Foreign capital can be obtained either in the form of concessional assistance or non-concessional assistance or foreign investment . Concessional assistance includes grants and loans obtained at low rates of interest with long maturity period. Such assistance is provided generally on bilateral basis (government to government) or through multilateral agencies like the World Bank, International Development Association etc. Loans have generally to be repaid in terms of foreign currency but in certain cases the donor may allow the recipient country to repay in terms of its own currency. For instance, the U.S. Government allowed the Government of India to repay loans under PL 480 in terms of rupees. Grants do not carry any obligation of repayment and are mostly made available to meet some temporary crisis. Non-concessional assistance includes mainly external commercial borrowings, loans from other governments/multilateral agencies on market terms and deposits obtained from non-residents. Foreign investment is generally in the form of private foreign participation in certain sectors of the domestic economy.
The main advantage of this form of assistance is that generally the foreign investor also brings with him technical expertise, machines, capital goods, etc. which are scarce in underdeveloped countries. The disadvantage is that a large part of the profits are repatriated to the foreign investor. If the underdeveloped country in question chooses to depend too much on private foreign investment, it would be risking too much interference in the conduct of its affairs. This would be against the long- term interests of the country
Countries around the world, particularly developing economies, are vying with each other to attract foreign investment capital to boost their domestic rates of investment and also to acquire new technology and managerial skills. Intense competition is taking place among the fund-starved less developed countries to lure foreign investors by offering repatriation facilities, tax concession and other incentives. However, foreign investment is not an unmixed blessing. Governments in developing countries have to be very careful while deciding the magnitude, pattern and condition of private foreign investment.
Foreign Investment is of two types:
(1). Direct Investment- Investment by branches of foreign companies, investment by subsidiaries of foreign companies and investment by other foreign-controlled companies.
(2). Portfolio Investment- Equity holdings by non-residents in the recipient country’s joint-stock companies, credit capital from private sources abroad invested in recipient country’s stock companies and credit capital from official sources in recipient country’s joint stock companies.
Investment in a country by individuals and organisations from other countries is an important aspect of international finance. This flow of international finance may take the form of direct investment (creation of productive facilities) or portfolio investment (acquisition of securities).
FDI is the outcome of the mutual interests of multinational firms and host countries. According to the International Monetary fund, FDI is defined as “investment that is made to acquire a lasting interest in an enterprise operating in an economy other than that of the investor. The investor’s purpose being to have an effective voice in the management of the enterprise.” Its definition can be extended to include investments made to acquire lasting interests in enterprises operating outside of the economy of the investor.
FDI is a cross-border corporate governance mechanism through which a company obtains productive assets in another country. It is a measure of foreign ownership of productive assets, such as factories, mines and land. Increasing foreign investment can be used as one measure of growing economic globalization. The essence of FDI is the transmission to the host country of a package of capital, managerial, skill and technical knowledge. FDI is generally a form of long-term international capital movement made for the purpose of productive activity and accompanied by the intention of managerial control or participation in the management of a foreign firm.
Determinants of Foreign Investment
One of the most important determinants of foreign direct investment is the size as well as the growth prospects of the economy of the country where the foreign direct investment is being made. It is normally assumed that if the country has a big market, it can grow quickly from an economic point of view and it is concluded that the investors would be able to make the most of their investments in that country.
The World Investment Report , 1998 gave a comprehensive list of host country determinants of FDI.
Economic, political and social stability.
Rules regarding entry and operations.
Standards of treatment of foreign affiliates.
Policies on functioning and structure of markets (especially competition and M&A policies).
International trade and investment agreements.
Trade policy (tariffs and non-tariff barriers) and coherence of FDI and trade policies.
Economic Determinants (1+2+3)
Market size and per capita income.
Access to regional and global markets.
Country-specific consumer preferences.
Structure of markets.
Low-cost unskilled labour.
Technological, innovatory and other creative assets (i.e. brand names), including as embodied in individuals, firms and clusters.
Physical infrastructure (ports, roads, power, telecommunications).
Cost of resourced and assets, adjusted for productivity for labour resources.
Other input costs, e.g. transport and communications costs to/from and within host economy and costs of other intermediate products.
Membership of a regional integration agreement conducive to the establishment of regional corporate networks.
Investment promotion (including image-building, investment-generating activities and investment facilitation services).
Hassel costs (corruption, administrative efficiency, etc.)
Social amenities (bilingual schools, quality of life, etc.)
Alternate investment services.
New Industrial Policy of 1991 and its impact on FDI
The government of India initiated major structural changes in its economic policy since July 1991. The main aim of the policy was to make Indian Industry more competitive, these changes included some critical reforms in its industrial policy, trade policy, policy towards financial markets and institutions and towards foreign direct investment. The role of FDI has been clearly mentioned in the process of economic development of India. Till 1991, the FDI had played only a marginal role in Indian economy in financing India's external needs. However, since the structural adjustment programmes of July 1991, a much larger role has been envisaged for FDI in India and India has cleared the way for the attraction of FDI in India. India has taken active steps for the reduction of administrative and regulatory barriers to FDI, providing various fiscal incentives and other measures aimed at improving the climate for FDI. The changes made in FDI policy that the government was implemented since July 1991 can be broadly classified into four categories. They are as follows:
Choice of Product : The number of products, where FDI was not permitted under the previous policy framework had been reduced.
Choice of Market : The foreign investors are permitted to compete in the domestic market.
Choice of Ownership Structure : In most cases, the foreign investors are free to own a majority share of the firm's equity.
Simplifications of Procedures : Most of the procedures relating to applications and approvals of foreign investment- based business ventures were simplified.
The new policy framework attempts to raise FDI flows into India by expanding the number of investors, who consider India as a favorable industrial location. Procedural simplifications, along with several of the other policy reforms that have been initiated, serve to reduce the cost of choosing India as a host country