Solution Manual for Financial Accounting, 11th Edition by Robert Libby, Patri...
Foreign direct investment
1. Foreign Direct Investment:-
Foreign direct investment (FDI) or foreign investment refers to the net inflows of
investment to acquire a lasting management interest in an enterprise(long term) operating in
an economy other than that of the investor. It is the sum of equity capital, other long-term
capital, and short-term capital as shown in the balance of payments. It usually involves
participation in management, joint-venture, transfer of technology, expertise, building
factories & infrastructure in the capital importing country. FDI excludes investment through
purchase of shares.
Forms of Foreign Direct Investment:-
FDI can takes place broadly in three forms:-
Greenfield Investment:- Greenfield investment can be made through opening of
branch in a host country or through making investment in the equity capital of
the host country firm. It is also known as financial collaboration. If the parent
holds the entire equity of the host country firm, the later is called a wholly-
owned subsidy of the parent. If it a more than half, it is known as subsidiary.
Merger & Acquisitions:- Merger & Acquisition are either outright purchase of a
running company abroad or an amalgamation with a running foreign company.
While in the former, the acquiring company maintains its existence & the target
company loses its existence; in the later, both lose their existence in favor of a
new company. M&A are either horizontal or vertical or conglomerate. Horizontal
M&A are found in cases where two or more firms engaged in similar line of
activities combine. On the contrary, vertical M&A occurs among firms involved in
different stages of production of a single final product.
Brownfield Investment:- It is a combination of Greenfield investment & Merger
& Acquisition. It exists when a company first goes for an international M&A &
then makes huge investment for replacing plant & machinery in the target
company.
Types of Foreign Direct Investment:-
Inward Foreign Direct Investment:- The economy in which the investment is
made(inflow).
Outward Foreign Direct Investment:- It refers to the transfer of capital from an host
nation to another country(Outflow).
2. FDI may be done in the following ways:-
an individual
a group of related individuals
an incorporated or un incorporated company
a public company or private company
a group of related enterprises
a government body
Origination And Evolution of Foreign Direct Investment in India:-
The origination of foreign companies started in India during the British rule, The East
India Company being the first company as such. Many more companies came into existence
during that period which continued their operation after the Independence as well. During the
tenure of Jawaharlal Nehru to Rajiv Gandhi government many MNCs came amongst which
some has to face the anti – MNCs feeling of the Indian consumers. Driven by the Nehru’s desire
for a planned economy within a socialist climate (since 1951), rigorous regulation were
implemented since 1991 in order to achieve self reliance, eradicate poverty, promote the
development of indigenous technology & protect the local private sector & small firms.
The foreign exchange crisis of 1980 – a consequence of the second oil shock – obliged
Indira Gandhi’s government to seek a loan from the International Monetary Fund. Some of
these loan conditions called for certain local reforms. De facto changes were announced, such
as the extension of the number of delicensed categories in the industrial area and the
encouragement of joint ventures (such as Maruti Suzuki for instance, in 1984). After Indira
Gandhi’s assassination, her son Rajiv Gandhi implemented new deregulation measures. More
export and import licenses were liberalized, credit facilities were encouraged and the tax policy
streamlined. The first results of these reforms were positive: between 1980 and 1991, the
average GDP growth reached 5.6% with 3.4% for the Primary sector, 7% for the Secondary and
6.7% for the Tertiary. However, the improvement of the economic situation and the decline of
poverty and self-sufficiency that were reached – thanks to the effect of the Green Revolution –
only served to mask the limits of Indian growth and of its model of development. As a result of
the isolationist policy, the trade deficit, which was below 1% of GDP in the 1960s, swiftly
increased and led to a current account deficit of 9% in 1986-87. In 1988, India became the
biggest debtor in all Asia, with a total debt of nearly US$ 60 billon. Thus, the budgetary drift
could not be curbed by economic growth, and the impact of the new measures was not
sufficient to correct these imbalances mainly because of low FDI levels, among other reasons.
3. The trade deficit in 1990 reached US$9.44 billion and the current account deficit was
US$9.7 billion. With below US$1 billion of foreign exchange reserves, the first measures of
change implemented in the 1980s became the credo of the new elected government of
Narasimha Rao. Led by his Finance Minister, Manmohan Singh (Prime Minister since 2004), they
agreed new policies. The first significant measure was the dismantling of the Licence Raj with
the exception of only six industries (tobacco, alcoholic beverages, industrial explosives,
chemicals, drugs and pharmaceuticals, electronic, space and defense equipment). Additionally,
the number of reserved items for the Small Scale Industries (SSI) was reduced. The second
measure linked to the Balance of Payment crisis was to improve the trade balance by a revision
of the exchange-rate policy. In 1991, the country still had a fixed exchange-rate system where
the rupee was linked to a basket of its major trading partners’ currencies. Consequently, the
rupee was devalued by 20%. The last major set of measures concerned the custom tariffs.
Tariffs were lowered from 150% before 1991 on average, to 30% in 1997. This new
international orientation also allowed a move from an import substitution policy to export
promotion, and gave foreign trading firms the opportunity to invest up to 49 or even 51% (and
even more depending on the sectors) in a joint venture. At the same time, the approval process
became much simpler and more systematic.
Sectors in which FDI is allowed in India:-
Hotel & Tourism:-
100% FDI is permissible in the sector of Hotel & Tourism.
The term hotels include restaurants, beach resorts, and other tourist complexes providing
accommodation and/or catering and food facilities to tourists. Tourism related industry include
travel agencies, tour operating agencies and tourist transport operating agencies, units providing
facilities for cultural, adventure and wild life experience to tourists, surface, air and water
transport facilities to tourists, leisure, entertainment, amusement, sports, and health units for
tourists and Convention/Seminar units and organizations.
Terms & Conditions
up to 3% of the capital cost of the project is proposed to be paid for technical and
consultancy services including fees for architects, design, supervision, etc.
up to 3% of net turnover is payable for franchising and marketing/publicity
support fee, and up to 10% of gross operating profit is payable for management
fee, including incentive fee.
4. Non – Banking Financial Companies:-
49% FDI is allowed from all sources on the automatic route subject to guidelines issued
by RBI from time to time. The NBFC activities include:-
Merchant Banking
Underwriting
Portfolio Management Services
Investment Advisory Services
Financial Consultancy
Stock Broking
Asset Management
Venture Capital
Custodial Services
Factoring
Credit Reference Agencies
Credit Rating Agencies
Leasing & Finance
Housing Finance
Foreign Exchange Brokering
Credit Card Business
Money Changing Business
Micro Credit
Rural Credit
Terms & Conditions:-
Minimum Capitalization Norms for fund based NBFCs:
For FDI up to 51% - US$ 0.5 million to be brought upfront.
For FDI above 51% and up to 75% - US $ 5 million to be brought upfront.
For FDI above 75% and up to 100% - US $ 50 million out of which US $ 7.5
million to be brought upfront and the balance in 24 months.
Minimum capitalization norms for non-fund based activities:
Minimum capitalization norm of US $ 0.5 million is applicable in respect of all
permitted non-fund based NBFCs with foreign investment.
5. Insurance Sector:-
FDI up to 26% is allowed in insurance sector subject to obtaining license from Insurance
Regulatory & Development Authority.
Telecommunication Sector:-
In basic, cellular, value added service & global mobile personal communications by
satellite, FDI is limited to 49% subject to licensing and security requirements and adherence by
the companies.
FDI up to 100% is allowed for the following activities in the telecom sector:-
ISPs not providing gateways (both for satellite and submarine cables)
Infrastructure Providers providing dark fiber.
Electronic Mail and
Voice Mail
Terms & Conditions:-
FDI up to 100% is allowed subject to the condition that such companies would
divest 26% of their equity in favor of Indian public in 5 years, if these companies
are listed in other parts of the world.
The above services would be subject to licensing and security requirements,
wherever required.
Trading Sector:-
Trading is permitted under automatic route with FDI up to 51% provided it is primarily
export activities, and the undertaking is an export house/trading house/super trading house/star
trading house. However, under the FIPB route.
100% FDI is permitted in case of trading companies for the following activities:
exports;
bulk imports with ex-port/ex-bonded warehouse sales;
cash and carry wholesale trading;
other import of goods or services provided at least 75% is for procurement and sale of
goods and services among the companies of the same group and not for third party use or
onward transfer/distribution/sales.
6. FDI up to 100% permitted for e-commerce activities subject to the condition that such
companies would divest 26% of their equity in favor of the Indian public in five years, if these
companies are listed in other parts of the world. Such companies would engage only in business
to business (B2B) e-commerce and not in retail trading.
Power Sector:-
Up to 100% FDI allowed in respect of projects relating to electricity generation,
transmission and distribution, other than atomic reactor power plants. There is no limit on the
project cost and quantum of foreign direct investment.
Drugs & Pharmaceutical Sector:-
FDI up to 100% is permitted on the automatic route for manufacture of drugs and
pharmaceutical, provided the activity does not attract compulsory licensing or involve use of
recombinant DNA technology, and specific cell / tissue targeted formulations.
FDI proposals for the manufacture of licensable drugs and pharmaceuticals and bulk drugs
produced by recombinant DNA technology, and specific cell / tissue targeted formulations will
require prior Government approval.
Roads, Highways, Ports & Harbors:-
FDI up to 100% under automatic route is permitted in projects for construction and
maintenance of roads, highways, vehicular bridges, toll roads, vehicular tunnels, ports and
harbors.
Pollution Control & Management:-
FDI up to 100% in both manufacture of pollution control equipment and consultancy for
integration of pollution control systems is permitted on the automatic route.
7. Call Centers in India:-
FDI up to 100% is allowed subject to certain conditions.
Business Process Outsourcing In India:-
FDI up to 100% is allowed subject to certain conditions.
FDI inflows during 2009 – 2010 (Billions of Dollars)
8. Balance of Payment position of India (2007 – 2011) (amount in billion)
5000
4279
4000
2833
3000
2440
2000
Current A/C
1000
290 Capital A/C
0
2007-08 2008-09 2009-10 2010-11
-1000 -635
-1276
-2000
-1797
-2101
-3000
What is retailing?
Retailing is a distribution channel function, where one organization buys products from
supplying firms or manufactures produces themselves, and then sells these directly to
consumers.
In majority of retail situations, the organization, from whom a consumer buys, is a reseller of
products obtained from others, and not the product manufacturer. However, some
manufacturers do operate their own retail outlets in a corporate channel arrangement.
Retailers offer many benefits to suppliers and customers as resellers. Consumers, for instance,
are able to purchase small quantities of an assortment of products at a reasonably affordable
price. Similarly, suppliers get an opportunity to reach their target market, build product
demand through retail promotions, and provide consumer feedback to the product marketer.
An Overview Of The Indian Retail Sector
The origins of retailing in India can be traced back to the emergence of Kirana stores and mom-
and-pop stores. These stores used to cater to the local people. Eventually the government
supported the rural retail and many indigenous franchise stores came up with the help of Khadi
& Village Industries Commission. The economy began to open up in the 1980s resulting in the
change of retailing. The first few companies to come up with retail chains were in textile sector,
9. for example, Bombay Dyeing, S Kumar's, Raymonds, etc. Later Titan launched retail showrooms
in the organized retail sector. With the passage of time new entrants moved on from
manufacturing to pure retailing.
Retail outlets such as Foodworld in FMCG, Planet M and Musicworld in Music, Crossword in
books entered the market before 1995. Shopping malls emerged in the urban areas giving a
world-class experience to the customers. Eventually hypermarkets and supermarkets emerged.
The evolution of the sector includes the continuous improvement in the supply chain
management, distribution channels, technology, back-end operations, etc. this would finally lead
to more of consolidation, mergers and acquisitions and huge investments.
Phases in the evolution of retail sector
Weekly markets, Village & Rural melas
(Source of entertainment & commercial
exchange)
Convenience Shops, Mom & Pop & Kirana shops
(Rapid urbanization, easy availability, time
constraint)
PDS outlets, Khadi stores, co-operatives
(Government supported, low cost availability &
distribution)
Exclusive brand outlets, hypermarkets & supermarkets, department stores & shopping malls
(Modern format, organized under one roof)
10. Percentage of organized retail across the world as per Dec. 2010
The Indian retail industry is divided into organized & unorganized sector. Organized retailing
refers to trading activities undertaken by licensed retailers, that is those who are registered for
sales tax, income tax etc. These include the corporate backed hypermarkets & retail chains &
also the privately owned large retail businesses. Unorganized retiling on the other hand, refers
to traditional formats of low cost retailing, for example the local kirana shops, general stores,
convenience stores etc.
India’s retail sector is wearing new clothes with a compounded annual growth rate of 46.64% &
is the fastest growing sector in the Indian economy. Traditional markets are making new way
for new formats such as departmental stores, hypermarkets, supermarkets & specialty stores.
Western style malls began increasing in metros & second – rung cities alike giving the consumer
a unparallel shopping experience.
The last few years witnessed immense growth by this sector, the key drivers being changing
consumer profile & demographics, increase in the number of international brands available in
the Indian market, economic implication of the government increasing urbanization, credit
availability, improvement in the infrastructure, increasing investment in the technology & real
estate building a world class shopping environment for the consumers. In order to keep pace
with the increasing demand, there has been a hectic activity in terms of entry of international
labels, expansion plans & focus on technology, operations & processes.
11. Challenges in the Organized Retail Sector:-
Changing Habit:- The behavior pattern of the Indian consumer has undergone a major
change. This have happened for the Indian consumer is earning more now, western
influences, women working force is increasing, desire for luxury items and better
quality. One now wants to eat, shop, and get entertained under the same roof. All these
have lead the Indian organized retail sector to give more in order to satisfy the Indian
customer.
Lack of Retail Space:- The biggest challenge facing the Indian organized retail sector is
the lack of retail space. With real estate prices escalating due to increase in demand
from the Indian organized retail sector, it is posing a challenge to its growth. With Indian
retailers having to shell out more for retail space it is effecting there overall profitability
in retail.
Lack of Skilled Manpower:- Trained manpower shortage is a challenge facing the
organized retail sector in India. The Indian retailers have difficultly in finding trained
person and also have to pay more in order to retain them. This again brings down the
Indian retailers profit levels.
Cash Stripped:- Most of the Indian Retail majors such as Reliance, Future Group, Adani
Group are facing the cash stripped situation and are under the burden of huge debt
which decreases their operational efficiency.
Parasitic Middlemen:- The middlemen are the connecting link between the original
producer & the big retailers and are an important component in the supply chain. But,
the middlemen are procuring goods from the producer by paying them lesser amount
and thus acts as parasites.
Lack of Infrastructure & Storage facility:- Lack of infrastructure & storage facility adds
to lower productivity for the country. India is the largest producer of agricultural
product and at the same time the largest wastages of food product is also made in India.
Wastages does not mean that the agricultural products cannot be consumed, it is the
dietary value that gets reduced.
Main Proposals Of The Government FDI Push:-
Will Enable Walmart, Tesco & Carrefour to set up deep discount Stores in India
About half of the FDI should be made in back-hand infrastructure such as ware –
housing.
The minimum FDI in any multi – brand retail project should be Rs. 450 crore.
State governments can prohibit FDI in retail if they wish to.
Stores can be set up in cities with a population of at least 1 million.
12. At least one third of sales should be made to small retailers.
At least 30% of sales should be made to small retailers either directly or through
wholesale units set up for this purpose.
State will be empowered to put conditions for integrating small retailers & kirana
merchants in the value chain.
At least 30% of the value manufactured items procured should be sourced from small &
medium enterprises.
States will be empowered to set up framework for monitoring compliance with these
conditions.
Protectionists Moves:-
The opposition feels that the Indian market will be flooded by Chinese product since
multi – nationals like Wal-Mart buy from places where the goods are available at
cheaper rate & India would end up producing a generations of sales girls & boys.
The farmer’s group pointed that since the big retailers have the bargaining power &
would result in lower share of value to them, dictating of the production techniques and
output by the larger retailers and destruction of diversity in Indian agriculture.
It can led to price manipulations & total lack of level playing field.
The small traders feel that they cannot withstand the competition from the MNCs since
they can procure products at low cost & can sell them at a cheaper rate which the small
traders cannot.
Wal-Mart has a disastrous impact on small shopkeepers & neighborhood communities
in America and called Indians to learn from them and not to allow Wal-Mart to operate
in India.
Recommendations:-
Should strengthen the manufacturing sector in order to produce goods at cheaper cost
which can force the big MNCs to procure goods from India.
Development of the small, micro & medium scale enterprise so as to provide them a
level playing field in the international arena as well as increasing their bargaining power
to a level of the big MNCs.
Development of the Export Promotion Councils so as to make our Current Account
surplus because more the Capital Account Convertibility more it leads to loss of
ownership.