FDI in India in the 1990s

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S p e c i a l articlesForeign D i r e c t Investment

i n I n d i a i n t h e 1 9 9 0 sT r e n d s a n d I s s u e s

This paper documents the trends in foreign direct investment in India in the 1990s,and compares them with those in China. Noting the data limitations, the study raises someissues on the effects of the recent investments on the domestic economy. Based onthe analytical discussion and comparative experience, the study concludes bysuggesting a realistic foreign investment policy.R NAGARAJ

IntroductionC ompared o most industrialisingconomies,India fol-lowed afairlyrestrictive foreign privateinvestment policyuntil 1991 - relying more on bilateral and multilateralloanswithlong maturities.Inward oreign direct investment (FDI,orforeigninvestment, orforeign capital hereafter)was perceivedessentially as a means of acquiringindustrialtechnology that wasunavailable hrough icensing agreementsandcapitalgoods import.Technology imports were preferred to financial and technicalcollaborations. Even for technology licensing agreements, therewere restrictions on the rates of royalty payment and technicalfees. Development banks largely met the external financial needsfor importing capital equipment. However, foreign investmentwas permitted in designated industries, subject to varying con-ditions on setting up joint ventures with domestic partners, ocalcontent clauses, export obligations, promotion of local R and Dand so on - broadly similar to those followed in many rapidlyindustrialising Asian economies.

ForeignExchange andRegulation Act (FERA), 1974 stipulatedforeign firms to have equity holding only up to 40 per cent,exemptions were at the government's discretion. Setting up ofbranchplants was usually disallowed; foreign subsidiaries wereinduced to gradually dilute their equity holding to less than 40percent in the domestic capital market. The law also prohibitedthe use of foreign brands, but promoted hybrid domestic brands(Hero-Honda, for instance). However, pragmatism prevailed toensure stable domestic supply at reasonable prices.Such a restrictivepolicy is believed to have retarded domestictechnical capability (as reflected in the poor quality of Indiangoods); it also meant a loss of export opportunity of labour-intensive manufactures - in contrast to many successful eastAsian economies. Moreover, such a policy is said to haveencouraged 'rent seeking' by domestic partners on importedtechnology - with little efforts to improve product quality,undertake innovation, and seek export markets [Ahluwalia1985]. This popular perception was perhaps best illustrated by

the passenger car industry that produced obsolete (and fuel-inefficient) models of the 1950s at very high costs in smallnumbers.Withoutdenying some of these argumentsandevidence, othershave shown that the regulation reduced costs of technologyimports[Subramaniam1991], andpromotedexportof goods withrelatively stable technologies where domestic firms had theopportunityof 'learningbydoing' bycateringto thelargedomesticmarket - as illustrated by successful firms like TELCO (com-mercial vehicles) and BHEL (heavy electrical equipment) [Lall1982]. The recent international achievements of some Indianpharmaceutical irms (Cipla,Ranbaxy, Dr Reddy's Laboratories,for instance) is also attributed o the regulatory andpromotionalpolicies, and the patent laws [Chaudhari 1999] that sought toencourage domestic production to reduce drug prices.However, the 1980s witnessed a gradual relaxation of theforeign investment rules- perhapsbest symbolised by the settingupof Maruti,a centralgovernmentjoint venturesmall carprojectwith Japan's Suzuki Motors in 1982. It was followed by Pepsi'sentry in the second half of the decade, to primarily exportprocessed food products from Punjab, and also to bottle its wellknown beverages for the domestic market.

Reforms in the 1990sAll this changed since 1991. Foreign investment is now seenas a source of scarce capital, technology and managerial skillsthat were considered necessary in an open, competitive, worldeconomy. India sought to consciously 'benchmark' its policiesagainst those of the rapidly growing south-east Asian economiesto attract a greater share of the world FDI inflows. Over thedecade, India not only permitted foreign investment in almostall sectors of theeconomy (barringagriculture,and,untilrecently,real estate), but also allowed foreign portfolio investment - thuspractically divorcing foreign investment from the ersts hiletechnology acquisition effort. Further, laws were changed toprovide foreign firms the same standing as the domestic ones.1

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What are the trends in the quantum and composition of theFDI inflow; andwhat aretheir benefits and costs to theeconomy?This paper seeks to provide a preliminary answer for thesequestions. To do so, we first discuss, very briefly, the recentliterature on foreign investment and economic development(Section I). The limitations of the available data to test thepropositions following from the analytical literatureare discussedin Section II.As afirststepinourassessment, Section IIIdescribesthe trends in FDI in the 1990s. Section IV contains a briefcomparison of foreign investment in India and China - an issuethat has a bearing on the current policy discussion. Based onthe available, limited and preliminary, information, Section Vmakesan initial assessment of foreign investment byraisingsomeissues for furtherwork. Section VI suggests a morerealisticpolicyon the basis of the analytical discussion and comparative expe-rience. Section VII concludes by summarisingthe study's mainfindings.

ABriefAnalytical eviewMuch of thecurrentlyheld perceptions of foreign investment's

role essentially take a macroeconomic view: it is a source ofadditional external finance (andof riskcapital), augmenting fixedinvestment, potential output and employment.2 Such a positiveview gained currency mainly after the crises in Latin Americain the early 1980s, more recently in east Asia, when other formsof capital inflows quickly dried up (or reversed), accentuatingthe macroeconomic vulnerability of these economies. As againstportfolio investment, FDI is also seen as a source of technologyand managerial skills, creating tangible (and intangible) assetsin the host economy. Foreign firms seek not only the domesticmarket,but also provide access to external markets by sourcingmanufactured products (and services) from domestic firms.The crux of the policy, therefore, is how the benefits of suchinvestments are distributed between the foreign firms and thehost country, as also between the various factors of productionwithin the host country. In other words, the real question is thecost of foreign capital to the host economy: is it too high,compared to the alternative sources of external finance andtechnology, in the short and the long run?However, in a microeconomic perspective, a different set ofquestions is usually asked: What does FDI do to the workingof the domestic markets, and their effect on output and produc-tivity growth [Caves 1996]. If, as is often the case, the entry ofa foreign firm results in the creation of a domestic monopoly,then the benefits of such investment may be limited, unlessaccompanied by a sound anti-trustlaw (or competition policy).Similarly, if FDI inflow results in the displacement of domesticmonopolies with the foreign ones, then again, social benefits ofsuch investments may be marginal (if any), as any monopolist,regardlessof its origin, would maximise profits eitherby varyingprice or output (or both). Moreover, the host government mayhave considerable difficulty in enforcing domestic laws ad-equately, as foreign firms often seek protection under compli-cated legal structures.3Inindustrialorganisation literature, rom a varietyof analyticalperspectives, foreign firms are seen as having firm-specificadvantages - including significant marketpower that they seekto exploit in many countries.4 Availability and costs of theseresources forthe host economy depend on the relativebargaining

strength of the foreign firms vis-a-vis the domestic firms (andthe host government). While the foreign firms' advantages liein their size, control over technology and marketing strengthworldwide, the host country can use its domestic market, accessto cheap labour, location and quality of infrastructure (all ofwhich go to reduce the cost of production to service the inter-national market) to bargain with the foreign firms.Thus, a social cost benefit approach is perhaps a meaningfulmethod to assess the potential effects of FDI. If such a view isvalid, then what countries should do is perhaps not to maximiseforeign investment inflow per se, but to channel it in the desireddirections to maximise long-term returns to the economy. Fromthe development economics perspective, the questions one askscould get even deeper. In a world with unequal resources andtechnological capabilities (including brand names), how doesFDI affect the ownership and control of industrial firms? In themarketfor industrialtechnologies that is invariably oligopolistic,does foreign capital inflow augment or reduce access to techno-logy and domestic R andD efforts? Does foreign capital improveexports (and export capability) from the host country? What isthe cost of FDI over a long period; is it necessarily lower thanthat of external debt [Helleiner 1989]?5It is perhaps worthreiterating that markets for industrialtech-nologies continue to be imperfect and probably have got accen-tuated with the recent international agreements like the TRIPS.Moreover, theexperience of thelasthalf acentury clearly suggeststhatcountries with liberal FDI and technology import policy arenotnecessarilytheexamples of successful industrialisationBruton1989]. They may have become either outposts of foreign firmsservicing regional markets (like Singapore), or partners in theinternational division of labour with limited mastery over pro-duction technology and generation of domestic brand names(Brazilian automobile industry, for example).In the development literature, well reflected in the Indiandiscourse, there is a wide consensus thatregulation reduces costs

of imported technology [Lall 1989]. One of the ways to acquirethe disembodied technology is to 'unbundle' the package thatforeign firms offer, and to buy the technology outright, whileprovidingforcapital investment by the domestic financial system.This has been the time-tested method of all the successful lateindustrialising economies [Amsden 2001].6

IIDataon FDI ndTheirLimitationsTo understandhow the recent changes in foreign investmentpolicy have influenced the economy, quantitative information isneeded on broad dimensions of the investment (and its distri-

bution) across industries, regions and by size of projects; firmand industry level production accounts, and audited financialstatements. However, such information is scarce. The most easilyavailable (and widely used) data in India are on FDI approvals(contracted), by broad industry group (1-digit ISIC), by countryof origin, and by states (regions) of destination. This representsmere intentions of investment. The actual (or realised) foreigninvestment is not available by the same classification, but ac-cording to the administrative and institutional channels of theinflow. Therefore, it is not possible to compare the realisedwith the intentions, in any meaningful manner. Apparently,even the concerned official agency does not seem to know - letalone monitor- how the actual inflows aretranslated ntocapital

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Figure 1: FDI nto India,1992-200060000 -8050000 -- 6040000 68o 30000 40a: 20000- 40 2010000 '0 - I i i 0

1992 1993 1994 1995 1996 1997 1998 1999 2000YearFDI realised r FDIapproved *- Realised to approvedratio

formation, transfer of assets or change in managerial control.The actual FDI inflow is recorded under five broad heads:(i) Reserve Bank of India's (RBI) automatic approval route forequity holding up to 51 percent, (ii) Foreign Investment Board'sdiscretionaryapprovalrouteforlargerprojectswithequity holdinggreater than 51 per cent, (iii) acquisition of shares route (since1996), (iv) RBI's non-resident Indian (NRI) schemes, and(v) external commercial borrowings (ADR/GDR route). Report-edly, the Indian definition of FDI differs from that of the IMF,as well as of the UN's WorldInvestmentReport. IMF's definitionincludes external commercial borrowings, reinvested earningsandsubordinated ebt,while the World nvestmentReportexcludesexternal commercial borrowings.7Ideally, FDI inflow should get reflected in (i) capital formation(ii) formation of new firms and factories, (iii) increase in foreignequity holding in the existing firms, and (iv) mergers and ac-quisitions of existing firms and factories (or parts of them).However, the availability of information on them depends ontheir legal status. We know very little about those registeredoutside the country, and in tax shelters, like Mauritius. Forinstance, Enron's Dabhol Power Company - the largest foreigninvestment project yet - is incorporated in India as an unlimitedliability company. But it is a shell company that Enron controlsthroughat least six holding companies registered in various off-shore locations [Mehta 1999].8Similarly, fully owned private limited companies of foreignfirms(orbranchplants) reveal very little information about theirinvestmentandoutput.An increasingly large proportionof foreignfirms have set up fully owned subsidiaries that have becomemanufacturers(and distributors) by acquiring domestic firms.They provide very little audited financial information to assesstheimpactof the firms on the industry,andthecorporatesector.9Considering these legal problems, many of their operations donot seem to get recorded in the RBI's survey of financial per-formance of foreign controlled companies - a valuable datasource in the earlier times.

Therefore, the assessment of foreign investment reported inthisstudyremainspreliminary.However, based on the precedingdiscussion, the issues raised below can perhaps be taken asworking hypotheses for further research.IIIThe Trends

FDIApprovals and Its CompositionApproved FDI rose from about Rs 500 crore in 1992 to aboutRs 55 thousand crore in 1997 [Economic Survey, 2001-02](Figure 1).Cumulative approvedforeign investment during 1991

and2000, indollarterms,is about$ 67bn - -at anaverageexchangerate of Rs 40 to a dollar. A fifth of it is from the US (Table 1).Mauritius is the second largest source; reportedly a conduit formany US based firms, as India has a tax avoidance treaty withit since 1982. In Asia, South Korea has emerged as a new sourceof foreign investment.10 A quarterof the approved FDI is forpower generation (Table 2), followed by telecommunications(mobile phone firms) at 18.5 per cent, and electrical equipment(mainly software) at 10 percent. While the proportionof projectswith investment up to Rs 5 crore is high, their share is less than5 per cent in value. At the other end of the distribution, largerprojects with Rs 100 crore andabove account for over two-thirdsof the total value of approvals (Table 3). Evidently, very littleof the FDI has gone to augment exports that are mostly fromlabour-intensive unregistered manufacturing. The economicallyadvanced states of Maharashtra,Delhi, Kamataka, Tamil Naduand Gujarat have attracted one-half of the approved foreigninvestment (Table 4).Table 5 provides the actual FDI inflow as estimated by fourdifferent agencies, for 1991 to 2000. IMF's and the WorldInvestment Report's estimates of the cumulative inflow duringthe 1990s areroughly the same - at about $17bn. The EconomicSurvey estimate is about $ 22bn, while that by RBI is $17.3bn.The difference between the last two estimates is mainly onaccount of ADR/GDR inflows. While the Economic Surveyclassifies them as FDI, RBI records them underforeign portfolioinvestment.As there has been a gradual improvement in the actual inflowfrom a low base, and a slow down in the approvals after 1997,

Table 1: Top 10 Investing Countries in India,1991-2000Country/Region Share (inPerCent)US 20.4Mauritius 11.9UK 6.4Japan 4.0South Korea 3.9Germany 3.4Australia 2.7Malaysia 2.3France 2.1Netherlands 1.9Note: Inaddition o thecountries,externalcommercialborrowings nd non-resident Indians NRIs)contributed 7.2 and 3.9 percent of the FDIapprovals.Source:Handbook f Industrial olicyand Statistics,2001.

Table 2: Sectoral Distributionof FDIApprovals, 1991-2000Sector No of Approvednvest- ShareApprovals ment(Rs Billion) (inPerCent)Powerandfuel 541 634531.2 25.7Telecommunications 579 458845.0 18.5Servicessector 790 152389.0 6.2Chemicals otherhan ertilisers) 809 123016.2 5.0Foodprocessing 648 87574.9 3.5Transportector 722 184467.6 7.5Metallurgicalndustries 304 143796.8 5.8Elecequipmentincl oftware) 2491 245791.5 10.0Textiles 548 33617.8 1.4Paperandpaperproducts 111 31580.6 1.3Industrial achinery 530 22438.5 0.9Others 2404 348976.2 14.2Total 11965 2467025.3 100.0Note: Data is forthe period,August1991 to March1998.Source: Handbook f Industrial olicyand Statistics,2001.

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Figure 2: India's Share in World FDI2.5 .........1.5 -

0.5 -

1992 1993 1994 1995 1996 1997Year

- India's share in world FDIFigure3: Actual FDIby Different Routes

8070' 60 '~ 0SOT - - - - -- - -- - - - - -- - - - -- - -~'7 - --- -

ro .40--20- _____2 ,/

o10

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001Year--- FIPB ---- RBIroute -- Share acquisition

-- NRI route -*- ADRs/GDRs

there is an increase in the ratio of the actual-to-approved FDIin the last few years. On average, it is a little over one-third inthe 1990s (Figure 1). India's share in world foreign investmentincreased from 0.5 per cent in 1992, to 2.2 per cent in 1997(Figure2).Figure3 describes the actual inflow by various routes discussedin the previous section. The FIPB route - representing largerprojects requiring the government's discretionary approval -accounts for the bulk of the inflow, though its share is somewhatdeclining. Automatic approval route via RBI meant for smallersized investments received modest inflow; and the NRI route'sshare has declined sharply. Proportion of the inflow to acquireshares in the domestic firms, and flotation of ADRs/GDRs havegained in prominence in the second half of the 1990s.

Interpreting the TrendsThough it is not possible to compare the actual with theapproved FDI for the reasons discussed earlier, some broadgeneralisation can perhapsbe made based on the available quali-tative information. While the bulk of the approvals is for infra-structure, the actual inflow seems to be largely in registered

manufacturing more precisely, in consumer durablegoods andautomotive industries;very little of it hasgone into capital goodsindustries.The inflow in telecommunication industry s probablyto get licences for mobile phone operations,not for manufacturingequipment. The investments in electrical machinery industryareapparentlyto set up local offices to produce computer software.Much of the realised FDI has also come in as fully ownedsubsidiaries (or branch plants) of their parents abroad. Table 6provides an illustrative list of such foreign entities. Most of themhave not issued IPOs in the domestic bourses, hence are notquoted companies. Quite contrary to the earlier period, thegovernment has so far not insisted on enforcing its policy in thisrespect (more about this later).

About40 percent of the inflowseemsto have been used foracquiringxisting ndustrial ssets,andtheirmanagerialontrol(Table7 (i)); and,thereseems to be a gradualncrease n suchmergerand acquisitions n the 1990s (Table7 (ii)). Further,Table8 providesan illustrative ist of plants anddivisions)ofIndiancontrolled irmsacquiredby foreign irms in the 1990s.This is also evident rom thefact that oreign irmsseem to usea largerproportionf their otal fundsfor suchacquisitionhanfor capitalformation, ompared o Indianowned firms in theprivatecorporate ector,the ratioof fixed capital ormation ototal uses of fundsby foreignfirmsis lower thanthatby thedomesticcompanies[Nagaraj1997].Predominance f acquisitions n India as a routeto FDI issimilar othe rendsnmanydeveloping conomies.For nstance,in Brazil,the ratio s as high as 70 percent,mainlyfueledbyprivatisation rive in the 1990s.11Foreignfirms seem to findit a quickandcheaperrouteto entera new market,andsecurea sizeablemarket hare.Oflate,takingadvantage f thechanges n therulesgoverningthestockmarketisting,in a situationof low shareprice evel,manyexisting oreign irmsarere-purchasingheir quity o exitTable 3: Distribution of FDI by Size of Investment, 1991-97

Investment No of FDIApprovals Quantumf FDIApproved(Rs Crore) Number Share(inPerCent) Amount Share(inPerCent)0-1 3040 49.2 919.4 0.91-5 1686 27.3 3800.8 3.65-25 906 14.7 10046.0 9.525-50 212 3.4 7503.5 7.150-100 128 2.1 8828.4 8.4100-500 173 2.8 38699.0 36.6Over500 38 0.6 35992.4 34.0Note:Thisdistributions forthe approvalsduringAugust1991 andMay1997.Source: Rao andMurthy1999).

Table 4: Top Five Destinations of Approved FDIamong the Indian StatesState No of Financial ApprovedFDI ShareCollaborations pproved ($ Million) (inPerCent)

Maharashtra 2015 11135.9 16.9Delhi 1226 9226.7 13.1Karnataka 1078 5247.1 8.1TamilNadu 1223 5073.8 7.7Gujarat 458 3129.6 4.5State not indicated 3119 19476.4 27.9Source: Handbookof Industrial olicyandStatistics,2001.

Table 5: Alternative Estimates of the Actual FDI, 1991-2000Year Economic RBI International World nvestmentSurvey (RsCrore) Financial tatistics Report

(Rscrore) (Million) (Million)1991 351 316 1551992 675 965 276.5 2611993 1787 1836 550.1 5861994 3289 4126 973.3 9471995 6820 7172 2143.6 21441996 10389 10015 2426.1 25911997 16425 13220 3577.3 36131998 13340 10358 2634.7 26141999 16868 9338 2168.6 21542000 19342 10686 2315.1 2315Tota! 89286 68034 17065.3 17080Sources: EconomicSurvey,various ssues; RBI'sHandbookof StatisticsonIndianEconomy,2001; IMF's nternational inancialStatisticsCD-ROM;UN's World nvestmentReport,various ssues.



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Figure4: FDI n Selected Asian Economies, 1991-200090-8070

u) 60-D 50

I?4?t "B t t

40000 dia3300

25000200 *00 * ---

15000

o1990 1992 194 1996 18 2Figure 5: FDI n India and China

50000 China40000 India in t35000300002500020000 /1500010000

50001990 1992 1994 1996 1998 2000 2001

from the domestic bourses. Table 9 provides an illustrative listof such firms. This represents a reversal of the positive effectthat the foreign firms' domestic listing has had on the develop-ment of the primary stock market since the late 1970s [Nagaraj1996].IVA Comparison f FDI n IndiaandChina

Though the actual FDI inflow in India in the 1990s increasedsignificantly over the past, it is modest compared to many Asianeconomies (Figure4); and, it palesnto insignificance incompari-son to China (Figure 5).12,s3 UNCTAD's ranking of countriesin termsof foreign investment (relative to thesize of theeconomy)for the period 1998-2000 is 119 for India, and47 for China. Therankinga decade ago was 121 and61 respectively (The New YorkTimes, August 28, 2002). It shows that even at the start of thereforms,China's rankingwas way aheadof India' s; China movedup in the ranking much faster than India did in the 1990s.These statistics are widely seen as an evidence of the failureof India' reforms,since greater nflow of foreign capital inChinais believed to be largely responsible for its exceptional growthand export performance. As this perception is much discussedin the currentpolicy discourse, we examine the quality of theIndian and the Chinese estimates, and the evidence on the roleof FDI on economic performance in the recent years.According to IFC (2002), India does not follow the standardIMFdefinition as it excludes (i) externalcommercial borrowings,that s ADRs/GDRs, (ii) reinvested profits and (iii) subordinateddebt.14 IFCis probably right,butonly partially. As noted earlier,the Economic Survey estimates include external commercialborrowings,but not the remaining two items. Thus, notwithstand-ing the underestimation of FDI in the Indian statistics, there islittledoubt hat oreign nvestment nflow in India s negligible

as compared o China.However, t is well recognised hata largeshareof theinvest-ment nflowin Chinarepresentsround ripping' recyclingofthe domesticsavingvia Hong Kong to takeadvantage f tax,tariffsand otherbenefitsofferedto non-residentChinese.Thisis estimatedo be in therangeof 40-50 percentof the totalFDI(IFC, Global Financial Report, 2002).Further, bouta quarter f the inflow in China s invested nrealestate TsengandZebregs 002].Someof theChinese oastalcitieshaveattractedonsiderablepeculative apitaln thissectorin the 1990s afterthe collapseof the propertypricesin HongKong. It is widely accepted, especially after the east Asianfinancial risis, hat oreign nvestmentnrealestate s inherentlyproblematic,sthissectorcan asilygiverise ofinancial ubbles,with potentiallyadversemacroeconomic onsequences.Of the remaining, nly a small fractionhas gone into large-scale manufacturinghat can potentiallyaugmentdomesticcapability ndexports. nfact,FDIfrom headvanced conomiesthat couldbring n newertechnologyandmanagerial racticesare limited, as the Chinese still seem to have a fairly strictregulation n such inflows.Reportedly,n 31 industriesChinadoes not allow wholly foreign owned enterprises; nd in 32others,Chinesepartnersmust hold majority hareholding.15Basedonthe oregoing,heInternationalinanceCorporation'sstudyof businessenvironment,n fact,placesIndiamarginallyaheadof China from the viewpointof foreign nvestors IFC2002]. The studyalso found thatthequantum f FDI inflow inChinaand India,as proportionsof their respectiveGDP, isroughly omparable. hus, hewidelyheldviewofChina'sabilityto attractenormousforeign capital needs to be taken withconsiderable ircumspection.Do countries hat attractargerFDI inflow necessarilygrowfaster?In otherwords,is therea positive associationbetweenforeign nvestmentnflowandGDPgrowth?Evidence sfar romunambiguous.f China'sexceptionalperformances believed obe largelyon accountof theforeigncapital nflow,thenone alsohasto contendwith the recentBrazilian xperience hatprovesthecontrary. t hasprobablyattracted he largestFDIfrom theindustrialised conomiessince 1994.As notedearlier,muchofit has gone to acquiredomestic assets that were privatisedona largescale. But neitherBrazil'sgrowthor its exportperfor-manceimproved n the recentyears.Firm evel studiesalso do not showanyevidence hat oreigninvestments mproveoutputand productivitygrowth [Caves1996].Thereare,however,numerous ross-countrytudies hatprovide onflicting videnceon this issue.But,theyoften sufferfromseriousmethodological roblems.A recent tudy hat eeksto addressmanyof theconcernsassociatedwithsuchexercises,

Table 6: Illustrative List of Foreign Firms Not Listed in theDomestic Stock MarketProductGroup ForeignFirmsAutomobiles nd allied GM,Ford,MercedesBenz, Honda,Hyundai, iat,products Toyota,Volvo,Yamaha,Cummins,GoodyearFoodandbeverages Coca-cola, CadburySchweppes, Kellogg, Heinz,Seagram, HiramWaker,United Distillers,Perfitti,Wrigley,KFC,McDonaldsConsumer urable oods Daewoo, Samsung, Sony, General Electric, LGElectronics, lackandDecker,Kimberley larkPersonal areproducts Revlon,L'Oreal, ussons,UnileversSource:Rao, Murthynd Ranganathan 1999).

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Figure6: Decline in Technical Collaborations Agreements1200r -80

2804 ^iYearI600 -"

~~2 ~ .1011991 1992 1993 1994 1995 1996 1997 1998 1999 2000YearI IFTAs - Share of FTAs in total

seems to find no evidence of a positive association between FDIinflow and output growth [Carkovic and Levine 2002].16Thus, the quantum of FDI inflow into China, and its positiveeffect on the economy are perhaps overstated. Without gettinginto simplistic comparisons, what we need to appreciate fromthe Chinese experience is perhaps how to take advantage of theopenness to investment andtrade,to expand domestic capabilityand get access to external markets for its labour intensivemanufactures.VAPreliminaryssessment

Focus on Domestic MarketAs notedearlier,India'sseemingly large(andgrowing) domesticmarket is probably the main attraction for foreign firms. Forinstance, internationalsoft drinksproducers and fast food chainsthat were unknown a decade ago have acquireda visible presencein the metropolitan cities, though their quantitative significancemay yet be marginal. These firms have brought with them theoligopolistic market structuresandfirmrivalries that are evident

in the developed economies. While such market structuresmayhave some desirable properties, if they lead to tacit collusion tobar new entry, then it may not be a positive development in thelong run.Similarly, almost all major nternationalautomobile companieshave set up assembly and manufacturing facilities in varyingextent. The same probably holds true for washing machines,refrigerators, and entertainment electronics. Such large-scaleentry of firms has resulted in increased price and non-pricecompetition, leading to a greaterchoice andqualityimprovement- a desirable outcome for consumers.Initially, there were considerable apprehensions that interna-tional firms with their superiortechnology, marketingskills andfinancial strength would wipe out domestic firms (and brandnames) inmanyof theseindustries.To some extent thishas indeedhappened - in the aerated drink market, for instance. The sameis partly true in the automotive industry as well: Fiat graduallyacquired Premier Auto (its erstwhile licensee); HindustanMotors (an erstwhile GM licensee) has largely become a sub-contractor for GM and Ford, producing engines and trans-mission equipment.But many technologically strongandfinancially sound domes-tic firms seem to have withstood the growing competition - atleast so far. In some cases, domestic firms have severed theirties with their foreign collaborators to assert their managerialindependencefter omeyearsof association,hough uchcases

areonly a few.17 Further,contraryto many early apprehensions,bulk of the domestic firms (and brand names) have not beendisplaced from the market. Dominant domestic firms have soughtto protect their market shares by expanding capacity and distri-bution networks, contributing, among other factors, to the boomin fixed investment in registered manufacturing in the 1990s[Nagaraj 2002].Though foreign firms have acquired a visible presence inconsumer durablegoods industries, by andlarge, it hasapparentlynot been an easy entry for them. While, again, no definitiveestimates are available, popular reports suggest many of themoverestimated the size (and the growth) of the domestic market,and the appeal of internationalbrands, and thus now suffer fromexcess capacity and poor profits (Financial Times, April 25,2002). Foreign firms seem to have realised the smallness of thedomestic market, and price sensitivity of its consumers.18Reportedly, afew foreign firms have left India,while manyothershave staggered their investment and expansion plans.19However, realising the narrowness of the domestic market,many foreign firms are discovering the way out is to indigeniseproduction to reduce costs and secure economies of scale.Moreover, there seems to be a growing appreciationof the costadvantage of domestic manufacturing for exports. For instance,discovering that their car was too expensive for the domesticmarket,Ford has now found itprofitable to use its Indian facilitiesfor the externalmarket.Reportedly, it has exported 30,000 CKDkitstoChinaandSouth Africalastyear[BusinessWorld,December2, 2002]. Samsonite is apparentlyexpanding its Indianoperationsfor exports, while closing down its Europe plants. There aresimilar reports from ABB (electrical equipment manufacturer)and Cummnis (Diesel engine manufacturer) as well. If such atendency gathers momentum, India could possibly emerge as acompetitive manufacturingbase in these firms' global productionnetworks.

Problems with Infrastructure InvestmentForeign investment in power generation that attracted thelargest approved FDI was predicated on securing a high andassured rate of returnon invested capital - modeled afterEnron'sDPC. It was the first of its kind,offering exchange rateguaranteed

Table 7 (i):Share of Mand A as in FDIInflowsin IndiaYear FDIInflow MandA Fund Shareof MandA Fund($ Million) ($ Million) in FDIInflowPerCent)1997 3200 1300 40.61998 2900 1000 34.51999 (Jan-Mar) 1400 2800 39.4Source: Kumar2000: 2852).Table 7 (ii):Foreign Firms Related Mand A in IndiaYear Mergers Acquisitions Total1993-94 4 9 131994-95 - 7 71995-96 - 12 121996-97 2 46 481997-98 4 61 651998-99 2 30 321999-2000(Upto Jan2000) 5 74 79Total 17 239 256Source:Kumar2002:2852).



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16 per cent rate of return on investment on power purchase bythe MaharashtraState Electricity Board. The agreement was notbased on competitive bidding, violating many established normsof investment planning for a project of that size and scope. Thiswas apparentlydone in the early years of the reforms to signalIndia's eagerness to invite foreign investment.Most of these power projects did not fructify, as they werebased on unrealistic assumptions regarding the profitability andthe marketsize. Moreover, as the Enron's Indiansaga unraveled,most foreign firms discovered the state governments' inabilityto ensuretheguaranteedreturn,hence cancelled their investmentplans. The speed and secrecy, with which the Enron project waslaunched, ignoring the checks and balances in public decision-making,invoked considerable debate in the press, parliamentandacademia. In retrospect, many of the criticisms seem valid,denting foreign investment's popular image (and the credibilityof its exponents).However, there are probably other reasons as well. Much oftheprojecteddemandforpower that formed the basis for invitingsuch a large FDI in this sector was apparently inflated.20 Afterthe industrial low down since themid-1990s, thedemand-supplygapwas found to be relatively modest [Nagaraj2002]. Moreover,cost of production of the thermal power plants of many stateelectricity boardsusing domestic raw material andcapital equip-ment were found to be lower than that of the proposed FDI(invariably using imported feedstock). With hindsight - consis-tent withmuch of what the critics maintained - the problem withthepower sector was not so much the inefficiency of generation,but pricing and recovery of the user charges. Despite the muchpublicisedreforms n the 1990s, theaverage revenue-to-cost ratioin the power sector has not improved.

Net Foreign Exchange InflowFor long it has been held that foreign firms bring in limited

net resources in the host economy, as they usually take a largesurplus out of the country as dividends and royalties [Chandra1991]. This, to some extent, is probably true of what happenedin India in the early 1990s, though it may be hard to substantiate.One of the earliest changes in the foreign investment rules afterthe reforms was to remove the restriction on the foreign equityholding in the existing foreign firms - reversing the policy

initiatives of the earlierperiod. Foreign firms were quick to seizethe opportunity to issue large equity to themselves at a fractionof the marketprices (when the stock market was booming). Thismeant, in principle, a substantial FDI inflow in the book ofaccounts during 1991-94, but in reality it was simply a booktransferwithoutanyfreshcapital inflow. With a larger proportionof equity held by the parent firms, it is now possible for themto take out an ever-larger share of surplus in perpetuity.21 Table10 provides an illustrative list of the foreign firms that followedsuch a practice, and their gains due to the discount on the issueprice of the fresh equity.It only goes to show how sensitive foreign firms are about themanagerial control. In the absence of suitable regulations, theywould like to retain an absolute control thatmay not be desirablefor the host country. However, it is often argued that majorityequity holding is necessary for international firms to be assuredenough to bring in the latest technology that could potentiallyhave positive spillover in the host economy. This view seemssuspect. There is some evidence to show it is not the majoritycontrol, but the market structure thatdetermines innovation andthe introductionof new technology. Mani (1983), in a case study,showed that in the 1970s when the world's leading firmsdominated the Indian automotive tyre industry, it was the newIndian entrants like Apollo and Vikrant Tyres that introducedinnovations, and not the incumbent firms. Faced with such athreat,foreign firmsquickly followed suit to protect their marketshares.

Technology SpilloversAs noted earlier, one of the arguments in favour of FDI isthe potential positive externality of technology into the hosteconomy. However, in reality, the process may not be thatsimple. We have seen, that foreign investment does not neces-sarily lead to fixed capital formation; moreover, technical spill-

overs depend on the extent of value addition that is carried outin the host economy. For instance, assembly operations or pro-duction of simple consumer products is likely to have marginalexternality.For instance, most automobile firms - barring Hyundai andto a less extent Ford - have essentially set up minimal facilityto assemble and paint their imported CKD kits, leading to aTable 8: Illustrative List of Units/Divisions Transferred to Foreign Firms

Units o be Transferred/Transferred RemarkAparLightingDivision Transferredo thejoint-ventureJV)GE-AparLtdCompressorunitof Kirloskar rothers Transferredo Kirloskar opelandCompressorunitof SIELand Kelvinator TakenoverbyTecumsehVentureEnginevalvedivisionof KirloskarOilEngines Proposedto be transferred o a JV withMWP, ubsidiaryof MahelGermany.HalolPlantof HindMotors Transferredo a JV withGM,of the USHinditronomputers AcquiredbyDigitalEquipmentCorpIndiaLinoleum Transferred o a JVwithDLW f GermanyPremierAuto Takenoverby FiatLuxar en Transferred o a JVwithGilletteElectricmetersof VXLLtd Transferred o VXLLandysGys LtdMotor ycle divisionof Escorts Transferred o EscortsYamahaLtdOralCareDivision f Parle AcquiredbyGilletteRefrigeratorivision f Godrej&Boyce Transferredo Godrej-GE ppliancesSpecialtychemicalsdiv of MaxIndia Transferredo Max-AtotechStabiliserdivision f Jan Auto Takenover byNHK ai suspensions LtdSugar machinery ivof KCPLtd Transferred o FCB-KCPLtdCeat's Two-and three-wheeler yreplant Transferredo SouthAsiaTyresLtdwithGoodyearSource:Rao,MurthyndRanganathan 1999)



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proliferation of firms and models with modest rise in domesticproduction and technological capability.22'23In other durable goods industries too, foreign firms haveacquired dormant domestic firms and/or resorted to contractmanufacturing with the existing firms rather than set up greenfield plants.24 While these may be efficient strategies for thefirms concerned, the social benefit of such arrangements mayremainmodest. Ourcontention is consistent with RichardCaves'sobservation:...While productivity pilloversfromforeignsubsidiaries o localfirms areapparentlywidespread, hey areneitherubiquitousnorindependent f firms' marketambient tructure.... Spilloversmaybe ajustification orLDCgovernmentpolicies to encourage lowof foreigndirect investment. ... Justification s likely to be con-ditionalon the country's state of development and the structureof particularndustries n which foreign subsidiariesmight alight[Caves 1999: 17].

Decline in CompetitionFDI, in principle, brings in greater market discipline on theincumbentfirmsby increasing competition. But, as we have seen,

foreign firms often acquired dominant positions by taking overdomestic firms (and brands). This, again, is best illustrated byCoca Cola's acquisition of the dominant domestic competitor,ThumsUp;and HindustanLever's-Indian subsidiaryof Unilever- acquisition of its largest domestic rival, and the second largestfirm in the industry, TOMCO, and the largest cosmetics firm,Lakme.In principle, in a well functioning market economy suchacquisitions would have attracted the provisions of the compe-tition law. But they went unchallenged in India as the MRTPAct - the anti-trust law - was practically abolished as part ofthe economic reforms.Further, hegovernment ignoredthepublicand academic criticisms of such acquisitions, as it was keen tosignal a positive outlook towards FDI. Thus, ourexamples show,the widely held view of foreign investment per se leading togreater competition needs to be taken with caution.

Foreign Exchange EarningsOne of the common apprehensions against foreign investmentis the net drainof foreign exchange in the host countries. Manycountries seek to overcome this problem by imposing foreignexchange neutrality clauses. Reportedly even the UK appliedsuch a clause while permitting Japanese automotive firms in theearly years of conservative reforms in late 1970s and the early1980s. Many states in the US apply conditions of job creationwhile offering incentives for Japanese automotive firms. Thoughwe do not have data to examine net foreign exchange outgo onaccount of foreign firms that came into India in the 1990s, thegovernment, reportedly, has been lax in enforcing this clause orhas diluted it.25 This could be a serious matter,especially withmany automotive firms that have set up are largely limitedassembly plants.

Brand NamesIn consumer goods industries intangible assets like brandnames mattermost; and, it takes a long time and effort to createthem.A largehome market s widely accepted to be advantageous

in building such assets before 'exporting' them. India followeda prudent policy in this respect up to the 1980s. However, inthe 1990s, as mentioned earlier, in soft drinkindustry,Coca Colabought rival brand Thumps Up; Gold Spot and Limca; Pepsipurchased Mongola, Dukes and so on. The foreign firms de-stroyed many of the purchased brands that competed with theirinternational ones. Coca Cola "killed" all competing brandsexcept Thums Up, as it was too uneconomical to do so. Report-edly, even now, this cola drink sells four times as much as theworldwide brand of Coke. It only seems to show how 'pathdependent' brand loyalty can be in consumer goods. Thereforethere seems to be considerable merit in promoting indigenousbrands that have the potential to compete in the world market.Such hasty policy changes could prove a costly mistake in thelong runfor India, as consumer goods arenothing buttheir brandnames.26Loss of Bargaining Power in the Technology Market

It is well accepted that dominant international firms havesubstantial marketpower, and many developed countries widelyintervene in the technology market to protect and promote in-terests of their firms.27 Indian policy, after the reforms, prac-tically ceased to intervene in the technology market,significantlyweakening domestic firms' bargaining position.With the increasing role of financial collaborations, foreigntechnical agreements as a source of technology have steadilyTable 9: An Illustrative List of Foreign Firms Moving to De-Listfrom Domestic BoursesSI Company Acquirer's urrent OfferPrice Post-offerHoldingNo HoldingPerCent) (Rs) (PerCent)1 Cabot 60 100 922 Cadbury 51 500 903 Carrier ircon 51 100 864 CentakChemicals 75 200 935 Hoganas 51 100 856 Otis 69 280 797 Philips 51 105 838 Reckitt&Colman 51 250 Yet oopen9 Sandvik 73 850 89Source:Business India,April1-14, 2002: 118.Table 10: An Illustrative List of Foreign Companies that Issuedto Themselves Shares at a ConcessionSl Company Noof Shares Preferential Market rice Gain otheNo Allotted Issue Price onAllotment Company in(inmillion) (inrupees) Date(rupees)millionupees)1 Colgate 11.3 60 700 7227.52 Castrol 3.5 110 1050 3325.73 Sesa Goa 3.3 120 1025 2968.44 Asea BrownBoveri 4.8 60 325 1260.05 Bata 4.7 35 325 936.76 CoatsViyelia 7.5 65 260 1444.77 AlfaLavel 3.4 73 290 738.88 Nestle 4.8 70 285 1021.69 Glaxo 4.5 75 255 808.010 Hoechst 2.2 70 370 645.311 Lipton 3.5 105 380 972.412 Proctor&Gamble 4.8 70 285 1021.613 Proctor&Gamble 1.9 225 340 223.114 Philips 7.7 40 205 340.015 Reckitt&Colman 3.0 100 380 848.4Totalgain o theforeign irms 24737.0Source:Jain(2001:219).



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dwindled n the 1990s - both in absoluteand relativeterms(Figure ) [Economic urvey, 001-02].Evidently, oreign irmsdo notwant o partwith their echnology,as theycan nowcomeinto Indiawithouta domesticpartner.Consideringheirsuperior inancial and technicalstrengths,many oreign irms n the capitalgoods industry eem to havewrestedmanagerialontrol n the existing oint ventures n the1990s.Forexample,CaterpillaroughtoutBirla'sstake ntheirjointventuremanufacturingarthmovingquipment lthoughhefirmwasdoingwell in themarket.Manyautomotive irms tartedasjointventures,butgradually oreign partnersncreased heirfinancial takeby buyingoutdomesticpartners,s Indian artnerswereunable o bring n theresources o makeupfor the lossesin theearlyyearsof the firms'operations.This happened t atime when the domestic interest rates were higher than theinternationalates.Foreignpartnersound t aninexpensivewaytoacquire greatermanagerialontrol, speciallyas thecurrencywas steadilydepreciating.Forinstance,Hondaboughtout the Sriramgroup,andFordacquiredMahindras's takein their oint venturecar projects.However,morerecently,there are instancesof the converse,where ndian irms haveboughtout their oreignerpartners;orinstanceTVS MotorsandSuzuki,KineticmotorsandHonda.and LML andPiaggio.But such instancesseem far fewer.Arguably,heaboveexamples llustrate he virtuesof a marketdrivenprocess or corporate ontrol hat s best left to it. Sucha benignview maynotnecessarily avourdevelopingcountriesand theirconsumers n the long run.For instance, he demiseof Spanish utomotiveirmswith ts integrationn theEuropeanUnion,and the lack of technologicaland marketdynamismnthe Brazilian uto ndustry despitesubstantialnvestment ndoutput rowth- probably uggeststhatstrategicnterventionosupport omestic irms andindustryarenot incompatiblewithsecuringdynamiccomparative dvantageandexportcompeti-tiveness.In sum,while the entryof foreignfirms has increased om-petition nd mprovedhevarietyandqualityof consumer oods,thereare some disturbingignals. Foreign nvestmentn infra-structures afailure.Gradualoss of managerialontrol nmanyindustrial irms, decline in competitionin some industries,extinctionof some leadingdomestic brandnames and limited

improvementn domesticproduction apability eemto besignsof concern.VITowardsa RealisticFDIPolicy

It is widelybelieved hatIndiahas not doneenoughof policyreformso attract ubstantiallymoreforeign nvestment.More-over, t is not the financial ncentivesbutthe lack of adequateinfrastructure,ureaucraticelaysandaboveall,therigid ndus-trial abour aws that have come in the way of attractingmoreinvestmentsSachsandBajpai2001]. This view seemsto havemany imitations. or nstance, here s no evidenceof apositiveassociation etween he extentof marketorientedreformsandFDI inflows across developing economies [Easterly2001].Moreover,s discussed arlier, reateroreign nvestmentnflowdoesnotnecessarilymean asteroutput ndexportgrowth.What,then,shouldguideIndia'sforeigninvestmentpolicy?If historys any guide, foreign nvestment n infrastructurespotentiallyproblematic.Latin Americawitnesseda wave of

foreign nfrastructurenvestment rom he US in the 1930s,onlyto leave withthe bitter xperience f nationalisationsnacoupleof decades. It bearsrepetition hat infrastructures inherentlycapital ntensivewith long gestation ags, and low (but stable)returnsveralongperiod.Market ailuresareubiquitousntheseindustries,with considerablenetwork economies necessarilyinvitingwide anddeepstate ntervention. n a worldconsistingof politicallyindependentnations with a growingnumberofdemocracies,hepricing f infrastructures bound o beapoliticaldecision.Foreign irmswithshortpay backperiods nvariablyfind t hard ostayon,as itconflictswiththegoalsof developingeconomies aughtnan ncreasingly ncertain orld conomy.28There are also perhapssome India specific factors for therelatively mall oreigncapital nflow.Itseems worth eiteratingthat Indiais still largelyan agrarian conomy,with landpro-ductivitybeinga thirdof China's,where heaveragedisposableincome aftermeeting ood andclothing(wage goods) require-ment sstillrelativelymall.Price-income-ratiof mostconsumergoods thatforeignfirmsusuallysell is highby domesticstan-dards,accentuatedperhapsby culturalfactors and regionalheterogeneity f markets FinancialTimes,April25, 2002].Ininfrastructurendustries,herupeecost of electricity upplyby foreign firms seems high. Given India's fairlydiversifiedindustrialapability, nd ow labour osts,foreign irmsmaynothavea cost advantage ver thedomesticproducers especiallywith thecurrency epreciatingn nominal erms.This is perhapsbest llustrated,gain,bytheEnron'sDPC.With mported apitalgoodsand uel,andhighoperatingostdue ointernationalormsof costing,Enron'scost of productionwas found to be higherthan hecomparableewplantsusingdomestic apital quipment[Morris1996].At thesame ime,Hyundai'sarge nvestmentwithconsciouslybuilt-inhigh domestic contentsecuredthrougheconomies ofscale has succeeded n producinga smallcar that seems com-petitiveboth npriceandquality.Reportedly,Hyundaiproposesto use its Indianplantas a global hub for its small car [TheEconomicTimes,January , 2003]. Thus,thekey to increasingFDI nflowseems o iein ndustriesandproducts)withrelativelyhightechnology hat have largeeconomiesof scale, with sub-stantialdomesticcontent.However, heforegoingreasoning till does notexplain whyforeign nvestment oes notcometo usecheap abourand skillsforexportof labour ntensivemanufactures as it hashappenedin China.We are nclined o believe thattheforeign nvestmentpolicylacksa clearfocus.UnlikeChina, ndiahasnot investedin export nfrastructure.n fact, as is widelyacceptednow, theshareof infrastructuren fixed capitalformationhas declinedsharplyfor nearlyone and half decade now [Nagaraj1997].Further,what is needed is perhapsnot large investmentbutsuitable nducemento internationalmarketers tradinghousesandretailchains to setuppurchase ffices and esting acilitiestotapthepotential f the domesticmanufacturers.29t is widelyacknowledgedhatChina'sexportsuccess largelylies in mar-rying ts low costmanufacturingapabilitynTown andVillageEnterprisesTVEs)withHongKong'shighlydeveloped radinghouses and other long-establishedcommercialorganisationscatering o internationalrade.While it is out of questionforIndia oreplicatehelocational ndhistorical dvantage f HongKongforChina, nvestmentn export nfrastructuren strategiclocations ndcarefullyailoredncentives ointernationalradinghouses (andretailers)merit a seriousconsideration. imilarly

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such nvestmentsreperhaps quallynecessaryotap hegrowingpotentialorusingIndia's abour ost advantageordoingbackofficejobs - businessprocessesoutsourcing for internationalfirms [The Economist, May 5, 2001].Realistically,what s it that ndiaexpectsfrom oreign nvest-ment,and how to secureit? In principle,opennessto foreigninvestment houldbestrategic, otpassive orunilateral).Historydoes not seem to support uch an uncritical nternationalnte-grationas a provenroute o growthandefficiency.If the recentexperience s any guide, foreign capital is far from a majorproviderof externalsavings for rapid ndustrialisationf anylargeeconomy.It canonly supplementhedomesticresources,wherever hey necessarily ome bundledwithtechnology,andaccess o internationalroductionnddistributionetworks.Theterms fforeignnvestmentwilldepend n therelativebargainingpowerof the foreignfirm vis-a-visdomesticfirms,backedbythe tate. ndian dvantagesre heavailabilityf skilledworkforce,cheap abour, nd hesize of thedomesticmarket,which tshouldleverage smost uccessful ountries avedone.Atelling nstanceof it is perhapsKorea'sbig leapin semiconductor nd telecomequipmentmanufacturingn the recentyears,as it seems to havetied liberalisationf domesticmarket o sharingof productiontechnology.Ifthisviewhasanyvalue, henhow shouldwegoaboutnvitingFDIthat s consistentwith the economy'slong-termnterests?Foreign nvestment houldbe allowedmainly n manufacturingto acquire technology,and to establish internationalradingchannels or promoting abour ntensiveexports.

VIISummaryndConclusionEnding ts long held restrictive oreigninvestmentpolicy in1991,India ought o competewith thesuccessfulAsianecono-mies to get a greatershare of the world's FDI. Cumulative

approvedoreign nvestment ince then is about$67bn,buttherealisedamount s about a thirdof it - the ratioroughlycom-parableo China's.While the foreign nvestment nflowrepre-sents a substantialumpover the 1980s, it is modestcomparedto manyrapidlygrowingAsianeconomies,and minisculecom-paredto China. While the bulk of the approvedFDI is forinfrastructure,herealised nvestment s largely n manufactureof consumer urable oodsandthe automotivendustry eekingIndia'sseemingly argeandgrowingdomesticmarket.Foreigninvestment n telecom and softwareindustrieshas also beensignificant.ApprovedFDIhaslargelygone to a few developedstates similaro tsconcentrationnthesouthernoastalprovincesin China.A sizable partof the foreign investmentseems torepresent gradual ncreasein foreignfirms' equity holding(hencemanagerialontrol) n theexistingfirms,andacquisitionof industrial ssets (andbrandnames).China'sability to attracta phenomenalamount of foreigninvestments apuzzle ormany.About40-50percentof China'sFDIrepresentsts domestic avingrecycledasforeignnvestmentvia Hong Kong to take advantageof economic incentives-popularly alled the "round ripping".Another25 per cent orso, seems to represent nvestment n real estate by overseasChinese hat spotentially roblematic,s such nvestmentsouldeasily giverisetoproperty ubbles.Thus hequantum f foreigninvestment rom the advancedeconomies thatcould improvedomesticproductionapabilitysperhaps otverydifferent rom

that n India, n relation o its domesticoutput.Contraryo thepopularbelief,China'sforeign nvestment egime s said to bemore restrictive han India's.Therefore,what India should beconcernedabout is not so muchthe absolutequantumof theinflow, but how effectively it uses its externalopenness toaugmenthe domesticcapability, ndaccessforeignmarkets orits labour ntensive manufactures.For a careful economic analysis of the effects of foreigninvestment, onsiderabledetailed statistical nformation s re-quired both at theaggregateand at the firmor industryevel.In theirabsence,much of our analysisis indicative n nature,raisingquestions or further nquiry.As the 1990s'experience hows,quitecontraryo thepopularperception,hesize of India'sdomesticmarketsrelatively mall,giventhe owlevels ofpercapitancome.Aftermeeting heneedsof food andclothing wage goods),income eft forspending nproductshatmostforeignfirmsoffer seems small;theirprice-income ratiotoo high for Indianconsumers.Therefore,manyof themseem to be makingefforts to indigeniseproductionoreduce osts andsecureeconomiesof scale.Inthisprocess,manyforeign irmsarediscovering hepotentialof low cost of manu-facturing or exports.Much of the approvedFDI in infrastructureid not fructify,as therupeecost of electricity upplyby foreignfirms s muchtoo highfor Indian onsumers.This seems true or two reasons:one, pricesof goods like electricityarewidelysubsidised,andcannotbe increasedwithout nvitingpublic opposition; econd,

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1710 Economicand PoliticalWeekly April26, 2003


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Indiaproducesmuchof these services at lower cost usingdomesticraw material and capital equipment.Foreigninvestment in consumer goods industries has increaseddomestic competition, resulting in greater choice and qualityimprovement.While FDI inflow displaced some domestic firms(andbrandnames), the bulk of them have - at least yet - largelybeen able to withstand the competition by making large capitalinvestment, and in expanding distribution networks.However, in industrial goods there have probably beensizable acquisitions of domestic firms (and factories) whosedetails are not known. There are many instances of foreign firmsgradually acquiring controlling interests, edging out domesticpartners. Whether these firm-level changes get reflected inindustrial efficiency in the aggregate - as many expected - isa moot point.What should be done to increase foreign investment? It ispopularly believed that a more liberal policy regime, industriallabourmarketreforms, and infrastructure nvestment are needed.While infrastructuremprovement surely merits a close attention,one is not so sure if the extent of the reforms and the quantumof foreign investment inflow are positively related. Moreover,there is little evidence that greater FDI inflow ensures fasteroutputand export growth. Such simplistic associations, usuallybased on cross-country analysis, seem to have support neitherin principle nor in comparative experience.What is needed is a strategic view of foreign investment asa means of enhancing domestic production and technologicalcapability, and as also to access the external market for labourintensive manufactures- as China has precisely done. It seemsvaluable to reiterate what K N Raj, a perceptive observer ofcomparative economic development, noted early on in China'sliberalisationdrive, "Itis certainly not without good reason thatChina has chosen to be hospitable even to multinationals withworld-wide ramifications like IBM, evidently in the expectationof securing the know-how for building up semi-conductor in-dustryof its own. Those who do not realise the implications ofall this for India are living in a dream world of their own..."[Raj 1985].Such interventions need selectivity, and strategic intent.Comparativeexperience seems to clearly favour such a policystance. [1Address or correspondence:[email protected]

Notes[This s arevised version of a paperpresentedat the Conferenceon ForeignDirectInvestment Opportunities ndChallenges for Cambodia,Laos andVietnamorganised by the State Bank of Vietnam and the IMF in Hanoiin August 2002. Following the usual disclaimers, the author gratefullyacknowledges he comments and suggestions that he received on this studyfrom K V Ramaswamy,C RammanoharReddy and M H Suryanarayana.The author s also indebted to PradyumnaKaul for sparingtime to discusssome issues on foreign infrastructurenvestment.]

1 Forachronological ccountof thepolicy reforms,see appendixof Bajpaiand Sachs(2001). For detailedofficial statementson the policy changes,refer to the ministry of industry's annual publication, Handbook ofIndustrialStatistics.2 There s some evidence to support his view. For instance,using cross-section datafor 58 developingcountriesduring1978-95, BosworthandCollins (1999) show that a dollar of FDI translates nto an equivalent

domestic investment,while no such association was found with respectto foreign portfolio investment.3 For a long time developing countries have complained about foreignfirms,as they seemed to hide their trueoperations rom the host countryrules. But in the recentyears under easier capital flow regime the samelegal maze seems to have begunto hurt ax compliancein thedevelopedcountries as well. Recently a reportin the New York Times sought tounveil the legal maze of such operations [Johnston2002].4 Though largely ignoredin the mainstream conomic writings, muchofthe literatureon the behaviour of international irms builds on StephenHymer's (1976) original contribution that focused on firm specificcharacteristic, ncluding their marketpower.5 It has long been held in the developmentliterature hatwhile short runcost of foreign debt is high, the long-termcosts of FDI could be evenhigher [Lewis 1953]. In fact, it is such a view that prevailed in thesuccessful industrialisationefforts of Japan, Korea and Taiwan thatcarefully regulatedforeign investment inflow.6 However, some recent literature n mainstreameconomics has arguedthat while the state may have succeeded in steering these economiesin thepast, there s littleguarantee hat n the developingcountries odaythe state has similarcapabilityto repeatthe performance WorldBank1993].7 "Flowof FDI comprisescapitalprovided eitherdirectlyorthroughotherenterprises)by a foreign directinvestor to an FDI enterpriseor, capitalreceived from an FDI enterpriseby a foreign directinvestor. Therearethreecomponents n FDI:equity capital,reinvestedearnings,and intra-company loans." (World InvestmentReport, 2001: 275).8 Apparently, here is a discrepancy n Enron's declarationof its equityholding in the Indianentity.To the US bankruptcy ourtit has declaredthat it holds 50 per cent, but here it has declared that it owns 65 percent equity.9 The law requiresall closely held (private imited)companies to submittheir annualauditedaccountsto the department f companyaffairs thatare, in principle,available to the public. But practice seems differentas the law enforcement seems poor.10 Koreanfirms have aggressively moved in to India, since they perceiveit as their only chance to get into the last unexploredmarket,to beattheir established corporaterival from Japan and the US.11 Assessing the Brazilian reforms, Rocha (2002) said, "Mergers andacquisitionsof private irms havebeenequallycentral o therestructuringof the Brazilianeconomy...A recentstudyshows thatbetween 1995 and1999 there were 1,233 mergersand acquisitions n which multinationalcorporationsacquiredcontrol or participation n Brazilian industriesthe devaluationof the real since 1999 makingsuch purchasescheaper.A KPMG survey reveals that 70 per cent of all acquisitions in Brazilduringthe same periodwere undertakenby multinationals, o the tuneof some $50 billion of FDI inflows" [Rocha 2002: 23].12 Data for this graph is from the various issues of the UN's WorldInvestmentReport.13 Figure5 is fromIFC (2002). In this graph,x-axis representsyears, andy-axis measures FDI in million US dollar.14 I am gratefulto Cherian Samuel for providingthis unpublishedstudy.15 Quoting an OECD study, China in the World Economy, Srinivasan(2002) reports hatmajorityChineseequityholdingis mandatoryn coalmining, design and manufactureof aircraft,oil and gas, printingandpublishing, gricultural roductionngrains, ottonandoil seeds,domesticcommerce, foreign trade,medical instrumentsand repairs, design andmanufactureof ships.16 I am grateful to EdwardGraham for this unpublishedpaper.17 For instance, n the two-wheelerindustry,TVS, Kinetic and LML haveterminated heir technical and/or financial collaboration with Suzuki,Honda and Piaggio respectively to introduce indigenously developedmotorcycle/scooter models that have been well received in themarket.Bajajhas stoppedmakingmotorcyclesinjoint brandnamewithKawasaki for the domestic market, to introduce its own brand ofmotorcycles. In consumer products,Godrej, a leading domestic firm,terminated ts comprehensive ties with Proctor and Gamble, and re-promotedown brands to regain its lost market share. In wristwatchindustry,Titanindustriesceased its collaborationwith Timex to expandinternationally.18 External iberalisationwas predicatedon the proposition hat India has



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a core of about200 million consumers with purchasingpower close tothat in the developed economies. After a decade's experience, manymarket esearchagencieshavereportedlypruned he estimateto aquarterof the original.19 For instance, BMW (motorcycles), Piaggio (scooters), Nine Gold(broadcasting),Kokna and Haier (Chinese electronics firms), Roche,Merck(pharmaceuticals),Blue Bunnies (ice cream)and so on have leftIndia (Business Standard,October 28, 2002).20 Duringthe earlierpolicy regime, the CentralElectricity Authority anautonomousbody- wasresponsible orlookinginto the techno-economicfeasibility keepingin view the networkexternalityof power generationanddistribution ystem. Apparentlyafter the deregulation, uch officialscrutinywas largely ignoredin the belief that, 'marketsknow the best'.Hence, based on power demand projections drawn up by privateconsultants, arge numbers of projects were approved.21 Admittedly, he shareof foreigncontrolledfirms in theprivatecorporatesector s, bymostreckoning, mall.However, heyaccount ora substantialshare of total profits and dividend in this sector.22 Infact,considering hefragmentednature f themarket,manyautomotivefirms view their Indianoperations as mainly distribution and 'brandbuilding'exercises, rather hanmanufacturing nes. Therefore, t is hardto expect such operations to have significant positive spillovers.23 Accordingto knowledgeable sources, the Indian auto industrynow isasfragmented s the Brazilian ndustrywas whenit liberalised tsindustrysome30 yearsago. While Brazil failed to climbupthetechnologyladder,it was strategic technology importingcountries like Japanand Koreathatproducedworld-class automotivemanufactures. f the present rendpersists it seems likely that India will follow the Brazilianpath,ratherthan the Japanese a':: !i-e Korean one.24 To illustrate,Hydra-i:,dAllwyn, acquiredby Voltas, afterprivatisation,hasbeenengagedincontractmanufacturingor the Korean irmSamsung[BusilnessStandard, November 11, 2002].25 Reportedly,Coca Cola has repeatedlyrefused to comply with the lawin diluting ts equityin the domesticcapitalmarket or thepastsix years[Guha 2002].26 Apparently, heUS tax lawsprovide ax credit orpromotionof Americanbrands abroad. We do not have evidence to substantiate his claim.27 The US protectionof the supercomputersmanufacturer,Cray, despitecompeting productsby Japan'sHitachi andFijitsubeing much cheaperis a well knowncase. Recentlywhen,forthe firsttime,theUS departmentof agriculturebought a Fujitsu super computer,The New York Timesconsidered the decision news worthy to reportit (June 14, 2002).28 Writingat the height of the foreign infrastructurenvestmentboom inthe 'emerging markets' in the mid-1990s, Wells and Gleason (1995)cautioned heAmericanbusinessman gainstrushing nto such nvestmentprecisely on the above arguments.29 Infact, it was MrinalDatta Chaudhuri1981) who long ago emphasisedthe role of large domestic and international radinghouses as marketinstitutions n promotingmanufacturedxportsfromKoreaand Taiwan.

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FDI in India in the 1990s

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