eee 40 : NAGESH KUMAR Foreign Direct and Portfolio Investments Flows and Development A Perspective-on Indian Experience The Context Foreign capital flows have emerged-as key channels of global economic integration all across the w@rld over the past two decades. While foreign direct investment (FDf)/Hows have been undertaken for a long time by multinati Es) in the course of their overseas expansion, foreign portflfo investments (FPls) representing equity and debt flows unaccon{panied by management control have become highly visible and ofj@h' dominant components of the foreign capital flows in recent yegP with the rise_of foreign institutional investors (FIIs) and sover wealth funds on the horizon that seek to make quick returns thr short-term speculative activities abroad. FDI flows represen(onger-term investm« de abroad bringing together with capi ip. technology and managerial Know how and sonfetimes even market access, hence are seen by developing countries%s catalysts of development. Therefore, most developing countries actively seek to attract EDI flows with different policy instruments. FPIs, in contrast, tend to have limited potential of contributing to development, if at all, given their short-term and speculative nature. Their distribution across countries is highly uneven as they target only’the fast growing emerging economies and those with deep capital markets to benefit from their dynamism. In fact they are rs soften seen to be bringing volatility to the financial and exchange rate Revised August, 2014. nH HHH HAH HAHAH @€ SOPRDODDAMDHROHRT ON OO-_ INDIAN ECONOMY SINCE INDEPENDENCE + UMA KAPILA (ED) 1056. ' markets. Hence, a number of emerging market economies are seeking to moderate their volatility through a variety of capital controls. Recent years have also seen the rise of FDI and EPI flows in India. ‘This can be Partly attributed to substantial liberalisation of the policy regime since 1991 and with her economy embarking on robust growth trajectory in the n ‘ew millennium, India also begun to attract increasing attention Es as well as Flls lestination for inve: stments. The Past decade also marked the emergence of India as sources of outward investments. Indian ente: tprises havé begun to use outward EDI as a_ strategic tool for strengthenin, i petitiveness. As a “result, EDT flows are increasingly of bi-directional in nature rather than only one sided with India playing host. Against that background, this paper experience in attracting FDI and FPI and Patterns and prospects for these flows As the country also emerges as a sour briefly touches upon the trends in th policy lessons._ oO Evolution of Policy Regime TowargS D1 and FPIs in India Indian government policy, tune with the requirements phases (see Kumar, 2005a), aQilmarises the Indian ews the recent trends, ‘ir developmental impact. DI as well, the Paper also ‘ows. It concludes with some an ct tgwards FDI has evolved over time in process of development in different on after Inde, endence, India embarked on a strategy of import ‘ituting is ialisation in the framework. se lea capability Bicavy industries including te eh chslgy shila beprensuais ae me jenna a ives FB vena coe Fa, he : 2. advantageous terms, though the majorit ee ‘he ty local ownership was preferred, » » “government adopted a more restrictive attitude te Onthe Tate 1960s as the 1 owards F! local base of machine manufacturing capability abroad on account of servicing of EDI and technol, logy imports sharply. Restrictions 't on proposals of FDIs unaccompanii e technology transfer and those seekin; ownership. Bro, more than 40 per cent foréigi = 973 onwards, t ictivities of foreig companies (along wi i i were putFOREIGN DIRECT AND PORTFOLIO INVESTMENTS... + NAGESH KUMAR 1057 Exchange Regulation Act (FERA) of 1973 required all foreign companies, g in India to register under Indian corporate legislation with up_ to40 per cent foreign equity. Exceptions from the general limit of 40 per cent were made only for companies operating in high priority or high technology sectors, tea plantations or those producing predominantly for exports. In the 1980s, the attitude towards FDI began to change as a part of the strategy of modernisation of industry with liberalised imports of capital goods and technology, exposing the Indian industry to foreign competition, and assigning a greater role to MNEs in the promotion of manufactured exports. The policy changes ae the 1980s covered “Wberalisation of industrial licensing (approval)auls, a host of incentives, and exemption from foreign equity restricti6a under FERA to 100 et export-oriented units and a degree “eee concerning foreign ‘ownership. After pursuing a restrictive policy, gprs FDI over the four decades with a varying degree of selectivity India changed tracks in 1990s and embarked on a broader process“of reforms designed to increase restricted to a select group of core or high priority industries. The Foreign her integration with the global ecyRomy. Among the reform measures implemented included a depargive from the restrictive policy towards EDI, a much more liberal trade\policy besides reforms of capital market and exchange controls. The lew Industrial Policy (NIP), announced on 24 JulyL991, marked\t-iajor departure with respect to FDI policy with the abolition of dustrial licensing system except where it is required for strategic, environmental grounds, creation of a system of automatic cle D1 proposals fulfilling the conditions laid down, such as the ownerghp levels of 50 per cent, 51 per cent, 74 per cent aii 100 per cent foreign equity, and opening of new sectors such as mining, banking, insurance, telecommunications, construction and management “Forts: harbours, roads and highways siinesand defence conse to foreign-owned companies subject to sectoral caps. Foreign ownership ‘up to 100 per cent is permitted in most manufacturing sectors—in some sectors even on automatic basis—except for defence equipment where it is limited to 26 per-cent and for items reserved for production by small- scale industries where it is limited to 24 per cent. The dividend balancing and the related export obligation conditions on foreign investors, which applied to 22 consumer goods industries, were withdrawn in 2000 (Kumar, 2005a). In September 2012, India allowed FDI in multibrand | OGODDOOHOMDTONRK DMD HMO OH on TO T|INDIAN ECONOMY SINCE INDEPENDENCE + UMA KAPILA (ED) 1058 ij ce ° 2014 in some sectors like telecom to 100 per cent, in insurance to 49 per cent, and in defence equipment beyond 26 per cent on a case-by-case ‘basis. — In September 1992, the Indian government announced guidelines for investments by FIIs in the Indian capital market. FIIs were now welcome to invest in all types of securities traded on the primary and secondary market with full repatriation benefits and without restrictions on either volume of trading or lock-in period. This liberalisation has led to considerable inflows of portfolio inflows making the country one of the most exposed to portfolio inflows. In June 20: investments were reclassified ich is subje i qualify as FDI. ay Recognising the importance of ward investment for competitiveness of enterprises, the policy-poverning outward FDI has also been liberalised since 1991. With uild-up of foreign exchange and Indian enterprises are now permitted to invest abroad India has also entered into Double Taxation Avoidance Treaties, and Bilateral Investment Pro: ion and Protection Agreement (BIPAs) with 82 countries. & ~ @ ~ = Foreign Direct Investmesit Flows and Their Quality ~ Trends in FDI Inflows EDI inflows tafndia have been growing since 1991, but the big break came in 2006, when annual inflaws to the country nearly tripled in one year from $7.6 billion to $20 billion and increased from that level: aking to $47 billion in init 27 billion in 2010sin: the wake of the global Raced SAE ETE ee 2011 (Table 40.1A). With the slowdown of Indian economy since 2011, however, it declined again and was at $28 billion in 2013. India’s share in. global FDI inflows nearly doubled over 2005-06 and again between 2006 and 2009 to nearly 2.9 per cent before declining to little 2.1 per cent.in: 2011 (Table 40.1, Figure 40.1A). ‘The relative importance of the flows in relation to gross fixed investment has also risen from 2.9 per centin 2 ¢ share of FDI in gross fixed investments1059 + NAGESH KUMAR FORBIGN DIRECT AND PORTFOLIO INVESTMENTS, SEE EEE EU OOH EG SS ‘Zuo posum nme ‘(@TOZ) 98¢q FEP BUTTUO (YLONA) Watudopeaag pur apery uo aouararuoy suoTeN p> OF 9s sh bz zo ee 2 . v9 6 Tr toes Te ee cet Or Ger ee ec ee Gt OL Ok gE Qe cor fe sce cee ga at zoe Toe roe 9002 4002 +9002 ~—-Soe wo ~—«eDOZ ~—«OOE ~—«*LOOE 209 f i TeatdeD pextg s90xp jo yus> xed ¥ ve smopay 1G “d BET Y8T BIT «BET «BET Doe wr wo Teo wo seo wo PEON Oy "Epa jo azeys i a a sequioto[g i On. Roxoqoag 05 uy espa yo axegs 499 «= ue'S HR ELD) HOTT = BETE HED 2889/5) Co ee SO 49, ‘uyeppa] jo aregs G6TSZ 96TH OGTOE TERLZ LOGE ETL SESE BLED Sts a eas apa T9SSe ZhPZE ZLEP BEOSE LZPTP E99S LSE 08SAZ_—ZBTH tse 6The —89S0T Le89 BV MiEMAMOS SSE9z> OTSTR ZZO0E TZOGOP EBOEZE STONE TeSsE shevse ccaTEC €ABYzEOTSET Loos TeSTT MY SeMMOUNE OBSZES 851899 I9TTES 698ZE> SzPTPE exoee efggt ECEZLT OTSTE saruoucng ZLEBLL GPYELL OPBPZL B0zEE : _ ISH ELZOEET COOOOLT SSLLZPT OPTZZT FERBTST LEETOOT TOGTePT PIL9ES ZASLEL EOEFO9 OBLEL9 SPLLES PHOM eroc chor -00z «oor ~—«6O0z_—«BOOL_—«LOOL_~—900_—SUKE_— HOOT eT zo0c — s00e a : {isn wore ‘er0z-r002 renuae ‘smog 1a PreAET "Y (ssa vom) £T02-T00Z ‘Tonuuy ‘smopy quawyseauy ea uBjasoy pancnuy TO o19eL 1382 A EcoNOMY SINCE INDEPENDENCE + UMA KAPILA (ED) ee Die eal Figure 40.4 India’s Attractiveness as a Destination of FDI Inflows A: India’s Share in Global Inflows B: Share of EDI in 4 Capital Formation in Developing Economies and India 16.0 @ 140 r 120 S 00 § 40 60 40 20 oo RERRERE REE [= Developing Reonomies: Asia 139, 2 in |] cate Per, Atte,=a FOREIGN DIRECT AND PORTFOLIO INVESTMENTS... + NAGESH KUMAR io in India has been lower than for other developing countries but was catching up. In 2008 when EDI inffows peaked in India, this ratio at 10.8 per cent was quite close to that for developing Asia at 10.6 per cent. Afterwards it has declined in the wake of financial crisis indicating the potential for a rise in the future (Table 40.1B and Figure 40.1B) Investment Climate and Prospects for FDI Inflows ‘The empirical studies of determinants of FDI inflows have found "an important role of market size, extent of urbanisation, quality of infrastructure, geographical and cultural proximity with major sources of capital, and policy factors, e.g., tax rates, investment incentives, performance requirements, among other factorg (Kumar, 2000). In the light of these findings, while India’s large jon base may be an advantage, Yelatively low incofte levels, lof\level® of urbanisation Furthermore, India also does not have th cultural proximity with major sources of Japan. However, over time the relativ untry is rowth frat and other aspects of macroeconomic performaycf. A recent inter-temporal analysis for India has found a broad cor such as the US, Europe or crowd-in EDI inflows as well << The recent rise in DEntiows since 2006 reflect/ Improving e th the acceleration of growth rate since dvantage in knowle sed ef only evident from the rising magnitudes of FDI inflows but also from investor surveys conducted by global consultancy organisations. In the FDI Confidence Index published by AT Kearney, a global consultancy organisation, covering 25 top destinations for EDI, India has moved up from 6" place in 2003 to 2in 2005 and stayed there before swapping the 3" rank with the US in 2010 (Table 40.2). In 2012, asain regained the second position in the global rankings (AT Kearney, 2012). In 2013, India moved down to the 5" rank globally as the US moved up to the 1* rank as the prospects for growth improved and as their natural resources bases helped Brazil (3) and Canada (4) moved up. Among the Asian developing countries, India continues to remain 2"!ee fea * eee after China. Similar upgrading in India’s ranks has been reported by the surveys of investors conducted by the Japanese Bank of International Cooperation (JBIC) as well as in UNCTAD’s World Prospects Survey 2013-2015, where India is ranked as the 3" most preferred FDI location (UNCTAD, 2014). Recent reforms adopted by the country to allow FDI in multibrand retail and civil aviation and large infrastructure projects such as Delhi-Mumbai Industrial Corridor are also likely to help in realising its potential for FDI inflows. ‘This is in sharp contrast to the World Bank’ studies on Ease of Doing Business based on perception surveys that tend to put India at a very poor rank of 132. It is clear therefore that foreign investors get attracted to a country by the potential of benefiting from its dynamism and are willing to put up with hardships rather than going to countries with easier business conditions but h poorer prospects of making profits. FDI inflows may also assist ufacturing-oriented structural transformation of the economy ‘echnological upgrading of exports that India needs by bringing wehbe and other resources working together with local entrepreneusf0) Tabl Select Asian Ranking i BDI Confidence Index ee A les — - re . —— China 1 tar a al 1 2 (1.97) og) (2.19) (2.21) (193) (2.02) India 6 2 2 3 5 (a.04) wt (1.95) 2.09) 6a) (85) Thailand 16 20 20 17 083) E087) (1.05) 63) Singapore 28 18 18 7 24 10 © aon 475) .as) 77) Malar 15 16 a 25, 06) (0.92) 163) 1.22) a6) Hong Kong 22 8 10 5 4 6) 99) a2) 78) a.28) "Note: Index values are in parentheses, Source. Author's caleulation based on AT different years. Quality of FDI Inflows ‘There can be several indicators of quality of FDI inflows (see Kumar, 2002). In what follows, we discuss India's performance in terms of a few such indicators. Kearney, Foreign Direct Investment Confidence’ Index, FeFOREIGN DIRECT AND PORTFOLIO INVESTMENTS... + NAGESH KUMAR os vee 1063 Sectgral Composition {%°'y of FOL) One-of the indicators of quality is the sectoral composition of EDI inflows. It matters whether FDI is going to the modern technology- intensive sectors and building productive capabilities or to conventional sectors crowding out domestic investments. In terms of the sectoral composition, of FDI inflows, there is a shift since 1991 in India's case Earlier thé Bulk of FDI inflows used to be directed to manufacturing especially, the high technology industries through a selective policy. After the liberalisation, a substantial proportion of FDI inflows has been directed to services. Manufacturing has accounted for only about 40 per cent of inflows in the post-1991 period with services accounting for about 35 per cent share. Furthermore, among the manufacturing subsectors, FDI stock in the post-1991 peri 80 ) more evenly distributed between food and beverage: transport equipment, metals and metal products, electricals and electron{cby chemicals and allied fucts, and miscellaneous manufacturings {Mis stands in contrast to the situation prior to 1990 when there wa@avery heavy concentrati@h in relatively technology-intensi achinery, chemicals, electricals, and transport equipment ( r, 2005a). = Tn China, on the other hand, the’ bulk of FDI inflows have been directed by the government potiggte manufacturing (of the export- oriented type) and very little has @gne to services (Yongding, 2006). Of the FDI in manufacturing in Chia, 11 per cent has gone in electronics and telecommunication equipment helping it emerge as the leading — producer and exporter of thie products. A policy guidixg-FDI inflows to manufacturing has helpgd in China’s emergence as a global factory. Therefore, FDI inflows igShina have been directed to assist in industrial development of the jnfustry that has made China a global factory, generating in the pr&c&ss billions of dollars of output and exports and millions of jobs. & Impact of FDI on Growth and Domestic Investment EDI inflows could contribute to growth rate of the host economy by augmenting the capital stock as well as with infusion of new technology. However, high growth rates may also attract more FDI inflows by enhancing the investment climate in the country. Therefore, the FDI. growth relationship is subject to causality bias given the possibility of two- way relationship. What is the nature of the relationship in India? A recent study has examined the direction of causation between FDI and growth 142 : kar ~~ TODDOODOODHTTONRH ORM HO HHO nM ennINDIAN ECONOMY SINCE INDEPENDENCE + UMA KAPILA (fp, 1064 “ . - — empirically for a sample of 107 countries for the 1980s and 1990s period. In the case of India, the study finds a Granger neutral relationship as the direction of causation was not pronounced (see Kumar and Pradhan, 2005, for more details of the methodology and results). It has also been shown that sometimes FDI projects may actually crowd-out or substitute domestic investments from the product or capital markets with the market power of their well-known brand namés and other resources and may thus be immiserizing (see Fry, 1992; Agosin and Mayer, 2000, for evidence). Therefore, it is important to examine the impact of FDI on domestic investment to evaluate the impact of EDI on growth and_welfare in the host economy. An earlier study to examine the effect of FDI on domestic investment in a dynamic setting, however, did not find a statistically significant of EDI on domestic investment in the case of India (see Kuma und Pradhan, 2005). It appears, therefore, that FDI inflows received’by/{ndia have been of mixed type combining some inflows crowdin; mestic investments while others crowding them out, with no predominant pattern emerging in the case of India. In the case of East Asfin countries such as South Korea and Thailand, the relationship was Barly indicating FDI crowding-in domestic investments (Ibid.). TherGfore, the quality of FDI in India in respect to its impact on growth aqWon domestic investment is of mixed type and leaves scope for improyétnent ‘The empirical studies on €hr nature of the relationship between FDI and domestic investments@)iggest that the effect of F] “investment depends onyyst government policies’ Governments have extensively employed tive policies and imposed various performance requirements such as9cal content requirements (LCRs) to deepen the commitment of Mio the ie economy. The Indian government had imposed a conditioW/of phased manufacturing programmes (or LCRs) in the auto industry to promote vertical inter-firm linkages and encourage development of the auto component industry (and crowding-in of domestic investments). A case study of the auto industry where such a policy was followed shows that thes} ‘policies (in combination with other performance requirements viz., foreign exchange neutrality) have succeede ilding an i ionally competitive vertically integrated auto sector in the country (Ibid.). The Indian experience in this industry, therefore, is in tune with the experiences of Thailand, Brazil and Mexico as documented by Moran (1998),FOREIGN DIRECT AND PORTFOLIO’ INVESTMENTS... + NAGESH KUMAR 1065 FDI and Export-platform Production (a¥2l:by 2) ro) ~ A number of developing countries have used FDI to exploit the resources of MNEs such as globally recognised brand names, best practice technology or by increasing integration with their global production networks, among others, for expanding their manufactured exports. In this respect, China has had a considerable success in exploiting the potential of FDi for export-ori ion. A very substantial foreign invested enterprises, which account for as much as 80 per cent of all technology-intensive exports (UNCTAD, 2005). Foreign enterprises while setting up export-oriented production bases created 23 million jobs by 2003 making China a global factory. Export-oriented EDI also helps in bringing world’s best practice technolog@as the affiliate has to compete globally right from the beginning. I enhances the chances of FDI inflows crowding in domestic iny&tments and reducing the chances of crowd-out as the foreign affiligtg, ould be mainly catering to the outside markets rather than mee domestic firms’ markets. It would also create fresh possibilities of Ptarket information spillovers for domestic firms on export possteps Unlike the East Asian countriggy India has not been able to explo the potential of FDI for export@fiented production. The bulk of FDI inflows ‘in India ate matket-adQing coming for tapping eedeew ty market with the share of iates i cent. Therefore, the quality of En respect of export orientation compared to FDI recBiv observations can be performance are begi to er CEN. oy is poorer East Asian countries. In this respect, two le. The first is that recent studies of export ing to indicate a relatively superior performance of foreign enterprigedin terms of export orientation compared to eatly studies suggestirfg)a poorer performance of foreign companies (see Kumar and Joseph, 2007). Therefore, MNEs are be inning to exploit the Potential of India as base for export-oriented production, The second observation is.about the role of host country policies in exploiting the potential of FDI for export-oriented production. A quantitative study analysing the determinants of the patterns of export orientation of MNE affiliates across 74 countries in seven branches of industry over three points of time has shown that in host countries with large domestic markets, the export obligations were effective for promoting export orientation of foreign affiliates to third countries (see Kumar, 1998). “4INDIAN ECONOMY SINCE INDEPENDENCE + UMA KAPILA (ED) 1066 aces ae Export obligations have also been employed fruitfully by many countries to prompt MNB affiliates fo exploit the host country’s potential for export, platform production, For instance, in China which has succeeded in expanding manufactured exports with help of MNE affiliates, regulations stipulate that wholly owned foreign enterprises must undertake to export more than 50 per cent of their output (Rosen, 1999: 63-71). As a result of these policies, the proportion of foreign enterprises in manufactured exports has steadily increased to over 55 er cent as observed above. India has not imposed export obligations on MNE affiliates except for those entering the products reserved for SMEs. However, indirect export obligations in the form of dividend balancing have been imposed. for enterprises producing primarily consumer (since phased out in 2000). Under these policies, a foreign enterpitige was obliged to earn the foreign exchange that it wished to remit 4Dxoad as dividend so that there was no adverse impact on host co ’s balance of payment (BoP). Sometimes a condition of foreign @xghange neutrality has been imposed where the enterprise is requivell to earn foreign exchange enough to even cover the outgo onCaccount of imports. Therefore, —these regulations have acted as indfr8ct export obligations prompting foreign enterprises to export to €arn the foreign exchange required by them. The evidence that is avfifable suggests that such regulations have prompted foreign enterpfiges to undertake exports. In the case of auto industry, 7 their export commitments to y with fore neutrality condition, foreign auto majors ents from India which have not opened new oppgfinities for Indian component manufactufers fut ‘also in that mabe found profitable opportunities for business (Kumar, 2005). Hexi@@) exports of auto components from India are now growing rapidly ant exceeding the obligations several times oY. These regulations have acted to remove the information asymmetry existing about the availability of quality components in India among the foreign auto majors, In that respect, India’s experience is very similar to that of Thailand that has emerged as the major auto hub of Southeast Asia (as documented by Moran, 1998, and Kumar, 2005). R&D and Other Knowledge-based Activities and Local Technological Capability Covetity) A comparison of R&D (research & development) intensity of foreign firms in India and in other countries has not been possible due to lack ofFORBIGN DIRECT AND PORTFOLIO INVESTMENTS... + NAGESH KUMAR a Oe ieee ecient ceed 7 1067 data. Within the country, foreign firms appear to be spending more on R&D activity in India than local firms, although gap between their R&D intensities has tended to narrow down. A study analysing the R&D activity of Indian manufacturing enterprises in the context of liberalisation has found that after controlling for extraneous factors, MNE affiliates reveal a lower R&D intensity compared to local firms, presumably on account of their captive access to the laorat ries of their parents and associated companies. The study also obser iad ifertes in the nature or ion of R&D activity of foreign and local firms. Local firms seem to recting their R&D activity towards absorption of imported knowledge and to provide a backup to their outward expansion. MNE affiliates, on the other hand, focus on customisation of their parents’ technology for the local market (Kumar and Agarwal, 2005). % ‘An important issue is diffusion and absorptip af technology brought by foreign firms in the-host countries. Some soproments have imposed technology transfer requirements on forei; terprises, e.g., Malaysia. However, such performance requirements. not appear to have been very successful in achieving their objectives (UNCTAD, 2003). Instead, other performance requirements mi local content requirements or domestic equity requirements may be more effective in transfer of technology. As observed above, logaf‘content requirements and export performance requirements have pted foreign enterprises to transfer and diffuse some knowledge to-pmestic enterprises in order to comply the domestic equity requirements may of the knowledge brought in by foreign irtant pre-requisite of the local technological case studies of Indian two-wheeler industry where Indian joint yéytures with foreign firms were able to absorb knowledge broughtGip By the foreign partner and eventually become self-reliant not only to continue production but even to develop their own world-class models for domestic market and exports on their own (see Kumar, 2005). Some have expressed the view that domestic equity requirements may adversely affect the extent or quality of technology transfer (Moran, 2001). However, it has been shown that MNEs may not transfer key technologies even to their wholly owned subsidiaries abroad fearing the risk of dissipation or diffusion through mobility of employees. Furthermore, even if the content and quality of technology transfer is superior in the case of a sole venture than in the case of a joint venture, from the host country point of view, the latter may have facilitate the quick absorpti6 enterprises which is an i capability, as is evident toINDIAN ECONOMY SINCE INDEPENDENCE + UMA KAPILA (ED, 1068 eae more desirable externalities in terms of local learning and diffusion of ~ the knowledge transferred. FPI Inflows and Their Impact The rapid rise in inflows of portfolio investments in India since 2003-04 is summarised in Table 40.3. Large magnitudes of portfolio investments in the form of short-term equity investments by FII have flowed in as the Indian economy gathered momentum and capital markets started giving attractive returns. The annual net inflows, however, are highly volatile. Table 40.3 FDI and Foreign Portfolio Investment sto India Gross Direct FDI by e Net Teal Inflows/ Investment India COED Portfoio’ vation Gross toIndia & Investment USD) Investments 2000-01 40294029 S270 ee ircce enicaeaae 2001-02 6130 6125 har34 19526686 2003-04 4322 4372 1954 7088 377 a5765 2004-05 6051 soa 227432 9291 13008 2005-06 8961 89 5867-3033 = 1249215525 2006-07 22826 15046 7693 goa) ae40 2007-08 34843 Qn 1883615891 -27434~ 43305 2008-09 41873 CS41707 ~—« 9864 22343-44032 at 200910 3774s CN aa108 asus 1796530996 soset zororr 3487 DP 27829 16524 1130530292 1597 2011-12 «46556 32957 1109722860717 39031 201213 34298 26953 7134198192691 aero ‘Source: Extracted fom RBY's Handbook of Statstis on Indian Economy, 2013, and wine rBlorgin Fl ws rose to a sizeable $27 ion in 2007-08 that led to not only s booming, with BSR Sensex more than doubli ng from Soe ee OOO Est also tht pee exchange rate appreciating in the wake of global financial crisis, there was a net outflow of FIl to the tune of $14 billion that brought dawn the BSE Sensex from neatly 20,000 points to less than 9,000 points in the early part of 2009. Much 147FORBIGN DIRECT AND PORTFOLIO INVESTMENTS... « NAGESH KUMAR 2008-09. Ho s FIs re et in the wake of recovery, the FIl inflows to the country i ere of the order of $32, billion bringing the Sensex back above 20,000 points in October 2010- Despite the RBI's market intervention to offset the subsequent exchange fate PEssure: the rupee appreciated by nearly 8 per cent, although foreign exchange reserves were augmented to about $284 billion. FIT inflows have become primary determinants of the@npvements in the stock exchange indices and the exchange rate of ‘upee (see Kumar, 2011). As there are, shai movements in these j developments, they become channels of transfii¥sion of instability to the country’s financial system. As a result, tl coaster ride: from ¥ 44 per dollar in Janudry“2007 to & 39 in January 2008 to increase again to € 49 per dolln January 2009 to % 44 in October 2010. The rupee fluctuated arouyid ¥ 54 in 2012 and early 2013 and after May current account deficit (CAD) meGated, Besides the volatility, PII j Among foreign resources s Indian (NRD deposits, depositary receipts (G terms of servicing buy ws have a very high servicing burden, EDI, foreign borrowings, non-resident ican Depositary Receipts (ADRs), global }), FIL investments are most expensive in chase primarily good returns at the stock markets and exchange rate per cent return. That means for every dollar India received in FIL flows, it became liable to pay $1.44 in one year. As k price makers rather than takers, they manage to exit safely before major crashes of markets thereby precipitating the declines. One may argue that FI inflows help a country to build foreign exchange reserves) What is not appreciated very well is the fact that exposure to these mflows also enhances the need to have large foreign exchany due to their highly volatile nature. Therefore, developing countries such as India should rely for their foreign resource 148 "279 ODD HH OHH *ILA (ED.) Joy SINCE INDEPENDENCE + UMA KAPILA (ED.) INDIAN #08 1070 “ a and needle ma EDI inflows and where possible raise ADRs/GDRs A aoa deposits from NRls rather than relying on the Fils. In view of oe ; cost and their other deleterious effects such as volatility, a num! = emerging economies such as Brazil, South Korea and ee ae recently imposed capital controls to moderate their volatil jity. a ‘unprecedented injection of liquidity by the governments in develope countries in the wake of global financial crisis is likely to find its way to emerging economies of Asia like India to take advantage of higher returns. There is now a growing consensus on the relevance of capital controls as aspects of-the policy tool kit for the governments in emerging economies (UN-ESCAP, 2010; Ostry et¢gl., 2010). ‘The benefits of maintaining open capital accounts, if any, x biguous. India as an Emerging Source of FDI Outfloy Another important emerging trend {ath respect to FDI in India is its emergence as a significant source of FDI outflows. Like FDI inflows the major turnaround in their outfl@wys came in 2006 when outflows more than quadrupled inane yor (424 billion and peaked to nearly $20 illion in subsequent years in the wake of global finddcial crisis (Table 40.4). The big break came with Indian enterprises usjhg their outward investments to acquire _ larger companies in the adyfgieed economies as a part of their effort to augment their bundles of gyategic assets including known bran proprietary knowledge jlobal marketing networks in order to jump start their global oridftation. The past few years have seen several multi-billion dollar oe s of western firms by Indian companies including Tasers Motor Ja/Land Rover, Handalco- Novelis, among others. During 2012 and 2013, outward FDI flows declined dramatically as Indian companies struggled with slowdown of Indian economy (Table 40.4). A recent analysis of India's outward FDI flows has shown that among the emerging markets,the relative scale of India's outward EDI was quite Significant (Kumar, 2008). The emergence of Indian enterprises on the slobal scene is striking considering their origin in a lower middle-income country. Their ability to acquire much larger enterprises in the developed world reflects their confidence in ™managing the newly acquired entities successfully. It has been argued that the source of their ownership or competitive advantage lies in their accumulation of skills for managing large multi-location operations across diverse cultures in India and in thee aaa ee |Tenet ec? ANDIPORTFOUIO INvaserays_ ; NAGESH KUMAR 1071 ability to deliver value for money with their ‘frugal engineering skills’ honed up while catering to the larger part of income Pyramid in India (Ibid.). Table 40.4 Foreign Direct Investment Outflows Originating in India (Million USD) World Developing Developin India roping: ping: Beonomies __Bconomien Asia 2001 747657 83087 7 49155 - 1397 2002 528496 7484 34987 1678 2003 370679 46868 1 1876 2004 925716 122792 (04 2175 2005 « 888561 132507 “\ s6425 2985 2006 1415094 239396 Mi51400 14285 2007 2198025 316863? 228154 19594 2008 1960336 za 20118 19257 2009 1175108 2604 210925 13927 2010 1451365 40014 273033 13151 zou 171652 wm 0429s 12456 2012 1346671 4 302130 486 2013 1410810 7 3261013 1679 Source: Extracted from UNCTAD database, 2934 MN the Indian enterprises undertaking eir origins in import-substitution based d the selective FDI policy regime, it would appear that the policy @t infant industry protection with supportive institutional framewekk tan assist in enterprise development by giving to them access to domestic market to grow and build capabilities (Ibid ): However, the protection needs to be phased out once the capabilities are built up to expose the enterprises to international competition and sharpen their competitiveness. In fact, the reforms of 1991 have sparked of a considerable restructuring of Indian industry which emerged from it leaner, more efficient and competitive. The exposure also gave to the Indian firms global ambitions and also the confidence to pursue them. In some ways, the Indian experience follows in the Japanese and Koreas tradition of enterprise development policies and may have lessons for other developing countries. The acquisition-base Indian enterprises in the Considering-that near! outward investments ha industrialisation strate; ‘d strategy of internationalisation adopted by recent years by acquiring strategic assets, such nnn nnn w: A (ED) INDIAN ECONOMY SINCE INDEPENDENCE + UMA KAPILA (El 1072 as technology, known brands, access to customers and global Scotprins for jump starting their internationalisation, is challenging as it involves managing across diverse cultures and win over the confidence of workforce to successfully exploit the synergies. Indian enterprises can face this challenge by relying on their experience and their skills in cross-cultural management honed in India, their emphasis on corporate social responsibility and their sensitivities to workers’ rights from the beginning (Ibid.). Concluding Remarks and Policy Lessons ‘The above discussion has reviewed the India’s experience with FDI and FPI inflows. These inflows to India have grown in the recent years in response to policy liberalisation and as the ¢; aI’ economy picked up momentum. Although starting from a lowDase, India has also been able to increase its share in FDI inflows receive by developing countries especially in the past few years and is catching up with Southeast Asian countries in terms of share of these inf{gws in capital formation. India is also attracting large magnitudes oftpprtfolio equity flows from FIIs which are highly volatile, The above discussion also tows that even though India may be attracting increasing magnitities of FDI inflows, they are yet to harness their development pea fully. The empirical studies suggest that the country has receiy¥DI inflows of mixed quality and the developmental impact has b@jh uneven. India can learn a great deal from the experiences of Chiitihd other Southeast Asian countries in this regard. China has had aglich greater success in harnessing the potential of EDI for building technology export-oriented industrial base using a variety of ref reman and performance requirements, On the other hand, Indfa is getting exposed in a significant manner to the FPI flows that are not only highly volatile but are expensive in terms of servicing burden. uv Policy Lessons In general, the above analysis brings out the role of government Policy in attracting and benefiting from FDI inflows for development. In light of this discussion, we may now draw a few policy lessons for the region and other similarly placed developing countries, Eirst of all, liberalisation of FDI policy may be necessary but not sufficient for expanding FI The overall macroeconomic Performance continues to exercise a major influence on the magnitude‘onomic and creating a stable fo The evidence suggests that the government policies play an Pot an a: wee in determining the quality or @félopmental impact of FDI and in facilitating the exploitation of iteMoiential benefits by host country's development. The various perfo i nts such as hased manufacturing programmes, ex erformance requirements and domestic ownership recuitemenis ee also been employed by the Ove! S nik devslopseptal nalicy objectives Even with liberalised policy, some policy direc fidh to FDI is desirable as has been demonstrated by the case of East AGian countries One way to maximise the conttiBution of FDI to the host development is to improve chance: ing-i ic investments and estic investments. In this utheast Asian countries such as Malaysia, __ context, the experiences o} Korea, China and Thailafél in channelling FDI into export-oriented . manufacturing throug® selective polici ort performance e . . . otential to generate more favourable externalities for . domestic investment (see UNCTAD 1999; 2001, for examples). Similarly because MNE entry through acquisition of domestic enterprises is likely . to generate less favourable externalities for domestic investment than . ; — . % 152"6D) INDIAN ECONOMY SINCE INDEPENDENCE -+ UMA KAPILA ( 1074 : greenfield investments, some governments discourage acquisitions by foreign enterprises (see Agosin and Mayer, 2000, for examples). Another sphere where governmental intervention may be required to maximize gains from globalisation is in diffusion of knowledge brought in by foreign enterprises. An important channel of diffusion of knowledge brought in by MNEs in the host economy is vertical inter-firm linkages with domestic enterprises. Many governments—in developed as well as developing countries alike—have imposed local content requirements on ® MNEs to intensify generation of local linkages and transfer of technology (See Kumar, 2005b, for evidence). The host governments could also consider employing proactive measures that encourage foreign and local firms to deepen their local content as a nysBer of countries, e.g, Singapore, Taiwan, Korea and Ireland, have so successfully (see Battat et al., 1996). The knowledge diffusio also be accomplished by creating sub-national or sub-regio1 of inter-related activities () which fai itate the spillovers of knowle hrough informal and social ee raditional seller links. UNCTAD (2001) also highlights the pqligy measures employed by different governments in promoting linkages, Investments made by goveryGpents in building local capabilities for higher education and ie technical disciplines, centres of excellence, and in other aspedtW of national innovation systems have substantial favourable extergfaities as is demonstrated by the case study of BDI in India’s knowledga hased industries Finally, rising CAD ppBes an important challenge for policy makers and need urgent attegfjon. With widening merchandise trade deficits driving this trend, jmlnediate attention needs to be Paid to reviving export growth and @iploiting the opportunities for import substitute For reviving exports, attention needs to be paid to strengthening ° their competitiveness by addressing exchange rate distortions. Export competitiveness needs to be strengthened by maintaining relative exchange rate stability with a slight tendency towards depreciation rather than appreciation. Besides that, policy disto1 structures need to be removed and flow of strengthened (see Kumar and Joseph, 200 support measures). In a situation of slow. as at present, a major expansion of export: environment of excess capacities througho growing threat of protectionism and the t. f trade finance needs to be 7, for an inventory of policy ‘down of the global economy s can be challenging given an ut the Asia-Pacific region, the 'emptation of dumping by thoseFOREIGN DIRECT AND PORTFOLIO INVESTMENTS... « NAGESH KUMAR 1075 with deep pockets. In such circumstance: s, it might be also critical to look at new opportunities for, strategic import substitution. As observed: earlier, while large bulk imports of fuels and raw i be price inelastic, attention should be paid to very large and fast growing import: of electronics, non-electrical machinery, and defence equipment, among others, that provide opportunities for strategic import substitution. An effort needs to be made to start domestic manufacture of these products leveraging India's large domestic market size and by targeting MNEs to set up local manufacturing facilities through creation of incentives” for pioneering industries, as has been done in East Asian countries like Malaysia, besides incentives in public procurement like:‘buy America’ programmes. These policies are part of industrial policies and infant industry protection that have been widefgractised in different developed and emerging economies (Kumar 4yd Gallagher, 2007). The strategic import substitution will also lead Eb Ymore balanced structural change by creating more manufacturing iqhs hich is critical for poverty reduction (Kumar, 2013). Oo Referenpds = ‘Aggarwal, Aradhna and Nagésh Kumar (2012),:tfuctural Change, Industrilisation and Poverty Reduction: The Case of India’, BSCAP-Ss lopment Papers 1206, http//sewa.unescap org meeting/documents/Dev-Challenges/SSW-Development. Papers 1206. Oxtober2012 pif ‘Agosin, M.R. and Ricardo Mayer (2000), *Fef@n Investment in Developing Countries: Does it Crowd in Domestic Investment?” UNCTA ion Paper, No. 146, Geneva: UNCTAD. AT Kearney (2013). FDI Confidence Ing&QO13, woww.athearney com and previous years. Battat, Joseph Isiah Prank and: Shen (1996). Suppliers co Multinationals: Linkage Programmes to Strengthen Local Capabil loping Countries. Washington, DC: Flas. Freire, C. (2012). “Structural tion for Inclusive Development in South and South-West ‘Asia, BSCAP-SSWA Papers 1204; http://sswa.unescap.org/meetng/dcments/Dev Challenges/SSWA_D. Papers_1204_ August2012 pdf Fry, Maxwell J. (1992).CBBreign Direct Investment in a Macroeconomic Framework: Finance, Eificiency, incentives and Distortions", PRE Working Paper, Washington, DC-The Werld Bane Kamar, Nagesh (1996). “Multinational Enterprises, Regional Economic Integration, and Export Platform Production inthe Host Countries: An Empirical Analysis for the US and Japronse Corporations", Weltwirtschaflches Archiv 134(3): 450-83, 2000). “Explaining the Geography and Depth of International Productions The Case of US ‘and Japanese Multinational Enterprises", Weltwirtchaftiches Archiv 126(3) 442.76. 200d. “Determinants of Location of Overseas RAD Activity of Multinational Enterprise: ‘Tee Case of US and Japanese Corporations” Research Policy 30. 159-74 p20). Glebatzation and the Quatty of Foren Direct Investment. Delhi: Oxford University in Kevin Gallagher (ed.) (2005), ‘The Importance of Policy Space bs the WTO and International Fanta ‘Inseieations. London: Zed Press. pp179-94, :