Foreign direct investment in the manufacturing sector of India

Indian liberalisation began in early 1990s’ leading to gain in momentum of foreign direct investment  inflows into the country. However it was only after 2000 that the investment became significantly higher (Bibek Rya Chaudhuri, Pradyut Kumar, 2013). During the initial phase of liberalisation inflows of the foreign direct investment in manufacturing sector was highest as compared to the service sector. However over the period of time service sector has emerged as the major sector attracting most of the foreign investment  (Akhtar, 2013).

Foreign investment is considered as an important sector especially for the manufacturing sector of the developing countries as foreign investors tend to bring with it the capital, technology and skills needed for industrial development. Until 1991, India did not have enough savings to meet the capital requirements. Moreover, the licensing agreements as well as capital goods imports also did not give it the requisite industrial technology. But with the inflow of foreign funds after 1991 certain gaps with regard to capital, technology for industrial development have been fulfilled.

Trends in foreign direct investment in manufacturing sector since 1991

The total inflow of foreign direct investment in India was around US$ 1.7 billion during 1990-2000 which has increased to US $324 billion during 2000 – 2014 (DIPP, 2016). In pre-liberalisation era, the manufacturing sector used to receive the maximum foreign investment. However the share has declined from 85% in 1990 to 48% in 1997. In post reform period, the inflow of foreign funds was mainly in the form of mergers and acquisitions (Kumar, 2005) and there has been an increase in foreign direct investment in the capital intensive sectors of manufacturing (Kunal Sen, n.d.).

Inflow of foreign direct investment in manufacturing sector in India.
Inflow of foreign direct investment in manufacturing sector in India (Source: Reserve Bank of India, 2014).

In 2009, there was a decrease in foreign direct investment in manufacturing sector following the global financial crisis of 2008. Due to mergers and acquisitions, only few industries like electrical and electronic equipment received higher investments during that period (Madem, Gudla, & Rao, 2012). Though, for period after 2000 as a whole, there has been an increase in foreign direct investment in manufacturing sector despite economic crisis of 2008-2010. However, there is sharp decline in the flow of investments in manufacturing after 2012. The institutional factors that reduce investor confidence could be the reason of moderation (Sharma & Singh, 2013).

Major manufacturing industries attracting foreign direct investment

Among the various manufacturing industries in India, major industries attracting foreign direct investment includes:

  • foods and beverages (6.66%),
  • transport equipment (6.73%),
  • machinery and machine tools (5.29%),
  • electrical goods and machinery (8.31%),
  • chemicals and allied products (8.91%) (Kumar, 2005).

Figure 2 shows  two of the industries which attract the highest amount of foreign investment  in the period 2003-04 to 2013-14. The Metallurgical industry which was not able to attract foreign investment before 2000 has become one of the major sectors to receive foreign investment after 2000.

Inflow of foreign direct investment in metallurgical industry (Source: Department of Industrial Policy and Promotion).
Inflow of foreign direct investment in metallurgical industry (Source: Department of Industrial Policy and Promotion).

Since 2000, automobile industry has seen a steep increase in the inflow of foreign investment (US $11048.18 million in period 2000-2014) due to the provision of 100% foreign direct investment in this sector (Rajeswari & Akilandeswari, 2015). There has been extensive inflow of foreign investement in pharmaceutical industry on account of multinational pharmaceutical corporations outsourcing of various functions like research and development (Sagar, 2013).

Foreign technology collaboration agreements and foreign direct investment

The foreign technology collaboration agreements (FTCA) is an effective way to attract foreign direct investment. Thus showing an increase in the inflow of foreign direct investment in the manufacturing sector. In the period 1991-2000, out of the total approved proposals, electrical equipment has a maximum of 10% share. Similarly share of other industries include:

  • chemicals (other than fertilizers)  5%,
  • metallurgical industries (5.8%),
  • good processing (3.5%),
  • electrical equipment (including software) (10%),
  • textiles (1.4%),
  • paper and paper products (1.3%) and
  • industrial machinery had 0.9% share (Nagaraj, 2003).

As per Azhar & Marimathu (2012), between 2000 to 2010 more than 8000 foreign technology collaborations agreements were approved by the Reserve Bank of India, Secretariat for Industrial Approvals and Foreign investment promotion board. Electrical equipments, chemicals, industrial machinery, metallurgical industry, drugs and pharmaceuticals recorded 15.6%, 11.2%, 10.8%, 5% and  3.6% respectively of the total approvals. As per RBI 2015 manufacturing had received 70.1% and 77.5% of total foreign technology collaboration agreement approvals in 2010-12 and 2012 -14 respectively.

FDI equity inflows in chemicals other than fertilisers (Figures in USD million. Source: Department of Industrial Policy and Promotion).
FDI equity inflows in chemicals other than fertilisers (Figures in USD million. Source: Department of Industrial Policy and Promotion).

Policies before 1991

Since independence several policies for foreign investment came up in tandem with the requirements of the same. After independence, India had adopted import substituting industrialisation, thus encouraging limited foreign investment in order to help the Indian domestic industries to develop without facing any competition (Sharma & Singh, 2013). As the Indian machinery and manufacturing sector developed, the Indian government adopted more restrictive policies in the late 1960s’. These policies included not permitting proposals without technology transfer involving more than 40% foreign ownership (Kumar, 2005). As per Foreign Exchange Regulation Act (FERA) 1973 except for high priority and high technology sectors, tea plantations etc, foreign equity holdings were allowed upto 40% (Kumar, 2005).

However during the early 1980s’, the Indian government started developing separate Special Economic Zones (SEZs). Delicensing and liberalisation of imports of capital goods and technology was adopted via a series of new policies, namely Industrial Policy Technology Policy of 1983 (Sharma & Singh, 2013).

Policies after 1991

India’s reforms speeded up with the introduction of Indian Economic Reforms of 1991, whereby attempts were made to integrate the Indian economy with the rest of the world. As part of these reforms, business expansion was aimed by removing the restriction in foreign investment and liberalising trade. New sectors were opened to foreign owned companies with certain sectoral caps and automatic clearance to direct investment. Similarly ownership levels of foreign equity at 50%, 51%, 74% and 100% were brought into picture for various sectors (Kumar, 2005). Government also introduced two different routes namely the automatic route and Government’s approval routes for foreign investment.

Similarly for the protection of foreign investors various bilateral and Multilateral Investment Guarantee Acts (MIGA) were introduced (Sharma & Singh, 2013). However, there was a cap for foreign direct investment in some sectors like defence equipment (26%) and small scale industries (24%)(Kumar, 2005). In 1991 the Indian government introduced Foreign Exchange Management Act (FEMA). This made easier to do business in India by removing a series of restrictions and simplifying the process which made India one of the major destinations for the foreign investors (Majumdar, 2008).

Foreign direct investment scenario after 2001

In 2000 the Indian government removed 22 consumer good industries from dividend balancing and export obligations on foreign investors (Kumar, 2005). During the period of 2006-07, 51% of foreign direct investment was permitted in a single brand retailing which was further pushed to 100% in 2012. Similarly 51% foreign direct investment in multi brand retailing was permitted in the same year (Sharma & Singh, 2013). Starting from 2001, a negative list approach was used for liberalisation along with the automatic route for all other activities and relaxation in equity caps (Bibek Rya Chaudhuri, Pradyut Kumar, 2013).

Thus, it is evident that on account of the liberalised policies adopted by the Indian government, there has been a significant surge in foreign direct investments in the manufacturing sector of India. There are several factors responsible to attract such high foreign investment in the manufacturing sector. A study conducted on foreign direct investment by Chaudhuri et al, (2013) concluded that foreign direct investment in manufacturing sector in India is negatively affected by tariffs, import intensity and low R&D intensity. On the other hand foreign investment is positively related to sectors where market imperfections give way to higher profits.


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