Contribution Of Fdi To Indian Economy

Published Date: 02 Nov 2017

Anjana Rajagopalan

MPhil 2012-14

Term Paper 1

TerDRAFT: TERM PAPER 1

DRAFT: TERM PAPER 1

CONTRIBUTION OF FDI TO INDIAN ECONOMY: PAST TWO DECADES

Abstract

This paper attempts to look at channels through which FDI affects the economy: as a non-debt creating source of funding CAD, as export-promoting and as a source for technology-spillovers using data published by Reserve Bank of India in its Annual Reports under the Finances of Foreign Direct Investment Companies. The results show that Foreign Direct Investments have been important in financing the Current Account Deficits. Exports of Foreign Direct Investment companies have been gradually falling below imports, while export intensity of sales of domestic Indian firms is found to be higher than Foreign Direct Investment companies. As for technology spillovers, there exists a debate in the literature as to actual knowledge spillovers with the arrival of Foreign Direct Investments.

introduction

India has been prudent in terms of allowing capital inflows until recently. In the early 1990s, India’s Balance of Payments consisted of a large proportion of debt as compared to equity due to the 1990 crisis. Also, a large trade deficit existed, driven by problems of food scarcity. Post-liberalisation, the situation has reversed.

The trade-deficit in India is still fairly high, leading to a Current Account Deficit (nearly 4.5% of GDP in 2011-12). India has however been able to mitigate problems of high CAD by funding it through foreign capital in the form of Foreign Direct Investments. Currently, India’s Balance of Payments shows a surplus in the Capital Account which is due to the large share of a stable FDI scenario as opposed to high but volatile remittances from abroad, along with remarkable decrease in the proportion of debt compared to equity. This improvement in the Capital Account creating a surplus therein has enabled India to fund its CAD in a non-debt creating fashion, given that the burden of debt is shared in Foreign Direct Investments.

Another contribution of FDI to India’s overall economic growth can be envisioned in the form of increased exports from India both from foreign companies established in the country, as well as domestic firms which become more productive due to increased competition and technology-spillovers from the foreign companies. With increased competition and rising exports of foreign companies, more foreign companies invest in India, causing a circular-flow of argument.

The direct contributions of FDI to India’s economic growth can be seen from the proportion of FDI to GDP and GFCF in India, which has been rising (3% and 8% respectively in 2010-11). In this context, measuring contribution of FDI in terms of non-debt creating source of funding BOP deficits, and expanding foreign and domestic exports alongwith increase in technology and knowledge spill-overs becomes interesting, to clearly define the role played by FDI in contributing to the Indian economy over the past two decades, especially post-liberalisation.

A succinct definition of FDI would be useful at this stage. [1] According to the BPM5 [2] , Foreign Direct Investment is the ‘category of international investment that reflects the objective of obtaining a lasting interest by a resident entity in one economy in an enterprise resident in another economy’. The lasting interest implies ‘existence of a long-term relationship between the direct investor and the enterprise and a significant degree of influence by the investor on the management of the enterprise’ (IMF definition)

The paper is structured as follows. The next section consists of a detailed literature review on various aspects of Foreign Direct Investments. This is followed by a section explaining the data sources and the methodology used for this analysis. The final section comprises of the results and concluding remarks.

Literature review

FDI has a bearing on growth of an economy directly and indirectly. FDI affects growth through a variety of channels such as employment-generation, increasing exports and improving productivity by enhancing competition. More indirectly, foreign companies are thought of as contributors to the technological-base of host economies by knowledge spillovers within and among industries.

Foreign investors would ideally prefer to invest in countries which are economically well-off. More FDI flows into an economy would help it to grow further. This causes a bi-directional relationship between FDI and GDP, which has been tested and found true in literature. Boon (2001), found a two-way causal link between FDI and economic growth; growth in GDP attracts FDI, FDI also contributes to output-increases.

Along with increasing growth potential of the host economy, the flow of FDI into target sectors would enable development in terms of value-adding employment generation. For instance, FDI in relatively labour-intensive sectors such as food-processing, textiles, leather, etc. with plants in small cities close to rural areas, would have high employment-generating potential (NCAER, 2009).

In a similar vein, Varblane et al (2005) discuss the role of FDI in job-creation and changing employment structure and stress on the importance of greater diversity in FDI which would result in greater spillover and skill-transfer across different sectors, improving growth in host economies.

Apart from employment generation, FDI flows are also essential determinants of international relations. According to Meyer (2003), when emerging economies integrate into global economies, international trade and investment will accelerate.

At this juncture, the main motives behind foreign investors investing in a country become important in the light of maintaining international relations and seeking benefits therefrom. Banik et al (2004) find that FDI flows are more influenced by market-size and export-intensity. In other words, foreign investors are market-seeking, and expect to use the host country as a base for producing and exporting thereafter. Contrarily, the motive can be just resource-seeking, which implies export-promotion via FDI does not necessarily take place.

Lall and Mohammad (1985) found that industries with high foreign shares (measured by share of dividend paid abroad) tended to be more export-intensive. Majumdar and Chhiber (1998) find that among foreign-controlled firms, there is positive correlation between level of foreign equity ownership and export-performance only when foreign affiliates have majority control. Export-seeking as a driver of FDI does seem to have some basis in literature.

Along with trade relations via exports, FDI also contributes to the host country in terms of additional funds to finance their BOP in a non-debt creating fashion, given that FDIs have a lower proportion of debt associated and more equity (Chari, 2012).

FDIs are also associated with technology-spillover benefits to host country. Andreas (2004) relates FDI and economic growth brought out by technology-spillovers and physical capital inflows. He argues that economic growth strengthens the incentives for market-seeking FDI, creating a circular argument for FDI.

However, evidence is mixed on the magnitude and direction of knowledge-spillovers from FDI. According to Smeets (2008), issues to be considered in this context are: spillover-channels, mediating-factors, and FDI-heterogeneity. However, there still is a case for technology-benefits from FDI. Host countries enjoy productivity gains if competition from FDI companies is effective, and if domestic firms are able to innovate or imitate successfully (Athreye and Kapur, 1999). This would require more skilled workers and result in employment generation.

Having stressed on the possible gains from FDI, it becomes important to look at India in the light of a destination for FDI, and its policies since liberalisation to gain better insights into the trends and patterns of FDI in India over the years.

FDI Policy Framework in India [3] 

A. Pre reform period:

Before the 1991 reforms, India had followed a prudential approach while allowing FDI. This was driven majorly by the view that industrialization should be led by import-substitution for self-reliance. Protection of domestic companies was the main motive, which resulted in restricting FDI only to high technology industries.

The regulations included the enactment of Foreign Exchange Regulation Act (FERA, 1973), whereby, foreign equity holding in a joint venture was allowed only up to 40 per cent. Additionally, special economic zones (SEZs) were established, which only succeeded in export-promotion post the 2000 EXIM Act.

A partial liberalisation in trade and investment policy was initiated in 1980s to enhance export-competitiveness and modernization through Trans-national Corporations (TNCs). The Industrial Policy (1980 and 1982) and Technology Policy (1983) led to a liberal attitude towards FDI by policy changes, which included de-licensing industrial rules, promoting manufacturing exports, and allowing imports of capital-goods and technology. This was supported by trade-liberalization measures such as tariff-reduction and shifting of items from import-licensing to Open General Licensing (OGL).

B. Post-Liberalization Period

In 1991, India entered a phase of economic liberalisation aimed at increasing its international relations to enhance growth. Industrial policy reforms were targeted at removing restrictions on investment projects and businesses. Liberalisation also aimed at increasing access to foreign-technology and inflow of additional funds.

Some measures aimed at liberalizing foreign investment included: (i) introduction of dual- route of approval of FDI – RBI’s automatic route and Government’s approval (SIA/FIPB) route, (ii) automatic permission for technology agreements in high-priority industries and removal of restriction of FDI in low-technology areas, and liberalizing technology imports, (iii) signing the Convention of Multilateral Investment Guarantee Agency (MIGA) for protection of foreign investments. This alongwith Foreign Exchange Management Act (FEMA, 1999) promoted FDI.

Policies include WTO norms on imports of raw-materials by countries to give a level-playing field, as well as anti-dumping policies to protect domestic economies. Such protective acts also seek to protect against tariff-jumping FDIs, which through import-protection allow a foreign firm to avoid trade barriers by locating production within destination-markets.

fdi in india

Compared to post-reform economies with substantial increase in FDI, FDI constitutes a comparatively lower share of total-investment in India. In 1998, share of FDI to total-investment was only 2.5 per cent, quite low compared to other Asian countries (Beena et al). However, role of FDI in India is becoming increasingly important.

A. FDI and BOP:

Current Account Deficit has been widening over the last two years in India. Along with slowed growth and fiscal-deficit, capital flows have become volatile. In such a scenario, Rangarajan and Mishra (2013) estimate that the sustainable current deficit to GDP ratio for India should be 2.3%. They assert that ‘even to sustain 2.3% CAD, India would need net capital inflows of at-least $50-70 billion annually for five years’.

As noted by Chari (2012), composition of financial flows to India has changed over time. In 1990-91, FDI and portfolio-flows were not significant proportions of the capital account. However, share of FDI and portfolio-investment in the capital account has increased to almost 60% in 2011-12. Debt-flows have however reduced to 30% in 2011-12 compared to 80% in 1990-91, though they have increased in absolute terms.

The advantage of FDI equity-flows over debt-flows is the risk-sharing between the lender and borrower. India’s persistent CAD since 1990–91 (barring 2001–04), has increased its dependence on private capital inflows to finance CAD (Mohanty, 2012).

B. FDI and Exports

FDI is postulated to increase exports through increased competition and productivity. However, Sharma (2000) states that FDI has statistically no significant impact on export-performance although its coefficient has a positive sign.

Bhattacharya and Bhattacharya (2011) attempt to study the link between FDI inflows and services-export of India post-liberalization. A unidirectional causality is observed by them from FDI inflows to services-export. They claim that FDI inflows in the services-sector, consultancy and transport services influence services-export.

However, impact of FDI on exports varies for countries. Whether FDI substitutes trade (alternative means of supplying foreign markets) or complements trade (facilitates exports of host country) depend critically on the motives of foreign investors, industry-mix and the nature of investment (Dunning, 1988).

C. Technology spillovers:

Literature on benefits of FDI to host country in terms of technology-spillovers is divided. Arguments in favour claim FDI leads to knowledge-spillovers within and between industries. FDI companies increase competition for domestic industries and hence lead to productivity advances. However, the argument against FDI companies is that they tend to monopolise over the domestic resources and tend to protect their knowledge-base. This thwarts any possibility of technology-spillovers to domestic companies. Moreover, high remittances by these FDI companies can exacerbate deficits in BOP.

Developing countries are increasingly trying to attract FDI. Liberalisation has enabled India to attract increased inflows and led to changes in sectoral-compositions, alongwith changing sources and entry-modes of FDI. The increasing recognition of India’s locational advantages in knowledge-based industries among MNEs has led to increasing investments in software-development and global R&D centres set up in India to exploit these advantages (Kumar, 2005)

Wang and Blomstrom (1992) isolate channels for spillover-processes; ‘disembodied aspects of better technologies used by foreign companies spread to domestic firms through workers, managers and technical guidance provided to vertically-linked domestic suppliers. The mere presence of foreign firms exposes domestic firms to superior technologies (demonstration effect). Also, competition from foreign firms (lower prices or higher product-quality) forces domestic firms to improve their technologies’. Gains from spillovers however require a developed technological base in the host country to be able to absorb and grow (Malik, 2010).

For domestic companies to gain from technology-spillovers from FDI, mode of FDI is also important; from Brownfield to Greenfield investments, wherein new units are set, creating employment, should lead to more technology-spillovers, and thereby higher productivity and efficiency (Beena S, 2010). Increasing greenfield investments are hence more growth-promoting compared to brownfield or greyfield investments which are just increases in share-holdings.

Joseph and Reddy find no significant spillover-effects from the presence of foreign firms on the export-performance of domestic firms in Indian manufacturing industry. They claim that domestic firms do not gain in terms of export-performance through buyer-supplier linkages with the MNEs, arguing that India has attracted a more domestic market-seeking FDI than export-oriented one. Gains in exports from FDI are not manifest hence. Also, countries pursuing export-led growth strategy and firms in clusters benefit more from FDI. Domestic firms in a cluster benefit from the presence of foreign firms in other clusters as well (Dua et al, 2011). As described by Subrahmanian and Pillai (1976), a substitution-led strategy would require foreign inputs and technology-dependence, and can be used to create an export-base.

In the case of India, existing evidence indicates that positive effects of FDI offset negatives. Sinha(2007) found that India has grown due to its human-capital, market-size, rate of growth of the market and political-stability whereas for China, congenial business climate, creating strategic infrastructure at SEZs and taking strategic policy initiatives and creating flexible labour law were drivers for attracting FDI. In a similar case, Ghosh (2005) finds that if India follows China’s lead, then it can realize its full potential. In fact, the desired level of FDI required to generate spillovers is lower in India than China (Balasubramanyam and Sapsford, 2007). Basu et al (2007) find India as not only cost- effective but also a sought-after destination for R&D activities, which brings in FDI for the software industry, which has high R&D which can be channelized in the form of export-promotion.

Motivation

This paper attempts to consolidate literature on the ways in which FDI has contributed to the Indian economy over the past twenty years. The main motivation behind this being to study the channels through which FDI affects the economy: as a non-debt creating source of funding CAD, as export-promoting and as a source for technology-spillovers.

Data and Methodology

The major data sources used for this analysis are the Finances of Foreign Direct Investment Companies in the Annual reports from the RBI, which gives data on FDI companies’ trade, finances and performance, and data on India’s Balance of Payments. This is supplemented with data from the World Investment reports. Though the number of FDI firms (745 in 2010-11) in each RBI report varies, a clear trend about the scenario of such companies can nevertheless be discerned.

The aim is to look at the direct and obvious ways in which FDI affects India’s economy; this is done by looking at the ratio of FDI to GDP at factor cost, and to GFCF. Following this, the more indirect ways of FDI funding BOP deficits and facilitating exports are checked.

Main findings

FDI is becoming increasingly important in India’s economic framework. FDI as a proportion of GDP (at factor costs) has been showing an increasing trend over the last twenty years, while FDI as a proportion of Gross Fixed Capital Formation (at constant prices, 2004-05 base years) has also been growing since 1990 till date, showing the accelerating impact of FDI in terms of growth as well as capital formation in the economy.

Source: Calculated from RBI Database on Indian Economy

Although FDI inflows to India have been increasing over the last twenty years, the ratio of net-FDI to gross-FDI has been declining. Also, the amount of repatriation abroad from these FDI companies or their disinvestments has been increasing. This casts some doubt as to whether FDI inflows can be actually a source of financing the rising CAD.

Source: Calculated from RBI Database on Indian Economy

Given the increasing number of FDI firms selling-off and leaving India, the theory of using FDI to balance the BOP needs to be tested. The following graph shows the trends of Current Account Deficit and Net-FDI flows into India.

Source: Calculated from RBI Database on Indian Economy

FDI inflows are rising in India, which can play a major role in funding the rising CAD, as they are more stable in nature, owing to the fact that they cannot be disinvested in a short time-span as compared to FIIs, and is non-debt creating. However, it cannot be conclusively concluded that FDI is used to finance the CAD, although it is evident that the absence of these FDI flows into India would worsen the BOP deficit. Since the CAD is mainly caused due to a trade deficit, the impact of FDI companies and their trade patterns in India are analysed below to obtain insights into the extent to which FDI flows are creating exports, and to what extent does FDI contribute to financing the CAD.

Table 1: Year-wise export intensity of sales of FDI companies in India

Year

Export intensity of sales (%)

1991-92

9.9

1992-93

10.6

1993-94

11.5

1994-95

9.9

1995-96

9.2

1996-97

9.2

1997-98

10

1998-99

10.7

1999-00

10.5

2000-01

14.4

2001-02

14.6

2002-03

14.7

2003-04

15

2004-05

11.1

2005-06

11.9

2006-07

15.3

2007-08

14.0

2008-09

13.7

2009-10

12.3

2010-11

12.3

Source: Calculated from RBI Annual Reports, Finances of Foreign Direct Investment Companies, various issues

Export-intensity of FDI companies has been declining, and has remained at around 12% over the last two years. Compared to the export-intensity out of their total sales, domestic companies seem to be exporting at a higher proportion (25%) compared to FDI companies in India (RBI, 2010). Assuming that FDI firms come to India with a market-seeking intention, their sales in domestic market would be higher while exports will not be as significant.

The following table shows the trade-patterns of FDI and Non-FDI companies in India, and the share of FDI and Non-FDI companies in financing CAD.

Table 2: Year-wise trade balance, Invisibles balance, and Current Account balance of FDI and Non-FDI companies in India

 

Trade Balance

Invisibles Balance

Total Current Account Balance

 

 

Year

FDI

Non-FDI

India

FDI

Non-FDI

India

FDI

Non-FDI

India

FDI/CAD

Non-FDI/CAD

1991-92

83468

-732868

-649400

-16962

442862

425900

66506

-290006

-223500

0.30

-1.30

1992-93

65395

-1789295

-1723900

-17676

465176

447500

47719

-1324119

-1276400

0.04

-1.04

1993-94

122618

-1394918

-1272300

-8239

917139

908900

114379

-477779

-363400

0.31

-1.31

1994-95

-22008

-2819892

-2841900

3438

1780162

1783600

-18570

-1039730

-1058300

-0.02

-0.98

1995-96

-137539

-3668561

-3806100

-19304

1860804

1841500

-156843

-1807757

-1964600

-0.08

-0.92

1996-97

-134898

-5121202

-5256100

-1296

3629196

3627900

-136194

-1492006

-1628200

-0.08

-0.92

1997-98

-101265

-5679235

-5780500

66347

3625853

3692200

-34918

-2053382

-2088300

-0.02

-0.98

1998-99

8245

-5556045

-5547800

-25372

3894272

3868900

-17127

-1661773

-1678900

-0.01

-0.99

1999-00

73565

-7809465

-7735900

-52569

5755369

5702800

20996

-2054096

-2033100

0.01

-1.01

2000-01

208695

-5882395

-5673700

-434

4514334

4513900

208261

-1368061

-1159800

0.18

-1.18

2001-02

37063

-5532563

-5495500

-85309

7223409

7138100

-48246

1690846

1642600

-0.03

1.03

2002-03

107432

-5277132

-5169700

-60940

8296640

8235700

46492

3019508

3066000

0.02

0.98

2003-04

-455900

-5882700

-6338600

58000

12678900

12736900

-397900

6796200

6398300

-0.06

1.06

2004-05

-859100

-14317400

-15176500

127400

13831700

13959100

-731700

-485700

-1217400

-0.60

-0.40

2005-06

-1093000

-21873400

-22966400

208400

18384300

18592700

-884600

-3489100

-4373700

-0.20

-0.80

2006-07

-1458000

-26538200

-27996200

-945000

24502900

23557900

-2403000

-2035300

-4438300

-0.54

-0.46

2007-08

-3063500

-33706500

-36770000

-2483700

32903700

30420000

-5547200

-802800

-6350000

-0.87

-0.13

2008-09

-3810730

-50929270

-54740000

-2600270

44580270

41980000

-6411000

-6349000

-12760000

-0.50

-0.50

2009-10

-3822180

-52167820

-55990000

-2708363

40728363

38020000

-6530543

-11439457

-17970000

-0.36

-0.64

2010-11

-4392640

-55167360

-59560000

-3524744

42074744

38550000

-7917384

-13092616

-21010000

-0.38

-0.62

Source: Calculated from RBI Annual Reports, Finances of Foreign Direct Investment Companies, various issues

The table looks at Trade balance, Invisibles balance and Current Account balance for India [4] , FDI and Non-FDI companies. Trade balance (exports – imports) for FDI companies has been taken from RBI’s survey on Finances of FDI companies. Non-FDI companies’ trade balance is the difference between India’s trade balance (from the BOP Current Account) and FDI companies’ trade balance [5] . Invisibles balance has been calculated similarly. Invisibles include receipts in the form of service export, interest and commission receipts net of payments including dividend, interest, travelling expense, royalties, technical fees, professional and consultation fees. FDI and Non-FDI firms’ current account balance is obtained by summing trade balance and invisibles balance. The ratio of FDI companies’ balance to India’s Current Account balance shows that over the years, FDI has been contributing to financing the CAD to some extent (38% in 2010-11). A brief glance at the trade-balance of FDI companies reveals that their imports generally have exceeded their exports. This indicates that these firms were more interested in the domestic market and their export-intensity is hence lower compared to even the domestic companies. Also, this widening gap between FDI companies’ exports and imports is lessening the ability of FDI inflows to finance CAD, since outflows are also increasing. At this juncture, it is useful to look at sector-wise trends in FDI and Non-FDI companies over the past few years.

Table 3: Year-wise and sector-wise export intensity of sales of FDI and Non-FDI companies in India

 

Export intensity of sales (FDI companies)

Export intensity of sales (Non-FDI companies)

Select Industries

2006-07

2007-08

2008-09

2009-10

2010-11

2006-07

2007-08

2008-09

2009-10

2010-11

1. Manufacturing

 

17.2

15.6

15.4

 

22.3

23.9

24.5

a. Food products and beverages

5.1

4.6

7

6.3

8.7

10.5

9.3

11.6

9.8

11.8

b. Chemicals and chemical products

16.9

17.7

21.6

21.9

22

24.3

25.5

24.8

24.3

24

c. Rubber and plastic products

15.2

12.8

13.1

15.6

23.7

18.5

16.7

14

14.7

15

d. Machinery and machine tools

21.3

18.1

20.2

17.6

17.9

10.2

9

8.4

7.9

6.5

e. Electrical machinery and apparatus

13

12.9

15.2

13

11.6

15.7

17.6

11.4

13.5

9.2

f. Motor vehicles and other transport equipment

5.1

5.5

15.8

15.2

11.2

9.8

9.5

9.1

9.8

11

2. Services

 

1.3

3

3

 

5.2

5.7

5

a. Wholesale and retail trade

9.2

8.9

1.9

2.7

2.2

17.5

20.9

14.8

19.4

16.1

b Computer, related work

11.3

12.9

3.5

7.7

8.2

2.2

2.8

3.5

2.5

2.4

Source: Calculated from RBI Annual Reports, Finances of Foreign Direct Investment Companies, various issues

For Foreign companies in India, export-intensity has been slightly falling for motor-vehicles, and electrical machinery. Rubber-products and machine-tools seem to have the highest export-intensities. For exports of domestic firms in India, a preliminary glance shows that export-intensity of most goods remains more or less same, showing that perhaps FDI has little impact on exports of foreign or domestic firms in India.

Chart 4: Growth in exports of FDI and Non-FDI companies in India (manufacturing sector)

Source: Calculated from RBI Annual Reports, Finances of Foreign Direct Investment Companies, various issues

The charts above show that growth of exports for FDI companies has been positive and higher compared to Non-FDI companies especially in the case of rubber and food, although exports growth for motor-vehicles for FDI companies is negative while it is positively increasing for Non-FDI companies. However, these trends only depict the direction and magnitude of the growth rate of exports. Actual values as discussed earlier show imports are increasing faster than exports for FDI companies in general.

A glance at growth of imports of FDI companies vis-à-vis Non-FDI companies shown below reveals that imports of FDI companies in general have been growing faster than that of Non-FDI companies, especially for motor-vehicles (32.1% growth in 2010-11 for FDI companies compared to 27.5% for Non-FDI companies), rubber and chemicals. It is evident from the above analysis that imports of FDI companies exceed exports, causing trade-deficits and renders difficult the chances of FDI flows to be used to finance CAD in India.

Chart 5: Growth in imports of FDI & Non-FDI companies in India (manufacturing sector)

Source: Calculated from RBI Annual Reports, Finances of Foreign Direct Investment Companies, various issues

Although outward FDI and imports by FDI companies in India have been increasing along with increase in FDI inflows into India, there are still some positive aspects in support of FDI companies in India. The charts below indicate debt-to-equity ratios of FDI and Non-FDI companies in India for the manufacturing sector (since manufacturing imports exceed exports causing trade-deficits); the proportion of debt as compared to equity is lower for FDI companies for all sectors under manufacturing as charts 6 show. For each sector, FDI companies have more equity and is non-debt creating.

Another interesting observation is that the profit-margin of FDI firms (comparing 2010-11 figures) calculated as earnings before interest payments, tax, depreciation and amortisation of loans to total sales is significantly higher compared to domestic companies, the most significant sectors being machinery and machine-tools (profit-margin being 12% for FDI companies as compared to just 4.5% for Non-FDI companies), followed by food-products (9.5% for FDI companies as compared to 4.5% for domestic companies). This is possibly because FDI companies have access to better technologies and are more efficient in production.

Chart 6: Debt to equity ratio of FDI & Non-FDI firms in India (manufacturing sector)

Source: Calculated from RBI Annual Reports, Finances of Foreign Direct Investment Companies, various issues

Chart 7: Profit margin of FDI and Non-FDI companies in India (manufacturing sector)

Source: Calculated from RBI Annual Reports, Finances of Foreign Direct Investment Companies, various issues

Immediately following these observations, the debates in literature on technology-spillovers becomes evident. Since FDI firms have advanced technology, their efficiency in production and hence profit-margins are higher than Non-FDI companies. Though it is expected that domestic firms would get benefitted from FDI companies via technology-spillovers due to their interaction, it is not evident from their performance in terms of profit-margins. This might be because multi-national firms do not let their knowledge to other firms, to remain monopolistic.

conclusions

Ratio of debt-to-equity for FDI companies is decreasing compared to non-FDI companies. This shows that FDI flows are non-debt creating sources of additional funds in the host economy, and are of a more stable nature compared to repatriations from abroad that India receives, currently comparable to FDI inflows but of an uncertain nature. FDI flows are hence a better way out to pump-in more funds to balance CAD.

An important finding is that export intensity of FDI companies is significant (12%) but low compared to domestic firms in India (25%). This is because FDI companies seek markets in India and do not use India as a source for exporting elsewhere. Trade-balance of FDI and Non-FDI companies seems to be increasingly in deficit; hence still high CAD despite high FDI. This makes the future ability of FDI inflows to fund CAD doubtful. Profitability of the samples of FDI companies taken by RBI seems higher than non-FDI companies.

With increase in economic growth, size of the host country market enlarges and there is an incentive for market-seeking FDI. Institutional development and infrastructure are the main determinants of FDI inflows and should be focused for India to remain a global destination for FDI, alongwith encouraging FDI in multiple-sectors for diverse spillovers and skill-transfers. Firms in clusters would gain significantly from FDI in their region, within-industry and across other industries in the region.