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The Impact of FDI on the Indian Economy since 1990 Report


Introduction

The Foreign Direct Investment (FDI) is a major source of income for a majority of economies across the world. Developed nations like the United States of America have an astounding percentage of their staggering economic totals annually coming from foreign investments whether from those that are based in the United States or the returns and royalties of their multiple firms abroad.

FDI inflows and outflows can largely determine who dictates the terms of in the international economic arena based on one’s financial muscles. For this reason, governments of countries with rich histories of contention or conflicts have set their differences aside and entered into agreements that would foster trade between them and thus enhance their FDI inflow.

This move should explain regional treaties on the limitation of barriers on tariffs that are commonly referred to as Free Trade Agreements. The effect of this multinational cooperation lies in the very competitive status of the international market and a country that can successfully make itself attractive enough for investors to consider it as an investment destination, which goes a long way in securing its own economic growth and development.

This paper focuses on the impact of FDI on India since 1990. Nevertheless, it begins by issuing a brief overview of FDI history in India since it attained independence in 1947. This segment is helpful in explaining the sudden unparalleled growth of its FDI ratio post 1991.

The paper follows this analysis by addressing the FDI index since 1990 to date and providing a comprehensive reflection of why the figures changed as they did. It also outlines the implications of these new figures on India as a country from an economic, political, and socio-cultural perspective.

Finally, the paper concludes by offering recommendations on how in future, India could manage its FDI scales better and reap more results from the same.

Definition and Background: An analysis of FDI since independence

FDI, which stands for Foreign Direct Investment as aforementioned, refers to the fund that often flows between countries as in flows or out flows.

This fund presents the respective states or nations with the option of either reaping the benefits of investments or return the profits into the pool and achieve higher profits by improving performance, thus enhancing their position in an international scale or perspective (Borensztein, De Gregorio & Lee 1998).

FDI is a critical economic catalyst and it improves the domestic economy by providing stimulation for domestic investment, increasing the productivity that is derived from human capital, and facilitating the transfer of technology between nations for the benefit of those that are less advanced in terms of technology.

It is noteworthy that FDI should best be regarded as a double-edged sword. On one hand, it can boost economic growth especially when applied with regard to fast growing sectors such as agricultural exports and other beneficial investments.

On the other hand, if this investment is done blindly and the domestic market or resources are not harnessed, it could easily result in a monopoly of foreign investors in a country, which would create unhealthy competition for local producers (Agosin & Machado 2005).

Within no time, cheaper goods from foreigners would infiltrate the market and put local traders out of business, which would be a very precarious position for any country.

Additionally, in the second scenario, other critical areas would suffer such as environmental sustainability, and this aspect would greatly jeopardise the future generations’ resource pool (Bandyopadhyay 2012). Consequently, a safer bet would be the management of FDI so that the country makes the most out of foreign in flows, mostly by striving to become self-reliant.

India attained its independence in 1947 and immediately afterwards, legislators realised that the FDI was a goldmine that they needed to exploit. Consequently, the policies that were made in this era had an entrepreneurial spirit and the main objectives were to benefit from others’ advanced technologies as well as the mobilisation of the foreign exchange resource.

In a move calculated at boosting its FDI inflows, the Indian government allowed foreign enterprises to participate equally in its economy. This element meant that the enterprises’ foreign status did not automatically single them out to higher taxes or any other trade barrier, but they were in fact granted national status, which is the rates at which local or domestic investors traded in (Carkovic & Levine 2002).

Additionally, the government accorded investors with a myriad of business incentives such as tax concessions, simplifying the procedure of obtaining licenses and work permits, and ‘de-reserving’ some industries such as drugs and fertiliser manufacturers.

Nevertheless, it also became apparent that these efforts were still insufficient to promote India’s economy because the FDI outflows exceeded the in flows (Alfaro , Chanda & Sayek 2003). The out flows took the form of royalties and remittances of dividends and profits from the country’s foreign reserve.

Indeed, the investors were landing in India in droves, but they seemed to be siphoning all the gains of their businesses back to their own nations.

Consequently, in 1973, the Indian government created a Foreign Investment Board and enacted the Foreign Exchange Regulation Act whose main objective was the oversight and regulation of FDI flows into India.

The government also brought into office the Foreign Investment Promotion Board (FIPB) whose duties included offering proposals for FDI in India as well as attending to those proposals on projects or from sectors that did not automatically qualify for approval by the Reserve Bank of India.

The FIPB also handled those proposals that fell without the present FDI policy in place in India at the time. The cumulative effect of all these policy land marking was the stabilisation of the FDI flows to and from India.

From then onwards, the inflows grew by a minimum margin each year, but it was not until 1990 that a staggering amount was reaped from the inflows following the enactment of some policy directives by the relevant Ministry of Commerce and Industry in India (Sahoo 2006).

Concerning foreign relations, India has an impressive resume. For instance, it is one of the pioneer member states of GATT– General Agreement on Tariffs and Trade.

In addition, it has maintained Double Tax Avoidance Agreements (DTAA) with more than 70 states globally, which is why Mauritius is leading in its FDI in flows annually, because the rates it coined for Mauritius on dividend tax are significantly lower that the figures stipulated for the United States of America (Basu, Nayak & Vani 2007).

The United States thus uses Mauritius as a back door for investing in India so that it can benefit from these reduced rates of 5 per cent on dividend tax as compared to its 15 per cent. By 2006, India had signed 57 Bilateral Investment Treaties (BITS) with other states and this move allowed it to take advantage of their resources as they did to its resources too (Srivastava 2003).

India is also a signatory of the World trade organisation (WTO) and the South Asian Free Trade Agreement (SAFTA). Finally, it is a member of the Multilateral Investment Guaranty Agency (MIGA) (Barro 1991).

All these affiliations have opened up the borders of India and it is no wonder that it is being ranked top three in most surveys regarding the attractiveness of various nations as investment destinations.

In 2012, the International Monetary Fund (IMF) ranked India amonst the “less-developed” countries, but with the current developments as stipulated above might catapult India to a developed country in the next decade with proper investment stategies being put in place.

The effects of FDI since 1991 and what they have meant for the Indian economy

Pursuant to the aforementioned directives, the government introduced liberalisation measures in view of the policy provisions that dealt with FDI. One remarkable effect of carrying out this exercise was the increase in FDI amounts from Rs. 2705 crores in 1990 to Rs. 123378 crores in 2010 (Luthra 2012).

Therefore, it is clear that within two decades, India’s FDI index appreciated by 45 per cent. In terms of the countries that India is involved with in economic transactions based on their investments in India, the figure shifted from a paltry 29 in 1990 to 150 in 2010 (Luthra 2012).

Consequently, the policy directives introduced by the government in 1990 went a long way in improving the economic state of India. Over the past two decades, it has become apparent that close to two thirds of its FDI inflow comes from a select group of countries that invest heavily.

These countries include Mauritius, Singapore, the United States of America, the United Kingdom, Germany, Cyprus, the Netherlands, France, Japan, and the United Arab Emirates. Mauritius is at the top of the list although it only joined the race in 1992.

This scenario plays out because the United States’ firms mostly use Mauritian firms as their fronts for various businesses in India. The cause for this action would be the tax treaty between Mauritius and India that levies a limited dividend tax of only 5 per cent for Mauritius, yet the same treaty between India and the United States requires the United States to pay dividend tax at the rate of 15 per cent (Basu, Nayak & Vani, 2007).

A brief summary of the direct effects of the FDI increase in India on its economy would take note of the technological upgrading that India has received since it opened its doors to foreign investors. Part of the trade concessions requires that a percentage (often the greater percentage) of the workers be Indian by nationality.

Such workers acquire skills and knowledge on how to use advanced technology and this knowledge remains in India for manipulation in the domestic market.

Conventionally, it costs firms more money and resources to hire expatriates compared to what they would use if they hired natives. In addition, as aforementioned, the skills acquired by Indians remain in the country and thus individuals use the so acquired skills to start businesses, which ultimately contribute to the growth of the country.

Another benefit is that India can comfortably compete internationally with other giant economies in a highly effective manner (Luthra 2012). The investors often form branches of companies or firms that have their headquarters in their nations.

As a result, if for instance, the firm under discussion is the American AIG group, India benefits by receiving the standard of insurance services enjoyed by the American citizens. Additionally, other players from other countries that also use AIG can comfortably transact with India because they share a common ground. Therefore, it is for a myriad of other sectors and products that hail from India.

Yet another benefit that accrues to India due to its increased FDI totals would be that India gains access to global managerial skills and practices. For a firm to have invested both in its original country of residence and later in other states successfully, it requires top-notch management skills, which is part of the benefits that accrue to India as a host to such successful firms.

The firms deal with other domestic Indian firms in the ordinary course of business and this aspect provides some sort of apprenticeship for Indian firms.

Additionally, one of the perquisites that come with these relationships is that the foreign firms often provide opportunities for talented locals to pursue further training in their various countries of origin, for instance, in the USA or other international institutions across Europe and around the world.

This element gives the Indian population a chance to upgrade to global standards in terms of skill acquirement and they can come back and teach these nuggets of wisdom and knowledge to their kin in India. Ultimately, Indians have managed to be at par with international standards in different business aspects.

The final benefit that shall be mentioned in this segment is the chance that India gets to utilise its human and natural resources optimally. India has the largest population in the world and frankly, this aspect is one of its attractions explaining why it is such a hub for investors worldwide.

Its large population translates into abundance of the labour force; therefore, on its own, without foreign investment, it would prove impossible to support such a large population on the resources accessible to such a government. However, since there are numerous foreign firms that have invested in India, it benefits greatly by having its population offered employment opportunities in various factories, firms, or industries.

In addition, its youth get quality education in various internationally sponsored institutions coupled with having various NGO commence and run long-term projects on health matters or even Research and Development (R & D) agendas (Bandyopadhyay 2012).

Such projects often amass profits for the nation in the long term especially where such NGOs or investors leave the firms in the hands of Indians to manage as per the arising needs of future generations.

Conversely, even if it may be true that the natural and human resources in India can be realised even without the aid of foreign investors, it would be unwise to try such option for such a move would lock out any chances of advancement or development in technology, education, or research and development (R & D).

India needs and highly appreciates foreign investors for they provide the much needed diversity and freshness that the economy needs to flourish (Luthra 2012).

An interesting fact that has come up in various research surveys, particularly one on Canada, shows that Canada specifically does not find India attractive in terms of investment because India has not availed to the public any information regarding the various investment opportunities in its country (Barro 1991).

Additionally, Canada feels that India does not have sufficient concentration of export processing Zones. This element is a concern shared by several countries such as Turkey and Spain, but it is also interesting to note that the various international organisations such as the World Trade Organisation and the United Nations classify India as top ten in the world in terms of attractiveness as an investment destination.

In an attempt to make this phenomenon clear, it is important to mention that, for instance in 2005, the United Nations Conference on Trade and Development ranked India as number three (3) in the global FDI noting that it had potential to remain one of the top five global FDI attractions before 2012 (Mahanta 2012).

Additionally, A.T. Kearney’s 2007 Global Services Locations Index ranked India as the most preferred destination in view of financial attractiveness, the availability of labour resources, as well as market for goods and a conducive business environment. All these observations came up after India put into place the renowned Liberalisation, Privatisation and Globalisation (LPG model) reforms (Madem, Gudla, & Rao 2012).

The objective of these reforms was to make the Indian market more attractive to foreign investors by providing irresistible business incentives such as tax concessions and cheap local labour. However, they were also to make the FDI structure more domestic centred in a way that would ensure the development of local production through the acquisition of technological know how and managerial skills of global standards.

In the next section, this paper shall analyse the various segments of the Indian economy that have been affected by the increased FDI in flows. Particularly, the focus shall be on the millennial era beginning in the year 2000 and special emphasis shall be laid on the effect of the 2008 global recession, a crisis that set back several global economies.

It shall be interesting to learn how India was holding up before the crisis and how that crisis affected the country and to do this task, it shall be helpful to use a table that captures all the appropriate figures followed by a general discussion of what those figures represent.

Table 1.1: GDP Growth Rate of Sectors (Bandyopadhyay 2012, p. 15)

Year Agri. Mining Manu Elect Const Hotel Finance Comm.
2000-01 0.002 0.024 0.077 0.021 0.062 0.073 0.041 0.047
2001-02 0.063 0.018 0.025 0.017 0.040 0.092 0.073 0.041
2002-03 0.072 0.088 0.068 0.047 0.079 0.094 0.080 0.039
2003-04 0.100 0.031 0.066 0.048 0.120 0.120 0.056 0.054
2004-05 0.000 0.082 0.087 0.079 0.161 0.107 0.087 0.068
2005-06 0.058 0.049 0.091 0.051 0.162 0.121 0.114 0.071
2006-07 0.040 0.088 0.118 0.053 0.118 0.128 0.138 0.057
2007-08 0.049 0.033 0.082 0.053 0.101 0.124 0.117 0.068
2008-09 0.016 0.036 0.024 0.034 0.072 0.090 0.078 0.131
2009-10 0.004 0.069 0.088 0.064 0.070 0.097 0.092 0.118
2010-11 0.066 0.058 0.083 0.057 0.081 0.103 0.099 0.070

Note: “Agri.: Agriculture and Allied activities including Fishing and Forestry; Mining: Mining and Quarrying; Manu: Manufacturing; Elect: Electricity, water and gas supply; Const: Construction and Housing; Hotel: Hotels, Trade, Transportation and Communication; Finance: Financial and Non Financial Business Services,

Real Estate and Insurance; Social: Community, social and personal services” (Bandyopadhyay 2012, p.15).

Agriculture: It is noteworthy that agriculture only accounts for a very small percentage of the overall FDI inflows. It is also important to note that this discussion turns at 2008 when the entire world went through the great recession that started in the United States and washed through the world. India was bound to be affected by the meltdown because the US is one of the biggest sources of its FDI.

Mining and Quarrying: The trend is similar as it is for agriculture, but it is notable that whereas the FDI in flows from mining dropped at the onset of the recession, they maintained at that reduced rate without nose-diving further and immediately upon the end of the recession they sky rocketed again.

Electricity, water, and gas supply: There has been a steady increment of the FDI inflows from these three products and even the 2008 crisis did not dent the FDI rate very deep. It is noteworthy that this element is a good sign in terms of sustainable development because it means that India has a level of self-reliance, which kept its domestic producers afloat even when the rest of the world was at a crisis.

An important factor to consider alongside FDI inflows is the sustainability of the development being advanced by the in flows. The government ought to be aware that it is not only responsible for the present generations’ sustenance, but that the future generations’ resources are bequeathed in the present.

This knowledge ought to propel such a government to pursue sustainable development and in the end, the FDI index shall reflect such efforts by maintaining stability even at times of great unrest and instability across the world. The trick is to make FDI investments as efficient as possible.

Manufacturing: The table indicates that the manufacturing industry has been on the decline for quite a while and that during the crisis, it fell even sharper off the mark. Several possible elements can explain this decline including the idea that India probably depends so much on other countries for the technology and management in and of its industries, which would explain the sharp decline during the recession.

If this assertion is the case, then it is a clear indication that the development pertaining to manufacturing industries in India is not sustainable. Moreover, it is clear that the Indian labour force entails largely the natives from the Indian population and this aspect being the case means that in case of a repeat of the recession or another event with similar proportions, India would suffer greatly.

One of the advantages of FDI on a country’s economy is the skills gained by the citizens hosting the foreign individuals. India would be better placed if it brought its domestic manufacturers up to speed to be at a competitive level with the foreign firms. In the very least, this move would secure its future production.

What becomes apparent from this analysis is that India is not cushioned when it comes to international financial matters. Without a doubt, the FDI is a perquisite to any country’s economy, especially developing economies like that of India.

However, as observed from the effect of the recession on India’s FDI dependent sectors like the service industry particularly tourism and in other dependent appendages like construction, India should come up with counter measures to deal with such occurrences in the future.

Ideally, the government of India should ensure that the FDI system is structured to maximise positive spill over while minimising any negative results (Madem, Gudla & Rao 2012).

Recommendations

The Indian government is already doing a commendable job at managing the country’s FDI structure. However, there is room for improvement and this room lies with policy makers. As such, it follows that this paper shall give two policy recommendation that if applied could probably boost the economic growth in India.

First, with regard to what has already been mentioned above about the need for the FDI in flows to be handled as efficiently as possible, it would be beneficial for India to concentrate on particular segments of its economy while ratifying investment proposals in future. Some of these segments include infrastructure and agriculture.

Agriculture forms the backbone of most successful economies globally because if a country can comfortably produce sufficient food to feed its population, it can seldom be forced into a transaction that it would otherwise not condone. There is power in becoming self reliant and self-sufficient and by focusing on the agricultural sector, India could achieve this goal.

Regarding infrastructure, most countries see India as the number one investment destination globally, but given its poor quality infrastructure, investors could shy off. However, if the government concentrates on improving its infrastructure, it may be slightly expensive in the short term but the long-term rewards shall be worth the sacrifice.

The second policy recommendation proffered by this paper is with regard to the increase of exports. This would be a genius way of multiplying its profits while simultaneously providing local or domestic producers with a high bargaining power against the foreign investors.

To fail to do so would jeopardise India’s economy in terms of stability because it would mean that foreign investors are giving domestic producers a run for their money. If this were the case, in case of a repeat of the recession crisis, the economy of India could easily be submerged within no time.

Conclusion

This paper has carried out a thorough analysis of the impact of FDI on the economy of India since 1990. It has defined FDI as the fund that flows among countries due to their investment activities, which may either be recycled in investment or withdrawn for local uses.

It has looked at the history of India and identified the major landmarks of its present affluence as its membership in various trade enhancing organisations and a signatory of several free trade area treaties such as SAFTA.

It has also reviewed the effect of the 2008 global recession on the Indian economy and noted that India could well benefit from further proofing of its FDI structure to prevent the monopoly of foreign firms in the country at the expense of domestic production.

India truly is an attractive investment destination, and with proper structures in place. The country could reap handsomely from FDI investments given its unparalleled attractiveness in terms of investment destination preference amongst international investors.

Reference List

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Archana, V, Nayak, N & Basu, P 2007, ‘Foreign Direct Investment in India: Emerging Horizon’, Indian Economic Review New Series, vol.42 no. 2, pp. 255-266.

Bandyopadhyay, P 2012, ‘FDI and its Impact on Indian Economy’, Journal of Finance Today, vol.11 no.3, p. 6-15.

Barro, R 1991, ‘Economic Growth in a Cross Section of Countries’,Quarterly Journal of Economics, vol. 106 no.2, pp. 407-443.

Borensztein, E, De Gregorio, J & Lee, J 1998, ‘How Does Foreign Direct Investment Affect Growth’, Journal of International Economics , vol. 45 no.1, pp. 115-35.

Carkovic, M & Levine, R 2002, ‘Does Foreign Direct Investment Accelerate Economic Growth’, World, vol. 25 no. 11, pp. 1925-36.

Luthra, S 2012, Determining India’s Economic Trajectory: The Role of Foreign Direct Investment, <>

Madem, S, Gudla, S & Rao, B 2012, ‘FDI Trends During the Last Decade and its Effect on Various Sectors in India’, International Journal of Scientific and Research Publications, vol.2 no. 12, pp. 1-6.

Mahanta, D 2012,’Impact of Foreign Direct Investment on Indian economy’, Research Journal of Management Sciences, vol. 1 no.2, pp. 29-31.

Sahoo, P 2006, Foreign Direct Investment in South Asia: Policy, Trends, Impact and Determinants, Asian Development Bank Institute, Tokyo.

Srivastava, S 2003, What is the true level of FDI flows to India’, Economic and Political Weekly,vol. 19 no.7, pp. 608-610.

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IvyPanda. "The Impact of FDI on the Indian Economy since 1990." May 1, 2019. https://ivypanda.com/essays/the-impact-of-fdi-on-the-indian-economy-since-1990-report/.

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IvyPanda. 2019. "The Impact of FDI on the Indian Economy since 1990." May 1, 2019. https://ivypanda.com/essays/the-impact-of-fdi-on-the-indian-economy-since-1990-report/.

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IvyPanda. (2019) 'The Impact of FDI on the Indian Economy since 1990'. 1 May.

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