International Investment

Peter Drucker observes that Increasingly world investment

rather than world trade will be driving the international
economy. Exchange rates, taxes, and legal rules will become
more important than wage rates and tarifs.

Types of Foreign Investment

!oreign Investment
Port"olio Investment
Investment in
#D$s etc
Investment by !IIs
!oreign Direct Investment
%c&uisition 'oint (enture
)holly owned
subsidiary
*ypes o" "oreign investment+

!DI re"ers to investment in a "oreign country where

the investor retains control over the investment. It
typically takes the "orm o" starting a subsidiary,
ac&uiring a stake in an existing ,rm or starting a -oint
venture in the "oreign country. Direct investment and
management o" the ,rms concerned normally go
together. It re"ers to investments in real assets like
"actories, sales o.ces etc. by "oreign ,rms.

Port"olio investment re"ers to where the investor uses

his capital in order to get a return on it, but has not
much control over the use o" the capital. It re"ers to
cross border transactions in bonds and e&uities

#D$s / %D$s and !001s are instruments issued by

Indian companies in "oreign markets "or mobili2ing
"oreign capital by "acilitating port"olio investment by
"oreigners in Indian securities

*ypes o" "oreign Investment
*ypes o" "oreign Investment

% depository receipt is a negotiable certi,cate denominated in

34 dollars in case o" %D$s, that represents a non 34 company5s
publicly traded local currency 6Indian $upee7 shares.

D$s are created when the local currency shares o" an Indian
company are delivered to the depository5s custodian bank,
against which the Depository 1ank issues D$s in 34 dollars.

!DIs are governed by long term considerations as the

investments cannot be easily li&uidated while port"olio
investments can be easily li&uidated and are in8uenced by
short term gains.

*here are three motives o" !DI ie resources seeking, market

seeking and e.ciency seeking ie. 6low cost o" production due
to cheap labor7.

%ccording to the International 9onetary !und5s

1alance o" Payments 9anual :, !DI is that category o"
international investment that re8ects the ob-ective o"
obtaining a lasting interest by a resident entity in one
economy in an enterprise resident in another
economy.
*he lasting interest implies the existence o" a long;term
relationship between the direct investor and the enterprise
and a signi,cant degree o" in8uence by the investor in the
management o" the enterprise.

Institutional investors on the other hand are

speciali2ed ,nancial intermediaries managing savings
collectively on behal" o" investors, especially small
investors, towards speci,c ob-ectives in terms o" risk,
returns, and maturity o" claims.
0aps can be o" three types+

i7 a separate cap on !DI,

ii7 a separate cap on !II, and

iii7 a composite caps on !DI and !II combined together.

4eparate caps on !DI and !II, in turn, can be o" ,ve
types+

I7 ban on both !DI and !II 6e.g. lottery business,

gambling and betting7,

II7 non;2ero separate caps on both !DI and !II 6<e.g.,

D*=;broadcasting>7, <D*= has composite ceiling o"
?@A with a sub;ceiling "or !DI at BC per cent>

III7 a composite non;2ero cap on !DI and !II 6banking D

E?A, insurance D BFA7,

I(7 ban on !DI with a non;2ero cap on !II 6e.g., retail

trading7, and

(7 ban on !II with a non;2ero cap on !DI 6e.g. print media7.

Signifcance of Foreign Investment
Signifcance of Foreign Investment

!oreign capital "acilitates essential imports re&uired "or

carrying out development programmes, like capital goods,
know;how, raw materials and other inputs and even
consumer goods which might not be indigenously available.

)hen export earnings are insu.cient to ,nance vital

imports, "oreign capital could reduce the "oreign exchange
gap.

!oreign investment may also increase the country5s exports

and reduce the import re&uirements i" such investments
take place in export oriented and import competing
industries.

%s long as "oreign investment raises productivity, it would

bene,t domestic labor in the "orm o" increased real wages,
consumers in case i" "oreign investment is cost reducing in
a particular industry, the consumers might gain through
lower product pricesG government i" the increase in
production and "oreign trade increases the ,scal revenue o"
the government.

Foreign investment brings about four Es

efciency, equity, experience an expertise!
Signifcance of Foreign "irect Investment
Signifcance of Foreign "irect Investment

=elps increase the investment level and thereby the income

and employment in the host country.

It "acilitates trans"er o" technology to the recipient country,

It may kindle a managerial revolution in the recipient

country through pro"essional management and employment
o" highly sophisticated management techni&ues.

!oreign capital may enable the country to increase its

exports and reduce import re&uirements.

!oreign investment might stimulate domestic enterprises to

per"orm better and increase competition and break
domestic monopolies.
!or developing countries, !DI has the "ollowing advantages+

!DI shi"ts the burden o" risk o" an investment "rom domestic
to "oreign investors.

$epayments are linked to pro,tability o" the underlying

investment, whereas under debt ,nancing the borrowed
"unds must be serviced regardless o" pro-ect costs.

!DI is the only capital in8ow strongly associated with higher

#DP growth
0riticism against !oreign 0apital
0riticism against !oreign 0apital

!oreign capital tends to 8ow to the high pro,t

areas rather than to the priority sectors.

*echnology imported might not be adapted to the

needs o" the customers.

9H0s could undermine economic autonomy and

control and their activities might not be in "avor o"
national interests.

!oreign investment could have un"avorable efect

on the 1alance o" Payments o" a country i" the
out8ow is higher due to payment o" royalty etc.

!oreign investors at times engage in un"air

practices and unethical trade practices.

!oreign investment could result in minimi2ing /

eliminating competition and "acilitate creation o"
monopolistic structure.
!actors afecting International
!actors afecting International
Investment
Investment
$esources+ %vailability and there"ore exploitation o"
resources in the host country.
9arkets+ !DI largely 8ows to the countries which have large
markets with comparatively good in"rastructure and political
stability.
E.ciency+ Iow cost o" production, derived "rom cheap labor
is the driving "orce o" many !DIs in developing countries.
$ate o" interest+ Diference in the rate o" interest acts as a
stimuli to attracting "oreign investment. 0apital has a
tendency to move "rom a country with a low rate o" interest
to a country where interest rate is higher.
Pro,tability+ Private "oreign capital is largely in8uenced by
the pro,t motive. It is attracted to countries where the return
on investment is higher.
Economic conditions+ Economic conditions particularly
market potential and in"rastructural "acilities in8uence
"oreign investment.
#overnment Policies and Political !actors+ Policies
encouraging !II4 and !DIs and a stable #overnment largely
encourages the movement o" "oreign capital into the country
Foreign Investment in
Foreign Investment in
Inia
Inia

Direct "oreign investment in India was adversely afected by the
"ollowing "actors+

Public sector was assigned a dominant position in the

important industries and thus the scope o" private
investment, both domestic and "oreign was limited.

)hen public sector enterprises needed "oreign technology or

investment, there was a pre"erence "or the "oreign
government sources.

#overnment policy towards "oreign capital was selective.

!oreign investment was normally permitted in high
technology industries in priority areas and in export oriented
industries.

!oreign e&uity participation was normally sub-ect to a ceiling

or ?CA.

Payment o" dividends abroad, etc. as well as inward

remittances were sub-ect to stringent laws

0orporate taxation was high and tax laws and procedures

were complex. *hese "actors either limited the scope o" or
discouraged "oreign investment in India.
Foreign Investment in Inia
Foreign Investment in Inia
#overnment Policy+

Pre J@@J, India was "ollowing a very restrictive policy towards "oreign
capital and technology. !oreign collaboration was permitted only in
,elds o" high priority and in areas where the import o" "oreign
technology was necessary. *he government had issued list o"
industries where+
!oreign investment may be permitted
Knly "oreign technical collaboration 6but no "oreign investment7 may
be permitted.
Ho "oreign collaboration 6,nancial or technical7 was considered
necessary.
*he government policy on "oreign e&uity participation was thus
selective. *echnical collaborations were to be considered on the
basis o" annual royalty payments which were linked with the value o"
total production.

*he !oreign Exchange $egulation %ct, J@EL served as a tool "or

implementing the national policy on "oreign private investment in
India. *he !E$% empowered the $1I to regulate or exercise direct
control over the activities o" "oreign companies and "oreign nationals in
India. . %ccording to !E$%, non residents, "oreign students resident in
India and "oreign companies re&uired the permission o" $1I to accept
appointment as agents or technical management advisors in India.

*he trading, commercial and industrial activities in India o" persons

resident abroad, "oreign citi2ens in India and "oreign companies were
regulated by !E$%. *hey had to obtain permission "rom $1I "or carrying
on in India any activity o" a trading, commercial or industrial nature.
Foreign Investment in Inia
Foreign Investment in Inia
T#e $e% &o'icy(

!oreign investment in most o" the industries is now eligible "or

automatic approval route. 3nder the automatic route, the "oreign
investor has to in"orm $1I within LC days o" bringing the !DI and
again within LC days o" issue o" shares.

3ntil Dec J@@F, only LF industries were eligible "or automatic

approval o" !DI upto :JA o" the total e&uity. *he automatic route has
been subse&uently expanded signi,cantly and now there are
diferent categories o" industries on the basis o" the ceiling o" "oreign
e&uity participation+

Industries in which !DI does not exceed BFA

Industries in which !DI does not exceed ?@A

Industries in which !DI does not exceed :JA

Industries in which !DI does not exceed E?A

Industries in which JCCA "oreign e&uity is permitted.

In !eb BCCC, #overnment placed all items under the automatic route
"or !DI / H$I/ K01 investment except "or a small negative list which
includes the "ollowing+

Items re&uiring industrial license

!oreign investment being more than B?A in the e&uity capital o"
units manu"acturing reserved "or small scale sector

Proposals having previous venture / tie;up in India with "oreign

collaborator

Proposals relating to ac&uisition o" shares in existing Indian company

by "oreign / H$I / K01 investor
Foreign Investment in Inia
Foreign Investment in Inia

4ub-ect to sectoral policies, the automatic route would be

available to all "oreign and H$I investors with the "acility to bring
in JCC !DI / H$I / K01 investment. %ll proposals "or investment
in public sector units would &uali"y "or automatic approval.

%ll other proposals which do not con"orm to the guidelines "or

%utomatic %pproval are considered by the !IP1. *he !IP1
therea"ter would recommend the proposal to the #overnment.
!or technical collaborations there are two routes+

%utomatic approval by $1I is available "or any proposal with

lumpsum payment not exceeding 34D B million and royalty o"
upto :A on domestic sales and MA on exports

In all other cases the Pro-ect %pproval 1oard considers the

proposals and makes recommendations to the Industry 9inistry.
Kther measures which encourage "oreign investment include+

Ending the government monopoly in insurance

Kpening up o" the banking sector

Divesting public enterprises

Establishment o" a !oreign Investment Implementation %uthority

6!II%7 to ensure that approvals "or "oreign investments are
processed "ast.
FII Investments(
Indian stock market was opened in J@@B;@L and since then there has
been a signi,cant increase in !II investments. %ccording to the
regulations, !IIs may invest in+

4ecurities in the primary and secondary markets including shares,

debentures and warrants o" companies listed on a recogni2ed stock
exchange in India and 3nits o" schemes 8oated by domestic "unds
including 3*I, whether listed on a recogni2ed stock exchange or not.

!IIs can invest only up to B? per cent o" the paid up capital o" the
Indian company whereas "or H$Is and PIKs this ceiling is kept up to
JC per cent. =owever "or investment in public sector banks, including
the 4tate 1ank o" India the limit is BC per cent o" the paid up capital.

*he ceiling o" B? per cent "or !II investment can be raised up to
sectoral cap/statutory ceiling, i" it is approved by the board and the
general body o" the company through a special resolution. 4imilarly
the ceiling limit "or H$Is and PIKs can be raised to B?A "rom JCA i" it
is approved by the general body o" the company passing a resolution
to that efect.

*he ceiling "or !IIs is independent o" the ceiling o" JC/B? per cent "or
H$Is/PIKs.
Foreign Investments by Inian )ompanies(

3ntil J@@J, Indian companies made very little

investments abroad. =owever, subse&uent to the
opening o" the economy and the growing competition
at home, many Indian companies have been planning
"or a ma-or thrust abroad. !oreign investment, both in
#reen,eld enterprises and mergers and ac&uisitions,
is a part o" the globali2ation strategy o" many Indian
companies. Direct investments abroad by Indian
companies recorded a strong growth.

$1I had liberali2ed overseas investment norms "or

Indian corporates some time back. Indian corporates
are allowed to invest directly in e&uity o" their -oint
ventures abroad and or wholly owned subsidiaries
upto a limit o" 34D JCC million annually. *he norms
allow industries, except banking and real estates.