FOREIGN DIRECT INVESTMENT AND INDIAN ECONOMY

ARCHANA UPADHYAY

SENIOR RESEARCH FELLOW

BANARAS HINDU UNIVERSITY

ABSTRACT

Globalization and liberalisation brings lots of new innovative products to the world, Foreign
Direct Investment is the one among this, also there are number of different forms of FDI is
available currently.. Foreign Direct Investment is one and only major instrument of attracting
International Economic Integration in any economy. It serves as a link between investment
and saving. Many developing countries like India, are facing the deficit of savings. This
problem can be solved with the help of Foreign Direct Investment. This research paper aims
to examine the impact of FDI on the Indian economy, particularly after two decades of
economic reforms, and analyzes the challenges to position itself favourably in the global
competition for FDI. This paper also tries to find out the scenario and role and Scope of
Foreign Direct Investment in India. In this paper we study the effects of Foreign Direct
Investment (FDI) with respect to India and its economy. We try to analyze the merits and
demerits of FDI upon implementation in the Indian domestic market.
KEYWORDS: FDI, GLBALISATION, INNOVATIVE PRODUCTS

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 Introduction

Foreign Investment in India or more precisely Foreign Direct Investment (FDI) in India is
one of the most talked about issues in the entire world economy in recent times. Rated among
the top emerging nations, India's liberalization policies are paying rich dividends to the
economy as a whole. Foreign Direct Investment (FDI) is defined as "investment made to
acquire lasting interest in enterprises operating outside of the economy of the investor."
India, post liberalization, has not only opened it's doors to foreign investors but also made
investing easier for them by implementing the following measures:
 Foreign exchange controls have been eased on the account of trade.
 Companies can raise funds from overseas securities markets and now have considerable
freedom to invest abroad for expanding global operations.
 Foreign investors can remit earnings from Indian operations.
Foreign direct investment (FDI) refers to the net inflows of investment to acquire a lasting
management interest (10 percent or more of voting stock) in an enterprise operating in an
economy other than that of the investor. It is the sum of equity capital, other long-term
capital, and short term capital as shown in the balance of payments. It usually involves
participation in management, joint venture, transfer of technology and expertise. There are
two types of FDI: inward foreign direct investment and outward foreign direct investment,
resulting in a net FDI inflow (positive or negative) and "stock of foreign direct investment",
which is the cumulative number for a given period. Direct investment excludes investment
through purchase of shares.FDI is one example of international factor movements. Foreign
Direct Investment (FDI) inflow into the core sectors is assumed to play a vital role as a
source of capital, management, and technology in countries of transition economies. It
implies that FDI can have positive effects on a host economy’s development effort (Caves,
1974; Kokko, 1994; Markusen, 1995; Carves, 1996; Sahoo, Mathiyazhagan and Parida 2001).
On this line, it has been argued that FDI can bring the technological diffusion to the sectors
through knowledge spillover and enhances a faster rate of growth of output via increased
labour productivity in India. There were also few evidences demonstrate that there is a long-
run relationship between Gross Domestic Product, FDI and export in India (Sahoo and
Mathiyazhagan, 2003). In fact, many countries like India have offered incentives to
encourage FDI to their economies. India is also opened up its economy and allowed MNEs in
the core sectors such as Power and Fuels, Electrical Equipments, Transport, Chemicals, Food

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Processing, Metallurgical, Drugs and Pharmaceuticals, Textiles, and Industrial Machinery as
a part of reform process started in the beginning of 1990s. In this context, it is imperative to
assess the impact of FDI inflows in to these core sectors in India. It is also motivated by
recent political developments in India following the opening of sectors like insurance and
telecommunication with increased financial gap for the private players.
The role of foreign direct investment (FDI) in stimulating economic growth is one of the
controversial issues in the development literature. The great promise of foreign direct
investment (FDI) by multinational corporations is that capital will stimulate dynamic growth.
Beyond boosting income and employment, the hope is that manufacturing FDI will bring
knowledge that indirectly effect in building skill and technological capacities of local firms,
catalysing broad-based economic growth. The part played by foreign direct investment (FDI)
in the development process has undergone several changes. In the 1960s, FDI was seen in
most countries as a partner in the development endeavours. India adopted a regime that was
perceived to be restrictive towards FDI. .Explicit curbs on foreign investment were imposed
through the introduction of the Foreign Exchange Regulation Act (FERA) in 1973 by
restricting foreign ownership of shares in enterprises incorporated in India. At the same time,
foreign firms operating in India were subjected to “local content” and “foreign exchange
balancing” rules that curbed their freedom of operation. The Industrial Licensing System
under the Industries Development and Regulation Act, 1951 and the Monopolies and
Restrictive Trade Practices Act, 1969 sought to channelize their activities into high
technology and export-oriented production.

Review of Literature
After independence in India 1947, FDI gained attention of the policy makers for acquiring advanced
technology and to mobilize foreign exchange resources. This section reviews the empirical studies on
the relation between FDI and economic activities in India. One school of thought argued that FDI has
a negative impact on the growth of India because FDI flows mainly towards the primary sector which
basically promoted the less market value (Weisskof, 1972). However another school of thought
argued that FDI inflow into the core sectors is assumed to play a vital role as a source of
capital,management and technology in countries transaction economies (Sahoo et al., 2002).A list of
Existing Literatures have been documented for the same.

Dutta M.K(2001) gives the paper on Foreign Direct Investment In India Since 1991: Trends,
Challenges And Prospects. (With the initiation of new economic policy in 1991 and

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subsequent reforms process, India has witnessed a change in the flow and direction of foreign
direct investment (FDI) into the country. This is mainly due to the removal of restrictive and
regulated practices.

Priya (2002) gives the paper on FDI inflows into India slip, despite best efforts. Foreign
direct investment into India has been steadily declining, the emphasis on attracting greater
FDI notwithstanding. During April-August 2002 FDI inflows were 7.6 percent lower than
during the first five months last fiscal year.

Tiwari (2007) gives paper on India's policies to attract FDI in R&D. For the last 30 years the
world has experienced a steady increase in foreign direct investment (FDI) cash flows.
According to UNCTAD, an intergovernmental forum for the integration of developing
countries in the world economy, FDI inflows are the biggest component of net inflows to
developing countries. Thus, FDI acts as a major driver for their development.

Singh (2009) stated in their study that foreign direct investment (FDI) policies play a major
role in the economic growth of developing countries around the world. Attracting FDI
inflows with conductive policies has therefore become a key battleground in the emerging
markets. The paper highlighted the trend of FDI in India after the sector-wise economic
reforms.
Kumar and Karthika (2010) found out in their study that Foreign Direct Investment has a
major role to play in the economic development of the host country. Most of the countries
have been making use of foreign investment and foreign technology to accelerate the pace of
their economic growth. FDI ensures a huge amount of domestic capital, production level and
employment opportunities in the developing countries, which a major step towards the
economic growth of the country.

Devajit (2012) conducted the study to find out the impact of foreign direct investments on
Indian economy and concluded that Foreign Direct Investment (FDI) 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, short
and long term project in the field of healthcare, education, research and development.

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Objectives:
The research paper covers the following objectives:
• To study the trends and pattern of flow of FDI.
• To assess the determinants of FDI inflows.
• To evaluate the impact of FDI on the Indian economy.
• To know the flow of investment in India

Research methodology
Data
This study is based on secondary data. The required data have been collected from various
sources, i.e., World Investment Reports, Asian Development Bank’s Reports, various
Bulletins of Reserve Bank of India, publications from Ministry of Commerce, Govt. of India,
economic journals, books, magazines and internet etc.

FDI and Economic Growth

The historical background of FDI in India can be traced back with the establishment of East
India Company of Britain. British capital came to India during the colonial era of Britain in
India. After Second World War, Japanese companies entered Indian market and enhanced
their trade with India, yet U.K. remained the most dominant investor in India. Further, after
Independence issues relating to foreign capital, operations of MNCs, gained attention of the
policy makers. Keeping in mind the national interests the policy makers designed the FDI
policy which aims FDI as a medium for acquiring advanced technology and to mobilize
foreign exchange resources. With time and as per economic and political regimes there have
been changes in the FDI policy too. The industrial policy of 1965, allowed MNCs to venture
through technical collaboration in India. Therefore, the government adopted a liberal attitude
by allowing more frequent equity. In the critical face of Indian economy the government of
India with the help of World Bank and IMF introduced the macro-economic stabilization and
structural adjustment program. As a result of these reforms India open its door to FDI inflows
and adopted a more liberal foreign policy in order to restore the confidence of foreign
investors . Further, under the new foreign investment policy Government of India constituted
FIPB (Foreign Investment Promotion Board) whose main function was to invite and facilitate
foreign investment. India is suffering from the scarcity of financial resources and low level of
capital formation because it has to majorly depend upon the external sources of Finance.Also
the domestic resources are entirely inadequate to carry out development programmes.

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The changes in the sentiments towards FDI were given effect to in the form of a series of
changes in the policies. These included removing the ceilings on foreign equity imposed by
the FERA, lifting of restrictions on the use of foreign brand names in the domestic market,
removing restrictions on entry and expansion of foreign direct investment into consumer
goods, abandoning the “local content” and “foreign exchange balancing” rules, among others.
The parallel process of virtual withdrawal of the Industrial Licensing System and the
retreating from the primacy given to public sector also enhanced the scope for FDI
participation in India. Together with liberalizing the FDI regime, steps were taken to allow
foreign portfolio investments into the Indian stock market through the mechanism of foreign
institutional investors. The objective was not only to facilitate non- debt creating foreign
capital inflows but also to develop the stock market in India’s FDI Inflows: lower the cost of
capital for Indian enterprises and indirectly improve corporate governance structures. On
their part, large Indian companies have been allowed to raise capital directly from
international capital markets through commercial borrowings and depository receipts having
underlying Indian equity. Thus, the country adopted a two-pronged strategy: one to attract
FDI and to encourage portfolio capital flows which ease the financing constraints of Indian
enterprises. As a result of the above-mentioned policy changes, India now follows an FDI-
friendly regime that is quite comparable to that adopted by most countries.

FDI-India - Brand Equity Foundation

India is set to emerge as the world’s fastest-growing major economy by 2015 ahead of China,
as per the recent report by The World Bank. India’s Gross Domestic Product (GDP) is
expected to grow at 7.5 per cent in FY 2015-16, as per the report. The improvement in India’s
economic fundamentals has accelerated in the year 2015 with the combined impact of strong
government reforms, RBI's inflation focus supported by benign global commodity prices
Market size
According to IMF World Economic Outlook April, 2015, India ranks seventh globally in
terms of GDP at current prices and is expected to grow at 7.5 per cent in 2016. India’s
economy has witnessed a significant economic growth in the recent past, growing by 7.3 per
cent in FY2015 as against 6.9 per cent in FY2014. The size of the Indian economy is
estimated to be at Rs 129.57 trillion (US$ 2.01 trillion) for the year 2014 compared to Rs
118.23 trillion (US$ 1.84 trillion) in 2013. According to Department of Industrial Policy and
Promotion (DIPP), the total FDI inflows soared by 24.5 per cent to US$ 44.9 billion during
FY2015, as compared to US$ 36.0 billion in FY2014. FDI into India through the Foreign

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Investment Promotion Board (FIPB) route shot up by 26 per cent to US$ 31.9 billion in the
year FY2015 as against US$ 25.3 billion in the previous year, indicating that government's
effort to improve ease of doing business and relaxation in FDI norms is yielding results.
Data for FY2015 indicates that the increase in the FDI inflows was primarily driven by
investments in infrastructure and services sector. Within Infrastructure, Oil & Gas, Mining
and Telecom witnessed higher FDI inflows, whereas IT services and trading (wholesale, cash
& carry) drove the services inflows. Most recently, the total FDI inflows for the month of
June 2015 touched US$ 2.05 billion as compared to US$ 1.9 billion in the same period last
year. During FY2015, India received the maximum FDI equity inflows from Mauritius at
US$ 9.03 billion, followed by Singapore (US$ 6.74 billion), Netherlands (US$ 3.43 billion),
Japan (US$ 2.08 billion) and the US (US$ 1.82 billion). Healthy inflow of foreign
investments into the country helped India’s balance of payments (BoP) situation and
stabilised the value of rupee.
According to the data released by Grant Thornton India, the total merger and acquisitions
(M&A) and private equity (PE) deals in the month of August 2015 were valued at US$ 2.6
billion (151 deals), which is 62 per cent higher in volume as compared to August 2014.
Government Initiatives
The Government of India has amended the FDI policy regarding Construction Development
Sector. The amended policy includes easing of area restriction norms, reduction of minimum
capitalisation and easy exit from project. Further, in order to provide boost to low cost
affordable housing, it has indicated that conditions of area restriction and minimum
capitalisation will not apply to cases committing 30 per cent of the project cost towards
affordable housing. Relaxation of FDI norms is expected to result in enhanced inflows in
Construction Development sector consequent to easing of sectoral conditions and
clarification of terms used in the policy. It is likely to attract investments in new areas and
encourage development of plots for serviced housing given the shortage of land in and around
urban agglomerations as well as the high cost of land. The renewed policy is also expected to
encourage development of low cost affordable housing in the country and of smart cities.
The Government of India recently relaxed the FDI policy norms for Non-Resident Indians
(NRIs). Under this, the non-repatriable investments made by the Persons of Indian Origin
(PIOs), Overseas Citizens of India (OCI) and NRIs will be treated as domestic investments
and will not be subject to FDI caps.
The government has also raised FDI cap in insurance from 26 per cent to 49 per cent through
a notification issued by the DIPP. The limit is composite in nature as it includes foreign

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investment in the form of foreign portfolio investment, foreign institutional investment,
qualified foreign investment, foreign venture capital investment, and non-resident investment.
The Cabinet Committee on Economic Affairs (CCEA) has raised the threshold for foreign
direct investment requiring its approval to Rs 3,000 crore (US$ 469 million) from the present
Rs 1,200 crore (US$ 187 million). This decision is expected to expedite the approval process
and result in increased foreign investment inflow. India’s cabinet cleared a proposal which
allows 100 per cent FDI in railway infrastructure, excluding operations. Though the initiative
does not allow foreign firms to operate trains, it allows them to invest in areas such as
creating the network and supplying trains for bullet trains etc.
India is likely to grant most favoured nation (MFN) treatment to 15 countries that are in talks
regarding an agreement on the Regional Comprehensive Economic Partnership
(RCEP),which would result in significant easing of investment rules for these countries. The
Government of India plans to further simplify rules for Foreign Direct Investment (FDI) such
as increasing FDI investment limits in sectors and include more sectors in the automatic
approval route, to attract more investments in the country.
Road ahead
According to United Nations Conference on Trade and Development (UNCTAD) World
Investment Report 2015, India acquired ninth slot in the top 10 countries attracting highest
FDI in 2014 as compared to 15th position last year. The report also mentioned that the FDI
inflows to India are likely to exhibit an upward trend in 2015 on account of economic
recovery. India also jumped 16 notches to 55 among 140 countries in the World Economic
Forum’s Global Competitiveness Index that ranks countries on the basis of parameters such
as institutions, macroeconomic environment, education, market size and infrastructure among
others.India will require around US$ 1 trillion in the 12th Five-Year Plan (2012–17), to fund
infrastructure growth covering sectors such as highways, ports and airways. This would
require support from FDI flows. During 2014, foreign investment was witnessed in sectors
such as services, telecommunications, computer software and hardware, construction
development, power, trading, and automobile, among others.

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 Total FDI Flows in India
50000

45000

40000

35000

30000

25000

20000 Total FDI Flows in India

15000

10000

5000

RBI’s Bulletin February, 2015 dt.10.02.2015 (Table No. 34 – FOREIGN INVESTMENT INFLOWS).

The above graph clearly exhibits the trend of FDI for the period 2000-2015 . the pattern has
continuously increased year by year after the globalisation policy of the government in 2008.
After that with a little fluctuations FDI in India has made prominent place in Indian Economy
due to several reasons.

Conclusions
Foreign direct investment would allow India to secure foreign infrastructure into India, which
would increase India’s capital base rapidly. If India can attract FDI in the big picture it’s
nothing but positive things. No doubt, FDI plays a crucial role in enhancing the economic
growth and development of the country. Moreover, FDI as a strategic component of
investment is needed by India for achieving the objectives of its second generation of
economic reforms and maintaining this pace of growth and development of the economy.

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Hence FDI is a significant factor which influences the level of economic growth in India. It
provides a sound base for economic growth and development by enhancing the financial
position of the country. It also contributes to the GDP and foreign exchange reserves of the
country. MNCs should be allowed to set up in such a manner that they help increase the
standard of living of our country instead of sole profit making.

References

 Dutta M.K(2001) “Foreign Direct Investment In India Since 1991: Trends, Challenges
And Prospects” Journal of Finance
 Ahmad Shahnawaz(2002) “FDI in India” Journal of Finance
 Priya (2002) “FDI inflows into India slip, despite best efforts” Journal of Finance
 Mohanty B.K(2003) “FDI inflows into Retail Revolution- emerging dimensions for
rural upliftment” The Management Accountant, Vol.20, No.5, 2003
 Rajnish Tiwari (2007) “India's policies to attract FDI in R&D” The Management
Accountant, Vol.40, No.7, 2007
 A.T. Kearney’s (2007): Global Services Locations Index”, www.atkearney.com
 Alhijazi, Yahya Z.D (1999): “Developing Countries and Foreign Direct
 Investment”, digitool.library.mcgill.ca.8881/dtl_publish/7/21670.htm.
 Andersen P.S and Hainaut P. (2004): “Foreign Direct Investment and Employment in
the Industrial Countries”, http:\\www.bis\pub\work61.pdf.
 Balasubramanyam V.N, Sapsford David (2007): “Does India need a lot more
 FDI”, Economic and Political Weekly, pp.1549-1555.
 Basu P., Nayak N.C, Archana (2007): “Foreign Direct Investment in India:
 Emerging Horizon”, Indian Economic Review, Vol. XXXXII. No.2, pp. 255-266.

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