India’s FDI Trends and Analysis

April 8, 2011 Posted by India Briefing Reading Time: 6 minutes

Apr. 8 – India has emerged as the preferred destination for many foreign international enterprises due to constructive factors such as high economic growth, fast population growth, English speaking people, and lower costs for workers.

Location determinants of foreign direct investment
Location-specific rewards are further classified by three types of FDI motives.

Market-seeking investment is undertaken to uphold existing markets or to exploit new markets. For example, due to tariffs and other forms of barriers, the firm has to relocate production to the host country where it had previously served by exporting
When firms invest abroad to obtain resources not available in the home country, the investment is called resource- or asset-seeking. Resources may be natural resources, raw materials, or low-cost inputs such as labor
The investment is streamlined or efficiency-seeking when the firm can gain from the general governance of organically dispersed activities in the presence of economies of scale and scope

The host country factors or fundamentals can be grouped in two categories: the first group comprises of natural resources, most kinds of labor, and proximity to markets. The second group include of a range of environmental variables that act as a function of political, economic, legal, and infra-structural factors of a host country.

India’s inward investment rule went through a series of changes since economic reforms were escorted in two decades back. The expectation of the policy-makers was that an “investor friendly” command will help India establish itself as a preferred destination of foreign investors. These expectations remained largely unfulfilled despite the consistent attempts by the policy makers to increase the attractiveness of India by further changes in policies that included opening up of individual sectors, raising the hitherto existing caps on foreign holding and improving investment procedures. But after 2005‐06, official statistics started reporting steep increases in FDI inflows. Portfolio investors and round-tripping investments have been important contributors to India’s reported FDI inflows thus blurring the distinction between direct and portfolio investors on one hand and foreign and domestic investors on the other. These investors were also the ones which have exploited the tax haven route most.

Inward investments have been constantly rising since the sharp drop witnessed in 2009, following the global financial crisis. Hiccups apart, foreign investors see huge long-term growth potential in the country. As much as 75 percent of global businesses already present in the country are looking to considerably expand their operations going forward according to the Indian attractive survey by Ernst & Young. This also confirms that India is undergoing a changeover, both in terms of investor perception of its market potential, and in reality.

With GDP growth anticipated to surpass 8 percent yearly and the number of people in the Indian middle class set to triple over the next 15 years, with an equivalent impact on disposable income, domestic demand is expected to grow exponentially. India’s young demographic profile also helps it in providing an increasingly well-educated and cost-competitive labor force. These factors put India in a good position to attract an increasing proportion of global FDI.

As project numbers and jobs created are still some way off highs reached in 2008, which saw 971 projects, the trend over the last decade has shown a steady, if not dramatic, upward movement. Generally project numbers in 2010 were up 60 percent over 2003 and the number of jobs created up 30 percent.
The strong domestic market enabled India to deliver a flexible performance during the global economic slowdown. India today is rising as a manufacturing destination, both for the domestic and global markets. As business leaders battle for growth in the new economy, there is a sense of urgency among leading players to grab the prospects offered by the Indian market.

With the liberty of the simplified compendium on foreign direct investment, numerous processes on FDI and associated routes of investment too are being ratified with a view to speed up the process of inflows into India.

The out of the country Indian investors too would find it simpler to entry nodal bodies and invest in India. Though, a note of caution – the Reserve Bank of India too is attempting to legalize certain sections in Foreign Exchange Management Act (FEMA) which also allow NRIs, routes to invest in India. Its argument is that NRIs tend to invest much more than the cap allowed in the sectors through these other routes, thereby exceeding allowed limits for FDI. The government may also remove the liberties provided to NRIs in sectors such as aviation, real estate etc.

More reforms to make investing in India a simpler process, such as FDI in multi-brand retail, defense production, and agriculture, are in the discussion stage and the government intends to bring out tangible policies in this direction. Proposals can also be sent to DIPP online. This facility will allow all abroad investors to speed up their investment proposals.

Tax incentives to SEZ developers

Income tax

Deduction from profits and gains from export of goods/services as follows (Section 10AA)
100 percent income tax exemption for first five years
50 percent income tax exemption for next five years
Income tax exemption for next five years to the extent of profits
Reinvested (maximum 50 percent)
Capital gains tax exemption on relocation to SEZ (Section 54GA): This is a controversial issue as to be eligible for income tax exemption; the unit should be a new unit. Further, a press statement from Hon. Minister for Commerce and Industry, Mr. Kamal Nath, mentions that SEZs are basically for fresh investments
No TDS by overseas banking units on interest on deposits/borrowings from non-resident or person not ordinarily resident
No minimum alternate tax
Transferee developer enjoys 100 percent income tax exemption for balance period of 10 assessment years

Indirect tax

SEZ units may import or procure from domestic sources duty free, all their requirements of capital goods, raw materials, consumables, spares, packaging materials, office equipment, DG sets for implementation of their project in the zone without any license or specific approval
No import duty on these goods imported
No excise duty on these goods procured from domestic tariff area
No service tax on services availed from domestic tariff area
No value added tax and central sales tax on goods procured from domestic tariff area
On goods procured from DTA, drawback under section 75 allowed to SEZ unit
Goods imported/procured locally duty free could be utilized over the approval period of five years

Other incentives
A foreign institutional investor investing in shares and securities in India would be accountable to tax at 10 percent on its long-term capital gains and 30 percent on short-term capital gains. The least amount period of investment in the case of equity shares would be more than one year to be considered long term, and three years in the case of other securities. Dividends, interest or long-term capital gains of an infrastructure capital fund or infrastructure Capital Company that earns from investments made on or after June 1, 1998 in any venture engaged in the business of developing, maintaining and working any infrastructure facility, and which has been permitted by the central Government, is not liable from tax. Dividends paid by local players to their shareholders are excused from tax. Though, the domestic corporation would have to pay an extra tax —termed as “tax on circulated profits” — which is computed at the rate of 10 percent of the amounts spread as dividends by the local company.

Current statistics
Indian has been attracting foreign direct investment for a long period. The sectors like telecommunication, construction activities and computer software and hardware have been the major sectors for FDI inflows in India. As per the fact sheet on FDI, there was Rs. 6,30,336 crore FDI equity inflows between the period of August 1991 to January 2011.

Top 10 investing FDI investing countries in India are Mauritius, Singapore, United States, UK, Netherlands, Japan, Cyprus, Germany, France and UAE. According to media reports, the decline in the FDI inflows would be a major concern for the economy, as the Indian economy is heading to reach the 9 percent growth rate.

The trend of declining FDI tells us very little about statistics of FDI as it refers to FDI equity inflows. Though, equity inflow is a better indicator of portfolio investment (also known as FII inflows) than of FDI. To understand this, it is essential to define FDI.

Definition of FDI is complex. The main reason is that unlike portfolio investment, FDI involves a bunch of activities like managerial inputs, technology infusion etc which are not measured in the equity definition of FDI.

For developing countries like India, the most important reason to attract FDI is the availability of better technology. This does not mean that overseas companies transfer technology. All studies stated that the presence of foreign companies which positively impacts productivity of domestic firms through learning the use of new technologies. This is really important than obtaining technology through purchases of drawings and designs. If we accept this, then a better indicator of FDI interest is the long term trends of FDI in India.

Real FDI is increasing in India
An annual FDI inflow indicates that FDI went up from around negligible amounts in 1991-92 to around US$9 billion in 2006-07. It then hiked to around US$22 billion in 2007-08, rising to around US$37 billion by 2009-10. It is now clear that FDI was related to the recessionary conditions in the western economies. In other words, the stock of FDI has jumped by almost US$100 billion since 2006-07. The recent flattening of monthly FDI flows is a sign more of recovery in the western economies than any loss of long term interest in the Indian economy. The monthly figure only shows that the incremental FDI is going back to the prerecession years rather than indicating decline of FDI into India. In fact, a monthly inflow of US$1.1 billion is about 30 percent higher than pre-recession years.

Also, FDI is all about long term investment. Companies have already invested in to India and are unlikely to move elsewhere. Unless any dramatic negative changes in policy, FDI will continue to inch upwards.

The crucial test for India is how to move from US$10-12 billion FDI economy to one where investment levels are US$30-40 billion.

Dezan Shira & Associates is boutique professional services firm providing foreign direct investment business advisory, tax, accounting, payroll and due diligence services for multinational clients in India. To contact the firm, please email india@dezshira.com, visit www.dezshira.com, or download the firm’s brochure here.