This article has been written by Chaitali B. Memane, pursuing Diploma in Corporate Litigation ( FEB-01-2023 ) and has been edited by Oishika Banerji (Team Lawsikho).
This article has been published by Sneha Mahawar.
Foreign direct investment (FDI) is a major source of non-debt financial resources for economic development. It has allowed India to achieve some financial stability, growth, and development. It is done for a variety of reasons, namely, taking advantage of lower incomes in the region and special investment privileges such as tax exemptions provided by the country as an opportunity to obtain tax-free entry to the country’s markets. The present favourable policy regime and healthy business environment have ensured the continuous flow of foreign investments. The government has taken many initiatives in changing the FDI norms across all major sectors. India has liberalised its FDI policy regime considerably since 1991 besides opening new sectors to FDI, recently the govt. announced a consolidated policy in 2020. Moreover, many initiatives in recent years have been taken in relaxing FDI norms across sectors such as defence, PSU oil refineries, telecom, powers exchanges and stock exchanges. Though India has taken many steps for increasing FDI inflow, the same continues to be sluggish because foreign investors face major hurdles. All this made India a far less attractive investment destination for FDI than most of its competitors. This article discusses the impact of FDI on the Indian economy in detail.
Meaning and concept of FDI
Foreign Direct Investment (FDI) is defined as “investment made to acquire lasting interest in enterprises operating outside the economy of the investor.” When a company acquires controlling ownership of a business entity in another country, this is referred to as FDI. International companies that engage in FDI are directly involved in the day-to-day operations of the other country. It is a major source of non-debt financial resources for economic development. It is a process that enables one country to directly invest their funds in another country which enables them to exercise control over the investment in terms of production, management, distribution, effective decision-making, employment, etc.
Costs to the home country
- The outflow of factors of production like skilled manpower, professionals, experts and capital can hinder the home country’s growth and development.
- The BOP account of the home country also suffers on three counts:
- Initial capital outflow.
- If an MNE invests abroad to take advantage of low-cost locations and then sells the products manufactured in the foreign location back to the home country, the home country’s imports will rise.
- If the foreign operation results in the substitution of domestic exports, then the decrease in the home country’s exports will again adversely affect the balance of payment.
- If the MNE decides to conduct foreign operations with the intention of shutting down the home country’s operation, then the home country will suffer in terms of unemployment.
Benefits to the host country
- FDI brings capital, advanced technologies, management skills, and experience to the host economy, accelerating the rate of economic growth and development. Furthermore, the host economy gains access to the home economy’s continued research and growth.
- FDI also helps to generate employment opportunities in the host country. The employment of labour force in MNE results in increased income levels and increased demand. This in turn helps to create more jobs. MNEs also train the labour force which helps to create a pool of trained personnel in the host economy.
Costs to the host country
- Foreign investment can damage a country’s balance of payments by causing income to be repatriated, dividends, interests, and royalties to be paid, and so on. If overseas activities necessitate the import of raw materials from the domestic economy, the balance of payments will suffer once more.
- MNEs Because of their large scale, economic strength, and greater financial capital, will destroy competition, replace local producers, and curtail the growth of native industries. They are able to produce economies of scale that local manufacturers cannot compete with due to their activities being spread across countries and successful supply chains.
India’s policy towards Foreign Direct Investment
Policies of FDI : Pre & Post-Independence
Phase I (1948- 1966) was marked by a cautious approach and it was followed by Phase II (1967-1979) which was characterised by a restrictive regime. Phase III (1980-1990) exhibited a progressive reduction of regulations and Phase IV (1991-onwards) witnessed a liberal foreign investment environment.
International investment attitudes are expressed in India’s official policy against private foreign investment (PFI) and technology. Beginning with the Prime Minister’s policy statement on foreign capital in 1949, successive policy statements have acknowledged PFI’s technical and financial contribution to the economy. Foreign firms have been assured that there would be no restrictions on the repatriation of capital and remittances of profits and that there would be no nationalisation without compensation. Tax exemptions and tax concessions have also been given to foreign companies. Although the policy structure has not been friendly to foreign enterprise participation in general, PFI has been subject to a comprehensive collection of regulations governing its sectoral allocation and the scope of its participation. The regulatory system has influenced the composition and organisational structure of international business articulation in India.
New trends of MNCs in FDI
MNCs establishing research facilities in India represent one of the latest trends in foreign investment. In India, MNCs such as IBM, Microsoft, GE, Sony-Ericsson, and many others have established research facilities. This also makes use of cheaper labour, as scientists and professionals from India may receive pay that is lower than that of their colleagues from wealthy nations. It takes entire teams of scientists to conduct research, not just a single scientist. India is now recognised for having a large pool of highly qualified scientists and technologists. Many of the patents that have been purchased outside of India in the IT sector were created by MNC research centres in India that were established to tap into this supply. India’s knowledge-based industries, such as software and R&D, are where it is becoming more powerful, as evidenced by the rise in international investment in these fields. It is important to take note of the current trend in MNC activities in developing economies, the involvement of foreign capital in the establishment of research centres in India.
Another trend is witnessed in the shape of non-investment foreign-controlled Production. Foreign influences over the host country’s economic activities can well occur without any capital investment at all. This occurs in a country in a number of new forms of relationship – contracted manufacturing and farming, outsourcing of services, and franchising or licensing. One increasingly common form of global production is that of contracted production within global production networks (GPNs) or global value chains (GVCs).
It is more than two decades since India abolished its restrictive FDI regimes and replaced them with one of the most transparent and relaxed regimes in the world. However, the debate continues over how much more flexible India should be to FDI. FDI inflow into India has remained sluggish due to major roadblocks faced by foreign investors. All this made India a far less attractive investment destination for FDI than most of its competitors. Indian policymakers must weigh the reasons behind the low volume of FDI inflow.
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