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Foreign Capital in India


The capital from the foreign sources can be broadly classified under three broad categories:

  • Concessional Assistance
  • Non Concessional Assistance
  • Foreign Investments (FDI, Portfolio Investments, Non Resident Deposits)

Concessional assistance

The concessional assistance comprises loans and grants that are obtained at the rate of interest which is lower than the international market rate. Such assistance is provided to meet some crisis, generally has long maturity period and are provided by multilateral bodies like IMF and World Bank.

Non-concessional assistance

The non-concessional assistance mainly consists of External Commercial Borrowings are obtained on the market rate. 

Foreign investment

While the Foreign assistance (both concessional and non concessional) have the aim on developmental and social goals, the foreign investment is categorically aimed to maximize the shareholders wealth.  The Indian government differentiates cross-border capital inflows into various categories like foreign direct investment (FDI), foreign institutional investment (FII), non-resident Indian (NRI) and person of Indian origin (PIO) investment.

Foreign Direct Investment (FDI)

It refers to the net inflows of investment from a foreign player to acquire a lasting management interest in an enterprise operating in a country. Foreign direct investment targets a specific enterprise, with the aim of escalating its capacity/productivity or altering its management control.

Investment by Non Resident Indian and Overseas Corporate Bodies

NRIs and OCBs are eligible to bring investment through the automatic route of RBI. All other proposals, which do not fulfill any or, all of the criteria for automatic approval are considered by the Government through the Foreign Investment Promotion Board (FIPB).

Foreign Institutional Investment (FII)

The term refers to the outside companies/institutions investing in the financial (share) markets of India. Unlike individuals and citizens in India who can invest in financial market, only foreign institutions (not individuals) can invest in Indian financial markets. However recently some Qualified Foreign Investors (QFIs) are allowed to directly invest in Indian equity market.

The mechanisms through which foreign investors can invest abroad

There are specialized financial medium through the foreign investors invest abroad. The most common are: 

Depository Receipts

Depository Receipt is a medium through which an investor could invest in the foreign companies through their regular equity trading account from the local stock exchange. Depository Receipts also allow the investors to trade stocks without undergoing cross currency transaction. A Depository Receipt is a physical certificate which allows the investors to hold shares in equity of the foreign countries. A Depositary Receipt (DR) is a type of financial security that is traded on a local stock exchange but represents a security generally in the form of equity issued by a foreign company.

Depository Receipts are excellent means of investment for NRIs and foreign nationals wanting to invest in India. By buying these in their local stock exchanges, they can invest directly in Indian companies– since depository receipts are traded like any other stock, NRIs and foreigners can buy these using their regular equity trading accounts.

ADR and GDR

In the absence of full convertibility of rupee, ADR and GDR are financial products to mobilize financial capital from international market by Indian companies. ADR refers to American Depository Receipt while GDR refers to Global Depository Receipt. ADR represents ownership in a non-U.S stock that is traded in U.S financial markets. GDR are also similar to ADR, however GDR are issued by international bank (like JP Morgan), which can be subject of worldwide circulation on capital markets.

FDI v/s FII: Which is better?          

FDI is considered to be better than FII because of following reasons:

  • FDI is a long term investment while FII is very volatile in nature.
  • The purpose of FII is to enjoy the capital gains, so that when the share prices go up the investors may sell their share in the country and quit. However the purpose of FDI is expansion of global business, networks and operations.
  • FII ensures only capital inflow into the country, but in case of FDI the capital inflows are complemented with transfer of technology and sound management skills.

Tobin Tax

Since FII and other portfolio investments are very volatile (short term) in nature, Tobin Tax was proposed by Nobel laureate James Tobin. The purpose of this tax is to make the portfolio investment stable by imposing a tax on their flight from a country. The investment in share market is generally very speculative in nature also referred as “hot money”; the flight of capital from a country’s financial market could destabilize the whole economy. Thus if a tax is imposed on the flight of investment from a country, it would discourage the investors from frequent investment and disinvestment thus stabilizing the economy.

FDI: Indian scenario

There has been a paradigm shift in the policy related to FDI after 1991. In this era of reforms, the country has adopted an “open door” policy on foreign investment, foreign technology collaboration and foreign exchange. There was a paradigm shift in the policy related to foreign investments; which after 1991 envision management of foreign exchange rather than its restriction. The ongoing measures since 1991 are focused towards dismantling of both direct and indirect barriers to foreign investment.

This change in paradigm at policy level was explicitly manifested when FERA (Foreign Exchange Regulating Act, 1973) was replaced with FEMA (Foreign Exchange Management Act, 1999)

FERA v/s FEMA

The following are major differences in FERA and FEMA:

  • The essence of FERA was to regulate the foreign exchange while that in case of FEMA is management of foreign exchange.
  • Any offence under FERA was considered to be a criminal offence liable to imprisonment however in case if FEMA and offence is considered to be civil offence.
  • Under FERA nothing was permitted unless mentioned as “permitted”, in case of FEMA everything is permitted unless it is mentioned as “prohibited”.
  • Under FERA it was necessary to obtain permission from RBI; however it’s not the case with FEMA.

Thus the objective of FEMA is “to facilitate external trade and payments and promote the orderly development and maintenance of foreign exchange market in India”.

Importance of FDI for India

  1. FDI bridges the gap between the investment required and investment available in India.
  2. It provides the technology up gradation, infuses sound management principles and skill set in the projects across different sectors.
  3. It plays an important role in the employment generation directly and indirectly.

Routes of FDI in India

There are three routes through which FDI is permitted in India:

  1. Automatic route: Under this route foreign investors can straightaway brings in the investment in India. All they need to do is inform RBI within 30 days. The government has notified the sectors which are open to foreign investors under the automatic route e.g. infrastructure.
  2. Foreign Investment Promotion Board (FIPB): FIPB was set up in 1992. A foreign investor requires prior approval from FIPB in the sectors which are not listed under automatic route.
  3. Cabinet Committee on Foreign Investment (CCFI): The prior approval of Cabinet Committee on Foreign Investment (CCFI) is required before the foreign investment if:
  • ​The sector is not is not notified in the automatic route
  • The cost of project is Rs 6000 million or more.

Factors attracting FDI in India

The factors that make India an attractive destination for FDI are:

  • Huge market size with the growing middle class.
  • The GDP growth rate of about 8-9% in recent past.
  • The easy availability of abundant and cheap labor.
  • The rise in consumption culture especially in the younger generation.

Factors hindering FDI inflow in India

The major factors which hinder the inflow of FDI are:

  • Infrastructural bottlenecks: lack of proper connectivity, bad roads, power deficiency etc.
  • Red tapeism, bureaucratic apathy and rampant corruption prevailing in the country
  • Rigid labor laws and Exit policy.
  • Multiple regional parties ruling the states at times brings in political instability or delay in the implementation of the decisions of facilitating FDI.

Cumulative inflow of FDI (2000-2011) in India from the counties (in descending order):

1.Mauritius

2.Singapore

3.U.S.

4.U.K.

5.Netherland

Sectors attracting the highest FDI

The following are the sectors in India which have attracted highest cumulative FDI

(In descending order)

1.Service Sector

2.Computer and Software

3.Telecommunications

4.Housing and real Estate 

5. Construction

World’s Investment Report 2011

As per 'World Investment Report 2011', released by UNCTAD, India attracted FDI worth $ 25 billion in 2009-10. In the last fiscal i.e. 2008-09, India attracted FDI worth $ 36 billion. As a result its ranking dropped from 8th in 2009 to 14th in 2010. According to UNCTAD, foreign direct investment inflows worldwide in 2009-10 climbed to about $1.24 trillion. India saw FDI inflows of $19.42 billion in 2010-11.

 

Year

 

FDI inflow in India

 

2008-09

 

$ 36 billion

 

2009-10

 

$ 25 billion

 

2010-11

 

$ 19.4 billion

 

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