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Current Economic Downturn and Foreign Direct Investment (FDI) in

Published & Updated as on - 2010-02-18


INTRODUCTION

For the developing countries foreign capital plays a role of catalyst in the industrialization and economic development. Actually it is not only confined to developing countries, the experiences of the World showed that 'Nearly every developed country has had the assistance of foreign finance to supplement its own meager savings during the early stages of its development. England borrowed from Holland in the 17th and 18th Centuries and in turn came to lend to almost every country in the World in the 19th and the 20th centuries. The U.S., now the richest in the world, borrowed heavily in the 19th century, and in turn became the major lender of the 20th century. Foreign capital flows are mutually beneficial to both the home country and the host country. For home country it is generating income through expanding business activities globally and for the host country, it promotes production activities, boosts domestic exports and finally lead to long run economic growth. In a broader sense the main sources of flow of foreign capital are:(i)Foreign Direct Investment (FDI) (ii)Foreign Collaboration (iii)Inter-Government Loans and Grants(iv)Loans from International Institutions and (v)NRI Investments.

Foreign Direct Investment (FDI) could be defined as an investment made in the form of financial capital along with technological, managerial and intellectual capital that jointly represents a stock of assets for the production of goods and services. This is linked with the profitability, export intensity, the level of taxation, capital intensity and the degree of vertical integration. It has been observed that all the sources of foreign capital except FDI are unsustainable and erratic in nature. Therefore FDI is superior to other forms of foreign capital and is generally guided by the long term interests.

The Indian economy grew at a slower than expected 5.3% in the December quarter, slowing sharply from the previous quarter's 7.6%, as the global economic crisis cut Demand and exports. Factory output that contracted by 2% in December 08, the biggest drop in 15 years, and exports dipped for the fourth consecutive month by 16%to US$12.4 billion in January 2009. Half a million people lost their jobs between October and December 2008.Inflation continues to fall, to 3% for the week ended February 21, following slowing demand. The Government of India (GOI) has reduced their estimate for the economy to 7.1% for FY08/09 (2% below last year's 9%). The RBI survey of professional forecasters estimates GDP growth at 6.3% in 2009-10. The deteriorating fiscal outlook has prompted Standard & Poor's to revise India's long-term sovereign credit rating to negative from stable.

The GOI presented its interim 2009/10 budget on 16 February in the run up to the general elections. There is a predicted deficit of at least 10% in GDP. The Government also unveiled its third stimulus package, on 24 February, focusing on tax cuts to revive consumer demand. In yet another stimulus, the GOI, announced its interim trade policy for 2009-10 including elements of duty reduction, reducing "red tape" and a special package for certain industries. The authorities have also eased FDI norms to attract more foreign investment although businesses are still seeking clarity on the practical implementation of these measures.

Regarding specific sectors, in the last Parliamentary session before the elections the Prevention of Money Laundering (Amendment) Bill, 2009 was passed, but other economic legislation such as the Insurance Bill, the Pension Bill and the Banking bill will now have to wait for the new government to take charge. Railways minister Lalu Prasad in his interim 2009/10 Rail Budget cut rail fares across ticket categories by 2% and announced plans for 43 new trains, as the UPA government fired the first of presumably many economic salvos expected ahead of the elections.

Current Economic Downturn and its impact on FDI, we can see in actual inflows. The economic crisis emerged in September 2008 with the failure, merger, or conservator ship of several large United States-based financial firms and spread with the insolvency of additional companies, governments in Europe, recession, and declining stock market prices around the globe. India, like most other emerging market economies, has so far, not been seriously affected by the recent financial turmoil in developed economies.

The Indian economy is now a relatively open economy, despite the capital account not being fully open. The current account, as measured by the sum of current receipts and current payments, amounted to about 53 per cent of GDP in 2007-08, up from about 19 per cent of GDP in 1991. Similarly, on the capital account, the sum of gross capital inflows and outflows increased from 12 per cent of GDP in 1990-91 to around 64 per cent in 2007-01. With this degree of openness, developments in international markets are bound to affect the Indian economy and policy makers have to be vigilant in order to minimize the impact of adverse international developments on the domestic economy.

The relatively limited impact of the ongoing turmoil in financial markets of the advanced economies in the Indian financial markets, and more generally the Indian economy, needs to be assessed in this context. Whereas the Indian current account has been opened fully, though gradually, over the 1990s, a more calibrated approach has been followed to the opening of the capital account and to opening up of the financial sector. This approach is consistent with the weight of the available empirical evidence with regard to the benefits that may be gained from capital account liberalization for acceleration of economic growth, particularly in emerging market economies. The evidence suggests that the greatest gains are obtained from the opening to foreign direct investment, followed by portfolio equity investment.

With this background, the objective of this study is to provide an analytical framework related to inflow of FDI in India during 1991 – 2004 with comparative analysis of year 2008-09. Paper also focused to find out the country that has maximum share in FDI inflows.

REGULATORY FRAMEWORK FOR FDI

The government of India policy towards foreign capital, after independence has been characterized by the cautious promotions strategy, and restrictive nature and was geared towards import substitution measures and in 100 per cent export promotion measures, where the major emphasis was placed on technology transfer and not on investment. A real thrust is said to begun with the announcement of the economic reform measures taken since July 1991. India's market-oriented economic reforms undertaken in 1991 which were directed towards increased liberalization, privatization and deregulation of the industrial sector, and to re-orient the economy towards global competition by reducing trade barriers, and gradually opening up its capital account, has led India to increasingly become a favorable destination for foreign investors. This has provided a fairly liberalized policy framework to attract FDI in India, which were competent with those in several other Asian countries. This has delicensed all the major industrial units and also accorded automatic permission for foreign participation up to specified percentage. In May 1994, Government announced its intention to allow foreign participation in telephone service network and in December 1996, foreign participation up to 74 per cent by RBI route in categories of industries was announced. In January 1997, government has brought a list of guidelines, which was not yet covered under the automatic approval route. The 1999-2000, budget brought several measures which includes among others, automatic clearance for foreign participation within 30 days, creation of FIIA and also allowed NRIs/OCBs to invest up to 100 per cent for all items except those reserved for the small scale sector. In the budget 2000-01, FDI policies have been further liberalized and all FDIs permitted under the automatic approval route except for a small negative list. In e-commerce, FDI up to 100 per cent has been permitted subject to specific conditions, and the existing limit of Rs. 1500 crores for projects involving electricity generation, transmission and distribution have been dispensed with. The ceiling for FDI in oil- refining has been extended to 100 per cent, 26 per cent for insurance sector and 100 per cent for telecom sector. FDI under automatic route has been permitted up to 100 per cent for all manufacturing activities with certain exceptions in SEZs. In order to boost the foreign investor's confidence on November 1, 2001, the few EPZs have been converted into SEZs and approvals have been placed for setting - up of several SEZs.The major policies to attract FDIs through automatic route includes non - banking financial companies with foreign equity up to 100 per cent, 100 per cent in airports where 74 per cent requires approval from the government, 100 per cent in courier services except the distribution of letters, 100 per cent in the drugs and pharmaceuticals, hotels, tourism and mass rapid transport including associated commercial development of real estate, 100 per cent in defense industry, where FDI beyond 26 per cent requires permission from the government, the ceiling limit for other sectors includes environmental control 100 per cent and construction 100 per cent, 74 per cent in private sector banks.

Moreover, in July 2002, 100 per cent FDI in tea sector was allowed and in January 2004, these guidelines on equity cap on FDI has been further liberalized which includes 100 per cent in printing scientific and technical magazines, periodicals and journal with prior approval of the government, 100 per cent in petroleum product marketing, 100 per cent in oil exploration and petroleum products and FDI up to 100 per cent is permitted under natural Gas/CNG subject to approval from government.

IMPACT OF GLOBAL DOWNTURN

Government data showed that shrinking agriculture and manufacturing activities in the third quarter of the current fiscal year led to economic growth losing steam and dropping to 5.3%, down from 8.9% at the same time last year and 7.6% in the previous quarter. In the nine months to December, the economy grew by 6.9%, down from the 9% recorded in the same period last year. It was the slowest growth since the March quarter of 2003. The farm sector fell by 2.2% in October-December, 2008-09 against the growth of 6.9% a year ago, which was due in part to sharp decline in coarse cereals, pulses and commercial crops output. For the quarter, manufacturing declined by 0.2% against a substantial expansion of 8.6% a year previously.

The Index of Industrial Production (IIP) went into negative territory for the second time in the current fiscal year owing to a combination of a high base effect and lower output by factories. IIP contracted 2% in December 2008, compared to 8% growth the year previously. IIP had declined by 0.3% in October 2008 a first negative growth in factory output since 1994. However the subsequent pick-up in November 2008 had raised hopes that attempts by the RBI and government at reviving industry were bearing fruit, hopes deflated by the December figures.

India's exports and imports have together dipped for the first time in seven years, signaling weakening of domestic and external demand against the global backdrop. Data released by the Commerce Ministry showed exports dipping for the fourth consecutive month by 16% to $12.4 billion in January 2009; imports contracted by 18.2% to $18.5 billion. The trade deficit stood at $6 billion in January compared with $7.8 billion in January 2008. This has narrowed significantly from a high of nearly $14 billion in August 2008 mainly due to sharp decline in commodity prices. However, in rupee terms, both exports and imports expanded. This is because the Indian rupee has depreciated by nearly 25% in the year to January 31.

Minister of State for Labor and Employment Oscar Fernandez who resigned on 3 March noted that the global financial crisis was affecting particular segments of the economy and that the government was concerned about the adverse impact of the crisis on labor. The half million figure was based on a sample survey in some sectors and the minister asserted that the government had taken several measures to instill confidence in the economy, spur growth and promote employment. Fernandez said the government had set up a crisis monitoring group and was working on enhancing skill levels of the unemployed along with retraining facilities, to provide transferable skills.

Wholesale Price Index (WPI) inflation fell to its lowest level since October 2002 following an overall drop in prices of the 435 articles that make up the index. The annual rate of inflation was 3% for the week ended February 21, as compared with 5.7% in corresponding week a year ago. Commentators suggest the sharp decline in inflation rate provides an opportunity for the RBI to further reduce key interest rates.

Conclusion

In 1991, NEP measures have marked a departure in the FDI regime and brought the emergence of quantitative along with qualitative changes in the economy. The simplification of the procedural outlets, extension of the automatic route, increasing openness and growing global nature of trade and investment regime has served as a major factor for widening the sectoral as well as the source country composition of FDI flows. India's share in global FDI has marginally increased from 0.1 per cent in 1990 to 0.8 per cent in the year 2004 with an annual average growth rate by US $2.3 billion a year. The Indian economy has also witnessed a percentage change in annual growth of FDI to GDI by 383.3 per cent, exports to GDP by 58.9 per cent, gross domestic saving to GDP by 17.5 per cent, while gross fixed capital formation to GDP by 11.3 per cent per annum during the Post –WTO regime.

As per the source of RBI monthly bulletin the country U.S. was one of the biggest countries to invest in FDI in India till the year 2004 but due to current economic downturn U.S. lost its maximum share. FDI inflow was maximum in Electrical equipment and Transportation industry till the year 2004. Due to this current economic downturn FDI inflows moved maximum in service sector.

FDI inflow is significantly related with the Economic Condition of a country. If Economic condition of a country is healthy then FDI inflow will be more and with the downturn inflow will decreasing. Lastly, the growing trends of merger and acquisitions opening - up of soft areas have to be in line with the development of other demand generating sectors. The steps are needed to attract FDI in manufacturing sectors with export orientation, development of EPZs and the reduction of the gap between the approvals and actuals, red - tapism, price stability and the improvements in the socio-economic fundamentals.

Source:www.indianmba.com

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