Chapter 1: Aim and Objectives
All nations need a vision for future which stirs the thoughts and motivates different segments of society to a greater effort and thus inclines them to work toward the common cause that is economy growth of the individual nation. The market oriented policies normally have exclusionary impact which needs to be prevented through articulate response of the policy makers. India is the third-largest economy in the world in PPP (purchasing power parity) terms foreign direct investments (FDI), But China is currently a favourite nation and is more successful in attracting FDI over India Ballabh (2008). Hence, this thesis strives to analyse the past trend of FDI in India and China, its types, its critical analysis with regards to host country and investing firm, important factors of globalisation and foreign direct investments (FDI) strategies to be adopted, Finally, Its comparison with China’s FDI and empirical evidences would help us cover aim of our thesis which is among India and China, Why is China more successful in attracting FDI than India and is favoured over India?
Therefore this paper has been divided in seven sections. It starts with brief introduction to FDI and its types in section 1. Section 2 covers background information and literature review that gives us a picture of the FDI policies in the past, Its trends and impact on MNCs in context to India and China, FDI’s role on host economy and MNCs, , Its critical analysis based on Moran’s model, and finally investment strategies adopted by MNCs where to invest and what to invest. This would give us greater insight into the chosen topic by discussion of various forms of FDI, its impact on MNCs, on host economy and presenting an argument on discussion. Section three; presents the discussion on methodology to be used for the data collection and analysis. Section four is our data analysis and discussion section that is further divided into two sections, first half covers China’s FDI spread-its Sectoral & regional trends, the figures from the data sorted to analyse the growth in FDI over years and in different sectors, FDI distributions and opportunity sector that is playing increasingly important role by embracing FDI growth. The other half covers India’s FDI Spread-Sectoral and Country wise distribution. Again we use graphs and charts to analyse the trend.
Comparative analysis of China with India would act as an indispensable step in structuring a consensus on a broad national development strategy to attract foreign investors that encompasses the roles and responsibilities of different agents in the economy, like Central, the private corporate sector, State and local government. Therefore finally presenting a logical explanation why China is a favourable nation over India and is highly successful in attracting FDI, hence the same is to be discussed in section five. Section Six is about building a feasible policy framework toward attracting FDI for the interest of the MNCs and host economy with reference to China’s successful strategy in attracting FDI and summary of the literature followed by the concluding remarks are presented in the last section.
The Concept of FDI is now an integral part of every nation’s economic prospect but the term remains vague to many, despite the thoughtful effects on the host economy and MNCs, despite the extensive studies on FDI, there has been little illumination forthcoming and it remains a contentious topic. The research findings will throw up a range of interesting possibilities in two countries, critical issues and crucial decision-points for government and private bodies to decide upon investment for future action in the favoured country. Therefore, the paper would explores the uneven beginnings of FDI in two countries, examine and present many important theoretical and empirical evidences on FDI and its impact on economy and MNCs, and would find reasons why China is more successful in FDI over India develop a feasible policy framework towards FDI in particular sector in India or China and making most out of it.
Chapter 2: Introduction
Foreign direct investment has multiple effects on the investing firm and on the economy of a host country. FDI influences the production, employment, income, prices, exports, imports, balance of payments, economic growth, and general welfare of the receiving economy Maniam (1998). Hence this section covers definition and types of Foreign Direct Investment, FDI’s role been so far based on background information, discussion of resources and finally the theoretical aspect of why and where firms decide to invest abroad for benefits with special reference to India and China alongside host country’s motive to attract FDI.
Definition of FDI
Bergman (2006) defined FDI as a direct or portfolio investment. A direct investment is an acquisition or construction of physical capital by a firm from one source country into another (host) country. The FDI is an investment that involves a long-term relationship and control by a resident entity of one country, in a firm located in a country other than that of the investing firm. There is more involved in the direct investment than only money capital, for instance, managerial or technical guidance. FDI is generally defined as resident firms with at least 10% of foreign participation (UNCTAD, 2002).
Types of FDI
MNCs have various options to enter into a foreign market. FDI’s Different types have different levels of control and risks. For example, ‘Green field investment’ is when a firm establishes a subsidiary in a new country and starts its own production. In this type of investment a new plant is constructed rather than the purchase of an existing plant or firm. For this reason, there is large risk and has high set up costs because the foreign firm most likely does not have enough legislation knowledge, nor it has an existing distribution network and neither a local management skills. But still, the foreign firm has more control.
On the contrary, ‘Brown field investment’ is FDI that involves the purchase of an existing plant or firm, rather than building of a new plant. Joint venture is an equity and management partnership between the foreign firm and a local firm in the host market. Most host countries prefer the formation of joint ventures, as a way to build international co-operation, and to secure technology transfer (Samli & Hill, 1998). In This type of investment the foreign partner’s contribute toward technology or products, the financial resources, and at the same time the local partner provides the manpower, skills and knowledge required for managing a firm in the host country (Bergman 2006). On UNCTAD’s website we can have a comprehensive understanding of it and its types. It defines FDI as an investment that involves a long-term relationship and reflects a permanent interest of a resident entity in one economy (direct investor) in an entity resident in an economy other than of the investor. The direct investor’s idea is to put forth a significant degree of influence on the management of the enterprise resident in the other economy. FDI covers both the opening and subsequent transaction between the two entities and among affiliated enterprises, both incorporated and unincorporated. FDI may be undertaken by individuals, as well as business entities. It further is classified as follows:
FDI Stock: it is the value of the share (For associate and subsidiary enterprises,) of their capital and reserves (including the retained profits) attributable to the parent enterprise (this is equal to the total assets minus total liabilities), plus the net indebtedness of associate or subsidiary to the parent firm. For branches, it is value of fixed assets and the value of current assets and investments, excluding amounts due from parent, less liabilities to third parties.
Reinvested Earnings: The part of an affiliates earnings accruing to the foreign investor that is reinvested in that enterprise.
FDI Flows: FDI flows (For associate and subsidiary enterprises) consists of the net sales of shares and loans (including non-cash acquisitions made against equipment, manufacturing rights, etc.) to the parent company plus the parent firm’s share of the affiliate’s reinvested earnings plus total net intra-company loans (short- and long-term) provided by the parent company. And, for branches, FDI flows consist of the increase in reinvested earnings plus the net increase in funds received from the foreign direct investor.
Equity Capital: The foreign direct investor’s net purchase of the shares and loans of an enterprise in a country other than its own.
Other Capital: Short- or long-term loans from parent firms to affiliate enterprises or vice versa. Also included are trade credits, bonds and money market instruments, financial leases and financial derivatives.
Chapter 3: Background Information and Literature Review
History of FDI in India
India’s foreign trade and investment regime has been identified in two different phases- Pre-1991 reforms phase and the post-1991 phase. Pre-1991 reforms phase that stretched over to four decades is worth reviewing in some detail as although the regime was marked by extensive regulation of trade and investment, it did not shun foreign enterprise participation in the economy and the nature of the regulatory framework was mostly complex and cumbersome. This has been extensively analysed by Kidron (1965) & Kumar (1994). The specification of sectors in which both foreign financial and technical participation were allowed, those in which only technical collaboration was permitted, and those in which neither technical and nor financial participation was allowed, reflects the desire to restrict foreign ownership and control to sectors of the economy in which its contribution was deemed to be essential. A preference to technical collaboration agreements instead of foreign equity ownership reflects the desire to promote the twin objectives of preserving freedom from foreign control over operations and simultaneously gaining access to foreign technology and know-how. The Foreign Exchange Regulation Act (FERA) of 1973 under Prime Minister Indira Gandhi was considered a hostile act. The FERA required foreign firms to dilute their equity holdings to less than 40% or export a substantial share of their total output. This resulted to closure of renowned MNCs like IBM and Coca Cola to shut their operations in India.1967-79, the number of collaborations agreements per year reached an all-time low of 242.
The Mid- 1980s saw a considerable though not a radical relaxation of the dirigiste trade and investment regime, with a relatively benign attitude towards foreign enterprise participation. The major crucial change during this period was a significant change in the pattern of foreign investment in India away from plantations, minerals and petroleum toward the manufacturing sector. By the end of decade of eighties manufacturing accounted for nearly 85% out of total stock of FDI of about Rupees 28 billion. Inflows of private capital remained meagre in the 1980s: they averaged less than $0.2 billion per year from 1985 to 1990 (Kapur & Athreye 1999).
In the year 1991, India too liberalised its highly regulated FDI regime, in place for more than three decades. Arguably Balasubramanyam (2004) in his book stated that, it took an economic crisis for India to liberalise its trade and FDI regime rather than a fundamental change in attitude towards the role of FDI in development process. Nonetheless, the 1991 reforms marked a major break from the earlier dirigiste regime with its regulation of the spheres of foreign enterprise participation on its mode of operation. And the policy framework was opaque with the implementation of policy based on bureaucratic consideration of each case on its merits. Hence the 1991 reforms were to change all this: The abolition of the industrial licensing system, controls over foreign trade and foreign investment were considerable relaxed, including the removal of ceilings on equity ownership by foreign firms. The reforms did result in increased inflows of FDI during the decades of the nineties as it considerable relaxed the dirigiste regime that prevailed for more than four decades (Balasubramanyam & Mahambare 2004). Hence with the liberalisation of the economy, fresh foreign investment was invited in a range of industries. Inflows to India rose steadily through the 1990s, exceeding $6 billion in 1996-97. The fresh inflows were primarily as portfolio capital in the early years (that is, diversified equity holdings not associated with managerial control), but increasingly, they have come as foreign direct investment (equity investment associated with managerial control). This was further supported by historically low interest rates in the US that encouraged global investment funds to diversify their portfolios by investing in emerging markets. International flows of direct investment, which had averaged $142 bn per year over 1985-90, more than doubled to $350 billion in 1996, with the developing countries receiving $130 billion (Kapur & Athreye 1999).
1996-1998, the period of the coalition government has been an imperative period in our study; Singh (2005) classified this as a period when government has shown willingness to understand FDI by placing policies that would result in an increase in FDI and further liberalization for the common cause. There was an increased understanding on the role of FDI in all sectors. Industries still lead the reforms whereby automatic approval of FDI was increased up to 74% by the Reserve Bank of India (RBI) in nine categories of industries, including electricity generation and transmission, non-conventional energy generation and distribution, construction and maintenance of roads, bridges, ports, harbours, runways, waterways, tunnels, pipelines, industrial and power plants, pipeline transport , water transport, cold storage and warehousing for agricultural products, mining services including silver and precious stones, manufacture of iron ore pellets, pig iron, semi-finished iron and steel and manufacture of navigational, meteorological, geophysical, oceanographic, hydrological and ultrasonic sounding instruments and items based on solar energy (indiabudget.nic.in).
January 1997, Government announced the first ever guidelines for FDI speedy approval in areas that are not covered under automatic approval. Above trends illustrates the earlier point of the government recognizing and carrying forth of the previous work done by the Rao government. While the advantage of FDI did not reach the mindset of the common man but government seemed to show possibilities of overall development through FDI. For example when Indian industry registered a modest growth rate of 7.1% in 1996-97, which was much lower than the 12.1% in 1995-96, there was research carried out which revealed this was partially attributable to the mining and electricity generation sectors which recorded very low growth rates of 0.7 % and 3.9 % respectively. Hence, the policy was immediately rectified and re-enforced by expanding the list of industries eligible for foreign direct equity investment under the automatic approval route by RBI in 1997-1998 (indiabudget.nic.in).
2004-05, embraced FDI for being an integral part of national development strategies. Its global popularity along with positive output in augmenting of domestic capital, productivity and employment; has made it an essential tool for initiating economic growth for nations. During this phase, India evolved as one of the most favoured destination for FDI in Asia. It has displaced US as the second-most favoured destination for FDI in the world after China. According to an AT Kearney’s FDI Confidence Index, India attracted more than three times foreign investment at US$ 7.96 bn during the first half of 2005-06 fiscal, as against US$ 2.38 bn during the corresponding period of 2004-05. FDI in India has contributed effectively to the overall growth of the economy in the recent times. FDI inflow has an impact on India’s transfer of new technology and innovative ideas, improving infrastructure, a competitive business environment (Indianground.com).
Ballabh (2008) in his article mentioned about the Balance of payments (BOP) since independence, India’s BOP on its current account has been negative. Since liberalisation in the 1990s (precipitated by a BOP crisis), India’s exports have been consistently rising, covering 80.3% of its imports in 2002-03, up from 66.2% in 1990-91. Although India is still a net importer, since 1996-97, its overall BOP (including the capital account balance), has been positive, largely on account of increased FDI and deposits from NRIs; until this time, the overall balance was only occasionally positive on account of external assistance and commercial borrowings. As a result, India’s foreign currency reserves stood at $141bn in 2005-06. India’s recently liberalised FDI policy (2005) allows up to a 100% FDI stake inventures. Industrial policy reforms have significantly reduced industrial licensing requirements, removed restrictions on expansion and facilitated easy access to foreign technology and foreign direct investment FDI.
History of FDI in China
FDI’s main source in China from 1950s had been Soviet Union. However, it was after 1978 that China began to open up itself to the rest of the world for FDI inflows. From the start of 1978 China witnessed its exit from its self-dependent strategies since Mao’s era with the country announcing a remarkable program to reform its economic system by opening itself up to the outside world. From the beginning of 1978, FDI in China became desirable and began to add in the development of the Chinese economy. In general, the development of FDI in China can be divided into following five stages.
Experiment Stage (1979 – 1983)
China started from an experimental approach, which they called “crossing the river by feeling the stones under the water.” FDI was permitted into China in a step-by-step manner. One key action of the first step was the establishment of four Special Economic Zones (SEZs), namely Shen Zhen, Shan Tou, Zhu Hai and Xia Men, in July 1981. These SEZs were chosen for the absorption and utilization of foreign Investment. These provided foreign investors with preferential treatment for their Businesses. As China’s “window to the world”, these zones succeeded in attracting FDI. Meanwhile, China was putting up effort to complete its legislative system. First to come was, the Equity Joint Venture Law (the Law of People’s Republic of China on Joint Ventures Using Chinese and Foreign Investment) that was enacted in July 1979. The legislation validated the existence of FDI in China and guaranteed the right and benefits of foreign investors. Second important policy taken at this stage included Regulation for the Implementation of the Law of the People’s Republic of china on Chinese -foreign Equity Joint Ventures (1983).
Growth Stage (1984 – 1991)
Until 1984 there were flaws in China’s handling FDI. China’s restraints on FDI outside the SEZs remained rigid. Laws and regulations limited foreign ownership. FDI projects often encountered a long approval process even though they provided sufficient materials and explanation. This was simplified gradually between 1983 and 1985. Following is the list of new laws and regulations at this stage year on year basis.
- Wholly Owned Subsidiaries (WOS) Law (1986)
- Provision for the FDI Encouragement (1986)
- Constitutional Status of Foreign invested Enterprises in Chinese Civil Law (1986)
- Adoption of Interim provision on guiding FDI (1987)
- Delegation on approval of selected FDI projects to more local governments (1988)
- Laws of cooperative joint ventures (1988)
- Revision of equity joint venture law (1990)
- Rules for implementation of WOS law (1990)
- Income tax law and its rules for implementation (1991)
1984 witnessed two historic activities. First was when Deng Xiaoping remarked that China needed to open wider instead of checking upon the opening process (Zheng, 1984). Second was when Chinese government announced the decision on reform of the economic structure, and called for the building of a socialist commodity economy by assigning a larger role to the market in the domestic economic. Besides SEZs, Chinese government took a further step to give FDI access to other parts of the country. Fourteen coastal cities were announced to be opened to the outside world. They are Dalian, Qinhuangdao, Tianjin, Yantai, Qingdao, Lianyungang, Nantong, Shanghai, Ningbo, Wenzhou, Fuzhou, Guangzhou, Zhanjiang and Beihai. The local government from these cities could approve FDI projects with capital investment up to certain level. For example, Shanghai could approve all FDI projects under 30 million USD (Yuan, 2006). They were also given the right to spend foreign exchange yielded by local FDI for their own growth. The approval procedures for FDI projects were eased. The Law of People’s Republic of China on Wholly Foreign-owned Enterprises (WFOEs) of 1986, was laid to protect the profits and interest of foreign investors. In addition to this series of other laws and regulations further relaxed China’s restriction in promoting FDI with measures for enterprise autonomy, profit remittances, labour recruitment and land use.
In December 1990, the central government promulgated Detailed Rules and Regulations for the Implementation of the People’s Republic of China Concerning Joint Ventures with Chinese and Foreign Investment. The regulation aimed to encourage joint ventures that adopted sophisticated technology or equipments, saved energy and raw materials and upgraded products.
Peak Stage (1992 – 1993)
This stage has witnessed the rise of Shanghai as China’s economic hub. The Chinese government wanted to develop Shanghai into an international hub for finance, economy and trade. Their intention was to carry out the experiment of new policies and apply successful practices within the rest of Shanghai and across the country. Shanghai’s location in Southeast China drew attention of Chinese government’s in shifting emphasis to the area to avoid overly concentration of FDI. Hi-tech enterprises, established manufacturers and financial companies were encouraged to set up their China operation at Pudong with various preferential treatments from central and local government. With the implementation of a new framework for further opening up the economy, the Chinese government showed great effort to encourage FDI. A number of new Sectors were also opened up to foreign investors, including banking and insurance, accounting and information consultancy, wholesaling and retailing at the same time, governmental procedures were simplified in terms of FDI administration.
The year of 1992 witnessed the remarkable growth of FDI in China. In the same year, the Chinese government announced its intention to adopt the strategy of “socialist market economy” and improve the economic framework for standard market Operations. Following are the series of laws and regulations related to market operations were passed during 1992 and 1993, which included:
- Adoption of Trade Union Law (1992)
- Company Law (1993)
- Provision regulations of value-added tax, consumption tax, business tax and Enterprise income tax (1993)
Adjustment Stage (1994 – 2000)
After 1994, the growth rate of FDI in China went down to a steady level from the relatively high rate in past two years, which indicated that a new stage had arrived.
1995s Provisional Guidelines for Foreign Investment Projects provided preferential treatment to various enterprises in various industries. The directory of the Guidelines categorized all the FDI projects into four types: encouraged, restricted, prohibited and permitted (Yuan, 2006).
The projects in infrastructure or underdeveloped agriculture and with advanced technology or manufacturing under-supplied new equipment to satisfy market demand fell into the ‘encouraged’ category. Those whose production exceeded domestic demand and those who engaged in the exploration of rare and valuable resources were put into restricted. The ‘prohibited’ category included projects that would risk national security or public interest, or those endangering military facilities.. The last one is classified as permitted. Annual utilization of FDI reached to its peak in 1997 and 1998 but then moved downward in the following two years.
Post-WTO Stage (2001 – present)
November 11, 2001, saw China’s admission as an official member of the World Trade Organization (WTO), after a 15-year negotiation. It was after accession to WTO, China started to fulfil its obligation such as basic principles of non-discrimination, pro-trade and pro-competition. This historic event had significant Impact on FDI inflows to China. This gave incentives to more export-oriented FDI. China’s export market becomes larger and more predictable. Also, China’s domestic market attracts FDI in industries where there is large market potential. Usually, these industries used to be dominated by relatively inefficient state-owned enterprises, such as telecommunication, banking and insurance. Foreign investors, especially large multinational companies (MNCs), have now growing interest in these industries. Becoming a WTO member, China had to restructure its legal framework. This, in consequence, improves China’s business environment and helps attract more foreign investment.
Yuan (2006), in his literature has revealed, throughout the years, China has steadily reduced its industrial tariffs in a wide range of sectors. Foreign firms are granted direct trading rights for the first time, which means they can import and export themselves without going through a Chinese state-owned trading firm. Clearly, China’s acquiring WTO membership boosts investors’ confidence the Chinese economy and its market and thus attracts more FDI inflows.
FDI’s: Critical Analysis
FDI’s in other countries are now been continuously studied. There are numerous factors and studies motivating this type of investment for the benefit of source and host countries. There has been a substantial change in policies and attitudes towards FDI on the part of most developing countries in recent years. Disbelief and suspicion of FDI’s in the past now appears to have given place to a new found faith in its ability to encourage growth and development for the investing firm and host countries. This perception is due to number of factors: steep fall in alternative sources of finance such as bank credit in the wake of the debt crisis, the self-evident success of Asian countries like India and China, and growth in Knowledge and understanding of the nature and operations of multinational enterprises (Balasubramanyam & Mahambare, 2004). In regards to stability aspect of FDI toward the growth of investing firm and host countries, empirical studies have found FDI to be more stable than other forms of capital (UNCTAD, 1998, World Investment Report, Geneva). Examination of a variety of capital flows in developing countries during East Asian financial crisis revealed FDI was more stable than other capital flows past studies analysis that FDI is the result of certain competitive advantage. Paul et al. (2002), revealed in their book; many developing countries like India favour FDI over other capital inflows and there is a substantial benefit that such investment benefit the host country and thereby attracting more foreign firms for investment as the benefits in this form of investment is both ways. Knowing the benefits of FDI in host countries would make the legislation system clear and simple and would enable foreign firm for investment based on long-term profits. Swamy (2000) in his book has done calculation the rate of return of FDI in India. His results revealed the rate of return on FDI in India higher than the rate of return obtained on global outward FDI. To quote from his studies,” FDI Enterprises were able to earn relatively higher profit rates in India, despite higher level of taxation and tariffs etc. Thus the low level of FDI Inflows until the end of 1980s seems to have been caused restrictive policy environment rather than profitability considerations”. Pradhan (2000) has scrutinised the various aspects of FDI from source as well as Host countries’ point of view, with a focus on the risk from the firm’s perspective and on the strategies to attract FDI to be adopted by host countries. His study thereby revealed that the higher rate of return for an MNC comes with FDI is, in fact, the result of existing market opportunities combined with the host countries policies towards FDI. Thereby, Indicating strong signals of overall growth of Host countries (developing) in conjunction with FDI and higher rate of return for MNCs.
Lensink & Morrissey (2001), literature suggests that FDI by MNCs is one of the major channels in providing LDCs (least developed countries) with access to advanced technologies and generating high revenue for MNCs involved in investment for them. The underlying theory differs illustrates the benefits of FDI for MNCs and host countries.
The ‘imitation channel’ is based on the view that domestic firms may become more Productive by imitating the more advanced technologies or managerial practices of Foreign firms for foreign firms and at the same time adding to GDP for their own country. Also, the competition channel emphasises that the entrance of more foreign firms from abroad intensifies competition in the domestic market, thereby encouraging domestic firms to become more efficient and productive by upgrading their technology base.
The ‘linkages’ channel stresses that foreign firms may relocate new technology to Domestic firms through transactions, and would develop buyer-seller relationship. This would necessities Training from the foreign firm to the domestic firm. Hence the training channel needs to be enforced on new technologies. This can only be adopted when the labour force feels comfortable to work with their foreign partner and when embraced works for the benefits of foreign firms as well.
Beside these studies, in some of the literature the contribution of FDI to foreign firm and host countries economic growth has been debated quite extensively. Findings reveals that FDI has both benevolent and a dangerous impact. Empirical evidence that FDI generates positive spillovers for firms is mixed. Few studies have found positive spillover effects, few finds no effects and few even conclude that there are negative effects (see Aitken and Harrison, 1999). The conventional argument is that an inflow of FDI positively contributes as; it brings technology, know-how and management techniques. It integrate the operation of local firms into the networks of foreign investors, it helps to place local production on international markets and integrates the national economies into worldwide production and distribution systems. Hence, concluding that FDI can contribute positively and increase the export activity of the host economy (Adam 2002). On the other hand, some of the recent literature points to the role of FDI as a channel of international technology transfer. It can deliver rather controversial effects. Foreign firms can out-compete local producers, reduce local production capacities close down research and development units, break up traditional subcontractor relationships and substitute them with imported goods, and repatriate profits thus deteriorating the balance of payments position of the host economy. Sometimes, could lead to absolute shut-down of foreign firms when opposed by local people of host countries. For example Coca-Cola Company had shut down bottling plant in India during a community-led campaign that demanded the closure of the Coca-Cola bottling plant because of indiscriminate pollution as well as illegal occupatio