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Advances I n Management Vol. 6(8) Aug. (2013)

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Case Study:

Impact of Foreign Direct Investment on Indian EconomyRangappa E.

Department of Commerce, University College, Palamuru University, Mahabubnagar 509 001 (Andhra Pradesh), INDIA

[email protected]

Abstract

Investment provides the base and pre-requisite for

economic growth and development. Apart from a

nations foreign exchange reserves, exports,

governments revenue, financial position, available

supply of domestic savings, magnitude and quality of

foreign investment are necessary for the well being of a

country. Developing nations, in particular, consider

FDI as the safest type of international capital flows outof all the available sources of external finance available

to them. FDI provides a win win situation to the host

and the home countries. Both countries are directly

interested in inviting FDI because they benefit a lot

from such type of investment. There is a considerable

change in the attitude of both the developing and

developed countries towards FDI. They both consider

FDI as the most suitable form of external finance.

FDI is a predominant and vital factor in influencing the

contemporary process of global economic development.This study is entirely based on secondary data. The

present study is limited to assess the determinants of

Foreign Direct Investment flows and its impact on

Indian economy. It is concluded that the Government

should design the FDI policy in such a way where FDI

inflows can be utilized as means of enhancing domestic

production, savings and exports through the equitable

distribution among states so that they can attract FDI

inflows at their own level. FDI can help to raise the

output, production and export at the sectoral level of the

Indian economy. It is advisable to open up the exportoriented sectors and higher growth of economy could be

achieved through the growth of these sectors.

Keywords:FDI, Investment, Government, Indian economy.

Introduction

One of the most striking developments of Nations progress

and prosperity is reflected by the pace of its sustained

economic growth and development. Investment provides the

base and pre-requisite for economic growth and development.

Apart from nations foreign exchange reserves, exports,

governments revenue, financial position, available supply of

domestic savings, magnitude and quality of foreign

investment are necessary for the well being of a country.

Developing nations, in particular, consider FDI as the safest

type of international capital flows out of all the available

sources of external finance available to them. In fact, FDI

provides a win win situation to the host and the home

countries. Both countries are directly interested in inviting

FDI because they benefit a lot from such type of investment.

The home countries want to take the advantage of the vast

markets opened by industrial growth.

On the other hand, the host countries want to acquire

technological and managerial skills and supplement domestic

savings and foreign exchange. Moreover, the paucity of all

types of resources viz. financial, capital, entrepreneurship,

technological know- how, skills and practices, access to

markets- abroad- in their economic development, developing

nations accepted FDI as a sole visible panacea for all their

scarcities. Further, the integration of global financial markets

paves ways to this explosive growth of FDI around the globe.

Developing countries look at FDI as a source of filling the

savings, foreign exchange reserves, revenues, trade deficit,

management and technological gaps. FDI is considered as an

international economic integration as it brings a package of

assets including capital, technology, managerial skills and

capacity and access to foreign markets. The FDI may also

affect the government trade barriers and policies for the

foreign investments and leads to effective contribution in

economy as well as in GDP of the economy.

Developed economies consider FDI as an engine of market

access in developing and less developed countries vis--vis

for their own technological progress and in maintaining their

own economic growth and development. There is a

considerable change in the attitude of both the developing anddeveloped countries towards FDI. They both consider FDI as

the most suitable form of external finance. FDI is a

predominant and vital factor in influencing the contemporary

process of global economic development. Hence there is a

need to analyze the important dimensions of FDI and Its

impact on Indian economy.

Research Methodology

This study is entirely based on secondary data. The required

data have been collected from various sources i.e. World

Investment Reports, various bulletins of Reserve Bank of

India, publications from Ministry of Commerce, Government

of India and websites of RBI, EXIM Bank etc.

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Scope of the study

All the economic / scientific studies are faced with various

limitations and this study is no exception to the phenomena.

The present study is limited to assess the determinants of

Foreign Direct Investment flows and its impact on Indianeconomy. The data collected and used for this purpose are

based on only secondary data.

Determinants of FDI in India

FDI has been one of the most debated and significant factor

in the economic development of the last 3 decades. In Asia,

foreign direct investment (FDI) has increased significantly

over the past two decades. However, this FDI has been

concentrated in a few countries. In the early 1990s, seven

East Asian countries China, Korea, Singapore, Indonesia,

Malaysia, Philippines and Thailand received more than 60 per

cent of the FDI inflows than all other Asian countries. Themajor determinants of outward and inward Foreign Direct

Investment (FDI) in India, such as income, exchange rate,

technology, human capital and openness of the economy are:

Income: The first independent variable is GDP of the

economy. It is generally observed that the pattern of

International Trade in terms of the composition and

direction changes with development of an economy. As

the income of the nation increases, there is always a

possibility that firms start accumulating advantages

which are owner specific or are resource specific.

Exchange Rate: The appreciation and depreciation of

currency does have an impact on the price of exports and

imports making their comparative position and

competitiveness in international markets fluctuate

sometimes towards advantage to the home country and

sometimes disadvantage. The link between the interest

rate and exchange rate also makes it more beneficial for a

firm to go in for a FDI as the currency appreciates.

Interest Rate: Foreign operations require significant

commitment in capital, especially if they are undertaken

in capital intensive sectors where production is

characterized by extensive economies of scale as the case

is for most FDI.

Technology: This factor is widely recognized as one

factor that does have a sure and great impact on FDI. In

fact, the FDI sometimes may be the cause for increasing

technological progress as it also gets influenced by the

level of technological progress of the economy. Every

firm across different countries has its own ability to

organize and produce technological inputs.

Human Capital: The availability of the human

resources is one factor that plays an important role in

determining the FDI; however the sheer number does not

affect the inflow as the quality of the human resource

does. The size of labour force may be instrumental indetermining the price of the factor, as low labour cost

may increase the cost competitiveness of the firm. But in

a skill intensive industry, the quality of the labour force

determined by the number of people who are educated

and the number of science and technology professionals

that exist, matters. The human capital supply variesdepends largely on the education systems and also the

government policies.

The Openness of the Economy: The FDI activities of

the firms are constrained when there is protectionist

policy followed; therefore these activities are encouraged

when the country embarks on the path of liberalization.

The firms of an open economy may choose retaliation

against the competition that FDI has brought in by

different modes and may also involve themselves in the

home markets of the import producing countries. The

exports plus imports level of a country are taken as a

variable to represent this degree of economies openness.

Impact of FDI on Indian economy

Economic growth in any country depends upon the sustained

growth of productive capacity, supported by savings and

investment. Low levels of savings and investment,

particularly in developing countries and least developed

countries, result in a low level of capital stock and economic

growth. The recognition of the role of knowledge capital in

economic growth creates a basis for analyzing the role of FDI

which brings new technology and knowledge along with

capital. In recent years, the need for FDI inflows has

increased as MNCs have assumed significant importance as asource of economic growth and development. Foreign direct

investment (FDI) is always contributing in the positive

growth toward the economy of one country due to the

investment by another country or countrys personnels.

The effectiveness and efficiency of Global economy depends

upon the investors perception, if investment seen with the

purpose of long terms investment in the social-economical

development, then it is said that the investment contributes

positively towards global economy, if it is short term for the

purpose of making profit, then it may be less significant than

that long term and disinvestment leads negative effect. The

FDI may also be affected due to the governmental tradebarriers and policies for the foreign investments and leads to

less or more effective toward contribution in economy as well

as GDP and GNP of the country.

After independence in India 1947, FDI gained attention of the

policy makers for acquiring advanced technology and to

mobilize foreign exchange resources. In order to boost the

FDI inflows in the country, Indian government is allowing

frequent equity participation to foreign enterprises apart from

many incentives such as tax concessions, simplification of

licensing procedures and de-reserving some industries like

drugs, fertilizers, aluminum etc. But due to significant

outflow of foreign reserve in the form of remittances of

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dividends, profits, royalties etc., Government of India set up

Foreign Investment Board in 1973 and enacted Foreign

Exchange Regulation Act in order to regulate flow of FDI to

India. Further Government of India set up Foreign Investment

Promotion Board (FIPB) for processing of FDI proposals inIndia.

The Board is the apex inter-ministerial body of the Central

Government that deals with proposals relating to FDI into

India for projects or sectors that do not qualify for automatic

approval by the Reserve Bank of India (RBI) or are outside

the parameters of the existing FDI policy. The list ofinvesting countries to India reached to 150 in 2013 ascompared to 29 countries in 1991. Nevertheless, still a lions

share of FDI comes from only a few countries.

Table 1

Share of top ten investing countries in FDI Inflows (Financial Year wise)

Amount Rupees in Crores (US$ in Million)

Ranks Country2010-11

(April - March)

2011-12

( April - March)

2012-13

(AprilSept.)

Cumulative

Inflows

(April 00 - Sept.12)

% age to total

Inflows

(in terms of US $)

1. MAURITIUS 31,855 (6,987) 46,710 (9,942) 34,139 (6,259) 323,610 (70,428) 38 %2. SINGAPORE 7,730 (1,705) 24,712 (5,257) 6,151 (1,120) 83,739 (18,273) 10 %

3. U.K. 12,235 (2,711) 36,428 (7,874) 3,153 (592) 77,814 (17,061) 9 %

4. JAPAN 7,063 (1,562) 14,089 (2,972) 7,305 (1,320) 65,156 (13,633) 7 %

5. U.S.A. 5,353 (1,170) 5,347 (1,115) 1,492 (273) 49,382 (10,837) 6 %

6. NETHERLANDS 5,501 (1,213) 6,698 (1,409) 5,242 (968) 37,567 (8,078) 4 %

7. CYPRUS 4,171 (913) 7,722 (1,587) 1,538 (284) 31,208 (6,683) 4 %

8. GERMANY 908 (200) 7,452 (1,622) 2,354 (430) 23,182 (5,051) 3 %

9 FRANCE 3,349 (734) 3,110 (663) 1,419 (260) 14,797 (3,187) 2 %

10. U.A.E. 1,569 (341) 1,728 (353) 556 (100) 10,876 (2,343) 1 %

Total FDI Inflows* 97,320 (21,383) 165,146 (35,121) 70,132 (12,845) 845,138 (183,825) -Source: Fact sheet on Foreign Direct Investment from April 2000 to September 2012.

*Includes inflows under NRI Schemes of RBI.

Note: %age worked out in US$ terms and FDI inflows received through FIPB/SIA+ RBIs Automatic Route + acquisition of

existing shares only.

Above table shows the actual investment flows of top ten

countries during the period of 2010-11 to 2012-13. The FDI

stock for this period from Mauritius is the largest 38 percent.

The other top nine countries are Singapore, USA, UK,

Netherlands, Japan, Cyprus, Germany, France and UAE. It

implies that these top ten countries accounted for well over

84 percent of the FDI inflows during the above period.

The Mauritius which was not in the picture till 1992 has the

highest growth rate because such investment is represented

by the holding companies of Mauritius set up by the US

firms. The reason behind the US companies have routed

through Mauritius is the tax treaty between Mauritius and

India stipulates a dividend tax of five percent while the treaty

between Indian and US stipulated a dividend tax of 15

percent. The growth of FDI gives opportunities to Indian

industry for technological up gradation, gaining access to

global managerial skills and practices, optimizing utilization

of human and natural resources and competing internationally

with higher efficiency.

Conclusion

Foreign Direct Investment as a strategic component of

investment is needed by India for its sustained economic

growth and development through creation of jobs, expansion

of existing manufacturing industries, education and research

and development etc. Government should design the FDI

policy such a way where FDI inflows can be utilized asmeans of enhancing domestic production, savings and exports

through the equitable distribution among states so that they

can attract FDI inflows at their own level. FDI can help to

raise the output, production and export at the sectoral level of

the Indian economy. It is advisable to open up the export

oriented sectors and higher growth of economy could be

achieved through the growth of these sectors.

References

1. Nayak D.N., Canadian Foreign Direct Investment in India: Someobservations,Political Economy Journal of India, 8, 51-56 (1999)

2. Ministry of Finance, Report of the economic survey,

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Government of India, New Delhi (2003-04)

3. Basu P., Nayak N.C. and Vani A., Foreign Direct Investment inIndia: Emerging Horizon, Indian Economic Review, 25, 255-266

(2007)

4. Srivastava S., What is the true level of FDI flows to India?,Economic and Political Weekly, 19, 1201-1209 (2003)

5. Gupta Jaya, Gloablisation and Indian Economy: Sector-wiseAnalysis of FDI inflows (2007)

6. Handbook of Industrial Policy and Statistics, Government ofIndia (2007-08).

(Received 25th

May 2013, accepted 30th

June 2013)

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