1. LIBERALISATION, FDI FLOWS AND DEVELOPMENT

2. Evolution of Government policy towards FDI 1948-late 60s Import substitution (with local products) prevalent; for improving the local capabilities in heavy industries The created assets were limited, so FDI with majority local ownership became welcome. Late 60s- 1973 FDI-related outflows like dividends, profits, royalties, technical fees and payments of imports rose Local manufacturing capability (especially machinery) and entrepreneurship had developed. So, restrictions imposed on FDIs claiming more than 40% ownership and those unaccompanied by technology transfer. 1973 – 80s Foreign exchange regulation act / FERA – all foreign cos. operating in India to register under Indian corporate legislation with a maximum of 40% foreign equity Exceptions from the 40% limit rule – high priority or high technology sectors, tea plantations and export oriented firms.

3. Evolution of Government policy towards FDI 1980s Liberalisation of licensing rules and incentives for imports of capital goods and technology. Exemption from foreign equity-related FERA restrictions for 100% export oriented units Flexibility allowed for the foreign equity – rule. Primary intention – facilitate the increased role of MNEs in manufactured exports and expose Indian industry to more global competition 1990s New Industrial Policy (NIP,1991,Jul 24) – abolition of industrial licensing system except in the case of strategically or environmentally sensitive areas. NIP allowed automatic clearance of FDI proposals fulfilling the different levels of foreign equity (50%, 51%, 74% and 100% for different sectors) Opening of new sectors to FDI - mining,banking,insurance,telecommunications,construction,airlines,infrastructure management and defence equipment. 100% foreign ownership permitted in most manufacturing areas (exceptions like defence(26%) and items reserved for SSIs(24%)) 2000 Dividend balancing and export obligation conditions on foreign investors (applicable to 22 consumer goods industries) were withdrawn

4. Trends and patterns in FDI inflows versus Liberalisation Trend is of an increasing nature (3.6 bn USD in 1997; 4.3 bn USD in 2003) Reasons for the rise (till 1997) Sharp increase in the global scale of FDI outflows in the 90s. Decline in FDI inflows after 1997 to around 2.5 bn USD was despite the continued policy reforms. Macro-economic variables of the host countries (the most powerful explanatory variables as per studies) Similar trends in industrial output and FDI inflow growth rate (with lag, i.e, growth in industrial output this year means a higher FDI inflow next year) Above arguments lead to the conclusion that liberalisation was a necessary but not a sufficient condition for FDI inflows. Macroeconomic policies chiefly dictate the FDI inflows.

5. Liberalisation & changing sectoral composition of FDI Mining, Petroleum and plantation saw a fall [from 9% of the total FDI stock in 1980 to 2% in 1997] Manufacturing sector saw a fall [from 87% of total FDI stock in 1980 48% by 1997] Increased shares of the total FDI stock for services and infrastructural (mainly power) sectors post- liberalisation. Even distribution within manufacturing amongst the different subsectors in 1997 (heavy focus on tech- intensive sectors in 1980s) Infrastructural sectors had half of total approved investments in 1990s. (almost marginal FDI in the 1980s) 61% of approved service sector FDI in 1991-2000 went to telecommunications. Financial and banking sector commanded 14% of the total service sector FDIs (post 1991).

6. Liberalisation & changing sources and modes of FDI Source European countries - major FDI sources pre-liberalisation (69% of FDI stock in ‘80) Their share fell to 31% in ‘97. US emerged as an important source ……[share of 19% of FDI stock in ‘92] U.S share of 13.75% in ‘97 is underestimated because a majority of U.S investments were(are) routed through Mauritius. The Double taxation Avoidance Agreement is understood to be the reason for the emergence of Mauritius as the biggest source (18% of FDI in 1997) Mode of entry Majority of the FDI was made through greenfield entries in the pre-reform area. M&As gained significance post reform in the late 90s……[39% of FDI inflows during 97-99 were through M&As] The trend is argued to be unfavourable because of the higher knowledge-spillovers, competition effects and addition to productive capital associated with greenfield entries.

7. FDI inflows: India in the east Asian context Argument _ “Although FDI inflows rose post liberalisation, India’s share is still very small. “ India’s FDI of 3.4 bn USD in 2001 was just 1.7% of that received by the developing nations. China’s 46.8 bn USD was about 23% of the same total. Counter-arguments Indian FDI counts only the fresh foreign equity additions. Globally (IMF guidelines), reinvested earnings and inter-corporate debt flows are also counted. Chinese FDI inflows are inflated because of round tripping # effects The Chinese economy is much larger – the figures have to be normalised. Adjusting for these, the estimates of FDI inflows : GDP of 3.6% in China and.5% in India get revised to 2% and 1.7% respectively (2000) Adoption of global practices led to near doubling of India’s FDI inflows (from 3.9 bn USD to 6.1 bn USD in 2001-02) #Round tripping : The practice of selling assets and buying them back with additions to both revenues and capital expenditures without changing profits. Done for tax reduction.

8. FDI inflows: India in the east Asian context ….Even then (& with a big domestic market), Indian FDI inflows are lower compared to other developing nations because of Low income levels Low levels of urbanisation Poor quality of infrastructure Geographical & cultural proximity of nations like Japan & Korea with major sources of capital Lack of fiscal incentives like tax concessions to attract FDI Behind her neighbours in the introduction of policy reforms (lags behind China by 12 years) Special economic zones in China which allow specialised infrastructure and flexibility in regulations like labor laws. Post –reform rise of services, infrastructure and low technology intensive consumer goods has led to a lack of focus on the manufacturing sector in India. While China and other east Asian economies have also liberalised, some policies like export obligations have led to an FDI-led export growth in these countries.

9. Impact of FDI : Shares in Sales, capital and output Decline in foreign firms’ contribution to total sales in 1980-1990 (restrictive policies) Eg. Foreign firms’ share in total sales in manufacturing fell from 31% in 1980 to 26% in 1990 Rise in share of foreign firms’ sales in total sales from 1990 -2000 Rising ratios of FDI inflows to gross fixed capital formation (.3% in 1980 to 4% in 2003) Rising ratio of inward FDI stocks to GDP (.5% in 1980 to 5.4% in 2003)

10. Impact of FDI : Growth High FDI implies augmented capital stock and new technology leading to growth High growth implies better investment climate leading to more FDI inflows! These are general arguments For India, studies have shown the absence of a significant direction of causation for FDI inflows and growth rates.

11. Impact of FDI : Domestic investment Domestic investments are argued to be crowded out during times of FDI inflows. For India, studies did not establish a statistically significant effect of FDI on domestic investment. Empirical studies show that government policies have a major role to play. Policies - Performance requirements like the LCRs(Local content requirements) Eg. Phased manufacturing program and other policies in the Indian manufacturing industry has led to development of the auto component industry (crowding in of domestic investments) and better inter-firm vertical linkages

12. Impact of FDI : Exports and BoP Previous studies - No statistically significant difference between the export performance of local firms and foreign subsidiaries/ventures (Indian) in the pre –liberalisation phase. FDI had no significant impact on export performance during 1970 -1998(although the relationship was positive). Export performance of foreign firms in India were marginally better than that of the local firms during 1996-2000 (better difference in the case of medium – high technology sectors) Controlling for industry and firm specific characters and fiscal incentives, foreign subsidiaries/ventures were found to perform better than the local firms with regards to exports, in manufacturing. [ period 1988 -2001] Argument – reforms have prompted foreign MNEs to use India as an export-platform to a modest extent. Trade liberalisation was found to be an important factor that facilitated such export orientation in host countries (another study)

13. Impact of FDI : Exports and BoP Export obligations have been used effectively by countries like China to boost FDI-led export growth Wholly owned foreign enterprises must export more than 50% of their output in China As a result, 44% of manufactured exports were made by foreign enterprises by the end of 90s MNE affiliates accounted for over 80% of China’s high technology exports India doesn’t impose such obligations except in the case of products related to SMEs. However Indian policies like dividend balancing* and foreign exchange neutrality** have increased the MNE affiliates’ export orientation. Eg. Indian auto component exports grew to levels much more than the imposed obligations. The regulations gave the auto majors and Indian component manufacturers profitable opportunities for business. Pepsi’s example of contract farming in Punjab is also an example of such mutual benefits related to export orientation – here the farmers benefited from new technology.

14. Impact of FDI : R&D _ Technological capability R&D expenditures of MNE affiliates appear to be more than those of local firms during 1990 - 2001. But by 2001 the gap narrowed significantly. Difference in motivation behind R&D For MNE affiliates R&D focuses on customisation of parents’ tech for the local market. For local firms R&D is for absorption of imported knowledge and for their outward expansion. Studies have also shown that Indian MNE affiliates spent more for foreign technology purchases, reducing their R&D.

15. Impact of FDI : R&D Diffusion Knowledge-spillovers - when the knowledge gap between the foreign and local firms is wide, the spillovers have a negative effect on productivity (positive when the gap is narrow). Technology transfer requirements (Malaysia) have found to be ineffective in creating local learning and diffusion when compared to domestic equity requirements, export obligations (discussed earlier) and local content requirements. Indian two –wheeler industry : domestic equity requirements have made possible the quick absorption of knowledge brought in by MNEs. They became self-reliant in production and developing their own quality models. Argument : domestic equity requirements affect the quality and extent of technology transfer. Counter arguments : Foreign enterprises wont fully transfer their technology anyway (fear of dissipation through mobility of employees) Studies have shown that technology transfers to joint ventures and partnerships are more beneficial for local learning and diffusion than those to sole ventures (wholly owned subsidiaries)

16. Impact of FDI : Firm size, profitability and efficiency Foreign affiliates have been larger in size than their local rivals. Reason : they usually employ non-price rivalry like product differentiation; economies of scale becomes important. Foreign firms have higher profitability margins than their local rivals. Reason : They usually target the upper segments of the market with product differentiation. There was no significant evidence to suggest that they utilise their resources better than the local firms. Foreign affiliates’ profit margins have been found to more stable than that of their local rivals.

17. FDI & Indian Software industry Indian software industry’s growth: Grew at a compound annual rate of over 50% during the 90s. 12 bn USD export earnings in 2003-04 from a meagre 100 million USD in 1989-90. Has facilitated creation of employment and entrepreneurship. Mainly driven by local enterprise, talent and resources. Role of MNEs was limited All the major software MNEs are present. Some were Indian cos. Taken over by foreign entities. Some are promoted by NRIs and others software/application development centres for parent software/non-software companies. Their contribution to exports is limited.

18. FDI & Indian Software industry The distributed gains from these MNEs’ activities are limited Mostly the design and development centres of MNEs produce results that are valuable to them (Eg. SAP’s DRM, Oracle’s network computer) Revenue sharing is limited. Mostly a mark-up of 10-15% on these products sold to Indian subsidiaries. There are no inter-firm linkages with domestic entities. Almost all the interactions are with their parents abroad. No knowledge-spillovers to the domestic industry. Qualified professionals form domestic cos. are usually attracted to these cos. (backward flow however, is negligible)

19. FDI & Global R&D activity in India The development of ICT (International Communication and Information Technologies) has enabled foreign entities to create Research hubs and networks. The research sub-projects are carried out in nations with the required skills and resources. This reduces the chance of dissipation of their priced knowledge. India’s developed S&T infrastructure and resources have prompted MNEs to setup such hubs here. Infrastructure : centres of excellence like the IISc Resources : cheap and qualified research manpower. Some facts: Around 100 MNEs setup their R&D centres in India from 1999-2003. More than 1000 patents applied in the U.S were filed through outputs from Indian R&D hubs. Such centres have sprouted in a few cities like Bangalore and Hyderabad.

20. FDI & Global R&D activity in India. MNES also enter into research contracts with institutes Eg. Astra AB’s and Daimler Benz’s( Benz- project in avionics) collaboration with IISC DuPonts contracts with IICT and NCL. The cumulative investments made by the government in this regard are termed ‘national innovation systems’. (+ve externalities) Argued as public funded infrastructure crowding in private investments in skill intensive activities.

21. OUTWARD FDI FROM INDIA - TRENDS

22. Facts Published data are known to underestimate the correct values of OFDI. Foreign investment projects weren’t registered Many subsidiaries were left out Measurement of the size of investments was an issue. Colonial times Indian businessmen invested in raw materials processing facilities Mainly in parts of the British empire like East Africa, Burma and Ceylon (with which trade existed) Mostly however, the investors settled in the host countries Post 1950 Birla established a textile mill in Ethiopia in the mid-1950s (first industrial investment) 1960s - industrial ventures were started in Kenya, Malaysia, Nigeria, Uganda, Ceylon and Thailand. Birlas held a chunk of these investments.

23. Two – Wave Hypothesis of Indian OFDI(Pradhan) First Wave (pre-1991) Manufacturing – led OFDI Indian equity – minority owned. Reasons for OFDI : Access to large markets & resources Strict domestic regulations Monopolistic advantages : Low-cost Indian tech. and mgmt. skills Ability to adapt imported tech. to Indian machine. Greenfield type OFDI (largely) Second Wave (Since 1990s) All sectors [service dominated] Indian equity – majority owned. Reasons for OFDI: Market seeking Acquiring tech. & brands Acquire trade-supported networks Monopolistic advantages: Increased innovation Brand acquisition Growing size and efficiency Brownfield type OFDI (largely)

24. OFDI growth Indian OFDI-growth started post – 2000 (marginal before that) India - 21 st largest outward investor [UNCTAD 2010] Reasons for the spike: Improvements in economic performance Competitiveness of firms Easy access to capital (& fin resources) Ongoing liberalisation in OFDI policies. Emergence of ambitious and competent Indian cos. More capital inflows meant lesser restrictions on outflows [incl. OFDI]

25. Indian OFDI policies (RBI’s take) Phase I 1992-95 Automatic approval* established; cash remittances introduced Compulsory repatriation of dividends Upper cap of USD 2 million [cash-share <.5 million in a block of 3 yrs] Phase II 1995-2000 Approvals transferred from Ministry of Commerce to RBI {single window for clearance} Fast track route ** – cap raised to USD 4 million Phase III 2000 - _ Per annum upper cap increased to USD 100 million [for automatic route till 2003]. Post 2003 – Indian cos. abroad can invest to the extent of 400% of their net worth.# Cos. allowed to invest in all bona-fide activities except real estate and banking. Cos. allowed to finance overseas acquisitions using SPVs.##

26. Descriptions of certain points in the previous slide *Automatic approval - no prior approval needed from the ministry or RBI; approach authorized dealers like banks instead ** Divided cases into ‘normal’ and ‘fast track’ – fast track cases were allowed automatic approval #Exceptions – funds through Global Depository Receipts, energy and natural resource sectors. ##SPVs – separate entities created for acquisitions or financing assets – removes financial risk of the parent co.

27. Indian OFDI policies (Pradhan’s take) Phase I : 1978 - 1992Phase 2 : 1992 onwards Policy Objectives For South-South co-operation*For global competitiveness Maximise economic gains with minimum forex costs Maximise exports, acquire foreign tech. & join emerging trade blocs. Strategies Only minority-owned JVsRemoval of ownership restrictions Equity participation through exports of Indian tech. and capital equipment Participation allowed through cash transfer as well. Equity participation through exports of old machinery not allowed Such capitalisation allowed. Cash remittances are allowed only in select cases. Equity participation through ADR/GDR allowed. Overseas JVs must be in the same line of business Allowed for any business activity (with exceptions) * - used to refer to the developing nations (also called “Global South”) which shared their resources

28. Changes in patterns of OFDI Geography Concentrated in developing nations in 70s and 80s India & these nations – same colonial heritage & presence indian diaspora. familiarity with restrictive outward policies. Similarities have waned out in the post reform period. Sector OFDI mainly in manufacturing in the 60s, 70s and 80s. Post reform – diversification to sectors with competitive advantages. These sectors - services, IT software and pharma. % of manufacturing in approved capital (OFDI) fell from 72% to 44% during 2004 - 2008

29. Changes in patterns of OFD Entry mode Till mid 90s – Greenfield investments; No acquisitions Mostly JVs with minority ownership. From 2000 to 2008 acquisitions increased from 25 to 277 Acquisitions were 80% of Indian OFDIs (at 22 bn USD, during 2005-08) Players 1980s – large conglomerates like Birlas & Tatas Post reform – new players entered (small & medium scale firms) Acquisitions are still concentrated in a few large firms Refer 3 rd slide for general differences

30. Thank you.