Drop in FDI Inflows

Foreign Direct Investment (FDI) to India has dipped to $1.49 billion in February 2009 from $5.67 billion a year ago amid the global credit crunch, but inflows in the 11-month period (April-February 2008-09) of the fiscal have already crossed the inflows in the entire preceding fiscal.

Despite over 73 per cent year-on-year drop in inflows in February, the FDI for the 11-month period of fiscal 2008-09 has aggregated to $25.38 billion against $24.57 billion in the previous fiscal. Inflows remained robust in the first half of 2008-09 but with the deepening of international financial crisis, it slowed down.

Though the country would not achieve even the truncated FDI target of $30 billion in 2008-09, it has already seen an inflow expansion in the midst of difficult global environment.
India's cumulative FDI inflows from April 2000 to February 2009 stand close to $88 billion.

What is FDI?
According to a report of the World Trade Organisation (WTO), FDI occurs when an investor based in one country (the home country) acquires an asset in another country (the host country) with the intent to manage that asset. This investment is made through branch office, joint venture or even wholly-owned subsidiary.
FDI comprises three major components:
(i) New equity from the parent company in the home country to the subsidiary in the host country;
(ii) Re-invested profits of the subsidiary; and
(iii) Long and short-term net loans from the parent to the subsidiary.
Despite above definition, each country follows its own methods of calculating FDI by including or excluding certain items.

Current FDI Policy of India
Foreign corporate and individual investment in India, termed collectively as FDI when it relates to control or ownership of a company in India, takes one of the two routes:
Automatic route or Automatic Approval: This requires no prior approval for FDI. Post-facto filing of data relating to the investment made with the Reserve Bank of India (RBI) are for record and data purposes. This route is available to all sectors or activities that do not have a “sector cap”, i.e., where 100% foreign ownership is permitted, or for investments that are within a sector cap (e.g. less than or equal to 26% share of an insurance company) and where the automatic route is allowed.
FIPB Approval: The Foreign Investment Promotion Board (FIPB) approves investment proposals:
* where the proposed shareholding is above the prescribed sector caps; or
* where the activity belongs to that small list of sectors where FDI is either not allowed or where it is mandatory that proposals be routed through the FIPB (sectors that require industrial licensing, for example).

Changed Policy
A comprehensive review of the FDI policy was undertaken. Based on that, certain changes have been made in the policy. Some of the major policy changes on the FDI front were:
1. Increase in Equity Caps: FDI caps have been increased to 100 per cent and automatic route extended to coal and lignite mining for captive consumption, setting up infrastructure relating marketing in petroleum and natural gas sector, and exploration and mining of diamonds and precious stones.
2. FDI in New Activities: FDI has been allowed up to 100 per cent on the automatic route in power trading, and processing and warehousing of coffee and rubber. FDI has been allowed up to 51 per cent for ‘single brand’ product retailing, which requires prior Government approval. Specific guidelines have been issued for governing FDI for ‘single brand’ product retailing.
3. Removal of Restrictive Conditions: Mandatory divestment condition for B2B e-commerce has been dispensed with.
4. Procedural Simplification: The transfer of shares from resident to non-residents including acquisition to non-residents including acquisition of shares in an existing company has been placed on the automatic route subject to sectoral policy on FDI.
5. Equity caps on FDI are presently only on limited sectors, viz. up to 20 per cent—FM Radio Broadcasting; up to 26 per cent—Insurance, Defence production, Petroleum refining in the PSUs; Print and Electronic Media covering news and current affairs; up to 49 per cent—Air Transport Services; Asset Reconstruction Companies; Cable Network; DTH; Hardware for uplinking, HUB, etc.; up to 51 per cent—Single Brand retailing of products; up to 74 per cent—Atomic Minerals; Private Sector Banking; Telecom Services; Establishment and Operation of Satellites.

Comparison with China
It is widely said that the level of FDI that India attracts is nowhere as compared to that of China. Though this is true to some extent, there are two major reasons behind this vast difference.

The first and most important reason is the mode of computation of FDI. International definition of FDI includes equity capital, reinvested earnings and other capital. Equity capital consists of cash and non-cash inflows, which again is in the form of tangible and intangible components such as technology fee, brand name, etc. But in India’s FDI reporting, the actual inflows are vastly underestimated because it excludes short and long-term loans, financial leasing, trade credits, grants, bonds, reinvested earnings, non-cash acquisition of equity, investment made by foreign venture capital investors, earnings data of indirectly held FDI enterprises, control premium, non-competition fee, etc. According to an informal official study on FDI-India and China—A comparison, China’s equity capital of FDI in 2000 composed of $6.24 billion of non-cash, $7.28 billion round tripping, $16.02 billion of reinvested earnings, $1.35 billion of other capital and $7.28 billion of cash out of a total of $38.35 billion FDI in that year.

The second reason is China’s FDI policy. It gives incentives in terms of taxation, relaxation in labour law, etc. It gives preferential treatment to the FDI by non-resident Chinese. As a result over 60 per cent of FDI inflows into China emanate from non-resident Chinese composed of business leaders and professionals.

The Road Ahead
In future, India needs to move at a fast pace in attracting FDI. For this, it has to ensure following :
* Improvement in physical and social infrastructure and better quality of human capital;
* Ability to convert the approval into actual inflows. At present only 21 per cent of the approved FDI results into actual investment due to delay in getting various clearances and lethargy of the bureaucracy;
* Concentrate on increasing FDI in services sector which has huge potential as we already saw in the figures.