This was presented by CA. Sudha G. Bhushan as a key note speaker in the national seminar on Foreign INvestment Flows in India organised by Lala Lajpat Rai Institute of Management.

1. Foreign Investment flows in India
By : CA. Sudha G. Bhushan
Presented in National Seminar of Lalalajpat Rai Institute of
Management
1/12/2013
This write up talks about the flow of Foreign Investment in India and the truths and myths relating to it.

2. Foreign Investment Flows to India
‘Investment’ is understood as financial contribution to the equity capital of an enterprise or purchase of
shares in the enterprise. ‘Foreign investment’ is investment in an enterprise by a Non-Resident
irrespective of whether this involves new equity capital or re-investment of earnings. Foreign
investment is of two kinds –
(i) Foreign Direct Investment (FDI) and
(ii) Foreign Portfolio Investment.
International Monetary Fund (IMF) and Organization for Economic Cooperation and
Development(OECD) define FDI similarly as a category of cross border investment made by a resident in
one economy (the direct investor) with the objective of establishing a ‘lasting interest’ in an enterprise
the direct investment enterprise) that is resident in an economy other than that of the direct investor.
The motivation of the direct investor is a strategic long term relationship with the direct investment
enterprise to ensure the significant degree of influence by the direct investor in the management of the
direct investment enterprise. Direct investment allows the direct investor to gain access to the direct
investment enterprise which it might otherwise be unable to do. The objectives of direct investment are
different from those of portfolio investment whereby investors do not generally expect to influence the
management of the enterprise.
In Indian context ‘FDI’ means investment by non-resident entity/person resident outside India in the
capital of the Indian company under Schedule 1 of FEM(Transfer or Issue of Security by a Person Resident
Outside India) Regulations 2000.
FDI constitutes three components; viz., equity; reinvested earnings; and other capital.
Reinvested earnings represent the difference between the profit of a foreign company and its
distributed dividend and thus represents undistributed dividend. Other capital refers to the
intercompany debt transactions of FDI entities
It is the policy of the Government of India to attract and promote productive FDI from nonresidents in
Regulatory Framework
Contributed by CA. Sudha G. Bhushan
activities which significantly contribute to industrialization and socio-economic development. FDI
supplements the domestic capital and technology.
Foreign Direct Investment by non-resident in resident entities through transfer or issue of security to
person resident outside India is a ‘Capital account transaction’ and Government of India and Reserve
Bank of India regulate this under the FEMA, 1999 and its various regulations. Keeping in view the
current requirements, the Government from time to time comes up with new regulations and

3. amendments/changes in the existing ones through order/allied rules, Press Notes, etc. The Department
of Industrial Policy and Promotion (DIPP), Ministry of Commerce & Industry, Government of India makes
policy pronouncements on FDI through Press Notes/ Press Releases which are notified by the Reserve
Bank of India as amendment to notification No. FEMA 20/2000-RB dated May 3, 2000. These
notifications take effect from the date of issue of Press Notes/ Press Releases. The procedural
instructions are issued by the Reserve Bank of India vide A.P.Dir. (series) Circulars. The regulatory
framework over a period of time thus consists of Acts, Regulations, Press Notes, Press Releases,
Clarifications, etc.
It is the intent and objective of the Indian Government to promote foreign direct investment through a
policy framework which is transparent, predictable, simple and clear and reduces regulatory burden.
The system of periodic consolidation and updation was therefore introduced as an investor friendly
measure.
Prior to 1991, the FDI policy framework in India was highly regulated. The government aimed at
exercising control over foreign exchange transactions. All dealings in foreign exchange were regulated
under the Foreign Exchange Regulation Act (FERA), 1973, the violation of which was a criminal offence.
Through this Act, the government tried to conserve foreign exchange resources for the economic
development of the nation. Consequently the investment process was plagued with many hurdles
including unethical practices that became part of bureaucratic procedures. Under the deregulated
regime, FERA was consolidated and amended to introduce the Foreign Exchange Management Act
(FEMA), 1999. The new Act was less stringent and aimed at improving the capital account management
of foreign exchange in India. The Act sought to facilitate external trade and payments and to promote
orderly development and maintenance of the foreign exchange market in India. It resulted in improved
access to foreign exchange.
Foreign Exchange Management Act, 1999 (“FEMA”) has come in force from 1st June, 2000 by replacing
Foreign Exchange Regulations Act (“FERA”). The main change that has been brought is that FEMA is a
civil law, whereas the FERA was a criminal law. FERA was popular for its draconian provisions. The shift
of FERA to FEMA was the shift of control of foreign exchange to regulation and promotion and orderly
development of Foreign exchange. FEMA is forward looking legislation which aims to facilitate foreign
trade.
FEMA aims to achieve self regulation instead of imposed restrictions. The rationale for strict regulations Contributed by CA. Sudha G. Bhushan
under FERA 1973 after Independence was that India was left with little forex reserves and during the
oil–crisis of seventies ballooning oil import bills further drained foreign exchange reserves.
Unsatisfactory reserves made it imperative to put in place stringent controls to conserve foreign
exchange and to utilise it in the best interest of the country.
Foreign Direct investment policy
As per the policy the investment can be made in India through two routes being Automatic route or
approval route. Under the automatic route the investment can be made without prior approval of
central government but in the case of approval route the prior approval of Central government is

4. required. India has among the most liberal and transparent policies on FDI among the emerging
economies. FDI up to 100% is allowed under the automatic route in all activities/sectors except the
following, which require prior approval of the Government:-
1. Sectors prohibited for FDI
2. Activities/items that require an industrial license
3. Proposals in which the foreign collaborator has an existing financial/technical collaboration in
India in the same field
4. Proposals for acquisitions of shares in an existing Indian company in financial service sector and
where Securities and Exchange Board of India (substantial acquisition of shares and takeovers)
regulations, 1997 is attracted)
5. All proposals falling outside notified sectoral policy/CAPS under sectors in which FDI is not
permitted
Most of the sectors fall under the automatic route for FDI. In these sectors, investment could be made
without approval of the central government. The sectors that are not in the automatic route, investment
requires prior approval of the Central Government. The approval in granted by Foreign Investment
Promotion Board (FIPB). In few sectors, FDI is not allowed.
Current Account Transactions and Capital account transactions
All transactions involving the foreign exchange are divided into two
• Current account transactions
• Capital account transactions
Getting FDI is capital account transaction. The two types have been described briefly below.
“current account transaction” means a transaction other than a capital account transaction and without
prejudice to the generality of the foregoing such transaction includes,—
(i) payments due in connection with foreign trade, other current business, services, and short-term
banking and credit facilities in the ordinary course of business,
(ii) payments due as interest on loans and as net income from investments,
Contributed by CA. Sudha G. Bhushan
(iii) remittances for living expenses of parents, spouse and children residing abroad, and
(iv) expenses in connection with foreign travel, education and medical care of parents, spouse and
children;
As per section 5 of FEMA
“Any person may sell or draw foreign exchange to or from an authorised person if such sale or drawal is
a current account transaction:
Provided that the Central Government may, in public interest and in consultation with the Reserve Bank,
impose such reasonable restrictions for current account transactions as may be prescribed. “

5. Capital account transactions
“capital account transaction” means a transaction which alters the assets or liabilities, including
contingent liabilities, outside India of persons resident in India or assets or liabilities in India of persons
resident outside India, and includes transactions referred to in sub-section (3) of section 6;
Introduction with Regulators
FDI policy in India is regulated by following regulators as indicated in the diagram below. Brief
description of ach authority is provided later on.
Regulators Under FEMA
Central Goverment Reserve Bank of India
Ministry of Commerce
Ministry of finance
and Industry
Department of Policy Department of
Department of Revenue
and Promotion Economic Affiars
Enforcement Foreign Investment
Directorate Promotion Board Contributed by CA. Sudha G. Bhushan
Reserve Bank of India
The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the
Reserve Bank of India Act, 1934.The Central Office of the Reserve Bank was initially established in
Calcutta but was permanently moved to Mumbai in 1937. The Central Office is where the Governor sits
and where policies are formulated. Has 22 regional offices, most of them in state capitals. Though

6. originally privately owned, since nationalisation in 1949, the Reserve Bank is fully owned by the
Government of India.
Preamble
The Preamble of the Reserve Bank of India describes the basic functions of the Reserve Bank as:
"...to regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary stability
in India and generally to operate the currency and credit system of the country to its advantage."
Department of Industrial Policy and Promotion
The Department of Industrial Policy & Promotion was established in 1995 and has been reconstituted in
the year 2000 with the merger of the Department of Industrial Development. Earlier separate Ministries
for Small Scale Industries & Agro and Rural Industries (SSI&A&RI) and Heavy Industries and Public
Enterprises (HI&PE) were created in October, 1999.
With progressive liberalisation of the Indian economy, initiated in July 1991, there has been a consistent
shift in the role and functions of this Department. From regulation and administration of the industrial
sector, the role of the Department has been transformed into facilitating investment and technology
flows and monitoring industrial development in the liberalised environment.
Foreign Investment promotion Board
The Foreign Investment Promotion Board (FIPB) is a government body that offers a single window
clearance for proposals on Foreign Direct Investment (FDI) in India that are not allowed access through
the automatic route. FIPB comprises of Secretaries drawn from different ministries with Secretary,
Department of Economic Affairs, MoF in the chair. This inter-ministerial body examines and discusses
proposals for foreign investments in the country for sectors with caps, sources and instruments that
require approval under the extant FDI Policy on a regular basis. The Minister of Finance, considers the
recommendations of the FIPB on proposals for foreign investment up to 1200 crore. Proposals
involving foreign investment of more than 1200 crore require the approval of the Cabinet Committee
on Economic Affairs (CCEA).
Enforcement Directorate
Contributed by CA. Sudha G. Bhushan
Central Government has established a Directorate of Enforcement for the purpose of enforcement of
Act [section 36].
Officers under Directorate of Enforcement are known as Officers of Enforcement. The officers shall
exercise the like powers which are conferred on the Income Tax authorities under the Income tax Act,
1961 [subject to such conditions and limitations as the central government may impose] [Section 37].
These officers can investigate the contraventions of FEMA.
The Role of Directorate of Enforcement is as under:

7.  To collect and develop intelligence relating to violation of the provisions of Foreign Exchange
Management Act.
 To conduct searches on suspected persons, conveyances and premises for seizing
incriminating materials (including Indian and foreign currencies involved).
 To enquire into and investigate suspected violations of provisions of the Foreign Exchange
Management Act.
 To adjudicate cases of violations of Foreign Exchange Management Act for levying penalties
and also for confiscating the amounts involved in contraventions;
 To realize the penalties imposed in departmental adjudication;
Secretariat for Industrial Assistance (SIA)
The Secretariat for Industrial Assistance (SIA) has been set up by the Government of India in the
Department of Industrial Policy and Promotion, Ministry of Commerce & Industry to provide a single-
window service 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 monitoring the implementation of projects. It also notifies all government
policy decisions relating to investment and technology, and collects and publishes monthly production
data for select industry groups.
Foreign Investment Implementation Authority FIIA
Foreign Investment Implementation Authority (FIIA) The Government of India has set up the Foreign
Investment Implementation Authority (FIIA) to facilitate quick translation of Foreign Direct Investment
(FDI) approvals into implementation, and to provide a pro-active one-stop after-care service to foreign
investors by helping them obtain necessary approvals, sort out operational problems and meet with
various government agencies to find solutions to their problems. The Secretariat for Industrial
Assistance (SIA) in the Department of Industrial Policy & Promotion (DIPP) functions as the Secretariat of
the FIIA.
Contributed by CA. Sudha G. Bhushan

8. Importance of Foreign Investments
As described above FDI is a source of finance to the country. It is usually preferred over other forms of
external finance because they are non-debt creating, non-volatile and their returns depend on the
performance of the projects financed by the investors. FDI also facilitates International trade and
transfer of knowledge, skills and technology. In a world of increased competition and rapid technological
change, their complimentary and catalytic role can be very valuable.
Further, FDI plays an important role in raising productivity growth in sectors in which investment has
taken place. In fact, sectors with a higher presence of foreign firms have lower dispersion of productivity
among firms, thus indicating that the spill-over effects had helped local firms to attain higher levels of
productivity growth
FDI helps in the transmission of capital and technology across home and host countries. Benefits from
FDI inflows are expected to be positive, although not automatic. A facilitating policy regime with
minimal interventions may be ideal to maximise the benefits of FDI inflows.
An important question that arises is whether FDI merely acts as filler between domestic savings and
investment or whether it serves other purposes as well. At the macro–level, FDI is a non-debt-creating
source of additional external finances. This might boost the overall output, employment and exports of
an economy. At the micro-level, the effects of FDI need to be analysed for changes that might occur at
the sector-level output, employment and forward and backward linkages with other sectors of the
economy. There are fears that foreign firms might displace domestic monopolies, and replace these with
foreign monopolies which may, in fact, create worse conditions for consumers. Thus, it is important to
have an efficient competition policy along with sector regulators in place.
Besides capital flows, FDI generates considerable benefits. These include employment generation, the
acquisition of new technology and knowledge, human capital development, contribution to
international trade integration, creation of a more competitive business environment and enhanced
local/domestic enterprise development, flows of ideas and global best practice standards and increased
tax revenues from corporate profits generated by FDI.
Besides being an important source for diffusion of technology and new ideas, FDI plays more of a
complementary role than of substitution for domestic investment. FDI tends to expand the local market,
attracting large domestic private investment. This “crowding in” effect creates additional employment in
Contributed by CA. Sudha G. Bhushan
the economy. Further, FDI has a strong relation with increased exports from host countries. FDI also
tends to improve the productive efficiency of resource allocation by facilitating the transfer of resources
across different sectors of the economy. Increased flow of capital raises capital intensity in production,
resulting in lower employment generation. However, a higher level of investment accelerates economic
growth, showing wider positive effects across the economy.
While the quantity of FDI is important, equally important is the quality of FDI. The major factors that
might provide growth impetus to the host economy include the extent of localisation of the output of
the foreign firm’s plant, its export orientation, the vintage of technology used, the research and
development (R&D) best suited for the host economy, employment generation, inclusion of the poor
and rural population in the resulting benefits, and productivity enhancement.

9. Capital formation is an important determinant of economic growth. While domestic investments add to
the capital stock in an economy, FDI plays a complementary role in overall capital formation and in filling
the gap between domestic savings and investment. At the macro-level, FDI is a non-debt-creating source
of additional external finances. The below chart shows the FDI flows in India.
FDI EQUITY INFLOWS (MONTH-WISE) DURING
THE FINANCIAL YEAR 2012-13
October, 2012
August, 2012
Amount of FDI inflows
June, 2012 (In Rs. Crore)
April, 2012
0 5,000 10,000 15,000 20,000 25,000 30,000
Spillover effect of FDI
Besides having direct benefits FDI also have spillover effects. The spillover effect of FDI can be
Horizontal or vertical. The top FDI receiving sectors, as per the DIPP 4-digit classification, have strong
backward and / or forward linkages with the economy. The sectors with strong backward and forward
linkages include construction; fuels; chemicals; and metallurgical industries. The sectors with strong
backward linkages include electrical equipment; drugs and pharmaceuticals; food processing; and
textiles. Services sectors, telecommunications, and consultancy services have strong forward linkages.
The backward and forward linkages provide for spillover effects of FDI.
When mutlinational Domestic firms may also
Horizontal
Vertical
entities enter into host benefit when they are
countries, the Domestic employed as suppliers or
firms are supposed/forced subcontractors to MNEs as
Contributed by CA. Sudha G. Bhushan
to increase their that helps them to expand
productivity by adopting output and achieve
the brand new economies of scale
technologies of MNEs.
There is both a positive competition effect from the presence of foreign firms and a positive
complementary effect due to backward linkages between domestic firms and foreign firms, where local
firms act as suppliers of raw materials to the foreign firms.

10. The level of positive spillover effects of FDI are also dependent on the how much the domestic firms are
Emerging Markets:
able to absorb the technology, systems etc. brought in by Transnational companies. The R&D effort of
domestic firms is found to be a critical factor in absorbing the positive spillovers from foreign firms both
as competitors and as suppliers.
It is known fact that during the past two decades there is shift in global attention to the emerging
markets., especially the BRICS Countries, I,e. Brazil, Russia, India, China and South Africa. The shift is
driven by their remarkable growth rates. Also, there have been significant changes in the growth models
of developing economies/emerging markets . Many of these economies, including India, have moved
away from inward-oriented import substitution policies to outward oriented and market-determined
export-oriented strategies. The skepticism about the role of FDI in reinforcing domestic growth has
given way to greater openness to FDI, with a view to supporting investment and productivity of the host
countries. While developing countries have started accepting FDI inflows with some caution the
developed countries have moved their investments to foreign locations, subject to safety and
profitability of their business operations in foreign lands. The markets are broadly divided into three
types as described below:
Frontier Emerging Developed
Markets Economies Markets
 Developed markets like U.S., Canada, France, Japan and Australia. It consists of the largest,
most industrialized economies. Their economic systems are well developed, they are politically
stable, and the rule of law is well entrenched. Developed markets are usually considered the
safest investment destinations, but their economic growth rates often trail those of countries in
an earlier stage of development. Investment analysis of developed markets usually concentrates
on the current economic and market cycles; political considerations are often a less important
consideration. Contributed by CA. Sudha G. Bhushan
 Emerging markets are the economies which experience rapid industrialization and demonstrate
extremely high levels of economic growth. This strong economic growth is attractive to
developed markets as for them it may translate into investment returns that are superior to
those that are available in developed markets. However, emerging markets are also riskier than
developed markets; there is often more political uncertainty in emerging markets, and their
economies may be more prone to excessive booms and busts. We have discussed the various
type of risk in emerging markets below. Many of the fastest growing economies in the world,
including China, India and Brazil, are considered emerging markets.
 Frontier markets are generally either smaller than traditional emerging markets, or are found in
countries that place restrictions on the ability of foreigners to invest. They are the "the next

11. wave" of investment destinations. Although frontier markets can be exceptionally risky and
often suffer from low levels of liquidity, they also offer the potential for above average returns
over time. Examples of frontier markets include Nigeria, Botswana and Kuwait.
FDI Policy and Institutional Framework in Select Countries
Year Objective Incentives Priority Sectors Unique
of features
Libera
lisation
China 1979 Transformation of Foreign joint ventures were provided with Agriculture, energy, Setting up of
traditional preferential tax treatment. Additional tax transportation, Special
agriculture, benefits to export-oriented joint ventures and telecommunications, Economic Zones
promotion of those employing advanced technology. basic raw materials, and
industrialization, Privileged access was provided to supplies of high-technology
infrastructure and water, electricity and transportation (paying industries.
export promotion. the same price as state-owned enterprises)
and to interest-free RMB loans.
Chile 1974 Technology Invariability of tax regime intended to All productive activities Does not use tax
transfer, export provide a stable tax horizon. and sectors of the incentives to
promotion and economy, except for a attract foreign
greater domestic few restrictions in areas investment.
competition. that include coastal
trade, air transport and
the mass media.
Korea 1998 Promotion of Businesses located in Foreign Investment Manufacturing and Loan-based
absorptive Zone enjoy full exemption of corporate services borrowing to an
capacity and income tax for five years from the year in FDI-based
indigenisation of which the initial profit is made and 50 percent development
foreign reduction for the subsequent two years. High- strategy till
technology tech foreign investments in the Free late1990s.
through reverse Economic Zones are eligible for the full
engineering at the exemption three years and 50 percent for the
outset of following two years. Cash grants to high-tech
industrialisation green field investment and R&D investment
while restricting subject to the government approval.
both FDI and
foreign licensing.
Malaysia 1980s Export promotion No specific tax incentives. Manufacturing and Malaysian
services. Industrial
Development
Authority was
recognised to be
one of the
effective
agencies in the
Asian region
Thailand 1977 Technology No specific tax incentives. The Thai Board of Manufacturing and -
transfer and Investment has carried out activities under the services Contributed by CA. Sudha G. Bhushan
export promotion three broad categories to promote FDI.
1. Image building to demonstrate how the
host country is an appropriate location for
FDI.
2. Investment generation by targeting
investors through various activities.
3. Servicing investors
Source : http://www.rbi.org.in/scripts/bs_viewcontent.aspx?Id=2513

12. Risk in investment in foreign markets especially emerging
Mere openness to FDI inflows may be a necessary but insufficient condition and the host economy
needs to provide a sufficiently enabling environment to attract foreign investors. It needs to create a
level playing field through developing an efficient, competitive and regulatory regime, such that both
domestic and foreign invested companies play a mutually reinforcing role within a healthy competitive
environment. Following types of risk are seen in the emerging markets:
 Political Risk
 Regulatory Risk
 Industry Risk
 Population Demographics Risk
 Economic Risk
Openness
Macroeconomic
Market Size
stability
Variables significant
in determining FDI
Exchange Rate
Governence
valuation
Clustering Effects
Contributed by CA. Sudha G. Bhushan
Vertical and Horizontal FDI
FDI in host country can come through different types. Investor may decide to replicate its process in
other countries or it may decide to produce different parts of production process internationally,

13. locating each stage of production in the country where it can be done at the least cost. Broadly FDI can
be divided into two as mentioned below:
• Vertical FDI: It takes place when the multinational fragments the production process
internationally, locating each stage of production in the country where it can be done at the
least cost.
• Horizontal FDI: - occurs when the multinational undertakes the same production activities in
multiple countries.
In other words, A vertical pattern arises when the multinational firm fragments the production process
internationally, locating each stage of production in the country where it can be done at the least cost. A
horizontal pattern occurs when the multinational produces the same product or service in multiple
countries. Vertical FDI may compress the skilled-nonskilled wage differential across countries as well as
change the income distribution within countries. Horizontal FDI may increase income in each country
with minor distributive impact.
Horizontal FDI is considered to be more beneficial for host country as it transfers the whole production
cycle to the host company. Also , vertical FDI is risky for the investor if it is completely dependent on the
investment in other country for completing its production cycle.
Horizontal production also entails lower exposure to sovereign risk than does a vertical production
structure. Suppose that the host country reverses its attitude towards multinationals and tries to force
the multinational to renegotiate policies by threatening nationalization, production disruptions or
similar actions. Hence, predatory behavior by the host country is more costly to the multinational
engaged in vertical FDI.
Global Competitiveness of India’s FDI*
Another method of assessing the investment potential of an economy is its rank on global
competitiveness.5 The Global Competitiveness Index (GCI) is a comprehensive index developed
by the World Economic Forum (WEF) to measure national competitiveness and is published in
the Global Competitiveness Report (GCR). It takes into account the micro- and macro-economic
foundations of national competitiveness, in which competitiveness is defined as the set of
Contributed by CA. Sudha G. Bhushan
institutions, policies and factors that determine the level of productivity6 of a country and
involves static and dynamic components. The overall GCI is the weighted average of three
major components:
a) basic requirements (BR)7;
b)efficiency enhancers (EE); and
c) innovations and sophistication factors (ISF).
Within the information available for 131 countries, the United States is ranked the highest, with
an overall index of 5.67, and Chad is ranked the lowest with an overall index of 2.78; the overall
index is 107 for Bangladesh, 92 for Pakistan and 70 for Sri Lanka. The overall rank of India at 48
is still below that of China at 35. In terms of the components, India holds a relatively low rank

14. for BR (74), but higher ranks for EE (31) and even higher for ISF (26). Compared to China, India’s
Types of Foreign Investment in India
BR rank is lower, but it is higher than China’s on EE and ISF.
*Source : Study by National Council of Applied Economic Research
The choice of entry mode is considered a strategic decision by the foreign investor. The key
driving forces in such decisions depend on the investor’s interest in seeking resources, markets,
and efficiency or strategic asset ownership in the host country. While the major motive of any
investment is profit, a firm may opt for a particular entry strategy best suited to its short- or
long-term interests.
The entry modes in India are as follows :
Foreign Institutional Foreign Direct Foreign Venture Capital Qualified Foreign
Investors (FIIs) / sub- Investment (FDI) Investments (FVCI) Investors (NEW)
account
Portfolio Investment Strategic investments Long term investment in New Investment Route
identified ventures
Investment in Equity, Routes:Automatic or SEBI Registration: Investment: Equity, Mutual
Debt, F&O FIPB Approval Required but perpetual Fund, Corporate Debt
SEBI Registration: Investments: Private Subscription to IPO: SEBI Registration: Not Required
Required but perpetual placements of listed / Permitted as per limits
unlisted equity, CCDs (QIB status)
Trade listed securities: Permitted Trades: No Permitted Trades: No Trade listed securities: Stock
Registered Brokers secondary market secondary market Exchanges
purchases purchases Contributed by CA. Sudha G. Bhushan
Foreign direct investment (FDI) constitutes three components; viz., equity; reinvested earnings;
and other capital. Equity FDI is further sub-divided into two components, viz., greenfield
investment; and acquisition of shares, also known as mergers and acquisitions (M&A). FDI may
come through Joint ventures (merger and acquisition (M&As)) and wholly owned subsidiaries.
Wholly owned subsidiary is also referred as Greenfield Investment.

15. While these two modes of entry for direct investment are generally considered to be
alternatives, there may be situations where only M&As appear to be the realistic option. For
instance, in the absence of any domestic buyers for a large firm that has been declared sick, a
cross-border M&A is viable option.
Opening of wholly owned subsidiary by foreign entity is more useful to developing countries. As
it is more likely to furnish the host country with financial assets, technology and skill resources,
Foreign Direct Investment: Myths
enhance productive capacity and generate additional employment.
In all the Euphoria about the increasing FDI in India, we should not forget to look into look into
few facts keenly
 The purpose of investment in genuinely to earn profits or is the entity created just to
earn some tax benefits.
 Money coming from other countries is the clean and genuine or it is the black money
which is coming in the country through FDI mode?
 Is it creating any political threat to the country.
 India being a country where savings are more than spending do we need FDI or can we make the
internal systems stronger to generate the liquidity required by our corporations?
 Are Indian Brands dying away? Contributed by CA. Sudha G. Bhushan
We have discussed few of these issues in detail below:
Shifting of profits from high tax jurisdiction to low tax jurisdiction
Differing tax rates in different tax jurisdictions provide avenues to corporations to shift taxable
income from jurisdictions with relatively high tax rates to jurisdictions with relatively low tax
rates as a means of minimising their tax liability. As a matter of fact more than 60 per cent of
global trade is carried out between associated enterprises of multinational enterprises (MNEs).

16. Allocation of costs and overheads and fixing of price of product/services are highly subjective,
MNEs enjoy considerable discretion in allocating costs and prices to particular
products/services and geographical jurisdictions. Such discretion enables them to transfer
profit/income to no tax or low tax jurisdictions. For example, a foreign parent company could
use internal ‘transfer prices’ for overstating the value of goods and services that it exports to its
foreign affiliate in order to shift taxable income from the operations of the affiliate in a high tax
jurisdiction to its operations in a low-tax jurisdiction.
Use of participatory Notes
Participatory notes are instruments used for making investments in the stock markets. However,
they are not used within the country. They are used outside India for making investments in
shares listed in the Indian stock market. Foreign institutional investors (FIIs) and their sub-
accounts mostly use these instruments for facilitating the participation of their overseas clients,
who are not interested in participating directly in the Indian stock market. Investment in the
Indian Stock Market through PNs is way in which the black money generated by Indians is re-
invested in India. The investor in PNs does not hold the Indian securities in her/his own name.
These are legally held by the FIIs, but s/he derives economic benefits from fluctuation in prices
of the Indian securities, as also dividends and capital gains, through specifically designed
contracts. Thus, through the instrument of PNs, investment can be made in the Indian securities
market by those investors who do not wish to be regulated by Indian regulators due to a variety
of reasons. It is possible to hide the identity of the ultimate beneficiaries through multiple layers.
The ultimate beneficiaries/investors through the PN Route can be Indians and the source of their
investment may be black money generated by them.
Investment in NGO
Foreign Contribution for Charitable purposes is regulated through the Foreign Contribution
Regulation Act. However, how much of these contributions are genuine is not known. As per
the search of non-government organisations (NGOs), and associations receiving foreign
contributions more than 70% of the funds goes in acquisition of immovable property. They are Contributed by CA. Sudha G. Bhushan
required to file an annual return to the Ministry of Home Affairs in Form FC-3. In the said form,
only the name and address of the foreign donors are mentioned, with no further details of the
beneficial owners. It is possible that in many such cases, the black money generated by Indians
is being routed back to India.
Flouting of FDI policy
The FDI policy of government is based on the sectoral needs and Department of policy and
promotion decides the levels of FDI to be allowed in any sector based on the need of the sector

17. and the based on the maturity. Those sector which are of national importance or where it is
considered that the sector need more time to mature or there is no benefit that can be derived
from FDI in the sector are not opened. Entries in these sectors is either prohibited or is subject
to restrictions. Few companies however, have been able to flout the FDI policy and come with
complex structure. One of such sector recently is FDI in E-Commerce. Retail trading. , in any
form, by means of e-commerce, is not permissible for companies with FDI, engaged in the
activity of multi-brand retail trading. A wholesale/cash & carry trader cannot open retail shops
to sell to the consumer directly. , says the Department of Industrial Policy and Promotion’s
(DIPP) ‘Consolidated FDI Policy’ document dated 10 April 2012. That’s the law. The reality is,
every foreign-funded e-tailer goes around it using the two-company route.
Round tripping of money
One of the other key factor is whether the money which is coming from outside India is Indian money
(black) routed through different routes to India. The illicit money transferred outside India may
come back to India through various methods such as hawala, mispricing, foreign direct
investment (FDI) through beneficial tax jurisdictions, raising of capital by Indian companies
through global depository receipts (GDRs), and investment in Indian stock markets through
participatory notes.
As per data by the Department of Industrial Policy and Promotion (DIPP), from April 2000 to
March 2011 FDI from Mauritius is 41.80 per cent of the entire FDI received by India. The two
topmost sources of the cumulative inflows from April 2000 to March 2011 are Mauritius (41.80
per cent) and Singapore (9.17 per cent) (refer the chart below). Mauritius and Singapore with
their small economies cannot be the sources of such huge investments and it is apparent that
the investments are routed through these jurisdictions for avoidance of taxes and/or for
concealing the identities from the revenue authorities of the ultimate investors, many of whom
could actually be Indian residents, who have invested in their own companies, though a process
known as round tripping.
A large number of foreign institutional investors (FIIs) who trade on the Indian stock markets Contributed by CA. Sudha G. Bhushan
operate from Mauritius. According to the Double Taxation Avoidance Agreement (DTAA)
between India and Mauritius, capital gains arising from the sale of shares are taxable in the
country of residence of the shareholder and not in the country of residence of the company
whose shares have been sold.
Therefore, a Company resident in Mauritius selling shares of an Indian company will not pay tax
in India. Since there is no capital gains tax in Mauritius, the gain will escape tax altogether.
Further, the treaty does not include a limitation of benefit (LOB) clause, which is like a “look
through” provision in tax treaties to ensure that only residents of treaty countries who are
beneficiaries avail such benefits.

18. SHARE OF TOP INVESTING COUNTRIES FDI 1 MAURITIUS
2 SINGAPORE
EQUITY INFLOWS 2012-13(April–Oct.) 3 U.K.
4 JAPAN
5 U.S.A.
6 NETHERLANDS
7 CYPRUS
8 GERMANY
9 FRANCE
10 U.A.E.
Investment by SWF
A sovereign wealth fund (SWF) is a state-owned investment fund composed of financial assets
such as stocks, bonds, property, precious metals or other financial instruments. Sovereign
wealth funds invest globally. There is an increase in investment by SWF in Indian economy. SWF
being the state owned investment may raise political issues. There have been investment from
Singapore, Russian funds etc. Although, the matter is already overly debated in developed
Conclusion
countries yet a keen watch is required.
India is one of the most desired global investment destinations because of the growth rate it
had been able to sustain in the last decade. The foreign investment is welcome and promoted.
The Government is taking active steps in liberalizing the regulations for making them more
investor friendly. Recent decision of government to open multi brand retail, civil aviation for
foreign participation is example for this. FDI not only provide the much required liquidity to the
Contributed by CA. Sudha G. Bhushan
industry also it provides technology up gradation. However, as we move towards fuller account
convertibility the internal systems should be strong and self-sustaining so as to avoid any crisis
like Asian Crisis of 1997. The proper check and balances have to be in place.