Saturday, 28 April 2012
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What is foreign investment?
What is foreign investment?
Any investment flowing from one country into another is foreign investment. A simple and commonly-used definition says financial investment by which a person or an entity acquires a lasting interest in, and a degree of influence over, the management of a business enterprise in a foreign country is foreign investment. Globally, various types of technical definitions — including those from IMF and OECD — are used to define foreign investment.
How does the Indian government classify foreign investment?
The Indian government differentiates cross-border capital inflows into various categories like foreign direct investment (FDI), foreign institutional investment (FII), non-resident Indian (NRI) and person of Indian origin (PIO) investment.
Inflow of investment from other countries is encouraged since it complements domestic investments in capital-scarce economies of developing countries, India opened up to investments from abroad gradually over the past two decades, especially since the landmark economic liberalisation of 1991. Apart from helping create additional economic activity and generating employment, foreign investment also facilitates flow of technology into the country and helps the industry to become more competitive.
Why does the government differentiate between various forms of foreign investment?
FDI is preferred over FII as it is considered to be the most beneficial form of foreign investment for the economy as a whole. Direct investment targets a specific enterprise, with the aim of increasing its capacity or changing its management control. Direct investment to create or augment capacity ensures that the capital inflow translates into additional production.
In case of FII investment that flows into the secondary market, the effect is to increase capital availability, rather than availability of capital to a particular enterprise. Translating an FII inflow into additional production depends on production decisions by someone other than the foreign investor — some local investor has to draw upon the additional capital made available via FII inflows to augment production.
In case of FDI that flows in for the purpose of acquiring an existing asset, no addition to production capacity takes place as a direct result of FDI inflow. Just like in case of FII inflows, in this case too, addition to production capacity does not result from the action of the foreign investor — the domestic seller has to invest the proceeds of the sale in a manner that augments capacity for the foreign capital inflow to boost domestic production.
There is widespread notion that FII inflows are hot money — that creates volatility in the stock market and exchange rates. FDI tends to be more stable than FII inflows. Moreover, FDI brings not just capital but also better management and governance practices and, often, technology transfer. The know-how transferred along with FDI is often more crucial than capital per se. No such benefit accrues in case of FII inflows, although the search by FIIs for credible investment options has tended to improve accounting and governance practices among listed companies.
According to the Prime Minister’s Economic Advisory Committee, net FDI inflows amounted to $8.5 billion in 2006-07 and is estimated to have gone up to $15.5 billion in 2007-08. The panel feels FDI inflows would increase to $19.7 billion during the current financial year. FDI up to 100% is allowed in sectors like textiles or automobiles while the government has put in place foreign investment ceilings in case of sectors like telecom (74 per cent). In some areas like gambling or lottery, no foreign investment is allowed.
According to the government’s definition, FIIs include asset management companies, pension funds, mutual funds, investment trusts as nominee companies, incorporated/institutional portfolio managers or their power of attorney holders, university funds, endowment foundations, charitable trusts and charitable societies.
FIIs are required to allocate their investment between equity and debt instruments in the ratio of 70:30. However, it is also possible for an FII to declare itself a 100 per cent debt FII in which case it can make its entire investment in debt instruments. There are peculiar cases like airlines where foreign investment, including FII, is allowed to the extent of 49 per cent, but FDI from foreign airlines is not allowed.
What restrictions do FIIs face in India?
FIIs can buy/sell securities on Indian stock exchanges, but they have to get registered with stock market regulator Sebi. They can also invest in listed and unlisted securities outside stock exchanges if the price at which stake is sold has been approved by RBI. No individual FII/sub-account can acquire more than 10 per cent of the paid-up capital of an Indian company.
All FIIs and their sub-accounts taken together cannot acquire more than 24 per cent of the paid-up capital of an Indian Company, unless the Indian Company raises the 24 per cent ceiling to the sectoral cap or statutory ceiling as applicable by passing a board resolution and a special resolution to that effect by its general body in terms of RBI press release of September 20, 2001 and FEMA Notification No.45 of the same date.
In addition, the government also introduces new regulations from time to time to ensure that FII investments are in order. For example, investment through participatory notes (PNs) was curbed by Sebi recently.
Any investment flowing from one country into another is foreign investment. A simple and commonly-used definition says financial investment by which a person or an entity acquires a lasting interest in, and a degree of influence over, the management of a business enterprise in a foreign country is foreign investment. Globally, various types of technical definitions — including those from IMF and OECD — are used to define foreign investment.
How does the Indian government classify foreign investment?
The Indian government differentiates cross-border capital inflows into various categories like foreign direct investment (FDI), foreign institutional investment (FII), non-resident Indian (NRI) and person of Indian origin (PIO) investment.
Inflow of investment from other countries is encouraged since it complements domestic investments in capital-scarce economies of developing countries, India opened up to investments from abroad gradually over the past two decades, especially since the landmark economic liberalisation of 1991. Apart from helping create additional economic activity and generating employment, foreign investment also facilitates flow of technology into the country and helps the industry to become more competitive.
Why does the government differentiate between various forms of foreign investment?
FDI is preferred over FII as it is considered to be the most beneficial form of foreign investment for the economy as a whole. Direct investment targets a specific enterprise, with the aim of increasing its capacity or changing its management control. Direct investment to create or augment capacity ensures that the capital inflow translates into additional production.
In case of FII investment that flows into the secondary market, the effect is to increase capital availability, rather than availability of capital to a particular enterprise. Translating an FII inflow into additional production depends on production decisions by someone other than the foreign investor — some local investor has to draw upon the additional capital made available via FII inflows to augment production.
In case of FDI that flows in for the purpose of acquiring an existing asset, no addition to production capacity takes place as a direct result of FDI inflow. Just like in case of FII inflows, in this case too, addition to production capacity does not result from the action of the foreign investor — the domestic seller has to invest the proceeds of the sale in a manner that augments capacity for the foreign capital inflow to boost domestic production.
There is widespread notion that FII inflows are hot money — that creates volatility in the stock market and exchange rates. FDI tends to be more stable than FII inflows. Moreover, FDI brings not just capital but also better management and governance practices and, often, technology transfer. The know-how transferred along with FDI is often more crucial than capital per se. No such benefit accrues in case of FII inflows, although the search by FIIs for credible investment options has tended to improve accounting and governance practices among listed companies.
According to the Prime Minister’s Economic Advisory Committee, net FDI inflows amounted to $8.5 billion in 2006-07 and is estimated to have gone up to $15.5 billion in 2007-08. The panel feels FDI inflows would increase to $19.7 billion during the current financial year. FDI up to 100% is allowed in sectors like textiles or automobiles while the government has put in place foreign investment ceilings in case of sectors like telecom (74 per cent). In some areas like gambling or lottery, no foreign investment is allowed.
According to the government’s definition, FIIs include asset management companies, pension funds, mutual funds, investment trusts as nominee companies, incorporated/institutional portfolio managers or their power of attorney holders, university funds, endowment foundations, charitable trusts and charitable societies.
FIIs are required to allocate their investment between equity and debt instruments in the ratio of 70:30. However, it is also possible for an FII to declare itself a 100 per cent debt FII in which case it can make its entire investment in debt instruments. There are peculiar cases like airlines where foreign investment, including FII, is allowed to the extent of 49 per cent, but FDI from foreign airlines is not allowed.
What restrictions do FIIs face in India?
FIIs can buy/sell securities on Indian stock exchanges, but they have to get registered with stock market regulator Sebi. They can also invest in listed and unlisted securities outside stock exchanges if the price at which stake is sold has been approved by RBI. No individual FII/sub-account can acquire more than 10 per cent of the paid-up capital of an Indian company.
All FIIs and their sub-accounts taken together cannot acquire more than 24 per cent of the paid-up capital of an Indian Company, unless the Indian Company raises the 24 per cent ceiling to the sectoral cap or statutory ceiling as applicable by passing a board resolution and a special resolution to that effect by its general body in terms of RBI press release of September 20, 2001 and FEMA Notification No.45 of the same date.
In addition, the government also introduces new regulations from time to time to ensure that FII investments are in order. For example, investment through participatory notes (PNs) was curbed by Sebi recently.
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