"Foreign Direct Investment in India

Case study submitted in partial fulfillment of the requirements for the

award of the Degree of
MASTER OF BUSINESS ADMINISTRATION
Of
BANGALORE UNIVERSITY

By
Bhavana Hegde
Register No. 141GCMD021
Under the guidance of

Mr. Rajiv
Professor

Rashtreeya Sikshana Samithi Trust

R V INSTITUTE OF MANAGEMENT
CA-17, 36th Cross, 26th Main, 4th T Block,
Jayanagar, Bangalore 560 041
20152016

Meaning of FDI:FDI stands for Foreign Direct Investment, a component of a country's national financial
accounts. Foreign direct investment is investment of foreign assets into domestic structures,
equipment, and organizations. It does not include foreign investment into the stock markets.
FDI is thought to be more useful to a country than investments in the equity of its companies
because equity investments are potentially "hot money" which can leave at the first sign of
trouble, whereas FDI is durable and generally useful whether things go well or badly. FDI
Means Investment By Non-resident Entity/Person Resident Outside India In The Capital Of
An Indian Company Under Schedule 1 Of Foreign Exchange Management (Transfer Or Issue
Of Security By A Person Resident Outside India)

Advantages for FDI In India: 30% Of Products Should

Be Sourced From Small Industries With

Infrastructure Investment Not Exceeding $ 1 Million( 5.36 Cr)

Retail Trading Through E Commerce Will Not Be Permissible For
Companies Invest In Retail FDI
Present Indian Retail Market Is Around $435 Billion And Growing At A
CAGR Of 10-12%
Indian Retail Market Is Still Dominated By The Unorganised Sector
FDI In Retail Is Supposed To Create Around 1crore New Jobs In Organised
Sector But On The Flip Side Will Deplete Jobs From The Unorganized
Sector
Limitation of FDI In INDIA:

Retail Trading (except single brand product retailing)

Lottery Business including Government /private lottery, online lotteries, etc.

Gambling and Betting including casinos etc.

Chit funds

Nidhi company

Trading in Transferable Development Rights (TDRs)

Real Estate Business or Construction of Farm Houses

Manufacturing of Cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco

substitutes

Activities / sectors not open to private sector investment e.g. Atomic Energy and
Railway Transport (other than Mass Rapid Transport Systems).

Factors Affecting FDI To Come In INDIA:

Stable democratic environment over 60 years of independence

Large size of the economy, particularly the large and growing middle class

Open door policy towards FDI

Abundance of natural resources

Diversified industrial sectors

Large and growing market

Cost-effective and skilled labour

World class scientific, technical and managerial manpower

Cheap and abundant availability of technical manpower at various level of skills

Large English speaking population

Stable political system

Well-established legal system with independent judiciary

The Product Cycle Theory

The product cycle theory (PCT) of trade builds on the imitation lag hypothesis in its treatment
of delay in the diffusion of technology. However, the PCT also relaxes several other
assumptions of traditional trade theory and is more complete in its treatment of trade patterns.
This theory was developed in 1966 by Raymond Vernon.
The PCT is concerned with the life cycle of a typical new product and its impact on
international trade. Vernon developed the theory in response to the failure of the United States
- the main country to do so - to conform empirically to the Heckscher-Ohlin model. Vernon
emphasizes manufactured goods, and the theory begins with the development of a new
product in the United States. The new product will have two principal characteristics: (a) it
will cater to high-income demands because the United States is a high-income country; and

(b) it promises, in its production process, to be labor-saving and capital-using in nature. (It is
also possible that the product itself - for example, a consumer durable such as a microwave
oven - will be labor-saving for the consumer.) The reason for including the potential laborsaving nature of the production process is that the United States is widely regarded as a laborscarce country. Thus, technological change will emphasize production processes with the
potential to conserve this scarce factor of production.
The second stage of the life cycle is called the maturing product stage. In this stage, some
general standards for the product and its characteristics begin to emerge, and mass production
techniques start to be adopted. With more standardization in the production process,
economies of scale start to be realized.
Other developments also occur in the maturing product stage. Once U.S. firms are selling to
other high-income countries, they may begin to assess the possibilities of producing abroad in
addition to producing in the United States. If the cost picture is favorable (meaning that
production abroad costs less than production at home plus transportation costs), then U.S.
firms will tend to invest in production facilities in the other developed countries. If this is
done, export displacement of U.S.-produced output occurs. With a plant in France, for
example, not only France but other European countries can be supplied from the French
facility rather than from the U.S. plant. Thus, an initial export surge by the United States is
followed by a fall in U.S. exports and a likely fall in U.S. production of the good. This
relocation-of-production aspect of the PCT is a useful step because it recognizes - in contract
to H-O and Ricardo - that capital and management are not immobile internationally. This
feature also is consistent with the very large amount of direct investment by U.S. firms in
Western Europe during the 1960s and 1970s and, in a more recent context, by Japanese firms
The final stage is the standardized product stage. By this time in the products life cycle, the
characteristics of the product itself and of the production process are well known; the product
is familiar to consumers and the production process to producers. Vernon hypothesized that
production may shift to the developing countries. Labor costs again play an important role,
and the developed countries are busy introducing other products. Thus, the trade pattern is
that the United States and other developed countries may import the product from the
developing countries. Figure 1 summarizes the production, consumption, and trade pattern for
the originating country, the United States.
In summary, the PCT postulates a dynamic comparative advantage because the country source
of exports shifts throughout the life cycle of the product. Early on, the innovating country
exports the good but then it is displaced by other developed countries - which in turn are

ultimately displaced by the developing countries. A casual glance at product history yields this
kind of pattern in a general way. For example, electronic products such as television receivers
were for many years a prominent export of the United States, but Europe and especially Japan
emerged as competitors, causing the U.S. share of the market to diminish dramatically. More
recently, Japan has been threatened by South Korea and other Asian producers. The textile and
apparel industry is another example where developing countries (especially China, Taiwan,
South Korea, and Singapore) have become major suppliers on the world market, displacing in
particular the United States and Japan. Automobile production and export location also shifted
relatively from the United States and Europe to Japan and later still to countries such as South
Korea and Malaysia. This dynamic comparative advantage, together with factor mobility and
economies of scale, makes the product cycle theory an appealing alternative to the HeckscherOhlin model.
The product life cycle theory its connection with FDI:The Product Life Cycle Theory set forth by Vernon (1966, 1971) has
intended to address the apparent inadequacy of the comparative
advantage framework in explaining trade and foreign investment and to
concentrate on the issues of timing of innovation, effects of economies of
scale and, to a lesser extent, the role of uncertainty. Product life cycle
theory also seeks to explain how a company will begin by exporting its
products and eventually undertake foreign direct investment (FDI) as the
product moves through its life cycle. Besides that, the theory also says
that for a number of reasons, a countrys export eventually becomes its
import. The theory has suggested three stages in the life of a product,
there are new product stage, maturing product stage and standardized
product stage. FDI occurs in the later two stages, there are in the maturing
product stage and standardized product stage.
In new product stage, a firm introduces an innovative product in
response to a felt need in the domestic market. As the fortunes of the
product are not known, it is produced in a limited quantity and is sold
mainly in the domestic market. Export are either non-existent or take
place in a limited way, gradually growing late in a new product stage.
Overall, in this stage, a product is produced in the home country only, as

its fortunes are not yet known. The production process is kept close to the
research department that has developed the product.
Next, for the maturing product stage, as the product picks up in
consumer acceptance and popularity, demand for it rises both in domestic
as well as in foreign markets. The innovating firm sets up manufacturing
facilities abroad to expand production capacity, and to meet growing
demand from domestic and foreign consumers. Domestic and foreign
competitions begin as the product emerges clear winner in the market.
Near the end of the maturity stage, attempts are made to produce the
product in the developing countries. Two of the characteristics of this stage
are a decline in the need for flexibility and an increased concern for cost
rather than product characteristics. However, as the product matures, the
demand increases while there is also an increase in standardization, which
leads to a lower need for flexibility and higher expectations of economies
of scale and long term commitments. Overall, in this stage, the firm
directly invests in production facilities in countries where demand is high
thus necessitating own production facilities.
Standardized product stage is the last stage in the product life cycle
theory. Here, market for the product stabilizes. The product becomes a
commodity, the market becomes price sensitive and the manufacturers
are motivated to search for low cost producing countries in order to bring
down the cost of production. As a result, the product begins to be imported
into the innovating firms home country. In some cases, imports may result
in winding up of domestic production facilities. Overall, in this stage,
increased competition creates pressures to reduce production costs. In
response, the company builds production capacity in low-cost developing
nations to serve its markets around the world.
The advantage of product life cycle is its flexibility in explaining not
only why trade takes place and also why FDI replaces trade. Next, product
life cycle theory also has many takers, for example, the product life cycle
model suggests that many products go through a life cycle during which
high-income, mass consumption countries are initially exporters, then lose
their export markets and finally become importers of the product.