FDI Policies of India and China

Chapter – 1: Introduction

1.1. Overview

Foreign Direct Investment is a hot topic in most policy circles as it is associated in many instances with significant macroeconomic changes and improvements in the range of goods and services produced in recipient countries. Furthermore growth in recipient countries is often ascribed to these inflows and so competition for higher inflows of FDI has become competitive. Most of the developing and developed countries increase their economy by enhancing their share in the global market through FDI inflows. As FDI shows more impact on the country’s economy, most of the foreigners are investing their amount in other countries for improving their profits with less manpower and minimum initial cost. These inflows were easily achieved by the investors by just fulfilling their basic requirements and maintaining their policies. FDI can be used by the countries only when they meet some of the major requirements like transfer of capital, a source of funds for foreign operations, Control investment and a balance of payments flow (Nicolas, B., 2010). Even though the FDI inflows in developing countries are low that is nearly 5%, this shows more impact on the economy in terms of the development programs by introducing new technologies. This change will be occurred only in the surroundings of investment areas. Here, in this research the FDI inflows between India and China are studied by comparing both the countries. Further of this study clearly explains the various aspects that are considered by the India and China for increasing the FDI inflows in the global market and also illustrates the policies that are followed by China as most of the investors prefer China when compare to the India. Finally, it recommends some of the policies and the changes that need to be made by the Indian Government for improving its FDI inflows.

1.2. Aim and Objectives

Aim:

To study the variations between the FDI policies of Indian and China based on their inflows and overall performance of the economy.

Objectives:

To study the importance of FDI and the required fundamental policies for acquiring the FDI.

To research on the impact of FDI inflows in India and China based on their overall performance.

Identifying the possible steps for Indian policy makers for improving their FDI inflows.

Statistically evaluating the comparison between India and China in terms of FDI inflows.

1.3. Purpose of Study

This study mainly focuses on the Foreign Direct Investment, the role of FDI in India and China and also illustrates the comparison between these two countries in terms of FDI. This research is selected in order to know more about the investments made by the developing countries and the involvement in international financial banking markets to influence the global and political aspects. This study is mostly useful for the people who are willing to know about the role played by FDI in the fast growing countries like India and China where these two countries differs in their environmental conditions. While researching about the FDI in both countries, one can easily analyze that China is showing more interest in attracting the FDI and is leading their economy when compare to India. So in order to clearly investigate on this point, this study also focuses on the aspects and the policies that need to be designed by the Indian country for attracting the investors and also to increase the overall performance of the economy by raising the inflows when compared to China.

1.4. Research Context

In this study the researcher is focused on the world’s largest two most populated countries: India and China with a greatest history background. These two countries are known to be fast growing countries in the world and are known for their ample facilities and environmental conditions. These two countries are economically improving their standards in terms of technology and infrastructural growth. However, China is considered to be more positive in terms of attracting FDI’s and are almost leading the comparison with India. In this research the time is a biggest constrain and to understand the research physically is really a tough target for the researcher by visiting both countries to meet and interview/ survey the financial organizations experts from various locations. However it is also noticed that in India only the FDI policies are changing from place to place based on the local governments rules and regulations. All the major rules and regulations governed by RBI and Government of India are applicable, addition to that the investing company also needs to ensure that the environmental and ethical issues are not disturbed by the foreign investors in local and urban areas of various parts of India. As an example, there are some pilgrim places of India which does not allow non – vegetarian food or related items so in that circumstance neither Government of India or RBI cannot allow the foreigners to invest their amount for a restaurant or bar and etc. Similarly in China it is one of the largest countries in the world and is having different cultures and backgrounds with in the country. Hence from the above context it is understood that this research will mainly focus on the secondary data available and in some areas it can get into the help of people related to the financial and banking industry.

1.5. Research Methodology

For conducting any type of research, the data needs to be gathered by the researcher where this collected information should be in such a way that it is valid and accurate. Researcher need to choose a suitable method from various research methods, by which the researcher can successfully finish the research. Generally there exist two different types, primary data and secondary data. Primary data mainly focus on the aim of the research where the researcher can easily collects the information from various methods like surveys, interviews, etc. Where as in the secondary data, the researcher can collect the data only from the sources like journals, books, magazines, online articles, etc. where the researcher need to collect the accurate data as these recourses will not focus on the aim of research (Kumar, R., 2005). Here in this research, researcher collects the information through secondary data as the main aim of this research is to compare the FDI inflows in both India and China. As the time is the biggest constrain, it will be really tough target for the researcher to select the primary data as the researcher either need to do interview /survey with the concern persons by visiting two countries where it cannot be possible with the period of time. So, it’s better to prefer secondary data for gathering accurate information for the research by referring various resources. Hence, the research can be successfully completed by analyzing the collected information and drawing the conclusion from this data.

Chapter – 2: Literature review

2.1. Overview

This chapter will provide the suitable information and required material for completing research successfully with no issues during the research process. At the same time the literature review gives a basic idea about the research problem solving background with additional material from their related background history. The growth of multinational enterprise (MNE) activity in foreign direct investment (FDI) has grown at a faster rate than most other international transactions as well as the trade flows between countries. The research literature review covers the objects related to foreign direct investment, detailed introduction and description of FDI and impacts of FDI. International Monetary Fund (IMF) has defined the FDI as an international investment of one company with the target of enduring relationship i.e. Investments made by company must exceed the equity of Target Company by 10%. The major requirements of the investors will help in faster growth of their organization which is explained by Nicolas, B. (2010) in terms of Control investments, supply of funds for foreign operations, a balance of payments flow and Capital transfers.

2.2. Brief History and background of Foreign Direct Investment

In the present world, there exist various investment techniques for the corporations for increasing their growth. If these industries lacks in making right decisions in their investment then it may lead to reduce their growth and their level in the global market. So, many of the countries prefer Foreign Direct Investment (FDI) compare to other techniques because most of the corporations get affected financially due to their investment decisions. Mostly FDI is preferred as it is considered as an integral part of an open and effective international economic system and also referred as the major catalyst to development (OECD, 2002). In the present market, USA stood a number one position in FDI flows. According to Nicolas Breitfeld (2010, p.1), ‘Foreign Direct Investment (FDI) is defined by the IMF as an international investment of one company with the intention of lasting relationship’. Foreign Direct Investment (FDI) plays an important role in the financial sector. Generally most of the countries believe that increasing the international linkages through FDI is an important feature of financial globalization and elevates the major challenges for statistics and policymakers in industrial and developing countries (Neil, K. P., 2004). Further of this section, it clearly discusses the views of authors on FDI, the importance of FDI and mainly focuses on the issues that are being faced by the countries while introducing the FDI. Even-though authors define Foreign Direct Investment (FDI) in different ways based on their research it is mainly mend to development on country’s and globalization. Some of the author’s views on FDI are discussed below:

According to Organization for Economic Co-Operation and development (OECD) (2008, p.62), ‘Foreign Direct Investment (FDI) occurs when a business located in one country (the direct investor) invests in a business located in another country (the direct investment enterprise) with the objective of creating a strategic and a lasting relationship’. Here, the author suggests that occurrence of FDI exists only when the business persons invests their money in another country. They invest their income in another country by making some rules and regulations in their relationship. But according to Alexander, L. and IMFD, (2002), foreign direct investment defined as the integration of three components which are illustrated below:

The branch profits need to be distributed and divided in equity without any holding withholding taxes.

Accrued interest need to be paid to the direct investor by the direct investment enterprise, this can also be referred as income on debt.

Earnings are reinvested in proportion with the direct investment stake.

In this context, author says that the investment and the interest benefited by the business people need to be redistributed in an equal proportion among the investor and the direct investment enterprise.

At the same time, Neil, K. P. (2004, p.3), discusses that according to BPM5 (Balance of Payments Manual) FDI defined ‘as a category of international investment that reflects the objective of a resident in one economy (the direct investor) obtaining a lasting interest in an enterprise resident in another economy (the direct investment enterprise)’.  Here, the author discuss that FDI indirectly affects the economy of another country as the other country invest their income on another country for gaining interest on their investment. Even though the opinions and views of the authors differs in defining the FDI but all the authors focus on only one point that is the benefit dragged by the investor and the direct investment enterprise. These investors of get benefited globally with FDI on the interest on their investment and also increases their international linkages with the industries established in another country.  

2.3. Impacts of FDI

Foreign Direct Investment is considered as a driver of economic growth and development for developing countries which often lack the technology or capital to promote sustained economic growth and development. Mostly, FDI is considered as one of the major drivers of globalization as it continuously raises with the high growth rates before the financial crisis hit the world economy. The way through which FDI promotes economic growth and development to the countries is contentious because there is no definitive evidence and lags in supporting the literature. Even though there is no empirical evidence in representing the impact of FDI on the countries there are some theoretical explanations from which one can easily analyse the impacts of FDI on developed and developing countries. According to Bora, B. (2002, p.168), ‘FDI flows were increasing rapidly much more quickly than international trade flows, which in turn were increasing faster than world GDP’. Laura Alfaro (2003) says that FDI offers great advantages to host countries because many of the academics and policy makers argue that there exists a most important positive effect on the development of host countries. FDI not only acts as the source of the valuable technology but also helps the countries in developing the linkages with the local firms that indirectly helps the country in raising the economy. Due to these reasons, most of the developing and industrialized countries offer incentive for encouraging the FDI in their economies. The environmental impacts of foreign direct investment may be positive, negative or neutral based on the institutional and industrial context. Gorg and Greenwood (2002) comes under a conclusion that the effect due to FDI is negative by reviewing the information from the foreign-owned to domestically owned firms. But Lipsey (2002) supports the positive benefits in preferring FDI. FDI flows attained a new record level right from the year 1990 to 2000. Then, from the year 2001 the growth in the investment failed and the later years it saw a steady and steep decline in global FDI flows.

,

Figure: Shows trends in global FDI flows during the year 1991 to 2003 (FDI, 2007, p.7).

FDI affects the economic growth of the country in various aspects like it raises the formation of human capital, provides a facility to transfer the technology between the host countries and also stimulates the domestic investment. The relationship between the impact of FDI and economic growth can be easily analyzed with the help of production function and also with the other variables that affect economic growth such as domestic, trade, labour and capital (Falki, N. 2009). Production function was done based on the endogenous growth. According to Kumar, N. (1998, p.112), ‘Direct investment was thought of mainly as a flow of capital, possibly replacing local capital or possibly representing marginal additions to the host country’s capital stock, followed by the necessity of financing dividends and interest, and possibly repatriation of capital’. Some of the authors studied on the impact of FDI on economic growth in developing countries where those opinions are illustrated below:

Authors views on ‘Does FDI promote Economic Growth in developing countries’

S.No.

Author’s name

Researched during the year

Does FDI promote Economic Growth in developing countries (Yes/No/May be)

Explanation

1.

Balasubramanyam

1996, 1999

May be

Requires open or neutral trade regime

2.

Borensztein

1998

May be

Depends on education level of workforce

3.

De Mello

1999

May be

Depends on degree of complementarily and substitution between FDI and domestic investment

4.

Graham and Wada

2001

Yes

Raised per capita GDP in Chinese provinces with FDI concentration

5.

Graham

1995

May be

TNC’s market power can generate negative impacts

6.

Loungani and Razin

2001

May be

Risks

7.

Lim

2001

May be

Depends on tax incentives, regulatory and legal impediments, macroeconomic instability

8.

Marino

2000

May be

Requires open trade and investment policies

9.

Mallampallyand Sauvant

1999

May be

Requires human resource development, information and other infrastructure

10.

Markusen and Venables

1999

Yes

Raises productivity and exports of domestic firms, generates spillovers

11.

Rodrik

1999

No

Reverse causality: TNCs locate, rather than drive growth, in more productive and faster growing countries

Table: Shows the authors explanation on Does FDI Promote Economic Growth in developing Countries—this is a question? (LyubaZarsky, 2005, p.25)

From the above table, it can be understood that out of 11 authors, only 2 authors support that FDI promotes economic growth in the developing countries as they explain that it raises the productivity, exports of domestic firms and stated a practical example that it raised the percapita GDP of china government with the help of FDI. Rodrik, opposed the views of the other authors on supporting the FDI as based on their research. From Rodrik research, it has been stated that it doesn’t shown impact rather it was derived as a reverse causality. Apart from these three authors, the remaining 8 authors were in a dynamo whether to support the FDI or not because all these authors states that the impact on FDI on economic growth depends only on the circumstances that the author considers but not on any other aspects. For example: FDI shows more impact on economic growth only when the government fulfil some basic needs such as require open trade, investment policies, human resource development, information, other infrastructure, etc. If these requirements are fulfilled by the government then automatically it get benefited with the FDI but if it fails in reaching those needs then it may face some risks due to the policies and the agreement between the countries. Hence, it can be stated that impacts of FDI directly depends on the situations and circumstances that are being considered by the government.

By tightening of international financial conditions will have as awful effect on inflows of FDI. In the recent years, this has been main source of assets for many countries (U. N. Staff. 2009).FDI shows more effect on the economic growth of the countries as it provides various benefits to the countries that acquire FDI are illustrated below (Khan Arshad, 2007):

Introduces the latest techniques and technologies of marketing and management – with the help of FDI, the developing countries can know more about the latest techniques and the technologies that are being used by the developed countries. By acquiring and implementing these latest technologies in the developing countries, to some extent it can increase its growth in terms of economy.

Exploitation and utilization of local raw materials – usage of raw materials in the countries will be increased by exporting these excess materials to other countries and get benefited with them by importing other raw materials from other country which are shortage in their countries.

Can be easily access to the new technologies – as there will be a rapid flow between the countries, each of the country can know more easily about the other country and their religion. Based on this analysis, it can assess and access the technologies in their own region by making contract with the other countries.

Financial flows between the countries – Foreign inflows between the countries are used for financing current account deficits. The finance flows between the countries are transferred in the form of FDI where it doesn’t generate interests and repayment of principal but internally raises the human capital stock through job training.

Chapter – 3: Empirical Literature on FDI based on INDIA and CHINA

3.1. Effects of FDI on all other countries when compared with India and china

The existence of a strong negative relationship between trade share and country size was supported by the literature on trade and development. Country size and trade ratio are inversely proportional in size (larger the size of the country smaller is the trade ratio), the foreign trade, investment, and technology transfer between countries will directly affect the degree of sincerity and competitive pressures emanating from abroad (Pieter, B. 2007). Thus, the impact of these competitive pressures would be much less in a large country such as China and India than that among other East Asian NICs. In recent years china had recognized its need towards foreign trade, investment and technology with the aim of modernization, nothing like the Third World developing countries (India) that impoverished foreign capital.

1984-85

1994-95

1999-2000

2004-05

2006

2007

World

2.2

4.8

18.3

9.0

12.9

14.8

Developed economies

2.1

3.9

19.1

7.7

12.80

15.6

Developing economies

2.8

8.1

15.8

11.9

12.5

12.6

Developing Asia

2.3

7.9

12.1

9.9

11.0

10.6

East Asia

1.9

9.0

14.8

9.3

8.7

8.6

China

1.8

15.9

10.4

7.7

6.4

5.9

South Asia

0.2

1.7

2.4

3.3

6.2

5.7

India

0.1

1.7

2.7

3.1

6.6

5.8

Table – 2: shows FDI inflow as percentage of gross domestic fixed capital formation (GDFCF), 1944 -2007. (Source: Prema, C. A. 2009, p.379)

The average annual level of FDI inflow for developing Asia had raced sharply from US$ 19 billion during 1984 – 1985 to US$ 500 billion till 2007, at the same time share to developing countries have raised from 15.1 to 17.4 percent which is shown in the above table. The gross domestic fixed capital (GDFCF) as a share of FDI inflow is higher for all the developing countries in the period 1984 – 1996 and reversal due to the Asian financial crisis during 1997 – 98. FDI inflow for developing Asia with the average FDI/GDFCF ratio during entire period 1984 – 2007 is approximately 9 percent and 7.1 per cent when compared with all the developing countries at the same time the global average is 7.4 per cent. China is the recipient country of inward flow and the largest developing country from past two decades where it has been investigated a theoretical increase in inflow with in developing Asia. Among all the countries china was in the second position for total FDI flow as per the ASEAN countries, with increased average annual level of US$ 3 billion during 2000-2007, and from the year 1980 to 1997 almost before six years china was in the second half with US$ 30 billion which was the onset effect of financial crises from 1997-98, due to decline and with determination from about US$ 35 billion per annum before the year 1997 to an annual average of about US$ 24 billion between 1997-79. Establishment of export-oriented industries is heavily concentrated by china’s FDI, there observation on the share of FIEs for total exports in transition economies of china is two percent of expended persistently before 1980 and approximately 60 percent by the year 2006. India process to increases FDI participation in export- oriented activities which had remained at a outlier region of FDI whose one/third FDI during the independence in 1947 was a major amount of stock as a primary sector with plantation, mining and oil at the same time one/forth was the manufacturing and all the remaining stocks are in services, mostly trade, construction, transportation and utilities. The inflow started increasing in manufacturing from 1960s although with a divestment from this sector of FDI, since, low-wages, low skilled manpower are the India’s huge supply it can attract garments and other simple assembly activities which would indirectly favor the heavy foreign investment industry thus primarily focusing towards domestic market. From mid 1990s a slight increase in software is observed as well as significant competition with the world market at industrial production was not notable (Park, J. H. 2002).some of the difficulties which are to be faced and over come for fast development of the country . India faced many difficulties to attract foreign investors in both products and services market now it is only success to service industry of IT mainly. In order to overcome these difficulties to stimulate domestic demand this is given in three steps:

The interest rates should be competitive in RBI.

Value added tax (VAT) are to be implemented.

Reduce the budget deficit through government.

Figure: shows the financial states of India and china GDP the total china’s financial assets is approximately 220 per cent of GDP at the same time India’s financial assets is 160 per cent, countries savings and investment is the great strength for china’s financial system and India’s financial system is outside occur in savings and investments (Sources: Slide share 2008, slide No:18).

3.2. Fundamental policies of FDI

India followed market-distorting policies on both foreign and private investments thus with this estimation about barriers for imports and exports are analyzed. Thus it become necessary to control the production and distribution as well as administered price controls etc. The impacts of opening up policies are likely to open up with foreign trade, investment and technology transfer, which would be much less in large countries of china and India when compared with all other East Asian NICs. China’s opening policies in recent years is the success story with the favorable impact is not only for small economies but also for all large continental economies. China and India may not suffer from a large country constriction for adopting the export-oriented, outward-looking development strategy considerably (Park, J. H. 2002). The reformist policy is to fill the domestic savings gap which is necessary for economic development with foreign capital inflows, along with other goals in advanced foreign technology and managerial skills, and to promote exports to increase the foreign exchange earnings of the country. Due to open-door policy China’s trade and inflow of foreign direct investment and loans are impressive, thus within a very short time china became a major exporting country, and an export competitor with the East Asian NICs (Newly Industrializing Countries) and ASEAN (Association of Southeast Asian Nations) countries in the Asia Pacific region. The opening policies in china have contributed to the country’s economic growth and development considering all domestic economic events. The India’s economic reforms undertaken in 1991 in light of China’s experience with the export-oriented, foreign direct investment strategy for economic growth and development which has been examined with superiority of export-oriented, outward-looking development strategies. Thus China can provide important lessons and policy implications in economic development for all Third World developing countries like India. The success story of china open to world’s economy made it ideal for studying the relationship between trade and development as well as for testing the validity of export-promoting development strategy.

3.3. Historical Background and National Goals

3.3.1. History of FDI in India

The generational explanation of history is given as follows after India’s independence: during 1947 to 48 there was the British owned the private foreign capital through the national policies resolution which is Swadeshi movement & Industrial policy. In the next generation i.e. from 1949 to 1953 foreign investments where far away from trio of domestic business house with foreign capital as well as with the government – nationalist sentiments. The second Economic plan was launched in 1957 as industrialization through import substitution and encouraging private investment. Some of the selected industries got foreign collaboration and JV mostly manufacturing companies which are retained participation in India’ FDI since 1960s, the devaluation of rupee encouraged the socialist idealism banks and foreign oil majors nationalized after late 1960s. After almost 8 years in 1968 the foreign investment board had encouraging investments on there own terms and conduction. In the year 1973as per the Foreign Exchange Act (FERA) which launched a new article that all firms should come together for their foreign equity, holding 40% of foreign equity to be considered as Indian companies due to which IBM as well as coca cola is exited. After seven years of strict vigilance on FDI, from the year 1980 licensing procedures were liberalized to softened, technology transfer and royalty payments relaxed, foreign investment was encouraged wherever possible. During 1900-s rupee value got down, withdrawal of NRI money, India turned to IMF; there was liberalization on trade regime and regulatory frame work. Many of the industries were invited by FDI and in some cases limit was increased from 51% to 100%. The service sector was again opened for FDI. The political instability after 1995 had started but a perception towards FDI had changed due to changes in government kept focus on FDI.

3.3.2. History of FDI in China

China has joined the joint venture with other countries in the year1979, and by the year 1986 china became fully foreign owned enterprise. It was divided into four zones namely Shantou, Shenzhen, and Xiamen in the year 1980. After four years in 1984 it was found that china’s economic zone has fourteen cities and whole china combined by late 1900’s. There was a rapid economic growth in reform period due to profusion of labour and its low costs, Rapid expansion of China’s domestic market at the same time plays important role of overseas Chinese for increasing integration with world economy. The marketing effects are generally obtained by imports and exports in both bilateral countries. FDI is very essential for developing countries for Off setting the capital deficiency, Acquiring advanced technology, Gaining production know-how, Promoting exports as well as to

Table – 2: shows FDI in India-China products Trade (in million US Dollars). (Source: Prema, C. A. 2009, p.379)

The two highest population countries of the world are India and China which together contain approximately 40 per cent of the world’s humidity on an adjacent landmass in Asia. Both countries are pride in birthplace of civilization entering the era of sharing world’s greatest development problem. The underdeveloped areas of these two countries is due to huge population relative to land and other resources, around 1950’s there was no commitment to national planning for economic modernization as there was new governments of China and India, led by Mao Zedong and Jawaharlal Nehru so as to eliminate poverty and raise the standard of living (Park, J. H. 2002).

Approaches to Development: Some of the important characteristics shared within India and China as the wealth of people relative to other rare resources such as arable land, natural resources, and capital suggesting the appropriate strategies for development would have involved production of labor-intensive goods. Among these some are exchanged for imports of capital goods and technology as per the necessity for development. For economic