Module 5

Drivers of FDI, Flow of FDI in India, EXIM Policy of India Direction

of India’s Foreign Trade (imports and exports scenario), Role of
RBI in exchange rate management

Notes

Students should be able to perceive the concepts in

recent EXIM policy of India and relate it to the flow of
FDI as well as direction of Indian foreign trade.

MBA Semester 2
Course – International Business

Topics Covered
1. Drivers of FDI, Flow of FDI in India
2. EXIM Policy of India
3. Role of RBI in exchange rate management

IB Notes – Compiled by Prof. Abdul Karim

 Module – 5
Drivers of FDI, Flow of FDI in India, EXIM Policy of India Direction
of India’s Foreign Trade (imports and exports scenario), Role of
RBI in exchange rate management

Drivers of FDI

FDI has the potential to bring several benefits to the recipient country. The arrival of MNEs in a
country can foster efficiency through increased competition. It can also produce positive
productivity spill over as MNEs integrate domestic firms into their production processes through
forward and backward linkages. In addition, MNEs tend to make new technology available and
provide access to new markets, improving the training and qualifications of the local workforce
and increasing wages and employment. The extent of these positive outcomes will depend partly
on the host country’s absorptive capacity.
MNEs can engage in FDI activities for a number of strategic reasons (using local platforms to
enhance market penetration, absorbing or transferring new technologies, gaining access to
resources or control of competitors, reducing production costs, etc.). A firm’s internationalisation
usually depends on three basic preconditions:
(i) high productivity, as only the most productive firms have the capacity to invest abroad;
(ii) the existence of firm-specific advantages which are not easily transferable to third
parties and are at the core of the firm’s output; and
(iii) a relatively strong market position in the home country.

The determinants of FDI can in turn be grouped in the following way:

(i) ownership, which allows a firm to best exploit its competitive advantages abroad;
(ii) location, which involves exploiting locational advantages across the globe (e.g. supply of labour
or natural resources); and
(iii) internalization, whereby a firm internalizes foreign markets for the use or generation of
assets.

Accordingly, FDI is driven by four main factors: (i) markets; (ii) assets; (iii) natural resources; and
(iv) efficiency seeking.

FDI is driven by four main factors: (i) markets; (ii) assets; (iii) natural resources; and (iv) efficiency
seeking.

First, by investing abroad, companies may seek access to promising new markets. From this
perspective, inward FDI should tend to be positively correlated with the size of the host country
economy and its market potential in terms of economic growth.

Second, asset-seeking FDI is driven by access to new, complementary resources and capabilities.
This type of investment is motivated by a firm’s desire to improve or expand its existing
technologies, managerial skills or labour force. It is often directed towards advanced countries. In

IB Notes – Compiled by Prof. Abdul Karim

the EU, technological progress has been among the main drivers of IFDI. Conversely, in the case of
EMEs, a positive correlation between technological intensity and IFDI is not expected.

Third, FDI flows may also be driven by the desire for access to natural resources. This type of FDI
is more likely to be directed towards EMEs which have abundant natural resources. However,
large natural resource endowments can also deter IFDI into EMEs owing to what is known as the
“natural resource curse”, i.e. the negative long-term impact of large natural resources on a
country’s development (e.g. in terms of economic growth, institutional quality or capital
allocation), which may hamper its capacity to attract FDI.

This outcome, however, is neither universal nor unavoidable, but affects certain countries under
certain conditions, such as high dependence of exports and fiscal revenues on resource wealth,
low saving rates, highly volatile resource revenues, and crowding-out of other activities.

Fourth, efficiency-seeking FDI is mainly driven by lower labour costs and higher productivity. In
the case of labour costs, existing evidence in the literature is far from conclusive. This type of
investment is generally expected to be directed towards EMEs with large supplies of cheap labour
(e.g. China and Vietnam) for the development of low value added economic activities.

EXIM POLICY OF INDIA

Export Import Policy or better known as Exim Policy is a set of guidelines and instructions related
to the import and export of goods. The Government of India notifies the Exim Policy for a period
of five years (1997-2002) under Section 5 of the Foreign Trade (Development and Regulation Act),
1992. The current policy covers the period 2002 2007. The Export Import Policy is updated every
year on the 31st of March and the modifications, improvements and new schemes becomes
effective from 1st April of every year. All types of changes or modifications related to the Exim
Policy is normally announced by the Union Minister of Commerce and Industry who coordinates
with the Ministry of Finance, the Directorate General of Foreign Trade and its network of regional
offices.

Features of Exim Policy includes:

1. Service Exports
Duty free import facility for service sector having a minimum foreign exchange earning of Rs. 10
lakhs. The duty free entitlement shall be 10% of the average foreign exchange earned in the
preceding three licensing years.
However, for hotels the same shall be 5 % of the average foreign exchange earned in the preceding
three licensing years. Imports of agriculture and dairy products shall not be allowed for imports
against the entitlement. The entitlement and the goods imported against such entitlement shall be
non transferable.

2. Status Holders
1. Duty free import entitlement for status holder having incremental growth of more than
25% in FOB value of exports (in free foreign exchange). This facility shall however be available to
status holder having a minimum export turnover of Rs. 25 crore (in free foreign exchange).

IB Notes – Compiled by Prof. Abdul Karim

2. Annual Advance Licence facility for status holder to be introduced to enable them to plan
for their imports of raw material and component on an annual basis and take advantage of bulk
purchase.
3. Status holder in STPI shall be permitted free movement of professional equipment’s like
laptop/computer.

3. Hardware/Software
1. To give a boost to electronic hardware industry, supplies of all 217 ITA1 items from EHTP
units to Domestic Tariff Area (DTA) shall qualify for fulfillment of export obligation.
2. To promote growth of exports in embedded software, hardware shall be admissible for
duty free import for testing and development purpose. Hardware up to a value of US$ 10,000 shall
be allowed to be disposed off subject to STPI certification.
3. 100% depreciation to be available over a period of 3 years to computer and computer
peripherals for units in EOU/EHTP/STP/SEZ.

4. Gem & Jewellery Sector

1. Diamonds & Jewellery Dollar Account for exporters dealing in purchase /sale of diamonds
and diamond studded jewellery .
2. Nominated agencies to accept payment in dollar for cost of import of precious metals from
EEFC account of exporter.
3. Gem & Jewellery units in SEZ and EOUs can receive precious metal Gold/silver/platinum
prior to export or post export equivalent to value of jewellery exported. This means that they can
bring export proceeds in kind against the present provision of bringing in cash only.

5. Removal of Quantitative Restrictions

1. Import of 69 items covering animals products, vegetables and spice antibiotics and films
removed from restricted list
2. Export of 5 items namely paddy except basmati, cotton linters, rare, earth, silk, cocoons,
family planning device except condoms, removed from restricted list.

6. Special Economic Zones Scheme

1. Sales from Domestic Tariff Area (DTA) to SEZ to be treated as export. This would now
entitle domestic suppliers to Duty Drawback / DEPB benefits, CST exemption and Service Tax
exemption.
2. Agriculture/Horticulture processing SEZ units will now be allowed to provide inputs and
equipment to contract farmers in DTA to promote production of goods as per the requirement of
importing countries.
3. Foreign bound passengers will now be allowed to take goods from SEZs to promote trade,
tourism and exports.
4. Domestics sales by SEZ units will now be exempted.
5. Restriction of one year period for remittance of export proceeds removed for SEZ units.
6. Netting of export permitted for SEZ units provided it is between same exporter and
importer over a period of 12 months.
7. SEZ units permitted to take job work abroad and exports goods from there only.
8. SEZ units can capitalize import payables.
9. Wastage for sub contracting/exchange by gem and jewellery units in transactions between
SEZ and DTA will now be allowed.

IB Notes – Compiled by Prof. Abdul Karim

10. Export/Import of all products through post parcel /courier by SEZ units will now be
allowed.
11. The value of capital goods imported by SEZ units will now be amortized uniformly over 10
years.
12. SEZ units will now be allowed to sell all products including gems and jewellery through
exhibition and duty free shops or shops set up abroad.
13. Goods required for operation and maintenance of SEZ units will now be allowed duty free.

7. EOU Scheme
Provision of SEZ (Special Economic Zone) scheme, as mentioned above, apply to Export Oriented
Units (EOUs) also. Besides these, the other important provisions are:

1. EOUs are now required to be only net positive foreign exchange earner and there will now
be no export performance requirement.
2. Period of Utilization raw materials prescribed for EOUs increased from 1 years to 3 years.
3. Gems and jewellery EOUs are now being permitted sub contracting in DTA.
4. Gems and jewellery EOUs will now be entitled to advance domestic sales.

8. EPCG Scheme
1. The Export Promotion Capital Goods (EPCG) Scheme shall allow import of capital goods for
preproduction and post production facilities also.
2. The Export Obligation under the scheme shall be linked to the duty saved and shall be 8
times the duty saved.
3. To facilities upgradation of existing plant and machinery, import of spares shall be allowed
under the scheme.
4. To promote higher value addition in export, the existing condition of imposing an
additional Export Obligation of 50% for products in the higher product chain to be done away
with.
5. Greater flexibility for fulfillment of export obligation under the scheme by allowing export
of any other product manufactured by the exporter. This shall take care of the dynamics of
international market.
6. Capital goods up to 10 years old shall also be allowed under the Scheme.
7. To facilitate diversification in to the software sector, existing manufacturer exporters will
be allowed of fulfil export obligation arising out of import of capital goods under the scheme for
setting up of software units through export of manufactured goods of the same company.
8. Royalty payments received from abroad and testing charges received in free foreign
exchange to be counted for discharge of export obligation under EPCG Scheme.

9. DEPB Scheme
1. Facility for provisional Duty Entitlement Pass Book (DEPB) rates introduced to encourage
diversification and promote export of new products.
2. DEPB rates rationalize in line with general reduction in Customs duty.

10. DFRC Scheme

1. Duty Free Replenishment Certificate (DFRC) scheme extended to deemed export to provide
a boost to domestic manufacturer.
2. Value addition under DFRC scheme reduced from 33% to 25%.

IB Notes – Compiled by Prof. Abdul Karim

Objectives of The Exim Policy: -

Government control import of non-essential items through the EXIM Policy. At the same time, all-
out efforts are made to promote exports. Thus, there are two aspects of Exim Policy; the import
policy which is concerned with regulation and management of imports and the export policy
which is concerned with exports not only promotion but also regulation. The main objective of the
Government's EXIM Policy is to promote exports to the maximum extent. Exports should be
promoted in such a manner that the economy of the country is not affected by unregulated
exportable items specially needed within the country. Export control is, therefore, exercised in
respect of a limited number of items whose supply position demands that their exports should be
regulated in the larger interests of the country. In other words, the main objective of the Exim
Policy is:

• To accelerate the economy from low level of economic activities to high level of economic
activities by making it a globally oriented vibrant economy and to derive maximum benefits from
expanding global market opportunities.
• To stimulate sustained economic growth by providing access to essential raw materials,
intermediates, components,' consumables and capital goods required for augmenting production.
• To enhance the techno local strength and efficiency of Indian agriculture, industry and
services, thereby, improving their competitiveness.
• To generate new employment.
• Opportunities and encourage the attainment of internationally accepted standards of
quality.
• To provide quality consumer products at reasonable prices.

Role of RBI

Reserve Bank of India (RBI) is India's Central bank. It plays multi-facet role by executing multiple
functions such as overseeing monetary policy, issuing currency, managing foreign exchange,
working as a bank of government and as banker of scheduled commercial banks, among others. It
also works for overall economic growth of the country.

• RBI is responsible for administration and regulates the market by issuing license to the
bank and other select institution to act as authorized dealers in foreign Exchange. The FDE are
responsible for the regulation and development of market.
• Regulating transactions related to the external sector and facilitating the development of
the foreign exchange market
• Ensuring smooth conduct and orderly conditions in the domestic foreign exchange market
• Managing the foreign currency assets and gold reserves of the country.

Currency Issue
Reserve bank of India is the only authority who is authorized to issue currency in India. While
coins are minted by Government of India (GoI), the RBI works as an agent of GoI for distributing

IB Notes – Compiled by Prof. Abdul Karim

and handling of coins. Upto Re.1 coins are minted by GoI although RBI ensures their distribution
in the country.

RBI also works to prevent counterfeiting of currency by regularly upgrading security features of
currency. RBI prints currency at its 4 currency printing facilities at Dewas, Nasik, Mysore and
Hyderabad. The RBI is authorized to issue notes up to the value of Rupees 10,000 (Ten thousand).

Banker to Government
Like individuals, firms and companies who need a bank to carry out their financial transactions
effectively & efficiently, Governments also need a bank to carry out their financial transactions.
RBI serves this purpose for the Government of India (GoI). As a banker to the GoI, RBI maintains
its accounts, receive in and make payments out of these accounts. RBI also helps GoI to raise
money from public via issuing bonds and government approved securities.

Supervisor of Banks: Bankers’ Bank

RBI also works as banker to all the scheduled commercial banks. All the banks in India maintain
accounts with RBI which help them in clearing & settling inter-bank transactions and customer
transactions smoothly & swiftly. Maintaining accounts with RBI help banks to maintain statutory
reserve requirements. RBI also acts as lender of last resort for all the banks.

RBI has the responsibility of regulating the nation's financial system. As a regulator and supervisor
of the Indian banking system it ensures financial stability & public confidence in the banking
system. RBI uses methods like On-site inspections, off-site surveillance, scrutiny & periodic
meetings to supervise new bank licenses, setting capital requirements and regulating interest
rates in specific areas. RBI is currently focused on implementing Basel-III norms to regulate the
hidden Non Performing Assets (NPAs) in Banking system.

RBI as Country’s Foreign Exchange Manager

RBI has an important role to play in regulating & managing Foreign Exchange of the country. It
manages forex and gold reserves of the nation.

On a given day, the foreign exchange rate reflects the demand for and supply of foreign exchange
arising from trade and capital transactions. The RBI’s Financial Markets Department (FMD)
participates in the foreign exchange market by undertaking sales / purchases of foreign currency
to ease volatility in periods of excess

IB Notes – Compiled by Prof. Abdul Karim