Investment Policy in India - CUTS Internationalcuts-international.org/CR_indAB.pdf6 w Investment Policy in India Œ Performance and Perceptions Acronyms ADRs American Depository Receipts

CUTS Centre forCompetition, Investment& Economic Regulation

Discussion Paper

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Investment Policy in India � Performance and Perceptions

Investment Policy in India� Performance and Perceptions

CUTS Centre for Competition,Investment & Economic Regulation

Investment Policy in India� Performance and PerceptionsPublished by:

CUTS Centre for Competition, Investment & Economic RegulationD-217, Bhaskar Marg, Bani Park, Jaipur 302 016, IndiaPh: +91.141.220 7482, Fax: +91.141.220 7486Email: [email protected], Website: www.cuts.org

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Acknowledgement: This report* is being published as a part of the Investment for Development Project, withthe aim to create awareness and build capacity on investment regimes and internationalinvestment issues in seven developing and transition economies: Bangladesh, Brazil,Hungary, India, South Africa, Tanzania and Zambia. It is supported by:

Copyright: CUTS, 2003

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Citation: CUTS, 2003, Investment Policy in India – Performance and Perceptions

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ISBN 81-8257-007-7

*Other country reports are also available with CUTS

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DFIDDepartment forInternationalDevelopment, UK UNCTAD

Contents

Foreword ........................................................................................................................ 8

Preface .......................................................................................................................... 10

Introduction .................................................................................................................. 12

1. Overview of Macroeconomic Context ................................................................... 151.1. Market Size and Growth ...................................................................................... 151.2. Rates of Interest and Inflation .............................................................................. 151.3. Investment Inflow ................................................................................................. 171.4. Balance of Payments: Capital and Current Accounts .......................................... 22

2. Overview of Main Policy Trends ............................................................................. 252.1. Economic Reforms in India .................................................................................. 252.2. Membership in International and Regional Trade Agreements .............................. 262.3. Capital Controls: Capital Account Liberalisation .................................................. 26

3. Investment Policy Audit .......................................................................................... 313.1. Liberalisation of Inward FDI Policies .................................................................... 313.2. Entry and Establishment ..................................................................................... 323.3. Registration Procedure ........................................................................................ 323.4. Repatriation of Profits .......................................................................................... 353.5. Investment Facilitation Initiatives/Institutions ....................................................... 35

4. Evaluation of Foreign Investment Policy Regime ................................................ 374.1. Regime for FDI .................................................................................................... 374.2. Policy Regime: the Reality .................................................................................. 38

5. Analysis of Civil Society Surveys ........................................................................... 435.1. Introduction ......................................................................................................... 435.2. Sectoral Destination of FDI .................................................................................. 435.3. Impact of FDI ....................................................................................................... 445.4. India’s Experience with FDI Flows ....................................................................... 445.5. General Policy Implications ................................................................................. 46

6. Case Studies ............................................................................................................ 496.1. The IT Sector ....................................................................................................... 496.2. Automobile Sector .............................................................................................. 526.3. The Power Sector ................................................................................................ 55

Conclusion ................................................................................................................... 61

Annexure ...................................................................................................................... 6 3

Bibliography ................................................................................................................ 64

Endnotes ....................................................................................................................... 66

List of Tables

Table 1: Growth Rate of GDP and Industrial Production in India .............................................................. 15

Table 2: Domestic Prime Lending Rates ................................................................................................. 16

Table 3: Domestic Inflation Rates ........................................................................................................... 17

Table 4: Total Foreign Investment Inflows over the 1990s ........................................................................ 18

Table 5: Industry Distribution of FDI Approvals Between 1991-2001 ........................................................ 19

Table 6: Actual FDI Inflow into India in the 1990s .................................................................................... 19

Table 7: Sectoral Distribution of Foreign Direct Investment...................................................................... 20

Table 8: FDI Inflow & Cross-border Acquisitions in India, 1991-December 1998 ...................................... 21

Table 9: Number of Technical and Technical-cum-Financial Foreign Collaborations in India ..................... 21

Table 10: India’s Overall Balance of Payments ......................................................................................... 22

Table 11: Exchange Rate of Rupee & Foreign Exchange Reserves of RBI. ............................................... 23

Table 12: Savings, Investment Rates, Current Account (CAD) & Trade Deficit (TD);

as Percentage of GDP in Current Prices ................................................................................... 24

Table 13: Significant Regulatory Changes Involving FII in India over 1990s ................................................ 29

Table 14 Proposed Changes in Sectoral Limits on FDI ............................................................................ 40

Table 15: Negative Perceptions of Civil Society ......................................................................................... 45

Table 16: Positive Perceptions of Civil Society .......................................................................................... 45

Table 17: Civil Society’s Inclination towards FDI ....................................................................................... 46

Table 18: Policies to Increase the Benefits of FDI ..................................................................................... 47

Table 19: Growth of Indian Software Industry Revenues ............................................................................ 50

Table 20: Automobile Industry- Selected Statistics ................................................................................... 52

Table 21: Index of Concentration, Market Size and Domestic

Consumption of Various Segments of Auto industry .................................................................. 54

6 w Investment Policy in India � Performance and Perceptions

Acronyms

ADRs American Depository Receipts

CAD Current Account Deficit

CBU Completely Built Unit

CCFI Cabinet Committee on Foreign Investment

CEA Central Electricity Authority

CKD Completely Knocked Down

CMM Capability Maturity Model

CUTS Consumer Unity & Trust Society

DFID Department for International Development

DGFT Director General of Foreign Trade

DPC Dabhol Power Company

ECB External Commercial Borrowing

EEFC Export Earners Foreign Currency

EPZ Export Processing Zone

ESI Electricity Supply Industry

FCB Foreign Currency Bond

FCCB Foreign Currency Convertible Bonds

FCRC Foreign Controlled Rupee Companies

FDI Foreign Direct Investment

FERA Foreign Exchange Regulation Act

FI Financial Institution

FIIs Foreign Institutional Investors

FIPB Foreign Investment Promotion Board

FIPL Foreign Investment Promotion Law

FPO Fruit Product Order

GDI Gross Domestic Income

GDP Gross Domestic Product

GDR Global Depository Receipt

IDBI Industrial Development Bank of India

IIA International Investment Agreement

IFD Investment for Development

IMF International Monetary Fund

IPP Independent Power Producer

IPR Intellectual Property Rights

IRDA Insurance Regulatory and Development Authority

IS Import Substitution

IT Information Technology

Investment Policy in India � Performance and Perceptions w 7

JV Joint Ventures

MNE Multinational Enterprise

MoU Memorandum of Understanding

MRTP Monopolies and Restrictive Trade Practices

MSEB Maharashtra State Electricity Board

MUL Maruti Udyog Ltd.

NASSCOM National Association of Software and Service Companies

NEP New Economic Policy

NIE Newly Industrialised Economy

NRG National Reference Group

NRI Non-resident Indian

OCBs Overseas Corporate Bodies

ODA Overseas Development Assistance

OEM Original Equipment Manufacturers

PLF Plant Load Factor

PLR Prime Lending Rate

QR Quantitative Restrictions

RBI Reserve Bank of India

REER Real Effective Exchange Rate

RoE Return on Equity

SAARC South Asian Association for Regional Cooperation

SAFTA South Asian Free Trade Arrangement

SAPTA Agreement on SAARC Preferential Trading Arrangement

SBA Stand-by Arrangement

SEBs State Electricity Boards

SEI Software Engineering Institute

SEZ Special Economic Zones

SIA Secretariat of Industrial Assistance

SKD Semi Knocked Down

SOE State-owned Enterprise

SSI Small Scale Industry

STP Software Technology Parks

TD Trade Deficit

TEC Techno-economic Clearance

TI Texas Instruments

TRAI Telecom Regulatory Authority of India

TRIPs Trade Related Intellectual Property Rights

UNCTAD United Nations Conference on Trade and Development

WOS Wholly Owned Subsidiaries

WPI Wholesale Price Index

WTO World Trade Organisation


Foreword

India continued with its receptive attitude towards FDI for about a decade after it gainedindependence in 1947. This was on account of limited domestic base of created assets viz.,technology, skills and entrepreneurship. During this period foreign investors were assured offree remittances of profits and dividends, fair compensation in the event of acquisition, andwere promised national treatment. However, the second five-year plan (1956-61) made asignificant departure by emphasising self-reliant economic development and adopting a restrictiveattitude towards FDI in order to protect the domestic base of created assets. Further in 1973,the Foreign Exchange Regulation Act (FERA) came into force which prescribed a ceiling of 40percent in equity by foreigners in Indian companies. This resulted in many foreign companiesleaving India in the late 1970s.

However, there was a reversal in the policy stance during 1980s. The liberalisation of industrialand trade policies during this decade was accompanied by an increasingly receptive attitudetowards FDI and foreign collaborations. In order to modernise the Indian industry greater rolewas sought to be given to trans-national corporations (TNCs). Further, exceptions from thegeneral ceiling of 40 percent on foreign equity were allowed on the merits of individual investmentproposals.

Riding on the wave of reforms, full-scale liberalisation measures were initiated in 1990s with aview to integrating the Indian economy with the world economy. The policy allowed automaticapproval system for priority industries by the Reserve Bank of India. For the purpose of grantingautomatic approval three slabs of foreign ownerships were defined viz., up to 50 percent, up to51 percent and up to 74 percent. Albeit such limits were relaxed year after year. For instance,in some sectors, up to 100 percent foreign investment on automatic basis is allowed now.

Foreign Investment Promotion Board (FIPB) was set up to process applications for cases notcovered by automatic approval. Replacement of FERA by Foreign Exchange ManagementAct (FEMA) removed shareholding and business restrictions on TNCs. Further policies relatingto foreign technology purchase and licensing were liberalised to improve access to foreigntechnology. Finally, outward investments by Indian enterprises were liberalised and proposalssatisfying certain specified norms were given automatic approval. These changes in nationalFDI policies were complemented by bilateral investment treaties (BITs) and double taxationavoidance treaties (DTATs), many of which have been signed by India in recent years.

Foreign investment started pouring in after India launched its liberalisation programme in 1991.However, India’s performance in terms of attracting foreign investment has not been veryencouraging. India’s inward FDI stock as a percentage of GDP in 2001 stood at 4.7, one of thelowest in the world. The factors that determine “location decision” of the TNCs, which makemost of FDI may be tax structure, special programmes and schemes, competition regime,entry and establishment requirements, investment protection, technology transfer, naturalresources and skill levels, incentives and institutional mechanism. However, what actuallydetermines the flow of FDI (and how) is quite a complex issue. For example, on most of theseaccounts, India may look to be more attractive than China, but fails to attract even one-tenthof FDI inflows that China receives.

It is however often argued that such great enthusiasm towards attracting FDI shown by mostdeveloping countries is more because of ideological factors rather than changes on the ground.It is also widely recognised that receiving more FDI is not the route for development in developingcountries. China has maintained high GDP growth along with huge FDI flows.


Brazil, however, has shown lacklustre economic performance despite an impressive record inattracting FDI. India, on the other hand, managed to perform reasonably well in terms of GDPgrowth despite its poor performance in attracting FDI. The issue, therefore, needs carefulanalysis.The challenge before India is not only to attract more FDI that matches its size andpotential but also to get quality FDI that fosters development. It is therefore important tocarefully look at the different aspects of FDI and its impact. For each of the stakeholders it isimportant to understand the issues so that they can play their appropriate role in fosteringdevelopment through FDI. The present volume would hopefully contribute in promoting suchunderstanding and awareness.

November 2003 Pradeep S. MehtaSecretary General


Preface

Many developing countries, once hostile to the entry of foreign direct investment (FDI) orinclined to restrict it severely, now compete to attract foreign firms. Experience with thedevelopment process over the last couple of decades is partly responsible for these attitudes.Foreign investment operating through multiple channels is seen as an important tool for raisingproductivity in the economy. There are other reasons for this change in attitude.

Firstly, there has been a rise in multinational enterprises (MNEs), which command over themost productive segments of the world economy. Recent evidence indicates that workers inMNE affiliates produce about seven times as much as the national average output per worker.The margin in developing countries is even greater, perhaps as much as 15 times the averageoutput per worker. Thus MNEs are highly productive firms, and their operations in host countriesreflect the productivity of the parent firms. Indeed MNE plants in emerging markets are oftenthe world leaders in productivity.

Secondly, FDI may increase productivity of capital in the host country more widely byintroducing methods of production more efficient than those of local firms. Moreover, FDIpromotes growth by introducing new industries into the host country and into its portfolio ofexport products.

Another source of productivity gains for the host country, which has received considerableresearch attention, is the possibility of so called spillover effects: productivity advances passingfrom foreign affiliates to locally owned firms. Locally owned firms might increase their efficiencyby copying foreign firms (such as through marketing/managerial know-how) to raise profits,reach export markets, or merely survive in the domestic market.

It should be noted that most of the benefits are more likely to accrue if the domestic marketremains competitive, rather than being monopolised by either domestic players or individualmultinationals.

In the light of the importance of FDI in the framework of developing countries, Consumer Unity& Trust Society (CUTS), Jaipur with the support of Department for International Development(DFID), UK and, in collaboration with the United Nations Conference on Trade and Development(UNCTAD) has undertaken a study to analyse the investment regimes of seven developing /transition economies and build capacity of civil society on these issues. The emphasis is onco-operation between countries and within regions, sharing information and experience andengineering joint initiatives. The National Council of Applied Economic Research (New Delhi)is working with CUTS as the partner organisation in India. I would like to thank CUTS for itscontinuing partnership with NCAER in areas of common interest.

This report attempts to study the investment regime and actual performance of India with aview to build capacity and awareness in investment issues and draw out the lacuna of thepresent system. The study is based on existing literature along with feedback obtained fromsurveys of stakeholders, namely civil society groups and local firms.

I would like to thank Dr. Sanjib Pohit and Ms. Shalini Subramanyam for their hard work inpreparing this report.


Authors have benefited from the participants’ comments at the second and third NRG meetingsheld in June 2002 and March 2003 respectively and the Asia-Pacific Regional Meeting held atNew Delhi in November 2002. We have also gained from the participants’ comments at theInternational Conference on Investment for Development, 9-10 May 2003, Geneva, Switzerland.We would also like to thank John.H.Dunning - Emeritus Professor of International Business,University of Reading, UK and Pradeep Mehta - Secretary General, CUTS for their thoughtfulcomments. We are grateful to Aradhna Agarwal, Senior Fellow, Indian Council for Researchon International Economic Relations (ICRIER) and Richard Eglin of the World Trade Organisationfor reviewing the paper. We have benefited from the comments provided by Laveesh Bhandariof Indicus Analytics, New Delhi and the CUTS team. Finally NCAER would like to thankPraveen Sachdeva for Computer and Design Support.

Portion of the report has been taken from two other reports prepared for the CUTS-Investmentfor Development Project namely, ‘‘Report A: Investment Policy - India” (authored by BiswatoshSaha of Xavier Labour Relations Institute (XLRI), Jamshedpur, India) and “Report B: Perceptionsof Impact of FDI on Economy” (authored by Poonam Munjal, Sanjib Pohit and ShaliniSubramanyam).

November 2003 Suman BeryDirector General

National Council of Applied Economic ResearchNew Delhi, India


Introduction

Since the 1980s, a consensus has been growing, even among thedeveloping countries, that the net result of foreign direct investment (FDI)can be positive. The phenomenal drop in total Overseas DevelopmentAssistance (ODA) in the 1990s has also forced most of the countries toincreasingly look at FDI as an alternative source for financing development.It is considered to be a better option compared to bank credit, becauseof high and variable interest rates, and portfolio investment, which carriesits own risks. It is also being considered as the principal channel for thetransfer of long-term private capital, technology and managerial know-how, as well as a link between national economies and the world market.

The importance of FDI in development has dramatically increased in recentyears. FDI is now considered to be an instrument through whicheconomies are getting integrated at the level of production into the globaleconomy by accessing a package of assets, which include capital,technology, managerial capacities and skills, and foreign markets. It alsostimulates technological capacity building for production, innovation andentrepreneurship within the larger domestic economy through catalysingbackward and forward linkages1 .

The trade effects of FDI depend on whether it is undertaken to gain accessto natural resources or consumer markets, or whether FDI is aimed atexploiting locational comparative advantage and other strategic assetssuch as research and development capabilities2 . By its very nature, FDIbrings into the recipient economy resources that are only imperfectlytradable in markets, especially technology, management know-how, skilledlabour, access to international production networks, access to majormarkets and established brand names. In addition, FDI can make acontribution to growth in a more traditional manner, by raising theinvestment rate and expanding the stock of capital in the host economy.It has thus been widely recognised by governments that FDI could play akey role in the economic growth and development process.

Glancing back at the pages of history, India, if not completely hostile,wasnot very receptive to foreign private capital. Long cherished dreams of thenationalists to build strong home-grown champions and apprehensionsabout FDI eroding sovereignty and culture dominated Indian economicscenario. Today, such fears look vastly overblown, and the Indian policy-makers openly welcome FDI.

Though the Government of India has been trying hard these days to attractFDI, the flows into India as a share of Gross Domestic Product (GDP)have been much more modest than many other developing countries.

In the light of this shift in policy regime and India’s inability to attract FDIin a big way, this report attempts to study the investment regime andactual performance of India with a view to build capacity and awarenessin investment issues and draw out the lacuna of the present system.The study is based on existing literature along with feedback obtainedfrom surveys of stake holders, namely civil society groups, and localfirms.

FDI is now considered to be aninstrument through which

economies are being integrated atthe level of production into theglobal economy by bringing a

package of assets.

Glancing back at the pages ofhistory, India if not completely

hostile,was not very receptive toforeign private capital. Today, the

Indian government is openlywelcoming foreign direct

investment. Though theGovernment of India has been

trying hard to attract FDI, the flowsin India (as a share of Gross

Domestic Product) have beenmodest.


The report is organised in the following manner: Chapter 1 gives a broadmacro-view of India in recent years, while Chapter 2 discusses the mainpolicy trends since launching of the economic reforms in 1991. In Chapter3 the discussion on Investment Policy Audit, highlights the parametersof investment policy, including registration, rights to entry andestablishment, investor protection, dispute settlement, internationalinvestment agreements, taxation, movement of capital, intellectualproperty rights regime, performance requirements, incentives for investmentand export, characteristics of the regulatory regime, etc. In Chapter 4, anattempt is made to evaluate the present investment policy regime. Chapter5 examines the perception of the civil society on FDI flows, impact of FDIon specfic sectors, means to increase FDI flows and benefits thereof.Chapter 6 follows up the Indian experience of FDI inflows with three casestudies. Finally, the conclusion summarises the main findings.



CHAPTER-1

Brief Overview of Macroeconomic Context

1.1. Market Size and Growth

In terms of the overall market size of the economy (as measured by GDPat current market prices), India’s GDP was around US$510bn in 2000-01. A cursory look at Table 1 illustrates that the growth rate of both GDPand industrial production shows a decline to very moderate levels in thelate 1990s after a brief spurt in the mid-1990s.

There has been a debate among economists centring on the growthperformance of the economy in the post reform period. While the morepopular view is that growth has accelerated after the implementation ofthe reforms package, Nagaraj (2000), after a more robust statisticalanalysis of growth rates of GDP and its various components using datafor 1980-2000 argues that there is no significant increase in the trendrate of growth of GDP in the 1990s. According to this estimate, the averagegrowth rate during 1980-81 to 1999-2000 was 5.7 percent while the sameduring 1980-81 to 1990-91 was 5.6 percent. In fact, a statisticallysignificant decline in the secondary sector can be identified over the lastdecade, i.e. post reforms.

1.2. Rates of Interest and Inflation

1.2.1. Rates of Interest

Table 2 shows the movement of nominal interest rates of scheduledcommercial banks in India over the 1990s. Over the 1980s, interest rateswere regulated, the prime lending rate (PLR) of State Bank of India (thelargest scheduled commercial bank) being pegged at about 16 percentand that of Industrial Development Bank of India (IDBI, which is a termlending institution; also called a financial institution, FI) pegged at 14percent. Domestic interest rates were raised sharply in mid-1991, as aresult of the monetary contraction that was part of the InternationalMonetary Fund (IMF) style ‘stabilisation’ package. Mid-1992 onwards,however, interest rates were slowly brought down to lower levels, thedeclining trend continuing till date.

Since October 1994, banks were allowed freedom to set their own lendingrates for most categories of advances. As a result, different banks startedannouncing different lending rates according to their own businessjudgements – so data for the later period shows the range within whichPLRs of the five largest scheduled commercial banks in the country varied.As the data in Table 2 show, the declining trend in nominal interest rateswas reversed in early 1995.

Table 1: Growth Rate of GDP and Industrial Production in India (in percent)

1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-2000 2000-01

GDP growth 6.2 7.8 7.2 7.8 4.8 6.6 6.4 5.2

Growth in IIP* 6 8.4 12.7 6.1 6.6 4.1 6.7 5.1

Source: RBI Annual Report, various issues * Index of Industrial Production

While the popular view is thatgrowth has accelerated after the

implementation of the reformspackage, Nagaraj argues that

there is no significant increase inthe trend rate of growth of GDP in

the 1990s.

Domestic interest rates were raisedsharply in mid-1991, as a result of

the monetary contraction that waspart of the International MonetaryFund style ‘stabilisation’ package.

Mid-1992 onwards, however,interest rates were slowly brought

down to lower levels, the decliningtrend continuing till date.


It is worth mentioning here that banks could set their lending rates freelyfrom October 1994, and this rise in interest rates was, perhaps, a reflectionof banks’ strategy. This was mainly because recovery in industrial growthin 1994-95 and 1995-96 resulted in rising demand for credit from industryfrom around early 1995.

Though Reserve Bank of India (RBI), in general, has tried to bring downthe interest rate structure, its efforts were circumvented every time dueto depreciation in the foreign exchange market forcing it to raise short-term domestic interest rates (in order to encourage inflow of foreignexchange through banking channels as well as from exporters/importers).

Table 2: Domestic Prime Lending Rates (% per annum)

Year Average interest rates

1990-91 16.5

1991-92 16.5

1992-93 19.0

1993-94 19.0

1994-95 15.0

1995-96 16.5

1996-97 14.5

1997-98 14.0

1998-99 13.0

1999-00 12.0

2000-01 11.9

2001-02 11.5

2002-03 11.3

Source: RBI Annual Report, various issues

1 Figures relate to the minimum PLR among the 5 major scheduled commercial banks during theperiod. Real interest rates were calculated using annual average inflation rates formanufactured goods.Source: RBI Annual Report, various issues

0

2

4

6

8

10

12

14

4/13/91 4/13/92 4/13/93 4/13/94 4/13/95 4/13/96 4/13/97 4/13/98 4/13/99

% p

er a

nnum

Figure 1: Real Prime Lending Rates in India in the 1990s. (Figures in %) 1


1.2.2. Rates of Inflation

Of course, it is real rather than nominal interest rates that are of importanceas far as economic activity is concerned. Table 3 shows different measuresof inflation in the economy through the 1990s. Figure 1 plots the trends inmovement of real interest rates using the average annual changes ofprice of manufactured goods to derive the real rates. As shown in figure1, real interest rates remained high, at more than 8 percent, throughmost of the 1990s - except for a brief period in 1994-95, when real ratesdeclined to about 4-6 percent. So, the decline in nominal rates in thelater half of the 1990s was not accompanied by a decline in real rates asinflation rates, especially that for manufactured goods, fell sharply duringthat period.

The high real rates of interest prevailing in the domestic economy createsa ‘cost of capital’ disadvantage for domestic enterprises, vis-à-vis theirforeign competitors, headquartered in economies with lower interest rates,which can translate into a strategic disadvantage as well. Domesticbusiness groups and chambers of commerce have, in fact, beencomplaining about the high cost of capital that they are facing over thelast decade.

1.3. Investment Inflow (1992-2001)

After the liberalisation of capital controls in 1991, there has been asubstantial increase in the inflow of foreign investments into India. Table4 gives the year-wise break-up of foreign investment inflows. Thoughliberalisation in the foreign investment regime for direct investment occurredin July 1991 and for portfolio investment in September 1992, foreigninvestment inflows picked up in earnest only from the last quarter of1993. As Table 4 indicates, FDI as percent of GDP has increasedsignificantly in the last decade.

Table 3: Domestic Inflation Rates 1

All commodities Manufactured productsPoint to point Average Point to point Average

1990-91 12.1 10.3 8.9 8.4

1991-92 13.6 13.7 12.6 11.3

1992-93 7.0 10.0 7.9 10.9

1993-94 10.8 8.3 9.9 7.8

1994-95 2 10.4 10.9 10.7 10.5

1995-962 5.0 7.8 5.0 9.1

1996-972 6.9 6.4 4.9 4.1

1997-98 5.3 4.8 4.0 4.1 1998-992 4.8 6.9 3.7 4.5

1999-2000 6.5 3.3 2.4 2.7

2000-2001 4.9 7.2 3.8 3.1

2001-02 1.5 3.6 0.5 1.9

2002-03 6.5 3.4 5.4 2.61 Figures based on Wholesale Price Index (WPI) calculated by RBI with base 1981-82 = 1002 Figures from 1994-95 onwards are based on the new WPI series with 1993-94 = 100Source: RBI Annual Reports, various issues

The high real rates of interestprevailing in the domestic economy

creates a ‘cost of capital’disadvantage for domestic

enterprises, vis-à-vis their foreigncompetitors, headquartered in

economies with lower interest rates,which can translate into a strategic

disadvantage as well.


However, portfolio investment did not show a consistent trend after 1995and even touched a negative figure in 1998 and then again startedincreasing in 1999-2000 followed by marginal decline in 2000-2001.Movement in direct investment flow reflected considerable rise fromUS$6mn in 1990-91 to US$4784mn in 1997-98, but beyond 1998 therecame a brief period of downtrend. But soon resurgence came with a risein FDI to US$5102 in 2000-01.

It must be mentioned that the definition of FDI and computation of FDIstatistics used by Reserve Bank of India (RBI) does not conform to theguidelines of the IMF. Some of the main discrepancies are that Indiaexcludes reinvested earnings in its estimate of actual FDI inflows. It doesnot include the proceeds of the foreign equity listings and foreignsubordinated loans to domestic subsidiaries which, according to IMFguidelines, are part of inter-company loans (long- and short-term net loansfrom the parents to the subsidiary) and which should be a part of FDIinflows. India also excludes overseas commercial borrowings, whereasaccording to IMF guidelines financial leasing, trade credits, grants, bonds,etc should be included in FDI estimates.

Recently, the government has reorganised FDI data for 2000-01, 2001-02, and 2002-03 along the lines recommended by the IMF, to includesome uncaptured elements of capital, to end under-reporting of FDI.3

The new formula would include control premiums, non-competition fees,reinvested earnings and intercorporate borrowings as FDI.

1.3.1. Approved and Actual Inflows of FDI

After the liberalisation of entry norms for foreign investors in India in 1991,FDI flows into the economy have increased, especially in comparison tothe levels of inflow experienced prior to 1991. Table 5 summarises theindustry-wise distribution of foreign collaboration approvals granted overthe 1990s (between August 1991 and August 2001). The total approvedamount of FDI in these proposals was US$56.5bn.4 Only about 8

Table 4: Total Foreign Investment Inflows over the 1990s in US$mn90-91 91-92 92-93 93-94 94-95 95-96 96-97 97-98 98-99 99-00 00-01

Direct Investment - - 280 403 872 1419 2058 2956 2000 1581 2342

Portfolio Investment 6 4 244 3567 3824 2748 3312 1828 -61 3026 2760

Total 6 4 524 3970 4696 4167 5370 4784 1939 4607 5102

FDI as % of GDP 0.03 0.05 0.14 0.21 0.41 0.60 0.73 0.87 0.59 0.48 0.49

FDI as % of GDI 0.12 0.21 0.55 0.93 1.57 2.25 2.99 3.47 2.56 2.05 2.08

Source: Report B

Box A: FDI Definition Widened

The composition of balance of payments would change after the inclusion of these items

although it would not alter the balance of payments for the last three financial years.

Component-wise revised FDI data (in US$mn)

Year Equity Reinvested Other FDI Inflows toIndia FDI Inflows to India DifferenceEarnings Capital – Revised Data – Current Data

2000-01 2400 1350 279 4029 2342 1687

2001-02 4095 1646 390 6131 3905 2226

2002-03* 2700 1498 462 4660 2574 2086Source: Business Standard, July 1, 2003.* Figures for 2002-03 are estimates.


Table 5: Industry Distribution of FDI Approvals Between 1991-2001

No. of Approvals Amount of FDI Percent of TotalIndustry Approved (US$mn) Amount ApprovedMetallurgical industry 314 3076 5.44Fuels 575 16004 28.32 Power 229 7909 14 Oil Refinery 136 5206 9.21Computer software 1846 1206 6.39Electronics 303 677 1.2Telecommunications 617 11269 19.94Transportation industry 768 4033 7.14Chemicals(other than fertiliser) 852 2641 4.67Drugs 225 573 1.01Textiles 561 718 1.27Paper and pulp 116 682 1.21Food processing 662 1879 3.32Services 838 3493 6.18 Financial services 370 2388 4.23Hotel & Tourism 324 1019 1.8Total 13028 56511 100

All approvals given between August 1991 and August 2001 have been included. Data includesapprovals given through FIPB for GDR/FCCB issues.Note: Approved amount of FDI is calculated using Exchange rate prevailing in the month of Aug 2001Source: Secretariat of Industrial Assistance Newsletter, August 2001, Ministry of Industry, Government ofIndia

Table 6: Actual FDI Inflow into India in the 1990s (in US$mn)

1991 1993 1995 1996 1997 1998 1999 2000 2001 2002Govt. Approval,FIPB, SIA 78.36 321.35 1232.18 1674.65 2823.51 2085.94 1473.50 1476.38 2043 1432

RBI approval - 78.63 168.79 180.29 241.70 154.67 181.18 393.83 687 803

NRI Schemesoperated by RBI 65.64 182.70 627.71 599.61 289.93 90.88 83.09 81.19 49 2

GDR/FCCB - - 143.31 478.35 957.90 12.91 1595.40 1626.51 527 636Inflow on transferof shares fromresident tonon-resident - - - 88.40 265.96 1027.53 465.22 665.22 628 1083

Sub-Total 144.00 582.67 2172.00 3021.29 4579.00 3371.94 3798.39 4056.73 3934 3956

Advancepending issueof shares underFIPB/SIA/RBI approval - - - - - - 215.94 445.27 149.8 406.8

Total 144 583 2172 3021 4579 3377 4016 4502 4083.8 4362.8Notes:Special NRI Schemes were administered by RBI from 1st January 1991Source: “Secretariat of Industrial Assistance Newsletter,” various issues. January 2001, Ministry of Commerce and Industry,Government of India.


industries accounted for about 70 percent of the approved FDI amount,signifying that FDI inflow has remained confined/concentrated within afew industrial sectors.

Table 7 shows the sectoral distribution of FDI. Until the early 1990s, FDIwas heavily concentrated in manufacturing.

Following 1991 liberalisation programme, however, there has been a sharprise in approved foreign investment in tertiary sector that encompassescritical elements of the modern economy namely Information Technology(IT) sector (comprising telecommunications, computer software, consultingservices, etc), power generation and hotel & tourism.

Increased FDI flows to service sector and power generation is a welcomedevelopment because these areas had long been reserved for the publicsector enterprises which were inefficient in managing these services,making India’s trade and industrial sector least competitive in internationalcontext. The share of service sector rose significantly from one percentin 1992-93 to about 12 percent in 2000-01.

1.3.2. Cross-border Mergers & AcquisitionsCross-border mergers and acquisitions (M&As) has been a very importantfeature of inward FDI flow into India over the 1990s. Table 8 shows therelative importance of the various categories of cross-border M&As inIndia between 1991-1998. FDI, involving financial inflow of over US$3691mn,financed cross-border M&A activity, either through acquisition ofsubstantial equity stakes in existing ventures or through buy-out of realassets through asset sales.

Among the categories of cross-border M&As shown in Table 8, the mostimportant in the early part of the 1990s was investment by foreign parentsin erstwhile Foreign Controlled Rupee Companies (FCRC) to raise theirequity stake after the relaxation of restrictions on foreign equity investmentimposed by FERA.

Increased FDI flows to service sectorand power generation is a welcome

development because these areashad long been reserved for the

public sector enterprises whichwere inefficient in managing these

services.

Table 7: Sectoral Distribution of Foreign Direct Investment (as a percentage of total)

Sector/Industry 92-93 93-94 94-95 95-96 96-97 97-98 98-99 99-00 00-01

Chemicals & AlliedProducts 17 18 16 9 15 9 19 8 7

Engineering 25 8 15 18 35 20 21 21 14

Domestic Appliances 6 1 12 0 1 2 0 0 0

Finance 1 10 11 19 11 5 9 1 2

Services 1 5 11 7 1 11 18 7 12

Electronics & ElectricalEquipment 12 14 6 9 7 22 11 11 11

Food & DairyProducts 10 11 7 6 12 4 1 8 4

Computers 3 2 1 4 3 5 5 6 16

Pharmaceuticals 1 12 1 4 2 1 1 3 3

Others 25 19 19 24 14 22 13 35 30

Total 100 100 100 100 100 100 100 100 100

Source: RBI Annual Reports, various issues


1.3.3. Technology CollaborationsA sectoral break-up of FDI inflow in India showed (as discussed earlier)that a large part of FDI inflow came into ‘medium’ or ‘low technology’industries, in which case the positive externality arising from technologyspillovers would also be limited. A liberal FDI regime might also weakenthe bargaining position of domestic firms in the international technologylicensing market, as foreign firms make equity participation a preconditionfor technology transfers.

Data for India actually shows a very sharp increase in the share oftechnology-cum-financial collaborations approved in total foreigntechnology collaboration approvals (which includes foreign technologycollaborations with or without financial collaboration) from 1991 to 2000(see Table 9).

Table 8: FDI Inflow & Cross-border Acquisitions in India, 1991-December 1998Category Number Amount Amount as percent-

of Cases (US$mn) age of Total FDI

Inflows and Acquisitions

Erstwhile FCRC companies1 80 407.72 11.0

To increase stake in Joint Ventures2 123 1279.53 34.7

To acquire stake in Indian company3 155 1379.15 37.4

Strategic alliance or portfolio investment4 85 448.95 12.2

Asset Sale5 15 176.15 4.8

Total 458 3691.50 100

1 Denotes cases where FDI inflow financed rise in equity stake of foreign parents in their Indian subsidiaries,or the erstwhile FCRC.

2 Denotes cases where FDI inflow financed rise in equity stakes of foreign partners in their existing jointventures with Indian promoter groups.

3 Denotes cases where FDI inflow financed acquisition of equity stake by foreign companies in Indian firms,where they did not have any previous equity participation.

4 Denotes cases where FDI inflow financed acquisition of minority stake (less than 26 percent) by foreignfirms in Indian companies.

5 Denotes cases of asset sales (like brands or manufacturing assets) by Indian companies to foreign controlledfirms.

Source: Saha 2001.

Table 9: Number of Technical and Technical-cum-Financial Foreign Collaborations in India

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

1.Technical collaborations 661 828 691 792 982 744 660 595 498 418

2.Technical-cum-financial collaborations 289 692 785 1062 1355 1559 1665 1191 1726 1726

3.Total foreign collaborations 950 1520 1476 1854 2337 2303 2325 1786 2224 2144

Source: SIA Newsletter, October 2001, Ministry of Industry, Government of India


1.4. Balance of Payments: Capital and Current Accounts

Table 10 shows the overall balance of payments data and composition ofthe total capital account in India over the 1990s. Average foreign investmentinflows between 1993-2001 were more than 20 times the average levelsbetween 1985-1991.

This sharp increase in the level of foreign investment flows, however, didnot lead to an equally sharp increase in the total capital account surplus(i.e. net capital account inflows), because of offsetting declines in othercomponents of the capital account, particularly in net aid flows and netNRI Deposits5.

The increase in foreign investment inflows nonetheless led to a change inthe composition of the capital account, with foreign investment becominga more important component of the capital account in the 1990s.

1.4.1. Foreign Exchange Rate

The RBI, over the period 1993/94-2000/01, intervened aggressively in theforeign exchange market as a net buyer of foreign exchange which hadthe effect of resisting ‘the upward pressure on the exchange rate of theRupee’.

Table 10: India’s Overall Balance of Payments (in US$mn)

91-92 92-93 93-94 94-95 95-96 96-97 97-98 98-99 99-00 00-01

Current AccountDeficit 1178 3526 1158 2701 5910 4619 5500 4038 4698 2579

Capital AccountExternal Assistance,net 3037 1859 1901 1434 883 1109 907 820 901 427

CommercialBorrowing, net 1456 -358 607 1029 1275 2848 3999 4362 313 4011

Short term credit,net -515 -1079 -769 330 49 838 -96 -748 377 105

NRI Deposits, net 290 2001 1205 847 1103 3350 1125 1742 1540 2317

Foreign Investment,net 139 555 4235 4895 4805 6153 5390 2412 5191 5102

Rupee debt service -1240 -878 -1053 -1050 -952 -727 -767 -802 -711 -617

Other capital, net 801 866 3709 1321 -3074 -1565 -714 779 2833 -2322

Total capital account 3968 2966 9835 8806 4089 12006 9844 8565 10444 9023

Overall Balance 2790 -560 8677 6105 -1221 6793 4511 4222 6402 5856

IMF, net 786 1288 187 -1146 -1715 -975 -618 -393 -260 -26

Reserves andmonetary gold(increase -,decrease +) -3576 -728 -8864 -4959 2936 -5818 -3893 -3829 -6142 -5830

Foreign investmentas % of total capitalaccount surplus 3.5 18.7 43.1 55.6 117.5 51.2 54.8 28.2 49.7 56.54

Source: RBI Annual Reports, 1995-96 (for 1991-95) and 1998-99, for the rest.

Sharp increase in the level offoreign investment flows, however,

did not lead to an equally sharpincrease in the total capital

account surplus (i.e. net capitalaccount inflows), because of

offsetting declines in othercomponents of the capital account,

particularly in net aid flows andnet NRI Deposits.


Table 11 shows the nominal exchange rate of the Rupee against the USDollar at end-March of each year during this period. As the figuresindicate, RBI successfully prevented any nominal appreciation of the Rupeewith respect to all major currencies. Over this period, it in fact, allowed adepreciation of the domestic currency to the extent of about 48 percent

in nominal terms, with respect to the US Dollar.However, in terms of the REER (Real Effective Exchange Rate), basedon the 36-country ‘trade-weighted’ series published by the RBI6, the Rupeeshows an appreciation of 12 percent between 1993-2001. If we look intothe foreign exchange reserves of the RBI, between March 1993, andMarch 2001, it shows an accretion to the tune of about US$32bn.

1.4.2. Savings and Investment Rates

Table 12 gives gross domestic savings and investment rates as alsotrade and current account7 deficits, as a percentage of GDP at currentmarket prices, that the economy has been running over the recent years.

The figures show that between 1992-93 and 2000-01, the economy hasbeen running, on an average, a current account deficit of only 1.1 percentof GDP, which is slightly lower than the current deficit in the early 1980s(1.3 percent of GDP) and substantially lower than that in the secondhalf of 1980s (2.2 percent of GDP).

The average current account deficit during 1991-2001 was around 1.04percent of GDP at current market prices, much lower than the averagefor the second half of the 1980s, i.e. 2.2 percent of GDP. Therefore, itimplies that in spite of larger foreign capital inflows in the 1990s, foreignfinancial inflows hardly played any significant role in augmenting domesticinvestment rates.

Table 11: Exchange Rate of Rupee & Foreign Exchange Reserves of RBI. 1

1993 1994 1995 1996 1997 1998 1999 2000 2001

Nominal exchangerate ‘r’ 2

Rs./US$ 31.5 31.4 31.44 34.35 35.9 39.5 42.43 43.62 46.64

Annual % change in ‘r’(- implies depreciation) _ 0.32 -0.13 -9.2 -4.5 -10.03 -7.42 -2.8 -6.9

REER 3 59.15 63.55 63.2 61.92 65.87 66.04 68.33 63.30 66.46

Reserves 4 9.8 19.25 25.19 21.70 26.42 29.38 32.49 38.04 42.28

Changes in reserves 5 0.6 9.45 5.94 -3.49 4.72 2.96 3.11 5.55 4.24

1 All data relate to March-end figures for corresponding years2 Nominal exchange rate of the Rupee in terms of 1 US$; RBI Reference Rate3 36-country trade weighted Real Effective Exchange Rate published by RBI. Base 1985=100; a decrease in REER implies

a real depreciation of the Rupee4 Foreign exchange reserves of RBI, in billions of US dollars5 Change in foreign exchange reserves of RBI, over last year (in US$bn )

Source: RBI Annual Reports, various issues

In spite of larger foreign capitalinflows in the 1990s, foreign

financial inflows hardly played anysignificant role in augmenting

domestic investment rates.


Table 12: Savings, Investment Rates, Current Account (CAD) & Trade Deficit (TD);as Percentage of GDP in Current Prices

85-901 90-91 91-92 92-93 93-94 94-95 95-96 96-97 97-98 98-99 2 99-00 00-01

GrossDomesticSavings 20.6 24.3 22.8 22.1 22.5 25 25.5 23.3 24.7 22.3 22.3 -

GrossDomesticInvestment 23.1 27.7 23.4 24 23.1 26.1 27.2 24.6 26.2 23.4 23.3 -

CAD 2.2 3.2 0.5 1.5 0.5 1.1 1.8 1.2 1.3 1.0 1.0 0.5

TD 3.2 3.2 1.0 2.0 0.5 1.4 3.1 3.7 3.7 3.2 4 3

1Provisional Figures. Figures from 1996-97 onwards are based on the new series of GDP estimates being calculated from1994-95, which gives a higher estimate of GDP compared to the old series.

Notes:1. Difference between gross domestic savings and investment rates do not equal current deficit due to rounding off.2. CAD and TD figures for 1980s and 1990s are not strictly comparable, as the 1990s figures are reported according to the

revised format suggested by the High Level Committee (constituted in November, 1991) on Balance of Payments, headed byDr.C.Rangarajan. The trade deficit figures for the 1990s includes gold brought in by NRIs with baggage, with a contra entryin private transfers, and some non-customs defence related imports funded through bilateral debts. Therefore, TD and CADin the 1990s has an upward bias compared to the figures for the 1980s. (RBI Bulletin, August 1993, pp.1139-1180)

Source: RBI Annual Reports; Economic Survey, Ministry of Finance, Government of India, various issues.

Issues for Comments

l Domestic firms are at a comparative disadvantage due to highcost of capital as against foreign firms headquartered in economieswith lower interest rates. What steps do we need to take torestructure the real interest rates for attaining equilibrium in interestrates between domestic and foreign competitors? Why FDI inflowsin India remain concentrated within a few industrial sectors?

l In spite of liberalising capital controls in 1991, why is India notreceiving FDI flows commensurate with the size of the economy?

l What might be the factors behind lower actual FDI flows againsthigher approved FDI flows?

l In India there is sharp increase in the share of technology-cum-financial collaborations in total foreign technology collaborationapprovals. Is it good for the economy?

l Has the policy of maintaining a large foreign exchange reserveresulted in marginalising the role of foreign financial inflows inaugmenting domestic investment rates?

l Does FDI in India serve as an engine of growth?


CHAPTER-II

Overview of Main Policy Trends

2.1. Economic Reforms in IndiaThe ‘economic reforms’ or ‘economic liberalisation’ programme wasimplemented with the announcement of the New Economic Policy (NEP)in 1991. It included wide-ranging changes in industrial policy, trade policyand foreign investment policy, a redefinition of the role of the public sectorin the economy and a redesigning of the architecture of the domesticfinancial system. These radical policy changes were, however, notstrategy-driven8. It was more a crisis-driven response.

2.1.1. BackgroundBetween late 1990 and the middle of 1991, the economy faced severebalance of payments difficulties, coming close to defaulting on its externalpayment obligations in January and June of 1991. In January 1991, theGovernment accessed the Compensatory and Contingency FinancingFacility of the International Monetary Fund (IMF) and in June 1991negotiations were initiated for loans under SBA (Stand-by Arrangement)lending facility of the IMF.

What followed was the implementation of the conventional IMF-WorldBank prescription of short-term ‘stabilisation’, consisting of devaluation,temporary import compression, fiscal and monetary compression with arise in interest rates. This was followed by more long-term ‘structuraladjustment’ measures, seeking to restructure the domestic economy.The New Economic Policy was an outcome of implementation of the‘structural adjustment programme’9.

2.1.2. Domestic OpinionThough the initiation of the economic reform program was ‘crisis-driven’,it is also true that domestic opinion favouring a more liberal economicpolicy environment was building up over the 1980s. Concerns about inwardlooking trade regime, public sector inefficiencies and a restrictive industriallicense policy (the ‘license-permit Raj’, in popular parlance) were beingraised – generating a debate and rethinking on the development policy ofthe country10.

2.1.3. Changes in Industrial PolicyThe main industrial policy changes, brought in trail of NEP, were as follows:l Industrial licensing system was abolished except for a very short list

of 18 industries (Appendix II of Statement on Industrial Policy, 1991),where compulsory licensing was retained. In many sectors within these18 industries (like white goods and entertainment electronics), licensingwas discontinued from 1993.

l The Monopolies and Restrictive Trade Practices (MRTP) Act 1969was amended to abolish ‘pre-investment scrutiny of the investmentdecisions of the MRTP companies’ (large firms with assets higherthan the threshold limit as declared in the Act from time to time) and

The implementation of theconventional IMF-World Bank

prescription of short-term‘stabilisation’, consisting of

devaluation, temporary importcompression, fiscal and monetarycompression with a rise in interestrates, was followed by more long-

term ‘structural adjustment’measures, seeking to restructurethe domestic economy. The New

Economic Policy was an outcome ofimplementation of the ‘structural

adjustment programme’.

Though the initiation of theeconomic reform program was

‘crisis-driven’, it is also true thatdomestic opinion favouring a more

liberal economic policyenvironment was building up over

the 1980s.


to obtain prior approval of central government for ‘expansion,establishment of new undertakings, mergers, amalgamations andtakeover’ of other firms by firms that came under the purview of MRTPAct. Though the MRTP Act was diluted, a new competition law hasnot yet been put in place.

l The list of industries reserved for the public sector was reduced from17 to 6. Privatisation of state-owned enterprises (SOEs) has, however,been very slow and the government has not been able to meet itstargets for divestment of government stake in SOEs. Unlike in manyother developing economies, particularly in Latin America and EasternEurope, FDI inflow into India has not been driven by privatisation andsale of SOEs to foreign investors.

l Norms for foreign technological and financial collaboration wereconsiderably liberalised and foreign firms were allowed greater freedomto enter and operate in the economy.

2.1.4. Financial Liberalisation

Financial liberalisation has been the other important cornerstone of theeconomic reform programme. It followed the well-known path of deregulationof capital markets and banks, deregulation of interest rates, withdrawalof credit targeting and interest subsidies, introduction of stricter accountingnorms in the banking sector (following the Basle Standards) and integrationof domestic financial markets with the global financial system throughliberalised capital control measures to allow greater freedom for cross-border capital flows. All this, again, can be expected to have effects onthe domestic industry by affecting costs and availability of capital.

2.2. Membership in International and Regional Trade Arrangements

India has been a member of the WTO since its inception in 1995. Certainpolicies of trade liberalisation have been driven by WTO conditionalities,the most recent being the removal of Quantitative Restrictions on importsby April 2001 after India lost a dispute at the WTO with the USA11.

The industrial policy changes, particularly the discontinuance of thelicensing system permitted business firms to pursue their own investmentand expansion strategies without being restricted by the licensingrequirements. However, simultaneous lowering of trade barriers andliberalisation of foreign investment regime, allowing foreign firms to enterand operate in the domestic economy, exposed domestic firms tosignificant foreign competition.

India, as a member of the SAARC, is also part of SAPTA (Agreement onSAARC Preferential Trade Arrangement). However, there has been littleprogress in dismantling trade barriers among the member countries asyet, though India has made a start in reducing barriers bilaterally withNepal, Sri-Lanka and vis-a-vis Pakistan.

2.3. Capital Controls: Capital Account Liberalisation

2.3.1. GDR/ADR issues by domestic firmsIndian companies were allowed to raise capital in overseas markets byissuing Global Depository Receipts (GDRs), American DepositoryReceipts (ADRs) and Foreign Currency Convertible Bonds (FCCB) from1992.

Financial liberalisation has beenthe other important cornerstone of

the economic reform programme. Itfollowed the well-known path of

deregulation to allow greaterfreedom for cross-border capital

flows.

The industrial policy changes,permitted business firms to pursue

their own investment and expansionstrategies without being restricted

by the licensing requirements.However, simultaneous lowering of

trade barriers and liberalisation offoreign investment regime, exposed

domestic firms to significantforeign competition.


The first Indian GDR issue (by Reliance Industries) was made in May1992. There were no limits to the amount that could be raised throughGDR issues, but only companies having a good track record (for threeconsecutive years prior to the issue) were given permission to accessthe GDR market12. The funds raised through GDR issues could be utilisedin any manner, except that such funds could not be invested in the stockmarket and used for real estate investments.

The end-use restrictions began to be enforced from September 1994.Inflows through GDR issues are considered by the Ministry of Industryas part of FDI inflow and are, hence, subject to the limits/sectoral capsaccording to the FDI policy. GDR issues, not falling within the automaticFDI approval category, therefore, have to seek FIPB approval prior to theissue13.

Indian companies were also permitted to raise debt from the internationalmarket through External Commercial Borrowings (ECBs). Debt issues,however, were more regulated with the necessary precondition of priorRBI permission14. RBI set overall limits on the level of aggregate ECBsand borrowings beyond that stipulated limit were not allowed.

2.3.2. Other Capital Account Liberalisation Measures

Though capital controls were considerably liberalised for inflows of foreigncapital, either in the form of direct investment or portfolio investment,restrictions continued to exist for outflows on the capital account,especially for domestic residents, the domestic non-banking corporatesector and the banking sector. The norms for outward FDI by Indiancompanies were also much more stringent than inward investment rules.The limits and conditions under which Indian companies could investabroad (outward FDI) are discussed below (Guidelines, as existing inMay 2001).

1. Less than 25 percent of the annual average export/foreign exchangeearnings of the Indian firm in the preceding three years.

2. Funded out of GDR proceeds (upto 100 percent of GDR issue) or outof Export Earners Foreign Currency (EEFC) Account balances uptoUS$15mn16.

Indian companies investing in Wholly Owned Subsidiaries (WOS) andJoint Ventures (JVs) abroad are given automatic approval by RBI, if theamount of investment is less than US$30mn for SAARC countries,US$15mn15 for elsewhere and US$25mn for Nepal and Bhutan for aperiod of three years.

2.3.3. Outward FDI: Automatic Approval

Automatic approval is subject to the condition that the full amount of theinvestment17 has to be repatriated by way of dividends, royalty, technicalfees etc. within a period of 5 years from the date of first remittance ofequity to the foreign concern. Only one such automatic approval (for asingle proposal) is provided for a company within a block of three years.(Government of India, 1999)

The investment norms were liberalised further in 1999-2000 by raisingthe limit for automatic approval for outward FDI to US$50mn (instead ofUS$15mn, as indicated above) and further on in 2000-2001, to US$ 50mn

Indian companies were alsopermitted to raise debt from the

international market throughExternal Commercial Borrowings(ECBs). Reserve Bank of India set

overall limits on the level ofaggregate ECBs and borrowings

beyond that stipulated limit werenot allowed.

The investment norms wereliberalised further in 1999-2000 and

then in 2000-2001 by raising thelimit for automatic approval for

outward FDI.


every year (instead of every three years). The limit for external investmentby computer software companies with export/ foreign exchange earningswas raised to a higher level of US$100mn in a block of three years18 .

2.3.4. Outward FDI: Case-by-case Approvals

Investments not eligible for automatic approval are approved on a case-by-case basis. The RBI notification states that investments beyondUS$15mn (revised to US$50mn from 1999-2000) can be approved only inexceptional circumstances, where the company has a strong track recordof exports or where other compelling benefits exist for the Indian company(Government of India, 1999).

The outward FDI regime is, therefore, much more stringent than the inwardFDI regime. The clause subjecting Indian overseas investment to fullrepatriation of the invested amount within 5 years, by way of dividend,technical fee etc., is particularly restrictive. It precludes aggressiveinvestment behaviour by Indian companies in overseas markets as theyare under pressure to generate profits within a short period of investing inoverseas markets.

2.3.5. Trade Liberalisation

Apart from the domestic corporate sector, capital controls were liberalisedfor other domestic economic agents as well, but very cautiously mostlythrough the second half of 1990s. Exporters were permitted to retaintheir export earnings abroad for upto 180 days before repatriating it.Exporters and importers were also allowed to take forward cover for theirtrade-related transactions (either forward sale or purchase of foreignexchange) in the foreign exchange market, on the basis of businessprojections and documents substantiating the trade-related transaction.

Though trade-related transactions continue to be the basis of exporters'/importers’ participation in the foreign exchange market, the limited freedomallowed does enable them to take ‘positions’ with respect to their foreigncurrency exposure, depending on their expectations (or speculations)about movements of the domestic currency. This also established a linkbetween the current and capital accounts.

2.3.6. Liberalisation in the Banking Sector

The domestic banking sector was allowed limited freedom on its capitalaccount transactions. Banks could borrow or invest up to 15 percent oftheir Tier I capital abroad. They were allowed to engage in swaptransactions19 in the foreign exchange market without seeking prior RBIapproval.

Banks could also maintain open positions20 with respect to their foreigncurrency exposure, within limits (called ‘gap limits’) specified by the RBIfor each bank. This limited freedom allowed to banks enabled them toengage in arbitraging between the domestic money market and foreignexchange market, thus, forging links between two segments of the financialsystem21 .

Exporters, importers and domestic commercial banks thus participatedin the foreign exchange market, their transactions being guided, at leastin part, by speculation motives and driven by expectations about movementof the exchange rate of domestic currency.

The outward FDI regime is,therefore, much more stringent

than the inward FDI regime.Itprecludes aggressive investment

behaviour by Indian companies inoverseas markets as they are underpressure to generate profits within

a short period of investing inoverseas markets.

The domestic banking sector wasallowed limited freedom on itscapital account transactions.

Exporters, importers and domesticcommercial banks participated in

the foreign exchange market.


2.3.7. Foreign Institutional Investors (FIIs)Since 1991, Government of India has undertaken several steps to liberalisethe norms for FII in the country (see Table 13).

Approved categories of FIIs were allowed to engage in purchase andtrading of securities in the country and were given full rights to repatriatetheir capital and income/profits. Total FII (along with NRI investments)22

was limited to 24 percent of paid-up capital of a company, with anadditional limit of 5 percent (raised to 10 percent through an amendmenton October 9, 1996) on the investment made by a single FII sub-account.In 1996, two changes raised the limit on total FII in a company. Firstly,by separating FII and NRI investments and making the limit on FII alone24 percent, and secondly, by allowing FII up to 30 percent in companieswhich obtained shareholders' permission to allow the enhanced level ofFII. 23

With the passage of the SEBI (FII) Regulations Act, 1995, regulationsgoverning FII investments, which were initially under administrativejurisdiction of RBI and Ministry of Finance, were brought under thejurisdiction of the independent stock-market regulator, SEBI in 1995. Theregulations were amended a number of times over the 1990s, allowinggreater freedom to FIIs for their operations (SEBI, 1995).

Table 13: Significant Regulatory Changes Involving FII in India over 1990s

Date Regulatory change

14 September, 1992 RBI notification permitting FII in Indian securities.

December 1993 FIIs allowed to invest in the new schemes of mutual funds

May 1994 Companies allowed to issue preferential equity to FIIs

14 November, 1995 Securities and Exchange Board of India (SEBI) (FII) Regulations, 1995 introduced;SEBI levies a registration fee of US$10,000 per sub-account of an FII for registeringas an approved FII for a period of 5 years.

9 October, 1996 The category of eligible FIIs expanded to include university funds, endowments,foundations or charitable trusts or charitable societies. FIIs were also allowed toinvest in warrants of unlisted firms.

19 November 1996 FIIs are permitted to invest upto 100 percent of funds of dedicated ‘debt’ sub-accounts in debt securities. Previously only 30 percent of the total investmentcould be put into debt instruments.

20 April, 1998 FIIs are allowed to invest in dated Government securities; also allowed to lendsecurities through approved intermediaries.

18 May, 1998 FIIs are allowed to invest in Treasury Bills.

30 June, 1998 FIIs are allowed to invest in derivatives listed in recognised stock exchanges;also allowed to invest in unlisted debt securities.

31 March, 1999 FIIs are allowed forward foreign exchange cover on their investments (full amount)remitted after 31 March 1999. The total amount of outstanding investments thatcan be hedged, however, was limited to 15 percent on outstanding investmentsof an FII and an additional 15 percent, on a case by case basis after RBI approval.

6 April, 1999 FIIs are allowed to participate in open offers in accordance with SEBI TakeoverCode, 1997.

Source: SEBI (1995), and newspaper reports retrieved from VANS, various dates


2.3.8. Fiscal Regime for FIIs

Initially, FIIs were given favourable tax treatment compared to Indianinvestors with respect to taxation of dividend income and capital gainsarising from their trading in securities. The favourable tax treatmentprevailed right from the announcement of the entry norms for the FIIs.They were taxed at 20 percent on income received from securities, 10percent on long-term capital gains24 and 30 percent on short-term capitalgains realised from trading of securities.

In contrast, the tax rate on long-term capital gains was 46 percent fordomestic companies (23 percent for venture capital funds) and that onshort-term capital gains was 51.75 percent for widely held domesticcompanies and 57.5 percent for closely held domestic companies. Therates on investment income were the same as the ones on short-termcapital gains. The FIIs tax rates were also lower than those applicablefor NRI investments. Many of these asymmetries were eventuallyaddressed, by lowering the tax rates for domestic companies and NRIinvestors to bring them at par with the rates applicable to FIIs in 1996-97(VANS, various dates).

FIIs were given favourable taxtreatment compared to Indian

investors. Many of theseasymmetries were eventually

addressed, by lowering the taxrates for domestic companies andNRI investors to bring them at parwith the rates applicable to FIIs in

1996-97

Issues for Comments

l Were the 1991 economic reforms a strategy-driven choice or acrisis-driven response?

l Does a mechanism exist ensuring positive externalities of foreigninvestment along with FDI flows?

l Would financial liberalisation reduce the cost and availability offinance to the domestic industry?

l Would the liberalisation of norms for outward FDI flow for computersoftware companies benefit the same?

l Is the impact of liberalisation of banking sector postive on foreignexchange market and should the banks be allowed more freedomon their capital account transactions?

l Are domestic investors now on a level playing field vis-à-vis ForeignInstitutional Investors with respect to taxation of dividend incomeand capital gains arising from their trading activation in securities?


CHAPTER-3

Investment Policy Audit

3.1. Liberalisation of Inward Foreign Direct Investment Policies

Very few industries are actually out of bounds for FDI under the presentpolicy. Defence and strategic industries, agriculture (including plantation),and broadcasting are some of the few sectors where FDI is not allowed.In some sectors like insurance, FDI upto 26 percent foreign equityparticipation has been allowed only recently. In other sectors, liketelecommunications services (paging, cellular and basic services), directFDI participation is allowed to the extent of 49 percent of the paid-upcapital of licensees.

Therefore, under the current policy regime, there are, for foreign directinvestors, three broad categories of industries. In a few industries, FDI isnot allowed at all; in another small category, foreign investment is permittedonly till a specified level of foreign equity participation; and finally a thirdcategory, comprising the overwhelming bulk of industrial sectors, whereforeign investment upto 100 percent equity participation by the foreigninvestor is allowed. The third category has two subsets – one subsetconsisting of sectors where automatic approval is granted for foreign directinvestment (often foreign equity participation less than 100 percent ) andthe other consisting of sectors where prior approval from the FIPB isrequired.

3.2. Entry and Establishment

Currently, foreign investors are allowed to set up a liaison office,representative office or wholly or partially owned subsidiary (or joint venture)in India. Here we discuss the entry restrictions and the changes in theregulations governing FDI (defined to include all investment where foreigninvestor owns greater than 10 percent of the paid-up capital of a companyregistered in India).

The Statement on Industrial Policy (Government of India, 1991), madeFDI in 34 industries (listed in Annex III of Statement on Industrial Policy,1991) eligible for automatic approval upto a foreign equity participationlevel of 51 percent of the paid-up capital of a company. The automaticapproval was, however, conditional on the requirement that capital goodsimport be financed out of foreign equity inflow and dividend repatriation bebalanced by export earnings over a period of time (though the time periodwas not stated in the Policy Statement; these restrictions, moreoverwere further liberalised subsequently).

The new policy (announced in 1991) was far more liberal in comparisonwith the then existing Act, FERA, that limited foreign equity participationto a maximum of 40 percent, except in very few special cases. (Chaudhuri,1977) The policy revision, therefore, was more important in terms of thechange in the level of control allowed to foreign firms over their Indianoperations.

Under the current policy regime,there are, for FDI, three broad

categories of industries. In a fewindustries, FDI is not allowed at all;

in another small category, FDI ispermitted only till a specified level

of foreign equity participation; andfinally a third category, comprising

the overwhelming bulk ofindustrial sectors, where FDI upto

100 percent equity participation isallowed.

The Statement on Industrial Policymade FDI in 34 industries eligible

for automatic approval upto aforeign equity participation level

of 51 percent of the paid-up capitalof a company.


The FDI policy has undergone a number of changes over the 1990s, witha further expansion of the list of industries eligible for automatic approvalupto 51 percent foreign equity participation and a general movementtowards further liberalisation of the foreign investment regime. Withoutgoing into an enumeration of these changes, we are studying in somewhatgreater detail the policy regime governing foreign investment, as it existedin August 200125.

3.3. Registration ProcedureForeign investors setting up operations in India have to register themselveswith the Registrar of Companies (just like domestic investors). Tax holidaysand other such special incentives are available for investment in certainsectors (like infrastructure projects), but these policies are sector specificand also apply to domestic investment in the relevant sectors. Incentiveshave been rule-based to a large extent (the most important incentive wasperhaps the grant of ‘guaranteed return’ at excessive levels to the ‘fasttrack’ power projects promoted by foreign investors in the early 1990s;such policies were, however, discontinued after series of protests by civilsociety and litigation in courts).

However, lobbying (both by domestic interests opposed to entry of foreignfirms and by foreign firms willing to invest in the country) has played arole in setting the rules/policies regarding entry of foreign firms. Notableamong them being the intense lobbying that was witnessed when thetelecom or insurance sectors were being opened.

3.3.1. Routes of ApprovalThere are two major procedural routes currently available for approval ofFDI proposals, besides simplified mechanisms with the Secretariat forIndustrial Assistance (SIA).

3.3.1a Automatic Approval

All investment proposals, except those listed below, are eligible forautomatic approval, which is given by the Reserve Bank of India (RBI).Currently, in areas where automatic approval is applicable, investors areeven allowed to make the investment prior to seeking RBI approval withthe statutory requirement that they inform the RBI Department concernedwithin a month of making the investment.

The cases not eligible for automatic approval are –

1. Proposals where investment is in Annexure II26 industries, i.e. thoserequiring compulsory industrial licensing. There are 6 industries inAnnexure II, including distillation and brewing of alcoholic drinks,manufacture of cigars and cigarettes, electronic aerospace and defenceequipment, industrial explosives, hazardous chemicals and drugs andpharmaceuticals.

2. Proposals where 24 percent or more foreign equity investment is beingsought to be made in manufacturing units reserved for the small-scalesector (If FDI beyond 24 percent is made in such small scale industry(SSI) units, the unit loses its SSI status. As per the Reservation Policyof SSI, units not falling under the SSI Sector have to take a licenseand export 50 percent of their production for producing items reservedfor SSI Sector) and where FDI falls under the restrictions imposeddue to ‘locational policy’ of the Industrial Policy.

Foreign investors setting upoperations in India have to register

themselves with the Registrar ofCompanies (just like domestic

investors). Tax holidays and othersuch special incentives are

available for investment in certainsectors (like infrastructure

projects) but these policies aresector specific and also apply to

domestic investment in the relevantsectors as well.

All investment proposals, except afew, are eligible for automatic

approval, which is given by theReserve Bank of India.


3. Proposals with a foreign collaborator who has a previous tie-up/venturein India.

4. Cases that involve acquisition of shares of existing Indian companies(only cases involving transfer of existing shares from residents to non-residents; so cases where foreign investor gets higher equity stakethrough preferential issue of shares by its subsidiary does not comeunder this provision).

The Government notifies different lists of industries, through Gazettenotifications, for which automatic approval is to be granted upto 51, 74and 100 percent of foreign equity participation. In 1991, only the list withapproval upto 51 percent was there. The original list of 34 industries wasexpanded to include other industries and new lists of industries, eligiblefor automatic approval for foreign equity participation upto 74 and 100percent, over the 1990s. These lists were also altered a number of timesover the 1990s, to transfer industries in the 51 percent list to the 74 or100 percent list. In general, the direction of change has been towards amore liberal regime.

3.3.1b FIPB Approval

FDI proposals, which do not fall within these notified lists (for automaticapproval) or fall under categories 1-4 above, are required to go throughthe second procedural route. Such proposals are scrutinised by the ForeignInvestment Promotion Board (FIPB) for approval. The FIPB is, in principle,a single window facility made available to foreign investors for seekingapproval. Before each proposal is considered in the FIPB, the commentsand observations (concurrence or opposition) of the relevant administrativeministry/ministries (for instance, a FDI proposal in oil refining would comeunder jurisdiction of the Petroleum Ministry) on the proposal are madeavailable to the FIPB.

The FIPB follows some general guidelines in taking its decisions. Oneimportant guideline relates to proposals where the foreign investor alreadyhas an existing tie-up/joint-venture operating in India or the foreign companywishes to acquire shares in existing Indian companies. In such cases, ano-objection certificate from the Indian partner of the existing venture or aresolution adopted in the Annual General Meeting of the company’sshareholders approving the investment by the foreign collaborator isessential to get an FIPB approval.

There are, however, instances where the domestic promoters/majorityshareholders are unwilling to cede or reduce equity control, and thusdomestic companies are provided with protection from hostile take-overattempts by foreign investors. In general, FIPB approval is granted easilyif the ministries, having administrative jurisdiction over the industryconcerned, do not have any objection to the proposal. In cases wheresuch objection exists, FIPB has to deliberate and arrive at a decision.

In cases where the foreign investment amounts to less than US$130mn,the Ministry of Industry approves the FDI proposal directly on the basis ofthe recommendation of FIPB and in cases where the proposed investmentis greater than US$130mn, the proposals are given final approval by theCabinet Committee on Foreign Investment (CCFI). However, FIPB mayalso refer proposals with investment less than US$130mn to CCFI.

The Foreign Investment PromotionBoard (FIPB) is, in principle, a

single window facility madeavailable to foreign investors for

seeking approval.

FIPB approval is granted easily ifthe ministries, having

administrative jurisdiction over theconcerned industry, do not haveany objection to the proposal. In

cases where such objection exists,FIPB has to deliberate and arrive at

a decision.


3.3.1c Simplified Mechanisms

Under the existing Industrial Policy, a short list of only six industries iskept under licensing. All applications for which approval is required fromthe Government, are to be filed with SIA and considered by subject specificCommittees/Boards and decisions are taken in a time bound manner.These Committees include the Project Approval Board (PAB) for foreigntechnology agreement cases; the Board of Approval (BOA) for 100 percentExport Oriented Units; the Licensing Committee (LC) for industrial licence,the Inter Ministerial Committee for Electronic Software & Electric HardwareTechnology Park Sectors (EHTPs & STPs), Empowered Committee forgranting concessions under the Income Tax Act for Industrial ModelTowns, Industrial Parks, etc.

3.3.2. Special Provisions

In addition to the general policies on FDI, certain special provisions havebeen made for direct investment by NRI and Overseas Corporate Bodies(OCBs), where NRIs hold at least 60 percent equity. For example, NRI/OCBs are allowed to invest upto 100 percent equity in air taxi operationsand civil aviation, where the general limit for FDI is 40 percent27.

NRI investments are also allowed in housing and real estate, where generalforeign investors are not allowed. NRI investment in housing/real estate,however, carries restrictions of a 3-year lock-in period for the investmentand a limit of 16 percent on dividend repatriation. Further, NRI investmentsare allowed in sick industries, for the purpose of their revival.

3.3.3. Requirements for Foreign Technology Collaborations

Along with the liberalisation of FDI rules, norms for foreign technologycollaboration (with or without equity participation of the foreign collaborator),payment of technology fees, royalties on technology, brands or copyrightshave also been made liberal.

Foreign firms, for instance, obtained an automatic right over theirinternational brands in Indian market from 1992 onwards, after theprovision, requiring foreign firms to seek special Government permissionfor using their international brands in the domestic market was revoked.(Recall that when PepsiCo launched soft drinks in India in 1989-90, ithad to use the Lehar-Pepsi brand name) A royalty payment of 2 percentfor exports and 1 percent for domestic sales is also allowed underautomatic RBI approval for use of trademark or brand name of any foreignfirm without technology transfer. Currently, the RBI, through its regionaloffices, accords automatic approval to all industries for foreign technologycollaboration agreements subject to:

1. lump sum payments not exceeding US$2mn;

2. payable royalty amount being limited to 5 per cent for domestic salesand 8 per cent for exports, subject to a total payment of 8 per cent onsales over a 10 year period;

3. the period for payment of royalty not exceeding 7 years from the dateof commencement of commercial production, or 10 years from thedate of agreement, whichever is earlier (the aforesaid royalty limits arenet of taxes and are calculated according to standard conditions); and

4. payment of royalty upto 8 percent on exports and 5 percent on domesticsales by wholly owned subsidiaries to offshore parent companies withoutany restriction on the duration of royalty payments.

In addition to the general policieson FDI, certain special provisions

have been made for directinvestment by Non-resident Indians

(NRI's) and Overseas CorporateBodies (OCBs).

Although there is some amount ofpre-investment scrutiny by the

Government, foreign firmsoperating in India are given

‘national treatment’, post-entry,except that the incidence of

corporate tax is higher.


For technology collaboration arrangements not covered under the abovecategories and cases of collaboration in industries requiring compulsorylicensing or in sectors reserved for small-scale enterprises, approval isrequired from the Ministry of Industry, Government of India28.

Although there is some amount of pre-investment scrutiny by theGovernment, foreign firms operating in India are given ‘national treatment’post-entry, except that the incidence of corporate tax is higher (40 percentas compared to 35 percent for domestic firms).

3.4. Repatriation of Profits

Foreign direct investors have, moreover, been allowed full repatriability oftheir investment capital and the income/dividend generated therefrom,except in cases where dividend balancing conditions applied. In 22industries, FDI approval was accompanied by dividend balancingconditionalities, whereby the foreign investor has to balance the dividendrepatriated over a seven year period (from date of remittance) with exportearnings, either through export of products manufactured by the investorin India or products sourced from other producers29.

The 22 sectors were all consumer goods industries, including white goods,entertainment, motor cars, leather manufacturing/processing and footwearmanufacturing, soft drinks and carbonated water, food products (includingdairy and bakery products), tea, coffee, wood products/furniture, spiritsand wine, tobacco products and manufacture of sugar, common salt andhydrogenated oil30.

Dividend balancing has, however, been discontinued from 2000 end. Apartfrom the dividend balancing conditions, FDI approval through the automaticroute does not involve imposition of any other conditions, unless a sector-specific guideline imposes anything additional31.

3.5. Investment Facilitation Initiatives/Institutions

The Government has also taken steps to smoothen the process ofinvestment facilitation. The Industry Ministry website of Government ofIndia has all relevant information regarding the policies and restrictionson FDI. Approval (where one is required) is granted through the single-window facility, through FIPB – where foreign investors can send proposalsto FIPB for approval even through the Internet. The status of any applicationis conveyed within 30 working days (the status can be either accepted,rejected or ‘put on hold’, which implies that the FIPB could not resolvethe issue in its meeting).

However, investors also need to get other statutory approvals, includingenvironmental clearance, clearance for land acquisition (many of theseclearances are given by the state government departments) and approvalsfrom sectoral regulatory agencies (like Insurance Regulatory andDevelopment Authority for insurance, Telecom Regulatory Authority ofIndia for telecom services, Telecom Evaluation Committee for telecomequipment etc.) if the investment is made in those sectors. These statutoryclearances are, however, required for domestic investors as well.

It is often argued that the procedural impediments faced by foreigninvestors in getting these clearances from different levels of bureaucracyis acute, but it needs to be realised that these hurdles adversely affectdomestic investments as well.

Foreign direct investors have,moreover, been allowed full

repatriability of their investmentcapital and the income/dividend

generated therefrom, except incases where dividend balancing

conditions applied. Dividendbalancing has, however, been

discontinued from 2000 end.

The Government has also takensteps to smoothen the process of

investment facilitation. TheIndustry Ministry website ofGovernment of India has all

relevant information regarding thepolicies and restrictions on FDI.

Foreign investors can sendproposals to FIPB for approval

even through the Internet.


3.5.1. Institutions

The FIPB and other facilitation agencies in the Industry Ministry of CentralGovernment help and guide foreign investors in getting the approvals andall large projects are monitored by the Ministry of Industry32 to smoothentheir actual implementation.

There are also Country Focus Windows, within Ministry of Industry, (ofCentral Government) for countries with sizeable investment interest inIndia. At present, the Focus Window covers countries such as USA,Germany, France, Switzerland, UK, Australia, Japan and Korea. For eachfocus window a senior officer in the department provides facilitation andassistance.

However, FDI approval by the FIPB can be accompanied by otherconditions, imposed on the recommendation of ministries concerned,like export obligations, local content requirements (imposed, for instance,in motor cars and automobile sector till it was revoked after an adverseWTO ruling in 2001 after US registered a complaint), restriction on importof capital goods, imposition of a floor on foreign equity investment (tohave adequately capitalised domestic operations) etc.

Issues for Comments

l Do official procedures and regulations governing the pre-investmentscrutiny of FDI proposals act as a barrier to FDI flows in India?

l What would be the impact of lobbying in setting the rules/policiesregarding entry of foreign firms in India?

l Is there a need to simplify the RBI automatic approval and FIPBapproval - the currently available procedural routes for approval ofFDI?

l Is the sector specific limit on foreign equity participation inhibitingFDI flows to India?

l What other steps should be taken to enhance the flow of foreigntechnology collaboration?

l Is there a scope for improving the functioning of investment facilitationinstitution?

l Does the ‘single window’ in reality serve the purpose of providing allrelevant information as also of sending prompt feedback to FDIapplications?


CHAPTER -IV

Evaluation of ForeignInvestment Policy Regime

4.1. Regime for FDI

The current policies with regard to inward FDI flow in India can be arguedto be liberal. Post-entry, foreign firms are afforded national treatment ingeneral, while there are some pre-investment scrutiny requirementsdepending on the industry in which the investment is being made. Thedifferential treatment is limited to a few entry rules spelling out theproportion of equity that the foreign firm can hold in an Indian (registered)company or business. There are only a few banned sectors (like lotteriesand gaming and legal services) and some sectors with limits on foreignequity proportion.

As noted earlier, the entry rules are clear and well defined and equitylimits for foreign investment in selected sectors are quite explicit andwell known. The procedural route has now been made more simple andnon-discriminatory. There exist sector specific incentives, but these arealso accorded to domestic investors. To a large extent, the incentiveshave been made transparent and rule-based.

What emerges from the above discussion is that India now has in placea liberal policy regime towards FDI. However, investment climate in Indiaappears to be far less than satisfactory as reflected by a huge differencebetween the approved and actual inflows of FDI. As The Economist (22February 1997: 23) points out (taken from Srinivasan, 1998):

‘the system simply does not work as it is supposed to. The rules may beliberal in principle…(but) delays, complexities, obfuscation, overlappingjurisdictions and endless requests for more information remain much thesame as they have always been.’

Box A: Stylised Facts on FDI Procedures and Delay in India

l According to Boston Consulting Group, investors find it frustratingto navigate through the tangles of bureaucratic controls andprocedures in India.

l McKinsey (2001) found that the time taken for application/bidding/approval of FDI projects was too long. Multiple approvals, excessivetime taken (2-3 years) such as in food processing and long leadtimes of up to six months for licenses for duty free exports, leadto loss of investors’ confidence despite promises of a considerablemarket size.

l According to a CII study, a typical power project requires 43 centralgovernment and 57 state government (including localadministration) clearances. Similarly, the number of clearancesfor a typical mining project is 37 at the central government and 47at the state government level.

Source: Report of the Steering Group on FDI, 2001.

Post-entry, foreign firms areafforded national treatment while

there are some pre-investmentscrutiny requirements depending

on the industry in which theinvestment is being made.

India now has in place a liberalpolicy regime towards FDI.

However, investment climate inIndia is far less than satisfactory as

reflected by a huge differencebetween the approved and actual

inflows of FDI.


To identify factors inhibiting higher FDI flows, Government of Indiaconstituted in August 2001 a Steering Group on Foreign Direct Investmentunder the chairmanship of Mr N K Singh. The group has recently submittedits report with recommendation of accelerating the rate of growth of FDIflows. In the section below, we would briefly look at their findings.

4.2. Policy Regime: the Reality 33

At the outset, it should be noted that the delays mentioned by foreigninvestors are not at the stage of FDI approval per se, i.e., at the entrypoint, whether through RBI automatic route or FIPB approval. By andlarge, the FIPB considers applications on the basis of notified guidelinesand disposes them within a 6-8 weeks timeframe, as has been laid downby the Cabinet34.

The major implementation problems are encountered at the state level,as project implementation takes place at the state level.

The report of the Steering Group has mentioned that the domestic policyframework affects all investment, whether the investor is an Indian or aforeigner. The policy problems, identified by the report, acting as additionalhurdles for FDI are laws, regulatory systems and government monopoliesthat do not have contemporary relevance. This is based on feedback ofdifferent consulting firms who made presentation to the Steering Group(see Box A for an overview).

Bureaucracy and red tapism topped the list of investor concerns as theywere cited by 39 percent of respondents in the A T Kearney survey. Ofthe three stages of a project, namely general approval, clearance andimplementation, the second was the most oppressive. The respondentsof the survey also indicated that the division of execution mechanismbetween the central and state governments in the treatment of foreigninvestors could undermine the FDI promotion efforts of the centralgovernment. Bureaucracy in general is quite uncooperative in extendingthe necessary facilities to any project that is being set up.

It is important to note that weak credibility of regulatory systems andmultiple and conflicting roles of agencies and government can have moreadverse impact on new FDI investors compared to domestic investors.For example, the outdated Fruit Product Order (FPO) and Prevention ofFood Adulteration Act is a major hurdle for FDI in food processing. As aTask Force had recommended some years ago, we need to formulate asingle integrated Food Act (including weights & measures).

Similarly, labour laws discourage the entry of Greenfield FDI because ofthe fear that it would not be possible to downsize if and when there is adownturn in business. Labour laws, rules and procedures have led todeterioration in the work culture and the comparative advantage recognisedby responsible trade unions.

The Urban Land Ceiling Act and Rent Control Act are serious constraintson the entire real estate sector35. Recently the Centre has repealed theUrban Land Ceiling Act, but each state has to issue a notification torepeal the Act in that state. The Central Government has set up an UrbanReform Facility to provide funds to states that repeal the State LandCeiling Act, reform the Rent Control Act and carry out other urban reforms.

The report of the Steering Group onForeign Direct Investment (N.K.

Singh Report) has mentioned thatthe domestic policy framework

affects all investment, whether theinvestor is an Indian or a foreigner.

The policy problems, identified bythe report, acting as additional

hurdles for FDI are laws, regulatorysystems and government

monopolies that do not havecontemporary relevance.

It is important to note that weakcredibility of regulatory systems

and multiple and conflicting rolesof agencies and government can

have more adverse impact on newFDI investors.


At present, the entire FDI policy and procedures, as notified by thegovernment from time to time, are duly incorporated under ForeignExchange Management Act (FEMA) regulations. Many of the entryconditions had greater justification at the time they were imposed. With amuch stronger and more competitive economy many of these can beremoved. To increase FDI flows, the Steering Committee has recommendedthat the entry barriers to FDI should be further relaxed (see Table 14).

With regard to policy regime, the committee has recommended thefollowing:

l Enact a Foreign Investment Promotion Law (FIPL) that incorporatesand integrates aspects relevant to promotion of FDI.

l Encourage states to enact a special investment law relating toinfrastructure to expedite all investments in infrastructure sectors.

l FIPB should be encouraged to give initial central level approvals wherepossible.

l Change government’s Rules of Business to empower FIIA to expeditethe processing of administrative and policy approvals.

l Sectoral FDI caps should be reduced to the minimum and entry barrierseliminated.

l To attract FDI, the broad approach should be one of targeting specificcompanies in specific sectors.

l The informational aspects of the strategy should be refined in the lightof the perceived advantages and disadvantages of India as an investmentdestination.

l The Special Economic Zones (SEZs) should be developed as the mostcompetitive destination for export related FDI in the world, by simplifyingapplicable laws, rules and administrative procedures and reducing redtape levels.

l Domestic policy reforms in the power sector, urban infrastructure andreal estate, and de-control/de-licensing should be expedited to promoteprivate, domestic and foreign investment.


Table 14 Proposed Changes in Sectoral Limits on FDI

Sector Equity Limits Entry Route Change in (percent) Conditions

Existing Proposed Existing Proposed1 Manufacturing1.1 Drugs (recombinant DNA) 100 100 FIPB Automatic1.2 Petroleum, Refining-PSUs 26 100 FIPB Automatic1.3 Oil marketing 74 100 FIPB Automatic1.4 SSI 24 49 FIPB Automatic Export 50% ->0%

2 Mining & Quarrying2.1 Diamond, Precious Stones 74 100 Automatic Automatic2.2 Petro Explore: Small Field, bid 100 No FIPB Automatic

change2.3 Petro Explore:Un incorp JV 60 100 FIPB Automatic2.4 Petro Explore: Incorp JV 51 100 FIPB Automatic2.5 Coal & Lignite 50 100 Automatic Automatic

Power User 100 FIPB Automatic Other User 74 FIPB Automatic

2.6 Coal Washery 50 100 Automatic Automatic100 FIPB Automatic

3 Infrastructure Services3.1 Airports 74 100 Automatic Automatic

100 FIPB Automatic3.2 Civil Aviation 40 49 FIPB Automatic Incld Foreign Airlines

3.3 Telecom3.3.1 Basic & Mobile 49 74 FIPB No change3.3.2 Total Bandwidth 74 100 FIPB Automatic3.3.3 Gateway 74 100 FIPB Automatic3.4 Pipeline: Oil & Gas 51 100 FIPB Automatic

4 Financial Services4.1 Banking (private) 49 100 Automatic No change4.2 Insurance 26 49 Automatic No change4.3 Investing Companies 49 100 FIPB Automatic

5 Knowledge Services5.1 Information Tech5.1.1 ISP (Internet Service Provider) 100 No change FIPB Automatic5.1.2 Email, Voicemail 100 No change FIPB Automatic5.1.3 Radio Paging 74 100 FIPB Automatic5.2 Broadcasting - DTH, KU 20 49 FIPB No change Remove sub-limits

(FDI, FII)5.2.1 Up Linking 49 No change FIPB No change

6 Other Services6.1 Advertising 74 100 Automatic No change6.2 Trading (Export, SSI.) 51 100 Automatic

100 percent FIPB Automatic6.3 Courier Service 100 No change FIPB Automatic

7 Currently Banned Sectors7.1 Plantations (other) 0 49 FIPB7.2 Real Estate7.2.1 Complexes (all Categories) 0 100 Automatic7.2.2 Individual House/Building/Shed 0 100 FIPB

Source: Report of the Steering Group on FDI, 2002.


Issues for Comments

l What steps should be taken to translate approved foreign investmentinto actual inflows of FDI?

l How to encounter the implementation lag and lack of administrativeco-ordination between the central and state governments resultingin discriminatory treatment to foreign investors? Would it underminethe FDI promotion efforts by the central government?

l To what extent are bureaucratic tangles and red-tapism inhibitingIndia’s industrial growth?

l How soon would the government accept the recommendations ofthe Steering Group on FDI?



CHAPTER-V

Analysis of Civil Society Surveys

5.1 Introduction

It is clear from the above discussion that India has put in place a liberalpolicy regime for foreign investment. However, a liberal policy for foreigninvestment may not turn out to be a liberal one at the implementationstage unless the government officials or the implementers take a positiveview towards FDI flows. Since they are a part of the civil society, it isimportant to know for the study the civil society’s perception of theinvestment environment in India.

In this chapter, we have done the same by a primary survey conductedby e-mail all over India during the months of February 2002 and January2003. The survey questionnaire was designed to elicit information oncontribution of FDI on the development, sector-wise distribution of FDI,as well as impact of FDI on various parameters relating to economy,technology, policies, etc.

What needs to be mentioned here is that it was not a random samplewith the population being largely the mailing lists of National ResourceGroup (NRG) of CUTS. We have in all only 38 responses, and thus theresults of the survey findings can only be considered as indicative andnot conclusive.

5.2. Sectoral Destination of FDI

Is our sample of civil society group well informed about the destination ofFDI? To check this, we have displayed in Chart 1 perception of our civilsociety group regarding the top 9 sector-wise recipients of FDI flows inthe recent years (1996-2001) and their ranks based on actual FDI approvalsduring the same period.

Chart 1: Perception of Destination of FDI by Civil Society and Actual Inflows (Ranked in Decreasing Order)

0

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Ran

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Ranking of sectors by PerceptionRanking of sector by Actual Inflows

A liberal policy for foreigninvestment may not turn out to be a

liberal one at the implementationstage unless the government

officials or the implementers take apositive view towards FDI flows.

1 12 2

3

7

4

8

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65

76

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Ranking of sectors by PerceptionRanking of sectors by Actual Inflows


It is interesting to note that our survey has been able to pick out correctlymost of the sectors receiving the largest amount of FDI in the recentyears. As Chart 1 shows, our survey has identified the InformationTechnology (IT) sector as the maximum recipient of FDI flows in the past5 years. The other sectors of importance are power, automobiles, etc36.

5.3. Impact of FDIGiven the fact that India has been attracting FDI in a big way only in theyears after liberalisation, it is not unexpected that majority of respondentsresponded by saying that FDI did not have much role in the past in nationaldevelopment.However, their perception differs significantly wheninformation was sought regarding the sectoral impact of FDI on the localeconomy, society and environment in the last 5 years.

Among the sectors which have attracted most of the FDI flows as perceivedby civil society, namely IT, power, automobiles, chemical, engineeringgoods (Chart 1), civil society has responded that FDI has definitelyimparted considerable impact on these sectors. As Chart 2 shows,telecom/IT, automobiles and engineering/electronics are the sectors inwhich the respondents perceived that FDI has maximum impact. Notethat FDI has an impact on power sectors as well, albeit on a lower scale.

5.4. India’s Experience with FDI Flows

As noted earlier, FDI can supplement domestic investible resources in adeveloping economy like India, enabling higher rates of growth. Foreignfirms contribute to the technological base of the host economy, bothdirectly and also through technological spillovers, thereby increasingproductivity and international competitiveness of the host economy. Globallinkages of multinational firms may facilitate the marketing of exports.

Against these positive features of FDI, critics claim that multinationalenterprises (MNEs) monopolise resources, supplant domestic enterprise,introduce inappropriate products and technology and often exploit theweak environmental standards in developing countries (recall the UnionCarbide disaster at Bhopal in 1984) etc. Our questionnaires were designedto get feedback on these issues from the civil society based on India’sexperience in the last decade. The results are summarised in tables 15and 16.

Majority of respondents respondedby saying that FDI did not have

much role in the past in nationaldevelopment. However, their

perception differs significantlywhen information was sought

regarding the sectoral impact ofFDI on local economy, society and

environment in the last 5 years.

Chart 2: Sectorwise Impact on Economy

50.0

14.3 14.3

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Telecom Automobiles Engineering Pow er

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of r

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Placed at 1st Rank Placed at 2nd Rank


Majority of the respondents are of the opinion that MNEs are only interestedin getting access to domestic market (see Table 15). FDI brings inenvironmentally harmful technologies and reduces the profitableopportunities available to domestic investors. The respondents are alsoof the opinion that the foreign investors do not care about their impact oncivil society.

However, most of our sample of respondents agree that FDI brings invaluable new technologies as well as management techniques, improvesthe access to world markets, and increases the competitiveness of theeconomy. It is interesting to point out that our surveys of local firms in theIT and automobiles sectors did capture these positive aspects of FDI viz.improved product quality and precision, efficient management techniques,shop floor practises, and new technologies (see Annex 1). Furthermore,it is an important source of foreign capital and supplements domesticinvestment.

There is no clear agreement among the survey respondents on the impactof FDI on exports. Note that while 18 respondents agree that FDI helps inincreasing exports, 12 have reserved their comments on the role of FDI inenhancing exports. Does FDI flows help in reducing imports? Again thereis no consensus: one-third have responded affirmative, one-third haveanswered negative while one-third have reserved their opinion.

Table 15: Negative Perceptions of Civil Society

Negative Perceptions Agree Agree Neither Agree Disagree Disagree Total Strongly Partly nor Disagree Partly Strongly Responses

FDI brings in environmentally 3 12 14 8 1 38harmful technologies

Foreign investors are only interested in 16 10 6 3 1 36getting access to the domestic market

FDI reduces the profitable opportunities 4 8 9 9 6 36available to domestic investors

FDI results out of unfair advantages of 6 7 15 5 1 34multinational firms

Foreign investors do not care about the 10 7 12 7 2 38impact of their investments on civilsociety

Table 16: Positive Perceptions of Civil Society

Negative Perceptions Agree Agree Neither Agree Disagree Disagree Total Strongly Partly nor Disagree Partly Strongly Responses

FDI makes up for insufficient domestic 7 13 8 8 36investment

FDI brings in valuable new technologies 8 23 4 3 38

FDI brings in valuable new 13 19 4 36management techniques

FDI improves the competitiveness of 12 18 5 1 2 38the national economy

FDI increases access to world markets 10 13 5 5 5 38

FDI is a valuable source of foreign capital 14 20 2 2 38

FDI helps to enhance exports 5 13 12 4 4 38

FDI helps to reduce imports 2 11 12 7 6 38

Majority of the respondents are ofthe opinion that MNEs are only

interested in getting access todomestic market. FDI brings in

environmentally harmfultechnologies and reduces the

profitable opportunities availableto domestic investors. The civil

society is also of the opinion thatthe foreign investors do not care

about their impact on civil society.


5.5. General Policy Implications

There is a strong agreement (about 88 percent of the respondents) in oursurvey that India has attracted less foreign investment than it should, giventhe size of her economy. When the respondents were asked to identify thereasons for it, most agreed that bureaucracy and the regulatory environmentwere the two most important factors inhibiting FDI flows to India.

In this connection, it is important to point that a global survey conductedby AT Kearney has also found that bureaucracy and regulatory environmenttop the list of investor concerns inhibiting FDI flows to India37 . Most of ourrespondents felt that regulatory environment was not transparent, leadingto bureaucratic hassles and corruption.

The other notable factors identified by a majority of the civil societyrespondents were the infrastructural shortages, political instability andlack of consensus among the political leadership with regard to FDI flows.

According to the respondents, to increase FDI flows, the policy frameworkneeds to be reoriented in terms of transparency, simplifying bureaucraticprocedures and time bound clearance of proposals. Some opine thateasier policy for entry/exit rules for firms and improved infrastructurefacilities are essential if India has to increase FDI flows substantially.Nearly 80 percent agreed that the policy framework should be lessrestrictive.

By and large, civil society is now positively inclined towards FDI. AsTable 17 shows, nearly 80 percent of our respondents are positivelyinclined towards FDI against 20 percent of the same being negativelyinclined.

Our sample of civil society strongly felt (75 percent of respondents) thatcertain sectors should specifically be targeted for FDI. Probably becauseof the poor state of infrastructure in India, most have agreed thatinfrastructure should be the focus area for FDI.

Civil society respondents perceive (80 percent of our sample) thatgovernment policies can be fine-tuned to increase the benefits of FDIflows to the local economy and the society. Opinions of the respondentsacross various realms of government policies and the results aresummarised in Table 18.

For maximising the benefits from FDI, the civil society observes the needto strengthen the environmental, labour, sectoral, and Intellectual PropertyRights (IPR) regulations, to introduce competition policy and to supportlocal businesses to upgrade technology/gain access to finance. Majorityof the respondents felt that there should be specific requirements onforeign firms in respect of job creations, export commitments, transfer oftechnology, transferring skills and know-how to local subsidiary and non-affiliate firms, and training local technical and managerial manpower. Thesurvey also reflects that any foreign exchange impact needs to bebalanced to endow the economy with greater benefits of FDI.

Table 17: Civil Society’s Inclination towards FDINumbers Percent

Positively inclined towards FDI 30 78.9

Negatively inclined towards FDI 8 21.1

Total 38 100

There is a strong agreement (about88 percent of the respondents) in

our survey that India has attractedless foreign investment than it

should, given the size of hereconomy.

When the respondents were askedto identify the reasons for it, most

agreed that bureaucracy andregulatory environment were the

two most important factorsinhibiting FDI flows to India.


Table 18: Policies to Increase the Benefits of FDI

Alternative Policies Positively Inclined Negatively Inclined All to FDI to FDI

Yes Don’t Yes Don’t Yes Don’t Know Know Know

a) Support local businesses to upgrade 17 4 7 - 24 4technology/gain access to finance, etc.

b) Strengthen environmental regulation 15 5 7 - 22 5

c) Introduce/strengthen competition 18 1 7 1 25 5policy

d) Strengthen sectoral regulation 16 3 4 1 20 4

e) Strengthen labour legislation 15 4 4 2 19 6

f) Strengthen intellectual property 15 - 5 1 20 1rights legislation

g) Impose requirements on firms to:

i) Create jobs 13 2 4 - 17 2

ii) Employ local managers 8 3 4 1 12 4

iii) Transfer technology 15 2 4 1 19 3

iv) Source supplies from local firms 12 4 3 3 15 7or impose local content norms

v) Export from the economy 13 3 4 - 17 3

vi) Balance foreign exchange impact 5 8 4 2 9 10

vii) Transfer skills and know-how to 14 5 6 - 20 5local subsidiary firms

viii) Transfer skills and know-how to 9 6 5 1 14 7local non-affiliate firms

ix) Train local technical and 15 3 5 - 20 3managerial manpower

Issues for Comments

l Are the stakeholders well informed regarding the sectoraldestination of FDI flows?

l What are the impacts of FDI flows on Indian economy perceivedthrough the survey of civil society? Is the civil society positivelyinclined towards FDI flows?

l What should the government do to maximise the benefits fromFDI? What changes in policies does the civil society feel arenecessary?

l What are the factors that the civil society group consider asinhibiting FDI flows to India?



CHAPTER-VI

Case Studies

This section reports the findings of three case studies of sectoralperformance of FDI in India. In view of the importance in respect of FDIflows and civil society’s perceptions, we have chosen three sectors:automobiles, telecom/IT and power, to study in detail. To be specific,these case studies have been selected to explore and investigate a numberof areas of concern about investment in India.

The studies embrace issues like contribution of FDI to the governmentdevelopment objectives premised on generating employment, technologytransfer and spurring economic growth; success of government policesin attracting FDI and required policy changes to be made in order toattract and benefit from increased FDI flows. The case studies have beenselected for the following reasons:

l IT sector: This sector probably had the most remarkable developmentof the 1990s in India. This sector is of particular importance foreconomic development because it has direct impact on the natureand level of economic activity, specially when the global trend ofcommunication rests largely on computerisation. Among all thesectors, this is the one which has benefited the earliest and the mostfrom FDI flows.

l Automobiles: For long, a few firms controlled the automobile sectorin India. The technology was obsolete and there was almost nopenetration in the export market. These all have now changed with FDIflows in this sector. This sector has now definitely become moreproductive and is able to compete globally.

l Power: Since the economic reforms of the 1990s, the government hasbeen actively seeking FDI flows for this sector to meet the rising demandfor power within the country. The policies have been liberalised timeand again. However, despite significant amount of approved FDI in thepower sector, actual FDI flows have been minimal.

All these sectors have attracted large FDI flows. At the same time, thepositive impact of FDI flows on the economy is visible in the first twosectors, while the experience of the third sector (power) in the past 5-6years has shown that mere policy changes may not be enough for realisingthe gains from FDI flows in an infrastructure sector like power. An analysisof these case studies should, therefore, provide valuable insights into theperformance of FDI flows in India.

6.1. The IT Sector

One of the most remarkable developments of the 1990s in India has beenthe growing emergence of the ‘new economy’ or the IT economy. To bespecific, the IT economy comprises all the activities involved in valueaddition (i.e. GDP), adjusted for exports and imports, by way of IT services,software systems and communication equipment, such as computercompanies, telecommunications utilities and related enterprises. The majorsegments of IT-enabled services are content development, medical

IT, automobiles and power sectorshave attracted large FDI flows. Thepositive impact of FDI flows on the

economy is visible in the first twosectors, while the experience of thethird sector (power) in the past 5-6

years has shown that mere policychanges may not be enough for

realising the gains from FDI flowsin an infrastructure sector like

power.


transcription, call centres, database services, support and maintenance,training/retraining products and packages, projects and professionalservices.

6.1.1 Stylised Facts of IT Sector

The IT economy in India is no more a myth. Total revenues of the softwaresector, a symbol of the IT economy, may cross US$10bn in 2001-02. Theother segments of the IT economy, notably telecommunicationss andinfotainment, are also expanding fast, compared with aggregate GDP ofabout US$500bn. As Table 19 shows, the fastest growing segment of theIT economy, viz. the software industry has grown at an astonishing rateof 46 percent over 1994-2001. Unlike the other industries in India, growthof the software industry has been fuelled by external demand. This sectoris likely to have a stable growth due to expanding human resources (abank of 4-5 million technical/professional workers, incrementally 85,000professionals per annum), skills and credibility38.

Unfortunately, national accounts statistics have not yet provided separateestimates of the share of IT sector in GDP. IT application at aggregatelevel in agriculture, mining, and most of the manufacturing and transportsectors seems to be insignificant and also there remains minimalapplication of IT components in the service sectors.

But recognising the GDP contribution of the software sector with domesticand export revenues respectively of about US$200mn in 1997-98 andUS$790mn in 2000-01, the total size of the IT economy in India is estimatedby Raipuria (2002) to be 1.7 percent of aggregate GDP in 1997-98 andabout 3.7 percent in 2000-0139. According to Raipuria, even if one takesinto account second or third-tier links of IT, the share of IT economy maystill be below 10 percent in the medium term.

The evolution of the Indian software industry is intimately linked to thetrend of globalisation of the value adding activities in large MNEs. It wasTexas Instruments (TI), a US based MNE, which had set up a softwaredevelopment centre in Bangalore as far back as 1986, to tap the highlyqualified workforce available in the vicinity. Subsequently, a host of otherMNEs began to follow the footsteps of TI.

Table 19: Growth of Indian Software Industry Revenues (US$mn)

Year Total Domestic Exports

1989-90 n.a. n.a. 105.4

1994-95 835 350 485

1995-96 1224 490 734

1996-97 1755 670 1085

1997-98 2700 950 1750

1998-99 3900 1250 2650

1999-2000 5750 1750 4000

2000-01 8300 2100 6200

Compound Annual Growth Rate (%)

1994/2001 46.63 34.80 229.44

Source: Kumar (2002), Raipuria (2002).

Total revenues of the softwaresector, may cross US$10bn in 2001-

02. The other segments of the IT-economy notably

telecommunications andinfotainment, are also expanding

fast though still remain narrow,compared with aggregate GDP of

about $500bn.


Realising the potential, a number of Indian companies engaged in computerhardware started to spin-off their software divisions. Despite the entry ofleading MNEs in India for software development, the industry is stilldominated by domestic companies and talent. The top six softwarecompanies in India, ranked either on the basis of overall sales or theoverall turnover, are all domestically owned. Among the top 20 softwarecompanies too, no more than five or six are MNE affiliates or joint ventures.

The Indian software exporting companies themselves are sufficiently globalin their outlook. As many as 212 Indian software companies have eithersubsidiaries or branch offices overseas. Nearly 32 Indian softwarecompanies have received Software Engineering Institute (SEI) USA’sCapability Maturity Model (CMM) Certification40 . Six of them have reachedLevel 5 of this certification scheme, a distinction, which has been awardedonly to 12 companies worldwide.

Indian companies cater to the needs of large MNEs (203 of the Fortune1000) in the developed countries which outsource their softwarerequirement from India. Many of them have got listed on the Nasdaqstock exchange in the USA. Hence, the Indian software industry isintimately linked to the emerging trend of globalisation and outsourcingthat is taking place worldwide.

6.1.2 Policy Framework and FDI Flows

To a large extent, the success of the Indian IT sector has been attributedto the role played by the government in providing an enabling framework.It was way back in 1984 that a new computer policy was introduced thatfacilitated import of computers at a significantly reduced tariff rate.Subsequently in 1986, a computer software policy was formulated, aSoftware Development Agency was set up and entry into the softwareindustry was de-licensed.

In 1988, the Electronics and Computer Software Export Promotion Councilwas set up to provide marketing help to software companies in theirexport and the industry also re-organised itself and set up the NASSCOMas their apex body to lobby for their common cause with the government.1988 onwards, the government focused on providing telecommunicationsinfrastructure, and its Software Technology Parks (STP) scheme beganto evolve slowly.

Gradually, the STP of India Limited has evolved into an autonomousorganisation under the Department of Electronics to provide a conduciveenvironment to entrepreneurs operating under the STP scheme. Thisscheme offers zero import duty on import of all capital goods, a special10 year income tax holiday and it also provides infrastructual facilitieslike high speed data-communication links etc.

Having recognised the potential of the software industry, the governmentset up a National Task Force on Information Technology and SoftwareDevelopment in May 1998. The Taskforce submitted the InformationTechnology Action Plan comprising 108 recommendations in July 1998.All these recommendations have since been accepted by the governmentthrough a Gazette Notification issued in July 1998 itself.

The Action Plan includes opening of internet gateway access, encourageprivate STPs, zero duty on IT software, income tax exemptions to softwareand services' exports, etc. As a follow-up of the Action Plan, a new Internet

The Indian software exportingcompanies themselves are

sufficiently global in their outlook.As many as 212 Indian software

companies have either subsidiariesor branch offices overseas.

1988 onwards, the governmentfocused on providing

telecommunications infrastructure,and its Software Technology Parks

(STP) scheme began to evolveslowly.


policy has come into being and a large number of internet service providershave been licensed. Now, a separate Ministry of Information Technologyhas been set up to co-ordinate the promotional role of the governmentand the industry.

India now has a liberal policy for FDI in the telecom sector. FDI up to 100percent is allowed in various categories of this sector, such as,manufacturing of telecom equipment, internet service (not providinginternational gateways), e-mail service and voice-mail service. Upto 74percent FDI is allowed in two major areas of telecom sector, namely,internet service (providing international gateways) and radio paging service.On the other hand, FDI upto 49 percent is permitted for national longdistance service, basic telephone service, cellular mobile service and forvalue-added service.

During the period August 1991 to January 2002, actual inflow of FDI inthe telecom sector has been US$1696mn and out of this, US$794mnhas come in the year 2001 alone. Out of the actual inflows, the cellularservices has attracted about US$443mn, contributing about 30 percentof overall telecom FDI flows during the period. On the other hand, basictelephone services attracted FDI inflows to the tune of US$80mn. Theactual flow for the telecom sector during the same period is about 20.11percent of total FDI approved. It deserves mention here that in terms ofapproval of FDI, the telecom sector is the second largest after the energysector.

6.2. Automobile SectorThe automobile industry has emerged as an important driver of theeconomy. Although the automobile industry in India is nearly six decadesold, until 1982, it had only three manufacturers - M/s. Hindustan Motors,M/s. Premier Automobiles and M/s. Standard Motors which ruled themotor car sector. Owing to low volumes, it perpetuated obsoletetechnologies and was out of line with the world industry.

In 1982, Maruti Udyog Ltd. (MUL) came up as a government initiative incollaboration with Suzuki of Japan to establish volume production ofcontemporary models. With launching of the economic reforms in 1991and lifting of licensing in auto-sector in 1993, 17 new ventures havecome up of which 16 are for manufacture of cars, while the 17th is byVolvo for investment in heavy vehicles.

The industry encompasses commercial vehicles, multi-utility vehicles,passenger cars, two wheelers, three wheelers, tractors and autocomponents. There are in place 15 manufacturers of cars and multi utilityvehicles, 9 of commercial vehicles, 14 of two/three wheelers and 10 oftractors besides 5 of engines. India manufactures about 38,00,000 two-wheelers, 5,70,000 passenger cars, 1,25,000 multi utility vehicles,1,70,000 commercial vehicles and 2,60,000 tractors annually. India rankssecond in the production of two wheelers and fifth in commercial vehiclesin the world. With an investment of $10000mn, the turnover was $11900mnin automotive sector during 1999-2000. It employs 4,50,000 people directlyand 1,00,00,000 people indirectly and is now inhabited by global players.India’s automotive component industry manufactures the entire range ofparts required by the domestic automobile industry and currently employsabout 2,50,000 persons. Auto component manufacturers supply to twokinds of buyers – original equipment manufacturers (OEM) and thereplacement market.

India now has a liberal policy forFDI in the telecom sector. FDI up to

100 percent is allowed in variouscategories of this sector, such as,

manufacturing of telecomequipment, internet service (not

providing international gateways),e-mail service and voice-mail

service.

The automobile industry hasemerged as an important driver of

the economy. Although theautomobile industry in India is

nearly six decades old, until 1982, ithad only three manufacturers.


The replacement market is characterised by the presence of several small-scale suppliers who score over the organised players in terms of exciseduty exemptions and lower overheads. The demand from the OEM market,on the other hand, is dependent on the demand for new vehicles.Automotive components manufactured in India are of top quality and areused as original components for vehicles made by such top internationalcompanies as General Motors, Mercedes, IVECO and Daewoo amongothers.

The Indian automobile industry is still too small to influence the worldmarket. Currently, almost half of the global car production comes fromthree countries: the US (20 percent), Japan (19 percent), and Germany(12 percent)41. Countries such as France, Spain, Canada, South Korea,Italy and the UK contribute another quarter. India and China contribute 1 percent each. All major car manufacturers target the US market vigorously.Until now, no Indian company has been able to set up its units there.

6.2.1 Stylised Facts of Auto industry

Since delicensing, automobile industry including auto component sectorshas shown great advances. The contribution of the automotive industryto GDP has risen from 2.77 percent of GDP in 1992-93 to current (2002)value of 4 percent of the GDP. It contributes about 17 percent of theindirect tax revenue.

The rapid growth in the automobile sector and the automobile ancillariesis shown in Table 20. The turnover of the automobile sectors has jumpednearly three times from US$3646mn in 1993-94 to US$10463.8mn in1999-2000. The auto component industry has also achieved rapid growth.Not only that, exports have also increased sharply between the years,more so in the case of ancillary units.

These sectors have been doing well as indicated by rising ratios of retainedprofits/total sources of funding. Both these sectors have attracted largeFDI inflows, as a result of which capital employed in the automobileindustry (auto component sectors) has risen from US$1554mn in 1993-94 to US$5384.4mn in 1999-00.

Table 20: Automobile Industry- Selected Statistics (US$mn )

Automobile Sector 1993-94 1995-96 1997-98 1998-99 1999-00

Gross Sales 3646 6631 7652.8 7769.6 10463.8

Total Exports 242.8 402 417.8 433.2 419.4

Capital Employed 1553.8 2400.4 4605.2 5202.8 5384.4

Retained Profits/Total Sources (percent ) 3.5 16.2 19.6 16.6 56.9

External Sources/Total Sources (percent ) 83.3 73 64.4 72.1 -18.8

Automobile Ancillary UnitsGross Sales 860.4 1536.8 1879.4 1917.2 2390.8

Total Exports 58 99 147.4 166.6 169

Capital Employed 412 703 1024.4 1105 1232

Retained Profits/Total Sources (percent ) 18.3 19.3 25.6 11.5 19.9

External Sources/Total Sources (percent ) 48.9 65.3 40.4 53.4 44.2Source: CMIE Corporate Sector, 2001

The Indian automobile industry isstill too small to influence the

world market. Currently, almosthalf of the global car production

comes from three countries: the US(20 percent), Japan (19 percent),

and Germany (12 percent).


The entry of new firms in the automobile industry has led to reduction inthe market concentration ratios of some of the segments of the industryas revealed by Herfindahl Index of Concentration (see Table 21)42 . Thereduction is evident particularly in passenger cars and scooters' segmentsof the industry. It can also be seen from the table that market size hasincreased significantly in different segments of the industry. Surely thisis the result of delicensing of the sector.

6.2.2 Policy FrameworkBefore the removal of quantitative restrictions (QRs) with effect from 1st

April 2001, the policy placed import of capital goods and automotivecomponents under open general licence, but restricted import of carsand automotive vehicles in Completely Built Unit (CBU) form or inCompletely Knocked Down (CKD) or in Semi Knocked Down (SKD)condition. Car manufacturing units were issued licences to importcomponents in CKD or SKD form only on executing a Memorandum ofUnderstanding (MOU) with the Director General of Foreign Trade (DGFT).The MOU laid down the following conditions for the signing companies:1. Establish actual production of cars and not merely assemble vehicles;2. Minimum foreign equity of US$50mn is a must for joint venture involving

majority foreign equity ownership;3. Indigenise components upto a minimum of 50 percent in the third and

70 percent in the fifth year or earlier from the date of clearance of thefirst lot of imports. This condition is, however, no longer in place as aresult of a ruling by the WTO.

4. Neutralise foreign exchange outgo on imports (CIF) by export of cars,auto components etc. (FOB). This obligation was to commence fromthe third year of start of production and to be fulfilled during thefunctioning of the MOU. From the fourth year imports were to beregulated in relation to the exports made in the previous year.

Table 21: Index of Concentration, Market Size and Domestic Consumptionof Various Segments of Auto industry

Various Segments 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00

Medium and Heavy Commercial Vehicles

Herfindahl Index of Concentration 0.570 0.584 0.574 0.538 0.515 0.521

Market Size (Value ) US$mn 836.8 1136.2 1407.2 927 889.8 1219.2

Light Commercial Vehicles


Market Size (Value) US$mn 549.6 769.4 717.8 547.2 500 558.2

Passenger Cars


Market Size (Value) US$mn 1142.6 1718 2187.6 2182.4 2111.6 3290.2

MotorcyclesHerfindahl Index of Concentration 0.247 0.241 0.220 0.257 0.261 0.283

Market Size (Value) US$mn 338.2 432.4 536 655.8 802.2 1018

Scooters


Market Size (Value) US$mn 343.6 466.2 521.6 500.4 600 588.8

Bicycles


Market Size (Value) US$mn 180 220 250 260 280 310Source: CMIE, Corporate Sector, May 2002


Prior to 2000, automatic approval in the automobile sector was grantedonly for FDI with a maximum equity participation of 51 percent . Sinceearly 2000, 100 percent FDI was allowed only on a case to case basis.Under the new auto policy announced in March 2002, the governmenthas permitted 100 percent FDI in the automobile and component sectorsunder the automatic route.

The new automobile policy does not prescribe any minimum investmentnorms. As part of the policy, the government has promised to give adequateaccommodation to indigenous industry in respect of items such as buses,trucks, tractors, completely built units and auto components, which havebound rates under the World Trade Organisation guidelines. In respect ofitems such as cars, utility vehicles, motorcycles, mopeds, scooters andauto rickshaws (which do not have a bound rate), the new policy proposesto design import tariff “so as to give maximum fillip to manufacturing inthe country without extending undue protection to the domestic industry.”The policy intends to further improve research and development by vehiclemanufacturers by “considering” a rebate on the applicable excise dutyfor every one per cent of the gross turnover of the company spent onresearch activities.

The lack of investment norms may open the door for small Chinese firmsto set up shops in India and virtually trade their products rather thanresort to local manufacturing. Almost all countries including China nowallow 100 percent FDI. The new policy only gives minor tax benefits onR&D investment. No other incentive is offered for improved technologysuch as fuel saving, non-pollution of the environment etc, which isimperative for meeting targeted objectives on which the new auto policyhas discussed extensively. Most important, the new policy has ignoredthe current global auto-manufacturing trend of close co-operation betweenassemblers and component-makers; this is crucial for the survival of majorglobal players.

Global car factories are reeling under excessive over-capacity, rangingfrom 25 percent in North America to 30 percent in Europe. Shutdown ofmajor car factories has become common. The entire industry isdisintegrating and vehicle assemblers are increasingly out-sourcing. Theauto-policy should have set the tone for an effective assembler-component-maker equation to take over the global competition. In sum, the newpolicy depicts a domestic-oriented industry, relying more on homedemand, regardless of the fact that India can be a good workshop for itsneighbours.

The Indian auto market is growing fast and is well supported by theeconomic reforms that have been put in place, particularly in the financialsector, and FDI participation. However, the industry needs to be exposedto foreign competition under realistic bound rates. The domestic marketneeds to be enlarged through fiscal changes and particular attention needsto be paid to the development of the components sector.

6.3 The Power Sector

The Indian power sector grew from a mere 1700 MW of installed capacityin 1950 to 1,00,136 MW in 2000. However, as per the 1991 census, only42 percent Indian households were electrified, with about 71 percentrural and 24 percent urban households remaining unelectrified.

In the context of persistent shortages in the supply of electricity, and theinability of the government sector to mobilise funds for establishing the

The lack of investment norms mayopen the door for small Chinese

firms to set up shops in India andvirtually trade their products

rather than resort to localmanufacturing.

The new policy depicts a domestic-oriented industry, relying more on

home demand, regardless of thefact that India can be a good

workshop for its neighbours. TheIndian auto market is growing fast

and is well supported by theeconomic reforms that have been

put in place in the financial sector,and FDI participation.

However, as per the 1991 census,only 42 percent of the Indian

households had electricity facility,with about 71 percent in the rural

and 24 percent in the urbanhouseholds remaining

unelectrified.


necessary electricity generating capacity, the Central Governmentannounced a series of policy measures to allow the participation of privatepower companies (domestic and foreign) in the power sector sincelaunching of the economic reforms in 1991. The new policy on powercomprises initiatives with respect to legislative, administrative and financialaspects. The salient features of the policy, announced in October 1991,(including amendments and additions) are:

LegalPrivate Indian and foreign promoters were allowed to set up power plantsof any size and based on any source, including hydroelectric plants.Accordingly, the Electricity (Supply) Act and the Indian Electricity Actwere amended.

Administrative1. For projects awarded through competitive bidding, the limit on capital

outlay for mandatory concurrence of the Central Electricity Authority(CEA) was raised to US$86mn (with effect from December 1995).

2. A two-stage clearance procedure was adopted for granting the CEAclearance. The first-stage is granted on the basis of the pre-feasibilityreport of the project. The 2nd-stage “techno-economic clearance” (TEC)is on the basis of the detailed project report.

3. The number of clearances required for obtaining TEC for thermal powerprojects was reduced to 5 from 17.

4. Renovation and modernisation schemes involving outlay of less thanUS$107.5mn are exempted from CEA clearance.

5. Co-generation plants were exempted from obtaining TEC from CEA.

Financial1. Up to 100 percent foreign equity participation was allowed and the

requirement to balance dividends by export earnings was waived.2. A debt-equity ratio of 4:1 was allowed.3. Promoter’s contribution required to be at least 11 percent of the total

outlay.4. Minimum 60 percent of the project outlay required to be arranged from

sources other than Indian Public Financial institutions.5. Average rate of depreciation under the Electricity Supply Act was raised

to 7.84 percent .6. Five-year income tax holiday was extended to power generation

companies.7. Customs duty on power plant equipment was progressively reduced.8. FDI proposals involving up to 74 percent equity would be accorded

approval by the RBI, without having to go through the FIPB.9. Relaxation in foreign debt equity norm to be 3:1.

In order to determine the tariff for the purchase of power, a notificationwhich laid down the guidelines for a two-part tariff, was issued. The mainfeatures of the notification were:l The tariff would constitute two parts - a fixed part comprising return on

equity (RoE), interest on loan capital, depreciation, operations and avariable part comprising fuel costs.

l A maximum of 16 percent RoE (with protection against fluctuationsin exchange rate) was allowed to be included in the tariff.

l Fixed costs could be recovered at a Plant Load Factor (PLF) of 68.5percent (revised subsequently to 70 percent ) in case of thermal plantsand at an availability factor of 90 percent in case of hydro power.

l As an incentive, a maximum of 0.7 percent additional RoE could begiven for every 1 percent increase in PLF or availability.

The new policy on power comprisesinitiatives with respect to

legislative, administrative andfinancial aspects.


Subsequently, with a view to promote more investment in the power sector,the government has decided to permit 100 percent foreign equity forautomatic approval of companies undertaking power projects includingelectricity generation, transmission, and distribution provided that foreignequity in any such project does not exceed US$300mn and the electricalenergy is not produced in atomic reactor power plants. The new policyalso permits 100 percent foreign owned companies to set up power projectsand repatriate profits without any export obligations.

l Since private power companies have to sell their power to the financiallyweak state electricity boards (SEBs), there are concerns aboutwhether the foreign investors would get their money back. To allaytheir fears, the government provides guarantees to foreign investors inprojects found viable. Various attempts have also been made by theWorld Bank and independent researchers to improve the financial healthof SEBs. Such attempts to attract private investors have resulted inlittle success. Despite great interest shown by private investors, theprogress in terms of capacity building has been miniscule. Thus, theIndependent Power Producer (IPP) Policy is broadly viewed as a flawedand half-hearted approach to reforms. For easy reference, thechronology of electricity sector reforms in India over the 1990s is shownin Box B.

Box B: Chronology of Electricity Sector Reforms in India

l 1991: Electricity Laws (Amendment) Act allows private sectorparticipation in power generation, with 11 percent ownership for foreigninvestors.

l 1992-97: Eight projects were given “fast-track” approval status andsovereign guarantees by the central government.

l 1995: Orissa Electricity Reform Act established the Orissa ElectricityRegulatory Commission and provided for unbundling of Orissa StateElectricity Board.

l 1996: World Bank approved support for Orissa Power SectorRestructuring Project Loan.

l 1996: Chief Ministers’ conference formulated a common minimumaction plan for electricity.

l 1997: World Bank approved Haryana Power Sector RestructuringProject Loan, and Haryana State Government passed the HaryanaElectricity Reform Act.

l 1998: Electricity Regulatory Commission's Ordinance Notificationprovides for establishment of a Central Electricity RegulatoryCommission and state-level electricity regulatory commissions.

l 1999-2001: Andhra Pradesh, Karnataka and Uttar Pradesh proceedwith preparation of Electricity Reform Acts. The World Bank hasprepared and approved projects supporting reform in each of thesestates.

l 2001: Energy Conservation Bill passed by Parliament.l 2000-2002: Draft of Central Government Electricity Bill prepared and

introduced in Parliament.

Source: Power Politics Edited by Navroz.K.Dubash (2002).

The new policy also permits 100percent foreign owned companies

to set up power projects andrepatriate profits without any

export obligations.


l Since the primary reason for the poor health of SEBs stems fromsupplying power to the agriculture sector at highly subsidised rates,the central government, in 1991, made an attempt to solve the problemof subsidised electricity supply to farmers. A committee recommendedthe establishment of a common minimum agricultural tariff, and asubsequent Chief Ministers’ conference proposed that agriculturaltariffs should meet the modest target of 50 percent of average cost ofsupply. However, in the face of mobilised farmer vote banks, stategovernments took little action.

In the mid-90s, the World Bank played a major role in arguing forfundamental reforms of SEBs, and in persuading a few states, led byOrissa, to initiate reforms (see Box C). Of course, the Bank’s policy ofnot financing or providing guarantees for electricity projects in states thatdid not undertake restructuring was the very element in persuading manyof the states to reform their SEBs.

By 1998, Orissa had managed to demonstrate that it could privatise itsdistribution business. However, the results have not been positive. Sinceprivatisation, the new owners have brought neither new funds nordiscernible management skills to the newly established companies.Revenues from privatisation were not ploughed back into the sector, butabsorbed into the government budget for other purposes. The public hasfaced substantial tariff increases but has seen few benefits in service,which has led to growing political discontent with the reform process anda call to bring back the publicly owned system.

Despite these problems, the fact that Orissa has embarked on and beenthrough several stages of reform process, including privatisation provideda powerful demonstration effect within India. Many states have followedthe basic parameters of the Orissa model, in many cases guided by thesame consultants, but with significant differences. States like Gujarat,Madhya Pradesh and Tamil Nadu have decided to focus oncommercialisation of their SEBs rather than going down the road towardsprivatisation.

Box C: The World Bank Led Orissa Model

The World Bank’s “Orissa Power Sector Restructuring Project” requiredUS$997.2mn, and was partially funded by the then OverseasDevelopment Agency, now DFID, of the United Kingdom. Almost three-fourths (74 percent) of the financing went to rehabilitation of distributionand transmission and 23 percent was allotted to demand sidemanagement and the rest to support reform process.

Content of Reforms:l Unbundling generation, transmission and distribution.l Allowing for private participation in generation and distribution utilities.l Establishing an autonomous regulatory agency.l Reforming tariffs at the bulk electricity, transmission and retail levels.

The Orissa Electricity Reform Act, 1995 provided for the establishmentof an independent regulatory commission and the divestment of equityin generation and distribution to the private sector. Attracting investorsfor privatisation in Orissa proved to be a difficult task. Privatisationwas carried out, but there was limited interest and few bids.Source: Power Politics Edited by Navroz.K.Dubash (2002).

In the mid-90s, the World Bankplayed a major role in arguing forfundamental reforms of SEBs, and

in persuading a few states, led byOrissa, to initiate reforms.

By 1998, Orissa had managed todemonstrate that it could privatiseits distribution business. However,the results have not been positive.


Recently, the Central Government has introduced a new Act, the ElectricityBill, 2000 that replaces the Indian Electricity Act, 1910, Indian Electricity(Supply) Act, 1948 and the Electricity Regulatory Commissions Act,1998. A very significant provision in the Bill is that all the existing StateElectricity Boards (SEBs) will wither away within six months of the newAct coming into effect. The Bill envisages time-bound radical restructuringin terms of unbundling and corporatisation.

All the states have to establish State Regulatory Commissions, authorisedto supervise, direct and control all the activities in the electricity supplyindustry (ESI). This implies that government interference in the day today affairs of the sector will be minimised, though the government willstill be allowed to wield significant powers.

The Bill also seeks to establish spot market for electricity through poolingarrangements. A major criticism levelled against the Bill is that there isnot much emphasis on rural electrification. The Bill as such has causedmuch protest and many states and SEB employees suspect the centralmove as an attempt to usurp the state’s authority on the ESI, and imposerestructuring where the state is unwilling.

Between 1991 and 2001, only about 4000 MW of capacity has been addedby the private power projects. Out of these, there was only one mega project(Dabhol, developed by Enron, USA) involving foreign investment, which ledto an addition of 740 MW of capacity (see Box D). The project soon startedgenerating severe financial problems for Maharashtra. Maharashtra StateElectricity Board (MSEB), which had been profitable in 1998-1999, plungedinto losses exceeding US$300mn (excluding subsidies received from thestate government) in 1999-2000.

Box D: The Enron Affair

The fast-track Dabhol power project, promoted by the US utility giantEnron had soon turned into a bitter pill for all the players concerned.The root of the problem was that not only Enron succeeded in obtainingguarantees and counter-guarantees from the government, but alsomanaged to sign a purchasing power agreement (PPA) with theMaharashtra State Electricity Board that committed the MSEB to payfor 86 per cent of Dabhol’s capacity, irrespective of how much power itwould actually pick up. In other words, the rate of electricity, to someextent, was inversely proportional to the amount of electricitypurchased. The MSEB would end up paying more even if it would buyless.

In October 1992, the Congress-led Government of Maharashtraannounced that it had signed a memorandum of understanding withthe DPC, the Indian subsidiary of the US based Enron Corporation, fora liquefied natural gas plant of 2000 to 2400 megawatt capacity, andto purchase electricity for 20 years. In what later became a source ofcontroversy, the deal was completed with alacrity and secrecy, despitethe considerable size and financial obligations of the project, amountingto an expenditure of roughly US$1.3bn per year. Despite strongreservations expressed by some state and central governmentbureaucrats and by the World Bank, the project was cleared.

The Central Government hasintroduced a new Act, the

Electricity Bill, 2000 that replacesthe Indian Electricity Act, 1910,

Indian Electricity (Supply) Act, 1948and the Electricity RegulatoryCommissions Act, 1998. A very

significant provision in the Bill isthat all the existing State Electricity

Boards (SEBs) will wither awaywithin six months of the new Act

coming into effect.


In December 2000, the Maharashtra government sought a review of theproject, saying that the tariff was too high. It then wanted the centre tobear the burden of buying Dabhol power and route it through the NationalPower Grid. Enron, in turn, invoked the Centre’s counter-guarantee whenthe MSEB defaulted on its November and December payments.

Subsequently, the Dabhol Power Company (DPC) issued a preliminarytermination notice, initiating the process to invalidate the power purchaseagreement. The government, in turn, had also backed out of the agreement.The Enron saga has definitely adversely affected further FDI flows in thepower sector. The domestic private power companies would also thinktwice before investing their capital in it. Whether the Enron case wouldaffect FDI flows in other infrastructure sectors or not, only time would tell.

Electricity sector policy in India has been locked into adverse arrangementat least twice in its history. The first was when agriculture consumptionwas demetered and extensive subsidies were offered. The second waswhen the SEBs signed IPP contracts with major fiscal implications.

A third set of circumstances, with the potential for equally powerful formsof institutional rigidities, seems to be coming up with the reproduction ofthe Orissa model on a national scale. These circumstances may yieldfavourable institutions, like democratic and transparent regulation, butmay also result in unfavourable ones, such as locking out integratedresource planning or scaling back programmes to expand services torural areas.

Issues for Comments

l Do the liberal government policies and various promotional roles bythe Ministry of Information Technology help to benefit the IT sectormost from FDI flows in India?

l How far the new automobile policy will be able to boost the domesticcar manufacturing industry, against the backdrop of global recessionin the industry?

l Will the absence of close co-operation between assemblers andcomponent-makers in the new automobile policy cost dear for thedomestic automotive industry?

l What are the impediments of getting desired flow of FDI in thepower sector for meeting the rising demand for power within thecountry?

l Did the precarious financial condition of the SEBs discourage flowof FDI to the power sector? Did the World Bank policy of initiatingreforms to the SEBs mitigate the problem or aggravate it?

l Is the provision of replacing the SEBs with State RegulatoryCommissions under the new Electricity Bill 2000 a right steptowards the power sector reform?

l Will the new power sector reforms have any adverse impact on theexpansion of electricity services to rural areas?

The Enron saga has definitelyaffected further FDI flows in the

power sector. The domestic privatepower companies would also thinktwice before investing their capital

in it.


Conclusion

With the initiation of the economic reform process in 1991, India alsostarted to open up her economy and now India has stepped into aliberalised foreign investment regime. This is definitely a positivedevelopment. Rising and continuous inflows of FDI could promise a varietyof potential benefits to India. Apart from providing a relatively stable andgrowing source of finance, FDI inflows could impart positive impact inIndia though various channels like:(a) FDI inflows can raise domestic investment rates in India if its mode of

entry is “greenfield” investment;(b) FDI can promote technology spillovers;(c) Export-oriented FDI can play an important role in the process of export-

led industrialisation in India; and(d) FDI can enhance the marginal productivity of the capital stock in the

Indian economy and thereby promote growth.

Though the Government of India has been trying hard these days to attractFDI, FDI inflows into India (as a share of GDP) have been much moremodest than many other developing countries. India’s glaring failureobviously warrants introspection. In this context, this report has attemptedto study the investment regime and actual performance of India with aview to build capacity and awareness in investment issues and draw outthe lacuna of the present system. The study is based on the existingliterature along with the feedback obtained from the surveys of stake-holders, namely civil society groups and local firms.

The following points have emerged from this report:l India now has in place a liberal policy regime towards FDI. Though it

has done well in attracting FDI flows of late, given her size, India attractsonly small amounts of FDI flows. This is the general opinion of all thestake holders.

l Most of the FDI flows have gone to the IT industry, automobile,chemicals and power sectors.

l The government is working on ways to double FDI to over $8bn in ayear. The Steering Committee on FDI has proposed a number ofmeasures to attract more FDI. These include opening up of new sectorsfor FDI, reforming sectors like power to bring in functional marketstructures and easing procedural hurdles. The idea is to identify sectorswith vast potential to woo FDI and fix specific targets.

l The Steering Group has advocated that a Foreign Investment PromotionLaw (FIPL) be enacted to incorporate and integrate aspects relevantto promotion of FDI. It has also suggested that the informationalaspects of the policy strategy should be refined in the light of theperceived advantages and disadvantages of India as an investmentdestination.

l The biggest stumbling block is India’s bloated bureaucracy.Approximately, only 20 percent of FDI approvals translate into actualinvestment. This implies that the initial enthusiasm to invest petersout by the time companies actually go through the process. Accordingto investor’s feedback, environmental clearances and legal work arestill time-consuming.

India has started to open up hereconomy and has stepped into a

liberalised foreign investmentregime. However, FDI flows into

India have been much more modestthan many other developing

countries.

India now has in place a liberalpolicy regime towards FDI. Though

it has done well in attracting FDIflows of late, given her size, India

attracts only small amounts of FDIflows.

The biggest stumbling block isIndia’s bloated bureaucracy. The

initial enthusiasm to invest petersout by the time companies actually

go through the process.Environmental clearances and

legal work are still time-consuming.


l To some extent, the present Indian federal structure where many ofthe clearance authorities are the state governments, adds to proceduraldelays. Moreover, there is political uncertainty at the central and thestate levels.

l Unlike the past, civil society is now more open towards FDI. Accordingto the perception of the civil society group, FDI brings in valuable newtechnologies as well as management techniques, improves the accessto world markets, and increases the competitiveness of the economy.It is expected that the local firms would gain from the spill-over effectwith the entry of MNEs. Indeed our surveys of local firms have revealedthat they are now more conscious to adopt new managementtechniques, new technologies and improve qualities.

l The majority of respondents from the civil society group agree thatbureaucracy and regulatory environment are the two most importantfactors inhibiting FDI flows to India. Most agree that regulatoryenvironment is not transparent, leading to bureaucratic hassles andcorruption. Understandably, the policy framework needs to be re-oriented in terms of transparency, along with simplification ofbureaucratic procedures to attract more FDI. By and large, therespondents from local and foreign firms in our case studies supportthese views.

l All the stake-holders are of the opinion that improved infrastructuralfacilities are essential if India has to attract FDI in a big way.

l Currently, the local firms are also positively disposed towards FDI.They also want the government to take a very pro-active stand tomaximise the benefits from FDI.

l Given the present circumstances, the present environment is not veryconducive towards FDI flows in the power or infrastructure sectors ingeneral.

l There is an urgent need to get an action plan to give an impetus toFDI. In this regard, the state governments should be encouraged toenact a special investment law to expedite all investment ininfrastructural sectors.

l As per the recommendation of Steering Group on FDI, the SpecialEconomic Zones (SEZs) should be developed as the most competitivedestinations for export related FDI in the world, by simplifying applicablelaws, rules and administrative procedures and reducing red tape levels.

l Domestic policy reforms in the power sector, urban infrastructure andreal estate and de-control/de-licensing should be expedited to promoteprivate, domestic and foreign investment.

The policy framework needs to bere-oriented in terms of

transparency, along withsimplification of bureaucratic

procedures to attract more FDI. Therespondents from local and foreignfirms support these views and are of

the opinion that improvedinfrastructural facilities are

essential if India has to attract FDIin a big way.

The present Indian federal structurewhere many of the clearance

authorities are the stategovernments, adds to procedural

delays. Moreover, there is politicaluncertainty at the central and the

state levels.


Table A1: Impact on Local Firms Due to MNEs Entry (Percentage of Respondents)

Impact on the firmbecause of MNC presence Positive Negative No Impact Total

Available technologies 52 10 38 100

Know-how including shopfloor practices 60 12 28 100

Product quality/precision 56 8 36 100

Management techniques 49 17 34 100

Annexure

It is expected that entry of foreign firms would benefit the local firms(through technological spillovers) in terms of better managementtechniques and better quality. Has it really happened in the Indiancontext? To answer this question, we conducted a small survey (30respondents) of local firms in the IT and automobile sectors to solicitinformation on some of these aspects. The findings are shown in TableA1. As table A1 shows, by and large, the local firms have attempted tolearn from the MNEs operations. The learning process has been appliedto manage time effectively to increase productivity, to adopt newtechnology and global quality standard.


Endnotes

1 UNCTAD IX, 1996, “A Partnership for Growth and Development”, paragraph 36.2 UNCTAD, 1999, Foreign Direct Investment and Development, UNCTAD Series on issues in international

investment agreements.3 The Economic Times, July 1, 2003.4 This includes approved amounts towards GDR/FCCB(Global Depository Receipt/Foreign Currency Convertible

Bonds) issues for which Foreign Investment Promotion Board (FIPB) approval was required5 There was a substantial decline in net aid flows during 1991-98. Net NRI deposits also declined, but to a much

lesser extent.6 The 36-country trade weighted REER is the trade weighted average of real exchange rates of the Indian Rupee

vis-à-vis currencies of the 36 most-important trading partners of the country. The real exchange rates betweenIndian Rupee and the various currencies are calculated on the basis of nominal exchange rates and the inflationdifferential (the Indian inflation rate used being that based on the WPI). An increase in the REER suggests a realappreciation.

7 Current Account deficit is equal to the domestic savings-investment gap and signifies the net transfer of foreignfinancial resources into the economy.

8 See Bhaduri and Nayyar, 1996, pp 48 - 53.9 However, it is not clear whether, external compulsions through World Bank - IMF conditionalities, would have

forced the government to go the ‘whole hog’, as it actually did, in embracing the new policy package, though atactical acceptance of the ‘conditionalities’ was almost a sine-qua-non (see Bhaduri and Nayyar, 1996, pp 48-53).

10 See Chaudhuri, 1998 for a review of major debates and Bhaduri and Nayyar, 1996, p 49.11 India also has to change its domestic IPR regulations by 2005 to comply with the agreement on TRIPs. The

changes will be relevant, mostly, for the pharmaceutical industry as the Indian Patent Act recognised processpatents, which is not permissible under TRIPS. The amendment to Indian Patent Act has, however, not beenmade yet.

12 GDR issues to finance projects in power generation, telecommunications, petroleum exploration and refining,ports, airports and hotels were exempt from ‘consistent track record’ criterion.

13 Some of the GDR issues require FIPB approval and these are categorised as FDI inflows by the Ministry ofIndustry. Total GDR inflows are, however, recorded as portfolio flows by RBI.

14 ECB issues are subject to maturity restrictions; a minimum maturity of 3 years for ECBs less than US$ 15 millionand 7 years for amounts greater than that. ECBs by 100% EOUs can have a maturity of three years even foramounts greater than US$15mn. It also has end-use restrictions. ECB proceeds cannot be invested in stockmarket and real estate. ECB proceeds can be utilised only for project-related foreign exchange expenses(capital goods imports). Rupee expenses are allowed only for infrastructure projects.

15 This limit was US$4mn earlier, which was raised in December 1998.16 Before 2000-2001, upto 50% of funds raised through GDR could be used for overseas investments.17 Except if the investment is financed from an EEFC account balance or the proceeds from GDR issue.18 See RBI Annual Report, 1999-2000 and RBI Press Notification, no. 2000-2001/1225, dated March 2, 2001.19 Currency swaps basically involve an exchange of one set of financial obligations denominated in one currency,

with another set denominated in another currency.20 When an agent has a currency mismatch between its assets and liabilities that is not hedged through forward

cover, and the agent remains susceptible to exchange rate fluctuations, he/she is said to have an ‘open position’.21 Depending on a bank’s expectation about movement of the domestic currency and existing interest rate differential

between domestic and foreign money markets, it can, within limits, transfer funds into or out of the country,forging a link between foreign exchange and money market. See RBI Annual Report, various issues.

22 Hence, in companies where NRIs held part of the equity, the effective limit for FII investment got decreased.23 This limit was raised to 40 percent in 1999-2000 and 49 percent in 2000-2001 (RBI Press Notification, no. 2000-

2001/1225, dated March 2).24 Investments in shares held for over one-year are classified as long-term investments for tax purposes, while for

other securities the period is 36 months.25 See Manual on Industrial Policy and Procedures, Secretariat of Industrial Assistance, Ministry of Industry,

Government of India, 2001, available at www.nic.in/indmin.26 Annexure to the Manual on Industrial Policy and Procedures in India, Secretariat of Industrial Assistance,

Government of India, August 2001, available at Ministry of Industry website at www.nic.in/indmin.27 Operators of airlines were also barred from making any direct investment in the aviation sector till the recent

policy change in 2000.


28 In the case of ventures where prior foreign equity participation existed, the condition applies to dividend onincremental foreign equity investments only.

29 Information from Manual on Industrial Policy and Procedures, available at SIA website, http://indmin.nic.in.30 See Annexure VI to ‘Manual on Industrial Policy and Procedures in India’.31 Automatic approval for FDI up to 51 percent in hotel and tourism industry, for instance, is subject to a limit of three

percent on share of capital cost payable for technical and consultancy services, three percent on the share ofturnover payable as franchising/marketing fee and ten percent on the share of gross operating profit payable asmanagement fee to foreign collaborator.

32 Foreign Investment Implementation Authority has been set up around late 1990s to liase with other governmentagencies whose statutory clearances are essential before project implementation can begin and to look into anyproblems being faced by investors.

33 This section draws from Mr N K Singh’s report.34 See Report of the Steering Group on FDI, 2002.35 This is another sector that has attracted large amounts of FDI in many countries including China.36 In Chart 1, engineering goods sector also includes electronics.37 See Business Line, 24.7.2001.38 See Raipuria (2002), pp.1062.39 The marginal share of IT in GDP in India is not surprising. Even in the US, with a very high IT spending and

penetration, the share of the IT economy in GDP according to US Commerce Department (2000), was 8.1percent.

40 See Kumar, Nagesh 2002, for details.41 Kanhaiya Singh, Automotive industry: Perspectives and Strategies.42 The Herfindahl Index of Concentration is a summary of statistics denoting the level of concentration of the market

share in the hands of a few companies. The index takes value between 0 and 1, where 0 indicates no concentrationat all and 1 indicates monopoly. It is computed as follows: H = S1

2 + S22 + S3

2 + … + Sn2, where Si is the market

share of the ith company, and there are n companies in the industry.


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