This blog is intended to give the reader an overview view of various aspects of FDI from the perspective of development. We've organized it into four parts:
  • The first post by Shoeb Siddiqui introduces the reader to FDI and its related terms and highlights its role in development.
  • The second post written by Adarsh Chavakula discusses the various positive and negative aspects of FDI.
  • In the third post, which is a case study, Anusha writes about FDI in the retail sector.
  • In the last post, Vaishnavh takes up another case study of FDI in defence sector, focussing on the changes made by the new government. 

FDI: Role in development

Shoeb Siddiqui - EP11B021


FDI (Foreign Direct Investment), is defined as a controlling ownership in a business enterprise in one country by an entity based in another country. Foreign Direct Investments differ from passive investment in stocks and bonds by the element of control.
According to the Financial Times, "Standard definitions of control use the internationally agreed 10 per cent threshold of voting shares, but this is a grey area as often a smaller block of shares will give control in widely held companies. Moreover, control of technology, management, even crucial inputs can confer de facto control."
The origin of the investment does not impact the definition as an FDI, i.e. the investment may be made either by buying a company in the target country or by expanding operations of an existing business in that country.
Foreign direct investment broadly includes mergers and acquisitions, building new facilities, reinvesting profits earned from overseas operations and intra company loans. In a narrow sense, foreign direct investment refers just to building new facilities. The numerical FDI figures based on varied definitions are not easily comparable. FDI is the sum of equity capital, other long-term capital, and short-term capital as shown the balance of payments. FDI usually involves participation in management, joint-venture, transfer of technology and expertise. Stock of FDI is the net cumulative FDI for any given period. Direct investment excludes investment through purchase of shares.
Types of FDI
  1. Horizontal FDI arises when a firm duplicates its home country-based activities at the same value chain stage in a host country through FDI.
  2. Platform FDI Foreign direct investment from a source country into a destination country for the purpose of exporting to a third country.
  3. Vertical FDI takes place when a firm through FDI moves upstream or downstream in different value chains i.e., when firms perform value-adding activities stage by stage in a vertical fashion in a host country.
Methods
The foreign direct investor may acquire voting power of an enterprise in an economy through any of the following methods:
•           By incorporating a wholly owned subsidiary or company anywhere
•           By acquiring shares in an associated enterprise
•           Through a merger or an acquisition of an unrelated enterprise
•           participating in an equity joint venture with another investor or enterprise
 
Role of FDI
Apart from contributing to the up-gradation of knowledge, foreign investment can serve two broad purposes, namely, raise investment and relieve foreign exchange shortages. Insofar as these are among the key factors influencing growth in developing countries, FDI has the potential to become an important vehicle of growth.
·        FDI and Privatization Initiatives
·        FDI, Cross-Border Mergers & Acquisitions
·        FDI, Domestic Capital Formation, Gross Domestic Product and Exports
·        FDI and Balance of Payments
·         
Significance for developing countries
FDI has become an important source of private external finance for developing countries. It is different from other major types of external private capital flows in that it is motivated largely by the investors' long-term prospects for making profits in production activities that they directly control. Foreign bank lending and portfolio investment, in contrast, are not invested in activities controlled by banks or portfolio investors, which are often motivated by short-term profit considerations that can be influenced by a variety of factors (interest rates, for example) and are prone to herd behavior. These differences are highlighted, for instance, by the pattern of bank lending and portfolio equity investment, on the one hand, and FDI, on the other, to the Asian countries stricken by financial turmoil in 1997: FDI flows in 1997 to the five most affected countries remained positive in all cases and declined only slightly for the group, whereas bank lending and portfolio equity investment flows declined sharply and even turned negative in 1997.
While FDI represents investment in production facilities, its significance for developing countries is much greater. Not only can FDI add to investible resources and capital formation, but, perhaps more important, it is also a means of transferring production technology, skills, innovative capacity, and organizational and managerial practices between locations, as well as of accessing international marketing networks. The first to benefit are enterprises that are part of transnational systems (consisting of parent firms and affiliates) or that are directly linked to such systems through non-equity arrangements, but these assets can also be transferred to domestic firms and the wider economies of host countries if the environment is conducive. The greater the supply and distribution links between foreign affiliates and domestic firms, and the stronger the capabilities of domestic firms to capture spillovers (that is, indirect effects) from the presence of and competition from foreign firms, the more likely it is that the attributes of FDI that enhance productivity and competitiveness will spread. In these respects, as well as in inducing transnational corporations to locate their activities in a particular country in the first place, policies matter.


Advantages and Disadvantages of Foreign Direct Investment

[Adarsh Chavakula - CH11B003]



Foreign Direct Investment is a two sided coin. Its merits and demerits have been debated over several times in the past few decades. There are groups which argue in favor of FDI and several that are against it altogether. A few arguments in favor of FDI and a few counter-arguments have been briefly summarized here.

Advantages of Foreign Direct Investment:

Economic growth and inflow of cash


FDI results in the direct inflow of cash into the economy. This can be an extremely important boost to the various economic sectors, especially in developing countries like India. This is the foremost reason why developing countries open up to foreign investment. India emerged out of an economic crisis in 1991 by opening up its markets to foreign investment. This increased the foreign investment from $132 million in 1992 to $5.3 billion in 1996. Subsequently, this led to the emergence of several Indian cities as major hubs for development, innovation and industrial growth. The recent efforts made by the Indian Prime Minister, Shri. Narendra Modi to get more foreign investment reflects the importance of this point. Following Mr. Modi’s visit, Japan has agreed to invest a massive sum of $33.5 Billion over the next five years. This will give a much needed boost to various sectors of our economy like defense and manufacturing.


Access to resources and superior technology
Developing countries can gain access to sophisticated technology through FDI. Several of India’s technological advances in fields like transportation, telecom have been brought in through FDI. India is now set to gain the financial, technical and operational support to introduce bullet trains from Japan over the next few years. This can drastically alter the scenario of public transportation in Indian metropolitan cities. India also plans on procuring vast amounts of Uranium, the raw material for nuclear power from Australia along with the technology to build sophisticated and efficient nuclear reactors. This will ease India’s power paralysis by a large extent. Given that we are a developing country, we cannot afford to waste our resources on carrying out expensive research in sophisticated technologies like high speed bullet trains. Hence it is essential for us to be able to access these technologies through foreign investments.


Financial boost to manufacturing

Manufacturing is the backbone for development. It has been the chief driver for development in several nations around the world. India however has been severely lagging behind in this sector. Our manufacturing sector’s performance has been abysmal over the last 10 years with 2013/14 witnessing a negative growth of -0.2%. This comes as a sharp contrast to China which sees double digit growth rates in this sector. Manufacturing has been the sole platform for China to emerge as a global super-power. This is primarily because of the Chinese government’s attitude towards foreign investment in this sector. The freedom provided to foreign Multinationals to set up and maintain manufacturing establishments in China has resulted in a paradigm shift in the global manufacturing scenario. Most multinational companies carry out their production operations almost completely out of China. China now single-handedly dominates the manufacturing sector across the globe. 

 

India too has all the elements needed to generate a manufacturing boom, except for the required capital investment. With a large workforce in the 18-35 years age-group, we can tap into the huge potential of this sector to help our economy grow rapidly. The currently popular phrase “Make in India” introduced by the prime minister is a step in this direction and lays emphasis on the importance of FDI in manufacturing. Through this initiative, India has extended invitations to developed countries to set up large scale manufacturing units in India. This would give a boosted financial inflow into the currently stagnant manufacturing sector. This would also help India develop into a hub for large scale production like China and create employment for millions of people.

Improved competition and fair pricing
This is a critical factor in sectors like retail and manufacturing. With an inflow of goods and services of superior quality, the domestic retail and manufacturing sectors are forced to raise the quality of their own goods and services to stay in competition. This helps consumers get access to quality services at competitive prices. 


Benefits to agricultural producers
FDI is also beneficial to the producers – farmers and cultivators. Several farming groups like Bharat Krishak Samaj, Consortium of Indian Farmers Associations (CIFA), Shriram Gadhve of All India Vegetable Growers Association (AIVGA) etc. have extended support towards retail reforms. This is driven by the fact that farmers are usually very poorly paid under the current retail structure. They often get only a fraction of the fair price for their produce and the rest is pocketed by middlemen as commissions and markups. Inquiries suggest that farmers often get only one-third of the price that consumers pay in the case of staple crops. The fraction is a lot less at just about 12% to 15% in case of horticulture produce and less than 10% for potatoes. Introduction of organized retail through FDI gets rid of middlemen and hence is far more rewarding for farmers. Introduction of cold storage and cold transportation gives the farmers the flexibility to sell perishable crops likes fruits and vegetables at better prices without having to worry about spoilage.
FDI has also been directly involved in improving farming practices. This often comes in the form of an overall supply chain enhancement including introduction of high-yield crop variants, introducing sustainable farming and scientific crop diversification, better storage and transport facilities and sometimes just better compensation to the farmers. An example here is an initiative taken up by PepsiCo in India and China to help farmers improve their yields and incomes. Under this program farmers are provided with agricultural implements and seeds at subsidized prices, credit at low rates and an assured buy-back mechanism to insulate from market fluctuations.


Disadvantages of Foreign Direct Investment

Wipeout of unorganized retail sector
This is probably the biggest and the most effective counter-argument against FDI in the Indian context. It stems from the fact that most of the retail in India is unorganized (kirana stores). Introduction of very large scale retailers like Wal-Mart, Carrefour and Tesco could take away a major share of the retail space, rendering millions of kirana store-keepers jobless. The effects of FDI in the retail sector are discussed in greater detail in the case study section.



Social Impact
This is an extremely subtle idea which has gained momentum over the last few years. Many developing countries, or at least countries with a history of colonialism, fear that foreign direct investment may result in a form of modern day economic colonialism, exposing host countries and leaving them and their resources vulnerable to the exploitations of the foreign company. This is not hard to understand if one looks at how big some of the well-known Multinational companies are. Some of these companies are several times bigger than the entire GDPs of small countries. Hence they possess the power to influence governmental policies and decision making. They can also single-handedly control a small nation’s economic course.


References:


FDI in Retail Sector: A case study

By Anusha G ( NA11B011): 

 Retailing is one of the pillars of Indian economy and accounts for 14 to 15 percent of the country's GDP. The Indian retail market is estimated to be US $ 500 billion and one of the top five retail markets in the world by economic value.

 The retail industry is mainly divided into:- 1) Organised and 2) Unorganised Retailing

 Organised retailing refers to trading activities undertaken by licensed retailers, that is, those who are registered for sales tax, income tax, etc. These include the corporate-backed hypermarkets and retail chains, and also the privately owned large retail businesses.

 Unorganised retailing, on the other hand, refers to the traditional formats of low-cost retailing, for example, the local kirana shops, owner manned general stores, paan/beedi shops, convenience stores, hand cart and pavement vendors, etc
The Indian retail sector is highly fragmented with 97 per cent of its business being run by the unorganized retailers. The organized retail however is at a very nascent stage. The sector is the largest source of employment after agriculture. The retail industry – both organized and unorganized employs about 40 million Indians (3.3% of Indian population).

History:

In 1997, India allowed foreign direct investment (FDI) in cash and carry wholesale with prior government approval. The approval requirement was relaxed, and automatic permission was granted in 2006. Between 2000 to 2010, Indian retail attracted about $1.8 billion in foreign direct investment, representing a very small 1.5% of total investment flow into India.
Before 2011, India had prevented innovation and organized competition in its consumer retail industry. Because of unorganized retail, in a nation where malnutrition remains a serious problem, food waste is rife. Over 30% of food staples and perishable goods produced in India spoils because of poor infrastructure and small retail outlets.
Until 2011, Indian central government denied foreign direct investment (FDI) in multi-brand retail, forbidding foreign groups from any ownership in supermarkets, convenience stores or any retail outlets, to sell multiple products from different brands directly to Indian consumers. Even single-brand retail was limited to 51% ownership and a bureaucratic process.
On 14 September 2012, the government of India announced the opening of FDI in multi-brand retail, subject to approvals by individual states. On 7 December 2012, the Federal Government of India allowed 51% FDI in multi-brand retail and 100% in single brand retail in India. The government managed to get the approval of multi-brand retail in the parliament despite heavy uproar from the opposition. Some states will allow foreign supermarkets like Walmart, Tesco and Carrefour to open while other states will not. This decision was welcomed by economists and the markets, but caused protests and an upheaval in India's central government's political coalition structure.
The opening of retail industry to global competition is expected to spur a retail rush to India. It has the potential to transform not only the retailing landscape but also the nation's ailing infrastructure. A Wall Street Journal article claims that fresh investments in Indian organized retail will generate 10 million new jobs and about five to six million of them in logistics alone; even though the retail market is being opened to just 53 cities out of about 8000 towns and cities in India.

Controversy over allowing Foreign retailers:
  • Entry of global retailers like Walmart can wipe off independent small retailers ( kirana stores ) and leave millions of Indians jobless
  • Global retailers after eliminating local competition , can exercise monopolistic power to raise product prices. It is argued this was the case of the soft drinks industry, where Pepsi and Coca-Cola came in and wiped out all the domestic brands.
  • FDI in retailing can upset the import balance as international retailers may prefer to source their products globally
  • Work will be done by Indians, profits will be enjoyed by foreigners.
  • Like the East India Company, global retailers could enter India as a trader and then take over politically
Supporters Claim:
  • Organised retail will need workers. In addition, millions of additional jobs will be created during the building of and the maintenance of retail stores and other retail supporting organizations.
  • Competition between global retailers will keep prices in check and ensure quality products
  • Global integration can potentially open export markets for Indian farmers and producers. Beyond capital, the Indian retail industry needs knowledge and global integration. Global retail leaders, some of which are partly owned by people of Indian origin, can bring this knowledge.
  • With 51% FDI limit in multi-brand retailers, nearly half of any profits will remain in India. Any profits will be subject to taxes, and such taxes will reduce Indian government budget deficit.
  • Indian small shops employ workers without proper contracts, making them work long hours. Many unorganized small shops depend on child labour. A well-regulated retail sector will help curtail some of these abuses
      The advantages outweigh the disadvantages of allowing unrestrained FDI in the retail sector. Other Asian countries like China, Malaysia, Taiwan, Thailand and Indonesia see foreign retailers as catalysts of new technology and price reduction; and they have benefited by welcoming FDI in retail. In Indonesia and China, the issue of allowing FDI in the retail sector was first met with incessant protests, but allowing such FDI led to GDP growth and a rise in the level of employment. India too will benefit by integrating with the world, rather than isolating itself.  

In a pan-Indian survey conducted in 2011, overwhelming majority of consumers and farmers in and around ten major cities across the country supported the retail reforms. Over 90 per cent of consumers said FDI in retail will bring down prices and offer a wider choice of goods. Nearly 78 per cent of farmers said they will get better prices for their produce from multi-format stores. Over 75 per cent of the traders claimed their marketing resources will continue to be needed to push sales through multiple channels, but they may have to accept lower margins for greater volumes.


The entry of FDI in multi brand retail in India can be growth enhancing only if proper safeguards are in place and the market environment is regulated.

 References:

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