AN ECONOMIC ANALYSIS OF FOREIGN DIRECT INVESTMENT IN INDIA

DOCTORAL THESIS BY

SUMANA CHATTERJEE

DEPARTMENT OF ECONOMICS
FACULTY OF ARTS
THE MAHARAJA SAYAJIRAO UNIVERSITY OF BARODA VADODARA, GUJARAT, INDIA

AN ECONOMIC ANALYSIS OF FOREIGN DIRECT INVESTMENT IN INDIA

A THESIS SUBMITTED TO THE MAHARAJA SAYAJIRAO UNIVERSITY OF BARODA FOR THE AWARD OF THE DEGREE OF

DOCTOR OF PHILOSOPHY IN ECONOMICS

BY

SUMANA CHATTERJEE

RESEARCH GUIDE PROFESSOR P.R. JOSHI

DEPARTMENT OF ECONOMICS
FACULTY OF ARTS THE MAHARAJA SAYAJIRAO UNIVERSITY OF BARODA VADODARA, GUJARAT, INDIA

AUGUST 2009

DECLARATION

I hereby declare that this submission is my own work and that, to the best of my knowledge and belief, it contains no material previously published or written by another person nor material which has been accepted for the award of any other degree or diploma of the university or other institute of higher learning, except where due acknowledgment has been made in the text.

Place: Vadodara Date : 27th August 2009

Name Signature

: Sumana Chatterjee :

Registration No : 007487

CERTIFICATE

This is to certify that the thesis entitled An Economic Analysis of Foreign Direct Investment in India, submitted by Ms. Sumana Chatterjee for the award of the degree of Doctor of Philosophy in Economics in the Department of Economics, Faculty of Arts, The Maharaja Sayajirao University of Baroda, Vadodara, Gujarat has been carried out under my guidance.

The matter presented in this thesis incorporates the findings of independent research work carried out by the researcher herself. The matter contained in this thesis has not been submitted elsewhere for the award of any other degree.

Professor P. R. Joshi
Research Guide and Head Department of Economics Faculty of Arts The Maharaja Sayajirao University of Baroda Vadodara, Gujarat

To action alone hast thou a right and never at all to its fruits; Let not the fruits of action be thy motive; Neither let there be in thee any attachment to inaction. - Shri Bhagvatgita (Chapter 2 verse 47)

ACKNOWLEDGMENTS

As I have learned during the past years, writing a dissertation in economics is not only a stimulating but also a very challenging undertaking and I have occasionally asked myself whether I would actually be able to complete this project. Now, when the goal finally has been reached, I would like to take this opportunity to express my gratitude to all the people who helped me make this possible.

First and foremost, I would like to thank my supervisor Prof. P.R. Joshi, who motivated me to start this project and his comments and recommendations have been invaluable for me to successfully finish this dissertation.

I have also benefited significantly from the co-operation and discussions with Prof. A.S. Rao. He has been immensely helpful in providing suggestions for improvements of the empirical work.

I would also like to express my appreciation for all comments and suggestions from my other friends, colleagues and well-wishers at the economics department during the years.

My parents and my son have always supported and encouraged me. I owe them a lot.

Vadodara August 2009

Sumana Chatterjee

LIST OF ABBREVIATIONS

1 2 3 4 5 6 7 8 9

AFTA APEC ASEAN BITs BOP BPO CIS CUFTA DAC

: : : : : : : : : : : : : : : : : : : : : : : :

ASEAN Free Trade Area Asia-Pacific Economic Cooperation Association for South East Asian Nations Bilateral Investment Treaties Balance of Payments Business Process Outsourcing Commonwealth of Independent States Canada United States Free Trade Agreement Development Assistance Committee Department of Industrial Policy and Promotion European Bank for Reconstruction and Development Export Oriented Unit European Union Foreign Direct Investment Gross Domestic Product Gross Fixed Capital Formation International Bank for Reconstruction and Development Inward Foreign Direct Investment International Monetary Fund Indian Oil Corporation Intellectual Property Rights International Organisation for Standardisation Information Technology Mergers and Acquisitions

10 DIPP 11 EBRD 12 EOU 13 EU 14 FDI 15 GDP 16 GFCF 17 IBRD 18 IFDI 19 IMF 20 IOC 21 IPR 22 ISO 23 IT 24 M&As

25 MNC 26 NAFTA 27 NRI 28 ODA 29 OECD 30 OFDI 31 ONGC 32 R&D 33 RBI 34 SIA 35 TNC 36 UK 37 UNCTAD : 38 US 39 WIR 40 WTO

: : : : : : : : : : : :

Multi National Corporation North American Free Trade Agreement Non-Resident Indians Official Development Assistance Organisation for Economic Cooperation and Development Outward Foreign Direct Investment Oil and Natural Gas Corporation Research and Development Reserve Bank of India Secretariat of Industrial Assistance Trans National Corporation United Kingdom United Nations Cooperation for Trade and development

: : :

United States World Investments Report World Trade Organisation

II

LIST OF TABLES

TABLE NO. 3.1

CONTENTS Measures of integration of the Indian economy with the world economy

PAGE NO. 66

3.2 3.3 3.4 3.5

Share of India in Global GDP and its growth Inward FDI stock Inward FDI flows Foreign direct investment inflows in selected Asian

67 69 70 71

developing countries 3.6 3.7 FDI Inflows and GDP figures in India Inward FDI flows as a percentage of Gross Fixed Capital Formation by host region and economy 3.8 3.9 3.10 3.11 Inward FDI Performance Index of Some Selected Countries Inward FDI Potential Index of Some Selected Countries Share of top investing countries FDI inflows Statement on RBIs regional office-wise (with state covered) FDI equity inflows 3.12 3.13 3.14 4.1 Sectoral analysis of FDI inflows Major sectors: change in FDI stocks and output growth FDI characteristics Outward foreign direct investment: world and developing countries 4.2 4.3 FDI outflows originating in developing countries Indian OFDI stock 108 111 Continued 85 86 8889 107 75 76 81 83 73 74

III

TABLE NO. 4.4 4.5 4.6 4.7 FDI outward stock FDI outflows

CONTENTS

PAGE NO. 112 113 114 115

FDI flows as a percentage of GFCF Country wise approved Indian direct investments in joint ventures and wholly-owned subsidiaries

4.8 4.9 4.10 4.11 4.12 4.13 4.14 4.15

Distribution of Indian OFDI stock by host regions Changing ownership structure of Indian OFDI Cross-border Mergers & Acquisitions Indian purchases Overseas M&As by Indian enterprises Sector-wise OFDI of India Cumulative OFDI approvals by Indian enterprises Indias direct investment abroad by sectors Some of the biggest acquisitions by Indian companies

117 119 119 120 122 122 123 125126

IV

LIST OF BOXES

BOX NO. 3.1 3.2 3.3 3.4 4.1 4.2 5.1

CONTENTS Matrix of Inward FDI Performance and Potential 2002 Matrix of Inward FDI Performance and Potential 2005 Various incentive schemes for attracting FDI Liberalisation of FDI policy Characteristics of India OFDI Characteristics of OFDI at different stages of the IDP OLI advantages and MNC channels for serving a foreign market

PAGE NO. 78 79 95 95 110 110 144

5.2 5.3 5.4

Locational determinants of foreign direct investment Determinants of FDI Summarised Correlation matrix of IFDI flows and the determinants of IFDI flows

154 161 167

6.1 6.2 6.3

Push Factors determining OFDI Determinants of OFDI Summarised Correlation matrix of OFDI flows and the determinants of OFDI flows

189 189 197

TABLE OF CONTENTS

Acknowledgements List of Abbreviations List of Tables List of Boxes I III V

CHAPTER 1: Introduction 1.1 Theoretical exposition of FDI 1.2 Relevance of the present study 1.3 Objectives of the present study 1.4 Methodology and Sources of data 1.5 Thesis Outline

1 2 16 18 27 29

CHAPTER 2: Review of Literature 2.1 Studies from the Global perspective 2.2 Studies from the Indian perspective

33 35 47

CHAPTER 3: Trends and Patterns of Inward FDI 3.1 Indian economic integration with the world economy 3.2 Trends and patterns of inward FDI 3.3 Findings and Conclusions

66 68 71 99

CHAPTER 4: Trends And Patterns of Outward FDI 4.1 Explaining the investment development path 4.2 Trends and patterns of outward FDI 4.3 Findings and Conclusions

103 105 110 139

CHAPTER 5: Determinants of Inward FDI 5.1 Theories of FDI: A chronological overview 5.2 Theoretical Framework 5.3 Literature Review 5.4 Hypothesis and Methodology 5.5 Findings and Conclusions

145 145 157 167 170 175

CHAPTER 6: Determinants of Outward FDI 6.1 Theories of outward FDI 6.2 Literature Review 6.3 Hypothesis and Methodology 6.4 Findings and Conclusions

186 186 190 200 204

CHAPTER 7: Summary, Conclusions and Recommendations 7.1 Inward FDI in India 7.2 Outward FDI from India 7.3 Contribution of the Study

218 219 225 234

Bibliography Appendix Tables

i xx

CHAPTER 1 INTRODUCTION

INTRODUCTION

During last twenty to twenty-five years, there has been a tremendous growth in global Foreign Direct Investment (FDI). In 1980 the total stock of FDI equaled only 6.6 percent of world Gross Domestic Product (GDP), while in 2003 the share had increased to close to 23 percent (UNCTAD 2004). This dramatic development has taken place simultaneously with a substantial growth in international trade. The growth in international flows of goods and capital implies that geographically distant parts of the global economy are becoming increasingly interconnected as economic activity is extended across boundaries. FDI is an important factor in the globalisation process as it intensifies the interaction between states, regions and firms. Growing international flows of portfolio and direct investment, international trade, information and migration are all parts of this process. The large increase in the volume of FDI during the past two decades provides a strong incentive for research on this phenomenon.

This dissertation investigates different aspects of FDI at the macro economic level using aggregated data for FDI. The choice of research topics has been made in order to allow for the possibility of finding results that can provide knowledge about the nature of FDI that may help policy makers of both home and host 1 country to take appropriate decisions.

Henceforth, host country refers to a country that receives an inflow of FDI while home country refers to a country that generates an outflow of FDI.

SECTION 1.1

THEORETICAL EXPOSITION OF FDI

Financial flows can be put into four categories:

1. Private Debt Flows: They are comprised of bonds, bank loans and other credits issued or acquired by private sector enterprises in a country without any public guarantee.

2. Official Development Finance: It consists of Official Development Assistance (ODA) and other official flows

i. Official Development Assistance: ODA consists of net disbursements of loans and grants made on concessional terms by official agencies of the members of the Development Assistance Committee (DAC) and certain Arab countries to promote economic development and welfare in recipient economies that are listed as developing by the DAC. Loans with a grant element of more than 25 percent are included in ODA. ODA also includes technical co-operation and assistance. ii. Other Official Flows: These are transactions by the official sector whose main objective is other than development or whose grant element is less than 25 percent such as official export credits, official sector equity and portfolio investment and debt re-organisation undertaken by the official sector on non-concessional terms.

3. Foreign Portfolio Investment: Foreign portfolio investment involves

i. Purchase of existing bonds and stocks with the sole objective of obtaining dividends or capital gains. ii. Investment in new issues of international bonds and debentures by the financial institution or foreign government.

4. Foreign Direct Investment: Direct investment is assumed to have occurred when an investor has acquired 10 percent or more of the voting power of a firm located in a foreign economy. (IMF 2004a) 2

CONCEPTS OF FDI

1. Foreign Direct Investment Entity

There are different ways in which firms and individuals can hold assets in a foreign country. The definition of a foreign direct investment entity decides which of these are considered as direct investment and which firms are considered as multinational enterprises. A foreign direct investment entity has been defined differently for Balance of Payment (BOP) purposes and for the purpose of the study of firm behavior. The definition of foreign direct investment as a capital flow and a capital stock has changed correspondingly.

The dominant current definition of FDI entity prescribed for BOP compilations by the IMF (1993) and endorsed by the OECD avoids the notion of control by

Lipsey (2003) provides a detailed description of how the definition of FDI has changed over time.

the investor. Direct investment is the category of international investment that reflects the objective of a resident entity in one economy obtaining a lasting interest in an enterprise resident in another economy (the resident entity is the direct investor and the enterprise is the 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 by the investor on the management of the enterprise. (IMF 1993)

A direct investment enterprise is defined in the IMF BPM5 (Balance of Payments manual 5) as an incorporated or unincorporated enterprise in which a direct investor, who is a resident in another economy, owns 10 percent or more of the ordinary shares or voting power (for an incorporated enterprise) or the equivalent (for an unincorporated enterprise) (IMF, 1993).

The IMF definition is governing for BOP compilations, but there is a different, but related, concept and a different official definition in the United Nations System of National Accounts, the rule book for compiling national income and product accounts, that retains the idea of control and reflects a more micro view. In these accounts, which measure production, consumption, and investment, rather than the details of capital flows, there is a definition of Foreign Controlled Resident Corporation. Foreign controlled enterprises include subsidiaries more than 50 percent owned by a foreign parent. Associates of which foreign ownership of equity is 10-50 percent . May be included or excluded by individual countries according to their qualitative assessment of foreign control (Inter-Secretariat Working Group on National Accounts, 1993, pp. 340-341). Thus from the view point of the host country and for analyzing production, trade, and employment, control remains the preferred concept.

2. FDI Flows

The definition of FDI flows has changed over time as the definition of FDI enterprises has changed. Direct investment capital flows are made up of equity capital, reinvested earnings, and other capital associated with various inter-company debt transactions. (IMF, 1993) The last category is the most difficult, covering the borrowing and lending of funds including debt securities and suppliers credits between direct investors and subsidiaries, branches and associates. This includes inter-company transactions between affiliated banks (depository institutions) and affiliated financial intermediaries. However, the later are now to be included in direct investment only if they are associated with permanent debt (loan capital representing a permanent interest) and equity (share capital) investment or, in the case of branches, fixed assets. Deposits and other claims and liabilities related to usual banking transactions of depositary institutions and claims and liabilities of other financial intermediaries are classified under portfolio investment or other investment. (IMF, 1993)

DEFINITION OF FDI

There is no specific definition of FDI owing to the presence of many authorities like the OECD, IMF, IBRD, and UNCTAD. All these bodies attempt to illustrate the nature of FDI with certain measuring methodologies. Generally speaking FDI refers to capital flows from abroad that invest in the production capacity of the economy and 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. It is also described as a source of economic development, modernisation and employment generation, whereby the overall benefits triggers technology spillovers, assists human capital formation, contributes to international trade integration and particularly exports, helps to create a more competitive business environment, enhances enterprise development, increases total factor productivity and improves efficiency of resource use.

IMFOECD DEFINITION

FDI statistics are a part of the BOP statistics collected and presented according to the guidelines stated in the IMF BPM5 Manual, fifth edition (1993) and OECD Bench mark definition of FDI (2003).

The IMF definition of FDI is adopted by most of the countries and also by UNCTAD for presenting FDI data.

According to IMF BPM5, paragraph 359, FDI is the category of international investment that reflects the objective of a resident entity in one economy (direct investor or parent enterprise) obtaining a lasting interest and control in an enterprise resident in another economy (direct investment enterprise).

The two criteria incorporated in the notion of lasting interest are:

i. The existence of a long term relationship between the direct investor and the enterprise.

ii. The significant degree of influence that gives the direct investor an effective voice in the management of the enterprise.

The concept of lasting interest is not defined by IMF in terms of a specific time frame, and the more pertinent criterion adopted is that of the degree of ownership in an enterprise. The IMF threshold is 10 percent ownership of the ordinary shares or voting power or the equivalent for unincorporated enterprises. If the criteria are met, then the concept of FDI includes the following organisational bodies:

i. Subsidiaries: (in which the non resident investor owns more than 50 percent) ii. Associates: (in which the non resident investor owns between 10-50 percent) iii. Branches: (unincorporated enterprises, jointly or wholly owned by the nonresident investor)

COMPONENTS OF FDI

The BPM5 and the benchmark recommend that FDI statistics can be compiled as a part of the BOP and international investment position statistics. Consequently countries are expected to collect and disseminate FDI data according to the standard components presented in the BPM5. The concept of FDI includes the capital funds that the direct investor provides to a direct investment enterprise as well as the capital funds received by the direct investment enterprises from the direct investor. It comprises not only the initial transaction establishing the relationship between the investor and the enterprise but also all subsequent transactions between them and among affiliated enterprises, both incorporated and unincorporated (IMF, 1993).

The components of Direct Investment constitute direct investment income, direct investment transactions and direct investment position. FDI flows are the sum of three basic components; viz. equity capital, reinvested earnings and other capital associated with inter-company debt transactions:

i. Equity Capital: It consists of the value of the MNCs investment in shares of an enterprise in a foreign country. It consists of non cash which can be in the form of tangible and intangible components such as technology fee, brand name etc. It comprises equity in branches, all shares in subsidiaries and associates and other capital contributions. ii. Reinvested Earnings: It consists of the sum of the direct investors share (in proportion to the direct equity participation) of earnings not distributed as dividends by subsidiaries or associates and earnings of branches not remitted to the direct investor. iii. Other Direct Investment Capital: They are also known as inter-company debt transactions. They cover the short and long term borrowing and lending of funds including debt securities and suppliers credit-between direct investors and subsidiaries, branches and associates (BPM5). In sum direct investment capital transactions include those operations that create or liquidate investments as well as those that serve to maintain, expand or reduce investments.

The IMF definition thus includes as many as twelve different elements, namely: equity capital, reinvested earnings of foreign companies, inter-company debt transactions including short term and long term loans, overseas commercial borrowing (financial leasing, trade credits, grants, bonds), non cash acquisition of equity, investment made by foreign venture capital investors, earnings data of indirectly held FDI enterprises, control premium, non competition fee and so on.

FDI defined in accordance with IMF guidelines can take the form of Greenfield investment in a new establishment or merger and acquisition of an existing local enterprise known as Brownfield investment.

FDI ACCOUNTING IN INDIA

FDI statistics in India are monitored and published by two official sources: Reserve Bank of India (RBI) and Secretariat of Industrial Assistance (SIA) in the Ministry of Commerce and Industry.

REVISED FDI DEFINITION

In the Indian context till the end of March 1991, FDI was defined to include investment in:

i. Indian companies which were subsidiaries of foreign companies ii. Indian companies in which 40 percent or more of the equity capital was held outside India in one country iii. Indian companies in which 25 percent or more of the equity capital was held by a single investor abroad.

As a part of its efforts to bring about uniformity in the reporting of international transactions by various member countries, the IMF has provided certain guidelines which enable inter-country comparisons. Reflecting this with effect from March 31, 1992 the objective criterion for identifying direct investment has been modified and is fixed at 10 percent ownership of ordinary share capital or voting rights. Direct

investment also includes preference shares, debentures and deposits, if any, of those individual investors who hold 10 percent or more of equity capital. In addition to this, direct investment also includes net foreign liabilities of the branches of the foreign companies operating in India.

A committee was constituted by the Department of Industrial Policy and Promotion (DIPP) in May 2002 to bring the reporting system of FDI data in India into alignment with international best practices. Accordingly, the RBI has recently revised data on FDI flows from the year 2001 onwards by adopting a new definition of FDI. The revised definition includes three categories of capital flows under FDI; equity capital, reinvested earnings and other direct capital. Previously the data on FDI reported in the BOP statistics used only equity capital.

TYPES OF FDI

i. Inward Foreign Direct Investment: This refers to long term capital inflows into a country other than aid, portfolio investment or a repayable debt. It is done by an entity outside the host country in the home country. ii. Outward Foreign Direct Investment: This refers to a long term capital outflow from a country other than aid, portfolio investment or a repayable debt. It is done by an entity outside the host country in the home country. iii. Horizontal Foreign Direct Investment: This refers to a multi-plant firm producing the same line of goods from plants located in different countries iv. Vertical Foreign Direct Investment: If the production process is divided into upstream (parts and components) and downstream (assembly) stages, and only the latter stage is transferred abroad, then the newly established assembly plants demand for parts and components can be met by exports

10

from home-country suppliers. This is what Lipsey and Weiss (1981, 1984) and other researchers describe as Vertical FDI, whose aim is to exploit scale economies at different stages of production arising from vertically integrated production relationships. v. Greenfield Foreign Direct Investment: Greenfield FDI is a form of investment where the MNC constructs new facilities in the host country. vi. Brownfield Foreign Direct Investment: Brownfield FDI implies that the MNC or an affiliate of the MNC merges with or acquires an already existing firm in the host country resulting in a new MNC affiliate.

MULTINATIONAL CORPORATIONS

Multinational Corporations (MNC) or Transnational Corporations (TNCs) are the most important carriers of FDI. According to the World Investment Directory, MNCs are incorporated or unincorporated enterprises comprising parent enterprises and their foreign affiliates. A parent enterprise is defined as an enterprise that controls assets of other entities in countries other than its home country, usually by owning a certain equity capital stake.

An equity capital stake of 10 percent or more of the ordinary shares or voting power for an incorporated enterprise or its equivalent for an unincorporated enterprise is normally considered as a threshold for the control of assets.

A foreign affiliate is an incorporated or unincorporated enterprise in which an investor who is a resident in another economy owns a stake that permits a lasting interest in the management of that enterprise.

11

An MNC can be defined as an entity which has one or more of the following criterion:

i. Sole proprietorship held abroad ii. Foreign branches of the company iii. Subsidiaries of the company iv. Associates

TYPES OF MNCs

i. National Firms: This refers to single plant firms with headquarters and plant in the same country. ii. Horizontal Multinationals: This refers to two plant multinationals which engage in producing the same line of goods across plants in different countries. iii. Vertical Multinationals: This refers to two plant multinationals which engage in dividing the production process in parts and components across different plants across the nations to take advantage of the scale economies arising from vertically integrated production relationships.

COMPILATION OF FDI DATA

Generally, there are two main alternatives for compiling FDI data:

i. To use Balance Of Payments statistics or ii. To perform firm surveys

The Balance of Payments data measures FDI as the financial stake of a parent in a foreign affiliate. The advantage of Balance of Payments data is that they can be

12

collected relatively easy for virtually all existing countries. Unlike Balance of Payments data, firm surveys focus on the actual operations of MNCs.

FDI data is reported as a stock or a flow value. As described in IMF (2004a), flows of FDI consist of equity capital, reinvested earnings and what is usually referred to as other capital. Data on FDI flows are on a net basis i.e. (capital transactions credits less debits between direct investors and their foreign affiliates). Net decreases in assets (outward FDI) or net increases in liabilities (inward FDI) are recorded as credits (recorded with a positive sign in the balance of payments), while net increases in assets or net decreases in liabilities are recorded as debits (recorded with a negative sign in the balance of payments). The negative signs are reversed for practical purposes in the case of FDI outflows. Hence, FDI flows with a negative sign indicate that at least one of the three components of FDI (equity capital, reinvested earnings or intra-company loans) is negative and is not offset by positive amounts of the other components. These are instances of reverse investment or disinvestment. Stocks of FDI are similarly composed of equity capital, reinvested earnings and other capital. However, data on FDI stocks is presented at book value or historical cost, reflecting prices at the time when the investment was made

Inflows of FDI and the inward stock of FDI is a result of investment performed in the host country by foreign MNCs. Correspondingly, outflows of FDI and the outward stock of FDI represents investment in foreign countries performed by MNCs based in the source country.

FDI data is collected and reported by several international organisations:

i. IMF compiles and reports FDI data for the majority of the countries in the world. The data is based on balance of payments statistics and according to

13

IMF (2004a) compiled from international transactions reporting systems and data from exchange control or investment control authorities. ii. UNCTAD prepares the annual publication of the World Investment Report. The report presents data for both flows and stocks of FDI as well as additional data such as the share of FDI in GDP. The report presents data for most countries. UNCTAD primarily tries to collect data directly from national official sources such as the central banks and statistical offices of individual economies. If this is not possible, data is complemented or obtained from the IMF or the OECD. iii. OECD reports FDI data for its member countries. The data is primarily based on Balance of Payments statistics as reported from the central banks and is presented in the International Direct Investment Statistics Yearbook. Data for bilateral flows of FDI is reported and there is some data for the distribution of FDI among industrial sectors in the OECD economies. iv. The World Bank includes FDI data among the so-called World Development Indicators. The data is primarily based on Balance of Payments data from the IMF and cover most countries. v. There are also a number of regional organisations such as ASEAN and EBRD reporting data for particular geographical regions. The EBRD presents FDI data for the European transition economies in the annual publication Transition Report (e.g. EBRD 2004). The FDI data is compiled on the basis of data from the IMF, data from central banks and EBRDs own estimates and survey.

LIKELY BENEFITS OF FDI

i. FDI is less volatile than other private flows and provides a stable source of financing to meet capital needs.

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ii. FDI is an important and probably dominant channel of international transfer of technology. MNCs, the main drivers of FDI are powerful and effective vehicles for disseminating technology from developed to developing countries and are often the only source of new and innovative technology which is not available in the arms length market. iii. The technology disseminated through FDI generally comes as a package including the capital, skills and managerial knowhow needed to appropriate technology properly.

LIKELY COSTS OF FDI

Recent years have seen increased public concern that the benefits of FDI have yet to be demonstrated and that, where benefits exist, they may not be shared equitably in the society. The adjustment costs associated with FDI include:

i. Higher short term unemployment due to corporate restructuring ii. Increased market concentration iii. Incomplete utilisation of FDI benefits due to incoherent institutional policies and regulatory conditions, unavailability of skilled labor and infrastructure.

The debate on the likely costs and benefits has reached new heights. Under these circumstances it is important to inform the discussion by drawing lessons from the country experience and to assist the Government in identifying the conditions and policy requirements for maximising the benefits of FDI and minimising the risks and potential costs.

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SECTION 1.2

RELEVANCE OF THE PRESENT STUDY

It is widely known that capital flows into developing economies like India have risen sharply in nineties and has, therefore, become a self propelling and dynamic actor in the accelerated growth of the economies. This study focuses on FDI as a vector of Indian globalisation. Recently not only did India become a more frequent destination for FDI, but also many Indian firms have started investing abroad in a big way. Thus we find a surge in both inward and outward FDI flows. The impassioned advocacy of increased FDI flows (inward and outward) is based on the well worn arguments that FDI is a rich source of technology and knowhow; it can invigorate the labour oriented export industries of India, promote technological change in the industries and put India on a higher growth path. This exuberance of FDI needs to be based on analytical review of Indias needs and requirements and her potential to participate in huge investment flows. Thus there is a definite need to incorporate the various dimensions of FDI into a theory of open economy development so as to explain in one integrated theoretical paradigm, the undercurrents of both inward and outward FDI flows.

The empirical literature on the relationship between FDI and development is mixed. Despite a number of studies and seeming contradictions, two consistent issues that repeatedly arise are:

i. What are the motivations / reasons for FDI flows? ii. What are the economic implications of FDI flows?

16

Hence a detailed analysis of FDI into India requires an examination of the determinants and impact of FDI in the Indian economy. Studying both inward and outward FDI flows together will help to assess the nature and the true extent to which the Indian economy has globalised.

This study takes a closer look at the structure of Foreign Direct Investments into and from India. It traces the development of Indias economic policy regarding FDI and the resulting changes in both inflows and outflows. The expansion of FDI into and from India has been accompanied by a rapid economic growth and an increasing openness to the rest of the world. It is equally important to understand why India has become one of the important beneficiaries of FDI in the world and what drives the more recent progress of Indias outward FDI.

17

SECTION 1.3

OBJECTIVES OF THE STUDY

In order to appreciate the importance of FDI flows for the Indian economy, it would be pertinent to examine the changes in the global FDI flows and the place of India within. In this respect the following issues shall be studied with respect to inward flows to and outward flows from India:

The nature and extent of Indian economys integration with the world economy

The nature of the regional distribution of FDI flows from the global FDI flows The comparative standing of FDI among developing countries The pattern of originating and destination countries of Indian FDI flows The nature of change in the sectoral composition of FDI in India The regional distribution of inward FDI in India The structure of cross border mergers and acquisitions from India The FDI flows as a percentage of GDP and GFCF FDI performance v/s potential in India Major policy initiatives taken to boost FDI flows

Why do firms go abroad? Why do they choose to invest in a specific location? These are some of the questions that have plagued scholars since the advent of interest in FDI. The origins of the theoretical literature on the determinants of FDI are to be found in Stephen Hymers (1960) doctoral dissertation. His thesis, briefly put, is that firms go abroad to exploit the rents inherent in the monopoly over advantages they possess and FDI is their mode of operations. The advantages firms possess include

18

patented technology, team specific managerial skills, marketing skills, and brand names. All other methods of exploiting these advantages in external markets, such as licensing agreements and exports are inferior to FDI because the market for knowledge or advantages possessed by firms tends to be imperfect. In other words they do not permit firms to exercise control over operations essential for retaining and fully exploiting the advantages they own. Hymers insights form the basis of other explanations such as transactions costs and internationalisation theories, most of which in essence , argue that firms internalise operations, forge backward and forward linkages in order to bypass the market with all its operations.

John Dunning (1977, 1981) neatly synthesises these and other explanations in his well known eclectic paradigm or the OLI explanation of FDI. For a firm to successfully invest abroad, it must possess advantages which no other firm possess (Ownership), the country it wishes to invest should offer locational advantages (Location), and it must be capable of internalising operations (Internalisation) i.e. the OLI theory. Internalisation is synonymous with the ability of the firms to exercise control over such operations. And such control is essential for the exploitation of the advantages which the firm possesses and the location advantage which the host country offers. It is the location advantages emphasised by Dunning which forms much of the discussion on the determinants of FDI in developing countries. The two other attributes necessary for FDI are taken as given from the perspective of the developing countries. Dunning set the ball rolling on econometric studies with a statistical analysis of survey evidence on the determinants of FDI. His study identified three main determinants of FDI in a particular location: market forces (including market size and growth as determined by the national income of the recipient country), cost factors (such as labour cost and availability and the domestic inflation situation) and the investment climate (as determined by such considerations as the extent of foreign indebtedness and the state of BOP).

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Foreign investors are attracted to economically dynamic countries. They look for factors like high and growing per capita incomes, large domestic markets, well educated work force, well developed physical and technological infrastructure, proximity to export markets, social and political stability and the presence of other foreign investors called as agglomeration effect. What is crucial in attracting FDI is the countrys absorptive capacity or those factors that promote domestic economic growth through investment, infrastructure and human capital development. Accordingly it can be said that, growth and development leads to FDI rather than FDI leading to growth and development. Labour costs might be a more significant determinant of inward FDI in developing countries when these inflows reflect an intention to minimise production costs. This type of FDI is commonly referred as efficiency seeking and market seeking FDI. Resource seeking investors come into countries in order to exploit natural resources and factors like physical infrastructure and the pool of labour jointly determine the profitability of such investments. Market seeking investors make investments in order to sell their products in the host countrys domestic markets so they are more concerned with factors like domestic market size and per capita income.

Although the empirical literature continues to grow unabated, its overall message can be summarised in the following propositions, some of which shall be put to an examination in this study:

i. Host countries with a sizeable domestic market, measured by GDP per capita and sustained growth of these markets measured by growth rates of GDP, attract relatively large volumes of FDI.

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ii. Resource endowments of a host country including natural and human resources are a factor of importance in the investment decision process of the foreign firms. iii. Infrastructure facilities including transportation and communication are important determinants of FDI. An unexplored issue has been the role of information decisions. FDI requires substantial fixed costs of identifying an efficient location, acquiring knowledge of the local regulatory environment and coordination for supplies. Thus access to better information may make FDI to that location more likely. iv. Macro economic stability signified by stable exchange rates and low rates of inflation is a significant factor in attracting foreign investors. v. Political stability in the host countries is an important factor in the investment decision process of foreign firms. vi. A stable and transparent policy framework towards FDI is an attractive factor to potential investors. vii. Foreign firms place a premium on a distortion free economic and business environment. An allied proposition here is that a distortion free foreign trade regime which is neutral in terms of the incentives it provides for Import Substitution (IS) and Export Promoting (EP) industries attracts relatively large volumes of FDI than either an IS or EP regime. viii. Fiscal and monetary incentives in the form of tax concessions do play a role in attracting FDI. MNCs are potentially subject to taxation in both the host and home countries. It is found that the way in which parent country reduces double taxation on their MNCs can have implications for FDI. ix. Trade protection is also found to encourage FDI. It is found that FDI response to these trade actions (tariff jumping FDI) occurs only for firms with previous experience as MNCs.

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x. Wages are an important factor determining inward FDI. It is possible that lower wages are associated with higher levels of inward FDI. However, where there is a control for productivity, there could be a positive association found between FDI and the types of labour standards that may raise wages but that ultimately contributes to workers productivity. It is found that FDI is positively correlated to the right to establish unions, to strike, to collective bargaining and to the protection of the union members.

The aim of this study is to investigate the determinants of FDI in India from the perspective of country characteristics, identifying the most significant factors in India that influence foreign investors decision to invest in the country. Several location advantages as determinants of FDI in India, drawn from previous studies, will be tested.

Traditionally rich developed economies started FDI into other developed / developing economies to maximise the economic rent earned on capital. The developing and underdeveloped economies were viciously gripped by low levels of productivity leading to a low wage level and hence low level of savings and investment. Low levels of investment again perpetuate low levels of productivity. This inward spiral needs an external stimulus in the form of FDI. This could raise efficiency and expand output leading to economic growth in the country. The inward spiral then could turn outward signaling growth and prosperity. The direction of FDI by countries Inward Direct Investment (IDI) and Outward Direct Investment (ODI) was developed by John Dunning in a theory named Investment Development Path or IDP. He said that outward and inward direct investment position of a country is systematically related to its economic development relative to the rest of the world. The IDP suggests that countries tend to go through five main stages of development and these stages can

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be classified according to the propensity of those countries to be outward or inward direct investors. In sequence these stages are:

i. Non-existence of both inward and outward FDI ii. Emergence and expansion of inward FDI and bare existence of outward FDI iii. Expansion of outward FDI and slowing growth of inward FDI iv. Outward FDI stock exceeding inward FDI stock v. Net outward FDI stock (Gross outward FDI stock Gross of FDI stock) fluctuating to zero level

This suggests that a countrys outward FDI will not be large until the inward FDI increases. As indicated by the IDP path, India has already started its move as an outward investor and is in the second stage of the IDP.

Initiating from nineties, Indias successful industrialisation contributed to the growth of its FDI abroad. This increase in outward FDI (OFDI) suggests that the country is moving rapidly towards becoming a developed and mature economy.

As regards the outward foreign direct investment from India, the hypothesis examined is as follows:

Outward FDI from India has undergone a fundamental shift, which can be successfully explained as stage two, within the framework of the Investment Development Path

There are several factors that explain the emergence of India as a heavy OFDI investor. First the surge of OFDI has coincided with that of all FDI. Since the mid 1980s, worldwide flows of FDI have grown at unprecedented rates. Indian MNCs

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were influenced by this trend and began to participate actively by organising their own corporate network around the world. Rapid economic growth in the Asia-Pacific region has been the second factor contributing to Indian international investment. Many countries in the Asia-Pacific region adopted policies towards international trade and investment which helped to accelerate domestic economic growth. Third, Indias emergence as an outward investor was the direct result of the countrys rapid industrialisation strategy and outward looking policies. Finally shifts in Indias comparative advantage have played an important role in increasing the countrys foreign presence.

Following are the push factors explaining OFDI, some of which shall be put to examination in this study:

i. Economic Growth: The most important factors that may affect the FDI flows, as recognised in the literature, are the domestic market-related variables. Both current market size and potential market size can have a significant influence on outward FDI. Small market size and potential risk of losing market share may act as push factors for outward FDI. One of the main factors contributing to the outward FDI can be linked to the income of a country. Increase in the income of a country eventually will lead to structural changes to the economy of the country. The mounting of income enables firms to gain competitive advantage by enlarging the production scale as well as adoption of new technology. Ultimately, firms are able to acquire ownership advantages which become the driving force for establishing foreign production ii. Exports: Increased exports may assure the producers of existing markets and therefore lower the uncertainties and risks attached to investments, thereby encouraging outward FDI. This effect is stronger if exports are targeted towards a region with trade and investment agreements, which ensures access

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to larger integrated markets and the possibility of cross-border vertical integration and smooth operations of affiliates. Such outward FDI are undertaken mainly with the motive of expansion. iii. Imports: Increased imports into the country may have a displacement effect on investments, which may then be channeled outward into economies with lower manufacturing costs and greater access to larger markets. Such investments are undertaken mainly with the motive of relocation. iv. Inflow of FDI: Inward FDI flows may be a potential factor that may influence the capability of domestic investors to undertake outward FDI. FDI is expected to improve the technological standards, efficiency and competitiveness of domestic industry. FDI is also associated with bringing in "relatively" more upto-date technology into the industry since markets for technology are imperfect. The higher the inflow of FDI, the higher will be the capability of domestic investors to undertake investments abroad. Though existing FDI stock as a determinant of inward FDI flows has been used in many studies, none of the studies have as yet estimated the impact of inward FDI on outward FDI. v. Infrastructural Availability: It is expected that the lower the availability of infrastructure, higher will be the infrastructure costs and higher will be the outward FDI. vi. Cost Factors: Other domestic drivers of outward FDI are those that cause investment cost differentials across countries. These include costs of labour, capital and infrastructure. Cost factors may significantly influence the choice of an investment location for the resource-seeking and efficiency-seeking FDI. It is expected that higher real wages and efficiency wages in the home country increases outward FDI. vii. Regional Trade Agreements: With regard to the regional trade agreements, it is found that an increasing number of trade agreements of the home country will likely shift the production units into the site with the lower costs of production

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since access to home as well as host-country markets becomes available. Further, many regional trade agreements not only improve market access but also improve the investment environment to make it more conducive to a free flow of FDI. viii. Tax Policies: Domestic policies with respect to taxes can also influence the cost of investments across economies. The higher the tax, the higher will be outward FDI. ix. Domestic Labour Environment: A favourable labour environment, which is influenced by flexible labour laws, also influences the decisions to invest. The more rigid the labour laws, the higher will be the incentive to invest abroad. x. Exchange Rates: Exchange rate is an influential factor in affecting the outward FDI. Appreciation of the currencies enables firms from those countries to gain benefits in financial terms to support their abroad investment relative to countries with weaker currencies.

The literature on outward FDI from the developing economies is limited. Although studies have examined the trends in outward FDI from the developing countries and analyzed the drivers, few studies have empirically estimated the impact of these drivers on outward FDI, especially from the developing countries.

The purpose of this study is to empirically investigate the dynamic relationship between changes in macro economic factors and changes in FDI made by the Indian firms. The impact of inward FDI coming to India on the outward FDI from India is also examined. The study focuses on the period from 1980-2005. 1980 is chosen as the starting point as OFDI began in a small way from that period onwards.

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SECTION 1.4

METHODOLOGY AND SOURCES OF DATA

The data used in this study is aggregate annual time series at current prices, covering the period 1980-2005. A process of gradual relaxation of controls and regulations with a view to attract large inflows of foreign investments was discernable from the year 1981. In a limited and phased manner market forces were allowed to govern the foreign investment flows during this period. Hence this period was selected. The inward and outward FDI data have been considered as flow measures rather than stocks because inward and outward FDI behavior is more

comprehensively measured for flows than for stocks.

This study builds on existing research studies and methodologies, to test the determinants of inward and outward investment from India. Relevant studies, done so far, have been both qualitative and quantitative in nature. The qualitative methods used include surveys and questionnaires and oral interviews. However, there are a number of challenges and issues that crop up when qualitative methods are used specially in econometric studies. These include subjectivity and bias of responses and the inability to incorporate such biases in the econometric studies. As such this study uses the method of Multiple Linear Regression model. In order to estimate the regression model, a statistical software, Statistical Package for Social Sciences (SPSS), has been used.

The data was extracted from the following sources:

i. Hand Book of Statistics on the Indian economy, RBI, various issues

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ii. UNCTAD, WIR series, various issues iii. Economic Survey, Government of India, various issues iv. World Development Indicators, World Bank

The following two hypotheses are studied using this methodology.

i. Pull (Locational) factors determine the flow of Inward Foreign Direct Investment to India. ii. The Push factors determine the flow of Outward Foreign Direct Investment from India.

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SECTION 1.5

THESIS OUTLINE

Chapter 1: Introduction

The areas covered in this chapter are as follows:

Theoretical exposition of Foreign Direct Investment Definition and concepts of FDI Relevance of the present study Objectives of the present study Methodology and sources of data

Chapter 2: Review of Literature

This chapter comprises a review of the major works done in the area of Foreign Direct Investment in India and internationally.

Chapter 3: Inward Foreign Direct Investment in India: Trends And Patterns

The issues that have been studied in this chapter are:

The nature and extent of Indian economys integration with the world economy.

The nature of the regional distribution of FDI flows from the global FDI flows. The comparative standing of FDI among developing countries.

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The pattern of originating countries of Indian FDI flows. The nature of change in the sectoral composition of FDI in India. The regional distribution of inward FDI in India. The structure of cross border mergers and acquisitions from India. The FDI flows as a percentage of GDP and GFCF. FDI performance v/s potential in India. Major policy initiatives taken to boost FDI flows.

Chapter 4: Outward Foreign Direct Investment in India: Trends And Patterns

The issues that have been studied in this chapter are:

The comparative standing of India among developing countries The pattern of destination countries of Indian FDI flows The nature of change in the sectoral composition of FDI flows from India The structure of cross border mergers and acquisitions from India The FDI flows as a percentage of GDP and GFCF FDI performance v/s potential in India Major policy initiatives taken to boost FDI out flows

Two major questions are addressed here:

Whether the OFDI from India has undergone a fundamental shift that might be considered as a distinct second wave of OFDI, which differs substantially from the first wave?

Whether this new wave can be successfully explained within the framework of the IDP (Investment Development Path)?

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As regards the outward foreign direct investment from India, the hypothesis examined is as follows:

Outward FDI from India has undergone a fundamental shift, which can be successfully explained as stage two, within the framework of the Investment Development Path

Chapter 5: Determinants of Inward FDI to India

The issues studied in this chapter are as follows:

Theories of inward FDI Literature review and theoretical framework Empirical determination of the Locational determinants (Pull factors) of FDI to India

Chapter 6: Determinants of Outward FDI from India

The issues studied in this chapter are as follows:

Theories of outward FDI Literature review and theoretical framework Empirical determination of the Push factors of FDI from India

Chapter 7: Summary, Conclusions and Recommendations

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REFERENCES

1.

Dunning, J.H. (1977). Trade, location of economic activity and the MNE: a search for an eclectic approach in The International Allocation of Economic Activity ed. by Ohlin, B. and P.O. Hesselborn: 395-418, London, Macmillan.

2.

Dunning, J.H. (1981). Explaining the International Direct Investment Position of Countries: Towards a Dynamic or Developmental Approach,

Weltwirtschaftliches Archiv 117: 30-64. 3. Hymer, S.H. (1960). The International Operations of National Firms, PhD thesis, MIT (published by the MIT Press 1976). 4. IMF, (2004a). Foreign Direct Investments, Trends, Data Availability, Concepts, and Recording Practices, IMF, February 9, Online. 5. IMF (2004b). Direction of Trade Statistics Yearbook, Washington, International Monetary Fund. 6. IMF and OECD (2003). Foreign Direct Investment Statistics: How Countries Measure FDI, Washington, International Monetary Fund. 7. IMF, (1993). Balance of Payments Manual, 5th edition, International Monetary Fund, Washington, International Monetary Fund. 8. Lipsey, R.E. and M.Y. Weiss (1981). Foreign Production and Exports in Manufacturing Industries, Review of Economics and Statistics 63(4): 488-494. 9. Lipsey, R.E. and M.Y. Weiss (1984). Foreign production and exports of individual firms, The Review of Economics and Statistics 66: 304-308. 10. Reserve Bank of India, (RBI), www.rbi.org.in 11. Secretariat of Industrial Assistance, Department of Industrial Policy and Promotion, Ministry of Industry, Government of India. www.dipp.nic.in 12. WIR (2004). The Shift Towards Services, World Investment Report, UNCTAD, United Nations, Geneva.

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CHAPTER 2 REVIEW OF LITERATURE

A lot of research has already been done across the globe analyzing the various aspects of FDI. These studies can be broadly classified into two categories:

MACRO VIEW

The studies done in this group focus on FDI as a particular form of capital across national borders from home to the host countries as measured in the BOP. The variables of interest in these studies are the flows of financial capital, the value of stock capital that is accumulated by the investing firms and the flows of incomes from these investments.

MICRO VIEW

Studies under this group try to explain the motivation for investment in controlled foreign operations from the view point of the investor. The emphasis here is on examining the consequences of the operations of the MNCs to the home and the host countries. These consequences arise from their trade employment, production, and their flows of stocks of intellectual capital unmeasured by the capital flows and the stocks in the BOP.

Most of the currently held perceptions of foreign investments role take a macro view. Such a positive view gained currency mainly after the Latin American crisis in the early eighties and the South-East Asian crisis in the late nineties and accordingly the structural importance of FDI has been restored back in comparison to foreign financial flows. The crux of the policy, therefore, is how the benefits of such investments are distributed over the foreign firms and the host country. However, in a

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micro perspective, a different question is asked what does FDI do to the working of the domestic markets and their effect on productivity and output.

In the development literature, well reflected in the International as well as the Indian discourse, there has been a lot of debate generated along various aspects of FDI. Some of the major works are reviewed here. For simplification purpose the studies have been divided in two categories.

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SECTION 2.1

STUDIES FROM THE GLOBAL PERSPECTIVE

Mihir Desai, Foley and Antras (2007) in their study try to provide an integrated explanation for MNC activity and the means by which it is financed. They are of the view that the ways in which the firms try to obtain external finance can create many frictions for the firm, which leads, further to multinational activity. However, the desire to exploit technology is not affected by the financing decisions. They try to relate the level of financial development of an economy to MNC activity and they find that the propensity to do FDI, the share of affiliate assets financed by the parent firm and the share of affiliate equity owned by the parent are higher in countries with weak financial developments, but the scale of MNC activity is lower in such settings. They conclude that in India MNC activity is likely to be limited by concerns over managerial opportunism and weak investor protection and the ability of the Indian MNCs to employ their internal capital markets opportunistically will help dictate their overseas and domestic success.

Foley et. al. (2005) in their study try to evaluate the evidence of the impact of outbound FDI on the domestic investment rates. They find that OECD countries with high rates of outbound FDI in the eighties and nineties exhibited lower domestic investment than other countries, which suggests that FDI and domestic investment are substitutes for each other. However, in the US, in the years in which US MNCs had greater foreign capital expenditures, coincided with greater domestic capital spending by the same firms, implying that foreign and domestic capital are complements in production by the MNCs. This effect is consistent with cross sectional evidence that firms whose foreign operations expand simultaneously

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expand their domestic operations and suggest that interpretation of the OECD crosssectional evidence may be confounded by omitted variables.

In another study James Markusen (2003) and others have tried to explain the phenomenon of export platform (a situation where the affiliates output is largely sold in the third markets rather than in the parent or the host markets). They find that pure export platform production arises when a firm in each of the high cost economies has a plant at home and a plant in the low cost country to serve the high cost country. Another case of export platform arises when there is trade liberalization between one of the high cost countries and small low cost countries. The outside high cost country may wish to build a branch plant inside the free trade area due to the market size but chooses the low cost country on the basis of the cost.

Lee Bransteeter et. al. (2007) in their study try to theoretically and empirically analyse the effect of strengthening IPRs on the level and composition of industrial development in the developing countries. They develop a North-South product cycle model in which northern innovation, southern imitation and FDI are all endogenous variables. The model predicts that IPR reform in the south leads to increased FDI from the north as the northern firms shift production to the southern affiliates. This FDI accelerates southern industrial development. Also as the production shifts to the South, the northern resources will be reallocated to R&D, driving an increase in the global rate of innovation. Testing the models predictions the study finds that MNCs expand the scale of activities in reforming countries after the IPR reforms.

In a different study Mihir Desai et. al. (2005) focus on the impact of rising foreign investment on domestic activity. It is observed that firms whose foreign operations grow rapidly exhibit coincident rapid growth of domestic operations but this pattern is inconclusive as foreign and domestic business activities are jointly determined. Their

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study uses foreign GDP growth rates interacted with lagged firm specific geographic distributions of foreign investments to predict changes in foreign investment by a large number of American firms. Estimates indicate that 10 percent greater foreign capital invested is associated with 2.2 percent greater domestic investment and 10 percent greater foreign employee compensation is associated with 4 percent greater domestic employee compensation. They find that the changes in foreign and domestic sales, assets, and no. of employees are positively associated and also greater foreign investment is associated with additional domestic exports and R&D spending.

Jonathan Haskel (2004) and others in their study try to find out whether there are any productivity spillovers from FDI to the domestic firms and if so how much should the host countries be willing to pay to attract FDI to their countries. Using plant level panel covering U.K. manufacturing from 1973 through 1992 they estimate a positive correlation between domestic plants TFP (Total Factor Productivity) and the foreign affiliates share of activity in that plants industry. Typical estimates suggest that a 10 percent point increase in foreign presence in the U.K. industry raises the TFP of that industrys domestic plants by about 0.5 percent. These estimates are used to calculate the job value of these spillovers. These calculated values appear to be less than per job incentives that the Government has granted in some cases.

In an interesting study Volcker Nocke and Stephen Yeaple (2004) develop an assignment theory to analyse the volume and composition of FDI. Firms conduct FDI by either engaging in Greenfield investment or in cross border acquisitions. They find that in equilibrium, Greenfield FDI and cross-border acquisitions coexist, but the composition of FDI between these modes varies with firm and country characteristics. They observe that firms engaging in Greenfield investment are systematically more efficient than those engaging in cross border acquisitions. They

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find that most FDI takes the form of cross border when factor price differences between countries are small, while Greenfield investment plays a more important role for FDI from high wage to low wage countries.

In an edited volume Dilip Das (2001) studies the world of private capital flows and concludes that FDI has positively contributed to growth and development, especially in the case of China. Analyzing the flows of FDI and its composition world wide, he posits that earlier the flows were composed largely of commercial bank debt flowing to the public sector where as the recent years have witnessed an increase in the level of private sector portfolio and direct flows. One reflection of the importance of the investment climate is that the levels, location, motive for FDI into transition economies are strongly associated with the progress in transition.

Magnus Blomstrom and Ari Kokko (2005) suggest that the use of investment incentives to attract more FDI is generally not an efficient way to raise national welfare. The strongest theoretical motives for financial subsidies to attract investment are spillovers of foreign technology and skills to local industry and the authors argue that these benefits may not be an automatic consequence of foreign investment. The potential spill over benefits is realized only if the local firms have the ability and motivation to invest in absorbing foreign technology and skills. To motivate subsidization of foreign investment, it is, therefore, necessary at the same time to support learning and investment in local firms as well.

In his study on human capital formation and FDI in developing countries, Koji Iyamoto (2003) takes a view of the complex linkages between the activities of the MNCs and the policies of host developing countries. The literature indicates that a high level of human capital is one of the key ingredients for attracting FDI as well as for the host countries to get maximum benefits from these activities. He finds that one

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way to improve human capital formation and attract more FDI is to provide a strong incentive for MNCs and Investment Promotion agencies to participate in formal education and vocational training for workers employed with domestic firms .In addition FDI promotion activities can target high value added MNCs that are more likely to bring new skills and knowledge to the economy that can be tapped by the domestic enterprises.

Analyzing foreign investment trends, Vincent Palmade and Andre Anayiotas (2004) find no reason to be skeptical about the fall in FDI since 1999 and the growing share of China in FDI, which worries most of the developing countries. They say that the decline is largely a one time adjustment following the investment boom of the nineties. They assure that FDI is now more varied as it is coming from more countries and going to more sectors. The conditions for attracting FDI varies by sectors: in labour intensive manufacturing, efficient customers and flexible labour markets are the key while in the retail sector, access to land and equal enforcement of the tax rules matter the most. In the interests of the domestic investors and also to attract more investment they advise to sort out the various micro issues by different sectors.

Studying the trends of FDI in the OECD countries, Hans Christiansen and Ayse Bertrand (2004) conclude that though the FDI in the OECD countries continued to fall in 2003, because of sluggish macro economic performance which depresses outward and inward FDI, it does not imply that FDI activity is low by any longer term historic standard. The reasons they give for low FDI activity is that companies operating in the economies with poor macro economic performances are less attractive to the outside investors and scale back their outward investment also. Another reason is that several sectors that saw rampant cross-border investment in the late 1990s and 2000 have entered into a phase of consolidation during which enterprises tend to be

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disinclined to embark on new purchases while still in the process of integrating foreign acquisitions of recent years in their corporate strategies.

Nagesh Kumar (2001) analyses the role of infrastructure availability in determining the attractiveness of countries for FDI inflows for export orientation of MNC production. He posits that the investment by the governments in providing efficient physical infrastructure facilities improve the investment climate for FDI. He first constructs a single composite index of infrastructure availability of transport, telecommunication, and information and energy for 66 countries over 1982-94 periods using principal component analysis. The role of infrastructure index in explaining the attractiveness of foreign production by MNCs is evaluated in the framework of an extended model of foreign production. The estimates corroborate the fact that infrastructure availability does contribute to the relative attractiveness of a country towards FDI by MNCs, holding other factors constant. These findings suggest that infrastructure development should be an integral part of the strategy to attract FDI inflows in general and export oriented production from MNCs in particular.

Douglas Brooks and Sumulong (2003) in their study analyse the policy context in which FDI flow occurs. They find that a favorable policy framework for FDI is the one that generally provides economic stability, transparent rules on entry and operations, equitable standards of treatment between domestic and foreign firms and secures the proper functioning and structure of the markets. In general empirical evidence suggests that policies encouraging domestic investment help to attract domestic investment. They find that FDI contributes to the development process by providing capital, foreign exchange, technology, competition and export market access, while also stimulating domestic innovation and investment.

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In her paper on FDI and gender equity, Elissa Braun (2006) presents a review of research and policy on the links between foreign investment and development. This work provides broad and consistent evidence for the contention that growth leads to FDI rather than FDI leading to growth. The work also underscores the importance of economic policy context for gaining development benefits from FDI. Besides keeping the production costs low to attract more FDI, countries must also have adequate domestic capacities to benefit from FDI. These capacities are related to economic growth including high level of investment, infrastructure and human capital. Looked from a gender perspective, foreign investment in female intensive industries has had a significant impact on womens work and development. She finds that there is likely to be some short term improvement in womens income as FDI expands but the trajectory of womens wages is less promising .These findings are consistent with those that indicate trade and FDI have done little to narrow the gender wage gap.

In a study done by the Japan Bank for International Cooperation (2002) on key development issues related to FDI, following were the findings. The outflows of global FDI have increased with cross border mergers and acquisitions among OECD countries triggered by policy initiatives like implementation of EUs single market program and the creation of NAFTA. ASEAN and South Asia began cross border mergers and acquisitions after their financial crisis. Also in the 1990s the US emerged as the worlds largest recipient of FDI while China led the race of attracting FDI inflows. The study also finds that FDI tends to crowd in domestic investment as the creation of complementary activities outweighs the displacement of the domestic competitors and that spillover effects of FDI on the productivity growth of the local firms do not occur automatically. The magnitude of these spillovers depends on various home country and firm level characteristics like relative and absolute absorption capacities of individual host countries and firms. The study concludes by stating that host countries government policies should attach greater importance to

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the stability and predictability of the local business environment in which foreign trade occurs.

Maria Carkovich and Ross Levine (2002) conclude that an economic rationale for treating foreign capital favorably is that FDI and portfolio flows encourage technology transfers that accelerates overall economic growth in the recipient countries. While micro economic studies give a pessimistic view of the growth effects of the foreign capital, macro economic studies find a positive link between FDI and growth. However, the authors say that the previous macro economic studies do not fully control for endogenity, country specific effects and inclusion of lagged dependent variables in the growth regression. After reducing many statistical problems plaguing past macro-economic studies and using two new data bases, they find that FDI inflows do not exert an independent influence on economic growth. Thus while sound economic policies may spur both growth and FDI, the results are inconsistent with the view that FDI exerts a positive impact on growth that is independent of the other growth determinants.

Analyzing the influence of IPRs in encouraging FDI, Keith Maskus (1998) finds that while there is evidence, that strengthening IPRs can be an effective means of inducing additional inward FDI, it is only one component among a broad set of factors. Emerging economies must recognize the strong complementary relationships among IPRs, market liberalization and deregulation, technological development policies and competition regimes. He suggests that given the complexity and trade offs for market participants, governments and emerging economies should devote considerable attention and analysis to the strategies to achieve net gains from stronger IPRs.

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The Global Business Policy Council (2005) prepared a FDI confidence Index, in which the following findings were made. In 2005 China, India and Eastern Europe reached new heights of attractiveness as destinations for FDI as they competed for higher value added investments including R&D. The U.S dropped to the third place, Western Europe was likely to remain a low priority and Eastern Europe would enjoy better prospects despite rising costs. Though FDI appears to be on rise, corporate savings overhang and investor pessimism about the global economy could dull the prospects of cross border corporate investment. However, the globalization of R&D would not be a zero sum game. Rather it would be a balancing act, as companies leverage opportunities in knowledge centers in the developing world in conjunction with traditional R&D hubs in the industrial world.

Studying production, distribution and investment model for an MNC, Zubair Mohammed et. al. (2004) develop an integrated production, planning, distribution and investment model for a multinational firm that produces products in different countries and distributes them to geographically diverse markets. They argue that since MNCs operate in different countries under varying exchange and inflation rates, varying opportunities for investing and differing regulations, these factors should be included in the decision process. In the modeling, the paper incorporates these factors and elicits the performance of the model through an example and discusses the results. The results indicate that the exchange rates and the initial capacity levels of the firms have significant effects on the production, distribution and investment decisions and consequently on the profits.

Galian et. al. (2001) build an empirical study based on the eclectic paradigm, aiming to find out the main ownership, internationalization and location factors which affect such internationalization process. The results confirm the importance of

factors such as the existence of specific assets of an intangible nature .They also

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show that the transaction costs and other questions related to knowledge transfer and accumulation are relevant in the choice of FDI over alternative forms of internationalization. Current and future markets and their expected growth are the key factors for selecting a destination.

Examining location aspects of foreign investment in developing countries, Jalilian (1996) attempts to incorporate new forms of foreign investment in a unified model .He uses the model to show how differences in production environment in particular are likely to affect both the timing and modes that any foreign investment is likely to take. The explanatory variables in this model are the relative efficiency gap and the variable cost differential between producing at home or in less developed country; which includes those related to the differences in the production environment.

Studies included in an edited volume by Rajesh Narula and S. Lall (2006) aim at understanding the factors that led to an optimization of the benefits from FDI for the host country. Despite the diversity of the countries covered and the methodology used, the chapters in this volume point to a basic paradox. With weak local capabilities, industrialization has to be more dependent on FDI. However, FDI cannot drive industrial growth without local capabilities. The studies here do not support the view that FDI is a sine qua non for economic development. They unmistakably show that market forces cannot substitute for the role of the government and argue in favour of a proactive industrial policy. Thus FDI per se does not provide growth opportunities unless the domestic industrial sector exists which has the necessary technological capacity to profit from the externalities from MNC activity.

In his study of FDI and trade patterns in Malaysia, Bernard Tai Khiun Mien (1999) explores the relationship between incoming FDI and trade orientation in the Malaysian manufacturing sector. It is found that by pursuing an open proactive trade

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and industrial strategy, Malaysia has been able to realize the benefits of FDI. This study shows that Malaysias manufacturing sector which is driven strongly by foreign investment has become increasingly outward looking since the past two decades. Increased export-orientation has been accompanied by a favorable shift in the comparative advantage of non traditional manufacturing sub sectors in Malaysia.

A paper by Bishwanath Goldar (1999) analyses the trends of FDI in Asia, with a special focus on FDI flows from Japan. He relates the FDI flows to changing industrial structure and to trade flows. An econometric analysis is also done to identify key determinants of FDI flows to Asian countries. It is found that Japan has been the main source of FDI flows to Asia. Japanese FDI has helped cost reduction and export promotion in the host countries but in the process Japan has created a large trade surplus with these countries.

Explaining FDI flows to India, China and the Caribbean, Arindam Banik et. al. (2004) look at FDI inflows in an alternative approach based on the concepts of neighborhood and extended neighborhood, rather than on the basis of conventional economic indicators as market size, export intensity, institutions etc. The study shows that the neighborhood concepts are widely applicable in different contexts. There are significant common factors in explaining FDI inflows to select regions. While a substantial fraction of FDI inflows may be explained by select economic variables, country specific factors and idiosyncratic component account for more of the investment inflows in Europe, China and India.

Jongsoo Park (2004) has tried to build a Korean perspective on FDI in India based on the case study of Hyundai Motors. He contends that since the launch of reforms, Korean companies have invested in joint ventures or Greenfield projects in automobiles, consumer goods and others. This case study of Hyundai Motor

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Industries set against an exploration of Indias FDI experience from a Korean perspective indicates that industrial clusters are playing an important role in economic activity. The key to promoting FDI inflows into India may lie in industries and products that are technology intensive and have the economies of scale and significant domestic content.

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SECTION 2.2

STUDIES FROM THE INDIAN PERSPECTIVE

Chandra Mohan (2005) in his study on FDI in India is of the view that India has not been able to attract a good level of FDI and he argues that the current level of FDI appears respectful due to a more liberal definition of FDI which was actually adopted to make our comparison with the Chinese FDI more comfortable. He says that the Government must not consider foreign investments sacrosanct. Instead he advises the Government to indulge in more proactive strategies to seek more FDI for which it must help in removing the procedural hassles at the state level. Also the government should make the investment climate more conducive along with a proper regulatory approach for the flagship investors which would encourage the risk-averse small manufacturing enterprises to turn out in larger numbers.

Bary Rose Worth, Anand Virmani and Susan Collins (2007) study empirically Indias economic growth experience during 1960-2004 focusing on the post 1973 acceleration. The analysis focuses on the unusual dimensions of Indias experience: the concentration of growth in the service production and the modest level of human and physical capital accumulation. They find that India will need to broaden its current expansion to provide manufactured goods to the world market and jobs for its large pool of low skilled workers. Increased public saving as well as rise in foreign saving, particularly FDI could augment the rising household saving and support the increased investment necessary to sustain rapid growth.

Examining Indias experience with capital flows, Ajay shah and Ila Patnaik (2004) discuss Indias policies towards capital flows in the last two decades. They point out

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that since the early nineties India has implemented policies aimed at liberalizing trade and deregulating investment decisions. Throughout most of this period India has maintained strong controls on debt flows and has encouraged FDI and portfolio flows. At the same time the Indian authorities have adopted a pegged nominal exchange rate. According to them, domestic institutional factors have resulted in relatively small FDI and large portfolio flows. They also point out that one of Indias most severe policy dilemmas during this period has been related to the tension between capital flows and currency regime. They agree that in spite of the progress achieved since the reforms were adopted the goal of finding a consistent way to augment investment using current account deficits has remained elusive.

Commenting on FDI in India, P.L Beena et. al. (2004) agree to the fact that India has come a long way since 1991 as regards the quantum of FDI inflows is concerned, though there is a view that the MNCs are discouraged from investing in India by bureaucratic hurdles and uncertainty of the economic reforms. However, they feel that very little discussion has taken on the experience of the MNCs and the relationship between their performance and experience with the operating environment and the extent of spillovers in the form of technology transfers. The importance of the former is that the satisfaction of the expectations of the MNCs that are already operational within India is an important precondition for growth in FDI inflow. Transfer of technology and know how on the other hand is at least likely to have an impact on Indias future growth and the quantum of FDI inflow. They argue that to the extent that Indias future growth will depend on the global competitiveness of its firms, the importance of such spillovers can be paramount.

In order to provide foreign investors a latest picture of investment environment in India, Peng Hu (2006) in his study analyses various determinants that influence FDI inflows to India including economic growth, domestic demand, currency stability,

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government policy and labour force availability against other countries that are attracting FDI inflows. Analyzing the new findings it is interesting to note that India has some competitive advantage in attracting FDI inflows, like a large pool of high quality labour force which is an absolute advantage of India against other developing countries like China and Mexico, to attract FDI inflows. In consequence this study argues that India is an ideal investment destination for foreign investors.

Kulwinder Singh (2005) has analysed FDI flows from 1991-2005. A sectoral analysis in his study reveals that while FDI shows a gradual increase and has become a staple of success in India, the progress is hollow. The telecommunications and power sector are the reasons for the success of infrastructure. He comments that FDI has become a game of numbers where the justification for the growth and progress is the money that flows in and not the specific problems plaguing the individual sub sectors. He finds that in the comparative studies the notion of infrastructure has gone a definitional change. FDI in sectors is held up primarily by telecommunications and power and is not evenly distributed.

Mohan Guruswamy, Kamal Sharma et. al. (2005) discuss the retail industry in India in their study on FDI in the retail sector. They focus on the labour displacing effect on employment due to FDI in the retail sector. They say that though most of the strong arguments in favour of FDI in the retail sector are not without some merit, it is not fully applicable to the retailing sector and the primary task of the Government in India is still to provide livelihood and not create so called efficiencies of scale by creating redundancies.

In their study on FDI and its economic effects in India, Chandana Chakraborty and Peter Nunnenkamp (2006) assess the growth implications of FDI in India by subjecting industry specific FDI and output to causality tests. Their study is based on

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the premise that the composition and type of FDI has changed in India since 1991 which has led to high expectations that FDI may serve as a catalyst to higher economic growth. They find that the growth effects of FDI vary widely across sectors. FDI stocks and output are mutually reinforcing in the manufacturing sector. They also find only transitory effects of FDI on output in the services sector which attracted the bulk of FDI in the post-reform period. These differences in the FDI growth relationship suggest that FDI is unlikely to work wonders in India if only remaining regulations were relaxed and more industries opened up to FDI.

V.N. Balasubramanyam and Vidya Mahambre (2003) in their study of FDI in India conclude that FDI is a very good means for the transfer of technology and know how to the developing countries. They do not find any reasons to regard China as a role model for India. They agree with the advocacy of the policies designed to remove various sorts of distortions in the product and factor markets. These are policies which should be adopted in the interests of both the domestic and foreign investment. A level playing field for one and all may be a much better bet than specific policies geared to the promotion of FDI. The study suggests that India may be better placed than in the past to effectively utilize licensing and technical collaboration agreements as opposed to FDI.

Studying export growth in India, Kishore Sharma (2000) finds that export growth in India has been much faster than GDP growth over the past few decades. Several factors have contributed to this phenomenon including FDI. However, despite increasing inflows of FDI in recent years there has been no attempt to assess its contribution to Indias export performance one of the channels through which FDI influences growth. Using annual data from 1970-1998, he investigates the determinants of export performance in India .Results suggest that the demand for Indian exports increases when its export prices fall in relation to the world prices.

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Further the real appreciation of the rupee adversely affects the Indian exports. Export supply is positively related to domestic relative price of exports and higher domestic demand reduces export supply. Foreign investment appears to have statistically no significant impact on export performance although the coefficient of FDI has a positive sign.

Commenting on FDI and globalization trends in India, Francoise Hay (2006) says that since India opened up in 1991 within the framework of legal economic reforms, the FDI inflows were stimulated in industries and services benefiting from the many comparative advantages of the country. In parallel some Indian firms started to grow in importance and to invest abroad. They had the financial means, experience and ambition to acquire international recognition and they were encouraged by the Indian Government. He finds that the FDI from the Indian firms were principally addressed to the developing countries and Russia, however, the share of the industrialized countries was on the rise and the manufacturing and non-financial sectors accounted for the bulk of it.

Balasundaram Maniam and Amitava Chatterjee (1998) in their study on the determinants of US foreign investment in India, trace the growth of US FDI in India and the changing attitude of the Indian Government towards it as a part of the liberalization program. They review previous research on the determinants of FDI and use regression analysis on 1962-1994 data to identify the factors affecting US FDI in India, current trends and the impact on the Indian economy. They find that only the relatively weak exchange rate appears to be a significant factor and that the US FDI has been increasing in dollar amounts and relative percentage growth. They call for an improvement in infrastructure and reductions in red tape and protectionism to encourage further growth.

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Ranjan Das (1997) in his study on defending against MNC offensives, states that the waves of liberalization are blowing across developing countries leading to the creation of new opportunities for MNCs. He proposes that MNCs should respond to such new opportunities with a set of offensive moves that can give them a salient position in the newly liberalized economies. He posits that domestic firms in India respond to these offensives through a combination of three broad responses and clear emphasis on achieving pre-emptive position: attaining a critical size, creating national brands, exploiting national competitive advantages adopting the best international practices and altering core values.

T.N Srinivasan (2001) in his study evaluates Indias transition from an inward oriented development strategy to greater participation in the world economy. While tariff rates have decreased significantly over the past decade, he finds India still as one of the more autarkic countries. Despite improvement over the past in export performance, India still continues to lag behind its South and East Asian neighbors. Secondly official debt flows have largely been replaced by FDI and portfolio investment flows in 1990s. He argues that Indias participation in the future round of multilateral trade negotiations would benefit India. He says that further reforms are required in labour and bankruptcy laws, real privatization and fiscal consolidation.

There have been a lot of studies on FDI and the determinants for its flow. It is generally agreed that low capital output ratio and high labour productivity are the two attractive reasons for the flow of FDI. It is also commonly held that high wage is a deterrent to the flow of FDI. In his study, Birendra Kumar and Surya Dev (2003) show, with the data available in the Indian context, that the increasing trend in the absolute wage of the worker does not deter the increasing flow of FDI. To explain this intriguing phenomenon the authors have considered the ratio of wage to the value a worker adds. It is found that this ratio is declining though the absolute wages are

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increasing. It is this decline in the ratio that correspondingly promises more return on the capital invested and, therefore, is held as an important reason for the flow of FDI; not withstanding the increase in absolute labour wage. This ratio in his study is taken as a definition for the measure of the bargaining power of labour. The study undertaken here implies that the bargaining power of the labour cannot be ignored as a determinant for the flow of FDI.

Raghbendra Jha (2003) has made his study on the recent trends in FDI flows in India. He finds that FDI flows to India have not been commensurate with her economic potential and performance. With FDI becoming a significant component of investment recently, accounting practices in India lagged behind international norms. However, the GOI revised its computation of FDI figures in line with the best international practices, which has led to a substantial improvement in FDI figures. The author, however, says that the quality of FDI as manifest in technological spillovers, export performance etc. is more important than its quantity.

FDI limits were liberalized in India to allow greater than 51 percent ownership of private sector banks in February 2002. Portfolios of private sector and Government owned banks posted significant and large value gains surrounding the

announcement, the gains by private sector banks almost being double than that of the government banks. An analysis done by Chinmoy Ghosh et. al. (2004) shows that the price increase is higher for smaller banks that have less debt, are less efficient, less productive and burdened with non performing assets. They conclude that the evidence is consistent with the hypothesis that the valuation gains reflect the vulnerability to and premium of potential takeover of the inefficient banks following the liberalization.

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Rashmi Bangas (2003) study on the differential impact of Japanese and U.S FDI on exports of Indian manufacturing is motivated by the fact that studies have found that FDI has not played a significant role in exports of the Indian manufacturing sector in the post reform period and concludes that FDI in India has led to export diversification. The impact of FDI on export intensity differs with respect to the source of FDI both at the industry and the firm level. The U.S FDI has a positive and significant impact on the export intensity of the industry and the firms and also the U.S FDI has greater spill over effects on the exports of the domestic firms.

A paper on labour conflict and foreign investments by Nidhiya Menon and Paroma Sanyal (2004) analyses the patterns of FDI in India. They investigate how labour conflict, credit constraints and indicators of a states economic health influence location decisions of the foreign firms. They account for the possible endogenity of labour conflict variables in modeling the location decisions of the foreign firms. This is accomplished by using a state specific fixed effects framework that captures the presence of unobservable, which may influence investment decisions and labour unrest simultaneously. Results indicate that labour unrest is highly endogenous across the states of India, and has a strong negative impact on foreign investment.

Milan Bhrambhatt et. al. (1996), in their study have identified four major weaknesses in Indias ability to integrate with the world economy. They are inadequate macroeconomic policies, relatively high levels of protection, inefficient transportation and communications infrastructure and poorly equipped and inflexible labour markets. They argue that these weaknesses discourage Indian firms and FDI investors from focusing on the export market. They contend that FDI can help raise the private investment rate without incurring additional debt and can help relax key infrastructure constraints. But its greatest long run benefit may come from its direct and indirect effects in improving productivity. They advice that to meet the plans and

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targets for exports spelled out in the five year plans, distortions from the various policies should be addressed.

Sebastian Morris (2004) has discussed the determinants of FDI over the regions of a large economy like India and developed a framework drawn from the advantage concept of Kindelberger and from location theories rooted in regional science. He argues that, for all investments (other than those strictly confined to locations due to their requirements of either natural resources or the need to be very close to the markets), it is the regions with metropolitan cities, that have an advantage in headquartering the country operations of MNCs in India, and, therefore, attract the bulk of FDI. Even more than the quantum of FDI, the employment effects and the spill over effects are large for such regions. He finds that Gujarat has been particularly handicapped in not having a large and metropolitan city unlike the southern states which have Bangalore and Hyderabad besides the other metros of Chennai. Adjusting for these factors the FDI into Gujarat was large enough over the period when the state had grown rapidly in the first six years following the reforms of 1991-92. Since then the slow down of growth has been a retardant to FDI since the kind of FDI that Gujarat can hope for are largely industrially oriented. Similarly regulatory uncertainty especially with regard to gas, but also electric power and more generally in the physical infrastructure sectors had hurt Gujarat more than other states. He concludes by suggesting that there are vast gains to be made by attracting FDI especially in services, high-tech, and skilled labour seeking industries because then the resulting operations are more externally oriented and the investments arise from competing firms. The fortunes of Gujarat are linked very closely with the growth of manufacturing in the country as a whole.

Studying outward FDI by India Prof. Subramanyam and Prof. Bhuma (2006) find that government expenses and labour outflows have significant elasticity with respect to

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remittances. They say that the level of overseas investment is closely related to the comfort level of the investors. Tangible data collection and validation support the hypothesis that, when outward FDI becomes a reality, significant skilled personnel from the country get employed in the venture and thus contribute towards the remittances. They contend that government expenditure to promote the tertiary education and increasing the pool of skilled manpower and the no. of people emigrating has a direct bearing on the remittances.

In a different study Rashmi Banga (2004) has analysed the impact of Japanese and US FDI on the productivity growth. She has examined the impact of Japanese and US FDI on total factor productivity growth of the firms in the Indian automobile, electrical and chemical industries in the post reform period. The results show that the domestic firms have witnessed both efficiency and growth and technological progress in the electrical and chemical industries in the post reform period.

In his study on European and Japanese affiliates in India, N.S Siddharthan (1999) attempts to identify the variables that distinguish Japanese FDI from European FDI and to test for their significance in differentiating the conduct and performance of Japanese and European firms in India. There have been studies which demonstrated that MNCs as a group behave differently from non affiliated local firms. This study highlights intra MNC differences related to nationality of the MNC, nature of the Indian partner and industry specific characteristics.

N.S. Siddharthan and K.Lal (2004) analyse the impact of FDI spillovers on the productivity of the Indian enterprises for the post liberalization years 1993-2000. This study argues in favour of using an unbalanced panel that takes into account the entry and exit of the firms. Further it also advocates the estimation of separate firm level cross section equations for each year to analyse the possible changes in the values

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of the spillover time. The results show the presence of significant spillover effects from FDI. During the initial years of liberalization the spill over effects were modest, but increased sharply later on. Firms with better endowments in terms of productivity and technology benefited from liberalization and MNC presence. Firms with large productivity gaps became the victims.

V.N Balasubramanyam and David Spasford (2007) compare the inflow of FDI in China and India and find that India may not require increased FDI given Indias factor endowments and the structure and composition of her economy. There are a variety of explanations for the low volumes of FDI in India relative to that in China. This paper suggests that there may be yet another explanation i.e. the structure and composition of the manufacturing and services sector in India and her endowments of human capital. Indias manufacturing sector consists of a substantial proportion of science based and capital intensive industries. The requirements of managerial and organizational skills of these industries are much lower than that of the labour intensive industries such as those in China. Also India has a large pool of well trained engineers and scientists capable of adapting and restructuring imported know how to suit local factor and product market conditions. All these factors promote effective spillovers of technology and know how from foreign to locally owned firms. The optimum level of FDI which generates substantial spillover enhances learning on the job and contributes to the growth of productivity, is likely to be much lower in India than in other developing countries including China.

Nagesh Kumar (2000) has made an exploratory attempt to examine the patterns of MNC related mergers and acquisitions in India in the nineties with the help of an exclusive data base. He finds that the liberalization of policy framework since the early nineties has led the MNCs to increasingly use the Merger and Acquisition route to enter and strengthen their presence in the country. In the recent years, two fifths of

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all FDI inflows took the form of M&A s compared to virtually all of FDI inflows coming from Greenfield ventures earlier. The deals relating to MNCs are predominantly horizontal rather than vertical in nature .In terms of development implications he finds that FDI inflows in the form of M&A s are of an inferior quality compared to Greenfield investments. These findings, therefore, emphasize the need for adopting a comprehensive competition policy framework in India.

Jaya Prakash Pradhan (2005) provides an overview of the changing patterns of the outward FDI from India over 1975-2001. She shows that the increasing number of Indian MNCs during nineties have been accompanied by a number of changes in the character of such investments which include tendency of Indian outward investors to have full or majority ownership, expansion, into new industries and service sectors.

Vinoj Abraham and Pradhan (2005) examines the patterns and motivations behind the overseas mergers and acquisitions by Indian enterprises. It is found that the main motivation of Indian firms overseas acquisitions have been to access international markets, firm specific intangibles like technology and human skills and overcome constraints from limited home market growth.

As a matter of concluding remarks, the studies referred here highlight both the macro and micro perspectives of FDI debated internationally. However, in the Indian discourse the emphasis is found on studying the causes and effects of inward FDI. But of late India is witnessing an upsurge in outward FDI, which is found changing the trajectories of Indian investment flows. This new trend needs to be integrated in the main stream studies and analysed in detail to provide a more meaningful picture of the extent to which India has really globalized. There have been some studies focusing on outward FDI in India but they are few and far between. To get a more concrete picture of investment flows in India, it is imperative to carry further the

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research already done on FDI, focusing on new dimensions and areas. This research attempt as an extension of the earlier studies done on Indian FDI tries to integrate both inward and outward FDI flows and analyse them parallely to provide a more complete, balanced, comprehensive and comparative picture of the economic undercurrents of FDI in India.

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International Economic Relations, Working paper 106, New Delhi. 7. Banga, R. (2004). Impact of Japanese and US FDI on Productivity Growth A Firm Level Analysis, Economic and Political Weekly, January 31. 8. Banik, A., P. Bhaumik and S. Iyare (2004) Explaining FDI Inflows to India, China and the Caribbean: An Extended Neighbourhood Approach, Economic and Political Weekly, July 24. 9. Beena, P.L., L. Bhandari, S. Bhaumik, S. Gokarn and A. Tandon (2004). Foreign Direct Investment in India, In Investment Strategies for Emerging Markets, Chapter 5: 126-147.

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10. Bertrand, A. and Christiansen (2004). Trends and Recent Developments in FDI, Investment Division, Directorate for Financial and Enterprise affairs, OECD. 11. Bhuma, S. and R. Subramanyam (2006). Outward Foreign Direct Investment by India-A New Dimension, Social Science Research Network, No. 929054 (electronic paper collection). 12. Blomstrom, M. and A. Kokko (2005). The Economics of Foreign Direct Investment, NBER Working Paper No. 168, National Bureau of Economic Research, Cambridge. 13. Brahmbhatt, M., T.G. Srinivasan and Kim. Murrell (1996). India in the Global Economy, World Bank Policy Research Working Paper No. 1681, International Economics Department, International Economics Analysis and Prospects Division. 14. Bransteeter, L., R. Fisman, C. Foley, and K. Saggi (2007). Intellectual Property Rights, Imitation and Foreign Direct Investment: Theory and Evidence, NBER Working Paper No. 13033, National Bureau of Economic Research, Cambridge. 15. Brooks, H.D. and R.S. Lea (2003). Foreign Direct Investment: The Role of Policy, Asian Development Bank (ADB). 16. Buiter, W. and P.L. Hans (2001). International Financial Institutions-Adapting to a World of Private Capital Flows, In Perspectives in Global Finance ed. by Das. D., Routledge, London and New York. 17. Carkovic, M. and R. Levine (2002). Does FDI Accelerate Economic Growth, In Financial Globalization: A Blessing or Curse ed. by World Bank, Washington. 18. Chakraborty, C. and P. Nunnenkamp (2006). Economic Reforms, FDI and its Economic Effects in India, Working Paper No. 1272, The Kiel Institute of World economy, Germany.

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19. Chandra Mohan N. (2005). Stepping Up Foreign Direct Investment in India, Margin 37 (3), NCAER, National Council of Applied Economic Research, New Delhi. 20. Collins, M.S., B. Roseworth and A. Virmani (2007). Sources of Growth in the Indian Economy, NBER Working Paper No. 12901, National Bureau of Economic Research, Cambridge. 21. Das, R. (1997) Defending Against MNC Offensives: Strategies of the Large Domestic Firm in A Newly Liberalizing Economy, Management Decisions 35 (8): 605-618. 22. Desai, A.M., C.F. Foley and A. Pol (2007). Multinational Firms, FDI Flows and Imperfect Capital Markets, NBER Working paper No. 12855, National Bureau of Economic Research, Cambridge. 23. Desai, A.M., C.F. Foley and R.H. Jr. James (2005). Foreign Direct Investment and the Domestic Capital Stock, NBER Working Paper No.11075, National Bureau of Economic Research, Cambridge. 24. Desai, A.M., C.F. Foley and R.H. Jr. James (2005). Foreign Direct Investment and Economic Activity, NBER Working Paper No. 11717, National Bureau of Economic Research, Cambridge. 25. Ekholm, K., R. Forslid and J. Markusen (2003). Export-Platform Foreign Direct Investment, NBER Working Paper No. 9517, National Bureau of Economic Research, Cambridge. 26. GBPC (2005). FDI Confidence Index, vol.8, Global Business Policy Council. 27. Ghosh, C. and B.V. Phani (2004). The Effect of Liberalization on Foreign Direct Investment Limits on Domestic Stocks: Evidence from the Indian Banking Sector, Social Science Research Network, No. 546422 (electronic paper collection). 28. Goldar, B. and E. Ishigami (1999). Foreign Direct Investment in Asia, Economic and Political Weekly, May 29.

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29. Gonzalez, B. and I.J. Galian (2001). Determinant Factors of Foreign Direct Investment: Some Empirical Evidence, European Business Review 13 (5): 269-278. 30. Guruswamy, M., K. Sharma, J.P. Mohanty and J.T. Korah (2005). Foreign Direct Investment in Indias Retail Sector: More Bad than Good? Center for Policy Alternatives, New Delhi. 31. Haskel, E.J., C.S. Pereria and J.M. Slaughter (2004). Does Inward Foreign Direct Investment Boost the Productivity of the Domestic Firms, NBER Working Paper No. 8724, National Bureau of Economic Research, Cambridge. 32. Hay, F. (2006). FDI and Globalization in India, International Conference on the Indian Economy in the Era of Financial Globalization, September28-29, Paris. 33. Hu, P. (2006). Indias Suitability for Foreign Direct Investment, Working Paper No.553, International Business with Special Reference to India, University of Arizona. 34. Iyamoto, K. (2003). Human Capital Formation and FDI in Developing Countries, OECD Working Paper No. 211, OECD Development Center. 35. Jalilian, H. (1996). Foreign Investment Location in Less Developed Countries: A Theoretical framework, Journal of Economic Studies 23 (4):1830. 36. JBIC (2002). FDI and Development: Where do we stand?, Research Paper No.15, Japan Bank for International Cooperation. 37. Jha, R. (2003). Recent Trends in FDI Flows and Prospects for India, Social Science Research Network, No. 431927 (electronic paper collection). 38. Jongsoo, P. (2004), Korean Perspective on FDI in IndiaHyundai Motors, Industrial Cluster, Economic and Political Weekly, July 31.

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39. Kumar, N. (2000). Mergers and acquisitions by MNCs-Patterns and Implications, Economic and Political Weekly, August 5. 40. Kumar, N. (2001). Infrastructure Availability, FDI Inflows and their Export Orientation: A Cross Country Exploration, Research and Information System for Developing Countries, No. 1.2 November 20, India. 41. Maskus, K. (1998). The Role of IPRs in Encouraging FDI and Technology Transfers, In Strengthening IPRs in Asia: Implications for Australia, Australian Economic papers No. 346: 348-349, University of Colorado, Australia. 42. Menon, N. and P. Sanyal (2004). Labour Conflicts and Foreign Investment: An Analysis of FDI in India, International Industrial Organisation Conference, Brandeis University, USA. 43. Mohamed, M.Z. and A.Y. Mohamed (2004). A Production, Distribution and Investment Model for a Multinational Company, Journal of Manufacturing Technology Management, 15 (6): 495-510. 44. Morris, S. (2004). A Study of the Regional Determinants of Foreign Direct Investment in India, and the Case of Gujarat, Working Paper No. 2004/03/07, Indian Institute of Management. 45. Narula, R. and S. Lall (2006). (ed.) Understanding FDI Assisted Economic Development, Routledge, London and New York. 46. Nayak, B.K. and S. Dev (2003). Low Bargaining Power of Labour Attracts FDI in India, Social Science Research Network, No. 431060 (electronic paper collection). 47. Nocke, V. and Yeaple, S. (2004). An Assignment Theory of Foreign Direct Investment, NBER Working Paper No. 110063, National Bureau of Economic Research, Cambridge.

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48. Patnaik, I. and A. Shah (2004). Indias Experience with Capital Flows: The Elusive Quest to Current Account Stability, paper presented at NBER International Capital Flows Conference, Santa Barbara, California. 49. Pradhan, J. P. (2005). Outward Foreign Direct Investment from India: Recent Trends and Patterns, GIDR Working Paper, No. 153, February. 50. Sharma, K. (2000). Export Growth In India: Has FDI Played a Role? Center Discussion Paper No. 816, Charles Stuart University, Australia. 51. Siddharthan, N.S. (1999). European and Japanese Affiliates in IndiaDifferences in Conduct and Performance, Economic and Political Weekly, May 29. 52. Siddharthan, N.S. and K. Lal (2004). Liberalization, MNC and Productivity of Indian Enterprises, Economic and Political Weekly, January 31. 53. Singh, K. (2005). Foreign Direct Investment in India: A Critical Analysis of FDI from 1991-2005, Center for Civil Society, Research Internship Programme, New Delhi. 54. Srinivasan, T.N. (2001). Indias Reform of External Sector Policies and Future Multilateral Trade Negotiations, Center Discussion Paper No. 830, Yale University, USA. 55. Stein, B.E. (2006). Foreign Direct Investment, Development and Gender Equity: A Review of Research and Policy, Occasional Paper No. 12, United Nations Research Institute for Social Development. 56. Tai Khium Mien, B. (1999). Foreign Direct Investment and patterns of Trade: Malaysian Experience Economic and Political Weekly, May 29.

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CHAPTER 3 TRENDS AND PATTERNS OF INWARD FOREIGN DIRECT INVESTMENT

The Indian Economy opened up in 1991 within the framework of liberal economic reforms. The variations in the policy reforms are reflected in the trends and patterns of inward and outward FDI flows. FDI inflows were stimulated in industry and services benefiting from the many comparative advantages of the country (human resources, emerging markets etc).

The present chapter analyses the trends and patterns of inward FDI flows of India, focusing specially on the period of post liberalisation .The issues that have been studied in this chapter are:

The nature and extent of Indian economys integration with the world economy

The nature of the regional distribution of FDI flows from the global FDI flows The comparative standing of FDI among developing countries The pattern of originating countries of Indian FDI flows The nature of change in the sectoral composition of FDI in India The regional distribution of inward FDI in India The structure of cross border mergers and acquisitions from India The FDI flows as a percentage of GDP and GFCF FDI performance v/s potential in India Major policy initiatives taken to boost FDI flows

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This chapter, divided into three parts, is structured as follows:

Section 3.1 studies the extent of the Indian economys integration with the world economy.

Section 3.2 examines the trends and patterns of inward FDI into India. Section 3.3 discusses the findings and conclusions.

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SECTION 3.1

INDIAS INTERNATIONAL TRADE: TOWARDS GLOBAL INTEGRATION

The year 2006 witnessed robust growth in the world economy and vigorous trade expansion. According to data available in (UNCTAD 2007), global GDP growth accelerated to 3.7 percent, the second best performance since 2000. All major regions recorded GDP growth in excess of population growth. Economic growth in the least-developed countries continued to exceed 6 percent for the third year in a row. A large part of the stronger global economy is attributable to the recovery in Europe in early 2006, which turned out to be stronger than expected. The United States economy maintained its overall expansion as weaker domestic demand was balanced by a reduction in the external deficit, mainly due to a faster export growth. In Japan somewhat faster economic growth was achieved despite weaker domestic demand reflected in a widening of its external surplus. China and India continued to report outstandingly high economic and trade growth.

The more favourable investment climate is also reflected in a sharp rise in global foreign direct investment flows in 2006, which approached the record levels of the past. UNCTAD reports that global FDI inflows surged by one-third to US$ 1.23 trillion, the second highest level ever. The high growth of global FDI flows can be attributed partly to increased mergers and acquisitions activity and higher share prices.

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INDICATORS OF THE EXTENT OF INTEGRATION OF THE INDIAN ECONOMY IN THE WORLD MARKET FOR GOODS AND SERVICES

Integration of the domestic economy with the world market can be indicated by the extent of international trade in the domestic economy as measured by the share of exports and imports in GDP and in the global economy as measured by the share of countrys exports and imports in global exports and imports.

The relevant data are given below in the table:

Table 3.1: Measures of Integration of the Indian Economy with the World Economy (percent total)
Measures of Integration
Share in GDP of Exports of Goods and Services Share in GDP of Imports of Goods and Services Share in World Merchandise Exports Share in World Merchandise Imports Country Share in World Exports of Commercial Services Country share in World Imports of Commercial Services 1994 10 10 0.6 0.6 0.6 0.8 2004 18 20 0.8 1.1 1.9 2.0

Sources: World Bank 2006 and WTO, 2005

It is evident from above that India has become increasingly integrated with the world economy. During the period 1990-2004 the share of exports and imports in Indias GDP almost doubled, but the increase in Indias share in its world merchandise exports was proportionately far less. However, because of the success in the IT service sector, Indias share in world exports of commercial services tripled during the same period. This would imply that excluding the services sector, the effect of greater integration is mostly domestic. This is because of rising share of trade in domestic GDP, rather than Indias GDP growth, affecting the global GDP growth.

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Table 3.2: Share of India in Global GDP and its Growth

Share in GDP of Share in Global GDP (percent) Low And Middle Income Countries (percent) 1990 1.46 2004 1.67 1990 7.92 2004 8.23 Growth Rate of GDP (percent) 1990 6.0 2004 6.2 Share in Growth of World GDP (percent) 1990 3.58 (3.12.) 2004 4.14 (3.62) Share in Growth Rate of Low And Middle Income Countries (percent) 1990 12.66 (12.18) 2004 10.63 (10.23)

Source: Srinivasan (2006) pp.7 Note: Using shares of the two countries in global and low and middle income countries GDP of 2004 respectively as weights. Figures in parenthesis use corresponding shares in GDP of 1990 as weights.

The share of India in global and low income countries GDP respectively has increased over time. And Indias share of GDP among low and middle income countries is naturally higher than in global GDP and its contribution to GDP growth in low and middle income countries is even higher (table 3.2).

The IMF (2005) recognizes that policy makers in India are actively seeking to strengthen Indias global linkages and to accelerate its integration with the world economy. Success in these efforts would increase the role of India in the world economy.

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SECTION 3.2

TRENDS AND PATTERNS OF INWARD FDI IN INDIA

The stock of foreign direct investment in India soared from less than US$ 2 billion in 1991, when the country undertook major reforms to open up the economy to world markets, to almost US$ 51 billion in 2006 (table 3.3). Reforms are being done to deregulate FDI restrictions further, e.g., by allowing FDI in retail trade. Policymakers in India as well as external observers attach high expectations to FDI. According to the Minister of Finance, Mr. P. Chidambaram, FDI worked wonders in China and can do so in India (Indian Express, November 11, 2005). The Deputy Secretary General of the OECD reckoned at the OECD India Investment Roundtable in 2004 that the improved investment climate has not only resulted in more FDI inflows but also in higher GDP growth (OECD India Investment Roundtable 2004). This implicitly means that higher FDI has caused higher growth 1 . Bajpai and Sachs (2000) advice policymakers in India to throw wide open the doors to FDI which is supposed to bring huge advantages with little or no downside.

Fischer (2002) makes this assumption explicit when stating that greater openness to FDI would permit a significant increase in growth in India.

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SIZE AND MAGNITUDE OF INWARD FDI

Table 3.3: FDI Inward Stock (US$ billion)

Year 1992-97* 1998 1999 2000 2001 2002 2003 2004 2005 2006 World 2662.8 4168.21 4939.44 5810.18 6210.76 6789.2 8185.38 9570.52 10048.01 11998.83 Developing Economies 694.92 1224.05 1558.68 1707.63 1786.91 1727.49 1978.06 2287.69 2621.61 3155.85 India 5.4 14.06 15.42 17.51 20.32 25.4 30.82 38.67 44.01 50.68

* Annual average

Source: World Investment Report, 2007

At the first impression it appears that India is an underperformer in attracting FDI. However, FDI flows are not easy to analyse because they are generally low and fluctuating. Data relating to FDI inflows are underestimated because of their national definition and interpretation. The RBI and SIA, which officially publishes statistics on foreign investment, have, since 1991, only reported the equity component of FDI. And reinvested earnings 2 have not been taken into consideration, though the IMF guidelines estimate that they are a part of FDI inflows. The Indian data on FDI include neither the proceeds of foreign equity listings nor foreign subordinated loans to domestic subsidiaries. Overseas commercial borrowing as well as some depository receipts over 10 percent of the equity coming from the foreign institutional investors are also disregarded (Srivastava, 2003). Hence, there is a lot of scope to bring Indias statistics in line with the international standards.

That is the part of foreign investors profits that are not distributed to share holders as dividends and reinvested in the affiliates in the host country.

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At the end of 2006, Indias stock of inward FDI amounted to US$50.6 billion which is only 0.4 percent of the world stocks, and 1.6 percent of the investments received by the developing countries. It can be seen, however, that Indian stocks were 2.6 times greater in 2006 than in 1998 (table 3.3). In 2004, India held the 15th slot in terms of inward stock among developing nations. (WIR, 2005)

Table 3.4: Inward FDI Flows (US$ Billion)

Year 1992-97* 1998 1999 2000 2001 2002 2003 2004 2005 2006 World 312.23 709.3 1098.89 1411.36 832.56 621.99 564.07 742.13 945.79 1305.79 Developing Economies 114.65 189.64 228.46 256.08 212.01 166.31 178.69 283.03 314.31 379.07 India 1.67 2.63 2.16 3.58 5.47 5.62 4.32 5.77 6.67 16.88

*Annual Average

Source: World Investment Report, 2007

Indian inward FDI flows surged to US$ 6.67 billion in 2005 and US$ 16.88 billion in 2006, which is a record level. It represented 0.7 percent of the world FDI flows and 2.12 percent of the developing economies flows in 2005. However, the ratios improved to 1.29 percent and 4.45 percent in 2006 respectively, which shows marked progress (table 3.4). In 2004, FDI reached a record level of US$ 5.7 billion, and India held the 7th rank among developing countries to attract foreign investors. (WIR, 2005)

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Table 3.5: FDI Inflows in selected Asian developing countries (1990-2004) (US$ billion)
Country China Hong Kong India Indonesia Korea Malaysia Philippines Singapore Srilanka Thailand Developing Economies World 1990 3.48 (1.72) 3.27 (1.62) 0.23 (0.11) 1.09 (0.54) 0.759 (0.37) 2.61 (1.29) 0.55 (0.27) 5.57 (2.76) .043 (0.02) 2.57 (1.27) 35.89 (17.80) 201.59 2004 60.63 (8.16) 34.03 (4.58) 5.77 (0.77) 1.89 (0.25) 8.98 (1.2) 4.62 (0.62) 0.68 (0.09) 19.82 (2.67) 0.23 (0.03) 5.86 (0.78) 283.03 (38.13) 742.13

Source: DIP&P, Ministry of Commerce, 2005 Note: Figures in the parenthesis are % share of the World total

The above table shows that the share of world investment received by India remains weak (0.11 percent in 1990 and 0.8 percent in 2004), however, it is gradually increasing. However, if the distortions in FDI data measurement, as previously mentioned, are taken into consideration, then the actual FDI will be higher than the official figures. If reinvested earnings by foreign firms are added, FDI inflows have to be increased by about US$ 1.8 billion in 2003 and 2004. So, India would have received about US$ 7 billion of FDI in 2004. (RBI bulletin, 2005)

The growing trend in FDI inflows is also pushed by Greenfield investments. The amount of Greenfield investment has risen by 82.8 percent in 2003 with 457 projects, and by 50 percent in 2004 with 685 projects (WIR, 2005). As far as Mergers and Acquisitions by the foreign firms, they amounted to US$ 949 million in 2003 and US$ 1760 million in 2004. (WIR 2005)

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INDICATORS OF FDI PERFORMANCE

1. FDI / GDP Ratio

A good indicator of a countrys openness to FDI is FDI normalized by the size of the host economy which indicates the attractiveness of an economy to draw FDI. Countries vary in their economic and market size and the size of FDI flows should be assessed relative to the size of host economy.

A country with a ratio of FDI to GDP that is greater than unity is reckoned to have received more FDI than that implied by the size of its economy. It indicates that the country may have a comparative advantage in production or better growth prospects reflecting larger market size for foreign firms. However if the country has the ratio value of less than one may be protectionist and backward or may possess a political and social regime that is not conducive for investments. Overall, FDI-GDP ratio is an index of the prevailing investment climate in the host economy.

Table 3.6 gives a picture of FDI as a percentage of GDP for India for some selected years. The share of FDI inflows in GDP has been very small in absolute terms, remaining less than one (2000, 2003, and 2005). However the ratio improved dramatically (1.85) in 2006, which reflects the growth in the domestic economy, improvement in the investment climate as well as the buoyancy in FDI flows.

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Table 3.6: Indias FDI inflows and GDP figures (US$ billion)
Year 1997 2000 2001 2002 2003 2004 2005 2006 FDI 3.57 3.58 5.47 5.62 4.32 5.77 6.67 16.88 GDP Current 410.91 460.19 478.29 507.91 601.86 695.84 805.73 911.81 FDI / GDP (%) 0.86 0.77 1.14 1.1 0.71 0.82 0.82 1.85

Source: World Development Indicators data base, World Bank 2006

2. Inward FDI flows as a percentage of Gross Fixed Capital Formation

A common measure of the relative size of the FDI is the FDICapital Formation Ratio given by the amount of FDI inflows in one year divided by the total fixed asset investments made by domestic and foreign firms in the same year. This measure can provide a crude measure of the importance of FDI in an economys capital formation. The share of inward FDI flows as a percentage of GFCF measures the relative weight of FDI in total aggregate investment taking place in the host economy. Total investment includes both public and private sector investment taking place in the host economy. India is at a much lower rank improving from 0.4 in 1992 to a ratio of 3 in 2003 and then showing a marked improvement reaching to a ratio of 9 in 2006 (table 3.7). This implies that FDI is increasingly playing a greater role in the capital formation of the domestic economy which has implications for the growth prospects.

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Table 3.7: FDI inflows as percentage of GFCF by host region and economy (1992-2006)
Year 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 World 3.2 4.1 4.4 5.3 6 7.5 11.1 16.5 20.6 12.5 9.3 7.5 8.5 10.4 12.6 Developing Countries 5.1 6.5 8.2 8 9.4 11.8 12.9 15.8 16.2 13.7 10.4 9.8 12.9 12.6 13.8 India 0.4 0.9 1.4 2.4 2.9 4 2.9 2.2 3.5 5.1 `5.0 3..2 3.2 3.6 8.7

Source: World Investment Report, 2007

3. Inward FDI Performance Index

The inward FDI performance index of the UNCTAD is an instrument to compare the relative performance of countries in attracting FDI inflows. This measure ranks countries by the FDI they receive relative to their economic size 3 . It is the ratio of a countrys share in global inward FDI flows to its share in global GDP. An index value greater than one indicates that the country receives more FDI than its relative economic size given by its relative GDP, a value below one suggests that it receives less and a negative value means that foreign investors disinvest in that period. This exercise is intended to provide policy makers with data on some variables that can be quantified for a large number of countries. This index thus captures the influence on FDI of factors other than market size, assuming that other things being equal, size
3

The inward FDI performance index is shown for a three year period to offset annual fluctuations in the data. The indices cover 140 economies for as much of the period as the data permit; however, some countries could not be ranked in the early years for the lack of data.

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is the base line for attracting investment. These other factors can be diverse, ranging from the business climate, economic and political stability, the presence of natural resources, infrastructure, skills and technologies, to opportunities for participation in privatization or the effectiveness of FDI promotion 4 .

Table 3.8: Inward FDI Performance Index of some selected countries

Country China Hong Kong India Indonesia Republic of Korea Malaysia Pakistan Philippines Singapore Thailand United States 1988-1990 Rank 46 3 98 56 81 4 72 30 1 17 41 Index 1.033 5.292 0.066 0.794 0.369 4.355 0.493 1.689 13.599 2.562 1.115 1998-2000 Rank 51 2 119 137 91 49 114 87 7 44 78 Index 1.198 6.033 0.155 -0.570 0.587 1.248 0.216 0.641 3.737 1.375 0.805 2000-2002 Rank 50 2 121 121 107 70 116 90 6 80 92 Index 1.331 6.508 0.215 -0.528 0.330 0.923 0.278 0.618 4.755 0.753 0.589

Source: UNCTAD, World Investment Report, various issues

It is evident that India has an index that is significantly lower than a few other EastAsian economies like Singapore, Malaysia, Philippines, Indonesia, and Republic of Korea. The index value remained consistently much below one although it showed a gradual improvement over subsequent periods (table 3.8). This improvement shows that the policy regime in India must be slowly moving towards a more open economy shedding the protectionist economic policies. However, India also shows deterioration in terms of the ranking of the indices. If India has to compete strongly for more FDI then larger reforms are required at the macro economic front.

The Inward FDI Performance Index methodology is given as:

th

INDi = [(FDIi) / (FDIw)] / [(GDPi) / (GDPw)] where i is the i country and w is world as given in World Investment Report.

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4. Inward FDI potential index

The Inward FDI Potential Index 5 of the UNCTAD is an instrument to compare the relative potentials of different countries in attracting FDI inflows on the basis of the selected variables that capture the host of socio-economic factors apart from market size affecting inward FDI flows.

Table 3.9: Inward FDI Potential Index of some selected countries

Country China Hong Kong India Indonesia Republic of Korea Malaysia Pakistan Philippines Singapore Thailand United States 1988-1990 Rank 45 17 72 42 20 38 92 76 13 40 1 Index 0.176 0.355 0.120 0.177 0.312 0.205 0.095 0.110 0.402 0.182 0.727 1998-2000 Rank 42 13 91 85 17 32 129 69 2 53 1 Index 0.255 0.426 0.156 0.161 0.410 0.302 0.103 0.193 0.500 0.225 0.706 2000-2002 Rank 39 12 89 82 18 32 128 57 4 54 1 Index 0.273 0.413 0.159 0.163 0.387 0.292 0.104 0.212 0.465 0.215 0.659

Source: UNCTAD, World Investment Report, various issues Note: The indices are measured on a scale of 0 (minimum potential) to 1 (maximum potential)

Even in the Inward FDI Potential Index India lags behind Singapore, Hong Kong, and Korea among the East Asian countries (table 3.9). The comparative performance of India in the FDI arena is being studied extensively. (Wei, 2000; Srinivasan, 2003; Swamy, 2003; Bajpai and Dasgupta, 2003)

The Inward FDI Potential Index is shown for three year periods to offset annual fluctuations in the data. The index covers 140 economies for the period covered. For the methodology see www.unctad.org

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COMPARING PERFORMANCE AND POTENTIAL

Comparing the two indices a four fold matrix can be drawn up of inward FDI performance and potential:
FDI Performance High Potential High FDI Low Front Runners Above Potential Low Below Potential Under Performers

Front Runners: Countries with high FDI potential and performance. Above Potential : Countries with low FDI potential but strong FDI performance

Below Potential : Countries with high FDI potential but low FDI performance Under Performers : Countries with both low FDI potential and performance

Based on the following matrix, the results for the years 2000-02 and 2005 are given below. Though FDI in India is showing buoyant trends, it is still ranked as an under performer, when the performance and potential is compared with other countries in the world (Box 3.1 & 3.2). This calls for wider and more meaningful reforms to induce capital flows.

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Box 3.1: Matrix of Inward FDI Performance and Potential (2000-2002)

High Performance Front Runners Bahamas, Botswana, Belgium Brazil, and Brunei, Luxembourg, Darussalam, Low Performance Below Potential Australia, Austria, Bahrain, Belarus, Egypt, Greece, Iceland, Islamic Republic of Iran, Italy, Japan, Kuwait, Lebanon, Libyan Arab Jamahiriya, Norway, Oman, Philippines, Qatar, Republic of Korea, Russian

Bulgaria, Canada, Chile, China, Costa Rica, Croatia, Cyprus, Czech Republic, Denmark, Dominican High Potential Republic, Estonia, Finland,

France, Germany, Guyana, Hong Kong (China), Hungary, Ireland, Israel, Jordan, Latvia, Lithuania, Malaysia, Malta, Mexico, Mongolia, Panama, Slovakia, Netherlands, Poland, Slovenia, New Zealand, Singapore, Sweden,

Federation, Saudi Arabia, South Africa, Taiwan Province of China, Thailand, United Arab Emirates and United States.

Portugal, Spain,

Switzerland, Trinidad and Tobago, United Kingdom and Vietnam. Above-Potential Albania, Bolivia, Angola, Colombia, Armenia, Ecuador, Azerbaijan, Gambia, Algeria, Under-Performers Argentina, Bangladesh, Benin,

Burkina Faso, Cameroon, Cote d'Ivoire, Democratic Republic of Congo, El Salvador, Ethiopia, Gabon, Ghana, Guatemala,

Georgia, Honduras, Jamaica, Kazakhstan, Mali, Morocco, Mozambique, Namibia,

Nicaragua, Republic of Congo, Republic of Low Potential Moldova, Sudan, TFYR Macedonia, Togo, Tunisia, Uganda and United Republic of Tanzania.

Guinea, Haiti, INDIA, Indonesia, Kenya, Kyrgyzstan, Madagascar, Malawi,

Myanmar, Nepal, Niger, Nigeria, Pakistan, Papua New Guinea, Paraguay, Peru,

Romania, Rwanda, Senegal, Sierra Leone, Sri Lanka, Suriname, Syrian Arab Republic, Tajikistan, Turkey, Ukraine, Uruguay,

Uzbekistan, Venezuela, Yemen, Zambia and Zimbabwe. Source: UNCTAD.

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Box 3.2: Matrix of Inward FDI Performance and Potential (2005)

High Performance Front Runners Azerbaijan, Bahamas, Bahrain, Belgium, Botswana, Brunei Darussalam, Bulgaria, Chile, China, Croatia, Cyprus, Czech Algeria, Low Performance Below Potential Argentina, Australia, Austria,

Belarus, Brazil, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Islamic Republic of Iran, Italy, Japan, Kuwait,

Republic, Dominican Republic, Estonia, High Potential Hong Kong (China), Hungary, Iceland, Israel, Jordan, Kazakhstan, Latvia,

Libyan

Arab

Jamahiriya,

Mexico,

New

Lithuania, Luxembourg, Malaysia, Malta, Netherlands, Panama, Poland, Portugal, Qatar, Singapore, Slovakia, Thailand,

Zealand, Norway, Oman, Republic of Korea, Russian Federation, Saudi Arabia, Slovenia, Spain, Sweden, Switzerland, Taiwan

Trinidad and Tobago, Ukraine, United Arab Emirates and United Kingdom Above-Potential Albania, Congo, Ethiopia, Angola, Costa Armenia, Rica, Ecuador, Gambia, Colombia, Egypt, Georgia,

Province of China, Tunisia, Turkey, United States and Venezuela. Under-Performers Bangladesh, Benin, Bolivia, Burkina Faso, Cameroon, Democratic Republic of Congo, Cte d'Ivoire, El Guinea, Salvador, Haiti, Ghana, INDIA,

Gabon,

Guyana, Honduras, Jamaica, Kyrgyzstan, Low Potential Lebanon, Mali, Mongolia, Morocco,

Guatemala,

Indonesia, Kenya, TFYR of Macedonia, Madagascar, Niger, Guinea, Nigeria, Malawi, Myanmar, Papua Nepal, New

Mozambique, Namibia, Nicaragua, Republic of Moldova, Romania, Sierra Leone, Sudan, Suriname, Tajikistan, Uganda, United

Pakistan, Peru,

Paraguay,

Philippines,

Republic of Tanzania, Uruguay, Vietnam and Zambia.

Rwanda, Senegal, South Africa, Sri Lanka, Syrian Arab Republic, Togo, Uzbekistan, Yemen and Zimbabwe. Source: UNCTAD.

Following are some of the reasons that can explain the low levels of inward FDI flows registered until recently:

Being a developing country with a low GDP per capita, many illiterate people and poor social and economic infrastructures, India could not attract FDI. India implemented, after its independence an inward looking strategy including planning, nationalization, an import substitution policy, where tax structure was complex and FDI was conditionally tolerated for internal needs and minority shares.

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If some measures of de-licensing were taken in 1985-86, it was mainly in 1991 that India opened up to foreign investment, parallel with liberalisation of the economy. Private and foreign firms were permitted to invest in activities previously reserved for the public sector. FDI was allowed not only for the domestic market but also for exports, investment ceilings were raised; policy environment and procedures were simplified and streamlined 6 . This was beneficial for the Indian economy. However, India began to emerge with inertia.

Until 1992 all the foreign investors in India and the repatriation of foreign capital required prior approval of the government, and the Foreign Exchange Regulation Act rarely allowed foreign majority holdings.

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REGIONAL (COUNTRY WISE) DISTRIBUTION OF FDI

Table 3.10: Share of top investing countries FDI inflows in Rs. Crores (US$ million)
Aug Ranks Country 91 Mar 02 27,446 (6,632) 12,248 (3,188) 5,099 (1,299) 3,856 (986) 4,263 (1,106) 3,455 (908) 1,997 (515) 1,947 (492) 2,189 (594) 1,200 (325) 92,611 (23,829) Apr 02 Mar 03 3,766 (788) 1,504 (319) 1,971 (412) 836 (176) 1,617 (340) 684 (144) 180 (38) 534 (112) 188 (39) 437 (93) 14,932 (3,134) Apr 03 Mar 04 2,609 (567) 1,658 (360) 360 (78) 2,247 (489) 769 (167) 373 (81) 172 (37) 176 (38) 110 (24) 207 (45) 12,117 (2,634) Apr 04 Mar 05 5,141 (1,127) 3,055 (668) 575 (126) 1,217 (267) 458 (101) 663 (145) 822 (184) 537 (117) 157 (35) 353 (77) 17,138 (3,754) Apr 05 Oct 06 5,033 (1,144) 1,498 (340) 410 (93) 70 (39) 845 (192) 170 (39) 660 (150) 36 (8) 251 (57) 171 (39) 11,397 (2,590) Cumulative Inflows (Aug 91 Oct 05) 43,995 (10,358) 19,963 (4,876) 8,416 (2,008) 8,325 (1,956) 7,952 (1,906) 5,346 (1,317) 3,829 (925) 3,229 (768) 2,894 (749) 2,367 (579) 1,48,195 (35,942) Source: DIP&P, Ministry of Commerce,2005 1.93 2.37 2.64 3.13 4.37 6.50 6.80 6.88 16.31 35.95 Percentage with inflow

1.

Mauritius

2.

U.S.A.

3.

Japan

4.

Netherlands

5.

U.K.

6.

Germany

7.

Singapore

8.

France South Korea Switzerland

9.

10.

Total FDI inflows *

* Includes inflows under RBI NRI Schemes, stock swapped and advances pending issue of shares.

FDI inflows show a skewed pattern in terms of their originating destinations. Between 1991 and 2005, investments of 10 countries accounted for 80 percent of FDI, the main investor countries being Mauritius, the USA, the Netherlands, Japan, and the United Kingdom. According to the data relating to the period 1991-2005, Mauritius has been the biggest source of FDI. This could be because of common cultural

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patterns in both the countries and also close political and bilateral ties. Mauritius has low rates of taxation and an agreement with India on double tax avoidance regime. For these reasons, some MNCs set up companies in Mauritius before going to India. Investments from Mauritius take place both in the public 7 and private 8 sector.

Apart from Mauritius, the US is another important investor in India. It contributed about 16 percent of total IFDI between 1991 and 2005. The reason could be that both countries have close relations. The US is the largest trading partner of India and a broad Indian community lives in it. Far behind the USA, Japan (7 percent of FDI inflows received by India), Netherlands (7 percent), U.K. (6.5 percent) are significant investors. Germany follows (4 percent), then Singapore (3 percent), France (3 percent), South Korea (2 percent) and Switzerland (2 percent). The European Unions FDI is higher than that from the US. FDI from Netherlands, United Kingdom, Germany and France registered between 1991 and 2005 accounts for 20 percent of the total (table 3.10).

For instance, it is the case of Life Insurance Corporation, New India Assurance, State Bank of India International, Bank of Baroda, Indian Oil Corporation and so on
8

It is the case, notably, of Infosys, Ajanta Pharma, Apollo Tyres, Pentafour, Arvind Mills, Ashok Leyland and so on.

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Table 3.11: Statement on RBIs regional office-wise (with states covered) FDI equity inflows1 (April 00Feb 08)
% with Ranks RBIs - Regional Office
2

State covered

FDI inflows (in Rs. terms)

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17.

Mumbai New Delhi Bangalore Chennai Hyderabad Ahmedabad Kolkata Chandigarh Panaji Kochi Bhopal Bhubaneshwar Jaipur Kanpur Guwahati Patna

Maharashtra, Dadra & Nagar Haveli, Daman & Diu Delhi, Part of UP and Haryana Karnataka Tamil Nadu, Pondicherry Andhra Pradesh Gujarat West Bengal, Sikkim, Andaman & Nicobar Islands Chandigarh, Punjab, Haryana, Himachal Pradesh Goa Kerala, Lakshadweep Madhya Pradesh, Chattisgarh Orissa Rajasthan Uttar Pradesh, Uttranchal Assam, Arunachal Pradesh, Manipur, Meghalaya, Mizoram, Nagaland, Tripura Bihar, Jharkhand RBIs regions not indicated 3

29.51 20.27 7.15 5.80 4.25 3.78 1.45 0.77 0.44 0.23 0.20 0.17 0.15 0.03 0.02 0.00 25.78

Source: DIP&P, Ministry of Commerce, 2008

1 2

Includes equity capital components only. The Region-wise FDI inflows are classified as per RBIs - Region-wise inflows, furnished by RBI,

Mumbai.
3

Represents inflows through acquisition of existing shares by transfer from residents. For this, Region-

wise information is not provided by Reserve Bank of India.

The regional distribution of FDI inflows in the above table shows highly concentrated patterns. Eight regional offices received around more than 70 percent of Indian FDI inflows. Mumbai, New Delhi and their surroundings include almost the half of the FDI received by India since 2000. The areas of Bangalore and Chennai with almost 7

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percent and 6 percent each respectively lag behind. Then there are places surrounding Hyderabad (4 percent) and Ahmedabad (4 percent).

Most software companies are in Mumbai and Bangalore where the Indian Industry originally developed, but they are also developing quickly in Delhi and its surroundings as well as in Andhra Pradesh and Tamil Nadu .As to the main poles of competitiveness, they are mainly concentrated in the South on the axis of Madras and Bangalore, and around Delhi and Mumbai.

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Table 3.12: Sectoral Analysis of FDI Inflows

Amount of FDI Inflows Apr Ranks Sector 02 Mar 03 Electrical Equipments 1. (incl. computer software & electronics) 2. Transportation Industry 3,075 (644) 2,173 (455) Services Sector 3. (financial & nonfinancial) Telecommunications 4. (radio paging, cellular mobile, basic telephone services) 5. Fuels (Power + Oil Refinery) Chemicals (non-fertilizers) Food Processing Industries Drugs & Pharmaceuticals Cement and Gypsum Products Metallurgical Industries 551 (118) 611 (129) 177 (37) 192 (40) 101 (21) 222 (47) 521 (113) 94 (20) 511 (111) 502 (109) 44 (10) 146 (32) 759 (166) 909 (198) 174 (38) 1,343 (292) 1 (0) 881 (192) 150 (34) 856 (194) 158 (36) 499 (114) 1,970 (452) 560 (126) 10,711 (2,521) 7,456 (1,890) 4,678 (1,173) 4,051 (949) 3,231 (747) 2,695 (627) 8.41 1,058 (223) 532 (116) 588 (129) 886 (198) 12,199 (2,890) 9.58 1,551 (326) Apr 03 Mar 04 2,449 (532) 1,417 (308) 1,235 (269) Apr 04 Mar 05 3,281 (721) 815 (179) 2,106 (469) Apr 05 Dec 06 3,796 (841) 830 (187) 2,035 (462) Cumulative Inflows (Aug 91 Dec 05) 21,006 (4, 886) 13,162 (3,143) 12,274 (2,972) Percentage with inflow

16.50

10.34

9.64

6.

5.86

7.

3.67

8.

3.18

9.

2.54

10.

2.12

Source: DIP&P, Ministry of Commerce, 2008

Between 1991 and 2005, most of the FDI received by India was mainly in manufacturing. Notably sectors such as electrical equipment (including computer software and electronics) received 17 percent of FDI inflows, transportation industry (11 percent), telecommunications (10 percent), fuels (9 percent) and chemicals (6 percent). Services accounted for 10 percent (table 3.12). In recent years some sectors such as electrical equipment, services, drugs and pharmaceuticals, cement and gypsum products, metallurgical industries have shown impressive results.

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Since 2002, services hold the third rank in attracting FDI. Business services (IT, software, financing, insurance, real estate, etc) are gathering momentum. India is the main destination for off-shoring of most services as back office processes, customer interaction and technical support, R&Ds 9 (WIR, 2005). According to the data

provided by OCO consulting (2005), India is by far the country which attracted the greatest number of projects in IT and software. Since 2002 of 1913 projects observed, it attracted 519 10 , which is 27 percent.

Table 3.13: Changes in FDI Stocksa and Output Growthb in Major Sectors (87 04)
19871991 All Sectors FDI Output Primary Sector FDI Output Manufacturing Sector FDI Output Services Sector FDI Output 1.41 6.8 3.14 7.1 56.06 7.9 N.A. 7.8 1.24 5.6 2.05 9.8 2.03 5 N.A. 6.6 1.35 5 1.65 3.6 1.17 2.7 N.A. 2.6 1.26 6 2.07 6.4 6.39 5.9 N.A. 6.3 19911995 19952000 20002004

a Ratio final over initial year of the respective period b Annual growth rate of GDP and contribution to GDP respectively in constant prices c Includes electricity, gas and water Source: UNCTAD 2000; Central Statistical Organisation; Reserve Bank of India (Database on Indian Economy).

Among them we find, abstracting, and indexing, call centers, data entry and processing, electronic publishing, mailing list management, secretarial services, technical writing, telemarketing, web site design, interpretation of medical scans, flight reservations and so on. (WIR, 2005)
10

Among them are notably investments by Microsoft, Oracle, Syntel, SAP and Cybernet Software Systems.

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FDI and Output trends for major sectors are given in table 3.13. Output growth showed a declining trend in the primary sector despite the relatively strong increase in FDI during 1991-95. The manufacturing sector experienced temporary growth acceleration after reforms in 1991 when FDI stocks doubled. However, output growth in manufacturing weakened between 1995-00, even though the FDI stocks continued to rise. Patterns within the manufacturing sector are too diverse to reveal a clear picture of the links between FDI and output growth.

The services sector reported relatively high output growth even before the FDI boom started. Increasing FDI stocks since the mid-nineties were matched with higher output growth. These results could imply that FDI was attracted to the service sector by its favourable growth performance and at the same time was a stimulus to a better performance (table 3.13).

Survey data compiled by the RBI (various issues) on the FDI companies indicate that in addition to the increased significance and changing composition of FDI, the type and character of FDI has changed in several respects since the reform program of 1991.

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Table 3.14: FDI Characteristics (9091, 0203)

Imports of Raw Imports of materials, Export % of Capital Goods prod. Exports / (% of total Stores & Spares Imports (% of imports) indigenous) Royalty Payments (% of prod.) 1990-1991 All industries Memorandum Salaries R&D (% (% of prod. of prod.) Companies of Val No. prod. (all industries= 100)

9.3

1.3

20

0.11

0.09

300

100

Tea plantations 13.7

95.7

18.4

0.5

17

24

6.3

Textiles 16.4

3.5

19.5

18.7

0.04

14.4

Rubber products 11.2

1.7

7.2

12.8

0.01

7.9

3.5

Chemicals 9.5 1.2 2.9 23.3 0.02 0.06 2 63 29.3

Engg.

0.8

12.3

26.6

0.24

0.14

9.5

126

38.7

Trade

16.3

2.1

61.6

0.3

0.05

7.4

0.7

2002-2003 All industries 14.8

1.3

7.7

20.6

0.26

0.38

8.3

490

100

Tea plantations 22.4

49.3

9.8

1.5

0.05

37.2

10

91

Food products 8.9

2.9

5.1

4.6

0.01

0.09

5.6

16

3.3

Rubber / Plastic 16.4 products

1.9

16.2

18.8

0.21

11

Chemicals 11.8 0.9 3.4 23.6 0.28 0.39 5.7 76 28.2

Engg.

11.1

0.9

9.2

22.7

0.49

0.65

8.7

153

26.3

Machinery & tools 13.5

3.4

23.8

0.27

0.68

9.5

85

8.5

Elect. & Mech. 11.4

0.8

6.7

30.4

0.25

0.47

7.5

33

5.9

Transportequip ment 9.2

16.9

18.6

0.76

0.72

8.8

35

11.9

Computer& related 12.7 act.

74.8

0.05

0.77

31.8

23

4.4

Trade

19.9

1.4

0.5

0.01

1.8

9.3

20

1.2

Source: Reserve Bank of India (Database on Indian Economy)

Facts and figures point to an increased world market orientation of FDI. Exports accounted for almost 15 percent of production by all FDI companies surveyed in 2002-03, compared to less than 10 percent in 1990-91. Accordingly, FDI in India continues to be motivated by serving local markets in the first place. However there is a rise in the export orientation of the Indian companies which may have favourable

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effects on Indias economic development. The increasing export orientation of FDI appears to be due to two factors:

a. The emergence of new industries that attracted FDI (notably computer and related activities). b. Rising shares of exports in the production of industries in which FDI has a longer tradition (such as tea plantations, rubber products, and engineering).

Overall imports increased by the same order as exports, leaving the ratio of exports to imports constant. However, import of capital goods still account for a minor share in overall imports, though this share still varies widely across industries. As a consequence, the extent to which India may benefit from technology transfers embodied in imports of capital goods seems to be limited. On the other hand, concerns that rising imports by FDI companies would crowd out local suppliers seem to be unfounded. The ratio of imported to indigenous supplies of raw material, stores and spares is more or less constant 11 when comparing this indicator for all surveyed FDI companies in 1990-91 and 2002-03.

Another

major

change

in

FDI

characteristics

concerns

its

technological

sophistication. This has two aspects. First, rising payments of royalties suggest that FDI companies have increasingly transferred foreign technologies which may support Indias industrial upgrading. In 1990-91, such transfers were largely confined to FDI in engineering. They still figure most prominently in this area, with transport equipment standing out with the highest ratio of royalties to production by far. However, other industries notably the chemical industry has also drawn increasingly on technologies available abroad. The second aspect relates to R&D undertaken by
11

In addition, FDI in financial services gained considerably in importance. By contrast, FDI stocks in services such as electricity and water distribution, trade, and transport and storage continued to be of minor importance.

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FDI companies in India. Measured as a percentage of production, local R&D has gained in significance by still more than transfers of foreign technology. This applies to all industries for which the data is available. Yet local R&D is concentrated in exactly the same industries, namely chemical and engineering which stand out in terms of transfers of foreign technology. This strongly suggests that transfers of foreign technology and local R&D represent complementary means for industrial upgrading, rather than the former substituting the latter (table 3.14).

EXPLAINING INDIAN INWARD FDI

Liberalisation has been combined with globalization, thus benefiting from the international context of deregulation, lower transport costs, and rapid expansion of internet. Growing international division of labour and fragmentation of MNCs has also proved beneficial. Since 2000 India has kept pace with some other more conspicuous developing counties such as the Asian dragons, Brazil and China.

India is becoming an attractive location for global business on account to its buoyant economy, its increasing consumption market, infrastructure growth and cost efficiency. According to experts and MNC managers, India is ranked just behind China and behind or on equal terms with U.S (WIR, 2005) 12 This trend was again recently confirmed by AT Kearneys FDI Confidence Index 13 Though literacy and education rates are comparatively at a lower level, however, when human resources are normalized by population size, this factor does not remain a deterrent. Indeed, Indian skills in research, product design, and customization of services, are acknowledged. India has one of

12

.In response from experts, China is the favourite destination (85percent), followed by the US (55percent), and India (42 percent). In the responses from MNCs China comes first (87percent), followed by India (51 percent), and the US (51 percent).
13

This index tracks investor confidence among global executives to determine their order of preference.

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the largest pools of scientists, engineers, and technicians in the world, particularly in information technology, with competitive wage levels when compared to those of industrial countries and the use of English in business and technical and managerial education. In the eighties some foreign companies such as Texas Instruments, (semiconductor design) and Astra-Zeneca biopharmaceuticals were pioneers in research activity in India. They were followed in the nineties by groups such as Motorola (telecommunication software), Microsoft (computer operating systems), ST Microelectronics (semiconductor design), DaimlerBenz (avionics system), and Pfizer (biometrics). Nowadays more than 100 MNCs 14 run research activities in India and their number is growing fast. The availability of qualified workers, the existence of internationally reputed R&D institutes (Indian Institute of Technology, Indian Institute of Science, Indian Institute of Chemical Technologies, Center for Drug and Research etc), and the emergence of many Indian firms as service providers or as partners 15 contributed to attract MNCS in India to perform R&D. On account of its cost advantages, India is nowadays the third destination for R&D, just behind China and the US (WIR, 2005). It also benefits from the fact that the kind of R&D that is suited for expansion in developing countries is not very different from that which may be kept at home. (WIR, 2005). Being the second most populous country in the world, India is also attractive for market seeking FDI. Half of the population is under 25 years of age. Indias consumer market is growing quickly with an average of 12 percent a year. Living standards are rising, a vibrant middle class estimated to be 300

14

For e.g. we can quote General Electric, Intel, Casio, Hewlett-packard, IBM, Lucent, Boeing, ZTE, Huawei, Flextronics, or pharmaceutical companies such as Eli Lily, Glaxo Smithkline, Novartis, SanofiAventis.
15

Indian software companies like TCS, Wipro, and Infosys have alliances with Ericsson, Nokia, and IBM.

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million with spending power is emerging in cities and infrastructure needs are tremendous. India is a more and more active partner in regional arrangements and agreements such as ASEAN 16 , Gulf Cooperation council, BIMSTEC 17 , South Asia Free Trade Area, Indian Ocean Rim Association for regional Cooperation and SAARC 18 . Since 2000 India has signed, many bilateral investment and trade agreements as well as double taxation treaties with increasing number of countries that stimulated exports and investments (elimination of quotas, reduction of customs duties) 19. FDI is now freely allowed in many sectors 20 with automatic approval 21 , freedom of location and choice of technology. Imports and exports, repatriation of profits, dividends and capital are also free 22 . Also IPRs are guaranteed. Since November 2005, FDI is allowed up to 100 percent in most activities under the automatic route 23 . The government also aims to attract foreign investments by setting up Special Economic Zones 24 , Science Parks and Free Trade and Warehousing Zones 25 . The Indian Investment Commission is charged with the

responsibility of wooing investors 26 . Foreign investment is particularly sought after in power generation, telecommunications, ports, roads, petroleum exploration and processing and mining. A ten year tax holiday is offered to
16 17 18

. Cambodia, Laos, Malaysia, Philippines, Singapore, Thailand, Vietnam, Myanmar Including since 1997, Bangladesh, India, Myanmar, Sri Lanka, Thailand Economic Cooperation and Bhutan and Nepal since 2004. South Asian Association for Regional Cooperation
19

Such a trend was reinforced by the end of textiles and clothing quotas (UNCTAD 2005)
20

Sectoral ceilings remain in some activities

21

Initially FDI approval relied on matching exports and dividend repatriation. In July 1991, this approval became automatic in 34 industries designated high priority, up to an equity limit of 51 percent.
22

Recently foreign equity ceilings in aviation services, private banks, non news print publications and the petroleum industry have been adjusted.
23

Without any prior approval

24

For e.g. export oriented units and units in export processing zones benefit of tax holiday (100 percent) for 5 years.
25

In free trade warehousing zones, FDI is permitted up to 100 percent.

26

The Foreign Investment Promotion Board is a one stop service center and facilitator for FDI.

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companies applications.

engaged

exclusively

in

scientific

R&D

with

commercial

Foreign trade also increased although its share in world exports remains low 0.8 percent for merchandise exports (ranked 30) and 1.7 percent for services trade in 2004 (rank 16). In 2004 exports grew by 30 percent for merchandises to reach US$ 75.5 billion 27 and by about 70 percent for commercial services to reach US$ 39.5 billion (WTO, 2005).

Since the end of nineties the dynamism of services and high tech sectors have contributed to modernize the Indian economy and to boost international trade and investments. Policies implemented have been decisive to support information and communication technology industries as well as the pharmaceutical and

biotechnology sector. Thus India became well known all around the world for its services and software activities. Between the beginning of nineties and 2005, computing and information technology services registered an annual growth rate of 8-9 percent. In 2005 it accounted for 5 percent of Indian GDP. Such dynamism created many jobs, gave confidence to entrepreneurs and attracted many MNCs which started to outsource their business process to India.

ECONOMIC REFORMS SOME MILESTONES

Following are some of the measures taken by the government to boost the inflows of FDI in the country:

27

Gems and Jewellery, engineering goods, petroleum products, ores and minerals, and chemicals and related products were key drivers of Indian exports.

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1. Abolition of industrial licensing, except in few strategic sectors. 2. Foreign Direct Investment up to 100 percent allowed in most sectors under the Automatic Route 3. Rationalization of both indirect and direct tax structure. 4. Portfolio investments by foreign institutional investors allowed in both equity and debt markets. 5. Rupee made fully convertible on trade account. 6. Removal of quantitative restrictions on imports. 7. Financial sector reforms and decontrol of interest rates. 8. The Fiscal Responsibility and Budget Management (FRBM) Act enacted in 2003

Box 3.3: Various incentive schemes for attracting FDI

100 State Government percent profit deduction for developing, maintaining and operating infrastructure facilities. Central Tax exemption of 100 percent on export profits for 10 years. Government Investment Deduction in respect of certain inter-corporate dividends to the extent of dividend declared. Investm ent Incentives Various capital subsidy schemes and fiscal incentives for expansion in the north eastern region. Incentives Tax deduction of 100 percent on profits for 5 years and 50 percent for the next two years for undertakings in the special economic zones. Single window approval system for setting up industrial units. Electricity duty, registration fee, and stamp duty exemptions. Reservation of plots for NRIs, EOUs and foreign investment projects. Rebate on land costs, tax concessions and octroi refunds Interest rate and fixed capital subsidy.

Box 3.4: Liberalisation of FDI policy

Pre 1991 Allowed selectively up to 40 percent 1991 Up to 51 percent under Automatic Route for 35 priority sectors 1997 Up to 74 / 51 / 50 in 111 sectors under Automatic Route, 100 percent in some sectors 2000 Up to 100 percent under Automatic Route in all sectors except a small negative list Post 2000 More sectors opened, equity cap raised, conditions relaxed, foreign exchange management

Source: Compiled from Media Reports

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SECTION 3.3

FINDINGS AND CONCLUSIONS

This chapter has examined the growth patterns and changing nature of Indian inward Foreign Direct Investment, with an emphasis on the post liberalization period, since FDI, along with trade, has been an important mechanism which has brought about a greater integration of the Indian economy with the world economy. The changing patterns reflect the growing investor confidence in the country.

India is growing at an average growth rate of close to 6 percent a year since 1980, with some evidence that growth is accelerating and can be sustained at 8 percent a year in the coming decades. With population of 1.1 billion in 2003, India presents a huge and fast growing domestic market for a range of goods and services, and thus export opportunities for producers in the rest of the world. Large and growing market opportunities in India are widely seen, as evidenced by the large flows of foreign direct investment, attractive both for production for the domestic market, and also to use exports to the rest of the World.

Inward FDI has boomed in post-reform India. The Indian government policy towards FDI has changed over time in tune with the changing needs in different phases of development. The changing policy framework has affected the trends and patterns of FDI inflows received by the country. At the same time, the composition and type of FDI has changed considerably. Even though manufacturing industries have attracted rising FDI, the services sector accounted for a steeply rising share of FDI stocks in India since the mid-nineties. Thus, although the magnitude of FDI inflows has increased, in the absence of policy direction the bulk of them have gone into services

99

and soft technology consumer goods industries bringing the share of manufacturing and technology intensive among them down. In terms of investing countries, it can be noted that there is a high degree of concentration with more than 50 percent of the investment coming from Mauritius, U.S and Japan. Also, while FDI in India continues to be local market seeking in the first place, its world-market orientation has clearly increased in the aftermath of economic reforms. Thus while the growth of FDI inflows to India seem to be fairly satisfactory; Indias share in the global FDI regime is still minuscule. This calls for further liberalisation of norms for investment by present and prospective investors. It underlines the need for efficient and adequate infrastructure, availability of skilled and semiskilled labour force, business friendly public administration and moderate tax rates.

Opening up the Indian economy and the resulting FDI flows have really created new opportunities for Indias development and boosted the performances of local firms as well as the globalization of some of them. Such a trend has undeniably raised Indians stature among developing countries.

However, the potential of the country to catch up the levels of the leading economies in the coming decades, often touched on, is not quite guaranteed. India has an extremely hard job to perpetuate its advantages, to achieve further productivity gains and to ensure that all segments of its population participate in the income growth.

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REFERENCES

1. Bajpai, N. and N. Dasgupta (2003). Multinational Companies and Foreign Direct Investment in India and China, Columbia Earth Institute, Columbia University. 2. Bajpai, N., and J.D. Sachs (2000). Foreign Direct Investment in India: Issues and Problems in Development Discussion Paper 759, Harvard Institute for International Development, Harvard University, Cambridge. 3. Chakraborty, C., and P. Nunnenkamp (2006). Economic Reforms, Foreign Direct Investment and its Economic Effects in India, Kiel working paper no.1272, Kiel Institute for the World Economy, Duesternbrooker Weg 120, 24105, Kiel, Germany. 4. Central Statistical Organisation (CSO), Ministry of Statistics and Programme Implementation, Government of India, various issues. 5. IBEF (2006). Indian Brand Equity Foundation, www.ibef.org 6. International Monetary Fund, Balance of payments Year book, 2005. 7. Ministry of Finance, Department of Economic Affairs, Government of India, http://finmin.nic.in. 8. OCO consulting (2005), LInde, grande puissance mergente, Questions Internationales, n15, September-October. 9. RBI Bulletin (2005), Reserve Bank of India, www.rbi.org.in 10. RBI, Data Base on Indian Economy, Reserve Bank of India, various issues. 11. Secretariat of Industrial Assistance, Department of Industrial Policy and Promotion, Ministry of Industry, Government of India, various issues. www.dipp.nic.in 12. Srinivasan, T.N. (2003). China and India: Economic Performance, Competition, and Cooperation, An Update, Stanford Center for International Development, Working Paper Series, December.

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13. Srinivasan, T.N. (2006). China, India and the World Economy, Working paper no. 286: 7, Stanford Center for International Development, Stanford University. 14. Srivastava S. (2003). What is the true level of FDI flows to India? Economic and Political Weekly, February 15. 15. Swamy, S. (2003). Economic Reforms and Performance: China and India in Comparative Perspective, Konark Publishers Pvt. Ltd., New Delhi. 16. UNCTAD (2000), online data base, www.unctad.org 17. WIR (2004). The Shift Towards Services, World Investment Report, UNCTAD, United Nations, Geneva. 18. WIR (2005). TNCs and the Internalisation of R&D, World Investment Report UNCTAD, United Nations, Geneva. 19. WIR (2007). Transnational corporations, Extractive Industries and Development, World Investment Report, UNCTAD, United Nations, Geneva. 20. Wei, S. (2000). Sizing up Foreign Direct Investment in China and India, Stanford Center for International Development, Working Paper Series, December. 21. World Development Indicators, Data Base, 2006, World Bank. 22. World Bank (2004). India: Investment Climate and Manufacturing, South Asia Region, World Bank. 23. World Bank (2006), www.worldbank.org 24. WTO (2005). International Trade Statistics, World Trade Organization, Geneva.

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CHAPTER 4 TRENDS AND PATTERNS OF OUTWARD FOREIGN DIRECT INVESTMENT

Increasing outward foreign direct investment from some developing countries, especially in Asia, over the past decade, represents another and perhaps more dynamic aspect of their growing economic integration with the world economy, in addition to their deepening trade linkages and FDI inflows. In view of this, the objective of this chapter is to evaluate the outward FDI from India in light of the IDP (Investment Development Path) version as given by John Dunning and also to analyze the major motivations and implications for these investments. This is done by analyzing the trends and patterns in the FDI flows of India indicating their motive for supporting non-price competitiveness and also examining the government policy change towards outward flows.

The present chapter analyses the trends and patterns of outward FDI flows from India, focusing specially on the period of post liberalisation .The issues that have been studied in this chapter are as follows:

The comparative standing of India among developing countries. The pattern of destination countries of Indian FDI flows. The nature of change in the sectoral composition of FDI flows from India. The structure of cross border mergers and acquisitions from India. The FDI flows as a percentage of GDP and GFCF. FDI performance v/s potential in India. Major policy initiatives taken to boost FDI out flows.

Two major questions are addressed here: Whether the OFDI from India has undergone a fundamental shift that might be considered as a distinct second wave of OFDI, which differs substantially from the first wave?

103

Whether this new wave can be successfully explained within the framework of the IDP (Investment Development Path)?

As regards the outward foreign direct investment from India, the hypothesis examined is as follows:

Outward FDI from India has undergone a fundamental shift, which can be successfully explained as stage two, within the framework of the Investment Development Path.

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SECTION 4.1

EXPLAINING THE INVESTMENT DEVELOPMENT PATH

The level of development of an economy is an important determinant of FDI as propositioned by Dunning. It explains how the net outward investment position of a country is related to the various stages of development. Using data on the flows of FDI and per capita GDP of sixty-seven countries covering the period 1967-1975, Dunning has shown that after per capita income reaches a threshold limit, further increases are associated with rising gross outward and gross inward investment but the shape of net outward investment takes a U or J type shape.

Earlier the countries were divided into four stages of development defined by the average per capita income range. However, the concept of Investment Development Path (IDP) has been revised and extended in several papers and books (Dunning 1986, 1988, 1993; Narula, 1993, 1995; Dunning and Narula 1994, 1996). According to the revised studies there are five stages of development outlined below:

Stage I

There is no gross outward investment either because the countrys own enterprises have no specific advantages, or are exploited by minority direct investment. Smallness of gross inward investment may be due to small market size, poor infrastructural facilities and lack of trained and educated workforce.

105

Stage 2

Inward investment is more which leads to expanding the domestic market. Outward investment is small as the domestic enterprises are yet to fully develop the Ownership specific advantages. Frequently inward foreign investment is stimulated by host governments imposing desirable tariff and non tariff barriers. A country must posses some desirable Locational (L) characteristics to attract inward direct investment, although the extent to which the foreign firms are able to exploit these will depend upon its development strategy and the extent to which it prefers to develop technological capabilities of the domestic firms. The extent to which outward direct investment is undertaken will be influenced by home country induced push factors such as subsidies for exports and technology development or acquisition, as well as the changing Locational advantages such as relative production costs.

Stage 3

In this stage a country begins to get specialization in direct investment. The country seeks to attract inward direct investment in those sectors in which the comparative Locational advantages are strongest and comparative Ownership advantages of its enterprise are the weakest. Countries in this stage are marked by a gradual decrease in the rate of growth of inward direct investment, and an increase in the rate of growth of outward direct investment that results in increasing NOI (Net Outward Investment). Comparative advantages in labour intensive activities will deteriorate, domestic wages will rise, and outward direct investment will be directed more to countries at lower stage in their Investment Development Path. The original Ownership advantages of foreign firms also begin to be eroded as domestic firms acquire their own competitive advantages and compete with them in the same

106

sectors. The role of government induced advantages is likely to be less significant in this stage as those of FDI induced Ownership advantages take on more importance.

Stage 4

It is a situation in which local firms develop strong Ownership advantages to be reaped best through Internationalization of foreign investment abroad. Firms are induced to invest abroad due to rising domestic labour costs and lower rates of productivity.

Stage 5

During this stage, The NOI position of a country first falls and later fluctuates around the zero level. At the same time both inward and outward FDI are likely to continue to increase. This is the scenario which advanced industrial nations are now approaching. Stage 5 of the Industrial Development Path represents a situation in which no single country has an absolute hegemony on created assets. Moreover the Ownership advantages of the MNCs will be less dependent on their countrys natural resources but more on their ability to acquire assets and on their ability of firms to organize their advantages efficiently and to exploit the gains of cross border common governance.

EXPLAINING OLI (OWNERSHIP, LOCATIONAL, INTERNALISATION) THEORY

Dunning developed the idea of firm-specific advantages further resulting in the socalled OLI (Ownership, Locational, Internalisation) paradigm of FDI, also known as

107

the Eclectic Theory of FDI. This paradigm was presented in Dunning (1977). The contribution of the OLI paradigm is that it provides a framework for a discussion of the motives for FDI. It also allows for a discussion of the choice of an MNC between licensing, exports and FDI in order to serve a foreign market. This choice is determined by Ownership advantages, Location advantages and Internalisation advantages, thus the acronym OLI.

Ownership Factors

Ownership advantages are based on the concept of firm-specific advantages. To cancel out the disadvantage of operating in a foreign country, a firm must possess an ownership advantage. The ownership advantage comes in the form of an asset reducing the firms production cost and allows it to compete with domestic firms in the foreign economy despite the information disadvantage. Ownership advantages come in the form of assets such as patents, management or technology. In order to provide an ownership advantage, the possessing firm has to be able to exclude competing firms from using the asset. To create conditions for FDI, ownership advantages also have to be transferable to a foreign country and possible to use simultaneously in more than one location, to create conditions for FDI.

Locational Factors

Locational advantages determine how attractive a location is for production. A strong location advantage reduces a firms production costs in that location. Location advantages can never be transferred to another location but can be used by more than one firm simultaneously. For example, a supply of cheap labour can provide a location advantage for several labour-intensive firms. If the home country provides the strongest location advantage to the firm, FDI does not take place. Instead,

108

production is located in the home country, and the output is exported in order to meet demand in the foreign economy.

Internalisation Factors

The existence or non-existence of an Internalisation advantage determines how the MNC chooses to use its Ownership advantage. Internalisation gains concern those factors which make it more profitable to carry out transactions within the firm rather than to rely on external markets. Such gains arise from avoiding market imperfections like uncertainty, economies of scale, problems of control etc. Existence of an Internalisation advantage implies that the firms most efficient alternative of using an ownership advantage is through exports or FDI. If an internalization advantage is missing, it is more profitable for the firm to exploit its ownership advantage through selling the right of its use to another firm through licensing. Existence or non-existence of an Internalisation advantage determines a MNCs choice between own production and licensing of the production to an external firm.

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SECTION 4.2

TRENDS AND PATTERNS OF OUTWARD FDI

Table 4.1: Outward FDI world and developing countries (US$ billion)
Item World Outward FDI flows Outward FDI flows from developing economies of which: South Africa Brazil China Korea India Singapore Russian Federation World outward FDI stock Income on outward direct investment Cross border M & As Total assets of foreign affiliates Exports of foreign affiliates Employment of foreign affiliates (in thousands) Value at current prices 2004 877 117 1.4 9.8 5.5 4.7 2.2 8.1 13.8 10325 607 381 42807 3733 59458 2005 837 116 0.9 2.5 12.3 4.3 2.5 5.0 12.8 10579 845 716 42637 4197 63770 2006 1216 174 6.7 28.2 16.1 7.1 9.7 8.6 18.0 12474 972 880 51187 4707 72627

Source: RBI Bulletin 2008 and WIR 2007

According to the UNCTAD's World Investment Report (2007), the global outward FDI amounted to US$ 1,216 billion in 2006, recording a significant growth from US$ 230 billion in 1990. The global outward FDI stock stood at US$ 12,474 billion in 2006, as compared with US$ 1,815 billion in 1990. OFDI from developing economies amounted to US$ 174 billion in 2006, representing about 14 percent of world outward FDI flows (US$ 1,216 billion). (Table 4.1)

UNCTADs World Investment Report 2004 noted that India stood out among Asian developing countries, not only because of the recent significant increase in the OFDI flows but also because of its potential to be a large outward investor with annual

110

outflows averaging US$ one billion during the period 2001-2003 (UNCTAD 2004). A growing number of Indian enterprises are beginning to see OFDI as an important aspect of their corporate strategies and are emerging as MNCs in their own right.

Table 4.2: FDI outflows originating in developing countries 1982-2007 (US$ million)
1982-1987 Ann. Avg Global outflows (World) Developing Countries percent Share 3760 5 11913 5 13490 7 55079 15 52820 10 115860 12 69369 229598 195516 363251 492622 837194 1990 1991 1995 1990-2000 Ann. Avg 2005

Selected Asian Developing Countries China Hong Kong Rep. of Korea Malaysia Singapore Taiwan Thailand India 333 106 178 162 29 3 830 2448 1052 129 2034 5243 154 6 913 2825 1489 175 526 2055 183 -11 2000 25000 3552 2488 6787 2983 887 119 2195 20393 3101 1550 4757 3777 370 110 12261 27201 4298 2971 6943 6028 503 2495

Source: WIR 2007, UNCTAD

Table 4.2 summarizes the data on the global outflows of FDI. It shows that the developing countries which contributed just 5 percent of the global FDI flows in early eighties currently provide around 12 percent of the global flows. It can be said that the bulk of these flows originate in the developing countries in the east, south east and south Asian countries, which contribute around 90 percent of all FDI outflows originating in the developing countries (WIR, 2007). However, it must be mentioned that this increase is also on account of a big increase in the annual outflows of FDI from Hong Kong which have increased rapidly from 1995 onwards. It can be seen that Hong Kong accounts for the highest share among the developing countries (23 percent). This can account for the overblown nature of the FDI flows. However, the

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data shows the emergence of countries like Korea, Taiwan, China, Malaysia, and India each providing more than about US$ 7 billion in annual outflows. This is an impressive amount considering the fact that the inflows of FDI to all the developing countries averaged around US$ 30 billion in a year.

EVOLUTION OF INDIAN OUTWARD FDI

Indian firms have been investing abroad for a long time; however, it is only in recent years that Indian OFDI has become more notable. The evolution of OFDI flows from India can be divided in the pre liberalisation period and post liberalisation period. Changes in the nature of Indian OFDI flows can be explained in terms of size and growth, geographical spread, sectoral characteristics, pattern of ownership and motivations (Box 4.1 & 4.2). This classification explains how the liberalisation policies have affected the quantum, character and motivations of OFDI flows.

Based on the nature and cross-border production activities undertaken by Indian firms, the emergence of OFDI from India can be divided into three distinct periods:

1. From 1975 to 1990 (Pre-Liberalisation period) 2. 1991 onwards (Post-Liberalisation period) 3. 2001 onwards (Post Second Generation Reforms)

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Box 4.1: Characteristics of India OFDI Pre-liberalisation to Postliberalisation

Pre-Liberalisation (1975-1990) 1.OFDI was largely led by the manufacturing sector 2. Developing countries were the dominant host 3. Indian equity participation was largely minority owned 4. Reasons for OFDI were access to larger markets, natural resources, and escaping from government restrictions on firm growth in domestic market Post-Liberalisation (1991 onwards) 1. OFDI originated from all the sectors of the economy, but the service sector is the dominant 2. Emergence of developed countries as host countries 3. Indian equity participation is largely majority owned 4. Reasons for OFDI are market seeking to acquire strategic assets like technology, marketing and brand names, efficiency seeking and to establish trade supporting networks

Box 4.2: Characteristics of Indian OFDI at different stages of the IDP

Pre-Liberalisation (stage 1) Regional FDI
Destination

Post-Liberalisation (stage 2) Majority still regional but expanding to global basis In developing countries -

Post 2nd Generation Reforms (stage 2) Large share of developed countries

(Neighbouring and other developing countries)

Resource seeking and

Motivation

resource and market seeking In industrialized countries asset seeking and market seeking

Efficiency seeking Motivation aimed at optimizing use of countrys comparative and competitive advantage

market seeking in developing countries

In developing countries Types of OFDI

In developing countries - natural asset intensive In developed countries assembly type market seeking and asset seeking investment

Capital and knowledge intensive sectors. Capital / Labour ratio dependent on natural created assets of host

natural asset intensive, small scale production in light industries

Ownership Advantages (OA)

Primarily Country of Origin specific: Basic OA Both Firm and Country specific

Mainly Firm Specific Advanced OA

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Conglomerate group ownership, Conglomerate group ownership, technology,

Examples of Ownership Advantages

Large size economies of scale, access to capital markets, technology, product differentiation, marketing know how, cross country management skills, globally efficient intra firm activity, vertical control over factor and product-markets
Adapted from John Dunning

management adapted to third world conditions, low cost inputs, ethnic advantages, product differentiation, limited marketing skills, vertical control over factor an product market, subsidized capital

management adapted to third world countries, low costs inputs and ethnic advantages

SIZE AND MAGNITUDE OF INDIAN OFDI FLOWS

Analysing the growth trends, the nineties represents a structural period in the emergence of Indian OFDI with an upward shift in the quantum of outward investment, numbers of approved OFDI applications and numbers of outward investing Indian firms as can be seen from the following table:

Table 4.3: Indian OFDI Stock 19762006 (US$ million)

Number of Approvals 133 204 208 214 1016 2204 8620 OFDI Stock (US$ million) Approved Value 38 119 90 NA 961 4151 16395 % Change ----213 -24 ----------332 295 Value 17 46 75 NA 212 794 8181 Actual % Change ----171 63 ------275 930

Year

1976 1980 1986 1990 1995 2000 2006

Source: Pradhan, 2007 pp.4

OFDI activity from India became significant since the onset of economic reforms in 1991, though a few Indian enterprises were investing abroad in the mid-sixties (Lall, 1983, 1986). OFDI underwent a considerable change in the nineties in terms not only of magnitude, but also the geographical focus and sectoral composition of the flows

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(Kumar, 2004). As seen from the above table the number of OFDI approvals increased considerably from 214 in 1990 to 1016 in 1995. It can be argued that the change in the geographical and sectoral composition of OFDI has been in line with the change in their motives from essentially market-seeking to more assetseeking ones to support exporting with a local presence (Kumar, 1998).

Alongside the liberalization of policy dealing with inward FDI, the policy governing OFDI has also been liberalized since 1991. The guidelines for Indian joint ventures and wholly-owned subsidiaries abroad, as amended in October 1992, May 1999 and July 2002, provided for automatic approval of OFDI proposals up to a certain limit that was expanded progressively from US$ 2 million in 1992 to US$ 100 million in July 2002. In January 2004, the limit was removed altogether and Indian enterprises are now permitted to invest abroad up to 100 percent of their net worth on an automatic basis. Hence the magnitudes of OFDI flows as well as their numbers have risen considerably over the past few years.

Table 4.4: FDI Outward Stock (US$ billion)

Developing Economies 325.29 575.28 728.72 858.92 856.5 862.03 942.68 1106.29 1284.85 1600.3

World

India

1992-97* 1998 1999 2000 2001 2002 2003 2004 2005 2006 * Annual Average

2842.28 4347.76 5204.84 6209.45 6642.42 7433.87 8779.52 10151.83 10578.8 12474.26

0.4685 0.7 1.7 1.85 2.61 4 5.82 7.75 10.03 12.96 Source: WIR 2007

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Though Indian outward FDI was very low, growth has been very impressive, notably since 2000. From a meager US$ 0.70 billion in 1998 the stock value grew to US$ 12.96 in 2006 (table 4.4). In 2004, India held 16th slot in terms of outward stock among developing economies (12th if we exclude tax havens such as Virgin Islands, Cayman Islands, Panama, and Bermuda). (WIR, 2005)

Table 4.5: FDI Outflows (US$ billion)

World 1992-97* 1998 1999 2000 2001 2002 2003 2004 2005 2006 3238.2 697.05 1108.35 1239.19 745.47 540.71 560.08 877.3 837.19 1215.78 Developing Economies 51.3 50.66 68.65 133.34 80.56 47.06 45.37 117.36 115.86 174.38 India 0.09 0.047 0.08 0.5 1.39 1.67 1.87 2.17 2.49 9.67

* Annual Average

Source: WIR 2007

Indian FDI outflows surged to US$ 2.2 billion in 2004, and US$ 9.6 billion in 2006, which was a record level. Though it only represents only 0.24 percent of the world FDI outflows and 1.84 percent of the outflows issued by developing countries (2004) and 0.79 percent and 5.53 percent respectively (2006), the progression of Indian Investments has really been spectacular since 2001 when they reached US$ 1.3 billion (table 4.5).

Indian outward FDI flows amounted to 0.5 percent of the gross fixed capital formation in 2000 and 5.0 percent in 2006. It was less than the average in the developing countries (8.6 percent) in 2004; however, comparatively better (6.4 percent) in 2006 (table 4.6). In 2004, India held the 7th rank among the developing countries for its

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investments in foreign countries (behind Hong Kong, Singapore, Brazil, Taiwan, South Korea and Mexico). (WIR, 2005)

Table 4.6: FDI outflows as a percentage of GFCF

World 2000 2001 2002 2003 2004 2005 2006 18.1 11.2 8.1 7.5 10.1 9.2 11.8 Developing Economies 8.6 5.3 3 2.5 5.5 4.7 6.4 India 0.5 1.3 1.5 1.4 1.2 1.4 5

Source: WIR 2007

Indian outward FDI garnered a new dimension in 2001-02 when it became more diversified, involving a large no. of countries and companies. The Government encouraged outward FDI and overseas Mergers and Acquisitions 1 . Even public sector enterprises were at the forefront of these investments. Since 2000, ONGC has set up large businesses abroad (notably in Russia, Angola) and Indian Oil Corporation invested massively in Libya in 2004-05.

Many Indian firms have developed Ownership specific advantages which spur on their investments abroad. Further, Indian firms have comfortable financial means and can afford to invest abroad. This investment is funded by former profits, banking loans, and stock markets. India has a great no. of experienced and competitive companies with capabilities in large areas of activities, from raw materials to cutting edge services.

For instance, in January 2004, the Indian Government removed the ceiling of US$100 million on foreign investment by Indian Companies and raised it to equal their net worth.

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REGIONAL DISTRIBUTION OF INDIAN OUTWARD FDI FLOWS

Between 1996 and 2004, developing countries and Russia received about 70 percent of FDI from India. This trend could be explained by the various geographic, economic and social proximities to these regions. Another reason could also be the need to secure natural resources like energy etc many of which are located in Africa, Latin America and Russia. The share of Asia in receiving these flows has also been increasing over a period of time. Hong Kong, Singapore, and Vietnam taken together accounted for 10 percent of the total Indian FDI. China is also becoming one of Indias largest trading partners 2 . In case of industrial countries, the share of FDI outflows from India has been booming since 2000. North America and European countries respectively accounted for about 30 percent and 12 percent of Indian FDI abroad between 1996 and 2005 (table 4.7). Indian firms are increasingly attracted by the US and EU.

Table 4.7: Country-wise approved Indian direct investments in joint ventures and wholly-owned subsidiaries, main countries (US$ million)
Apr96- Mar02 Russia USA Mauritius Virgin Islands Bermuda Sudan United Kingdom Hong Kong Singapore Australia Netherlands UAE Vietnam
2

2002-03 0.15 185.27 133.35 3.27 28.95 75.0 34.53 14.8 46.79 94.97 15.92 12.6 0.06

2003-04 1.43 207.14 175.59 4.92 142.46 162.03 138.48 16.15 15.85 92.87 30.18 32.07 0.04

2004-05 1076.17 251.73 149.38 131.41 221.26 51.55 71.85 73.64 239.03 158.76 30.65 41.85 0.06

2005-06 (Aug) 1.068 135.83 55.9 14.71 2.6 43.13 120.09 22.22 19.49 28.97 124.56 61.30 0

Total 2827.450 2320.780 1132.56 930.84 627.9 1006.71 775.58 571.93 474.12 382.56 359.23 258.06 228.95

1748.68 1540.83 618.34 776.53 232.63 410.62 445.12 152.96 6.99 157.92 110.24 228.79

The top Indian IT Indian service players have already invested in China.

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Oman China

204.88 38.8

0.35 30

1.51 27

5 15

1.7 44

213.44 153

Source: Reserve Bank of India (Database on Indian Economy).

According to RBI sources ten countries account for 86.1 percent of approved Indian FDI abroad since 1996. Russia accounted for 23 percent of the total cumulative Indian FDI outflows due to oil and gas industries 3 . The USA is the second destination of Indian outward FDI it received 18 percent of it between 1996 and 2005. It is one of the favourite destinations of Indian FDI. Two tax havens, Bermuda and British Virgin Islands account together for 13 percent of the cumulative FDI, followed by Mauritius (9 percent) 4 .

With 8 percent of Indian FDI outflows, Sudan also appears as a favourite destination. This rank is related to many investments in the oil sector. However, its share is not regular according to the years. The U.K is the sixth destination of Indian FDI outflows (6 percent). It is a privileged destination in relation to the former colonial and human networks, and on account of the use of English use by businessmen. (Table 4.7)

In all, Indian FDI in Russia, Sudan, and other developing countries is mainly boosted by the research of raw materials and energy, while FDI in the USA (most of the investments in the USA have gone into IT and pharmaceuticals), the UK and other industrial countries is either driven by market targets or by access to know how and technology. As to Bermuda, Virgin Islands and Mauritius they are mainly targeted by financial goals.

3 4

Notably the acquisition of Sakhalin Oil field by the Oil and Natural Gas Commission, ONGC. The double taxation avoidance treaty between India and Mauritius have encouraged Indian firms to practice round trip investment through Mauritius and other tax havens to take advantage of the tax benefits enjoyed by the overseas investors. (WIR, 2005)

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Table 4.8: Distribution of Indian OFDI Stock by Host Regions 19762006 (In Percent)
Host Region / Economy Developed economies Europe European Union Other developed Europe North America Other developed countries Developing economies Africa North Africa Other Africa West Africa Central Africa East Africa Southern Africa Latin America and the Caribbean South and Central America South America Central America Caribbean and other America Asia and Oceania Asia West Asia South, East and South-East Asia East Asia South Asia South-East Asia Oceania South-East Europe and CIS South-East Europe CIS World Memoranda No. of Host Countries Source: i. Ministry of Commerce (1976) as quoted in Indian Institute of Foreign Trade (1977) Indias Joint Ventures Abroad, pp. 5964 ii. Indian Investment Centre (1981) Indian Joint Ventures Abroad: An Appraisal, pp. 2529 iii. Indian Investment Centre (1986) as quoted in Federation of Indian Chambers of Commerce & Industry (1986) 22 37 35 84 128 127 1976 10.12 5.41 5.41 4.71 89.88 23.85 23.85 1.42 22.43 66.03 64.89 5.74 59.15 0.25 0.37 58.53 1.14 100 1980 5.02 1.89 1.88 0 3.06 0.07 92.91 28.85 0.11 28.74 15.17 13.52 0.05 64.06 63.94 5.44 58.5 0.07 9.53 48.9 0.12 2.07 2.07 100 1986 1.61 1.18 1.15 0.02 0.36 0.06 96.31 36.06 1.18 34.88 20.81 14.06 60.25 59.64 3.46 56.18 0.07 3.99 52.12 0.6 2.09 2.09 100 1995 40.8 26.8 25.69 1.11 10.87 3.13 53.97 7.99 0.25 7.74 0.62 6.9 0.23 1.75 0.71 0.01 0.69 1.04 44.23 44.22 18.09 26.13 5.57 6.04 14.51 0.01 5.23 0.08 5.15 100 2000 29.62 16.82 16.19 0.63 11.85 0.95 68.17 9.93 0.98 8.96 0.85 7.55 0.55 23.39 0.66 0.47 0.19 22.73 34.85 34.84 12.13 22.71 11.28 4.26 7.17 0 2.21 0.02 2.19 100 2006 32.17 13.54 12.75 0.79 15.44 3.19 50.5 20.39 10.59 9.8 0.41 0 9.15 0.23 10.4 0.75 0.59 0.17 9.65 19.71 19.7 5.25 14.45 5.12 1.93 7.39 0.01 17.34 0.06 17.27 100

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iv. Report of Workshop on Indian Joint Ventures Abroad and Project Exports, New Delhi, pp. 7477 v. Indian Investment Centre (1991) Monthly Newsletter 25th May, pp. LXVI-LXVII vi. Indian Investment Centre (1998) Indian Joint Ventures & Wholly Owned Subsidiaries Abroad Up To December 1995, pp. 12 and pp.5960 vii. The website of the Investment Division, Department of Economic Affairs, Ministry of Finance, Government of India.

Indian OFDI had largely been concentrated in the developing regions in the pre liberalized period. Developing countries accounted for about 90 percent of the OFDI stock in 1976 and their share went up to about 96 percent in 1986. The share of developed countries for Indian outward investment firms was comparatively marginal and their share in OFDI stock had in fact declined from 10 percent in 1976 to 2 percent in 1986.

The regional patterns of OFDI activity underwent noticeable changes in the post liberalized period. Increased locational diversification was observed, where developed countries started drawing growing attention of outward investing Indian firms. Total number of host countries for Indian OFDI which was just 37 in the pre 1990s has increased to about 128 in post 1990 period. The share of developed country which was less than 2 percent in 1986 went up to 41 percent in 1995 and consistently stayed above 30 percent share of total OFDI stocks in 2000 and 2006. In the developed region North America followed by the Europe comes out as two top host regions. The sharp rise in the shares of North America and the Europe is on account of larger proportion of Indian OFDI being directed at the USA and UK respectively. The share of developing countries has got significantly reduced from 96 percent in 1986 to 54 percent in 1995 and further to 50.5 percent in 2006. Notably, the countries in the CIS have improved their attractiveness to Indian investors and their share has gone up from 5 percent in 1995 to about 17 percent in 2006. (Table 4.8)

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STRATEGIC ASSET SEEKING INVESTMENTS

OWNERSHIP PATTERN

Table 4.9: Changing Ownership Structure of Indian OFDI (Number; Percentage)

Equity Range (Percent) 020 2050 5080 80100 Total No of OFDI Approval 51 91 53 28 223 197590 Percent 22.9 40.8 23.8 12.6 100 Cumulative Percent 22.9 63.7 87.4 100 No. of OFDI Approval 41 230 211 637 1119 199101 Percent 3.7 20.6 18.9 56.9 100 Cumulative Percent 3.7 24.2 43.1 100

Source: Indian Investment Centre (1987) Fact sheets on Indian Joint Ventures Abroad, as quoted in Ranganathan (1990) Export Promotion and Indian Joint Ventures, Ph.D. thesis, Kurukshetra University, India, pp. 136

The structure of Indian ownership participation underwent a complete shift in the post liberalized period as compared with the pre liberalisation. While the share of minority ownership OFDI projects declined from 64 percent to only 24 percent, the share of majority ownership increased from 13 percent to 57 percent. (Table 4.9)

Table 4.10: Cross-Border Mergers & Acquisitions Indian Purchases (US$ million)
Year 1997 1998 1999 2000 2001 2002 2003 Sales 1520 361 1044 1219 1037 1698 949 Purchases 1287 11 126 910 2195 270 1362

Source: ICICI-EPWRF data base, 2006

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Another significant feature of the post-liberalized period is the emergence of mergers and acquisitions as an important mode of internationalization by Indian enterprises in the nineties. OFDI has begun to grow rapidly, particularly through M&As. As per the RBIs annual report for 2004-05, in 2003 Indian enterprises total cross border acquisitions were worth US$ 1,362 million. (Table 4.10)

The late nineties saw a surge in overseas acquisitions by Indian enterprises. As many as 119 overseas acquisitions were made by Indian enterprises in 2002-2003. Most of the acquisitions were in the software industry followed by pharmaceutical and mining activities. The lion's share of the M&A purchases in the same period was in developed countries, dominated by the United States and United Kingdom. (Table 4.11)

Table 4.11: Overseas M&As By Indian Enterprises, 2000-2003 (Number, Percentage)

Sectoral composition Sector Primary Mining, petroleum and gas Industry Pharmaceuticals Paints Plastic & products Services Software All sectors No. 9 9 34 12 4 4 76 67 119 Percent 7.6 7.6 28.6 10.1 3.4 3.4 63.9 56.3 100 Regional composition Region Developed countries United Kingdom United States Australia Developing countries Africa Latin America and the Caribbean Asia and the Pacific All regions No. 93 16 53 8 20 5 3 12 119 percent 78.2 13.4 44.5 6.7 16.8 4.2 2.5 10.1 100

Source: UNCTAD Case Study, 2005

In the period prior to 1990 Indian OFDI was dominated by Greenfield investments. As opposed to this overseas acquisition has come out as the preferred strategy of Indian companies to enlarge their overseas presence in the post liberalized period. Since the late 1990s a growing number of Indian firms have adopted acquisitions as a less 123

risky mode of foreign market entry and as an easier method of acquiring new technology, skills, experience and marketing intangible assets. Since the motive of Indian firms is to acquire new technologies along with gaining access to large market, developed countries seem to be the ideal destination as they are the centre of frontier technological activities globally and have large-sized domestic markets. A very large proportion of Indian overseas acquisition is being done by software firms with 56 percent of total acquisition, followed by pharmaceutical companies with a share of 10 percent (WIR 2005). These two categories of Indian firms are aggressively looking into expanding their market position in developed countries and are thus using acquisition for the above purpose.

According to a recent study by Grant Thornton (2006), between 2001 and 2005 (until August); Indian companies were involved in 4690 overseas M&As in the world. These deals have been prominent in the IT software services and pharmaceutical industries, and many of them have been made in Europe (50 percent of deal value in 2005), and in North America (24 percent of deal value in 2005). The United States and the United Kingdom have been the countries that garnered the more important outbound deal share.

Access to established brand names and novel product technology constitutes an important aspect of non price rivalry. A considerable proportion of the countrys FDI has gone into acquisitions of industrialized country enterprises. This is done to augment the asset bundles of investing enterprises with complementary assets, often established brand names. For example, Dr. Reddys Lab acquired Betapharm of Germany, Ranbaxy Labs acquired RPG Aventis Laboratories of France, Tata Motors acquired Daewoo Commercial Vehicles of Korea.

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TRADE SUPPORTING INVESTMENTS

SECTORAL DISTRIBUTION OF INDIAN OFDI FLOWS

Table 4.12: Sector-wise OFDI of India, 1975-2001 (US$ million)

Services Period 1975-1985 1986-1990 1991-1995 1996-2001 1975-2001 Number 56 43 356 962 1417 Equity 24 49 326 2194 2595 Manufacturing Number 80 48 419 817 1364 Equity 88 57 406 1273 1824 Total Number 139 91 778 1783 2791 Equity 116 106 733 3529 4484

Source: ICICI-EPWRF Database, 2006

Table 4.13: Cumulative OFDI Approvals by Indian Enterprises, 1975-2000 (US$ million; Number; Percentages in parenthesis)
Sectoral Composition Total Period No. 197590 19912000 19752000 2 791 (100) 4484.68 (100) 10 (0.36) 65.18 (1.45) 1 364 (48.87) 1 824.14 (40.67) 1 417 (50.77) 2 595.39 (57.87) 230 (100) 2 561 (100) Equity 222.45 (100) 4262.23 (100) Extractive No. 3 (1.30) 7 (0.27) Equity 4.04 (1.82) 61.14 (1.43) Manufacturing No. 128 (55.65) 1 236 (48.26) Equity 145.22 (65.28) 1 678.92 (39.39) No. 99 (43.04) 1 318 (51.46) Services Equity 73.22 (32.91) 2 522.17 (59.17)

Source: UNCTAD Case Study, 2005

During the period 1975 to 1990, around 230 OFDI activities were registered, of which 128 were from the manufacturing sector and 99 from the services sector. During this period, Indian manufacturing firms dominated OFDI activities and in most cases they were directed to developing countries with levels of development similar to, or lower than, those of India. (Table 4.12)

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The manufacturing industry accounted for 65 percent and the services industry accounted for about 33 percent of the approvals in terms of equity value, while the extractive sector accounted for less than 2 percent (table 4.13). Figures reported by UNCTAD 2005 show that low and middle-ranking technology manufacturing industries such as fertilizer and pesticides (18 percent), leather (9 percent), iron and steel (7 percent), and wood and paper (5 percent) were the main sources of Indian manufacturing OFDI in the pre-liberalized period. The three leading service industries in this period were financial services and leasing (12 percent), hotels and tourism (11 percent), and trading and marketing (6 percent).

In the post-liberalized period, while the share of manufacturing sector decreased to 39 percent of approved OFDI equity that of service industries rose to 60 percent of equity value and 52 percent of OFDI approvals (table 4.13). Figures reported by UNCTAD 2005 show that the Indian IT industry emerged as the largest source of Indian services OFDI, accounting for 32 percent of total OFDI flows during the post 1990s, followed by media, broadcasting and publishing (17 percent). The leading manufacturing OFDI sources were fertilizers and pesticides (8 percent) and pharmaceuticals (6 percent). Recent years have witnessed a significant increase in natural resources OFDI from India, contributed by acquisitions made by such companies as ONGC-Videsh.

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Table 4.14: Indias direct investment abroad by sectors (US$ million) (trade supporting investments)
Industry Manufacturing 2000-01 169 (23.8) Financial Services Non-financial Services Trading Others Total 6 (0.8) 470 (66.3) 52 (7.3) 12 (1.7) 709 (100) 2001-02 528 (53.8) 4 (0.4) 350 (35.7) 79 (8.1) 20 (2.0) 981 (100) 82 (4.6) 38 (2.1) 1789 (100) 113 (7.6) 31 (2.1) 1494 (100) 181 (11.0) 108 (6.6) 1647 (100) 215 (8.0) 239 (8.9) 2679 (100) 3 (0.2) 404 (22.5) 1 (0.1) 456 (30.5) 2002-03 1271(70.7) 2003-04 893 (59.8) 2004-05 1068 (64.8) 7 (0.4) 283 (17.2) 2005-06 1538 (57.4) 156 (5.8) 531 (19.8)

Source: ICICI-EPWRF Database, 2006

The liberalisation of OFDI policy of India during the nineties has provided the ultimate impetus for Indian firms to use OFDI as a means of competitive strength and survival in the globalizing world economy. During the period 2001 onwards the regime for Indian investments overseas has been substantially liberalized in order to provide Indian industry access to new markets and technologies, including R&D, with a view to increasing competitiveness globally and strengthening exports. Overseas investments, which started off initially with the acquisition of foreign companies in the IT and services sector have now spread to other areas, particularly pharmaceuticals, automobiles and petroleum. In addition, many large Indian enterprises in basic industry such as steel, copper and viscose fiber have acquired upstream companies in developed countries such as Canada and Australia with the objective of backward integration. Some of the Indian Pharmaceutical companies are trying to develop stand-alone local operations in overseas market, while Indian telecom enterprises have bought underground telephone cable networks from foreign companies for integrating their domestic telephone networks in the international market.

In recent years, Indian companies have increased their export competitiveness in the global market by investing heavily so as to raise the scale of operations to global size

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capacities. Total (equity and loans) investment abroad by Indian companies in 200506 stood at US$ 2.7 billion, most of which went to the manufacturing sector (57.4 percent). Thus, during this phase, it is the share of manufacturing sector in OFDI which is witnessing a buoyant growth; such outflows have increased to US$ 1,538 million in 2005-06 from US$ 169 million in 2000-01 (table 4.14).

Pharmaceuticals, software and IT-related services have been the main drivers of Indian FDI abroad. As early as 1975-1990, Indian FDI outflows in services went to Singapore, Thailand, Sri Lanka and Malaysia. By the 1990s, most of Indian FDI in services concentrated in developed countries, mainly in the United Kingdom and the United States (UNCTAD, 2005). However, some investors moved into selected developing-countries, especially China, South-East Europe and in the CIS Indian call centers and business-process outsourcing companies started to set up foreign affiliates in countries such as the Philippines and Mexico (WIR, 2005). By 2004, the top 15 Indian software and related service companies had all invested abroad, and many software and pharmaceutical MNCs had global R&D operations

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STRATEGIC ACCESS TO MARKETS SEEKING INVESTMENTS

Table 4.15: Some of the biggest acquisitions by Indian companies in last 3-5 Years
Indian purchaser ONGC Company Purchased, Place of FDI Sakhalin, Russia; Royal Dutch Shell, Angola; a Refinery in Sudan; an oil filed in Brazil, Indian Oil Corp. Tata Steel a large oil block in the Sirte Basin of Libya Nat Steel (Singapore), Millennium Steel Company - Cementhai Holding (Thailand) (US$ 130 million) Tata Chemicals Reliance Ranbaxy Infosys Wipro VSNL Videocon Apeejay Surrendra Matrix Laboratories Brunner Mond Group Ltd, United Kingdom (US$ 110 million) Flag Telecom (USA) ; Trevira (Germany) RPG Aventis (France) Expert Formation (Australia Nerve Wire, USA Tyco Global Network (USA) Thomson - division picture-tube, France (US$ 289 million) Premier Foods (tea), United Kingdom (US$ 138 million) Docpharma NV Belgium (US$263 million), Mchem in China, 43 percent stake in Swiss firm Explora Videsh Nigam Dr Reddys United Phosphorous Sun Pharma Continental Engine Sundram Fasteners SFL) Bharat (BFL) Mittal Steel Forges FAW Corporation (forging industry, automotive), China Carl Dan Peddinghaus Gmbh, Germany ISCOR, South Africa Able Labs, USA Vege Motors, Netherlands Peiner Umformtechnik, Textron Deutschland Germany Betapharm, Germany Advanta, Netherlands Sanchar Teleglobe International Holdings Ltd USA

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Table 4.15: Some of the biggest acquisitions by Indian companies in last 3-5 Years
Acquirer Dr. Reddys Lab Ranbaxy Labs Ranbaxy Labs Aurobindo Pharma Matrix Laboratories Nicholas Piramal Nicholas Piramal Wockhardt Cadila Health M&M Tata Motors Tata Motors Bharat Forge Tata Steel Tata Steel Subex Systems TCS TCS Satyam Computer Infosys Wipro Videocon VSNL VSNL Reliance Industries Reliance Industries Tata Chemicals ONGC Videsh HPCL Tata Tea Tata Tea Tata Tea Tata Tea Hindalco Aditya Birla United Phosphorous Acquired Company Betaphram Terapla SA RPG (Aventis) Laboratories Milpharm Docpharma NV Rhodias IA Avecia CP Pharmaceuticals, Alpharma SAS Jiangling Tractor company Daewoo Commercial Vehicles Hispano Carrocera Carl Dan Peddinghaus Millennium Steel NatSteel Asia Azure Solution Comicrom FNS Citisoft Expert Information Services Nerve Wire Inc, Thomson SA Teleglobe Tyco Flag Telecom BermudaTrevira Brunner Mond Brazilian Oil Fields from Shell Kenya Petroleum Refinery Tetley Good Earth JEMCA Energy Brands Inc. Glaceau Straits Ply Dashiqiao Chem Oryzalin Herbicide Bermuda Germany UK Brazil Kenya UK US Czech Rep. US Australia China US UK Chile Australia UK Australia US France Canada 140 3.1 18.5 290 240 130 212 95 177 1,400 500 407 50 12.5 677 56.4 8.5 21.3 Fertilisers Country Germany Romania France UK Belgium UK UK UK France China Korea Spain Germany Thailand 130 18 5.7 118 263 Deal Value (US$ mn) 570 324 Industry Pharmaceutical Pharmaceutical Pharmaceutical Pharmaceutical Pharmaceutical Pharmaceutical Pharmaceutical Pharmaceutical Pharmaceutical Automobile Automobile Automobile Automobile Steel Steel IT IT IT IT IT IT Electronics Telecom Telecom Telecom Telecom Chemicals Oil & Gas Oil & Gas FMCG FMCG FMCG FMCG Metals

Source: Compiled from Media Reports

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Interestingly, the big deals are not only driven by the technology sector but also by traditional sectors such as pharmaceuticals, telecommunications, auto components and other manufacturing activities.

EXPLAINING INDIAN OUTWARD FDI

The explanations behind the second wave of Indian OFDI are mostly related to the shifts in the structure of the world economy and the transformation of their own economies. The following points can be noted:

The industrial structure in the country has evolved from being primarily based on labour intensive manufacturing (textiles, sundries and other light industry goods) as the leading export sector to industries based on scale economies (chemical and pharmaceutical) and also differentiated industries

(automobiles, electric and electronic goods). This process of industrial upgrading reflects important changes in the OLI configurations and subsequent shifts from stage 1 of the IDP to stage 2. Since the initiation of an export oriented industrialization policy, IFDI was also encouraged and the authorities played an active role in maximizing the benefits the MNCs could offer by matching domestic Locational and Ownership advantages in the optimal manner. Upgrading the resources and capabilities of the Indian economy has also led to more intense direct competition with producers from major trading partners. Because of many external reasons the exporting from the home economy became less attractive, stimulating FDI in production facilities overseas. As compared to the pre liberalized period, Indian FDI has become less of a regional phenomenon. Hence industries require Ownership advantages

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based on scale economies, making the maintenance and expansion of overseas markets mandatory. Another reason for the expansion of value adding activities is the accumulation of firm specific advantages related to marketing. This is one principal motive behind the increased M&A activities of firms from these countries. In addition to M&As, Greenfield investments in industrialized countries have also offered opportunities for the MNCs in the third world to search for foreign business environments. Examples are many Indian computer firms that have affiliates in the Silicon Valley to tap locally available technological know how. Rapid advance of India to stage 2 of their IDP has not been possible without a major change in government policy with regard to outward investment. During the first wave government policies towards outward FDI in most developing countries were mainly directed to capital export restrictions (UNCTAD 1995). This attitude changed in the early nineties when the Indian government confronted with eroding comparative advantages in traditional sectors and with the growing needs of indigenous firms to seek new assets overseas decided to drastically liberalize their policy with regard to capital outflows. Indian acquisition abroad entails synergies between, on the one hand, new local distribution networks abroad which boost their sales and, on the other hand, low-cost manufacturing based in India and the possibility to achieve higher scales of production. Some Indian firms notice that many Western companies have their own financial problems increased by stringent labour and environmental regulations prevailing in their country: this is very true in Europe where the costs of compliance add significantly to overall manufacturing costs (Darel , 2006).

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The limited spread and growth of OFDI in the pre liberalized era was because of the following reasons:

Lack of international experience The ownership advantages were suited to the locational advantages that were based on technology at the end of their product life cycle

First wave investors had few transaction type ownership advantages They had very basic form of asset type of ownership advantages

The Ownership advantages were affected by the presence of inward looking, import substituting policy regimes among the developing countries which encouraged small scale production. The Ownership advantages of these firms were country specific, determined by the market distortions introduced by the home country policies and sustainable only where similar Locational advantages existed in other countries.

However, the trends suggest that India has entered into the second wave of investment. This could be because of the fact that the Ownership advantages of the investing firms have increased to the extent that they are able to compete with traditional MNCs in their home. Another fact to note is that India also experienced rapid economic growth during this period.

According to the IDP, countries in stage 2 are home to firms engaging in elementary OFDI. As they acquire experience in their international operations and improve their Ownership advantages, their Locational advantages also improve over time and they engage in more OFDI. As these countries develop, they enter and progress through stage 3 of the IDP: i.e. these countries gain further experience in

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international business activities and develop competitive advantages that can be exploited in the overseas market. It is interesting to note that many first wave countries have remained in stage 2 and have seen no improvement in their locational advantages (Hikino and Amsden, 1994). Conversely India has shown rapid economic growth. This has been further enhanced by direct results of globalization. These changes, from Indias perspective can be of two types:

a. External changes b. Internal changes

The external changes have manifested in the Indian economy converging with the developed countries rather than diverge, as a result of which there have been two effects on the converging country:

Firms in the domestic market are presented with larger markets leading to large economies of scale

Technology has also converged in a way that firms in some sectors are competing with other firms in the same country in the same or different industries

The internal changes have been related with the actions and policies of the government. The main change has been change in the policies of the country from import substitution role to an export oriented look.

The motives for OFDI from India differ across industries and over a period of time. However, certain factors stand out as the main drivers.

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1. The increasing numbers of home grown Indian firms (e.g., Tata Group, Ranbaxy, and Infosys) and their improving Ownership specific advantages, including financial capability are among the main drivers. In addition the growing competitiveness of the Indian firms involved in providing outsourced business and IT services to foreign clients has proved a push for these firms themselves to go offshore to operate near their clients and to expand their growth opportunities in markets abroad. The success of the Indian firms as service providers in the outsourcing of IT services, BPO and call centers by developed country companies has exposed them to knowledge and methods for conducting international business and induced FDI through demonstration and spill over effects. 2. Indian firms are investing abroad to access foreign markets, production facilities and international brand names. 3. Access to technology and knowledge has been a strategic consideration for Indian firms seeking to strengthen their competitiveness and to move up their production value chain. 4. Securing natural resources is becoming an important driver for Indian OFDI.

More broadly , Indian firms are increasingly subject to the same forces that increasingly shape firm behaviour; competition through imports, inward FDI, licensing, franchising, etc is everywhere in the globalizing world economy. Indian firms like their developed countries counterparts need to develop a portfolio of Locational assets as a source of their international competitiveness.

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REGULATORY FRAMEWORK FOR OUTWARD FDI

Improvements in the regulatory framework and encouragement by the Government have played an important role in the increase in Indian Investment abroad. Initial liberalization of Indian policy towards OFDI was made in the early nineties. However, significant policy changes since 2000 have contributed to the recent rapid growth of the Indian OFDI flows.

SELECTED SIGNIFICANT INDIAN OVERSEAS INVESTMENT POLICY CHANGES SINCE 2000

1. Indian companies can make overseas investment by market purchases of foreign exchange without prior approval of the RBI up to 100 percent of their net worth, up from the previous limit of 50 percent. 2. An Indian company with a proven track record is allowed to invest up to 100 percent of its net worth within the overall limit of US$ 100 million by way of market purchases for investment in a foreign entity engaged in any bona fide business activity starting fiscal year 2003-04. The provision restricting overseas investment in the same activity as its core activity at home of the Indian company is removed. Listed Indian companies, residents and mutual funds are permitted to invest abroad in companies listed on a recognized stock exchange and in company which has the share holding of at least 10 percent in an Indian company listed on a recognized stock exchange in India. 3. The annual limit on overseas investment has been raised to US$100 million, up from US$50 million and the limit for direct investment in South Asian Association for Regional Cooperation countries excluding Pakistan and Myanmar has been raised to US$ 150 million up from US$ 75 million; for rupee investment in Nepal

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and Bhutan the limit has been raised to Rs. 700 crores up from Rs. 350 crores under the automatic route. 4. Indian companies in Special economic zones can freely make overseas investment up to any amount without the restriction of the US$100 million ceiling under the automatic route, provided the funding is done out of the Exchange earners Foreign Currency Account balance. 5. The three years profitability condition requirement has been removed for Indian companies making overseas investment under the automatic route. 6. Overseas investments are allowed to be funded up to 100 percent by American Depository receipts, General depository receipt proceeds, up from the previous ceiling of 50 percent. 7. An Indian party which has exhausted the limit of US$100 million may apply to the RBI for a block allocation of foreign exchange subject to such terms and conditions as be necessary. 8. Overseas investments are opened to registered partnerships and companies that provide professional services. The minimum net worth of Rs. 150 million for Indian companies engaged in financial sector activities in India has been removed for investment abroad in financial sector. 9. During fiscal year 2003-04 the policy in Indian FDI abroad has further streamlined with the following change: a. Indian firms are allowed to undertake agricultural activities, which was previously restricted either directly or through an overseas branch. b. Investments in joint ventures or wholly owned subsidiary abroad by way of share swap are permitted under the automatic route. 10. In January 2004 the RBI has further relaxed the monetary ceiling on Indian companies investment abroad. With effect from fiscal year 2003-04, Indian companies can invest up to 100 percent of net worth without any separate monetary ceiling even if the investment exceeds the US$ 100 million ceiling

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previously imposed. Further more Indian companies can now invest or make acquisitions abroad in areas unrelated to their business at home. (RBI and Ministry of Finance, Indian Direct Investment in JVs/WOS abroad, February, 2004)

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SECTION 4.3

FINDINGS AND CONCLUSIONS

OFDI from India has increased appreciably over the past decade following the reforms and liberalization of policies undertaken by the Government since 1991. OFDI has emerged as an important mechanism through which the Indian economy is integrated with the global economy, along with growing trade and inward FDI. The OFDI behaviour of Indian firms in the earlier periods of seventies and eighties was found to be limited to a small group of large-sized family-owned business houses investing mostly in a selected group of developing countries. The restrictive government policies on firms growth followed in India seems to have pushed these firms towards OFDI. In many cases, the Ownership pattern of Indian OFDI projects was minority-owned. The joint venture nature of Indian OFDI with intermediate technologies has been found to be appropriate to the needs and requirement of fellow developing countries. The Indian OFDI policy that time was more restrictive with cumbersome approval procedures.

However, the character of OFDI has undergone significant changes since the nineties. A large number of Indian firms from increasing number of industries and services sectors have taken the route of overseas investment to expand globally. Unlike the earlier periods, Indian outward investors have gone for complete control over their overseas ventures and increasingly started investing in developed parts of the world economy. This increased quantum of OFDI from India has been led by a number of factors and policy liberalization covering OFDI has been one among them. The sharp rise in OFDI since 1991 has been accompanied by a shift in the geographical and sectoral focus. Indian companies have also diversified sectorally to

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focus on areas of the countrys emerging comparative advantages such as in pharmaceuticals and IT software automobiles, auto-ancillary and telecom etc. Indian enterprises have also started to acquire companies abroad to obtain access to marketing

It is contended that the new wave of OFDI reflects changes in the structure of the world economy that are a result of globalization and regionalization of economic activity. These phenomena are associated with:

Technological advances within the sectors Liberalization of markets Establishment of regional trading blocks

It is also contended that the second stage of OFDI is complementary to the first stage and simply is an intermediate stage of evolution of OFDI as the home country moves along its IDP. Such OFDI has been a result of government assisted upgrading of location specific advantages of home country, which in turn has helped upgrade the competitive advantages of their firms. Also while these Ownership specific advantages remain primarily countryoforigin specific they are being supplemented by FDI intended to augment rather than exploit such advantages.

In light of the foregoing analysis, regarding the outward direct investment from developing countries especially India, it can be said that there has been a distinct and comprehensive change. The evidence presented here shows that the evolution of Indian OFDI is entirely consistent with the predictions of the IDP. Each stage has been appropriate to the extent and pattern of the countrys economic development.

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Such a growth has been conditional on the sustained improvement of the Ownership specific advantages of the firms, resulting from a continuous up gradation of the Locational specific advantages of the home country. While improved Locational advantages are a natural consequence of economic development and restructuring as the country moves from stage 2 to stage 3, this process can be accelerated by a market oriented and a holistic government policy towards trade, industrial development and innovation. This has not only helped to upgrade its indigenous resources but has encouraged the domestic firms to augment their competitive advantages by acquiring foreign resources.

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REFERENCES

1.

Darel, P. (2006). The Indian MNCs, IBEF, Indian Brand Equity Foundation, January, www.ibf.org.

2.

Dunning, J.H. (1977). Trade, Locational of Economic Activity and the MNE: A Search For An Eclectic Approach in The International Locational of Economic Activity ed. by Ohlin, B. and P.O. Hesselborn: 395-418, Macmillan, London.

3.

Dunning, J.H. (1981). Explaining the International Direct Investment Position of Countries: Towards a Dynamic or Developmental Approach,

Weltwirtschaflliches Archiv 119: 30-64. 4. Dunning, J.H. (1986). The Investment Cycle Re Invested, Weltwirtschaftliches Archiv 122: 667-77. 5. Dunning, J.H. (1988). Explaining International Production, Unwin Hyman, London. 6. Dunning, J.H. (1993). Multinational Enterprise and the Global Economy, Workingham, Addison-Wesley, England. 7. Dunning, J.H. and R. Narula (1994). Transpacific FDI and the Investment Development Path: the Record Accessed, University of South Carolina Essays in International Business 10. 8. Dunning, J.H. and R. Narula (1996). Foreign Direct Investment and Governments: Catalyst for Economic Restructuring, Routledge, New York and London. 9. Hay, F. (2006). FDI and Globalisation in India, International Conference on the Indian Economy in the Era of Financial Globalisation, September 28-29, Paris. 10. Hikino, T. and A. Amsden (1994). Staying Behind, Stumbling back, Sneaking up, Soaring Ahead: Late Industrialization in Historical Perspective, in

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Convergence of Productivity: Cross Country Studies and Historical Evidence ed. by Baumol, W. , R. Nelson and E. Wolff, Oxford University Press, New York. 11. ICICI research centre.org-EPWRF Data Base Project 12. Indian Institute of Foreign Trade/IIFT (1977) Indias Joint Ventures Abroad, New Delhi. 13. Kumar, N. (1998). Emerging Outward Foreign Direct Investments from Asian Developing Countries: Prospects and Implications, Routledge, London. 14. Kumar, N. (2004). India in Managing FDI in a Globalizing Economy: Asian Experiences, ed. by Douglas H. Brooks and Hal Hill, New York: Palgrave Macmillan for ADB: 119-52. 15. Kumar, N. and Dunning, J. (1998). Globalization, Foreign Direct Investment, and Technology Transfers: Impacts on and Prospects for Developing Countries, Routledge, London and New York. 16. Lall, R.B. (1986). Multinationals from the Third World: Indian Firms Investing Abroad, Delhi, Oxford University Press. 17. Lall, S. (1983). Multinationals from India in The New Multinationals: The Spread of Third World Enterprises ed. by S. Lall, John Wiley & Sons, New York. 18. Ministry of Finance, Department of Economic Affairs, Government of India, http://finmin.nic.in. 19. Narula, R. (1993). Technology, International Business and Porters Diamond: Synthesising a Dynamic Competitive Model, Management International Review, special issue 2. 20. Narula, R. (1995). R&D Activities of Foreign Multi-Nationals in the U.S, International Studies of Management and Organisation 25(12): 39-73. 21. Pradhan, J. (2007). Growth of Indian Multinationals in the World Economy: Implications for development, Working paper no. 2007/04, Institute for Studies in Industrial Development, New Delhi.

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22. Pradhan, J. P. (2005). Outward Foreign Direct Investment from India: Recent Trends and Patterns, GIDR Working Paper, No. 153, February. 23. Pradhan, J. P. and Abraham, V. (2005). Overseas Mergers and Acquisitions by Indian Enterprises: Patterns and Motivations, Indian Journal of Economics 338 : 365-386 24. Ranganathan, K.V.K. (1990). Export Promotion and Indian Joint Ventures,

published Ph.D. thesis, Kurukshetra University, India. 25. RBI (2006). Reserve Bank of India, www.rbi.org.in 26. RBI Bulletin (2008). Reserve Bank of India. 27. Thornton G. (2006) http://www.gt india.com/downloads/DealtrackerAnnual_06.pdf site 28. WIR (1995). Trans National Corporations and Competitiveness, World Investment Report, UNCTAD, United Nations, Geneva.. 29. WIR (2004). The Shift Towards Services, World Investment Report, Geneva, UNCTAD, United Nations, Geneva.. 30. UNCTAD (2004). Indias Outward FDI: A Giant Awakening?

UNCTAD/DITE/IIAB/2004/1, October 20. 31. WIR (2005). TNCs and the Internalisation of R&D, World Investment Report, UNCTAD, United Nations, Geneva.. 32. WIR (2007). Transnational corporations, Extractive Industries and

Development, World Investment Report, UNCTAD, United Nations, Geneva. 33. UNCTAD (2005). Outward Foreign Direct Investment by Indian Small and Medium-Sized Enterprises, Case study, Trade and Development Board, Commission on Enterprise, Business Facilitation and Development Expert Meeting on Enhancing Productive Capacity of Developing Country Firms Through Internationalization, December 5-7 , Geneva.

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CHAPTER 5 DETERMINANTS OF INWARD FOREIGN DIRECT INVESTMENT

SECTION 5.1

THEORIES OF FDI A CHRONOLOGICAL OVERVIEW

Considering the large number of motives an individual firm can have to undertake FDI, it is not surprising that there exists no general theory that can comprehensively explain the existence of MNCs and FDI. As a result of this, the FDI literature is diverse and spans over several different disciplines including international economics, economic geography, international business as well as management. There exist several studies providing overviews of FDI theories, for example, Agarwal (1980), Cantwell (1991), Meyer (1998) and Markusen (2002). Whereas this thesis primarily focuses on a developing economy, most of the theories described in this section can be applied to all types of economies.

Early theories of FDI

Most theories of FDI have emerged during the post-war period, when the forces of globalisation began to grow. The growing importance of MNCs and FDI during the fifties and sixties gave an impetus to researchers to find theories able to explain the behaviour of MNCs and the existence of international production. The early theories could only explain a limited share of the total FDI flows. These theories were also inadequate because they failed to bring out the fact that FDI is not only a capital flow but also constitutes a package including other components such as management and technology transfer.

Consequently, some of the approaches to develop a theory of FDI failed to incorporate the fundamental difference between portfolio and direct investment. An

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example is the Capital Markets Approach (Aliber, 1970). These approaches used the already existing theories for flows of portfolio investment to explain flows of FDI. FDI was treated as portfolio investment and accordingly it was considered that FDI should flow to locations where the financial return on investment was the highest.

During the sixties, researchers started to focus more explicitly on MNCs and their activities. Vernon (1966) applied the idea of the product-life-cycle to international trade in order to explain the existence of international production as well as trade. According to Vernon, as a product moves through the product-life-cycle, the characteristics of the product change. These changes imply that the optimal location for production of the product also changes over time. The product-life-cycle begins when innovations are transformed into actual products. Increasing competition eventually forces production to move from higher to lower income economies in order to reduce production costs. As the product and its production process become more standardized, the product moves into the mature stage of its life-cycle. Consequently production in high and average income economies declines as a result of ever fiercer competition. The demand for the product is then met through exports from low income, developing economies to the rest of the world.

Vernons theory was a contribution since it could explain some of the outflows of FDI from the US during the fifties and sixties. It was also the first theory that treated trade and direct investment as two dynamic alternatives to serve demand in a foreign market. Unfortunately, the theory fails to explain the large flows of FDI between developed economies. The focus on innovations also makes the theory difficult to apply to outflows of FDI from industries which are not innovative.

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Firm-specific advantages and the OLI paradigm

Stephen Hymer came up with his theory of firm specific advantages approximately at the same time as Vernons theory. Hymers dissertation (1960) laid the foundation necessary for eclectic paradigm that has had a large impact on FDI theories. The theory of firm-specific advantages was the first theory treating international production explicitly, and the first focusing on the MNC itself.

According to Hymer, firms operating in a foreign location are at a disadvantage compared to the domestic firms. The domestic firms are assumed to have lower costs of operation since they are more familiar with local conditions such as legislation, business culture, language and so on. It therefore becomes imperative for a foreign firm to have an offsetting, firm-specific advantage allowing it to compete with domestic firms. Firm-specific advantages include superior technology, brand name, managerial skills and scale economies. However, this approach could not explain the actual decisions about FDI. This void was filled by John Dunning, who further developed the idea of firm-specific advantages, resulting OLI paradigm of FDI, also known as the eclectic theory of FDI.

The OLI paradigm (Dunning, 1977) provides a strong framework for a discussion of the motives for FDI. It also allows for a discussion of the choice of an MNC between licensing, exports and FDI in order to serve a foreign market. This choice accordingly, is determined by Ownership advantages, Locational advantages and Internalisation advantages, thus the acronym OLI.

Ownership advantages are based on the concept of firm-specific advantages. To overcome the disadvantage of operating in a foreign country, a firm must possess an Ownership advantage. The Ownership advantage comes in the form of an asset

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reducing the firms production cost and allows it to compete with domestic firms in the foreign economy despite the information disadvantage.

Ownership advantages come in the form of assets such as patents, management or technology and should have the characteristics of excludability and transferability. The foreign firm should be able to exclude competing firms from using the asset. Also to create proper conditions for FDI, the Ownership advantages should be transferable to a foreign country and possible to use simultaneously in more than one Location.

Locational advantages determine how attractive a location is for production. A strong Locational advantage reduces a firms production costs in that location. Locational advantages can never be transferred to another location but can be used by more than one firm simultaneously. For example, a supply of cheap labour can provide a Locational advantage for several labour-intensive firms. If the home country provides the strongest Locational advantage to the firm, then instead of FDI, production is located in the home country, and the output is exported in order to meet demand in the foreign economy.

The existence or non-existence of an Internalisation advantage is important to determine how the MNC chooses to use its Ownership advantage and also choose between own production and licensing of production to an external firm. Existence of an Internalisation advantage implies that the firms most efficient alternative of using an Ownership advantage is through exports or FDI. If an internalization advantage is missing, it is more profitable for the firm to exploit its Ownership advantage through selling the right of its use to another firm through licensing. While possession of an Ownership advantage is a prerequisite for a firm to be able to serve demand in a

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foreign market, it is the existence of Locational and Internalisation advantages that determines how the foreign market is served.

Box 5.1: OLI advantages and MNC channels for serving a foreign market
Channel for Serving Foreign Market FDI Exports Licensing Ownership Advantage Yes Yes Yes Internalisation Advantage Yes Yes No Locational Advantage in Foreign Country Yes No No Source: Dunning (1981)

FDI only occurs when the MNC possesses both an Ownership and an Internalisation advantage and the foreign country has a Locational advantage. For the case where the MNC lacks an Internalisation advantage, production is licensed to local firms in the foreign market. If the MNCs home country has the strongest Locational advantage, the MNC uses exports to serve the foreign market. The OLI paradigm can, therefore, also be used as a framework for a discussion about the relationship between FDI and trade.

Dunning (1981, 1986) use the framework of the OLI paradigm as a base for the Investment Development Path (IDP) theory. The idea of the IDP theory is that there exists a U-shaped relationship between the level of an economys development and the net outward flows of FDI. In the first low income stage, FDI inflows are small and outflows are zero or close to zero. Domestic firms have not yet acquired Ownership advantages and therefore have no prospects for investing abroad whereas Locational advantages are too weak to attract inward FDI inflows. Economies where significant improvement of the Locational advantages take place (for example, an improvement of the educational level), enter the second stage. Inflows of FDI increase substantially while outward FDI remains very small, resulting

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in an increasingly negative net outward FDI position. During the third stage, net outward flows are still negative but increasing. There are two possible causes for this. The first possibility is that outward investment is constant and inward investment is falling. Alternatively, the outflows of FDI are rising faster than the inflows due to eroded Ownership advantages of the foreign investors or as a result of domestic firms developing Ownership advantages, generating outflows of FDI. During the fourth stage, the outward flows of FDI surpasses the inflows of FDI, implying domestic firms have developed strong Ownership advantages. Empirical applications of the IDP theory include Barry et al. (2003), who analyse inward and outward FDI flows for Ireland. They find that the growing inflows and subsequent outflows of FDI are consistent with the IDP theory.

FDI and the new trade theory

The new trade theory developed in response to the failure of classical trade theories of incorporating concepts observed in actual flows of international trade such as intra-industry trade. The new trade theories contributed by constructing general equilibrium trade models which could include increasing returns to scale, imperfect competition and product differentiation (Helpman and Krugman ,1985).

A weakness of the early contributions to the new trade theory was that they failed to incorporate MNCs and FDI. The dominant assumption in these theories was about the single plant national firms, which limited the usefulness of these models explaining FDI. However, during the eighties and nineties, James Markusen (1995) and other researchers modified the new trade models to allow for inclusion of MNCs and FDI. An important contribution of new trade theory models incorporating MNCs is that they can be used to analyse a firms decision between FDI and exports. The decision between foreign production and exports revolves around the proximity-

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concentration trade-off, where MNCs compare trade costs to the costs of producing at several locations. The advantage of producing in a single location to achieve scale economies is compared to the reduction in trade cost achieved when production takes place at several locations close to the local market. The proximityconcentration trade-off has resulted in the idea of two primary forms of FDI, horizontal and vertical. The distinction between these forms has been fundamental for modeling MNCs and FDI (Markusen 2002).

Horizontal FDI means that an MNC replicates the same activities in several different geographical locations, whereas vertical FDI implies that an MNC locates production stages according to factor costs.

Vertical and horizontal FDI have different motives. Horizontal FDI occurs when the motive of the MNC is primarily market-seeking and the firm wants to satisfy foreign market demand by local production. In this case there exists a foreign market with a demand that the MNC wants to serve by producing close to the market. A reason for this might be that it is necessary to adapt the product to the preferences of local customers. Higher trade costs in the form of tariffs tend to increase the incentive for horizontal FDI.

An MNC performing vertical FDI has primarily an efficiency-seeking motive, that is, the MNC exploits differences in factor costs between geographical locations. The MNC decomposes the production process geographically into separate stages according to factor intensity. For example, the labour-intensive stage of production should be located where labour costs are low. Similarly, a capital-intensive stage should be located where the cost of capital is low. Vertical FDI can be seen as a special version of the spatial product cycle model described in Andersson and Johansson (1984).

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The focus on a horizontal / vertical distinction of FDI and MNCs has strongly dominated trade theory models incorporating FDI. Two of the earliest models of vertical and horizontal MNCs are given in Helpman (1984) and Markusen (1984), respectively. Helpmans model is a general equilibrium model based on differences in factor endowments, where vertical MNCs locate production according to factor intensities, whereas Markusen presents a horizontal model of MNCs, where FDI is driven by firm-level scale economies.

The nineties saw an increasing number of trade models incorporating international production and MNCs. Modeling efforts were still based on the distinction between horizontal and vertical FDI since these were believed to be the main forms of FDI. Markusen (2002) provides an overview of how new trade theory models have incorporated MNCs and foreign direct investment, with a focus on general equilibrium models. Brainard (1993) presents a two-sector, two-country general equilibrium model, where firms choose between exports and foreign investment. The choice is determined by the trade-off between proximity to the market and scale economies at the plant level providing advantages to concentrating production in one country. According to him, national firms can coexist with MNCs in equilibrium. Brainards (1997) study is an econometric study of MNCs using bilateral data for 27 economies with affiliate activity with the U.S. She finds that higher transport costs and foreign trade barriers result in an increase in FDI, providing support for a horizontal model of FDI. Markusen and Venables (1998) develop a two-country general equilibrium model where both national and multi-national firms arise endogenously. Simulation results imply MNCs become more important when countries are similar in size and relative endowments. The simulations also indicate that MNCs tend to arise when firm-level scale economies and tariff or transport costs

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are large relative to plant-level scale economies, confirming the results found by Brainard (1993).

The framework of these general equilibrium models of FDI can also be used for studies not primarily aimed at analysing the form FDI takes. An example is Markusen and Zhang (1999), who investigated host country characteristics that attract FDI and the reasons for developing economies receiving only small inflows of FDI despite being labour abundant. They construct a general equilibrium model based on a high income country and a country abundant in unskilled labour. Simulation indicates that small economies receive less FDI per capita than larger ones and their lack of skilled labour can be an explanation for the small inflows of FDI.

Knowledge-Capital and complex FDI forms

The classification of FDI into a horizontal and a vertical form has recently been extended by the introduction of the concept of knowledge-capital which has added more realism to the strict distinction between horizontal and vertical FDI. According to Markusen (1995), MNC firm-specific advantages are primarily based on knowledge-capital, consisting of intangible assets such as patents, human capital (skilled engineers, for example), trademarks or brand name. He points to the significance of knowledge-capital for MNCs and claims that this fact primarily provides MNCs with an opportunity for international production. Markusen argues that MNCs tend to have large R&D expenditures and technically advanced products suggesting knowledge-capital is important. Knowledge-based assets share

characteristics giving rise to FDI. It is easy and inexpensive to transfer knowledge based assets to new geographical locations and knowledge has a joint character. It can create a flow of services at several production facilities without affecting its productivity.

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Markusen argues that the importance of knowledge for MNCs has implications for the choice between licensing and foreign production. The character of knowledge implies that it can be copied at low cost by a potential licensee that instead starts its own business. Therefore, licensing increases the risk of the MNC losing its firmspecific advantage through technology spillovers, which explains why an MNC prefers to Internalise and choose FDI.

According to this reasoning, the growing importance of knowledge for MNC activities can be an important explanation for the surge in global FDI during the last decades. MNC dependence on knowledge capital provides a strong incentive for Internalising Ownership-advantages resulting in larger volumes of FDI.

To emphasize the importance of knowledge, researchers have constructed models, attempting to formalise the idea of a knowledge-capital based MNC (Markusen 1997). The two-country, two-goods, two-sectors, models presented in these studies allow combinations of vertical and horizontal MNCs as well as national firms to arise endogenously. Carr et al. (2001) constructed a model that can be used for empirical testing of the theory of a knowledge-based MNC. This model incorporates both horizontal and vertical motives for FDI, and econometric testing supports the idea that MNCs are characterised by knowledge-based assets.

Markusen and Maskus (2002) used a general equilibrium framework to determine the importance of horizontal, vertical and knowledge-capital models of MNCs. Computer simulations are performed to test the three alternative models of FDI. Simulation along with estimation of the models based on data for U.S. FDI provides strong support for the horizontal model and rejects the vertical model. The results suggest FDI is most likely to take place between countries similar both in relative

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endowments and size. They also provide strong support for knowledge-capital FDI but can not distinguish it from the horizontal model of FDI.

It has always been interesting to find out how the distinction between vertical and horizontal MNCs fit the form of MNCs actually observed. While studies such as Markusen and Maskus (2002) suggest horizontal MNCs and FDI tend to dominate, empirical studies using detailed firm-level data indicate the existence of more complex forms of FDI. Feinberg and Keane (2005) argue that actual MNC forms seldom can be classified as purely vertical or horizontal. Using firm-level data for U.S. MNCs with affiliates in Canada, they find that only 31 percent of the firms in the dataset could be classified as purely vertical or horizontal. Similarly, Hanson et al. (2001), using detailed data on U.S. MNCs, conclude that the actual choice of strategies done by MNCs is too varied to fit into the distinction between horizontal and vertical FDI.

These empirical observations indicating the existence of more complex forms of FDI led to models where MNCs are not strictly defined as being vertical, horizontal or based on knowledge capital. Yeaple (2003) presents a three-country model where MNCs follow so-called complex integration strategies. In this model, MNCs perform FDI in order both to minimise transport costs and take advantage of differences in factor costs simultaneously. Consequently, MNCs are integrated both vertically and horizontally. The model shows how complex integration strategies result in a complicated structure of FDI determined by complementarities between host countries.

Another example of a complex MNC integration strategy was provided by Ekholm et al. (2004) where export-platform FDI is modeled as an additional form of FDI. They define export-platform FDI as MNC production in a host economy when the output is

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sold in third markets and not in the parent or host country market. The objective of the MNC is to create an export-platform in the host economy. Ekholm et al. argue that export-platform FDI cannot be classified as either horizontal or vertical FDI since it shares characteristics of both forms of FDI. They construct a three-country model with two high-cost countries and one low-cost country. Export-platform FDI occurs when a firm in a large high-cost country constructs a plant in the low cost country in order to supply the other high-cost country. Numerical simulations of the model are performed in order to find conditions resulting in export platform FDI. The likelihood for this form of FDI is determined by the interaction of shipping costs and cost advantages between the three countries.

There are many empirical observations about export platform FDI. Ireland is an example of a host country that has received substantial inflows of export platform FDI. Barry and Bradley (1997) argue that foreign firms perform FDI in Ireland to produce for export rather than to satisfy local demand. FDI inflows to Ireland have been dominated by U.S. MNCs strongly focused on exporting their output to the rest of the EU.

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SECTION 5.2

THEORETICAL FRAMEWORK

It is widely agreed that FDI takes place when three sets of determining factors exist simultaneously: the presence of Ownership specific competitive advantages in a transnational corporation (MNC), the presence of Locational advantages in a host country, and the presence of superior commercial benefits in an intra-firm as against an arms-length relationship between investor and recipient.

The Ownership-specific advantages (e.g. proprietary technology) of a firm, if exploited optimally, can compensate for the additional costs of establishing production facilities in a foreign environment and can overcome the firms disadvantages vis--vis local firms.

The Ownership-specific advantages of the firm should be combined with the Locational advantages of host countries (e.g. large markets or lower costs of resources or superior infrastructure).

Finally, the firm finds greater benefits in exploiting both Ownership-specific and Locational advantages by internalisation, i.e. through FDI rather than arms-length transactions. This may be the case for several reasons. For one, markets for assets or production inputs (technology, knowledge or management) may be imperfect, and may involve significant transaction costs or time-lags. Also it may be in a firms interest to retain exclusive rights to assets (e.g. knowledge) which confer upon it a significant competitive advantage (e.g. monopoly rents).

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While the first and third conditions are firm specific determinants of FDI, the second is Locational-specific and has a crucial influence on a host countrys inflows of FDI. If only the first condition is met, firms will rely on exports, licensing or the sale of patents to service a foreign market. If the third condition is added to the first, FDI becomes the preferred mode of servicing foreign markets, but only in the presence of Locational-specific advantages. Within the trinity of conditions for FDI to occur, Locational determinants are the only ones that host governments can influence directly. (UNCTAD, 2006)

To explain differences in FDI inflows, and to formulate policies to capture inbound investment, it is necessary to understand how Locational factors influence the FDI decisions of a firm.

The objective of this chapter is therefore to review the Locational-specific (hostcountry) determinants of FDI flows.

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Box 5.2: Locational determinants of foreign direct investment

Policy framework for FDI Core FDI Policy Regime Rules Regarding Entry and Operations Standards of Treatments of Foreign Enterprise Policies on Functioning Economic determinants Market Seeking FDI Market Size and Per Capita income Market Growth Access to Regional and Global Markets Country Specific Consumer Preferences Structure of Markets Trade Policy Regimes Resource Seeking FDI Structure of Markets Raw Material Low Cost Unskilled Labour Skilled Labour Technology innovatory and other created assets Physical Infrastructure Intellectual Property Protection Regime Efficiency Seeking FDI Cost of Resource and Assets Other Input Costs Economic Country Monetary Policy Fiscal Policy Political and Social Stability International Agreements on FDI Bilateral Treaties Regional Integration Frameworks Multi Investment Frameworks Source: Dunning John H, The Theory of Transnational corporations, Transnational Corporations, department of Economic and Social Development, 1998. Stability of the Business facilitation factors Investment Promotion Measures Investment Incentives Hassle Costs (corruption, administrative inefficiency) Social Amenities After Investment Services

Several caveats are required before reviewing the FDI determinants:

1.

Direct investment abroad is a complex venture. As distinct from trade, licensing or portfolio investment, FDI involves a long-term commitment to a business endeavour in a foreign country. It often involves the engagement of

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considerable assets and resources that need to be coordinated and managed across countries and to satisfy the principal requirements of successful investment, such as sustainable profitability and acceptable risk/profitability ratios. Typically, there are many host country factors involved in deciding where an FDI project should be located and it is often difficult to pinpoint the most decisive factor. Although the analysis that follows treats each of the three sets of determinants separately, the interrelationships among them have to be considered.

2. The relative importance of different location specific determinants depends on at least four aspects of investment:

a. The motive for investment (e.g. resource-seeking or market seeking FDI) b. The type of investment (e.g. new or sequential FDI), the sector of investment (e.g. services or manufacturing) c. The size of investors (small and medium-sized MNCs or large MNCs). d. The relative importance of different determinants also changes as the economic environment evolves over time. It is, therefore, entirely possible that a set of host country determinants that explains FDI in a particular country at a given time changes as the structures of its domestic economy and of the international economy evolve. At the same time, there are also location specific determinants that remain constant. In the analysis that follows, only the most important host country determinants will be examined.

3. As a general principle, host countries that offer what MNCs are seeking, and/or host countries whose policies are most conducive to MNC activities,

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stand a good chance of attracting FDI. But firms also see Locational determinants in their interaction with Ownership-specific and Internalisation advantages in the broader context of their corporate strategies. These strategies aim, for example, at spreading or reducing risks, pursuing oligopolistic competition, and matching competitors actions or looking for distinct sources of competitive advantage. In the context of different strategies, the same motive and the corresponding host country determinants can acquire different meanings. For example, the market-seeking motive can translate, in the case of one MNC, into the need to enter new markets to increase the benefits arising from multi-plant operations; in the case of another MNC, it can translate into the desire to acquire market power; and for still another MNC, it can aim at diversifying markets as part of a risk reducing strategy. This point to the need for host countries not only to understand the motives of potential investors but also to understand their strategies.

EXPLAINING THE LOCATIONAL FACTORS

1. Market Size

Market size is one of the most important considerations in making investment Locational decisions. The attractiveness of large markets is related to larger potential for local sales, because local sales are more profitable than export sales specially in larger countries where economies of scale can be eventually reaped. Also large countries offer more diverse resources which makes local sourcing more flexible. The higher the GDP, the better is the nations economic health and better are the prospects that the direct investment will be profitable. Thus GDP has a positive influence on direct investment from abroad.

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2. Economic stability of the country

Monetary and fiscal policies which determine the parameters of economic stability such as the interest rates, tax rates, and the state of external and budgetary balances, influence the investment rates, described as follows:

a. Interest Rates

Interest rates affect the cost of capital in a host country, directly affecting one of the determinants of the investment decision. The effects of interest rates on FDI are smaller than on domestic investment because MNCs normally have a greater choice of sources of financing.

b. The level of External Indebtedness

The level of external indebtedness is expected to have a negative impact on FDI inflows. The level of indebtedness shows the burden of repayment and debt servicing on the economy thus making the country less attractive for foreign investors.

c. Debt Service Ratio

This is represented by total debt service as a percentage of total income of the country. The higher this ratio, the higher will be the burden of the country to service the debt out of the income of the country. The FDI inflows are expected to increase with a small debt service ratio. Thus this variable is expected to have a negative correlation with the FDI inflows.

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d. Foreign Exchange Reserves

The higher the level of foreign exchange reserves in terms of import cover reflects the strength of external payments position and helps to improve the confidence of the prospective investors. Therefore a positive relationship is expected between the foreign exchange reserves and the inflow of foreign direct investment.

e. Exchange Rate Regime

Exchange rate represents the investment climate in the country. High exchange rate will erode the profitability of foreign investment, increase the cost of production and introduce distortions in the host countrys economy. As a consequence, a negative relationship can be hypothesized between the exchange rate and the flow of foreign capital.

f.

Inflation Rate

A high rate of inflation is a sign of internal economic tension and of the inability or unwillingness of the government and the central bank to balance the budget and to restrict the money supply. As a rule, the higher the inflation rate, the less will be the FDI inflows. A negative relationship is expected.

g. Deficit in the Balance Of Payments

A large deficit in the BOP indicates that the country lives beyond its means. The danger increases that free capital movement will be restricted and that it

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will be more difficult to transfer the profits from the direct investments into the investing country. Hence a negative relationship can be expected.

3. Availability of human capital

The continued expansion of MNCs was in the past, a response to differential availability of factor endowments in various countries. Cheap and productive labour reduces the cost of production and yields high profitability. Low wage rates and higher labour productivity thus is expected to have a positive influence on FDI inflows.

4. Availability of natural resources

Historically the most important host country determinant of FDI has been the availability of natural resources. The availability of natural resources (raw material) for manufacturing is one of the most important factors in investment decision making. If the resources are available locally the cost of production remains low, as the cost of transportation is saved. It is the sustained availability of the resources which matter in the investment decisions. In case of planned and long term industrial investments, the availability of raw material for a short period is not considered favorable.

5. Economic policies of the host country

Economic policies include the industrial policies, trade policies, tax structures, the intellectual property protection regime, bilateral investment treaties, regional integration frameworks, multilateral investment frameworks etc of a county. Government policies are a possible determinant of FDI since the Government

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considers FDI flows as a means to fight unemployment and enhance national growth rates.

6. Infrastructural facilities

The establishment of industry requires a highly developed infrastructure. The development of roads, rails, electricity and communication system are important infrastructural facilities which are vital for the development of the industry. These factors are responsible for the attraction of FDI and the lack of them becomes a hindrance.

7. Agglomeration effects

Agglomeration effects are also significant in attracting FDI. Agglomeration economies arise from the presence of other firms, other industries, as well as from the availability of skilled labour force. Agglomeration effects correspond to positive spillovers from investors already producing in this area. This gives rise to economies of scale and positive externalities, including knowledge spillovers, specialized labor and intermediate inputs. Thus high FDI today implies high FDI tomorrow. Such high persistence over time is reinforced by the nature of FDI, which involve high sunk costs and is often accompanied by physical investment that is irreversible during short run.

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Box 5.3: Determinants of FDISummarised

Determinant Market Size, Market Growth Level of development Possible Proxy Variable GDP, GDP Growth Rate GDP per Capita, GDP per Capita Growth Rate Urbanisation Human Capital Agglomerations Percentage of Urban Population Secondary School Enrolment Ratio FDI Lagged One Period Number of Firms in the Region GDP Economic Integration Governments, Trade Regime Member of EconomicPolitical Union (Exports + Imports) / GDP FDI as a fraction of GDP Infrastructure (Roads) Labour Costs Exchange Rate Variability Wages and Salaries Absolute / Relative Change in Real Exchange Rate Political Instability Interaction Between the Foreign Investor and the Domestic Firms Foreign Debt as a Fraction of GDP R&D Marketing process +/ +/+ +/+ + + + + + + +/ Effect +++ ++

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SECTION 5.3

LITERATURE REVIEW

An extensive set of determinants has been analyzed in the literature on the determinants of FDI. Numerous empirical studies (Agarwal, 1980; Gastanaga et. al., 1998; Chakrabarti, 2001; and Moosa, 2002) lead to a set of explanatory variables that are widely used and found to be significant determinants of FDI. Markusen and Maskus (1999), Love and Lage-Hidalgo (2000), Lipsey (2000) and Moosa (2002) highlight how the domestic market size and differences in factor costs can relate to the Locational of FDI. This factor is important to foreign investors who operate in industries characterized by relatively large economies of scale. This is because they can exploit scales economies only after the market attains a certain threshold size. The most widely used measures of market size are GDP, GDP/Capita and growth in GDP. The signs of these coefficients are usually positive.

Discussing the labor cost, which is one of the major components of the cost function, it is found that high nominal wages, other things being equal, deter FDI. This must be particularly true for the firms, which engage in labor-intensive production activities. Therefore, conventionally, the expected sign for this variable is negative. There are studies that find no significant or a negative relationship of wage and FDI (Kravis and Lipsey, 1982; Wheeler and Mody, 1990; Lucas, 1993; Wang and Swain, 1995; and Barrell and Pain, 1996). Nonetheless, there are other researchers who have found out that higher wages do not always deter FDI in all industries and have shown a positive relationship between labor costs and FDI (Moore, 1993; and Love and LaveHidalgo, 2000). This is because higher wages indicate higher productivity and hi-tech

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research oriented industries, in which the quality of labor matters, prefer high-quality labor to cheap labor with low productivity.

Recently, a few researchers have also studied the impact of specific policy variables on FDI in the host countries. These policy variables include openness of trade, tariff, taxes and exchange rate. Gastanga et al (1998) and Asiedu (2002) focus on policy reforms in developing countries as determinants of foreign direct investment inflows. They find corporate tax rates and degree of openness to foreign direct investment to be significant determinants of FDI. Similarly many recent models highlight the effect of tariffs on FDI in the context of horizontal and vertical specialization within MNCs (Ethier, 1994 and 1996; Brainard, 1997; Carr, Markusen, and Maskus, 2001).

Likewise the effect of exchange rate movements on FDI flows is a fairly well studied topic, although the direction and magnitude of influence is not very certain. Froot and Stein (1991) claimed that a depreciation of the host currency should increase FDI into the host country, and conversely an appreciation of the host currency should decrease FDI. Similarly, Love and Hidalgo (2000), also acknowledge that the lagged variable of exchange rate is positive which indicates that a depreciation of the peso encourages US direct investment in Mexico after some time. Contrary to Froot and Stein (1991), Campa (1993), while analyzing foreign firms in the US puts forth the hypothesis that an appreciation of the host currency will in fact increase FDI into the host country that suggests that an appreciation of the host currency increases expectations of future profitability in terms of the home currency.

Sayek Selin (1999), explained the relationship between FDI and inflation. This researchs results from an impulse response analysis supported the theoretical model, shown a 3 percent increase in Canadian inflation reducing US FDI in Canada by 2 percent and increasing USA domestic investment by one percent. Similarly, a 7

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percent increase in Turkish inflation reduces US FDI in Turkey by 1.9 percent, increasing US domestic investment by 0.3 percent.

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SECTION 5.4

HYPOTHESIS AND METHODOLOGY

In the present chapter the Locational specific (host country) determinants of the foreign direct investment inflows are studied. A brief analysis of these variables that would set as a background for the empirical analysis of the determinants of FDI in India has already been given in the previous section. Based on the theory of John Dunning, several variables affecting FDI have been discussed in this present section. The present study is a version of an explanation of the inward flow of FDI into India from 1980-81 to 2005 based on some important quantifiable policy and economic variables. A process of gradual relaxation of controls and regulations with a view to attract large inflows of foreign investments was discernable from the year 1981. In a limited and phased manner market forces were allowed to govern the foreign investment flows during this period. Hence this period has been selected.

Considering the principal determinants of FDI inflows the equation is specified is as follows:

IFDI =a0+a1 GDP+a2 WAGE+a3 INFL+a4 EXDBT+a5 INFR+a6 OPEN+a7 REER+a8 AGGL Where,

i. IFDI ii. GDP iii. WAGE iv. INFL v. EXDBT

: Foreign direct investment net inflows measured as BOP current US$ billion : Gross Domestic Product at factor cost measured in current US$ billion : Total emoluments paid to the workers measured in Rs. Lakhs. : (Inflation) GDP deflator measured as annual percentages : Total external debt measured in current US$ billion

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vi. INFR capita. vii. OPEN viii. REER

: (Infrastructure) Proxied by energy use measured as Kg. of oil equivalent per

: Sum of Exports + Imports divided by GDP [(Ex+Im) / GDP] : Indices of Real Effective Exchange Rate of the Indian Rupee36 country

bilateral weights with base 1985=100 ix. AGGL : Agglomeration effect measured by a two year lag values of net FDI inflows

Hypothesis

Locational factors (pull factors) determine the flow of inward foreign direct investment to India.

Empirical Analysis

For the purpose of the study, aggregate annual time series data at country level at current prices is used. Aggregate data is normally very useful in establishing long term econometric relationships between the variables.

As it is known that usually economic time series move together, therefore, if all the variables are included simultaneously in the equation there may be possibility of multicollinearity. To examine the variables which may not be included simultaneously in the equation, a bivariate correlation matrix for all the expected explanatory variables and the dependent variable was obtained. Based on the correlation matrix several variables were selected as the possible explanatory variables. The correlation matrix also shows high degree of association between all the explanatory variables.

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Box 5.4: Correlation matrix of inward FDI flows and the determinants of inward FDI flows
IFDI IFDI GDP EXDBT INFR INFL OPEN REER AGGL WAGE 1 .933 .750 .889 -.788 .924 -.524 .885 .932
** ** ** ** ** ** ** **

GDP .933 ** 1 .817** .911** -.731** .947** -.572** .921** .927**

EXDBT .750** .817** 1 .954** -.482* .832** -.921** .712** .905**

INFR .889** .911** .954** 1 -.675** .911** -.828** .847** .981**

INFL -.788** -.731** -.482* -.675** 1 -.640** .270 -.775** -.676**

OPEN .924** .947** .832** .911** -.640** 1 -.628** .880** .957**

REER -.524** -.572** -.921** -.828** .270 -.628** 1 -.456* -.734**

AGGL .885** .921** .712** .847** -.775** .880** -.456* 1 .865**

WAGE .932** .927** .905** .981** -.676** .957** -.734** .865** 1

** Correlation is significant at the 0.01 level (2-tailed). * Correlation is significant at the 0.05 level (2-tailed).

(Estimates based on appendix tables)

Simple correlation between IFDI and GDP is found very high at 0.933. Correlation between IFDI and WAGE is also very high at 0.932. OPEN is correlated with IFDI with r = 0.924. Agglomeration effects (AGGL) are correlated with IFDI at 0.885. INFR is correlated to FDI with r = 0.889. REER and INFL have a negative correlation with IFDI as expected with r = 0.524 and r = 0.788 respectively. EXDBT should have a negative correlation with IFDI. However, it is positive with r = 0.75.

Using Multiple Linear Regression (MLR), the explanatory variables are regressed. In order to estimate the regression model, a statistical package, Statistical Package for Social Sciences (SPSS), is used. SPSS is run and from the output, the values of the constant, (slope), coefficient of regression. In addition, the output shows the tstatistic and p-values for the coefficients which results in either rejecting or failure to reject the hypothesis at a specified level of significance. The p-value is the probability of getting a result that is at least as extreme as the critical value. The null hypothesis is rejected if the p-value is less than or equal to the critical value.

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REGRESSION RESULTS
(Estimates based on appendix tables) Regression Analysis Explaining the Variations in IFDI flows Dependent Variable Period N : : : IFDI flows 1980 To 2005 26

Regression Model 1 Model Summary:

R Square 0.936 Adjusted R Square 0.927 F-Value 102.291

Coefficients:
Coefficient (Constant) GDP WAGE EXTDBT - 1041.348 5.559 1037.631 - 31.809 Beta 0.400 0.958 - 0.439 t - 2.017 2.664** 4.645* - 3.333**

Notes: * Significant at 1% / ** Significant at 5%

Excluded Variables:
Beta In ENRGY INFL OPEN AGG 0.506c - 0.114c - 0.022c - 0.009c t 1.174 - 1.227 - 0.091 - 0.063

c. Predictors in the Model: (Constant), GDP, WAGE, EXT_DBT

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Regression Model 2 Model Summary:

R Square 0.919 Adjusted R Square 0.911 F-Value 129.614

Coefficients:
Coefficient (Constant) OPEN INFL - 958.273 28523.012 - 259.380 Beta 0.711 - 0.333 t - 1.069 9.174* - 4.293*

Notes: * Significant at 1% / ** Significant at 5%

Excluded Variables:
Beta In ENRGY AGG 0.107b 0.011b t 0.700 0.073

b. Predictors in the Model: (Constant), OPEN, INFL

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SECTION 5.5

FINDINGS AND CONCLUSIONS

The above findings corroborate the theoretical predictions emanating from recent propositions in the theory of international trade and are able to explain about 92% of the variations in FDI in India. Size of the market indicated by GDP, labour productivity measured by WAGE, economic stability measured by level EXDBT and INFL and OPEN are found to be statistically significant and have proper signs. The coefficients of WAGE and OPEN are positive and highly significant in explaining the FDI inflows. The coefficients of INFL and EXDBT are negative and statistically significant. Other variables like AGGL, and INFR are statistically insignificant and do not explain the variations in FDI inflows.

The results both confirm and complement findings of other studies where it has been found that cost related factors, macro economic factors and countrys profile of political risk index are the major determinants of inward FDI flows. (Markusen and Maskus, 1999; Love and Lage-Hidalgo, 2000; Lipsey, 2000; Moosa, 2002; Moore, 1993; Sayek Selin, 1999)

Over a period of time general and specific FDI policies have become less restrictive to inward FDI in India. With fewer policy barriers, other factors have become emerged as important determinants. Prominent among them are basic economic pull factors such as good quality and productive human resources on the supply side, and market size on the demand side. Macro-economic policies that shape the underlying fundamentals of cost-competitiveness, economic stability of the country

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and degree of integration with the world economy have also become more important over time in attracting FDI.

Market size is an important factor affecting FDI; however, in India, this important traditional variable has decreased in importance. At the same time, cost differences between locations, spillovers from increased competition on the domestic turf, the ease of doing business and the availability of skills have become more important. This is validated in the results of this study.

Thus although FDI remains strongly driven by its traditional determinants, the relative importance of different Locational determinants for competitiveness enhancing FDI is shifting. Cheap and skilled labour is an important determinant attracting FDI to India. A high wage adjusted productivity of labour has attracted efficiency seeking FDI aiming to produce for the domestic economy as well as for exports to other countries. India remains a country with a large supply of skilled human capital attracting more FDI, particularly in sectors that are relatively intensive in the use of skilled labour. While low cost remains a Locational advantage, the increasingly sought after advantages are competitive combinations of wage, skills and productivity. This explains the growing volume of vertical efficiency seeking FDI in which foreign companies seek to produce intermediate and/or final products in the cheapest (real) cost locations primarily for exports to third markets. It is found that the FDI flows were already skewed towards manufacturing and services sector in 1990, but increasingly have shifted towards services in the past 15 years. India has been able to attract increasing amounts of FDI in high value-added services. Now, even the most strategic of functions such as R&D are expanding in some developing countries as multinational corporations seek to benefit from pools of talent at competitive costs, particularly in those countries that have actively helped to create this (incl. Singapore, Malaysia, China and India). (UNCTAD, 2005)

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This has implications on the success of domestic policies to attract inward FDI. The nature and sequencing of general and specific policies in areas covering investment, trade, innovation and human resources are all important. Appropriate policies to benefit from FDI include building up local human resource and technological capabilities to capture productivity spillovers. Lall (2000) argues that FDI Locational decisions will increasingly depend on economic factors and not on temporary policy interventions.

One important hypothesis from various studies is that gains from FDI are far higher in an open regime. Trade openness generally positively influences the export oriented FDI inflow into the economy. As shown in our results trade openness in the Indian economy has emerged as an important factor attracting FDI inflows.

The results also suggest that long term investment benefits from stability as it reduces the risks for the long-term investor. This is backed up by investor surveys and to a large extent by the evidence. Politically unstable countries tend to receive relatively small amounts of FDI. Government finance is another important issue that affects capital flows. A high level of external debt in India has emerged as a deterrent for FDI inflows.

To conclude, the Locational strategies chosen by firms are likely to be highly contextual and would vary according to industry specific characteristics, the motives for FDI, and the functions being performed by MNC subsidiaries. The government should recognize that the Locational specific advantages sought by mobile investors are changing. Over all, India needs to maintain the growth momentum to improve market size, frame policies to make better use of their abundant labour forces and follow more open trade policies for attracting FDI. Field surveys of the rankings of

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various countries by business executives compiled and published by the EIU in the 2000 and 2001 editions of the World Investment Prospects (E.I.U. 2002) show that business executives are increasingly ranking the political stability, quality of infrastructure and government policies towards private enterprise and competition, along with the macro economic environment, as the critical variables likely to affect the future geography of FDI in the early years of the 21st century. The government needs to give constant attention to the upgrading and reconfiguring of their own unique Locational bound advantages, both actual and potential. However, regional initiatives need to be designed carefully to ensure the benefits of new FDI are broadly spread across the regions and sectors.

It is possible that government regulations and policies may deter some forms of FDI, particularly where they affect Ownership. Thus the Government needs to assess the benefits of such interventions against the costs of creating impediments to FDI, which reduce the ability of the country to compete with other developing countries for foreign investments.

Many of the motivations influencing the investment decisions of multinational companies apply equally to domestic investors. Addressing the problems identified by foreign investors already committed to the region should not only in the long run make India more attractive to new FDI but should in the shorter term encourage increased domestic investment.

If the economy has to benefit from the FDIs spillover effects and economic growth, the country needs to attract FDI formulating a bundle of policies that caters for the interests of all the potential investors from different countries. This implies that the country needs stable macro economic indicators, better country risk profile followed by cost related and investment environment improving factors.

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Thus India should continue its program of economic reforms, as a sustained healthy economic growth is the biggest attraction for foreign capital. However, any political reforms need to ensure that instability does not ensue. Further, the government should create specific Locational advantages in areas and sectors which have not been able to attract more FDI, such as skilled employees and improving the infrastructure. This will help reduce the disparities in development across regions and sectors.

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LIMITATIONS AND SCOPE FOR FURTHER RESEARCH

Limitations

Like all research, the findings here need to be interpreted cautiously given the inherent data constraints of the macro economic time series data and the scope of this research. It is possible that the importance of the Locational factors will differ depending on sector, type and motivation of FDI and a more detailed study at the micro level would yield meaningful insights.

Scope of Further Research

An interesting topic for future research would be to analyze how foreign direct investment in India is affected by factor endowments such knowledge capital, in order to better explain the driving forces of FDI and more closely determine whether FDI tends to be vertical rather than horizontal in nature. It would also be very pertinent to study the impact of FDI inflows on various domestic macro and micro economic variables. Another interesting research avenue would be to undertake a causal analysis to determine whether the relationship between FDI and growth is unidirectional or bidirectional.

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Weltwirtschaftliches Archiv 117:30-64. 16. Dunning, J.H. (1986). The Investment Development Cycle Revisited, Weltwirtschaftliches Archiv 122: 667-677. 17. Ekholm, K. (2004). Multinational Enterprises and Their Effect on Labour Markets, in Globalization and the Welfare State ed. by Sdersten, B., Palgrave Macmillan, New York. 18. Ethier, W. J. (1996). Theories about Trade Liberalisation and Migration: Substitutes or Complements in International Trade and Migration in the APEC Region ed. by Lloyd, P. J. and. L. Williams, Oxford University Press, Oxford. 19. Ethier, W.J. (1994). Multinational Firms in the Theory of International Trade, in Economics in a Changing World ed. by Bacha, E., Macmillan, London. 20. Feinberg, S.E. and M.P. Keane (2005). Accounting For the Growth of MNC Based Trade Using a Structural Model of U.S. MNCs., manuscript, University of Maryland.

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21. Froot, K. A., and J. C. Stein (1991). Exchange Rates and Foreign Direct Investment: An Imperfect Capital Markets Approach, Quarterly Journal of Economics 106:191-217. 22. Gastanaga, V. M., J. B. Nugent and B. Pashamova (1998). "Host Country Reforms and FDI Inflows: How Much Difference Do They Make?" World Development 26 (7): 1299-314. 23. Hanson, G.H., R.J. Mataloni and M.J. Slaughter (2001). Expansion Strategies of U.S. Multinational Corporations, Brookings Trade Forum 2001:245-294. 24. Helpman, E. (1984). A Simple Theory of International Trade with Multinational Corporations, Journal of Political Economy 92(3): 451-471. 25. Helpman, E. and P.R. Krugman (1985). Market structure and foreign trade, the MIT Press, Cambridge. 26. Hymer, S.H. (1960). The International Operations of National Firms, PhD thesis, MIT (published by the MIT Press 1976). 27. Kravis, I. B. and R. E. Lipsey (1982). "The Locational of Overseas Production and Production for Exports by US Multinational Firms." Journal of International Economics 12: 201-23. 28. Lall, S. (2000). FDI and Development: Policy and Research Issues in the Emerging Context, Working Paper No.43, Queen Elizabeth House, University of Oxford. 29. Lall, S. and S. Urata (2003) Competitiveness, FDI and Technological Activity in East Asia, Edward Elgar, Cheltenham. 30. Lim, E.G. (2001). Determinants of, and the Relation between Foreign Direct Investment and Growth: A Summary of Recent Literature, IMF working paper no. 01/175, November. 31. Lipsey, R. E. (2000). "Interpreting Developed Countries' Foreign Direct Investment." NBER Working Paper No. 7810, National Bureau of Economic Research, Cambridge.

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32. Love, J. H. and F. Lage-Hidalgo. (2000). "Analysing the Determinants of US Direct Investment in Mexico." Applied Economics 32: 1259-67. 33. Lucas, R. E. (1993). "On the Determinants of Direct Foreign Investment: Evidence from East and Southeast Asia." World Development, 21(3): 391-406. 34. Markusen, J. and K. Maskus (1999). Discriminating Among Alternative Theories of the Multinational Enterprises. NBER working paper 7164, National Bureau of Economic Research, Cambridge. 35. Markusen, J.R. (1984). Multinationals, Multi-Plant Economies and the Gains From Trade, Journal of International Economics 16: 205-226. 36. Markusen, J.R. (1995). The Boundaries of Multinational Enterprises and the Theory of International Trade, Journal of Economic Perspectives 9 :169-189. 37. Markusen, J.R. (1997). Trade versus investment liberalization, NBER Working Paper No. 6231, National Bureau of Economic Research, Cambridge. 38. Markusen, J.R. (2002). Multinational Firms and the Theory of International Trade, the MIT Press, Cambridge. 39. Markusen, J.R., and A.J. Venables (1998). Multinational Firms and the New Trade Theory, Journal of International Economics 46: 183-203. 40. Markusen, J.R., and K.E. Maskus (2002). Discriminating Among Alternative Theories of the Multinational Enterprise, Review of International Economics 10: 694-707. 41. Markusen, J.R., and K.H. Zhang (1999). Vertical Multinationals and Host Country Characteristics, Journal of Development Economics 59:233-252. 42. Meyer, K.E. (1998). Direct Investment in Economies in Transition, Edward Elgar, Cheltenham. 43. Moore, M. O. (1993). "Determinants of German Manufacturing Direct Investment in Manufacturing Industries." Weltwirtschaftliches Archiv 129:12037.

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44. Moosa, I.A. (2002). Foreign Direct Investment: Theory, Evidence and Practice, Palgrave, London. 45. Sayek, S. (1999). FDI and inflation: Theory and Evidence. Duke University, Advisor: Kimbrough, Kent. 46. Vernon, R. (1966). International Investment and International Trade in the Product Cycle, Quarterly Journal of Economics 80:190-207. 47. Wang, Z. Q. and N. J. Swain (1995). "The Determinants of Foreign Direct Investment in Transforming Economies: Empirical Evidence from Hungary and China." Weltwirtschaftliches Archiv 131: 359-82. 48. Wheeler, D. and A. Mody (1990). Risk and Rewards in International Locational Tournaments: The Case of US Firms, The World Bank, Washington DC. 49. WIR (2005). TNCs and the Internalisation of R&D, World Investment Report, UNCTAD, United Nations, Geneva. 50. WIR (2006). FDI from Developing and Transition Economies: Implications for Development, World Investment Report, UNCTAD, United Nations, Geneva. 51. World Investment Prospects (2002). The Economist Intelligence Unit, London. 52. Yeaple, S.R. (2003). The Complex Integration Strategies of Multinationals and Cross Country Dependencies in the Structure of Foreign Direct Investment, Journal of International Economics 60: 293-314.

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CHAPTER 6 DETERMINANTS OF OUTWARD FOREIGN DIRECT INVESTMENT

SECTION 6.1

THEORIES OF OUTWARD FOREIGN DIRECT INVESTMENT

Economic literature has identified various factors that motivate outward FDI flows from the developing home countries. Aykut and Ratha (2003) have broadly categorised the determinants of FDI outflows from the Asian developing countries into demand side pull factors and supply side push factors. Pull factors are the economic, financial and institutional (micro and macro) characteristics of the host country markets that attract FDI towards them. Push factors, on the other hand are the micro and macro supply side factors originating from the economic, financial and institutional characteristics and conditions of the home / source / capital exporting country that push (induce and sometimes compel) outward FDI into the destination economies. Various push factors may compel a home country to make overseas FDI (e.g., diminished expected profit margin or global downturn in a sector, need for additional resources and ensuring their long-term supply, less than adequate domestic physical infrastructure, liberalised trade regime, high inflation rate, depreciated exchange rate) or induce it (increased supply of capital, loosened capital controls, regional integration, etc.) to make market-seeking, efficiency-enhancing and resource-augmenting FDI abroad (Ariff and Lopez, 2007).

Four key types of push and pull factors, and two associated developments help explain the drive for internationalisation by developing country MNCs.

First, market-related factors appear to be strong forces that push developing-country MNCs out of their home countries or pull them into host countries. In the case of Indian MNCs, the need to pursue customers for niche products, for example, in IT

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services and the lack of international linkages are key drivers of internationalisation. Chinese MNCs, like their Latin American counterparts, are particularly concerned about bypassing trade barriers. Over-dependence on the home market is also an issue for MNCs, and there are many examples of developing-country firms expanding into other countries in order to reduce this type of risk.

Secondly, rising costs of production in the home economy, especially labour costs are a particular concern for MNCs from East and South-East Asian countries such as Malaysia, the Republic of Korea and Singapore, as well as Mauritius (which has labour-intensive, export orientated industries, such as garments). Crisis or constraints in the home economy, for example, where they lead to inflationary pressures, were important drivers in countries such as Chile and Turkey during the nineties. However, interestingly, costs are less of an issue for China and India, two growing sources of FDI from the developing world. Clearly, this is because both are very large countries with considerable reserves of labour, both skilled and unskilled.

Thirdly, competitive pressures on developing-country firms are pushing them to expand overseas. These pressures include competition from low-cost producers, particularly from efficient East and South-East Asian manufacturers. Indian MNCs, for the present, are relatively immune to this pressure, perhaps because of their higher specialisation in services and the availability of abundant low cost efficient labour. For them, competition from foreign and domestic companies based in the home economy is a more important impetus to internationalise. Similarly, competition from foreign MNCs in Chinas domestic economy is widely regarded as a major push factor behind the rapid expansion of FDI by Chinese MNCs. Domestic and global competition is an important issue for developing-country MNCs, especially when these MNCs are increasingly parts of global production networks in industries such as automobiles, electronics and garments.

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Fourthly, home and host government policies influence outward FDI decisions. Chinese MNCs regard their Governments policies as an important push factor in their internationalisation. Indian firms, on the other hand, have been enticed by supportive host-government regulations and incentives, as well as favourable competition and inward FDI policies. South African MNCs, among others, mention transparent governance, investment in infrastructure, strong currencies, established property rights and minimal exchange-rate regulations as important pull factors. Most importantly, liberalisation policies in host economies are creating many investment opportunities, for example through privatisations of state-owned assets and enterprises.

Apart from the above mentioned factors, there are two other major developments driving developing-country MNCs abroad.

First, the rapid growth of many large developing countries, foremost among these being China and India, is causing them concern about running short of key resources and inputs for their economic expansion. This is reflected in strategic and political motives underlying FDI by some of their MNCs, especially in natural resources.

Second, there has been an attitudinal or behavioural change among the MNCs. They increasingly realise that they are operating in a global economy, not a domestic one, which has forced them to adopt an international vision.

These two developments, along with push and pull factors, especially the threat of global competition in the home economy and increased overseas opportunities arising from liberalisation adds empirical weight to the idea that there is a structural shift towards earlier and greater FDI by developing country MNCs.

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In principle, four main motives influence investment decisions by MNCs market seeking, efficiency-seeking, resource-seeking (all of which are asset exploiting strategies) and created-asset-seeking (an asset augmenting strategy). (UNCTAD 2006)

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SECTION 6.2

LITERATURE REVIEW

Outward FDI, that was a strong forte of the developed countries till the early period of 1990, has been extensively explained in the literature. Early studies drew heavily from the international trade theory and emphasised on the comparative advantage of the host countries as the most important determinant of FDI. This view successfully explained "resource-seeking" FDI. However, in the early 1970s, researchers started looking for alternative explanations as this theory could not explain the reasons of substitution of trade by FDI. Alternatively, market access was put forward as an explanation for FDI. The market imperfection hypothesis postulated that FDI was the direct result of an imperfect global market environment (Hymer, 1960). This approach successfully analysed the "tariff-jumping" FDI, which was prevalent in the countries encouraging import substituting industrialisation policies in the late seventies. However, in the eighties there was a need to explain the rising volumes of FDI despite the world markets becoming integrated. An alternative explanation came forth in the stream of thought that proposed the Internalisation theory (Rugman, 1986). This theory explained FDI in terms of a need to internalise transaction costs so as to improve profitability and explained the emergence of "efficiency-seeking" FDI.

However, the above theories were short of explaining the reasons as to why FDI tended to exploit relevant assets in some countries as against others. In this regard, Dunning's approach to international production gave Locational issues explicit importance by combining them with firm-specific advantages and transaction costs elements (Dunning, 1993). According to Dunning, FDI takes place owing to

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Ownership, Internalisation and Locational advantages. Ownership advantages are firm-specific competitive advantages (tangible and intangible) which an investing firm possesses over local firms in serving particular markets. These include unique assets relating to technological know how, marketing expertise and managerial skills. These skills must be combined with some of the location-specific advantages of the host countries such as natural resources, cheap inputs, large markets and so forth. To minimise transaction costs and increase profitability, investing firms must exploit their Ownership and Locational advantages through "Internalisation" rather than arms length transactions.

Although the OLI theory explains to a large extent outward FDI emerging from developed countries and going into developing economies, it may not be an exhaustive framework to explain in particular outward FDI emerging from the developing economies and going into the developed countries. To explain such a phenomenon, Rashmi Banga (2007) uses three sets of factors (a) trade-related drivers; (b) capability-related drivers; and (c) domestic drivers to explain outward FDI from Asian countries.

few

studies

explore

push

and

pull

factors

behind

Chinas

MNCs

internationalisation (Wong and Chan, 2003; Wu and Chen, 2001; Cai, 1999). Surveys, such as the FIAS/IFC/MIGA survey (FIAS, 2005), conducted in 2005 provide information on the determinants of OFDI that are often classified in terms of push (home country), pull (host country), and policy factors (in both home and host countries). (UNCTAD 2006)

Traditional theories have characterised exports and FDI as alternative strategies. It was argued that firms can either produce at home and export, or produce abroad and substitute local sales of foreign affiliates for exports. The growing complexities in the

191

relationship between trade and FDI in the globalised era of integrated markets have led to the emergence of new approaches to study them. Some studies indicate that FDI is used to preserve markets that were previously established by exports (Grosse and Trevino, 1996) while others suggest that FDI follows exports (Eaton and Tamura, 1994). Following Mundell (1957), it was long thought that FDI substituted trade. This proposition was challenged by Agmon (1979), and subsequently a number of studies emphasised potential complementarities between FDI and trade. This literature has been reviewed by Ethier (1994, 1996) and Markusen (1995). Further, there have been some studies that have explored the relationship between FDI and trade by taking a unified approach, in which the two flows are determined simultaneously. (Markusen and Maskus, 2002) These studies can be divided into three categories. First, some researchers argue that the determinants of FDI and trade are similar and therefore the factors that determine trade also determine FDI flows (Ekholm, 1998). Second, others postulate econometric models in which FDI, exports and imports are determined simultaneously. They argue that all three are endogenous variables and therefore, their interactions should be taken into account (Hejazi and Safarian, 2003). Some of the studies found that openness to trade and regional trade and investment agreements were an important determinant of FDI in the decade of the 1990s (Binh and Haughton 2002; Worth 2002; and Banga, 2004). Banga (2004) shows that regional trade agreements such as AFTA and APEC increase the size of the market in those regions and therefore encourage FDI into the region.

Studies have also estimated the impact of BITs on inward FDI and argue that BITs encourage FDI as the risks associated with investments decline with greater commitments. Globerman and Shapiro (1999) found that the CUFTA and the NAFTA increased both inward and outward FDI. Blomstrom and Kokko (1998) separated the effects of regional trade agreements along two dimensions the indirect effect on FDI through trade liberalisation; and the direct effects from changes in investment

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rules connected with the regional trade agreements. According to them, lowering interregional tariffs can lead to expanded markets and increased FDI, but lowering external tariffs can reduce FDI to the region if the FDI is tariff-jumping.

With a number of studies indicating productivity spillovers from FDI (Caves, 1996; Globerman, 1979; Blomstrom and Wolf, 1994; Djankov and Hoekman, 2000; and Banga, 2004), the higher the inflow of FDI, the higher will be the capability of domestic investors to undertake investments abroad.

Meanwhile, higher degree of openness is linked with greater level of outward FDI. Kogut (1983) stressed that the adoption of export-oriented policy eventually enable firms to acquire knowledge on the foreign market as well as skills in running operations abroad. Ultimately, this will become the force for the firms to shift their strategy from exporting to abroad investment.

Kyrkilis and Pantelidis (2003) noticed that income is the most important determinant of FDI outflows for Germany. In addition, they also discovered that exchange rate is an influential factor in affecting the outward FDI of Brazil and Singapore. Meanwhile, low interest rate in the home country relatively will lead to higher tendency of outward FDI (Prugel, 1981; Lall, 1980; Grubaugh, 1987). Indeed, investments abroad require sound financial support and capital abundance in terms of low interest rate that enables the firms to access capital markets. Therefore, firms can obtain necessary funding to finance their abroad investment. In relation to that, exchange rate also has significant impacts towards the outward FDI. Although countries with stronger currencies, as compared to firms from countries with weak currencies, will discourage exports, however, this will lead to higher propensity to perform abroad investment due to appreciation of the currencies (Aliber, 1970; Kohlhagen, 1977; Stevens, 1993).

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The main objective in this chapter is to identify the main determinants (home country push factors) of outward FDI from India during the period 1980 to 2005.

For the purpose of this study the push factors have been classified in three categories:

Box-6.1: Push Factors determining OFDI

Structural Factors Economic Growth Domestic Employment Gross Domestic Savings Development of Stock Exchange Exports Imports Inflow of FDI Infrastructural Availability Labour Skill Levels Availability of cheap capital Institutional Factors Tax Policies New Economic Policies Bilateral Agreements Labour Laws Cyclical factors Inflation Exchange Rate

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Box-6.2 Determinants - Summarised

Determinant Economic Growth Level of Development Possible Proxy Variable GDP, GDP Growth Rate GDP per Capita, GDP per Capita Growth Rate, Domestic Savings Infrastructure Capital Costs Agglomerations Roads, Energy, Water Interest Rates IFDI Lagged One Period Number of Firms in the Region Economic Integration Member of EconomicPolitical Union Bilateral Agreements Governments, Trade Regime Labour Costs Exchange Rate Variability Economic Instability (Exports + Imports) / GDP Taxes Wages and Salaries Absolute / Relative Change in Real Exchange Rate Inflation + + + + + + + +/+/ + Effect + /+ /-

As discussed above, both higher exports and higher imports may lead to higher outward FDI though the motive for undertaking outward investments in the two situations may differ.

With regard to the regional trade agreements, an increasing number of trade agreements of the home country will likely shift the production units into the site with the lower costs of production since access to home as well as host-country markets becomes available. Further, many regional trade agreements not only improve market access but also improve the investment environment to make it more conducive to a free flow of FDI.

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An important potential driver is inward FDI into the home country, as it may lead to spillover effects and improve the capability of domestic investors to undertake outward FDI in developing countries.

The most important factors that may affect the FDI flows, as recognised in the literature, are the domestic market-related variables. Both current market size and potential market size can have a significant influence on outward FDI. Small market size and potential risk of losing market share may act as push factors for outward FDI.

Other domestic drivers of outward FDI are those that cause investment cost differentials across countries. These include costs of labour, capital and infrastructure. Cost factors may significantly influence the choice of an investment location for the resource-seeking and efficiency-seeking FDI. It is expected that higher wages in the home country increases outward FDI.

It is expected that the lower the availability of infrastructure, the higher will be the infrastructure costs and the higher will be the outward FDI.

Domestic policies with respect to taxes can also influence the cost of investments across economies. The higher the tax, the higher will be outward FDI.

A favourable labour environment, which is influenced by flexible labour laws, also influences the decisions to invest. The more rigid the labour laws, the higher will be the incentive to invest abroad.

Following is a detailed explanation of some of the important push factors determining OFDI:

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Exports

Exporting activity of tradable goods and services helps the initial exploration of overseas markets, enhances international competitiveness of the firms and also provides valuable information on emerging opportunities in other countries. Higher exports may assure the home country firms of the existing markets in the foreign economies and therefore, lower the risks and uncertainties attached to OFDI (Banga, 2007). As the trend shift towards more regional trade and increasing trade and investment agreements, the access to larger integrated markets also increases. This in turn increases the possibility of vertically-integrated outward FDI, making exports and OFDI more complementary.

Overall, FDI literature is ambiguous about the relation between OFDI and exports. While perfect substitutability was noted by Mundell (1957), later various other economists, for example Lipsey and Weiss (1981, 1984), Markusen (1984), Brenton, Di Mauro and Lcke (1999) and Kawai and Urata (1998), indicated the complementarity of the relationship. Literature has also shown that the nature of this relationship depends on the type of industries (Kawai and Urata, 1998; Buch, Kleinert and Toubal, 2003) and the location of the host countries (Graham, 1996; Brainard and Riker, 1997).

OFDI activities of home country firms (including India) can either complement or substitute its aggregate export activities, depending on the type and nature of OFDI projects undertaken by its domestic enterprises (Pradhan, 2007). In general, when trade barriers inhibit exports from the home country or when the home country tries to avoid domestic inefficiencies such as exchange rate volatility or high capital costs due to poor country-risk ratings, OFDI can be a direct path to market expansion acting as a substitute to exports. (UNCTAD, 2006)

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Horizontal and vertical OFDI can potentially be substituted or complemented by exports. When the home country firms undertake horizontal OFDI projects to exploit firm specific advantages in the host economy or to avoid trade barriers, transportation costs and other transaction costs, this reasonably indicates the substitution of exports of final products from parent firms (Carr, Markusen and Maskus, 2001). However, such horizontal OFDI projects may also promote intermediate exports from the home country through the additional exports of raw materials, intermediate inputs, capital goods, spare parts, etc. On the other hand, if the OFDI projects from the home country are vertical in nature, then there may be a complementary relationship between OFDI and exports. However, the vertical OFDI in the form of building trade-supporting infrastructure abroad could help to improve and complement exports of final product from the home country (Vernon, 1966).

Imports

Lowering of tariff barriers as a consequence of the opening up of the investing economies is likely to induce higher imports into the home country and this may have a crowding out effect on domestic investments inducing the domestic firms to relocate outward into economies with lower manufacturing costs and higher access to larger markets (Banga, 2007). The Indian economy which had a protectionist policy for a long period, opened up in the early through complete removal of non-tariff barriers and drastic reduction in import duties. This led to import competition that could probably be a push factor for the recent growth of OFDI from India. Also, the vertical OFDI projects from the home country firms seeking to acquire sources of raw materials and inputs from abroad may directly result in higher imports into the home country.

198

FDI Inflows

Higher FDI inflows may also enhance the capability of the home country in undertaking outward FDI, by enhancing the flow of non-debt private capital and technological and managerial skills, creating domestic employment through backward linkage effects and also by building up the foreign exchange reserves of the country (Banga, 2007). This is relevant for India. Thus, FDI inflows and outflows could be complementary. However, it is also possible that increased presence of foreign firms increases competition in the domestic market, which in turn makes the domestic firms to seek additional markets through exporting and OFDI. India has taken active steps in attracting FDI inflows by improving its overall investment climate. It is, therefore, meaningful to know about the effect of FDI inflows into corresponding outflows in the Indian context.

Market Size and Income of the Country

In term of the macro economics perspective, one of the main determinants contributing to the outward FDI can be associated to the income of a country. Higher income of a country has relevant implications towards the structural changes in the economy of the country. As pointed out by Chenery et al. (1986) and Aykut and Ratha (2004), firms are able to gain competitive advantage in term of economies of scale in the production despite adoption of new technologies. Eventually, firms are able to acquire Ownership advantages which become the driving force for establishing foreign production (Lall, 1980; Grubaugh, 1987).

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SECTION 6.3

HYPOTHESIS AND METHODOLOGY

Hypothesis

The push factors determine the flow of outward foreign direct investment from India.

Methodology

In the present chapter the home country push factors (determinants) of the foreign direct investment outflows are studied. A brief analysis of these variables, set as a background for the empirical analysis of the determinants of FDI from India, has already been given in the previous section. Based on the theory of John Dunning, several variables affecting FDI have been discussed in this present section. The present study is a version of an explanation of the outward flows of FDI from India from 1980-81 to 2005 based on some important quantifiable policy and economic variables. A process of gradual relaxation of controls and regulations with a view to induce outflows of foreign investments was discernable from the year 1981. In a limited and phased manner market forces were allowed to govern the foreign investment flows during this period. Therefore, this period has been selected for the study. The objective in this chapter is to examine the effects of international trade and investment related macro economic variables, namely, exports, imports, FDI inflows, wages etc on the outflows of FDI from India over 1980 through 2005.

200

Considering the principal determinants of FDI inflows the equation is specified is as follows:

OFDI = a0 + a1GDP + a2IFDI + a3WAGE + a4EX/GDP + a5IM/GDP + a6INFR + a7PCI

Where,

1. OFDI: Foreign direct investment net outflows measured as BOP current US$ bn 2. IFDI: Foreign direct investment net inflows measured as BOP current US$ bn 3. GDP: Gross Domestic Product at factor cost measured in current US$ bn 4. WAGE: Total emoluments paid to the workers measured in Rs. Lakhs. 5. INFR: (Infrastructure) Proxied by energy use (in Kg. of oil equivalent per capita) 6. EX/GDP: Exports measured in US$ bn divided by the GDP 7. IM/GDP: Imports measured in US$ bn divided by the GDP 8. PCI: Gross National income per capita (Atlas Method) measured in current US$ bn

EMPIRICAL ANALYSIS

For the purpose of the study, aggregate annual time series data at country level at current prices is used. Aggregate data is normally very useful in establishing long term econometric relationships between the variables.

As it is known that usually economic time series move together, therefore, if all the variables are included simultaneously in the equation there may be possibility of multi-collinearity. To examine the variables which may not be included

simultaneously in the equation, a correlation matrix for all the expected explanatory variables and the dependent variable was obtained. Based on the correlation matrix several variables were selected as the possible explanatory variables. The

201

correlation matrix also shows high degree of association between all the explanatory variables.

Box-6.3: Correlation matrix of OFDI flows and the determinants of OFDI flows
OFDI OFDI IFDI GDP PCI WAGE INFR IM/GDP EX/GDP 1 .891 .898 .877 .766 .725 .885 .859
**

IFDI .891 1 .933** .878** .932** .889** .929

** **

GDP .898** .933** 1 .977** .927** .911** .963

**

PCI .877** .878** .977** 1 .856** .854** .926

**

WAGE .766** .932** .927** .856** 1 .981** .928

**

INFR .725** .889** .911** .854** .981** 1 .880

**

IM/GDP .885** .929** .963** .926** .928** .880** 1 .975**

EX/GDP .859** .930** .956** .903** .962** .939** .975 1

**

**

**

**

**

**

**

.930**

.956**

.903**

.962**

.939**

**Correlation is significant at the 0.01 level (2-tailed) *Correlation is significant at the 0.05 level (2-tailed) Estimates based on appendix tables

Simple correlation between OFDI and GDP is found very high at 0.898. OFDI is also very highly correlated with IFDI at 0.891, with IM/GDP at 0.885, EX/GDP at 0.859 and PCI at 0.877. The correlation of OFDI with wage at 0.76 and energy at 0.725 is at a relatively lower level.

Using Multiple Linear Regression (MLR), the explanatory variables are regressed. In order to estimate the regression model, a statistical package, Statistical Package for Social Sciences (SPSS), is used. In addition, the output shows the t-statistic and pvalues for the coefficients which results in either rejecting or failure to reject the hypothesis at a specified level of significance. The p-value is the probability of getting a result that is at least as extreme as the critical value. The null hypothesis is rejected if the p-value is less than or equal to the critical value.

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REGRESSION RESULTS
(Estimates based on appendix tables) Regression Analysis Explaining the Variations in OFDI flows Dependent Variable Period N : : : OFDI flows 1980 To 2005 26

Model Summary:
R Square 0.946 Adjusted R Square 0.935 F-Value 87.198

Coefficients:
Variables (Constant) IFDI GDP WAGE EX/GDP
Notes: * Significant at 1% ** Significant at 5%

Coefficient - 1017.356 0.301 3.021 - 510.510 148.726

Beta 0.843 0.609 - 1.323 0.767

t - 4.949 5.067* 3.156** - 6.385* 3.188**

Excluded Variables:
Variables INFRA PCI IM/GDP Beta In - 0.090c - 0.363c - 0.443c t - 0.311 - 1.189 - 1.419

c. Predictors in the Model: (Constant), IFDI, GDP, WAGE, EX/GDP

SECTION 6.4

FINDINGS AND CONCLUSIONS

203

The above findings corroborate the theoretical predictions emanating from recent propositions in the theory of international trade and are able to explain about 94 percent of the variations of OFDI from India. The strength of the economy and market measured by GDP, labour productivity measured by WAGE, trade indicated by the EX/GDP ratio and IFDI to the economy are found to be statistically significant and have proper signs. The coefficient of WAGE is negative as expected and has the maximum explanatory power in explaining the OFDI flows from India. The coefficient of IFDI is positive and has a good explanatory power explaining the Indian outflows. INFR, PCI and IM/GDP ratio are found to be statistically insignificant.

The above results both confirm and complement the findings of earlier studies explaining the macro economic determinants of outward FDI flows (Helpman, 1984; Helpman and Krugman, 1985; Markusen and Zhang, 1999; Vernon, 1966; Chenery et al. 1986; Aykut and Ratha, 2004; Banga, 2007, Dasgupta, 2005).

As postulated, exports positively influence outward FDI, as they ensure markets and encourage vertical FDI. This result confirms the assumption that exports are important in determining OFDI from India and that the economys ability of improving the FDI outflows will be related to the countrys performance in its trade front. The rising volumes of exports from the Indian sub-region reflect the increasing competitiveness of the economy. However, it can be said that exports have been complemented by outward FDI, since the rising number of free trade agreements has made possible access to larger markets and large-scale production. Higher level of export activities by the Indian firms also implies that the need to undertake trade supporting OFDI to support their exports is also very high. According to the World Development Indicators 2007, exports, as percentage of GDP in India, exceeded the 10 percent mark in 1994 and in 2005 it was around 23 percent. Around this period

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OFDI as a percentage of GDP also showed a rise from virtually zero to around 0.3 percent. In this regard OFDI can be considered as complementing the home country exports. Hence, this calls for active OFDI promotion as it would complement export promotion resulting in greater integration with the world markets. The vertical OFDI in the form of building trade-supporting infrastructure abroad, like distribution networks, customer care centers, service centers etc., by the Indian firms to strengthen the Locational advantages could help to increase the exports of the final products from the home economy. In the case of the Indian software sector, for example, on-shore presence through OFDI is critical to ensure exports of software services.

The results also corroborate the fact that the Indian companies, mainly motivated by cost considerations, undertake vertical FDI to disaggregate the production process geographically and locate specific stages of the value chain in the home country benefiting from the relative cost advantages.

However, trade in itself may not be able to boost outward FDI if the domestic investors lack the capability to invest abroad. Inward FDI flows have, of late, been identified as one of the drivers of outward FDI, which improve the capabilities of the domestic investors to undertake outward FDI. Better technology, better skills and information regarding the home economies of inward FDI are all necessary ingredients for enhancing domestic competitiveness.

The success of India in attracting FDI flows has had a dual impact on the domestic firms. On one hand, it has induced growing competition at home and encouraged Indian firms to go abroad, adopting a diversification strategy in generating revenues. On the other hand, exposure to international business has played a part in encouraging Indian firms to venture abroad through demonstration and spillover effects on domestic firms. Once they venture out, the Indian MNCs begin to acquire

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advantages related to "transnationality-confidence, and knowledge of operating in a foreign environment. As noted by UNCTAD (2003), more Indian firms are aspiring to become global players by investing and operating abroad. More generally, the greater integration of India in the world economy and the intensification of international competition through imports and inward FDI to which Indian firms are confronted, the more MNCs will expand outside India to acquire a portfolio of

Locational assets that helps them to improve their international competitiveness.

Domestic factors can be important push factors for outward FDI. Studies in the literature have found that the market size of the home economies is the most important variable which propels FDI. India has seen a sustained increase in the national income since liberalisation. Increased market size along with a buoyant manufacturing and the services sector has allowed the domestic firms to gain a competitive edge by acquiring suitable Ownership advantages. As a result, domestic firms are encouraged to invest overseas.

One reason behind the Indian companies investing more in the developed countries can be the growing Ownership advantages of the manufacturing and the services sector, which enables them to efficiently cater to the demand in those countries. The strengthening of the Ownership advantages is linked to the various linkages derived from the growth of the domestic market and competition. For example, many Indian firms in the pharmaceutical sector now have focused on product and process development, which strengthens their Ownership advantage to compete efficiently in the world market. Indeed, developed countries have been the main source of opportunities for service firms in software sector to grow and integrate with the global economy. Since much of the software activities require proximity with their developed country customers, OFDI has been used by Indian software firms to establish their fully controlled branches or subsidiaries abroad and to acquire overseas competitors

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for gaining market access and additional intangible assets. It is also interesting to note that the Indian companies have been able to offer a range of relatively low cost but high quality products to the consumers in the host countries. For example, Indian pharmaceutical companies have been able to provide cheap generic drugs to the people in the developed nations.

Apart from the traditional motivation of market access, OFDI has been increasingly resorted to develop trade-supporting networks abroad. A large number of customer care and service centers have been created to ensure strong Locational advantages and also to improve exports from the Indian economy. Thus the technologically advanced Indian firms have been able to exploit Ownership advantages in efficient manner by utilising the superior Locational advantages offered by host countries. Indian firms also had a strong motivation to use OFDI in the Brownfield form to acquire additional technologies, skills, management expertise, marketing distribution networks overseas.

Since the early nineties the Indian firms have grown globally through OFDI for a variety of reasons. The past industrialisation and developmental process had improved Indias Locational advantages like skills (general, technical and managerial), physical and scientific infrastructures and institutions. The firm-specific technological efforts were strongly complemented by these growing Locational advantages and Indias much pursued policy of achieving technological self-reliance. A large number of Indian firms across a wide range of industries have emerged with higher levels of competitive advantages based on productivity, technology, skills, management expertise, quality and scale of production. The process of increasing globalization including internal liberalization, resulting in higher FDI flows, had offered capable Indian firms business opportunities at a global scale and OFDI became the efficient strategy for expanding operation overseas.

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The liberalisation of government policy with respect to OFDI like granting automatic approval to the OFDI applications, removal of ceiling on the amount of outward investment, allowing Indian companies to raise financial resources for overseas acquisitions and relaxation of other restrictive rules has provided ultimate impetus to the overseas expansion activities of Indian enterprises.

The emergence of knowledge-based segment of Indian economy such as drugs and pharmaceuticals, software and broadcasting as the leading outward investors indicate the rapid pace at which India is enhancing global position in knowledge based economy. During the second wave, the technological capabilities of Indian enterprises have seen diversification towards basic and frontier research activities under the facilitating role of national innovation system. For example, many of the leading Indian pharmaceutical firms like Ranbaxy, Dr. Reddys Labs, among others, have made significant progress in directing their R&D focus on new product developments. Maybe modestly, the Ownership advantages of Indian OFDI in industries such as pharmaceutical, software and transport now seem to be based on advanced technologies. (Pradhan, 2005)

While rapid rise of OFDI is a natural process in an open economy, it faces many uncertainties and risks in sustaining their global sales and revenues. With increasing globalisation, Indian companies will have to continuously adapt themselves to successfully counter increasing competition. To manage technology as a global firm, Indian firms need to take up technology, when it is in the growth stage, develop design capabilities, bring out product innovations and differentiate their products / services with technology. The large R&D expenditure of companies can translate into substantial competitive strength for them. Indian companies suffer the disadvantage

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of inadequate expenditure on R&D to develop process know-how and engineering skills.

Another issue that hampers trade is the lack of protection for IPR. Generally, countries and companies trading with India feel that intellectual property protection is weak in India. However, there is a rise in the number of patent applications, given the general increase in economic activity in the same period.

Not many Indian consulting firms have ISO accreditation that can enhance the quality image of Indian firms in the eyes of overseas investors. Project export companies have made good progress in areas like civil construction, turnkey projects, technical services, and earned a niche for themselves. The projects range from power generation, transmission and distribution, dams, tunnels, oil exploration, operation and maintenance to export of capital goods, transport equipment and consultancy services. But presently the Indian companies have been facing competition primarily from, exporters from developed countries and newly industrialising countries. Simultaneously at the macro level, the boom in the outward investments is likely to increase external pressure on India to quickly reduce tariffs and dismantle the remaining restrictions on capital inflows. Calibrating these moves without forgoing the interests of the vast unincorporated sector enterprises and the rural economy would remain a challenge for policy-maker.

Although the OFDI from India is currently low in volume and value as also in the numbers of investing firms relative to the global scale, yet it is growing at a fast pace at higher relative terms compared to past years as also in comparison to some other comparable countries. Indian OFDI is visible in a wide range of manufacturing, information technology and knowledge based industries such as automobiles, software and pharmaceuticals, particularly through the route of mergers and

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acquisitions. The motivations have been market seeking, resource seeking and efficiency seeking, as can be seen from the empirical results. Outward FDI flows in India is pursued not only by the private corporate sector but also by the public sector entities that have aggressively sought to acquire equity in the natural resources (petroleum and gas) sectors of key producer countries as a strategic initiative to manage the growing energy intensity of the economy. Ongoing liberalisation of the policy framework has provided a favorable environment for FDI from India.

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SECTION 6.4

LIMITATIONS AND SCOPE OF FURTHER RESEARCH

Limitations

Due to the inherent data constraints of the macro economic time series data, the above results are admittedly tentative. Yet it is true that they reveal certain new facets of the FDI outflows from India that have not been examined earlier. Moreover, Indias success in outward FDI is very recent, dating back to the economic reforms of the nineties. With such a short history, it is yet to be seen whether the time series data can sustainably display the relations that that the empirical evidence of this study suggests or whether the interaction of the home country and host country economic forces change the prevailing relationship pattern.

Scope of Further Research

A natural extension of this study would be to examine the effects of international trade and variables on the FDI outflows of the competing Asian countries like China and South Korea and compare the outcomes with those of India. There is a possibility that the drivers of OFDI differ in significance with respect to different sectors. A detailed and separate analysis is, therefore, required for explaining OFDI from the manufacturing and the services sector. Another interesting research avenue would be to examine the impact of OFDI on the exports and employment of the Indian economy. A study on harmonizing inward and outward policies so as to enhance mutual growth inducing effects in the home and host country would also be very much in place.

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CHAPTER 7 SUMMARY, RECOMMENDATIONS AND CONCLUSIONS

The reforms undertaken since 1991 in India have unleashed the potential growth of the economy and stimulated international trade with its linkages to inward and outward FDI. Changes have been so many that investors have started to take a new look at India. At the same time, some Indian firms have become global players. In this study various dimensions of FDI were incorporated into a theory of open economy development, so as to explain, in one integrated theoretical and empirical paradigm, the undercurrents of both inward and outward FDI flows. It was particularly interesting to do a parallel study of the evolution of Indian FDI inflows and outflows, which helped to assess the nature and the true extent of globalisation of the Indian economy.

In different chapters, the trends and patterns of inward and outward FDI were examined and analysed along with an empirical study of their determinants. The broad findings and conclusions along with suitable recommendations and limitations are summarised in this chapter under the headings of Inward FDI and Outward FDI.

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SECTION 7.1

INWARD FDI IN INDIA

India is growing at an average growth rate of close to 6 percent a year since 1980, with some evidence that growth is accelerating and can be sustained at 8 percent a year in the coming decades. With population of 1.1 billion in 2003, India presents a huge and fast growing domestic market for a range of goods and services, and thus export opportunities for producers in the rest of the world. Large and growing market opportunities in India are widely seen, as evidenced by the large flows of foreign direct investment, attractive both for production for the domestic market, and also to use exports to the rest of the World.

Inward FDI has boomed in post-reform India. The Indian government policy towards FDI has changed over time in tune with the changing developmental needs in different phases of development. The changing policy framework has affected the trends and patterns of FDI inflows received by the country. At the same time, the composition and type of FDI has changed considerably. Even though manufacturing industries have attracted rising FDI, the services sector accounted for a steeply rising share of FDI stocks in India since the mid-nineties. Thus, although the magnitude of FDI inflows has increased, in the absence of policy direction, the bulk of them have gone into services and soft technology consumer goods industries bringing the share of manufacturing and technology intensive among them down. In terms of investing countries, it can be noted that there is a high degree of concentration with more than 50 percent of the investment coming from Mauritius, U.S and Japan. Also, while FDI in India continues to be local market seeking in the first place, its world-market orientation has clearly increased in the aftermath of economic reforms. Thus while

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the growth of FDI inflows to India seem to be fairly satisfactory; Indias share in the global FDI regime is still minuscule. This calls for further liberalisation of norms for investment by present and prospective investors. It underlines the need for efficient and adequate infrastructure, availability of skilled and semiskilled labour force, business friendly public administration and moderate tax rates.

Opening up the Indian economy and the resulting FDI flows have really created new opportunities for Indias development and boosted the performances of local firms as well as the globalisation of some of them. Such a trend has undeniably raised Indians stature among developing countries. However, the potential of the country to catch up the levels of the leading economies in the coming decades, often touched on, is not quite guaranteed. India has an extremely hard job to perpetuate its advantages, to achieve further productivity gains and to ensure that all segments of its population participate in the income growth.

The findings of the empirical study on determinants of inward FDI are consistent with the trend and patterns of inward FDI flows.

Over a period of time general and specific FDI policies have become less restrictive to inward FDI in India. With fewer policy barriers, other factors have become emerged as important determinants. Prominent among them are basic economic pull factors such as good quality and productive human resources on the supply side, and market size on the demand side. Macro economic policies that shape the underlying fundamentals of cost-competitiveness, economic stability of the country and degree of integration with the world economy have also become more important over time in attracting FDI.

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Market size is an important factor affecting FDI, however, in India this important traditional variable has decreased in importance. At the same time, cost differences between locations, spillovers from increased competition on the domestic turf, the ease of doing business and the availability of skills have become more important. This is validated in the results of this study.

Thus although FDI remains strongly driven by its traditional determinants, the relative importance of different Locational determinants for competitiveness enhancing FDI is shifting. Cheap and skilled labour is an important determinant attracting FDI to India. A high wage adjusted productivity of labour has attracted efficiency seeking FDI aiming to produce for the domestic economy as well as for exports to other countries. India remains a country with a large supply of skilled human capital attracting more FDI, particularly in sectors that are relatively intensive in the use of skilled labour. While low cost remains a Locational advantage, the increasingly sought after advantages are competitive combinations of wage, skills and productivity. This explains the growing volume of vertical efficiency seeking FDI in which foreign companies seek to produce intermediate and / or final products in the cheapest (real) cost locations primarily for exports to third markets. It is found that the FDI flows were already skewed towards manufacturing and services sector in 1990, but increasingly have shifted towards services in the past fifteen years. India has been able to attract increasing amounts of FDI in high value-added services. Now, even the most strategic of functions such as R&D are expanding in some developing countries as multinational corporations seek to benefit from pools of talent at competitive costs, particularly in those countries that have actively helped to create this (incl. Singapore, Malaysia, China and India).

This has implications on the success of domestic policies to attract inward FDI. The nature and sequencing of general and specific policies in areas covering investment,

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trade, innovation and human resources are all important. Appropriate policies to benefit from FDI include building up local human resource and technological capabilities to capture productivity spillovers. FDI location decisions will increasingly depend on economic factors and not on temporary policy interventions.

One important hypothesis from various studies is that gains from FDI are far higher in an open regime. Trade openness generally positively influences the export oriented FDI inflow into the economy. As shown in our results trade openness in the Indian economy has emerged as an important factor attracting FDI inflows.

The results also suggest that long term investment benefits from stability as it reduces the risks for the long-term investor. This is backed up by investor surveys and to a large extent by the evidence. Politically unstable countries tend to receive relatively small amounts of FDI. Government finance is another important issue that affects capital flows. A high level of external debt in India has emerged as a deterrent for FDI inflows.

To conclude, the locational strategies chosen by firms are likely to be highly contextual and would vary according to industry specific characteristics, the motives for FDI, and the functions being performed by MNC subsidiaries. The government should recognise that the location specific advantages sought by mobile investors are changing. Over all, India needs to maintain the growth momentum to improve market size, frame policies to make better use of their abundant labour forces and follow more open trade policies for attracting FDI. Field surveys of the rankings of various countries by business executives, compiled and published by the EIU in the 2000 and 2001 editions of the World Investment Prospects, show that business executives are increasingly ranking the political stability, quality of infrastructure and government policies towards private enterprise and competition, along with the

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macro economic environment, as the critical variables likely to affect the future geography of FDI in the early years of the 21st century. The government needs to give constant attention to the upgrading and reconfiguring of their own unique location bound advantages, both actual and potential. However, regional initiatives need to be designed carefully to ensure the benefits of new FDI are broadly spread across the regions and sectors.

It is possible that government regulations and policies may deter some forms of FDI, particularly where they affect ownership. Thus the Government needs to assess the benefits of such interventions against the costs of creating impediments to FDI, which reduce the ability of the country to compete with other developing countries for foreign investments.

Many of the motivations influencing the investment decisions of multinational companies apply equally to domestic investors. Addressing the problems identified by foreign investors already committed to the region should not only in the long run make India more attractive to new FDI but should in the shorter term encourage increased domestic investment.

If the economy has to benefit from the FDIs spillover effects and economic growth, the country needs to attract FDI formulating a bundle of policies that caters for the interests of all the potential investors from different countries. This implies that the country needs stable macro economic indicators, better country risk profile followed by cost related and investment environment improving factors.

Thus India should continue its program of economic reforms, as a sustained healthy economic growth is the biggest attraction for foreign capital. However, any political reforms need to ensure that instability does not ensue. Further, the government

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should create specific location advantages in areas and sectors which have not been able to attract more FDI, such as skilled employees and improving the infrastructure. This will help reduce the disparities in development across regions and sectors.

Limitations

Like all research, the findings here need to be interpreted cautiously given the inherent data constraints of the macro economic time series data and the scope of this research. It is possible that the importance of the locational factors will differ depending on sector, type and motivation of FDI and a more detailed study at the micro level would yield meaningful insights.

Scope for Further Research

An interesting topic for future research would be to analyse how foreign direct investment in India is affected by factor endowments such as knowledge capital, in order to better explain the driving forces of FDI and more closely determine whether FDI tends to be vertical rather than horizontal in nature. It would also be very pertinent to study the impact of FDI inflows on various macro and micro economic variables. Another interesting research avenue would be to undertake a causal analysis to determine whether the relationship between FDI and growth is unidirectional or bidirectional.

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SECTION 7.2

OUTWARD FDI FROM INDIA

OFDI from India has increased appreciably over the past decade following the reforms and liberalisation of policies undertaken by the Government since 1991. OFDI has emerged as an important mechanism through which the Indian economy is integrated with the global economy, along with growing trade and inward FDI. The OFDI behaviour of Indian firms in the earlier periods of seventies and eighties was found to be restricted to a small group of large-sized family-owned business houses investing mostly in a selected group of developing countries. The restrictive government policies on firms growth followed in India seems to have pushed these firms towards OFDI. In many cases, the ownership pattern of Indian OFDI projects was minority-owned. The joint venture nature of Indian OFDI with intermediate technologies had been found to be appropriate to the needs and requirement of fellow developing countries. The Indian OFDI policy in the pre-liberalised era was more restrictive with cumbersome approval procedures.

However, the character of OFDI has undergone significant changes since nineties. A large number of Indian firms from increasing number of industries and services sectors have taken the route of overseas investment to expand globally. Unlike the earlier periods, Indian outward investors have gone for complete control over their overseas ventures and increasingly started investing in developed parts of the world economy. This increased quantum of OFDI from India has been led by a number of factors and policy liberalisation covering OFDI has been one among them. The sharp rise in OFDI since 1991 has been accompanied by a shift in the geographical and sectoral focus. Indian companies have also diversified sectorally to focus on areas of

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the countrys emerging comparative advantages such as in pharmaceuticals and IT software automobiles, auto-ancillary and telecom etc. Indian enterprises have also started to acquire companies abroad to obtain access to marketing.

It is contended that the new wave of OFDI reflects changes in the structure of the world economy that are a result of globalisation and regionalisation of economic activity. These phenomena are associated with:

Technological advances within the sectors Liberalisation of markets Establishment of regional trading blocks

It is also contended that the second stage of OFDI is complementary to the first stage and simply is an intermediate stage of evolution of OFDI as the home country moves along its IDP. Such OFDI has been a result of government assisted upgrading of location specific advantages of home country, which in turn has helped upgrade the competitive advantages of their firms. Also while these ownership specific advantages remain primarily country-of-origin specific they are being supplemented by FDI intended to augment rather than exploit such advantages.

In light of the foregoing analysis, regarding the outward direct investment from developing countries especially India, it can be said that there has been a distinct and comprehensive change. The evidence presented in this study shows that the evolution of Indian OFDI is entirely consistent with the predictions of the IDP. Each stage has been appropriate to the extent and pattern of the countrys economic development.

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Such a growth has been conditional on the sustained improvement of the ownership specific advantages of the firms, resulting from a continuous up gradation of the locational specific advantages of the home country. While improved Locational advantages are a natural consequence of economic development and restructuring as the country moves from stage 2 to stage 3, this process can be accelerated by a market oriented and a holistic government policy towards trade, industrial development and innovation. This has not only helped to upgrade its indigenous resources but has encouraged the domestic firms to augment their competitive advantages by acquiring foreign resources.

The findings of the empirical study are consistent with the trends and patterns of OFDI emerging from the country.

As postulated, exports positively influence outward FDI, as they ensure markets and encourage vertical FDI. This result confirms the assumption that exports are important in determining OFDI from India and that the economys ability of improving the FDI outflows will be related to the countrys performance in its trade front. The rising volumes of exports from the Indian sub region reflect the increasing competitiveness of the economy. However, it can be said that exports have been complemented by outward FDI, since the rising number of free trade agreements has made possible access to larger markets and large-scale production. Higher level of export activities by the Indian firms also implies that the need to undertake trade supporting OFDI to support their exports is also very high. Hence this calls for active OFDI promotion as it would complement export promotion resulting in greater integration with the world markets. The vertical OFDI in the form of building tradesupporting infrastructure abroad, like distribution networks, customer care centers, service centers etc., by the Indian firms to strengthen the locational advantages could help to increase the exports of the final products from the home economy. In the

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case of the Indian software sector for example, on-shore presence through OFDI is critical to ensure exports of software services.

The results also corroborate the fact that the Indian companies, mainly motivated by cost considerations, undertake vertical FDI to disaggregate the production process geographically and locate specific stages of the value chain in the home country benefiting from the relative cost advantages.

However, trade in itself may not be able to boost outward FDI if the domestic investors lack the capability to invest abroad. Inward FDI flows have of late been identified as one of the drivers of outward FDI, which improve the capabilities of the domestic investors to undertake outward FDI. Better technology, better skills and information regarding the home economies of inward FDI are all necessary ingredients for enhancing domestic competitiveness.

The success of India in attracting FDI flows has had a dual impact on the domestic firms. On one hand, it has induced growing competition at home and encouraged Indian firms to go abroad, adopting a diversification strategy in generating revenues. On the other hand, exposure to international business has played a part in encouraging Indian firms to venture abroad through demonstration and spillover effects on domestic firms. Once they venture out, the Indian MNCs begin to acquire advantages related to "transnationality-confidence and knowledge of operating in a foreign environment. More generally, the greater integration of India in the world economy and the intensification of international competition through imports and inward FDI to which Indian firms are confronted, the more MNCs will expand outside India, to acquire a portfolio of locational assets that helps them to improve their international competitiveness.

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Domestic factors can be important push factors for outward FDI. Studies in the literature have found that the market size of the home economies is the most important variable which propels FDI. India has seen a sustained increase in the national income since liberalisation. Increased market size along with a buoyant manufacturing and the services sector has allowed the domestic firms to gain a competitive edge by acquiring suitable ownership advantages. As a result, domestic firms are encouraged to invest overseas.

One reason why the Indian companies are investing more in the developed countries can be because of the growing Ownership advantages of the manufacturing and the services sector, which enables them to efficiently cater the demand in those countries. The strengthening of the Ownership advantages is linked to the various linkages derived from the growth of the domestic market and competition. For example, many Indian firms in the pharmaceutical sector now have focused on product and process development, which strengthens their Ownership advantage to compete efficiently in the world market. Indeed, developed countries have been the main source of opportunities for service firms in software sector to grow and integrate with the global economy. Since much of the software activities require proximity with their developed country customers, OFDI has been used by Indian software firms to establish their fully controlled branches or subsidiaries abroad and to acquire overseas competitors for gaining market access and additional intangible assets. It is also interesting to note that the Indian companies have been able to offer a range of relatively low cost but high quality products to the consumers in the host countries. For example, Indian pharmaceutical companies have been able to provide cheap generic drugs to the people in the developed nations.

Apart from the traditional motivation of market access, OFDI has been increasingly resorted to develop trade-supporting networks abroad. A large number of customer

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care and service centers have been created to ensure strong locational advantages and also to improve exports from the Indian economy. Thus the technologically advanced Indian firms have been able to exploit Ownership advantages in efficient manner by utilising the superior locational advantages offered by host countries. Indian firms also had a strong motivation to use OFDI in the brownfield form to acquire additional technologies, skills, management expertise, marketing distribution networks overseas.

Since the early nineties the Indian firms have grown globally through OFDI for a variety of reasons. The past industrialisation and developmental process had improved Indias locational advantages like skills (general, technical and managerial), physical and scientific infrastructures and institutions. The firm-specific technological efforts were strongly complemented by these growing Locational advantages and Indias much pursued policy of achieving technological self-reliance. A large number of Indian firms across a wide range of industries have emerged with higher levels of competitive advantages based on productivity, technology, skills, management expertise, quality and scale of production. The process of increasing globalisation including internal liberalisation, resulting in higher FDI flows, had offered capable Indian firms business opportunities at a global scale and OFDI became the efficient strategy for expanding operation overseas.

The liberalisation of government policy with respect to OFDI like granting automatic approval to the OFDI applications, removal of ceiling on the amount of outward investment, allowing Indian companies to raise financial resources for overseas acquisitions and relaxation of other restrictive rules has provided ultimate impetus to the overseas expansion activities of Indian enterprises.

230

The emergence of knowledge-based segment of Indian economy such as drugs and pharmaceuticals, software and broadcasting as the leading outward investors indicate the rapid pace at which India is enhancing global position in knowledge based economy. During the second wave the technological capabilities of Indian enterprises have seen diversification towards basic and frontier research activities under the facilitating role of national innovation system. For example, many of the leading Indian pharmaceutical firms like Ranbaxy, Dr Reddys Labs among others have made significant progress in directing their R&D focus on new product developments. May be modestly, the ownership advantages of Indian OFDI in industries such as pharmaceutical, software and transport now seem to be based on advanced technologies.

While rapid rise of OFDI is a natural process in an open economy, it faces many uncertainties and risks in sustaining their global sales and revenues. With increasing globalisation, Indian companies will have to continuously adapt themselves to successfully counter increasing competition. To manage technology as a global firm, Indian firms need to take up technology, when it is in the growth stage, develop design capabilities, bring out product innovations and differentiate their products / services with technology. The large R&D expenditure of companies can translate into substantial competitive strength for them. Indian companies suffer the disadvantage of inadequate expenditure on R&D to develop process know-how and engineering skills.

Another issue that hampers trade is the lack of protection for Intellectual Property Rights. Generally, countries and companies trading with India feel that intellectual property protection is weak in India. However, there is a rise in the number of patent applications, given the general increase in economic activity in the same period.

231

Not many Indian consulting firms have ISO accreditation that can enhance the quality image of Indian firms in the eyes of overseas investors. Project export companies have made good progress in areas like civil construction, turnkey projects, technical services, and earned a niche for themselves. The projects range from power generation, transmission and distribution, dams, tunnels, oil exploration, operation and maintenance to export of capital goods, transport equipment and consultancy services. But presently the Indian companies have been facing competition primarily from, exporters from developed countries and newly industrialising countries. Simultaneously at the macro level, the boom in the outward investments is likely to increase external pressure on India to quickly reduce tariffs and dismantle the remaining restrictions on capital inflows. Calibrating these moves without forgoing the interests of the vast unincorporated sector enterprises and the rural economy would remain a challenge for policy-maker.

Limitations

Due to the inherent data constraints of the macro economic time series data, the above results are admittedly tentative. Yet it is true that they reveal certain new facets of the FDI outflows from India that have not been examined earlier. Moreover, Indias success in outward FDI is very recent, dating back to the economic reforms of the nineties. With such a short history, it is yet to be seen whether the time series data can sustainably display the relations that that the empirical evidence of this study suggests or whether the interaction of the home country and host country economic forces change the prevailing relationship pattern.

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Scope of Further Research

A natural extension of this study would be to examine the effects of international trade and variables on the FDI outflows of the competing Asian countries like China and South Korea and compare the outcomes with those of India. There is a possibility that the drivers of OFDI differ in significance with respect to different sectors. A detailed and separate analysis is therefore required for explaining OFDI from the manufacturing and the services sector. Another interesting research avenue would be to examine the impact of OFDI on the exports and employment of the Indian economy. A study on harmonising inward and outward policies so as to enhance mutual growth inducing effects in the home and host country would also be very much in place.

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SECTION 7.3

CONTRIBUTION OF THE STUDY

Since outward FDI from India is a recent phenomenon, studies in this area have been few and far between. In this study an attempt has been made to examine the applicability of John Dunnings Investment Development Path to understand the evolution of outward FDI flows from India. The analysis shows that India surely has evolved to Stage 2 of the IDP on the parameters proposed by Dunning.

Furthermore, both inward and outward FDI flows have been studied in the light of the Eclectic Paradigm put forward by John Dunning. The findings shed light on factors which are consistent with the new developments in the area of international trade and have not been comprehensively studied in the earlier studies. The outcomes also link inward and outward FDI together in a way that gives meaningful insights to make the second generation reforms more successful.

Facts and empirical results evidenced in this study show that the motives for both inward and outward FDI are changing. Efficiency seeking investment is gaining more importance as compared to market seeking both for domestic as well as foreign investors. Productivity in the economy has emerged as a very important factor which is attracts more vertical FDI as compared to horizontal FDI. Growing competition and economic spillovers from increased FDI inflows along with cost advantage due to productivity gains have induced more FDI abroad which is also increasingly vertical in nature. Thus inward FDI has emerged as an all contributing and important factor influencing outward FDI flows from India. This implies that the growth of IFDI and OFDI is complementary and policies need to be framed in a way

234

that the linkages between them are strengthened and beneficial to the overall economy.

235

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xix

APPENDIX TABLES

APPENDIX TABLE 1: INDIAS FOREIGN TRADE (US$ MILLION)

Indias Foreign Trade (US$ million) Year

1980-81 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06

Exports Oil
32 246 1,278 1,536 1,529 527 322 500 349 418 523 415 476 398 417 454 482 353 89 39 1,870 2,119 2,577 3,568 6,989 11,640

Imports Total
8,485 8,704 9,108 9,449 9,878 8,905 9,745 12,089 13,970 16,613 18,145 17,865 18,537 22,238 26,331 31,795 33,470 35,006 33,219 36,822 44,560 43,827 52,719 63,843 83,536 103,091

Non-oil
8,453 8,458 7,830 7,914 8,349 8,378 9,423 11,588 13,622 16,194 17,623 17,451 18,061 21,841 25,914 31,341 32,988 34,654 33,129 36,784 42,691 41,708 50,143 60,274 76,547 91,451

Oil
6,655 5,786 5,816 4,673 4,550 4,078 2,200 3,118 3,009 3,768 6,028 5,325 6,100 5,754 5,928 7,526 10,036 8,164 6,399 12,611 15,650 14,000 17,640 20,570 29,844 43,963

Non-oil
9,212 9,387 8,970 10,638 9,863 11,989 13,527 14,038 16,488 17,452 18,044 14,086 15,782 17,553 22,727 29,150 29,096 33,321 35,990 37,059 34,886 37,413 43,773 57,580 81,673 105,203

Total
15,867 15,173 14,787 15,311 14,412 16,067 15,727 17,156 19,497 21,219 24,073 19,411 21,882 23,306 28,654 36,675 39,132 41,485 42,389 49,671 50,537 51,413 61,412 78,149 111,517 149,166

Source: Directorate General of Commercial Intelligence and Statistics

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APPENDIX TABLE 2: ANNUAL SERIES FOR PRINCIPAL CHARACTERISTICS

(Value Figures in Rs. Lakhs, Mandays in Thousand and Others in Number)

Year 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06

Characteristics Number of Factories 105,037 93,166 96,706 100,328 101,016 97,957 102,596 104,077 107,992 110,179 112,286 119,494 121,594 123,010 134,571 132,814 136,012 131,706 131,558 131,268 128,549 127,957 129,074 136,353 140,160 Fixed Capital 3,470,259 4,100,600 4,860,554 5,484,211 6,008,524 6,723,094 7,847,463 8,912,356 10,692,778 13,364,756 15,190,240 19,287,139 22,441,333 27,764,512 34,846,773 38,004,439 42,308,227 39,115,145 40,186,473 39,960,422 43,196,013 44,475,938 47,333,140 51,306,925 60,694,028 Working Capital 1,505,488 1,631,988 1,850,402 2,232,323 2,379,864 2,180,329 2,755,102 2,724,616 3,386,365 4,252,036 4,446,816 6,249,011 8,710,857 8,729,632 10,766,313 17,165,931 15,461,658 10,274,034 10,378,436 10,520,839 10,040,585 10,012,110 11,923,049 16,005,396 18,446,260 Invested Capital 5,399,127 6,299,198 7,249,434 8,050,202 8,811,181 9,769,297 11,393,383 13,297,905 15,914,036 19,491,285 22,123,418 27,772,858 32,054,715 38,753,459 48,996,925 52,215,413 57,682,603 53,706,813 56,663,430 57,179,940 60,591,285 63,747,308 67,959,786 75,941,770 90,157,861 Continued.page2

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Appendix Table 2 Continued. Year 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 Characteristics Outstanding Loans 3,349,934 3,852,135 4,811,656 5,247,519 6,207,203 7,009,633 7,943,693 6,546,478 8,430,536 10,456,557 11,018,723 16,128,731 16,271,340 20,637,103 24,693,365 25,960,884 32,460,512 22,820,981 25,378,161 25,795,392 26,921,926 26,339,233 28,977,564 33,463,375 35,150,737 Number of Workers 6,105,622 6,312,673 6,158,837 6,091,409 5,819,169 5,806,866 6,061,786 6,026,328 6,326,541 6,307,143 6,269,039 6,649,310 6,632,323 6,970,116 7,632,297 7,208,143 7,652,254 6,364,464 6,280,659 6,135,238 5,957,848 6,161,493 6,086,908 6,599,298 7,136,097 Mandays-Workers 1,686,248 1,791,856 1,851,719 1,855,498 1,795,111 1,789,947 1,871,201 1,851,385 1,962,805 1,949,506 1,935,646 2,040,458 2,045,434 2,163,012 2,393,812 2,303,625 N.A N.A 1,904,067 1,858,844 1,800,576 1,870,226 1,840,986 1,995,220 2,154,187 Number of Employees 7,777,868 8,009,792 7,824,121 7,871,712 7,471,515 7,441,879 7,785,580 7,743,344 8,142,550 8,162,504 8,193,590 8,704,947 8,707,909 9,102,407 10,044,697 9,448,643 9,997,573 8,588,581 N.A 7,917,810 7,686,654 7,870,529 7,803,395 8,383,278 9,038,523 Continued.page3

xxii

Appendix Table 2 Continued. Year 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 Characteristics Mandays-Employees 2,154,214 2,337,524 2,383,165 2,406,722 2,298,690 2,325,830 2,425,810 2,400,364 2,549,238 2,542,346 2,557,384 2,715,117 2,726,927 2,854,829 3,196,414 3,037,414 N.A N.A 2,482,671 2,411,969 2,332,893 2,397,579 2,368,602 2,544,598 2,739,729 Total Person Engaged 7,894,254 8,166,168 7,994,406 7,981,370 7,584,007 7,548,755 7,903,826 7,858,281 8,256,712 8,279,403 8,319,563 8,835,952 8,837,716 9,227,097 10,222,169 9,536,282 10,073,485 N.A 8,172,836 7,987,780 7,750,366 7,935,948 7,870,081 8,453,624 9,111,680 Wages to Workers 439,417 514,828 592,078 675,730 709,209 785,043 893,370 1,029,223 1,179,567 1,319,205 1,358,263 1,683,112 1,759,741 2,201,946 2,797,035 2,655,459 2,978,167 2,482,648 2,630,427 2,767,074 2,743,824 2,968,905 3,047,777 3,363,505 3,766,366 Total Emoluments 677,753 804,609 921,825 1,066,021 1,108,113 1,229,918 1,408,105 1,572,832 1,840,888 2,058,633 2,097,048 2,756,026 2,863,967 3,534,151 4,511,605 4,640,358 5,237,112 4,462,585 4,784,351 5,071,873 5,105,957 5,515,801 5,833,675 6,440,594 7,400,820

Source: Annual Survey of Industries 1981-2006

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APPENDIX TABLE 3: INDICES OF REAL EFFECTIVE EXCHANGE RATE (REER) OF THE INDIAN RUPEE
(36-country bilateral weights) (Base: 1985 = 100)

Year 1980-81 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04

Export-Based Weights 106.15 105.74 102.09 104.51 100.44 97.85 90.12 85.39 80.26 77.34 73.33 61.36 54.42 59.09 63.29 60.94 61.14 63.76 60.13 59.7 62.47 64.36 67.92 69.66

Trade-Based Weights 104.48 104.48 101.17 104.24 100.86 98.27 90.24 85.36 80.41 78.44 75.58 64.2 57.08 61.59 66.04 63.62 63.81 67.02 63.44 63.29 66.53 68.43 72.76 74.14

Source: Hand Book of Statistics on Indian Economy, RBI

Note: i Data up to 1991-92 are based on official exchange rates and data from 1992-93 onwards are based on FEDAI (Foreign Exchange Dealers Association of India) indicative rates ii REER indices are recalculated from 1994-95 onwards using the new Wholesale Price Index (WPI) series (Base: 1993-94 = 100). iii REER indices are estimated using the common price index and the exchange rate for the Euro, thus representing 31 countries and the Euro area w.e.f. 01.03.2002.

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APPENDIX 4: INWARD FDI FLOWS, BY HOST REGION AND ECONOMY, 1980 - 2005
(US$ million)

Region / Economy World Developed Economies Developing Economies Asia South Asia Afghanistan Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka

1980 55,262 47,575 7,664 663 203 9 9 .. 79 0 0 64 43

1981 69,437 45,322 24,103 13,329 255 0 5 .. 92 0 0 108 50

1982 59,393 32,931 26,461 17,136 204 0 7 .. 72 -3 0 64 64

1983 50,682 33,012 17,652 10,894 73 .. 0 .. 6 0 -1 29 38

1984 58,956 41,228 17,736 11,557 108 .. -1 .. 19 0 1 56 33

1985 57,959 43,748 14,197 5,421 173 .. -7 .. 106 1 1 47 24

1986 88,613 72,931 15,710 9,299 247 .. 2 .. 118 5 1 92 28

1987 140,647 119,267 21,373 13,426 391 0 3 .. 212 5 1 110 58

1988 164,932 134,635 30,275 18,058 272 .. 2 .. 91 1 1 134 43

1989 192,899 162,254 30,630

1990 201,594 165,627 35,892 22,642

1991 154,803 114,617 39,951 24,154 424 0 1 1 75 7 2 272 67

1992 170,465 115,494 53,188 32,919 746 0 4 .. 252 7 0 361 123

459 .. 0 .. 252 4 0 184 18

575 .. 3 2 237 6 6 278 43

Continued.

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Continued. Region / Economy World Developed Economies Developing Economies Asia South Asia Afghanistan Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka 77,585 56,020 1,147 0 14 .. 532 7 0 399 194 103,550 68,191 1,950 0 11 .. 974 9 0 789 166 115,963 80,008 2,808 0 92 0 2,151 7 0 492 65 147,048 94,140 3,359 1 232 1 2,525 9 19 439 133 190,569 105,763 5,371 -1 575 -1 3,619 11 23 711 433 189,642 95,268 3,889 0 576 .. 2,633 12 12 506 150 228,461 111,510 3,234 6 309 1 2,168 12 4 532 201 256,088 148,333 4,658 0 579 0 3,585 13 0 309 173 212,017 113,451 6,415 1 355 0 5,472 12 21 383 172 166,318 98,310 6,984 1 328 2 5,627 12 -6 823 197 178,699 114,987 5,469 2 350 3 4,323 14 15 534 229 283,030 169,999 7,601 1 460 3 5,771 15 0 1,118 233 314,316 208,744 9,866 4 692 9 6,676 9 2 2,201 272 143,271 148,210 222,000 239,422 286,638 509,095 860,151 1,146,238 609,027 442,284 361,192 418,855 590,311 1993 224,126 1994 254,259 1995 342,592 1996 392,743 1997 489,243 1998 709,303 1999 1,098,896 2000 1,411,366 2001 832,567 2002 621,995 2003 564,078 2004 742,143 2005 945,795

Source: World Investment Report 2007, UNCTAD

xxvi

APPENDIX TABLE 5: OUTWARD FDI FLOWS, BY HOST REGION AND ECONOMY, 1980 - 2005
(US$ million)

Region / Economy World Developed Economies Developing Economies Asia South Asia Afghanistan Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka

1980 53,829 50,676 3,153 1,146 4 0 .. 0 4 0 0 0 ..

1981 52,922 51,350 1,572 314 2 0 .. 0 2 0 0 0 ..

1982 27,556 25,049 2,508 1,160 1 0 .. 0 1 0 0 0 ..

1983 36,772 34,834 1,938 1,364 5 0 .. 0 5 0 0 0 ..

1984 50,411 48,037 2,374 1,885 -1 0 .. 0 4 0 0 -5 ..

1985 62,604 58,693 3,912 2,924 29 0 .. 0 3 0 0 25 1

1986 97,478 92,350 5,128 3,933 34 0 .. 0 -1 0 0 34 1

1987 141,392 134,684 6,701 5,517 55 0 .. 0 5 0 0 49 1

1988 180,273 168,234 12,025 10,702 59 0 .. 0 11 0 0 46 2

1989 230,451 210,705 19,743 14,100 38 0 .. 0 10 0 0 26 2

1990 229,598 217,649 11,913 10,948 9 0 1 0 6 0 0 2 1

1991 195,516 182,014 13,490 8,046 -10 0 0 0 -11 0 0 -4 5

1992 192,249 167,423 23,241 17,119 14 0 0 0 24 0 0 -12 2

Continued

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Continued
Region / Economy World Developed Economies Developing Economies Asia South Asia Afghanistan Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka 1993 237,634 197,228 39,351 31,103 5 0 0 0 0 0 0 -2 7 1994 275,212 227,341 47,537 39,468 91 0 0 0 82 0 0 1 8 1995 363,251 307,536 55,079 44,678 126 0 2 0 119 0 0 0 6 1996 397,709 332,658 64,095 53,870 266 0 13 0 240 0 0 7 7 1997 483,079 405,814 73,841 51,451 97 0 3 0 113 0 0 -24 5 1998 697,051 644,998 50,663 30,917 113 0 3 0 47 0 0 50 13 1999 1,108,354 1,037,379 68,650 41,676 125 0 0 0 80 0 0 21 24 2000 1,239,190 1,102,666 133,341 82,230 524 0 2 0 509 0 0 11 2 2001 745,479 662,220 80,565 47,123 1,449 0 21 0 1,397 0 0 31 0 2002 540,714 488,180 47,866 35,427 1,723 0 4 0 1,679 0 0 28 11 2003 560,087 503,966 45,372 22,412 1,932 0 6 0 1,879 0 0 19 27 2004 877,301 745,970 117,336 87,461 2,247 0 6 0 2,179 0 0 56 6 2005 837,194 706,713 115,860 77,747 2,579 0 2 0 2,495 0 0 44 38

Source: World Investment Report 2007, UNCTAD

xxviii

APPENDIX TABLE 6: WORLD BANK ECONOMIC INDICATORS (INDIA), 1980 - 2005

Variables Foreign Direct Investment, Net Inflows (BoP, Current US$) External Debt, Total (DOD, Current US$) Short-term Debt Outstanding (DOD, Current US$) Total Debt Service (% of Exports of Goods, Services and Income) Exports of Goods and Services (% of GDP) GDP (Current US$) GNI per capita, Atlas method (Current US$) GNI, Atlas method (Current US$) Imports of Goods and Services (% of GDP) Energy use (Kg of Oil Equivalent per capita) Inflation, GDP Deflator (Annual %)

1980 79,160,000 20,694,770,000 1,271,000,000 9 6 183,798,611,968 270 186,003,111,936 9 304 11

1981 91,920,000 22,709,430,000 1,597,000,000 11 6 190,454,153,216 300 207,896,035,328 9 312 11

1982 72,080,000 27,545,700,000 2,397,000,000 13 6 197,660,868,608 290 207,164,571,648 8 317 8

1983 5,640,000 32,139,248,000 3,338,000,000 16 6 215,169,253,376 290 209,287,839,744 8 321 5,640,000 Continued..

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Continued.. Variables Foreign Direct Investment, Net Inflows (BoP, Current US$) External Debt, Total (DOD, Current US$) Short-term Debt Outstanding (DOD, Current US$) Total Debt Service (% of Exports of Goods, Services and Income) Exports of Goods and Services (% of GDP) GDP (Current US$) GNI per capita, Atlas method (Current US$) GNI, Atlas method (Current US$) Imports of Goods and Services (% of GDP) Energy use (Kg of Oil Equivalent per capita) Inflation, GDP Deflator (Annual %) 209,669,767,168 280 212,903,952,384 8 328 8 1984 19,240,000 34,035,811,000 3,672,000,000 18 6 229,940,576,256 300 226,414,280,704 8 338 7 1985 106,090,000 40,951,475,000 4,358,000,000 22 5 246,369,599,488 320 247,547,379,712 7 342 7 1986 117,730,000 48,124,255,000 4,946,000,000 32 5 276,003,782,656 360 284,428,926,976 7 348 9 Continued.. 1987 212,320,000 55,570,203,000 5,673,000,000 31 6

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Continued.. Variables Foreign Direct Investment, Net Inflows (BoP, Current US$) External Debt, Total (DOD, Current US$) Short-term Debt Outstanding (DOD, Current US$) Total Debt Service (% of Exports of Goods, Services and Income) Exports of Goods and Services (% of GDP) GDP (Current US$) GNI per capita, Atlas method (Current US$) GNI, Atlas method (Current US$) Imports of Goods and Services (% of GDP) Energy use (Kg of Oil Equivalent per capita) Inflation, GDP Deflator (Annual %) 293,149,966,336 400 325,551,063,040 8 359 8 1988 91,250,000 60,476,622,000 6,358,000,000 30 6 292,917,379,072 400 329,066,938,368 8 369 8 1989 252,100,000 75,406,873,000 7,501,000,000 30 7 317,466,607,616 390 330,864,656,384 9 377 11 1990 236,690,000 83,628,388,000 8,544,000,000 32 7 267,523,506,176 350 305,374,199,808 9 384 14 Continued.. 1991 73,537,638 85,421,425,000 7,070,000,000 30 9

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Continued.. Variables Foreign Direct Investment, Net Inflows (BoP, Current US$) External Debt, Total (DOD, Current US$) Short-term Debt Outstanding (DOD, Current US$) Total Debt Service (% of Exports of Goods, Services and Income) Exports of Goods and Services (% of GDP) GDP (Current US$) GNI per capita, Atlas method (Current US$) GNI, Atlas method (Current US$) Imports of Goods and Services (% of GDP) Energy use (Kg of Oil Equivalent per capita) Inflation, GDP Deflator (Annual %) 245,553,168,384 330 291,945,152,512 10 392 9 1992 276,512,439 90,264,257,000 6,340,000,000 27 9 1993 550,370,025 94,342,412,000 3,626,000,000 27 10 276,037,369,856 310 282,588,184,576 10 393 10 1994 973,271,469 102,482,700,000 4,264,000,000 29 10 323,506,143,232 330 303,658,991,616 10 401 10 1995 2,143,628,110 94,463,676,000 5,049,000,000 30 11 356,298,981,376 380 350,210,785,280 12 416 9 Continued..

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Continued.. Variables Foreign Direct Investment, Net Inflows (BoP, Current US$) External Debt, Total (DOD, Current US$) Short-term Debt Outstanding (DOD, Current US$) Total Debt Service (% of Exports of Goods, Services and Income) Exports of Goods and Services (% of GDP) GDP (Current US$) GNI per capita, Atlas method (Current US$) GNI, Atlas method (Current US$) Imports of Goods and Services (% of GDP) Energy use (Kg of Oil Equivalent per capita) Inflation, GDP Deflator (Annual %) 1996 2,426,057,022 93,466,122,000 6,726,000,000 24 11 388,343,922,688 410 390,740,213,760 12 422 8 1997 3,577,330,042 94,316,595,000 5,046,000,000 22 11 410,915,176,448 420 405,160,165,376 12 431 6 1998 2,634,651,658 97,637,058,000 4,329,000,000 21 11 416,252,428,288 420 415,132,581,888 13 433 8 1999 2,168,591,054 98,313,138,000 3,933,000,000 16 12 450,476,441,600 440 443,914,321,920 14 451 4 Continued..

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Continued.. Variables Foreign Direct Investment, Net Inflows (BoP, Current US$) External Debt, Total (DOD, Current US$) Short-term Debt Outstanding (DOD, Current US$) Total Debt Service (% of Exports of Goods, Services and Income) Exports of Goods and Services (% of GDP) GDP (Current US$) GNI per capita, Atlas method (Current US$) GNI, Atlas method (Current US$) Imports of Goods and Services (% of GDP) Energy use (Kg of Oil Equivalent per capita) Inflation, GDP Deflator (Annual %) 2000 3,584,217,307 99,098,937,000 3,462,000,000 14 13 460,195,397,632 450 458,104,307,712 14 452 4 2001 5,471,947,158 98,484,517,000 2,742,000,000 15 13 478,290,444,288 460 478,697,455,616 14 452 3 2002 5,626,039,508 105,019,902,000 4,093,000,000 17 14 507,917,926,400 470 492,816,138,240 15 457 4 2003 4,322,748,000 112,854,556,000 5,040,000,000 19 15 601,826,918,400 530 568,812,240,896 16 461 4 Continued..

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Continued.. Variables Foreign Direct Investment, Net Inflows (BoP, Current US$) External Debt, Total (DOD, Current US$) Short-term Debt Outstanding (DOD, Current US$) Total Debt Service (% of Exports of Goods, Services and Income) Exports of Goods and Services (% of GDP) GDP (Current US$) GNI per capita, Atlas method (Current US$) GNI, Atlas method (Current US$) Imports of Goods and Services (% of GDP) Energy use (Kg of Oil Equivalent per capita) Inflation, GDP Deflator (Annual %) 2004 5,771,297,000 124,375,815,000 7,524,000,000 14 18 695,842,897,920 630 680,446,787,584 20 482 4 Source: World Development indicators, 2006, World Bank 2005 6,676,524,000 123,128,063,000 8,788,000,000 13 20 805,732,024,320 730 804,077,699,072 23 491 4

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