“Role of Fdi & Fii in Indian Economic Growth” Essay Example
“Role of Fdi & Fii in Indian Economic Growth” Essay Example

“Role of Fdi & Fii in Indian Economic Growth” Essay Example

Available Only on StudyHippo
  • Pages: 16 (4165 words)
  • Published: June 30, 2018
  • Type: Research Paper
View Entire Sample
Text preview

Role of FDI & FII in Indian Economic Growth

It is essential to express gratitude to the individuals who have supported us as it plays a significant role in successfully completing a project.

Life is an accumulation and discharge of debts, some of which are immeasurable. Gratitude alone cannot fully repay these debts, but they can be acknowledged. When it comes to understanding and incorporating different knowledge, guidance and advice are often necessary.


This research examines the relationship between foreign direct investment (FDI), financial markets, and economic growth. The aim is to evaluate if countries with stronger financial systems can effectively utilize FDI.

FDI plays a dual role in economic growth, but nations with well-established financial markets reap substantial benefits from it. These findings hold true regardless of different metrics used to gauge financial market development, the incorporation of othe


r factors that impact economic growth, and the consideration of endogeneity. The Indian government categorizes international capital inflows into several groups, including FDI, FII, NRI, and PIO investments. Encouraging inflows of investment from foreign countries is crucial as it complements domestic investments in developing economies where capital is scarce. India has gradually embraced foreign investments over the past two decades, especially after significant economic liberalization occurred in 1991.

Foreign investment has multiple benefits including promoting economic activity, job creation, technology transfer, and enhancing industry competitiveness. The Indian economy and society view the inflow of FDI and FII as a solution to their problems. It is now common for our finance ministers to actively promote India in international forums and encourage global leaders in industry and commerce to invest here. We are eager to understand the extensive impact of FDI on our

View entire sample
Join StudyHippo to see entire essay

economy, specifically its potential hindrances on economic growth. Fortunately, recent years have witnessed India's economic growth being largely driven by domestic savings, particularly those made by middle-class households. The success achieved should acknowledge the contribution of housewives from such households.

To achieve a 10% growth rate, it is necessary to have an investment rate of 35%, considering the capital-output ratio of 3.5. However, the reliability and applicability of this measurement are questionable as it does not apply to our service sector, which makes up about 60% of our economy and drives its growth.

Moreover, foreign direct investment (FDI) plays a significant role in our economy by ensuring a steady flow of funds and contributing to a dynamic capital market. In the last decade, numerous multinational corporations (MNCs) have opted to delist from the stock market and become unlisted subsidiaries of foreign parents. Analyzing this trend alone would provide insights into how foreign investment impacts our capital market.

MNCs can obtain funds domestically through the presentation of "comfort letters" from their parent company, obviating the necessity to seek external funding. In India, there are various local financial institutions, both Government and private, that are willing to lend to MNCs at rates lower than the prime rate because of their worldwide presence. Moreover, these institutions do not withhold funds from foreigners. Additionally, in today's age of information sharing and technology markets, technology transfer is readily achievable, enabling entrepreneurs to acquire the necessary technology.

India, a country known for its high scores in "technology diffusion" or "absorption," faces no issues when it comes to technological advancements. Even in the rural areas of Punjab, one can witness the unexpected use of washing machines

for churning lassi on a large scale. The Indian Diaspora plays a crucial role in adopting complex modern technology, and there are already significant connections between non-resident Indians (NRIs) and domestic capitalists. Another point of discussion is the increasing global flow of funds that nation-states cannot disregard. Interestingly, globalizers reacted strongly when Mr. Lakshmi Mittal attempted to acquire Arcelor or when China Petroleum tried to take over Unocal in the US.

Unlike the traditional approach of funds searching for markets, we now have the power to choose whom we invite. However, our politicians persist in promoting India as an enticing market - a skill observed in many of them. The sectors that draw foreign direct investment (FDI) in India encompass retail trade, restaurants, road transport, and construction.

Non-corporate, family-run businesses dominate all these activities. In most of these sectors, the share of partnership/proprietorship firms is more than 80 per cent. We want global corporate to come into India and turn these millions of entrepreneurs into workers. Can there be anything more perverse than this? What they need is adequate credit at reasonable rates and less bribes demanded by government minions. What additional technological wonders will be brought about by FDI in these areas?

Foreign Direct Investment

Foreign direct investment (FDI) refers to an investor's investment in a company located in a different nation from their country of origin. The purpose of FDI is to serve the business interests of the investor. The FDI relationship consists of a parent business enterprise and its foreign affiliate.

The MNC is formed by the parent enterprise's foreign direct investment aiming to have significant control over the foreign affiliate company. The United Nations defines 'control'

as owning equal to or more than 10% of ordinary shares or having the right to vote in an incorporated firm. A similar criterion should be applied to unincorporated firms.

Classification of Foreign Direct Investment

Inward FDI, also known as foreign capital investment in local resources, experiences growth due to factors like tax breaks, relaxed regulations, low-interest loans, and grants.

The main idea is that the advantages of long-term funding are greater than the drawbacks of temporary income loss. Factors like ownership restrictions and performance differences can limit the inflow of foreign direct investment (FDI).

Outward FDI

Outward FDI, also referred to as "direct investment abroad", entails investing local capital in foreign resources. It can also be used in import and export transactions with a foreign country.

Government-backed insurance at risk coverage promotes the growth of outward FDI. Foreign direct investment can be categorized into two main types: Greenfield investment and Acquisitions and Mergers. Greenfield investments focus on either establishing new production capacities in the host country or expanding existing production facilities.

  • The benefits of foreign direct investment (FDI) include increased employment opportunities, relatively high wages, R&D activities, and capacity enhancement.
  • However, there are disadvantages such as declining market share for domestic firms and repatriation of profits to foreign countries that could have been used for capital accumulation within the nation.
  • Multinationals often rely on mergers for FDI. Prior to 1997, mergers and acquisitions accounted for about 90% of FDI flow to the US economy. However, FDI through acquisitions does not provide long-term benefits compared to Greenfield investments.

Some other forms of FDI are categorized as Horizontal FDI, Forward Vertical FDI, Vertical FDI, and

Backward Vertical FDI. India's foreign direct investment includes investments in infrastructure development projects (such as construction of bridges and flyovers), the finance sector (including banking and insurance services), real estate development, retail sector, etc. The definition of foreign direct investment states that it refers to direct investments in productive assets by foreign companies in a country. FDI in India includes both inflows and outflows.

In India, both inward and outward flows of foreign direct investment (FDI) and foreign institutional investment (FII) have been increasing. The FDI policy in India, which is shaped by the norms and policies governing FDI, plays a significant role in attracting such investments. These regulations are imposed by the government as part of its theory. It is crucial to understand that FDI has advantages like infrastructure development through the contribution of foreign investors. However, it also has disadvantages such as loss of ownership rights to foreign companies and potential risks like increased liquidity and inflation due to excessive FDI inflow into India.

The rupee currency of India is facing pressure because of the increase in foreign direct investment (FDI); however, FDI has advantages such as enhancing fund management and establishing higher quality standards within the country. Additionally, the FDI policy oversees FDI stocks, which could potentially decrease confidence among global investors and impede both FDI and economic growth in India. FDI and GDP collaborate to bring about reforms in the Indian economy. Another form of foreign investment, known as foreign portfolio investment (FPI), is a more readily tradable and temporary type of investment.

Investment in foreign enterprises without long-term financial relationship plans is made through stocks and bonds in FPI. The government has taken

measures to provide technical education on FDI to improve the country's FDI database. FDI and trade are interdependent, as they work together in a symbiotic situation. Additionally, FDI trends have led to increased employment opportunities and growth in organizational structure due to improvement in the basic infrastructure of organizations.

The FDI news in India covers notations, strategies, and guidelines for foreign funds entering the country. Since 1992, India has also been involved in its own direct investment abroad and has gradually simplified procedures and liberalized policies since 1995. Currently, Indian corporate and registered partnership firms have the ability to invest up to 100% of their net worth in overseas businesses. However, there are restrictions on FDI in certain sectors such as arms and ammunition, atomic energy, railway transport, coal and lignite mining, as well as other mineral extractions. In the fiscal year 2006-07, net FDI inflows amounted to $8.5 billion and are estimated to have increased to $15.

The forecast of the panel predicts that FDI inflows in 2007-08 amounted to $5 billion but are expected to rise to $19.7 billion this fiscal year. Different sectors have varying FDI regulations, with textiles or automobiles permitting 100% FDI and telecom having a foreign investment limit of 74%. However, gambling and lottery activities do not allow foreign investment.

Factors Affecting Foreign Direct Investment

The host country's economy size and growth prospects significantly impact foreign direct investment.

A country's large market frequently results in quick economic growth, presenting investors with significant opportunities to maximize their investments. The size of the host country plays a crucial role in foreign direct investments focused on exporting as it creates possibilities for economies of scale and spill-over

effects. The potential of a substantial customer base appeals to foreign direct investors, which is influenced by the population of a country. Additionally, if a country possesses high per capita income or its citizens have strong spending power, it offers exceptional performance prospects for foreign direct investors. Furthermore, attracting international direct investment also depends on the quality of human resources within a country.

China's requirement for all citizens to receive nine years of education has led to enhanced labor standards. Countries like Saudi Arabia, with ample natural resources, attract foreign investment from companies seeking to exploit these resources. Furthermore, possessing a low-cost workforce is a crucial element in enticing foreign direct investment.

The rise of BPO and IT companies in countries like India has shown the importance of cheap labor in attracting foreign direct investment.

Advantages of Foreign Direct Investment

Foreign direct investment has many benefits, including its contribution to the economic progress of the host country. This is especially beneficial for developing nations. In the 1990s, foreign direct investment played a vital role in providing financial support to countries experiencing economic growth.

Foreign direct investment is crucial for countries facing economic difficulties as it enables the exchange of technologies and provides capital inputs. In contrast to trading goods, services, or investing financial resources, foreign direct investment is essential in ensuring this technology transfer. Furthermore, it aids in promoting competition within a country's local input market.

Foreign direct investment enables countries to receive capital resources and enhance their human capital through employee training. The generated profits from these investments can contribute to the recipient country's corporate tax revenues. Moreover, foreign direct investment promotes job creation and facilitates salary growth for workers.


direct investment has several advantages for a recipient country, such as enhancing the quality of life and providing better amenities. Moreover, it plays a vital role in the expansion of the manufacturing sector. Furthermore, foreign direct investment brings advanced technology and expertise to the country, opening doors for new research opportunities.

Foreign direct investment has multiple benefits. Initially, it contributes to income growth by generating tax revenues. Additionally, it promotes enhanced productivity in host nations. Likewise, when countries invest in other countries, they also reap advantages. Businesses obtain access to fresh markets, leading to increased income and profits. Moreover, it affords these nations an opportunity to export their advanced technology resources.

It has been observed that receiving foreign direct investment from other countries allows recipient countries to maintain lower interest rates. This benefits small and medium-sized business enterprises as it becomes easier for them to borrow finances at lower interest rates.

Disadvantages of Foreign Direct Investment

The drawbacks of foreign direct investment mainly involve operations, distribution of profits, and personnel. An indirect disadvantage is that the economically disadvantaged section of the host country is inconvenienced when foreign direct investment is negatively affected. The responsibility usually falls on the host country to control the impact of foreign direct investment.

It is important for the host country to ensure that entities investing in their country adhere to the country's environmental, governance, and social regulations. Disadvantages of foreign direct investment arise when the host country has sensitive national secrets that should not be disclosed. In some cases, foreign direct investment has posed risks to a country's defense. Workers in the recipient country may not appreciate certain foreign policies adopted as a result of

foreign direct investment. Additionally, those making the investment themselves may also face disadvantages.

Foreign direct investment can lead to increased travel and communication costs. There may be challenges due to language and cultural differences between the investor's country and the host country. Additionally, there is a risk of losing ownership to a foreign company, which has made many companies approach foreign direct investment cautiously. In some cases, there is significant instability in certain geographical regions.

This causes a significant inconvenience to the investor, as both the size of the market and the condition of the host country are crucial factors in foreign direct investment. If the host country is not well connected with more advanced neighboring countries, it creates challenges for investors. Sometimes, host country governments face issues with foreign direct investment and have limited control over wholly owned subsidiaries of overseas companies. Despite the drawbacks, foreign direct investment has played a pivotal role in shaping the economic fortunes of many countries worldwide.

Methods to attract FDI

Various strategies are employed by developed and developing countries to entice foreign direct investment (FDI), serving as a crucial determinant of competition. This rivalry persists even amidst economic integration. Traditional drivers for FDI, such as access to natural resources, markets, and cheap labor, are further amplified by contemporary trends. Globalization facilitates the division of production across national boundaries, thanks to technological advancements. Advancements in information and communication technologies, coupled with improved logistics, enable production to be situated near markets while capitalizing on distinctive characteristics of each production location.

Different countries employ various strategies to attract investment. Some offer financial incentives such as tax concessions, cash grants, and specific

subsidies. Others concentrate on enhancing infrastructure and skills to meet the needs of foreign investors. The improvement of the overall business environment through the reduction of administrative barriers and red tape is another approach. Many governments have established state agencies to assist investors in navigating through administrative paperwork.

Most countries have now joined international governing arrangements to enhance their appeal for increased investment. The need for a "Better Investment Climate" is essential. The presence of a favorable investment climate is critical for economic growth. Microeconomic reforms that aim to simplify business regulations, strengthen property rights, improve labor market flexibility, and enhance firms' access to finance are necessary to uplift living standards and alleviate poverty within a nation. The implementation of reforms is vital in fostering an investment-oriented climate. Effective management of these reforms holds significance as investment climate reforms are influenced by political factors.

They often prefer disorganized groups to organized ones and the advantages tend to accumulate only in the long term, while the costs are experienced upfront. Political decisions play a significant role in this context. All countries around the world are taking steps to change the business environment in order to attract more investment. Many nations opening up their doors have forced them to adopt reforms.

Foreign Institutional Investment

Foreign institutional investors refer to entities established or incorporated outside of India that intend to invest in India. Positive news about the Indian economy, combined with a rapidly growing market, have made India an appealing destination for foreign institutional investors.

An option for a foreign company planning to establish business operations in India is to incorporate a company under the Companies Act, 1956. Through this method, foreign equity

in Indian companies can reach up to 100%, depending on the investor's requirements. However, there are equity caps in place for certain activities under the Foreign Direct Investment (FDI) policy. Another option is for the foreign company to operate as an unincorporated entity. In this case, any investment from one country into another is considered foreign investment. Foreign investment is defined as a financial investment whereby a person or entity acquires a lasting interest in, and a degree of influence over, the management of a business enterprise in a foreign country. Various technical definitions, including those from the IMF and OECD, are used globally to define foreign investment.

FDI is viewed as more advantageous than FII as it is seen as the most beneficial form of foreign investment for the overall economy. FDI specifically targets a particular enterprise, with the goal of boosting its capacity or altering its management control. By investing directly in order to create or enhance capacity, the influx of capital results in additional production. In contrast, FII investment that goes into the secondary market primarily increases the availability of capital, rather than making it available to a specific enterprise.

Translating an FII inflow into additional production relies on production decisions made by someone other than the foreign investor. A local investor must utilize the extra capital provided by FII inflows to enhance production. When it comes to FDI that is received for acquiring an existing asset, there is no direct increase in production capacity as a consequence of the inflow. Just like with FII inflows, in this scenario as well, the foreign investor does not directly contribute to the expansion of production capacity.

It is the domestic seller who must invest the proceeds from the sale in a manner that increases capacity, allowing the foreign capital inflow to stimulate domestic production. There is a prevailing belief that FII inflows are considered "hot money" that causes instability in both the stock market and exchange rates.

FDI inflows are generally more stable compared to FII inflows, providing not only capital but also improved management, governance practices, and often technology transfer. The transfer of know-how through FDI is often considered more important than the actual capital. However, such benefits do not apply to FII inflows, although the involvement of FIIs searching for reliable investment options has helped enhance accounting and governance practices among listed companies.

According to the government's definition, Foreign Institutional Investors (FIIs) encompass various entities such as asset management companies, pension funds, mutual funds, investment trusts as nominee companies, incorporated/institutional portfolio managers or their power of attorney holders, university funds, endowment foundations, charitable trusts and charitable societies. FIIs must allocate their investment between equity and debt instruments in a 70:30 ratio. However, it is also possible for an FII to declare itself as a 100% debt FII, allowing it to invest entirely in debt instruments. Certain cases, such as airlines, have specific regulations where foreign investment, including FII, is limited to 49%, while foreign direct investment (FDI) from foreign airlines is not permitted. The government periodically introduces new regulations to ensure the compliance of FII investments. For instance, the Securities and Exchange Board of India (SEBI) recently imposed restrictions on investment through participatory notes (PNs).

Entering the capital market as a foreign institutional investor (FII) is now quite easy. All that is

required is a SEBI registration and a quick due diligence before trading can begin in the Indian stock market. Exiting is also uncomplicated. However, the process is much more challenging for foreign direct investment (FDI). Both entry and exit pose difficulties, particularly in sectors that are supposedly open to FDI.

There are numerous clearances that must be obtained at the state and district levels, as well as practical obstacles like infrastructure bottlenecks, which all make entry into the market challenging. The process of exit is even more complex. Fig 3: Net FII inflows in India Year |Net FII inflows(US $ million)

Impact of FDI on Indian economic growth

The Government of India recognizes the significant role of Foreign Direct Investment (FDI) in economic development, not only as an addition to domestic capital, but also as an important source of technology and global best practices. The Government of India has implemented a liberal and transparent FDI policy.

In recent times, many developing countries have changed their attitude towards providing an investor-friendly environment in order to keep up with global integration. They are now offering financial and non-financial incentives to multinational corporations to encourage increased direct investment flows. With open door policies and external factors like low interest rates and economic growth, FDI inflows into developing countries have been on the rise in the past decade. India, for example, used to be one of the lowest recipients of FDI among developing countries until the 1970s when it received cumulative inflows of about US$454 million or 0.20% of gross domestic investment.

India has liberalized its market by reducing tariff and non-tariff barriers since the early 1990s, particularly from July 1991. Investment policy has

also been liberalized, allowing up to 100% foreign direct investment (FDI) in most sectors/activities through the automatic route. Among emerging economies, India is considered to have one of the most liberal FDI policies. The automatic route permits foreign and non-resident Indian (NRI) investors to invest up to 100% in most sectors, including the services sector, without prior approval.

Foreign direct investment (FDI) in sectors/activities under the automatic route does not necessitate any prior approval from either the Government or the RBI. FDI has become an essential component of national development strategies for countries worldwide. Its widespread acceptance and beneficial impact on domestic capital, productivity, and employment have made it a crucial catalyst for economic growth in nations. India is increasingly emerging as a preferred FDI destination in Asia and the Pacific region.

According to AT Kearney's FDI Confidence Index, India has surpassed the US as the second-most favored destination for foreign direct investment (FDI) worldwide, after China. During the first half of the 2005-06 fiscal year, India attracted over three times the amount of foreign investment, amounting to US$ 7.96 billion, compared to US$ 2.38 billion in the subsequent period of 2004-05. FDI has significantly contributed to India's overall economic growth in recent times. It has facilitated the transfer of new technology and innovative ideas to India while also enhancing infrastructure, thereby creating a more competitive business environment.

Foreign direct investment plays a crucial role in the economic development of the host country, providing a launchpad for further improvements. This trend has been observed in the past two decades, as foreign direct investment brings in significant capital, knowledge, and technological resources to bolster the host economy.

The foreign direct

investors have played a significant role in the economic development of recipient countries. This is because these countries have altered their economic strategies and permitted foreign direct investors to enter and enhance their economies. It is frequently noted that economically developing and underdeveloped countries rely on economically developed countries for financial aid in order to attain some level of economic stability. In return, economically developed countries can provide financial support by investing in these countries. This financial assistance can be directed towards different sectors of the economy.

Channelization is typically based on sector-specific requirements, and foreign direct investment has been found to enhance a country's infrastructure. Furthermore, foreign direct investment presents significant opportunities for technological development. The host country's general public can experience an improved standard of living through foreign direct investment. Additionally, many recipient countries have seen benefits in their health sectors resulting from foreign direct investment.

Foreign direct investment (FDI) plays a significant role in a country's economic and social development. While private sector companies may not always prioritize infrastructure improvement activities, FDI can provide the necessary resources for such initiatives. These infrastructural projects often yield long-term gains rather than immediate benefits, which may discourage local businesses. Additionally, FDI can also bring in technology indirectly by either providing it directly or enabling the import of technology from other countries.

Get an explanation on any task
Get unstuck with the help of our AI assistant in seconds