Chapter-1 Introduction

The Foreign Direct Investment means “cross border investment made by a resident in one
economy in an enterprise in another economy, with the objective of establishing a lasting
interest in the investee economy. FDI is also described as “investment into the business of a country
by a company in another country”. Mostly the investment is into production by either buying a
company in the target country or by expanding operations of an existing business in that country”.

Such investments can take place for many reasons, including taking advantage of cheaper
wages,specialInvestment privileges (e.g. tax exemptions) offered by the country. Foreign Direct
Investment (FDI) broadly encompasses any long-term investments by an entity that is not a resident
of the host country. Typically, the investment is over a long duration of time and the idea is to make
an initial investment and then subsequently keep investing to leverage the host country’s advantages
which could be in the form of access to better (and cheaper) resources, etc.

This long-term relationship benefits both the investor as well as the host country. The investor
benefits in getting higher returns for his investment than he would have gotten for the same
investment in his country and the host country can benefit by the increased know how or technology
transfer to its workers, increased pressure on its domestic industry to compete with the foreign
entity thus making the industry improve as a whole or by having a demonstration effect on other
entities thinking about investing in the host country.

The FDI Report is based on the recent update of the on line FDI Database. It provides a presentation
and analysis of FDI flows and stocks in Central, East and South East Europe (CESEE) and keeps
track of their most important features.

This issue of the FDI Report is the first to apply the sixth edition of the IMF’s Balance of Payments
and International Investment Position Manual (BPM6). Also, the FDI Database has been adaptedto
the new methodology. Following international practice, FDI data are primarily presented on the
basis of the directional principle. FDI flow data based on the asset/liability principle are also
included for comparison and in relationship to other balance of payments positions. Deviations from
the international standards are marked if a country has not applied the new standards or does not
provide data based on the directional principle.
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Meaning:

These three letters stand for foreign direct investment. The simplest explanation of FDI would be a
direct investment by a corporation in a commercial venture in another country. A key to separating
this action from involvement in other ventures in a foreign country is that the business enterprise
operates completely outside the economy of the corporation’s home country. The investing
corporation must control 10 percent or more of the voting power of the new venture.

According to history the United States was the leader in the FDI activity dating back as far as the
end of World War II. Businesses from other nations have taken up the flag of FDI, including many
who were not in a financial position to do so just a few years ago.

The practice has grown significantly in the last couple of decades, to the point that FDI has generated quite a
bit of opposition from groups such as labor unions. These organizations have expressed concern that
investing at such a level in another country eliminates jobs. Legislation was introduced in the early 1970s
that would have put an end to the tax incentives of FDI. But members of the Nixon administration, Congress
and business interests rallied to make sure that this attack on their expansion plans was not successful. One
key to understanding FDI is to get a mental picture of the global scale of corporations able to make such
investment. A carefully planned FDI can provide a huge new market for the company, perhaps introducing
products and services to an area where they have never been available. Not only that, but such an investment
may also be more profitable if construction costs and labor costs are less in the host country

The definition of FDI originally meant that the investing corporation gained a significant number of
shares (10 percent or more) of the new venture. In recent years, however, companies have been able
to make a foreign direct investment that is actually long-term management control as opposed to
direct investment in buildings and equipment.

FDI growth has been a key factor in the “international” nature of business that many are familiar
with in the 21st century. This growth has been facilitated by changes in regulations both in the
originating country and in the country where the new installation is to be built. Corporations from
some of the countries that lead the world’s economy have found fertile soil for FDI in nations where
commercial development was limited, if it existed at all. The dollars invested in such developing-
country projects increased 40 times over in less than 30 years. The financial strength of the
2
investing corporations has sometimes meant failure for smaller competitors in the target country.
One of the reasons is that foreign direct investment in buildings and equipment still accounts for a
vast majority of FDI activity. Corporations from the originating country gain a significant financial
foothold in the host country. Even with this factor, host countries may welcome FDI because of the
positive impact it has on the smaller economy.

Foreign direct investment (FDI) is a measure of foreign ownership of productive assets, such as
factories, mines and land. Increasing foreign investment can be used as one measure of growing
economic globalization. Figure below shows net inflows of foreign direct investment as a
percentage of gross domestic product (GDP). The largest flows of foreign investment occur
between the industrialized countries(North America, Western Europe and Japan).But flows to non-
industrialized countries are increasing sharply.Foreign direct investment (FDI) refers to long term
participation by country A into country B.

It usually involves participation in management, joint-venture, transfer of technology and expertise.

There are two types of FDI: inward foreign direct investment and outward foreign direct
investment, resulting in a net FDI inflow (positive or negative) .Foreign direct investment reflects
the objective of obtaining a lasting interest by a resident entity in one economy (‘‘direct investor’’)
in an entity resident in an economy other than that of the investor (‘‘direct investment
enterprise’’).The lasting interest implies the existence of a long-term relationship between the direct
investor and the enterprise and a significant degree of influence on the management of the
enterprise. Direct investment involves both the initial transaction between the two entities and all
subsequent capital transactions between them and among affiliated enterprises, both incorporated
and unincorporated.

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DEFINITION

Foreign direct investment is that investment, which is made to serve the business interests of
the investor in a company, which is in a different nation distinct from the investor's country of
origin. A parent business enterprise and its foreign affiliate are the two sides of the FDI
relationship. Together they comprise an MNC.

The parent enterprise through its foreign direct investment effort seeks to exercise substantial
control over the foreign affiliate company. 'Control' as defined by the UN, is ownership of
greater than or equal to 10% of ordinary shares or access to voting rights in an incorporated
firm. For an unincorporated firm one needs to consider an equivalent criterion. Ownership
share amounting to less than that stated above is termed as portfolio investment and is not
categorized as FDI.

FDI stands for Foreign Direct Investment, a component of a country's national financial
accounts. Foreign direct investment is investment of foreign assets into domestic structures,
equipment, and organizations. It does not include foreign investment into the stock markets.
Foreign direct investment is thought to be more useful to a country than investments in the
equity of its companies because equity investments are potentially "hot money" which can
leave at the first sign of trouble, whereas FDI is durable and generally useful whether things go
well or badly.

FDI or Foreign Direct Investment is any form of investment that earns interest in enterprises
which function outside of the domestic territory of the investor. FDIs require a business
relationship between a parent company and its foreign subsidiary. Foreign direct business
relationships give rise to multinational corporations. For an investment to be regarded as an
FDI, the parent firm needs to have at least 10% of the ordinary shares of its foreign affiliates.
The investing firm may also qualify for an FDI if it owns voting power in a business
enterprise operating in a foreign country.

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HISTORY

In the years after the Second World War global FDI was dominated by the United States, as
much of the world recovered from the destruction brought by the conflict. The US accounted
for around three-quarters of new FDI (including reinvested profits) between 1945 and 1960.
Since that time FDI has spread to become a truly global phenomenon, no longer the exclusive
preserve of OECD countries.

FDI has grown in importance in the global economy with FDI stocks now constituting over 20
percent of global GDP. Foreign direct investment (FDI) is a measure of foreign ownership
ofproductive assets, such as factories, mines and land. Increasing foreign investment can be
used as one measure of growing economic globalization. Figure below shows net inflows of
foreign direct investment as a percentage of gross domestic product (GDP). The largest flows
of foreign investment occur between the industrialized countries (North America, Western
Europe and Japan). But flows to non-industrialized countries are increasing sharply

.
FDI was introduced in 1991 with liberalization of Indian economy and financial sector
reforms in Indian banking industry. Any policy takes some time period to show significant
results and impact. So it was almost about 1995 when we first see FDI in the Indian banks
with the new private sector banks getting formed such as ICICI, etc.

The bank wise FDI data that is available with RBI is from 2000-01 to 2011-12.So, the time
period for the study is also chosen from 2000-01 to 2011-12.The effect of FDI on
performance of banks is studied by panel data regression method using dummy variable as
year 2005=1 as that was the year of enhancement of FDI from 49 per cent to 74 percent in
Banks in the post FDI liberalization periodDeter

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OBJECTIVES
1. To study the significance of FDI for developing countries in bridging the gap between the
saving and Investment.

2. To analyze the trends of FDI & FIIs in the recent past in developing country like India after
economic reforms.

3. To study the impact of FDI & FIIs in improving the quality and availability of goods has
been beyond doubt.

4. To know the requirement of amount of foreign investment by India, for its economic
Development.

5. To consider the short run and long run relationship between FDI and economic growth.

6.To consider the perception of the civil society, and foreign from coward FDI.

6
CHAPTER-2 ADVANTAGES OF FDI IN INDIA

Huge Market Size and a Fast Developing Economy

India is the second largest country in the world just behind China in terms of population. Currently the total
population is about1.2 billion. This huge population base automatically makes a huge market for the business
operators to capture. Therefore FDI investors automatically get a huge market to capture and also ample
opportunity to generate cash inflows at relatively quicker times. The economy of India is also moving at
faster pace than most of the economy of the world and inhabitants of the country also obtaining purchasing
power at the same rate (Athreye&Kapur, 2001;WorldBank, 2004)

Availability of Diversified Resources and Cheap Labour Force

The huge advantageevery company gets by investing in India is the availability of diversified resources. It is
acountry where different kinds of materials and technological resources are available. India isa huge country
and has forest as well as mining and oil reserve as well. These are alsocoupled with availability of very cheap
labour forces at almost every parts of the country

Increasing Improvement ofInfrastructure:

A lot of research study in India finds out that historically the country fails to attract a significant amount of
FDI mainly because ofproblems in infrastructure. But the scenario is changing. The Indian government has
takenhuge projects in transportation and energy sectors to improve the case. The Indian nationalgovernment
also granted permission for FDIs to provide up to 100% of the financing requiredfor the construction of
bridges and tunnels, but with a limit on foreign equity of INR 1,500crores, approximately $352.5 million.

Growth Drivers of Indian Retail Sector:

Rising Income and increase in convergence ofconsumer taste and preferences. Dual family
Income.Knowledge about different productthrough different medium like Internet, Television etc. Also
knowledge about the latest trendand fashion.47% of the India’s population is under the age of 30.

• This category is driving the consumption story.

• Emergence of new retailing format.

• Availability of Credit Facilities.

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Openness towards FDI:

Recently the Government of India has liberalized their policies in certain sectors, like increase in the FDI
limits in different sectors and also made theapproval system far easier and accessible. Unlike the historical
tradition, today for investing in India government approval do not require in the special cases of investing in
various important sectors like energy, transportation, telecommunications etc. Now days Government of
India is allowing FDI in defense and Railway sector of India.

Regulatory Framework and Investment Protection:

In the process of accelerating FDI in the country the government of India has make the regulatory framework
lot more flexible In the context of foreign direct investment, advantages and disadvantages are often a matter
of perspective. An FDI may provide some great advantages for the MNE but not forthe foreign country
where the investment is made. On the other hand, sometimes the deal canwork out better for the foreign
country depending upon how the investment pans out. Ideally, there should be numerous advantages for both
the MNE and the foreign country, which isoften a developing country. We'll examine the advantages and
disadvantages from bothperspectives.

Advantages for MNEs

1. Access to markets: FDI can be an effective way for you to enter into a foreign market.Some countries may
extremely limit foreign company access to their domestic markets.Acquiring or starting a business in the
market is a means for you to gain access.

2. Access to resources: FDI is also an effective way for you to acquire important naturalresources, such as
precious metals and fossil fuels. Oil companies, for example, often maketremendous FDIs to develop oil
fields.

3. Reduces cost of production: FDI is a means for you to reduce your cost of productionif the labor market is
cheaper and the regulations are less restrictive in the target foreignmarket.

For example, it's a well-known fact that the shoe and clothing industries have beenable to drastically reduce
their costs of production by moving operations to developing countries.

Advantages to Foreign Countries

1. Source of external capital and increased revenue. FDI can be a tremendous source ofexternal capital for a
developing country, which can lead to economic development. Forexample, if a large factory is constructed
8
in a small developing country, the country willtypically have to utilize at least some local labor, equipment
and materials to construct it.This will result in new jobs and foreign money being pumped into the economy.
Once thefactory is constructed, the factory will have to hire local employees and will probablyutilize a least
some local materials and services. This will create further jobs and maybe433even some new businesses.
These new jobs mean that locals have more money to spend,thereby creating even more jobs.

2. Additionally, tax revenue is generated from the products and activities of the factory, taxesimposed on
factory employee income and purchases, and taxes on the income andpurchases now possible because of the
added economic activity created by the factory.Developing governments can use this capital infusion and
revenue from economic growthto create and improve its physical and economic infrastructure such as
building roads, communication systems, educational institutions and subsidizing the creation of new
domestic industries. Development of new industries. Remember that a MNE doesn't necessary own all of the
foreign entity. Sometimes a local firm can develop a strategic alliance with a foreign investor to help develop
a new industry in the developing country. The developing country gets to establish a new industry and
market, and the MNE gets access to a new market through its partnership with the local firm.

3. FDI exposes national and local governments, local businesses and citizens to new business practices,
management techniques, economic concepts, and technology.

Main advantages of FDI in domestic country

1. Inflow of Foreign Capital. Capital base of domestic country increases.

2. Increase in tax revenue.

3. Boost economy by GDP growth.

4. Increase competition, productivity and efficiency.

5. Large employment opportunities -FDI in retail will create lakhs of jobs.

6. Inflow of technology, expertise and know how.

7. Infrastructure facilities improve and it will bring growth and prosperity.

8. Reduce cost of production. Prices of products will come down. This will tameInflationary pressure in the
economy.

9. Increase in international trade.

10. High quality products that will help them develop local businesses and industries.

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11. Decrease in food wastage: Today a major chunk of the food that is almost 30%, 40%of the produce is
wasted in transportation. A lot of grains are also wasted in the government storage and go-downs. The
government has made it compulsory to invest 50% of the investment in the development of infrastructure in
logistics. Thus it will become critical to save a lot in storage and logistics. More investments in the end to
end supply chain and world class cold storage facilities.

12. Benefits to the farmers: Farmers were long been left behind and squeezed between the price raise.
Worldwide the big retail giants buy the produce directly from the farmers eliminating the middle men and
offering them at least 15% – 20% higher prices then they get.

13. Increase in Forex reserves: As per Government’s proposal in increasing the FDI in retail the each retail
giant is supposed to invest a minimum of 100 million dollars. Each retail giant is expected to open atleast 15
stores across India and to open each4 store it may require 10- 15 million dollars which can total in billions of
dollars in Forex reserves.

14. Better consumer choice: Since most of the retail giants work on a large scale, they have large number
product varieties which generally the kirana stores in your neighborhood are not able to store. Better options
and offers to the consumer.

15. Reduction in food inflation: The increase in FDI will create stronger competition among the retailers and
will eliminate the middle man, which will eventually help in reducing food prices and the stocks will help in
reducing the supply constraint.

16. Increase in economic growth by dealing in various international products.

17. Billion dollars will be invested in Indian retail market.

18. FDI in defense sector will reduce imports; improve country’s capacity to produce defense equipment
locally and save foreign money. Definitely, it will create employment opportunities. It will give them a hope
that Indian defense equipment will become globally competitive. High technology and expertise will flow to
the country.

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Disadvantages of FDI in India

Investing in India definitely has some negative sides as well. Most noticeably India considered as a huge
market but a major portion of that is a lower and middle class person who still suffers from budget shortage.
The infrastructure of the country also needs to be improved a lot and already it is under huge strain. There are
also problems exists in the power demand shortfall, port traffic capacity mismatch, poor road conditions deal
with an inefficient and sometimes still slow-moving bureaucracy. The huge market in India is an advantage
but it is also very diverse in nature. India has 17 official languages, 6 major religions, and ethnic diversity.
This makes the tasks difficult for the companies to make appropriate product or service portfolio.

India is not a member of the International Centre for the Settlement of Investment Disputes also not of the
New York Convention of 1958. That make life bit difficult for the foreign investors. India still has a heavy
regulation burden among other countries, for example the time taken to start business or to register a property
is higher in India. Similarly, indirect taxes, entry-exit barriers and import duties have been major
disadvantages.

1. One has to remember that FDI in the past has been capital intensive and not laborintensive. Foreign
companies tend to use more technology to retain their competitiveness and flexibility than go for hiring more
workers. Most are afraid of encountering labor problems. Millions of jobs, however, are needed in India and
therefore there has to be a policy of encouraging labor intensive FDI. In mining industry, there is a danger of
FDI harming the environment in their extractive maneuvers. Hence India has to study carefully what kind of
FDI it wants.

2. Choosing the right kind of investors is critical because India already has many consumer goods industries.
What it needs is investment in infrastructure and capital35 goods industries. Yet most investors are reluctant
to enter the infrastructure sector because returns are low and slow.

3. India ranks low (134th position) in World Bank's 'Ease of Doing Business'. It has to be seen whether these
age old bureaucratic methods can be reformed easily. For example, both exporters and importers need to
undertake a huge amount of paper work and get different types of clearances that spawn corruption and
delays, all of which can cause patience to run out, making foreign investors pack up and go

4. May cause monopoly by foreign companies in the absence of proper control by domestic Government.

5. Internal insecurity:-But will it affect internal security of the country? In a country like India, where
internal security issues like terrorism are more relevant, allowing 100 % FDI in the major area of protection
from enemies may have a chance of giving negative results. It may also affect the domestic companies
involved in defense production.

11
6. May exploit the domestic resources without giving benefits to domestic country.

7. Domestic companies may feel uprooted.

8. Government does not have any clear stands on the FDI. They have not done any survey and cost benefit
analysis of this issue.

9. As claimed by the government that it will create Jobs, opposition does not buy it but millions of retailers
have to shut their shops

10. Will affect million small merchants in India.

11. An economically backward class person may suffer from price raise in future.

12. Retailer faces heavy loss of employment and profit.

13. Inflation may be increased

14. The rural India will remain deprived of the services of foreign players

Disadvantages to Multinational Enterprises (MNEs)

Unstable economic conditions. Much of FDI takes place in the developing world, which is just developing its
economic systems. The market conditions in the developing world can be quite unstable and unpredictable
.Unstable political and legal system. A bigger problem may be unstable or underdeveloped political and legal
systems. A company may have to deal with a corrupt or unstable political system. Additionally, the legal
system may be underdeveloped. Contracts and property rights may not be easily enforced.

FDI is a debt inflow or liability foreign exchange. Why? Simple, because the profits or returns it generates
will have to be repatriated in foreign exchange. Secondly, all the men, material and merchandise imported in
the years to come will have to be paid in foreign exchange. Finally, at the time of winding up/selling off, the
proceeds will flow out of the country in foreign exchange. And, it is noteworthy here; all this will end up in
the outflow of foreign exchange, many times more than the initial inflow.

12
CHAPTER-3Determinants of Foreign direct investment
I) Host Country Determinants:
1. Policy framework for F.D.I.
2. Economic, political & social stability
3. Rules regarding entry & operations.
4. Standards of treatment of foreign affiliates.
5. Policies on functioning & structure of markets (esp. competition & merger and acquisition
[M&A] Policies
6. International agreements on FDI
7. Privatization Policy.
8. Trade policy (barriers-tariff & non-tariff) and coherence of FDI and trade policies
9. Tax policy

II) Principal Economic Determinants in Host Countries

1. A Market-seeking
2. Market size & per captaincies
3. Market growth
4. Access to regional and global markets
5. Country specific consumer preferences
6. Structure of markets

III) Economic Determinates

1. Resource/Asset- Seeking
2. Raw materials
3. Low-cost unskilled labor
4. Skilled labor
5. Technological, innovatory and other created
6. Assets (e.g. brand name as embodied in dividable, firms and clusters
7. Physical
8. Infrastructure (Ports, roads, power & telecommunication

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IV) Business Facilitation
1. Investment promotion
2. Investment incentives (including image building & investment generating activities and
investment facilitation services)
3. Hassle costs (corruption, administrative efficiency & the like)
4. Social amenities (bilingual schools, quality of life etc.)
5. After-investment services

V) Efficiency Seeking

1. Cost of resources and assets adjusted for productivity for labour resources.
2. Other input costs like easy transport & communication economy and cost of other
intermediate products
3. Membership of a regional integration agreement conducive to the establishment of regional
corporate networks

Importance of FDI

FDI plays a major role in developing countries like India. They act as a long term source of capital
as well as a source of advanced and developed technologies. The investors also bring along best
global practices of management. As large amount of capital comes in through these investments
more and more industries are set up.

This helps in increasing employment. FDI also helps in promoting international trade. This
investment is a non-debt, non-volatile investment and returns received on these are generally spent
on the host country itself thus helping in the development of the country.India needs inflows to
drive investment in infrastructure, a lack of which is often cited as restricting the country's
economic growth.

Investment is also needed to expand capacity and technology in sectors such as autos and steel, as
well as to offset a big current account deficit. In 2009, India attracted $36.6 billion in FDI funds,
equivalent to 2.7% of its gross domestic product. China attracted $95 billion, or 1.9% of GDP. But

14
 foreign direct investment flows into India fell by over 24% in the first seven months this year to
$12.56 billion, putting pressure on domestic investment to take up the slack.

 Railway.
 Atomic energy.
 Defense.
 Coal and light

The financial crisis in global markets has made the outlook of Indian economy grim. While the
consistently volatile markets and the rupee plunging to an all-time low against the USD are some
major concern at this moment, natural calamities and economic scandals seem to be the icing on the
cake. Two decades ago, in the early 90’s, India faced a similar crisis. At that time India’s major
concerns were the problem in balance of payments and poorforeign exchange reserves.

During the crisis, Dr. Manmohan Singh, the Finance Minister of India at that time, came up with a
solution to reform the Indian economy. He liberalized the economy by ending the license raj and
gave rise to the phenomena of foreign investments in India. Thus, opening the gates for foreign
players to come and invest in India.

License Raj: A term used to describe the regulation of the private sector in India between 1947 and
the early 1990s. In India at that time, one needed the approval of numerous agencies in order to set
up a business legally.

Since then, foreign investments have been the backbone of the Indian economy and like the 90’s
this time too, it would seem that foreign investments might be holding the magic wand that may be
able to pull India out of the current economic slump.

Foreign investments are flows of capital from one nation to another in exchange for significant
ownership stakes in domestic companies or other domestic assets. There are two types of foreign
investments that play a major role in the growth of Indian economy; Foreign Direct Investments
(FDI) and Foreign Institutional Investments (FII)

CHAPTER-4 TYPES OF FDI

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FDIs can be broadly classified into two types:
1 Outward FDIs
2 Inward FDIs
This classification is based on the types of restrictions imposed, and the various prerequisites
required for these investments.

Outward FDI:

An outward-bound FDI is backed by the government against all types of associated risks. This
form of FDI is subject to tax incentives as well as disincentives of various forms. Risk
coverage provided to the domestic industries and subsidies granted to the local firms stand in
the way of outward FDIs, which are also known as 'direct investments abroad.’

16
 Inward FDIs:

Different economic factors encourage inward FDIs. These include interest loans, tax breaks,
grants, subsidies, and the removal of restrictions and limitations. Factors detrimental to the
growth of FDIs include necessities of differential performance and limitations related with
ownership patterns.

Other categorizations of FDI

Other categorizations of FDI exist as well. Vertical Foreign Direct Investment takes place
when a multinational corporation owns some shares of a foreign enterprise, which supplies
input for it or uses the output produced by the MNC
.
Horizontal foreign: direct investments happen when a multinational company carries out a
similar business operation in different nations.

• Horizontal FDI – the MNE enters a foreign country to produce the same products product at
home.
• Conglomerate FDI – the MNE produces products not manufactured at home.
• Vertical FDI – the MNE produces intermediate goods either forward or backward in the
supply stream.
• Liability of foreignness – the costs of doing business abroad resulting in a competitive
disadvantage.

Methods of Foreign Direct Investments

The foreign direct investor may acquire 10% or more of the voting power of an enterprise in an
economy through any of the following methods:

•By incorporating a wholly owned subsidiary or company.

• By acquiring shares in an associated enterprise.
•Through a merger or an acquisition of an unrelated enterprise.
•Participating in an equity joint venture with another investor or enterprise.

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Foreign direct investment incentives may take the following forms:
 Low corporate tax and income tax rates.

 Tax holidays.

 Preferential tariffs.

 Special economic zones.

 Investment financial subsidies.

 Soft loan or loan guarantees.

 Free land or land subsidies.

 Relocation & expatriation subsidies.

 Job training & employment subsidies.

 Infrastructure subsidies

FDI in India by Merger and Acquisition Route:

Merger & Acquisitions are increasingly been recognized as a business tool. The mostwidely
practiced business strategy i.e. organic growth story - involving steps that acompany would
take to augment its human resource, clients, infrastructure resourcesetc. thus resulting in
organic growth of its revenues and profits.

The M&A route interchangeably used as inorganic growth story would provide immediate
extension of company’s human resource, clientele, infrastructure thus catalyzing the growth.
Given the fact that the economies are globalizing, more and more M&A are happening.M&A
are now driven more with business consideration rather than dominated byregulations.

18
Yet the local legislations do play in role in shaping the M&A .With the FDI policies
becoming more liberalized since the last many years, Mergers,Acquisitions deals are growing
at a good rate. The list of past and anticipated mergers and acquisitions in India covers every
size and variety of business providing plat form for the small companies being acquired by
bigger ones.
India companies merge with some big foreign companies as well as the some big foreign
companies merge with India companies for getting the advantage of large Indian market. The
merger andacquisition deals in India after liberalization followed continuous growth this
growth get accelerated after 2003 – 04 and it was highest in year 2008-09,then face global
crisis and declined by a substantial share. These routes are preferred by strategic investors
who are utilizing the economic resource of a country.

FDI in India by NRI schemes

Non-Resident Indians (NRIs), and Persons of Indian Origin (PIOs) are allowed to invest in the
primary and secondary capital markets in India through the portfolio investment scheme
(PIS). Under this scheme, FIIs/NRIs can acquire shares/debentures of Indian companies
through the stock exchanges in India. The ceiling for overall investment for FIIs is 24 per cent
of the paid up capital of the Indian company and 10 per cent for NRIs/PIOs. The limit is 20
per cent of the paid up capital in the case of public sector banks, including the State Bank of
India. The ceiling of 24 per cent for FII investment can be raised up to sectoral cap/statutory
ceiling, subject to the approval of the board and the general body of the company passing a
special resolution to that effect. And the ceiling of10 per cent for NRIs/PIOs can be raised to
24 per cent subject to the approval of the general body of the company passing a resolution to
that effect.

Foreign Capital through Various NRI schemes

Investment in India by this route not generate any substantial share after liberalizing
India economy, this was one of the low considered route for foreign inflow in India. It
start picked growth in 1994-95 (Figure – 4.5), maintained that for 1996 0nly, it was
633 million US $ in 1995 (maximum), then 600 million US $ in 1996, then it start
declining and dropped up to 290 million US $ in 1997. After 2003 onwards foreign

19
investors reject that route of investment in India.

Foreign Portfolio Investment

Foreign portfolio investment typically involves short-term positions in financial assets of

international markets, and is similar to investing in domestic securities. FPI allows investors to take
part in the profitability of firms operating abroad without having to directly manage their
operations. This is a similar concept to trading domestically: most investors do not have the capital
or expertise required to personally run the firms that they invest in.The Reserve Bank of India (RBI)
has simplified foreign portfolio investment (FPI) norms by putting in place an easier registration
process and operating framework with an aim to attract inflows. "The portfolio investor registered
in accordance with SEBI guidelines shall be called Registered Foreign Portfolio Investor (RFPI),"
the RBI said in a notification on Tuesday.

The notification is effective from March 19. The existing portfolio investor class - namely, foreign
institutional investors (FIIs) and qualified foreign investors (QFIs) - registered with market
watchdog Securities and Exchange Board of India (SEBI) shall be subsumed under RFPIs, it said.
The guidelines for the Portfolio Investment Scheme for foreign institutional investors (FIIs) and
qualified foreign investors (QFIs) have since been reviewed and it has been decided to put in place a
framework for investments under a new scheme called Foreign Portfolio Investment scheme, it said.
An RFPI may purchase and sell shares and convertible debentures of an Indian company through a
registered broker on recognized stock exchanges in India as well as purchases shares and
convertible debentures which are offered to public in terms of relevant SEBI guidelines, the RBI
said. Such investors "may also acquire shares or convertible debentures in any bid for, or
acquisition of, securities in response to an offer for disinvestment of shares made by the Central
Government or any State Government", it said. These entities would be eligible to invest in
government securities and corporate debt subject to limits specified by the RBI and SEBI from time

to time, it added.

Foreign institutional investors have gained a significant role in Indian capital markets.
Availability of foreign capital depends on many firm specific factors other than economic
development of the country. In this context this paper examines the contribution of foreign

20
institutional investment particularly among companies included in sensitivity index (Sensex)
of Bombay Stock Exchange. Also examined is the relationship between foreign institutional
investment and firm specific characteristics in terms of ownership structure, financial
performance and stock performance. It is observed that foreign investors invested more in
companies with a higher volume of shares owned by the general public. The promoters’
holdings and the foreign investments are inversely related. Foreign investors choose the
companies where family shareholding of promoters is not substantial. Among the financial
performance variables the share returns and earnings per share are significant factors
influencing their investment decision .Foreign portfolio inflows through FIIs, in India, are
important from the policy perspective, especially when the country has emerged as one of the
most attractive investment destinations in Asia. In this paper an effort has been made to
develop an understanding of the investment decisions in different group of shares in BSE, and
behavior of the FIIs in the Indian equity market of last ten years.

This study show that the FII in India was maximum in 2004 then it starts declining then it
faced the challenged of global crisis, in 2007 the net sale of shares by foreign investors is
mare then net purchases.

FDI v/s FII after liberalization

There are two main routes foreign direct investment (FDI) and foreign institutional investment
(FII) for inflow of foreign capital in a country. FDI is considering as economically viable and
strategic foreign investment, because it is mobilizing the economic resources of the country
and it is a long lasting investment. FII consider as an opportunistic investment because it
based on the state of capital market, it is lees consistent as compare to FDI.

As the foreign investment through FDI start growing from 1992, it was grown by positive
growth rate up to 1997-98, but suddenly it was decline again pick the growth up to 2007-08,
this was the year when world economy face financial crisis. India economy have shown the
straight impact on foreign capital invested in India, this year FDI dropped by more then 50
percent. Foreign Portfolio investors have shown the same behavior for investment in India this
year but it was found by correlating FDI and FII investment in India, that investment in terms

21
of FDI was declined but not stopped but institutional investors have shown the opportunistic
behavior resulted FII sale more securities and purchases from Indian capital market.

FDI FPI

Volatility Having smaller in net inflows Having larger net inflows

Management Projects are efficiently managed Projects are less efficiently

managed

Involvement - Involved in management and ownership No active involvement in

direct or control; long-term interest management. Investment
indirect instruments that are more
easily traded, less permanent
and do not represent a
controlling stake in an
enterprise.

Sell off It is more difficult to sell off or pull out. It is fairly easy to sell
securities and pull out because
they are liquid.

Comes from Tends to be undertaken by Multinational Comes from more diverse

organisations sources e.g.a small company's
pension fund or through
mutual funds held by
individuals; investment via
equity instruments (stocks) or
debt (bonds) of a foreign

22
 enterprise.

What is Involves the transfer of non-financial assets Only investment of financial

invested e.g. .technology and intellectual capital, in assets.
addition to financial assets.

Scope of FDI in India

India is the 3rd largest economy of the world in terms of purchasing power parity and thus looks
attractive to the world for FDI. Even Government of India, has been trying hard to do away with
the FDI caps for majority of the sectors, but there are still critical areas like retailing and insurance
where there is lot of opposition from local Indians / Indian companies.

Some of the major economic sectors where India can attract investment are as follows:-

 Telecommunications

 Apparels

 Information Technology

 Pharma

 Auto parts

 Jewellery

 Chemicals

In last few years, certainly foreign investments have shown upward trends but the strict FDI policies
have put hurdles in the growth in this sector. India is however set to become one of the major
recipients of FDI in the Asia-Pacific region because of the economic reforms for increasing foreign

23
investment and the deregulation of this important sector. India has technical expertise and skilled
managers and a growing middle class market of more than 300 million and this represents an
attractive market.

24
CHAPTER-5Guidelines for Investment In Banking Sector

The limits of FDI in the banking sector have been increased to 74% of the paid up capital of bank.

FDI in the banking sector is allowed under the automatic route in India.

FDI and portfolio investment in the public or nationalized banks in India are subject to limit of
20% in totality.

This ceiling is also applicable to the investors in SBI and its associated banks.

FDI limits in banking sector of India were increased with the aim to bring in more FDI inflows in
the country along with the incorporation of advanced technology and management practices.

The objective was to make the Indian banking sector more competitive.

The RBI of India governs the investment matters in the banking sector.

FDI in Indian Banking Sector

In the private banking sector of India, FDI is allowed up to a maximum limit of 74 % of the paid-up
capital of the bank. On the other hand, Foreign Direct Investment and Portfolio Investment in the
public or nationalized banks in India are subjected to a limit of 20 % in totality. This ceiling is also
applicable to the investments in the State Bank of India and its associate banks. FDI limits in the
banking sector of India were increased with the aim to bring in more FDI inflows in the country
along with the incorporation of advanced
Technology and Management practices. The objective was to make the Indian banking sector more
competitive. The Reserve Bank of India governs the investment matters in the banking sector.

The global banking industry weathered turbulent times in 2007 and 2008. The impact of the
economic slowdown on the banking and insurance services sector in India has so far been moderate.
The Indian financial system has very little exposure to foreign assets and their derivative products
25
and it is this feature that is likely to prove an antidote to the financial sector ills that have plagued
many other emerging economies. Owing to at least a decade of reforms, the banking sector in India
has seen remarkable improvement in financial health and in providing jobs. Even in the wake of a
severe economic downturn, the banking sector continues to be a very dominant sector of the
financial system. The aggregate foreign investment in a private bank from all sources is allowed to
reach as much as 74% under Indian regulations.

A foreign bank or its wholly owned subsidiary regulated by a financial sector regulator in the host
country can now invest up to 100% in an Indian private sector bank. This option of 100% FDI will
be only available to a regulated wholly owned subsidiary of a foreign bank and not any investment
companies. Other foreign investors can invest up to 74% in an Indian private sector bank, through
direct or portfolioinvestment.

The Government has also permitted foreign banks to set up wholly owned subsidiaries in India.The
government, however, has not taken any decision on raising voting rights beyond the present 10%
cap to the extent of shareholding.

The new FDI norms will not apply to PSU banks, where the FDI ceiling is still capped at 20%.
Foreign investment in private banks with a joint venture or subsidiary in the insurance sector will be
monitored by RBI and the IRDA to ensure that the 26 per cent equity cap applicable for the
insurance sector is not breached.

All entities making FDI in private sector banks will be mandatorily required to have credit rating.
The increase in foreign investment limit in the banking sector to 74% includes portfolio investment
[ie, foreign institutional investors (FIIs) and non-resident Indians (NRIs)], IPOs, private placement,
ADRs or GDRs and acquisition of shares from the existing shareholders. This will be the cap for
any increase through an investment subsidiary route as in the case of HSBC-UTIdeal.

In real terms, the sectorial cap has come down from 98% to 74% as the earlier limit of 49% did not
include the 49% stake that FII investors are allowed to hold. That was allowed through the portfolio
route as the sector cap for FII investment in the banking sector was 49%.

The decision on foreign investment in the banking sector, the most radical since the one in 1991 to
26
allow new private sector banks, is likely to open the doors to a host of mergers and acquisitions.
The move is expected to also augment the capital needs of the private banks.

FDI in Public Sector Banks

In Private Sector Banks FDI is permitted with a cap of 74% of equity.

It is observed from the table that FDI CAGR for old public sector banks is fallingcontinuously
for both, the entire study period and the FDI liberalization period as compared withnew public
sector banks. However, new public sector banks have shown that for the entire studyperiod
FDI CAGR is rising but in post FDI liberalization period it is falling, although not asmuch as
for old public sector banks.
Average FDI in Old public sector banks is found be around 3.82 per cent and in New
public sector banks is at 6.77 per cent. Average Business for old public sector banks is at
Rs.176911.27 Cr. as against Rs.137735.12 Cr. for New Public Sector banks and Average Net
Profits of old public sector banks is at Rs.1114.99 Cr. and Rs.818.90 Cr. for new public sector
banks.
Average Income of old public sector banks is at Rs.11313.63 Cr. and for new public
sector bank it is at Rs.8044.41 cr. and Average Expenditure is at Rs.9503.83 Cr. for old public
sector while it is Rs.6791.94 Cr. for new public sector banks.
Average Investment is at Rs.38779.91 Cr. for old public sector banks and Rs.28180.84 Cr.
for new public sector banks. ROA is at Rs.4.90 Cr. for old public sector banks and Rs.3.91Cr.
for new public sector banks. Total number of staff is 32,44,675 for old public sector banks
and for new public sector banks itis at 55,30,147 for all 12 years of our study.

FDI in Private Sector Banks

In Private Sector Banks FDI is permitted with a cap of 74% of equity.It is observed that new
private sector banks, such as HDFC, ICICI, Axis, IndusIndandDCB, came into existence with
FDI as they are the outcome of reforms and they are found tohave more FDI as compared to
the old private sector banks and they have crossed 50% of total holdings.
Average FDI in Old private sector banks is found be around 14.63 per cent and for New
Private sector bank it is at 45 per cent. Average Business for old private sector banks is at

27
16088.82 cr. as against Rs.45837 crore for New private Sector banks. Average Net Profits of
olda private sector bank is at Rs.11797 Cr. and Rs.98894 Cr. for new private sector banks and
Average Income of old private sector banks is at Rs.1087 Cr. and for new private sector bank
it is at Rs.7515.75 and Average Expenditure is at Rs.925.74 Cr. for old private sector and
Rs.6036.66 Cr. for new private sector banks and Average Investment is at Rs.3759.90 Cr. for
old private sector banks and Rs.25696.63 for new private sector banks. ROA is at 1.02 for old
private sector banks and 1.04 for new private sector banks. Total number of staff is 588243
for old private sector banks and for new private sector banks it is at 887194 for all 12 years of
our study. It must be noted that the staff number of 887194 can be attributed to FDI policy as
thisemployment generation is due to FDI capital by which these new private sector banks
have comeinto existence.

ANALYSIS AND DISCUSSION

The fact of the matter is that governance rules in the banking system have indeed been
changed to accommodate the private investor (domestic and foreign) after liberalisation.
Besides permitting the entry and consolidation of new private banks, the government (through
the Ministry of Commerce) had as far back as March 5, 2004, announced a set of decisions
with reference to foreign investment in the banking sector, which relaxed the cap on foreign
equity in Indian banks to 20 per cent in the case of public sector banks and 74 per cent in the
case of private banks. This was in addition to the permission granted to foreign banks to
operate in the country through wholly owned subsidiaries subject to increasingly relaxed
rules.

Consequent to the Ministry of Commerce announcement, the Reserve Bank of India issued a
more detailed and comprehensive set of policy guidelines on ownership of private banks.
Recognizing that the 5th March 2004 notification by the Union Government had hiked foreign
investment limits in private banking to 74 per cent, the guidelines first clarified that this
ceiling was applicable to the sum total of foreign investment in private banks from all sources
(FDI, Foreign Institutional Investors, Non-Resident Indians).

28
More importantly, in the interests of diversified ownership the guidelines had declared that no
single foreign entity or group could hold more than 10 per cent of equity. There was also a 10
per cent limit set for individual FIIs and an aggregate of 24 per cent for all FIIs, with a
provision that this can be raised to 49 per cent with the approval of the Board or General
Body. Finally, the 2004 guidelines set a limit of 5 per cent for individual NRI portfolio
investors with an aggregate cap for NRIs of 10 per cent, which can be raised to 24 per cent
with Board approval. Finally, in keeping with this more cautious policy, the RBI decided to
retain the stipulation under the Banking Regulation Act, Section 12 (2), that in the case of
private banks the maximum voting rights per shareholder will be 10 per cent of the total
voting rights (1 per cent for public banks).

The 10 per cent ceiling on equity ownership by a single foreign entity was partly geared to
aligning ownership guidelines with the rule on voting rights.

The response to this from liberalisation advocates was that the whole exercise was pointless
inasmuch as the ceiling on single investor ownership and voting rights would deter foreign
investors. The evidence shows that this expectation has turned out to be completely false. As
Chart 1 shows, the share of foreign investors in private bank equity exceeds 50 per cent in five
banks and stands at between athird and a half in another eight. Moreover, Chart 2 shows that
in a number of instances the share of foreign equity has increased between 2005 (when the
guidelines had come into force) and 2012. Problems arose only in the case of those entities in
which single foreign entities held more than 10 per cent equity. This was, for example, true of
the Development Credit Bank (which had the Aga Khan Fund for Economic Development as
lead shareholder with around 25 per cent of equity) and the Catholic Syrian Bank (in which
Surachan Chawla of the Siam Vidhya group from Thailand had acquired 36 per cent shares in
the 1990s and has since been able to reduce the total to only 21 per cent). The problem faced
by these entities is that of finding buyers willing to acquire small blocks of equity to ensure
adequate dilution of lead stakeholder ownership in a bank being run by a dominant foreign
shareholder. As a resultthey have been under pressure for not complying with the RBI‟s
demand to dilute equity and faced with threats of penal action.

The implication of this is clear. The problem with well-performing private banks is not that it
is difficult to attract foreign equity investment. The problem is that current rules do not allow
29
entry of those whose intent is to exercise control over a local bank with an adequate share
holding and equivalent voting rights. Hence, if the need is to allow foreign equity infusion to
meet prudential requirements such as the Basel norms that is still possible. What is not
allowed is the entry of single foreign investors seeking to establish or acquire domestic private
banks with a controlling stake and voting rights

The case for such regulation of foreign presence had been clearly specified in the past. The
RBI has for long strongly advocated diversified ownership of banks. The RBI‟s Report on
Trend and Progress of Banking in India, 2003-04 states: “Concentrated shareholding in banks
controlling substantial amount of public funds poses the risk of concentration of ownership
given the moral hazard problem and linkages of owners with businesses. Corporate
governance in banks has therefore, become a major issue. Diversified ownership becomes a
necessary postulate so as to provide balancing stakes.”

A more elaborate exposition of the RBI‟s views on the matter came from Rakesh Mohan, a
former Deputy Governor of the RBI. In a speech made at a Conference on Ownership and
Governance in Private Sector Banking organized by the CII at Mumbai on 9th September
2004 he remarked.

The banking system is something that is central to a nation’s economy; and that applies
whether the banks are locally-or foreign-owned. The owners or shareholders of the banks
have only a minor stake and considering the leveraging capacity of banks (more than ten to
one) it puts them in control of very large volume of public funds of which their own stake is
miniscule. In a sense, therefore, they act as trustees and as such must be fit and proper for the
deployment of funds entrusted to them. The sustained stable and continuing operations
depend on the public confidence in individual banks and the banking system. The speed with
which a bank under a run can collapse is incomparable with any other organization. For a
developing economy like ours there is also much less tolerance for downside risk among
depositors many of whom place their life savings in the banks…Hence diversification of
ownership is desirable as also ensuring fit and proper status of such owners and It is evident
that the RBI, which is the regulator of the banking sector, had a strong case for issuing
30
 elaborate guidelines on bank ownership to ensure diversification. Those reasons retain their
relevance even today. So there is no case for altering them, especially if the evidence suggests
that accessing foreign equity, if needed, to enhance the capital of banks is possible within the
current regulatory framework.

India is considered to be the Third most preferred investment destination in the world after
China and United States.

 Service Sector is one of the most dominating sectors of Indian economy in attracting highest
FDI Equity inflows which account for 19 per cent of total FDI Equity inflows.

 Among the sub sectors of Service Sector, Financial Services stood at top place in attracting
more FDI Equity inflows (7.28%), followed by Non-Financial/ Business Services (5.62%),
Banking Services (1.74%) and Insurance Services (1.68%). directors.

 Top countries that are investing in the form of FDI in Service Sector are- Mauritius (39.12%),
Singapore (14.78%) and United Kingdom (8.24%).

 FDI in Banking Sector can solve various problems such as Inefficient Management, Non-
Performing Assets, Financial Instability and Poor Capitalization.

 FDI Equity inflows in Banking Sector have been increasing year by year in an increasing
trend.

Benefits Of FDI In Banking Sector In India

 Technology Transfer

As due to the globalization local banks are competing in the global market, where innovative
financial products of multinational banks is the key limiting factor in the development of local bank.
They are trying to keep pace with the technological development in the banks. Nowadays banks
have been prominent and prudent in the rapid expansion of consumer lending in domestic as well as

31
in foreign markets. It needs appropriate tools to assess (how such credit is managed) credit
management of the banks and authorities in charge of financial stability.

 Better Risk Management

As the banks are expanding their area of operation, there is a need to change their strategies exert
competitive pressures and demonstration effect on local institutions, often including them to
reassess business practices, including local lending practices as the whole banking sector is crying
for a strategic policy for risk management. Through FDI, the host countries will know efficient
management technique. The best example is Basel II. Most of the banks are opting Basel II for
making their financial system safer.

 Financial Stability and Better Capitalization

Host countries may benefit immediately. From foreign entry, if the foreign bank re-capitalize a
struggling local institution. In the process also provides needed balance of payment finance. In
general; more efficient allocation of credit in the financial sector, better capitalization and wider
diversification of foreign banks along with the access of local operations to parent funding, may
reduce the sensitivity of the host country banking system and lead towards financial stability.

32
CHAPTER-6 Foreign Direct Investment and Benefits

International Monetary Fund (IMF) and Organization for Economic Cooperation and
Development(OECD) define FDI similarly as a category of cross border investment made by
a resident in one economy (the direct investor) with the objective of establishing a „lasting
interest‟ in an enterprise (the direct investment enterprise) that is resident in an economy other
than that of the direct investor. The motivation of the direct investor is a strategic long term
relationship with the direct investment enterprise to ensure the significant degree of influence
by the direct investor in the management of the direct investment enterprise.

If we take into consideration the root cause of these problems, the reason is low-capital base
and all the problems are the outcome of the transactions carried over in a bank without a
substantial capital base. In a nutshell, we can say that, as the FDI is a non- debt inflow, which
will directly solve the problem of capital base. As due to the globalization local banks are
competing in the global market, where Innovative financial products of multinational banks is
the key limiting factor in the development of local bank. They are trying to keep pace with the
technological developmentin the banks. Now a days banks have been prominent and prudent
in t he rapid expansion of consumer lending in domestic as well as in foreign markets. It needs
appropriate tools to assess (how such credit is managed) credit management of the banks and
authorities in charge of financial stability. It may need additional information and techniques
to monitor for financial vulnerabilities. Host countries may benefit immediately. From foreign
entry, if the foreign bank re capitalize a struggling local institution. In the process also
provides needed balance of paymentfinance. In general; more efficient allocation of credit in
the financial sector, better capitalization and wider diversification of foreign banks along with
the access of local operations to parent funding, may reduce the sensitivity of the host country
banking system and lead towards financial stability.

These following sections will analyze the presence and role of FDI in public and private
banks separately as they were subject to different conditions of FDI.

33
 Problem Faced By Indian Banking Sector

 Inefficiency in management.

 Instability in financial matters.

 Innovativeness in financial products or schemes.

 Technical developments happening across various foreign markets.

 Non-performing areas or properties.

 Poor marketing strategies.

 Changing financial market conditions.

Non-Banking Financial Companies (NBFC):

49% FDI is allowed from all sources on the automatic route subject to guidelines issued from
RBI from time to time.

 FDI in Insurance sector in India:

FDI up to 26% in the Insurance sector is allowed on the automatic route subject to obtaining
license from Insurance Regulatory & Development Authority (IRDA)

 FDI in Telecommunication sector:

In basic, cellular, value added services and global mobile personal communications by
satellite, FDI is limited to 49% subject to licensing and security requirements and adherence
by the companies (who are investing and the companies in which investment is being made)
to the license conditions for foreign equity cap and lock- in period for transfer and addition of
equity and other license provisions.
34
 a) ISPs with gateways, radio-paging and end-to-end bandwidth, FDI is permitted up to 74%
with FDI, beyond 49% requiring Government approval. These services would be subject to
licensing and security requirements.

b) No equity cap is applicable to manufacturing activities.

c) FDI up to 100% is allowed for the following activities in the telecom sector :

 FDI in Trading Companies in India

Trading is permitted under automatic route with FDI up to 51% provided it is primarily export
activities, and the undertaking is an export house/trading house/super trading house/star
trading house. However, under the FIPB route:-
100% FDI is permitted in case of trading companies for the following activities:

a)exports;

b)bulk imports with ex-port/ex-bonded warehouse sales;

c)cash and carry wholesale trading;

d)other import of goods or services provided at least 75% is for procurement and sale of
goods and services among the companies of the same group and not for third party use or
onward transfer/distribution/sales.

 FDI in Power Sector in India:

Up to 100% FDI allowed in respect of projects relating to electricity generation, transmission

and distribution, other than atomic reactor power plants. There is no limit on the project cost
and quantum of foreign direct investment.

 Roads, Highways, Ports :

FDI up to 100% under automatic route is permitted in projects for construction and
maintenance of roads, highways, vehicular bridges, toll roads, vehicular tunnels, ports.

35
 Pollution Control and Management :

FDI up to 100% in both manufacture of pollution control equipment and consultancy for
integration of pollution control systems is permitted on the automatic route.

 Call Centers in India :

FDI up to 100% is allowed subject to certain conditions.

 Business Process Outsourcing in India:

FDI up to 100% is allowed subject to certain conditions.

 Foreign Direct Investment in Small Scale Industries (SSI's) in India :

Recently, India has allowed Foreign Direct Investment up to 100% in many manufacturing
industries which were designated as Small Scale Industries.

Regulatory Framework for Foreign Investment in India:

Foreign Investment in India is governed by the FDI policy announced by the Government of
and the provision of the Foreign Exchange Management Act(FEMA) 1999. The Reserve Bank
of India (‘RBI’) in this regard had issued a notification, which contains the Foreign Exchange
Management (Transfer or issue of security by a person resident outside India) Regulations,
2000. This notification has been amended from time to time. The Ministry of Commerce and
Industry, Government of India is the nodal agency for monitoring and reviewing the FDI
policy on continued basis and changes in sectoral policy/ sectoral equity cap. The FDI policy
is notified through Press Notes by the Secretariat for Industrial Assistance (SIA), Department
of Industrial Policy and Promotion (DIPP).The foreign investors are free to invest in India,
except few sectors/activities, where prior approval from the RBI or Foreign Investment
Promotion Board (‘FIPB’) would be required.

36
How Does Foreign Direct Investment Promote Economic Growth?
The empirical literature finds mixed evidence on the existence of positive productivity
externalities in the host country generated by foreign multinational companies. We propose a
mechanism that emphasizes the role of local financial markets in enabling foreign direct
investment (FDI) to promote growth through backward linkages, shedding light on this
empirical ambiguity. In a small open economy, final goods production is carried out by
foreign and domestic firms, which compete for skilled labor, unskilled labor, and intermediate
products. To operate a firm in the intermediate goods sector, entrepreneurs must develop a
new variety of intermediate good, a task that requires upfront capital investments. The more
developed the local financial markets, the easier it is for credit constrained entrepreneurs to
start their own firms. The increase in the number of varieties of intermediate goods leads to
positive spillovers to the final goods sector. As a result financial markets allow the backward
linkages between foreign and domestic firms to turn into FDI spillovers. Our calibration
exercises indicate that

a) holding the extent of foreign presence constant, financially well-developed economies

experience growth rates that are almost twice those of economies with poor
financial markets

b) increases in the share of FDI or the relative productivity of the foreign firm leads to higher
additional growth in financially developed economies compared to those observed in
financially under-developed ones, and c) other local conditions such as market structure and
human capital are also important for the effect of FDI on economic growth.

Investments to grow an economy’s production capacity and

productivity
Investments to increase production capacity as the most effective means to promote
sustainable growth in an economy—investments that increase the quality and the quantity of a
nation’s production resources):

37
Economic infrastructure—public utilities, transportation infrastructure, information highways,
etc. Production infrastructure—plants/factories/office buildings, equipments—hardware and
software, and the entrepreneurs; Education of workforces;
Accumulation of knowledge—patents, etc.; other production resources.

Policy suggestions

Do not promote FDI in less developed countries, those less developed in R&Ds, as an
economic growth instrument. These investments have limited growth benefits to the host
country such as Taiwan. One example: financial institutions in Taiwan should not be
encouraged to setup foreign offices in PRC to provide credit to promote FDI by Taiwan’s
MNCs.

As an open economy, neither should Taiwan prohibit or restrict private investments abroad
(including PRC). However, comprehensive registration and reporting requirements should be
established.

Promote government R&D spending and business investments and entrepreneurship (startups
of entrepreneurial ventures) in Taiwan.
Develop databases to monitor and evaluate investment promotion programs

38
CHAPTER-7 Impact Of FDI On Indian Banks

The RBI's decision to allow foreign direct investment in Indian banks, the lifting of sectorial caps
on foreign institutional investors and a series of other policy measures could ultimately lead to the
privatisation of public sector banks. The series of policy announcements in recent weeks promises
to unleash a shakeout in the Indian banking industry. A major policy change, effected through an
innocuous "clarification" issued by the Reserve Bank of India (RBI) a few weeks ago, set the stage
for the increased presence of foreign entities in the industry. The RBI's move to allow foreign direct
investment (FDI) in Indian banks has been followed by the announcement in the Union Budget
lifting sectorial caps on foreign institutional investors (FII).

There are also reports that the RBI's forthcoming credit policy may feature more sops for private
and foreign banks. These changes are likely to hasten the process of consolidation of the banking
industry. Although there is some doubt over whether the moves will have any immediate impact,
there is consensus that the changes are merely a prelude to the wholesale privatization of the public
sector banks (PSBs). IDBI, the promoter of IDBI Bank, has already announced its intention to
relinquish control of the bank. Foreign banks have also mounted pressure on the Finance Ministry,
seeking the removal of legislative hurdles that set limits to private and foreign
holdings in PSBs. In the short term, the action is likely to be focused on the Indian private banks. Of
the 100 banks in India, 27 are PSBs (including eight in the State Bank of India group). There are 31
private sector banks, of which eight are of recent vintage (for example, ICICI Bank and HDFC
Bank); and there are 42 foreign banks with branches in India. The RBI's decision is seen as enabling
foreign banks to extend their operations, primarily by acquiring other banks.

Downfall In FDI

(Reuters) - Foreign direct investment (FDI) in India fell by nearly a quarter in the first seven months
of 2010 and the much-publicchaos around preparations for the Commonwealth games has added to
worries foreign firms could put off further investment.A UN survey found investors ranked India as
the second top-priority destination for FDI this year, replacing the United States, after China.

39
Physical infrastructure is the biggest hurdle that India currently faces, to the extent that regional
differences in infrastructure concentrates FDI to only a few specific regions. While many of the
issues that plague India in the aspects of telecommunications, highways and ports have been
identified and remedied, the slow development and improvement of railways, water and sanitation
continue to deter major investors.

Federal legislation is another perverse impediment for India. Local authorities in India are not part
of the approval process and the large bureaucratic structure of the central government is often
perceived as a breeding ground for corruption. Foreign investment is seen as a slow and inefficient
way of doing business, especially in a paperwork system that is shrouded in red tape

Statutory Limits

Foreign direct investment (FDI) up to 49% is permitted in Indian private sector banks under
“automatic route” which includes Initial Public Issue (IPO), Private Placements, ADR/GDRs; and
Acquisition of shares from existing shareholders.

 Automatic route is not applicable to transfer of existing shares in a banking company from
residents to non-residents. This category of investors require approval of FIPB, followed by
“in principle” approval by Exchange Control Department (ECD), Reserve Bank of India
(RBI).
 The “fair price” for transfer of existing shares is determined by RBI, broadly on the basis of
Securities Exchange Board of India (SEBI) guidelines for listed shares and erstwhile CCI
guidelines for unlisted shares. After receipt of “in principle” approval, the resident seller can
receive funds and apply to ECD, RBI, for obtaining final permission for transfer of shares.
 Foreign banks having branch-presence in India are eligible for FDI in private sector banks
subject to the overall cap of 49% with RBI approval.
 Issue of fresh shares under automatic route is not available to those foreign investors who
have a financial or technical collaboration in the same or allied field. Those who fall under
this category would require Foreign Investment Promotion Board (FIPB) approval for FDI in
the Indian banking sector.

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  Under the Insurance Act, the maximum foreign investment in an insurance company has
been fixed at 26%. Application for foreign investment in banks which have joint
venture/subsidiary in insurance sector should be made to RBI. Such applications would be
considered by RBI in consultation with Insurance regulatory and Development Authority
(IRDA).
 FDI and Portfolio Investment in nationalized banks are subject to overall statutory limits of
20%.
 The 20% ceiling would apply in respect of such investments in State Bank of India and its
associate bank.

The Impact of FDI on the Host Country Employment

 Firms attempt to capitalize on abundant and inexpensive

 Host countries seek to have firms develop labor skills and sophistication.

 Host countries often feel like “least desirable” jobs are transplanted from home
countries.

 Home countries often face the loss of employment as jobs move.

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 FDI Impact on Domestic Enterprises

 Foreign invested companies are likely more productive than local competitors.

 The result is uneven competition in the short run, and competency building efforts in the
longer term.

 It is likely that FDI developed enterprises will gradually develop local supporting industries,
supplier relationships in the host country.

Analysis of Impact of FDI

Though FDI in Indian banking can be traced with the entry of new private sector banks in
1995 the official data on FDI is not available before year 2000. The FDI policy liberalization
took place in the year 2005 raising limits to up to 74 per cent from 49 per cent. The present
study uses time dummy to gauge the performance of Indian banks in pre and post FDI
liberalization era. We are using time dummy for year 2005>1, which is, post FDI
liberalizationtime period and 2005<0 for pre FDI liberalization era.

The impact of FDI on Indian banks is measured on the performance of two factors, i.e., its
productivity and profitability. The productivity of banks, in turn, is measured by Profit per
Employee (PPE) and Business per Employee (BPE). The profitability of Indian banks is
measured by Net Profits, Total Income, Return on Assets (ROA), and Total Business.

THE IMPACT OF MONETARY POLICY ON BANK BALANCE SHEETS

This paper uses disaggregated data on bank balance sheets to provide a test of the lending
view of monetary policy transmission. We argue that if the lending view is correct, one should
expect the loan and security portfolios of large and small banks to respond differentially to a
contraction in monetary policy. We first develop this point with a theoretical model; we then
test to see if the model's predictions are borne out in the data.

When the Federal Reserve tightens monetary policy, it exchanges bonds for bank
reserves. A longstanding question is whether this interaction with the banking system has any
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effects beyond those on bond-market interest rates. That is, in addition to the textbook
"money" channel, does monetary policy also work in part through a distinct "bank lending"
channel? Over the last few years, there has been a resurgence of interest in this question, and
it has generated a good deal of both new research and controversy. In this paper, we propose
to attack the question from a quite different angle than has other recent work, by examining
what the so-called "lending view" has to say about cross-sectional differences in the way that
bank balance sheets respond to a monetary policy shock. More specifically, we argue that if
the tending view is correct, one should expect the loan and security portfolios of large and
small banks to respond differentially to a contraction in monetary policy. We first develop this
point with a theoretical model; then we then test to see if our predictions are borne out in the
data.

By focusing on disaggregated bank data, we can most directly address what skeptics seem
to think is the weakest part of the case for the lending view: the proposition that the Fed can,
simply by changing reserves, affect banks' loan supply schedules. A number of authors have
argued that this proposition is theoretically dubious. For example, Romer and Romer (1990)
emphasize that banks can always, if needed, finance themselves with non-deposit sources of
funds. Thus even if contractionary Fed policy can reduce the deposit financing available to the
banking sector, banks can simply and frictionlessly make up the shortfall by issuing, say,
large denomination CD's, medium-term notes, or some other security. The bottom line,
according to Romer (1990) and others, is that bank loan supply is effectively completely
insulated from Fed policy.

This argument is just an application of Modigliani-Miller logic to the banking firm. In

an M-M world, shocks to the liability side of a bank's balance sheet should not affect its "real
side" behavior, namely its willingness to supply loans for a given interest rate. Therefore, in
order to make a convincing case for a lending channel of monetary policy transmission, one
has to establish that the M-M argument does not apply to banking firms in this context. That
is, one has to show that because of capital market imperfections, shocks to banks' deposit base
cannot be frictionless offset with other sources of financing, and therefore translate into "real"
effects on their lending behavior.

We attempt to do so in two basic steps. First, we develop a theoretical model that is

43
designed to:

I) illustrate how the existence of capital market imperfections facing the typicalbanking firm
can generate a lending channel;

2) highlight the cross-sectional differences betweenbanks with different degrees of access to

non-deposit financing that arise when there are suchcapital market imperfections. Perhaps the
most important thing to emphasize about this modelof the banking firm is that it is exactly the
same sort of model that has been widely applied tostudy the implications of capital market
imperfections for non-financial companies.

Our second step is to begin to test the cross-sectional implications of this model
empirically. Again, the types of tests that we use are very closely analogous to those used to
study the investment behavior of non-financial firms. Loosely speaking, we test the following
sort of prediction of our model: Fed tightening should have a disproportionately large impact
on the lending behavior of smaller banks, who are more likely to have difficulty substituting
into non-deposit sources of external finance. This directly parallels the empirical strategy in
the literature on non-financial firms, where the test is typically of the following sort: shocks to
internal liquidity should have a larger impact on the investment behavior of smaller
companies, who are more likely to have a hard time accessing external sources of finance.
We stress the close relationship between our work here on banking firms and previous
work on non-financial firms that face capital market imperfections, because of what we see as
a curious dissonance in the recent literature on monetary policy. On the one hand, as we
discuss below, even most skeptics of the lending view have been very willing to embrace the
importance of capital market imperfections at the level of the non-financial firm. However, at
the same time, these same skeptics have implicitly tended to dismiss--often without any real
direct evidence--the possibility of similar imperfections at the level of the banking firm.
In our view, there is no a priori reason to think that capital market imperfections should
be less important for banking firms than for non-financial firms. Indeed, one might well
expect them to be more pronounced, to the extent that these imperfections have their roots in
information asymmetries between firms and their external capital suppliers. After all, banks
specialize in holding portfolios of hard-to-value assets--assets for which information
asymmetries tend to be substantial
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The remainder of the paper is organized as follows
In Section 2, we present a brief overview of where the debate on the lending view now
stands, and use this to motivate in more detail why our focus on the behavior of different
types of banks can be helpful.
In Section 3, we develop our model. Section 4 describes the data to be used in the empirical
work, and Section 5 presents our empirical results. Section 6 concludes. We begin by
specifying banks' asset and liability choices, taking the return on bank loans as exogenous. We
then close the model with two alternative specifications of loan demand.

However, there is a substantial literature that suggests that bank loans are in fact "special" for
some terms, so that such switching would not be frictionless.

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CHAPTER-8 INVESTMENT RISKS IN INDIA

Sovereign Risk

India is an effervescent parliamentary democracy since its political freedom from British rule
more than 50 years ago. The country does not face any real threat of a serious revolutionary
movement which might lead to a collapse of state machinery. Sovereign risk in India is hence
nil for both "foreign direct investment" and "foreign portfolio investment." Many Industrial
and Business houses have restrained themselves from investing in the North-Eastern part of
the country due to unstable conditions. Nonetheless investing in these parts is lucrative due to
the rich mineral reserves here and high level of literacy. Kashmir on the northern tip is a
militancy affected area and hence investment in the state of Kashmir are restricted by law

Political Risk

India has enjoyed successive years of elected representative government at the Union as well
as federal level. India suffered political instability for a few years in the sense there was no
single party which won clear majority and hence it led to the formation of coalition
governments. However, political stability has firmly returned since the general elections in
1999, with strong and healthy coalition governments emerging. Nonetheless, political
instability did not change India's bright economic course though it delayed certain decisions
relating to the economy.

Economic liberalization which mostly interested foreign investors has been accepted as
essential by all political parties including the Communist Party of India Though there are
bleak chances of political instability in the future, even if such a situation arises the economic
policy of India would hardly be affected.. Being a strong democratic nation the chances of an
army coup or foreign dictatorship are minimal. Hence, political risk in India is practically
absent.

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Commercial Risk

Commercial risk exists in any business ventures of a country. Not each and every product or
service is profitably accepted in the market. Hence it is advisable to study the demand / supply
condition for a particular product or service before making any major investment. In India one
can avail the facilities of a large number of market research firms in exchange for a
professional fee to study the state of demand / supply for any product. As it is, entering the
consumer market involves some kind of gamble and hence involves commercial risk

Risk Due To Terrorism

In the recent past, India has witnessed several terrorist attacks on its soil which could have a
negative impact on investor confidence. Not only business environment and return on
investment, but also the overall security conditions in a nation have an effect

Voting rights of foreign investors

Private Sector Banks Not more than 10 % of the total voting rights of all the
shareholders

Nationalized Banks Not more than 1 % of the total voting rights of all the
shareholders of the nationalized bank.

State Bank of India Not more than 10 % of the issued capital This does not apply
to Reserve Bank of India (RBI) as a shareholder. However,
government in consultation with RBI, ceiling for foreign
investors can be raised.

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SBI Associates Not more than 1%. This ceiling will not be applied to State
Bank of India. If any person holds more than 200 shares,
he/she will not be registered as a shareholder.

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 CONCLUSION
 FDI is an important stimulus for the economic growth of India.
 FDI shown a tremendous growth in second decade (2000 -2011) that is three times then the
first decade of FDI in services sector.
 Service sector is first and Banking and insurance sector is second segment of which pick the
growth in second decade of reforms.
 FDI create high perks jobs for skilled employee in Indian service sector.
 Mauritius and Singapore is the 2 top countries which has maximum FDI in India.
 FDI plays an important role in the development of infrastructure because many countries
invest in the infrastructure sector and service and banking finance sectors.
 Atomic Energy and Railway Transport are some important and life line of any country.
Therefore India also restricted FDI in this sectors.
 After above analysis , we can say that FDI has good future growth in Retailing and Real estate
sector in India.

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 SUGGESTION

It is important for countries to take measures to maximize their growth through more and
more FDI inflows. Benefits from FDI could be maximized if efforts are concentrated on
attracting long term productive FDI. To attract quality FDI, a developing country must ensure
a sound macroeconomic environment which requires adequate infrastructural facilities,
stability of exchange rate, political stability, strong administrative will, market perfection and
control over inflation. Some suggestions regarding FDI inflows are summarized as under:

The analysis of this study reveals that India’s performance regarding attraction of FDI
inflows is very poor as compared to China. India should improve its regulatory system
through better and effective monetary and fiscal reforms. There is need to strengthen
infrastructure network, reforms in marketing structure and strong political will to improve
international trade relations.

FDI has found to be influenced by trade openness of country which implies that a more
liberalized foreign investment policy framework is required in India to decrease the gap in
FDI inflows of India and China. Reserves are also playing important role in influencing FDI
inflows in India. There should be favorable economic environment in terms of increasing
efforts like provision of subsidized raw material, power, land and tax concession for the
development of export oriented manufacturing units, which in turns helps to escalate foreign
exchange reserves position in India.

Exchange rate and price stability must be foremost priority for the Indian economy to attract
the FDI as these are estimated to be important factors influencing FDI inflows in the country.
India can build a state of confidenceamong the foreign investors through taking effective
measures for controlling fluctuation in exchange rate and price level in a country. Serious
attention should be paid toward their stabilization as a necessary condition for foreign
investment attraction strategy in India.

Study also reveals that FDI promotes economic growth of a country through its positive
influence on GDP, exports, reserves and employment. Thus India should give special
attention towards creation of favorable environment to attract FDI to highest possible extent.

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It should be made integral part of development strategy of a country to achieve high growth
rate by raising exports, reserves and employment and thus income and output of the country
for uplifting living standard of people through increased foreign investment.

Positive impact of FDI on GCF of both the countries suggests that the competitive strategy
adopted by the country in the form of liberalized economic policy is not so harmful for the
domestic industry. This advocates that there is always scope in country to raise its level of
capital formulation through forward and backward linkages of FDI with domestic industries.
The intensity of the fear of adverse impact of FDI inflows on domestic capital and loss to
domestic industry due to increased competition with the foreign firms is not so severe.
Moreover, India should try to raise its level of capital formation through careful
implementation of foreign investment policy.

The present study has found a very little but positive impact of FDI on employment in both
the countries. Unemployment is the serious problem in India as well as in China on account of
large size of population. Though contribution of FDI in the generation of employment is not
so sizeable as compared to its influence on other parameters of the economy, yet its positive
impact on employment coveys the idea to the policy makers of these countries that foreign
investments can be helpful in reducing the level of unemployment in the economy. So, both
the countries should exploit properly this inbuilt potential of foreign direct investment to its
full extent by incorporating it as an essential part of employment elevation programmers’ in
the country.

The results of this study show that the influence of FDI on gross domestic product, gross
capital formation, exports and reserves is relatively more in China as compared to India. It is
required to change India’s development strategy in order to reap the full benefits of FDI
inflows due to its positive influence on these macroeconomic indicators reflecting the growth
of the economy. China has been able to utilize properly this potential of FDI inflows at a
much faster rate than India. There is need to pursue vigorously more economic reforms by the
Indian Government to frame suitable investment strategy for taking the full advantages of FDI
inflows which may result in the improvement in reserves, domestic investment, exports and
thus growth in all sectors of the Indian economy.

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Bi-causal relationship between imports and exports has been found in both the countries
which suggest that India and China should focus more on technology imports and its transfer
as an essential condition for expanding exports of these countries. Government of these
countries should use this perspective of imports as an effective measure in formulation of their
export promotion strategy. This will also promote industrial up gradation through advanced
machinery and equipment.

Concerns have arisen that competition to attract FDI will intensify among countries,
especially the type of FDI that can bring major benefits to recipient economies by enhancing
their export competitiveness or by providing linkages with domestic enterprises. In fact,
countries are increasingly recognizing the positive contribution of FDI towards economic
development of a country. So, there is a need of devising FDI policies and enhancing
legislative and institutional structures in order to attract new investment and building new
skills.

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BIBLOGRAPHY:

www.Legalserviceindia.com

www.Manupatra.com

www.Scribd.com

www.cci.in

www.rbi.org.in www.dipp.nic.in

www.legallyindia.com www.icsi.edu

www.retailguru.com

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