foreign direct investment in india china

7/27/2019 Foreign Direct Investment in India China

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1.

INTRODUCTION

FDI stand for foreign direct investment. The simplest explanation of FDI wouldbe a

direct investment by a corporation in a commercial venture in another country.

A key to separating this action from involvement in other ventures in a foreign

country is that the business enterprise operates completely outside the economy of

the corporations home country. The investing corporation must control 10 percent

or more of the voting power of the new venture.

According to history the United States was the leader in the FDI activity datingback

as far as the end of World War II. Businesses from other nations have taken up

the flag of FDI, including many who were not in a financial position to do so just a

few years ago.

The practice has grown significantly in the last couple of decades, to the point

that FDI has generated quite a bit of opposition from groups such as labour

unions. These organizations have expressed concern that investing at such a

level in another country eliminates jobs. Legislation was introduced in the early

1970s that would have put an end to the tax incentives of FDI. But members of

the Nixon administration, Congress and business interests rallied to make sure

that this attack on their expansion plans was not successful. One key to

understanding FDI is to get a mental picture of the global scale of corporations

able to make such investment. A carefully planned FDI can provide a huge new

market for the company, perhaps introducing products and services to an area

where they have never been available. Not only that, but such an investment

may also be more profitable if construction costs and labor costs are less in the

host country.

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The definition of FDI originally meant that the investing corporation gained a

significant number of shares (10 percent or more) of the new venture. In recent

years, however, companies have been able to make a foreign direct investment that

is actually long-term management control as opposed to direct investment in

buildings and equipment.

FDI growth has been a key factor in the international nature of business that

many are familiar with in the 21st century. This growth has been facilitated by

changes in regulations both in the originating country and in the country where

the new installation is to be built. Corporations from some of the countries that

lead the worlds economy have found fertile soil for FDI in nations where

commercial development was limited, if it existed at all. The dollars invested in

such developing-country projects increased 40 times over in less than 30 years.

The financial strength of the investing corporations has sometimes meant failure

for smaller competitors in the target country. One of the reasons is that foreign

direct investment in buildings and equipment still accounts for a vast majority

of FDI activity. Corporations from the originating country gain a significant

financial foothold in the host country. Even with this factor, host countries may

welcome FDI because of the positive impact it has on the smaller economy.

Foreign direct investment (FDI) is a measure of foreign ownership of

productive assets, such as factories, mines and land. Increasing foreign

investment can be used as one measure of growing economic globalization.Figure below shows net inflows of foreign direct investment as a percentage of

gross domestic product (GDP). The largest flows of foreign investment occur

between the industrialized countries (North America, Western

Europe and Japan). But flows to non-industrialized countries are increasing

sharply. Foreign direct investment (FDI) refers to long term participation by

country A into country B.

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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) .Foreign direct investment reflects the

objective of obtaining a lasting interest by a resident entity in one economy

(direct investor) in an entity resident in an economy other than that of the

investor (direct investment enterprise).The lasting interest implies the

existence of a long-term relationship between the direct investor and the

enterprise and a significant degree of influence on the management of the

enterprise. Direct investment involves both the initial transaction between the

two entities and all subsequent capital transactions between them and among

affiliated enterprises, both incorporated and unincorporated.

Foreign Direct Investment - when a firm invests directly in production

or other facilities, over which it has effective control, in a foreign

country.

Manufacturing FDI requires the establishment of production facilities. Service FDI requires building service facilities or an investment foothold

via capital contributions or building office facilities.

Host country - the country in which a foreign subsidiary operates. Flow of FDI - the amount of FDI undertaken over a given time. Stock of FDI - total accumulated value of foreign-owned assets. Outflows/Inflows of FDI - the flow of FDI out of or into a country. Stocks, bonds, other forms of debt. Differs from FDI, which is the investment in physical assets.

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1.1 Definition

Foreign direct investment is that investment, which is made to serve the

business interests of the investor in a company, which is in a different nation

distinct from the investor's country of origin. A parent business enterprise and its

foreign affiliate are the two sides of the FDI relationship. Together they

comprise an MNC.

The parent enterprise through its foreign direct investment effort seeks to

exercise substantial control over the foreign affiliate company. 'Control' as

defined by the UN, is ownership of greater than or equal to 10per cent of

ordinary shares or access to voting rights in an incorporated firm. For an

unincorporated firm one needs to consider an equivalent criterion. Ownership

share amounting to less than that stated above is termed as portfolio investment and

is not categorized as FDI.

FDI stands for Foreign Direct Investment, a component of a country's national

financial accounts. Foreign direct investment is investment of foreign assets intodomestic structures, equipment, and organizations. It does not include foreign

investment into the stock markets. Foreign direct investment is thought to be

more useful to a country than investments in the equity of its companies

because equity investments are potentially "hot money" which can leave at the

first sign of trouble, whereas FDI is durable and generally useful whether things

go well or badly.

FDI or Foreign Direct Investment is any form of investment that earns interest

in enterprises which function outside of the domestic territory of the investor.

FDIs require a business relationship between a parent company and its foreign

subsidiary. Foreign direct business relationships give rise to multinational

corporations. For an investment to be regarded as an FDI, the parent firm needs

to have at least 10per cent of the ordinary shares of its foreign affiliates. The

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investing firm may also qualify for an FDI if it owns voting power in a business

enterprise operating in a foreign country.

1.2 History

In the years after the Second World War global FDI was dominated by the

United States, as much of the world recovered from the destruction brought by

the conflict. The US accounted for around three-quarters of new FDI (including

reinvested profits) between 1945 and 1960. Since that time FDI has spread to

become a truly global phenomenon, no longer the exclusive preserve of OECD

countries.

FDI has grown in importance in the global economy with FDI stocks now

constituting over 20 percent of global GDP. Foreign direct investment (FDI) is a

measure of foreign ownership of productive assets, such as factories, mines and

land. Increasing foreign investment can be used as one measure of growing

economic globalization. Figure below shows net inflows of foreign direct

investment as a percentage of gross domestic product (GDP). The largest flows

of foreign investment occur between the industrialized countries (North

America, Western Europe and Japan). But flows to non-industrialized countries

are increasing sharply.

1.3 Foreign Direct investor

A foreign direct investor is an individual, an incorporated or unincorporated

public or private enterprise, a government, a group of related individuals, or a

group of related incorporated and/or unincorporated enterprises which has a

direct investment enterprise - that is, a subsidiary, associate or branch -

operating in a country other than the country or countries of residence of the

foreign direct investor or investors.

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1.4Types of FDI

1.4.1 BY DIRECTION:

Outward FDIs Inward FDIs

This classification is based on the types of restrictions imposed, and the various

prerequisites required for these investments.

Outward FDI: An outward-bound FDI is backed by the government against

all types of associated risks. This form of FDI is subject to tax incentives as well

as disincentives of various forms. Risk coverage provided to the domestic

industries and subsidies granted to the local firms stand in the way of outward

FDIs, which are also known as 'direct investments abroad.'

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Inward FDIs: Different economic factors encourage inward FDIs. These

include interest loans, tax breaks, grants, subsidies, and the removal of

restrictions and limitations. Factors detrimental to the growth of FDIs include

necessities of differential performance and limitations related with ownership

patterns.

1.4.2 Other categorizations of FDI

Other categorizations of FDI exist as well. Vertical Foreign Direct

Investment takes place when a multinational corporation owns some shares of a

foreign enterprise, which supplies input for it or uses the output produced by the

MNC.

Horizontal foreign direct investments happen when a multinational company

carries out a similar business operation in different nations.

Horizontal FDI - the MNE enters a foreign country to produce the sameproducts product at home.

Conglomerate FDI - the MNE produces products not manufactured athome.

Vertical FDI - the MNE produces intermediate goods either forward orbackward in the supply stream.

Liability of foreignness - the costs of doing business abroad resulting in acompetitive disadvantage.

1.5 Methods of Foreign Direct Investments

The foreign direct investor may acquire 10per cent or more of the voting power of an

enterprise in an economy through any of the following methods:

by incorporating a wholly owned subsidiary orcompany

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by acquiring shares in an associated enterprise through a mergeror an acquisition of an unrelated enterprise participating in an equityjoint venture with another investor or enterprise

Foreign direct investment incentives may take the following forms:

Low corporate tax and income tax rates tax holidays

other types of tax concessions preferential tariffs special economic zones investment financial subsidies soft loan or loan guarantees free land or land subsidies relocation & expatriation subsidies job training & employment subsidies infrastructure subsidies R&D support derogation from regulations (usually for very large projects)

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2.

ENTRY MODE

The manner in which a firm chooses to enter a foreign market throughFDI.

- International franchising- Branches- Contractual alliances- Equity joint ventures- Wholly foreign-owned subsidiaries

Investment approaches:- Greenfield investment (building a new facility) -Cross-border mergers

- Cross-border acquisitions- Sharing existing facilities

2.1 Why is FDI important for any consideration of going global?

The simple answer is that making a direct foreign investment allows companies to

accomplish several tasks:

1 . Avoiding foreign government pressure for local production.

2. Circumventing trade barriers, hidden and otherwise.

3. Making the move from domestic export sales to a locally-based national

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sales office.

4. Capability to increase total production capacity.

5. Opportunities for co-production, joint ventures with local partners, joint

marketing arrangements, licensing, etc;

A more complete response might address the issue of global business partnering

in very general terms. While it is nice that many business writers like the

expression, think globally, act locally, this often used clich does not really

mean very much to the average business executive in a small and medium sizedcompany. The phrase does have significant connotations for multinational

corporations. But for executives in SMEs, it is still just another

buzzword. The simple explanation for this is the difference in perspective

between executives of multinational corporations and small and medium sized

companies. Multinational corporations are almost always concerned with

worldwide manufacturing capacity and proximity to major markets. Small and

medium sized companies tend to be more concerned with selling their products

in overseas markets. The advent of the Internet has ushered in a new and very

different mindset that tends to focus more on access issues. SMEs in particular

are now focusing on access to markets, access to expertise and most of all

access to technology.

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3.FOREIGN DIRECT INVESTMENT IN INDIA

The economy of India is the third largest in the world as measured by

purchasing power parity (PPP), with a gross domestic product (GDP) of US

$3.611 trillion. When measured in USD exchange-rate terms, it is the tenth

largest in the world, with a GDP of US $800.8 billion (2006). is the second

fastest growing major economy in the world, with a GDP growth rate of 8.9per

cent at the end of the first quarter of 2006-2007. However, India's huge

population results in a per capita income of $3,300 at PPP and $714 at nominal.

The economy is diverse and encompasses agriculture, handicrafts, textile,

manufacturing, and a multitude of services. Although two-thirds of the Indian

workforce still earn their livelihood directly or indirectly through agriculture,

services are a growing sector and are playing an increasingly important role of

India's economy. The advent of the digital age, and the large number of young and

educated populace fluent in English, is gradually transforming India as an

important 'back office' destination for global companies for the outsourcing of their

customer services and technical support.

India is a major exporter of highly-skilled workers in software and financial

services, and software engineering. India followed a socialist-inspired approach

for most of its independent history, with strict government control over private

sector participation, foreign trade, and foreign direct investment. However,

since the early 1990s, India has gradually opened up its markets through

economic reforms by reducing government controls on foreign trade and

investment. The privatization of publicly owned industries and the opening up

of certain sectors to private and foreign interests has proceeded slowly amid

political debate. India faces a burgeoning population and the challenge of

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reducing economic and social inequality. Poverty remains a serious problem,

although it has declined significantly since independence, mainly due to the

green revolution and economic reforms. FDI up to 100per cent is allowed underthe

automatic route in all activities/sectors except the following which will require

approval of the Government: Activities/items that require an Industrial License;

Proposals in which the foreign collaborator has a previous/existing venture/tie

up in India

FDI in India includes FDI inflows as well as FDI outflow from India. Also FDI

foreign direct investment and FII foreign institutional investors are a separate

case study while preparing a report on FDI and economic growth in India. FDI

and FII in India have registered growth in terms of both FDI flows in India and

outflow from India. The FDI statistics and data are evident of the emergence of

India as both a potential investment market and investing country. FDI has

helped the Indian economy grow, and the government continues to encourage

more investments of this sort - but with $5.3 billion in FDI . India gets less than

10per cent of the FDI of China. Foreign direct investment (FDI) in India has

played an important role in the development of the Indian economy. FDI in

India has - in a lot of ways - enabled India to achieve a certain degree of

financial stability, growth and development. This money has allowed India to

focus on the areas that may have needed economic attention, and address the

various problems that continue to challenge the country. India has continually

sought to attract FDI from the worlds major investors.

In 1998 and 1999, the Indian national government announced a number of

reforms designed to encourage FDI and present a favorable scenario for

investors. FDI investments are permitted through financial collaborations,

through private equity or preferential allotments, by way of capital markets

through Euro issues, and in joint ventures. FDI is not permitted in the arms,

nuclear, railway, coal & lignite or mining industries. A number of projects have

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been announced in areas such as electricity generation, distribution and

transmission, as well as the development of roads and highways, with

opportunities for foreign investors. The Indian national government also

provided permission to FDIs to provide up to 100per cent of the financing

required for the construction of bridges and tunnels, but with a limit on foreign

equity of INR 1,500 crores, approximately $352.5m. Currently, FDI is allowed in

financial services, including the growing credit card business.

These services include the non-banking financial services sector. Foreign

investors can buy up to 40per cent of the equity in private banks, although there

is condition that stipulates that these banks must be multilateral financial

organizations. Up to 45per cent of the shares of companies in the global mobile

personal communication by satellite services (GMPCSS) sector can also be

purchased. By 2004, India received $5.3 billion in FDI, big growth compared to

previous years, but less than 10per cent of the $60.6 billion that flowed into

China. Why does India, with a stable democracy and a smoother approval

process, lag so far behind China in FDI amounts? Although the Chinese

Approval process is complex; it includes both national and regional approval in the

same process. Federal democracy is perversely an impediment for India. Local

authorities are not part of the approvals process and have their own rights, and this

often leads to projects getting bogged to projects getting bogged down in red tape

and bureaucracy. India actually receives less than half the FDI that the federal

government approves.

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4.

FOREIGN DIRECT INVESTMENT: INDIAN SCENARIO

4.1 FDI is permitted as under the following forms of investments -

Through financial collaborations.

Through joint ventures and technical collaborations.

Through capital markets via Euro issues.

Through private placements or preferential allotments.

4.2 Sector Specific Foreign Direct Investment in India

4.2.1 Hotel & Tourism: FDI in Hotel & Tourism sector in India

100per cent FDI is permissible in the sector on the automatic route,

The term hotels include restaurants, beach resorts, and other tourist complexes

providing accommodation and/or catering and food facilities to tourists.

Tourism related industry include travel agencies, tour operating agencies and

tourist transport operating agencies, units providing facilities for cultural,

adventure and wild life experience to tourists, surface, air and water transport

facilities to tourists, leisure, entertainment, amusement, sports, and health units for

tourists and Convention/Seminar units and organizations.

For foreign technology agreements, automatic approval is granted if

i. up to 3per cent of the capital cost of the project is proposed to be paid for

technical and consultancy services including fees for architects, design,

supervision, etc.

ii. up to 3per cent of net turnover is payable for franchising and

marketing/publicity support fee, and up to 10per cent of gross operating

profit is payable for management fee, including incentive fee.

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4.2.2 Private Sector Banking:

Non-Banking Financial Companies (NBFC)

49per cent FDI is allowed from all sources on the automatic route subject toguidelines issued from RBI from time to time.

a. FDI/NRI/OCB investments allowed in the following 19 NBFC activities

shall be as per levels indicated below:

i. Merchant banking

ii. Underwritingiii. Portfolio Management Services

iv. Investment Advisory Services

v. Financial Consultancy

vi. Stock Broking

vii. Asset Management

viii. Venture Capitalix. Custodial Services

x. Factoring

xi. Credit Reference Agencies

xii. Credit rating Agencies

xiii. Leasing & Finance

xiv. Housing Finance

xv. Foreign Exchange Brokering

xvi. Credit card business

xvii. Money changing Business

xviii. Micro Credit

xix. Rural Credit

b. Minimum Capitalization Norms for fund based NBFCs:

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4.2.4 Telecommunication:

FDI in Telecommunication sector

i. In basic, cellular, value added services and global mobile personal

communications by satellite, FDI is limited to 49per cent subject

to licensing and security requirements and adherence by the

companies (who are investing and the companies in which investment is

being made) to the license conditions for foreign equity cap and lock- in

period for transfer and addition of equity and other license provisions.

ii. ISPs with gateways, radio-paging and end-to-end bandwidth, FDI is

permitted up to 74per cent with FDI, beyond 49per cent requiring

Government approval. These services would be subject to licensing and

security requirements.

iii. No equity cap is applicable to manufacturing activities.

iv. FDI up to 100per cent is allowed for the following activities in the

telecom sector :a. ISPs not providing gateways (both for satellite and submarine

cables);

b. Infrastructure Providers providing dark fiber (IP Category 1);c. Electronic Mail; and

d. Voice MailThe above would be subject to the following conditions:

e. FDI up to 100per cent is allowed subject to the condition that such

companies would divest 26per cent of their equity in favor of

Indian public in 5 years, if these companies are listed in other parts

of the world.

f. The above services would be subject to licensing and securityrequirements, wherever required.

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e. Trading of hi-tech, medical and diagnostic items.f. Trading of items sourced from the small scale sector under which, based

on technology provided and laid down quality specifications, a company

can market that item under its brand name.

g.Domestic sourcing of products for exports.h.Test marketing of such items for which a company has approval for

manufacture provided such test marketing facility will be for a period of

two years, and investment in setting up manufacturing facilities

commences simultaneously with test marketing

FDI up to 100per cent permitted for e-commerce activities subject to the

condition that such companies would divest 26per cent of their equity in favor of

the Indian public in five years, if these companies are listed in other parts of the

world. Such companies would engage only in business to business (B2B) e-

commerce and not in retail trading.

4.2.6 Power:

FDI In Power Sector in India

Up to 100per cent FDI allowed in respect of projects relating to electricity

generation, transmission and distribution, other than atomic reactor power

plants. There is no limit on the project cost and quantum of foreign direct

investment.

4.2.7 Drugs & Pharmaceuticals

FDI up to 100per cent is permitted on the automatic route for manufacture of

drugs and pharmaceutical, provided the activity does not attract compulsory

licensing or involve use of recombinant DNA technology, and specific cell / tissue

targeted formulations.

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FDI proposals for the manufacture of licensable drugs and pharmaceuticals and

bulk drugs produced by recombinant DNA technology, and specific cell / tissue

targeted formulations will require prior Government approval.

4.2.8 Roads, Highways, Ports and Harbors

FDI up to 100per cent under automatic route is permitted in projects for

construction and maintenance of roads, highways, vehicular bridges, toll roads,

vehicular tunnels, ports and harbors.

4.3 Special Facilities and Rules for NRI's and OCB's

NRI's and OCB's are allowed the following special facilities:

1. Direct investment in industry, trade, infrastructure etc.2. Up to 100per cent equity with full repatriation facility for capital and

dividends in the following sectors

i. 34 High Priority Industry Groupsii. Export Trading Companies

iii. Hotels and Tourism-related Projects

iv. Hospitals, Diagnostic Centers

v. Shippingvi. Deep Sea Fishing

vii. Oil Exploration

viii. Power

ix. Housing and Real Estate Development

x. Highways, Bridges and Portsxi. Sick Industrial Units

xii. Industries Requiring Compulsory Licensing

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3. Up to 40per cent Equity with full repatriation: New Issues of ExistingCompanies raising Capital through Public Issue up to 40per cent of the

new Capital Issues.On non-repatriation basis: Up to 100per cent Equity in

any Proprietary or Partnership engaged in Industrial, Commercial or

Trading Activity.

4. Portfolio Investment on repatriation basis: Up to 1per cent of the Paid upValue of the equity Capital or Convertible Debentures of the Company by

each NRI. Investment in Government Securities, Units of UTI, National

Plan/Saving Certificates.

5. On Non-Repatriation Basis: Acquisition of shares of an Indian Company,through a General Body Resolution, up to 24per cent of the Paid Up

Value of the Company.

6. Other Facilities: Income Tax is at a Flat Rate of 20per cent on Incomearising from Shares or Debentures of an Indian

4.4 India Further Opens up Key Sectors for Foreign Investment

India has liberalized foreign investment regulations in key sectors, opening up

commodity exchanges, credit information services and aircraft maintenance

operations. The foreign investment limit in Public Sector Units (PSU) refineries has

been raised from 26per cent to 49per cent.

An additional sweetener is that the mandatory disinvestment clause within five years

has been done away with. FDI in Civil aviation up to 74per cent will now be

allowed through the automatic route for non-scheduled and cargo airlines, as also for

ground handling activities. 100per cent FDI in aircraft maintenance and repair

operations has also been allowed.

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But the big one, allowing foreign airlines to pick up a stake in domestic carriers

has been given a miss again. India has decided to allow 26per cent FDI and

23per cent FII investments in commodity exchanges, subject to the proviso that no

single entity will hold more than 5per cent of the stake.

Sectors like credit information companies, industrial parks and construction and

development projects have also been opened up to more foreign

investment. Also keeping India's civilian nuclear ambitions in mind, India has also

allowed 100per cent FDI in mining of titanium, a mineral which is abundant

in India.

Sources say the government wants to send out a signal that it is not done with

reforms yet. At the same time, critics say contentious issues like FDI and

multibrand retail are out of the policy radar because of political compulsions.

Sector-wise FDI Inflows ( From April 2000 to January 2010)

AMOUNTOFFDI

SECTOR INFLOWS

In US$

PERCENT OF TOTALFDI INFLOWS (In terms

of Rs)In Rs Million Million

Services Sector 787420.81 18118.40 22.39

Computer Software

& hardware 391109.74 8876.43 11.12

Telecommunications 275441.38 6215.55 7.83

ConstructionActivities 213595.12 5029.01 6.07

Automobile 146799.41 3310.23 4.17

Housing & Realestate 217936.02 5118.85 6.20

Power 137089.37 3129.66 3.90

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Chemicals (Otherthan Fertilizers)

87008.07 1964.06 2.47

Ports 63290.50 1551.88 1.80

Metallurgicalindustries 109563.20 2612.85 3.11

ElectricalEquipments 57379.63 1324.92 1.63

Cement & GypsumProducts 70781.19 1621.03 2.01

Petroleum & Natural

Gas 94417.17 2244.17 2.68

Trading 62416.85 1480.94 1.77

ConsultancyServices 48647.43 1112.92 1.38

Hotel and Tourism 52500.05 1217.50 1.49

Food ProcessingIndustries 34362.49 760.32 0.98

Electronics 33914.75 748.57 0.96

Information &

Broadcasting (Incl. 52115.90 1194.20 1.48Print media)

Misc. industries 180561.54 4162.55 5.19

Total Investmentin all Sector

3517310.79

81010.63

100.00

Stock Swapped(from 2002 to2008)

145466.35 3391.07 -

Advance of Inflows(from 2000 to2004)

89622.22 1962.82 -

RBI's NRISchemes 5330.60 121.33 -

Grand Total 3757729.96 86395.85 -


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5.

FOREIGN DIRECT INVESTMENT IN CHINA

The evolution of Chinas open door policy in the aspect of FDI needs to be

understood in the wider context of Chinas Political and economic reform, in

particular the difficult transition from a planning to a market economy as Deng

Xiaoping once said, reform in China is like crossing the river by feeling the

stones on the riverbed. This message has been translated into a series of

guiding principles for the reforms.

The Hard and Soft Investment Environment in China

Based on the policy evolution and the economic progress we can now delineate the

favorable and not so favorable factors responsible for huge flow of FDI into China.

Fengli and Jingli (1990) have classified factors under Hard and Soft

Environment as follows:

Foreign Investment Environment Hard Environment Soft Environment

5.1 KEY FACTORS

o Transportationo Tele Communicationso Energy Supplyo Public Utilitieso Other Infrastructureo Raw Material & components supplies

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o Historical Elementso Political Backgroundo Cultural and social structureo Economic Regimeo Social Securities & welfareo Law & Legal Systemo Human resourceso Labour Relationso Government Serviceso Business Services

Whereas the hard environment refers to the conditions and characteristics of the

tangible infrastructure, many of which are readily measurable in quantitative

terms, the soft environment factors are mostly intangible and are very difficult to

measure, but they are most often critical to the operation and development of

foreign invested enterprises.

5.2 Foreign Direct Investment in Chinas Economic Development

Chinese economic development since 1978 can be broadly conceptualized as

sequential process with the following phases:

1978-84: Agricultural transformation, massive increases in rural income and

saving and release of labour to industry.

1984-92: Growth of Township-Village Enterprises (TVEs) through

exploration of rural savings and demand and simultaneous explosion of FDI-

overwhelmingly from the overseas Chinese, in the Special Economic Zones

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and related coastal areas, primarily for export of labour-intensive light

manufactures.

1992-2000: Proliferation of Multinational Investments in heavier, more capital and

technology intensive industries, and infrastructure, mainly for the domestic

market or the non-tradable sector.

Further the following basic facts of Chinese economic growth amplify the

impact of FDI on its economy:

The Chinese economy has been growing of nearly 10 percent a year since last two

decades, the fastest rate of growth in the world.

The savings rate in China has been exceptionally high at almost 35 percent in

1994.

The magnitude of poverty has reduced to 6 percent from 22 percent. The

World Bank (2002) estimates also have substantiated it.

Nearly 190 million people have been pulled out of the poverty.

The enormous amount of investments that have been made in infrastructure,

especially in power and real estates, transportation in SEZs, boosted the

overall growth rates.

5.3 Poverty Reduction in China

In terms of number of people escaping absolute income poverty, china has

undoubtedly made the single largest contribution to global poverty reduction of

any country in the past 20 years. Using official income poverty lines as a bench

mark,(official income poverty line for china has been set at about $0.70 per day

which has base year of 1993 PPP or international prices) the number of poor in

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rural China fell from 250 million in 1978, the first year of the economic

reforms, to around 34 million in 1999. These gains are impressive not in

themselves but also in comparison with the trends in much of the rest of the

world.

However, it is perhaps legitimate to model the Chinese development process as one

in which the initial growth of huge domestic market through an Agricultural

Revolution, followed by rural industrialization and export explosion with its

domestic multiplier effects, acted as an irresistible lure for the inward rush of

large MNCs. The process gained momentum with the unfolding of international

division of labour. This model implies a two-tier FDI process:

1. Mainly export-oriented investment in light manufacturing by the overseas

Chinese;

2. An accelerating in flow of multinational investment eager to establish a

presence in what was apparently going to be, in a few years, the largest

domestic market.

5.4FDI Policy and Environment

China has a fairly restrictive policy frame work with all Foreign Direct

Investment Proposals being approved on a case-by case basis , FDI is

encouraged in most of the manufacturing industries and agricultural activities,

though all industries in the service sector are closed to foreign -investment100% foreign ownership is permitted in export- oriented hi-tech industries.

China permits repatriation of profits only out of net foreign exchange earnings.

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The important highlights of the FDI proposals are listed here under:

All FDI Proposals are approved automatically, except in manufacturing and

agricultural activities where it is done by case-by-case basis.

Repatriation of profits allowed only on net foreign exchange earnings.

Most enterprises exempted from duties on import of capital goods.

Corporate income taxed at a flat rate of 33 per cent tax holiday available for all

enterprises.

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6.

EFFECT OF FDI ON INDIA AND CHINESE ECONOMY

6.1 Introduction

India and China are the two emerging economic giants of the developing world,

both situated in Asia with 37% of world population and with more than 8%

growth in their respective GDP of their economies. Both the economies have

immense natural resources, skilled and unskilled, cheap but quality labour force,huge domestic market and above all the relatively stable political environment.

Both the economies hence have vast potential to attract Foreign Direct

Investment (FDI) to serve the local market and to become a more important part of

the global integration.

China got independence in 1949, after 2 years of Indias political Independence

(1947), but today, China has surged far ahead of India in socio-economic

development indicators. After Chinas entry into World Trade Organisation

(WTO) China has emerged into the most attractive FDI destination in the

developing world. The UNCTAD and Asian Development Outlook highlight

the fact that Indias FDI is far below that of China and there is a wide gap

between approvals and actual realization. The FDI in India is just 3.4% of FDI

flows as a percentage of Gross Fixed Capital Formation in India by 2004 and

5.9% of FDI stocks as a percentage of GDP by 2004, whereas in China it was

8.2% of FDI flows as a percentage of Gross Fixed Capital Formation and 34.9%

of FDI stocks as a percentage of GDP during the same year, In absolute terms

China attracted US$ 53,510 million in 2003 whereas India attracted only

US$3420 million and during 2004 China attracted US$ 60,600 million, whereas

India attracted only 4374 million US$ during the same period.

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6.2 The impact of FDI on various variables:

6.2.1 Macro Economic

The impact of FDI separately on various macro economic variables. As we all

by now known, FDI involves the transfer managerial resources to the host

country. There have been disagreements about the costs borne and the benefits

enjoy by host and recipient country between pro-liberalization and anti-

liberalization/anti-market views. One country losses need not necessarily be

another country gains. Kindelberger (1969) argues that the relationship arisingfrom the FDI process is not a zero sum game. Ex-ante, both countries must

believe that the expected benefits to them must be greater than the costs to be

borne by them, because an agreement would not otherwise be reached and the

under lying project would not be initiated. However, believing in something ex-

ante is not guarantee that it materializes ex-post. The impact of FDI on host

country can be classified into economic, political, and social effects. The main

intention at heart of every MNC is profitability and hence they invest where the

returns are high, buy raw materials including cheap labour where it is relatively

cheap. MNCs succeed because of market imperfections and cast doubts on it as

claim on welfare of host country. The conventional wisdom that FDI is always

improving is no longer a conventional wisdom (Leahy and Montangna, 2000).

The economic effect of FDI can be classified into micro and macro effects.

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6.2.2 Micro Effects:

The micro effects of FDI reflect on structural changes in the economic and

industrial organization. An important issue is whether FDI is conducive to the

creations of competitive environment in the host country. Markusen and

Venables (1997) put forward two simple analysis channels to find the micro

effect of FDI.

They are:

Product Market Competition (PMC)Through PMC the MNCs will be substituting the products of domestic firms in host

country.

Linkage EffectMNCs may work as complimentary firms to domestic firms in host country where

it is possible for FDI to act as a catalyst leading to the development of local

industry. FDI may have benefits, but it will not come without costs. The decade of

liberalization and the impact of the FDI on macro economic factors in India have to

be found in this study.

To assess the impact of FDI on various relevant macro-economic variables

namely exports, private final consumption expenditure, Forex, Gross Domestic

Investment, gross domestic savings, trade balance, balance of payments.

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7.

FDI IN INDIA AND CHINA; A COMPARATIVE ANALYSIS

China has been receiving substantial FDI compared to India. Although prior to

1980s India received higher FDI than China but because of the liberalization

policy adopted by China in 1978, turned the tables in favor of China. Since late

eighties and throughout nineties China has been in forefront of the developing

world in terms of FDI inflows and hence economic development.

The growth of FDI inflows in China has raised from 2.8 per cent in 1990 to 12.5

per cent by 2002 whereas in India also the FDI has grown by 10 per cent

annually. In FDI stock as a percentage of GDP, China by 2002 had 36.2 per cent

whereas India at the same time had 8.3 per cent of FDI stock as a percentage to

GDP. Per capita FDI flows were 40.7 per cent in China during 2002 and at the same

time it was 5.3 per cent in India. But of late, Indias FDI is getting major boost and

it had 153% of growth in 2006 over 2005.

Hence India in order to keep pace with China has to speed the second

generation reforms.

The policies of china and India regarding FDI have become significantly more

liberal during the past several years. The comparison of the two countries

polices in attracting foreign investment gives us fair idea to indicate the reasons for

the differences in inflows of FDI and will enable us to suggest how India canimprove its investment climate.

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7.1 Reforms

With open door policy adopted since 1979, China has tried to attract FDI to

modernize its economy in its own way, capitalistic characters, within the

socialistic system. FDI regime in China is delineated, in major investment laws and

their implementing regulations, featuring control over foreign investment and

requirements. In additions to these measures china offered number ofincentives

to attract FDIs since 1980s.

India also gradually opened its economy since 1991 removing itself from

license-control raj. But as RBI rightly points out .Despite all the talk, we are nowhere even close to being globalized in terms of any commonly used indicator

of globalization. In fact, we are still one of the least globalised among major

countries-however we look at it

Due to lack of political consensus the labour reforms, fiscal reforms and freeing

the economy from the iron grip of bureaucratic controls still has to take place in

India

7.2 Policy Changes and Initiatives

Indian government has regulated the inflow of FDI through a highly selective

policy. Indias first generation reforms in 1991, was restrictive, limiting the

maximum foreign equity participation generally to 51 percent though FIPB. It

also gave the discretionary powers to FIPB to permit 100 percent equityownership in some cases. It also gave liberal tax concessions to foreign

enterprises. Approvals for opening liaison offices by foreign companies were

liberalized and procedures for the out ward remittance of royalties and technical fees

were streamlined. Bhagawati (1993) rightly points out that the policy changes

were neither credible nor momentum-giving reforms as they were not

comprehensive in their scope and did not go for enough to make a

significant impact.

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Whereas China, too, grants preferential tax treatment to enterprises set up in

Special Economic Zones and specified coastal cities. Enterprises that qualify as

Export-oriented or technologically advanced also avail of a 50 percent reduction

in the income tax rate. A crucial characteristic missing in the Indian policy is the

absence of tax exemption on imported materials and equipment, some tax

reduction is possible in the case of power projects, coal mining, and petroleum

refining projects.

7.3 Employment and Infrastructure

The Indian FDI Policy, nevertheless, scores over the policies of other competingcountries in the matter of employment of foreign personal while restrictions on

their employment do not exist in India, they are prevalent in most countries in

the ASEAN countries as well as in China. Further, though India has a large

number of free trade Zones and 100 per cent export oriented units providing

similar benefits, their functioning is hampered by location-specific or

infrastructural problems. These schemes require greater attention of the policy

makers in India.

In terms of the policy areas, simplification of the entry routes, raising of equity

ceiling, introduction of a negative list, simplification of the operating systems and

procedures, IPR legislation and a comprehensive dispute settlement system are

critical.

Unless India and its policies are marketed vigorously, the anticipated fallouts

from policy liberalization will remain sub optimal. One way to create a better

image of India as a business location will be to introduce stability in the system

incremental policy changes as is being done in the case of the power and

telecom sectors can cause total confusion regarding the sincerity and stability of

any policy regime.

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7.4 Growth rate and Growing market

With 37 percent of the worlds population, India and china are potentially the

worlds largest markets and the biggest host countries for FDI from the

European Union. Investment from abroad has been a major driving force in the

attainment of high growth rates in these countries. It became clear to both the

Chinese and Indian governments that their economic takeoff could only be

achieved by attracting technology embodied foreign investment. Given their size

and their level of development, china and India are apparently direct

competitors for FDI.

In fact, size of domestic market has been the most important factor responsible

for the China fever with about 1.2 billion population and the economy growing

at an average rate of 10 percent for the past one decade, China has emerged as

one of the fastest expanding markets in the world. Hence, large members of

Multinational Corporations from the USA, Europe, Japan, and South Korea

have been moving into china to have a slice of investment opportunities.

India is not far behind in terms of the size of market it offers to investors, the

size of Indian market, which has over 350 million people in the middle-income

group, is considered to be the most important factor attracting overseas

investors. India, also is second largest pool of scientific, and technical

manpower in the world, the net result is India is exporting a very high quality

human resources to the world. The wages in India are also one of the lowest inthe world.

7.5 Sunrise Sector Investment

Although India is a First-Phase FDI recipient China as a more mature FDI

recipient attracts more investment in the sunrise sectors. Totally in opposition to

the Indian situation, the EU, a relatively small investor in China, tends to invest

more in the high-tech sectors than its Japanese or American counterparts.

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China example should be mentioned, so long as foreign capital is flowing in and

particularly in those areas where China is lacking, the Chinese authority is not

bothered about the type of technology the Foreign Investor is bringing. The

system is regimented and it has ruled about a debate in political circles, which are

very common in a democratic set up in India. This type of system has been found

to be very suitable for the foreign investors. South Korea also has been able to

import modern technology in crucial industries so that it can maintain

competitive edge in the export front.

7.6 FDI by Non-resident Chinese and Indians (NRCs and NRIs)

Chinas development as a haven for FDI and a source of labour intensive

exports is a logical as well as chronological sequel to the pacific miracle. Indias

development has no such organic link with the East Asian experience.

Expatriate Indian entrepreneurs played, but a minor role in East Asias growth

and expatriate investment had a negligible share in Indias total FDI. Of course,

the Open Door is a far more recent phenomenon in India, dating back only to

1991, as opposed to the early 1980s in China. However, enough time has passed

since 1991 to assert that India has not experienced anything like the early surge

of expatriate investment in China has been accelerating after a slow start and its

growth curve is not too similar to that of early MNC investment in china. Nor is

the character of MNC investment very different in the two countries. Largely, in

both countries, such investment has been oriented towards the domestic market

rather than to exports. It has been attracted by economics of scale and large

market sizes, not primarily by low-wage costs. Non-resident Indian (NRI)

Investment, on the other hand, has been far more export-oriented. It has also

tended to favor small-scale and labour-intensive technologies.

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During 1983, early stages of Chinese reforms NRCs contributed greatly for

surge in FDI inflows into China by contributing more than 66 per cent on

average in between 1983 to 1990. They initially were contributing around 59

per cent that rose to 75 per cent in 1989. India was not fortunate to get such a

monumental start from NRIs in boosting FDI in India. Though India opened her

doors to MNCs with a bang, NRIs did not do their role as their counter part,

NRCs did for China .NRCs contributed 71.28 in 1991, which rose to 82.91 per

cent in 1992, though marginally declined to 64.96 per cent by 1997. The NRIs

were no match, as their peak contribution of 45.59 per cent came when India

opened her doors for MNCs. Later on, they demanded and got more provisions

rather than increasing their share in total FDI. Their contribution instead of

increasing after getting more incentives is shrinking and it reached rock bottom

at 2.69 per cent during 1998. Because of which China could attract about 25 per

cent of total FDI inflow into the developing countries. The next country in the

line, that is, Brazil could attract only 10 per cent. The predominant position of

China in attracting FDI for 1995 onwards cannot be explained by normaleconomic parameter.

China on all accounts fair better in the factors of investment climate. FDI as

percentage of gross capital formation is 10.1 per cent in 2001 and India during

the same period is 3.2 per cent. In the entry regulation, India is restrictive and

China permits authorised investors only to enter but whereas once enter the

repatriation of income and capital is free in both the countries. The composite

international country risk guide rating of both the countries are good, but

China's rating is excellent. The institutional investor credit rating ranks the

countries on the chances of countries default, where China's rating is good at 59

per cent whereas India it is at 47.3 per cent. The Euro-money country credit

worthiness rating which studies the risk of investing in an economy, rates both

the countries as equally good. The Moody's sovereign Foreign or domestic

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currency long term and debt rating ranges from AAA which is extremely strong

capacity to C which is default ranks China's foreign currency ahead of India, but for

the domestic currency it has not calculator but for India both is at Ba2 which refers

to fair rating.

7.7 Similarities between India and China

In both cases, the approach is a multi-stage approach;

Reforms proceed by a series of steps that are constantly under review.

The use of a five-year plan in both countries as a synthetic framework of

economic policy helps in designing the reforms.

There are many common instruments of the economic reforms in the two

countries: outward-looking policies; attraction of FDI through fiscal incentive;

Creation of free trade zones (Special Economic Zones (SEZs) in China, and

Export Processing Zones (EPZs) in India);

Emphasis on technology-embodied FDI; willingness to tackle the regional

problem.

7.8 Major Differences between India and China

The first dividing factor is the different positioning of the two countries on the

learning curve. Since China initiated its new policy 12 years before India, it is well

able to fine-tune its incentive package, whereas India, as a "first phase FDI recipient

is primarily concerned with the revival of its growth rates.

The approach has been gradual in both cases indeed, but in Chinese case, there is a

continuous, logical, and chronological flow of policies and events, whereas in the

Indian case, there is a series of spurts followed by contractions.

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The Chinese five year plan is well thought of and is aimed at designing and

implementing coherent strategic choices, whereas in India the decision to accept

new foreign investor are taken on a case by case basis, a practice that leads to

arbitrariness, and that militates against a coherent view.

There are no clear policy guidelines for investment in different sectors, there are

no clear strategic choices, and the threat to reverse some freshly born policies

is all too vivid.

Another major difference between the two countries is the role played by

technology in the growth and development process. Technology imports andTechnology Transfer (TT) are strongly encouraged in China. TT has become a sine

qua non condition for a successful investment strategy in China.

In an effort to foster industrial upgrading and restructuring, China has been

spending heavily on imports of Technology, advanced machinery, and

equipment worth US $ 18.4 billion during the period 1979 - 1994 (Peoples

Daily 1996).

Another major difference is that the objective of National Interest is much

stronger in China than in India. In China, Sino-Foreign JVs and cooperative

enterprises are required to abide strictly by the principle of sharing the common

interest; both Chinese and foreign partners have to bear equal risk.

In attracting FDI, China wants to maximize its own national interest byaccepting beneficial inputs, while restricting and eliminating those which may

have an unfavorable impact (Beijing Review, 1994). Those activities with an

unfavorable impact are those that have resulted in the monopolization of the

market in obstructions to the development of national industry, and that have

created environmental pollution. In restricting foreign ownership to 51 per cent

in some industries, India is also dedicated to the principle of national interest

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but the country allows foreign firms to gain quick returns on their investment

regardless of the economic externalities.

Just as striking, China is basically a homogenous society, dominated by the Hans

race despite the presence of a few ethnic, religious and linguistic minorities

in regions such as Tibet, Xingjian and Manchuria. India, in contrast, is a veritable

museum with every conceivable variety of heterogeneous castes and religions,

languages, cult and culture.

The Chinese polity is a monolithic dictatorship of one party with a single

individual wielding vast power, or at least influence. The Indian political system is acomplex federal democracy with power so widely diffused that Galbraiths famous

description of it as a functioning anarchy remains to this day its apt

characterization.

In its quest to increase FDI flows, the Indian government has not (yet) been

able to discriminate between the beneficial and unfavorable activities. Some

first steps in this direction are perceptible the environment ministry had made it

mandatory for all thermal power stations to switch over to washed coal since

2000. The notoriously high ash content in Indian coal and the resulting carbon

dioxide emissions from them, make them one of the most polluting industries.

On the other hand, Indias poor performance in terms of competitiveness,

quality of infrastructure and skills, productivity of labour, were responsible for less

attractive ground for Foreign Direct Investment.

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7.9 Hindrances of India-China

Anti competitive practicing & financing.

Tax administration-High taxes.

Regulations.

Corruption

Exchange rate

Inflation

Political Instability or uncertainty

Infrastructure to taxes & regulations

Functioning of the organized crime

Environmental regulations

Customs regulations

Business regulations.

However, what is significant to note is that an internal IFC survey (foreign

investor survey) has found that while the main business environment in India is

better than China, but the legal and regulatory infrastructure for financial

institutions, bankruptcy law and commercial law enforcement, and above all the

corruption, Redtapesim, lack of transparency, bureaucratic hurdles makes India

less attractive.

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8.

CONCLUSION

A large number of changes that were introduced in the countrys regulatory

economic policies heralded the liberalization era of the FDI policy regime in India

and brought about a structural breakthrough in the volume of the FDI inflows

into the economy maintained a fluctuating and unsteady trend during the study

period.

The rich countries club, OECD rightly observed, The effective and thorough

implementation of Chinas WTO Commitments would be critical to its success

in achieving its potential in luring FDI. Besides, chinas success would also

rely on its ability to carryout complementary reforms, to open up domestic

markets, to improve the performance of state-owned enterprise, to better protect

intellectual property rights and to speed up competition and judicial

enforcement that are essential to the effective functioning of Chinas markets.

Whereas India is still far behind China in becoming the attractive FDI

destination, for the obvious reason such as power shortage, poor infrastructure,

security consideration, absence of an exit policy etc. If India has to reach its

target of attractive more FDI for its development, The Indian Policy makers

should understand that the good intentions and mere plan layouts alone are notsufficient condition, but a bold aggressive third generation reforms is the need of

the hour. Only then one can expect India to attract FDI to its potential and can

become a popular investment destination as China.

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BIBLIOGRAPHY

www.rbi.org www.fin.in.nic www.sebi.org

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http://www.rbi.org/http://www.fin.in.nic/http://www.sebi.org/http://www.rbi.org/http://www.fin.in.nic/http://www.sebi.org/

foreign direct investment in india china

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