FDI & FPI Flashcards
What is FDI/FPI/FII?
FII
Individual/Company invests in Indian companies upto 10% of the company’s shares.
FDI
Company invests in Indian companies more than 10% of the company’s shares.
FPI
Individual/Company invest in Indian companies in a diverse portfolio consisting of stocks, bonds, debt, debentures et cetera.
How has Indian policy been in the past w.r.t FDI and FPI?
I. Post independence Import Substituting Industrialization
Focus on improving local capability in heavy industries such as machinery manufacturing sector.
Since we had limited assets (entrepreneurship, technology, skills), we were receptive towards FDI.
Majority local ownership was preferred.
II. Late 1960s - More Restrictive Towards FDI
As local machinery manufacturing capability and entrepreneurship developed and outflow of profits and dividends as FDI increased, govt restricted FDI.
FDIs without tech transfer, FDI seeking more than 40% foreign ownership were restricted.
III. 1973 on, foreign companies’ activity restricted to high priority industries. FERA required all foreign companies in India to register under law with max 40% foreign equity. Exceptions were made for companies in high priority sectors etc.
IV. 1980s Liberalisation of Industrial Licensing
Strategy to modernize industry
Seek imports of technology and capital goods
Exposed Indian industry to foreign competition
Assigned greater role to MNE in promotion of manufactured exports
Gov offered incentives, exemption from FERA, and flexibility concerning foreign ownership.
V. 1990s Reforms
What decides how much FDI we get?
India
Market size Huge
Extent of Urbanization Low
Quality of Infrastructure Poor
Geographical and cultural proximity with sources of capital No
Policy factors (Tax rates, Investment incentives, performance requirements) Improving
What were the 1990s reforms (in context of FDI/FPIs)?
Decided to increase integration with global economy.
Departure from restrictive policy towards FDI towards a liberal trade policy
- Reforms of capital market and exchange control
- Abolished industrial licensing (except in strategic industries)
- Created system of auto clearance of FDI proposals
- Opened new sectors to foreign companies
(Mining, Banking, Insurance, Telecom, Construction, Port, Harbors, Highways, Airlines, Defence Equipment) with sectoral caps - Allowed FIIs to invest in all types of securities traded on financial markets without restrictions
- Outward FDI liberalized meaning Indian firms can now invest abroad upto 100%
How is quality of FDI flows judged?
Sectoral Composition of FDI
Sectoral FDI composition in one metric to judge quality of FDI flows in India.
Modern Tech intensive sectors (builds productive capacity) or Conventional sectors (crowds out domestic investment)
How does India fare in terms of sectoral composition of FDI?
Pre 1990, bulk of FDI inflows were directed to manufacturing especially after high technology industries like machinery, chemicals, electricals, and transport equipment but after liberalization a substantial portion of FDI has been directed towards services.
Post 1991, FDI stock is more evenly distributed between food and beverages, transport equipment, metals, electricals, chemicals and misc. manufacturing.
What is the impact of FDI on growth and investment?
FDI inflow increase capital stock and enhances technology. This leads to higher growth rate.
High growth rates attract more FDI by improving the investment climate of the country.
Therefore, FDI-growth rate relationship is subject to causality bias given the 2 way relationship.
In India, this relationship is neutral.
Sometimes FDI projects actually crowd out domestic investments from the market.
An earlier study however did not find a significant effect of FDI on domestic investment in India.
Therefore FDI inflows received by India have been mixed combining some inflows that crowd in domestic investments while others that crowd out.
Studies show that the relationship between FDI and domestic Investments depends on the host government policies.
The Indian government had imposed condition of phased manufacturing programs in the auto industry to promote vertical inter firm linkages and develop the auto component industry.
A case study shows that these policies have succeeded in building and internationally competitive vertically integrated auto sector in India.
FDI and Export Platform Production
Use - resources of MNEs - global brand name, technology, integration in GPNs to expand own manufactured exports eg China global factory. Higher chance that FDI crowd in domestic investment instead of crowd out.
India - unable because FDI inflows are market seeking, poor FDI quality, 2 observations
- Export-oriented production base India becoming attractive for MNEs
- Policies by host country for exploiting FDI
- Export Obligations
China - foreign owned enterprises must export more than 50% of their output
India: Indirect export obligations
- Dividend balancing imposed
MNE obliged to earn the foreign exchange that it sends abroad as dividend - Foreign exchange neutrality
MNE must ear the foreign exchange enough to cover outgo via imports
Evidence suggests - have been effective
Eg. Auto Industry India
Rising exports
new opportunities for indian manufacturers
competitiveness
R&D, Knowledge, Local Tech Capability
I.
- In India, foreign firms spend more on R&D than Indian firms
- MNEs lower R&D intensity than locals due to access to their headquarters
- Local focus on absorption of imported knowledge
- MNEs focus on customization of their parents’ tech for local market McAlooTikki
II. Diffusion & absorption of technology
- Tech transfer requirement not so effective eg Malaysia
- Local content requirements and export performance requirements have prompted MNEs to diffuse some knowledge
- Domestic equity requirements facilitate quick knowledge absorption, local capability, knowledge transfer, self reliance eventually for locals
- However, key technology may not transfer fearing diffusion through mobility of employees.
FPI Inflows and Their Impact
Rapid rise in inflows in portfolio short term equity investments
Indian capital markets giving attractive returns
Highly volatile
- Sharp movements linked to global developments, transfer global volatility into country, many countries imposed capital controls to contain volatility
- Expensive-High servicing burden because they come to chase good returns, in 2008 for 1 $, Indian markets were giving 1.44$ back
- Exposure to these enhances need for reserves
India emerging source of FDI outflows
Indians acquiring large companies in advanced economies to gain assets like global brand names, technology, knowledge, global marketing networks.
Acquisition based strategy for internationalization
Tata motors jaguar land rover
Indians skill for managing large operations delivering value for money
Conclusion & Policy Lessons
- Liberalization is not sufficient for FDI inflows - current economic scenario matters majorly by signaling investors
- Quality of FDI - policies of government - phased manufacturing programme
- Favorable spillovers and generates demand for intermediate goods
- FDI inflows ko new areas mie push karo to develop capability there
- Government intervention to maximize gains from globalization, vertical inter firm linkages, requirements, incentives ke thru
- Favorable externalities through FDI in education and skill training
- Widening CAD - Merchandize trade deficit, export growth and exploiting the opportunities for import substitution work on local production of …
