NEW COLLEGE OF CORPARATE SECATERIOSHIP CHAPTER-1:INTRODUCTION The last t wo d ecade of the 20 th century witnessed a dramatic world-wide increas e in foreign

direct investm ent (FD I), accompanied by a marked change in the attitude of most developing countries towards inward FDI. As against a highly suspicious attitude of these countries towards inward FDI in the past, most countries now regard FDI as beneficial for their development efforts and compete with each other to attract it. Such shift in attitude lies in the changes in political and economic systems that have occurred during the closing years of the last century.

The wave of liberalisation and globalization sweeping across the world has opened many national markets for international business. Global private i n v e s t m e n t , i n m o s t p a r t , i s n o w m a d e b y m u l t i n a t i o n a l c o r p o r a t i o n s (MNCs). Clearly these corporations play a major role in world trade and investments because of their demonstrated management skills, technology, financial resources and related advantages. Recent developments in global markets are indicative of the rapidly growing international business. The end of the 20 th century has already marked a tremendous growth in international investments, trade and financial transactions along with the integration and openness of international markets.

FDI is a subject of topical interest. Countries of th e world, particularly developing economies, are vying with each other to attract foreign capital

boost their domestic rates of investment and also to acquire new technology and managerial skills. Intense competition is taking place among the fund starved less d eveloped co untries to lure fo reign i n v e t o r s b y o f f e r i n g repatriation facilities, tax concessions and other incentives. However, FDI is not an unmixed blessing. Governments in developing countries have to be very careful while deciding the magnitude, pattern and conditions of private foreign investment. In the 1980s, FDI was concentrated within the Triad(EU, Japan and US).However, in the 1990s, the FDI flows to developed countries declined, while those to developing countries increased in response to rap id gro wth and fewer restrictions. Most FDI flows continue still to be concentrated in 10 to15 host countries overwhelmingly in Asia and Latin America. South, East and Southeast Asia has experien ced the fastest economic gro wth in the world, and emerged as the largest host region. China is now the largest host country in the developing world. However, small markets with low growth rates, poor infrastructure, and high indebtedness, slow progress in introducing marke t a n d p r i v a t e - s e c t o r oriented economic reforms and low levels of technological capabilities are not attractive to foreign investors. The remarkable expansion of FDI flows to developing countries had belied the fear that the opening of central and Eastern Europe and the efforts of the countries of that region to attract such investment would divert investment

flows from d eveloping countries. The most important factors making developing countries attractive to forei gn invest ors are rap id economic g r o w t h , privatization programmes open to foreign investors an d t h e liberalisation of the FDI regulatory frame work. In India, prior to economic reforms initiated in1991, FDI was discouraged by Imposing severe limits on equity holdings by foreigners and Restricting FDI to the production of only a few reserved items. The Forei gn Exchange R egulat ion Act (FER A), 1973 (now rep laced b y Foreign Exchange Management Act [FEMA]), prescribed the detailed rules in this regard and the firms belonging to this group were known as FERA firms. All foreign investors were virtually driven out from Indian industries by FERA. Technology transfer was possible only through the purchase of foreign technology. However, due to severe limits on royalty payments to forei gners to reduce forei gn exchange use, this option was ineffective. H o w e v e r , the government granted liberal tax incentives to enco u r a g e indigenous generation of technology by domestic firms. In the absence of f o r e i g n t e c h n o l o g y , I n d i a n i n d u s t r y s u f f e r e d b o t h i n t e r m s o f c o s t o f production and quality. The initial policy stimulus to foreign direct investment in India in came July1991 when the new industrial policy provided, inter alia, automatic approval for project with foreign equity participation up to 51 percent in high priority

Eareas. In recent years, the government has initiated the second generationre forms under which measures have been taken to furth er facilitate and broaden the base of foreign direct investment in India. The policy for FDIallows freedom of location, choice of technology, repatriation of capital anddividends. As a result of these measures, there has been a strong surge of international interest in the Indian economy. The rate at which FDI inflowhas grown during the post-liberalisation period is a clear indication that Indiai s f a s t e m e r g i n g a s a n a t t r a c t i v e d e s t i n a t i o n f o r o v e r s e a s i n v e s t o r s . Encouragement of foreign investment, particularly for FDI, is an integral part of ongoing economic reforms in India.Though India has one of the most transparent and liberal FDI regimesamong the developing countries with strong macro-economic fundamentals,its share in FDI inflo ws is dismally lo w. The country still su ffers fro mweaknesses and constraints, in terms of policy and regulatory framework,which restricts the inflow of FDI.Foreign investment policies in the post-reforms period have emphasizedgreater encouragement and mobalisation of non-debt creating privateinflows for reducing reliance on debt flows. Progressively liberal policieshave led to increasing inflows of foreign investment in the country.

VIVEK COLLEGE OF COMMERCE CHAPTER-2:WHAT IS FOREIGN DIRECT INVESTMENT? FDI is the process whereby residents of one country (the home country)acquire ownership of assets for the purpose of controlling the production,d i s t r i b u t i o n a n d o t h e r a c t i v i t i e s o f a f i r m i n a n o t h e r c o u n t r y ( t h e h o s t country) .IMF Definition According to the BPM5, FDI is the category of international investment thatreflects the objective of obtaining a lasting interest by a resident entity inone econo my in an enterprise resid ent in another econo my. Th e lastinginterest implies the existence of a long-term relationship between the directinvestor and the enterprise and a significant d egree o f in fluence b y th einvestor on the management of the enterprise .UNCTAD Definition The WIR02 defines FDI as an investment i n v o l v i n g a l o n g - t e r m relationship and reflecting a lasting interest and control by a resident entityin one economy (foreign direct investor or parent enterprise) in an enterpriser e s i d e n t i n a n e c o n o m y o t h e r t h a n t h a t o f the FDI enterprise, affiliateenterprise o r foreign a f f i l i a t e . F D I i m p l i e s t h a t t h e i n v e s t o r e x e r t s a sig nificant degree of influence on the management of the enterprise residentin the other economy. Such investment involves both the initial transaction between the two entities and all subsequent transaction between them among

foreign affiliates, both incorporated and unincorporated. Individuals as wellas business entities may undertake FDI.Flows of FDI comprise capital provided (either directly or through other related enterpris es ) b y a foreign direct investor to an FDI enterpris e, or capital received from an FDI enterprise by a foreign direct investor. FDI hast h r e e c o m p o n e n t s , v i z . , e q u i t y c a p i t a l , r e i n v e s t e d e a r n i n g s a n d i n t r a - company loans. Equity capital is the foreign direct investors purchase of share of anenterprise in a country other than its own. Reinvested earnings comprise the direct investors share (in proportionto direct equity participation) of earnings not distributed as dividends by affiliates, or ea rnings not remi tted to the direct invest or. Suchretained profits by affiliates are reinvested. Intra-company loans or intra-company debt transactions refer to shortor long term borrowing and lending of funds between direct investors(parent enterprises) and affiliate enterprises. OECD Bench mar k Definition of Foreign Direct Investm ent (ThirdEdition) FDI reflects the objective of obtaining a lasting interest by a resident entityin one economy (direct investor) in an entity resident in an economy other than that of the investor (direct investment enterprise). The lasting interestimplies the existence of a long

term relationship between the direct investor

And the enterprise and a significant degree of influence on the managementof the ent erpris e. Di rect investment involves bot h the initial transaction between the two entities and all subsequent capital transactions betweent h e m a n d a m o n g a f f i l i a t e d e n t e r p r i s e s , b o t h i n c o r p o r a t e d a n d unincorporated.A s i s e v i d e n t from the above definitions, there is a large degr e e o f commonality between the IMF, UNCTAD and OECD definitions of FDI.The IMF definition is followed internationally

CHAPTER-3:FOREIGN DIRECT INVESTMENT (FDI): THEORITICALSETTINGS Most of the present day underdeveloped countries of the world have set out a planned programme for accelerating the pace o f t h e i r e c o n o m i c develop ment. In a country planning for industrialization and aiming toachieve a target rate of growth, there is a need for resources. The resourcescan be mobilized through domestic as well as foreign sources. So far as, thedomestic sources are concerned, they may not be sufficient to acquire thefixed rate of growth. Generally domestic savings are less than the requiredamount of investment. Also the very process of industrialization calls for import of capital goods which can not be locally produced. Hence comes theneed for foreign sources. They not only supplement the domestic savings buta l s o p r o v i d e t h e r e c i p i e n t c o u n t r y w i t h e x t r a f o r e i g n e x c h a n g e t o b u y imports essential for filling the saving investment gap and foreign exchangegap.The means of getting foreign resources available to a developing country aremainly three:1.Through export of goods and services2 . E x t e r n a l a i d 3 . F o r e i g n i n v e s t m e n t

Export of goods and services do contribute to foreign resources but they canmeet only a small part of the total demand for foreign resources.External Aid from foreign governments and international institutions, byincreasing the rate of home savings and removing the foreign gap allows theutilization of previously under utilized resources and capacity. But generallythe aid is tied and distorts the allocation of resources. So its use has been onthe decline.Foreign investment is of following two types.1.Foreign Direct Investment (FDI) and2.Portfoli o Investm ent. Foreign Direct versus Portfolio Investment By Foreign Direct Investment (FDI) we mean any investment in a foreigncountry where the investing party (corporation, firm) retains control over investment. A direct investment typically takes the form of a foreign firmstarting a subsidiary or taking over control of an existing firm in the countryi n q u e s t i o n . F D I consists of equity capital, technical and m a n a g e r i a l s ervices, capital eq uipment and intermediate inputs and lega l ri ghts to patented or secret products, processes or trade marks. It is the direct type of forei gn investm ent which is associated with multinational corporations because most of FDI is transferred through firms and remains outside of ordinary, functioning markets.

FDI can be done in the following ways1.In order to participate in the management of the concerned enterprise, thestocks of the existing foreign enterprise can be acquired.2.The existing enterprise and factories can be taken over.3.A new subsidiary with 100% ownership can be established abroad.4.It is possible to participate in a joint venture through stock holdings.5.New foreign branches, offices and factories can be established.6.Existing foreign branches and factories can be expanded.7 . M i n o r i t y s t o c k a c q u i s i t i o n , i f t h e o b j e c t i v e i s t o p a r t i c i p a t e i n t h e management of the enterprise.8.Lon g term lending, particularly b y a parent company to its subsidiary, when the objective is to participate in the management of the enterprise.Portfolio investment, on the other hand, does not seek management control, but is motivated by profit. Portfoli o investment oc curs wh en individuali n v e s t o r s i n v e s t , m o s t l y t h r o u g h s t o c k b r o k e r s , i n s t o c k s o f f o r e i g n companies in foreign land in search of profit opportunities.FDI flows are usually preferred over other forms of external finance becausethey a re non-d ebt creating, non-volatile and their returns depend on the performance of the projects financed by the investors. FDI also facilitatesinternational trade and transfer of knowledge, skills and technology. In aw o r l d o f i n c r e a s e d c o m p e t i t i o n a n d r a p i d t e c h n o l o g i c a l c h a n g e , t h e i r complimentary and catalytic role can be very valuable.

Superiority of FDI over Other Forms of Capital Inflows FD I is perc ei ved superi or to other t yp es of capital i n f l o w s f o r s e v e r a l reasons: 1. In contrast to forei gn lenders a nd portfoli o invest ors, forei gn directinvestors typically have a longer-term perspective when engaging in ahost country. Hence, FDI inflows are less volatile and easier to sustain attimes of crisis.2.While debt inflows ma y finance consumption rather than investment inthe host country, FDI is more likely to be used productively.3.FDI is expected to have relatively strong effects on economic growth, asF D I provides for more than just capital. FDI o f f e r s a c c e s s t o internationally available technologies and management know-how, andmay render it easier to penetrate word markets.A recent United Nations report has revealed that FDI flows are less volatilethan portfoli o flows. To quote, FD I flows to developing and transitioneconomies in 1998 declined by about 5 percent from the peak in 1997, amodest reduction in relation to the effects on the other capital flows of thespread of the Asian financial crisis to global proportions. FDI flows aregenerally much less volatile than portfolio flows. The decline was modest inall regions, even in the Asian ec onomies m ost affected b y the financialcrisis.FDI is the appropriate form of external financing for developing countries,w h i c h h a v e l e s s c a p a c i t y t h a n h i g h l y d e v e l o p e d e c o n o m i e s t o a b s o r b external shocks. Likewise, the evidence supports the predominant view that

FD I is m ore stable than oth er t yp es of capital i n f l o w s . M o r e o v e r , t h e volatility of FDI remained exceptionally low in the 1990s, when severalemerging economies were hit by financial crisis.FDI is widely c onsidered an ess ential elem ent for achieving sustainabledevelopment. Even former critics of MNCs expect FDI to provide a stronger stimulus to income growth in host countries than other typ es of capitali n f l o w s . E s p e c i a l l y a f t e r t h e r e c e n t f i n a n c i a l c r i s i s i n A s i a a n d L a t i n America, developing countries are strongly advised to rely primarily on FDI,in ord er to supplem ent national savings by capital inflows and promot eeconomic development. Macro-economic and Micro-economic Aspects of FDI In judgin g the significanc e of FD I, esp ecia lly from t h e v i e w p o i n t o f developing countries, it is useful to make a distinction between ma cro-economic and microeconomic effects. The former is connected with issuesof domestic capital formation, balance of payments, and taking advantage of external markets for achieving faster growth, while the latter is connectedwith the issues of c ost reduction, product quality improvem ent, makingchanges in industrial structure and developing global inter-firm linkages.In this context, it needs to be recognized that FDI is an aggregate entity, thesum total of the investments made by many diverse multinationals, eachw i t h i t s own c orp orat e st rat egy. Th e micro-ec onomic effects of the

investment made by one multinational may be quite different from that of another multinational even if the investments are made in the same industry.Also, what benefits the local economy will depend on the capabilities of thehost country in regard to technology transfer and industrial restructuring. Resource-seeking and Market-seeking FDI Two major types of FDI are typically differentiated: resourceseeking FDIand market-seeking FDI.Resource-seeking FDI is motivated by the availability of natural resources inthe host countries. This type of FDI was historically important and remains arelevant source of FDI for va rious developing countries. However, on aworld-wid e scale, the relat ive importance of resourc eseeking FDI hasdecreased significantly.The relative importance of market-seeking FDI is rather difficult to assess. Itis almost impossible to tell whether this type of FDI has already become lessimportant due to economic globalization. Regarding the history of FDI indeveloping countries, various empirical studies have shown that the size andg r o w t h o f h o s t c o u n t r y m a r k e t s w e r e a m o n g t h e m o s t i m p o r t a n t F D I determinants. It is debatable, however, whether this is still true with ongoingglobalization.

Globalisation essentially means that g e o g r a p h i c a l l y d i s p e r s e d manufacturing, slicing up the value chain and the combination of marketsand resources through FDI and trade are becoming major characteristics of the world economy. Efficiency-seeking FDI, i.e. FDI motivated by creatingnew sources of competitiveness for firms and strengthening existing ones,ma y then em erge as the m ost important typ e of FD I. Acc ordingly, thec o m p e t i t i o n f o r F D I w o u l d b e b a s e d i n c r e a s i n g l y o n c o s t d i f f e r e n c e s between locations, the quality of infrastructure and business-related services,the eas e of doing business and the availabilit y of skills. Obvious ly, thisscenario involves major challenges for developing countries, ranging fromhuman capital formation to the provision of businessrelated services such asefficient communication and distribution systems. Nature of FDI Almost all modern (FDI) is carried out by c o r p o r a t i o n s r a t h e r t h a n individuals. Somewhat like portfoli o investm ent, the flows of FDI havehistorically been highly concentrated, both in terms of geography and byindustry and at both the investor and receptor poles. Geographically, theownership of global stocks of FDI is highly skewed towards on ly a fewl a r g e , h i g h i n c o m e c o u n t r i e s . E a c h i n v e s t i n g c o u n t r y h a s , w h e t h e r b y accident or design , tended to direct the major part of its FDI to only a veryfew receiving countries; in fact the pattern of global distribution of FDI have been highly similar to historical relationships based on colonial ties or other forms of political hegemony.

Viewed industrially, for any given country, FDI generally comes from lessthan four or five out of twenty or so major industry groups and inflows intothose same industries in the receptor country.General attribute of FDI is that it has evoked by type over time. Prior to FirstWorld War, a crude but valid generalization would that a large part of FDIwas in servic e s ector of t he host ec onom y (particularly transportation, p o w e r , c o m m u n i c a t i o n a n d t r a d i n g ) w h i l e m o s t o f t h e r e s t w a s o f t h e backward vertical integration type. During the inter-war period, most of the currently largest manufacturing multinational corporations (MNCs)m a d e t h e i r i n i t i a l f o r e i g n i n v e s t m e n t s , b u t t h e s e h o r i z o n t a l o r m a r k e t extension types of investments have now become major category.T h e f o u r t h recognized characteristic of manufacturing FDI is t h a t i t originates in industries that are technologically intensive, skill oriented or p r o g r e s s i v e . I n a d d i t i o n , t h e F D I p r o n e i n d u s t r i e s a r e t y p i c a l l y m o r e concentrated, have higher advertising outlays per unit of sales and exhibitabove a verage exp ort prop ensities. Industries from which FD I tends tooriginate display many characteristics associated with oligopoly.A n o t h e r u n i v e r s a l p r o p e r t y o f F D I i s t h a t i t i s r e a l l y a p a c k a g e o f complem entary inputs, a collective flow of both tangible and intangibleassets & services

FDI in Developing Countries FDI is now increasingly recognized as an important contributor to ad e v e l o p i n g c o u n t r y s e c o n o m i c p e r f o r m a n c e a n d i n t e r n a t i o n a l competitiveness.A f t e r the debt-crisis that hit the developing world in early 1 9 8 0 s , t h e conventional wisdom quickly became that it had been unwise for countriesto borrow so heavily from international banks or international bond markets.Rather countries should try to attract non-debt-creating privat e inflows(DF I). Th e financial advantage is that such capital inflows need not berepaid and that outflow of funds (remittance of profits) would fluctuate withthe cycle of the economy. It has also been widely observed that the structuraladjustment efforts of the 1980s failed to lead to new patterns of sustainedgrowth in developing countries. In particular, structural adjustment programsfailed to restore private investment to desirable levels. Again it is hoped thatFDI could play an important role; the World Bank observes that FDI can bean important complement to the adjustment effort, especially in countrieshaving difficulty in increasing domestic savings.Against this background of balance of payments problems and low level of private investment, it is probably not surprising that attitudes in developingcountries towards FDI have shifted. In the 1960s and 1970s many countriesmaintained a rather cautious, and sometimes an outright negative positionwith respect to FDI. In the 1980s, however the attitudes shifted radically