A report on the Factors of Foreign Direct Investment in India

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Natural and imposed locational characteristics of a country can have a major influence on a firm’s decision to invest in the country. A countrys attractiveness factor can vary from one company to another based on organizational context. Each firm may decide on a country’s attractiveness as a possible investment site according to criteria specific to the firm.

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Location characteristics of a country can have a major influence on a firm’s decision to invest in the country. Major factors that may influence FDI attractiveness of a country are – Economic/Financial Factors: The country’s GDP growth rate; Conditions for FDI resulting from the country’s economic policies; Infrastructure facilities; Economic incentives for FDI; Stability of its currency; Expected returns on investment. Political/Legal Factors: Political stability; Integrity of its legal system; Ease of protecting intellectual property rights in the country. Cultural Factors – Cultural similarity of the country to a firm’s home country. Market Factors: Current market size; Expected market growth rate; Proximity to other countries to facilitate exports from the FDI venture. Resource Factors: Availability of skilled workers; Lower labor costs (after including the effect of labor productivity); Availability of competent management staff; Availability of raw materials. Factors relating to IJV Formation: Ease in finding suitable IJV partners; Trustworthiness of IJV partners in maintaining long-term relationship.

Different Types of FDI by direction

Inward: Inward foreign direct investment is a particular form of inward investment when foreign capital is invested in local resources. Inward FDI is encouraged by: Tax breaks, subsidies, low interest loans, grants, lifting of certain restrict ions. The thought is that the long term gain is worth more than the short term loss of income. Inward FDI is primarily restricted by ownership restraints Outward: Outward foreign direct investment, sometimes called “direct investment abroad”, is when local capital is invested in foreign resources. Outward FDI is encouraged by: Government-backed insurance to cover risk. Outward FDI is restricted by: Tax incentives or disincentives on firms that invest outside of the home country or on repatriated profits

Why has Foreign Investment increased manifold in India

International investment levels have exploded in recent decades. These increases in the flows of foreign investment have themselves marked a new and distinct phenomenon in the era of globalization. Several factors like Technology, the thirst for high profits by capitalists, end of the cold war and Financial liberalization have played critical role in increasing the foreign investment in the past decade.

SHARE OF TOP INVESTING COUNTRIES FDI EQUITY INFLOWS (Financial year):

Amount Rupees in crores (US$ in million) Ranks

Country

2008-09

(April-

March)

2009-10

(April-

March)

2010-11

( April-

May)

Cumulative

Inflows

(April ’00 –

May ’10)

%age to total

Inflows

(in terms of US $)

1.

MAURITIUS

50,794

(11,208)

49,633

(10,376)

5,854

(1,294)

216,760

(48,534)

42 %

2.

SINGAPORE

15,727

(3,454)

11,295

(2,379)

3,856

(854)

49,002

(11,044)

10 %

3.

U.S.A.

8,002

(1,802)

9,230

(1,943)

802

(178)

37,991

(8,456)

7 %

4.

U.K.

3,840

(864)

3,094

(657)

507

(112)

26,505

(5,996)

5 %

5.

NETHERLANDS

3,922

(883)

4,283

(899)

1,358

(298)

21,483

(4,785)

4 %

6.

JAPAN

1,889

(405)

5,670

(1,183)

1,647

(369)

18,542

(4,083)

4 %

7.

CYPRUS

5,983

(1,287)

7,728

(1,623)

237

(53)

18,014

(3,952)

4 %

8.

GERMANY

2,750

(629)

2,980

(626)

136

(30)

12,604

(2,829)

2 %

9.

FRANCE

2,098

(467)

1,437

(303)

284

(63)

7,203

(1,593)

1 %

10.

U.A.E.

1,133

(257)

3,017

(629)

46

(10)

7,069

(1,559)

1 %

TOTAL FDI INFLOWS *

123,025 (27,331)

123,378 (25,888)

19,989 (4,427)

536,492 (120,155)

Note: (i) *Includes inflows under NRI Schemes of RBI, stock swapped and advances pending for issue of shares.

(ii) Cumulative country-wise FDI equity inflows (from April 2000 to May 2010) – Annex-‘A’.

(iii) %age worked out in US$ terms & FDI inflows received through FIPB/SIA+ RBI’s Automatic Route+ acquisition of existing shares only.

SECTORS ATTRACTING HIGHEST FDI EQUITY INFLOWS:

Amount Rupees in crores (US$ in million) Ranks

Sector

2008-09

(April-March)

2009-10

(April-March)

2010-11

( April-

May)

Cumulative

Inflows

(April ’00 –

May ’10)

% age to total Inflows

(In terms of US$)

1.

SERVICES SECTOR

(financial &non-financial) 28,411

(6,116)

20,958

(4,392)

2,643

(587)

108,054

(24,227)

21 %

2.

COMPUTER SOFTWARE &HARDWARE

7,329

(1,677)

4,350

(919)

1,333

(296)

45,179

(10,168)

9 %

3.

TELECOMMUNICATIONS

(radio paging, cellular mobile, basic telephone services) 11,727

(2,558)

12,338

(2,554)

4,023

(891)

44,729

(9,821)

9 %

4.

HOUSING &REAL ESTATE

12,621

(2,801)

13,586

(2,844)

738

(163)

38,107

(8,519)

7 %

5.

CONSTRUCTION ACTIVITIES

(including roads &highways) 8,792

(2,028)

13,544

(2,868)

594

(132)

36,316

(8,191)

7 %

6.

POWER

4,382

(985)

6,908

(1,437)

1,416

(313)

22,335

(4,940)

4 %

7.

AUTOMOBILE INDUSTRY

5,212

(1,152)

5,609

(1,177)

222

(50)

20,898

(4,615)

4 %

8.

METALLURGICAL INDUSTRIES

4,157

(961)

1,935

(407)

2,101

(461)

15,541

(3,591)

3 %

9.

PETROLEUM &NATURAL GAS

1,931

(412)

1,328

(272)

757

(169)

12,261

(2,834)

2 %

10.

CHEMICALS

(other than fertilizers) 3,427

(749)

1,707

(362)

175

(39)

11,449

(2,535)

2 %

Factors influencing foreign investment decisions

It is important to understand the other factors that influence where and why companies decide to invest overseas. These other factors relate not only to the overall economic outlook for a country, but also to economic policy decisions taken by foreign governments -aspects that can be very political and controversial. Direct investors tend to look at a number of factors relating to how they will be able to operate in a foreign country: the rules and regulations pertaining to the entry and operations of foreign investors standards of treatment of foreign affiliates, compared to “nationals” of the host country the functioning and efficiency of local markets trade policy and privatization policy business facilitation measures, such as investment promotion, incentives, improvements in amenities and other measures to reduce the cost of doing business. For example, some countries set up special export processing zones, which may be free of customs or duties, or offer special tax breaks for new investors restrictions, if any, on bringing home (“re-patriating”) earnings or profits in the form of dividends, royalties, interest, or other payments

How foreign companies enter India

A business presence in India may be established by a foreign entity through: Incorporating an Indian company with 100% foreign equity, operating as a wholly owned subsidiary; Incorporating a Joint V enture Company (JV C) with an Indian partner and/or with the general public and operating as a listed company; or Incorporating a JVC with an Indian partner and operating as an unlisted company. Branch Office A branch would mean an establishment carrying on substantially the same activity as its Head Office. Foreign companies intending to open a Branch Office (BO) in India need to obtain prior permission of RBI which would encompass even approval to the scope of activities that are intended to be carried out in India. Liaison Office A Liaison Office (LO) is in the nature of a representative office set up primarily to explore and understand the business and investment climate. A LO is not permitted to undertake any commercial / trading / industrial activity, directly or indirectly, and is required to maintain itself out of inward remittances received from abroad through normal banking channels. Project Office Foreign companies can establish Project Offices (POs ) in India specifically for the purpose of execution of specific projects. A PO is similar to a branch office opened for the limited purpose of executing a particular contract.

Conclusion

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 26% to 49%. An additional good point is that the mandatory disinvestment clause within five years has been done away with. Increasing foreign investment can be used as a measure of growing economic globalization. Foreign Direct Investment is generally preferred to Foreign Portfolio Investment, commonly referred to as Foreign Institutional Investment since FDI is expected to be long term whereas FII are viewed as good weather friends who would exit the country during the time of trouble. Moreover, along with financial investment, FDI brings access to modern technologies and export markets. On the other hand, FII also allows entrepreneurs to get access to huge amounts of capital but these flows of port folio can reverse at any time and has a tendency to flow towards globally competitive sectors of the economy.

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