Foreign direct investment (FDI)

Foreign Direct Investment (FDI) is one of the most important sources of non-debt foreign investment flows in developing countries like India. After the announcement of New Industrial Policy, 1991 and the current policies of liberalization, India has been experiencing an acceleration in the flow of foreign investment into the country.

FDI Policy of Government of India

Government of India has taken various effective steps to simplify the Foreign Direct investment policy. The Foreign Direct Investment Policy (FDI Policy) of the Government of India prescribes the foreign investment cap in specified industrial sectors. But in the recent times many activities have been transferred to unrestricted sectors in which 100% Foreign Direct investment is permitted. Broadly, the industrial sectors are categorized as:

  • Restricted
  • Prohibited
  • Unrestricted Sectors (Up to 100% foreign ownership)

All the sectors other than those mentioned below subject to terms and conditions in the FDI policy come under unrestricted sectors for example:

  • Mining (except Mining and mineral separation of titanium bearing minerals and ores, its value addition and integrated activities)
  • Manufacturing related commercial activities
  • Information Technology related activities
  • E-commerce (permitted in marketplace model and not the inventory based model. Also, it applies only to Business to Business e-commerce and not business to consumer e-commerce)

The Government of India embarked upon major economic reforms since mid-1991 with the intension of integrating with the world economy and to emerge as a significant, player in the globalization process. As a part of economic reforms, the government made necessary promotion of foreign direct investment.

As part of extant policy, FDI up to 100 per cent is allowed, under the automatic route, in most of the sectors or activities. FDI under the automatic route does not require prior approval either by the government or the RBI. Investors are only required to notify the regional office concerned of RBI within 30 days of receipt of inward remittances and file the required documents with that office within 30 days of issue of shares to foreign investors.

Under the government approval route, approvals for FDI proposals, other than Non-resident Indians, and proposals for FDI in ‘Singh Brand’ product retailing, and Multi-Brand Retail Trading (MBRT) are received in the Department of Economic Affaires.

Proposals for FDI in ‘Singh Brand’ product retailing, MB and by NRIs are received in the Department of Industrial Policy and Promotion. These proposals are then considered by the Foreign Investment Promotion Board (FIPB) which is housed in the Department of Economic Affaires.

Foreign investments in equity capital of an Indian Company under the port-folio Investment scheme are governed by separate regulations of RBI/securities and Exchanges Board of India (SEBI). The FDI policy has been extensively liberalized progressively through review of the policy on an ongoing basis and allowing FDI in more sectors under the automatic route. Three major reviews were undertaken on the year 2000, 2006 and 2007-08. A major policy stance defining indirect foreign investment was taken in 2009.

Impact of Foreign Direct Investment on  Economy

Foreign Direct Investment (FDI) plays an important role in the growth and development of an economy. It is more important where domestic savings is not sufficient to generate funds for capital investment. Not only it supplements the investment requirements of an economy but also it brings new technology, managerial expertise and adds to foreign exchange reserves.

FDI inflow is more beneficial particularly to developing and emerging countries than the developed ones. IMF has defined FDI as “a 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)”.

Prior to 1980s, economic theories were not delving extensively on the aspects of foreign direct investment and Multi-lateral enterprises (MNEs). During last three decades globalization has been the key to almost all countries’ economic policies. An important aspect of globalization is FDI inflows from home countries to host countries.

Though there is no general rule of developed and developing countries as home and host countries respectively, however, mostly it is seen that FDI flows from developed countries to developing and emerging countries. There has been growing competition among developing and emerging countries to attract FDI. India is not left behind in this regard.

FDI is believed to play many important roles in the host countries. It has different effects on different countries based on the host country policies, investment climate and other domestic macroeconomic conditions.

The first and foremost is, it acts as a capital supplement to the domestic capital for investment demand. Apart from capital it brings new, innovative technology to the host countries. In many countries it also promotes competition among the domestic firms to improve their level of technology adoption.

Effectively, they invest more in research and development (R & D) to upgrade their technology. With increased investment as supplement to domestic capital, it also generates more employment opportunities. With keen interest in the investee firms through FDI, the foreign firms improve their managerial competence, which also improves managerial skills in the country through competition and dissemination of the new ideas and skills.

The firms with improved technology and competition produce quality products, which are exportable, thus it improves the level of export and degree of openness of the host countries. With foreign partners, there are better tie ups with the importing firms abroad for potential exportable domestic products. With improvement in exports the foreign exchange earnings of the host countries gets boosted. Capital flow through FDI and improved export earnings can also increase the level of foreign exchange reserve in the host countries.

With higher foreign exchange reserve, the demand for domestic currency will go up. Hence the domestic currency of the host country is expected to appreciate as against the basket of foreign currencies mostly of trade partners.

FDI is also believed to improve the Gross domestic product (GDP) of the host country through improved production and competition among the domestic firms. With improved production and more employment, it also can improve gross domestic capital formation (GDCF) which cater to the increasing requirement of domestic investment in the country. Further, with competition, improvement in technology, the performance of the investee firms as well as other domestic firms can improve. Thus it can have a positive impact on return on capital and thereby on the stock prices.

Keeping in view the above mentioned relationships between inward FDI and other macroeconomic variables, which has already been found by some of the earlier researchers, this study tries to empirically establish the relationship between FDI and other macroeconomic variables in Indian context after undergoing some of the existing work in this area across economies.

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