FDI and FPI in India, External Commercial Borrowings, Foreign Exchange Reserves in India

Note4Students: External Commercial Borrowings

  • An external commercial borrowing(ECB) is an instrument used in India to facilitate the access to foreign money by Indian corporations and PSUs (public sector undertakings). ECBs include commercial banks loans, buyers’ credit, suppliers’ credit, securitised instruments such as floating rate notes and fixed rate bonds etc., credit from official export credit agencies and commercial borrowings from the private sector window of multilateral financial institutions such as International Finance Corporation (Washington), ADB, AFIC, CDC, etc. ECBs cannot be used for investment in Stock Market or speculation in real estate.
  • The DEA (Department of Economic Affairs), Ministry of Finance, Government of India along with Reserve Bank of India, monitors and regulates ECB guidelines and policies. For infrastructure and greenfield projects, funding up to 50% (through ECB) is allowed. In telecom sector too, up to 50% funding through ECBs is allowed. Recently Government of India allowed borrowings in Chinese currency yuan. Corporate sectors can mobilize USD 750 million via automatic route, whereas service sectors and NGO’s for microfinance can mobilize USD 200 million and 10 million respectively.
  • Borrowers can use 25 per cent of the ECB to repay rupee debt and the remaining 75 per cent should be used for new projects. A borrower can not refinance its entire existing rupee loan through ECB. The money raised through ECB is cheaper given near-zero interest rates in the US and Europe, Indian companies can repay part of their existing expensive loans from that.

Exports and Imports Performance of India

Source: World Bank, World Development Indicators

The data table highlights the following facts about India’s Exports since 1990’s:

  • There has been a consistent growth in exports as a percentage of GDP since 1990. The exports witnessed highest growth rate during 2000 to 2008.
  • The decline from 2008 onwards is mainly due to Global Financial crisis that hit the World in 2008.
  • Since 2009, exports recovered and reached a peak in the year 2013.
  • Following 2013, exports as a percentage of GDP declined mainly due to a slow recovery in India’s Key European markets.

Source: World Bank, World Development Indicators

The data table highlights the following facts about India’s imports since 1990’s:

  • There has been a consistent rise in imports as a percentage of GDP since 1990. The imports witnessed highest growth rate during 2000 to 2008.
  • The decline from 2009 onwards is mainly due to Global Financial crisis that hit the World in 2008 which had resulted in fall of commodity prices (Metals, Minerals, Agricultural Commodities) in the World markets.
  • Since 2009, imports started to rise and reached its peak in the year 2012.
  • Following 2012, imports as a percentage of GDP declined mainly due to fall in crude oil prices and slow recovery in the prices of key commodities.

Source: World Bank, World Development Indicators

  • One of the important impacts of favourable exports and managed Current account is reflected in India’s increasing Foreign exchange reserves.
  • Foreign exchange reserves after falling to an all-time low of less than USD 5 Billion recovered and increased to USD 41 Billion in the year 2000. The increase in Foreign exchange reserves is due to favourable exports earnings and Foreign investments. They both are the byproduct of India’s opened up economy.
  • The Foreign exchange reserves have risen steadily thereafter. The reserves were USD 250 Billion in the year 2008, USD 300 Billion in the year 2010 and more than USD 360 Billion in the year 2016.

What Caused the fall in India’s Exports in Recent Years

India’s goods exports had remained stagnant over the years. After recovering from Global Financial Crisis of 2008, India’s exports had reached a peak of USD 310 billion in the year 2011.

The successive years have shown stagnant exports till the year 2014. Post-2014, India’s goods exports have collapsed sharply and reached at USD 267 billion and USD 264 billion in the year 2015 and 2016 respectively.

The reason for the collapse of India’s exports are as follows:

  1. The Global economic situation has remained difficult and the Economies of the Developed World especially US, Europe and Japan are recovering very slow from the Global Financial Crisis of 2008. Due to their slow recovery, their capacity to imports has remained limited, as a result, India losing its important export destinations.
  2. The price of crude oil has collapsed since 2014. Due to fall in crude prices, the economies of Arab nations and oil exporting countries have suffered a lot and are growing at a dismal rate. The low growth rate had resulted in a slowdown in their imports as well. The countries of Arab nations like UAE, Saudi Arabia are key trading partners of India. Their slowdown has led to decline in India’s exports to these regions.
  3. The most important reason for India’s declining exports lies in domestic factors. The main culprit of which above all is India’s exchange rate. The exchange rate is the price of one country currency in terms of another country currency. In the Indian context, it simply determines ‘The amount of dollar or euro or any currency that can be bought using Indian Rupee’.
  4. The Indian Rupee has been overvalued for quite some time. The overvalued rupee simply means that rupee is very expensive for the other nations to buy. Consider the example now.

  1. The other underlying domestic factors that resulted in slow export performance are infrastructure bottlenecks. The health of India’s Roads, Highways, Ports and power sector remains poor and dismal. They all contribute in making export costly and uncompetitive. The poor quality of infrastructure simply increases the cost of transporting goods from factories to main destinations. The increase in cost results to increase in the prices, thereby making goods expensive and uncompetitive.

Foreign Direct Investment and Foreign Portfolio Investment in India

Foreign Direct Investment Foreign Portfolio Investment
FDI is an investment made by a company or individual in the business of another country in the form of either establishing a new business or acquiring the existing business. FPI is an investment made by a company or an individual in the stock markets or debt markets of another country. FPI investors merely purchase equities/shares/bonds/debentures of foreign based countries.
FDIs are mainly made in Open Economies as opposed to tightly controlled closed economies. FPIs are mainly made with the objective of making quick profits by buying and selling shares, bonds and debentures.
FDIs are made for a longer period as the foreign investor’s controls and owns the companies in which they have invested. FPIs are made for shorter periods as the foreign investor do not own the companies and only invest in shares of the existing companies.
FDIs are much Stable. FPIs are highly volatile.
As per Organisation of Economic Cooperation and Development (OECD), the threshold for an investment to be considered as FDI is 10 percent or more ownership stake. As per Organisation of Economic Cooperation and Development (OECD), investment of less than 10 percent in foreign companies is treated as FPIs. All FPI taken together cannot acquire more than 24 per cent of the paid-up capital of an Indian Company.
FDIs are normally categorised as being Horizontal or Vertical in nature.

  • A Horizontal investment refers to the foreign firms establishing the same type of Business operations in the host country as it operates in his home country.

Example; Apple opening up Apple manufacturing unit in India.

  • A Vertical investment refers to the foreign firms establishing different but related business in host countries. Example: Hyundai Motors acquiring or establishing a company in India that supplies car spare parts/raw materials required for manufacturing Cars by Hyundai.
FPI investor includes Foreign Institutional Investors (FIIs), Foreign Qualified Investors (FQIs).

  • Institutional investors are big institutions like Asset Management Companies, Mutual Funds, Insurance Houses etc. RBI has mandated such big institutions to established to make investments in India’s security markets.
  • FQIs are individual investors or associations residing in Foreign countries. FQIs are small individual investors who invest in foreign countries securities.

FDI Policy in India and Sectoral Limits

FDI in India is allowed under two major routes; Automatic Route (Without the approval of Government or RBI) and Government Route (requiring Government approval).

FDI in Sectors where Government approval is Required Cap/Limit Government Approval
Mining and mineral separation of titanium-bearing minerals and ores 100% upto 100%
Food Product Retail Trading 100% upto 100%
Defense 100% beyond 49%
Publishing Printing of Scientific abd Technical Magazines 100% upto 100%
Publication of Foreign Editions Newspaper 100% upto 100%
Print Media- Publishing of newspaper 26% upto 26%
Print Media – Publication of Indian editions of foreign magazines dealing with news and current affairs 26% upto 26%
Air Transport Service – Scheduled, and Regional Air Transport Service 100% beyond 49%
Investment by Foreign Airlines 49% upto 49%
Satellites- establishment and operation 100% upto 100%
Telecom Services 100% beyond 49%
Trading SBRT 100% beyond 49%
Pharma- Brownfield 100% beyond 74%
Banking Private Sector 74% beyond 49%
Banking Public Sector 20% upto 20%
Private Security Agencies 74% beyond 49%
FM Radio Broad Casting 49% upto 49%
Trading MBRT 51% upto 51%

Source: Ministry of Commerce

FDI POLICY Limits under Automatic Routes with Conditions Cap/Limits
Agriculture 100%
Plantation Sectors 100%
Mining of Metals and Non-Metal Ores 100%
Mining Coal and Lignites 100%
Manufacturing 100%
Food Retail Trading 100%
Broadcasting Carriage Services ( Teleports, DTH, Cable Networks, Mobile TV, HITS) 100%
Broadcasting Content Service – Up-linking of Non-‘News & Current Affairs’ TV Channels/ Downlinking of TV Channels 100%
Airport Greenfield 100%
Airport Brownfield 100%
Air Transport Service – Non-Scheduled 100%
Air Transport Service – Helicopter Services/ Seaplane Services 100%
Ground Handling Services 100%
Maintenance and Repair organizations; flying training institutes; and technical training institutions 100%
Construction Development 100%
Industrial Parks 100%
Trading Wholesale 100%
Trading B2B E-commerce 100%
Duty Free Shops 100%
Railways Infrastructure 100%
Credit Information Companies 100%
White Label ATMS 100%
Non-Banking Finance Corporations 100%
Pharma Greenfield 100%
Petroleum & Natural Gas – Exploration activities of oil and natural gas fields 100%
Petroleum refining by PSUs 49%
Infrastructure Company in the Securities Market 49%
Commodity Exchanges 49%
Insurance 49%
Pension 49%
Power Exchanges 49%

Source: Ministry of Commerce

How Beneficial is FDI for Developing Countries like India?

FDI has proved to be a stable and important source of capital for the developing countries like India. FDI flows were quite consistent and stable in East Asian Countries even during the Asian Financial Crisis of 1997-98. In sharp contrast to FDI, the other forms of foreign investment like Portfolio Investments, equity flows and debt flows were subject to huge reversals during the same period. The consistency of FDI was also evident during the Latin American Crisis of 1980s.

  1. The stability of FDI even during the crisis period led many developing countries to favour FDI over other forms of Short-term inflows. Developing countries favour FDI because it allows them (capital deficit countries) to access scarce capital and invest them in the domestic economy, which can lead to the generation of output and employment.
  2. The Foreign Countries Investors are willing to invest in Developing countries because it allows them to seek highest returns. It also reduces the risk faced by the owner of capital by allowing them to diversify their investment. Example: Imagine the havoc that Global Financial Crisis could have created if all the US and European money was invested only in Developed Countries. They must have lost all their money, had they not invested in developing countries, which were not affected so badly from Global Crisis. FDI thus provides a cushion to Foreign Investors.
  3. The easy movement of capital flows in order to seek high returns also contributes to Developing countries adopting a very high and competitive corporate governance standards, efficient legal institutions and integrated Financial markets. These high standards and integrated markets also help the domestic investors and firms as their money is also secure due to the efficient functioning of legal institutions.
  4. The pressure to attract FDI also improves the functioning of Governments in Developing Countries. The Governments in Developing Countries restricts themselves from pursuing bad economic policies due to the fear of reversal of Foreign Capital.
  5. The gains to the Developing Countries from FDI can also take the form of:
  • FDI allows transfer of technologies that cannot be achieved through other forms of short-term financial investments like FPIs.
  • FDI recipient’s countries also gain in the form of increased employment opportunities due to the investment made by Foreign Firms.
  • The Governments of the host countries also stands to gain due to increase in their corporate tax revenues.

Note for Students

The short-term capital or hot money flows poses many risks in developing countries as they are driven mainly by speculative actions based on interest rate or exchange rate differentials. there movements are only for short-term and leaves the host country as the first signs of trouble appears, thus can damage the host economy, thus they are considered as ‘Bad Cholesterol’.

In contrast FDI is considered as “Good Cholesterol” because it offers a lot of benefits as mentioned above. FDI cannot leave so easily at the first time of trouble, instead it provides a cushion to absorb the shock.

Reasons for Caution in Dealing with FDI

Despite the above-mentioned arguments developing countries should be a little cautious about taking a too uncritical attitude towards FDI.

  1. A very high level of FDI in total capital inflows may indicate a sign of weakness for the host country.
  2. It is found that FDI tends to flow in those developing countries which are a lot riskier and lacks proper legal institutions. What can explain these paradoxical findings? One reason could be that FDI is more likely to take place in countries with inefficient markets as Foreign investors can operate more aggressively and directly extracting much more than what they invest. Example: What East India Company have done to India or The US exploitation of Latin America in 20th Century or What Chinese Firms are Currently doing in African Nations.
  3. FDI not only leads to transfer of ownership from domestic to foreign residents but also a mechanism that makes foreign investor to take control of host country firms and their management.
  4. The foreign corporations take over the control of domestic firm not because they have some special competence regarding the operation of companies but simply because they have huge cash that domestic firm’s do not have.
  5. FDI allows Foreign investors to gain crucial inside information about firms they control. This gives them an information advantage over domestic investors who are investing in such firms.
  6. FDI tends to come only in those sectors where returns are high and are beneficial to foreign firms. FDIs has a long tendency to avoid crucial sectors of developing countries like Primary Health and Primary Education.
  7. FDI tends to make domestic firms indebted. The rising debt leads to rising interest burden and reparations of money from domestic firms to parent firms.
  8. Thus, developing countries should follow caution while accepting FDI and should give much more importance on improving the domestic environment for investment and functioning of markets.

Indian FDI Recent Trends

Source: Ministry of Commerce and RBI Statistics

  • India received $51 billion in foreign direct investment (FDI), the highest-ever FDI inflow in a fiscal, during April-February FY16. According to data from the DIPP, the previous highest FDI inflow was in FY12 when the country received $46.55 billion, which was a 34 percent increase over $34.8 billion it got in FY11 However, India recorded its largest-ever percentage increase in FDI when it received $22.8 billion in FY07, representing a 155 percent increase over the $8.9 billion in FY06.

Sectors witnessing Highest FDI inflow

  • Among the sectors, computer hardware and software segment attracted the highest FDI of $5.30 billion (Rs 36,426.9 crore) during the period
  • Followed by services sector ($4.25 billion, or Rs 29,210.25 crores) and trading business ($2.71 billion, or Rs 18,625.8 crore).
  • Automobile industry attracted FDI of $1.78 billion (Rs 12,233.9 crore), while chemicals sector cornered $1.19 billion (Rs 8,178.87 crore) foreign equity investment in April-December 2015.

Sources of FDI inflow

  •  Singapore replaced Mauritius as the top FDI source for India during the period.
  • India received $10.98 billion (Rs 75,465.5 crore) overseas inflows from Singapore, followed by Mauritius ($6.10 billion, or Rs 41,925.3 crore), the US ($3.51 billion or Rs 24,124.2 crore), the Netherlands ($2.14 billion, or Rs 14,708.22 crore), and Japan ($1.08 billion, or Rs 7,422.8 crore).

Destination of FDI inflow

  • A state-wise analysis of FDI inflows by the economic survey shows that Delhi, Haryana, Maharashtra, Karnataka, Tamil Nadu, Gujarat and Andhra Pradesh together attracted more than 70% of total FDI inflows to India during the last 15 years.
  • States with vast natural resources like Jharkhand, Bihar, Madhya Pradesh, Chhattisgarh and Odisha have lagged behind.

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University