Vikas Kapoor

Foreign Direct Investments In India
FOREIGN DIRECT INVESTMENTS: A STUDY BASED ON THE INDIAN ECONOMY
VIKAS KAPOOR
September 2007
A dissertation presented in part consideration for the Degree of MA Finance and Investment
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Abstract
Over the past few years, Indias inward Foreign Direct investment (FDI) has attracted many scholars interest. The objective of this study is to focus on the impact that Foreign Direct investment has for Indian economic growth and development. It seeks to briefly reveal why there has been a recent surge in FDI and also the factors that prevent India from attracting foreign direct investments. Main determinants of FDI will also be revealed in this paper.
In addition, this paper also compares the performance of china and India in terms of attracting FDI. This study also reveals importance of Indias liberalization policies in attracting FDI. Thus it becomes necessary to study impact of such inflows as it has important policy implications.
Acknowledgement
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This dissertation presents one of the most challenging projects that I will ever undertake. Completion of this dissertation would not have been possible without help and guidance of numerous people.
First of all, I would like to express my sincere gratitude to my dissertation supervisor Mr. Sourafel Girma who introduced me to such an interesting topic and provided guidance and encouragement for this research work. During this one year Masters Program, I also learned a lot from other module supervisors which proved very helpful for me in many ways during my research period. I also greatly appreciate my parents for their never ending support and encouragement throughout my stay in Nottingham.
I cannot forget my friends at Business School who have played a great role for always being there when I faced stress while completing this research work. They have played a vital role in making Masters Degree an enjoyable experience. I would like to thank everyone who is associated with this dissertation.
Table of contents
Abstract.............................................2 Acknowledgements...3 Introduction..7 Meaning of FDI..7 Foreign Direct Investor..7 I. The Beginning8 II. Significance of FDI9 III. Types of FDI10 IV. Impact of FDI on host country and investor.11 V. Outline of the Dissertation....12
Chapter one - Literature Review of Indian Economy 1.1 Introduction... ...14 1.2 Sectors of Indian economy16 1.2.1 Agriculture Sector.16 1.2.2 Manufacturing sector..18 1.2.3 Service Sector ...19 1.3 Current Status of Indian Economy.20 1.3.1 Industrial Growth.......20 1.3.2 Infrastructure Industry...........20 1.3.3 Telecommunication........20 1.3.4 Inflation Trends......................21 1.3.5 Fiscal Trends. 21 1.3.6 Foreign Trade22 1.3.7 Stock Market Trends.22 1.3.8 Foreign Exchange Reserves. 23 1.3.9 Trends in Exchange Rates 23 1.4 India and Globalization.24 1.5 Conclusion.25 Chapter Two Literature Review of FDI 2.1 Theories of FDI 26 2.2 Eclectic Paradigm.28 2.2.1 Ownership-Specific Advantages...28 2.2.2 Internalization Advantages.......29 2.2.3 Location-Specific Advantages..29 2.3 Product Life Cycle Theory........31 2.4 FDI Trends........32 2.5 FDI and India.36 2.5.1 Automatic Route....37 4
Foreign Direct Investments In India 2.5.2 Procedure for Automatic Route.37 2.5.3 Government Approval Route.38 2.5.4 List of activities where FDI is not allowed........39 2.6 Export Oriented Units........39 2.6.1 Automatic Approval...40 2.6.2 Government Approval.......41 2.7 Assistance for FDI.41 2.8 India vs. China.......43 2.9 Conclusion.46 Chapter Three Political Risk 3.1 3.2 3.3 3.4 3.5 Introduction48 Definition.......49 Meaning of political risk........49 The management of Political Risk.51 Political risk Assessment.......52 i) Subjective Approaches a) Grand Tours.......53 b) Old Hands..54 c) Delphi Techniques.54 ii) Objective Approaches........55 Conclusion.56
3.6
Chapter four Research Methodology 4.1 4.2 4.3 4.4 4.5 Introduction........................................................................................................57 Research Methods..57 Qualitative vs. Quantitative...58 why Qualitative Research......59 Primary Research...60 i) Interviews a. Structured Vs. Unstructured Interview..61 b. Advantages of interviewing...62 ii) Questionnaires a. Questionnaire Design.....64 b. Advantages of Questionnaire.65 Limitations of Research.66 Secondary Research...66 Summary66
4.6 4.7 4.8
Chapter five Data Analysis and Results 5.1 Introduction ........68 5.2 Impact of FDI from the perspective of 68 i) Indians in Foreign Companies 5.3 Views from Academics and Analysts......71 5.4 Determinants of FDI...72
Foreign Direct Investments In India Introduction.72 An examination of Determinants 72 1. Exchange Rate Effect..73 2. Incentives73 3. Infrastructure...74 4. Rate of Return.74 5. Institutions..75 6. FDI Policy...75 7. Market Size.....76 8. Skilled and English Speaking Manpower...76 5.5 Outlook of investors on India78 5.5.1 Introduction78 5.5.2 Reasons for Investing in India...78 5.6 The obstacles in further FDI in India.....80 5.6.1 Introduction....80 5.6.2 Result of Interviews...81 5.6.3 Corruption/Bureaucracy.82 5.6.4 Infrastructure..83 5.6.5 High Risk Investment83 5.6.6 Cultural Barrier..83 5.6.7 Security Risk..84 5.6.8 Policy Risk.84 5.6.9 Legal Risk..84 5.6.10 Regulatory Risk.85 5.6.11 Conclusion.85 5.4.1 5.4.2 Chapter six: Conclusion and Policy Recommendation
6.1 Policy Recommendations..87 i) Export Market.....87 ii) Banking and Financial System....87 iii) Strategic Alliances..88 iv) Infrastructure...88 v) Corruption...88 vi) Approval for FDI Projects..89 vii) Marketing89 viii) Other recommendation89 Conclusion89
6.2
References.92 Appendices...101
Introduction
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I. Meaning of FDI:
FDI is an activity in which an investor resident in one country obtains a lasting interest in, and a significant influence on the management of, an entity resident in another country. This may involve either creating an entirely new enterprise or, more typically, changing the ownership of existing enterprises (via Mergers and Acquisitions). Other types financial transactions between related enterprises, like reinvesting the earnings of the FDI enterprise or other capital transfers, are also defined as FDI (OECD, 2002a).
FDI are normally preferred over other forms of external finance because they do not create any debt. FDI also facilitates international trade and transfer of knowledge, skills and technology (Planning Commission of India, 2002) II. 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 or unincorporated enterprises which has a direct investment enterprise-that is, a subsidiary, associate or branch operating in a country other than country or countries of residence of foreign direct investor (OECD, 1999).
Foreign Direct Investments In India III. The Beginning:
The liberalization in India started in 1991. A significant protest took place against this liberalization in November 1991, a few months after the new liberal economic policy. The fight against globalization and privatization found its chief targets in Multinational corporations. FDI was seen as new form of western imperialism. Indian capitalist became anxious about the impact of liberalization on their well being and got together to complain that foreign capital would drive them out of business.
Even after congress came to power and reforms began, FDI was not in anyway defined in 1991 nor was it considered a mechanism for development. There was no clear understanding of FDI as a proper mechanism for development or its future role.
The far reaching unanimity for FDI came in 1995-96 when the government began to showcase the progress made as a result of FDI along with defending the changes to critics. The future of Indias growth and output was seen to be connected to FDI and it was deemed necessary for promoting higher growth of output, exports and employment.
In 1996 97, the Foreign Investment Promotion Council along with Foreign Investment Promotion Board (FIPB) was set up. The first ever guidelines were announced for consideration of FDI proposals by the FIPB, which were not covered under the automatic route (Economic Department, 1992).
The list of industries eligible for automatic approval of up to 51% foreign equity were expanded and there was a recognition that FDI flows provided savings without adding to the countrys external debt. By 1997 FDI trends were taken more seriously and FDI flow
Foreign Direct Investments In India had to be maintained for the economy to grow. The government recognized that greater procedural simplifications were still needed in the area of FDI.
In 1999-2000, when a second year of decline continued a Foreign Investment Implementation Authority (FIIA) was set up for providing a single point interface between foreign investors and the government machinery, including state authorities. This body was also empowered to give comprehensive approvals. After this point, FDI has acquired an acceptable status (Singh, 2005). IV. Significance of FDI:
It has been increasingly recognized that growing FDI inflows can contribute to economic development and promise a variety of potential benefits to poor country recipients. FDI can play vital role in accelerating growth and economic transformation. Consequently, FDI has become an important source of private external finance for developing countries.
FDI act as a means of transferring production technology, skills, innovative capacity, and organizational and managerial practices between locations, as well as of accessing international marketing networks. In addition, the FDI can improve over all growth by promoting competition in the domestic input market and also benefits domestic firms by increasing their knowledge, and access to advanced technology, by improving the over all skills of the worker and by increasing the demand for domestic firms products and the supply of inputs (Kyaw, 2003).
Furthermore, FDI can boost host country exports. Multinational Enterprises may help developing host country process and export locally produced raw materials, using their
Foreign Direct Investments In India marketing skills, Superior technology, and general know how. They facilitate the export of local production through their distribution networks, and they often account for a significant share of host country exports (Fontagne, 1997). V. Benefits to the Government: Greater Per Capita Income Increased Tax Paying Population Reduced Tax Evasion Greater Exports Employment Greater consumer spending due to Economic boom GDP growth
VI. Types of FDI:
FDI can be categorized under five major headings:
1. Greenfield Investment ( a new operation) 2. Brownfield Investment ( expansion or reinvestment in existing foreign affiliates or sites) 3. Mergers and Acquisitions 4. Privatization and equity investment 5. New forms of investment (joint venture, strategic alliance, licensing and other partnership agreements)
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Foreign Direct Investments In India Each of these types of FDI presents varying amounts of risk and reward to the investing entity and the host country. For example, a Greenfield investment benefits a host nation by creating jobs and production capacity while also transferring in expertise and technology. The latter benefits help the nation in the long term by allowing them to better compete in the global marketplace (Chowdhry, 2007) VII. Impact of FDI on host country and investor:
The chart below summarizes the positive and negative aspects for both host nation and investor in typical FDI scenarios.
Positive & Negatives of FDI Positives Negatives
Host Country
Foreign investor will crowd out local producers
Increase employment
in
domestic
Dependence on foreign technology Domestic and know how Shift from development domestic Balance improvement of
infrastructure
Payments
industrial/business to FDI-based development Potential between countries cultural investor dissonance and
Development of local business clusters of technology and
host Transfer expertise
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Foreign Direct Investments In India Repatriation of earnings to origin country Investor Has to deal with laws of foreign country Nationalization Risks Must contend Access to new markets Low cost labor New efficiencies from
with corruption in economies of scale
developing economies May have to develop
infrastructure
Source: DinarStandard
Outline of the dissertation:
I have included six chapters in my research work. Chapter one
Chapter one provides with an overview of the Indian economy along with its various sectors. It also tells us about the present situation of Indian economy.
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Foreign Direct Investments In India Chapter Two
It provides with a detailed literature review on FDI and also provides brief comparison of India and China in terms of FDI. Chapter Three
Chapter three of this research work deals with the issue of political risk. This chapter tries to explain the importance of political risk in making investment decisions. Chapter four
Chapter four defines Research methodology. It explains various reasons for choosing qualitative over quantitative. The next section explains primary and secondary source for collection of data. Chapter five
This chapter is one of the most important chapters of this research work. It comprises views of various respondents collected by way of interviews and questionnaires. It also focuses on positive and negative factors which affects investment in India. Chapter six
This chapter concludes the research work by summarizing the study findings. Finally it concludes by giving suggestions for improving FDI in India.
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Chapter one Literature Review INDIAN ECONOMY

________________________________________________________________________ 1.1 Introduction:
India is the largest democracy in the world and with its consistent performance and surplus skilled manpower provides enormous opportunities for investments in both foreign and domestic markets. India is ranked as fourth largest economy in terms of purchasing power parity and the tenth most industrialized country in the world. Crucial steps such as industrial decontrol, simplification of investment procedures, enactment of competition law, liberalization of trade policy, full commitment to safeguarding intellectual property rights, financial sector reforms, liberalization of exchange regulations etc., have been taken, which provide a liberal, attractive, and investor friendly investment climate (IBEF, 2007).
Indian economic policy after independence was influenced by the colonial experience (which was seen by Indian leaders as exploitative in nature) and by those leaders exposure to Fabian socialism. Policy tended towards protectionism, with a strong emphasis on import substitution, industrialisation, state intervention, in labour and financial markets. Jwaharlal Nehru, the first prime minister, along with the statistician Prasanta Chandra, carried on by Indira Gandhi formulated and oversaw economic policy. They expected favorable outcomes from this strategy, because it involved both public and private sectors and was based on direct and indirect state intervention.
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Foreign Direct Investments In India Until 1980 Indias economic growth was very low as compared with other Asian countries. There was surge in the economic growth in India after 1980 which can be attributed to the economic reforms introduced in the country. Rajiv Gandhi, 9
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prime
minister of India introduced an economic policy which aimed to ease restrictions on capacity expansion for incumbents, remove price controls and reduce corporate taxes. Major change in economic condition took place in 1991 with the introduction of economic liberalization policy initiated by P.V Narsima Rao and his finance minister Manmohan Singh. This policy was introduced in response to Balance of Payment (BOP) crisis. This policy terminated license restrictions and also ended many public monopolies, allowing automatic approval of FDI in many sectors.
Since 1990, India has emerged as one of the wealthiest economies in the developing world. During this period, the economy has grown constantly with only a few major set backs. This has been accompanied by increase in life expectancy, literacy rates and food security.
A growth rate of above 8% was achieved by the Indian economy during the year 200404. Growth in Indian economy has steadily increased since 1979, averaging 5.7% per year in 23 year growth record. The Indian economy has posted an excellent average GDP growth of 6.8% since 1994. Various factors which are behind the robust performance of the Indian economy are high growth rates in industry and service sector and benign world economic environment provided a backdrop conductive to Indian economy. Another positive feature was that the growth was accompanied by relatively stability of prices (IBEF, 2007).
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Foreign Direct Investments In India GDP Real Growth Rate
9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% 2003 2004 2005 2006 2007
GDP
Source - http://www.indexmundi.com/india/gdp_real_growth_rate.html
1.2 Sectors of Indian Economy:

1.2.1 Agriculture Sector
Agriculture is the most important sector of Indian economy as more than 58% of countrys population depends on agriculture. The 1970s saw a huge increase in India's wheat production. The increase in post -independence agricultural production has been brought about by bringing additional area under cultivation, extension of irrigation facilities, use of better seeds, better techniques, water management, and plant protection. Dependence on India agricultural imports in the early 1960s convinced planners that India's growing population, as well as concerns about national independence, security,
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Foreign Direct Investments In India and political stability, required self-sufficiency in food production. This perception led to a program of agricultural improvement called the Green Revolution.
Agriculture contributes only 22% of GDP. The agriculture sector recorded a growth of 9.1% in 2003 -04, which feel steeply to 1.1% in the 2004-05 primarily because of a bad monsoon. India is the largest producer of tea, jute and jute like fiber. India is not only largest producer but also largest consumer of tea in the world. India accounts for around 14% of the world trade in tea.
Among livestock cattle and buffalo are found maximum in India. Indian total milk production is highest in the world. India also holds the first rank in total irrigated land in terms of area in the world. Among cereals production, India is placed third, having second largest production in wheat and rice and the largest production in pulses
However, the full potential of Indian agriculture as a profitable activity hasn't been realized yet. Thus, there is a need to move Indian agriculture beyond its centuries old dependency on monsoon. Agriculture upliftment will not only benefit farmers and a large section of the rural poor, but also will give fillip to overall growth of the economy through the backward and forward linkages of agriculture with the rest of the economy.
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Foreign Direct Investments In India %share of Agriculture in National Export/Imports
16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 2001- 2002- 2003- 2004- 200502 03 04 05 06
Source: Director General of Commercial Intelligence & Statistics, Ministry of Commerce, Kolkata.
Exports Imports
http://dacnet.nic.in/eands/Imports-Exports-Inflation%20Rates13-14.htm 1.2.2 Manufacturing Sector
During the 1990s, the overall manufacturing sector exports increased at a trend annual rate of 10.6 per cent. Within the 1990s, however, one sees a remarkable difference in the growth rates during the two halves of the decade. While the growth of manufacturing exports was a strong 13.7 per cent per annum during the first half, it slowed down to 7.1 per cent during the second half. This decline was in line with the slower growth of world trade, triggered off by the Asian crisis.
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Foreign Direct Investments In India The growth rate of manufacturing sector was recorded as 11.3% rise in quarter one of 2006-07, according to the GDP data released by the central statistical organization. It was 10.7% in the corresponding period of the last fiscal year. Industries that performed well during the period are wood and wood products, furniture and fixtures, metal products and parts, food products, basic metal and alloy industries and cotton textiles. (http://www.nerve.in/tags:manufacturing+sector ) 1.2.3 Service Sector
Service sector has maintained a steady growth pattern since 96-97, except into a fall in 2000-01. Trade hotels, transport & communications have witnessed the highest growth of level 10.9% in 2004, followed by financial services (With a overall growth rate of (6.4) % and community, social & personal services (5.9)% of all the three sectors, services have been highest contributor to GDP growth rate.
IT enabled services, such as Business Process Outsourcing have been growing rapidly in the recent past and will continue to rise. India's large number of English speaking skilled manpower has made India a major exporter of software services and software workers (Economy Watch, 2004).
Service sector in India is increasing rapidly. It constitutes a larger share in the total Gross Domestic Product. The growth rate of services sector in India is faster than any other sectors. It constitutes more than 50 percent of the total GDP in the country. In the coming budget 2007-08, the services sector will be emphasized as a top source of revenue for the Government.
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Foreign Direct Investments In India 1.3 Current status of Indian Economy: 1.3.1 Industrial growth
Industrial production recorded a growth of 11% during April Feb. period of 2006-07 as compared with 8.1% in the corresponding period of previous year. Manufacturing remained the driver to the industrial growth. It grew by 12.1% as against 9.1% recorded previous year. Production of basic and intermediate goods recorded rise of 10.1% and 11.6% in April-Feb period of 2006-07. 12 of 16 industry sectors have recorded growth higher than what was posted in the previous year; those include basic metals, machinery and equipment, transport, cotton textiles, wood products and metal products. 1.3.2 Infrastructure Industry:
The six core infrastructure industries recorded a growth of 8.3% in April Feb. period of 2006 07 as against growth rate of 6.3% in previous fiscal. Among the six main infrastructure industries crude, petroleum, petroleum refinery and power registered growth of 5.8%, 11.8% and 7.2% respectively. 1.3.3 Telecommunication
Telecommunication is one of the fastest growing sectors in the country; in Feb. 2007 total telephone subscription numbers crossed 200 million, achieving 202.9 million registered phones. Total mobile phone subscription went up to 162.5 million, registering a 72 million rise in 11 months.
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Foreign Direct Investments In India 1.3.4 Inflation Trends
Inflation averaged for the month of March stood at 6.4% calculated on the basis weekly numbers available up to 24 march 2007; this was much above threshold of 5.5% set by the Reserve Bank of India (RBI) for 2006-07. There was rise in price index of primary food articles and manufactured items primarily responsible in pushing up the over all index. The identified factors responsible for the inflationary pressures were constraints on the supply side and rise in the credit off take.
th
The government attempted to control inflation by maintaining and increasing supply of the items that have shown a price rise in past weeks. The measures used were banning exports of items such as sugar and wheat. This was followed by further liberalization on the imports of wheat and pulses and restrictions on the forward trading of wheat and rice. The rise in the cash reserve ratio (CRR) on three occasions to check inflation was also one of the measures used by the government to tame inflation. 1.3.5 Fiscal Trends
The data collected for February shows that there is high growth in gross tax collection. It stood at 29.6% as compared to 21.6% in the same month of previous year. Corporate tax collection which is the maximum contributor to the tax kitty grew at 44.1% as compared to 26.9% in the same month of last fiscal. Income tax has shown an impressive growth rate of 29.9% in February 2007 as compared to a low of 19.4% in February 2006. It is to be noted that indirect taxes contribute more than 50% to the total tax collected. In the 11 month period of 2006-07 fiscal deficit was 80 percent of year's fiscal deficit target of Rs
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Foreign Direct Investments In India 1, 52,328 crore, compared to 90 per cent of the target a year earlier. The revenue deficit stood at Rs 82411 crore which was 98.8 per cent of the budgeted revenue deficit target for 2006-07. 1.3.6 Foreign Trade
As Indian rupee is appreciating against USD during this period, the exporters are much more defensive in their approach. It is to be noted that in February 2007 exports increased only by 7.8% (in USD terms) as against 12.3% rise in the corresponding month a year before. In February 2007, total imports have grown by 25% as compared to 21.3% in the same month of previous year. Non-oil imports growth went up by 39.7% during the month against 21.3% in the previous year, however, oil imports bill turned negative during the month. China, USA, Singapore , UAE, Hong Kong, UK and Germany remain the main partners for Indian exports during the 11 month period from April to December 2006-07. 1.3.7 Stock Market Trends
There are many studies supporting the positive link between stock market development and growth. Stock price index showed a sharp rise since the mid 1970s after a quarter century of very slow growth. The process slowed down in the 1990s. The share price rose at a statistically significant rate of 9 percent per annum over the whole period 1950-2004; during 1950-75, the growth was not statistically significant but afterwards there was a rapid growth of 14 percent per annum.
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Foreign Direct Investments In India The BSE sensex declined from 14267 points on 1st Feb 2007 to 13072 points on 30th March 2007, a decline of 8.4 percentage points. The NSE Nifty too had shed about 316 points slipping by 7.6 percentage points. It is felt that the fall was due to the concerns over inflation above the targeted range, high interest rates, slowdown in credit growth and ban on the exports of some commodities. 1.3.8 Foreign Exchange Reserves
A strong Balance of Payment (BOP) position in recent years has resulted in a steady accumulation of foreign exchange reserves. Forex reserves are close to USD 200 billion. On 2nd March 2006 total reserves touched194.6 billion. The capital inflows, current account surplus and the valuation gains arising from appreciation of the major non USdollar global currencies against US dollar contributed to such rise in Forex reserves. The rise in the total Forex reserves is ascribed to additions in the foreign currency assets by USD 15.0 billion in a months time to touch USD 187.2 billion. A substantial rise was also seen in the position of Gold in a months time that rose to USD 6883 million and reserve position in the IMF too increased to USD 467 million. 1.3.9 Trends in Exchange Rates
The yearly (2006-07) trend shows an appreciation in the Indian Rupee against the US dollar. Indian Rupee stood at Rs 44.90 to the USD in April 2006, and eventually got weaker, maintaining a range of Rs 45-46.0 from May to November 2006. However, from December 2006 onwards the Rupee hardened to touch Rs 44. On 14
th
June, 2007 Rupee
had touched an-eight year high of 40.65. It has been observed that Rupee has been
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Foreign Direct Investments In India appreciating as dollar inflows have come in through external commercial borrowings and other loans of corporate as well as FII inflows. The recent hike in interest rates and draining of liquidity from the market led Rupee to appreciate (FICCI, 2007) 1.3 India and Globalization:
The term Globalization in the context of FDI means the extent to which FDI in India has been globally represented. Globalization in India has been an outcome of the adjustment and alignment process of the Indian government to the dynamics of various domestic and international pressures since 1900s. (Nayak, 2000)
India opened up the economy in the early nineties following a major crisis that led by a foreign exchange crises that dragged the economy close to defaulting on loans. This resulted into new set of domestic and external sector policies. These new policies were in favour of more open and market oriented economy. Major measures included scrapping of the industrial licensing regime, reduction in the number of areas reserved for the public sector, amendment of the monopolies and the restrictive trade practices act, start of the privatisation programme, reduction in tariff rates and change over to market determined exchange rates (Balakrishnan, 2004).
Over the years more and more sectors have opened up for FDI and portfolio investments facilitating entry for foreign investors in telecom, roads, ports, airports, insurance and other major sectors. Many Indian companies have also started becoming respectable players of the international market.
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1.5 Conclusion:
Indias economy is on the fulcrum of an ever increasing growth curve with positive indicators such as stable 8%-9% growth, rising foreign exchange reserves of close to US $ 180 billion, a booming capital market with popular sensex index topping the majestic 14000 mark. The government is estimating FDI flow of US $ 12 billion in this fiscal and more than 35% surge in exports, it is easy to understand why India is a leading destination in attracting foreign investors.
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Chapter Two Literature Review Foreign Direct Investment

_____________________________________________________________
2.1 Theories of FDI:
According to the Macro level theory of FDI, industries in capital intensive countries will invest in labor intensive countries in order to maximize profits. Hymer (1960) criticized this theory for being too general as it does not account fro the anomalies which are associated with a birds eye view of situation. In 1960, Hymer introduced a microeconomic theory of the form, focusing on international production rather than trade, which Dunning and Rugman (1985) point out as being Hymer`s great insight.
Hymer noted four discrepancies (1) the older theory suggested that flow of capital was one directional, from developed to underdeveloped countries, whereas in reality, in the post-war years, FDI was two-way between developed countries; (2) a country was supposed to either engage in outward FDI or receive inward FDI only. Hymer observed that MNEs, in fact moved in both directions across national boundaries. (3) the level of outward FDI was found to vary between industries, meaning that if capital availability was the driver of FDI, then there should be no variation, as all industries would be equally able and motivated to invest abroad; (4) as foreign subsidiaries were financed locally, it did not fit that capital moved from one country to another.
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Foreign Direct Investments In India These points suggested that the Neo-Classical theory was insufficient in explaining the movement and causes of multinational enterprise (MNE); there seemed to be another element driving firms overseas. Hymer suggested that MNE can only exist in an imperfect market where firms have non financial ownership advantages vis a vis other firms in the same industry, meaning that the driver for the MNE lies with the individual firms, rather than the countrys capital availability.
FDI in Hymer stance is about increasing the market power. According to Hymer licensing only occurs when firms in the potential market have sufficient advantages of their own, and thus efforts to compete may put a negative effect on profits, and thus cooperation is the preferred mode of business (Graham, 2002). Thus Hymer`s work draws attention to what is necessary for the firm to invest overseas.
Hymers work has been criticized by Dunning and Rugman (1985). They point out that Hymer focuses more on the market power approach and ignores transaction costs. Yamin observes that Hymer assumes firms to be merely reacting to structural market failures. Yamin suggested that Hymer`s theory is incorrect as the economist believed that the purpose of ownership advantages was to reduce competition via the creation of oligopolies. In addition, today it is no longer only oligopolist firms which may invest abroad, which suggests that the market power as endgame strategy is unnecessary and that ownership advantages are key to the creation of successful MNEs. Hymer`s theory fails to incorporate the external environment, which is just as powerful in exerting control in corporate strategy. Gladwin and Giddy pointed out that Hymer`s theory does not
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Foreign Direct Investments In India explain the production location i.e. why a firm invests in a particular location; this is where the product cycle deserves its credit (Gladwin and Giddy. 1973). 2.2 Eclectic Paradigm:
The eclectic paradigm was originally introduced by Dunning in 1977 as a framework for examining the international production and FDI decision by firms. This theory provides a three-tiered framework for a company to follow when determining if it is beneficial to pursue direct foreign investment. The three major elements of the paradigm can be stated as ownership, Location and internalization. Together these three factors are called OLI paradigm. FDI takes place when three sets of determining factors exist simultaneously (Dunning, 1993). The OLI framework has been regarded by many as a leading explanation of the growth of multinational operations. 2.2.1 Ownership-Specific advantages (The O Factor)
They arise when a firm of one nationality possesses certain specific advantage over the competing firm of other nationalities. They are internal assets which are not available to other firms. They include both tangible assets such as natural endowments, manpower and capital. The intangible assets are technology and information, entrepreneurial expertise, knowledge, organizational and human skill. For example Pirellis technology to produce tires, Coca Cola Brand.
It is certain that a multinational firm operating in a foreign country is faced with certain additional costs in comparison with a local competitor. For MNE activities to be
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Foreign Direct Investments In India profitable the MNE must have an edge over its rivals. The use made of these ownership specific factors increases the wealth creating capacity of the firm (Dunning, 1992). 2.2.2 Internalization advantages (The I Factor)
These advantages arise when a firm internalizes the use of its ownership-specific advantage. To this extent, the firm perceives that it is better for company to exploit a foreign opportunity itself, rather than through an agreement with a foreign firm. For the firm, contracting out is risky as it involves transfer of specific capital outside the firm and revealing the related proprietary information for example how to use technology or the patent.
According to Dicken (1992), the key incentives for firm to internalize market are market imperfection and uncertainty. The greater degree of market imperfection and uncertainty, the greater will be the incentive for firm to perform the function of the market itself by internalizing the market transactions. Internalization is especially likely to occur in the case of knowledge and technology because they contain public-goods characteristics which are easily transmitted across the country boundary. Because of huge amount of money spent on R&D, firm will have incentive to retain technology and exploit it directly on the world-wide basis rather than sell or lease it to foreign firms. 2.2.3 Location-Specific advantages (The L Factor)
This factor affects the decision of the location of production. The foreign market must offer a location advantage that makes it more profitable to produce in the foreign market rather than producing in domestic market and exporting to foreign market. Dunning
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Foreign Direct Investments In India defines location-specific factors as those which are available, on the same terms, to all firms whatever their size and nationality, but which are specific in origin to particular locations and have to be used in those locations. The location advantage can change over time (Griffin and Pustay, 2004). Location is a broad category and it includes GNP, Government attitude and type of human capital.
This is the OLI explaining the existence of the multinationals. The O factor answers the "why?" question; that is, why the firm goes abroad. The reason is to exploit its firm specific advantages in other markets and countries. The L factor answers the "where?" question of location. The MNE chooses its where to locate its foreign operations by comparing each country's locational attractiveness in terms of country specific economic, social/cultural, and political factors. The I Factor answers the "how?" question as to what mode of entry the firm uses to penetrate the foreign location. The MNE has a variety of alternative contractual arrangements, ranging from arm's length international trade through the wholly owned foreign subsidiary, and weighs their relative benefits and costs to determine how the enterprise enters the foreign market and expands its operations over time (Wattanasupachoke, 2002).
The successful MNE simultaneously combines these ownership, location, and internalization advantages to design its network of activities and affiliates in ways that maximize its market shares and growth.
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Foreign Direct Investments In India 2.3 THE PRODUCT-LIFE-CYCLE THEORY
Raymond Vernon developed this theory in 1966. It was developed to explain the locational tendencies for each phase of the product cycle. At the first stage of the cycle, the production facilities take place in the home country with high income and labor costs. At this stage, the product is non-standardized. In the second stage, the product becomes more standardized and production base starts to expand. To increase the competitiveness and reduce the production costs, firms start moving the production activities to the other developed markets. In the last stage as the product becomes mature and labor becomes a more important ingredient of production cost, forms are forced to move their production facilities to exploit the relatively cheap labors in the developing countries (Wattanasupachoke, 2002).
The theory is successful in highlighting how the products development from a nonstandardized to standardized product, forces the company to seek market elsewhere.
Dicken (1992) points out that this model has its own merit in such a way that it is an ideal-type model which sheds the light on the dynamic nature of the processes. Dicken also criticizes this model by stating that this model can no longer explain the international investment pattern by the MNEs. Giddy (1978) points out that product cycle model has only limited explanatory power. The multinational enterprise, however, has succeeded in developing a number of other strategies for surviving in overseas production and marketing.
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Foreign Direct Investments In India The product-life-cycle theory still has significant power for explanation of internationalization process of firms. Carnoy (1996) points out that The equalization of labor costs and income per capita among the developed countries has not altered the power of product-cycle theory to explain the location of multinational production and R&D: the theory predicts that new product development will spread, and it has. 2.4 FDI Trends:
Foreign Direct investment has been one of the main engines of economic globalization. Foreign Direct Investment in 2005 grew for the second consecutive year, and it was a worldwide phenomenon. Developing countries have gained importance as recipients of FDI in terms of both inward flows and stocks. Inflows to developed countries in 2005 amounted to $542 billion, an increase of 37% over 2004, while to developed countries they rose to the highest level ever recorded i.e. $334 billion. The share of developed Countries increased somewhat, to 59% of global inward FDI. Portfolio flows are also playing an increasingly larger roe in the total financial flows towards developing countries. In 1999 they accounted for approximately 10% of total resource flows to developing countries
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Foreign Direct Investments In India Global FDI Flows, 2005 (Billions of Dollars)
334.3
542.3
Developed Economies Developing Economies
Source: UNCTAD, World Investment Report 2006: FDI from developing and transition Economies (www.unctad.org/fdistatistics).
Cross border M&A, especially those involving companies in developed countries, have spurred the recent increases in FDI. The value of Cross border M&As rose by 88% over 2004, to $716 billion, and the number of deals rose by 20%, to 6134. There is increase in investment by collective investment funds, mainly private equity and related funds. Factors like low interest rates and increasing financial integration, have led private equity firms to undertake direct investments abroad, which are estimated to have reached $135 billion in 2005 and accounted for 19% of total cross-border M&As (World Investment Report, 2006).
While FDI flows to developing countries have increased significantly, other forms of capital flows have remained fairly stagnant. FDI has therefore increasingly expanded its share in the aggregate net resource flows to these countries. Within Asia, China and India
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Foreign Direct Investments In India have gained FDI share relative to south East Asia. Today China and India are one of the most attractive markets for FDI. This is mainly due to more open economic policies in the two countries, as well as their sheer size and dynamic growth. Sensing the demand of foreign investors, the Indian government has liberalized the laws relating to FDI in February 2005. Now Non Resident Indians (NRIs) and Overseas Corporate Bodies (OCBs) can invest up to 100% in the sector. So, the liberalized FDI regime, coupled with the strong potential of the industry is going to help pump money into the sector (Press Release, 2006).
India has tremendous potential for absorbing greater flow of FDI in the coming years. Serious efforts are being made to attract greater inflow of FDI in the country by taking several actions on various policies.
INDIA: YEAR WISE FDI INFLOWS

20000 18000 16000 14000 12000
US $ MILLIONS 10000
8000 6000 4000 2000 0 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07* FDI Inflows
YEARS
Source: Department of Industrial Policy & Promotion. Ministry of Commerce and Industry
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(i)* Include Stock Swap of Shares US $ 3.2 billion for the year 2006-2007.
INDIA: Share of Top Investing Countries FDI Inflows
(August 1991-2005)
Source: Department of Industrial Policy & Promotion Ministry of Commerce and Industry (http://dipp.nic.in/fdi_statistics/India_top_countries.pdf)
2.5 FDI and India:
FDI is now recognized as an important driver for the growth of the country. Government is making all the efforts to attract and facilitate FDI from Non Resident Indians (NRI)
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Foreign Direct Investments In India including overseas corporate Bodies (OCBs) that are predominantly owned by them, to complement and supplement foreign investment. To make investment in India attractive, investments and return on them are freely repatriable, except where approval is subject to specific conditions such as lock -in period on original investment, dividend cap, foreign exchange neutrality, etc. as per the notified sectoral policy.
Foreign direct investment is freely allowed in all sectors including the services sector, except a few sectors where the existing and notified sectoral policy does not permit FDI beyond a ceiling. FDI for virtually all items/activities can be brought in through the Automatic Route under powers delegated to the Reserve Bank of India (RBI), and for the remaining items/activities through Government approval. Government approvals are accorded on the recommendation of the Foreign Investment Promotion Board (FIPB). Categories:
1) Cases in which FDI is allowed without government approval i.e. Automatic Route. 2) cases in which FDI is allowed with government approval 3) cases in which FDI is not allowed
2.5.1 Automatic Route:
Most of the sectors fall under the automatic route for FDI. In these sectors, investment could be made without approval of the central government. The business areas included
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Foreign Direct Investments In India in this FDI category are manufacturing, infrastructure development, hotels and tourism, hardware and software and venture capital funds. It can be viewed as a long term strategy to allow India to come at par with its global competitors.
The automatic route for FDI and/or technology collaboration would not be available to those who have or had any previous joint venture or technology transfer/trade mark agreement in the same or allied field in India. 2.5.2 Procedure for Automatic Route:
In a major drive to simplify procedures for foreign direct investment under the automatic route, RBI has given permission to Indian Companies to accept investment under this route without obtaining prior approval from RBI. Investors are required to notify the Regional Office concerned of the RBI of receipt of inward remittances within 30 days of such receipt and file required documentation within 30 days of issue of shares to Foreign Investors. This facility is available to NRI/OCB investment also (Govindarajan, 2003).
FDI in India on automatic route is not allowed in the following sectors:
Proposals that require an industrial license and cases where foreign investment is more than 24% in the equity capital of units manufacturing items reserved for the small scale industries.
Proposals in which the foreign collaborator has a previous venture/tie-up in India.
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Proposals relating to acquisition of shares in an existing Indian company in favor of a Foreign/Non-Resident Indian (NRI)/Overseas Corporate Body (OCB) investor; and
Proposals falling outside notified sectoral policy/caps or under sectors in which FDI is not permitted and/or whenever any investor chooses to make an application to the Foreign Investment Promotion Board and not to avail of the automatic route.
(Anonymous, 2007) 2.5.3 Government Approval Route:
FDI in activities not covered under the automatic route require prior government approval. Few activities in which FDI is allowed but with prior permission of government includes:
1. Petroleum sector (except for private sector oil refining), Natural gas 2. defense and Strategic Industries 3. Atomic minerals 4. Print media 5. Broadcasting 6. Postal Services 7. Courier services 8. tea sector 9. development of integrated township
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10. Investing
companies in infrastructure and services sector.
2.5.4 List of activities in which FDI is not allowed:
Investments into India are not permissible in the following cases
1. retail trading 2. atomic energy 3. lottery business 4. gambling and betting 5. housing and real estate business 6. agriculture (excluding floriculture, Horticulture, Development of seeds, Animal Husbandry, Pisciculture and cultivation of vegetables, Mushrooms etc under controlled Condition and services related to agro and allied sectors) and plantations (other than tea plantations). (Embassy of India, 2007) 2.6 Export Oriented Units/Special Economic Zones
100 per cent Export Oriented Units (EOUs) and units in the Export Processing Zones
(EPZs)/Special Economic Zones (SEZs), enjoy a package of incentives and facilities, which include duty free imports of all types of capital goods, raw material, and consumables in addition to tax holidays against export. 100% FDI is permitted under automatic route for setting up of industrial park/industrial model town/special economic zone in the country. To encourage investment in this sector, 100% income tax exemption
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Foreign Direct Investments In India for 10 years within a block of 15 years is also granted for the industrial parks set up during the period 1.4.1977 to 31.3.2006.
2.6.1 Automatic Approval
The Development Commissioners (DCs) of Export Processing Zones (EPZs) /Free Trade Zones (FTZS))/Special Economic Zones (SEZs) accord automatic approval to projects where
(a) Activity proposed does not attract compulsory licensing or falls in the services sector except IT enabled services
(b) Location is in conformity with the prescribed parameters.
(c) Units undertake to achieve exports and value addition norms as prescribed in the Export and Import Policy in force.
(d) Unit is amenable to bonding by customs authorities.
(e) Unit has projected the minimum export turnover, as specified in the Handbook of Procedures for Export and Import.
FDI upto100% is allowed through the automatic route for all manufacturing activities in Special Economic Zones (SEZs), except for the following activities:
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Foreign Direct Investments In India (a). arms and ammunition, explosives and allied items of defense equipments, defense aircraft and warships
(b). atomic substances
(c). narcotics and psychotropic substances and hazardous chemicals
(d). distillation and brewing of alcoholic drinks
(e). cigarettes/cigars and manufactured tobacco substitutes. 2.6.2 Government Approval
All proposals which do not meet any or all of the parameters for automatic approval will be considered and approved by the Board of Approval of EOU/EPZ/SEZ set up in the Department of Commerce (Govindarajan, 2003). 2.7 Assistance for FDI
It is important to note, bodies such as Foreign Investment Promotion Board (FIPB), secretariat for Industrial Assistance (SIA) and Foreign Investment Implementation Authority (FIIA) have been established to deal with investment activity. There are many others like the Investment Promotion Agencies (IPA), Single Window Service and Escort Service, State Industrial Development Corporation (SIDC) and small Scale Industries Development Corporation (SSIDC).
FIPB provides institutional arrangements, transparent procedures and guidelines for investment. They also recommend and approve proposals.
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Foreign Direct Investments In India SIA provides single window for entrepreneurial assistance, receives and processes applications, conveys government decisions, collects and publishes data for select industry groups. FIIA expediting approvals and permissions, foster partnership between government agencies and investors, keep Indias diplomatic services abroad informed about FDI investment and implementation.
(Investing in India, 2004)
Therefore, from an investors prospective, market entry has been made more accessible. Investors are provided with much needed industrial and legislative information for their potential investment. Other important discriminatory biases against foreign firms have been reduced. The most notable being the reversal of the ban on foreign brand names and trademarks.
India has taken major steps in promoting FDI. The policies are now investor friendly. It must be acknowledged, the aspects of policy have been discussed are from the Indian Governments point of view. Thus these FDI promotion sites are certainly not going to advertise the difficulties faced when investing in India. 2.8 India vs. China:
A noticeable trend is, china has been and receives greater amounts of FDI in comparison to India, and the chart below illustrates this.
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India has managed to spawn a number of companies that now compete internationally with the best that Europe and the United States have to offer. Moreover, many of these firms are in the most cutting-edge, knowledge-based industries-software giants Infosys and Wipro and pharmaceutical and biotechnology powerhouses Ranbaxy and Dr. Reddy's Labs, to name just a few. Last year, the Forbes 200, an annual ranking of the world's best small companies, included 13 Indian firms but just four from mainland China (Huang and Khanna, 2003).
According to a survey by Ernst and Young, India is one of the top three destinations attractive to foreign investors, along with China and the United States. The survey ranked investment preferences on the basis of market and access, labor and productivity, fiscal, legal, environmental and regional issues. According to the survey, 26 per cent of investors had cited India as being among their top three preferences in 2007, up from the 11 per cent in 2004 even as China continues to be the most attractive destination for foreign investment, the survey pointed out.
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Foreign Direct Investments In India 48 percent cited China as one of their top three preferred business locations in 2007, up from 41 per cent in the 2006 survey. They said they were drawn to China because of its low labor costs, more competitive rates and higher productivity. The country's infrastructure, quality of research and development, workforce education and political stability were cited as major advantages.
However, the survey revealed that China still lags behind in quality of workforce. Only four per cent of those surveyed said it is the most attractive country in terms of its labor skills (E & Y Survey, 2007).
Additionally, infrastructure is an important factor in attracting FDI because when potential investors hope to set up business in a market, they expect there is a strong infrastructure, which can support their operations. In India, the investors are put off by the fact that they cannot get reliable power and that road system is so dreadful (Bajpai and Sachs, 2000).
According to a United Nations report china has more business-oriented and more FDIfriendly policies than India. FDI has contributed to the rapid growth of China's merchandise exports at an annual rate of 15 per cent between 1989 and 2001. In India, by contrast, FDI has been much less important in driving export growth except in information technology. FDI in Indian manufacturing has been and remains domestic market seeking.
FDI accounted for only 3 per cent of India's export in early 1990s and even today, it is estimated to account for less than 10 per cent of India's manufacturing exports For China,
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Foreign Direct Investments In India the report says, the lion's share of FDI inflows in 2000-2001 went to a broad range of manufacturing industries. For India, most went to services, electronic and computer industries.
The two countries, it notes, focused on different types of FDI and pursued different industrial strategies. "China's special economic zones have been more successful than Indian export processing zones in promoting trade and attracting FDI". China's accession to World Trade Organization, it says, has led to the introduction of more favorable FDI policies. With further liberalization in the services sector, China's investment environment may be further enhanced (Shourie, 2003).
Following are few comments given by experts in the Business Week in August 2005.
By Mahadev Bhatkuly India has not grown as fast as China, but it appears as if India might grow faster over the next decade. There are two key differences in the growth of these two nations. First, China has seen significant investment in infrastructure and FDI, while India's growth has been without any meaningful investment in infrastructure and FDI. Second, India's growth has emerged through an era of capital deficiency, while China's growth been the result of flinging increasing amounts of capital at it.
China offers investors an environment, in terms of infrastructure and policy, in which they can efficiently and with ease operate in. China still offers the greater long term growth potential. But investors have undervalued both Chinas political risk and Indias longer-term growth prospects.
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Foreign Direct Investments In India The worlds Bank Doing Business database shows that the average time taken to secure the necessary clearances for a start up, or to complete a bankruptcy procedure, is much smaller in China as compared with India. Also Indian labor laws allow firms far less latitude with their employees than the labor does in china. On the positive side, Indias manufacturing firms face fewer tax and regulatory inspections than firms in China (Investment climate Assessment, 2004). 2.9 Conclusion:
China's export-led manufacturing boom is largely a creation of foreign direct investment (FDI), which effectively serves as a substitute for domestic entrepreneurship. During the last 20 years, the Chinese economy has taken off, but few local firms have followed, leaving the country's private sector with no world-class companies to rival the big multinationals. India has not attracted anywhere near the amount of FDI that China has. In part, this disparity reflects the confidence international investors have in China's prospects and their skepticism about India's commitment to free-market reforms.
China and India dominates the top two positions for most positive investor outlook. Global investors view these two destinations as distinctly different markets. China is viewed as worlds leading manufactures and fastest growing consumer market whereas India is viewed as the worlds business process and IT services provider.
Executives consider China to be the undisputed top FDI destination for a third year in a row. India displaced Mexico to become the third most attractive FDI destination
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Foreign Direct Investments In India worldwide and is increasing perceived as a R&D hub for a wide range of industries (ATKEARNEY, 2007).
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Chapter Three Political Risk

________________________________________________
3.1 Introduction:
Since past many years there has been a significant increase in developing and developed countries alike in the types and magnitudes of political risks that multinationals companies have found.
Significant political risk includes changes in tax or labor laws, the imposition of currency or trade controls etc. although the most extreme form of political risk is the risk of expropriation.
The concept of political risk in economic literature is linked to the political events of 1960,s whereby new independent countries tried to overcome their lack of capital by simply taking over the foreign subsidiaries of multinationals. In the 1960.s expropriation, confiscation and nationalization became critical concerns for companies with foreign operations. These increased concerns about political risk were treated in economic literature mostly in the conceptual framework of the relations between host countries and multinational enterprises (Wafo, 1998).
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Foreign Direct Investments In India 3.2 Definition:
Agmon Tamir (1985) defines Political risk as the unanticipated changes in political factors that affect the relative prices of traded factors of production, goods and services caused by the actions and reactions of governments and other political groups within and between countries. 3.3 Meaning of political risk:
Political risk refers to the loss caused from investing in a foreign country due to changes in a country's political structure or policies, such as tax laws, tariffs, expropriation of assets, or restriction in repatriation of profits. For multinational companies, political risk refers to the risk that a host country will make political decisions that will prove to have adverse effects on the multinational's objectives. Adverse political actions can range from very detrimental, such as widespread destruction due to revolution, to those of a more financial nature, such as the creation of laws that prevent the movement of capital.
Political risk is distinct from commercial risk, which refers to those risks arising in the normal course of business. Commercial risks include, but are not limited to: the prices of inputs and outputs; new technologies; legal risk; financial risks such as interest rate and foreign exchange risk, liquidity management and capital structure decisions; production risk; market demand and general changes in the overall competitive situation.
One of the distinctions that must be made is between firm-specific political risks and country-specific political risks. Firm-specific political risks are risks directed at a particular company and are, by nature, discriminatory. For instance, the risk that a
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Foreign Direct Investments In India government will nullify its contract with a given firm or that a terrorist group will target the firm's physical operations are firm-specific. By contrast, country-specific political risks are not directed at a firm, but are countrywide, and may affect firm performance. Examples include a government's decision to forbid currency transfers or the outbreak of a civil war within the host country (Wagner, 2000).
There is a second distinction to be made between types of political risk: government risks and instability risks. Government risks are those that arise from the actions of a governmental authority, whether that authority is used legally or not. Instability risks, on the other hand, arise from political power struggles. These conflicts could be between members of a government fighting over succession, or mass riots in response to deteriorating social conditions (Wagner, 2000)
The major political risk concerns of foreign investors are as follows: Fair and equal treatment from the host government Stability of local economy, and the absence of high inflation Freedom from arbitrary and changing government regulation Free transfer of profit from the host country The political willingness and ability to make structural reforms. The ongoing economic crises in Asia and Russia show that the political reluctance to conduct structural reforms are considered also as a political risk Ability to sell or liquidate investment and subsequently, to withdraw funds from the country
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Foreign Direct Investments In India having to abandon the investment or venture for an extended period due to an evacuation requirement or advice from the home government loss of the economic benefit of a venture or specific asset without fair compensation
(Wafo, 1998) 3.4 The Management of Political Risk:
It is the companys chief financial officer (CFO) or the risk manager who is responsible for assessing a companys exposure to political risks, as well as to develop specific risk mitigation strategies. There are a number of ways to protect your firm against political risks, proper planning and due diligence are most important. Efforts to manage political risk must begin before the investment is made and continued while the investment is negotiated with the host government. Margaret Kelly identified few measures to be taken to manage risk in foreign investment: The identification and analysis of loss exposure The measurement of losses associated with these risks The development of alternative techniques for treating each exposure The reduction and implementation of the best technique or combination of techniques forecasting each exposure The evaluation of results in an effort to improve the procedures of identification, measurement and treatment.
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Foreign Direct Investments In India One of the better solutions to manage political risk is to purchase political risk insurance (PRI). There are now more PRI providers with greater capabilities than ever before. Multinational companies can go to one of the many organizations that specialize in selling political risk insurance and purchase a policy that would compensate them if an adverse event occurred. Because premium rates depend on the country, the industry, the number of risks insured and other factors, the cost of doing business in one country may vary considerably compared to another. Most governments as well as the World Bank provide political risk insurance to encourage investment in emerging markets (Anonymous, 2006). 3.5 Political risk assessment:
The Foreign Direct Investment in any country requires a careful examination and assessment by the multinationals of numerous factors which relate to both general political environment of a proposed investment and the specific functions of the firm in that specific country. Political risk assessment encompasses the problems of trying to understand and foresee potentially dangerous consequences of future political situations or the potential course of political actions.
There are number of approaches to the assessment of Political risk including event-tree analysis, actuarial techniques or statistical decision theory. For the most part, a mixture of subjective and objective approaches dominates corporate attempts to analyze and assess a countrys political climate.
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Foreign Direct Investments In India The objective approach attaches importance to methodological and procedural solutions to the assessment of political risk. The objective approach could also be referred to as method or formal oriented approach. The second approach, known as subjective approach, makes use of human judgment, intuition and experience to predict and forecast the political environment in a specific country. While the objective approach works with in the context of statistical data and models, the subjective approach makes use of intensive use of survey, advice and the judgments of specialists and consultant firms. i. Subjective Approaches:
Subjective approach relies on human judgment and experience gained by specialists, businessman and diplomats. The classical subjective approaches to the assessment of political risk includes three methods; the Grand Tours, the old Hands and the Delphi techniques. a) Grand Tours
Grand tour method is a particularly old technique, generally based on the impressions and information gained by the multinationals. These impressions and informations are gathered through some preliminary market research or an inspection tour of the company representatives. The first impressions and information can also be gained through contact with local dealers, government officials and businessmen or through survey of the political landscape for several days by company representatives. All the information gathered are then analyzed and evaluated.
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Foreign Direct Investments In India b) Old Hands
Multinationals seek to acquire area or country expertise from diplomats, journalists, and businessman or firm experts on a consulting basis. The expertise of diplomats, journalists or business usually includes assessment of the objectives and personalities of a countrys current leadership, the strengths and weakness of competing political groups and the likelihood of new legislation. One of the drawbacks of this approach is its unsystematic character and the fact that it is based on judgment of outsiders. Rummel and Heenan points out, the old hands methods can never provide multinationals corporations with an improved understanding of the political dimension. c) Delphi techniques
The Delphi techniques offer an example of a more elaborate and systematic use of human judgment and experience. Initially corporate decision makers try to identify selective elements which could influence nations political destiny: size and composition of the arms forces; delays experienced by the foreign investors; political kidnapping etc. Next, a wide range of experts is asked to tank or weigh the importance of these factors for the country under consideration. Then responses are collected and a checklist of the ranked variables is constructed. Finally, the corporate decision makers aggregate the ranked variables of the checklist into an overall measure or index of political risk.
Shortcomings of such an approach involve the possible deficiency of the relevant questions and the fact that a single addition and classification of political variables
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Foreign Direct Investments In India without taking into consideration other variables such as social, cultural and economic variables is misleading and inaccurate ii. Objective approaches:
It involves intensive use of quantitative data on political factors and of the econometric and probabilistic methods to improve the accuracy, the precision and the predictability of political events. One important technique employed for the objective measurement of political risk is for instance multivariate analysis (MVA), which made multidimensional decisions possible. The MVA could provide very important source of information for analyzing complex issues such as political risk. Refined quantitative tools for analyzing political risk are gaining favor among decision makers of multinationals as another way to deal with political risk. The MVA can be classified on the basis of two possible uses: 1) to predict future political trends on the basis of current and historical information. 2) To describe more fully underlying relationships affecting the nation state.
One of the shortcomings of the quantitative approaches is related to the inherently complex and subjective nature of the political risk. Many important political issues seem to defy quantification, and decision makers are often forced to rely on their judgment and intuition to a greater degree than may be desirable. These days most corporate approached to political risk assessment focus on methodological and procedural solutions to the problem of political risk because of its precision and accuracy (Wafo, 1998).
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Foreign Direct Investments In India 3.6 Conclusion:
Political risk thus covers wide range of possible actions and events, ranging from war, act of terrorism, change in tax and labor laws etc. political risk therefore affects a host of factors such as cash flow, ownership, operations, money, transfer of capital etc.
Most recent studies on the impact of political risk on FDI support hypothesis that political risk exerts a negative influence on firms decision to invest in another country.
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Chapter four Research Methodology

__________________________________________
4.1 Introduction:
This chapter aims to justify the research methodology which has been applied for the completion of this project. To begin with, firstly I will distinguish between qualitative and quantitative research and secondly I will give reasons for choosing qualitative research as my research methodology. The use of qualitative technique is done to understand the perspective of MNCs behind their decision to invest in India. 4.2 Research methods:
The research methodology is one of the most fundamental aspects of the data collection and analysis of the dissertation. It is imperative that the researcher should know the suitability of methods applied as well as be aware of the limitation of using such methodology so that required precautions can be taken to increase reliability, validity and generalizability of research (Miles and Huberman, 1994). The research methods comprise of mainly two types of techniques which are quantitative and qualitative.
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Foreign Direct Investments In India 4.3 Qualitative vs. quantitative
Qualitative research methods were developed in the social sciences to enable researchers to study social and cultural phenomena. The motivation for doing qualitative research, as opposed to quantitative research, comes from the observation that, if there is one thing which distinguishes humans from the natural world, it is our ability to talk. Qualitative research methods are designed to help researchers understand people and the social and cultural contexts within which they live (Kaplan and Maxwell, 1994). Examples of qualitative methods are action research, case study research and ethnography. Qualitative data sources include observation, interviews, questionnaires, documents and texts and the researchers impressions and reactions.
On the other hand, in quantitative research we classify features, count them, and construct statistical models in an attempt to explain what is observed (Neill, 2006). Quantitative research mainly determines the relationships between an independent variable and dependent variable in a population (www.sportsci.org)
Qualitative research has the natural setting as the direct source of data and the researcher is the key instrument. Researchers enter and spend considerable time in schools, families, neighborhoods and other educational concerns. Data is collected by researcher on the premises and supplemented by the understanding that is gained by being on location.
Qualitative research is descriptive. The data collected are in the form of pictures rather than numbers. Researchers try to analyze the data with all of their richness as closely as possible to the form in which they were recorded or transcribed. The qualitative research
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Foreign Direct Investments In India approach demands that the world be approached with the assumption that nothing is trivial, that everything has potential of being a clue that might unlock a more comprehensive understanding of what is being studied. Qualitative researchers are concerned with making sure they capture perspectives accurately. Some researchers who use videotape show the completed tapes to the participants in order to check their own interpretations with those of the informants (Mehan, 1978). 4.4 Why Qualitative Research?
As part of my research I shall adopt qualitative approach as it takes into more detailed insight into the research problem. Van Mannen (1983) describes as an array of interpretative techniques which seeks to describe, decode, translate and otherwise come to terms with the meaning, not the frequency, of certain more or less naturally occurring phenomena in the social world.
One of the key factors for choosing qualitative research was to answer my research question in depth and to extract information from the Employees and senior executives working in foreign firms in India and abroad. I used interviews as well as questionnaire as part of my research. This lead to the flexibility in data collection which otherwise would not have been possible. The authors carter and Thomas (1997) believe that qualitative methods are most effective in explaining the social world and the social phenomena surrounding it. This is also one of the reasons in my view why this research method is more appropriate to my data collection and analysis.
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Foreign Direct Investments In India 4.5 Primary Research:
Primary research involves getting original data directly about the product and market. Primary research data is data that did not exist before. It is designed to answer specific questions of interest to the business. To collect primary data a business must carry out field research. The main methods of field research are:
Face-to-face interviews interviewers ask people on the street or on their doorstep a series of questions.
Telephone interviews - similar questions to face-to-face interviews, although often shorter.
Online surveys using email or the Internet. This is an increasingly popular way of obtaining primary data and much less costly than face-to-face or telephone interviews.
Questionnaires sent in the post (for example a customer feedback form sent to people who have recently bought a product or service).
The main advantages of primary research and data are that it is: Up to date. Specific to the purpose asks the questions the business wants answers to. Collects data which no other business will have access to. In the case of online surveys and telephone interviews, the data can be obtained quite quickly.
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Foreign Direct Investments In India Primary research was conducted for the purpose of this study in the form of face to face interviews, email interviews and questionnaires. 1. Interviews:
As suggested by Sanger (1996), for qualitative research methods, the interviews are the predominant means of data collection. Interviews provide in-depth information about a particular research issue or question. A good interview is the art and science of exploring the subjective knowledge, opinions, and beliefs of an individual. The knowledge, opinions, and beliefs of that person are a "system." The purpose of the interview is to explore that system and all of its elements
Kvale defines qualitative research interviews as "attempts to understand the world from the subjects' point of view, to unfold the meaning of peoples' experiences, to uncover their lived world prior to scientific explanations." a. Structured versus Unstructured Interviews:
The structured interview consists of a list of specific questions. The interviewer does not deviate from the list or inject any extra remarks into the interview process. The interviewer may encourage the interviewee to clarify vague statements or to further elaborate on brief comments. Otherwise, the interviewer attempts to be objective and tries not to influence the interviewer's statements. The interviewer does not share his or her own beliefs and opinions. The structured interview is mostly a "question and answer" session.
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Foreign Direct Investments In India The "unstructured" interview is more free-wheeling. You may ask the same sort of questions as in the structured interview, but the style is free-flowing rather than rigid. It is more conversational. You adjust your questions according to how the interviewee is responding. You may even inject your own opinions or ideas in order to stimulate the interviewee's responses. Therefore, the unstructured interview requires much more skill, is much more complex. (Anonymous) b. ADVANTAGES OF INTERVIEWING:
* Allows the participant to describe what is meaningful or important to him or her using his or her own words rather than being restricted to predetermined categories; thus participants may feel more relaxed.
* Provides high credibility and face validity; results "ring true" to participants and make intuitive sense to lay audiences.
* Allows evaluator to probe for more details and ensure that participants are interpreting questions the way they were intended.
* Interviewers have the flexibility to use their knowledge, expertise, and interpersonal skills to explore interesting or unexpected ideas or themes raised by participants.\
* Sometimes no existing standardized questionnaires or outcome measures are available that are appropriate for what your program is trying to accomplish.
The research began by preparing a rough set of questions and topics which was of interest for my study. These were framed in accordance with the aim and based on the existing literature,
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the researchers personal knowledge and the preliminary research done with respect to the particular organizations. The general question set remained the same as the primary objective was to talk about the FDI s in India.
I used face to face interview method, email method as well as telephone Interview method as part of my research. Face to face interview enables interviewer to establish rapport with the respondent and also allows the interviewer to observe as well as listen. Whereas telephone interview is less costly and less time consuming than personal interview. I observed during my research that telephonic interviews are more suitable when the number of questions are relatively small and time available to gather data is short. As a result of interviews being done via email and telephone the analysis may lack the depth, which can be acquired from an interview of a one to one basis.
There were some instances when the respondents were hesitant in sharing information. In such situations they were assured that their name would be kept anonymous and that this is a purely academic piece of work. Also, they did not want certain bits of information discussed to be written which was duly respected.
2. Questionnaires:
In conducting any research first step is to establish the goals of the project i.e. what you want to learn. These goals will determine whom you want to survey. If your goals are unclear the results will also be unclear. The second step is to know your sample i.e. whom you will interview or what is your target customer. You must make a decision about your sample size based on factors such as: time available, budget and necessary degree of precision. In my research target customers were employees working in MNC`s
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Foreign Direct Investments In India and Some companies executives and also some persons related to academic field. Once you have created the questionnaire, one must pre-test the questionnaire i.e. it must be practical. After entering data into questionnaires the final step is to analyze the data and produce reports (Anonymous, 2006).
In my research I have tried to limit biased sample to minimum. It was very difficult to avoid all biased sample but I have tried to discount some answers where I could feel biasness during my research. a. Questionnaire design:
While designing my questionnaire i tried to keep it as short as possible. If i presented a 20-page questionnaire most potential respondents will give up in horror before even starting. I have divided my questionnaire into three categories. The first set of questions are must know, next set can be categorized as useful to know and last one is nice to know. I also allowed a Don't Know or Not Applicable response to all questions, except to those in which I was certain that all respondents will have a clear answer.
Ideally, the early questions in a survey should be easy and pleasant to answer. These kinds of questions encourage people to continue the survey. In telephone or personal interviews they help build rapport with the interviewer. Grouping together questions on the same topic also makes the questionnaire easier to answer. (Oppenheim, 1993)
I included a cover letter with my questionnaire survey. A good cover letter or invitation to take a survey will increase the response rate. A bad one or none at all, will reduce the response rate. My covering Letter clearly mentioned the aim of research and provided
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Foreign Direct Investments In India confirmation that this survey is just for academic purpose and all information will be kept confidential. This is allowed respondents to answer more freely. Advantages of questionnaires:
Questionnaires are very cost effective when compared to face-to-face interviews. This is especially true for studies involving large sample sizes and large geographic areas. Written questionnaires become even more cost effective as the number of research questions increases. Questionnaires are less intrusive than telephone or face-to-face surveys. When a respondent receives a questionnaire in the mail, he is free to complete the questionnaire on his own time-table. Unlike other research methods, the respondent is not interrupted by the research instrument. Questionnaires are familiar to most people. Nearly everyone has had some experience completing questionnaires and they generally do not make people apprehensive (Anonymous, 2007). Questionnaires reduce bias. There is uniform question presentation and no middle-man bias. The researcher's own opinions will not influence the respondent to answer questions in a certain manner. There are no verbal or visual clues to influence the respondent. It gives you feedback from the point of view of the user. (Kirakowski, 1997)
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Foreign Direct Investments In India 4.6 Limitations of Research:
In carrying out any research some limitations are bound to exist. Due to time constraints and scope of the research, it was difficult to consider an analysis of more firms. In the qualitative research drawing wider inference is dependent on the reliability of data and validity of data. Researcher should collect data from reliable sources. Thus qualitative research involves lot pf personal observation, which may also lead to biasness. In my research I have tried not to be biased and I have chosen reliable sources for my interviews. 4.7 Secondary Research:
Secondary research involves the summary, collation and synthesis of existing research rather than primary research, where data is collected from research subjects or experiments. Secondary research is also applied as a research methodology for this study in order to fill the gaps which existed within primary research. The valuable sources of secondary research which have been used for the purpose of this study includes press releases, company reports, articles, internet and topic related books and journals.
4.8 Summary:
This dissertation is qualitative in nature. Primary data in the form of interviews and questionnaires and secondary data in the form of company reports, press releases and websites were analyzed. The following chapter will analyze the data collected from various respondents who are directly or indirectly involved with the research topic. I have
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Foreign Direct Investments In India made all the efforts in providing an interesting and balanced insight on the research topic at hand.
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Chapter Five Data Analysis and Findings

_____________________________________________________________
5.1 Introduction:
This section attempts to analyse interviews and questionnaire results and feedback. The conclusions developed in the analysis have been deduced from primary data. From large volume of email interview sent out, the analysis comprises of just few respondents. These impacts are not homogenous to the entire population but to a certain section, mainly those belonging to upper society. It was deemed important to get views of various groups of people like policy makers, academics, Indians in foreign firms and Indians in domestic firms. In doing so, one can assess the impact of FDI from different perspectives; reinforcing the fact that FDI is a multifaceted phenomenon. 5.2 Impact of FDI from the Perspective of: i) Indians in Foreign Companies
According to Mr. Rohan Kalra, working as a manager in Accenture, India has got an abundance of well qualified English speaking engineers. With the development and adoption of the Internet world wide it has become relatively easy to connect and work virtually from India. Hiring people in India helps Accenture provide high-end technology services to their clients at a much lower cost, helping Accenture compete against its
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Foreign Direct Investments In India competitors in the global market. Accenture was one of the first consulting companies to change its business model and invest heavily in developing their outsourcing offering in addition to direct client consulting work. Another benefit of investing in India is having teams located globally working on the same projects allows projects to maintain a 24*7 development cycle. Teams in the US handoff in the evening to teams in India and they do the same after their work shift. This increases Accenture overall productivity (Kalra, 2007)
India also is one of the fastest growing economies in the world. This opens a new set of opportunities for Accenture to get more clients in India based in India itself. Apart from outsourcing Accenture has growing its consulting workforce in India and trying to gain a further share in the Indian market (Kalra, 2007). A noticeable feature of India is its size, thus for many corporations this represents untapped potential.
In India, Accenture is a premier destination for both clients and prospective employees. Our business there includes systems building and scale provision of application outsourcing, infra-structure outsourcing and BPO services. Accenture also has continued to build its foundation for serving the domestic India market, which we expect will offer great potential (Kalra, 2007).
According to Mr. Narinder Jain, a dealer of Mitsubishi cars in India states, India provides the foreign investor with big cost savings because of low cost labor available (Jain, 2007). It is estimated that average labor cost is Rs. 310 for 8 hrs i.e. 6 days a week whereas in Europe and America it works out to nearly about Rs. 600/- per hour. Unskilled labor is available in India now on contract basis as well and the
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Foreign Direct Investments In India relevant legal laws of labor are very liberal in India than in Europe & America. India has varied and cheap trained and untrained manpower (Jain, 2007).
A noticeable feature of India is its size; India is the second largest populated country in the world. The requirement of population is huge and volume required is huge. Spending capacity of people is also on the rise which is encouraging foreign investments in India.
India also has large deposits of natural minerals, oils, gas etc. Electricity, petrol and diesel are available in plenty and is much cheaper which makes India as preferred destination for investment (Jain, 2007).
In the views of Mr. Harjinder Singh, Partner in Price Water House, FDI has helped in bringing about global connectivity. People are exposed to working cultures followed in different countries. FDI allows Indians to participate and belong to the international Business community. FDI also facilitate greater flow of ideas in and out of India.
This part of analysis has highlighted that majority of the respondents are in favor of investing in India. The reasons are Indias opening up, the huge pool of skilled labors, the cost advantage and market size. It is not only one factor, but a complex web of factors that motivates a firm investment decision. Moreover, the problem with data here is that the responses are not directly from those who make investment decision, thus these opinions may diverge from corporate reality.
According to Mr. Kalit Jain, working as senior research analyst for Mckinsey in India said, The ability to understand English, speak it clearly, exposure to worldwide news, an understanding of the culture of the people from where business process outsourcing work
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Foreign Direct Investments In India had been obtained, are essential requirements for the MNCs.. He believed that skilled and English speaking manpower is an important factor in attracting FDI to India.
China lacks behind India in English speaking which is a big bonus for India. English is now being taught in china in a big way to increase the number of people who could take up business process outsourcing work (Anonymous, 2005). (http://www.hindu.com/2005/01/13/stories/2005011314010300.htm) 5.3 The view of Academics and Analysts:
According to Mr. V.K Sareen, a senior professor in D.A.V College, Jalandhar states, rapid industrialization and liberalized government policies are key factors in promoting FDI. The foreign investors can now legally take back dividends and profits and set up an industry with majority share holding as well.
The foreigners appreciate the worlds largest democracy continuing to be democrat. Any government in power encourages foreign investment which reduces political risk of investors to some extent. It therefore encourages investment to India.
The impact of such foreign investment on the domestic industry is adverse. The small firms are not able to face the competition from the MNC. Because of reduction of many duties on imported goods they have become very reasonable. People prefer to buy foreign products even if they are getting same product at same price manufactured in India. (Sareen, 2007)
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Foreign Direct Investments In India Mr. Surinder Mahajan, a Charter Accountant by profession who manages accounts of many big MNCs argues that FDI is a key ingredient for economic growth as it supplements domestic industry to mobilize resources required for development in industrial as well as social sector. Therefore, in his opinion FDI acts as an extra source of input into the country. According to Mahajan with companies in a battle for market share, encourages the local firms to employ resources ore effectively and adapt faster to competition as they strive to maintain profits. Hence, FDI forces domestic companies to adopt world class systems, which in turn allows India to come on par with its global competitors. FDI is also preferred over other forms of external financing as it does not create additional debt on the government. 5.4 Determinants of FDI: 5.4.1 Introduction:
This section aims to discuss the various determinants of FDI in Indian economy, the impact that such investment has and the experience of MNC operating in the country. This is done through the means of interviews conducted involving a range of multinationals in the country. 5.4.2 An examination of Determinants:
In this section importance of the various determinants of FDI with respect to India are discussed based on the results from the interview. Importance of various determinants varies within every industry.
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Foreign Direct Investments In India One of the most fundamental questions about FDI activity is why a firm would choose to service a foreign market through affiliate production, rather than other options such as exporting or licensing arrangements. The general answer revolves around the existence of intangible assets specific to the firm, such as technologies, managerial skills etc. FDI is more likely to exist in countries which have surplus supply of capital and skilled labor. 1. Exchange rate effects:
The effect of exchange rates on FDI has been examined both with respect to changes in the bilateral level of the exchange rate between countries and in volatility of exchange rates. Froot and Stein (1991) shows an imperfect capital markets story for why a currency appreciation may actually increase foreign investment by a firm. Imperfect capital markets means that the internal cost of capital is lower than borrowing from external sources. Thus, an appreciation of currency leads to increased firm wealth and provides the firm with greater low cost funds to invest in the counterpart firms in the foreign currency that experience devaluation in the currency (Blonigen, 2005). 2. Incentives:
Number of incentives has been announced to promote investments. These include import of capital goods at concessional custom duty (subject to fulfillment of certain export obligations), liberalization of external commercial borrowing norms, tax holiday and concessional tax treatment for certain sectors. Moreover, many state government offer incentives, such as subsidy on fixed capital, loans at concessional rates of interest and
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Foreign Direct Investments In India attractive power rates. Many firms have been successful in negotiating favorable investment terms with the state government concerned (http://iic.nic.in/iic3_a.htm). 3. Infrastructure:
Infrastructure is an important ingredient for any foreign direct investments. India lags behind in roads, ports, rail, power and water. The reason is simple that India does not spend enough money on these essential economic underpinnings. According to Morgan Stanley's Mumbai-based chief economist Chetan Ahya, China spent $260 billion -- or 20 percent of its GDP -- on power, construction, transportation, telecommunications and real estate in 2002. In comparison, India spent just $31 billion, or 6 percent of GDP. Poor infrastructure leads to less foreign investments and less spillover benefits from the investment which comes to the country (Hiscock, 2004).
Other infrastructure problem is related to the operation of sea ports. Average time to clear goods from customs as reported by Indian firm is about twice high as in emerging countries like Korea or Thailand and 3 4 times as high as in Singapore. Aside from custom clearance, there is also the issue of how well ports operate. Inefficient ports add to transport cost, which makes a country less competitive (Stern, 2001). 4. Rate of Return:
High rates of return or the increase in shareholder value were also mentioned as important driver for investment. Participants expects rate of return to be higher in India as compared with other emerging markets.
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Foreign Direct Investments In India 5. Institutions:
The quality of institutions is likely an important determinant of FDI activity, particularly for less developed countries for variety of reasons. First, poor legal protection of assets increases the chance of expropriation of a firms asset, making investments less likely. Poor quality of institutions necessary for well functioning markets increases the cost of doing business and thus, should also diminish FDI activity. 6. FDI policy:
Core FDI policies consist of rules and regulations governing the entry and operations of foreign investors, the standards of treatment accorded to them, and the functioning of the markets within which they operate (UNCTAD, 1996). The importance of core FDI policy as determinant is proved by the obvious fact that FDI cannot take place unless it is allowed to enter in a country. Its potential relevance is also illustrated when policy changes in direction of more/less openness causes FDI inflows to swing in/out of the country.
According to Mr. K.P Singh President of Radico Khaitan Limited, recent liberalization in FDI policies has encouraged many foreign investors to invest in India. Investors confidence is growing in Indian economy as FDI policies are favoring investors a lot more than few years ago.
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Foreign Direct Investments In India 7. Market size:
The Size of the Indian Market is huge; it owes much of its credit to the fact that it is the second most populated country in the world. Many big firms like Accenture, Mckinsey attribute their recent entry, to the huge market size and the tremendous opportunity for growth. The actual market size appears to be more important for those firms producing products that are basic human necessities.
Mr. Nitin Kalra, dealer for Sony and LG products in India said huge customer base in India is motivating companies to invest here. The demand for luxury products is also on a rise as the economy is booming and there is a general positive sentiment towards global brands. Indian customers no longer mind paying a premium for good quality products.
Mr. S. Roy, president of Bacardi Martini India limited said that the potential market growth in India represents a major locational advantage for all firms. All the firms expect their market to grow significantly. 8. Skilled and English speaking manpower:
The abundant skilled manpower had made India the target destination for multinationals to back their end operations in India. The western companies are jockeying for a position in order to exploit the huge pool of educated talent available in India. India has the largest English-speaking talent pool in the world over 4,40,000 engineering degree- and diploma-holders, approximately 2.3 million other (Arts, Commerce and Science) graduates and 300,000 postgraduates are added each year. Mr. Satish kaul, Vice president
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Foreign Direct Investments In India of Allied Domecq spirits & Wine (P) Ltd also ranked English speaking skills as one of the key determinant of attracting FDI.
Bhardwaj, a manager with a leading call center says, By the time the other countries produce the required English-speaking manpower, the world will be used to the Indian way of speaking and business wont shift unless there is a substantial cost differential. A Chinese person speaking English will take a whole lot more time to get used to when Indians are already being spoken to on such a large scale. (Srivastava, 2004). Number of respondents Determinants of FDI supporting the factor
FDI policy Market size Cost advantage Skilled and
10 8 7 English 5
speaking manpower Infrastructure Incentives Institutions Exchange Rate effect Rate of return 5 3 1 1 1
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Foreign Direct Investments In India 5.5 Outlook of investors on India: 5.5.1 Introduction:
This part of the research attempts to analyse the investment climate in India. The obstacles to investment in India as well as the factors that provide India an edge over other emerging economies are discussed. In order to summarize the results of these findings, the views of foreign investors based on interviews and past survey has been put forth. 5.5.2 Reasons for Investing in India:
Because of the size of population and the potential of its market, India does not pass unnoticed on the radars of international investors. India offers great investment opportunities to the foreign investors whose main objective is to maximize profit by achieving economies of scale and scope. Indian markets have bee growing at a very fast pace since it has been liberalized. In a report by J.P Morgan (2003) it was stated that Indian companies had a higher return on equity than firms in china. Mentioned below are some of the favorable factors that make India an attractive destination of foreign investment:
Large consumer market up to 300-320 million people constitute market for branded consumer products. The policy environment provides clear guidelines for entry, freedom of location, choice of technology, production, repatriation of capital, dividends, etc., which is specifically aimed of enhancing the flow of FDI.
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Foreign Direct Investments In India Large sources of untapped natural wealth and agricultural sufficiency. Vibrant capital market consisting of 22 stock exchanges and over 9000 listed companies Skilled manpower and professional management including engineers, managerial personnel, accountants, and lawyers, available at competitive costs. Demand for innovation and technology up gradation. English preferred business language Stable democratic environment in 60 years of independence. Well developed R&D infrastructure and technical and marketing services.
Source: http://iic.nic.in/iic3_a.htm
The inflation rate in India was around 8 9 % few years ago but now inflation rate is between 4 5%, which speaks volume of the strength and depth of Indian economy. There are also no exchange rate fluctuations which used to be very erratic few years ago. The Indian currency is now more stable than ever before. All these factors have provided investors with lot of confidence in the Indian economy and everybody is quite upbeat about its continued growth.
All respondents indicated that opportunities for investment exist in India. Financial services, industrial products and telecom and high tech forms are most bullish towards India. These are the sectors in which concentrated investment promotion efforts are more likely to yield increased in FDI inflows.
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Foreign Direct Investments In India According to A.T Kearney report, senior executives hold strong opinion towards India. Only small percent of those surveyed felt neutral toward the country. 67% of the respondents said that they are positive about the countrys prospects and 26 % of respondents were negative about the prospects of the country.
CEO perspective on India
7% 26% Negative Positive Neutral 67%
Source: (A.T Kearney, 2001)
5.6 The obstacles in further FDI into India: 5.6.1 Introduction:
With the market liberalization and reforms of 1991 India appeared committed to attracting FDI. A decade later, investors are generally hesitant to invest in the country
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Foreign Direct Investments In India because of the perception that it has done less than other emerging markets to reduce fundamental obstacles in investment. 5.6.2 Results of Interviews:
The following chart summarizes reactions of the respondents who were asked to rate the obstacles to business start ups or expansions. Corruption and bureaucracy poses the major obstacle for most of the respondents. About quarter of respondents described infrastructure as major obstacle in the growth. Policy instability was also one of the big threats.
Policy Instability 15% Skill shortage

4%
Corruption
Corruption
38% Cultural Barrier 9%
Infrastructure
Security Risk
Security Risk 11%
Cultural Barrier
Skill shortage
Infrastructure 23%
Policy Instability
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Foreign Direct Investments In India 5.6.3 Corruption/Bureaucracy:
According to Sareen, Corruption is found to be one of the most damaging consequences of poor governance characterized by lack of both transparency and accountability. Corruption lowers investment and hinders economic growth. It also increases poverty, subverts the financial system, and undermines the legitimacy of the state. Thus, corruption is anti-poor, antidevelopment, anti-growth, anti-investment, and inequitable. The cost of corruption to a nation is very high.
India is amongst the most corrupt countries of the world with a score of only 2.7 out of 10 and ranks 71st amongst 102 countries in 2002. World Competitiveness Year Book 2000 also ranks India amongst those countries where bribing and corruption is very high. (http://unpan1.un.org/intradoc/groups/public/documents/APCITY/UNPAN019888.pdf)
A recent study by the Peruvian economist Paolo Mauro (1995 and 1998) found that a corrupt country is likely to face aggregate investment levels of approximately 5 percentage points less, than a relatively uncorrupt country. The evidence from India is particularly stark. If corruption levels in India were reduced, investments rates could increase annually by 12 percent and the GDP growth rate by almost 1.5 percent each year. (http://unpan1.un.org/intradoc/groups/public/documents/APCITY/UNPAN019103.pdf )
Indian businessmen agree that red tape and wide-ranging administrative discretion serve as a pretext to extort money. According to some foreign business representatives in India, the deluge of corruption lies in the lack of transparency in the rules of governance,
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Foreign Direct Investments In India extremely cumbersome official procedures, and excessive and unregulated discretionary power in the hands of politicians and bureaucrats. 5.6.4 Infrastructure:
According to Mr. Jayant Kapoor, chairman of Bacardi Martini India Limited, _The rapid growth of the last few years has put heavy pressure on Indias infrastructural facilities. There is urgent need for massive programs of expansion and modernization. Problems include power demand shortfall, poor road conditions, low telephone penetration, port traffic capacity mismatch. The unreliable power supply is a burden on all the industries. This leads to less foreign investments and less spill over benefits from the investment you attract.
A report of the committee on infrastructure planning says that the country will need to significantly strengthen infrastructure to maintain Gross Domestic Product growth rate at 9% in the next five years to fix roads, airports and power systems (David, 2007) 5.6.5 High risk investment:
India suffers from the perception that Asia over all is a high risk investment destination. Three fifth of the corporate executives surveyed in the FDI Confidence Index described Asia as high risk region (A.T Kearney, 2001). 5.6.6 Cultural Barrier:
Cultural barriers and income disparity in India pose problem for investment in certain sectors. These factors significantly reduce Indias effective demand and therefore its
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Foreign Direct Investments In India market size. Telecom and high tech firms included cultural barrier and income disparity, as real investment obstacles (A.T Kearney, 2001). 5.6.7 Security Risk:
Investor will not venture into territory where the lives of their personnel and their families are at risk. Investors also like safe cities, safe neighborhoods and safe schools for families to live, work and study. 5.6.8 Policy risk:
The other important deterrent to investment is the policy risk in India. Investors will live with any policy. They will factor in that policy and rework their numbers. But there must be a policy, and that policy must be stable. Investors like stable taxation policies. There have been too many policy gyrations in India. The ministry of finance has been the worst offender. It promised export friendly environment and then taxed export profits. It reintroduced taxed on dividends when it was generally believed that the debate had ended on the subject (Chidambaram, 2007). 5.6.9 Legal risk
Indias pride is the legal system, the common law and British jurisprudence. But the system contains many risks for the investor. At the top of the list is the legislative risk. What if parliament or a state legislature passed a law which upsets the investors assumptions and calculations? Such laws were made in India, for example in 1977, and IBM and coca cola were virtually thrown out of the country.
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Foreign Direct Investments In India 5.6.10 Regulatory Risk:
Many regulatory bodies have been established to regulate the players in different sectors. SEBI for the capital market, TRAI and TDSAT for the telecom sector, CERC and SERCs for the power sector, TAMP for port, IRDA for insurance and so on. These are supposed to be expert bodies. Many decisions have been handed down in recent months, and some of them are quite unfair. There is little evidence of expertise (Chidambaram, 2007).
The political environment is quite hostile to new investment. Regulators have only made it worse. In many cases, regulators act as the extended arm of the government. If some spirit is still left, the taxman effectively kills it. Below are few real life examples:
Nearly half a dozen power projects have withdrawn from Madhya Pardesh because of a misconceived letter from the central government. Moreover, the state government has refused to return the money taken as security deposit pleading lack of resources. In west Bengal, the government and the regulator are on a collision course, and the courts have had to step in more than once to interpret provisions of the electricity laws. In Andhra Pradesh, Public Sector Transmission Company is perhaps the biggest litigant and has its hands full with cases pending before the regulator, the high court and the Supreme Court. Enron remains the most debated case of a foreign investment gone sour and the most celebrated litigation that has yet to see its conclusion.
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Foreign Direct Investments In India These are examples drawn from the power sector alone. There are similar examples in the telecommunication, pharmaceutical, port and other sectors.
Although viewed by foreign investors as high risk and problematic business environment it presents certain advantages which make it one of the most preferred destinations (KPMG). 5.6.11 Conclusion:
In summary, India has come a long way from the regulated economy towards integrated one (with global economies). This journey has been gradual but in the direction which government though would be appropriate in the over all interest of the country. Last few years have set the trend for the bright future in terms of attracting FDI. There has been increasing confidence of investors in the Indian economy. In spite of few obstacles of FDI, India is still considered as one of the most attractive destination for investment as its strengths outweigh its problems. So, the interest of foreign investors would continue to grow in the Indian economy.
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Chapter six Conclusion and Policy Recommendations

________________________________________________________________________ 6.1 Policy Recommendations: i) Export Market:
Exports are the essential part of growing economy. In India export costs are higher because of unsound infrastructure in roads, ports and railways and taxes levied on the transportation of goods from state to state. Investors believe that good quality products can be manufactured in India but the country has yet to position itself as an attractive destination for export market. Addressing the issue of Indias image as a viable export platform is one key to unlocking Indias potential for new and increased investment flows. ii) Banking and financial systems:
We need further deepening and widening through a reform of our banking and financial system so that underlying potential of savings and resources can be mobilized and deployed efficiently. We also need to develop long term debt market which will fulfill both needs of long term savers and the massive investment needs of investment in infrastructure we need.
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Foreign Direct Investments In India iii) Strategic Alliances:
Executives expressed the need for the government to encourage strategic alliances between the Indian business community and foreign direct investors. Seeking protection from foreign competition is a natural reaction of local businesses. The benefits reaped from alliances with investors in Indian market could help local producers offset the costs of competing with foreign exports. iv) Infrastructure:
The development of Indian economy as a whole depends upon the development of infrastructure facilities. The poor infrastructure in India certainly restricts many investors to invest in India. There is need to increase investment in infrastructure. There is urgent need to improve conditions of roads, railways, telecommunication, power and ports. Improvements in such sectors will project India as viable and productive destination. v) Corruption:
The Indian government certainly needs to cut down corruption and encourage more transparent and supportive system. More transparent system will attract foreign investors as they will feel that they are not being cheated. This will create a suitable environment for foreign investors to work within.
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Foreign Direct Investments In India vi) Approval for FDI projects:
Government needs to accelerate the process of granting approval to start FDI projects. Lot of time is wasted in India in getting approvals from the government. Quick decision making will encourage investors to invest in India. vii) Marketing:
Marketing is an integral part for the success of any venture. It is crucial that government takes necessary steps in promoting the benefits of investing in India. There is need to create awareness to the outside world regarding all the investment opportunities available in India. It is also equally important that Indian people realize the benefits of FDI to India if it is to come at par with other emerging economies. viii) Other recommendations:
Some issues like the broadening of the government disinvestment strategy (i.e. privatization), the acceleration of Intellectual Property Rights Law and further reduction on caps to majority ownership. The Indian government can best respond to these concerns by accelerating the implementation of promised reforms. This is one of the signals that can strengthen the trust of international investors in the government commitment to increasing FDI inflows. 6.2 Conclusion:
The study of the research brings out the point that FDI brings many advantages to the host country. FDI is responsible for greater amount of growth and development. As we
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Foreign Direct Investments In India analyzed in our research that Indian economy is on the rise and it offers various benefits to the foreign investors. Because of growth in infrastructure, manufacturing and service sectors, FDI inflows have exceeded FII inflows for the first time. This signifies growing global confidence in Indias long term prospects. Government of India aims to create an environment conductive for risk taking and long term investment.
The investigation into various obstacles of FDI reveals that bureaucracy and lack of infrastructure facilities are the major obstacles. In the long run, excessive bureaucracy could act as greatest barrier to increasing FDI inflows by undermining Indias ability to materialize investor interest. This fact is also confirmed by Sareen and Kapoor during their interviews. A perceived slow down in the process of reform also generates doubt in the minds of investors about the markets long term potential.
India is a country with many advantages. India possesses advantage of skilled and English speaking manpower. The labor is also cheap, which aligns with corporations profit objectives. India also has a vast population and recent opening up of country, represents expansion opportunity for foreign investors. These are the key determinants in making India as the preferred destination for investment.
The impact of FDI on the domestic firms has been positive to a large extent. There is increased competition among domestic firms due to new entrants. This has forced domestic forms to be more efficient in their working as to retain lowering market share and profits. Thus, the consumer enjoys lower prices and better quality products. FDI is also providing significant employment opportunities within the country, which further leads to better standard of living and more purchasing power with the people.
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Foreign Direct Investments In India FDI can be categorized as biggest source of revenue for the government. The money earned through FDI should be utilized in a way which leads to development of the country. The revenues can help in building better infrastructure and also can help country in mobilizing its resources so as to achieve greater productivity. However, as mentioned earlier in the research that positive aspects of FDI overweigh negative aspects and therefore, flow of foreign funds through FDI will continue to grow in future.
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www.rediff.com www.worldbank.org www.indiainvest.com www.investopedia.com http://iic.nic.in/iic3_a.htm http://dacnet.nic.in

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Appendices ______________________________________________________
Appendix A: Research Questionnaire
Questions to ascertain impact of FDI in India: 1. What impacts do you believe this increasing foreign presence has for domestic companies in India? 2. How helpful is FDI in bringing about growth and economic development in India? 3. Does the Indian economy benefit from the up gradation of technology as a result of foreign capital?
Questions to ascertain determinants: 1. How helpful is the government attitude and foreign direct investment policies in attracting FDI? 2. Did the government offer any incentives to invest in India? 3. What importance was given to the political scenario before choosing India as the destination for investment? 4. Do you believe infrastructure is an important determinant in receiving FDI in India? 5. Why has there been a surge in FDI in India over the last 5 10 years? 6. How far the decision of investing in India was influenced by the availability of cheap labor or reduced cost? Was the company attracted because of abundant supply of natural resources? 7. How far the decision of investing in India was influenced by the availability of skilled and English speaking workforce? 8. How crucial was the market size of India in making a investment decision?
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Foreign Direct Investments In India Question to ascertain Investor outlook towards India: 1. What factors deter investments in India? 2. What measures can India take to improve their chances of receiving FDI? 3. What challenges does MNC face in the Indian market? 4. Was the banking system adequate to meet the needs of foreign investors? 5. Have u faced any intellectual property related issues while working in India?
6. Where do you rate FDI policies of Indian government for attracting FDI to India?
7. To what extent were you affected by security or terrorism concerns? 8. How do you rate India as a global business destination? Please add any additional comments, which you believe, can help me with my research. I would like to thank you for taking the time out to participate in my research. Regards Mr. Vikas Kapoor
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Appendix B: List of respondents
Name 1. Mr. Rohan Kalra 2. Mr. Narinder Jain 3. Mr. Harjinder Singh 4. Mr. Kalit Jain 5. Mr. V.K Sareen 6. Mr. Surinder Mahajan 7. Mr. K.P Singh 8. Mr. Nitin Kalra 9. Mr. S. Roy 10. Mr. Jayant Kapoor 11. Mr. Satish Kaul
Company/Institute/Profession Accenture Mitsubishi (India) Price Water House Mckinsey DAV College, Jalandhar Charter Accountant Radico Khaitan Limited Sony and LG Products Bacardi Martini India Limited Bacardi Martini India Limited Allied Domecq spirits & Wine (P) Ltd
Designation Manager Dealer for North India Partner Senior Research Analyst Senior Professor
President Dealer for North India President Chairman Vice- President
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Foreign Direct Investments In India

FOREIGN DIRECT INVESTMENTS: A STUDY BASED ON THE INDIAN ECONOMY

Foreign Direct Investments In India

Foreign Direct Investments In India

Foreign Direct Investments In India

4.6 4.7 4.8

Foreign Direct Investments In India

Foreign Direct Investments In India III. The Beginning:

VI. Types of FDI:

FDI can be categorized under five major headings:

Positive & Negatives of FDI Positives Negatives

Foreign investor will crowd out local producers

Development of local business clusters of technology and

host Transfer expertise

with corruption in economies of scale

developing economies May have to develop

Outline of the dissertation:

I have included six chapters in my research work. Chapter one

Foreign Direct Investments In India Chapter Two

Foreign Direct Investments In India

Chapter one Literature Review INDIAN ECONOMY

Foreign Direct Investments In India GDP Real Growth Rate

1.2 Sectors of Indian Economy:

Foreign Direct Investments In India %share of Agriculture in National Export/Imports

http://dacnet.nic.in/eands/Imports-Exports-Inflation%20Rates13-14.htm 1.2.2 Manufacturing Sector

Foreign Direct Investments In India 1.3.4 Inflation Trends

June, 2007 Rupee

Foreign Direct Investments In India

Foreign Direct Investments In India

Chapter Two Literature Review Foreign Direct Investment

Foreign Direct Investments In India 2.3 THE PRODUCT-LIFE-CYCLE THEORY

Developed Economies Developing Economies

INDIA: YEAR WISE FDI INFLOWS

Foreign Direct Investments In India

INDIA: Share of Top Investing Countries FDI Inflows

2.5 FDI and India:

2.5.1 Automatic Route:

FDI in India on automatic route is not allowed in the following sectors:

Proposals in which the foreign collaborator has a previous venture/tie-up in India.

Foreign Direct Investments In India

(Anonymous, 2007) 2.5.3 Government Approval Route:

Foreign Direct Investments In India

companies in infrastructure and services sector.

2.5.4 List of activities in which FDI is not allowed:

Investments into India are not permissible in the following cases

2.6.1 Automatic Approval

(b) Location is in conformity with the prescribed parameters.

(d) Unit is amenable to bonding by customs authorities.

(b). atomic substances

(c). narcotics and psychotropic substances and hazardous chemicals

(d). distillation and brewing of alcoholic drinks

(e). cigarettes/cigars and manufactured tobacco substitutes. 2.6.2 Government Approval

(Investing in India, 2004)

Foreign Direct Investments In India

Foreign Direct Investments In India

Chapter Three Political Risk

Foreign Direct Investments In India 3.2 Definition:

(Wafo, 1998) 3.4 The Management of Political Risk:

Foreign Direct Investments In India b) Old Hands

Foreign Direct Investments In India 3.6 Conclusion:

Foreign Direct Investments In India

Chapter four Research Methodology

Foreign Direct Investments In India 4.3 Qualitative vs. quantitative