Economic Reforms in Foreign Trade Sector India

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					                                  Sneha Rajan




FOREIGN DIRECT

     INVESTMENT

           IN INDIA
A STUDY OF ECONOMIC REFORMS AND RISKS




                              Sneha Rajan

                              PSCI 255
                                                                                     Sneha Rajan


                                       Abstract



       The Sub-continent has become the prime target for foreign direct investment. India

ranks 6th among the top 10 countries for Foreign direct investment1. Although not in the front

line, it has become an attractive destination for foreign investment. India’s economic policies

are tailored to attract substantial capital inflows and to sustain such inflows of capital. Policy

initiatives taken over a period of years2 have resulted in significant capital inflows of foreign

investment in all areas of economy including the public sector. This paper analysis the

structure of economic reforms during the pre- independence and post independence era in the

context of growth of foreign direct investment and the risks posed by the political, economic

and social conditions for foreign investors. Essentially, this paper seeks to analyse and

understand the economics and politics of India’s progressive integration with the global

economy.
                                                                                     Sneha Rajan


Introduction:



       Prior to understanding the economic progress of India, it is vital to first identify the

current economic status of India so that it is easy to retrace the process leading to the current

status. India presently enjoys the status of an attractive emerging market. However, this status

has been the result of numerous economic reforms adopted over the years. India intent to

open its markets to foreign investment can be traced back to the economic reforms adopted

during two prime periods- pre- independence and post independence.



       Pre- independence, India was the supplier of foodstuff and raw materials to the

industrialised economies of the world and was the exporter of finished products- the economy

lacked the skill and means to convert raw materials to finished products. Post independence

with the advent of economic planning and reforms in 1951, the traditional role played

changes and there was remarkable economic growth and development. International trade

grew with the establishment of the WTO. India is now a part of the global economy. Every

sector of the Indian economy is now linked with the world outside either through direct

involvement in international trade or through direct linkages with export and import

transactions of other sectors in the economy.



       Development pattern during the 1950-1980 period was characterised by strong

centralised planning, government ownership of basic and key industries, excessive regulation

and control of private enterprise, trade protectionism through tariff and non-tariff barriers and

a cautious and selective approach towards foreign capital. It was a quota, permit, licence

regime which was guided and controlled by a bureaucracy trained in colonial style. This

inward thinking, import substitution strategy of economic development and growth was
                                                                                   Sneha Rajan


widely questioned in the 1980’s. India’s economic policy makers started realising the

drawbacks of this strategy which inhibited competitiveness and efficiency and produced a

much lower growth rate that was expected.



       Consequently economic reforms were introduced initially on a moderate scale and

controls on industries were substantially reduced by 1985 industrial policy. This set the trend

for more innovative economic reforms and they got a boost with the announcement of the

landmark economic reforms in 1991. After nearly five decades of insulation from world

markets, state controls and slow growth, India in 1991 embarked on an accelerated process of

liberalization. The 1991 reforms ensured that the way for India to progress will be through

globalization, privatisation, and liberalisation. In this new regime, the government is now

assuming the role of a promoter, facilitator and catalyst agent instead of the regulator and

controller of economic activities.



       India has a number of advantages which make it an attractive market for foreign

capital namely, political stability in democratic polity, steady and sustained economic growth

and development, significantly huge domestic market, access to skilled and technical

manpower at competitive rates, fairly well developed infrastructure. FDI has attained the

status of being of global importance because of its beneficial use as an instrument for global

economic integration.
                                                                                   Sneha Rajan


Pre-Independence Reforms:



       Under the British colonial rule, the Indian economy suffered a major set-back. An

economy with rich natural resources was left plundered and exploited to the hilt under the

English regime. India is originally a agrarian economy. India’s cottage industries and trade

were abused and exploited as means to pave the way for European manufactured goods.

Under the British rule the economy stagnated and on the eve of independence India was left

with a poor economy and the textile industry as the only life support of the industrial

economy.
                                                                                   Sneha Rajan




Post – Independence Reforms:



       India’s struggle post independence has been an excruciating financial battle with a

slow economic growth and development which were largely due to the political climate and

impact of the economic reforms. The country began it transformation from a native agrarian

to industrial to commercial and open economy in the post independence era. India in the post

independence era followed what can be best called as a ‘trial and error’ path. During the post

independence era, the Indian Economy geared up in favour of central planning and resource

allocation. The government tailored policies that focussed a great deal on achieving overall

economic self-reliance in each state and at the same time exploit its natural resource. In order

to augment trade and investments, the government sought to play the role of custodian and

trustee by intervening in the practice of crucial sectors such as aviation, telecommunication,

banking, energy mainly electricity, petrol and gas.



       The policy of central planning adopted by the government sought to ensure that the

government laid down marked goals to be achieved by the economy thereby establishing a

regime of checks and balances. The government also encouraged self sufficiency with the

intent to encourage the domestic industries and enterprises, thereby reducing the dependence

on foreign trade. Although, initially these policies were extremely successful as the economy

did have a steady economic growth and development, they weren’t sustained. In the early

1970’s, India had achieved self sufficiency in food production. During the 1970’s, the

government still continued to retain and wield a significant spectre of control over key

industries such as power, mining, transportation and communications. 3
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       In the Early 1980’s-Macro-Economic Policies were conservative. Government control

of industries continued. There was marginal economic growth & development courtesy of the

development projects funded by foreign loans. The financial crisis of 1991 compelled

drafting and implementation of economic reforms. The government approached the World

Bank and the IMF for funding. In keeping with their policies there was expectation of

devaluation of the rupee. This lead to a lack of confidence in the investors and foreign

exchange reserves declined. There was a withdrawal of loans by Non Resident Indians

(NRI’S).
                                                                                     Sneha Rajan


Economic reforms of 1991:



       India has been having a robust economic growth since 1991 when the government of

India decided to reverse its socially inspired policy of a retaining a larger public sector with

comprehensive controls on the private sector and eventually treaded on the path of

liberalization, privatisation and globalisation.4



       During early 1991, the government realised that the sole path to India enjoying any

status on the global map was by only reducing the intensity of government control and

progressively retreating from any sort of intervention in the economy – thereby promoting

free market and a capitalist regime which will ensure the entry of foreign players in the

market leading to progressive encouragement of competition and efficiency in the private

sector. In this process, the government reduced its control and stake in nationalized and state

owned industries and enterprises, while simultaneously lowered and deescalated the import

tariffs. All of the reforms addressed macroeconomic policies and affected balance of

payments. There was fiscal consolidation of the central and state governments which lead to

the country viewing its finances as a whole. There were limited tax reforms which favored

industrial growth. There was a removal of controls on industrial investments and imports,

reduction in import tariffs. All of this created a favorable environment for foreign capital

investment.



       As a result of economic reforms of 1991, trade increased by leaps and bounds. India

has become an attractive destination for foreign direct and portfolio investment.
                                                                                      Sneha Rajan


Foreign Direct Investment and Indian Policy:



            FDI is investment of foreign assets into domestic structures, equipment, and

organizations. It does not include foreign investment into the stock markets. FDI is thought to

be more useful to a country than investments in the equity of its companies because equity

investments are potentially "hot money" which can leave at the first sign of trouble, whereas

FDI is durable and generally useful whether things go well or badly.



        Emerging markets pose a significant potential for foreign investment both direct and

portfolio. Foreign direct investment (FDI) is defined as the investment of foreign assets into

domestic structures, equipment and organizations. However, it doesn’t include foreign

investment in the stock markets. FDI is thought to be more beneficial to a country than its

investment in equity of its corporations because equity is considered to be potential ‘hot

money’, which can leave at the first sign of trouble. On the other hand FDI is durable and

generally useful whether things go well or badly.



        China currently ranks first among the top ten countries for foreign direct investment

among developing countries in 2001.5 Mexico, Singapore, Brazil are also among the top ten.

India although is also an attractive destination for foreign investment, it is not in the front

line. This is a stark reality despite the fact that the Indian economic, political and social

conditions stable.



        India is one of the largest economies of the world. Its strategic location in the sub-

continent provides it with continued access to South–Asian markets and middle-east markets.
                                                                                         Sneha Rajan


The country also enjoys a huge consumer markets. Fast moving consumer goods find a

significant market share in India, providing a market conducive to trade and finance.



       Foreign investment is open in India and there aren’t cumbersome procedures in force

for approval of inflows of foreign capital.6 India is also an attractive destination for foreign

investment because of its access to skilled labor at competitive costs. Being the one of the

largest manufacturing sectors of the world, it has a market conducive to trade and production.



       India also has in place well established legal and accounting system to ensure proper

administration of foreign capital to key sectors. Also, the stability of the political

environment is another factor which makes India an attractive destination for foreign capital.
                                                                                   Sneha Rajan


Mechanics of FDI:



   Foreign investment in India is permitted through the following modes:7

a. Through the route of foreign collaborations

b. Through Joint ventures and technical collaborations

c. Through capital markets via euro issues8

d. Through private placement or preferential allotment

Although, the Government of India has permitted FDI in crucial sectors such as power,

aviations, telecommunications etc., the following sectors cannot benefit from inflows of FDI:

a. Arms and Ammunition:- National defence and security is solely within the control,

   regulation and supervision of the Central Government

b. Atomic Energy: Due to its impact on national security, this subject is under the sole

   control of the Central Government. The Constitution of India stipulates 3 lists for

   legislation of numerous subjects namely the Central list, State list and the Concurrent

   List. Atomic Energy finds a mark on the Central List and the Central Government has so

   sole control on legislation.9

c. Railway Transport

d. Coal and Ignite

e. Mining of Iron, Manganese, Chrome, Gypsum, Sulphur, Gold, Diamonds, Copper and

   Zinc.

   While the government has opened most sectors for FDI, there are certain sectoral caps10

that are imposed to ensure that domestic corporations are not left out of the greater

participation in the privatisation schemes. Industry wide break –up in FDI ensures that

inflows of FDI are concentrated only on priority sectors. In order to ensure sustained and

accelerated growth in each sector, to increase the inflows of foreign capital and to introduce
                                                                                 Sneha Rajan


appropriate institutional arrangements and transparent procedures, the Government of India

has structured a Committee that shall implement policies and shall grant approval for foreign

investment in domestic corporations and State- owned Enterprises. This committee is called

the Foreign Investment Promotion Board. 11 The Board is the sole authority to consider

investment proposals.
                                                                                    Sneha Rajan


Implications of Foreign Direct Investment:



       Foreign direct investment affects economic growth through increased investment in

the country. An increase in the inflows of FDI would essentially increase foreign savings and

consequently would result in increased investment in the country. Another direct

consequence of enhanced inflows of FDI is the positive impact on improvement in

technology and infrastructure. FDI potentially brings new and emerging technologies to

emerging and developing markets, and this can contribute to economic growth and

development in the long run. Improved Technology also enhances the productivity of

domestic enterprises and industries, thereby leading to efficiency and creation of competitive

and open markets in sectors originally within the folds of state and central control.
                                                                                   Sneha Rajan


Policy Regime:



       Control and restraints on foreign investment has long been the subject of controversy

and major political debate in India. India drafted two major legislations which directly

address the issue of foreign capital namely the Foreign Exchange Regulation Act ( FERA)

and the Foreign Exchange Management Act ( FEMA). The policy framework for FDI is as

follows:

       a.        FDI in priority sectors like power and telecommunications enjoy automatic

                 approval from the FIPB

       b.        All other proposals for foreign investment have to go through the FIPB

                 approval route.

       c.        To provide enhanced and sustained access to foreign capital and to

                 encourage modernisation of traditional and small scale industries, FDI up to

                 the sectoral cap of 24% is permitted in traditional and small scale industries.

       d.        The Reserve Bank of India (RBI) – the apex central bank of India, grants

                 automatic approval for all industries with respect foreign technology

                 agreements and collaborations.

       e.        The licensing requirement which required industrial enterprises to apply for

                 and obtain industrial licences was abolished to enhance competition and

                 promote efficiency.

       f.        Majority investment by foreign parties is permitted. The FERA imposed

                 equity participation limits on foreign corporations. The new FEMA has

                 retrospectively altered this policy. As a result equity participation up to 51

                 % is permitted by foreign corporations.
                                                                                   Sneha Rajan


       The above policy design portrays that the government of India is making every

endeavour to project India as global markets by diminishing and eliminating restrictions and

restraints on the flow of foreign capital. The procedural framework for inflow of foreign

capital has also been structured in a manner to ensure that foreign players are not dissuaded

from investing because of cumbersome and tedious procedures. The policy also sought to

ensure that the granting of approval for foreign investment was transparent and was not

subject to whims, caprice and arbitrary decisions of the political; parties in power by

formulating the formation of the FIPB..
                                                                                   Sneha Rajan


Conclusion:



       Present day India enjoys the status of an emerging market. Skilled and managerial

labor and technical man-power are such as that they match the best available in the world. A

combination of these factors contributes to India having a distinct and a cutting edge in the

globe. India has been termed as the ‘stealth’ miracle economy of the new millennium. 12 It is

among the largest economies in the world. GDP shoots up to 10.4%. There has been the entry

of many multinational corporations (MNC’S). There has been the advent of outsourcing

which has put India on the global map.
                                                                                           Sneha Rajan


References

1
  World Investment Report, 2003.
2
  1947- till date ( 2004)
3
  http://india.punjabilit.com/economy.htm
4
  Privatization has been defined as the economic process of transferring the ownership of public sector
enterprises to the private sector. This process facilitates the establishment of a free market and fosters
competition and efficiency.
5
  World Investment report. *****
6
  Approval is required from the Foreign Investment Promotion Board, There are 60 industry categories
where approval is automatic.
7
  http://finance.indiamart.com/investment_in_india/fdi.html
8
  Indian Companies are allowed to raise capital through the issue of Global Depository Receipts. It
would be pertinent to note that GDR are denominated in dollars and there are no ceiling imposed on
investments in GDR’s. http://finance.indiamart.com/investment_in_india/fdi.html
9
  The structure of the Constitution stipulates that as far as subjects in the Central List is concerned the
Central Government has the sole legislative and regulatory power, subjects in State List are within the
legislative power of the state legislative assemblies, and subjects in the Concurrent List are shared in
the legislative power of both Central and State Government, however, the Central Government has
priority.
10
   Sectoral Caps stipulate the maximum amount of FDI that can invested in a particular sector.
11
   The Board is chaired by the Secretary of the Department of Industrial Policy and Promotion. The
two main functions of the Board are: a. Undertake investment promotion activities and b. Facilitate
investment in the country by Multi0national Corporations, Non-resident Indians and Foreign investors.
12
   ‘India to the Be the Next Economic Miracle’
http://www.meadev.nic.in/news/clippings/19991124/bs.htm

				
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