Financial Daily
from THE HINDU group of publications

Friday, March 31, 2000



Opinion | Next

FDI - opportunities and challenges for India

R. Parthasarathy

MERGERS and acquisitions are a major source of FDI inflows. This could mean that the net addition to total physical production capabilities annually is less than that implied by the value of annual FDI flows as most of the additions may well be created b y simply changing ownership. Also, the 10 largest home countries accounted for nearly 80 per cent of global FDI outflows with divergent trends between the developed and the developing.

Developing countries receive more FDI inflows per dollar of gross domestic product than do developed countries. There could be a justification for this as FDI may be attracted into developing countries by factors such as natural resources and not purely by the size of their economies. Most investments into Eastern Europe have been through the privatisation of government-owned enterprises although, of late, some direct FDI flows have also been noticed.

Russia has not yet successfully tackled the internal economic restructuring with the result that the privatisation route has not picked up as expected. In Latin America and the Caribbean, privatisation of service- or natural resource-based state enterpri ses continues to be the driving force of FDI inflows. China remains the largest FDI host country in Asia; By comparison, India was unable to get more than $4 billions, though the target is $10 billions this year. Africa is still awaiting the realisation of its potential; the most promising countries for FDI inflows in the continent are South Africa, Nigeria, Botswana, Cote d' Ivoire and Tunisia, although Ghana, Mozambique, Namibia, Tunisia and Uganda have also been identified as having good potential fo r FDI flows.

A contributing factor for the increased flow of foreign investment in the 1990s has been the extensive reform by host governments, removal of restrictive policies governing FDI flows and permitting free flows of capital. Approval procedures were simplifi ed and rationalised either by removing licensing requirements or keeping it to the bare minimum. A survey, by the European Round Table of Industrialists, of the improvements of conditions for investment in 25 developing countries, in the wake of liberali sation, noted that more companies were willing to invest in the developing world for strategic considerations and to realise the long-term economic potential of these markets. Towards that goal, regulatory efficiency, as opposed to simple deregulation, s hould be the policy focus. Improved conditions for investment are not automatically, or always, identical with deregulation, much less efficient regulatory framework. The demand for a competition policy and an open investment regime as demanded at the WT O, has its genesis in this premise.

What are the opportunities and challenges before developing countries such as India? The wave of M and As as a driving force for FDI will continue, particularly in crucial sectors such as IT, telecom, financial and pharmaceuticals. These might be aided b y trade liberalisation, investment in capital markets, deregulation and the fiercer competitive pressures resulting from globalisation and technological changes.

The Unctad study notes: ``Expanding firm size and managing a portfolio of locational assets becomes more important for firms, enabling them to take advantage of resources and markets worldwide. The search for size is also driven by the search for financi al, managerial and operational synergies, as well as economies of scale. Finally, size puts firms in a better position to keep pace with an uncertain and rapidly-evolving technological environment, a crucial requirement in an increasingly knowledge-inten sive world economy, and to face soaring research costs.

``Other motivations include efforts to attain a dominant market position as well as short-term financial gains in terms of stock value. In many instances the dynamics of the process feeds upon itself, as firms fear that if they do not find suitable partn ers, they may not survive, in the long run.''

From the host-country point of view, some important issues can be identified. To what extent can foreign investment serve the overall socio-economic goals in an open regime? Income disparities, employment generation, technology flows, environmental costs of industrial development, commitment to exports are some of the key issues.

There could be a crowding-out effect in the face of competition for scarce resources and markets. The pattern of investment and the routes FDI flows might take may undergo a significant change. For instance, M and As may become more common. There could b e takeovers of local firms in a few cases with implications for domestic brands. Takeovers per se are not to be frowned upon. But the ground rules for transparency and prevention of insider-trading practices must be enforced vigorously under SEBI guideli nes. Today, this is a weak area in Indian corporate mergers.

Improving the host country's negotiating power with TNCs needs attention. Information of cost and the status of technology offered and the global strategies of firms are vital to strengthen the bargaining capability.

There is likely to be an increasing role of the TNC home countries in controlling the flow of critical or dual technology on so called `security grounds' which issue musty be discussed to evolve suitable international standards.

With particular reference to portfolio investments and profit repatriation, host countries must evolve suitable financial policies and instruments to prevent capital market volatility.

As in Budget 2000-01, raising the level of investment by the FIIs which essentially operate in the capital market might have both advantages and disadvantages. The advantage is that this step might integrate India's financial market with the rest of the world. But there is a price: Market volatility could have a destabilising effect and bearish and bullish trends can be managed at will by large investors.

This might also be true when more Indian companies have their stocks listed in world capital markets where the volumes traded are high as is the velocity. The solution is not to argue against these measures if we want globalisation but to encourage indus trialisation and improve corporate performance to international standards. Also, the number of good scrips must increase as should the volumes traded.

The regulatory framework of the capital market must also improve with the professionalisation of brokerage firms, and the enforcement of strict dealing and settlement standards. Increasingly, trading velocity will be much higher, and scripless trading, w ith networked stock markets to rope in more investors, will be necessary.

Importantly, economic management should not give cause for alarm as FIIs are highly temperamental investors whose business is to maximise profits and minimise risks for their members and not necessarily to work for the development of the host country. Th is must be done keeping the markets liberalised and open so that investor confidence is not shaken.

The Malaysian example of placing an embargo on capital repatriation at a time of crisis is not to be emulated. However, to the extent to maintain a globally competitive regime movement of capital cannot have a totally disruptive effect. Otherwise, the ex perience of east Asian countries and Japan may be repeated.

With increased investment by TNCs, there should be effective tools in our tax system and the administrative machinery needs to be adequately adjusted to address the question of transfer pricing.

Lastly, evolving good corporate governance and proper internal checks and balances through independent audit committees is a must. So far, this area has been only a talking point among corporates with some leading chambers of commerce even treating this issue as a voluntary measure.


(The author is a New Delhi-based management and financial consultant.)

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