Foreign Capital and Aid, Economy Traditional Notes | Study Indian Economy for UPSC CSE - UPSC

Need

The need for foreign capital for a developing country like India can arise due to following reasons:

1. Since domestic capital is inadequate for purpose of economic growth it is necessary to invite foreign capital.
2. Since the underdeveloped countries have very low level of technology as compared to the advanced counrties and possess a strong urge for industrialisation to develop their economies it necessitates importing of technology from the developed countries. 
3. Such technology usually comes with foreign capital when it assumes the form of private foreign investment or foreign collaboration.
4. In the Indian case, technical assistance received from abroad has helped in filling up the technological gap through the following three ways : 
   • ​Provision of expert services;
   • training of Indian
   • educational research and training institutions in the country.
5. As number of underdeveloped countries possess huge mineral resources but do not possess the required technical skill and expertise to exploit it, they have to depend upon foreign capital for exploitation of their mineral wealth.
6. Underdeveloped countries suffer from acute scarcity of private entrepreneurs which creates obstacles in the programmes of industrialisation. But foreign capital can undertake the ‘risk’ of investment in the host countries and thus provide the much needed  impetus to the process of industrialisation. 
7. And as the industrialisation gets started with the initiative of foreign capital, domestic industrial activity starts picking up as more and more people of the host country enter the industrial field.
8. Domestic capital of the underdeveloped countries is often too inadequate to build up the economic infrastructure on its own.
9. Thus assistance of foreign capital is required to undertake this task.
10. In the beginning of economic development, the underdeveloped countries need much larger imports (in the form of machinery, capital goods, industrial raw materials, spares and components) than they can possibly export.
11. As a result BoP generally turns adverse. This creates a gap between the earnings and expenditure of foreign exchange. Foreign capital presents a short-run solution to the problem.

Thus the foreign investment has the following advantages:

1. Foreign investment constitutes a net addition to investable resources in host countries and as such raises their rates of growth;
2. Foreign investment constitutes a net addition to investable resources in host countries and as such raises their rates of growth;
3. Foreign investment results in a pattern of growth which is desirable from the point of view of underdeveloped countries since new products are introduced and marketed, new tastes are created, and specific needs of the host economy are met; and
4. Free flow of capital is conducive both to total world welfare and to the welfare of each individual country. The operations of foreign firms, especially of modern multinational firms, knit countries together and closer into the web of international commerce, both by (vertical and horizontal) economic integration and by the transmission of tastes, designs, ideas and technology.

Forms of foreign capital

• Foreign capital can be obtained either in the form of concessional assistance or nonconsessional flow or foreign investment.
• Concessional Assistance : It includes grants and loans obtained at low rates of interest with long maturity periods. 
• Such assistance is generally provided on a bilateral basis or through multilateral agencies like the World Bank, International Development Association, etc. 
• Loans have to be repaid generally in terms of foreign currency but in certain cases the donor may allow the recipient country to repay in terms of its own currency. 
• Grants do not carry any obligation of repayment and are mostly made available to meet some temporary crisis.
• Non-concessional Assistance : It includes mainly external commercial borrowings (from US Exim Bank, Japanese Exim Bank, ECGC of UK etc.) loans from other governments/ multilateral agencies on market terms and deposit obtained from nonresidents.
• Foreign Investment : It is generally obtained in the form of private foreign participation in certain sectors of the domestic economy. 
• The main advantage of this form of capital is that generally the foreign investor also brings with him technical expertise, machines, capital goods, etc., which are scarce in underdeveloped countries. 
• The disadvantage is that a large part of the profits are repatriated to the foreign investor. 
• If the underdeveloped country in question chooses to depend too much on private foreign investment, it could be risking interference in the conduct of its affairs. 
• This would be against the long-term interests of the country as some economists materialise to face temporary shortages in the economy. 
• Aid in the form of technical assistance can also be made available by the donors.

Government's policy towards foreign capital

• The attitude of Government of India towards foreign capital was one of fear and suspicion at the time of independence.
• This was natural on account of the previous exploitative role played by it in "draining away' resources from this country. 
• This suspicion and hostility found expression in the Industrial Policy of 1948 which, though recognizing the role of private foreign investment in the country, emphasized that its regulation was necessary in the national interest.
• Because of this attitude expressed in the 1948 Resolution, foreign capitalists got dissatisfied and as a result, the flow of imports of capital goods got obstructed.
• The Prime Minister had to give following assurances to the foreign capitalists in 1949:

1. The government of India will not differentiate between the foreign and Indian capital. 
2. The implication was that the government would not place any restrictions or impose any conditions on foreign enterprise which were not applicable to similar Indian enterprise.
3. The foreign interests operating in India would be permitted to earn profits without subjecting them to undue controls. 
4. Only such restrictions would be imposed which also apply to the Indian enterprise.
5. If and when foreign enterprises are compulsorily acquired, compensation will be paid on a fair and equitable basis as already announced in government's statement of policy.

• By a declaration issued on June 2, 1950, the government assured the foreign capitalists that  they can remit the foreign investments made by them in the country after January 1, 1950. In addition, they were also allowed to remit whatever reinvestment of profit had taken place.
• Despite these assurances the flow of foreign capital into India during the period of the First Plan was not significant. The atmosphere of suspicion had not changed substantially. 
• However, the policy statement issued in 1949 and continued practically unchanged in the 1956 Industrial Policy Resolution, opened up immense fields to foreign participation. 
• In addition, the trends towards liberalization grew slowly and gradually more strong and the role of foreign investment grew more and more important. 
• The important points of the July 1991 policy are:

1. Approval will be given for direct foreign investment upto 51 per cent foreign equity is no longer applied except for consumer goods industries.
2. The payment of dividends would be monitored though the Reserve Bank of India so as to ensure that outflows on account of dividend payments are balanced by export earnings over a period of time.
3. To provide access to international markets, majority foreign equity holding upto 51% equity will be allowed for trading companies primarily engaged in export activities.
4. Automatic permission will be given for foreign technology agreements in high priority industries upto a lumpsum payment of Rs. 1 crore, 5% royalty for domestic sales and 8% for exports, subject to a total payment of 8% of sales over a 10 year period from date of agreement or 7 agreement or 7 years from commencement of production.

• The government of India liberalised its policy towards foreign investment in 1991 to permit automatic approval for foreign investment upto 51 per cent equity in 34 Industries. 
• The Foreign Investment Promotion Board (FIPB) was also set up to process applications in cases not covered by automatic approval. 
• In subsequent period additional measures were taken to encourage direct foreign investment, portfolio  investment, NRI investment etc. 
• These measures are:

1. The dividend-balancing condition earlier applicable to foreign investment up to 51 per cent equity is no longer applied except for consumer goods industries.
2. Existing companies with foreign equity can raise it to 51 per cent subject to certain prescribed guidelines. 
3. Foreign direct investment has also been allowed in exploration, production and refining of oil and marketing of gas. Captive coal mines can also be owned and run by private investors in power.
4. NRIs and Overseas Corporate Bodies (OCBs) predominantly owned by them are also permitted to invest up to 100 per cent equity in high-priority industries with repatriablility of capital and income.
5. BRI investment up to 100 per cent of equity is also allowed in export houses, trading houses, star trading houses, hospitals, EOUs, sick industries, hotels and tourism related industries and without the right of repartriation in the previously excluded areas of real estate, housing and infrastructure.
6. Disinvestment of equity by foreign investors has been allowed at market rates on stock exchanges from 15 September 1992 with permission to repatriate the proceeds of such disinvestment.
7. India has signed Multilateral Investment Guarantee Agency Protocol for the protection of foreign investors on 13 April 1992.
8. Provisions of the Foreign Exchange Regulation Act (FERA) have been liberalised as a result of which companies with more than 40 per cent of equity are also now treated at par with fully Indian-owned companies.
9. Foreign companies have been allowed to use their trade marks on domestic sales.
10. The government has allowed reputed Foreign Institutional Investors (Flls) including pension funds, mutual funds asset management companies, investment trusts, nominee companies and incorporated or institutional portfolio managers to invest in the Indian capital market subject to the condition that they register with the Securities and Exchange Board of India (SEBI) and obtain RBI approval under FERA. 
11. Portfolio investments by the Flls in the primary and secondary markets are subject to an overall celling of 24 per cent of the issued share capital in any company.
12. Foreign investors can invest in Indian companies through the Global Depository Receipts (GDR) route without any lock in period. 
13. These receipts can be listed on any of the overseas stock exchanges and denominated in any convertible foreign currency.
14. Effective February 28, 1996, NRIs (and not OCBs) were permitted to invest funds on non-repatriation basis in Money Market Mutual Funds floated by commercial banks and public/private sector financial institutions.
15. In January 1997, the government announced the first ever guidelines for foreign direct investment for expeditious approval of foreign investment in areas not covered under automatic approval. 
16. Priority areas for foreign direct investment include infrastructure, export  potential, large-scale employment potential particularly for rural areas, items with linkages with the farm sector, social sector projects like hospitals, health care and medicines, and proposals that lead to induction of technology and infusion of capital.
17. Foreign direct investment approvals will, however, be subject to sectorial caps.
18. The new guidelines also allow foreign companies to set up 100 per cent companies on the basis of certain criteria.