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How Foreign Investment Works

Foreign investment examples, other types of foreign investment, multilateral development banks, foreign investment pros and cons, the bottom line.

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Foreign Investment: Definition, How It Works, and Types

James Chen, CMT is an expert trader, investment adviser, and global market strategist.

Investopedia / Daniel Fishel

Foreign investment represents part of the elaborate web of financial relationships between nations and corporations. It's a force that can transform skylines, revitalize industries, and reshape the economic destinies of entire regions. But it's also a phenomenon that raises critical questions about economic sovereignty, democratic preservation, and global power balance.

For the purposes of this article, we'll focus on foreign investment in its contemporary economic sense, leaving aside foreign aid and the investments in human capital and development by one country in another. We'll also set aside, at least explicitly, the historical context of military colonialism and imperialism that has long been intertwined with foreign investment and is broadly understood.

Key Takeaways

• Foreign investment refers to the investment in domestic companies and assets of another country by a foreign investor.
• Large multinational corporations will seek new prospects for economic growth by opening branches and expanding their investments in other countries.
• Foreign direct investments (FDIs) include long-term significant investments made by a company in a foreign country, such as opening plants or purchasing buildings.
• Foreign indirect investments or foreign portfolio investments (FPI) involve corporations, financial institutions, and private investors buying financial assets such as shares, bonds, or other securities in foreign companies that trade on a foreign stock exchange.
• Commercial loans are another type of foreign investment. They involve bank loans issued by domestic banks to businesses in foreign countries or their governments.

Historically, state engagements and corporate investments abroad have often been closely linked: foreign investments typically piggybacked on state alliances or military impositions in other regions. Examples range from the opening of China to foreign investment following efforts by various American administrations, starting with Richard Nixon, to the European colonialism that empowered domestic firms like the Dutch East India Company and their 20th-century successors that exploited so-called "banana republics" more beholden to foreign corporations than local populations.

Unlike colonialism, modern foreign investment, at least in theory, involves financial interests in a foreign region without direct political control; the transfer of capital is intended for both profit and mutual benefit. Foreign investment thus involves capital flows from one country to another, granting foreign investors ownership stakes in domestic companies and assets. This includes foreign direct investment (FDI), where investors have direct control over the foreign enterprise, and foreign portfolio investment ( FPI ), which involves purchasing securities and other financial assets without active management of the enterprise. The latter is also discussed as foreign indirect investment.

Below, we'll explore these two main types of foreign investment in detail, examining their characteristics, motivations, and impacts on investing and recipient countries. We'll also discuss the role of foreign investment in globalization and the ongoing debates surrounding its benefits and drawbacks. By understanding the nuances of foreign investment, investors can better appreciate its significance in shaping the global economic landscape and its implications for international relations and economic development.

$1.3 trillion

The amount of global FDI flows in 2023.

Foreign investment refers to the allocation of capital by individuals, companies, or governments from one country into the assets or businesses of another country. This movement of capital can take various forms and serves many purposes, including the pursuit of higher returns, diversification of investment portfolios, fostering economic growth in the host country, and solidifying cross-border alliances.

Most notably, it's rarely, if ever, without controversy. The influx of foreign capital often sparks debates about national sovereignty, cultural integrity, and economic independence. Examples abound, from the anxiety over Japanese investments in iconic American properties during the 1980s to contemporary concerns about American teenagers whiling away their days on Chinese-owned TikTok. In the United Kingdom, foreign ownership of prime real estate, particularly in London, has led to discussions about housing affordability and the changing character of neighborhoods.

These controversies often stem from fears of losing control over national assets, concerns about wealth inequality, and suspicions about the motives of foreign investors. Critics argue that foreign investment can lead to the exploitation of local resources, the displacement of domestic businesses, or even pose national security risks. Supporters of particular foreign investment projects, meanwhile, tend to emphasize the benefits of job creation, technology transfer, and economic stimulation that foreign investment can bring.

Foreign investment operates through two primary mechanisms: FDI and FPI. Each serves different purposes and has distinct characteristics.

The United States, China, and India are among the top destinations for FDI, attracting billions of dollars in foreign capital annually.

Foreign Direct Investment (FDI)

FDI involves an investor establishing foreign business operations or acquiring foreign business assets, typically by controlling ownership in a foreign company. This form of investment is characterized by significant control over the foreign enterprise, often defined as owning 10% or more of the voting stock. FDI is usually part of a long-term commitment. It can take various forms, such as building new operational facilities from the ground up ( Greenfield Investments ), buying or merging with an existing foreign company, or partnering with a foreign company to establish a new enterprise (joint ventures).

Beyond capital, FDI often involves the transfer of technology, expertise, and management practices. FDI is usually grouped into three types:

• Horizontal FDI : A company establishes the same type of business operation in a foreign country as it operates in its home country. For example, a U.S.-based smartphone provider purchasing a chain of phone stores in China illustrates horizontal FDI.
• Vertical FDI : A business acquires a complementary business in another country. For instance, a U.S. manufacturer might acquire an interest in a foreign company that supplies it with the raw materials it requires.
• Conglomerate FDI : A company invests in a foreign business that is unrelated to its core operations. Since the investing company has no experience in the foreign company’s field, this often takes the form of a joint venture.

Foreign Portfolio Investment (FPI)

FPI refers to individuals, corporations, or institutions investing in foreign financial assets such as stocks, bonds, or other securities. Unlike FDI, portfolio investors typically do not have control over the enterprises they invest in. FPI is generally more liquid than FDI, allowing for easier entry and exit, and often has a shorter-term focus. It provides investors with a chance to diversify their portfolios across international markets .

FPIs are subject to exchange rate risks, as the value of investments can be significantly affected by fluctuations in the currency exchange rates between the investor’s home country and the foreign country.

Foreign Portfolio Investments by Country

Foreign indirect investments involve corporations, financial institutions, and private investors buying stakes or positions in foreign companies that trade on a foreign stock exchange . In general, this type of foreign investment is less favorable, as the domestic company can easily sell off its investment very quickly, sometimes within days of the purchase.

FDI vs. Foreign Indirect Investments or FPI

Buying a significant, lasting interest in a company or asset in another country.

Could be a merger or acquisition, joint venture, or the opening of a subsidiary and manufacturing plants.

The investor generally gains influence over how the foreign asset or entity is run.

These investments aren't always liquid and are considered long term.

Purchasing shares, bonds or other securities in foreign entities.

Holdings can include stocks, ADRs, GDRs, bonds, mutual funds, and exchange traded funds (ETFs).

The investor doesn't usually gain direct control of the foreign entity it invests in.

These investments tend to be smaller and shorter term in nature.

Foreign Investments and Tax Havens

In addition, large corporations often look to do business with those countries where they will pay the least amount of taxes. They may do this by relocating their home office or parts of their business to a country that is a tax haven or has favorable tax laws aimed at attracting foreign investors.

Some of the more popular tax haven countries that attract foreign investors include the Bahamas, Bermuda, Monaco, Luxembourg, Mauritius, and the Cayman Islands.

FDIs generally involve taking a significant stake in a foreign company or building facilities in a foreign country. That could mean a merger or acquisition, a joint venture, or creating a foreign subsidiary .

Many companies set up big manufacturing facilities in countries where labor and other costs are cheaper. An American company, for example, could sell its goods in the U.S. but get them made, say, in Vietnam. By opening manufacturing facilities in Vietnam, the company is investing in the country. Its investments lead to jobs and paychecks that get spent in the local economy as well as taxes.

Indirect foreign investments are generally less grand in scale. They could involve a retail investor buying a foreign country's government bond, which would essentially mean lending that government money or shares in a company that doesn’t trade in their country.

If you buy shares in a foreign company, or any other type of investment, including bonds, mutual funds, and ETFs, you are indirectly helping to fund the economy of the country where it is located. However, unlike with the FDI, your investment should be easy to sell and will be passive in nature—you won’t be influencing how it is run. It should also be more affordable and accessible.

Two additional types of foreign investments should be considered: commercial loans and official flows.  Commercial loans  are typically bank loans issued by a domestic bank to businesses in foreign countries or the governments of those countries. Official flows are a general term that refers to different forms of developmental assistance that developed or developing nations receive from a domestic country.

Commercial loans were the largest source of foreign investment in developing countries and emerging markets until the 1980s. Following this period, commercial loan investments plateaued, and direct and portfolio investments increased significantly around the globe.

Foreign investment flows can be highly sensitive to changes in economic indicators such as interest rates, inflation, and political stability in both the investor's home country and the target market.

A different kind of foreign investor is the multilateral development bank ( MDB ), which is an international financial institution that invests in developing countries to encourage economic stability. Unlike commercial lenders who have an investment objective to maximize profit, MDBs use their foreign investments to fund projects that support a country's economic and social development.

The investments—which typically take the form of low- or no-interest loans with favorable terms—might fund the building of an infrastructure project or provide the country with the capital needed to create new industries and jobs. Examples of multilateral development banks include the World Bank and the Inter-American Development Bank.

Foreign investment can help to boost both the recipient’s economy and the economy of the country of origin. The foreign country benefits, for example, from the constriction of new infrastructure and the creation of jobs for their local workers, while the country of origin may indirectly benefit from the returns generated from the investment.

Foreign investment is also seen as an important part of building ties between different countries. It boosts international trade and makes it easier for the world to share its resources, which, in theory, should benefit everyone.

There are also plenty of disadvantages. Common criticisms about foreign investment include that it drives out local businesses and results in profits being reinvested elsewhere. Foreign investment is sometimes viewed as an unethical way for companies to save money. By opening operations in cheaper countries, they fatten their pockets without passing on the savings to consumers and take jobs away from their country of origin.

Likewise, foreign indirect investment comes with pros and cons. On the one hand, it's great that investors have the option to invest anywhere in the world. Meanwhile, it means investment capital is being directed abroad rather than domestically. If people start investing in foreign companies over domestic ones, it could lead domestic companies to struggle, which could lead to job losses and maybe even higher prices.

Why Is Foreign Investment Important?

Foreign investment helps develop ties between different countries, promotes international trade, and can be economically beneficial to both the foreign and domestic country. The International Trade Administration claims foreign investment “plays a major role in the U.S. economy, both as a key driver of the economy and an important source of innovation, exports and jobs.”

What Is the Difference Between Investment and Foreign Investment?

An investment is called foreign when it is made in a foreign country. If the investment was made in the country of the investor, it would simply be an investment. If, meanwhile, it was made in a foreign country, it could be labeled a foreign investment instead.

Can I Directly Invest in Foreign Stocks?

Investors can invest in foreign stocks via American depository receipts ,  global depository receipts , or directly by opening an account with a local broker in the target country. Alternatively, it’s possible to gain exposure to foreign stocks by investing in a mutual fund or ETF that invests in foreign shares.

Do I Have To Pay Taxes on Foreign Stocks?

When Americans buy foreign stocks, their income and capital gains are taxed in the U.S. and may also be taxed by the government of the country where they invested. If you are also taxed by the foreign country's government, you may qualify for a " foreign tax credit " that allows you to use all or some of those foreign taxes to offset your liability to Uncle Sam.

When an investor invests in the companies and assets of a different country, it is deemed a foreign investment. Foreign investment is generally classified in two ways: direct and indirect. Direct describes long-term significant investments such as the acquisition of plants and buildings. At the same time, indirect usually refers to investors buying shares in foreign companies that trade on a foreign stock exchange. Another form of foreign investment is through loans.

UN Trade & Development. " Global Foreign Direct Development Grew 3% in 2023 as Recession Fears Eased ."

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Internal Revenue Service. " Foreign Tax Credit ."

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Foreign capital in india: need and forms of foreign capital.

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Foreign Capital in India: Need and Forms of Foreign Capital!

Everywhere in the world, including the developed countries, governments are vying with each other to attract foreign capital. The belief that foreign capital plays a constructive role in a country’s economic development, it has become even stronger since mid-1980.

The experience of South East Asian Countries (1986-1995) has especially confirmed this belief and has led to a progressive reduction in regulations and restraints that could have inhibited the inflow of foreign capital.

1. Need for Foreign Capital:

The need for foreign capital arises because of the following reasons. In most developing countries like India, domestic capital is inadequate for the purpose of economic growth. Foreign capital is typically seen as a way of filling in gaps between the domestically available supplies of savings, foreign exchange, government revenue and the planned investment necessary to achieve developmental targets. To give an example of this ‘savings-investment’ gap, let us suppose that planned rate of growth output per annum is 7 percent and the capital-output ratio is 3 percent, then the rate of saving required is 21 percent.

If the saving that can be domestically mobilized is 16 percent, there is a shortfall or a savings gap of 5 percent. Thus the foremost contribution of foreign capital to national development is its role in filling the resource gap between targeted investment and locally mobilized savings. Foreign capital is needed to fill the gap between the targeted foreign exchange requirements and those derived from net export earnings plus net public foreign aid. This is generally called the foreign exchange or trade gap.

An inflow of private foreign capital helps in removing deficit in the balance of payments over time if the foreign-owned enterprise can generate a net positive flow of export earnings.

The third gap that the foreign capital and specifically, foreign investment helps to fill is that between governmental tax revenue and the locally raised taxes. By taxing the profits of the foreign enterprises the governments of developing countries are able to mobilize funds for projects (like energy, infrastructure) that are badly needed for economic development.

Foreign investment meets the gap in management, entrepreneurship, technology and skill. The package of these much-needed resources is transferred to the local country through training programmes and the process of learning by doing’. Further foreign companies bring with them sophisticated technological knowledge about production processes while transferring modern machinery equipment to the capital-poor developing countries.

In fact, in this era of globalization, there is a great belief that foreign capital transforms the productive structures of the developing economics leading to high rates of growth. Besides the above, foreign capital, by creating new productive assets, contributes to the generation of employment a prime need of a country like India.

2. Forms of Foreign Capital:

Foreign Capital can be obtained in the form of foreign investment or non-concessional assistance or concessional assistance.

1. Foreign Investment includes Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI). FPI includes the amounts raised by Indian corporate through Euro Equities, Global Depository Receipts (GDR’s), and American Depository Receipts (ADR’s).

2. Non-Concessional Assistance mainly includes External Commercial Borrowings (ECB’s), loans from governments of other countries/multilateral agencies on market terms and deposits obtained from Non-Resident Indians (NRIs).

3. Concessional Assistance includes grants and loans obtained at low rates of interest with long maturity periods. Such assistance is generally provided on a bilateral basis or through multilateral agencies like the World Bank, International Monetary Fund (IMF), and International Development Association (IDA) etc. Loans have to be repaid generally in terms of foreign currency but in certain cases the donor may allow the recipient country to repay in terms of its own currency.

Grants do not carry any obligation of repayment and are mostly made available to meet some temporary crisis. Foreign Aid can also be received in terms of direct supplies of agricultural commodities or industrial raw materials to overcome temporary shortages in the economy. Foreign Aid may also be given in the form of technical assistance.

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2020 Theses Doctoral

Essays on International Capital Flows

Wang, Mengxue

This dissertation consists of three essays on international capital flows. The first chapter documents the accumulation of foreign exchange reserves and the simultaneous increase in the foreign direct investment (FDI) for emerging market economies. The second chapter discusses the performance of FDI firms and domestic firms in creating jobs using firm-level data from Orbis. The third chapter studies the proper exchange rate and monetary policy when emerging market economies denominate their external debt in foreign currencies. In Chapter 1, I study why emerging market economies hold high levels of foreign exchange reserves. I argue that foreign exchange reserves help emerging markets attract foreign direct investment. This incentive can play an important role when analyzing central banks' reserve accumulation. I study the interaction between foreign exchange reserves and foreign direct investment to explain the level of reserves using a small open economy model. The model puts the domestic entities and international investors in the same picture. The optimal level of the reserve-to-GDP ratio generated by the model is close to the level observed in East Asian economies. Additionally, the model generates positive co-movement between technology growth and the current account. This feature suggests that high technology growth corresponds to net capital outflow, because of the outflow of foreign exchange reserves in attracting the inflow of foreign direct investment, thus providing a rationale to the `allocation puzzle' in cross-economy comparisons. The model also generates positive co-movement between foreign exchange reserves and foreign debt, thus relating to the puzzle of why economies borrow and save simultaneously. In Chapter 2, joint work with Sakai Ando, we study whether FDI firms hire more employees than domestic firms for each dollar of assets. Using the Orbis database and its ownership structure information, we show that, in most economies, domestic firms tend to hire more employees per asset than FDI firms. The result remains robust across individual industries in the case study of the United Kingdom. The analysis shows that an ownership change itself (from domestic to foreign or vice versa) does not have an immediate impact on the employment per asset. This result suggests that different patterns of job creation seem to come from technological differences rather than from different ownership structures. In Chapter 3, I investigate how the devaluation of domestic currency imposes a contractionary effect on small open economies who have a significant amount of debt denominated in foreign currencies. Economists and policymakers express concern about the "Original Sin" situation in which most of the economies in the world cannot use their domestic currencies to borrow abroad. A devaluation will increase the foreign currency-denominated debt measured in the domestic currency, which will lead to contractions in the domestic economy. However, previous literature on currency denomination and exchange rate policy predicted limited or no contractionary effect of devaluation. In this paper, I present a new model to capture this contractionary devaluation effect with non-financial firms having foreign currency-denominated liabilities and domestic currency-denominated assets. When firms borrow from abroad and keep part of the asset in domestic cash or cash equivalents, the contractionary devaluation effect is exacerbated. The model can be used to discuss the performance of the economy in interest under exchange rate shocks and interest rate shocks. Future directions for empirically assessing the model and current literature are suggested. This assessment will thus provide policy guidance for economies with different levels of debt, especially foreign currency-denominated debt.

• Capital movements
• Investments, Foreign
• Foreign exchange reserves
• International finance

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Foreign Capital, Meaning, Types, Role in Economic Development

Foreign Capital refers to the influx of capital from international sources into domestic economy. Know all about Foreign Capital in India, its Types & Role in Economic Development for UPSC exam.

Table of Contents

Foreign Capital

Foreign capital holds significant importance for the economic development of countries, and governments worldwide actively seek to attract it. It refers to the influx of capital from international sources into the domestic economy, and its contribution is recognized as constructive and valuable.

Read about: Tax System in India

Role of Foreign Capital in Economic Development 

The importance of foreign capital in the development of a country can be understood from the following points:

Increased Investment

Foreign capital inflows supplement domestic savings, providing additional funds for investment in key sectors such as infrastructure, manufacturing, and technology. The United Arab Emirates attracted foreign capital to develop Dubai as a global financial and tourism hub, resulting in the construction of world-class infrastructure, including airports, seaports, and skyscrapers.

Technology Transfer

Foreign capital brings advanced technology, expertise, and managerial skills, which can enhance productivity, upgrade industries, and foster innovation. South Korea attracted foreign capital and technology transfers in the 1960s, enabling the development of its electronics and automotive industries, and contributing to its transformation into a major global player.

Job Creation

Foreign capital investments create employment opportunities, reducing unemployment rates and improving living standards for the local population. In India, the establishment of Special Economic Zones (SEZs) attracted foreign capital, leading to job creation in industries such as manufacturing, IT services, and pharmaceuticals.

Access to Global Markets

Foreign capital facilitates access to international markets, helping countries expand their exports, diversify their economies, and integrate into the global value chains. Vietnam’s liberalization policies attracted foreign investment, driving its export-oriented manufacturing sector, with companies like Samsung establishing production facilities, leading to economic growth and increased exports.

Economic Stability and Development

Foreign capital inflows contribute to foreign exchange reserves, enhance economic stability, and support long-term development projects. Ethiopia has attracted foreign capital for infrastructure projects such as roads, railways, and power plants, contributing to its economic growth and development.

Read about: Direct Benefit Transfer

Types of Foreign Capital 

Here is an analysis of different types of foreign capital. 

Read about: Gold Monetisation Scheme

Foreign Capital in India

Foreign capital inflows in India have shown significant trends and changes over the years. Here are the key points:

Trends Over the Years

• Increasing FDI : India has witnessed a consistent rise in foreign direct investment (FDI) inflows, with sectors like services, manufacturing, and information technology attracting significant investments.
• Portfolio Investment: India has experienced fluctuations in portfolio investment flows, influenced by global market conditions and investor sentiment.
• Remittances : Remittances from overseas Indians have shown a steady upward trend, making India one of the top recipients globally.

Share of Different Types of Foreign Capital

• FDI Dominance: FDI has been the largest component of foreign capital inflows, contributing to infrastructure development, manufacturing, and job creation.
• Portfolio Investment: Portfolio investment, mainly in the form of foreign institutional investments (FIIs), plays a significant role in the Indian stock markets.
• Remittances : India receives a substantial amount of remittances from its diaspora, providing support to households and contributing to the country’s foreign exchange reserves.

Steps taken by the government to attract foreign capital

• Liberalization Measures: The government implemented economic reforms to create a favourable investment climate, including easing regulations, simplifying procedures, and promoting ease of doing business.
• Sectoral Reforms: Sector-specific policies, such as allowing higher FDI limits in various sectors and introducing measures like the Make in India initiative, have been implemented to attract foreign capital.
• Investment Promotion: The government has launched campaigns, conducted roadshows, and engaged in diplomatic efforts to showcase investment opportunities and attract foreign investors.
• Policy Reforms: Measures such as the introduction of the Goods and Services Tax (GST), bankruptcy code, and labour reforms aim to improve the business environment and enhance investor confidence.

Way Forward

• Infrastructure Development: Continued focus on developing infrastructure will attract foreign investments, particularly in sectors like transportation, energy, and logistics.
• Sectoral Diversification: Encouraging investments in emerging sectors like renewable energy, digital technologies, and healthcare can drive economic growth and innovation.
• Investor-friendly Policies: Maintaining stable and transparent policies, reducing bureaucratic hurdles, and ensuring ease of doing business will strengthen investor confidence.
• Skill Development: Investing in skill development initiatives will enhance the availability of a skilled workforce, attracting foreign capital that requires specific expertise.
• Sustainable Development : Emphasizing sustainable practices, green investments, and social responsibility will align with global trends and attract responsible foreign investors.

Read about: Bad Bank

Foreign Capital UPSC 

Understanding foreign capital is important for the UPSC (Union Public Service Commission) exam as it aligns with the UPSC Syllabus , which covers various aspects of the economy, international relations, and policies. Familiarity with the types of foreign capital, their significance in the development of a country, trends, government initiatives to attract foreign capital, and the way forward help aspirants grasp the dynamics of global economics and India’s position in the global market. Exploring this topic through UPSC Online Coaching and UPSC Mock Test can enable aspirants to deepen their understanding and develop critical thinking skills necessary for answering questions related to foreign capital in the exam.

Read about: Banking Ombudsman

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Foreign Capital FAQs

What is india's foreign capital.

India's foreign capital consists of inflows of investment and funds from overseas sources into the country's economy.

What are the types of foreign capital?

The types of foreign capital include foreign direct investment (FDI), portfolio investment, and remittances.

Is FDI a foreign capital?

Yes, FDI (Foreign Direct Investment) is a form of foreign capital.

What is the role of foreign capital ?

The role of foreign capital is to provide financial resources, technology, expertise, and market access, promoting economic growth and development in the receiving country.

What are the components of foreign capital?

The components of foreign capital typically include equity investments, loans, bonds, and remittances from overseas.

What are the benefits of foreign capital?

The benefits of foreign capital include increased investment, job creation, technology transfer, infrastructure development, access to global markets, and economic growth in the recipient country.

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Foreign Capital and Economic Growth in the First Era of Globalization

We explore the association between income and international capital flows between 1880 and 1913. Capital inflows are associated with higher incomes per capita in the long-run, but capital flows also brought income volatility via financial crises. Crises also decreased growth rates of income per capita significantly below trend for at least two years leading to important short term output losses. Countries just barely made up for these losses over time, so that there is no conditional long-run income loss or gain for countries that experienced crises. This is in contrast to the recent wave of globalization when capital importing countries that experienced a crisis seemed to grow relatively faster over fixed periods of time. We discuss some possibilities that can explain this finding.

Comments from Olivier Jeanne, Paolo Mauro, Brian Pinto, Moritz Schularick and conference participants at the World Bank, Strasbourg Cliometrics, the World Economy and Global Finance Conference at Warwick and the Conference on Globalization and Democracy at Princeton University were very helpful. Seminar audiences at Carlos III, Manchester University, Nova University Lisbon, Paris School of Economics, and Trinity College Dublin also provided generous feedback on an earlier version. Antonio David and Wagner Dada provided excellent research assistance for early data collection. We thank Michael Clemens, David Leblang, Moritz Schularick, Alan Taylor, and Jeff Williamson for help with or use of their data. The financial assistance from the UK's ESRC helped build some of the data set that underlies this paper and supported this research. We acknowledge this with pleasure. Errors remain our responsibility. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.

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• October 31, 2007

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Michael Bordo and Christopher Meissner. “ Foreign Cap ital, Financial Crises and Income in the first Era of Globalization ” European Review of Economic History October 2010

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Essay: Foreign Capital in India | Financial Management

Here is a compilation of essays on ‘Foreign Capital’ for class 9, 10, 11 and 12. Find paragraphs, long and short essays on ‘Foreign Capital’ especially written for school and college students.

Essay on Foreign Capital

Essay Contents:

• Essay on the Utilisation of Foreign Capital

Essay # 1. Introduction to Foreign Capital:

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Foreign capital can be obtained either in the form of concessional assistance or non-concessional flows 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 from 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.

In addition to these forms of assistance, the underdeveloped country can also receive direct supplies of agricultural commodities (food grains etc.) or industrial raw materials to face temporary shortages in the economy.

Essay # 2. Indian Governments Policy towards Foreign Capital:

At the time of Independence, the attitude towards foreign capital was one of fear and suspicion. This was natural on account of the previous exploitative role played by it in ‘draining away’ resources from this country.

The suspicion and hostility found expression in the Industrial policy of 1948 which, though recognizing the role of private foreign investment in the country emphasized that its regulation was necessary in the national interest. Because of this attitude expressed in the 1948 Resolution, foreign capitalists got dissatisfied and as a result, the flow of imports of capitals goods got obstructed.

As a result, the Prime Minister had to give following assurances to the foreign capitalists in 1949:

1. No Discrimination between Foreign and Indian Capital:

The Government of India will not differentiate between the foreign and Indian capital. The implication was that the government would not place any restrictions or impose any conditions on foreign enterprise which were not applicable to similar Indian enterprise.

2. Full Opportunities to Earn Profits:

The foreign interests operating in India would be permitted to earn profits without subjecting them to undue controls. Only such restrictions would be imposed which also apply to the Indian enterprise.

3. Guarantee of Compensation:

If and when foreign enterprises are compulsorily acquired, compensation will be paid on a fair and equitable basis as already announced in government’s statement of policy.

Though the Prime Minister stated that the major interest in ownership and effective control of an undertaking should be in Indian hands, he gave assurance that there would be “no hard and fast rule in this matter”.

Despite the above assurances, foreign capital in the requisite quantity did now flow into India during the period of the First Plan. The atmosphere of suspicion had not changed substantially. However, the policy statement of the Prime Minister issued in 1949 and continued practically unchanged in the 1956 Industrial policy Resolution, had opened up immense fields to foreign participation. In addition, the trends towards liberalization grew slowly and gradually more strong and the role of foreign investment grew more and more important.

The government relaxed its policy concerning majority ownership in several cases and granted several tax concessions for foreign personnel. Substantial liberalisation was announced in the New Industrial policy declared by the government in July, 1991 and doors of several industries have been opened up for foreign investment. Prior to this policy, foreign capital was generally permitted (as a matter of policy) only in those industries where Indian capital was scarce and was not normally permitted in trading activities, plantations, banking and financial institutions.

It was not permitted in those industries which had received government protection or which are of basic and/or strategic importance to the country. The declared policy of the government was to discourage foreign capital in certain ‘inessential’ consumer goods and service industries. However, this provision as frequently violated as a number of foreign collaborations even in respect of cosmetics, toothpaste, lipstick etc. were allowed by the government. It was also stated that foreign capital should help in promoting, exports or substituting imports.

The government also laid down that in all those industries where foreign capital investment is allowed, the major interest in ownership and effective control should always be in Indian hands (this condition was also often relaxed). The foreign capital investments and technical collaborations were required to be so regulated as to fit into the overall framework of the plans.

In those industries where foreign technicians and managers were allowed to operate as Indians with requisite skills and experience were not available, vital importance was to be accorded to the training and employment of Indians in the quickest possible manner.

In a bid to attract foreign capital and investments from Non- Resident Indians (NRIs), the government has in recent years announced a number of tax concessions, lower rates of taxation for certain designated priority industries, tax holiday on profits for a certain period to new industrial undertakings etc. NRIs investing in India were allowed higher investment limits, priority allotment of items in short supply, permission to buy shares in Indian companies etc. However, the real ‘opening up’ came with the announcement of the new industrial policy in July 1991.

The important measures announced in July, 1991 and afterwards are as follows:

1. The government has prepared a specified list of high- technology and high-investment priority industries wherein automatic permission will be available for direct foreign investment up to 51 per cent foreign equity.

Annexure III contains a list of 35 priority industries divided into the following areas:

(i) Metallurgical industries,

(ii) Boilers and steam generating plants,

(iii) Electrical equipment,

(iv) Telecommunication equipment’s,

(v) Transportation,

(vi) Industrial machinery,

(vii) Agricultural machinery,

(viii) Industrial instruments, and

(ix) Chemicals (other than fertilisers).

This facility of 51 per cent foreign equity participation will be available to those firms which are able to finance their capital equipment imports through their foreign equity.

2. A special empowered board has been constituted to negotiate with a number of large international firms and approve direct foreign investment in select areas. This would be a special programme to attract substantial investment that would provide access to high technology and world markets. The investment programmes of such firms would be considered in totality, free from pre-determined parameters or procedures.

3. Prior to 1991 the government generally discouraged foreign equity holdings in service areas except for hotels. The 1991 policy has invited foreign equity holdings upto 51 per cent by international trading companies. In addition to hotels, 51 per cent equity will also be welcomed in other tourist related areas.

4. The new industrial policy provides for automatic approval to foreign technology agreements in the case of the 35 priority industries listed in Annexure III within certain guidelines. For the present, these guidelines will allow royalty up to 5 per cent of domestic sales and 8 per cent of export sales, along-with lump sum technology payments of up to Rs. 1 crore. This automatic permission would be available to other industries also-if the payments can be made without resort to free foreign exchange resources.

5. To hasten the progress in the ailing power sector, the government (in a policy decision announced on July 31, 1991) has allowed 100 percent foreign equity participation for setting up power plants in the country. Hundred per cent foreign equity participation allows free repatriation of profits and other incentives. Besides, it will help foreign parties to set up power plants without delays which considerably escalate the cost.

6. Hiring of foreign technicians and testing of indigenously developed technology abroad earlier required case-by-case approval by the government. This involved unavoidable delay. Henceforth, no permission will be necessary for these purposes.

7. NRIs and Overseas Corporate Bodies (OCBs) predominantly owned by them, were allowed in 1992-93 to invest upto 100 per cent equity in high-priority industries with reparability of capital and income. NRI investment upto 100 per cent of equity is also allowed in export houses, trading houses, star trading houses, hospitals, EOUs, sick industries, hotels, etc. Foreign citizens of Indian origin are now permitted to acquire house property without the permission of the Reserve Bank of India.

8. Provisions of the Foreign Exchange Regulation Act (FERA) have been liberalised through on Ordinance dated January 9, 1993 as a result of which companies with more than 40 per cent of foreign equity are also now treated on par with fully Indian owned companies.

9. Foreign companies have been allowed to use their trade marks on domestic sales from May 14, 1992.

10. The government has allowed reputed Foreign Institutional Investors (FIls) including pension funds, mutual funds, asset management companies, investment trusts, nominee companies and incorporated or institutional portfolio managers to invest in the Indian capital market subject to the condition that they register with the Securities and Exchange Board of India (SEBI) and obtain RBI approval under FERA. Portfolio investments by the FIIs in the primary and secondary markets are subject to an overall ceiling of 24 per cent of the issued share capital in any company.

11. Disinvestment of equity by foreign investors no longer needs to be at prices determined by the Reserve Bank. It has been allowed at market rates on stock exchanges from September 15, 1992 with permission to repatriate the proceeds of such disinvestment.

12. Foreign investors can invest in Indian companies through the Global Depository Receipts (GDR) route without any lock-in-period. These Receipts can be listed on any of the overseas stock exchanges and denominated in any convertible foreign currency.

Essay # 3. Advantages of Foreign Capital:

Poor nations need foreign capital to improve their economy. But this investment too has its problems. But foreign capital has certain adverse effects on the economy of poor nations as well.

1. To Meet Foreign Exchange Needs:

In a poor country there is always shortage of resources. It is also always in a hurry to industrialise itself. But till the needs of the people cannot be deferred, these can be met by importing goods from various countries, where these are available. For this foreign exchange is needed. No poor nation has enough foreign exchange resources to meet these demands, with the result that these nations are always dependent upon the rich ones for meeting their foreign exchange needs, for which foreign assistance is unavoidable.

2. Need for Supplementary Resources:

Poor nations have very limited resources. In many cases, these are so limited that these cannot meet even minimum basic needs of the people. At the same time, these nations cannot hope to raise funds from internal resources, due to low paying capacity of the people. These nations therefore, need additional capital, by which these can supplement their resources. These supplementary resources can be available only from the foreign capital.

3. Necessary for Meeting Domestic Needs:

Poor nations are always in a vicious circle. These want to industrialise themselves, and to become self-sufficient. But for that money is needed which these cannot raise. In this way a never ending circle goes on. In order to break it, it is essential that the poor nations should have sufficient assistance from abroad and needless to say that foreign capital can go a long way in breaking the circle.

4. Better Mobilisation of Domestic Resources:

Usually it is seen that in poor countries the capital is shy and the masses wish to avoid payment of taxes, mostly because they are poor and have no paying capacity. But when foreign capital is prepared to invest in the country, on the condition that domestic capital is also available, then national capital begins to come forward. Not only this, but also the government makes every effort to see that national resources are mobilised and made available to the foreign investor, so that economic growth of the country does not suffer. Thus foreign capital helps in Mobilisation of economic resources.

5. Helps in Completing National Projects:

For economic development of a nation, it is essential that the nation should undertake projects which can accelerate economic growth. These projects can be setting up of new industries, modernising of existing industries, thereby increasing output and making them work to the fullest capacity and so on.

These projects can accelerate economic growth of the nation. But usually each project for its installation and completion will need foreign exchange. In its absence, not only this that economic growth will slow down, but the projects may even not be completed.

6. Multipurpose Schemes can be Undertaken:

A poor nation may take up short term and single purpose schemes; but at the same time may give up costly multipurpose schemes, on the plea that these are beyond nation’s reach. It may abandon them clearly knowing that if executed; these can help solving nation’s many problems very easily and quickly.

These schemes might also be abandoned simply because their completion will take very long item and the nation may not be in a position to strain resources for such long periods. Accordingly the nation might feel discouraged to take such projects on hand. But once foreign assistance and capital is available, the nation will definitely feel encouraged and tempted to undertake those projects.

7. Helps Maintaining Consumption Level:

Consumption level of the population in poor countries is very low. The masses have very poor income and as such cannot spend on anything and everything. Their purchasing power is very low. In case out of this limited income they are required to pay heavy taxes, their spending vis-a-vis consumption capacity will very much go down. When foreign capital is available to the people are not taxed heavily and as such they can maintain their minimum consumption standard.

8. Helps in Providing Employment:

One of the most serious problems of the poor countries is that of un-employment. Due to non-industrialisation, there are limited employment opportunities. The state is not in a position to provide employment by undertaking any multi-purpose long term costly project. The nation is not in a position to provide any employment even to very competent and qualified people.

The result of all this is that discontentment and dissatisfaction among the people increases. But when the foreign capital is available, new industries and projects can be started. The nation goes fast on the path of industrialisation. With this employment opportunities are bound to increase.

9. Help in Maintaining Financial Stability:

When a poor nation has limited economic resources and heavy demands by the people, one of the methods adopted is that of issuing paper currency without taking proper measures for checking inflationary tendencies. The result is that the value of the currency considerably goes down.

The nation is forced to devalue its currency in the international market, creating many more problems for the people. Purchasing capacity of the people still more goes down. There is great economic stability in the country.

The only way out to solve the problem is that of getting assistance from the foreign countries. With the aid of advanced countries, it becomes possible to meet demands of the people without much straining nation’s resources.

10. Exploitation of Resources:

Nature has blessed each country with some resources. These are very useful for the development of a country, if properly exploited. Rich countries have enough capital and technical knowhow to exploit those resources whereas poor nations have neither technical personnel, nor economic resources nor other facilities to exploit the resources.

The result of all this is that poor nations cannot make their proper use. These remain buried where these are. In case foreign capital is available and these resources can be properly exploited, then many economic problems of a poor nation can be solved.

11. Helps in Proper Utilisation of Man Power:

In developing countries usually there is population explosion and surplus manpower, which creates many social and economic problems instead of solving them. In case foreign capital is available, services of the surplus manpower-skilled, semi-skilled and unskilled can be used for constructive purposes, instead of destructive ones, as is the case in many poor nations these days.

12. New Techniques of Management:

Under developed or undeveloped nations usually do not have much knowledge about new and latest management techniques; with the result that even if foreign capital is made available to them, these might not be in a position to efficiently use that. But when a nation provides some assistance to another, usually new management techniques are discussed and even arrangements are made for providing sufficient training for new management techniques.

13. Helps in Research:

Research in all walks of life is a very costly affair, when poor nations cannot afford. But unless research is done, it is difficult to find out new avenues for development. Therefore, a situation is created in which without research there is no advancement and without money there is no research. This problem can best be solved if foreign assistance is available, either in the form of capital grant or necessary research facilities are made available to the nation.

14. Helps in Creating Permanent Assets:

Many new projects are undertaken with the help of foreign capital. These include construction of roads, bridges, dams, railways etc. etc. The foreign agency which constructs them, cannot take these capital projects back after agreements providing financial assistance are over.

These become permanent assets of the country, which can be used for all subsequent programmes of development. Had foreign capital not come to the aid of the poor countries, they would not have been in a position to build up these assets and their whole programme would have come to a standstill for quite sometime.

Foreign capital plays a very big and important role in the growth and development of economy of a poor nation. In many cases it even does pioneering work, in the sense that the money is spent in those projects, in which native capital is shy feeling that the money might not sink. The risk of loss is thus boldly borne by the nations which advance loan and importance of this aspect cannot be under-estimated in any manner.

Essay # 4. Disadvantages of Foreign Capital Investment:

1. Makes the Nation Dependent:

It is said that when foreign capital is available, the nation becomes dependent. The people themselves become lazy and lethargic. They do not work hard, since they know that for completing their projects, some country or the other will come forward with financial assistance. They would otherwise have worked hard and tried to ensure that with their own labour, their programme should be completed and targets achieved.

2. Opposed to Self Sufficiency:

Then another disadvantage is that this type of aid is opposed to idea of self-sufficiency. When foreign aid is available, then poor nations becomes slow in achieving self-sufficiency. These are in no hurry to set up machinery or acquire technical knowhow very speedily or readily.

3. Encourages Inflationary Tendencies:

Each nation has its own economic policies and programmes, which must keep pace with its economic resources. Budgets are prepared and finalised on the basis of those estimates. But when foreign money pours in. particularly unexpectedly, then more money become available.

It gets circulated and upsets the whole economy. Inflationary tendencies get encouragement. In this way poor nations are faced with the serious problem of inflation. We know that once this circle starts it becomes difficult to check that.

4. Sudden Burden on the Nation:

In order to meet the demands of the people or to gain popularity, the government of the day goes on borrowing. But after sometime, the question of repayment of the loan comes. At that time the nation is forced to save out of its limited resources. The result is that there is sudden burden on national economy, which many poor nations cannot afford. The result is that economies of many recipient nations are shaken from the very foundations.

5. Politically Unhealthy Effects:

Powerful and economically well off, almost always try financial aid to have direct or indirect strings attached to aid In case there are no such visible strings, the expectations always are that the recipient nation will depend on the powerful nation. In this way foreign aid upsets, political behaviour of the poor nations and makes them politically dependent on the powerful nations.

6. Heavy Cost of Foreign Capital:

Usually foreign capital is invested in an industry in which there are chances of quick returns and heavy profits. In fact when foreign capital is invested, share is demanded in profits and the investor is given some dividend. The capital also charges some interest.

Thus usually interest, dividend and profit come to about 40% of the total return. Thus 40% of the total income is drained out and only 60% is left for the labour of the natives. This drainage of 40% is obviously not reasonable or justifiable.

7. Undependable in Difficulties:

Foreign capital has always a tendency to earn maximum profit. This tendency becomes still more visible when the economy of the recipient nations begins to totter down. At this stage foreign investment should sick firmly to the aid of the poor country. But it is at this stage that it begins to withdraw itself.

8. Money cannot be Invested in Key Sectors:

Maximum investment is needed in key sector industries and it is in the development of these sectors e.g. manufacture of defence material, installation of steel factories etc. that every nation is most interested. But it is unfortunate that money cannot be spent in these sectors because that would mean leakage of national secrets, which can harm any nation, particularly when hostilities break out.

9. Exploitation of Natural Resources:

With the foreign capital there is always ruthless exploitation of natural resources resulting in unbalanced economic development. While spending, foreign nations always keep their interests before the interest of the recipient nations.

10. Natives Denied Responsible Jobs:

After the capital has been invested the loaning nation is very keen that it should preserve its interests and the capital. This is done by keeping all the key posts with itself. In this way their own incompetent people are preferred over competent natives. Thus all important jobs are denied to the natives and also they are not given proper training, so that they can deal with their own affairs in a most competent manner, after the foreign power has left the land.

Of course, inflow of foreign capital has its bad effects and influences on the economy of a poor nation and even sometimes may do considerable harm, yet no poor nation can ever think of disowning it. If the people are courageous, determined and decided to end dependence quickly, all that they can do is that with their efforts, and proper use of foreign capital they can reduce the period of dependence and nothing beyond that.

Essay # 5. Foreign Capital in India:

Prior to Independence, there was substantial amount of foreign investments in India. Much of this capital was engaged in plantations and extractive industries. Almost the entire tea plantations, most of the jute mills, petroleum sector, rubber industries and many of the consumer goods industries were owned by the foreign capitalists. Largest share of foreign investments in India belonged to the United Kingdom followed by the USA.

The other important countries who had made investments in India were Japan, Holland, France, West Germany and Canada. However, after Independence, the policy of the Government of India laid emphasis on accepting foreign investments with the majority participation of the Indian nationals. Further many of the foreign enterprises, particularly those in the petroleum sector were nationalised.

Equity capital of many others was diluted to give major share of ownership, management and control to the Indians. Consequently, the flow of foreign investments declined and became almost a trickle in the past few decades. Consequently, the Government adopted a more liberal policy towards foreign investments.

Essay # 6. Utilisation of Foreign Capital:

It is abundantly clear that no poor nation can make progress and go on the path of prosperity, unless capital from outside pours in. This leads us to another question, namely what is proper utilisation of foreign capital.

Some of the important methods which can be suggested in this regard are:

1. Use for Self Generation of Economy:

Foreign capital should be used for self-generating economy. When the capital is being used for setting up machines and industrialising the country, there will be growth in the economy. The capital spent will help in the generation of further capital. In this way dependency will reduce and economy will generate itself.

2. Should be Treated Supplementary and Not Substitute:

Foreign capital should always be treated as supplementary to the national capital and not substitute for it. In case it is considered as substitute, then there will be lethargy and slackness. The natives will feel that they have a substitute for their labour. If on the other hand it is considered as supplementary, then the intention will be that unless capital from national resources is available, foreign capital will have no meaning. It would mean equally hard work for creating capital form internal resources.

3. Should be Used for Creating Permanent Assets:

It is most essential that the capital should be used for creating permanent assets. Once these assets have been created then the nation will continue enjoy the benefits of these assets; no matter whether the loaning nation continues to extend financial support or not. Obviously after the creation of the assets, the nation which extended financial assistance cannot take them back.

4. Should be Used for Priority Projects:

Loan is not a charity. It is to be repaid with profit and interest; it is therefore, just burdening coming generations. Therefore, it should be spent only on priority projects. If the loan is being made available for low priority projects the nation may not even accept that. Therefore, only such loans should be obtained and utilized for the purpose for which the nation has fixed a priority.

5. Least Spent on Consumable Goods:

Usually there is tendency on the part of the poor nations that these spend heavily on the import of consumption goods, just to meet immediate demands of the people. The money spent on the import of consumption goods as cosmetics, stationery goods etc. is merely a waste and a costly luxury, which the nation cannot afford because money spent on the import of these goods is not better than the money wasted and this wastage should be saved for proper utilisation of foreign capital.

6. Should be Invested in Collaborative Projects:

One of the methods, which can be suggested for proper utilisation of foreign capital, is that it should be invested in collaborative projects. Before the start of the project the loaning nation must clearly indicate its commitments and the recipient nation has clear idea about its responsibilities.

In this way there is a joint effort to complete the project. But as already said the poor nation should clearly understand that the project is covered under the priority areas and not that a secondary project is getting priority over the primary project simply because foreign loan for the former is available.

7. Should be Spent Under National Management:

Foreign capital can be better utilised, if it is spent under national management. It can be properly utilised, if it is considered as a training ground for the local people and their managerial capital capacity is best developed and they are made to learn how best the alternatives are available to the nation, for spending available foreign capital.

8. Used for Producing Finished Goods:

A nation can only earn, if it can produce finished goods. If it goes on producing only raw material, then that will have to be taken out of the country normally at low rates of payment it will be turned into finished goods and sold in the same country which supplied raw material, at higher rates and the profit will be kept by the nation which turned material into finished goods. It will be proper and scientific use of foreign capital, if that is used for producing finished goods, instead of simply producing some raw material in rude or refine from and so on.

9. Improvement of Quality:

It is seen that some of the poor nations produce a commodity, which is of poor quality. Due to lack of sophisticated equipments of production, the goods cannot be produced in bulk, with the result that the cost also cannot come down.

The outcome of this is that goods cannot compete international market. Not only this, but the problem is that local people also do not accept low quality goods and they prefer foreign goods over the locally manufactured goods. They do not patronise local industry which at first suffers losses and then closure.

The Government is forced to spend heavily on the import of better quality goods from outside. If the foreign capital is available, one of its best use will be to use that for the improvement of quality of the goods already being produced, so that, these are acceptable to the society on the one hand, and can face international competition on the other.

These are some of the suggestions which can be made for proper utilisation of foreign capital. But it must be remembered that the conditions of economy differ from nation to nation and those who are on the spot can best decide about proper utilisation of available foreign capital, on thing however, all the nations take into consideration is that inflow of foreign capital, does not strain national economy, by creating inflationary tendencies and trends.

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Essay on Foreign Collaboration | India | Economics

Here is a compilation of ‘Foreign Collaboration’ for class 9, 10, 11 and 12. Find paragraphs, long and short essays on ‘Foreign Collaboration’ especially written for school and college students.

Essay on Foreign Collaboration

Essay Contents:

• Essay on the Problems of Foreign Aid

Essay # 1. Need for Foreign Collaboration:

ADVERTISEMENTS:

Lack of capital is a serious handicap in the way of economic development of underdeveloped countries. The internal resources are not sufficient, so they have to rely on foreign capital in the initial stages of their development. The pace of economic development primarily depends upon the rate of capital formation. But in the underdeveloped countries the per capita real income being very low, the rate of saving investment is very low.

Therefore, these countries are obliged to depend upon external sources of capital for initiating them process of economic development.

External capital cards in the form of (i) direct business investment commonly called, private foreign capital and (ii) international loans and grants more commonly known as foreign aid or external assistance.

In the earlier years more direct business investment was the major form of foreign capital. The private industries and multinational corporations made direct investment in various fields of economic activities—agriculture, industries, plantation, mining, etc. in the underdeveloped countries.

However, the flow of direct business investment or foreign capital has declined in the recent years and therefore, now the major form of foreign capital comes by way of international loans and grants. At one time there was great opposition to the use of foreign capital in India. It was said there was the danger of domination and economic exploitation.

Essay # 2. Contribution of Foreign Capital:

The underdeveloped countries are always capital scarce countries and that is a perpetual need of capital for economic development projects. The degree of dependence on foreign capital depends on the extent to which domestic resources could be mentioned. India has required foreign capital to speed up economic growth.

There was considerable opposition to the use of foreign capital in India. This was mainly due to the political role it played in the past. The colonial empires of the 19th and 20th centuries were built by European countries on the basis of trade and identity. The Government of India at one time was subjected to the pressure of foreign companies and foreign government.

ADVERTISEMENTS: (adsbygoogle = window.adsbygoogle || []).push({}); Essay # 3. Arguments in Favour of Foreign Capital:

India is a developing country, and has adopted the path of economic planning for growth. Her natural resources and labour force are in abundance but there is lack of capital. Our technological knowledge is outdated and industrial productivity is very low under these circumstances, the importance of foreign capital increases.

This can be explained as under:

1. Encouragement to Domestic Savings:

In a developing country like India the level of domestic savings is low because of low income of the people. Naturally it suffers from scarcity of investment and in this way is caught in the vicious circle of poverty. With the help of foreign capital, the savings and investments can be pushed up.

2. Proper Exploitation of Natural Resources:

India possesses abundant natural resources but due to lack of technological knowhow and capital, the natural resources cannot be properly exploited. Thus it is necessary that the help of foreign capital is sought in order to accelerate the pace of economic development.

3. Availability of Foreign Technology and Managerial Techniques:

Developing countries also lack new technology and modern scientific managerial techniques. With the help of foreign capital these can also be gained. This process is essential for the economic development of the country.

4. Establishment of Basic and Key Industries:

Basic and capital intensive industries cannot be set up for want of sufficient capital. The domestic capital is shy and does not come forward. Thus foreign capital can easily contribute to the development of such industries. Economic history of India is an evidence that foreign capital has played a vital role in the establishment of basic and key industries.

5. Solution of Unemployment Problem:

Unemployment is increasing constantly in India was the help of foreign capital. New industries can be set up and chance of expanding the old ones also increase. Thus the level of employment opportunities also increase.

6. Lack of Enterprising Spirit:

In an underdeveloped country like India, capital is shy. Capitalists are apprehensive of investing this capital in risky enterprises. Foreign capital is welcomed to face the initial rests.

7. Control over Inflation:

India needs more money for its economic growth. So she has been adopting a policy of deficit financing. This leads to increase of money in circulation and the prices level goes up. Thus a state of inflation arises (High prices) foreign capital including capital goods, machinery and equipment can easily control and check inflation.

8. Helpful in Accelerating the Pace of Economic Development:

To accelerate the pace of economic development the policy of comprehensive economic planning has to be followed. Its need cannot be met with domestic reasons. Thus foreign capital becomes essential in boosting the level of capital formation.

9. Improvement in the Balance of Payments Position:

In the early stages of economic development of India machines, equipment and raw materials had to be imported. This led to adverse balance of payments. If India imports foreign capital it can make the balance of payments favourable in the short run as well as in the long run.

Essay # 4. Arguments against Foreign Capital:

1. Obsolete Machines of Technology:

Foreign capital is responsible for obsolete machines and technology being passed on to Indian partners by the foreign collaborations.

2. Dependence on Foreign Countries:

Foreign collaboration has made Indian industries dependent to a considerable extent on imports and intermediate goods and parts of machinery. It has destroyed self-reliance.

3. Foreign capital offer Prize Posts and superior jobs to their own nationals. They disregard the claims of highly qualified Indians and thus follow the policy of discrimination.

4. Foreign capital derives the industrial profits out of the country. This may lead to the exhaustion of country’s valuable resources and the progressive impoverishment of the country.

5. Foreign capital and enterprise brings about economic development by the foreigners. Economic domination may entail political domination in some form. Foreign capital may thus give rise to vested interests which may oppose the political and economic advancement of the country.

6. Foreign capital bound to beat to great dependence on foreign countries. This may, it is apprehended, impede the attainment of socialist pattern of society.

7. Foreign capital can prove highly prejudicial to national defence if have and key industries are monopolized by the foreigners.

These are the disadvantages that accrue to the country from the use of foreign capital. But in spite of strong reaction in the country against the import of foreign capital we have to consider our need to foreign capital in the light of requirements of a backward country like India.

Essay # 5. Foreign Investment in Recent Years:

Till the end of 1980, foreign investment was generally allowed only in areas of hi-tech sophisticated industries and Indian industries which were in a position to export substantial part of their production. The normal ceiling for foreign investment was then 40 per cent of total equity capital of companies, though a higher percentage of foreign equity capital was favoured in private sector industries, if the technology was highly sophisticated and not available in the country, or if the industrial unit was largely export-oriented.

New Liberal Policy:

Government of India has adopted a more liberal policy in regard to foreign investment in India as part of the New Industrial Policy of July 1991.

The new regime of foreign investment contains the following:

(i) As against the past policy of considering all foreign investment on a case-by-case basis and that too within the normal ceiling of 40 per cent of total equity investment, the new policy provides for automatic approval of direct foreign investment up to 51 per cent foreign equity holding in 34 specified high priority, capital-intensive hi-technology industries provided the foreign equity covers the foreign exchange involved in importing capital goods and outflow on account of dividend payments are balanced by export earnings over a period of seven years from the commencement of production;

(ii) Foreign technology agreements are also liberalised for 34 industries with industrial units left free to negotiate the terms of technology transfer without the need for prior Government approval for hiring of foreign technicians;

(iii) Foreign equity holdings up to 51 per cent would be permitted for foreign trading companies with a view to exploit world markets adopting professional marketing activities; and

(iv) Boards of Investment Promotion has been set up to look into large foreign investment projects and expedite their approval or non-approval.

Consequence:

Though as a consequence of the new liberal economic and industrial policy of July 1991, much foreign equity investment was expected to flow into India, the response though increasing to some extent, has not been as expected.

The main reason is that in spite of the announcement of the liberal foreign investment policy, persistence of bureaucratic cobwebs and delays and sticking to rules and regulations still persist obstructing free and abundant flow of foreign equity capital into India. Also Western countries with funds to invest abroad have different priorities such as increasing investments in East Germany. Taiwan and some other Asian countries where there is political stability and greater chances of financial success.

Essay # 6. Dangers of Private Foreign Capital:

From the Indian experience since her independence, the following dangers of private foreign capital operating in India (through their Indian collaborators) have come to be noticed:

1. Foreign companies from the West European countries and from the United States are generally reluctant to enter into collaboration with public sector companies (i.e. Government companies) in India, mostly on ideological grounds. If insisted to do so, they would rather not come to India than offer their participation with the Public Sector Indian companies.

2. In certain areas of industrial production, Indian technology is fairly well developed. Collaboration with foreign companies in low priority areas like cosmetics and luxury goods has only meant duplication of technology which is unnecessary and often costly. Indian companies or entrepreneurs have the necessary technology in such low priority industries which means any collaboration in such areas is superfluous.

3. The rate of return on initial foreign investments in India is very high, making it possible to return the entire amount of foreign investment within 2 to 4 years. It is, therefore, argued that unless foreign collaboration agreements help to increase India’s exports and result in decrease in dependence on foreign countries for imports, outflow of foreign exchange might far outweigh initial gain from foreign collaboration agreements.

4. Often technology that is passed on by private foreign collaborators of Indian partners is obsolete on not appropriate to Indian conditions; often import of capital equipment was far in excess of India’s requirements. Thus, technology appropriate to Indian conditions or development of such technology in Indian itself through collaboration with foreign companies has not become possible to any very great extent.

5. It is noted that royalty payments and fees for technical services rendered by foreigners all result in increasing claims on India’s foreign exchange earnings and reserves which are relatively small in relation to the country’s requirements. One estimate is that total outgoings due to private foreign collaboration agreements were more than the inflow of foreign capital. For example, Coca Cola with a small investment of foreign currency used to send abroad many times that amount annually by way of profit until permission to continue its activities was refused to the country.

The same is true of the US oil companies like of ESSO and Caltex. For example, the ESSO with an investment of Rs. 30 crore (with Indian holdings of only Rs. 57 lakh) took away from India profit (in foreign currency) of Rs. 83 crore during 1968 to 1970 only.

6. On the whole, the impact of foreign private collaboration on India’s balance of payments has not been favourable. The main reason for his has been the substantially high level of imports consequent on foreign collaboration agreements as compared to the low level of exports, such foreign collaborations hardly adding to India’s export earnings.

For long under the private foreign collaboration agreements, as excessive number of technicians, often not suitable to Indian conditions were sent to India and designs and machines were not suitable to Indian conditions; but under the agreements, they were imposed on India.

7. There is also the myth of the policy of Indianisation. Under Section 29(1) of the Foreign Exchange Regulation Act, all foreign companies are required to dilute their ownership to 74 per cent and under Section 29(2) of the FERA, the Indian branches of foreign companies are to be converted into Indian companies with non­resident share in equity capital not exceeding 40 per cent.

It is observed that the dilution of equity form 100 per cent to 74 per cent (or from 100 per cent to 40 per cent) has hardly made any difference to the drain of foreign exchange from India to foreign countries in which the head offices of foreign collaborations are situated.

It is observed, for example, that Ponds and Warren Tea were able to send home net worth of their company’s investment every two years. In the case of Colgate-Palmolive, the highest limit of profit was 89 per cent which meant that the entire net worth of assets invested in India was repatriated within less than 14 months.

The new issues of such companies are excessively oversubscribed on the pretext of broadening the Indian of these companies are able to raise plenty of local capital and the Indian Shareholders with their personal interest only in view and in dividend, provided support to the functioning of multinational companies whenever the bogey of expropriation was raised in Indian Parliament.

It was not the existing equity capital that was shared with India national, but the new equity that was issued to Indians. The Indian shareholders were scattered all over India and even if they wanted, they could not take any concerted action against the policies of the company. In fact, Indian shareholders were only interested in dividend and hardly took any interest in the functioning of the company. Thus, the domination of foreign collaborators continued unabated in India.

The myth of Indianisation can be exposed by the fact that foreign partners or the parent companies in their collaboration agreement retained the absolute power of appointing chairman and managing directors of their Indian subsidiaries even when the dilution of shareholdings was brought down to 25 per cent.

It is also observed that by adopting the practice of wide dispersal of equity holdings and ownership rights, the foreign collaborators have also significantly blunted Indian people’s opposition to multinational foreign companies with subsidiaries in India while repaying very high returns on their investments.

It may be said that garb or covering of Indianisation is being cleverly exploited by many foreign multinational companies to convert the business environment in India in their favour and thus continue to make and transfer home enormous profits made in India annually.

Michael Kidron has estimated that during 1948 to 1961, foreign companies as a whole had taken out of India total funds worth three times their investments in India. It may be said that the situation did not change much during the 1970s.

8. Instead of allowing foreign private capital and its participation on a selective basis and only in the case of essential capital equipment and other essential inputs, foreign collaboration agreements were permitted out of overenthusiasm to bring foreign capital into India into lines of production of commodities such as chewing gum, cosmetics, boot-polish, cigarettes, hotels and so on.

Though government assumed powers under the FERA, no concrete results have followed and foreign companies continue to make enormous profit in India and remit them to their mother countries as before.

Essay # 7. Government’s Policy in Regard to Foreign Capital:

After India became independent in August 1947, Jawaharlal Nehru, the then Prime Minister of India, made a statement in April 1949 giving the following assurances to foreign capital:

1. There would be no discrimination between foreign companies and purely Indian companies which meant that foreign capital would get the same treatment as indigenous capital.

2. Foreign investors would be permitted to remit profits and repatriate capital, taking into consideration India’s position in regard to availability of foreign exchange.

3. In case a foreign company was nationalised, fair and equitable compensation will be given to foreign investors.

The above policy was based on several considerations. There was a shortage of indigenous capital and that needed supplementing by foreign capital, if rapid industrial and economic development were to be brought about. Also, there was need of capital goods and equipment and technical know-how from abroad as India then lacked these essential requisites of growth and development.

Tax Concessions:

In the initial stages, with a view to attract foreign capital (that is, foreign companies) to India, Government offered various tax concessions and to avoid delays in finalising foreign collaboration agreements, streamlined its licensing policy of procedures to quickly approve foreign collaboration agreements.

In 1961 the Indian Investment Centre was opened, the objective being to bring together Indian and foreign businessmen and appraise foreign investors of the vast business opportunities in India.

In 1972 the Government of India took another major step to attract foreign capital into the country. It permitted wholly-owned subsidiaries in India of foreign companies, provided they undertook to export 100 per cent of their production.

Export Liability:

If the export liability was less than 100 per cent of its output, the extent of permissible foreign capital was to be decided by negotiations between the foreign companies and the Government of India.

Thus, the Government of India had to choose between the Indianisation of foreign subsidiary companies in India or boosting up export through their help. Government preferred the second of the above two possible courses. But Government’s choice of the second policy was beset with many difficulties.

What if export targets laid down were not fulfilled by foreign companies? Have not, with the promise of boosting, exports, a large number of foreign companies opened their branches or entered into collaboration agreements with Indian companies, thus dominating the Indian industrial scene, making the country dependent on foreign countries and creating problems of balance of payments?

Limits on the Role of Foreign Capital and Foreign Collaboration Agreements:

While for a developing country like India, foreign capital as also foreign technical knowledge are important for the industrial development of the country, there are clear limits on the use of foreign capital and on foreign industrial collaboration agreements as instruments of industrial development in a country like India.

The limits on the above two or on the absorptive capacity of foreign capital and technical know-how for industrial development in a country like India are fixed by considerations such as availability of industrial raw materials in the country, level of industrial and economic development already attained, availability of skilled personnel in the country, availability of various infrastructural facilities, the extent to which industrial and commercial projects are prepared or can be prepared with speed, availability of local or indigenous capital, experience of Indian companies in the industrial and commercial fields and their willingness to enter into industrial collaboration agreements, capacity of the country to pay servicing and other charges in foreign currencies to foreign collaborators, political stability and political ideology governing industrial and economic policy of the government of the country, willingness of foreign investors and companies to enter into collaboration agreements with local companies (which depends upon the extent to which Indian companies inspire confidence among foreign investors and foreign companies) and above all, on Government of India’s policy in regard to foreign capital and foreign collaboration agreements in the industrial field.

Essay # 8. Instruments of Industrial Growth:

1. World Bank Loan:

Due to an unprecedented drought in the country in 1987-88, the World Bank has agreed to give India a loan of dollar 350 million to help India to pay for the imports necessitated by the drought. This is in addition to a dollar loan from Japan amounting to 200 million.

The crucial point is that, for the first time, India is borrowing from international lending institutions to pay for current consumption. In the past such borrowing were intended for creating assists that would be productive in future, and thereby enhance the country’s capacity to repay the loans in future. Now, however, India has taken another step towards the dreaded debt trap.

2. External or Foreign Debt of India—Latest Position:

Economic Survey of the Government of India for 1991-92 has following things to say about India’s foreign or external debt:

“India’s medium and long-term external debt, consisting of external assistance on Government and non-Government accounts external commercial borrowings and the IMF -liabilities amounted to Rs. 1,004 hundred crores (i.e. US dollars 51.1 billion) at the end of 1990-91 and constituted about 19 per cent of GDP. Including NRI deposits, the country’s external debt (other than short-term debt) stood at Rs. 1,212 hundred crores (US dollars 61.7 billion) constituting about 23 per cent of GDP. Adding the estimates of short-term debt of maturities to one year, India’s aggregate external debt amounted to Rs. 1,307 hundred crores or US. dollars 66.5 billion on march 31, 1991 which was around 25 per cent of the country’s GDP.”

3. External Assistance or Foreign Aid:

In recent decades, particularly after the World War II, whereas the flow of private foreign capital to the underdeveloped countries has gone down sharply, that of public development assistance (foreign aid), both from the individual national governments and multinational donor agencies (like IBRD, IDA, etc.) has gone up tremendously. Foreign aid or external assistance is that flow of capital funds to the underdeveloped countries whose objective is non-commercial from the point of view of the donor agencies. Further, such assistance is characterised by concessional terms i.e., it has a low rate of interest and its repayment period is considerably large.

These ‘softer’ terms of borrowings of foreign aid are in contrast to commercial borrowings which have high interest rate and stringent repayment schedule. During nearly five decades of her planned economic development, India has utilised substantial quantities of foreign aid. In the First Five Year Plan, the need for external assistance was not felt to greater degree because we heavily relied on the withdrawal of our accumulated foreign exchange reserves for supplementing the domestic capital.

The withdrawal of our foreign resources continued right till the middle of 1958, when they became so low that they were not considered sufficient even to meet the minimum requirements of the economy. It was at this time that the need for procuring foreign capital was urgently felt and the friendly countries along with the international institutions like the l. B. R. D. were approached for help. Ever since that time, there has been a continuous flow of external assistance to India which has come in the form of (a) loans, (b) grants, and (c) aid under U.S. Public Law 480 commonly known as PL 480 which was discontinued around the year 1971-72.

4. External Assistance- Authorization and Utilisation:

The total external assistance authorised to India till the end of March 1998 amounted to Rs. 1,82,319 crores, of which Rs. 1,61,326 crores or 88.5 per cent of the total authorisation were in the form of loans and Rs. 18219 crores or 10 per cent of the total were by way of grants, Rs.2,774 crores or 1.5 per cent being in the form of PL 480/665 U.S. assistance to India.

The actual Utilisation of total assistance of the end of March 1998 amounted to Rs. 1,29,352 crores which was only about 71 per cent of the total authorised assistance. In the total, aid utilised loans accounted for Rs. 1,13,851 crores (88 per cent of the total, assistance utilised) and grants Rs. 11,682 crores (9 per cent of the utilised assistance). The balance Rs. 2,819 crores (3 per cent of the total utilisation) was PL 480/665 assistance which was fully utilised by the end of 1971-72.

5. Aid in Pipeline:

Aid available in pipeline represents assistance committed over the years which has remained undisbursed and is available for disbursement in future. Total aid in pipeline, both in the form of loans and grants, amounted to Rs. 52,967 crores at the end of March 1998. The World Bank group’s share in the total undisbursed loans was over 50 per cent.

6. Low Utilisation of Aid:

Not only there is a decline in the quantum of fresh aid, but also the country has not been able to fully utilise the already committed aid. Utilisation of total authorised aid upto the end of March 1995 was only about 70 per cent. Among the reasons for lower utilisation are inadequate provision of matching rupee resources from the Government organisational and administrative inefficiency; undue delay in completion of projects, etc.

Cost-overruns consequent to inordinate delays in completion of projects in critical areas have not only slowed down timely utilisation of aid available in the pipeline, but has also started adversely affecting fresh commitments by donors.

7. Source-Wise External Assistance:

India has been receiving assistance from a number of countries/country groups and international agencies. As at the end of March 1998.the share of World Bank Group (IBRD and IDA) in the total authorisations was 42.8 per cent. Japan has emerged as the second largest contributor (16.2 per cent) followed by the Asian Development Bank (9.1 per cent). Among the other major donors are the U.K., Germany and the OPEC Group.

Essay # 9. Problems of Foreign Aid:

External assistance, which plays a crucial role in the economic development of the underdeveloped countries, has also some problems that dilute its good impact. Foreign aid is largely uncertain and fluctuating and, therefore, it becomes difficult to plan your development by placing much reliance on such aid.

It has been seen that the quantum of foreign aid has not much relation with the requirements and absorption capacity of the aid receiving country as much of it is governed by the political considerations. And then the tied-aid, which is the common form of aid these days, restricts the country’s choice of projects or choice of markets for import of necessary goods as the donor countries give aid only for specific projects on the condition that the equipment and machinery required for these projects will be bought only in the market of the donor country.

This naturally reduces the impact of such aid as the prices of goods in the donor countries may be higher and their technologies inappropriate for underdeveloped countries. Another problem of foreign aid is the debt-servicing burden it imposes. Interest has to be paid regularly and installments must be paid on time. All these payments have to be made in foreign currency.

With the meager export earnings of the underdeveloped countries such debt servicing may consume a substantial proportion of their export- earnings. For example, debt servicing payments in India now use almost 30 per cent of our export earnings. This leaves less foreign exchange for importing other essential items required for development. Thus, foreign aid is not an unmixed blessing; it has its evil consequences as well.

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