Why India is becoming one of the most preferred nations for Foreign Direct Investment

University Degree Business and Administrative studies

Table of Contents

Introduction 2

Stepping Stones 3

Determinants of FDI in India 4

Growth in Gross Domestic Product 6
Macroeconomic Stability 9
Favourable Regulatory Framework 9
Growth in Exchange Rate 13
Growing Consumerism 14
Abundant Human Capital 16
Favourable Foreign Trade Policy 18
Rising Infrastructure Facilities 18

Conclusion 21

References 22

Introduction- India is becoming one of the most preferred nations for attracting Foreign Direct Investment. Foreign Direct Investment as defined by A.T.Kearney (2007) is

“…investment in physical assets, such as plants and equipment, in a foreign country. Holdings of 10% or more equity in a foreign enterprise is the commonly accepted threshold between direct and portfolio investment as it demonstrates an intent to influence management of the foreign entity. The main types of FDI are acquisition of a subsidiary or production facility, participation in a joint venture, licensing and establishment of a Greenfield operation. The last is defined as a direct investment in new facilities or the expansion of existing facilities.”

The primary purpose of the assignment is to discuss, why India is becoming one of the most promising countries for the MNCs as they mark their presence on the global economy. It’s interesting to ponder about the developments that the world’s second most populous nation has undergone since independence. Its ongoing transformation from a closed command economy towards an open one caught the world’s attention. India as a lucrative FDI destination has a lot to offer in terms of its GDP growth, favourable regulatory policies in almost all the sectors, growing clout of the middle class as the symbol for consumerism, younger population which is not only driving consumption but also is learning globally integrating skills, fast developing infrastructure facilities largely deriving inspiration and rightly so from its big brother China and inherent macroeconomic / political stability. Given the limited scope of the study only those parameters shall be considered that make India strongly attractive despite its weaknesses. The same parameters shall be compared with other countries on a random basis to strengthen the argument.

Stepping Stones – India’s colonial experience framed a solid background which reinforced the belief that the free trade regime during that period was biased against Indian interests and that it cannot be relied upon to generate required growth and reduce poverty. This made India cringe in to a cocoon that was rooted in the belief that self reliance is the only way to move ahead without realizing that the country had little to be self dependent because that character was somewhat lost due to ages of foreign rule. This shift also portrayed India’s struggle for economic and political identity outside the sphere of UK and other western powers. India adopted the Soviet model of economic planning. There were three elements of India’s policy framework in the ‘License Raj’ that stifled efficiency and growth until 1970’s and somewhat to a lesser extent during the 1980’s as reforms were being initiated -

Bureaucratic stronghold over trade, investment and production
Inward looking foreign investment and trade policies
Priority to the public sector

The first two affected the overall efficiency and growth of the private sector and the second became the epitome of an inefficient enterprise. Domestic investment was hindered, foreign trade shriveled and foreign capital was kept out. .It was during this time that Mercedez Benz planned to enter into a joint venture with TELCO (Tata Engineering and Locomotive Company) but because of government sluggishness it went away only to return after 30 years again with TELCO, similarly in 1977 Coca Cola preferred to leave India then to reveal its formula and reduce its equity stake as required under FERA

Around 1991 balance-of-payment crisis occurred due to Gulf war induced oil price shocks. This led to huge borrowings from the IMF and the World Bank. Also the collapse of the Soviet Union set the stage for the initiation of the Economic reforms on a great scale. It took an economic crisis for India to liberalize its trade and FDI regime rather than a fundamental change in attitude towards an open economy. Nonetheless, the 1991 reforms marked a major break from the earlier Kafkaesque controls. Along with the virtual abolition of the industrial licensing system, controls over foreign trade and FDI were considerably relaxed, including the removal of ceilings on ownership by TNCs.

Determinants of Foreign Direct Investment in India

Growth in Gross domestic product (GDP)
Macroeconomic Stability
Favorable Regulatory framework.
Growth in Exchange rate
Growing Consumerism
Abundant Human Capital
Favourable foreign trade policy
Rising Infrastructure facilities

India is getting rapidly globalized through FDI .The AT Kearney 2007 Foreign Direct Investment Index and Global services location index sets the backdrop. India continues to be the second most preferred destination for FDI, a position it has guarded since 2005. It is also the top ranker in terms of its attractiveness for global services location. It shows the optimism of ...

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Determinants of Foreign Direct Investment in India

Growth in Gross domestic product (GDP)
Macroeconomic Stability
Favorable Regulatory framework.
Growth in Exchange rate
Growing Consumerism
Abundant Human Capital
Favourable foreign trade policy
Rising Infrastructure facilities

GDP growth rate

Indian economy has been growing steadily since 2000-01 .Indian economy grew at 9.6 % in 2007-08 and 9% in 2007-08 and emerged as the second fastest growing economy in the world after China (11.4%). The economy has been growing at an average growth of 8.8 % in the past four fiscal years (2004-08)

As per the above Mckinsey Global Institute’s India Consumer Demand Model, services have been and will be the main drivers of India’s GDP growth for the next 20 years. India had notably made its mark in the IT, Software and the BPO sector and is already a world leader in providing back office services. The country is poised to become the hub for R&D activities.

As per Goldman Sachs BRIC model projections (2003) India by the year 2050 is the most promising one in real GDP growth compared to other BRIC countries. By 2050 Indian economy shall be among the biggest in the world.

Goldman Sachs Model Projections

It s no surprise that the coming decades belong to the BRIC countries and G6 countries will lose the game to BRIC by 2050. Have a close look at India in Goldman Sachs BRICs model projections: by 2015 it will surpass the economy of Italy, by 2025 the economy of Germany shall be left behind and India shall be glorified by 2032 when Japanese economy will breathe heavily to catch up with the Indian economy. It clearly shows India’s position which is at no.2 with respect to China. The rise in India’s significance is evident.

Macroeconomic Stability- With the Credit Crunch as the buzzword and with slowing down of the economies of United States and Europe the opportunity of entering in to developing markets has given the global corporations a new window for their growth and profits. Despite the worldwide slowdown countries like India, Russia and China continue to have an 8% GDP growth in the year 2008. Pursuing expansion into new markets provide rationale to diversify their customer and operations base and to maximize shareholder return. Global financial crisis did not affect India much because of its high savings which also provided much needed investment. The banking and financial markets are mature, growing and globally connected. Also unlike its East Asian neighbors India does not rely on exports alone for its growth, the domestic consumption & investment itself are sufficient drivers to push the economic engine forward.
Favourable Regulatory Framework – Apart from other determinants of FDI a favourable regulatory policy is the fundamental attraction for the Multi National Corporations. Since the initiation of the economic reforms post 1991, successive governments have executed tough measures to liberalise the businesses and boost industrial momentum. Except six industries licensing requirements for all the other industries have been abolished which has invited fair competition from domestic and international players and thus provided the dynamism which India so needed. The government has been welcoming FDI in order to enable the industries to imbibe state-of-the-art technology and foreign collaborations. The FDI limit in all the sectors has been liberalized and procedural approvals simplified. Below are some of the examples of certain key industries and the statistics for their attractiveness –

Oil & Natural Gas – India is the world’s fifth largest consumer of oil & natural gas as primary energy. The consumption of primary energy grew at a CAGR of 4.6% between the years 1996 and 2006 while the global average was 2.14%. it is expected that India’s primary energy requirement shall be doubled over the next two decades. With the growing population the demand for oil & gas has risen sharply over the last decade. FDI up to 100% is allowed except in refineries owned by the national oil companies. The demand is projected to grow at 6.4% and 7.4% respectively from 2006-07 to 2024-2025. Foreign players such BG, Cairns Energy and Royal Dutch Shell are among the prominent players and to meet the increase in demand more players are expected.
Information Technology – IT industry has been a forerunner in India’s success story. India’s prowess as an IT-ITES hub is well established across the world. For the global IT-ITES sector India is a key sourcing nerve centre and a crucial market for the growth of the sector. Government has liberalized FDI regime and instituted various fiscal incentives for the sector. To make India a preferred destination for the manufacturing of semi-conductors and other high technology products a policy is proposed to be formulated shortly. Information Technology act 2000 is further amended for strengthening the information security environment.

Retail- Market size of USD 511 billion in 2008 makes India’s retails sector the most appealing one for the international player. The fact is only 4% of the market is organized so it leaves a huge scope for its systemic development. It’s politically sensitive thereby reforms are going at a slow but steady pace. FDI up to 100% through the automatic route is allowed in the cash & carry wholesale trading and export trading. FDI up to 51% is permitted in the retailing of single brand products. Over a period of 2-3 years the sector will further open up for Foreign Direct Investment. “India’s overall retail sector is expected to rise to $833 billion by 2013 and to $1.3 Trillion by the year 2018 at a CAGR of 10%.”(A.T.Kearney, 2008)

A.T.Kearney Global Retail Development Index

Real Estate- Real estate is one area where the demand for residential and office space is skyrocketing. 70 – 75% of the total office space requirement is being accounted for the IT-ITES sector. Currently there is a shortage of an estimated 24 million dwelling units and by the year 2012 it would increase to 26 million. Growth in organized retail has increased the demand for mall space throughout the country. Due to increased tourist and business travel the demand for hotel rooms has reached to 100,000 rooms. By 2020 India will be one of the most preferred tourist destinations in South Asia and by 2010 alone an investment of 8-9 billion is required for hospitality based real estate. FDI up to 100% is allowed under the automatic route with certain restrictions.
Entertainment- The entertainment sector is one of the fastest growing sectors in India. The current size is estimated at 12.5bn and is expected to double by 2011. The revenues of the film & television industry are also expected to grow manifolds by this time. 100% FDI is permitted in the film and advertising industry and in television broadcasting.
Telecommunications- The Indian telecommunications market is the third largest in the world with revenues exceeding 22 billion USD. In 2007 alone the Indian Telecom industry attracted 8 million subscribers every month. FDI ceiling for the telecom service companies have been relaxed from 49% to 74% in 2005.

Growth in Exchange rate – A growing exchange rate makes Foreign Direct Investment in a country seems attractive as it means greater profits while sending money abroad for the MNCs operating in the country. A rising exchange rate shows the potential and robustness of the economy. Rising exchange rate shall contribute significantly to the amount in USD dollar GDP. It is predicted by Goldman Sachs that about 1/3 of the increase in GDP in India shall come from rising currencies and the rest 2/3 from the increase in growth. Below chart shows the currency levels as projected by Goldman Sachs (2003)

Growing consumerism- With 1.2 billion of the population India is a fresh case of growing consumerism as the consumer spending increased sharply due to its youth population ( more than 33% of the country is below the age of 15). In the past four years consumer spending has increased to 75%. “India's middle class will swell by more than ten times - from its current size of 50 million, to 583 million people - by 2025. And over 23 million Indians - more than the present population of Australia today - will be counted as billionaires. By 2025, India will also become the 5th largest consumer market, surpassing Germany, moving up from the 12th position it occupied in 2007” (McKinsey Global Institute, 2007). The Boston Consulting Group (BCG) forecasts that Indian household spend is going to reach nearly US$ 325 billion by 2015 compared to US$ 150 billion in 2007.

According to the Mckinsey Global Institute’s below projections, by 2025 India’s household disposable income shall grow considerably. This acceleration in income shall catapult India to become the fifth largest consumer market in the world.

According to the Deutsche Bank research (2006) by 2050 there will be more people in India in the age group of 15-64 years then in any other country that shall constitute the largest segment consuming various products and services. This offers huge opportunities in terms of selling products and services in India.

Abundant Human Capital – Various studies by leading institutions in the world has projected the importance of India’s young population in the coming years. According to the Deutsche Bank research (2006) and BRIC outlook (2008). India’s working age population will rise significantly by 2025.

Economic growth does not merely depend on the quantity of labor available; it depends majorly on the quality of labor input. There are around 400 universities, 1500 research institutions, 1200 management colleges from which respectively around 30,000 engineers, 40,000 non engineering technicians, 10,000 PhD students and 3000 management graduates pass out annually. The biggest strength is the capability to speak English fluently which makes them highly sought after by international companies.

According to the above Goldman Sachs Projections, by 2050 working age population of India will decline to a lesser extent as compared to its BRIC and G6 counterparts.

As per the above Deutsche Bank Research (2005) India has more number of qualified engineers and skilled labors as compared to China. The reason is greater emphasis on higher education. Higher scores in the chart show high availability of engineers and skilled labors which shall not only be instrumental in fuelling services growth but also taking manufacturing strength to the next level.

Favourable Foreign Trade policy- The recent foreign trade policy has abolished quantitative restrictions for the free flow of trade. Under this scheme agriculture export zones are getting developed, various incentives are provided for the development of SEZs. Under the commitment to the WTO India is steadfast in increasing its trade with all the countries considered. India is a key proponent of a free trade policy.
Development of Infrastructure facilities – Infrastructure is the foundation of economic activities. India has the 2nd largest road network in the world (3.3 mn kms) . The government knows that it cannot fund all the investment needed so there has been an increase in public private partnerships and encouragement to foreign investment. Under the ambitious National Highway Development Programme (NHDP) the Golden Quadrilateral Highway project (5846 kms of 4 lane highways) and North-South and East-West corridor (7300 kms of 4 lane highways) initiated by India is the most ambitious infrastructure project since independence. It is running through various states fuelling development of hotels, SEZs, commercial centers, industrial townships. It is linking villages through state highways thus boosting social and economic integration. It has also helped in generating lot of employment

Similarly separate freight corridors shall be built on Delhi-Mumbai and Delhi-Calcutta rail track to facilitate trade flows. India’s 12 major ports, major international airports are being developed to match world standards. Similar developments are undergoing in power and telecom sectors. These developments create an atmosphere of confidence in foreign investors.

The below chart by Deutsche Bank Research (2007) shows India’s ambitious investment plan for different sectors in the coming few years.

Conclusion – India is certainly on a threshold of being a significant influencer to the world economy and to the way decisions are made in International boardrooms. India is certainly fairing well on its attributes related to market potential and economic growth. Its growth rate of roughly 6% since the 90s is substantial. Current GDP growth rate is averaging at 8% and is projected to surpass that of China in the coming years. Foreign Direct Investment has been increasing steadily since the reforms were introduced in the 90s. India’s overall record on macroeconomic stability is high as compared to other developing countries. India when compared to other developing economies is certainly fairing well. World bodies, Research groups and management think tanks have already through their various models and projections prophesied India to be the next global economic power in the next 50 years if reforms move ahead as anticipated. Huge youthful consumer population, rising income levels and favourable government policy initiatives are doing to global corporations / governments in the same way as honey does to a bee. In spite of all this brouhaha India has to be focused on issues like infrastructure development and education to all its citizens. Both of these factors are the most important aspects surrounding the current and projected growth sustainability. India is fast catching up, for sure, as it has the skills, the people and the dynamism.

The world is going to discover: this elephant can dance.

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