Impact of fdi banana republic or miracle growth

International Journal of Management (IJM), ISSN 0976 – 6502(Print), ISSN 0976 –
INTERNATIONAL JOURNAL OF MANAGEMENT (IJM)
6510(Online), Volume 4, Issue 1, January- February (2013)
ISSN 0976-6502 (Print)
ISSN 0976-6510 (Online)
Volume 4, Issue 1, January- February (2013), pp. 157-162
IJM
© IAEME: www.iaeme.com/ijm.asp
Journal Impact Factor (2012): 3.5420 (Calculated by GISI) ©IAEME
www.jifactor.com

IMPACT OF FDI: BANANA REPUBLIC OR MIRACLE GROWTH

Dr. Vinit Dani
Associate Professor
Symbiosis Institute of Management Studies (SIMS)
Range Hills Road, Kirkee, Pune-411020
Mrs. Vanishree Pabalkar
Assistant Professor
Symbiosis Institute of Management Studies (SIMS)
Range Hills Road, Kirkee,
Pune-411020

ABSTRACT

Indian economy is the fourth largest economy in the world in terms of purchasing
power; it is likely to touch new heights in coming years. The country is one of the G-20
major economies and a member of BRICS. The country because of global economy has been
experiencing double-dip recession and economic slowdown. As the infrastructure is the main
driver of economic development of country, India needs heavy investment on its
infrastructure development. With the current level of current account deficit and fiscal deficit,
India needs huge private investment to supplement the public investment in infrastructure
development in the 12th five plan period (2012 – 2017). In the 12th five year plan India
anticipates 10 percent growth rate and for this purpose drastic steps are to be taken to boost
the economic development of the country. As predicted by Goldman Sachs, the Global
Investment Bank, by 2035 India would be the third largest economy of the world just after
US and China. It will grow to 60% of size of the US economy. This booming economy of
today has passed through many phases before it can possibly achieve the predicted milestone
of 10% GDP. The conceptual paper tries to understand the reasons for slowdown in FDI and
factors affecting the Economic growth.

Key words: Purchasing power, Recession, Deficit, Infrastructure, FDI

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1. INTRODUCTION

FDI inflow generally comes as capital bundled with technology, skills and sometimes
even market cases. Therefore, they are widely perceived as important resource for expediting
the industrial development of the receiving countries. Most developing countries therefore,
have a welcoming attitude towards FDI. As a matter of fact, developing countries compete
with each other to vie for this coveted Investment; they go all the way to attract such
investors. India is considered amongst the developing economies along with countries such as
China, Brazil, Russia, South Africa etc. In the Asian continent the biggest beneficiary of FDI
is China. India's case is atypical in this context as it followed restrictive policy towards FDI
for the first forty years after independence. It was only in 1991 that India liberalized her
policy regime considerably. Although sectors like Mining, Banking, Insurance,
Telecommunications, Airlines, Construction and Management have been opened up partially
in the initial reform process, we need another round of constructive reforms to increase
India's FDI inflow. Other roadblocks affecting the growth are corruption, global economic
environment, inadequate infrastructure, volatility, macro-economic imbalances etc.

2. OBJECTIVES

The following are the objectives formulated to study the reasons and factors impacting India.
1. To study the reasons for slowdown of FDI in India
2. To understand the factors which are affecting the growth of India

3. LITERATURE REVIEW

The aspects of foreign direct investment i.e. political scenario and trends are analyzed
by most of the studies by and they are, Bhattacharya (1994), Jain (1994), and Prasad and
Chandra (1994), Subramanian, et al, (1996) and Kumar (1998) and (2000). These studies in
general highlighted the difference phases in the policies relating to FDI and brought out the
significant changes in the composition of FDI in the 1990s. A comprehensive study by
Bosworth and Collins (1999) provided evidence on the effect of capital inflows on domestic
investment for 58 developing countries during 1978-95. Bosworth and Collins find that an
increase of a dollar in capital inflows is associated with an increase in domestic investment of
about 50 cents. Studies by Subramaniam, et al. (1996) found that the availability of primary
material inputs for manufacturing and the large size of the domestic market for the sale of the
manufactured products are the two principal economics determinants of location of FDI
inflow. Other two factors that are influenced the FDI are the growth rate of GDP and the level
of infrastructure. P.D. Jeromi (2001) in his studies of Foreign Direct Investment in India,
Policy, Trend and Impact finds there three reasons for FDI in India viz, Real Sector reforms,
Infrastructure development and Privatization. According to global survey conducted by Ernst
and Young in June, 2008, India has been rated as the fourth most attractive FDI destination in
the world. One of the prime reasons for this the availability of educated and skilled work
force, which is the important factor behind attracting the Foreign Investors. Multinationals,
today do require such skilled employees to serve to their clientele. Studies like Mark & Moira
& FICCI 2002 have revealed success is the key reasons to have FDI in India.

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4. METHODOLOGY

The research paper presented here is a conceptual paper the data for which is collected
from various secondary resources like research papers, journals, magazines, articles from
other databases. In addition to this, various other data sources from RBI, CEIC, Central
statistical organization, World Bank and IMF are used.
5. DATA ANALYSIS
From early 1990s FDI inflows had increased after liberalization in investment
policies. In late 1990s FDI inflow was at abysmal $1.66 billion and it jumped to $17.5billion
by end of 2000, in a period of 2000-04 it doubled and almost quadrupled during 2004-10.
However, after a high of 3.2 percent of GD in 2008, the inflow of FDI in India along with
other emerging markets started declining. The FDI further declined by 32 percent in U.S
dollar terms to a stage of 1.5 percent of GDP in 2010, while other developing countries saw a
recovery by 10 percent. Based on sectoral reports, FDI in manufacturing improved but
services which accounts for 20 percent of inflow was badly impacted in 2010. In 2011, FDI
had recovered somewhat because of the some large deals with the most visible M&A deal
was the $3.7billion acquisition of Piramal Healthcare by US-based Abbott Laboratories.
Although Inflows in FDI recovered from slump in other countries, India faced unexpected
decline in 2010-11 (refer figure 5.1) because of reasons as under:

Figure 5.1

1. In 2010, the growth of exports of software and business process services was
sluggish, owing to weak demand in advanced economies. Investors were in a ―wait
and see mode until there was more certainty on the outlook for service sector exports.
2. Due to increasing scrutiny by the Ministry of Environment and Forests on
environmental safeguards there has been an increasing delay in some investment
projects. Some projects that appeared to have had all necessary clearances were
halted, some stopped altogether. Most notably, decisions include the cancellation of a
bauxite mine in the Niyamgiri Hills and alumina refinery in Orissa‘s Kalahandi
District, the scrapping of three hydro-electric projects in the Bhagirathi basin, the
withholding of environmental clearance to any other hydro-electric project planned in
the Alaknanda and Bhagirathi. Delays of a more temporary nature seem to have hit
the construction of the new city of Lavasa in Maharashtra Korean steel venture
POSCO and licenses for coal mining.

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3. Foreign investors may have been cautioned by recent scandals around the auction of
the 2G wireless spectrum, widespread media coverage of alleged cases of corruption,
and an enhanced scrutiny of off-shore bank accounts and investments from tax
havens. Income tax officials have been deputed to Mauritius, for example, to intensify
checks on FDI coming from there, especially into India‘s real estate sector.
4. Some analysts also cite concerns about high inflation, and large fiscal deficits which
constrain fiscal space to deal with the economic slowdown.

Apart from the above reasons some other possible reasons could be sluggish growth of
developed countries, a clamp down on tax evasion and general concerns regarding the
prospects of Indian economy.

5.1 Global economic environment

Christine Lagarde of the IMF had warned at the second half of 2011 that the global economy
has entered a “Dangerous phase” mainly due to concerns of fiscal sustainability of high
income countries like Europe leading to increasing risk aversion around the globe. Hardening
credit constraints and risk aversion has transferred financial sector difficulties to the real
economy, and economic growth has slowed, including in major emerging markets, most
notably being China and India.

5.2 Capital flows to developing countries weakened sharply due to market turmoil

The emerging-market equity funds concluded 2011 with about $48 billion in net outflows,
compared with a net inflow of $97 billion in 2010. Investors withdrew substantial sums from
developing-country markets in the second half of the year. In the second half of 2011 gross
capital flows to developing countries plunged to $170 billion, only 55 percent of the $309
billion received during the corresponding period of 2010. Most of the decline was in bond
and equity issuance. In contrast, syndicated bank loans held up well, averaging about $15
billion per month, slightly higher than the $14.5 billion in flows received during the same
period of 2010.

5.3 Major factors affecting Economic growth of India

a. Disinflation: There would be an output gap resulting from lower aggregate demand,
i.e. actual output would fall below potential. This reduction of capacity utilization
would mean lower pricing power for companies, and therefore downward pressure on
core inflation.
b. Rely on domestic growth: Declining stock markets, capital inflows and slowdown in
investment which was witnessed in 2011 may be due structural problems:
overexposure of banks to power projects, imbalances in revenue-expenditure of some
state electricity boards, mining scandals especially in Orissa and Karnataka, alleged
corruption in granting licenses in telecom sector. In order to improve investment
climate and strengthening domestic growth drivers’ major structural reforms need to
be introduced.

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c. High volatility of capital inflows: Due to uncertainty in health of the global economy,
volatility of portfolio could be high. Investors may be averse to invest because of poor
perception of global financial systems. On the other hand, global liquidity remains
unusually high with little prospect of monetary policy tightening in major developed
countries in 2012. High liquidity could lead to sudden FII surges in emerging markets.
To prevent unwanted volatility of the rupee RBI has been demonstrating its ability to
react quickly to short-term capital flows and its reserves remain sufficient.
d. Reducing macroeconomic imbalances: In a country like India where average growth
has been around 7 percent things can be changed by lowering borrowing, rationalizing
public spending and supporting private investment through lower interest rates.
Further, structural reforms can be done to improve the business climate.

6. CONCLUSIONS

Increasingly growing economy of India in most of its sectors, has made India one of
the most well-known and preferred destinations in the world, for FDI. India has been
expanding and the immense development is seen increasingly in areas like technology and
telecommunications, making it secure foreign investment. India has noticeably emerged out
as the second most attractive destination in the world, after China, for profitable FDI in
sectors like infrastructure, technology, telecom or hospitality. Countries like US, UK,
Mauritius, Singapore, and many others are eying for further investments in India. However,
there are some bottlenecks like Infrastructure, corruption, taxation system and bureaucratic
hurdles which are impacting the flow of FDI and growth of the economy.
Indian Prime Minister has touted an ambitious target for the 12th five year plan, which will
run from 2012-2013 to 2017-2018. The most eye catching figure in this plan is the proposed
investment in the infrastructure sector, a whopping 45,000 billion rupees or 1 trillion USD,
double of that in 11th five year plan. The prime minister’s office is hoping that through
double investment targets, real GDP growth can be sustained at an average of 10% per year
between 2012-2013 and 2017-2018. However it is very unlikely, an average read GDP
growth forecast for the period comes in only marginally lower than the 11th five year plan
period of around 7% per annum. While this is below the government’s target, the forecast is a
good one and highlights India’s attractiveness. But going by the trends that are shaping the
near future, growth will not reach double figures due to the country’s strained fiscal situation.
India’s public debt levels are very high at around 80% of GDP. This will constrain the fiscal
budget, however, if spending is not reduced, interest rates on government debt will be pushed
higher and this will constrain access to loans. In order to unlock the targeted double-digit
growth, it is imperative that the private sector plays a crucial role. With financing constrained
in the domestic project finance market and deep-rooted obstacles damaging the business
environment, the private sector’s ability to push growth this high is limited. During the 12th
Five-Year Plan, the government is targeting 50% of investment (equal to US$500bn) to come
from the private sector. It seems that while India remains an attractive market for
infrastructure investors – driven by the strong fundamentals of economic and population
growth – this target is a particularly ambitious one.

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