Foreign Direct Investment in India - Report Example

FDI in India Introduction: The World Investment Report of 2007 ranks India as the second most preferred destination for FDI investments after China. The Indian share of world FDI inflows has been increasing steadily over the past three years. While the FDI inflow recorded for 2005-2006 was 5.5 billion US dollars, during the three month period of April to July 2007 itself, the DFI inflow was 5.6 billion U.S. dollars as compared to U.S. 2.9 billion dollars for the same period the previous year.(Economy Mirror, 2007). The Inward FDI Performance Index is the ratio of the country’s share in global FDI inflows to its share of the global GDP and India ranks 113th in this aspect, but in terms of the Inward FDI Potential Index, the country ranks 85th, thereby enhancing the attractiveness of this destination for purposes of investment. India has registered the highest rates of economic growth after China and appears poised to continue with high levels of growth. Foreign investors are becoming increasingly interested in investing in the country, and India is emerging as a more competitive location to funnel foreign direct investment as compared to both the South east Asian countries of Indonesia and Malaysia. FDI Investment: The nature of FDI investment prior to the WTO regime was directed towards seeking out and exploiting intangible assets such as new technology, brand names and knowledge base in target markets, because exporting to these countries was difficult as a result of high trade tariffs and protectionist measures.(Caves, 1996). However, in the WTO regime, there has been a drastic reduction in trade tariffs and quotas have almost disappeared, as a result of which countries seek to exploit their intangible assets such as knowledge by exporting to these countries and augmenting their intangible assets by partnership in knowledge management with the host countries.(Belderbos 2001; Florida 1997). As a result, Multinational Enterprises are motivated to enter into and invest in areas where knowledge may be found and where it is possible to enter into partnership with knowledge intensive enterprises. India has a significant advantage over countries such as Malaysia and Indonesia because of the knowledge intensive resources that exist in the country, especially in terms of IT services. Applying the OLI framework, which states that in order to take up cross border investments, a firm must possess some ownership advantages which allows it to compete against the foreign firms, In addition, the extent of foreign activity will depend on the location specific advantages that a country offers. In the case of India, it may be noted that the high levels of IT proficiency in a global economy where technology is rapidly assuming a vital role, coupled with the lack of Government interference in this industry, provide it a location advantage that is unsurpassed by Indonesia or Malaysia. Another reason for India’s increasing attractiveness for Foreign Direct Investment is the fact that 100% FDI is allowed in almost all sectors of the economy, as compared to a cap of 40% in select sectors of the economy in 1991 when liberalization of the economy first took place. (Economy Mirror, 2007). There are only a few sectors where caps still exist, such as Print Media, Broadcasting, Single Brand retail and communications. Moreover, Japanese investment in India is also increasing, diverting from its traditional south east partners such as Malaysia and Indonesia after the 1997 Financial Crisis. As opposed to the Indian Government opening up its economy to FDI, the south east Asian countries such as Malaysia and Indonesia are still feeling the repercussions of the East Asian Financial crisis of 1997, which resulted in a drastic lowering of FDI investments into the south east Asian countries and especially Indonesia.(Eaber Newsletter, 2007). In Indonesia, increased outflows are on the rise, due to the volatile political and security situation in the country. FDI inflows into South East Asia were 7.7 percent from 1992 to 1997 but declined to 2.97 from 1999-2005, and increasing competition from China is also one of the reasons for lowered FDI investments into Indonesia and Malaysia (Eaber Newsletter 2007). In explaining the decline in FDI into Malaysia, Ramasamy (no date) has applied Dunning’s paradigm to understand the patterns of FDI investment into Malaysia, however he points out that the two most important factors that must be considered during times of economic uncertainty – reversibility and delayability. There was an element of political and economic uncertainty in Malaysia after the economic crisis of 1997 which the country is still trying to recover from. For instance, immediately after the crisis, the Government imposed strict capital controls, effectively closing off hot money which had a negative impact on foreign direct investment. Malaysia was also the only ASEAN country to register a decline in FDI inflows in 2005, dipping 14% to 3.27 billion dollars.(www.mier.org.my). There has been a greater level of selectivity by the Malaysian Government in the kinds of FDI it has been admitting, since those projects lower in the value chain and largely dependent on cheap labor have been turned away. In view of the fact that lower labor costs and the possibility of achieving economies of scale is one of the important reasons for FDI, such a trend by the Government has depressed FDI investment and this may also be the reason why more Japanese companies are turning away from Malaysia to India instead, where there is not only an abundance of cheap labor but also labor that is highly skilled even while it is cheap. Infrastructure: The degree of FDI investment into a country will also depend upon the physical and capital infrastructure that exists in it, as well as the labor costs. Lower labor costs are an important aspect governing the decision of foreign investors to invest their monies in another economy, however the availability of infrastructure facilities are even more important (Kumar 2000). In a study conducted by Wheeler and Mody (1992), which examined the investment decisions of U.S. Multinational enterprises, tax incentives offered by the host country were not found to significantly impact upon investment decisions, rather it was the quality of infrastructure and the availability of specialized services and supplies that attracted foreign direct investment. This study also found that while factors such as corruption and bureaucratic hassles are unfavorable factors when multinational enterprises consider investment decisions, nevertheless since corruption exists in all Asian countries including China, this factor does not play a significant role in investor decisions and it is the quality of infrastructure that attracts investment. Where Indonesia is concerned, the country has been under spending in this key area, and the level of spending has fallen from around 6% of the GDP before the Asian financial crisis to 2-3% at present.(www.abd.org). The deficiency in development of infrastructure coupled with a weak legal system and labor market rigidities added to bureaucracy and corruption have inhibited investment. In the case of Malaysia, there are negative perceptions among investors about its institutional domestic environment, with levels of government control being unnecessarily high, which have also contributed to negative investor perception. Infrastructure problems have been the factor plaguing the Indian economy and an estimated 320 billion dollars of investment in infrastructure is required during the Eleventh Plan from 2007-12.(www.finmin.nic.in). Thus, all the three countries suffer from infrastructure problems, however one significant aspect in which India differs from the other two countries is in the lower levels of Government control in the institutional domestic environment. Where electricity availability is concerned, Dickel (2003) points out that the Ninth Five Year Plan in India fell short of its target by 20,000 MW in adding a power generation capacity of 40,000 MW. He also points out that 40% of households in India do not have access to electricity and estimates that an extra 100,000 MW capacity of electricity would be required by 2012, which is almost double the existing capacity. Malaysia however, has ample electricity supply, with transmission voltages at 500 Kv, 275 Kv and 132 KV, with availability of three phase and single phase connections.(www.mida.gov.my). In the case of Indonesia, 27.9 million households had access to electricity, hence the electricity ratio in the country was 60.3%, with industries utilizing 49.2 percent of available electricity supplies. Electricity supply is largely controlled by state owned enterprises rather than companies and investments of 5.9 trillion Rp are planned to expand distribution networks.(www.kbri-bangkok.com). Hence, Malaysia and Indomesia are in a better position where electricity generation and availability are concerned, with Malaysia positioned best in this aspect, to attract FDI investment. In India, the Government has expressed also its commitment to promote economic growth in the country and to push it up to 9%. In order to achieve this goal, it proposes to spent 500 billion dollars on the improvement of infrastructure throughout the country over the next five years.(Pasricha, 2007). The Government intends to spend 70% of this amount itself and is petitioning domestic and foreign investors to contribute an additional 150 billion dollars to beef up the creaking infrastructure in the country. (Parischa, 2007). The Global Competitiveness Index ranks labor market efficiency and technology readiness as significant factors that will boost up a country’s rankings as a potential investment location. In the case of India, there is a large and skilled workforce that is available to multinational enterprises, especially in terms of technology readiness, with a large pool of IT professionals whose services can be hired at competitive wages. The available market in India is also much larger than in Indonesia and Malaysia, which produces better economies of scale. While the Indonesian economy is still characterized by unemployment and the Malaysian economy is still in the process of recoveries from the Asian Financial crisis, the Indian economy has been growing at the rate of 8% per annum and this has increased the level of interest of Japanese investors in terms of investments in the country.(Chand, 2006). FDI theory holds that market based economies are one of the most attractive factors fuelling foreign direct investment. With Indian liberalization of the economy and a steady economic growth which is the second largest in the world after China, coupled with high levels of population and availability of skilled labor, which are also attractive factors propelling FDI investment, India is placed at an advantage as compared to Malaysia and Indonesia. While these two countries were traditional Japanese targets for FDI, the political situation in both these countries and the restrictions in the economy may have contributed to the emergence of India as a preferred location as compared to these two south east Asian countries. In the case of Indonesia, there was a sharp lift in fuel prices in 2006, which produced a corresponding inflation that had an adverse impact on investments into the country. The rise in fuel prices produced a concomitant rise in interest rate. (WWW.adb.org). Although the situation has improved in 2007 with an increase in private consumption which has also produced a GDP growth of 6.3%, this is not comparable to India’s economic growth of 8% per annum which the country is aggressively trying to raise to 9 to 10% per annum. There has also been an increased deficit in the services and income accounts due to imports of construction and financial services, as well as the repatriation of profits by foreign companies in Indonesia. Inflation rates in Indonesia are also fluctuating, providing a somewhat unstable economic environment for investors, as opposed to India’s steady growth which has been sustained over the past few years. Business Environment: Porter’s diamond framework views the competitiveness of the business environment in a country as the interaction of four significant factors; (a) factor conditions – which comprises the efficiency, quality and specialization of inputs available to firms, including human and capital resources and infrastructure (b) demand conditions – the existence of a strong local demand for its goods and services (c) related and supporting industries which refers to the need for availability of capable local suppliers and (d) Firm structure, strategy and rivalry, which implies that there must be vigorous local competition and management structures and goals that are suited to a particular country (Porter, 1990). Apart from this, two other factors impacting upon the business environment are the policy of the Government and the element of chance, which includes such aspects as new inventions, wars and significant changes in the financial markets. Porter’s Diamond is especially relevant in the context of the IT industry in India, which is one of the most important reasons favoring the increase of foreign direct investment. The factor conditions were very suitable for the development of this industry because there were too many trained Indian engineering graduates with not enough jobs. Secondly, when IBM moved out of India due to its fear of piracy of its intellectual property rights, this provided a significant window of opportunity for Indian firms to enter the market, especially since many individuals already had experience working with high quality multi national corporations. There was no need for support from existing related industries, since the digital world was one that developed independently. Bangalore has emerged as a centre with a higher concentration of IT professionals, since it had the largest share of engineers due to the existence of organizations such as HAL. Lastly, the competition in the industry was intense and fierce, due to the availability of large numbers of skilled professionals and the lack of existing bureaucracy since most of the firms which emerged were new companies that were swift and savvy in dealing with the competition. The Government also contributed to the development of the IT industry in India, mostly by ignoring the industry and not placing any bureaucratic and administrative blocks in its way. This resulted in a fast development of private enterprise, which contrasted with the centralized, socialist systems that were in place due to the British legacy. In the case of Malaysia, it is the electronics industry that has been one of the drivers of the Malaysian economy and provides good scope for investors. The growth in exports in this sector has fuelled growth in the Malaysian economy (EE Times Asia, 2006). According to the annual survey conducted by the Malaysian American Electronics Industry, total revenues in this industry were projected to rise in 2006 by 9 percent to 19.5 billion dollars (EE Times Asia, 2006). This sector has shown steady growth in exports over 2005 and 2006 despite the inherent uncertainties in the economy. Indonesia has given a high priority to industrial expansion as a part of its development plans. The wood industry accounts for a 11-12% share in export value and the petroleum industry has been contributing to the GDP in the 1990s.(www.nationsencyclopedia.com). As compared to Malaysia and Indonesia however, India enjoys an advantage in the industrial sector due to the fallout being experienced by the two far east Asian countries from the Asian Financial crisis of 1997. Another aspect of the business environment which is very important from the perspective of FDI is the size of the consumer market in the target country. In this aspect as well, India has an advantage, because it is one of the large consumer markets in the world and has been projected to emerge as the fifth largest consumer market by 2025. The size of the consumer market is expected to leap to Rs.70 trillion in 2025 as opposed to only 17 trillion or 60% of India’s GDP in 2005.(Murali, 2007). The availability of a 300 million strong middle class consumers is a strong lure for FDI investment and places India in a more favorable position when compared to Malaysia and Indonesia, both of which have a much smaller consumer market.(Debroy, No Date) Conclusions: On the basis of the above, it may be noted that the major factor that has impacted negatively upon Foreign Direct Investment in both Malaysia and Indonesia is the Asian Financial Crisis of 1997 which produced wide ranging economic effects that are still being experienced today. As opposed to this, India has been experiencing a runaway economic growth, largely due to the development in its IT sector. In a global economy that is increasingly becoming dependent upon technology, the level of IT skills available in the country makes it a very attractive destination for investors. Foreign companies are able to access a large skilled workforce base at very low prices. India is a democracy as opposed to Malaysia and Indonesia where the levels of Governmental control are much higher than in India and where the political situation is often uncertain and fluctuating. Although all the three countries are democratic in the sense that they have had elections, India is the most robust and vibrant democracy among the three. In Malaysia and Indonesia, democracy has been emerging slowly and is still subject to some levels of authoritarian rule. These two countries have also been plagued by inflation and economic deficits and unemployment in Indonesia has been a persistent problem. Moreover, Malaysia has also regulated the kinds of FDI investment it allows, so that the available pool of foreign companies prepared to invest in Malaysia is whittled down still further. In contrast to this, the Indian Government does not interfere much in the It industry which is still in its nascent stages and is populated by new companies which are flexible and ready to adapt to changes with intelligent solutions. In terms of corruption and administrative bureaucratic delays and inefficiencies, all the three countries are comparable from the perspective of investors. But in the case of Indonesia, infrastructure investments have been low while in India, there are possibilities that the infrastructure in the country is about to receive a massive input of much needed funds. The creaking infrastructure in India is the single factor that inhibits investors who want to pump funds into the country, because infrastructure ranks even higher than governmental controls and bureaucratic inefficiencies. It is also the single factor that places it lower than China in terms of foreign direct investment, since China also suffers from the same problems of over population, corruption and bureaucracy, but has invested billions of dollars in improving its infrastructure to attract foreign direct investment. India enjoys the advantages of a democratic Government, the availability of a technologically savvy, skilled labor force that also demands wages that are far lower than the developed countries and an expatriate population that lives abroad and has also contributed significantly to investment in the country. It has enjoyed explosive economic growth in the past years and plans to improve and enhance this growth, with all of these reasons making the country far ore attractive than the other ASEAN countries in terms of foreign direct investment. Bibliography: * Asian Development Report, 2007. “Foreign money still flowing into Asia,” Retrieved December 12, 2007 from: http://www.adb.org/documents/periodicals/adb_review/2001/vol33_2/ecomon.asp * Belderbos, Rene, 2001. "Overseas innovation by Japanese firms: an analysis of patents and subsidiary data," Research Policy, 30: 313 * Caves, R. 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