Role of FDI on the Economic Development of India

The financial crisis in global markets has made the outlook of Indian economy grim. While the consistently volatile markets and the rupee plunging to an all-time low against the USD are some major concern at this moment, natural calamities and economic scandals seem to be the icing on the cake. Two decades ago, in the early 90’s, India faced a similar crisis. At that time India’s major concerns were the problem in balance of payments and poor foreign exchange reserves.

During the crisis, Dr. Manmohan Singh, the Finance Minister of India at that time, came up with a solution to reform the Indian economy. He liberalized the economy by ending the license raj and gave rise to the phenomena of foreign investments in India. Thus, opening the gates for foreign players to come and invest in India.

License Raj: A term used to describe the regulation of the private sector in India between 1947 and the early 1990s. In India at that time, one needed the approval of numerous agencies in order to set up a business legally.

Since then, foreign investments have been the backbone of the Indian economy and like the 90’s this time too, it would seem that foreign investments might be holding the magic hand that may be able to pull India out of the current economic slump.There are two types of foreign investments that play a major role in the growth of Indian economy; Foreign Direct Investments (FDI) and Foreign Institutional Investments (FII).

Foreign Direct Investments (FDI)

Foreign Direct Investments (FDI) is investment of foreign assets into domestic structures, equipment, and organizations. FDI inflows are into the primary market and do not include foreign investments into the stock markets. It is a long-term investment and is used by the developing countries as a source of their economic development, productivity growth, to improve the balance of payments and employment generation. Its aim is to increase the productivity by utilizing the resources to their maximum efficiency. Exit is relatively difficult in this phenomenon.

Foreign Institutional Investments (FII)

Foreign Institutional Investments (FII) denotes all those investors or investment companies that are not located within the territory of the country in which they are investing. It is generally a short term investment and invests only in the financial assets. FII inflows are only into the secondary market with an aim to increase the capital inflows. Exit is relatively easier in FII.

Role of FDI on the Economic Development of India

Forms of FDI incentives

Foreign direct investment incentives may take the following forms:

  • low corporate tax and individual income tax rates
  • tax holidays
  • other types of tax concessions
  • preferential tariffs
  • special economic zones
  • EPZ – Export Processing Zones
  • Bonded warehouses
  • Maquiladoras
  • investment financial subsidies
  • soft loan or loan guarantees
  • free land or land subsidies
  • relocation & expatriation
  • infrastructure subsidies
  • R&D support
  • derogation from regulations (usually for very large projects)
  • by excluding the internal investment to get a profited downstream.

Governmental Investment Promotion Agencies (IPAs) use various marketing strategies inspired by the private sector to try and attract inward FDI, including Diaspora marketing.Foreign-direct investments were seen sliding about 21% last fiscal.

However the recent announcements by the government of India on 100% FDI in telecom & defence sector, 100% FDI in single brand retail & 51% FDI in multi brand retail and 49% FDI in Insurance give us some ray of hope for the economic development.