ECONOMICS – II Final Project Report

Foreign Direct Investment and Its Impact on India

Submitted to

Prof. Sanjay Singh

Submitted By
Section B
Sarin (PGP25090)
Shivkumar (PGP25099)
Shreyas (PGP25100)
Soumen (PGP25101)
Souvick (PGP25102)
TABLE OF CONTENTS

1. FDI in India ................................................................................................................................................................... 3

1.1. What is foreign investment? ...................................................................................................................... 3

1.2. Entry Options for Foreign Investors...................................................................................................... 3

1.3. What is the difference between FDI and FII? .................................................................................... 3

1.4. Different TYPES of FDI in India: ............................................................................................................... 4

1.5. Current inflows for FDI in India ............................................................................................................... 4

1.6. Country contribution List of FDI in India............................................................................................ 4

2. Relationship of Foreign Investment with Macro Economic Factors............................................. 5

2.1. Foreign investment and GDP of india ................................................................................................... 5

2.2. FDI and Indian Currency .............................................................................................................................. 5

2.3. Foreign investment and employment growth ................................................................................. 5

2.4. FDI and INFLATION (WPI) ........................................................................................................................... 5

2.5. Foreign Investment And IIP ....................................................................................................................... 5

3. Time Series Analysis of Foreign investment and FDI in India ......................................................... 6

4. Political footprints on FDI in India .................................................................................................................. 6

5. How does government attracts and monitors FDI? ............................................................................... 7

6. What determines the FDI in the economy? ................................................................................................ 8

7. Annexure .................................................................................................................................................................... 10
1. FDI IN INDIA

1.1. WHAT IS FOREIGN INVESTMENT?

Any investment flowing from one country to another country is foreign investment. The
management of a business enterprise in a foreign country is foreign investment.

Indian Government classifies foreign investment in the following form:

 Foreign direct investment (FDI)
 Foreign institutional investment (FII)
 Non-resident Indian (NRI) investment

1.2. ENTRY OPTIONS FOR FOREIGN INVESTORS

A foreign company planning to set up business operations in India has the following
options:
Incorporate a company under the Companies Act, 1956 through:
Joint Venture or
Wholly owned Subsidiary

Foreign equity in such Indian companies can be up to 100% depending on the

requirements of the investor, subject to equity caps in respect of the sector/area of
activities under the FDI policy.
Enter as a Foreign Company through:
o Liaison Office/Representative Office
o Project Office
o Branch Office

Such offices can undertake activities permitted under the Foreign Exchange
Management Regulations, 2000 (Establishment in India of branch or office of other
place of business).

1.3. WHAT IS THE DIFFERENCE BETWEEN FDI AND FII?

Foreign direct investment (FDI) is defined as "investment made to acquire lasting

interest in enterprises operating outside of the economy of the investor."The FDI
relationship consists of a parent enterprise and a foreign affiliate which together form a
Multinational corporation (MNC). In order to qualify as FDI the investment must afford
the parent enterprise control over its foreign affiliate. The UN defines control in this
case as owning 10% or more of the ordinary shares or voting power of an incorporated
firm or its equivalent for an unincorporated firm; lower ownership shares are known as
portfolio investment. The definition of FDI originally meant that the investing
corporation gained a significant number of shares (10 percent or more) of the new
venture. In recent years, however, companies have been able to make a foreign direct
investment that is actually long-term management control as opposed to direct
investment in buildings and equipment.
FDI growth has been a key factor in the “international” nature of business that many are
familiar with in the 21st century. This growth has been facilitated by changes in
regulations both in the originating country and in the country where the new
installation is to be built.

FII generally means portfolio investment by foreign institutions in a market which is not
their home country. These institutions are generally Mutual Funds, Investment
Companies, Pension Funds, and Insurance Houses. Their investments are in the stock
market whereas FDI is generally a long term commitment to a particular company in a
sector in terms of equity investment by some foreign entity. FII funding is a paramount
maker of stock markets and there selling or buying moves the stock in a day. FDI have
long term commitment and hence we see flight of capital in terms of FII outflows but not
generally in FDIs.

1.4. DIFFERENT TYPES OF FDI IN INDIA:

Foreign direct investment (FDI) is permitted in India as under the following form:
 Financial collaborations
 Joint ventures and technical collaborations
 Capital markets via Euro issues
 Private placements or preferential allotments

1.5. CURRENT INFLOWS FOR FDI IN INDIA

CUMULATIVE FDI EQUITY INFLOWS

Rs Crores US$ Million

Cumulative FDI inflows (From April 2000 to March 393,126 89,840
2009)
FDI inflows during 2009-10 (From April to Sep 74378 15312
2009)
Cumulative amount of FDI Inflows (Up to Sep 467,504 105152
2009)
SOURCE: DIPP, Federal Ministry of Commerce & Industry, Government of India

1.6. COUNTRY CONTRIBUTION LIST OF FDI IN INDIA

The major countries contributing to the FDI inflow in India are Mauritius, USA, UK,
Singapore etc. Mauritius is the largest contributor in the cumulative FDI flow during the
period of 2000-2009. For detailed break up please refer to section ‘C’ of the Annexure.
2. RELATIONSHIP OF FOREIGN INVESTMENT WITH MACRO
ECONOMIC FACTORS

2.1. FOREIGN INVESTMENT AND GDP OF INDIA

Foreign investment shows a strong correlation (polynomial) with GDP in the last decade
(1998-2008). The R2 value for the same is 0.881. Please refer to section ‘A.1’ of the
Annexure for detailed data. FDI shows a strong linear correlation with the GDP of India.
R2 value of 0.904 shows the strength of the correlation between the two parameters.
For detailed data analysis, please refer to the section ‘A.2’ of Annexure.

2.2. FDI AND INDIAN CURRENCY

A trend analysis of the FDI inflows to India and the exchange rates prevailing in the
financial year 2008-09 shows a trend which doesn’t depict a very strong correlation
between the two chosen parameters. The best and strongest fit function for the trend
was given by the 6-degree polynomial function with a R^2 value of 0.461. The
exchange rate taken is taken with respect to US dollar. Please refer to section ‘A.3’ of
Annexure for further details.

2.3. FOREIGN INVESTMENT AND EMPLOYMENT GROWTH

The R^2 value is 0.174 for the 5-degree polynomial correlation between foreign
investment in India and employment. FDI shows a 4-degree polynomial correlation with
employment with an R^2 value of 0.264. For detailed data analysis, please refer to
section ‘A.4’ of the Annexure.

2.4. FDI AND INFLATION (WPI)

The correlation derived between Wholesale Price Index (WPI) and FDI based on the
monthly data available for the financial year 2008-09 shows a trend which is not as
strong as seen in the previous sections. The R^2 value for the correlation between the
two parameters is only 0.075. Please refer to section ‘A.5’ of the Annexure for further
reference.

2.5. FOREIGN INVESTMENT AND IIP

The correlation derived between Foreign Investment and Index for Industrial
Production (IIP) shows strong relationship with R^2 value of 0.91 for a linear
correlation. The R^2 value is 0.95 for a 2-degree polynomial correlation of FDI with IIP
which again shows a very strong relationship. Please refer to section ‘A.6’ of the
Annexure for further reference.
3. TIME SERIES ANALYSIS OF FOREIGN INVESTMENT AND FDI
IN INDIA

The best fit equation derived from the time series analysis of foreign investment in
India is given by the following 2-degree polynomial equation:
– y = 355.5x2 - 1E+06x + 1E+09
Where,
x represents time (year) and
y represents the foreign investment made in US $millions

The R2 value obtained for the above equation is 0.945.

The best fit equation derived from the time series analysis of FDI in India is given by the
following 3-degree polynomial equation:
y = 61.01x3 - 36592x2 + 7E+08x - 5E+11
Where,
x represents time (year) and
y represents FDI in US $millions.

The R2 value obtained for the above equation is 0.870.

For details and graphs corresponding to the analysis please refer to the section ‘A.7’ of
Annexure.

4. POLITICAL FOOTPRINTS ON FDI IN INDIA

Year Political Impact on FDI in India

1991  BJP: “We will make our economy truly Swadeshi by promoting native
initiatives".
 Congress: "Foreign investment will not be at the cost of self-reliance".
1993-94  The government realized the importance of FDI.
1995-96  The FDI Mindset sets into the Government but opposition were critical of
FDI and the Government's acceptance to IMF conditionality.
1996-97  United Front Government: Increase in understanding towards Foreign
Investment.
 Foreign Investment Promotion Council Setup.
1997  The first ever guidelines were announced for consideration of foreign direct
investment proposals by the FIPB, which were not covered under the
automatic route.
 The list of industries eligible for automatic approval of up to 51 per cent
foreign equity was expanded.
1998  When there was a decline in FDI the government had to take greater
technical measures in terms of liberalizing investment norms in bring in FDI.
1998-99  BJP admitted in its manifesto that “the country cannot do without FDI,
because besides capital stocks it brings with it technology, new market
practices and most importantly employment”.
 However BJP clarified that FDI will be encouraged in core areas so that it
usefully supplements the national efforts and it discouraged FDI in non
 priority areas.”
1999  When a second year of decline continued a Foreign Investment
Implementation Authority (FIIA) was set up for providing a single point
interface between foreign investors and the government machinery.
2004  FDI had become a non-electable issue as there was widespread acceptance
of the topic among all the party lines
2006  "FDI will continue to be encouraged and actively sought, particularly in
areas of infrastructure, high technology and exports and where local assets
are created on a significant scale. The country needs and can easily absorb at
least two to three times the present level of FDI inflows” – basis of CMP

5. HOW DOES GOVERNMENT ATTRACTS AND MONITORS FDI?

Foreign Investment Promotion Board FIPB:

This specially empowered Board in the office of the Prime Minister is the only agency
dealing with matters relating to FDI as well as promoting investment into the country. It
is chaired by Secretary Industry (Department of Industrial Policy & Promotion).
It promotes FDI into India by undertaking investment promotion activities in India and
abroad by facilitating investment in the country through international companies, non-
resident Indians and other foreign investors.

Foreign Investment Promotion Council FIPC:

The Government has constituted a Foreign Investment Promotion Council (FIPC) under
the chairmanship of Chairman ICICI, to undertake vigorous investment promotion and
marketing activities. The Presidents of the three apex business associations such as
ASSOCHAM, CII and FICCI will be members of the Council. Ministry of Industry
personnel will be Member-Secretary.

Foreign Investment Implementation Authority FIIA:

Foreign Investment Implementation Authority (FIIA) has been set up by the
government of India in order to encourage the implementation of the proposals for FDI
in the country. By doing this, Foreign Investment Implementation Authority (FIIA) has
given a major boost to the Indian economy.
 Role of Foreign Investment Implementation Authority (FIIA):
 To understand and solve the problems of the investors
 To understand and solve the problems of the approving authorities
 To refer the cases that have not been resolved at the level of FIA to the
agencies at the higher levels
 To start consultations with multiple agencies

Investment Commission:
The Investment commission of India is a three-member commission set up in the
Ministry of Finance in December 2004 by the Government of India. Mr. Ratan Tata is
Chairman and Mr. Deepak Parekh and Dr. Ashok Ganguly are members. The Investment
Commission has been set up to enhance and facilitate investment in India. The
Commission makes recommendations to the Government of India on policies and
procedures to facilitate investment, recommends projects and investment proposals
that should be fast tracked/mentored and promotes India as an investment destination

6. WHAT DETERMINES THE FDI IN THE ECONOMY?

 Growth of the economy:

o The growth rate of the home economy is an important determinant
of FDI into the country.
 Size of the economy:
o The FDI flows also depend on the size of the home economy.

 Real exchange rate:

o Any depreciation in the currency of India will make our country
more favorable for foreign investments.
 Degree of openness of the economy:
o Any FDI investment into a country depends upon how ‘open’ the
economy is towards foreign trade (both imports and exports). We
have captured the ‘openness’ of the economy through the proxy
variable, DO (Degree of Openness) where it is given by
 DO = (Imports+Exports)/GDP

An open-market operation where the RBI decides to buy government

bonds from the public will result in the expansion of the money supply.
From the above graph, we can see that the increase in the money supply
decreases the interest rate from i1 to i2. The decrease in the interest rate
increases the exchange rate (as the demand for foreign currency > supply
of foreign currency). As a result, the FDI increases in the host country.

Also, the decrease in the interest rate means the cost of capital decreases
since national income identity suggests that an increase in domestic
investment will positively impact on domestic output.(Y = C + I + G + X –
M). Open-market operations are likely to do a better job in attracting
more flows of FDI than other type of monetary policy. The reason is
because they impact on two determinants of FDI inflows - exchange rate
and GDP.
 Incorporating all these factors as determinants of FDI, we get the
following model:

FDIt = a +b ∆GDPt + c GDPt + d DOt+ e REERt+ ut

Where,

FDIt = Foreign Direct Investment in Period t

GDPt = Gross Domestic Product in Period t
∆GDPt = GDPt -GDPt-1
DOt = Degree of Openness in Period t and is equal to ratio of Sum of Exports and Imports
to GDPt
REERt = Real Effective Exchange Rate in Period t
ut = Error Term

Using the time series data, we ran a multi-variate regression of the above
equation to estimate the values of the coefficients and to check their significance levels.
We obtained an adjusted R square value of .783 which shows that the model explains
more than 70% of the data.

FDIt = -83110 + .011 ∆GDPt + .02 GDPt + 66970 DOt+ 633.5 REERt

Also, we note that all the coefficients are positive which is as expected and the t
statistic values indicate that all coefficients are significant.
7. ANNEXURE

FDI, FI, GDP, WPI, Unemployment and Currency statistics are taken from RBI’s Indian
Statistics Handbook 2009 mentioned below

http://www.rbi.org.in/scripts/AnnualPublications.aspx?head=Handbook%20of%20Sta
tistics%20on%20Indian%20Economy

A.1) Foreign investment in India and India’s GDP:

Year Foreign Investment ('000 US $ millions) GDP ('00000 In Rs Crore)

1998-99 2.401 17.86525
1999-2000 5.181 19.25017
2000-01 6.789 20.97726
2001-02 8.151 22.61415
2002-03 6.014 25.38171
2003-04 15.699 28.77706
2004-05 15.366 23.82068
2005-06 21.453 27.46928
2006-07 29.082 43.03654
2007-2008 34.36 50.234

A.2) FDI in India and India’s GDP:

Year FDI ('000 US $ millions) GDP ('00000 In Rs Crore)

1998-99 2.462 17.86525
1999-2000 2.155 19.25017
2000-01 4.029 20.97726
2001-02 6.13 22.61415
2002-03 5.035 25.38171
2003-04 4.322 28.77706
2004-05 6.051 23.82068
2005-06 8.961 27.46928
2006-07 22.07 43.04
2007-2008 34.36 47.234

A.3) Foreign Investment and Indian Currency

Month - Year RBI REFERENCE RATE WITH RESPECT TO USD FDI ('00 in US $ Million)
Sep-08 45.5635 25.62
Oct-08 48.6555 14.97
Nov-08 48.9994 10.83
Dec-08 48.6345 13.62
Jan-09 48.8338 27.33
Feb-09 49.2611 14.88
Mar-09 51.2287 19.56
Apr-09 50.0619 23.39
May-09 48.5330 20.95
Jun-09 47.7714 25.82
Jul-09 48.4783 35.16
Aug-09 48.5348 32.68
Sep-09 49.4697 15.12
A.4) Foreign Investment and Indian Employment

Public Private Total (Public + Private) in FDI in US FI in US $

Year Sector Sector millions $ millions millions
19.43 8.51 37.43
1995-96 2144 4892
19.56 8.69 39.14
1996-97 2821 6133
19.42 8.75 40.09
1997-98 3557 5385
19.41 8.70 40.37
1998-99 2462 2401
1999-
19.31 8.65 41.34
2000 2155 5181
19.14 8.65 42.00
2000-01 4029 6789
18.77 8.43 41.17
2001-02 6130 8151
18.58 8.42 41.39
2002-03 5035 6014
18.20 8.25 40.46
2003-04 4322 15699
18.01 8.45 39.35
2004-05 6051 15366
18.19 8.77 41.47
2005-06 8961 21453
A.5) Foreign Investment and Wholesale Price Index

Month -Year Wholesale Price Index FDI (’00 US $ Millions)

Sep-08 241.5 25.62
Oct-08 239 14.97
Nov-08 234.2 10.83
Dec-08 229.7 13.62
Jan-09 228.9 27.33
Feb-09 227.6 14.88
Mar-09 228.2 19.56
Apr-09 231.5 23.39
May-09 234.3 20.95
 Jun-09 235 25.82
Jul-09 238.4 35.16
Aug-09 240.8 32.68
Sep-09 242.7 15.12
WPI figures from http://www.eaindustry.nic.in/asp2/list_d.asp

FDI inflows figures from http://dipp.nic.in/fdi_statistics/india_FDI_September2009.pdf

A.6) Foreign Investment and Index for Industrial Production (IIP)

Annual Average IIP (Apr-Mar) Indices

Basic Capital Intermediate Non General
Year Goods Goods Goods Total Durables Durables Index
1995-96 121.4 115.0 125.7 126.5 146.2 122.1 123.3
1996-97 125.0 128.2 135.9 134.3 152.9 130.2 130.8
1997-98 133.6 135.6 146.8 141.7 164.9 136.5 139.5
1998-99 135.8 152.7 155.8 144.8 174.1 138.1 145.2
1999-00 143.3 163.3 169.5 153.0 198.7 142.5 154.9
2000-01 148.6 166.2 177.4 165.2 227.6 150.8 162.6
2001-02 152.5 160.6 180.1 175.1 253.7 157.0 167.0
2002-03 159.9 177.4 187.1 187.5 237.8 175.9 176.6
2003-04 168.6 201.5 199.0 200.9 265.4 186.1 189.0
2004-05 177.9 229.6 211.1 224.4 303.5 206.2 204.8
2005-06 189.8 265.8 216.4 251.4 349.9 228.8 221.5
2006-07 209.3 314.2 242.4 276.8 382.0 252.6 247.1
2007-08 223.9 370.8 264.1 293.6 378.0 274.2 268.0

IIP data flows from http://mospi.nic.in/iip_table4.htm

 Year FDI in US $ millions Foreign Investment US $ millions

1995-96 2144 4892

1996-97 2821 6133

1997-98 3557 5385

1998-99 2462 2401

1999-2000 2155 5181

2000-01 4029 6789

2001-02 6130 8151

2002-03 5035 6014

2003-04 4322 15699

2004-05 6051 15366

2005-06 8961 21453

2006-07 22826 29082

2007-08 34362 34360

FDI and FI figures are taken from RBI website mentioned below

http://www.rbi.org.in/scripts/AnnualPublications.aspx?head=Handbook%20of%20Sta
tistics%20on%20Indian%20Economy
A.7) Time series analysis of foreign investment in India

Year Foreign Investment

1995-96 4892
1996-97 6133
1997-98 5385
1998-99 2401
1999-2000 5181
2000-01 6789
2001-02 8151
2002-03 6014
2003-04 15699
2004-05 15366
2005-06 21453
2006-07 29082
Time series analysis for foreign investment in India

Year FDI (in US $ millions)

1995-96 2144
1996-97 2821
1997-98 3557
1998-99 2462
1999-2000 2155
2000-01 4029
2001-02 6130
2002-03 5035
2003-04 4322
2004-05 6051
2005-06 8961
2006-07 22079

Time series analysis of FDI in India

B) Sector wise FDI Inflows:

Ranks Sector 2006-07 2007-08 2008-09 2009-10 Cumulative % age to
(April-March) (April- (April-March) (April- Sept. Inflows total
March) ‘09) (April ’00 to Inflows
(In terms of
Sept. ‘09)
rupees)
1. SERVICES 21,047 26,589 28,411 12,782 97,235 22 %
SECTOR (4,664) (6,615) (6,116) (2,627) (21,876)
(financial & non-
financial)
2. COMPUTER 11,786 5,623 7,329 2,107 41,603 9%
SOFTWARE & (2,614) (1,410) (1,677) (434) (9,388)
HARDWARE
3. TELECOMMUNI 2,155 5,103 11,727 9,815 38,182 9%
 CATIONS (478) (1,261) (2,558) (2,010) (8,386)
(radio paging,
cellular mobile,
basic telephone
services)
4. HOUSING & 2,121 8,749 12,621 9,193 32,975 7%
REAL ESTATE
(467) (2,179) (2,801) (1,894) (7,407)

5. CONSTRUCTIO 4,424 6,989 8,792 4,814 26,991 6%

N ACTIVITIES
(including roads (985) (1,743) (2,028) (991) (6,182)
& highways)
6. POWER 713 3,875 4,382 5,805 19,816 4%
(157) (967) (985) (1,197) (4,387)
7. AUTOMOBILE 1,254 2,697 5,212 4,029 19,096 4%
INDUSTRY (276) (675) (1,152) (833) (4,222)
8. METALLURGIC 7,866 4,686 4,157 1,273 12,778 3%
AL (173) (1,177) (961) (263) (2,987)
INDUSTRIES
9. PETROLEUM & 401 5,729 1,931 1,019 11,196 3%
NATURAL GAS (89) (1,427) (412) (205) (2,598)

10. CEHMICALS 930 920 3,427 617 10,185 2%

(other than (205) (229) (749) (127) (2,261)
fertilizers)

C) Country wise break up of FDI inflow:

Top ten investing (FDI Equity) countries (In Rs. Crore)

Rank Country 2006-07 2007-08 2008-09 2009-10 Cumulative %age to total

s Inflows
(April- (April- (April- (April- Inflows
March) March) (April ‘00 to
March) Sept. ‘09) (in terms of
Sept. ‘09)
rupees)

1. MAURITIUS 28,759 44,483 50,794 31,761 193,034 44 %

(6,363) (11,096) (11,208) (6,520) (43,385)
2. SINGAPORE 2,662 12,319 15,727 5,763 39,615 9%
(578) (3,073) (3,454) (1,187) (8,998)
3. U.S.A. 3,861 4,377 8,002 5,991 33,951 8%
(856) (1,089) (1,802) (1,244) (7,579)
4. U.K. 8,389 4,690 3,840 1,364 24,268 5%
(1,878) (1,176) (864) (282) (5,508)
5. NETHERLANDS 2,905 2,780 3,922 2,761 18,614 4%
(644) (695) (883) (571) (4,161)
6. JAPAN 382 3,336 1,889 3,857 15,082 3%
(85) (815) (405) (793) (3,324)
7. CYPRUS 266 3,385 5,983 3,871 13,920 3%
(58) (834) (1,287) (794) (3,067)
8. GERMANY 540 2,075 2,750 1,815 11,304 3%
(120) (514) (629) (375) (2,548)
9. FRANCE 528 583 2,098 891 6,373 1%
(117) (145) (467) (185) (1,412)
10. U.A.E. 1,174 1,039 1,133 2,344 6,350 1%
(260) (258) (257) (484) (1,404)
TOTAL FDI INFLOWS 70,630 98,664 122,919 74,378 467,504 -
(15,726) (24,579) (27,329) (15,312) (105,153)

D) FDI Inflows month wise for 2009-2010

SOURCE: DIPP, Federal Ministry of Commerce and Industry, Government of India
Figures in bracket are in US$ million

FDI Inflows for 2009-2010

(In Rs. Crore) (In US$ mn)

1. April 2009 11,708 2,339

2. May 2009 10,168 2,095

3. June 2009 12,335 2,582

4. July 2009 17,045 3,516

5. August 2009 15,796 3,268

6. September 2009 7,326 1,512

2009-10 (Up to September 2009) 74,378 15,312

2008-09 (Up to September 2008) 73,111 17,211

%age growth over last year ( + ) 02 % ( - ) 11 %