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Foreign Direct Investment (FDI)

The process of increasing a country’s economic integration with the rest of the world by increasing trade in goods and services, increasing movement of physical and financial capital, increasing exchange of technology and increasing investments between the countries is called globalization.

Foreign Exchange Management Act, 1999

Foreign Exchange Regulatory Act

• MRTP Act means Monopolies and Restrictive Trade Practices Act, 1969.
• This act was framed to prevent enterprises from growing in large scale and establish monopolies.
• Later, MRTP Act was replaced by Competition Act, 2002 which aimed at reducing unhealthy competition among enterprises arising due to MRTP act.

The full form of MRTP is Monopolies and Restrictive Trade Practices Act, 1969. This act prevented enterprises from growing in large scale and establish monopolies. So, it was replaced by Competition Act, 2002. Competition Act was an act that aimed at reducing unhealthy competition among enterprises.

FEMA manages earnings from foreign exchange and transactions of enterprises instead of regulating them.

In FDt, foreign companies directly set up their business in India by constructing their plants, bringing in technology and producing or by collaborating with Indian companies for the same.

The act of selling some shares of the state in public enterprise to the private sector for example, 29% or 49% is called partial disinvestment.

The act of selling all the shares of the state in a public enterprise to the private sector is called complete disinvestment.

When the state transfers less than 51% shares to private sector then it is called minor disinvestment. However, if the state transfers more than 51% shares to private sector then it is called major disinvestment.

Globalization:

• The process of increasing a country’s economic integration with the rest of the world by increasing trade in goods and services, increasing movement of physical and financial capital, increasing exchange of technology and increasing investments between the countries is called globalization.
• The process of globalization can be done by gradually decreasing the policy controls that restricts and slows foreign trade.

Process of globalization in India:

• In 1991, International Monetary Fund (IMF) declared a list of several nations who had taken enormous loans from IMF. The IMF forced those countries to globalize and upgrade the technologies and hence grow their nations. Until the countries did this, the IMF would not give any further loans.
• India was one of those countries. Hence, India had to relax its policies of providing undue protection to domestic industries from foreign competition. Thus began the process of globalization in India and India allowed its people ; to conduct more trade with other nations.

(A) Globalization:

• The process of increasing a country’s economic integration with the rest of the world by increasing trade in goods and services, increasing movement of physical and financial capital, increasing exchange of technology and increasing investments between the countries is called globalization.
• The process of globalization can be done by gradually decreasing the policy controls that restricts and slows foreign trade.

(B) Process of globalization in India:

• In 1991, International Monetary Fund (IMF) declared a list of several nations who had taken enormous loans from IMF. The IMF forced those countries to globalize and upgrade the technologies and hence grow their nations. Until the countries did this, the IMF would not give any further loans.
• India was one of those countries. Hence, India had to relax its policies of providing undue protection to domestic industries from foreign competition. Thus began the process of globalization in India and India allowed its people ; to conduct more trade with other nations.

(C) The process of globalization underwent the following systematic process:

• The Import-Export licensing policy was made simpler and easier.
• India became member of World Trade Organization (WTO) in 1995. By doing so, India had to abide the rules of world trade.
• India began convertibility of Indian rupee into other currencies at market rate by gradually reducing conversion at the official rate. Hence, the value of our currency was now determined by the means of trade and not by the. government.
• India achieved sector wise systematic increase of foreign direct investment in India.
• Investors and producers in India were allowed to increase financial collaborations with their foreign counterparts.
• India changed its policies and stopped giving undue protection to Indian investors and enterprises against foreign competition.
• India strengthened its social and cultural ties with other nations. India also relaxed its policies of granting visas to people of other nations.

The changes brought about in economic policies since 1991 in order to change the economic system of India from one which was highly regulated by the state to one which is more market oriented. At the same time also reduce the extent of public sector in the mixed economic system are called economic reforms.

The international monetary organizations imposed a condition that unless India reduces its excessive and unnecessary controls on its economic activities it will not be provided any financial assistance.

Unfavourable effects of economic reforms:

1. Small and cottage industries could not withstand competition from multinational companies.

2. Globalization stated along with privatization. Before the Indian private sector companies could become efficient and modern, they started facing competition from foreign companies. Some Indian companies even suffered a setback.

3. Government reduced subsidies in many sectors. Hence services of these sectors became expensive.

4. Exchange rate determination i.e. determining value of Indian currency in line with foreign currencies was left to the market. Hence, rather than bringing Indian rupee under control it fluctuated more. Many companies suffered due to such fluctuations.

5. Some foreign companies started selling their goods at abnormally low prices in India. As a result many Indian companies selling similar goods received a setback since they could not produce and sell at such low prices. Such a method of foreign companies to sell the goods at very low price in large quantities is called ‘dumping’.

6. Many policies of World Trade Organization imposed strict quality measures. This made export difficult for countries like India especially for exports of agricultural goods.

7. India could not efficiently increase its infrastructural facilities like electricity, roads, etc. to cope up with the speed of privatization and globalization.

8. Inequalities of economic power increased.

9. The production and sale of life style goods increased compared to goods of basic needs.

10. Some people believe that the social and cultural foundations of India are threatened because of globalization.

India’s foreign trade policy after globalization (1991) :

• Though India made progress after independence, it was heavily indebted to international financial institutions. It was forced by the International Monetary Fund (IMF) to adopt economic reforms and undergo globalization.
• Hence, in 1991 India reformed its economic policies to boost trade and investments.
• India left its old and restricted foreign trade policy and adopted a new, bold and outward trade policy.
  India also allowed its currency i.e. Indian Rupee should be converted into foreign currencies at market rates from the earlier method of converting at official rates. ’
• It made import-export licensing easy. Today, strict licensing method exists only for crude, edible oils and chemical fertilizers.
• With promotion of FDI and privatization, foreign companies can now sell variety of goods in India.
• After globalization India’s trade with non-traditional trade partners i.e. new countries increased.
• The new trade policy aimed at increasing India’s percentage share in world trade.
• India became a member of World Trade Organization (WTO) in 1995. India changed its trade policy according to the rules framed by WTO. For example, India made changes in import-export rules for agricultural goods, trade related investment measures, etc.

India faces significant challenges in the area of trade policy—the global economic slowdown, increasing protectionism, the stalled mega-trade deals that could in time be revived, and perhaps more important, its own domestic pre- occupations.

To bring about economic reforms India had framed foreign trade policy. This policy regulates India’s trade with other countries.

Challenges faced by the foreign trade policy of India:

• India needs to control import of certain products so that it can protect domestic production from competition by foreign goods.
• Ensure enough imports of technology, machines, spare parts as well as, resources to help increase domestic production and import substitution.
• Control imports of those goods that are not needed for India’s development. This would help to save foreign exchange.
• Encourage exports so that earning of foreign exchange can be increased. This will help to make payment for items that we import.
• Many Indian goods could not compete against the quality of foreign goods. Hence it was difficult to increase the exports.
• Promote export of goods produced by small scale sector.
• The challenges of foreign trade are different from those of domestic trade as foreign trade involves foreign exchange.
• The foreign trade policy of India was formulated and amended from time to time so that India could deal with the above challenges in the best possible manner.

• After India became independent, there were several major social and economic issues to be addressed for stabilizing the nation.
• It demanded adopting such an economic system that could uplift India’s ruined economy, solve problems of widespread poverty and provide employment to people.
• Moreover, India had just come out of the Jong and torturing rule of the British rule i.e. rule of a foreign country. So, India was also under a fear that if it would again relax its foreign trade policies and conduct import-export freely then it may again fail in the trap of some foreign rule.
• Hence, India adopted a narrow-minded trade policy after independence.

The difference in value between a country’s imports and exports is called balance of trade.

• After India became independent, there were several major social and economic issues to be addressed for stabilizing the nation. It demanded adopting such an economic system that could uplift India’s ruined economy, solve problems of widespread poverty and provide employment to people.
• To achieve these objectives, the planners of independent India adopted mixed economy i.e. the mixed type of economic system with a major emphasis on socialist pattern of planning.

Need of economic reforms:

1. By 1980s, many experts felt that the planning strategies adopted between 1947 and 1990 failed to attain the goals of economic growth and development. They believed the main reason for the failure was that the states imposed several unnecessary regulations on economic activities which then restricted people from doing economic activities. This raised a need for bringing reforms in the economy to improve it.

2. Another reason was that in the early 90s the international monetary organizations that were controlled by the developed nations of the world imposed a condition on India for providing monetary assistance. As per the condition, until India reduces its excessive and unnecessary controls on the economic activities, it should not be provided any financial assistance.

3. India’s imports were quite high compared to its exports. This caused a severe deficit in India’s ‘balance of trade’ and India had to borrow a lot of foreign exchange from international institutions. Owing to these reasons, India reformed its economic policies in 1991. It also brought all the necessary institutional and regulatory changes needed for the reforms. The economic reforms focused on three major areas namely Liberalization, Privatization and Globalization (LPG).

1. Increase domestic income, employment and export income of the country.
2. Increase competitiveness of the Indian economy.

Economic reforms:

(A) Meaning:

Economic reforms refer to The changes brought about in economic policies . since 1991 in order to change the economic system of India from one which was highly regulated by the state to one which is more market oriented. At the same time also reduce the extent of public sector in the mixed economic system.’

(B) Objectives:

• To encourage private and foreign investments on a large scale. This would then utilize India’s abundant natural and human wealth for its economic development that too with higher productivity.
• Optimum and efficient allocation of India’s resources.
• Reduce and restrict state expenditures. Organize resources obtained through disinvestment of non-performing public enterprises in such a manner that their utility can be increased and public welfare can be done from the same.
• Increase domestic income, employment and export income of the country.
• Increase competitiveness of the Indian economy.
• Ensure steady economic growth and development of the Indian economy in the long run.

In order to fulfill these objectives, in 1991, the government of India started making systematic reforms in its economic policy.

The economic reforms focused on three main components. They are:

1. Liberalization
2. Privatization and
3. Globalization.

• Foreign investment i.e. investment of capital by foreign countries and companies in India became an important component of the process of globalization in India.
• India needed massive foreign exchange for investment, imports of essential goods and services, technology imports, etc. Under a relatively closed and controlled economy of India, it met these needs by borrowing the fund from international organizations and foreign governments.
• Initially India had put several controls on foreign investments in India. Hence, we had to buy more goods and technology from abroad. To satisfy India’s buying it needed huge foreign exchange.
• However, after 1991, India allowed foreign companies to directly invest in certain sectors of India that too in increased proportion.
• When these foreign companies started producing in India, our need to import started getting satisfied with this local production.
• Thus, India’s dependency on foreign borrowings reduced. Moreover, investment done by these companies in India created employment, produced a variety of goods, raised tax incomes and brought new technologies.

Types of foreign investment:

Foreign investment in India came through

1. Foreign Institutional Investment (or Investor) i.e. FII and
2. Foreign Direct Investment (FDI).

Objectives:

• To encourage private and foreign investments on a large scale. This would then utilize India’s abundant natural and human wealth for its economic development that too with higher productivity.
• Optimum and efficient allocation of India’s resources.
• Reduce and restrict state expenditures. Organize resources obtained through disinvestment of non-performing public enterprises in such a manner that their utility can be increased and public welfare can be done from the same.
• Increase domestic income, employment and export income of the country.
• Increase competitiveness of the Indian economy.
• Ensure steady economic growth and development of the Indian economy in the long run.
• In order to fulfill these objectives, in 1991, the government of India started making systematic reforms in its economic policy.

The economic reforms focused on three main components. They are:

1. Liberalization
2. Privatization and
3. Globalization.

• In 1991, International Monetary Fund (IMF) declared a list of several nations who had taken enormous loans from IMF. The IMF forced those countries to globalize and upgrade the technologies and hence grow their nations.
• IMF also declared that until the countries did this, it would not give any further loans.
• India was one of those countries. Hence, India had to relax its policies of providing undue protection to domestic industries from foreign competition.

Correct option is (D) None of these

• After 1991, India allowed foreign companies to directly invest in certain sectors of India that too in increased proportion.
• When these companies started producing in India, our need to import started getting satisfied with products produced in India by these foreign companies.
• Thus, India’s dependency on foreign borrowings reduced.

Evaluation of economic reforms after almost 25 years of its implementation since 1991 can be done in two parts as discussed below:

(I) Favourable effects of economic reforms:
The reforms in the economic policy that took place in the form of liberalization, privatization and globalization increased the importance of market forces of demand and supply.

• As a result, determination of prices, wages and interest became market oriented, more realistic and less regulated.
• Due to reduction in regulations, producers started making decisions regarding production, investment and distribution on the basis of market trends.
• The difference between domestic and foreign investments became narrow.

All these gave rise to various favourable effects for India which are discussed below:

• Consumers started getting a variety of goods of international quality that too easily and at reasonable prices.
• India’s foreign exchange reserves increased.
• India’s exports increased.
• Along with increase in FDI, the risk of certain investments and debt burden of the state for importing costly technology etc. reduced.
• Large scale investments increased in the private sector. This in turn increased production and employment.
• Factors of production became more mobile within the nation and also between nations.
• During the period of too many regulations, corruption, bureaucratic hurdles, delayed decisions and rigid administration were quite common. All these have gradually reduced after reforms.
• There are certain sectors which are quite significant for the growth and development of the nation. However, these were neglected due to scarcity of capital and government regulations.
• These sectors got a boost after reforms when private sector was allowed to invest in them. For example, natural gas pipelines, roadways, modernization of railways, etc.
• Shortage ot goods and services were overcome. In fact many more varieties of goods and services came to market.
• Social and cultural ties with other nations improved.

(II) Unfavourable effects of economic reforms:
1. Small and cottage industries could not withstand competition from multinational companies.

2. Globalization stated along with privatization. Before the Indian private sector companies could become efficient and modern, they started facing competition from foreign companies. Some Indian companies even suffered a setback.

3. Government reduced subsidies in many sectors. Hence services of these sectors became expensive.

4. Exchange rate determination i.e. determining value of Indian currency in line with foreign currencies was left to the market. Hence, rather than bringing Indian rupee under control it fluctuated more. Many companies suffered due to such fluctuations.

5. Some foreign companies started selling their goods at abnormally low prices in India. As a result many Indian companies selling similar goods received a setback since they could not produce and sell at such low prices. Such a method of foreign companies to sell the goods at very low price in large quantities is called ‘dumping’.

6. Many policies of World Trade Organization imposed strict quality measures. This made export difficult for countries like India especially for exports of agricultural goods.

7. India could not efficiently increase its infrastructural facilities like electricity, roads, etc. to cope up with the speed of privatization and globalization.

8. Inequalities of economic power increased.

9. The production and sale of life style goods increased compared to goods of basic needs.

10. Some people believe that the social and cultural foundations of India are threatened because of globalization.

• After independence, India adopted a mixed economic system with focus on socialist pattern of planning.
• By 1980s, many experts felt that the planning strategies adopted between 1947 and 1990 failed to attain the goals of economic growth and development.
• They believed the main reason for the failure was that the states imposed several unnecessary regulations on economic activities which then restricted people from doing economic activities. This raised a need for bringing reforms in the economy to improve it.
• Moreover, in the early 90s the international monetary organizations that were controlled by the developed nations of the world imposed a condition on India for providing monetary assistance.
• As per the condition, until India reduces its excessive and unnecessary / controls on economic activities, it should not be provided any financial assistance.
• India’s imports were quite high compared to its exports. This caused a severe deficit in India’s ‘balance of trade’ and India had to borrow a lot of foreign exchange from international institutions.
• Under all these circumstances India had no choice but to bring reforms and transform the nation. Hence, India was compelled to bring economic reforms.

Correct option is (D) 1999

Correct option is (C) 1991

Correct option is (C) Liberalization

Correct option is (D) None of these

The investment made by foreign companies in financial institutions and bond/stock/share markets of another country is called Foreign Institutional Investor (FII).

• The foreign companies interested in the home companies buy its shares or stocks or bonds. The home company thus receives the money via. the investment made by the foreign companies and hence this mode of obtaining money is very fast.
• However, the darker side of this form of money is that if the foreign company feels that the Indian company in which it has invested is not doing well then it may any time withdraw its money from the market. It can do this by simply selling the share/stock/bond of that company that it has bought.
• Hence, funds take a flight in and out of the country easily and thus this is considered to be a risky and unstable kind of foreign capital.

Those foreign companies that invest in financial institutions and bond/stock/share markets of another country are called Foreign Institutional Investors (FII). Such an investment is also called portfolio investment.

Correct option is (C) IMF

Correct option is (D) Both (B) and (C)

Foreign capital in a country comes in two ways. They are:

1. Foreign Institutional Investor (FII) and
2. Foreign Direct Investment (FDI)

1. Foreign institutional Investor (FII):

• Those foreign companies that invest in financial institutions and bond/ stock/share markets of another country are called Foreign Institutional Investors (Fll). Such an investment is also called portfolio investment. Fils are the big companies such as investment banks, mutual fund houses, etc. who invest considerable amount of money in the Indian markets.
• Such companies have to register in India as Foreign Institutional Investors. Then they buy such stocks from the bond/share market of India.
•  Thus, instead of investing in plant and machinery in another country like India these companies invest in the financial market.
• The limit of investment that these companies can make is decided by India.
• These investment companies do not have direct stake in the management of the ‘home companies’ i.e. the companies of India for which they buy share, bonds etc. from the market. As a result, the home companies do not get capital directly in their hands. They get it through the shares that Fils buy from the Indian market.
• An important characteristic of such investment is that home countries or say companies of home countries i.e. home companies receive the investment very fast and may also lose it very fast if the Fils sell the shares.
• Hence, funds take a flight in and out of the country easily. So this is considered to be a risky and unstable kind of foreign capital.

2. Foreign Direct Investment (FDI):

• When the home country invites capital from foreign countries by allowing * foreign investors/companies to produce and sell directly in India than such an investment is called foreign direct investment (FDI).
• In FDI, foreign companies directly set up their business in India by constructing their plants, bringing in technology and producing or by collaborating with Indian companies for the same.
• These companies either manage the entire business or have a partial control in management in case if they are collaborating partners.
• For example, Vodafone fully owns its business in India. Similarly, in Tata-AIG insurance company, AIG which is a foreign company has collaborated with Tata in India.
• India has systematically allowed FDI in increased proportion in various sectors and hence India’s foreign exchange earnings have increased.

Nature of Foreign Direct Investment:

• It is a physical establishment in the form of direct investment and hence a stable form of investment.
• It brings machines, materials and wealth to the home country.
• It brings new technology to the country.
• It brings a different work culture.

• Major changes were made in the industrial policy. One of the noteworthy changes was opening those areas for private sector in which initially only the public sector was allowed to invest.
• Currently, qnly three sectors are reserved for the public sector namely, atomic energy, some minerals related to atomic energy and railways.
• Another noteworthy change was that the government raised the limit of investment for small scale units. This helped such units to modernize and produce faster and better.

Liberalization refers to ‘Increasing the role of private sector and market oriented processes in economic planning in place of state regulated economic processes in India’s mixed economic system’.

Liberalization:

• The policy of increasing the freedom given to the private enterprises by allowing the market forces to play their role and reduce interference of the state is called the policy of liberalization.
• In other words, liberalization refers to relaxing the policy and the restrictions imposed on economic activities.

Liberalization in terms of India:
In the’context of Indian economy, liberalization refers to ‘Increasing the role of private sector and market oriented processes in economic planning in place of state regulated economic processes in India’s mixed economic system’.

Following things take place during the process of liberalization:

• The state gradually reduces the controls imposed by it on the economic activities.
• The role of market forces of demand and supply increases in decision making of economic activities
• The government systematically allows the private sector to invest in those areas which were previously reserved for the public sector.
• The government slowly and systematically reduces the protection granted by the state to domestic industries against foreign competition. This means that the government stops giving additional favour to the domestic industries and hence reduces the discrimination between domestic and foreign enterprises.
• This way a healthy market situation is generated even for the foreign companies and they start investing in the Indian markets.