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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 Name : Sumana Chatterjee

Date : 27th August 2009 Signature :

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 Sumana Chatterjee

August 2009

LIST OF ABBREVIATIONS

I

1 AFTA : ASEAN Free Trade Area

2 APEC : Asia-Pacific Economic Cooperation

3 ASEAN : Association for South East Asian Nations

4 BITs : Bilateral Investment Treaties

5 BOP : Balance of Payments

6 BPO : Business Process Outsourcing

7 CIS : Commonwealth of Independent States

8 CUFTA : Canada United States Free Trade Agreement

9 DAC : Development Assistance Committee

10 DIPP : Department of Industrial Policy and Promotion

11 EBRD : European Bank for Reconstruction and Development

12 EOU : Export Oriented Unit

13 EU : European Union

14 FDI : Foreign Direct Investment

15 GDP : Gross Domestic Product

16 GFCF : Gross Fixed Capital Formation

17 IBRD : International Bank for Reconstruction and Development

18 IFDI : Inward Foreign Direct Investment

19 IMF : International Monetary Fund

20 IOC : Indian Oil Corporation

21 IPR : Intellectual Property Rights

22 ISO : International Organisation for Standardisation

23 IT : Information Technology

24 M&As : Mergers and Acquisitions

25 MNC : Multi National Corporation

26 NAFTA : North American Free Trade Agreement

27 NRI : Non-Resident Indians

28 ODA : Official Development Assistance

29 OECD : Organisation for Economic Cooperation and Development

30 OFDI : Outward Foreign Direct Investment

31 ONGC : Oil and Natural Gas Corporation

32 R&D : Research and Development

33 RBI : Reserve Bank of India

34 SIA : Secretariat of Industrial Assistance

35 TNC : Trans National Corporation

36 UK : United Kingdom

37 UNCTAD : United Nations Cooperation for Trade and development

38 US : United States

39 WIR : World Investments Report

40 WTO : World Trade Organisation

II

LIST OF TABLES

TABLE NO. CONTENTS PAGE NO.

3.1 Measures of integration of the Indian economy with the

world economy

66

3.2 Share of India in Global GDP and its growth 67

3.3 Inward FDI stock 69

3.4 Inward FDI flows 70

3.5 Foreign direct investment inflows in selected Asian

developing countries

71

3.6 FDI Inflows and GDP figures in India 73

3.7 Inward FDI flows as a percentage of Gross Fixed Capital

Formation by host region and economy

74

3.8 Inward FDI Performance Index of Some Selected Countries 75

3.9 Inward FDI Potential Index of Some Selected Countries 76

3.10 Share of top investing countries’ FDI inflows 81

3.11 Statement on RBI’s regional office-wise (with state covered)

FDI equity inflows

83

3.12 Sectoral analysis of FDI inflows 85

3.13 Major sectors: change in FDI stocks and output growth 86

3.14 FDI characteristics 88–89

4.1 Outward foreign direct investment: world and developing

countries

107

4.2 FDI outflows originating in developing countries 108

4.3 Indian OFDI stock 111

III

Continued…

TABLE NO. CONTENTS PAGE NO.

4.4 FDI outward stock 112

4.5 FDI outflows 113

4.6 FDI flows as a percentage of GFCF 114

4.7 Country wise approved Indian direct investments in joint

ventures and wholly-owned subsidiaries

115

4.8 Distribution of Indian OFDI stock by host regions 117

4.9 Changing ownership structure of Indian OFDI 119

4.10 Cross-border Mergers & Acquisitions – Indian purchases 119

4.11 Overseas M&As by Indian enterprises 120

4.12 Sector-wise OFDI of India 122

4.13 Cumulative OFDI approvals by Indian enterprises 122

4.14 India’s direct investment abroad by sectors 123

4.15 Some of the biggest acquisitions by Indian companies 125–126

IV

LIST OF BOXES

BOX NO. CONTENTS PAGE NO.

3.1 Matrix of Inward FDI Performance and Potential 2002 78

3.2 Matrix of Inward FDI Performance and Potential 2005 79

3.3 Various incentive schemes for attracting FDI 95

3.4 Liberalisation of FDI policy 95

4.1 Characteristics of India OFDI 110

4.2 Characteristics of OFDI at different stages of the “IDP” 110

5.1 “OLI” advantages and MNC channels for serving a foreign

market

144

5.2 Locational determinants of foreign direct investment 154

5.3 Determinants of FDI – Summarised 161

5.4 Correlation matrix of IFDI flows and the determinants of IFDI

flows

167

6.1 Push Factors determining OFDI 189

6.2 Determinants of OFDI – Summarised 189

6.3 Correlation matrix of OFDI flows and the determinants of

OFDI flows

197

V

TABLE OF CONTENTS

Acknowledgements

List of Abbreviations IList of Tables IIIList of Boxes V

CHAPTER 1: Introduction 11.1 Theoretical exposition of FDI 21.2 Relevance of the present study 161.3 Objectives of the present study 181.4 Methodology and Sources of data 271.5 Thesis Outline 29

CHAPTER 2: Review of Literature 332.1 Studies from the Global perspective 352.2 Studies from the Indian perspective 47

CHAPTER 3: Trends and Patterns of Inward FDI 663.1 Indian economic integration with the world economy 683.2 Trends and patterns of inward FDI 713.3 Findings and Conclusions 99

CHAPTER 4: Trends And Patterns of Outward FDI 1034.1 Explaining the investment development path 1054.2 Trends and patterns of outward FDI 1104.3 Findings and Conclusions 139

CHAPTER 5: Determinants of Inward FDI 1455.1 Theories of FDI: A chronological overview 1455.2 Theoretical Framework 1575.3 Literature Review 1675.4 Hypothesis and Methodology 1705.5 Findings and Conclusions 175

CHAPTER 6: Determinants of Outward FDI 186

6.1 Theories of outward FDI 1866.2 Literature Review 1906.3 Hypothesis and Methodology 200

6.4 Findings and Conclusions 204

CHAPTER 7: Summary, Conclusions and Recommendations 218

7.1 Inward FDI in India 219

7.2 Outward FDI from India 2257.3 Contribution of the Study 234

Bibliography iAppendix Tables xx

CCHHAAPPTTEERR 11

IINNTTRROODDUUCCTTIIOONN

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 host1 country to take

appropriate decisions.

1 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.

1

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.

2

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

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

3

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).

4

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 supplier’s 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

5

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.

IMF–OECD 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:

6

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 non-

resident 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).

7

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 investor’s 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 supplier’s 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.

8

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.

9

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

10

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 plant’s demand for parts and components can be met by exports

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

12

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

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:

13

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

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 EBRD’s own estimates and survey.

LIKELY BENEFITS OF FDI

14

i. FDI is less volatile than other private flows and provides a stable source of

financing to meet capital needs.

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 arm’s 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.

15

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 India’s 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 India’s 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 India’s 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 economy’s 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

18

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 Hymer’s (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

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. Hymer’s 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.

19

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).

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 country’s “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 country’s 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:

20

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.

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.

21

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.

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 worker’s 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.

22

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

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 country’s 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, India’s 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”

23

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

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, India’s

emergence as an outward investor was the direct result of the country’s rapid

industrialisation strategy and outward looking policies. Finally shifts in India’s

comparative advantage have played an important role in increasing the country’s

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

24

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

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 up-

to-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.

25

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

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.

26

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:

27

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

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.

28

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 economy’s integration with the world

economy.

• The nature of the regional distribution of FDI flows from the global FDI flows.

29

• 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.

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?

30

• 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”

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

31

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

32

12. WIR (2004). “The Shift Towards Services’, World Investment Report, UNCTAD,

United Nations, Geneva.

CCHHAAPPTTEERR 22

RREEVVIIEEWW OOFF LLIITTEERRAATTUURREE

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.

33

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

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.

34

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.

35

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

expand their domestic operations and suggest that interpretation of the OECD cross-

sectional 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 affiliate’s 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 model’s predictions the study finds that MNCs

expand the scale of activities in reforming countries after the IPR reforms.

36

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

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 plant’s TFP (Total Factor Productivity) and the foreign

affiliates share of activity in that plant’s industry. Typical estimates suggest that a 10

percent point increase in foreign presence in the U.K. industry raises the TFP of that

industry’s 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.

37

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

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.

38

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

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.

39

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

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.

40

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 women’s work and development. She finds that there is likely

to be some short term improvement in women’s income as FDI expands but the

trajectory of women’s wages is less promising .These findings are consistent with

those that indicate trade and FDI have done little to narrow the gender wage gap.

41

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 world’s 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

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.

42

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.

43

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

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.

44

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

and industrial strategy, Malaysia has been able to realize the benefits of FDI. This

study shows that Malaysia’s 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.

45

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

Industries set against an exploration of India’s 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.

46

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 India’s

economic growth experience during 1960-2004 focusing on the post 1973

acceleration. The analysis focuses on the unusual dimensions of India’s 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.

47

Examining India’s experience with capital flows, Ajay shah and Ila Patnaik (2004)

discuss India’s policies towards capital flows in the last two decades. They point out

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 India’s

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 India’s future growth and the quantum of FDI inflow. They argue

that to the extent that India’s future growth will depend on the global competitiveness

of its firms, the importance of such spillovers can be paramount.

48

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,

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.

49

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

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.

50

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 India’s 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.

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.

51

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 India’s 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 India’s 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.

52

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

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.

53

Rashmi Banga’s (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 state’s 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.

54

Milan Bhrambhatt et. al. (1996), in their study have identified four major weaknesses

in India’s 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

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.

55

Studying outward FDI by India Prof. Subramanyam and Prof. Bhuma (2006) find that

government expenses and labour outflows have significant elasticity with respect to

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.

56

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

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 India’s 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. India’s 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.

57

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

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 firm’s overseas acquisitions have been to access international

markets, firm specific intangibles like technology and human skills and overcome

constraints from limited home market growth.

58

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

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.

59

REFERENCES

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Indian Enterprises: Patterns and Motivations”, Indian Journal of Economics

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2. Anayiotas, A. and V. Palmade (2004). “Looking Beyond the Current Gloom in

Developing Countries”, In ‘Public Policy for the Private Sector’ ed. by World

Bank Group.

3. Balasubramanyam, V.N. and D. Sapsford (2007). “Does India Need a Lot

More FDI?” Economic and Political Weekly, April 28.

4. Balasubramanyam, V.N. and V. Mahambre (2003). “FDI in India”, Working

Paper No.2003/001, Department of Economics, Lancaster University

Management School, International Business Research Group.

5. Balasundaram, M. and A. Chatterjee (1998). “The Determinants of US

Foreign Investment in India: Implications and Policy Issues”, Managerial

Finance 24(7):53-62.

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CCHHAAPPTTEERR 33

TTRREENNDDSS AANNDD PPAATTTTEERRNNSS OOFF

IINNWWAARRDD FFOORREEIIGGNN DDIIRREECCTT

IINNVVEESSTTMMEENNTT

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 economy’s 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

66

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

• Section 3.1 studies the extent of the Indian economy’s integration with the

world economy.

• Section 3.2 examines the trends and patterns of inward FDI into India.

67

• Section 3.3 discusses the findings and conclusions.

SECTION 3.1

INDIA’S 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.

68

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

country’s 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 1994 2004

Share in GDP of Exports of Goods and Services 10 18

Share in GDP of Imports of Goods and Services 10 20

Share in World Merchandise Exports 0.6 0.8

Share in World Merchandise Imports 0.6 1.1

Country Share in World Exports of Commercial Services 0.6 1.9

Country share in World Imports of Commercial Services 0.8 2.0

Sources: World Bank 2006 and WTO, 2005

69

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 India’s

GDP almost doubled, but the increase in India’s share in its world merchandise

exports was proportionately far less. However, because of the success in the IT

service sector, India’s 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 India’s GDP growth, affecting the global GDP growth.

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

Share in Global GDP (percent)

Share in GDP of Low And Middle

Income Countries (percent)

Growth Rate of GDP

(percent)

Share in Growth of World GDP

(percent)

Share in Growth Rate of Low And Middle Income Countries

(percent)

1990 2004 1990 2004 1990 2004 1990 2004 1990 2004

1.46 1.67 7.92 8.23 6.0 6.2 3.58 4.14 12.66 10.63

(3.12.) (3.62) (12.18) (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 India’s 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 India’s 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.

70

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 growth1. 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.”

71

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

SIZE AND MAGNITUDE OF INWARD FDI

Table 3.3: FDI Inward Stock (US$ billion)

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 earnings2 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 India’s statistics in line with the international standards.

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

72

Year World Developing Economies India

1992-97* 2662.8 694.92 5.4

1998 4168.21 1224.05 14.06

1999 4939.44 1558.68 15.42

2000 5810.18 1707.63 17.51

2001 6210.76 1786.91 20.32

2002 6789.2 1727.49 25.4

2003 8185.38 1978.06 30.82

2004 9570.52 2287.69 38.67

2005 10048.01 2621.61 44.01

2006 11998.83 3155.85 50.68

* Annual average Source: World Investment Report, 2007

At the end of 2006, India’s 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 World Developing Economies India

1992-97* 312.23 114.65 1.67

1998 709.3 189.64 2.63

1999 1098.89 228.46 2.16

2000 1411.36 256.08 3.58

2001 832.56 212.01 5.47

2002 621.99 166.31 5.62

2003 564.07 178.69 4.32

2004 742.13 283.03 5.77

2005 945.79 314.31 6.67

2006 1305.79 379.07 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)

73

Table 3.5: FDI Inflows in selected Asian developing countries (1990-2004) (US$

billion)

Country 1990 2004

China 3.48 (1.72) 60.63 (8.16)

Hong Kong 3.27 (1.62) 34.03 (4.58)

India 0.23 (0.11) 5.77 (0.77)

Indonesia 1.09 (0.54) 1.89 (0.25)

Korea 0.759 (0.37) 8.98 (1.2)

Malaysia 2.61 (1.29) 4.62 (0.62)

Philippines 0.55 (0.27) 0.68 (0.09)

Singapore 5.57 (2.76) 19.82 (2.67)

Srilanka .043 (0.02) 0.23 (0.03)

Thailand 2.57 (1.27) 5.86 (0.78)

Developing Economies 35.89 (17.80) 283.03 (38.13)

World 201.59 742.13

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)

74

INDICATORS OF FDI PERFORMANCE

1. FDI / GDP Ratio

A good indicator of a country’s 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.

75

Table 3.6: India’s FDI inflows and GDP figures (US$ billion)

Year FDI GDP Current FDI / GDP (%)

1997 3.57 410.91 0.86

2000 3.58 460.19 0.77

2001 5.47 478.29 1.14

2002 5.62 507.91 1.1

2003 4.32 601.86 0.71

2004 5.77 695.84 0.82

2005 6.67 805.73 0.82

2006 16.88 911.81 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 “FDI–Capital 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 economy’s 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.

76

Table 3.7: FDI inflows as percentage of GFCF by host region and economy

(1992-2006)

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 size3. It is the ratio of a

country’s 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.

77

Year World Developing Countries India

1992 3.2 5.1 0.4

1993 4.1 6.5 0.9

1994 4.4 8.2 1.4

1995 5.3 8 2.4

1996 6 9.4 2.9

1997 7.5 11.8 4

1998 11.1 12.9 2.9

1999 16.5 15.8 2.2

2000 20.6 16.2 3.5

2001 12.5 13.7 5.1

2002 9.3 10.4 `5.0

2003 7.5 9.8 3..2

2004 8.5 12.9 3.2

2005 10.4 12.6 3.6

2006 12.6 13.8 8.7

Source: World Investment Report, 2007

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 promotion4 .

Table 3.8: Inward FDI Performance Index of some selected countries

1988-1990 1998-2000 2000-2002 Country

Rank Index Rank Index Rank Index

China 46 1.033 51 1.198 50 1.331

Hong Kong 3 5.292 2 6.033 2 6.508

India 98 0.066 119 0.155 121 0.215

Indonesia 56 0.794 137 -0.570 121 -0.528

Republic of Korea 81 0.369 91 0.587 107 0.330

Malaysia 4 4.355 49 1.248 70 0.923

Pakistan 72 0.493 114 0.216 116 0.278

Philippines 30 1.689 87 0.641 90 0.618

Singapore 1 13.599 7 3.737 6 4.755

Thailand 17 2.562 44 1.375 80 0.753

United States 41 1.115 78 0.805 92 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 East-

Asian 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.

4 The Inward FDI Performance Index methodology is given as:

78

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

4. Inward FDI potential index

The Inward FDI Potential Index5 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

1988-1990 1998-2000 2000-2002 Country

Rank Index Rank Index Rank Index

China 45 0.176 42 0.255 39 0.273

Hong Kong 17 0.355 13 0.426 12 0.413

India 72 0.120 91 0.156 89 0.159

Indonesia 42 0.177 85 0.161 82 0.163

Republic of Korea 20 0.312 17 0.410 18 0.387

Malaysia 38 0.205 32 0.302 32 0.292

Pakistan 92 0.095 129 0.103 128 0.104

Philippines 76 0.110 69 0.193 57 0.212

Singapore 13 0.402 2 0.500 4 0.465

Thailand 40 0.182 53 0.225 54 0.215

United States 1 0.727 1 0.706 1 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)

5 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

79

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 Low

High Front Runners Below Potential

FDI

Pote

ntia

l

Low Above 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.

80

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

High Performance Low Performance

Front Runners Below Potential

High Potential

Bahamas, Belgium and Luxembourg,

Botswana, Brazil, Brunei, Darussalam,

Bulgaria, Canada, Chile, China, Costa Rica,

Croatia, Cyprus, Czech Republic, Denmark,

Dominican Republic, Estonia, Finland,

France, Germany, Guyana, Hong Kong

(China), Hungary, Ireland, Israel, Jordan,

Latvia, Lithuania, Malaysia, Malta, Mexico,

Mongolia, Netherlands, New Zealand,

Panama, Poland, Portugal, Singapore,

Slovakia, Slovenia, Spain, Sweden,

Switzerland, Trinidad and Tobago, United

Kingdom and Vietnam.

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

Federation, Saudi Arabia, South Africa,

Taiwan Province of China, Thailand, United

Arab Emirates and United States.

Above-Potential Under-Performers

Low Potential

Albania, Angola, Armenia, Azerbaijan,

Bolivia, Colombia, Ecuador, Gambia,

Georgia, Honduras, Jamaica, Kazakhstan,

Mali, Morocco, Mozambique, Namibia,

Nicaragua, Republic of Congo, Republic of

Moldova, Sudan, TFYR Macedonia, Togo,

Tunisia, Uganda and United Republic of

Tanzania.

Algeria, Argentina, Bangladesh, Benin,

Burkina Faso, Cameroon, Cote d'Ivoire,

Democratic Republic of Congo, El Salvador,

Ethiopia, Gabon, Ghana, Guatemala,

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.

81

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

High Performance Low Performance

Front Runners Below Potential

High Potential

Azerbaijan, Bahamas, Bahrain, Belgium,

Botswana, Brunei Darussalam, Bulgaria,

Chile, China, Croatia, Cyprus, Czech

Republic, Dominican Republic, Estonia,

Hong Kong (China), Hungary, Iceland,

Israel, Jordan, Kazakhstan, Latvia,

Lithuania, Luxembourg, Malaysia, Malta,

Netherlands, Panama, Poland, Portugal,

Qatar, Singapore, Slovakia, Thailand,

Trinidad and Tobago, Ukraine, United Arab

Emirates and United Kingdom

Algeria, Argentina, Australia, Austria,

Belarus, Brazil, Canada, Denmark, Finland,

France, Germany, Greece, Ireland, Islamic

Republic of Iran, Italy, Japan, Kuwait,

Libyan Arab Jamahiriya, Mexico, New

Zealand, Norway, Oman, Republic of Korea,

Russian Federation, Saudi Arabia, Slovenia,

Spain, Sweden, Switzerland, Taiwan

Province of China, Tunisia, Turkey, United

States and Venezuela.

Above-Potential Under-Performers

Low Potential

Albania, Angola, Armenia, Colombia,

Congo, Costa Rica, Ecuador, Egypt,

Ethiopia, Gabon, Gambia, Georgia,

Guyana, Honduras, Jamaica, Kyrgyzstan,

Lebanon, Mali, Mongolia, Morocco,

Mozambique, Namibia, Nicaragua, Republic

of Moldova, Romania, Sierra Leone, Sudan,

Suriname, Tajikistan, Uganda, United

Republic of Tanzania, Uruguay, Vietnam

and Zambia.

Bangladesh, Benin, Bolivia, Burkina Faso,

Cameroon, Democratic Republic of Congo,

Côte d'Ivoire, El Salvador, Ghana,

Guatemala, Guinea, Haiti, INDIA,

Indonesia, Kenya, TFYR of Macedonia,

Madagascar, Malawi, Myanmar, Nepal,

Niger, Nigeria, Pakistan, Papua New

Guinea, Paraguay, Peru, Philippines,

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.

82

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.

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 streamlined6. This was

beneficial for the Indian economy. However, India began to emerge with

inertia.

83

6 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.

REGIONAL (COUNTRY WISE) DISTRIBUTION OF FDI

Table 3.10: Share of top investing countries’ FDI inflows in Rs. Crores (US$

million)

Ranks Country Aug ‘91–

Mar ‘02

Apr ‘02–Mar ‘03

Apr ’03– Mar ‘04

Apr ’04–Mar ‘05

Apr ’05–Oct ‘06

Cumulative Inflows

(Aug ’91–Oct ‘05)

Percentage with inflow

1. Mauritius 27,446

(6,632)

3,766

(788)

2,609

(567)

5,141

(1,127)

5,033

(1,144)

43,995

(10,358)

35.95

2. U.S.A. 12,248

(3,188)

1,504

(319)

1,658

(360)

3,055

(668)

1,498

(340)

19,963

(4,876)

16.31

3. Japan 5,099

(1,299)

1,971

(412)

360

(78)

575

(126)

410

(93)

8,416

(2,008)

6.88

4. Netherlands 3,856

(986)

836

(176)

2,247

(489)

1,217

(267)

70

(39)

8,325

(1,956)

6.80

5. U.K. 4,263

(1,106)

1,617

(340)

769

(167)

458

(101)

845

(192)

7,952

(1,906)

6.50

6. Germany 3,455

(908)

684

(144)

373

(81)

663

(145)

170

(39)

5,346

(1,317)

4.37

7. Singapore 1,997

(515)

180

(38)

172

(37)

822

(184)

660

(150)

3,829

(925)

3.13

8. France 1,947

(492)

534

(112)

176

(38)

537

(117)

36

(8)

3,229

(768)

2.64

9. South

Korea

2,189

(594)

188

(39)

110

(24)

157

(35)

251

(57)

2,894

(749)

2.37

10. Switzerland 1,200

(325)

437

(93)

207

(45)

353

(77)

171

(39)

2,367

(579)

1.93

Total FDI inflows * 92,611

(23,829)

14,932

(3,134)

12,117

(2,634)

17,138

(3,754)

11,397

(2,590)

1,48,195

(35,942)

* Includes inflows under RBI NRI Schemes, stock swapped

and advances pending issue of shares.

Source: DIP&P, Ministry of

Commerce,2005

84

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

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 public7 and private8 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

Union’s 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).

7 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

85

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

Table 3.11: Statement on RBI’s regional office-wise (with states covered) FDI

equity inflows1 (April ’00–Feb ’08)

Ranks

RBI’s - Regional Office2 State covered

% with FDI inflows

(in Rs. terms)

1. Mumbai Maharashtra, Dadra & Nagar Haveli, Daman & Diu 29.51

2. New Delhi Delhi, Part of UP and Haryana 20.27

3. Bangalore Karnataka 7.15

4. Chennai Tamil Nadu, Pondicherry 5.80

5. Hyderabad Andhra Pradesh 4.25

6. Ahmedabad Gujarat 3.78

7. Kolkata West Bengal, Sikkim, Andaman & Nicobar Islands 1.45

8. Chandigarh Chandigarh, Punjab, Haryana, Himachal Pradesh 0.77

9. Panaji Goa 0.44

10. Kochi Kerala, Lakshadweep 0.23

11. Bhopal Madhya Pradesh, Chattisgarh 0.20

12. Bhubaneshwar Orissa 0.17

13. Jaipur Rajasthan 0.15

14. Kanpur Uttar Pradesh, Uttranchal 0.03

15. Guwahati Assam, Arunachal Pradesh, Manipur, Meghalaya,

Mizoram, Nagaland, Tripura 0.02

16. Patna Bihar, Jharkhand 0.00

17. RBI’s regions not indicated 3 25.78

Source: DIP&P, Ministry of Commerce, 2008 1

Includes equity capital components’ only. 2

The Region-wise FDI inflows are classified as per RBI’s - 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.

86

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

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.

87

Table 3.12: Sectoral Analysis of FDI Inflows

Amount of FDI Inflows

Ranks Sector Apr ‘02–Mar ‘03

Apr ’03– Mar ‘04

Apr ’04–Mar ‘05

Apr ’05–Dec ‘06

Cumulative Inflows

(Aug ’91–Dec ‘05)

Percentage with inflow

1.

Electrical Equipments

(incl. computer

software & electronics)

3,075

(644)

2,449

(532)

3,281

(721)

3,796

(841)

21,006

(4, 886) 16.50

2. Transportation Industry 2,173

(455)

1,417

(308)

815

(179)

830

(187)

13,162

(3,143) 10.34

3.

Services Sector

(financial & non-

financial)

1,551

(326)

1,235

(269)

2,106

(469)

2,035

(462)

12,274

(2,972) 9.64

4.

Telecommunications

(radio paging, cellular

mobile, basic

telephone services)

1,058

(223)

532

(116)

588

(129)

886

(198)

12,199

(2,890) 9.58

5. Fuels (Power + Oil

Refinery)

551

(118)

521

(113)

759

(166)

150

(34)

10,711

(2,521) 8.41

6. Chemicals

(non-fertilizers)

611

(129)

94

(20)

909

(198)

856

(194)

7,456

(1,890) 5.86

7. Food Processing

Industries

177

(37)

511

(111)

174

(38)

158

(36)

4,678

(1,173) 3.67

8. Drugs &

Pharmaceuticals

192

(40)

502

(109)

1,343

(292)

499

(114)

4,051

(949) 3.18

9. Cement and Gypsum

Products

101

(21)

44

(10)

1

(0)

1,970

(452)

3,231

(747) 2.54

10. Metallurgical Industries 222

(47)

146

(32)

881

(192)

560

(126)

2,695

(627) 2.12

Source: DIP&P, Ministry of Commerce, 2008

88

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.

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&Ds9 (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 51910, which is 27 percent.

Table 3.13: Changes in FDI Stocksa and Output Growthb in Major Sectors (‘87–

’04)

1987-1991

1991-1995

1995-2000

2000-2004

All Sectors

FDI 1.26 2.07 6.39 N.A.

Output 6 6.4 5.9 6.3

Primary Sector

FDI 1.35 1.65 1.17 N.A.

Output 5 3.6 2.7 2.6

Manufacturing Sector

FDI 1.24 2.05 2.03 N.A.

Output 5.6 9.8 5 6.6

Services Sector

FDI 1.41 3.14 56.06 N.A.

Output 6.8 7.1 7.9 7.8

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).

9 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.

89

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.

90

Table 3.14: FDI Characteristics (‘90–’91, ’02–’03)

91

Memorandum

E

xpor

t % o

f pr

od.

Exp

orts

/ Im

ports

Impo

rts o

f C

apita

l Goo

ds

(% o

f tot

al

impo

rts)

Impo

rts o

f R

aw

mat

eria

ls,

Sto

res

& S

pare

s (%

of

indi

geno

us)

Roy

alty

P

aym

ents

(%

of p

rod.

)

R&D

(%

of p

rod.

Sal

arie

s (%

of p

rod.

)

Com

pani

es

No.

Val

of

prod

. (al

l in

dust

ries=

10

0)

1990-1991

All

indu

strie

s

9.3 1.3 9 20 0.11 0.09 9 300 100

Tea

plan

tatio

ns

13.7 95.7 18.4 0.5 0 0 17 24 6.3

Text

iles

16.4 3.5 19.5 18.7 0 0.04 14.4 6 2

Rub

ber

prod

ucts

11.2 1.7 7.2 12.8 0.01 0 7.9 4 3.5

Che

mic

als

9.5 1.2 2.9 23.3 0.02 0.06 2 63 29.3

Eng

g.

7 0.8 12.3 26.6 0.24 0.14 9.5 126 38.7

Trad

e

16.3 2.1 61.6 0.3 0 0.05 7.4 8 0.7

2002-2003

All

indu

strie

s

14.8 1.3 7.7 20.6 0.26 0.38 8.3 490 100

Tea

plan

tatio

ns

22.4 49.3 9.8 1.5 0 0.05 37.2 10 1

Food

pr

oduc

ts

8.9 2.9 5.1 4.6 0.01 0.09 5.6 16 3.3

Rub

ber /

P

last

ic

prod

ucts

16.4 1.9 16.2 18.8 0 0.21 5 11 2

Che

mic

als

11.8 0.9 3.4 23.6 0.28 0.39 5.7 76 28.2

Eng

g.

11.1 0.9 9.2 22.7 0.49 0.65 8.7 153 26.3

Mac

hine

ry

& to

ols

13.5 1 3.4 23.8 0.27 0.68 9.5 85 8.5

Ele

ct.

&

Mec

h.

11.4 0.8 6.7 30.4 0.25 0.47 7.5 33 5.9

Tran

spor

t eq

uipm

ent

9.2 1 16.9 18.6 0.76 0.72 8.8 35 11.9

Com

pute

r &

rela

ted

act. 12.7 5 74.8 0 0.05 0.77 31.8 23 4.4

Trad

e

19.9 1.4 1 0.5 0.01 1.8 9.3 20 1.2

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

92

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

effects on India’s 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 constant11 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 India’s 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

93

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.

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 Kearney’s FDI Confidence Index13

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).

94

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

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), Daimler-

Benz (avionics system), and Pfizer (biometrics). Nowadays more than 100

MNCs14 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

partners15 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.

India’s 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, Sanofi-Aventis.

95

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

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 ASEAN16, Gulf Cooperation council, BIMSTEC17, South

Asia Free Trade Area, Indian Ocean Rim Association for regional

Cooperation and SAARC18. 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 sectors20 with automatic approval21,

freedom of location and choice of technology. Imports and exports,

repatriation of profits, dividends and capital are also free22. Also IPRs are

guaranteed.

Since November 2005, FDI is allowed up to 100 percent in most activities

under the automatic route23.

The government also aims to attract foreign investments by setting up

Special Economic Zones24, Science Parks and Free Trade and Warehousing

Zones25. The Indian Investment Commission is charged with the

responsibility of wooing investors26. 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. Cambodia, Laos, Malaysia, Philippines, Singapore, Thailand, Vietnam, Myanmar 17 Including since 1997, Bangladesh, India, Myanmar, Sri Lanka, Thailand Economic Cooperation and Bhutan and Nepal since 2004. 18 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.

96

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

companies engaged exclusively in scientific R&D with commercial

applications.

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 billion27 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.

97

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

Cen

tral G

over

nmen

t In

vest

men

t Inc

entiv

es • 100 percent profit deduction for developing, maintaining and operating infrastructure facilities.

• Tax exemption of 100 percent on export profits for 10 years.

• Deduction in respect of certain inter-corporate dividends to the extent of dividend declared.

• Various capital subsidy schemes and fiscal incentives for expansion in the north eastern region.

• 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.

Sta

te G

over

nmen

t In

vest

men

t In

cent

ives

• 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 1991 1997 2000 Post 2000

Allowed

selectively

up to 40

percent

Up to 51 percent

under

“Automatic

Route” for 35

priority sectors

Up to 74 / 51 / 50 in

111 sectors under

“Automatic Route”,

100 percent in

some sectors

Up to 100 percent

under ‘Automatic

Route’ in all

sectors except a

small negative list

More sectors opened,

equity cap raised,

conditions relaxed,

foreign exchange

management

Source: Compiled from Media Reports

98

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.

99

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

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; India’s 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 India’s development and boosted the performances of local firms as

well as the globalization of some of them. Such a trend has undeniably raised

Indian’s 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.

100

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), “L’Inde, grande puissance émergente”, Questions

Internationales, n°15, 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

101

12. Srinivasan, T.N. (2003). “China and India: Economic Performance, Competition,

and Cooperation, An Update”, Stanford Center for International Development,

Working Paper Series, December.

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

102

24. WTO (2005). International Trade Statistics, World Trade Organization, Geneva.

CCHHAAPPTTEERR 44

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OOUUTTWWAARRDD FFOORREEIIGGNN DDIIRREECCTT

IINNVVEESSTTMMEENNTT

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:

103

• 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)?

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.”

104

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 country’s 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 government’s 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

106

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

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 country’s 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

107

Dunning developed the idea of firm-specific advantages further resulting in the so-

called “OLI” (Ownership, Locational, Internalisation) paradigm of FDI, also known as

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 firm’s 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

108

Locational advantages determine how attractive a location is for production. A strong

location advantage reduces a firm’s 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,

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 firm’s 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.

109

SECTION 4.2

TRENDS AND PATTERNS OF OUTWARD FDI

Table 4.1: Outward FDI – world and developing countries (US$ billion)

Value at current prices Item

2004 2005 2006

World Outward FDI flows 877 837 1216

Outward FDI flows from developing economies of which: 117 116 174

South Africa 1.4 0.9 6.7

Brazil 9.8 2.5 28.2

China 5.5 12.3 16.1

Korea 4.7 4.3 7.1

India 2.2 2.5 9.7

Singapore 8.1 5.0 8.6

Russian Federation 13.8 12.8 18.0

World outward FDI stock 10325 10579 12474

Income on outward direct investment 607 845 972

Cross border M & As 381 716 880

Total assets of foreign affiliates 42807 42637 51187

Exports of foreign affiliates 3733 4197 4707

Employment of foreign affiliates (in thousands) 59458 63770 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)

110

UNCTAD’s 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

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 1990 1991 1995

1990-2000 Ann. Avg 2005

Global outflows

(World) 69369 229598 195516 363251 492622 837194

Developing

Countries 3760 11913 13490 55079 52820 115860

percent Share 5 5 7 15 10 12

Selected Asian Developing Countries

China 333 830 913 2000 2195 12261

Hong Kong - 2448 2825 25000 20393 27201

Rep. of Korea 106 1052 1489 3552 3101 4298

Malaysia - 129 175 2488 1550 2971

Singapore 178 2034 526 6787 4757 6943

Taiwan 162 5243 2055 2983 3777 6028

Thailand 29 154 183 887 370 503

India 3 6 -11 119 110 2495

Source: WIR 2007, UNCTAD

111

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

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)

112

Box 4.1: Characteristics of India OFDI – “Pre-liberalisation to Post-

liberalisation”

Pre-Liberalisation (1975-1990) Post-Liberalisation (1991 onwards)

1.OFDI was largely led by the manufacturing

sector

1. OFDI originated from all the sectors of the

economy, but the service sector is the dominant

2. Developing countries were the dominant

host

2. Emergence of developed countries as host

countries

3. Indian equity participation was largely

minority owned 3. Indian equity participation is largely majority owned

4. Reasons for OFDI were access to larger

markets, natural resources, and escaping from

government restrictions on firm growth in

domestic market

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”

113

Pre-Liberalisation

(stage 1) Post-Liberalisation

(stage 2) Post 2nd Generation Reforms

(stage 2)

Destination

Regional FDI

(Neighbouring and other

developing countries)

Majority still regional but

expanding to global basis

Large share of developed

countries

Motivation

“Resource seeking” and

“market seeking” in

developing countries

In developing countries -

“resource and market seeking”

In industrialized countries -

“asset seeking” and “market

seeking”

“Efficiency seeking”

Motivation aimed at optimizing

use of country’s comparative

and competitive advantage

Types of OFDI

In developing countries -

natural asset intensive,

small scale production

in light industries

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

Ownership Advantages (OA)

Primarily Country of

Origin specific: Basic

OA

Both Firm and Country specific Mainly Firm Specific – Advanced

OA

Examples of Ownership Advantages

Conglomerate group

ownership, technology,

management adapted to

third world countries,

low costs inputs and

ethnic advantages

Conglomerate group ownership,

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

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

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 1976–2006 (US$ million)

OFDI Stock (US$ million)

Approved Actual Year Number of Approvals

Value % Change Value % Change

1976 133 38 ----- 17 -----

1980 204 119 213 46 171

1986 208 90 -24 75 63

1990 214 NA ------ NA ----

1995 1016 961 ------ 212 ----

2000 2204 4151 332 794 275

2006 8620 16395 295 8181 930

Source: Pradhan, 2007 pp.4

114

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

(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 “asset-

seeking” 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)

World Developing Economies

India

1992-97* 2842.28 325.29 0.4685

1998 4347.76 575.28 0.7

1999 5204.84 728.72 1.7

2000 6209.45 858.92 1.85

2001 6642.42 856.5 2.61

2002 7433.87 862.03 4

2003 8779.52 942.68 5.82

2004 10151.83 1106.29 7.75

2005 10578.8 1284.85 10.03

2006 12474.26 1600.3 12.96

* Annual Average Source: WIR 2007

115

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

Developing Economies

India

1992-97* 3238.2 51.3 0.09

1998 697.05 50.66 0.047

1999 1108.35 68.65 0.08

2000 1239.19 133.34 0.5

2001 745.47 80.56 1.39

2002 540.71 47.06 1.67

2003 560.08 45.37 1.87

2004 877.3 117.36 2.17

2005 837.19 115.86 2.49

2006 1215.78 174.38 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).

116

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

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

Developing Economies

India

2000 18.1 8.6 0.5

2001 11.2 5.3 1.3

2002 8.1 3 1.5

2003 7.5 2.5 1.4

2004 10.1 5.5 1.2

2005 9.2 4.7 1.4

2006 11.8 6.4 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 Acquisitions1 . 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.

117

1 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.

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

India’s largest trading partners2. 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)

Apr’96- Mar’02 2002-03 2003-04 2004-05

2005-06 (Aug)

Total

Russia 1748.68 0.15 1.43 1076.17 1.068 2827.450

USA 1540.83 185.27 207.14 251.73 135.83 2320.780

Mauritius 618.34 133.35 175.59 149.38 55.9 1132.56

Virgin Islands 776.53 3.27 4.92 131.41 14.71 930.84

Bermuda 232.63 28.95 142.46 221.26 2.6 627.9

Sudan - 75.0 162.03 51.55 43.13 1006.71

United Kingdom 410.62 34.53 138.48 71.85 120.09 775.58

Hong Kong 445.12 14.8 16.15 73.64 22.22 571.93

Singapore 152.96 46.79 15.85 239.03 19.49 474.12

Australia 6.99 94.97 92.87 158.76 28.97 382.56

Netherlands 157.92 15.92 30.18 30.65 124.56 359.23

UAE 110.24 12.6 32.07 41.85 61.30 258.06

Vietnam 228.79 0.06 0.04 0.06 0 228.95

118

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

Oman 204.88 0.35 1.51 5 1.7 213.44

China 38.8 30 27 15 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 industries3. 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 Notably the acquisition of Sakhalin Oil field by the Oil and Natural Gas Commission, ONGC.

119

4 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)

Table 4.8: Distribution of Indian OFDI Stock by Host Regions 1976–2006 (In

Percent)

120

Host Region / Economy 1976 1980 1986 1995 2000 2006

Developed economies 10.12 5.02 1.61 40.8 29.62 32.17

Europe 5.41 1.89 1.18 26.8 16.82 13.54

European Union 5.41 1.88 1.15 25.69 16.19 12.75

Other developed Europe - 0 0.02 1.11 0.63 0.79

North America 4.71 3.06 0.36 10.87 11.85 15.44

Other developed countries - 0.07 0.06 3.13 0.95 3.19

Developing economies 89.88 92.91 96.31 53.97 68.17 50.5

Africa 23.85 28.85 36.06 7.99 9.93 20.39

North Africa - 0.11 1.18 0.25 0.98 10.59

Other Africa 23.85 28.74 34.88 7.74 8.96 9.8

West Africa 1.42 15.17 20.81 0.62 0.85 0.41

Central Africa - - - - - 0

East Africa 22.43 13.52 14.06 6.9 7.55 9.15

Southern Africa - 0.05 - 0.23 0.55 0.23

Latin America and the Caribbean - - - 1.75 23.39 10.4

South and Central America - - - 0.71 0.66 0.75

South America - - - 0.01 0.47 0.59

Central America - - - 0.69 0.19 0.17

Caribbean and other America - - - 1.04 22.73 9.65

Asia and Oceania 66.03 64.06 60.25 44.23 34.85 19.71

Asia 64.89 63.94 59.64 44.22 34.84 19.7

West Asia 5.74 5.44 3.46 18.09 12.13 5.25

South, East and South-East Asia 59.15 58.5 56.18 26.13 22.71 14.45

East Asia 0.25 0.07 0.07 5.57 11.28 5.12

South Asia 0.37 9.53 3.99 6.04 4.26 1.93

South-East Asia 58.53 48.9 52.12 14.51 7.17 7.39

Oceania 1.14 0.12 0.6 0.01 0 0.01

South-East Europe and CIS - 2.07 2.09 5.23 2.21 17.34

South-East Europe - 2.07 2.09 0.08 0.02 0.06

CIS - - - 5.15 2.19 17.27

World 100 100 100 100 100 100

Memoranda

No. of Host Countries 22 37 35 84 128 127

Source:

i. Ministry of Commerce (1976) as quoted in Indian Institute of Foreign Trade (1977) India’s Joint

Ventures Abroad, pp. 59–64

ii. Indian Investment Centre (1981) Indian Joint Ventures Abroad: An Appraisal, pp. 25–29

iii. Indian Investment Centre (1986) as quoted in Federation of Indian Chambers of Commerce &

Industry (1986)

iv. Report of Workshop on Indian Joint Ventures Abroad and Project Exports, New Delhi, pp. 74–77

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. 1–2 and pp.59–60

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.

121

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)

STRATEGIC ASSET SEEKING INVESTMENTS

OWNERSHIP PATTERN

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

1975–90 1991–01 Equity Range

(Percent) No of OFDI Approval

Percent Cumulative

Percent No. of OFDI

Approval Percent

Cumulative Percent

0–20 51 22.9 22.9 41 3.7 3.7

20–50 91 40.8 63.7 230 20.6 24.2

50–80 53 23.8 87.4 211 18.9 43.1

80–100 28 12.6 100 637 56.9 100

Total 223 100 1119 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 Sales Purchases

1997 1520 1287

1998 361 11

1999 1044 126

2000 1219 910

2001 1037 2195

2002 1698 270

2003 949 1362

Source: ICICI-EPWRF data base, 2006

122

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

RBI’s 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 Regional composition

Sector No. Percent Region No. percent

Primary 9 7.6 Developed countries 93 78.2

Mining, petroleum and gas 9 7.6 United Kingdom 16 13.4

Industry 34 28.6 United States 53 44.5

Pharmaceuticals 12 10.1 Australia 8 6.7

Paints 4 3.4 Developing countries 20 16.8

Plastic & products 4 3.4 Africa 5 4.2

Services 76 63.9 Latin America and the Caribbean 3 2.5

Software 67 56.3 Asia and the Pacific 12 10.1

All sectors 119 100 All regions 119 100

Source: UNCTAD Case Study, 2005

123

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

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 country’s 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. Reddy’s Lab acquired Betapharm of

Germany, Ranbaxy Labs acquired RPG Aventis Laboratories of France, Tata Motors

acquired Daewoo Commercial Vehicles of Korea.

124

TRADE SUPPORTING INVESTMENTS

SECTORAL DISTRIBUTION OF INDIAN OFDI FLOWS

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

Services Manufacturing Total

Period Number Equity Number Equity Number Equity

1975-1985 56 24 80 88 139 116

1986-1990 43 49 48 57 91 106

1991-1995 356 326 419 406 778 733

1996-2001 962 2194 817 1273 1783 3529

1975-2001 1417 2595 1364 1824 2791 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

Extractive Manufacturing Services Period

No. Equity No. Equity No. Equity No. Equity

1975-90

230

(100)

222.45

(100)

3

(1.30)

4.04

(1.82)

128

(55.65)

145.22

(65.28)

99

(43.04)

73.22

(32.91)

1991-2000

2 561

(100)

4262.23

(100)

7

(0.27)

61.14

(1.43)

1 236

(48.26)

1 678.92

(39.39)

1 318

(51.46)

2 522.17

(59.17)

1975-2000 2 791 4484.68 10 65.18 1 364 1 824.14 1 417 2 595.39

(100) (100) (0.36) (1.45) (48.87) (40.67) (50.77) (57.87)

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)

125

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).

126

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.

Table 4.14: India’s direct investment abroad by sectors (US$ million) (trade

supporting investments)

Industry 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06

Manufacturing 169

(23.8)

528

(53.8)

1271(70.7) 893 (59.8) 1068

(64.8)

1538

(57.4)

Financial Services 6 (0.8) 4 (0.4) 3 (0.2) 1 (0.1) 7 (0.4) 156 (5.8)

Non-financial Services

470

(66.3)

350

(35.7)

404 (22.5) 456 (30.5) 283 (17.2) 531 (19.8)

Trading 52 (7.3) 79 (8.1) 82 (4.6) 113 (7.6) 181 (11.0) 215 (8.0)

Others 12 (1.7) 20 (2.0) 38 (2.1) 31 (2.1) 108 (6.6) 239 (8.9)

Total 709 (100) 981 (100) 1789 (100) 1494

(100)

1647

(100)

2679

(100)

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.

127

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

capacities. Total (equity and loans) investment abroad by Indian companies in 2005-

06 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

128

STRATEGIC ACCESS TO MARKETS SEEKING INVESTMENTS

Table 4.15: Some of the biggest acquisitions by Indian companies in last 3-5

Years

Indian purchaser Company Purchased, Place of FDI

ONGC Sakhalin, Russia; Royal Dutch Shell, Angola; a Refinery in

Sudan; an oil filed in Brazil, …

Indian Oil Corp. a large oil block in the Sirte Basin of Libya

Tata Steel Nat Steel (Singapore), Millennium Steel Company - Cementhai

Holding (Thailand) (US$ 130 million)

Tata Chemicals’ Brunner Mond Group Ltd, United Kingdom (US$ 110 million)

Reliance Flag Telecom (USA) ; Trevira (Germany)

Ranbaxy RPG Aventis (France)

Infosys Expert Formation (Australia

Wipro Nerve Wire, USA

VSNL Tyco Global Network (USA)

Videocon Thomson - division picture-tube, France (US$ 289 million)

Apeejay Surrendra Premier Foods (tea), United Kingdom (US$ 138 million)

Matrix Laboratories Docpharma NV Belgium (US$263 million), Mchem in China, 43

percent stake in Swiss firm Explora

Videsh Sanchar

Nigam

Teleglobe International Holdings Ltd USA

Dr Reddy’s Betapharm, Germany

United

Phosphorous

Advanta, Netherlands

Sun Pharma Able Labs, USA

Continental Engine Vege Motors, Netherlands

Sundram Fasteners

SFL)

Peiner Umformtechnik, Textron Deutschland Germany

Bharat Forge’s

(BFL)

FAW Corporation (forging industry, automotive), China

Carl Dan Peddinghaus Gmbh, Germany

Mittal Steel ISCOR, South Africa

129

Table 4.15: Some of the biggest acquisitions by Indian companies in last 3-5

Years

Acquirer Acquired Company Country Deal Value (US$ mn)

Industry

Dr. Reddy’s Lab Betaphram Germany 570 Pharmaceutical

Ranbaxy Labs Terapla SA Romania 324 Pharmaceutical

Ranbaxy Labs RPG (Aventis) Laboratories France Pharmaceutical

Aurobindo Pharma Milpharm UK Pharmaceutical

Matrix Laboratories Docpharma NV Belgium 263 Pharmaceutical

Nicholas Piramal Rhodia’s IA UK Pharmaceutical

Nicholas Piramal Avecia UK Pharmaceutical

Wockhardt CP Pharmaceuticals, UK 18 Pharmaceutical

Cadila Health Alpharma SAS France 5.7 Pharmaceutical

M&M Jiangling Tractor company China - Automobile

Tata Motors Daewoo Commercial Vehicles Korea 118 Automobile

Tata Motors Hispano Carrocera Spain Automobile

Bharat Forge Carl Dan Peddinghaus Germany Automobile

Tata Steel Millennium Steel Thailand 130 Steel

Tata Steel NatSteel Asia Steel

Subex Systems Azure Solution UK 140 IT

TCS Comicrom Chile - IT

TCS FNS Australia - IT

Satyam Computer Citisoft UK - IT

Infosys Expert Information Services Australia 3.1 IT

Wipro Nerve Wire Inc, US 18.5 IT

Videocon Thomson SA France 290 Electronics

VSNL Teleglobe Canada 240 Telecom

VSNL Tyco 130 Telecom

Reliance Industries Flag Telecom Bermuda 212 Telecom

Reliance Industries BermudaTrevira Germany 95 Telecom

Tata Chemicals Brunner Mond UK 177 Chemicals

ONGC Videsh Brazilian Oil Fields from Shell Brazil 1,400 Oil & Gas

HPCL Kenya Petroleum Refinery Kenya 500 Oil & Gas

Tata Tea Tetley UK 407 FMCG

Tata Tea Good Earth US 50 FMCG

Tata Tea JEMCA Czech Rep. 12.5 FMCG

Tata Tea Energy Brands Inc. – Glaceau US 677 FMCG

Hindalco Straits Ply Australia 56.4 Metals

Aditya Birla Dashiqiao Chem China 8.5

United Phosphorous Oryzalin Herbicide US 21.3 Fertilisers

Source: Compiled from Media Reports

130

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.

131

• As compared to the pre liberalized period, Indian FDI has become less of a

regional phenomenon. Hence industries require Ownership advantages

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).

132

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.

133

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

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 India’s 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.

134

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.

135

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.

136

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

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.

137

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

previously imposed. Further more Indian companies can now invest or make

acquisitions abroad in areas unrelated to their business at home.

138

(RBI and Ministry of Finance, “Indian Direct Investment in JVs/WOS abroad”,

February, 2004)

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 firm’s 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.

139

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

focus on areas of the country’s 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 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 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 country’s economic development.

140

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.

141

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144

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Through Internationalization, December 5-7 , Geneva.

CCHHAAPPTTEERR 55

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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.

145

Consequently, some of the approaches to develop a theory of FDI failed to

incorporate the fundamental difference between portfolio and direct investment. An

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.

Vernon’s 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.

146

Firm-specific advantages and the “OLI” paradigm

Stephen Hymer came up with his theory of firm specific advantages approximately at

the same time as Vernon’s theory. Hymer’s 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”.

147

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

reducing the firm’s 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 firm’s 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.

148

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 firm’s 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

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

Ownership Advantage

Internalisation Advantage

Locational Advantage in Foreign Country

FDI Yes Yes Yes

Exports Yes Yes No

Licensing 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 MNC’s 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.

149

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 economy’s 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

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).

150

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 firm’s decision between FDI and exports. The

decision between foreign production and exports revolves around the “proximity-

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 “proximity-

concentration 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.

151

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).

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. Helpman’s 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.

152

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.

Brainard’s (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

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

153

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.

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 firm-

specific 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.

154

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

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.

155

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

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.

156

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 arm’s-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 firm’s

disadvantages vis-à-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

arm’s-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 firm’s interest to retain exclusive rights

to assets (e.g. knowledge) which confer upon it a significant competitive

advantage (e.g. monopoly rents).

157

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 country’s 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 (host-

country) determinants of FDI flows.

158

Box 5.2: Locational determinants of foreign direct investment

Policy framework for FDI Economic determinants Business facilitation factors

Core FDI Policy Regime

• Rules Regarding Entry and

Operations

• Standards of Treatments of

Foreign Enterprise

• Policies on Functioning

Market Seeking FDI

• Market Size and Per Capita

income

• Market Growth

• Access to Regional and

Global Markets

• Country Specific Consumer

• Preferences

• Structure of Markets

Investment Promotion

Measures

• Investment Incentives

• Hassle Costs (corruption,

administrative inefficiency)

• Social Amenities

• After Investment Services

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 Stability of the

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.

Several caveats are required before reviewing the FDI determinants:

159

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

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.

160

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,

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

161

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 nation’s 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.

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.

162

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 country’s 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.

163

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

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.

164

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

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.

165

Box 5.3: Determinants of FDI–Summarised

Determinant Possible Proxy Variable Effect

Market Size, Market Growth GDP, GDP Growth Rate + + +

Level of development GDP per Capita, GDP per Capita

Growth Rate

+ +

Urbanisation Percentage of Urban Population +

Human Capital Secondary School Enrolment Ratio +/-

Agglomerations FDI Lagged One Period

Number of Firms in the Region

GDP

+

+

+

Economic Integration Member of Economic–Political Union +

Governments, Trade Regime (Exports + Imports) / GDP

FDI as a fraction of GDP

Infrastructure (Roads)

+

+

+

Labour Costs Wages and Salaries -

Exchange Rate Variability Absolute / Relative Change in Real

Exchange Rate

+/ -

Political Instability Foreign Debt as a Fraction of GDP

R&D +/ - Interaction Between the Foreign Investor and the

Domestic Firms Marketing process +/-

166

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.

167

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 Lave-

Hidalgo, 2000). This is because higher wages indicate higher productivity and hi-tech

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.

168

Sayek Selin (1999), explained the relationship between FDI and inflation. This

research’s 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

percent increase in Turkish inflation reduces US FDI in Turkey by 1.9 percent,

increasing US domestic investment by 0.3 percent.

169

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 : Foreign direct investment net inflows measured as BOP current US$ billion

ii. GDP : Gross Domestic Product at factor cost measured in current US$ billion

iii. WAGE : Total emoluments paid to the workers measured in Rs. Lakhs.

iv. INFL : (Inflation) GDP deflator measured as annual percentages

170

v. EXDBT : Total external debt measured in current US$ billion

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

capita.

vii. OPEN : Sum of Exports + Imports divided by GDP [(Ex+Im) / GDP]

viii. REER : Indices of Real Effective Exchange Rate of the Indian Rupee–36 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.

171

Box 5.4: Correlation matrix of inward FDI flows and the determinants of inward

FDI flows

IFDI GDP EXDBT INFR INFL OPEN REER AGGL WAGE

IFDI 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, α (slope), coefficient of regression. In addition, the output shows the t-

statistic 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.

172

REGRESSION RESULTS

(Estimates based on appendix tables)

Regression Analysis Explaining the Variations in IFDI flows

Dependent Variable : IFDI flows

Period : 1980 To 2005

N : 26

Regression Model – 1

Model Summary:

R Square Adjusted R Square F-Value

0.936 0.927 102.291

Coefficients:

Coefficient Beta t

(Constant) - 1041.348 – - 2.017

GDP 5.559 0.400 2.664**

WAGE 1037.631 0.958 4.645*

EXTDBT - 31.809 - 0.439 - 3.333**

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

Excluded Variables:

Beta In t

ENRGY 0.506c 1.174

INFL - 0.114c - 1.227

OPEN - 0.022c - 0.091

AGG - 0.009c - 0.063

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

173

Regression Model – 2

Model Summary:

R Square Adjusted R Square F-Value

0.919 0.911 129.614

Coefficients:

Coefficient Beta t

(Constant) - 958.273 – - 1.069

OPEN 28523.012 0.711 9.174* INFL - 259.380 - 0.333 - 4.293* Notes: * Significant at 1% / ** Significant at 5%

Excluded Variables:

Beta In t

ENRGY 0.107b 0.700

AGG 0.011b 0.073

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

174

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 country’s 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)

175

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.

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.

176

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)

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.

177

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

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.

178

If the economy has to benefit from the FDI’s 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

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.

179

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.

180

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185

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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.

186

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

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.

187

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 China’s 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.

Fourthly, home and host government policies influence outward FDI decisions.

Chinese MNCs regard their Government’s 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.

188

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.

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)

189

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.

190

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

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.

A few studies explore push and pull factors behind China’s 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)

191

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

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.

192

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

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.

193

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).

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 Institutional Factors Cyclical factors

Economic Growth Tax Policies Inflation

Domestic Employment New Economic Policies Exchange Rate

Gross Domestic Savings Bilateral Agreements

Development of Stock Exchange Labour Laws

Exports

Imports

Inflow of FDI

Infrastructural

Availability

Labour Skill Levels

Availability of cheap capital

194

Box-6.2 Determinants - Summarised

Determinant Possible Proxy Variable Effect

Economic Growth GDP, GDP Growth Rate + /-

Level of Development GDP per Capita, GDP per Capita Growth Rate, Domestic

Savings

+ /-

Infrastructure Roads, Energy, Water -

Capital Costs Interest Rates +

Agglomerations IFDI Lagged One Period

Number of Firms in the Region

+

+

Economic Integration Member of Economic–Political Union

Bilateral Agreements

+

+

Governments, Trade

Regime

(Exports + Imports) / GDP

Taxes

+

+

Labour Costs Wages and Salaries +/-

Exchange Rate Variability Absolute / Relative Change in Real Exchange Rate +/ -

Economic Instability Inflation +

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.

195

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.

196

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

OFDI:

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 Lücke (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).

197

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)

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).

199

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.

201

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

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 IFDI GDP PCI WAGE INFR IM/GDP EX/GDP

OFDI 1 .891** .898** .877** .766** .725** .885** .859**

IFDI .891** 1 .933** .878** .932** .889** .929** .930**

GDP .898** .933** 1 .977** .927** .911** .963** .956**

PCI .877** .878** .977** 1 .856** .854** .926** .903**

WAGE .766** .932** .927** .856** 1 .981** .928** .962**

INFR .725** .889** .911** .854** .981** 1 .880** .939**

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

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

202

REGRESSION RESULTS

(Estimates based on appendix tables)

Regression Analysis Explaining the Variations in OFDI flows

Dependent Variable : OFDI flows

Period : 1980 To 2005

N : 26

Model Summary:

R Square Adjusted R Square F-Value

0.946 0.935 87.198

Coefficients:

Variables Coefficient Beta t

(Constant) - 1017.356 – - 4.949

IFDI 0.301 0.843 5.067*

GDP 3.021 0.609 3.156**

WAGE - 510.510 - 1.323 - 6.385*

EX/GDP 148.726 0.767 3.188**

Notes: * Significant at 1%

** Significant at 5%

Excluded Variables:

Variables Beta In t

INFRA - 0.090c - 0.311

PCI - 0.363c - 1.189

IM/GDP - 0.443c - 1.419

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

SECTION 6.4

203

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 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).

204

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 economy’s ability of improving

the FDI outflows will be related to the country’s 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

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.

205

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. 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.

206

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

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.

207

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 India’s 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 India’s 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.

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. Reddy’s 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)

208

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 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.

209

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

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.

210

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,

India’s 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

211

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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CCHHAAPPTTEERR 77

SSUUMMMMAARRYY,,

RREECCOOMMMMEENNDDAATTIIOONNSS AANNDD

CCOONNCCLLUUSSIIOONNSS

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”.

218

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.

219

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

the growth of FDI inflows to India seem to be fairly satisfactory; India’s 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 India’s development and boosted the performances of local firms as

well as the globalisation of some of them. Such a trend has undeniably raised

Indian’s 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.

220

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).

221

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. 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.

222

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

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 FDI’s 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.

223

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 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.

224

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 firm’s 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.

225

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

the country’s 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 country’s economic

development.

226

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.

227

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 economy’s ability of improving

the FDI outflows will be related to the country’s 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 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

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.

228

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.

229

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 India’s 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

India’s 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 Reddy’s 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,

India’s 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.

232

Scope of Further Research

233

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.

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 Dunning’s “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.

234

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

235

that the linkages between them are strengthened and beneficial to the overall

economy.

BBIIBBLLIIOOGGRRAAPPHHYY

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APPENDIX TABLES

APPENDIX TABLE 1: INDIA’S FOREIGN TRADE (US$ MILLION)

India’s Foreign Trade (US$ million)

Exports Imports Year

Oil Non-oil Total Oil Non-oil Total 1980-81 32 8,453 8,485 6,655 9,212 15,867

1981-82 246 8,458 8,704 5,786 9,387 15,173

1982-83 1,278 7,830 9,108 5,816 8,970 14,787

1983-84 1,536 7,914 9,449 4,673 10,638 15,311

1984-85 1,529 8,349 9,878 4,550 9,863 14,412

1985-86 527 8,378 8,905 4,078 11,989 16,067

1986-87 322 9,423 9,745 2,200 13,527 15,727

1987-88 500 11,588 12,089 3,118 14,038 17,156

1988-89 349 13,622 13,970 3,009 16,488 19,497

1989-90 418 16,194 16,613 3,768 17,452 21,219

1990-91 523 17,623 18,145 6,028 18,044 24,073

1991-92 415 17,451 17,865 5,325 14,086 19,411

1992-93 476 18,061 18,537 6,100 15,782 21,882

1993-94 398 21,841 22,238 5,754 17,553 23,306

1994-95 417 25,914 26,331 5,928 22,727 28,654

1995-96 454 31,341 31,795 7,526 29,150 36,675

1996-97 482 32,988 33,470 10,036 29,096 39,132

1997-98 353 34,654 35,006 8,164 33,321 41,485

1998-99 89 33,129 33,219 6,399 35,990 42,389

1999-00 39 36,784 36,822 12,611 37,059 49,671

2000-01 1,870 42,691 44,560 15,650 34,886 50,537

2001-02 2,119 41,708 43,827 14,000 37,413 51,413

2002-03 2,577 50,143 52,719 17,640 43,773 61,412

2003-04 3,568 60,274 63,843 20,570 57,580 78,149

2004-05 6,989 76,547 83,536 29,844 81,673 111,517

2005-06 11,640 91,451 103,091 43,963 105,203 149,166

Source: Directorate General of Commercial Intelligence and Statistics

xx

APPENDIX TABLE 2: ANNUAL SERIES FOR PRINCIPAL CHARACTERISTICS

(Value Figures in Rs. Lakhs, Mandays in Thousand and Others in Number)

Characteristics Year

Number of Factories Fixed Capital Working Capital Invested Capital

1981-82 105,037 3,470,259 1,505,488 5,399,127

1982-83 93,166 4,100,600 1,631,988 6,299,198

1983-84 96,706 4,860,554 1,850,402 7,249,434

1984-85 100,328 5,484,211 2,232,323 8,050,202

1985-86 101,016 6,008,524 2,379,864 8,811,181

1986-87 97,957 6,723,094 2,180,329 9,769,297

1987-88 102,596 7,847,463 2,755,102 11,393,383

1988-89 104,077 8,912,356 2,724,616 13,297,905

1989-90 107,992 10,692,778 3,386,365 15,914,036

1990-91 110,179 13,364,756 4,252,036 19,491,285

1991-92 112,286 15,190,240 4,446,816 22,123,418

1992-93 119,494 19,287,139 6,249,011 27,772,858

1993-94 121,594 22,441,333 8,710,857 32,054,715

1994-95 123,010 27,764,512 8,729,632 38,753,459

1995-96 134,571 34,846,773 10,766,313 48,996,925

1996-97 132,814 38,004,439 17,165,931 52,215,413

1997-98 136,012 42,308,227 15,461,658 57,682,603

1998-99 131,706 39,115,145 10,274,034 53,706,813

1999-00 131,558 40,186,473 10,378,436 56,663,430

2000-01 131,268 39,960,422 10,520,839 57,179,940

2001-02 128,549 43,196,013 10,040,585 60,591,285

2002-03 127,957 44,475,938 10,012,110 63,747,308

2003-04 129,074 47,333,140 11,923,049 67,959,786

2004-05 136,353 51,306,925 16,005,396 75,941,770

2005-06 140,160 60,694,028 18,446,260 90,157,861

Continued….page2

xxi

Appendix Table 2 Continued….

Characteristics Year

Outstanding Loans Number of Workers Mandays-Workers Number of Employees

1981-82 3,349,934 6,105,622 1,686,248 7,777,868

1982-83 3,852,135 6,312,673 1,791,856 8,009,792

1983-84 4,811,656 6,158,837 1,851,719 7,824,121

1984-85 5,247,519 6,091,409 1,855,498 7,871,712

1985-86 6,207,203 5,819,169 1,795,111 7,471,515

1986-87 7,009,633 5,806,866 1,789,947 7,441,879

1987-88 7,943,693 6,061,786 1,871,201 7,785,580

1988-89 6,546,478 6,026,328 1,851,385 7,743,344

1989-90 8,430,536 6,326,541 1,962,805 8,142,550

1990-91 10,456,557 6,307,143 1,949,506 8,162,504

1991-92 11,018,723 6,269,039 1,935,646 8,193,590

1992-93 16,128,731 6,649,310 2,040,458 8,704,947

1993-94 16,271,340 6,632,323 2,045,434 8,707,909

1994-95 20,637,103 6,970,116 2,163,012 9,102,407

1995-96 24,693,365 7,632,297 2,393,812 10,044,697

1996-97 25,960,884 7,208,143 2,303,625 9,448,643

1997-98 32,460,512 7,652,254 N.A 9,997,573

1998-99 22,820,981 6,364,464 N.A 8,588,581

1999-00 25,378,161 6,280,659 1,904,067 N.A

2000-01 25,795,392 6,135,238 1,858,844 7,917,810

2001-02 26,921,926 5,957,848 1,800,576 7,686,654

2002-03 26,339,233 6,161,493 1,870,226 7,870,529

2003-04 28,977,564 6,086,908 1,840,986 7,803,395

2004-05 33,463,375 6,599,298 1,995,220 8,383,278

2005-06 35,150,737 7,136,097 2,154,187 9,038,523

Continued….page3

xxii

Appendix Table 2 Continued….

Characteristics Year

Mandays-Employees Total Person Engaged Wages to Workers Total Emoluments

1981-82 2,154,214 7,894,254 439,417 677,753

1982-83 2,337,524 8,166,168 514,828 804,609

1983-84 2,383,165 7,994,406 592,078 921,825

1984-85 2,406,722 7,981,370 675,730 1,066,021

1985-86 2,298,690 7,584,007 709,209 1,108,113

1986-87 2,325,830 7,548,755 785,043 1,229,918

1987-88 2,425,810 7,903,826 893,370 1,408,105

1988-89 2,400,364 7,858,281 1,029,223 1,572,832

1989-90 2,549,238 8,256,712 1,179,567 1,840,888

1990-91 2,542,346 8,279,403 1,319,205 2,058,633

1991-92 2,557,384 8,319,563 1,358,263 2,097,048

1992-93 2,715,117 8,835,952 1,683,112 2,756,026

1993-94 2,726,927 8,837,716 1,759,741 2,863,967

1994-95 2,854,829 9,227,097 2,201,946 3,534,151

1995-96 3,196,414 10,222,169 2,797,035 4,511,605

1996-97 3,037,414 9,536,282 2,655,459 4,640,358

1997-98 N.A 10,073,485 2,978,167 5,237,112

1998-99 N.A N.A 2,482,648 4,462,585

1999-00 2,482,671 8,172,836 2,630,427 4,784,351

2000-01 2,411,969 7,987,780 2,767,074 5,071,873

2001-02 2,332,893 7,750,366 2,743,824 5,105,957

2002-03 2,397,579 7,935,948 2,968,905 5,515,801

2003-04 2,368,602 7,870,081 3,047,777 5,833,675

2004-05 2,544,598 8,453,624 3,363,505 6,440,594

2005-06 2,739,729 9,111,680 3,766,366 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 Export-Based Weights Trade-Based Weights

1980-81 106.15 104.48

1981-82 105.74 104.48

1982-83 102.09 101.17

1983-84 104.51 104.24

1984-85 100.44 100.86

1985-86 97.85 98.27

1986-87 90.12 90.24

1987-88 85.39 85.36

1988-89 80.26 80.41

1989-90 77.34 78.44

1990-91 73.33 75.58

1991-92 61.36 64.2

1992-93 54.42 57.08

1993-94 59.09 61.59

1994-95 63.29 66.04

1995-96 60.94 63.62

1996-97 61.14 63.81

1997-98 63.76 67.02

1998-99 60.13 63.44

1999-00 59.7 63.29

2000-01 62.47 66.53

2001-02 64.36 68.43

2002-03 67.92 72.76

2003-04 69.66 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)

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Region / Economy 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992

World 55,262 69,437 59,393 50,682 58,956 57,959 88,613 140,647 164,932 192,899 201,594 154,803 170,465

Developed Economies 47,575 45,322 32,931 33,012 41,228 43,748 72,931 119,267 134,635 162,254 165,627 114,617 115,494

Developing Economies 7,664 24,103 26,461 17,652 17,736 14,197 15,710 21,373 30,275 30,630 35,892 39,951 53,188

Asia 663 13,329 17,136 10,894 11,557 5,421 9,299 13,426 18,058 22,642 24,154 32,919

South Asia 203 255 204 73 108 173 247 391 272 459 575 424 746

Afghanistan 9 0 0 .. .. .. .. 0 .. .. .. 0 0

Bangladesh 9 5 7 0 -1 -7 2 3 2 0 3 1 4

Bhutan .. .. .. .. .. .. .. .. .. .. 2 1 ..

India 79 92 72 6 19 106 118 212 91 252 237 75 252

Maldives 0 0 -3 0 0 1 5 5 1 4 6 7 7

Nepal 0 0 0 -1 1 1 1 1 1 0 6 2 0

Pakistan 64 108 64 29 56 47 92 110 134 184 278 272 361

Sri Lanka 43 50 64 38 33 24 28 58 43 18 43 67 123

Continued…….

Continued…….

Region / Economy 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

World 224,126 254,259 342,592 392,743 489,243 709,303 1,098,896 1,411,366 832,567 621,995 564,078 742,143 945,795

Developed

Economies 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

Developing

Economies 77,585 103,550 115,963 147,048 190,569 189,642 228,461 256,088 212,017 166,318 178,699 283,030 314,316

Asia 56,020 68,191 80,008 94,140 105,763 95,268 111,510 148,333 113,451 98,310 114,987 169,999 208,744

South Asia 1,147 1,950 2,808 3,359 5,371 3,889 3,234 4,658 6,415 6,984 5,469 7,601 9,866

Afghanistan 0 0 0 1 -1 0 6 0 1 1 2 1 4

Bangladesh 14 11 92 232 575 576 309 579 355 328 350 460 692

Bhutan .. .. 0 1 -1 .. 1 0 0 2 3 3 9

India 532 974 2,151 2,525 3,619 2,633 2,168 3,585 5,472 5,627 4,323 5,771 6,676

Maldives 7 9 7 9 11 12 12 13 12 12 14 15 9

Nepal 0 0 0 19 23 12 4 0 21 -6 15 0 2

Pakistan 399 789 492 439 711 506 532 309 383 823 534 1,118 2,201

Sri Lanka 194 166 65 133 433 150 201 173 172 197 229 233 272

Source: World Investment Report 2007, UNCTAD

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APPENDIX TABLE 5: OUTWARD FDI FLOWS, BY HOST REGION AND ECONOMY, 1980 - 2005 (US$ million)

Region / Economy 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992

World 53,829 52,922 27,556 36,772 50,411 62,604 97,478 141,392 180,273 230,451 229,598 195,516 192,249

Developed Economies 50,676 51,350 25,049 34,834 48,037 58,693 92,350 134,684 168,234 210,705 217,649 182,014 167,423

Developing Economies 3,153 1,572 2,508 1,938 2,374 3,912 5,128 6,701 12,025 19,743 11,913 13,490 23,241

Asia 1,146 314 1,160 1,364 1,885 2,924 3,933 5,517 10,702 14,100 10,948 8,046 17,119

South Asia 4 2 1 5 -1 29 34 55 59 38 9 -10 14

Afghanistan 0 0 0 0 0 0 0 0 0 0 0 0 0

Bangladesh .. .. .. .. .. .. .. .. .. .. 1 0 0

Bhutan 0 0 0 0 0 0 0 0 0 0 0 0 0

India 4 2 1 5 4 3 -1 5 11 10 6 -11 24

Maldives 0 0 0 0 0 0 0 0 0 0 0 0 0

Nepal 0 0 0 0 0 0 0 0 0 0 0 0 0

Pakistan 0 0 0 0 -5 25 34 49 46 26 2 -4 -12

Sri Lanka .. .. .. .. .. 1 1 1 2 2 1 5 2

Continued………

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Continued………

Region / Economy 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

World 237,634 275,212 363,251 397,709 483,079 697,051 1,108,354 1,239,190 745,479 540,714 560,087 877,301 837,194

Developed Economies 197,228 227,341 307,536 332,658 405,814 644,998 1,037,379 1,102,666 662,220 488,180 503,966 745,970 706,713

Developing Economies 39,351 47,537 55,079 64,095 73,841 50,663 68,650 133,341 80,565 47,866 45,372 117,336 115,860

Asia 31,103 39,468 44,678 53,870 51,451 30,917 41,676 82,230 47,123 35,427 22,412 87,461 77,747

South Asia 5 91 126 266 97 113 125 524 1,449 1,723 1,932 2,247 2,579

Afghanistan 0 0 0 0 0 0 0 0 0 0 0 0 0

Bangladesh 0 0 2 13 3 3 0 2 21 4 6 6 2

Bhutan 0 0 0 0 0 0 0 0 0 0 0 0 0

India 0 82 119 240 113 47 80 509 1,397 1,679 1,879 2,179 2,495

Maldives 0 0 0 0 0 0 0 0 0 0 0 0 0

Nepal 0 0 0 0 0 0 0 0 0 0 0 0 0

Pakistan -2 1 0 7 -24 50 21 11 31 28 19 56 44

Sri Lanka 7 8 6 7 5 13 24 2 0 11 27 6 38

Source: World Investment Report 2007, UNCTAD

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APPENDIX TABLE 6: WORLD BANK ECONOMIC INDICATORS (INDIA), 1980 - 2005

Variables 1980 1981 1982 1983

Foreign Direct Investment, Net Inflows (BoP, Current US$) 79,160,000 91,920,000 72,080,000 5,640,000

External Debt, Total (DOD, Current US$) 20,694,770,000 22,709,430,000 27,545,700,000 32,139,248,000

Short-term Debt Outstanding (DOD, Current US$) 1,271,000,000 1,597,000,000 2,397,000,000 3,338,000,000

Total Debt Service (% of Exports of Goods, Services and Income) 9 11 13 16

Exports of Goods and Services (% of GDP) 6 6 6 6

GDP (Current US$) 183,798,611,968 190,454,153,216 197,660,868,608 215,169,253,376

GNI per capita, Atlas method (Current US$) 270 300 290 290

GNI, Atlas method (Current US$) 186,003,111,936 207,896,035,328 207,164,571,648 209,287,839,744

Imports of Goods and Services (% of GDP) 9 9 8 8

Energy use (Kg of Oil Equivalent per capita) 304 312 317 321

Inflation, GDP Deflator (Annual %) 11 11 8 5,640,000

Continued……..

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Continued…….. Variables 1984 1985 1986 1987

Foreign Direct Investment, Net Inflows (BoP, Current US$) 19,240,000 106,090,000 117,730,000 212,320,000

External Debt, Total (DOD, Current US$) 34,035,811,000 40,951,475,000 48,124,255,000 55,570,203,000

Short-term Debt Outstanding (DOD, Current US$) 3,672,000,000 4,358,000,000 4,946,000,000 5,673,000,000

Total Debt Service (% of Exports of Goods, Services and Income) 18 22 32 31

Exports of Goods and Services (% of GDP) 6 5 5 6

GDP (Current US$) 209,669,767,168 229,940,576,256 246,369,599,488 276,003,782,656

GNI per capita, Atlas method (Current US$) 280 300 320 360

GNI, Atlas method (Current US$) 212,903,952,384 226,414,280,704 247,547,379,712 284,428,926,976

Imports of Goods and Services (% of GDP) 8 8 7 7

Energy use (Kg of Oil Equivalent per capita) 328 338 342 348

Inflation, GDP Deflator (Annual %) 8 7 7 9

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Continued……..

Continued…….. Variables 1988 1989 1990 1991

Foreign Direct Investment, Net Inflows (BoP, Current US$) 91,250,000 252,100,000 236,690,000 73,537,638

External Debt, Total (DOD, Current US$) 60,476,622,000 75,406,873,000 83,628,388,000 85,421,425,000

Short-term Debt Outstanding (DOD, Current US$) 6,358,000,000 7,501,000,000 8,544,000,000 7,070,000,000

Total Debt Service (% of Exports of Goods, Services and Income) 30 30 32 30

Exports of Goods and Services (% of GDP) 6 7 7 9

GDP (Current US$) 293,149,966,336 292,917,379,072 317,466,607,616 267,523,506,176

GNI per capita, Atlas method (Current US$) 400 400 390 350

GNI, Atlas method (Current US$) 325,551,063,040 329,066,938,368 330,864,656,384 305,374,199,808

Imports of Goods and Services (% of GDP) 8 8 9 9

Energy use (Kg of Oil Equivalent per capita) 359 369 377 384

Inflation, GDP Deflator (Annual %) 8 8 11 14

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Continued……..

Continued…….. Variables 1992 1993 1994 1995

Foreign Direct Investment, Net Inflows (BoP, Current US$) 276,512,439 550,370,025 973,271,469 2,143,628,110

External Debt, Total (DOD, Current US$) 90,264,257,000 94,342,412,000 102,482,700,000 94,463,676,000

Short-term Debt Outstanding (DOD, Current US$) 6,340,000,000 3,626,000,000 4,264,000,000 5,049,000,000

Total Debt Service (% of Exports of Goods, Services and Income) 27 27 29 30

Exports of Goods and Services (% of GDP) 9 10 10 11

GDP (Current US$) 245,553,168,384 276,037,369,856 323,506,143,232 356,298,981,376

GNI per capita, Atlas method (Current US$) 330 310 330 380

GNI, Atlas method (Current US$) 291,945,152,512 282,588,184,576 303,658,991,616 350,210,785,280

Imports of Goods and Services (% of GDP) 10 10 10 12

Energy use (Kg of Oil Equivalent per capita) 392 393 401 416

Inflation, GDP Deflator (Annual %) 9 10 10 9

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Continued……..

Continued…….. Variables 1996 1997 1998 1999

Foreign Direct Investment, Net Inflows (BoP, Current US$) 2,426,057,022 3,577,330,042 2,634,651,658 2,168,591,054

External Debt, Total (DOD, Current US$) 93,466,122,000 94,316,595,000 97,637,058,000 98,313,138,000

Short-term Debt Outstanding (DOD, Current US$) 6,726,000,000 5,046,000,000 4,329,000,000 3,933,000,000

Total Debt Service (% of Exports of Goods, Services and Income) 24 22 21 16

Exports of Goods and Services (% of GDP) 11 11 11 12

GDP (Current US$) 388,343,922,688 410,915,176,448 416,252,428,288 450,476,441,600

GNI per capita, Atlas method (Current US$) 410 420 420 440

GNI, Atlas method (Current US$) 390,740,213,760 405,160,165,376 415,132,581,888 443,914,321,920

Imports of Goods and Services (% of GDP) 12 12 13 14

Energy use (Kg of Oil Equivalent per capita) 422 431 433 451

Inflation, GDP Deflator (Annual %) 8 6 8 4

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Continued……..

Continued…….. Variables 2000 2001 2002 2003

Foreign Direct Investment, Net Inflows (BoP, Current US$) 3,584,217,307 5,471,947,158 5,626,039,508 4,322,748,000

External Debt, Total (DOD, Current US$) 99,098,937,000 98,484,517,000 105,019,902,000 112,854,556,000

Short-term Debt Outstanding (DOD, Current US$) 3,462,000,000 2,742,000,000 4,093,000,000 5,040,000,000

Total Debt Service (% of Exports of Goods, Services and Income) 14 15 17 19

Exports of Goods and Services (% of GDP) 13 13 14 15

GDP (Current US$) 460,195,397,632 478,290,444,288 507,917,926,400 601,826,918,400

GNI per capita, Atlas method (Current US$) 450 460 470 530

GNI, Atlas method (Current US$) 458,104,307,712 478,697,455,616 492,816,138,240 568,812,240,896

Imports of Goods and Services (% of GDP) 14 14 15 16

Energy use (Kg of Oil Equivalent per capita) 452 452 457 461

Inflation, GDP Deflator (Annual %) 4 3 4 4

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Continued……..

Continued…….. Variables 2004 2005

Foreign Direct Investment, Net Inflows (BoP, Current US$) 5,771,297,000 6,676,524,000 External Debt, Total (DOD, Current US$) 124,375,815,000 123,128,063,000 Short-term Debt Outstanding (DOD, Current US$) 7,524,000,000 8,788,000,000 Total Debt Service (% of Exports of Goods, Services and Income) 14 13 Exports of Goods and Services (% of GDP) 18 20 GDP (Current US$) 695,842,897,920 805,732,024,320 GNI per capita, Atlas method (Current US$) 630 730 GNI, Atlas method (Current US$) 680,446,787,584 804,077,699,072 Imports of Goods and Services (% of GDP) 20 23 Energy use (Kg of Oil Equivalent per capita) 482 491 Inflation, GDP Deflator (Annual %) 4 4

Source: World Development indicators, 2006, World Bank

xxxv