Indian Institute of Technology, Kanpur ECO 202 – Macro-Economics

Term Project1

A Study of Foreign Direct Investments

Ankit Misra

Y3053 ankitm@iitk.ac.in

&

Rishabh Uppal Y3290

rishabh@iitk.ac.in

Abstract

With FDI stocks constituting over 20% of global GDP, FDI has come in lime light in the global economy. From a couple of years, investor confidence has soared in the emerging market countries such as China and India and they have become the most favored destinations for FDI. In 2005, China, India and Eastern European countries reached new heights of attractiveness as destinations for FDI as they competed for higher value-added investments, including R&D. All these facts make this term project topic a good fit to the theoretical understanding we have developed in the course. In this project we develop an understanding of the concepts related to FDI, analyze latest FDI trends in different countries and look at FDI in India in greater detail.

1 2006-07/I

1. Objective: The objective of this paper is to familiarize ourselves with different issues associated with foreign direct investment (FDI) and try to correlate the trends with the theoretical knowledge we have acquired in the course. The term project report is arranged as follows. In section 2 we explain the concept of FDI and its importance in an economy. We also look at the recent trends at global level and as to why India has become a favored FDI destination in recent past [1]. In section 3 we analyze FDI in India (its importance and problems in further increasing it) in greater detail. We also make a succinct comparison between FDI in India and China. Also we observe FDI trends in various different countries to get a better global picture. In section 4 we look at roles of few factors in deciding FDI (SEZ, disinvestment, tax reforms). Finally we end in section 5 summarizing our study of FDI. References have been reported in section 6.Appendix I-III consists of some extra but useful information. 2. Review: In lay man terms, FDI is defined as a long term investment by a foreign direct investor in an enterprise resident in an economy other than that in which the foreign direct investor is based. The FDI relationship consists of a parent enterprise and a foreign affiliate. So to qualify as FDI the investment afford the parent enterprise control over its foreign affiliate. 2.1 Types of FDI

• Mergers and Acquisitions is the primary type of FDI. This occurs when a transfer of existing assets from local firms to foreign firms takes place. These Cross-border mergers occur when the assets and operation of firms from different countries are combined to establish a new legal entity. Cross-border acquisitions occur when the control of assets and operations is transferred from a local to a foreign company, with the local company becoming an affiliate of the foreign company. Acquisitions provide no long term benefits to the local economy-- even in most deals the owners of the local firm are paid in stock from the acquiring firm, meaning that the money from the sale could never reach the local economy. Nevertheless, mergers and acquisitions are a significant form of FDI and until around 1997, accounted for nearly 90% of the FDI flow into the United States.

• Greenfield investment: direct investment in new facilities or the expansion of existing facilities. They create new production capacity and jobs, transfer technology and know-how, and can lead to linkages to the global marketplace. So these are the primary target of a host nation’s promotional efforts. Multinationals are able to produce goods more cheaply because of advanced technology and efficient processes and uses up resources labor, intermediate goods, etc so, it sometimes crowds out local industry. One more downside of greenfield investment is that profits from production do not feed back into the local economy, but instead to the multinational's home economy.

• Horizontal Foreign Direct Investment: is investment in the same industry abroad as a firm operates in at home.

• Vertical Foreign Direct Investment: It can be of two types:

1) Backward vertical FDI: where an industry abroad provides inputs for a firm's domestic production process 2) Forward vertical FDI: in which an industry abroad sells the outputs of a firm's domestic production processes.

2.2 Importance Following shows the significance of FDI:

It brings in investible resources to host countries. Introduces modern technologies. Provides access to export markets. The trans-national companies (TNCs/MNEs)

have large internal (inter-firm) markets, whose access is only available to affiliates. They also control large markets in unrelated parties having established brand names and distribution channels spread over several national locations. They can, thus, influence granting of trade privileges in their home (or in third) markets.

FDI flows 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. In a world of increased competition and rapid technological change, their complimentary and catalytic role can be very valuable 2.3 Factors affecting FDI Quality off Infrastructure Poor infrastructure leads to poor productivity of the economy as a whole which results in low GDP/per capita GDP. The industries which try to have a comparative advantage by using such infrastructure more intensely are also reduced. In the context of FDI, poor infrastructure has more worsening effect on export production than on production for the domestic market. FDI directed at the domestic market suffers the same handicap and additional costs as domestic manufacturers that are competing for the domestic market. Say, a foreign direct investor planning to set up an export base in developing/emerging economies has the option of choosing between India and other locations with better infrastructure, India is handicapped in attracting export oriented FDI. Poor infrastructure is found to be the most important constraint for construction and engineering industries. State Obstacles Taxes like octroi and entry taxes which are levied on transportation of goods from State to State adversely impact the economic environment for export production, this imposes both cost and time delays on movement of inputs used in production of export products

as well as in transport of the latter to the ports. Investments that could raise the productivity and quality and thus make them competitive in global markets remain unprofitable because they cannot overcome the tax advantage given to small producers in the domestic market. At the local level (sub-state) issues pertaining to land acquisition, land use change, power connection, building plan approval are sources of project implementation delay. Legal Delays India’s legal system as codified is otherwise considered to be superior to that of many other emerging economies by many legal experts, but is often found in practice to be a hurdle in investment. One of the reasons is the inordinate delay are the interlocutory procedures that characterize judicial procedures. As a result the “Rule of law,” which has often been cited as one of the attractive features of the Indian economy for foreign investors, is found to be a significant positive factor by only 3 per cent for FDI in India. 2.4 Trends Global foreign direct investment (FDI) almost quadrupled between 1995 and 2000. FDI in developed countries not only grew but also its proportion became more than the developing nations. FDI inflows into developing countries virtually halted in 1998 as a result of the Asian crisis. The share of developing countries in global flows reached a peak of 39.6 percent in 1996, declining rapidly thereafter to reach 18.9 per cent of total flows in 2000 (Table 1). Though absolute FDI amounts have declined in 2001, the share of developing countries has increased dramatically to 30 per cent. Table 1

2.5 India – A favored FDI destination Today, India is perceived as the second most favorable investment destination. The global economic growth is becoming more and more dependant upon Asia’s growth, in which India is playing an increasingly more important role. Economic Reforms in India Major initiatives put forth as a part of the liberalization and globalization strategy since the early Nineties. With the announcement of the new industrial policy the strategy of industrialization followed is an “outward looking’ one. All manufacturing activities, except a few (due to strategic, environmental reasons, etc.) are now open to competition

and the entrepreneurs are free to make investment decisions based on their commercial judgment. Over the years, there has been a steady liberalization of the exchange controls with full convertibility on current account transactions. Various reforms towards the road to liberalization include:

• Virtual scrapping of the industrial licensing regime. • Amendment of the Monopolies and the Restrictive Trade Practices Act • Reduction in the number of areas reserved for the public sector • Reduction in rates of both direct and indirect taxes and change over to market

determined exchange rates. • Launching of the privatization program • Opening of many new sectors to FDI. • Raising FDI equity caps in sectors already opened and procedural simplification.

Today, the FDI policy in India is widely reckoned to be among the most liberal in the emerging economies and FDI up to 100% is allowed under the automatic route in most sectors and activities. FDI under the automatic route does not require approval of the Government and merely involves intimating to the Reserve Bank of India with 30 days of inward remittances and filing of documents with in 30 days of issue of shares top foreign investors. Along with the policies on inward FDI, the policies on outward investment are also liberalized. Various steps taken for liberalization of outward FDI are:

• Controls on inward FDI and external commercial borrowing by domestic firms have been eased.

• The emergence of world-class Indian corporate is being encouraged by the lifting of controls on outward investment.

• Indian corporate can now invest up to 200% of their net worth overseas under the automatic route.

There has been a trend of increased overseas investments by Indian corporate. Industrial Licensing has already been liberalized in India since 1991. Reforms taken in Industrial licensing are:

• Now entrepreneurs are free to set up industries. • Opening of Companies has been made simple. • With the introduction of IT in operations of registrars of Companies, it has been

made possible to open a company even in a day. Registrations with tax authorities, local authorities and other are also were made IT friendly, thus resulting in lesser time taken.

The Indian customs tariff rates have been brought down.

Bullish Indian Economy Table 2

Real Growth Rates in GDP (at Factor Cost) Percentage change over the previous year

Item 1980-81 to

1991-92

1992-93 to

2000-01

1993- 94

1994- 95

1995- 96

1996- 97

1997- 98

1998- 99 (P)

1999- 2000

(Q)

2000- 01 (A)

Total GDP 5.4 6.4 5.9 7.3 7.3 7.8 4.8 6.6 6.4 6.0

(Source: www.indiastat.com ) The last decade has seen an annual average growth rate of around 6% per annum in India’s GDP. From the figures of H1 of 2005-06, GDP (at factor cost at constant prices) grew by 8.1% as against 7.1% in the corresponding period last year. Manufacturing GDP grew by 10.2% in H1 of 2005-06 as compared to 8.8% during the corresponding period last year. More importantly, India has been maintaining GDP growth of 6-8% year after year. FDI Components Revision FDI reporting in India was capturing only the capital component provided by the investor. However, FDI, as per international practices of reporting, includes equity capital, reinvested earning (refer to Appendix - 1) and intra company loans. Government had undertaken an exercise for adoption of the international practice in compilation of FDI statistics. Based on the information so far collected, the RBI has revised the FDI inflow figures since 2001-02. Industrial Performance

Table 3

Year IIP 1992-93 2.3

1993-94 6.0

1994-95 8.9

1995-96 13.1

1996-97 6.1

1997-98 6.6

1998-99 3.8

1999-00 8.1

2001-02 5.7 2002-03 7.0 2003-04 8.4 2004-05 8.8

Source: www.indiastat.com The year 2004-05 witnessed further industrial recovery. The industrial growth, measured in terms of Index of Industrial Production (IIP), increased from 2.7% in 2001-02 to 5.7% in 2002-03, 7.0% in 2003-04 and further to 8.4% in 2004-05. The robust industrial

growth continues and the IIP has grown by 8.8% during the period April-November2005 over the corresponding period last year. Prospects The A.T. Kearney in ‘The FDI Confidence Index 2005’ [1] has ranked India as the 2nd most attractive investment destination. ‘World Investment Report, 2005’ [5] has ranked India as 2nd most attractive investment destination among Transnational Corporations. The World Investment Community particularly Foreign Institutional Investors have responded strongly to share the Indian growth story. The Government of India has started very large national program for infrastructure modernization and creation. This has also resulted in unprecedented business prospects. Higher disposal income of ever increasing young population is also offering strong demand for consumer goods, which in turn fuels the manufacturing and services sectors. India has become a place to be. 3. Data and Analysis: 3.1 FDI in India

Table 4

India’s share in FDI inflows among developing countries reached a peak of 1.9 per cent in 1997. It declined sharply to 1 per cent in 1999 and 2000 but has recovered sharply to 1.7 per cent in 2001(Table 4). India’s performance on the FDI front has shown a significant improvement during 2001-02. FDI inflows grew by 65 per cent to US$ 3.91 billion during 2001-02 thus exceeding the previous peak of US $ 3.56 billion in 1997-98 (as per BOP2 accounts of RBI). This growth of 65 per cent is particularly encouraging at a time when global FDI inflows have declined by over 40 per cent. The upward trend in FDI inflows has been sustained during the current financial year with FDI inflows during

2 See Abbreviations in the Appendix-III.

April-June 2002 about doubles that during the corresponding period of 2001 (as per DIPP3data). Engineering, Services, Electronics and Electrical equipment and Computers were the main sectors receiving FDI in 2000-01 (Table 5). Domestic appliances, finance, food & diary products which were important sectors attracting FDI in the early nineties, have now seen a downtrend in the latter half of the nineties.

Table 5

Services and computer have seen an increasing trend in the latter half of the nineties. The inflow of FDI into computers increased from 6 per cent in 1999-00 to 16 per cent in 2000-01. On the whole there have been significant changes in the pattern and composition of FDI inflows with few clear trends over the decade as whole.

Table 6

In 2001, the sectors that account for maximum FDI are fuel (power, oil refineries, gas); telecom; electronic goods, IT and software; automobiles; and services. The major investing countries are Mauritius (mainly routed from developed countries), USA, Japan, UK, Germany, the Netherlands and South Korea. The States that account for maximum FDI are Maharashtra, Delhi, Tamil Nadu, Karnataka and Gujarat. During the first half of 2002 the FDI inflows went mainly into transportation industry, services, telecom and electronics/IT/software. Some of the factors that explain the recent spurt in FDI inflows into India are:

• Progressive liberalization of FDI policy has strengthened investor confidence – opening up of new sectors (integrated townships, defense industry, tea plantations, etc.); removal of FDI caps in most sectors, including advertising, airports, private sector oil refining, drugs and pharmaceuticals, etc.; and greater degree of automaticity for investment.

• Liberalization of foreign exchange regulations by way of simplification of procedures for making inward and outward remittances.

• Sectoral reforms, especially in sectors such as telecom, information technology and automobiles have made them attractive destination for FDI.

• Policy to allow foreign companies to set up wholly owned subsidiaries in India has enabled foreign companies to convert their joint ventures into wholly owned subsidiaries.

• Public sector disinvestment has finally emerged as an important means to promote FDI.

• Government has set up an inter-ministerial Committee to examine the extant procedures for investment approvals and implementation of projects, and suggest measures to simplify and expedite the process for both public and private investment.

• The Foreign Investment Implementation Authority (FIIA) has been activated and now meets at regular intervals to review and resolve investment-related problems.

3.2 Problems of FDI in India In this section we highlight some of the weakness and constraints on achieving higher FDI inflows into India. Not all are relevant to every originating country or every destination sector. Some factors are more relevant for first time investors with no previous experience of investment in India. Though economic reforms welcoming foreign capital were introduced in the nineties it does not seem so far to be really evident in our overall attitude. There is a perception abroad that foreign investors are still looked at with some suspicion. There is also a view that some unhappy episodes in the past have a multiplier effect by adversely affecting the business environment in India. Besides the “Made in India” label is not conceived by the world as synonymous with quality. When a foreign investor considers making any new investment decision, it goes through four stages in the decision making process and action cycle, namely,

a) Screening, b) Planning, c) Implementing and d) Operating and expanding.

The biggest barrier for India is at the first, screening stage itself in the action cycle. This is primarily because we do not get across effectively to the decision-making “board room” levels of corporate entities where a final decision is taken. Our promotional effort is quite often of a general nature and not corporate specific. India is, moreover, a multi-cultural society and a large number of multinational companies (MNC) do not understand the diversity and the multi-plural nature of the society and the different stakeholders in this country. Though in several cases, the foreign investor is discouraged even before he seriously considers a project, 220 of the Fortune 500 companies have some presence in India and several surveys (A T Kearney) [1] show India as the most promising and profitable destination. On the other hand China is viewed as ‘more business oriented,’ its decision-making is faster and has more FDI friendly policies. Despite a very similar historical mistrust of foreigners and foreign investment arising from colonial experience, modern (post 1980 China) differs fundamentally from India. Its official attitude to FDI, reflected from the highest level of government (PM, President) to the lowest level of government bureaucracy (provinces) is one of consciously enticing FDI with a warm welcome. 3.3 Comparison of India’s FDI with China

Figure 1

China remains in a class of its own among the largest other non-member economies, as a destination for FDI. China is among the world’s foremost recipients of direct investment. According to Chinese official pronouncements the sectoral balance of inward FDI, which was previously tilted toward manufacturing investment, is beginning to swing toward the service sectors.

China’s increasingly active role as an outward investor – in the 1980s and 1990s mainly in natural resources, but now increasingly also in high-tech sectors – is not yet fully reflected in internationally comparable FDI statistics. There is evidence of widespread evasion of the burdensome approval and registration procedures by Chinese enterprises, particularly in the non-state-owned sector, using funds parked abroad in subsidiaries and special purpose entities in low-tax jurisdictions as well as retained foreign earnings. Very large projected outflows of capital to the developing world, particularly Africa, are raising concern in some countries over competition for scarce energy resources and over possible undermining of internationally-recognized standards of corporate conduct, including in weak governance zones. FDI into India apparently continues to grow. National sources estimate inward direct investment in 2005 at an all-time high USD 6.5 billion. This is likely to be an underestimate, as recent sectoral liberalization measures have ensured that an increasing proportion of inward FDI now arrives unscreened via the “automatic route”, requiring only notification to the central bank – an obligation that is not enforced and therefore widely ignored. Although manufacturing is generally open to foreign investment and there has recently been substantial liberalization of the FDI regime in some sectors, such as telecommunications, others, notably the retail industry, remain closed to foreign investors. Direct investment in India is in public debate often linked with offshore outsourcing, especially in the information technology sector (though it should be noted that this is also an area of major domestic as well as foreign investment), but the real picture is more mixed. If borne out by the facts this could push up inward FDI further in the coming years and lead to an even stronger concentration in the service sectors. Also, while international direct investment in India is only recorded at about one-tenth of that in China, it should be noted that India receives far more equity investment than China in its more developed capital markets. India’s outward FDI is starting to become significant, though this may not yet be apparent from official statistics, possibly because of some under-recording. Much Indian outward FDI in 2005 was in the form of cross-border mergers and acquisitions, mainly in telecommunications, energy and pharmaceuticals, though these remained small by international standards. Larger M&A transactions on the part of Indian multinationals are likely to follow in future years. Some large Indian services companies specializing in offshore outsourcing have in recent years also been active in investing in a large number of developed countries. 3.4 Inter-Country FDI Comparisons In 2000, China with 17 per cent had the highest share of developing country FDI followed by Brazil with 13.9 per cent of developing country FDI. The gap between the shares of these two countries narrowed during the nineties with Brazil gradually catching up with China, but has again widened in 2001. Though the share of Argentina, South Korea, Singapore, Malaysia and Taiwan is much lower than that of China and Brazil, it

was, till 2000 two to five times that of India’s measured inflow. The most remarkable transformation has occurred in South Korea, whose share in developing country FDI inflows was identical to that of India in 1993, and which fell below that of India in 1994 and 1995, but was four times that of India’s in 2000 (Table 7). Because of the Asian crisis in 1997-98 and the effect of sanctions on investor’s sentiment, India’s share of developing country FDI fell at the end of the nineties. There has however been a significant improvement during 2001.

Table 7

Table 8

India’s measured FDI as a percentage of total Gross Domestic Product (GDP) is quite low in comparison to other competing countries (Table 8). India the 12th largest country in the world in terms of GDP at current exchange rates is able to attract FDI equal only to

0.9 per cent of its GDP in 2001. In contrast FDI inflows into Vietnam were 6.8 per cent of its GDP in 2000. Even Malaysia, which has recently developed an image of being somewhat against the globalization paradigm, receives FDI equal to 3.9 per cent of its GDP. Similarly China attracts FDI equal to 3.8 per cent of its GDP. Thailand, which has a relatively low FDI-GDP ratio among the major developing country recipients of FDI, had a ratio four times that of India in 2000. This gap probably narrowed in 2001 and could narrow further in 2002 if the recent acceleration in growth of FDI into India can be sustained.

Figure 2. FDI flows to and from OECD

As shown above, direct investment into OECD (Organization of Economic Cooperation & Development) countries picked up in 2005 and reached an estimated 622 billion US dollars (USD). This represents a 27 per cent increase over 2004 and is the highest level of inflows since the previous investment boom petered out in 2001. Developments in selected countries In the United Sates the net FDI inflows were USD 110 billion in 2005. This represents an 18 per cent decrease from 2004 (USD 133 billion) and is way below the levels of investment that were recorded around 2000, but is still relatively high in a longer perspective (Table 9 and Figure 3). US inflows increasingly reflect inter-company loans and reinvested earnings, whereas equity capital inflows actually decreased in 2005.

Total FDI outflows from Japan in 2005 were USD 46 billion, up from USD 31 billion in 2004. This is a spectacular increase. Even as the Japanese economy is traditionally one of the world’s most important outward investors, the 2005 figure is the highest on record since 1990. However, most of the rise does not derive from “new projects” (equity capital investment, in statistical parlance), but from reinvested earnings in existing projects. FDI in 2005, at USD 3 billion, was low by past standards and in comparison with other large economies.

Figure 3, Inward FDI in selected countries

German FDI inflows and outflows recovered briskly in 2005 from levels in previous years that were unusually low. Outflows totaled USD 46 billion, mostly in the form of equity capital. Inward direct investment in 2005, at USD 33 billion, was high compared with the recent past, but less impressive in a longer historical perspective. The figures were influenced by a few very large transactions, especially in the financial and pharmaceutical sectors. With inflows of USD 165 billion, the United Kingdom was the world’s largest recipient of inward FDI in 2005. This is the largest inward direct investment flow ever recorded in the United Kingdom, and it represents a tripling of the already internationally high inflows in 2004. Outward FDI likewise grew, from USD 95 billion in 2004 to USD 101 billion in 2005. In consequence, the United Kingdom, traditionally a net exporter of direct investment, in 2005 recorded large net inflows for the first time since 1990. France continued to attract large direct investment inflows. FDI into France more than doubled from USD 31 billion in 2004 to USD 64 billion in 2005. As in previous years,

one of the factors underpinning foreign direct investment in France was the acquisition by foreign companies of corporate and residential real estate. Moreover, France was the world’s largest outward direct investor in 2005. Total outflows for the year as a whole were estimated at close to USD 116 billion. This is mostly attributed to a few very large foreign corporate takeovers by companies domiciled in France. FDI inflows to Canada bounced back in 2005 from historically low levels in the previous years. Total inward FDI, at USD 34 billion, reached its second highest level ever, which has so far only been exceeded in the boom year 2000. One of the main factors at play seems to have been that the investment by large US-based enterprises in Canada has regained momentum. Several large corporate takeovers took place across the US-Canadian border in the course of 2005. Among the relatively new OECD member countries, the Czech Republic was very successful in attracting FDI in 2005. Total inflows reached USD 11 billion, which is the highest level ever recorded in this country and well above what small and medium-sized economies normally attract. FDI inflows into Mexico remained strong in 2005, remaining close to the level of around USD 18 billion around which they have fluctuated in recent years (at just above USD 18 billion in 2005). At the same time, Mexico’s role as an outward investor has also gathered pace, with outward FDI reaching an all-time-high of USD 6 billion in 2005. Among the non-member adherents to OECD’s investment instruments, Brazil confirmed its position as the world’s foremost destination for direct investment to developing and emerging economies outside Asia (Table 9). Inflows of USD 15 billion to this country in 2005 were not vast by historical standards, but easily the largest in South America. Investment was down a bit from the year before, but this reflects the one-off effect of a large investment in the brewery sector in 2004. Inward FDI in Argentina was close to USD 5 billion. This figure is low compared with the inflows of around USD 10 billion per year that were recorded prior to the Argentine financial crisis (and USD 23 billion in the peak year), but it is nevertheless a rebound from the depressed levels of 2001 to 2003. Direct investment into Chile, at USD 7 billion, was almost unchanged in 2005. With an already large foreign corporate presence in the country, much of the inflows represent reinvested earnings. In addition to mining, some of the main foreign-invested sectors in Chile are related to infrastructure, especially transport, communication and electricity. Direct investment in Israel jumped in 2005 to reach USD 6 billion, or more than three times the levels recorded in 2004. In the main this reflects foreign participation in a number of large-scale privatizations, including some in the financial sector. Israel is also one of the most active outward investors among the smaller non-member economies, including in technology-intensive sectors. For the last three years, total annual outflows have exceeded USD 2 billion and the indications are that levels in 2006 will be even higher.

Inward investment in Romania in 2005 remained high at around USD 6.5 billion for the second year in a row. Inflows continue to be influenced by an ongoing process of privatization. However, the high 2005 figure also includes considerable greenfield investment and extensions of previous investment projects, particularly in the automotive industry and the service sectors.

Table 9. FDI flows in selected non-member economies: 2001-05

Russian inward investment, estimated at USD 14.5 billion in 2005, remains at a high level following a sharp pick-up in 2004. However, the high figures appear to include non-trivial amounts of concurrent in- and outflows in the context of corporate restructuring. The main sectors of investment were manufacturing and the energy sector, which accounted for 45% and 32% respectively of total inflows.8 A final observation from Table 9 regards South Africa, which is active in direct investment by African standards but usually not comparable with the larger OECD economies. South Africa experienced massive FDI inflows in 2005 of close to USD 6.5 billion.

4. Role Government can play in FDI 4.1 Role of SEZs China’s success in attracting export related FDI and its success in labor intensive exports contrasts sharply with that of India. Many of the policy reforms that are politically difficult in India were equally difficult in China. China however was able to introduce these reforms on an experimental basis in their Special Export Zones and then use the demonstrated success of these reforms to make them deeper and wider.

4.1.1 State SEZ Law(s) States consider enactment of a Special Economic Zone (SEZ) law that would apply to all SEZs in the State. The Maharashtra SEZ law can be used as a basis or a possible model for this purpose. The law should cover State level industrial, labor, environmental, infrastructure and administrative issues, with a view to simplifying and promoting investment and production in the SEZs. 4.1.2 SEZ Infrastructure Policy Though it will take a decade or more to improve infrastructure services across the country, infrastructure availability and quality can be brought to global standards in the Special Economic Zones (SEZs) within a couple of years. The effect of a weak highway and railway system can be minimized by locating SEZs in the coastal regions as was done by China and many other countries in South East Asia. Among the measures needed for accelerated development of infrastructure in and exports from SEZs are:

a) Power generation and distribution for the SEZ needs to be isolated from the problem ridden SEBs to the extent possible. As size limitations make electricity generation for the SEZ alone, non-optimal, the private electricity generator for the SEZ should be allowed to sell excess power to parties outside the SEZ.

b) There should be free entry and exit of telecom service providers into the SEZ without any service, subject only to the condition that the spectrum would be auctioned if and only if it ceases to be a “free good” within the SEZ. Interconnectivity with other countries (international long distance) should be free and unrestricted (subject only to the condition that this cannot be used as a conduit for provision of unregulated telecom services into the Domestic Tariff Area (DTA).

c) Private parties would also be free to set up a private airport or port to service the SEZs (FDI is already automatic 100 per cent). If an unused harbour is not available nearby, the requisite number of berths in the closest port should be made available to private parties for the purpose of servicing the SEZ. These parties or another developer should be given the authority to set up toll highway connecting the port to the SEZ.

d) A law should be passed by the State governments under which 100 per cent privately owned townships could be set up and run by private developers as private municipalities. Private SEZs should be designated as private

municipalities under this law and road, electricity transmission and other linkages provided by State/Central government

4.1.3 Marketing of SEZ A special marketing effort is needed for export oriented FDI. For instance, Taiwanese and other exporters in East and South East Asia can be targeted for this purpose. Our missions in OECD and other FDI source countries should be fully briefed on the comparative advantages of SEZs in India and distribute the required literature. 4.2 Role of Dis-investment Across the world, dis-investment has acted as a magnet for FDI. Though foreign companies are allowed to bid for government strategic share sale, there is some apprehension about doing so. If a clear signal is given that foreign companies are not only allowed but also encouraged to bid in dis-investment auctions, this could attract a significant amount of FDI. This in turn means that additional outside capital and investment will flow into industry from outside the system rather than existing private investment moving from one industry or sector to another. FDI flow into privatization is more likely to be complimentary, strategic purchase by domestic investors may have some element of substitution. As the strategic sale route has now crystallized into a transparent, time-bound, non-discretionary process, FDI investors should have confidence in the mechanism. 4.3 Role of Tax Rules and Rates Many countries, such as Malaysia, Thailand and China have had at various times, tax rates that favor foreign direct investment over domestic direct investment. Our tax laws treat all companies incorporated in India equally, irrespective of the proportion of foreign equity holding (national treatment). Tax rates have however often been higher in the case of Indian branches of foreign incorporated companies (eg. foreign airlines and banks operating in India through such branches). There is also a clear case for making tax laws and rules as simple and internationally comparable for FDI. In contrast the benefit-cost ratio from providing favorable tax treatment to foreign direct investors vis-à-vis domestic investors is less clear. Lower rates for FDI can however be considered in selected high technology sectors (that will benefit the country), as they can act as a signaling device to attract attention to opportunities that may have been missed otherwise. Both domestic and foreign investment would also be encouraged by a reduction in the corporate tax rate (35 per cent) to the highest marginal rate on personal income (30 per cent). 5. Conclusion: In this term project we understood the dynamics of FDI. Importance and Implications of FDI goes a long way in determining the growth of an economy. The role of FDI has been

of great importance for the country, moreover in the recent past. Through the study done in this term project we developed understanding to interpret FDI trends. We would like to thank our supervisor for letting us choose this topic and for his constructive guidance. Also we are thankful to the authors of the cited references which made our study easier and making our term-project a successful study. 6. References

1. FDI confidence index, A T Kearney, Global Business Policy Council, 2005 Vol. 8.

2. Report of the steering group on foreign direct investment, Planning Commission, Govt. of India, August 2002.

3. Trends and Recent Developments in Foreign Direct Investment Part I, Chapter 1, INTERNATIONAL INVESTMENT PERSPECTIVES: 2006 EDITION.

4. Report of the committee on compilation of FDI in India, October 2002. 5. World Investment Reports, 2001-06.

Appendix – I

Foreign Direct Investment statistics: Main Concepts Direct investment is a category of cross-border investment made by a resident entity in one economy (the “direct investor”) with the objective of establishing a “lasting interest” in an enterprise resident in an economy. The lasting interest is evidenced when the direct investor owns 10 per cent of the voting power of the direct investment enterprise. A foreign direct investor is an entity that has a direct investment enterprise operating in a country other than the economy of residence of the foreign direct investor. A direct investor could be: an individual (or a group of related individuals; an incorporated or unincorporated enterprise; public or private enterprise (or a group of related enterprises); a government; estates, or trusts or other organizations that own enterprises. A direct investment enterprise is as an incorporated or unincorporated enterprise (including a branch) in which a non-resident investor owns 10 per cent or more of the voting power of an incorporated enterprise or the equivalent of an unincorporated enterprise. Direct investment is composed of: equity capital, reinvested earning and other capital. Equity capital comprises:

i) equity in branches; ii) all shares in subsidiaries and associates (except non-participating, preferred

shares that are treated as debt securities and included under direct investment, other capital); and

iii) iii) other capital contributions. Reinvested earnings of a direct investment enterprise reflect earnings on equity accruing to direct investors less distributed earnings; they are income to the direct investor. However, reinvested earnings are not actually distributed to the direct investor but rather increase direct investor’s investment in its affiliate. Other capital (or inter-company debt transactions) borrowing and lending of funds between direct investors and subsidiaries, associates and branches.

Appendix – II

International Direct Investment Statistics

Appendix – III

Acronyms Used in Text

ATK AT Kearney BOP Balance of Payments Crore 10 million DC Developing Countries DIPP Department of Industrial Policy & Promotion DTA Domestic Tariff Area FDI Foreign Direct Investment FIIA Foreign Investment Implementation Authority FII Foreign Institutional Investors GDP Gross Domestic Product GOI Government of India IMF International Monetary Fund IT Information Technology M&A Mergers & Acquisitions MNC Multinational Corporations MNEs Multinational Enterprises OECD Organization of Economic Cooperation & Development PM Prime Minister RBI Reserve Bank of India SEBI Securities & Exchange Board of India SEZ Special Economic Zone ST Sales Tax TNCs Transnational Corporations TRAI Telecom Regulatory Authority of India UN United Nations VCCs Venture Capital Companies