Foreign capital and foreign direct investment

Capital is the lifeblood of any production and distribution activity and it has been

playing an important role among the factors of production. The need of capital arises not

only at the beginning of the venture, but also throughout the life span of the venture.

However, capital, especially when in short supply, can be the limiting factor for starting,

expansion and diversification of a venture. In view of the economic crisis, shortage of

capital on one hand and, importance of foreign capital on the other, there has been taken

continuous effort by the Government of India in attracting foreign capital during the post-

liberalization period.

NEED FOR FOREIGN CAPITAL;

Economic developments of number of present day industrialized economies are

assisted by foreign capital and it has played an important role in the early stages of

industrialization of most of the advanced countries today. In the initial stage of

development, domestic savings is not sufficient to meet the capital requirements, foreign

capital helps by providing much needed resources for the development of the developing

economy.

There is a general view that foreign capital, if properly directed and utilized can assist the

development of the developing countries. The use of foreign capital inflows is more

important and urgent to gear up the economy, since the domestic savings are insufficient

to achieve the goals. Thus developing countries are very keen and making all efforts to

attract foreign capital for their rapid economic development.

Major Needs of Developing Countries like India:

a.) Building Infrastructure:

The developmental programs of developing economies depend on infrastructural

facilities in the country, which in turn require huge investments. Foreign capital can

provide necessary support towards developing such infrastructural facilities.

b.) The Technological Gap:

The prevailing technological gap amongst the developing and emerging economies and

the developed world is a known fact. Foreign capital is needed for updating the

traditional technology and for attaining international competitiveness.

c.) Scarcity of Resources:

The developing economies do not have capital resources due to low income – low saving

trap, foreign capital is urgently needed to support various investment projects.

d.) Initial Risk:

The emerging economies do face the lack of domestic capital at the initial stage of a

project due to lack of experience and expertise and high initial risk. The foreign capital

by undertaking the initial risk of investment can augment the flow of domestic capital in

the desired direction.

e.) BOP Support:

With foreign capital, there is no problem of balance of payments being adverse. Instead,

foreign debt can always create BOP problems. This is one reason why developing

countries prefer to have foreign capital.

TYPES OF FOREIGN CAPITAL:

There are various types of foreign capital inflows into the economy. Before the

introduction of new economic policy the foreign capital inflow channels were;

a.) Foreign Collaboration:

In recent years, there is a joint participation of foreign and domestic capital. India

has been encouraging this form of import of foreign capital. There are three types of

foreign collaborations. They are joint participation,

between private parties.

between foreign firms and Indian government.

between foreign governments and Indian governments.

b.) Trans – Governmental Loans:

Since the Second World War, there has been a growing tendency towards direct

inter- government loans and grants. Marshall Aid was a massive system of American Aid

given to the war-devasted European Countries to reconstruct their economies. Other

advanced countries too provide grants and loans to governments of less developed

countries.

c.) Loans from International Institutions:

Since 1946, the World Bank and its affiliates are the important suppliers of capital

to India. International Monetary Fund (IMF), Aid India Consortium, Asian Development

Bank (ADB) are the major sources of external assistance to India in recent years.

d.) Foreign Aid:

Foreign Aid refers to those foreign funds that flow into a country by way of

International loans and grants. These loans and grants are generally given by foreign

government or some international agencies like the World Bank to various countries for

financing their development programmes. While grants are non – returnable, the loans

have to be paid back over a specified period of time.

e.) External Commercial Borrowings:

External Commercial Borrowings (ECB) refer to commercial loans in the form of

bank loans, buyers’ credit, suppliers’ credit, securitized instruments (e.g. floating rate

notes and fixed rate bonds) availed of from non-resident lenders with minimum average

maturity of 3 years. An external commercial borrowing (ECB) is an instrument used in

India to facilitate the access of foreign money by Indian corporations and PSUs (public

sector undertakings). ECBs received from official export credit agencies and commercial

borrowings from the private sector window of multilateral financial Institutions such as

International Finance Corporation (Washington), ADB, AFIC, CDC. ECBs cannot be

used for investment in stock market or speculation in real estate

After the introduction of New Economic Policy, FDI and FPI are the principal

channels of capital inflows for India.

a.) Foreign Portfolio Investment is investment by individuals and firms of public bodies

in foreign instruments (eg: government bonds, foreign stocks). FPI is transitory in nature.

The investor makes the FPI in order to get return but they do not retain any significant

equity stake in a foreign business entity (i.e., the equity stake is less than 10%). It is

easily liquidable. This is indirect form of investment held by an individual or institutions

in the form of equities, bonds, or other securities. One such form comprising the category

of such investments is foreign institutional investment. These are the investments done in

the secondary markets like stock. For this the company needs to get registered in stock

exchange, an investor can sell or take back the money invested and hence not a reliable

and preferred form of investment.

b.) Foreign Direct Investment is also known as direct business investment. It occurs when

a firm invests directly in facilities to produce and/or market a product in a foreign

country. It is an investment having an essence of long term relationship and control over

residual equity.

FDI may be undertaken by individuals as well as business entities. It takes the

form of:

1. Acquisitions:

Acquiring stock of the existing foreign enterprises to participate in the

management of the concerned enterprise.

2. Establishment:

Establishing abroad new subsidiary with 100% ownership.

3. Mergers:

Participating in a joint venture through stock holdings.

4. Expansion:

Establishing new branches or expanding existing one.

FDI is prohibited in only the following activities:

(a) Retail Trading (except single brand product retailing)

(b) Atomic Energy

(c) Lottery Business including Government /private lottery, online lotteries, etc.

(d)Gambling and Betting including casinos etc.

(e)Business of chit fund

(f) Nidhi company

(g)Trading in Transferable Development Rights (TDRs)

(h)Real Estate Business or Construction of Farm Houses

(i) Activities/sectors not opened to private sector investment

(j) Manufacturing of Cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco

substitutes.

REASONS FOR INDIA BEING ATTRACTIVE FOR FDI;

There are number of factors which help FDI inflows into India. They are:

a. Market Share:

India has the largest middle class population in the world, which possess great

potential for companies to market their products here.

b. Expectations of further liberalization of capital movement internationally;

India is already fully convertible on the current account and is moving towards

full convertibility on the capital account. This makes it a very attractive destination

for investment.

c. Rationalization of Economic Policies;

The government has gone in for rationalization of economic policies, to make

India an attractive destination for investment. Also the disinvestment of government

companies adds to the overall outlook of the government to improve the economy to

make it attractive to foreign investors.

d. Improvement in Domestic Financial Institutions and Banks:

The banking system in India has improved dramatically over the last few years,

universal banking has been made possible by the presence of foreign banks and

investors.

e. Good manufacturing and outsourcing Hub:

In India, conduct of business is less costlier than many other countries. Availability

of labour at low cost and easy access to market in and around Asia has made

international investment very attractive. By comparison, doing business in US is four

times costlier than doing business in India.