BUSINESS: Text and Cases

(INTERNATIONAL
308
defines foreign direct inves
UNCTAD's World Investment Report ment (FD
(FD
a long-term relationship and reflectine
as an investment involving
resident entity economy (toreign diretasting
in one
ga lasting
interest and control by a ct
or parent enterprise) in
an enterprise resident in an economy other Vesto than investor
the foreign direct investor (FDI enterprise or affiliate enterprise of
or et
affiliate). FDI implies that the investor exerts a significant degree of infregn
the management of the enterprise resident in the other econom
investment involves both the initial transaction between the two entities ana Such
subsequent transactions between them and among foreign affiliatee
incorporated and unincorporated, FDI may be undertaken by individuals as both
wall
as business entities. Flows of FDI comprise capital provided (either directl well
or
through other related enterprises) by a foreign direct investor to an FDI
enterprise, or capital received from an FDI enterprise by a foreign direct investor
FDI has three components: equity capital, reinvested earnings and intra-companv
loans. It may be noted that Government ot India used to exclude reinvested
earnings from the estimation of FDI in India. Government sources have
however, indicated that Government would redefine FDI including reinvested
earnings also.
If the investor has only a sort of property interest in investing the capital in
buying equities, bonds, or other securities abroad, it is referred to as portfoio
investment. That is, in the case of portfolio investments, the investor uses his
capital in order to get a return on it, but has no much control over the use of the
capital
FDIs are governed by long-term considerations because these investments
cannot be easily liquidated. Hence factors like long-term political stability,
government policy, industrial and economic prospects, ete. intluence the PDl
decision, however, portfolio investments, which can be liquidated fairly easily, are
influenced by short-term gains. Portfolio investments are generally much more
sensitive than FDls. Direct investors have direct responsibility with the promotion
and management of the enterprise. Porttolio investors do not have such direct
involvement with the promotion and management.
Since the economic liberalisation of 1991, there has been a surge in the PDl
and portfolio investments in India.
There are mainly two routes of porttolio investments in India, viz., by
Foreign Institutional Investors (FIls) like mutual funds and through Global
Depository Receipts (GDRs), American Depository Receipts (ADRs) and Foreign
Currency Convertible Bonds (FCCBs).
GDRs/ADRs and FCCBs are instruments issued by Indian companies in the
foreign markets for mobilising foreign capital by facilitating portfolio investment
by foreigners in Indian securities. ince 1992, Indian companies, satisfying
certain conditions, are allowed to accesS foreign capital markets by Euro issues
With refe re nce to foreign investment in India, foreign investment may DE
classified as shown in Figure 8.1.
 Chapter 8
INTERNATIONAL INVESTMENT AND FINANCE 309
Foreign investment

Foreign direct investment

Portfolio investment

Investments Investment in
Joint
Wholly Acquisition by Flls GDRs, FDRs,
venture
Owned

FCCBs, etc.
subsidiary

FIGURE 8.1 Types of foreign investment.

in his For the Future observers, "increasingly

Managing
Drucker
3s Peter Drucker
Peter
than world trade will be driving the international
.

inyestment rather
vestment rathe
become more important than
rates, taxes, and legal rules will
Farlo

mExchange
ecnomy. ExC
investment is given in Box 8.1.
tariffs".'
and tariffs".
and Expansion of foreign
tes
rates
age

BOX 8.11
Expansion of Foreign Investment
universal liberalisation,
international investment, facilitated by the almost
expansion of in their role in global
The
has resulted in a substantial increase
see Box 1.5, Chapter
1), world FDI inflows to global
and trade. The ratio of
production, employment generation cent in 1999, compared with 2 per cent twenty
formation was 14 per 5 per cent to
gOss domestic capital to world GDP increased from
of world FDI stock
years ago. Similarly, the ratio
6 per cent during the same period. policy
have given rise to new

of international production benefits

corresponding
25Cendance and deepening international production, and of the international
distribution of the size of
ges. The most important
of these.
While
all countries have
8s0ciated with it, is one of the decades, not
over the past few of
international

has risen significantly measure

O an imperfect cent of
FDI, albeit received 74 per
panticipatedin it to the same extent.

of
countries-ten
countries
cent of
total FDI
production, is centrated in a handful
countries
received 80 per concentration

Blobal FDI flows in 1999. Just ten developing that the

there are no signs However, in
fows to the More importantly, time.
o developing
World.
countries have
o v e r
FDI, such
been declining a m o u n t s of FDI.
Ucn

intermationaloduction across received only

received
small
small
remains
amounts
challenge
a
many least countries that have
have What

vestment developed
investment.
quality FD
also higher
domestic
ent is is size of
important vis-a-vis the more,
but export
n only economy,
not domestic

bo Countries is the ability to attract to the

ly defined as investment with strong links effects.
defined
oTentati,on, advanced technology and skill
or spillover

Auresy: UNDP, World Investment Report,

2000.
 Cases
BUSINESS: Textand
sos.
I N T E R N A T I O N A L

312 model is true of

Reciverproduct like
Life Cycle D4l Prod..
lnternational
Product
c a s e on
Television
the Television
The
televaston sets,
as is
illustrated by the
Industry.
Eclectic Theory general theorv a e

John Dunning
has attempted
to
formulate

postulates
of
a

s o m e of
the other theorienati inteiCCord
ther theories. Ac rnationg
combining the
by results from three
results three
production
to Dunning.
foreign
investment by MNCS, comparative
which they enjoy, viz.,
advantages
advantages
1. Firm specific
2. Internalisation advantages

3. specific advantages
Location
and intangible resn
result from the tangible
Firm specific advantages the tirm and
which provide thei
firm a
at least temporarily, by
held exclusively, other firms.
over
comparative advantage not result 1n toreign investments unlesa
ess
advantages would
The firm specific
these advantages.
the firm internalises resources it may be able to serve
internalises its exclusive
Even when a firm (for example by exporting
investment
market without foreign
foreign country there should be
to take place in the foreign
a

Therefore, for the production the Eclectic theorv

advantages. One important deficiency of
s o m e location specific which have
investment for acquisitions
is that it does not explain the foreign
internationalisation.
important route to
become a very

Other Theories
Reaction and Multinational
According to Knickerbocker's theory of Oligopolistic
in a n oligopolistic industry,
Enterprise, when firm, especially the leader
one
defensive strategy.
market other firms in the industry followed
as a
entered a
being taken by the initial investor
ie., to defend their market share from away
with the advantage of local production.
Graham noted that there was a tendency for across investment by Europeau
American firms in certain oligopolistic industries. When American ru
and
invested in Europe the European firms retaliated by investing in America
and

vice versa, this was mostly a retaliatory strategy. r

There are also other reasons for investment like following the customed
eking
example the Japanese automobile ancillary firms to foreign markets) and se
knowledge example, Japanese and uropean investment in Silicon Valley.)
(for
These theories at best explain the reasons for some of of the
tne foreig
me
investments only.

SIGNIFICANCE OF FOREIGN INVESTMENT

Foreign investment 1s
playing an
increasing role in economic develor
e n t .
 Chaoter8 INTERNATIONAL INVESTMENT AND
FINANCE 313
sonomcreform
ms
a
and the
the
far-reaching political changes
in the international capital have esulted
resulted in
stantialc
changes

FDI nnow
FDI flows. very
Ubsta shareooffthe domestic
snificant investment,
i emplo
employment contributes to a
umber o f economies.
or
China 1s a classic generation, exports etc.,
example,
m a mber
num
out 15 per
cent of domestic
cent of where in 1997 FDI
o n t r i b u t e da b o u

rial output,
investment,
13 per cent of
41 per cent
of total exports,
19p e rc e n t tax revenue
and 18 million
composition
entyplay
ment

in
The changes in e the of the capital
nitude
of some of the flows and the
nrease i n
the magnitude of
flows, like FDI, have substantial
balance
changed the b
he
ai of ents and foreign
payme:
exchange reserves
remarkably
The debt creating tlows as a percentage of
ountries. The position of
cou total flows in the
raged aass much as 97 per cent during the Seventh
e r a lc o u

averaged

of
India
less 20 to less than Plan (1985-
declined
per cent
by mid 1990s.
surplusOn the BoP and a very remarkableEventually, India
but
990) rnerience
erience aa surplus improvement in
the r e s e r v e s p o s i t i o n .

eserevestment
Foreign i n v e s t n has assisted and is assisting the economic
growth of
ies. As
ny countries. As World Bank report points out, for the developing countries
the following advantages over the official development assistance

0DA):3

FDI shifts the burden of risk of an investment from domestic to foreign

1
investors.

9 Repayments are linked to profitability of the underlying investment,

the borrowed funds must be serviced
whereas under debt financing
costs.
regardless of the project
also been observed that FDI is the only capital inflow
3, Further, it has
associated with higher GDP growth since 1970.
that has been strongly
FDI to economic growth is highlighted by the fact that
The contribution of rose for
domestic investment (gross capital formation)
the ratio of FDI flow to the bulk of the
countries in the past. Although
95t developed and developing its share in their gross fixed capital formation
goes to developed countries, that in developing countries because of the
rC) is only about half of
a9TVeness of their GFCF. generated
technology transfer, FDI has
though
ngart from potential gains a number of countries.
in developing countries w
loyment opportunities savings, many
It may be
imitations of domestic economic growth.
aveh e to
accelerate for a long
rely on foreign investment

high GDP
growth-rate
Med that China
a has been able to
maintain a
inflow of
FDI.
mebeca huge to the
because of a high savings rate and
at the
s e m i n a r on
'moving
Confederation
of

arset.Addressing a infrastructure
the
OSSlon
on by organised 1997,
1997,
Gordon
Gordon

and Asia' a r c h 9,
march
m
Sustaining reforms in
dian Industry in New
India
Delhi
Delhi New
on
o n
E ' s - e f f i c i e n c y ,
equity,

(CI) and Asian society, four

society,
of profits.
has observeced tho
Servedthat foreigr
lan investment
brings ' E - e x p a t r i a t i o n

EAerahencen d expertise. In return,

there is a
fifth
 314 (INTERNATIONAL BUSINESS: Text and Cases

FDI and Production Linkages

The contribution of FDI to sustainable economic developmens
countries depends to a large extent on the production linkages h of
en for
affiliates and domestic firms. Such linkages can take the formen host
foreign
of
forward or horizontal.
Backuard linkages exist when foreign affiliates acquire ods
or
backward,
from domestic firms, and forward linkages when foreign affiliates eel rviceg
sell goodsor
services to domestic firms. Horizontal linkages involve interactions with
firms engaged in competing activities. Linkages, broadly defined, can alsodom
non-business entities like universities, training centres, research and involve
official or private techne
institutienology
institutes, export promotion agencies and other
These are depicted in Table 8.1.
The extent to which foreign affiliates establish backward linkages
mi
domestic suppliers is usually measured by the local content of production or
sourcing by foreign affiliates, although, tor local
many reasons, however, these
measures may not accurately reflecet the magnitude of backward linkages with
domestic firms.
Studies show that in selected developed host countries, affiliates sourea
between 10 and 20 per cent of their inputs locally (1.e., supplied by domestic
or
foreign-owned suppliers). In developing countries, the share of locally-sourced
inputs by foreign affiliates varies by industry and region.
Some of the important conclusions arrived at by the UNCTAD, after
surveying various studies are the following." A number of TNCs take various
steps to develop linkages between their foreign affiliates and suppliers in host
developing countries or economies in transition. Some affiliates provide assistance
in a broad range of areas, whereas others may only support suppliers on an ad
hoc basis, if at all. The most intense relationships are those affecting the
technological status of suppliers and their ability to meet the scale, quality and
cOst needs of the buyer. Meanwhile, it 8 clear that it has become more difficult
for domestic firms in host developing countries to qualify as suppliers to foreign
affiliates, in particular to affiliates that are a part of integrated international
production systems. In such cases, TNCS tend to focus their supplier development
efforts on key suppliers providing the most mportant inputs. On the other hand.
when TNCs have a strong self-interest in developing their supplier base in a host
country, foreign affiliates can extend considerable support to enhance the compe
titivenes8 of their domestic suppliers.
The transfer of information on technical specifications and production
requirements is, of course, a necessary part of all linkages; beyond this, there
are generally considerable flows of advice, information, assistance and support
from buyers to suppliers. The snape nkages varies by location, activity, firm,
the state of domestic and other local tirms, the nature of activities, the duration
and close ness of the buyer-seller-relationship and the costs and risks involvea.
The general picture 18 however, clear: TNCs invest in linkages if and when
they are expected to yield a positive (and competitive) return. Indeed, a survey o
 328(INTERNATIONAL BUSINESS: Text and Cases

acquired-Rs. 2052 crore through open offers and the balar

through the exemption route. Close to 700 companies a c o u g balance (Rs. 9550 cror
through open offers or trough the exemption route. Alm uired
acquisitions were for the purpose of consolidating holdings. No st half
half o hares either
the acquisitions were with the intention
ldings. Nearly
of change
in
nanagement. quae
the
aa
of 181 open offers made during the three year period,
33 (18 Of the
quarter
foreign companies. The foreign companies however, accon. cent) were
44 per cent of the total value of the shares
acquired by open
open offe indfor abou
that their acquisitions are more deep-pocket and
big-ticket. offers,
POREIGN INVESTMENT IN INDIA
The flow of direct foreign investment to India
has been
because of the type of industrial
development comparatively lim
foreign investment policy followed by the nation. strategy and the very Cat
Direct foreign investment (private) in India was
following factors. adversely affected by #h

1. The public sector was

assigned a
monopoly or dominant position in
most important industries and, the
therefore,
scope the of
private investment
both domestic and foreign, was limited.
2. When the public sector
enterprises needed foreign technology or
investment, there was a marked preference for the
sources. foreign government
3 Government policy towards foreign
capital was very selective. Foreign
investment was normally permitted only in
high technology industries in
priority areas and in export oriented industries.
4. Foreign equity participation was normally subject to a
cent, although exceptions were allowed on merit. ceiling or 40 per
5. Payment of dividends abroad, repatriation of capital,
inward remittances were subject to etc., as well as
stringent laws like the Foreign
Exchange Regulation Act (FERA), 1973. These
investment. discouraged foreign
6 Corporate taxation was high and tax laws and procedures were complex.
These factors either limited the scope of
investment in India.
or
discouraged the foreign

Government PolicY
The following paragraphs give a very brief account
policy towards foreign capital and of Government of India s

technology. First, the salient features of thne

Dolicy followed till the economie liberalisation
This is followed by an account of the new introduced in July 1991 are gven
India was following a very policy,
restrictive policy towards foreign capital aand
 er 8 INTERNATIONAL, INVESTMENT AND FINANCE
329
oreign collab aration was
permitted only in fields of high
m h n o l o e r .o

import of fore reign technology was priority and

where t hee

of technology was considered on merits

considered necessary. In
re) if substantial
h e rAreas a perio of 5 to 10
years and if exports
er teed
over
there were
he exports. The reasonable
government had issued lists of industries
Ffor such where:
of
Foreign investment may be permitted.
al Only foreign echnical collaboration (but no foreign investment) may
re be permitted.

ut ,foreign collaboration
c olla (financial or technical) was considered necessary.
foreign
g No
(b)
The ernment policy on foreign equity participation was, thus, selective.
the gove had to be justified with regard to factors such as the nature of
uchparticiypation
narticpa d whether
volved, whether it would promote exports which might not otherwise
N:hnolog

k tplace a n d
and the alternative terms available for securing the same or similar
ace transfers.
tran. Foreign equity participation was limited to 40 per cent,
nologica ons were allowed on merit. The foreign share capital was to be
ohnologica

hough e x c e p t i o n :

sh without being linked to tied imports of machinery and equipment

R ro fcash
for know how, trade marks, brand names, etc.
o payments foi
i e a l collaborations were to be considered on the basis of annual royalty
Technical

which were linked with the value of actual production. The percentage
dependent on the nature of technology. Whenever possible, the
AUmEnts

alty was
i amount of royalty per unit of production was preferred. Royalty
ment offixed
A
limite
were
to a period of 5 years.
Tments served as a tool for
The Foreign Exchange Regulation Act (FERA), 1973,
on foreign private investment in India. The
mlementing the national policy
the Reserve Bank of India to regulate or exercise direct
control
TRA empowered nationals in India. A foreign
the activities of foreign companies and foreign
ser
was defined as one (other than a banking company) which was not
mpany more than 40 per
acorporated in India or in which non-resident interest was
et or any branch of such a company.
citizens), foreign
non-residents (including Indian
According to the FERA, the
India and foreign companies
required the permission of
aens resident in advisers in India,
as agents or technical management
10 accept appointment the use of their trade
marks.
or company, or permit resident
Person activities in India of persons
and industrial the
. rading, commercial were regulated by
and foreign companies
foreign
ATThey
citizens in India carrying on in
lndia any
RA. had to obtain pérmission from the
RBI for
opening
branches/otfices
or
evity of a trading, Commercial or industrial nature;
business
undertaking
in India;
er places of business s s in India' acquiring
any
d
purchasing
RBI had
shares of Indian Companies.
certain
matters.
For example,
general
immovable

give general permi188 for

581on was
or hold any
to acquire to, any
activiy

granted to foreign companies

incidental

erty in India
India for, or
a
then which the permission of the
necessary

Mertaken bynemwith was RBl.

 2 8 (INTERNATIONAL BUSINESS: Text and
Cases
acquired-Rs. 2052 crore through open
through the exemption offers and th
through open offers
route. Close to 700
compan:
compani
acquisitions were for the
trough the exemption rc
or

acquisitions
of 181 purposee of consolidating
were with the consolidating hol
ho
open intention of change
offers made during the three change in
by foreign companies. in
44 per The
three year per
per
That
cent of the foreign companies how
companies
total value of the
their
acquisitions are the how
shares acquired
more
deep-pocket
PORETGN INVESTMENT and b1g-t
The flow of IN INDIA
because of thedirect foreign
foreign investment investment
type of industrial
industrial to India
haas
Direct
foreign policy
llowing factors. investment followed development
by the nation. strat
1. The (private) inin India
India was
was
most public sector was
both important assigned
industries a monopoly a
domestic and
When the public and, monopoly a
inven foreign, was therefore,
limi
limit the :