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Foreign Direct Investment (FDI)- UPSC Economy Notes

Foreign Direct Investment (FDI) is when a company from one country invests a substantial amount of money into a business in another country. This investment gives them a controlling stake or significant influence over the foreign business, fostering economic growth and knowledge transfer in the receiving country. FDI serves as a significant catalyst for economic growth, making it a crucial subject within the Indian economy segment of the UPSC syllabus.

Foreign Direct Investment (FDI)

FDI is an investment from an individual or firm located in a foreign country into another country.

  • Foreign Direct Investment (FDI) usually happens when a foreign company buys a big part of or controls a company in another country, or starts new businesses there. This is different from foreign portfolio investment, where foreign investors buy shares without being involved in running the business.
  • Unlike foreign portfolio investment, Foreign Direct Investment grants the foreign entity influence over the day-to-day operations of the invested company.
  • FDI encompasses not only financial capital but also the transfer of technology, knowledge, skills, and expertise, contributing significantly to a country’s economic development.
  • It serves as a primary source of non-debt financial resources crucial for economic growth, particularly in economies with growth potential and a skilled labour force.
  • FDI tends to occur in economies with growth prospects and a skilled workforce, reflecting its preference for regions with promising economic conditions.
  • Over recent years, FDI has undergone substantial growth, becoming a prominent method of international capital transfer.
  • However, the benefits of FDI are not uniformly distributed and heavily depend on the host country’s systems and infrastructure.

Determinants of FDI in host countries can be summarized as follows:

  1. Policy framework
  2. Rules regarding entry and operations (mergers/acquisitions and competition)
  3. Political, economic, and social stability
  4. Treatment standards for foreign affiliates
  5. International agreements
  6. Trade policy, including tariff and non-tariff barriers
  7. Privatization policy

Latest Update on Foreign Direct Investment (FDI)

Between April and August 2020, the total Foreign Direct Investment (FDI) inflow reached a record high of USD 35.73 billion, marking the highest ever for the first five months of a financial year. This increase occurred despite a significant 23.9% contraction in Gross Domestic Product (GDP) growth during the first quarter (April-June 2020).

Comparatively, the FDI inflow in the first five months of the fiscal year 2020-21, totalling USD 35.73 billion, reflects a notable 13% increase compared to the corresponding period in 2019-20, which amounted to USD 31.60 billion.

New Foreign Direct Investment (FDI) Policy

Here are the New Foreign Direct Investment (FDI) Policy. Check the below-mentioned policy.

  • Under the updated FDI policy, entities from countries sharing a land border with India, or where the beneficial owner of investment into India hails from such nations, are restricted to investing solely through the Government route.
  • Any transfer of ownership in an FDI transaction benefiting a country sharing a border with India necessitates government approval.
  • Investors from countries not affected by the new regulations are only required to notify the Reserve Bank of India (RBI) post-transaction, instead of seeking prior approval from the relevant government department.
  • Previously, the FDI policy permitted only Bangladesh and Pakistan through the government route across all sectors. However, the revised policy now includes companies from China under the government route protocol.

FDI in India

The investment climate in India has significantly improved since 1991 when the government initiated economic liberalization measures known as LPG (Liberalization, Privatization, and Globalization) strategies.

  • The easing of Foreign Direct Investment (FDI) norms has been a key factor contributing to this improvement.
  • Various sectors in India have gradually opened up for foreign investment, either partially or wholly, following the economic liberalization policies.
  • India currently ranks among the top 100 countries in terms of ease of doing business.
  • According to a UN report, in 2019, India was among the top ten recipients of FDI, attracting a total of $49 billion in inflows, representing a 16% increase from 2018.
  • In February 2020, the Department for Promotion of Industry and Internal Trade (DPIIT) announced a policy allowing 100% FDI in insurance intermediaries.
  • In April 2020, DPIIT introduced a new rule stipulating that entities from countries sharing a land border with India, or where the beneficial owner of investment into India is situated, can invest only with the approval of the Government of India, known as the Government route.
  • In early 2020, the government decided to divest a 100% stake in the national airline, Air India.

FDI Route in India

Three routes facilitate the flow of Foreign Direct Investment (FDI) into India, as outlined in the table below:

Category 1 Category 2 Category 3
100% FDI permitted through Automatic Route Up to 100% FDI permitted through Government Route Up to 100% FDI permitted through Automatic + Government Route

Automatic Route for FDI

Under the automatic route, foreign entities are not obligated to obtain prior approval from the government or the Reserve Bank of India (RBI).

Sector  FDI Limit
Medical devices Up to 100%
Thermal power Up to 100%
Services within Civil Aviation Services
Insurance Up to 49%
Infrastructure companies in the securities market Up to 49%
Ports and shipping
Railway infrastructure
Pension Up to 49%
Power exchanges Up to 49%
Petroleum Refining (By PSUs) Up to 49%

Government Route FDI

Under the government route, foreign entities are required to obtain approval from the government. They must apply through the Foreign Investment Facilitation Portal, which offers single-window clearance. This application is then forwarded to the respective ministry or department, which makes a decision on approval or rejection after consultation with the Department for Promotion of Industry and Internal Trade (DPIIT).

  • Broadcasting Content Services: 49%
  • Banking & Public sector: 20%
  • Food Products Retail Trading: 100%
  • Core Investment Company: 100%
  • Multi-Brand Retail Trading: 51%
  • Mining & Minerals separations of titanium-bearing minerals and ores: 100%
  • Print Media (publications/printing of scientific and technical magazines/speciality journals/periodicals and a facsimile edition of foreign newspapers): 100%
  • Satellite (Establishment and operations): 100%
  • Print Media (publishing of newspapers, periodicals and Indian editions of foreign magazines dealing with news & current affairs): 26%

FDI is Prohibited Sectors

Certain sectors completely prohibit Foreign Direct Investment (FDI). These sectors include:

  • Agricultural or Plantation Activities (with exceptions such as horticulture, fisheries, tea plantations, pisciculture, animal husbandry, etc.)
  • Atomic Energy Generation
  • Nidhi Company
  • Lotteries (online, private, government, etc.)
  • Investment in Chit Funds
  • Trading in TDRs (Transferable Development Rights)
  • Any Gambling or Betting businesses
  • Cigars, Cigarettes, or any related tobacco industry
  • Housing and Real Estate (except for townships, commercial projects, etc.)

Benefits and Drawbacks of Foreign Direct Investment

Foreign Direct Investment (FDI) offers various benefits and drawbacks. Check the table provided below.

Benefits of Foreign Direct Investment
Disadvantages of Foreign Direct Investment
– Facilitates the inflow of financial resources essential for economic development.
– Potential negative impact on domestic investment and local companies.
– Introduces new technologies, skills, knowledge, and expertise.
– Vulnerability of small domestic companies to competition from multinational corporations (MNCs), leading to possible closures.
– Creates additional employment opportunities, thereby reducing unemployment rates.
– Adverse effects on the exchange rates of the host country.
– Fosters a more competitive business environment within the country.
– Enhances the quality of products and services across various sectors.

Government Measures to Increase FDI in India

  • The government introduced schemes like the production-linked incentive (PLI) scheme in 2020 for electronics manufacturing to attract foreign investments.
  • In 2019, the government amended the FDI Policy 2017 to permit 100% FDI under the automatic route in coal mining activities, leading to enhanced FDI inflow.
  • FDI in manufacturing was already under the 100% automatic route; additionally, in 2019, the government clarified that investments in Indian entities engaged in contract manufacturing are also permitted under the 100% automatic route, provided it is undertaken through a legitimate contract.
  • The government allowed 26% FDI in digital sectors, which offer high return capabilities in India due to favourable demographics, substantial mobile and internet penetration, and massive consumption along with technology uptake, providing significant market opportunities for foreign investors.
  • The Foreign Investment Facilitation Portal (FIFP) serves as the online single-point interface of the Government of India with investors to facilitate FDI, administered by the Department for Promotion of Industry and Internal Trade, Ministry of Commerce and Industry.
  • FDI inflow is expected to increase further due to foreign investors’ interest in the government’s initiatives to allow private train operations and bid out airports.
  • Valuable sectors like defence manufacturing, where the government enhanced the FDI limit under the automatic route from 49% to 74% in May 2020, are also expected to attract significant investments in the future.

Regulatory Framework for FDI in India

In India, numerous laws govern FDI inflows, including:

  1. Companies Act
  2. Securities and Exchange Board of India Act, 1992 and SEBI Regulations
  3. Foreign Exchange Management Act (FEMA)
  4. Foreign Trade (Development and Regulation) Act, 1992
  5. Civil Procedure Code, 1908
  6. Indian Contract Act, 1872
  7. Arbitration and Conciliation Act, 1996
  8. Competition Act, 2002
  9. Income Tax Act, 1961
  10. Foreign Direct Investment Policy (FDI Policy)

Important Government Authorities in India concerning FDI

  • Foreign Investment Promotion Board (FIPB)
  • Department for Promotion of Industry and Internal Trade (DPIIT)
  • Reserve Bank of India (RBI)
  • Directorate General of Foreign Trade (DGFT)
  • Ministry of Corporate Affairs, Government of India
  • Securities and Exchange Board of India (SEBI)
  • Income Tax Department
  • Various Ministries of the Government of India, including Power, Information & Communication, Energy, etc.

FDI Way Forward

  • FDI plays a crucial role as a driver of economic growth and a vital source of non-debt finance for India’s economic development.
  • Ensuring a robust and easily accessible FDI regime is essential to harness its potential effectively.
  • Despite the challenges posed by the pandemic, India’s large market and post-pandemic economic growth prospects will continue to attract market-seeking investments.
  • The attractiveness of India’s market is expected to persist, making it a favourable destination for FDI in the foreseeable future.

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What is FDI and its importance?

FDI involves acquiring ownership stakes or establishing a significant level of control in the foreign entity. The purpose of FDI is to gain long-term involvement in the foreign market, generate profits, access new markets, and transfer technology and expertise.

In which sector is Foreign Direct Investment prohibited?

The present policy prohibits FDI in the following sectors: Gambling and Betting. Lottery business (including government/ private lottery, online lotteries etc) Activities /sectors not open to private sector investment (eg, atomic energy /railways).

Which country has the highest FDI in the world?

The United States remained the largest recipient of FDI, attracting 1 billion in inflows, followed by China and Singapore.

What are examples of foreign direct investment?

Horizontal: a business expands its domestic operations to a foreign country. In this case, the business conducts the same activities but in a foreign country. For example, McDonald's opening restaurants in Japan would be considered horizontal FDI.

Who regulates FDI in India?

FDI is regulated primarily by India's Department of Promotion of Industry and International Trade (DPIIT), under its Foreign Exchange Management Act regime (FEMA Regime).

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