Feb 14, 2007

Foreign Direct Investment – Is India a desired Destination?

  1. INTRODUCTION ON FOREIGN INVESTMENT –

Foreign Investment refers to investments made by residents of a country in financial assets and production process of another country. After the opening up of the borders for capital movement these investments have grown in leaps and bounds. But it had varied effects across the countries. It can affect the factor productivity of the recipient country and can also affect the balance of payments. In developing countries there was a great need of foreign capital, not only to increase their productivity of labor but also helps to build the foreign exchange reserves to meet the trade deficit. Foreign investment provides a channel through which these countries can have access to foreign capital. It can come in two forms:

  • foreign direct investment (FDI)
  • foreign portfolio investment (FPI)

Foreign direct investment involves in the direct production activity and also of medium to long-term nature. But the foreign portfolio investment is a short-term investment mostly in the financial markets and it consists of Foreign Institutional Investment (FII). The FII, given its short-term nature, might have bi-directional causation with the returns of other domestic financial markets like money market, stock market, foreign exchange market

2. WHY DO COMPANIES GO ABROAD –

1. Host countries with sizeable domestic markets, measured by GDP per capita and sustained growth of these markets, measured by growth rates of GDP, attract relatively large volumes of FDI

2. Resource endowments of host countries including natural resources and human resources are a factor of importance in the investment decision process of foreign firms.

3. Infrastructure facilities including transportation and communication net works are an important determinant of FDI.

4. Macro economic stability, signified by stable exchange rates and low rates of inflation is a significant factor in attracting foreign investors.

5. Political stability in the host countries is an important factor in the investment decision process of foreign firms.

6. A stable and transparent policy framework towards FDI is attractive to potential investors.

7. Foreign firms place a premium on a distortion free economic and business environment. An allied proposition here is that a distortion free foreign trade regime, which is neutral in terms of the incentives it provides for import substituting (IS) and export industries (EP), attracts relatively large volumes of FDI than either an IS or an EP regime.Fiscal and monetary incentives in the form of tax concessions do play a role in attracting FDI, but these are of little significance in the absence of a stable economic environment.

3. FACTORS IN INDIA THAT HAVE ENABLED FOREIGN INVESTMENTS –

How does India fare on these attributes? She does possess a large domestic market, she has achieved growth rates of around 5 to 6 percent per annum in recent years, her overall record on macroeconomic stability, save for the crisis years of the late eighties, is superior to that of most other developing countries. And judged by he criterion of the stability of policies she has displayed a relatively high degree of political stability. It is, however, India’s trade and FDI regimes which are seen as major impediments to increased inflows of FDI.

4. HISTORY OF REFORMS IN INDIA –

Two distinct phases can be identified in India’s foreign trade and investment regimes- the pre 1991 phase and the post 1991 phase

The Pre 1991 Phase

which stretches over four decades, was marked by extensive regulation of trade and investment. The cumbersome and complex nature of the regulatory framework during these years , Thespecification of sectors in which both foreign financial and technical participationwere allowed, those in which only technical collaboration was permitted, and those in which neither technical or financial participation was allowed reflect the desire to restrict foreign ownership and control to sectors of the economy in which its contribution was deemed to be essential. Restrictions on ownership of equity by foreign firms in cases where projects involved substantial inputs of foreign exchange or were export oriented, also reflect the desire to limit foreign control, but at the same time take advantage of FDIs foreign exchange earning potential where necessary and possible. The Foreign Exchange Regulation Act (FERA) of 1973 was Prime Minister Indira Gandhi's response to the economic crisis that bedevilled most years of her premiership.

The Post 1991 Phase

Relaxation of controls over FDI constituted a significant plank of the wide ranging economic reforms introduced in 1991 (Table 3) The three main elements of the reform were the abolition of the licensing requirements governing domestic investment, reduction in tariffs on imports and relaxation of controls over FDI. The principal changes in the foreign investment regime included automatic approval of FDI up to 51 percent of equity ownership by foreign firms in a group of 34
technology intensive industries, a case by case by consideration of applications for foreign equity ownership up to 75 percent in nine sectors, mostly relating to infrastructure, and the streamlining of procedures relating to approval of investment applications in general. Relaxation of controls over the extent of foreign ownership of equity signals a major departure from the earlier regime, although foreign ownership of equity over and above 50 per cent was subject to the requirement that the investors should balance all outgoings of foreign exchange on account of their operations with export earnings over a seven year period. The reform package as a whole heralded a departure from the earlier dirigiste regime. And FDI flows appear to have responded to the new initiatives; annual average inflows increased from around $384 million during the late eighties to around $ 3 billion during the late nineties.

5. POLICY CHANGES IN INDIA FOR FOREIGN INVESTMENTS –

1. Industrial Policy

The Government’s liberalization and economic reforms programme aims at rapid and substantial
economic growth, and integration with the global economy in a harmonized manner. The industrial policy reforms have reduced the industrial licensing requirements, removed restrictions on investment and expansion, and facilitated easy access to foreign technology and foreign direct investment.

Areas where changes were made are –

  • Industrial Licensing
  • Industrial Entrepreneurs Memorandum
  • Location Policy
  • Policy Relating to Small Scale Undertakings

2. Foreign Direct Investment

Foreign Direct Investment (FDI) is now recognized as an important driver of growth in the country. Government is , therefore, making all efforts to attract and facilitate FDI and investment from Non resident (NRIs) including Overseas Corporate Bodies (OCBs), that are predominantly owned by
them, to complement and supplement domestic investment. To make the investment in India attractive, investment and returns on them are freely repatriable, except where the approval subject to specific conditions such as lock -in period on original investment, dividend cap, foreign exchange neutrality, etc. as per the notified sectoral policy. The condition of dividend balancing that was applicable to FDI in 22 specified consumer goods industries stands withdrawn for dividends declared after 14th July 2000, the date on which Press Note No. 7 of 2000 series was issued.

Foreign direct investment is freely allowed in all sectors including the services sector, except a few sectors where the existing and notified sectoral policy does not permit FDI beyond a ceiling. FDI for virtually all items/activities can be brought in through the Automatic Route under powers delegated to the Reserve Bank of India (RBI), and for the remaining items/activities through government approval. Government approvals are accorded on the recommendation of the Foreign Investment Promotion Board (FIPB).

1.Automatic Route

  • New Ventures
  • Existing Companies

2. Government Approval

  • Issue and Valuation of Shares in case of existing companies
  • Foreign Investment in the Small Scale Sector
  • Foreign Investment Policy for Trading Activities
  • Other Modes of Foreign Direct Investments
  • Preference Shares

3. Foreign Technology Agreements

With a view to injecting the desired level of technological dynamism in Indian industry and for promoting an industrial environment where the acquisition of technological capability receives priority, foreign technology induction is encouraged both through FDI and through foreign technology collaboration agreements. Foreign technology collaborations are permitted either through the automatic route under delegated powers exercised by the RBI, or by the Government. However, cases involving industrial licenses/small scale reserved items do not qualify for automatic approval and would require consideration and approval by the Government. Automatic route for technology collaboration would also not be available to those who have, or had any previous technology transfer/trade-mark agreement in the same or allied field in India.Further, automatic approval for EOU/EHTP/STP units is governed by provisions

4. 100% Export Oriented Units/ Export Processing Zones/ Special Economic Zones

1a 100 per cent Export Oriented Units (EOUs) and units in the Export Processing Zones
(EPZs)/Special Economic Zones (SEZs), enjoy a package of incentives and facilities, which include duty free imports of all types of capital goods, raw material, and consumables in addition
to tax holidays against export. 100% FDI is permitted under automatic route for setting up of industrial park/industrial model town/special economic zone in the country. To encourage investment in this sector, 100% income tax exemption for 10 years within a block of 15 years is also granted for the industrial parks set up during the period 1.4.1977 to 31.3.2006”.

5. Automatic Approval

The Development Commissioners (DCs) of Export Processing Zones (EPZs) /Free Trade Zones (FTZS) )/Special Economic Zones(SEZs) accord automatic approval to projects where Activity proposed does not attract compulsory licensing or falls in the services sector except IT enabled services

  • Location is in conformity with the prescribed parameters;
  • Units undertake to achieve exports and value addition norms as prescribed in the Export and Import Policy in force;
  • Unit is amenable to bonding by customs authorities; and
  • Unit has projected the minimum export turnover, as specified in the Handbook of

Procedures for Export and Import.

All proposals for FDI/NRI/OCB investments in EOU/EPZ units qualify for approval through automatic route subject to sectoral norms. Proposals not covered under the automatic route would be considered and approved by FIPB. [For procedure for automatic approval, refer to para 10.1 & 10.5]. Conversion of existing Domestic Tariff Area (DTA) units into EOU is also permitted under automatic route, if the DTA unit satisfies the parameters mentioned above and there is no outstanding export obligation under any other Export Oriented scheme of the Government of
India.

FDI upto100% is allowed through the automatic route for all manufacturing activities inSpecial Economic Zones (SEZs), except for the following activities

  • Arms and ammunition, explosives and allied items of defence equipments, defence aircraft and warships;
  • Atomic substances;
  • Narcotics and psychotropic substances and hazardous chemicals;
  • Distillation and brewing of alcoholic drinks; and
  • Cigarettes/cigars and manufactured tobacco substitutes.
  • For services, norms as notified, would be applicable

Government Approval

All proposals which do not meet any or all of the parameters for automatic approval will be considered and approved by the Board of Approval of EOU/EPZ/SEZ set up in the Department of
Commerce.

6. ADVANTAGES FOR FOREIGN DIRECT INVESTORS IN INDIA

India had been a much closed economy for a very long time till 1991. Since then India has gradually started to liberalize its markets for foreign investors. Since then the foreign players has entered the India market. This has been very active since past 5 – 8 years. India has been wowing the foreign players in one and many ways.

In recognition of the important role of Foreign Direct Investment (FDI) in the accelerated economic growth of the country, Government of India initiated a slew of economic and financial reforms in 1991. India is now ushering in the second generation reforms aimed at further and faster integration of Indian economy with the global economy. As a result of the various policy initiatives taken, India has been rapidly changing from a restrictive regime to a liberal one, and FDI is encouraged in almost all the economic activities under the automatic route.

Over the years, FDI inflow in the country is increasing. However, India has tremendous potential for absorbing greater flow of FDI in the coming years. Serious efforts are being made to attract greater inflow of FDI in the country by taking several actions both on policy and implementation front. The advantages / prospects for investing in India are noted as below.

  • Stable democratic governance throughout 55 years of independence.
  • Large market of a middle class of 300-350 million people with increasing purchasing power as reflected by a sustained growth in sales of consumer durables in recent years.
  • Access to regional international markets through membership of regional cooperation frameworks such as SAARC, Indian Ocean Rim countries (IOC-ARC), and dialogue partnerships with EU and ASEAN. India also has Memoranda of Understanding / Cooperation partnerships with most African and Latin American regional groupings.
  • Foreign investment is welcome in almost all sectors barring those of strategic concern like atomic energy, railways and sensitive defence production.
  • Thrust on technology, innovation and knowledge based industries and services.
  • Well developed R&D infrastructure and technical and marketing services.
  • Large resources of untapped natural wealth.
  • Promising future in the burgeoning information technology and biotechnology industries.
  • Developed banking system, commercial banking network of over 63,000 branches, supported by a number of international banks, insurance and financial institutions.
  • Vibrant capital market comprising 23 stock exchanges with over 9,000 listed companies.
  • Developing as one of the largest cost-competitive technical workforce nation.
  • Conducive foreign investment environment that provides freedom of entry and exit, investment, location, choice of technology, import and export.
  • From April 2000 Special Economic Zones (SEZ) are set up in India with a view to provide an internationally competitive and hassle free environment for exports. Business units may be set up in SEZ for manufacture of goods and rendering of services. All the import/export operations of the SEZ units will be on self-certification basis. The policy provides for setting up of SEZ's in the public, private, joint sector or by State Governments. In simple terms the Special Economic Zones (SEZs) provide virtual offshore operation facilities and advantages of a free trade area.
  • Corporate Tax exemptions for a period of 5 years across all sectors.
  • Import Duty exemption for EOU’s
  • Tax Holidays are given as sops for investing by certain states

To promote FDI further many initiatives has been taken up by Government of India like setting up

Secretariat For Industrial Assistance for entrepreneurial assistance, investor facilitation, receiving and processing all applications which require Government approval, conveying Government decisions on applications filed, assisting entrepreneurs and investors in setting up projects, (including liaison with other organisations and State Governments) and in monitoring implementation of projects.

Foreign Investment Promotion Board to consider and recommend Foreign Direct Investment (FDI) proposals, which do not come under the automatic route.

Foreign Investment Implementation Authority to assist the foreign investors in getting necessary approvals and thereby facilitating quick translation of Foreign Direct Investment (FDI) approvals into implementation. Fast Track Committees have been set up in 30 Ministries/Departments for regular review of FDI mega projects (with proposed investment of Rs.1 billion and above), and resolution of any difficulties in consultation with the concerned Ministries/State Governments. Unresolved issues are brought before FIIA.

Foreign Investment Promotion Council for making the policy framework investor-friendly and transparent. Promotional measures are also taken to attract Foreign Direct Investment into the country. The basic function of the Council is to identify specific sectors/projects within the country that require Foreign Direct Investment and target specific regions/countries of the world for its mobilisation.

These are few and many more initiatives are taken by Government to make investment in India hassle free, lucrative and attractive. These are few of many advantages foreign investors enjoy when they decide to invest in India.

7. ADVANTAGE TO INDIA

  • Growth in Exports - India's exports have grown much faster than GDP over the past few decades. For example, its exports have grown over 11% per annum while growth in GDP is about 5% during 1970-98 periods. Exports have grown even faster since 1945-95. Several factors appear to have contributed to this phenomenon including foreign direct investment (FDI) which has been rising consistently especially from the early 1990s. By 1997 India became the ninth largest recipient of such investment among the developing economies (World Bank, 1998:20).

  • Economic Policy reforms have played a critical role in the performance of the Indian economy since 1991. Among other things, the reforms have involved opening up the economy, making it more competitive, getting the Government out of the huge morass of regulation, empowering the States to take more responsibility for economic management and thereby creating a kind of competition among them for foreign investment.
  • FDI has brought access to modern technologies (technology transfer) and export markets. FDI has also had a far more visible impact as it has involved setting up a production base i.e. factories, power plants, networks, that have generated direct employment. Further there has also been a (forced) multiplier effect on the back of FDI because of further domestic investment in downstream and upstream projects. Eg. Hyundai, Pepsi, Coke, IBM, Nokia, GE, LG, Samsung and the list is endless.
  • One idea is that multinational enterprises possess superior production technology and management techniques, some of which are captured by local firms when multinationals locate in a particular economy. A related source of spillovers is forward and backward linkages between multinational and host-economy firms (Rodriguez-Clare, 1996), which may result from multinationals providing inputs at lower cost to local downstream buyers or by their increasing demand for inputs produced by local upstream suppliers.
  • The indirect benefits to the Indian market include alignment of local Indian practices to international standards in trading, risk management, new instruments and equity research thus facilitating the markets to become more deep, liquid and efficient in feeding new information into prices resulting in a better allocation of capital to globally competitive sectors of the economy.
  • While these portfolio flows can technically reverse at any time, given that the surfeit of international capital chases growth, as long as India follows sensible economic policies, this risk is not as high as it is frequently made out to be.
  • The Indian experience over the last decade and a half – despite economic slowdowns, war, droughts, floods, political uncertainties and a nuclear test bears testimony to this.

8. DISADVANTAGES TO INDIA

There is hardly a facet of the Indian psyche that the concept of ‘foreign’ has not permeated. This term, connoting modernization, international brands and acquisitions by MNCs in popular imagination, has acquired renewed significance after the reforms initiated by the Indian Government in 1991. Contrary to the grand narrative of ‘opening of flood gates idea’ of 1991, what took place was a natural process of changes in policies of investment in certain sub sections of the Indian economy.

  • Some of the key disadvantages of the FI/FDI into India have been -
  1. Crowding out of Domestic Industries
FDI crowds out domestic entrepreneurship hence it is usually required of the investor to ensure a minimum level of local content, export commitment and technology transfer as also dividend balancing, forex neutrality and compulsory listing/dilution in the local market Eg – Walmart’s entry into the Indian market Vs the interests of the large Indian Retailers such as the Future Group, RPG etc.

  1. Increasing gap between rich and poor - Foreign investors are exploiting workers in poor countries and initiating a "race to the bottom" in environmental and labor standards. The experience comes from countries like Singapore, China, Chile and Ireland which demonstrate how foreign direct investment (FDI) - with its transfer of technical and organizational innovations and best practices stimulate rapid growth in incomes for all members of society.

When international flows of capital falter there's evidence that the poor in developing countries suffer the most. The extent to which foreign investment can help or harm the poor largely depends upon what our governments and firms choose to do. Many multinational companies voluntarily adopt environmental, social, and governance practices designed precisely to guard against abuse of the environment and the workforce when they invest in developing countries.

But governments in developing countries like India should facilitate and encourage the transfer of this social and environmental practice and maximize the benefits from FDI. If India is keen to ensure FDI is truly pro-poor should follow the following points

Ø Clear the way for free entry and exit in domestic markets by creating competition in product and labor markets and incentives to upgrade productivity and to prevent exploitation of consumers and workers.

Ø Promote education, worker training, and infrastructure to increase domestic capacity to absorb and diffuse good new practices introduced by foreign investors.

Ø Create a policy framework that encourages the adoption of appropriate social and environmental standards in corporate practices.

9. CONCLUSION

We think that Foreign Investment in India has a mutual advantage for both.India has the potential and the environment to grow. For the first time in 15 years, all 3 global ratings agencies — S&P, Moody’s and Fitch — have placed India in the ‘investment grade’. The decision marks a dramatic reversal of the situation India faced in 1991 when it was downgraded by S&P to below investment grade after the Balance of Payment crisis.

Feb 12, 2007

Better “Investment grade” for India by global rating agencies

For the first time in 15 years, all 3 global ratings agencies — S&P, Moody’s and Fitch — have placed India in the ‘investment grade’. The decision marks a dramatic reversal of the situation India faced in 1991 when it was downgraded by S&P to below investment grade after the Balance of Payment crisis.

Though Moody and Fitch has already upgraded some time before many players were waiting for S &P to upgrade Indian debt instruments

Standard & Poor’s is a leading provider of financial market intelligence. The world’s foremost source of credit ratings, indices, investment research, risk evaluation and data, Standard & Poor’s provides financial decision-makers with the intelligence they need to feel confident about their decisions. Many investors know Standard & Poor’s for its respected role as an independent provider of credit ratings and as the home of the S&P 500 benchmark index.

Date

Description

30 JAN 2007

BBB-/stable/A-3

19-APR- 2006

BB+/positive/B

2-FEB-2005

BB+/Stable/B

23-AUG-2004

BB/Positive/B

16-DEC-2003

BB/Stable/B

07-AUG-2001

BB/Negative/B

The upgrade “reflects the country’s strong economic prospects and external balance-sheet and its deep capital market, which supports a weak, but improving fiscal position,” said an S&P release. The sovereign rating now stands at BBB-/A-3 from BB+/B. The ‘stable’ outlook signifies that there is no threat to the present rating, but substantial improvements are required for a further upgrade.

It is a rebuff to skeptics who are yet to buy the India story.. The move will make it easier for Corporate India to raise cheaper loans in overseas money markets, pave the way for international funds who avoid investing in speculative grade and automatically lift the credit ratings of several Indian banks and financial institutions.

It is an acknowledgement of India’s improving macro-economic stability and strength. The concern over fiscal consolidation has waned. The growth rate is sustainable and though debt levels are high, revenue collections are good... Since India has had a volatile rating history, S&P possibly wanted to wait and make sure there is enough conviction behind the move.

Institutions, which now stand upgraded to investment grade, are SBI, ICICI Bank, IDBI, Bank of India, IOB and UTI Bank, Exim Bank, Power Finance Corp, and IRFC. All these institutions will be able to have wider choice of investors and consequently, cheaper foreign loans

What Grading means to India

  • Sentimental booster for the investors and borrowers of India
  • The announcement crystallizes the expectations built in by FIIs. It also opens the doors for a number of international funds, which by their charter are not allowed to participate in speculative grade investments. More foreign inflows of the market would drive the stock prices further up after more investments are expected to inflow into stock market.
  • Centre Government can tap overseas investors now. If it does for borrowing requirements, it will get better returns than what it has ever received.
  • Indian conservative funds like pension fund and provident fund – who has not invested in India’s debt instrument because of poor sovereign rating will now be able to invest. Better run state public organizations can get better investments from abroad.
  • Banks and institutions and companies can borrow with a competitive rate from the foreign instruments after the better rating.
  • Rupee value is expected to be appreciated with more investments

What lies ahead in the investment rating

Even with the upgrade, China, Malaysia and South Korea, Thailand, South Africa and Russia have higher ratings than India, while Mexico and a few East European countries are at the same level. However, India is a more sought-after destination due to its growth potential and the fact that it has the largest number of institutions whose ratings are constrained by the sovereign rating.

Feb 7, 2007

A different view on foreign direct investment (FDI)

Governments with over-optimistic expectations from foreign direct investment should be aware that it does not necessarily increase employment and can have negative effects on a fragile economy.

ONE of the myths that appears to be indestructible, despite growing evidence to the contrary, is that of the generally positive and desirable nature of foreign direct investment (FDI). It is certainly seen as being preferable to other forms of foreign capital inflow, such as commercial borrowing and portfolio investment. Furthermore, it is considered to be eminently advantageous in its own terms, and something to be actively sought by governments of developing countries. In fact, access to more FDI is now touted as one of the major benefits of the recent economic globalization, which is supposed to outweigh its many negative effects.In India, this perception has, if anything intensified in recent times.

Of course, one can quarrel with the Finance Minister's (false) notion that tax concessions will work to attract more FDI into a stagnating economy. But the more fundamental mistake is to assume that it is necessary to attract FDI in whatever form into the economy, and that this justifies tax and other concessions.

How little we actually know about even the extent of FDI, and especially stocks of FDI, in different countries? It emerges that official data - including those produced by the International Monetary Fund (IMF) and the World Bank - almost certainly underestimate to a substantial extent, the true value of inward FDI stocks and their absolute rate of increase. Far from trying to improve this state of affairs, the Fund and the Bank have promoted the liberalization of foreign investment regimes, which actually tends to reduce the availability of data and even the possibility of collecting it.

This matters not only because it is useful for a host country to know the exact stocks of inward FDI, but because inadequate assessment of their extent may lead to policy misjudgment and failure to anticipate potential crises.The lack of information on the extent of external liabilities contributed to the external debt crisis of the 1980s, and a similar process may be under way with respect to private investment today. Moreover, since FDI is not unambiguously positive, such lack of knowledge of the extent of inward FDI stocks can even be dangerous in other ways.

Consider, for example, the foreign exchange effects of FDI, which are often simplistically assumed to be positive. In actual fact, the foreign exchange effects are much more negative than what emerges from an idealised view of FDI.The positive effects arise only where new productive capacity is created in the export sector, or in very strongly import-substituting sectors. If FDI takes the form of purchase of existing capacity, even in the export sector it will have a negative foreign exchange effect even if export production goes up, unless the productivity of capital increases enough to offset the other increased foreign exchange costs. At lower levels of import substitution, the effects of "greenfield" FDI on new capacity are much more ambiguous, and may be negative.

Its misleading to assume that FDI necessarily contributes to increased employment. In fact, the employment effect will depend on a whole range of variables, including the balance between greenfield FDI and the purchase of existing assets; the labour intensity of new productive capacities or new organizational techniques; the extent to which FDI-based production substitutes for existing production and their relative labour intensities, and so on. In general, therefore, it is not the case that FDI creates much more net employment unless it is really very large in scale and heavily involved in greenfield activities, and even in such cases it need not be more employment-intensive.

Large-scale flows of FDI also have effects on other domestic economic policies. To begin with, reliance on such flows imposes severe constraints on domestic government policy because of the fear of withdrawal, and of course the potential impact of disinvestment increases as the FDI stock grows. Further, FDI is embodied in the presence of multinational corporations (MNCs) which tend to be large and powerful lobbies in the matter of domestic policies.

The very competition to attract more FDI by governments with over-optimistic expectations regarding such investment, means that all sorts of concessions are offered, which may turn out to be very expensive for the economy in the medium or long term. FDI promotion tends to focus heavily on the demand side, in terms of requirements imposed on host countries which involve changing their own policies in order to make themselves more attractive. Such unilateral concessions are increasingly sought to be entrenched through international agreements.

Much of the over-optimism surrounding foreign investment stems from a tendency to look at the host country in isolation from the developing world as a whole. But in fact there are strong negative spillover effects on other developing countries, which may outweigh whatever limited gains actually do accrue to the host country.

The 1990s boom in FDI to developing countries has the elements of a temporary surge similar to those affecting the market for equity (or portfolio) investment. While deregulation of foreign investment across the developing world has played a role, this has probably been less significant than the large-scale privatization programs, which have been a major source of both FDI and portfolio investment, and the debt-equity conversions, which were especially common in Latin America. Further, some flight capital may re-enter the country as FDI - some estimates suggest that this has been significant, for example, in China.

The globalization of production can be seen as a finite conversion process, albeit one which is more prolonged and complex. But it is important to note that all these features make FDI, along with portfolio investment, strongly pro-cyclical in nature.

FDI can contribute to the underlying fragility of an economy and make it more susceptible to balance of payments crises. First, as rapidly growing stocks of inward FDI generate similarly growing profits that form part of the foreign exchange outflow. Secondly, when FDI fuels an increase in imports, such as capital goods for investment projects and other such payments. Thirdly, because current foreign exchange costs of MNCs typically exceed the foreign exchange they tend to earn through exports of import substitution. Fourthly, through the role played by foreign affiliates, including those involved in retailing, in changing patterns of consumption through advertising and brand promotion.

FDI can contribute to large current account deficits, which tend to precede financial crises. They can also add to both the economic shocks preceding crises and to the process of contagion. Examples are of a number of East Asian economies and of Mexico prior to their respective financial crises. He does not mention Argentina, whose major crisis broke after this book was published, but it provides an even more classic example of his argument.

The "fire-sale" of domestic productive assets to foreign companies, which often accompanies attempts to come out of such financial crisis, may initially limit the reduction of FDI to the affected countries, as indeed happened in South Korea. But this occurs at a high long-term cost, in terms of the build-up of more FDI stock and further adverse balance of payments effects.

Once again, the case of Argentina over the past two decades provides a stark, if telling, example - indeed, it is almost as if this script were written for Argentina, in terms of the pattern of sale of public assets to foreign multinational companies in the early 1990s, followed by very adverse balance of payments effects which contributed in turn to the external debt build-up, which then precipitated the most recent crisis.

Conclusion

This more pessimistic - and more realistic - view of the impact of FDI provides a very different angle on the substantial and rapidly increasing stocks of inward FDI in a number of developing countries. Far from being a source of celebration, it may in fact be, as, "an accident waiting to happen". The latest round of crises in emerging markets has perversely operated to strengthen both the positive attitude to FDI and efforts to promote it. But in the new climate, in which developing country markets are seen as riskier and international investors are becoming more risk-averse, efforts to attract more FDI will involve even more concessions on the terms of such investment. The result will be to accelerate the build-up of liabilities without a commensurate effect on the now seriously limited capacity of national economies to bear them.

In fact, such a crisis appears to be almost inevitable, since any serious efforts to prevent it would require both a change in attitudes to foreign capital and a change in political structures. Only when governments represent the interests of their populations and both their business communities, and have (international) political influence proportional to the populations they represent, can we realistically expect to achieve an international financial and economic system which will genuinely serve the interests of people, and not of transnational companies.

Until then, it looks as if the world will have to brace itself for the next round of financial crises, this time probably emanating from the balance of payments problems caused by the current adulation of FDI. And we in India will have to bear with further concessions to multinational investment that may not be in our long-term interest, even if such investment does choose to come into the country.