Project Report on

Foreign Direct Investment: Current Scenario

Submitted By: Siddharth Dewangan

Roll no: 163

Semester-V

(B.A.L.L.B. Hons.)

Submitted To: Ms. Varendyam Jahnawi Tiwari (Faculty Corporate Law)

Date of Submission- 26th September, 2016

Hidayatullah National Law University

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 Acknowledgements

I would like to thank Ms. Varendyam Jahnawi Tiwari, Faculty, Corporate Law, HNLU, for
allotting me this topic to work upon. And I would like to thank my parents, my friends and all
those who helped me. A heartily thank to the university administration for providing us with a
good WI-FI facility, without which my project would not have completed.

THANK YOU.

Siddharth Dewangan

Semester V, Section B

Roll No. : 163

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 Research Methodology

 The objectives of the project are:

1. To understand the concept of FDI

2. To put forth the benefits and demerits of the FDI

 Methodology

 This study is based on secondary data. The required data has been collected by various
sources i.e., World Investment Report , various Bulletins of Reserve Bank of India,
publications from ministry of Commerce, Govt. of India , from websites of World Bank,
IMF , WTO, RBI , etc. Non empirical research work has been used in this project as the
material in this project mainly consists of the work of people which is already done.
Some potions of that work are referred in this project and citations are also provided
wherever they were necessary.

 Research Question: What is the significance of FDI in the current scenario?

 Hypothesis: FDI is regulated with the terms and rules as defined under the Indian

Companies Act, and which symbolize globalization. Although it is done internationally

but the regulations is followed that of the local government.

 Mode of citation: 19th bluebook citation style

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 CONTENTS

1. Introduction………………………….………………………….05
2. What is FDI……………………………………………………...06
3. Who can invest in India...…………………………………….....07
4. FDI : Theoretical Setting…………………………………….….11
5. Advantages of Foreign Direct Investment…………..………….14
6. Factors Affecting FDI…………………………………………...17
7. CONCLUSION……………………………………………….…18
8. BIBLIOGRAPHY……………………………………………….19

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 Introduction

Investment from one country into another (normally by companies rather than governments) that
involves establishing operations or acquiring tangible assets, including stakes in other
businesses.

The purchase or establishment of income-generating assets in a foreign country that entails the
control of the operation or organization.

FDI is distinguished from portfolio foreign investment (the purchase of one country’s securities
by nationals of another country) by the element of control. Standard definitions of control use the
internationally agreed 10 per cent threshold of voting shares, but this is a grey area as often a
smaller block of shares will give control in widely held companies 1. Moreover, control of
technology, management, even crucial inputs can confer de facto control.

FDI is not just a transfer of ownership as it usually involves the transfer of factors
complementary to capital, including management, technology and organizational skills.

1
http://theindiaeconomyreview.org/article

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 What is FDI

FDI is the process whereby residents of one country (the home country) acquire ownership of
assets for the purpose of controlling the production, distribution and other activities of a firm in
another country (the host country)

IMF Definition
According to the BPM5, FDI is the category of international investment that reflects the
objective of obtaining a lasting interest by a resident entity in one economy in an enterprise
resident in another economy. The lasting interest implies the existence of a long-term
relationship between the direct investor and the enterprise and a significant degree of influence
by the investor on the management of the enterprise2

UNCTAD Definition
The WIR02 defines 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 FDI enterprise, affiliate
enterprise or foreign affiliate3. FDI implies that the investor exerts as 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 transaction
between them among foreign affiliates, both incorporated and unincorporated. Individuals as
well as business entities may undertake FDI. 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,
viz., equity capital, reinvested earnings and intra-company loans4.

2
/www.imf.org/external
3
unctad.org/en
4
http://www.petersoninstitute.org

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Strategically FDI comes in three types:

- Horizontal: where the company carries out the same activities abroad as at home (for example,
Toyota assembling cars in both Japan and the UK.

- Vertical: when different stages of activities are added abroad. Forward vertical FDI is where the
FDI takes the firm nearer to the market (for example, Toyota acquiring a car distributorship in
America) and Backward Vertical FDI is where international integration moves back towards raw
materials (for example, Toyota acquiring a tyre manufacturer or a rubber plantation).

- Conglomerate: where an unrelated business is added abroad. This is the most unusual form of
FDI as it involves attempting to overcome two barriers simultaneously - entering a foreign
country and a new industry. This leads to the analytical solution that internationalisation and
diversification are often alternative strategies, not complements5.

• Equity capital is the foreign direct investor’s purchase of share of an enterprise in a country
other than its own.
• Reinvested earnings comprise the direct investors share (in proper into direct equity
participation) of earnings not distributed as dividends by affiliates, or earnings not remitted to the
direct investor. Such retained profits by affiliates are reinvested6.
• Intra-company loans or intra-company debt transactions refer to shorter long term borrowing
and lending of funds between direct investors (parent enterprises) and affiliate enterprises.

OECD Benchmark Definition of Foreign Direct Investment.

FDI reflects the objective of obtaining a lasting interest by a resident entity in one economy
(direct investor) in an entity resident in an economy other than that of the investor (direct
investment enterprise). The lasting interest implies the existence of a long term relationship
between the direct investor and the enterprise and a significant degree of influence on the
management of the enterprise. Direct investment involves both the initial transaction between the
two entities and all subsequent capital transactions between them and among affiliated
enterprises, both incorporated and un-incorporated. As is evident from the above definitions,

5
www.scribd.com
6
spectrum.library.

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there is a large degree of commonality between the IMF, UNCTAD and OECD definitions of
FDI. The IMF definition is followed internationally.

Who Can Invest in India?

A non-resident entity can invest in India, subject to the FDI Policy except in those
sectors/activities which are prohibited. However, a citizen of Bangladesh or an entity
incorporated in Bangladesh can invest only under the Government route. Further, a citizen of
Pakistan or an entity incorporated in Pakistan can invest, only under the Government route, in
sectors/activities other than defence, space and atomic energy and sectors/activities prohibited
for foreign investment7. NRIs resident in Nepal and Bhutan as well as citizens of Nepal and
Bhutan are permitted to invest in the capital of Indian companies on repatriation basis, subject to
the condition that the amount of consideration for such investment shall be paid only by way of
inward remittance in free foreign exchange through normal banking channels. OCBs have been
derecognized as a class of investors in India with effect from September 16, 2003. Erstwhile
OCBs which are incorporated outside India and are not under the adverse notice of RBI can
make fresh investments under FDI Policy as incorporated non-resident entities, with the prior
approval of Government of India if the investment is through Government route; and with the
prior approval of RBI if the investment is through Automatic route8.

An Indian company may receive Foreign Direct Investment under the two routes as given under:

i. Automatic Route: FDI is allowed under the automatic route without prior approval either of the
Government or the Reserve Bank of India in all activities/sectors as specified in the consolidated
FDI Policy, issued by the Government of India from time to time.

ii. Government Route: FDI in activities not covered under the automatic route requires prior
approval of the Government which are considered by the Foreign Investment Promotion Board
(FIPB), Department of Economic Affairs, Ministry of Finance9.

7
http://www.business-standard.com/article/economy-policy
8
ibid
9
www.emeraldinsight.com

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Foreign direct investment (FDI) inflows into India have been steadily rising in importance since
the early 2000s until the global financial crisis.

In absolute terms and as a share of GDP, net FDI inflows peaked in 2008, representing around
3% of the share in world FDI flows.

While the global financial crisis initially contributed to a slowdown in FDI inflows, the rather
sharp downward trend and the consequent sluggish recovery of FDI that can be observed in the
post global financial crisis phase has primarily been a result of a host of domestic factors.

Policy challenges on multiple fronts, including issues of governance, inadequate structural

reforms, tax and political uncertainties, all contributed to the lack luster performance of FDI in
India.

While there are signs of stabilization in net FDI inflows, India still has a long way to go to return
to the pre- global financial crisis peak. In this light, it is not surprising that the “Modi “
government has reiterated that the country’s FDI regime is highly open and conducive for
attracting such flows of foreign capital10.

Until 2012, about 40% of FDI inflows used to come from Mauritius, just under 10% from
Singapore, and another 5% from the Netherlands.

These tax havens and offshore financial centers (OFCs) together made up just over half of all
FDI inflows to India. In 2013, however, the composition changed, with Singapore’s share rising
to 25% (boosted by the double taxation avoidance agreement the two countries have signed
which has incorporated a Limitation of Benefit—LoB—provision), Mauritius with about 20%
and the Netherlands at around 5%.

While Singapore and Mauritius have swapped places as top investors in India, still about 50%
originates from these offshore financial centers. Clearly, these are not the original sources of
external financing with the offshore financial centers responsible for a degree of round-tripping
of funds from India and transshipping of funds from third countries 11. Accordingly, an analysis

10
www.rbi.org.in
11
www.thehindu.com

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based on such data can be quite misleading when trying to understand economic linkages
between countries.

If one wants to get a sense of the original source of these FDI flows, i.e. who is actually doing
the investment in India and to understand the de facto real linkages at the bilateral level, mergers
and acquisitions (M&A) data could offer a better, albeit partial, picture for that purpose. This is
so as M&A data are based on actual ownership of the company as opposed to flow of funds. The
M&A data only include direct investment that is foreign in nature and not merely round-tripping
back to India from domestic sources.

However, one has to be careful in comparing M&A versus FDI data. First, not all FDI are M&As
as they could be green field investments as well. Second, M&A transactions do not necessarily
result in international capital flows across borders (for example, swapping of shares). Third,
M&A data refer to the total deal value as at the date of completion though the deal value may be
paid out over a number of years. Fourth, unlike FDI data, M&A data do not include retained
earnings (which is a significant share of global FDI flows)12.

A comparison of the available FDI data to M&A data for India reveals an entirely different
picture. Countries like the US and the UK together make up 50% of M&A acquisitions into
India, and Japan is responsible for another 10%. This triad is effectively responsible for three-
fifths of FDI inflows into India (of the M&A variety at least). This provides us a more useful
geographic breakdown of who is actually doing the investments in India.

A sector analysis of FDI inflows suggests that, on average, between 2000 and 2012, more than
35% of FDI inflows have gone into services, telecom and construction sector, with
pharmaceuticals, chemicals and computer sector each receiving about 5% of the country’s total
FDI inflows over the corresponding period. However, M&A data at the sector level for the same
time span suggests telecom and pharmaceuticals (and healthcare) have attracted over one-third of
the foreign M&A acquisitions in India. Of late, pharmaceuticals has attracted a greater share of
M&As, with the sector taking about 20% of inbound M&A acquisitions between 2010 and
201313

12
www.scribd.com
13
indiainbusiness.nic.in

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 FDI: THEORETICAL SETTINGS

Most of the present day underdeveloped countries of the world have set out a planned
programmed for accelerating the pace of their economic development. In a country planning for
industrialization and aiming to achieve a target rate of growth, there is a need for resources. The
resources can be mobilized through domestic as well as foreign sources. So far as, the domestic
sources are concerned, they may not be sufficient to acquire the fixed rate of growth. Generally
domestic savings are less than the required amount of investment. Also the very process of
industrialization calls for import of capital goods which can not be locally produced. Hence
comes the need for foreign sources14. They not only supplement the domestic savings but also
provide the recipient country with extra foreign exchange to buy imports essential for filling the
saving investment gap and foreign exchange gap. The means of getting foreign resources
available to a developing country are mainly three:
1. Through export of goods and services
2. External aid
3. Foreign investment
Export of goods and services do contribute to foreign resources but they can meet only a small
part of the total demand for foreign resources. External Aid from foreign governments and
international institutions, by increasing the rate of home savings and removing the foreign gap
allows the utilization of previously underutilized resources and capacity. But generally the aid is
tied and distorts the allocation of resources. So its use has been on the decline. Foreign
investment is of following two types.
1. Foreign Direct Investment (FDI) and
2. Portfolio Investment.

FDI can be done in the following ways

1. 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 over15.
3. A new subsidiary with 100% ownership can be established abroad.
14
www.tradingeconomics.com
15
theindiaeconomyreview.org

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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. Minority stock acquisition, if the objective is to participate in the management of the
enterprise.
8. Long term lending, particularly by 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. Portfolio investment occurs when
individual investors invest, mostly through stockbrokers, in stocks of foreign companies in
foreign land in search of profit opportunities.FDI flows are usually preferred over other forms of
external finance because they are non-debt creating, non-volatile and their returns depend on the
performance of the projects financed by the investors. FDI also facilitates international trade and
transfer of knowledge, skills and technology. In a world of increased competition and rapid
technological change, their complimentary and catalytic role can be very valuable.

Resource-seeking and Market-seeking FDI

Two major types of FDI are typically differentiated: resource-seeking FD Iand market-seeking
FDI. Resource-seeking FDI is motivated by the availability of natural resources in the host
countries. This type of FDI was historically important and remains a relevant source of FDI for
various developing countries. However, on a world-wide16 scale, the relative importance of
resource-seeking FDI has decreased significantly. The relative importance of market-seeking
FDI is rather difficult to assess. It is almost impossible to tell whether this type of FDI has
already become less important due to economic globalization. Regarding the history of FDI in
developing countries, various empirical studies have shown that the size and growth of host
country markets were among the most important FDI determinants. It is debatable, however,
whether this is still true with ongoing globalization17.
Globalization essentially means that geographically dispersed manufacturing, slicing up the
value chain and the combination of market sand resources through FDI and trade are becoming
major characteristics of the world economy. Efficiency-seeking FDI, i.e. FDI motivated by
creating new sources of competitiveness for firms and strengthening existing ones, may then
16
www.imf.org/external
17
unctad.org/en

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emerge as the most important type of FDI. Accordingly, the competition for FDI would be based
increasingly on cost differences between locations, the quality of infrastructure and business-
related services, the ease of doing business and the availability of skills. Obviously, this scenario
involves major challenges for developing countries, ranging from human capital formation to the
provision of business-related services such a sufficient communication and distribution systems.

Advantages of Foreign Direct Investment

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Foreign Direct Investment has the following potential benefits for less developed countries.
1. Raising the Level of Investment
Foreign investment can fill the gap between desired investment and locally mobilised savings.
Local capital markets are often not well developed. Thus, they cannot meet the capital
requirements for large investment projects. Besides, access to the hard currency needed to
purchase investment goods not available locally can be difficult. FDI solves both these problems
at once as it is a direct source of external capital. It can fill the gap between desired foreign
exchange requirements and those derived from net export earnings.
2. Up gradation of Technology
Foreign investment brings with it technological knowledge while transferring machinery and
equipment to developing countries. Production units in developing countries use out-dated
equipment and techniques that can reduce the productivity of workers and lead to the production
of goods of a lower standard18.
3. By raising the level of efficiency and the standards of product quality, FDI makes a
positive impact on the host country’s export competitiveness. Further, because of the
international linkages of MNCs19, FDI provides to the host country better access to
foreign markets. Enhanced export possibility contributes to the growth of the host
economies by relaxing demand side constraints on growth. This is important for those
countries which have a small domestic market and must increase exports vigorously to
maintain their tempo of economic growth20.
4. Employment Generation debt flows were subject to large reversals during the same crisis.
Similar observations have been made in Latin America in the 1980s and in Mexico in
1994-95. FDI is considered less prone to crises because direct investors typically have a
longer-term perspective when engaging in a host country. In addition to risk sharing
properties of FDI, it is widely believed that FDI provides a stronger stimulus to economic
growth in the host countries than other types of capital inflows. FDI is more than just
capital, as it offers access to internationally available technologies and management
know-how.

18
spectrum.library
19
data.worldbank.org
20
unctad.org/en

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 5. Benefits to Consumers
Consumers in developing countries stand to gain from FDI through new products, and improved
quality of goods at competitive prices21.
6. Resilience Factor
FDI has proved to be resilient during financial crisis. For instance, in East Asian countries such
investment was remarkably stable during the global financial crisis of 1997-98. In sharp contrast,
other forms of private capital flows like portfolio equity and allowances, disguised public
subsidies and tariff protection provided by the host government.
7. Foreign firms may influence political decisions in developing countries. In view of their
large size and power, national sovereignty and control over economic policies may be
jeopardized. In extreme cases, foreign firms may bribe public officials at the highest
levels to secure undue favours22. Similarly, they may contribute to friendly political
parties and subvert the political process of the host country. Key question, therefore, is
how countries can minimize possible negative effects and maximize positive effects of
FDI through appropriate policies.

MAJOR BENEFITS OF FDI :

(a) Improves for ex position of the country;
(b) Employment generation and increase in production ;
(c) Help in capital formation by bringing fresh capital;
(d) Helps in transfer of new technologies, management skills, intellectual property
(e) Increases competition within the local market and this brings higher efficiencies
(f) Helps in increasing exports;
(g) Increases tax revenues

Why FDI is Opposed by Local People or Disadvantages of FDI :

(a) Domestic companies fear that they may lose their ownership to overseas company

21
finmin.nic.in/reports
22
www.scribd.com

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(b) Small enterprises fear that they may not be able to compete with world class large companies
and may ultimately be edged out of business;
(c) Large giants of the world try to monopolise and take over the highly profitable sectors;
(d) Such foreign companies invest more in machinery and intellectual property than in wages of
the local people;
(e) Government has less control over the functioning of such companies as they usually work
as wholly owned subsidiary of an overseas company23;

FACTORS AFFECTING FDI

23
www.rbi.org.in

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The factors that can narrow the gap between FDI approvals and actual foreign direct investment
inflows and indeed make India a preferred destination for global capital are,
1. Availability of infrastructure in all areas i.e. transports hospitality, telecom, power, etc.
2. Transparency of processes, policies and decision making and reduction of government
decision making lead time.
3. Stability of policies i.e. entry, exit, labour laws, etc. over a definite time horizon so that
definite plans can be made.
4. Acceptance of International Standards including accounting standards.
5. Capital account convertibility so that all capital and payments can flow easily in and out of the
economy.
6. Simplification of the regulatory framework in general and tax laws.
7. Improvement in bandwidth for internet and data communication.
8. Improvement in the enforcement of intellectual property rights.
9. Implementation of the WTO agreement full. All investments foreign and domestic are made
under the expectation of future profits. The economy benefits if economy policy fosters
competition, creates a well functioning modern regulatory system and discourages artificial
monopolies created by the government through entry barriers. A recognition and understanding
of these facts can result in a more positive attitude towards FDI. The future policies should be
designed in the light of the above observations. The most important initiatives that need attention
are: 1.Empowering the State Governments with regard to FDI. 2.Developing fast track clearance
system for legal disputes. 3. Changing the mind set of bureaucracy through HR practices.
4. Developing basic infrastructure. 5. Improving India’s image as an investment destination.
While the magnitudes of inflows have recorded impressive growth, they are still at a small level
compared to India’s potential24.

CONCLUSION

24
articles.economictimes.indiatimes.com

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Lastly it can is concluded that FDI is the participation of one country's resources in another
country's business and which results in benefitting the world as a whole, as it makes the goods
cheaper and for local traders there is now a wider platform which was earlier confined to a
particular state. Through there are several factors involved in the favour of the consumers as they
will be getting more options and the distributers also will be taking care of maintaing the quality
and services of their respective products as they will facing huge competition. FDI had made
possible for the goods to reach people worldwide. There are several factors affecting the FDI
such as transport, policies, better communication etc. which if provided results in the easement
of the FDI. But FDI also faces oppose of certain sections like from the local business as it had
increased the competition resulting in lowering their benefits , but if it is looked the otherway
round then why a consumer should think about the producer or distributer, consumer will
consume the goods best for them as this increases the competition for serving the consumer in
the best possible manner. This project concentrated on defining FDI and its functioning and the
benefitting of the individuals from it.

Bibliography

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1. International Law, Macmillan Publishers India Ltd., Gurdip Singh

2. www.scribd.com

3. www.unhcr.org

4. www.refworld.org

5. www.imf.org

6. www.worldbank.org

7. www.preservearticles.com

8. www.rbi.org

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