financial or technical) was considered necessary.
The government policy on foreign equity participation was, thus, selective. Such
participation had to be justified with regard to factors such as the nature of technology
involved, whether it would promote exports which might not otherwise take place and the
alternative terms available for securing the same or similar technological transfers. Foreign
equity participation was limited to 40 per cent, although exceptions were allowed on merit.
Prior to 1991, Govern-
ment policy severely
restricted FDI into India.
The foreign share capital was to be by way of cash without being linked to tied imports of
machinery and equipment or to payments for know-how, trade marks, brand names, etc.
Technical collaborations were to be considered on the basis of annual royalty payments
which were linked with the value of actual production. The percentage of royalty was
dependent on the nature of technology. Whenever possible, the payment of fixed amount of
royalty per unit of production was preferred. Royalty payments were limited to a period
of 5 years.
The Foreign Exchange Regulation Act (FERA), 1973, served as a tool for implement-
ing the national policy on foreign private investment in India. The FERA empowered the
Reserve Bank of India to regulate or exercise direct control over the activities of foreign
companies and foreign nationals in India. A foreign company was defined as one (other than
a banking company) which was not incorporated in India or in which non-resident interest
was more than 40 per cent or any branch of such a company.
According to the FERA, non-residents (including Indian citizens), foreign citizens
resident in India and foreign companies required the permission of the RBI to accept
appointment as agents or technical management advisers in India, of any person or company,
or permit the use of their trade marks.
The trading, commercial and industrial activities in India of persons resident abroad,
foreign citizens in India and foreign companies were regulated by the FERA. They had
to obtain permission from the RBI for carrying on in India any activity of a trading,
commercial or industrial nature; opening branches/offices or other places of business in India
acquiring any business undertaking in India; and purchasing shares of Indian companies.
RBI had given general permission for certain matters. For example, general permission
was granted to foreign companies to acquire or hold any immovable property in India which
was necessary for, or incidental to, any activity undertaken by them with the permission of
the RBI.
The New Policy
The Industrial policy statement of July 24, 1991, which observes that while freeing the
Indian economy from official controls, opportunities for promot-
ing foreign investment in India should also be fully exploited, has
liberalised the Indian policy towards foreign investment and
technology.
As pointed out earlier, in the pre-liberalisation era, foreign equity participation was
restricted normally to 40 per cent and foreign investment and technology agreements needed
prior approval. As against this, the new policy has allowed 100 per cent and majority of
foreign equity with automatic approval in a large number of industries.
The foreign investment policy has been further modified and liberalised now and then,
so that there is a very liberal, transparent and investor-friendly FDI policy, wherein FDI up
to 100 per cent is allowed under automatic route for most of the sectors/activities, where the
investor does not require any prior approval. Only notification to the Reserve Bank of India
within 30 days of inward remittance or issue of shares to nonresidents is required. There are
several sectors/activities subject to ceiling for foreign equity participation, ranging from 25
per cent to 74 per cent.
The economic reforms
substantially increased the
scope of FDI.
Cases requiring prior Government approval are considered by the Foreign Investment
Promotion Board (FIPB) in a time-bound and transparent manner.
Other measures which encourage foreign investment include the following: ending the
government monopoly in insurance; opening up of the banking sector; divesting public
sector enterprises; protection of international trade marks and patent by legislation;
conclusion of bilateral investment treaties and double taxation treaties; and establishment of
a Foreign Investment Implementation Authority (FIIA) in order to ensure that approvals for
foreign investments (including NRI investments) are quickly translated into actual investment
inflows and the proposals fructify into projects.
Recently, there has been a very significant improvement in the perception of India as an
investment destination. The FDI policy in India is considered as
one of the most liberal, with very few barriers. The Global
Competitiveness Report 200304 by the World Economic Forum
ranks India at 41st place on barriers to foreign ownership, against
67th for Malaysia, 75th for Thailand and 81st for China. A recent confidence survey by
global consultancy AT Kearney rated India as the third most favoured FDI destination, next
only to China and United States. Moreover, for the first time, manufacturing investors
surveyed by AT Kearney considered India as a superior manufacturing location than even
the US.
FII Investments
The Indian stock market was opened up to FII investment in 199293 and since then there
has been a significant increase in the portfolio investment by FIIs.
The Regulations on Foreign Institutional Investors, which were notified on November
14, 1995, contains various provisions relating to the definition of FIIs, eligibility criteria,
investment restrictions, procedures of registration and general obligations and responsibilities
of FIIs.
According to the Regulations, FIIs may invest only in:
(a) securities in the primary and secondary markets including shares, debentures and
warrants of companies listed on a recognised stock exchange in India, and
(b) units of schemes floated by domestic mutual funds including Unit Trust of India,
whether listed on a recognised stock exchange or not.
Joint ventures between a variety of domestic and foreign securities firms have been
approved in the stock broking, merchant banking, assets management and other non-banking
financial services sectors. The overall effect of FII investment and financial joint ventures
has been the introduction of international practices and systems to the Indian Securities
industry.
FIIs are permitted to invest in a company up to an aggregate of 24 per cent of equity,
which can be increased to 40 per cent subject to approval by the Board of Directors and a
Special Resolution of the General Body.
In 199697, Government liberalised the FII investment policy, allowing them to invest
in unlisted companies and in corporate and government securities.
India now is perceived as
a very attractive FDI
destination.
FII investment has become an important determinant of the stock market trends in
India. FII investments reached records levels in 2010.
Euro/ADR Issues
Since 199293, Indian companies satisfying certain conditions are allowed to access foreign
capital markets by Euro-issues of Global Depository Receipts (GDRs) and Foreign Currency
Convertible Bonds (FCCBs).
A Depository Receipt (DR) 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 the 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.
18
The prefix global implies that the ADRs are marketed globally rather than in a specific
country or market.
Companies 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 exempted from the condition of three-year
track record. It is expected to help companies in the infrastructure sectors to access cheap
overseas funds.
Earlier companies had to keep the funds raised through Euro-issues in foreign currency
deposits with banks and public financial institutions in India to be converted into Indian
rupees as and when required for expenditure on approved end uses up to 25 per cent of
the Euro-issue proceedings for meeting corporate restructuring and working capital
requirements. Companies are also permitted to raise funds through issue of Foreign Currency
Convertible Bonds (FCCBs) and ADRs.
An Evaluation of the New Policy
Until about the middle of the present decade, the FDI flow to India was very low for
example, in 2003 while China received nearly 10 per cent of the global FDI inflows, Indias
share was only 0.8 per cent. It was only 0.4 per cent in 2001 and 0.5 per cent in 2002. The
FDI inflow was nowhere near the annual target of $ 10 billion set by the Government many
years ago. This was because the infrastructural facilities were poor, several factors were
costly and the policy and procedural environment in India in several respects was far from
encouraging. However, recently there has been a significant pick up in FDI and FII
investments in India. FDI reached $ 25 billion in 2007 and $ 40 billion in 2008.
One important criticism of the liberalisation of foreign
investment has been that foreign investment would take place
mostly in non-priority sectors. However, the lions share of the
Most of the FDI in India
has gone to priority
sectors.
foreign investment in India since the liberalisation has gone to priority sectors. Now several
of the priority industries, including the infrastructural sector which were earlier exclusively
reserved for the public sector, are opened to foreign investment. Statistics of sector-wise FDI
inflows from August 1991 until November, 2004, indicates that the highest shares of FDI
inflows have gone to the data-processing software and consultancy services, followed by
pharmaceuticals and automobile industry (see Table 9.7).
TABLE 9.7 Sectors Attracting Highest FDI Flows
(Inflows in Rs. crores)
Sector Amount of FDI inflows Cumulative Share of inflows
inflows (per cent)
200405 200506 200607 200708 (April 2000 April April
(April (April (April (April to Nov. 2000 to Nov. to
March) March) March) Nov.) 2007) Nov. 2007 2007
Services sector
a
1,986 2,399 21,047 9,121 38,228 19.86 20.22
Computer software and hardware 2,441 6,172 11,786 4,217 30,760 15.98 9.35
Telecommunications
b
570 2,776 2,155 3,963 15,607 8.11 8.79
Construction
c
696 667 4,424 3,593 9,989 5.19 7.97
Automobile industry 559 630 1,254 1,191 8,350 4.34 2.64
Power 241 386 713 206 5,958 3.09 0.46
Chemicals except fertilizers 909 1,979 930 733 5,956 3.09 1.63
Housing and real estate 0 171 2,121 5,161 7,573 3.93 11.44
Drugs and pharmaceuticals 1,343 760 970 353 4,633 2.41 0.78
Metallurgical industries 836 654 787 1,909 4,572 2.37 4.23
a. Financial and non-financial services.
b. Radio paging, cellular mobile, basic telephone services.
b. Construction including roads and highways.
Source: Government of India, Economic Survey 20072008.
Country-wise, FDI inflows to India are dominated by Mauritius (34.49 per cent),
followed by the United States (17.08 per cent) and Japan (7.33 per cent).
There is high regional contribution of FDI in India. Five StatesMaharashtra, Delhi,
Tamil Nadu, Karnataka, and Gujaratwhich were the top recipients of FDI approvals,
accounted for nearly half of the FDI approvals in the country (see Table 9.8).
TABLE 9.8 State-wise FDI Approvals (From August 1991 to November 2004)
Rank State Approvals Amount of FDI approved Percentage
Total Tech. Financial Rupees US $
of total FDI
in crore in million
approved
1 Maharashtra 5,037 1,318 3,719 37,020 9,621 14.80
2 Delhi 2,810 307 2,503 30,519 8,445 12.20
3 Tamil Nadu 2,681 618 2,063 22,642 5,894 9.05
4 Karnataka 2,639 502 2,137 19,075 4,833 7.63
5 Gujarat 1,236 568 668 12,437 3,273 4.97
Note: RBI provides regional office wise information based on the intimation of investment received from
investors under the automatic route. Consequently, the above table may not necessarily indicate state-wise
investment intentions of investors.
Items like reinvested earnings used to be excluded from the estimation of FDI in India.
However, in June 2003 Government has aligned the methodology of compilation of FDI with
the international best practices.
13
The revised definition includes three categories of capital
flows under FDI: equity capital, reinvested earnings and other direct capital. Previously, the
data on FDI reported in the balance of payments statistics used to include only equity
capital. The revised estimates of FDI in India as per the new definition give a much high
figures.
There are many ardent critics of foreign investment and technology. Foreign invest-
ment and technology is not without problems. However, the opening up of the economies of
a number of nations for foreign companies and the several measures they have taken to woo
foreign companies are a clear indicators of the positive contribution foreign capital and
technology can make.
BOX 9.6 India vs. Other Nations
It is pointed out that one drawback of the Indian foreign investment policy is the lack of
focus. For instance, on FDI, theres been no clear policy focus to attract investments in
specific sectors or specified regions or even specific companies. Countries following such
routes have been fairly successful in attracting FDI, such as China Focusing on a particular
region and decentralisation has proved beneficial for countries like China and Malaysia.
China improved its infrastructure and changed its labour laws for the southern coastal
areas like Shanghai and Shenzhen. Now, it is introducing incentives for cities like Wuhan
and Chengdu in the Hinterland that have been largely ignored in the past.
Bureaucratic hurdles need to be removed too. The implementation phase often proves to
be the toughest for foreign investors. Once these companies get their FIPB or RBI
clearances, they still need to obtain between 41 and 61 clearances from various
government departments, before they can start their projects. According to an official in
the industry ministry, FIPB clearance is the easiest. Its when companies start dealing at
the district level with fire and labour inspectors that things turn sour. Comparing that
with China where once the investment has been cleared, a government official is entrusted
with the task obtaining all other clearances from both central and provincial departments.
A World bank study shows that the time required to complete business procedures are
relatively very high in India. Table 9.9 shows the time required to complete business
procedures of different countries.
Courtesy: Outward bound, The Economic Times (Editorial), 12 June, 2001; Anjuli Bhargava
and Alam Srinivas, Where Is The Money, Businessworld, 23 April, 2001.
TABLE 9.9 Doing Business Indicators
Procedure Brazil China India Sweden
Time required for Starting a Business (Days) 152 41 89 16
Time required for registering a property (Days) 42 32 67 2
Time required for enforcing contracts (Days) 566 241 425 208
Time required to complete insolvency proceedings (Year) 10 2.4 10 2
Courtesy: World Bank and IFC Doing Business in 2005, Oxford University Press, 2005.
FOREIGN INVESTMENT BY INDIAN COMPANIES
Until 1991, Indian companies made very little investment abroad. Although government of
Indias policy had been one of encouraging foreign investment by Indian companies, subject
to certain conditions, several factors like the domestic economic policy and the domestic
economic situation were deterrents to foreign investment by Indian companies.
By restricting the areas of operation and growth, the government policy seriously
constrained the potential of Indian companies to make a foray into the foreign countries
through investment. Added to this was the attraction of the protected domestic market which
was, in many cases, a sellers market and this made the Indian companies ignore the foreign
markets.
Indian companies have established subsidiaries and joint ventures in a number of
countries in different manufacturing industries and service sectors. The liberalisation, both
global and domestic, has imparted a global orientation to Indian business so that there has
been a substantial increase in Indian investments abroad. FDI outflow from India crossed
$ 18 billion in 2008 compared to the annual average of $ 121 million during 19002000.
An UNCTAD report observes that India also stands out among Asian investors, not so
much because of its recent and significant increase in outward FDI and because of its
potential to be a large outward investor, but because of the new trend set by some of
its information technology (IT) firms. Most Indian outward FDI is in manufacturing (about
55 per cent), but non-financial services also account for a significant share (25 per cent).
FDI in IT services in particular has begun to grow rapidly. The growing technological
capabilities of Indian firms and their rising exports, particularly in IT services and
pharmaceuticals, are driving the FDI growth. Access to markets, distribution networks,
foreign technology and strategic assets such as brand names, are the main motivations.
Securing natural resources is also becoming an important driver for FDI in the oil and gas
industries and mining.
19
The most important destination for Indian FDI has been the United States, accounting
for nearly one-fifth of its total outward flows since the mid-1990s
to 2003, followed by the Russian Federation (with 18 per cent)
mainly due to acquisitions in the oil and gas industries. Overall,
however, about half of total Indian outward FDI has gone to other developing countries.
20
Strategic M&As have been finding favour with corporate India too. M&As by Indian
companies involving foreign firms fall into three categories, viz., acquisition of foreign
firms, acquisition of MNC affiliates in India and acquisition of foreign brands.
Foreign investment, both in greenfield enterprises and mergers and acquisitions
(M&A), is clearly a part of the globalisation strategy of many Indian companies. Recently,
there has been a spurt in FDI by Indian companies.
In light of the economic liberalisation and the growing competition at home, many
Indian companies have been planning for a major thrust abroad. The value of a single
foreign acquisition in early 2007 (Corus by Tata Steel) was much more than the total FDI
inflow to India in the previous year.
Although there is a lot of talk about the procedural simplification, foreign companies
still find the procedures very perplexing and unbearably time-consuming.
FDI by Indian companies
has been rising fast.
One important criticism of the liberalisation of foreign investment has been that foreign
investment would take place mostly in non-priority sectors. However, the foreign investment
in India since the liberalisation has gone largely to priority sectors. Now several of the
priority industries, including the infrastructural sector which were earlier exclusively
reserved for the public sector, are opened to foreign investment. Foreign investment needs to
be directed to priority sectors.
INTERNATIONAL TRADE FINANCING
The international market is generally very competitive and sensitive and the credit facilities
made available to the buyers are one of the important determinants of export business.
The extent to which credit must be extended to the importer depends on the sale terms.
If the exporter gets cash in advance, there will not be any problem in respect of finance; but
this is not common. Even if the exporter gets the payment at the time of the shipment of
the goods, he has to make his own arrangements to meet his financial needs at the pre-
shipment stage. If the sale is on credit, as it usually is, the exporter will be still more
constrained financially. It is, therefore, necessary to make institutional credit available to the
export sector to meet its pre-shipment and post-shipment financial requirements; for such
credit facilities will enable the exporters not only to meet their financial requirements at the
pre-shipment stage but also to extend reasonable credit facilities to foreign buyers.
Sometimes, institutional credit is extended to foreign buyers instead of exporters. The
buyers credit is extended, usually, to the buyers of capital goods.
Payment Terms
Some knowledge of the important payment terms and methods of effecting payment would
be useful to understand the export financing methods and process. The credit requirements
of the exporter depend to a very large extent on the sale terms.
A sale contract should clearly specify when the payment will be made, where it will be
made, and how it will be made. As the payment terms are determined on the basis of the
specific circumstances of the particular buyer and seller, it would be difficult to make any
generalisation about payment terms. However, there are certain standard terms, which are in
common use.
Cash in advance
The most advantageous payment term from the sellers point of view is the remittance with
the order, or sometimes, before the shipment of goods. The remittance may be by draft,
cheque, mail or telegraphic transfer. Very seldom is an importer prepared to make cash
payments in advance; but in certain cases it becomes necessary. For instance, advance
payment may be insisted upon when goods ordered are those manufactured to order in
accordance with the specifications of the buyer. Further, when the buyer is unknown to the
seller or his creditworthiness is doubtful, the seller would like to get the payment in
advance.
If the seller enjoys a monopoly position or if there is a sellers market, it is easy
to obtain advance payment; but when the market is very competitive, it is very difficult
to do so.
Open account
Under trading on open account, the exporter ships the goods with no financial documents to
his advantage except the commercial invoice. Under this method, therefore, the seller carries
the entire financial burden with little or no documentary evidence. Because of the great risks
associated with the open account method, it is generally restricted to cases of transactions
between inter-connected companies, or where the exporter and overseas buyers have had a
long and well-established commercial relationship, and when there is no exchange
restrictions that complicate the settlement. Indian exporters are allowed to abroad on the
open account basis only with the special permission of the Reserve Bank of India. Normally,
this permission is given only to foreign companies operating in India.
Consignment sale
Under the consignment sale, the exporter consigns the goods to his agent representative in
the foreign markets, who arranges for the sale of the goods and makes payments to the
exporter. Goods consigned abroad include tea, coffee, wool, etc. which cannot be easily
standardised. Under this method, the exporter retains the title to the goods until the sale of
the goods is effected in the foreign market. The consignment sale involves a number of risks
for the exporter. As no bill of exchange is involved under this method, the seller is not
protected against default. He is also exposed to such risks as exchange rate fluctuations and
the loss that may arise if the consignee is inefficient or is not sincere and honest.
An Indian exporter selling goods on consignment basis must furnish a declaration
regarding the full export value of the goods, or if the full export value of the goods is not
ascertainable at the time of export, the value which the exporter, having regard to the
prevailing market conditions, expects to receive on the sale of the goods in the overseas
market.
Documents against payment
Under the D/P terms, also known as cash against documents (c.a.d.), the exporter ships
goods to the foreign buyer, but the documents giving title to the goods will be handed over
to the buyer through the bank only on payment. Under this type of transaction, until and
unless the buyer makes the payment, the ownership of the goods remains with the seller.
The exporter may obtain bank finance against D/P bills. If the bank is satisfied, it may
finance the exporter by purchasing the D/P bills, usually on a with recourse basis, so in the
event of non-payment by the drawee, the bank has recourse to the drawer.
Documents on acceptance
Under the D/P method, the documents and the title to the goods are handed over to the
buyer when he accepts the bill of exchange by signing it. The usance of the bill of exchange
may be 30 days, 60 days or 90 days. The exporter, thus, extends credit to the importer for
such periods. Under the D/A terms, the exporter relies on the honesty and creditworthiness
of the buyer; and therefore this facility is normally extended only to parties who have
proven business integrity and financial standing. Banks may finance to exporters by
purchasing the D/P bills with recourse.
Documentary letter of credit
The documentary letter of credit covers the major part of the export business. A letter of
credit is a document containing the guarantee of a bank to honour on it by an exporter,
under certain conditions and up to certain amounts. Instead of being drawn on the importer,
the draft is drawn on the importers bank. A letter of credit eliminates the risk for an
exporter, he will be definitely paid for his shipment provided, of course, that he fulfils his
obligations. He, therefore, ordinarily requests the importer to arrange for a letter of credit.
Apart from avoiding the risk of non-payment, an important advantage of a documentary
letter of credit from the point of view of the exporter is that, immediately after the
shipment of the goods, he can present the bill of exchange and other relevant documents and
obtain payment from a bank at his own centre. For details of the letter of credit financing
of the export business, see the appendix to the chapter.
We have outlined above the important payment terms. The actual payment term
adopted in a particular transaction is influenced by a number of factors, such as the
individual circumstances of the buyer and the seller, the nature of the product, the profit
margin, customs of the trade, the organisation of the firm, the legal limitations and the cost
and availability of credit.
INSTITUTIONAL FINANCE FOR EXPORT
Even if the exporter gets payment at the time of the shipment of goods, he has to arrange
for finance to meet the expenses involved until the time of shipment. These include
expenditure on the purchase of materials and components, processing, packaging, packing,
marking, transaction, warehousing, etc. In many instances, the exporter is compelled to
extend credit to the overseas buyer. In fact, in international marketing, the nature of the
sale/credit term offered is a very decisive factor in obtaining business. In many cases, the
exporter has to wait for a period of timeshort, medium or longeven after the shipment
of goods to obtain payment from the overseas buyer. He has, therefore, to arrange for post-
shipment finance, covering the period between the shipment of the goods and the receipt of
payment. All the countries which are serious about export promotion have, therefore, made
institutional arrangements for the provision of both pre-shipment and post-shipment finance.
In India, the export sector is regarded as a priority sector.
Pre-Shipment Credit
As the name indicates, pre-shipment finance, also known as packing credit, refers to the
credit extended to the exporter prior to the shipment of goods. Pre-shipment credit enables
him to meet his working capital requirements for the purchase of raw materials and
components, processing, packing, transportation, warehousing, etc. Packing credit is short-
term finance. It is also advanced against export incentives.
In India, pre-shipment credit is provided by Indian and foreign commercial banks
which are members of the Foreign Exchange Dealers Association. The packing credit
advances by commercial banks in India are governed by the Packing Credit Scheme of the
Reserve Bank.
The loan is advanced only on receipt of an export order.
To obtain the loan, the exporter should deliver to the bank either a letter of credit
established in his favour or a confirmed export order. However, where the letter of credit or
the confirmed export order is yet to be received, relevant evidence in the form of a cable,
letter, etc. is acceptable, provided that such cable, letter, etc. contains information regarding
at least the value of the order, the quantity and particulars of goods, the date of shipment
and the name of the buyer.
All the packing credit advances must be repaid from the proceeds of the relative export
bills negotiated or from the remittances received from abroad for the relative goods.
Packing credits are eligible for interest subsidy, normally for a period not exceeding
90 days, although the credits may be given for a period of 180 days for specified items,
such as engineering goods, with the permission of the Reserve Bank of India. In genuine
cases of delay of shipment of specified items, a further period of 90 days may be allowed
by the Reserve Bank of India. Packing credit is also available against certain incentives; such
advances should be repaid by the exporter as soon as these are realised.
Where a letter of credit or an export order is received in the name of an export house
or any merchant exporter, an advance made even to a sub-supplier falls within the Packing
Credit Scheme. In such a case the sub-supplier should submit a letter to the bank from the
export house/merchant exporter, giving details of export house/merchant and of the supply
allotted, and confirming that the export house/merchant exporter, will not avail itself/himself
of packing credit from any other source on the quantity so allotted. Since export bills are
negotiated in the name of the export house/merchant exporter, the repayment of such
packing credit should be made by inland letters of credit opened by the export house/
merchant exporter in favour of the sub-supplier, or by proceeds of bills drawn by the sub-
supplier on the export house/merchant exporter. Whenever the bill on the export house/
merchant exporter is not accompanied by a bill of lading, a certificate should be obtained
from the export house/merchant exporter for every quarter, stating that the goods have
actually been exported.
An undertaking from the sub-supplier shall be obtained that any advance payment
received towards the supply of goods would be adjusted to the packing credit.
Post-Shipment Finance
As has already been mentioned, the international market is, by and large, very competitive,
and the extension of credit facility to the buyers is one of the important determinants of the
expansion in the export business. Most exporters are not in a position to extend credit to
overseas buyers. To promote the export business, therefore, the burden of credit should be
shifted from the exporters by either the financial institutions providing credit, directly or
indirectly, to the buyers, or by extending credit to the exporters to enable them to extend
credit to their buyers. Accordingly, financial institutions provide buyers credit, line of
credit, and suppliers credit.
Buyers credit
Under the buyers credit system, credit is extended to the overseas buyer by either a
financial institution or a consortium of financial institutions. This credit enables the buyer to
pay for the goods he imports if the financial institution that provides the buyers credit is
located in the exporters country. The loan does not involve transfer of funds from the
suppliers country to the buyers country; the exporter may obtain the payment directly from
the financial institution on presentation of the relevant export documents. Buyers credit is
generally advanced for capital goods.
Line of credit
Line of credit is a sort of buyers credit. When a number of buyers are involved, instead of
negotiating credits with each one, the financial institutions in the suppliers country may
extend a line of credit to a financial institution in the buyers country which, in turn, will
disburse the credit to the buyers in respect of approved transactions. Apart from avoiding
the problem of dealing with several individual transactions, the great advantage of the line
of credit is that the responsibility for judging the credit worthiness of the buyers is shifted
to the financial institution in the buyers country.
Short-Term Finance
Short-term post-shipment credit is usually provided by the commercial banks, mainly by
negotiating documents under letters of credit, by purchasing D/P and D/A bills, by lending
against export bills tendered for collection abroad, and by advancing money against such
receivables as export incentives like cash assistance, refund of excise and customs duty
and reimbursement of the differentials between indigenous and international prices of certain
raw materials.
Medium and Long-Term Finance
In India, commercial banks, which provide most of the short-term post-shipment credit, play
an important role in offering medium and long-term post-shipment finance.
The Industrial Development Bank of India (IDBI) played a very important role in
long-term post-shipment finance. It provided re-finance facilities to commercial banks
against the long-term export credit extended by them, and had a scheme for direct financial
assistance to exporters in collaboration with approved commercial banks. The IDBI was also
operating a Buyers Credit Scheme for the promotion of capital goods exports from India.
Under this scheme, it provided credit to eligible foreign buyers for the purchase of goods
from India.
With the establishment of the Export-Import (Exim) Bank in 1982, export credit
functions performed by the IDBI were transferred to the Exim Bank.
EXIM BANK
The Export-Import Bank of India, set-up in 1982 by an Act of Parliament for the purpose
of financing, facilitating and promoting foreign trade of India, is the principal financial
institution in the country for coordinating working of institutions engaged in financing
exports and imports.
The Exim Bank is fully owned by the Government of India and is managed by a
Board of Directors which has representatives from the Government, Reserve Bank of India,
Export Credit Guarantee Corporation of India, a financial institution, public sector banks,
and the business community.
Mission
The mission statement of Exim Bank: to develop commercially
viable relationships with externally oriented companies by
supporting their internationalisation efforts, through a diverse
range of products and services.
Objectives
The objectives of the Exim Bank are:
1. To translate national foreign trade policies into concrete action points.
2. To provide alternate financing solutions to the Indian exporter, aiding him in his
efforts to be internationally competitive.
3. To develop mutually beneficial relationships with the international financial
community.
4. To initiate and participate in debates on issues central to Indias international trade.
5. To forge close working relationships with other export development and financing
agencies, multilateral funding agencies and national trade and investment promotion
agencies.
6. To anticipate and absorb new developments in banking, export financing and
information technology.
7. To be responsive to export problems of Indian exporters and pursue policy
resolutions.
Figure 9.3 shows the role of Exim Bank.
Global Networking
Exim Bank is quite unique in its global and national network of institutional and
professional linkages. Its several overseas offices in places such as Budapest, Johannesburg,
Exim Banks mission is to
facilitate globalisation of
Indian business.
Milan, Singapore and Washington D.C.have forged strategic institutional linkages for the
Bank with Multilateral agencies such as World Bank, Asian Development Bank, etc; Export
Credit Agencies; Trade and Investment Promotion Agencies abroad; and Trade and Industry
Associations in India.
The Banks extensive global network, supported by the Indian Missions abroad, makes
it uniquely capable of offering advisory services to Indian companies looking for market
opportunities, buyer information, technology suppliers and partners for overseas and
domestic joint ventures. Further, our overseas offices enable us to garner economic and
commercial intelligence on countries, companies and projects, assess credit risks, review
competitive export practices and provide alerts on new export opportunities.
The domestic offices of the Bank in several places are intended to help to respond to
regional developmental activities in the export sector. They are expected to identify special
needs of the export business through close interaction with existing and prospective clients
and suggest innovative instruments appropriate to the regions potential. They also regularly
interact with commercial/developmental/government agencies, and strengthen the Banks
policy mechanism with their critical inputs on market perceptions and the export
environment.
Functional organisation
The Banks functions are segmented into four major operating groups:
1. Overseas Investment Finance handles a variety of financing programmes for
Export Oriented Units (EOUs), importers, and overseas investment by Indian
companies.
2. Project Finance/Trade Finance handles the entire range of export credit services
such as suppliers credit, pre-shipment credit, lines of credit, buyers credit, finance
for export of projects and consultancy services, guarantees, forfeiting, etc.
FIGURE 9.3 Evolving role of EXIM Bank.
From financing,
facilitating and
promoting Indias
foreign trade.
To creating export
capability by
arranging competitive
financing at various
stages of the export
cycle.
To developing
commercially viable
relationship with a
target set of externally
oriented companies by
offering them a
comprehensive range of
products and services,
aimed at enhancing their
internationalisation
efforts.
3. Export Services Group offers a variety of advisory and value-added information
services aimed at investment promotion.
4. Agri-Business Group has been put in place to spearhead the initiative to promote
and support Agri-exports. The Group handles projects and export transactions in the
agricultural sector for financing.
Apart from these, there are the Support Services groups, which include: Planning &
Research, Corporate Finance, Management Information Services, Information Technology,
Legal, Human Resources Management and Corporate Affairs.
Assistances
Exim Bank plays a four-pronged role with regard to Indias foreign trade: those of a
coordinator, a source of finance, consultant and promoter.
The Bank finances exports of Indian machinery, manufactured goods, consultancy and
technology services on deferred payment terms. It also seeks to
co-finance projects with global and regional development agencies
to assist Indian exporters in their efforts to participate in such
overseas projects.
The Bank is involved in promotion of two-way technology transfer through the
outward flow of investment in Indian joint ventures overseas and foreign direct investment
flow into India. The Bank is also a Partner Institution with European Union and operates
for facilitating promotion of joint ventures in India through technical and financial
collaboration with medium sized firms of the European Union.
The Exim Bank, thus, extends both funded and non-funded assistance for promotion of
foreign trade.
The funded assistance programme of the Bank includes direct financial assistance to
exporters, rediscounting of export bills, technology and consultancy services financing,
refinancing of export credit and re-lending facility to banks abroad.
The non-funded assistance is in the form of guarantees which are in the form of bid
bonds, advance payment and performance guarantees, retention money guarantees, and
guarantees for raising finance abroad.
Financing Services
Exim Bank offers a diverse range of financing services for the Indian exporter, including
a variety of Export Credit facilities, and Finance for Export Oriented Companies (see
Figure 9.4).
Export credits
Exim Bank offers the following Export Credit facilities, which can be availed of by Indian
companies, commercial banks and overseas entities.
The Exim Bank operates a
wide range of financing
and promotional
programmes.
For Indian companies executing contracts overseas
Pre-shipment credit Where the manufacturing cycle of the export contract exceeds six
months, Exim Banks Pre-shipment Credit facility provides access to finance at the
manufacturing stageenabling exporters to purchase raw materials and other inputs.
Pre-shipment Rupee Credit is extended to finance temporary funding requirement
of export contracts. This facility enables provision of rupee mobilisation expenses for
construction/turnkey projects. Exporters could also avail of pre-shipment credit in foreign
currencies to finance cost of imported inputs for manufacture of export products to be
supplied under the projects. Commercial banks also extend this facility for definite periods.
Suppliers credit At the post-shipment stage, this facility enables Indian exporters to
extend term credit to importers (overseas) of eligible goods. Exim Bank offers Suppliers
Credit in Rupees or in Foreign Currency at post-shipment stage to finance export of eligible
goods and services on deferred payment terms. Suppliers credit is available both for supply
contracts and project exports; the latter includes construction, turn key or consultancy
contracts undertaken overseas.
Exporters can seek Suppliers credit in Rupees/Foreign Currency from Exim Bank in
respect of export contracts on deferred payment terms irrespective of the value of export
contracts.
For project exporters Indian project exporters incur Rupee expenditure while executing
overseas project export contracts. Exim Banks facility helps them meet these expenses.
These would generally include costs of mobilisation/acquisiton of materials, personnel and
equipment, payments to be made in India to staff, subcontractors and consultants, and
project-related overheads in Indian Rupees.
FIGURE 9.4 Scope of EXIM Banks Financing Programmes.
EXIM Banks Range of Financing Programmes
Forfaiting, Guarantees Export Credits Finance for EOUs
Finance for (EOUs)
1. Project Finance for setting up EOUs;
for textile and jute industries; for
Software industry; for Indian
companies involved in port
development and related activities
2. Equipment Finance for production
equipment; for vendors of EOUs
3. Working Capital Finance
4. Other Facilities. Finance for R&D
and export product development;
underwriting; export marketing
finance; import loans; guarantee; for
JVs between Indian and East Asian
companies
For Indian Companies
1. Pre-shipment credit
2. Post-shipment suppliers credit
3. Finance for deemed exports
4. Financing rupee expenditure for project
exports
5. Finance for consultancy and
technology services
For Commercial Banks
1. Export bills rediscounting
2. Refinance of export (suppliers) credit
3. Refinancing of foreign currency pre-shipment credit
For Overseas
Entities
1. Buyers credit
2. Lines of
credit
For exporters of consultancy and technological services Exim Bank offers a special
credit facility to Indian exporters of consultancy and technology services, so that they can,
in turn, extend term credit to overseas importers. The services covered include providing
personnel for rendering technical services, transfer of technology/know-how, preparation of
project feasibility reports, maintenance and management contracts, etc.
Guarantee facilities Indian companies can avail of these facilities to furnish requisite
guarantees to facilitate execution of export contracts and import transactions.
Forfaiting Forfaiting is a financing mechanism that enables a company to convert credit
sale to cash sale, on without recourse basis. Exim Bank acts as a facilitator for the Indian
exporter, enabling him to access the services of an overseas forfaiting agency. Forfaiting is
dealt in detail later in this chapter.
Other facilities for Indian companies Indian companies executing contracts within India,
but which are financed by multilateral funding agencies, can avail of credit under the Banks
Finance for Deemed Exports facility, aimed at helping them meet cash flow deficits.
For overseas entities
Buyers credit Overseas buyers can avail of Buyers credit from Exim Bank, for import
of eligible goods from India on deferred payment terms.
Lines of credit Exim Bank extends Lines of credit to overseas financial institutions,
foreign governments and their agencies, enabling them to onlend term loans to finance
import of eligible goods from India.
The lines of credit is extended by the Bank to overseas governments/agencies
nominated by them or financial institutions overseas to enable buyers in those countries to
import capital/engineering goods, industrial manufactures and related services from India on
deferred payment terms. This facility enables importers in those countries to import from
India on deferred credit terms as per the terms and conditions already negotiated between
Exim Bank and the overseas agency. The Indian exporters can obtain payment of eligible
value from Exim Bank against negotiation of shipping documents, without recourse to them.
The lines of credit are denominated in convertible foreign currencies or Indian Rupees
and extended to sovereign governments/agencies nominated by them or financial institutions.
Such governments/agencies/institutions are the borrowers and Exim Bank the lender. Terms
and conditions of different lines of credit are varying and details in respect of each line of
credit can be obtained from Exim Bank. It would need to be ascertained from time to time
that the lines of credit have come into effect and uncommitted balance is still available for
utilisation. Indian exporters also need to ascertain the quantum of service fees payable to
Exim Bank on account of pro rata export credit insurance premium and/or interest rate
differential cost that they can then add up in their prices to their importers.
Finance for Export Oriented Units (EOUs)
For the purpose of our financing, an Export Oriented Company is defined as any company
with a minimum export orientation of 10% of net sales, or annual export sales of Rs. 5
crores, whichever is lower.
Project finance
For setting up EOUs Exim Bank offers term loans for setting up new projects, and for
acquisition of assets for modernisation/upgradation/expansion of existing units. The Bank
also extends 100 per cent refinance to commercial banks, for term loans sanctioned by the
lending bank to an EOU.
For textile and jute industries The Bank also extends finance to eligible units in textile
and jute industries under the Technology Upgradation Fund Scheme, to enable them to
upgrade their manufacturing facilities.
For software industry The Bank offers a comprehensive financing/services package for
the software industry. These include project/equipment finance, working capital finance,
overseas investment finance, besides support for obtaining product/process certification,
export marketing, and export product development.
The Exim Bank extends term loans to software exporters for establishment/expansion
of software training institutes. Further, the Bank also facilitates setting up of Software
Technology Parks (STPs).
For Indian companies involved in port development and related activities Exim Bank
extends term loans to Indian companies involved in construction of ports/jetties, and for
acquisition of fixed assets for stevedoring, cargo handling, storage and related activities like
dry docks and ship breaking.
Equipment finance
Finance for production equipment To cater to the non-project related capital expenditure
of EOUs, Exim Bank offers a line of credit for acquisition of imported/indigenous
equipment, including equipment for packaging, pollution control, etc.
For vendors of EOUs Under the Export Vendor Development Finance facility, Exim
Bank offers term loans to vendors of EOUs, to enable them to acquire plant and machinery
and other assets required for increasing export capability.
Working capital finance
Exim Bank provides term loans (of 1 year, 12 years, and up to 5 years tenor) to eligible
EOUs, to help them meet their working capital (loan component) requirements.
Other facilities
Finance for R&D and export product development Exim Bank offers term loans to
EOUs for development of new technology to satisfy domestic and international environment
and standards, and to help them develop and/or commercialise new product/process
applications.
Underwriting Exim Bank extends underwriting commitment to Indian exporters, to help
them raise finance from capital markets through public/rights issues of equity shares/
debentures.
Export marketing finance Exim Bank offers term loans to Indian companies, to aid them
in their efforts to penetrate and retain their presence in overseas markets, particularly in
developed countries.
Import loans Exim Bank finances bulk imports of consumable inputs and canalised items
undertaken by manufacturing companies.
Guarantee facility Exim Bank issues different kinds of guarantees for EOUs. These
include: (a) export obligation guarantees; (b) deferred payment guarantees; and (c) guaran-
tees in favour of commercial banks/lending institutions abroad on behalf of Indian exporters.
For JVs between Indian and East Asian companies Under the Asian Countries
Investment Partners Programme, Exim Bank provides finance at various stages of a joint
venture project cycle viz., sector study, project identification, feasibility study, prototype
development and technical, managerial assistance.
Finance for ventures overseas
Exim Bank offers term loans to Indian companies, both for equity investment in their
ventures overseas and for onlending purposes.
Besides, Exim Bank also undertakes Direct Equity Stake in Indian Ventures Abroad, to
enable Indian companies to supplement their equity with Exim Banks equity contribution.
For commercial banks
Exim Bank offers Rediscounting facility to commercial banks, enabling them to rediscount
export bills of their SSI customers, with usance not exceeding 90 days. It also offers
Refinance of Suppliers Credit, enabling commercial banks to offer credit to Indian exporters
of eligible goods, who in turn extend term credit over 180 days to importers overseas.
Authorised dealers in foreign exchange can obtain from Exim Bank hundred per cent
refinance of deferred payment loans extended for export of eligible Indian goods.
Export services
Exim Bank offers a diverse range of information, advisory and support services, which
enable exporters to evaluate international risks, exploit export opportunities and improve
competitiveness.
For multilateral agencies funded projects overseas (MFPO) Exim Bank offers value-
added information and support services to Indian companies seeking business in projects
funded by multilateral agencies such as the World Bank, Asian Development Bank, African
Development Bank, European Bank for Reconstruction and Development, and other official
Development Agencies like the Overseas Economic Cooperation Fund of Japan. Services
offered include identification of business opportunities in funded projects; details on specific
projects of interest; information on procurement guidelines, policies and practices of
multilateral agencies; assistance for registration with multilateral agencies; advice on
preparation of Expression of Interest, Capability Profile, etc.; advice on bids, with regard to
bid evaluation, review of bid documents, etc.
Apart from these, the Bank also offers support services, such as liaising with Indian
missions, monitoring bid performance, aids in prequalification.
Commercial services Exim Bank undertakes customised research on behalf of interested
companies, in areas such as establishing market potential, defining marketing arrangements
and specifying distribution channels. It also assists companies in developing export market
entry plans, obtaining quality certifications and display of their products in their overseas
offices.
Country profiles Exim Bank also undertakes country profiles, which assess the economic,
political, currency and credit risks involved, along with the export opportunities in the
country concerned.
Financial counselling Exim Bank offers advice on how to access foreign currency finance
from multilateral institutions and import lines of credit, trade finance alternatives, collection/
payment systems, as well as on the credit worthiness of business entities and banks.
Internationalisation support Exim Bank helps in identifying technology suppliers,
partners, and in consummation of domestic and overseas joint ventures, through its network
of alliances and its overseas offices. It also advises companies on regulatory clearances, and
facilitates tying-up finance for equity and working capital.
Information access Exim Bank issues business opportunities alerts, which communicate
business leads, acquisition opportunities, industry trends, as well as collaboration oppor-
tunities from the European Commissions network, Bureau de Rapprochement des
Enterprises, of which Exim Bank is a partner institution.
Building export capability The Banks Eximius Learning Centres in Bangalore and
Ahmedabad organise training programmes, workshops and seminars for exporters. These
programmes, often on sector-specific issues, are conducted by international experts from
trade promotion organisations and multinational companies.
The Bank also carries out research on issues related to international trade, economics,
and sector/product/country studies, which it publishes in the form of Occasional Papers.
The Bank disseminates information on export opportunities and highlights develop-
ments that have a bearing on Indian exports, through its periodicals.
International merchant banking services Exim Bank provides advisory services to Indian
exporters to enable them to offer competitive financial packages when they bid for exports.
Joint Ventures
Global Procurement Consultants Limited (GPCL), is a successful consultancy
company, promoted by Exim Bank in 1996, in partnership with leading private and
public sector consultancy firms in India. GPCL provides procurement related
services to multilateral agencies such as World Bank, Asian Development Bank and
African Development Bank.
Global Trade Finance Private Limited (GTF), a Joint Venture, promoted by
Exim Bank with Westdeutsche Landesbank Girozentrale (WestLB), Germany and
International Finance Corporation (IFC), Washington, commenced business in
September 2001. GTF offers, for the first time in India, structured foreign trade
financing products such as forfaiting and factoring.
Promotional Programmes
Exim Bank, in association with Confederation of Indian Industry (CII), presents an Annual
Award for Business Excellence for the best TQM practices adopted by an Indian company.
The high performance standards set down in order to qualify for the Award serve to foster
strong commitments to TQM in the companys journey towards Business Excellence.
Under the Project Preparatory Services Overseas (PPSO) Programme, Exim Bank
provides loan/grant finance to enable Indian consultancy firms to take up project preparatory
studies in developing countries.
Under an arrangement with the International Finance Corporation (IFC), Washington,
Exim Bank is a participant in the trust funds set up by the IFC in different parts of the
world. As a result of this arrangement, Indian consultants can avail of grant finance for
undertaking specific assignments in select countries in Africa, Eastern Europe, and the
Mekong delta region (see Figure 9.4).
FORFAITING
The word forfait is derived from the French word a forfait which means the surrender of
rights. In a forfaiting transaction, the exporter surrenders, without
recourse to him, his rights to claim for payment on goods
delivered to an importer, in return for immediate cash payment
from a forfaiter. As a result, an exporter in India can convert a
credit sale into a cash sale, with no recourse to the exporter or his banker.
Forfaiting, in short, is a mechanism of financing exports:
By discounting export receivables.
Evidenced by bills of exchange or promissory notes.
Without recourse to the seller (viz. exporter).
Carrying medium to long-term maturities.
On a fixed rate basis (discount).
Up to 100 per cent of the contract value.
All exports of capital goods and other goods made on medium to long-term credit are
eligible to be financed through forfaiting.
Receivables under a deferred payment contract for export of goods, evidenced by bills
of exchange or promissory notes, can be forfaited. Bills of exchange or promissory notes,
backed by co-acceptance from a bank (which would generally be the buyers bank), are
Forfaiting is the non-
recourse discounting of
export receivables.
endorsed by the exporter, without recourse, in favour of the forfaiting agency in exchange
for discounted cash proceeds. The bankers co-acceptance is known as avalisation. The co-
accepting bank must be acceptable to the forfaiting agency.
Exim Bank has been authorised by the Reserve Bank of India to facilitate export
financing through forfaiting.
The role of Exim Bank will be that of a facilitator between the Indian exporter and
the overseas forfaiting agency. On a request from an exporter, for an export transaction
which is eligible to be forfaited, Exim Bank will obtain indicative and firm forfaiting
quotesdiscount rate, commitment and other feesfrom overseas agencies. The Bank will
receive avalised bills of exchange or promissory notes, as the case may be, and send them to
the forfaiter for discounting and will arrange for the discounted proceeds to be remitted to
the Indian exporter. It will issue appropriate certificates to enable Indian exporters to remit
commitment fees and other charges.
To be eligible for forfaiting, the export contract can be executed in any of the major
convertible currencies e.g., US dollar, Deutsche mark, Pound sterling, Japanese yen.
The duration of receivables eligible for forfaiting is normally between 1 year and
5 years.
The minimum value of an export contract eligible for forfaiting and acceptable to a
forfaiting agency will generally be the equivalent of US $ 1,00,000.
Eligibility of an export transaction for forfaiting can be determined when the forfaiting
agency is approached for a forfait quote. The availability of a forfaiting quote for a
particular country will depend on the forfaiting agencys perception of risk quality of export
receivables from that country. The forfaiting agency will indicate the maximum amount and
the period of discount while giving quote for forfaiting.
A forfaiting transaction has typically three cost elements: Commitment fee; Discount
fee; and Documentation fee. Exim Bank will charge a service fee for facilitating the
forfaiting transaction which will be payable in Indian rupees.
Benefits of Forfaiting
Converts a deferred payment export into a cash transaction, improving liquidity and
cash flow.
Frees the exporter from cross-border political or commercial risks associated with
export receivables.
Finance up to 100 per cent of the export value is possible as compared to 8085
per cent financing available from conventional export credit programmes.
As forfaiting offers without recourse finance to an exporter, it does not impact the
exporters borrowing limits. Thus, forfaiting represents an additional source of
funding, contributing to improved liquidity and cash flow.
Provides fixed rate finance; hedges against interest and exchange risks arising from
deferred export credit.
Exporter is freed from credit administration and collection problems.
Forfaiting is transaction specific. Consequently, a long-term banking relationship
with the forfaiter is not necessary to arrange a forfaiting transaction.
Exporter saves on insurance costs as forfaiting obviates the need for export credit
insurance.
Simplicity of documentation enables rapid conclusion of the forfaiting arrangement.
(More details about forfaiting are available on the www.eximindia.com)
Maturity Factoring by ECGC
Factors in general offer their clients bill discounting, credit protection, ledger maintenance
and receivable management in respect of approved customers.
Maturity factoring facility offered by the Export Credit Guarantee Corporation of India
Ltd. (ECGC) provides the following, viz., credit protection, ledger maintenance, receivable
management, enables client to avail discounting facility from bank by guaranteeing the
advances granted against the bill.
Thus, the facility offered by ECGC provides you the benefits of the traditional
factoring without disturbing your existing banking arrangement. Apart from this, it also
provides for sharing of losses where the goods/documents are not accepted due to insolvency
or financial condition of the buyer.
The following are the benefits to exporters: 100 per cent risk protection in respect of
transactions where the buyer accepts the bills/documents without recourse to the exporter;
sharing of loss in case of non-acceptance of goods/documents due to insolvency or financial
difficulty; receivable management and sales ledger maintenance; enables the exporter to avail
bank finance on easier terms. The exporter can avail of the above benefits without
disturbing existing system of banking arrangements.
EXPORT CREDIT RISK INSURANCE
The Export Credit Guarantee Corporation of India Ltd. (ECGC), a company wholly owned
by Government of India and which functions under the administrative control of the
Ministry of Commerce, has a number of schemes to cover several risks which are not
covered by general insurers.
The primary role of ECGC is to support and strengthen the export development of
India by:
Providing a range of credit risk insurance covers to exporters against loss of goods
and services.
Offering guarantees to banks and financial institutions to enable exporter obtain
better facilities from them.
In other words, the objectives of ECGC are:
1. To provide insurance cover to exporters against political and commercial risks.
2. To provide insurance cover to exporters against the risk of exchange rate
fluctuations in respect of deferred payments.
3. To provide insurance cover to banks against export credit and guarantees extended
by them.
4. To provide insurance cover to Indian investors abroad against political risks.
Insurance Covers
The covers issued by ECGC may be broadly divided into the following four groups:
1. Standard policies issued to exporters to protect them against payment risks involved
in exports on short-term credit.
2. Specific policies designed to protect Indian firms against payment risks involved
in exports on deferred terms of payment, services rendered to foreign parties
construction works and turnkey projects undertaken abroad.
3. Financial guarantees issued to banks in India to protect them from risks of loss
involved in their extending financial support to exporters at the pre-shipment as
well as post-shipment stages.
4. Special schemes.
SUMMARY
Broadly, there are two types of foreign investment: (1) Foreign direct investment (FDI),
where the investor has control over/participation in the management of the firm;
(2) Portfolio investment, where the investor has only a sort of property interest in investing
the capital in buying equities, bonds, or other securities abroad.
There are three broad economic motives of FDI, viz., resources seeking (i.e.,
exploiting the natural resources of the host country); market seeking (i.e. to exploit the
market opportunities of the host countries); and efficiency seeking (like low cost of
production deriving from cheap labour). The presence of any (or even all) of these
determinants alone need not attract FDI. Several other factors such as political environment,
government policies, bureaucratic culture, social climate, infrastructural facilities, etc. are
also important determinants of FDI.
There have been several attempts to provide theoretical explanation for foreign
investment.
Encouraged by the favourable business environment, fostered by the global
liberalisation, the international private capital flows have been increasing rapidly, with
periodic downturns. Cross-border M&As have been the major driver of the recent surge in
FDI.
Although foreign capital has many beneficial effects, it also has several limitations
and can have adverse effects too. However, foreign capital now contributes a significant
share of the domestic investment, employment generation, industrial production and exports
in a number of economies.
Although the international capital flows to the developing countries have increased
substantially in the last one decade or so, the FDI flow is still predominant between the
developed countries. A small number of countries account for the lions share of the
international capital inflows to the developing world. There has also been a significant
increase in FDI flows between the developing economies. Although India has substantially
liberalised its foreign investment policy, FDI inflows have been much below the targets.

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