The Impact of Inward FDI on Economic Growth - Coursework Example

?The Impact of Inward FDI on Economic Growth or Development of an Emerging Economy Table of Contents Introduction 3 The Economy of India 3 FDI in India 5 In the recent past 5 At present 6 Role of FDI in Economic Growth 9 Conclusion 11 References 12 Bibliography 14 Introduction In today’s globalised world Foreign Direct Investment (FDI) is one of the most important sources of economic growth for most of the developed as well as developing nations. Keeping record of statistical data regarding FDI is a must for making policies and analyzing economies. The need for comparable, comprehensive and updated data on FDI is increasing as it is assumed to be an important factor for the internationalization of various economic activities. There are several definitions which are provided by different international organizations like IMF and The United Nations. The International Monetary Fund’s (IMF) definition says that FDI refers to an investment that’s main objective is to obtain a ‘lasting interest’ in an entity which operates in an economy that is different from the economy where the investor operates in (Moosa, 2002). A ‘benchmark definition’ of FDI is provided by the Organization for Economic Co-operation and Development (OECD). It says “foreign direct investment reflects the objective of obtaining a lasting interest by a resident entity in one economy (direct investor) in an entity resident in an economy other than that of the investor (direct investment enterprise)” (Organisation For Economic Co-Operation And Development, 1999). This paper discusses the role of FDI in an emerging economy like India. It aims to provide a clear picture about how FDI has played an important role in the economic growth of the country. Furthermore, the paper also includes a brief overview of the Indian economy and the way in which it is performing over the past two decades. The Economy of India Over the past few years Indian economy is gradually turning into an open-market economy. Since early 1990 the country has experienced significant economic liberalization that includes industrial deregulation, reduction in control over foreign investment and trade and privatization of government owned enterprises. Since 1997, every year Indian economy has grown by almost 7% (Central Intelligence Agency, n.d.). The diverse economy of the country encompasses conventional farming, handicrafts, modern agriculture, multitude of services and different modern industries. Over half of the total work force is involved in agriculture whereas only one-third work force is associated with the service sector. However, services are the main source of economic development in the country. Almost 50% of the country’s total output is contributed by the service industry. India is enriched with its large educated population that is capable of speaking good English. Capitalizing on this aspect India has become one of the largest exporters of IT (Central Intelligence Agency, n.d.). Due to its strong foundation, the Indian economy protected itself very well from the recent global economic crisis, though the growth rate was significantly affected for a certain period. The weak monsoon of 2009 and inefficient food distribution system have resulted in high food prices. Inflation has been one of the key problems for the Indian government over the past two years. The country’s central bank (Reserve bank of India) has hiked the interest rate several times in order to control the inflation. In the fiscal year 2010-11, India experienced a deficit of 6.8% of its GDP and in the coming year the government aims to bring down this deficit to 5.5% of GDP (Central Intelligence Agency, n.d.). Some of the long standing challenges for Indian economy are widespread poverty, lack of social and physical infrastructure, insufficient access to the basics like higher education and drinking water and limited opportunities regarding non-agricultural employment. In 2010 India’s GDP was $4.046 trillion (in terms of purchasing power parity) and this is increased from the previous year’s $3.736 trillion. In 2010 the real growth rate was 8.3%. In India GDP per capita is found to be $3,400 in 2010 (Central Intelligence Agency, n.d.). The country capitalizes on its huge labor force of almost 478.3 million. Over 10% of the total population in India is unemployed. 25% people in the country still live below poverty line. Important agricultural products that are found in India are rice, wheat, cotton, oilseed, jute, sugarcane, tea, potatoes, onions etc. Major industries that influence Indian economy are textiles, steel chemicals, software, food processing, cement, mining, pharmaceuticals and petroleum. In 2010 the volume of foreign direct investment that was flowed in India was almost $191.1 billion (Central Intelligence Agency, n.d.). FDI in India In the recent past India does not have great history regarding attracting foreign direct investment. During 1970s there were hardly any foreign investors who wanted to invest in India, in fact some companies even decided to leave the country. In 1980s also inflows of capital from private companies were meager. During 1985-90 these inflows averaged up to only $0.2 billion (Athreye & Kapur, 1999). Such lowered capital inflows were actually the result of restrictive government policies regarding FDI. Situation started to change since 1991. As a result of the agreement with IMF, value of Rupee was lowered by 20%. Furthermore, regulatory framework and trade regime were liberalized. The system of Industrial Licensing was brought to an end. FDI was attracted in most of the industries that include ‘consumer goods’ as well. The limit on the participation of foreign equity was increased to 51% in case of most of the industries. In some cases it was increased to even 100% (Athreye & Kapur, 1999). Sectors where foreign investments were specifically invited include power generation, telecommunications, port and highway construction and natural gas and oil exploration. Service sector was also made reopen for the foreign investors. They were invited in retail banking and other financial services as well. Restrictions on using the international brands were taken away. During 1997-98, amount of FDI in India exceeded $3.2 billion (Athreye & Kapur, 1999). [Athreye & Kapur, 1999] Over the next ten years (2000-2010) the country has seen huge FDI inflows. By 2004 India received FDI of almost $5.3 billion (Economy Watch, n.d.). Since the liberalization process India received FDI of $54.6 billion till early 2007. In this regard 2006 is considered very important as capital in-flowed only in this year (January to December) was of $11.19 billion (Dwivedi, 2008). It was significantly increased from the previous two years’ figure. The following table gives a clear picture. [Source: Dwivedi, 2008] At present According to a report of United Nations Conference on Trade and Development (UNCTAD), India was the second most attractive destination for the foreign investors in 2010. The report has also predicted that the country will remain one of the top five attractive destinations for the foreign investors over the next two years (India Brand Equity Foundation, 2011). Such statistics look remarkable especially when they are compared with the previous years’ data. In 2001 India was at 32nd position in terms of the attractiveness as a foreign investment destination (according to UNCTAD data). As far as the developing countries are concerned, in 2005, India was the 13th most preferred destination for foreign investment, whereas in 2009 its rank improved to 4th (India Brand Equity Foundation, 2011). In December 2010 the country attracted almost $2014 million foreign direct investment. According to the statistics provided by the Department of Industrial Policy and Promotion (DIPP), the cumulative volume of FDI inflows starting from April 2000 to December 2010 is $186.79 billion (India Brand Equity Foundation, 2011). Over the last 8 months of 2010, the services sector that includes both financial as well as non-financial services brought in almost 21% of total foreign investment that came into India. This sector attracted investment of almost $2853 million (India Brand Equity Foundation, 2011). On the other hand telecommunication sector that includes basic telephone services, cellular mobile, radio paging attracted investment worth $1327 million during that same 8 months. Automobile industry was found to be the third largest industry in terms of attracting foreign direct investment and it is followed by the real estate sector that received investment worth $1024 million (India Brand Equity Foundation, 2011). In 2010 consolidated FDI policy was implemented in India and as a result of this, today, the country is considered as an important global trading partner. The consolidation started in March and it brings all the previous acts, press notes, regulations and the clarifications regarding FDI together in a single document. The modified policy allows the foreign investors to inject money through the automatic path of the country’s economy. In other words, investors do not need to take any permission from the government prior to making any investment. However, Indian organization that is receiving such investment needs to inform RBI regarding the investment (India Brand Equity Foundation, 2011). In the first month of the current year, amount of FDI equity that has flowed in is $1042 million. The figure is found to be almost 50% lowered than the figure of January, 2010 (Department of Industrial Policy and Promotion, 2011). Over the previous few years Mauritius has continued to be at the top among the countries where the investment has been coming from. Investors from this country have invested almost $6129 million (almost 42% of the total FDI inflows) over the period of April, 2010 – January, 2011. Investors from the countries like Singapore, USA and UK have also been injecting their funds into India over the years. Funds worth $1504 million have poured in from the investors of Singapore during the period of April, 2010 – January 2011. During the similar period, investors from USA have invested almost $1092 million. Following table gives a better idea (Department of Industrial Policy and Promotion, 2011). [Department of Industrial Policy and Promotion, 2011] Role of FDI in Economic Growth The role of FDI in the process of economic growth of a developing nation like India can be realized by understanding certain basic things. Firstly investments by foreign multinational companies bring money into the system. As mentioned earlier that in January, 2011 foreign investors have invested almost $1042 million. This actually means that $1042 million is been brought into the Indian economy. In other words Indian economy has grown by this amount in January, 2011. The cumulative volume of FDI inflows starting from April 2000 to December 2010 is $186.79 billion. In simple words, Indian economy has become bigger by $186.79 billion because of foreign direct investments that are brought in over the past ten years. Contribution of FDI in the GDP of India has improved from 0.77% to 2.31% during the period of 2003-07 (Hill, 2009). Such data reflects the way in which Indian economy has gained from inward FDIs. Foreign direct investments in India have brought in new technologies along with new methods in which business can be done. They have created new employment opportunities. Furthermore such investments have served as a powerful force that is capable of enhancing the skills of the work force (Paul, 2008). When foreign organizations build units or form joint ventures with their advanced technologies and better marketing and managerial practices, the productivity of the domestic firms are likely to improve due to ‘spillover’ effects. Different researches show the existence of considerable spillover effects as a result of FDI. During the early years of liberalization, the effects were modest, but with the passage of time they increased significantly (Radhakrishna, R et al, 2006). One must note in this regard that not all local firms in India have gained from the spillovers. Domestic firms that have high labor productivities as well as low productivity gaps with the multinational corporations are capable of enjoying high spillovers. A study that was conducted by Kathuria shows that the domestic firms that have significant investment in R&D have gained a lot from FDI spillovers (Radhakrishna, R et al, 2006). FDI plays crucial role in improving the export performance of a particular country. In case of India FDI inflows have played significant role in improving the performance regarding service and manufacturing export. Research conducted by N Prasanna, shows that the export performance regarding high end technology is improved due to increase in FDI, but similar extend of improvement is not found in case of manufacturing export. According to Prasanna, the most probable reason behind this is the fact that FDI inflows have failed to create spillover effects in case of manufacturing sector (Prasanna, 2010). The study shows that the improvement in India’s export performance during 1991-2007 is largely due to increase in inward FDI. As far as manufacturing sector is concerned, India is not one of those developing economies that have focused on export-oriented FDI. Most of the economic resources have been used in the service sector. Over the past decade India has emerged as one of the largest exporters of IT related services and this has attracted more inward FDIs in the country. More FDI inflows have increased the productivity which in turn has again increased the volume of export. Hence, it can be said that inward FDI is acting as both ‘cause’ as well as ‘effect’ (Siddiqui, 2007). As far as technology transfer is concerned FDI has played a significant role. With the arrival of new technologies, production processes have improved remarkably. However, it is important to note that most of the technologies that are transferred through FDI are ‘standardized’ in nature, whereas the most sophisticated and new technologies are yet to be transferred (Siddiqui, 2007). Another important fact is that most of the foreign investment has taken place in the large cities in India. As a result a huge section of the country is yet to be covered. If FDI starts flowing into these sections, then the country’s economy will grow by larger volume. Conclusion Today it is a proven fact that foreign direct investment is one of the key factors behind the growth of any developing or developed nations. Being, one of the fastest growing economies, India is largely impacted by the inflows of FDI. Prior to 1990, regulations for foreign investment were very strict and hence, volume of such investment was significantly low. However, after the economic reforms that took place during 1990-91, FDI started pouring in the country. Today, it is considered as one of most attractive destinations for FDI. Quite obviously Indian economy has greatly gained from these investments. Today, almost 4% of India’s GDP is sourced from FDI. Foreign investments have increased the productivity of local companies; they have made the local work force more skilled and most importantly the volume of export has gone up considerably due to such investments. However, there are several areas that are required to be improved to invite more FDI. First of all government policies should be more efficient, clear and structured. Furthermore, the country need to focus on the export oriented FDIs especially for manufacturing sectors. Lastly, India is a huge country and there are large numbers of small and medium sized cities that are untouched by FDIs. Industries and the government should try to bring in more investments for these cities so that the overall economy can grow at a faster rate. 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International Business 6E (Sie), Tata McGraw-Hill Education India Brand Equity Foundation, 2011, Foreign Direct Investment, [Online] Available at: http://www.ibef.org/economy/fdi.aspx Accessed on April 18, 2011 Moosa, I. 2002, Foreign direct investment: theory, evidence, and practice, Palgrave Macmillan Organisation For Economic Co-Operation And Development, 1999, OECD Benchmark Definition Of Foreign Direct Investment, OECD, pdf [Online] available at: http://www.oecd.org/dataoecd/10/16/2090148.pdf Accessed on April 18, 2011 Prasanna, N. 2010, Impact of Foreign Direct Investment on Export Performance in India, Journal of Social Science, pp 65-71 Paul, J. 2008, International Business, PHI Learning Pvt. Ltd Radhakrishna, R et al, 2006, India in a globalising world: some aspects of macroeconomy, agriculture, and poverty : essays in honour of C.H. Hanumantha Rao, Academic Foundation Siddiqui, A. 2007, India and South Asia: economic developments in the age of globalization, M.E. Sharpe Bibliography Chakraborty, C. 2008, Economic Reforms, FDI, and Economic Growth in India: A Sector Level Analysis, World Development. Vol. 36, pp. 1192–1212, Kochhar, K. et al, India’s pattern of development: What happened, what follows?, Journal of Monetary Economics, pp 981–1019 Khanna, T. No Date, Learning From Economic Experiments in China and India, Academy of Management Perspectives Read More