Unit 2
Foreign Capital and Economic Development
Foreign direct investment (FDI) or foreign investment refers to the net inflows of Investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy aside from that of the investor. It’s the sum of equality capital, reinvestment of earnings, other long-term capital and short-term capital as shown within the balance of payments.
It is usually participation in management, joint-venture, transfer of technology and expertise. Direct investment excludes investment through purchase of shares. FDI is one example of international factor movement. As investment abroad, usually where the company being invested in it controlled by the foreign corporation. The only explanation of FDI would be a direct investment by a corporation in a commercial venture in another country. A key to separating this action from involvement in other venture in foreign country is that the business enterprise operates completely outside the economy of the corporation’s home country. The role of FDI may be a vital ingredient of the globalization efforts of the world economy. The expansion of international production is driven by economic and technological forces. It’s also driven by the ongoing liberalization of Foreign Direct Investment (FDI) and trade policies. One outstanding feature of the present- day world has been the circulation of private capital flow within the kind of foreign direct investment (FDI) in developing countries, especially since 1990s.
Since the 1980s, multinational corporations (MNCs) have commenced as major actors within the globalization context. Governments round the world – in both advanced and developing countries – are attracting MNCs to come to the respective countries with their FDI. This experience may be related to the broader context of liberalization in which most developing and transition unparalleled opportunity for developing countries like India attain quicken economic growth through trade and investment. Within the period 1970s, international trade grew quicker than FDI, and thus international trade was far and away than most other important international economic activities. This example changed radically within the middle of the 1980s, when world FDI started to increase sharply. During this period, the world FDI has increased its importance by transferring technologies and establishing marketing and procuring networks for efficient production and sales internationally.
FDI flows comprises capital provided by foreign investors, directly or indirectly to enterprises in another economy with an expectation of obtaining profits derived from the capital participation within the management of the enterprises in which they invest. The foreign investors acquire ownership of assets in the host country firms in proportion to their equity holdings. This is often the empirical definition of FDI adopted by many countries to differentiate it from portfolio flows. Consistent with International Monetary
Fund (IMF). FDI is defined as “an investment that's made to acquire an enduring interest during an enterprise operating in an economy other than that of the investor. The investor’s purchase is to have an effective voice within the management of the enterprise. FDI is that the process by which the residents of 1 economy (the source country) acquire the ownership of assets for the aim of controlling the production, distribution and other productive activities of a firm in another country (the host country).
Foreign Capital in India
Everywhere within the world including the developed countries, governments are vying with each other to attract foreign capital. The belief that foreign capital plays a constructive role in a country’s economic development. It’s become even stronger since mid-1980.
The experience of South East Asian Countries (1986-1995) has especially confirmed this belief and has led to a progressive reduction in regulations and restraints that could have inhibited the inflow of foreign capital.
Need for Foreign Capital
The need for foreign capital arises owing to the following reasons. In most developing countries like India, domestic capital is inadequate for the aim of economic growth. Foreign capital is usually seen as how of filling in gaps between the domestically available supplies of saving, foreign exchange, and government revenue and therefore the planned investment necessary to achieve development targets.
To give an example of this ‘saving- investment’ gap, allow us to suppose that planned rate of growth output once a year is 7 percent and therefore the capital-output ration is 3 percent, then the speed of saving required is 21 percent.
If the saving which will be domestically mobilized is 16 percent, there's a shortfall or a saving gap of 5 percent. Thus, the foremost contribution of foreign capital to national development is its role in filling the resource gap between targeted investment and locally mobilized saving. Foreign capital is required to fill the gap between the targeted foreign exchange requirements and those derived from net export earnings plus net public foreign aid. This is often generally called the foreign exchange or balance of trade.
An inflow of private foreign capital helps in removing deficit within the balance of payments over time if the foreign-owned enterprises can generate a net positive flow of export earnings. The third gap that the foreign capital and specially, foreign investment helps to fill is that between governmental tax income and therefore the locally raised taxes. By taxing the profits of the foreign enterprises, the govt. Of developing countries is ready to mobilize funds for projects (like energy, infrastructure) that are badly needed for economic development. Foreign investment meets the gap in managements, entrepreneurship, technology and skill. The package of those much-needed resources is transferred to the local country through training programs and therefore the process of learning by doing. Further foreign companies bring with them sophisticated technological knowledge about production processes while transferring modern machinery equipment to the capital-poor developing countries.
In fact, during this era of globalization, there's a great belief that foreign capital transforms the products structures of the developing economic resulting in high rates of growth. Besides the above foreign capital, by creating new productive assets, contributes to the generation of employment a major need of a country like India.
Foreign Capital is often obtained within the kind of foreign investment or non-concessional assistance or concessional assistance.
1. Foreign Investment includes Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI). FPI includes the amounts raised by Indian corporate through Euro Equities, Global Depository Receipts (GDR’s), and American Depository Receipts (ADR’s).
2. Non-Concessional Assistance mainly includes External Commercial Borrowings (ECB’s), loans from governments of other countries/multilateral agencies on market terms and deposits obtained from Non-Resident Indians (NRIs).
3. Concessional Assistance includes grants and loans obtained at low rates of interest with long maturity periods. Such assistance is generally provided on a bilateral basis or through multilateral agencies just like the World Bank, International monetary fund (IMF), and International Development Association (IDA) etc. Loans need to be repaid generally in terms of foreign currency but in certain cases the donor may allow the recipient country to repay in terms of its own currency.
As the restrictions on foreign investments were reduced or removed, there was a sudden spurt in foreign net inflows. The number of approvals of foreign technical collaborations registered a dramatic increase in the new policy regime, and the number of foreign technology approvals went up. The value of FDI approvals also increased significantly in the post-reform period. 1997, $15.8 billion of FDI was approved in contrast to US$ 0.3 billion approved in 1991. Figure 5.1 highlights the increase in net FDI inflows after 1991. Net FDI inflows were only US$ 0.074 billion in 1991 increasing to US$ 3.6 billion by 1997, though falling in later years (US$ 2.6 billion in 1998). After 1991, foreign investment followed a steep upward curve: from 1981 to 1990, FDI grew by 23 per cent annually; this increased to 44 per cent annual growth during 1991 to 2001. Only US$ 0.1 billion of foreign capital was invested in 1991, compared with US$ 4.28 billion in 2001 (World Bank Development Indicators). However, FDI still constitutes a very low share of total investment in India. By 1998, this ratio was 2.5 per cent - much lower than that of most other Asian countries. In many other post-reform economies, FDI has been seen to increase substantially when there has been large-scale public sector privatisation. In India this has not happened as yet; indeed, domestic firms in India have proved capable of absorbing large state-owned firms that are being privatised, for example BALCO and VSNL. But the share of FDI, as a percentage of gross domestic investment (GDI) and GDP, has been growing. While the share of FDI in GDI was only 0.2 per cent in 1990, it increased to 3.98 per cent by 2001, while FDI as a per cent of GDP increased from 0.05 per cent in 1990 to 0.90 per cent in 2001. Although, inflows of foreign investments did gear up, they were not very impressive in comparison with some other countries. (See for example UNCTAD 2003) for a comparison of India with China). India's FDI share in the developing world was only 0.4 per cent in 1991. A marginal improvement was seen by 2001, when the share had increased to 1.7 per cent.
Distribution of FDI In the absence of details of actual FDI inflows into different sectors, the present sector-wise discussion depends on approval data only. The bulk of the approvals from early 1990s to 2002, were directed towards infrastructure and energy sectors. More approvals were made in non-manufacturing sectors. An analysis of half-yearly figures from the SIA Database reveals increasing shares of the metallurgy, power and fuel sectors in total number of approvals. Large falls were observed in transport, industrial machinery and food processing. The services sector including telecommunication increased its share during the initial years of 1992 to 1994. Its growth was limited by the domestic climate in the later years. A ranking of cumulative investment approved during the period 1991 to May 2002 reveals that USA was the largest investor in India with an investment of Rs. 570 billion. Mauritius, UK, Japan, Korea (South), Germany, Netherlands, Australia, France and Malaysia follow in that order. USA had a smaller share of FDI into India after 1997. Mauritius ranked next to USA in its cumulative investments since 1993. By 1997, the inflows from this country accounted for almost 20 per cent of FDI inflows, probably because of its status as a tax haven. Most of the approvals were in power, fuel, telecom and transport sectors.
1.Distort of the Pattern of Development of the Economy:
It is not suitable for countries who have adopted a scheme of planned development, while deciding about the investment projects the foreign capitalists will be guided by the maximization of profit criteria and not the plan priorities of the country. In other words, it always invests in low priorities of the economy.
2. Adverse Effect on Domestic Savings:
This sort of investment should be expected to have an income effect which will lead to a higher level of domestic savings. But at the same moment if private foreign investment reduces profits in domestic industries, it will adversely affect the income of profit earning and further will tend to reduce domestic savings.
3. Adverse Effect on Balance of Payments of the Recipient Country:
Foreign investors may earn huge profits which are to be repatriated in due course of time. The repatriation of these profits may turn into serious imbalances in the balance of payments of the recipient nation.
4. Not Useful on Political Grounds:
Private foreign investment in under developed countries is feared not only for economic reasons but also on political grounds. There is a great fear that it may lead to loss of independence of the recipient country. In the opinion of Prof. Lewis, “The loss of independence may be partial or complete; partial if the capitalists confine themselves to bribing politicians or backing one political group against another or complete if the debtor country is reduced to colonial status”.
These fears are quite widespread. They are mainly responsible for the reluctance on the part of developing countries to accept private foreign capital. In this connection Prof. WA. Lewis holds the view that, “These fears are one of the strongest reasons as to why the less developed countries are anxious that the United Nations should create adequate institutions for transferring capital so that they should not become dependent upon receiving capital from any one of the great powers”.
5. Limited Coverage:
Private capital usually restricts itself to certain limited spheres of economic life. For example, it chooses those industries where it can make large and quick profits, irrespective of the fact whether the development of those industries is in the development interest. Such industries are largely consumer goods industries or those industries in which the gestation period is not too long. It is for these reasons that in India before Independence, foreign capital mostly British, was directed to such industries as plantations, etc.
6. More Dependence:
The use of private capital often increases dependence on foreign sources. This happens at least on two counts. One is that the use of foreign technology appropriate to the resource-endowments of advanced countries does not permit the development of indigenous technology appropriate to the conditions of the recipient country.
On the contrary, it positively discourages the development of such a technology in competition with itself. This means the country in question will continue to depend upon the import of foreign technology. Two, the foreign technology used requires import of goods for replacement and maintenance, thereby creating balance of payments difficulties.
We have taken so much from the foreign technical know-how that we have not yet developed what may be described, as an appropriate technology suited to our resources and needs. Further, imports of replacement and maintenance goods are costing us a lot.
7. Restrictive Conditions:
In many cases foreign collaboration agreements contain restrictive clauses in respect of such things as exports. For example, foreign collaborators make investments to exploit the Indian market because they find it difficult to approach this market from outside.
But these collaborators do not want the Indian concern to export its goods to other countries which are already being supplied by the foreign collaborators from their concerns operating in other countries. Obviously, such agreements are of limited value for the country.
8. Remittance of Large Amounts:
Remittance of profits of course is a normal facility which the foreign investor expects. But often the profits earned in the early stages are high, involving big remittances. In many collaboration agreements, for example, the initial foreign capital is confined to the foreign exchange component of the project.
The rest of the resources are made available through internal sources. Since the rate of return on initial investment is usually very high, it makes it possible for the foreign collaborator to recover his amount in a relatively short time. Yet the payment on account of such things as technical services, royalty payments, etc., continues.
References:
- Misra S.K. And Puri V.K. Indian Economy, Himalaya Publishing House, Delhi
- Ruddar Datta and K.P.M. Sundaram, Indian Economy, S. Chand and Co., New Delhi.
Unit 2
Foreign Capital and Economic Development
Foreign direct investment (FDI) or foreign investment refers to the net inflows of Investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy aside from that of the investor. It’s the sum of equality capital, reinvestment of earnings, other long-term capital and short-term capital as shown within the balance of payments.
It is usually participation in management, joint-venture, transfer of technology and expertise. Direct investment excludes investment through purchase of shares. FDI is one example of international factor movement. As investment abroad, usually where the company being invested in it controlled by the foreign corporation. The only explanation of FDI would be a direct investment by a corporation in a commercial venture in another country. A key to separating this action from involvement in other venture in foreign country is that the business enterprise operates completely outside the economy of the corporation’s home country. The role of FDI may be a vital ingredient of the globalization efforts of the world economy. The expansion of international production is driven by economic and technological forces. It’s also driven by the ongoing liberalization of Foreign Direct Investment (FDI) and trade policies. One outstanding feature of the present- day world has been the circulation of private capital flow within the kind of foreign direct investment (FDI) in developing countries, especially since 1990s.
Since the 1980s, multinational corporations (MNCs) have commenced as major actors within the globalization context. Governments round the world – in both advanced and developing countries – are attracting MNCs to come to the respective countries with their FDI. This experience may be related to the broader context of liberalization in which most developing and transition unparalleled opportunity for developing countries like India attain quicken economic growth through trade and investment. Within the period 1970s, international trade grew quicker than FDI, and thus international trade was far and away than most other important international economic activities. This example changed radically within the middle of the 1980s, when world FDI started to increase sharply. During this period, the world FDI has increased its importance by transferring technologies and establishing marketing and procuring networks for efficient production and sales internationally.
FDI flows comprises capital provided by foreign investors, directly or indirectly to enterprises in another economy with an expectation of obtaining profits derived from the capital participation within the management of the enterprises in which they invest. The foreign investors acquire ownership of assets in the host country firms in proportion to their equity holdings. This is often the empirical definition of FDI adopted by many countries to differentiate it from portfolio flows. Consistent with International Monetary
Fund (IMF). FDI is defined as “an investment that's made to acquire an enduring interest during an enterprise operating in an economy other than that of the investor. The investor’s purchase is to have an effective voice within the management of the enterprise. FDI is that the process by which the residents of 1 economy (the source country) acquire the ownership of assets for the aim of controlling the production, distribution and other productive activities of a firm in another country (the host country).
Foreign Capital in India
Everywhere within the world including the developed countries, governments are vying with each other to attract foreign capital. The belief that foreign capital plays a constructive role in a country’s economic development. It’s become even stronger since mid-1980.
The experience of South East Asian Countries (1986-1995) has especially confirmed this belief and has led to a progressive reduction in regulations and restraints that could have inhibited the inflow of foreign capital.
Need for Foreign Capital
The need for foreign capital arises owing to the following reasons. In most developing countries like India, domestic capital is inadequate for the aim of economic growth. Foreign capital is usually seen as how of filling in gaps between the domestically available supplies of saving, foreign exchange, and government revenue and therefore the planned investment necessary to achieve development targets.
To give an example of this ‘saving- investment’ gap, allow us to suppose that planned rate of growth output once a year is 7 percent and therefore the capital-output ration is 3 percent, then the speed of saving required is 21 percent.
If the saving which will be domestically mobilized is 16 percent, there's a shortfall or a saving gap of 5 percent. Thus, the foremost contribution of foreign capital to national development is its role in filling the resource gap between targeted investment and locally mobilized saving. Foreign capital is required to fill the gap between the targeted foreign exchange requirements and those derived from net export earnings plus net public foreign aid. This is often generally called the foreign exchange or balance of trade.
An inflow of private foreign capital helps in removing deficit within the balance of payments over time if the foreign-owned enterprises can generate a net positive flow of export earnings. The third gap that the foreign capital and specially, foreign investment helps to fill is that between governmental tax income and therefore the locally raised taxes. By taxing the profits of the foreign enterprises, the govt. Of developing countries is ready to mobilize funds for projects (like energy, infrastructure) that are badly needed for economic development. Foreign investment meets the gap in managements, entrepreneurship, technology and skill. The package of those much-needed resources is transferred to the local country through training programs and therefore the process of learning by doing. Further foreign companies bring with them sophisticated technological knowledge about production processes while transferring modern machinery equipment to the capital-poor developing countries.
In fact, during this era of globalization, there's a great belief that foreign capital transforms the products structures of the developing economic resulting in high rates of growth. Besides the above foreign capital, by creating new productive assets, contributes to the generation of employment a major need of a country like India.
Foreign Capital is often obtained within the kind of foreign investment or non-concessional assistance or concessional assistance.
1. Foreign Investment includes Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI). FPI includes the amounts raised by Indian corporate through Euro Equities, Global Depository Receipts (GDR’s), and American Depository Receipts (ADR’s).
2. Non-Concessional Assistance mainly includes External Commercial Borrowings (ECB’s), loans from governments of other countries/multilateral agencies on market terms and deposits obtained from Non-Resident Indians (NRIs).
3. Concessional Assistance includes grants and loans obtained at low rates of interest with long maturity periods. Such assistance is generally provided on a bilateral basis or through multilateral agencies just like the World Bank, International monetary fund (IMF), and International Development Association (IDA) etc. Loans need to be repaid generally in terms of foreign currency but in certain cases the donor may allow the recipient country to repay in terms of its own currency.
As the restrictions on foreign investments were reduced or removed, there was a sudden spurt in foreign net inflows. The number of approvals of foreign technical collaborations registered a dramatic increase in the new policy regime, and the number of foreign technology approvals went up. The value of FDI approvals also increased significantly in the post-reform period. 1997, $15.8 billion of FDI was approved in contrast to US$ 0.3 billion approved in 1991. Figure 5.1 highlights the increase in net FDI inflows after 1991. Net FDI inflows were only US$ 0.074 billion in 1991 increasing to US$ 3.6 billion by 1997, though falling in later years (US$ 2.6 billion in 1998). After 1991, foreign investment followed a steep upward curve: from 1981 to 1990, FDI grew by 23 per cent annually; this increased to 44 per cent annual growth during 1991 to 2001. Only US$ 0.1 billion of foreign capital was invested in 1991, compared with US$ 4.28 billion in 2001 (World Bank Development Indicators). However, FDI still constitutes a very low share of total investment in India. By 1998, this ratio was 2.5 per cent - much lower than that of most other Asian countries. In many other post-reform economies, FDI has been seen to increase substantially when there has been large-scale public sector privatisation. In India this has not happened as yet; indeed, domestic firms in India have proved capable of absorbing large state-owned firms that are being privatised, for example BALCO and VSNL. But the share of FDI, as a percentage of gross domestic investment (GDI) and GDP, has been growing. While the share of FDI in GDI was only 0.2 per cent in 1990, it increased to 3.98 per cent by 2001, while FDI as a per cent of GDP increased from 0.05 per cent in 1990 to 0.90 per cent in 2001. Although, inflows of foreign investments did gear up, they were not very impressive in comparison with some other countries. (See for example UNCTAD 2003) for a comparison of India with China). India's FDI share in the developing world was only 0.4 per cent in 1991. A marginal improvement was seen by 2001, when the share had increased to 1.7 per cent.
Distribution of FDI In the absence of details of actual FDI inflows into different sectors, the present sector-wise discussion depends on approval data only. The bulk of the approvals from early 1990s to 2002, were directed towards infrastructure and energy sectors. More approvals were made in non-manufacturing sectors. An analysis of half-yearly figures from the SIA Database reveals increasing shares of the metallurgy, power and fuel sectors in total number of approvals. Large falls were observed in transport, industrial machinery and food processing. The services sector including telecommunication increased its share during the initial years of 1992 to 1994. Its growth was limited by the domestic climate in the later years. A ranking of cumulative investment approved during the period 1991 to May 2002 reveals that USA was the largest investor in India with an investment of Rs. 570 billion. Mauritius, UK, Japan, Korea (South), Germany, Netherlands, Australia, France and Malaysia follow in that order. USA had a smaller share of FDI into India after 1997. Mauritius ranked next to USA in its cumulative investments since 1993. By 1997, the inflows from this country accounted for almost 20 per cent of FDI inflows, probably because of its status as a tax haven. Most of the approvals were in power, fuel, telecom and transport sectors.
1.Distort of the Pattern of Development of the Economy:
It is not suitable for countries who have adopted a scheme of planned development, while deciding about the investment projects the foreign capitalists will be guided by the maximization of profit criteria and not the plan priorities of the country. In other words, it always invests in low priorities of the economy.
2. Adverse Effect on Domestic Savings:
This sort of investment should be expected to have an income effect which will lead to a higher level of domestic savings. But at the same moment if private foreign investment reduces profits in domestic industries, it will adversely affect the income of profit earning and further will tend to reduce domestic savings.
3. Adverse Effect on Balance of Payments of the Recipient Country:
Foreign investors may earn huge profits which are to be repatriated in due course of time. The repatriation of these profits may turn into serious imbalances in the balance of payments of the recipient nation.
4. Not Useful on Political Grounds:
Private foreign investment in under developed countries is feared not only for economic reasons but also on political grounds. There is a great fear that it may lead to loss of independence of the recipient country. In the opinion of Prof. Lewis, “The loss of independence may be partial or complete; partial if the capitalists confine themselves to bribing politicians or backing one political group against another or complete if the debtor country is reduced to colonial status”.
These fears are quite widespread. They are mainly responsible for the reluctance on the part of developing countries to accept private foreign capital. In this connection Prof. WA. Lewis holds the view that, “These fears are one of the strongest reasons as to why the less developed countries are anxious that the United Nations should create adequate institutions for transferring capital so that they should not become dependent upon receiving capital from any one of the great powers”.
5. Limited Coverage:
Private capital usually restricts itself to certain limited spheres of economic life. For example, it chooses those industries where it can make large and quick profits, irrespective of the fact whether the development of those industries is in the development interest. Such industries are largely consumer goods industries or those industries in which the gestation period is not too long. It is for these reasons that in India before Independence, foreign capital mostly British, was directed to such industries as plantations, etc.
6. More Dependence:
The use of private capital often increases dependence on foreign sources. This happens at least on two counts. One is that the use of foreign technology appropriate to the resource-endowments of advanced countries does not permit the development of indigenous technology appropriate to the conditions of the recipient country.
On the contrary, it positively discourages the development of such a technology in competition with itself. This means the country in question will continue to depend upon the import of foreign technology. Two, the foreign technology used requires import of goods for replacement and maintenance, thereby creating balance of payments difficulties.
We have taken so much from the foreign technical know-how that we have not yet developed what may be described, as an appropriate technology suited to our resources and needs. Further, imports of replacement and maintenance goods are costing us a lot.
7. Restrictive Conditions:
In many cases foreign collaboration agreements contain restrictive clauses in respect of such things as exports. For example, foreign collaborators make investments to exploit the Indian market because they find it difficult to approach this market from outside.
But these collaborators do not want the Indian concern to export its goods to other countries which are already being supplied by the foreign collaborators from their concerns operating in other countries. Obviously, such agreements are of limited value for the country.
8. Remittance of Large Amounts:
Remittance of profits of course is a normal facility which the foreign investor expects. But often the profits earned in the early stages are high, involving big remittances. In many collaboration agreements, for example, the initial foreign capital is confined to the foreign exchange component of the project.
The rest of the resources are made available through internal sources. Since the rate of return on initial investment is usually very high, it makes it possible for the foreign collaborator to recover his amount in a relatively short time. Yet the payment on account of such things as technical services, royalty payments, etc., continues.
References:
- Misra S.K. And Puri V.K. Indian Economy, Himalaya Publishing House, Delhi
- Ruddar Datta and K.P.M. Sundaram, Indian Economy, S. Chand and Co., New Delhi.
Unit 2
Foreign Capital and Economic Development
Foreign direct investment (FDI) or foreign investment refers to the net inflows of Investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy aside from that of the investor. It’s the sum of equality capital, reinvestment of earnings, other long-term capital and short-term capital as shown within the balance of payments.
It is usually participation in management, joint-venture, transfer of technology and expertise. Direct investment excludes investment through purchase of shares. FDI is one example of international factor movement. As investment abroad, usually where the company being invested in it controlled by the foreign corporation. The only explanation of FDI would be a direct investment by a corporation in a commercial venture in another country. A key to separating this action from involvement in other venture in foreign country is that the business enterprise operates completely outside the economy of the corporation’s home country. The role of FDI may be a vital ingredient of the globalization efforts of the world economy. The expansion of international production is driven by economic and technological forces. It’s also driven by the ongoing liberalization of Foreign Direct Investment (FDI) and trade policies. One outstanding feature of the present- day world has been the circulation of private capital flow within the kind of foreign direct investment (FDI) in developing countries, especially since 1990s.
Since the 1980s, multinational corporations (MNCs) have commenced as major actors within the globalization context. Governments round the world – in both advanced and developing countries – are attracting MNCs to come to the respective countries with their FDI. This experience may be related to the broader context of liberalization in which most developing and transition unparalleled opportunity for developing countries like India attain quicken economic growth through trade and investment. Within the period 1970s, international trade grew quicker than FDI, and thus international trade was far and away than most other important international economic activities. This example changed radically within the middle of the 1980s, when world FDI started to increase sharply. During this period, the world FDI has increased its importance by transferring technologies and establishing marketing and procuring networks for efficient production and sales internationally.
FDI flows comprises capital provided by foreign investors, directly or indirectly to enterprises in another economy with an expectation of obtaining profits derived from the capital participation within the management of the enterprises in which they invest. The foreign investors acquire ownership of assets in the host country firms in proportion to their equity holdings. This is often the empirical definition of FDI adopted by many countries to differentiate it from portfolio flows. Consistent with International Monetary
Fund (IMF). FDI is defined as “an investment that's made to acquire an enduring interest during an enterprise operating in an economy other than that of the investor. The investor’s purchase is to have an effective voice within the management of the enterprise. FDI is that the process by which the residents of 1 economy (the source country) acquire the ownership of assets for the aim of controlling the production, distribution and other productive activities of a firm in another country (the host country).
Foreign Capital in India
Everywhere within the world including the developed countries, governments are vying with each other to attract foreign capital. The belief that foreign capital plays a constructive role in a country’s economic development. It’s become even stronger since mid-1980.
The experience of South East Asian Countries (1986-1995) has especially confirmed this belief and has led to a progressive reduction in regulations and restraints that could have inhibited the inflow of foreign capital.
Need for Foreign Capital
The need for foreign capital arises owing to the following reasons. In most developing countries like India, domestic capital is inadequate for the aim of economic growth. Foreign capital is usually seen as how of filling in gaps between the domestically available supplies of saving, foreign exchange, and government revenue and therefore the planned investment necessary to achieve development targets.
To give an example of this ‘saving- investment’ gap, allow us to suppose that planned rate of growth output once a year is 7 percent and therefore the capital-output ration is 3 percent, then the speed of saving required is 21 percent.
If the saving which will be domestically mobilized is 16 percent, there's a shortfall or a saving gap of 5 percent. Thus, the foremost contribution of foreign capital to national development is its role in filling the resource gap between targeted investment and locally mobilized saving. Foreign capital is required to fill the gap between the targeted foreign exchange requirements and those derived from net export earnings plus net public foreign aid. This is often generally called the foreign exchange or balance of trade.
An inflow of private foreign capital helps in removing deficit within the balance of payments over time if the foreign-owned enterprises can generate a net positive flow of export earnings. The third gap that the foreign capital and specially, foreign investment helps to fill is that between governmental tax income and therefore the locally raised taxes. By taxing the profits of the foreign enterprises, the govt. Of developing countries is ready to mobilize funds for projects (like energy, infrastructure) that are badly needed for economic development. Foreign investment meets the gap in managements, entrepreneurship, technology and skill. The package of those much-needed resources is transferred to the local country through training programs and therefore the process of learning by doing. Further foreign companies bring with them sophisticated technological knowledge about production processes while transferring modern machinery equipment to the capital-poor developing countries.
In fact, during this era of globalization, there's a great belief that foreign capital transforms the products structures of the developing economic resulting in high rates of growth. Besides the above foreign capital, by creating new productive assets, contributes to the generation of employment a major need of a country like India.
Foreign Capital is often obtained within the kind of foreign investment or non-concessional assistance or concessional assistance.
1. Foreign Investment includes Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI). FPI includes the amounts raised by Indian corporate through Euro Equities, Global Depository Receipts (GDR’s), and American Depository Receipts (ADR’s).
2. Non-Concessional Assistance mainly includes External Commercial Borrowings (ECB’s), loans from governments of other countries/multilateral agencies on market terms and deposits obtained from Non-Resident Indians (NRIs).
3. Concessional Assistance includes grants and loans obtained at low rates of interest with long maturity periods. Such assistance is generally provided on a bilateral basis or through multilateral agencies just like the World Bank, International monetary fund (IMF), and International Development Association (IDA) etc. Loans need to be repaid generally in terms of foreign currency but in certain cases the donor may allow the recipient country to repay in terms of its own currency.
As the restrictions on foreign investments were reduced or removed, there was a sudden spurt in foreign net inflows. The number of approvals of foreign technical collaborations registered a dramatic increase in the new policy regime, and the number of foreign technology approvals went up. The value of FDI approvals also increased significantly in the post-reform period. 1997, $15.8 billion of FDI was approved in contrast to US$ 0.3 billion approved in 1991. Figure 5.1 highlights the increase in net FDI inflows after 1991. Net FDI inflows were only US$ 0.074 billion in 1991 increasing to US$ 3.6 billion by 1997, though falling in later years (US$ 2.6 billion in 1998). After 1991, foreign investment followed a steep upward curve: from 1981 to 1990, FDI grew by 23 per cent annually; this increased to 44 per cent annual growth during 1991 to 2001. Only US$ 0.1 billion of foreign capital was invested in 1991, compared with US$ 4.28 billion in 2001 (World Bank Development Indicators). However, FDI still constitutes a very low share of total investment in India. By 1998, this ratio was 2.5 per cent - much lower than that of most other Asian countries. In many other post-reform economies, FDI has been seen to increase substantially when there has been large-scale public sector privatisation. In India this has not happened as yet; indeed, domestic firms in India have proved capable of absorbing large state-owned firms that are being privatised, for example BALCO and VSNL. But the share of FDI, as a percentage of gross domestic investment (GDI) and GDP, has been growing. While the share of FDI in GDI was only 0.2 per cent in 1990, it increased to 3.98 per cent by 2001, while FDI as a per cent of GDP increased from 0.05 per cent in 1990 to 0.90 per cent in 2001. Although, inflows of foreign investments did gear up, they were not very impressive in comparison with some other countries. (See for example UNCTAD 2003) for a comparison of India with China). India's FDI share in the developing world was only 0.4 per cent in 1991. A marginal improvement was seen by 2001, when the share had increased to 1.7 per cent.
Distribution of FDI In the absence of details of actual FDI inflows into different sectors, the present sector-wise discussion depends on approval data only. The bulk of the approvals from early 1990s to 2002, were directed towards infrastructure and energy sectors. More approvals were made in non-manufacturing sectors. An analysis of half-yearly figures from the SIA Database reveals increasing shares of the metallurgy, power and fuel sectors in total number of approvals. Large falls were observed in transport, industrial machinery and food processing. The services sector including telecommunication increased its share during the initial years of 1992 to 1994. Its growth was limited by the domestic climate in the later years. A ranking of cumulative investment approved during the period 1991 to May 2002 reveals that USA was the largest investor in India with an investment of Rs. 570 billion. Mauritius, UK, Japan, Korea (South), Germany, Netherlands, Australia, France and Malaysia follow in that order. USA had a smaller share of FDI into India after 1997. Mauritius ranked next to USA in its cumulative investments since 1993. By 1997, the inflows from this country accounted for almost 20 per cent of FDI inflows, probably because of its status as a tax haven. Most of the approvals were in power, fuel, telecom and transport sectors.
1.Distort of the Pattern of Development of the Economy:
It is not suitable for countries who have adopted a scheme of planned development, while deciding about the investment projects the foreign capitalists will be guided by the maximization of profit criteria and not the plan priorities of the country. In other words, it always invests in low priorities of the economy.
2. Adverse Effect on Domestic Savings:
This sort of investment should be expected to have an income effect which will lead to a higher level of domestic savings. But at the same moment if private foreign investment reduces profits in domestic industries, it will adversely affect the income of profit earning and further will tend to reduce domestic savings.
3. Adverse Effect on Balance of Payments of the Recipient Country:
Foreign investors may earn huge profits which are to be repatriated in due course of time. The repatriation of these profits may turn into serious imbalances in the balance of payments of the recipient nation.
4. Not Useful on Political Grounds:
Private foreign investment in under developed countries is feared not only for economic reasons but also on political grounds. There is a great fear that it may lead to loss of independence of the recipient country. In the opinion of Prof. Lewis, “The loss of independence may be partial or complete; partial if the capitalists confine themselves to bribing politicians or backing one political group against another or complete if the debtor country is reduced to colonial status”.
These fears are quite widespread. They are mainly responsible for the reluctance on the part of developing countries to accept private foreign capital. In this connection Prof. WA. Lewis holds the view that, “These fears are one of the strongest reasons as to why the less developed countries are anxious that the United Nations should create adequate institutions for transferring capital so that they should not become dependent upon receiving capital from any one of the great powers”.
5. Limited Coverage:
Private capital usually restricts itself to certain limited spheres of economic life. For example, it chooses those industries where it can make large and quick profits, irrespective of the fact whether the development of those industries is in the development interest. Such industries are largely consumer goods industries or those industries in which the gestation period is not too long. It is for these reasons that in India before Independence, foreign capital mostly British, was directed to such industries as plantations, etc.
6. More Dependence:
The use of private capital often increases dependence on foreign sources. This happens at least on two counts. One is that the use of foreign technology appropriate to the resource-endowments of advanced countries does not permit the development of indigenous technology appropriate to the conditions of the recipient country.
On the contrary, it positively discourages the development of such a technology in competition with itself. This means the country in question will continue to depend upon the import of foreign technology. Two, the foreign technology used requires import of goods for replacement and maintenance, thereby creating balance of payments difficulties.
We have taken so much from the foreign technical know-how that we have not yet developed what may be described, as an appropriate technology suited to our resources and needs. Further, imports of replacement and maintenance goods are costing us a lot.
7. Restrictive Conditions:
In many cases foreign collaboration agreements contain restrictive clauses in respect of such things as exports. For example, foreign collaborators make investments to exploit the Indian market because they find it difficult to approach this market from outside.
But these collaborators do not want the Indian concern to export its goods to other countries which are already being supplied by the foreign collaborators from their concerns operating in other countries. Obviously, such agreements are of limited value for the country.
8. Remittance of Large Amounts:
Remittance of profits of course is a normal facility which the foreign investor expects. But often the profits earned in the early stages are high, involving big remittances. In many collaboration agreements, for example, the initial foreign capital is confined to the foreign exchange component of the project.
The rest of the resources are made available through internal sources. Since the rate of return on initial investment is usually very high, it makes it possible for the foreign collaborator to recover his amount in a relatively short time. Yet the payment on account of such things as technical services, royalty payments, etc., continues.
References:
- Misra S.K. And Puri V.K. Indian Economy, Himalaya Publishing House, Delhi
- Ruddar Datta and K.P.M. Sundaram, Indian Economy, S. Chand and Co., New Delhi.