Overview of foreign direct investment in pre and post economic reform in India

By Indra Giri & Shikha Chauhan on June 24, 2016

Foreign direct investment drives the economic growth of a country. Foreign direct investment plays a major role in the advancement of technology, generating employment opportunities, and promoting the overall development of the economy. The growth of foreign direct investment in India was retarded by the introduction of the Monopolies and Restrictive Trade Practices Act (MRTP) and Foreign Exchange Regulation Act (FERA) at the beginning of 1970’s (Shah & Parikh, 2012).

It was the 1980’s that saw an increase in foreign direct investment in the Indian economy which was characterized by an accelerated rate of economic growth (Agarwal & Whalley, 2013). The Gulf oil crisis in the late 1980s led to an adverse balance of payments leading to a crisis in India which was the linchpin to the domino effect of the new economic policy of 1991. Post-1991, the economic policy was re-oriented to aid the inflow of Foreign Direct Investment in India. The inflow of investment has contributed to the growth of the Indian economy. The Foreign Direct Investment inflow has increased from $129 million in 1991 to $3557 in 1997.

Investments and industrialization in the pre-reform period

In his paper (Kumar, 2014) identified a marked resurgence in the infrastructure investment in the 1980s’. As against only 4.2 percent per annum investment from 1965-66 to 1975-76, the increase in investment was as high as 9.7 percent per annum during 1979-80 to 1984-85. The infrastructure investment rose further by 16.0 percent in 1985-86 and 18.3 percent in 1986-87. According to (Ray & Ghosh, 2014), the top five sectors that attracted the bulk of FDI in the pre-reform period were:

  • Industrial machinery,
  • Chemicals,
  • Mechanical engineering,
  • Electrical and electronics and
  • Metallurgy.

These industries accounted for 54.87% of the total investment inflows in the year 1981.

Indian Economic Growth from 1980- 2010 (Source: Compiled by author from Data base of RBI)
Indian Economic Growth from 1980- 2010)

However, in 1990 the top five sectors were electrical and electronics, chemicals, industrial machinery, mechanical engineering, and metallurgy, and together they accounted for 68.14% of the total foreign direct investment.

Investments and industrialization in Post Reform Period

A paper by (Srinivasan, 2002) identifies that India’s protection from foreign competition until the reforms of 1991 had initiated from a long-standing distrust of foreign markets and international trade. There was apprehension fear that greater involvement in foreign trade would inevitably retard India’s industrialization. In the post-reform period, India’s policy with respect to the private foreign capital was significantly low. Capital flows by Foreign Direct Investment, (FDI), Portfolio Investment, and Debt had been as restrictive as the policy regarding trade in goods and services. Adding to this point, (Shah & Parikh, 2012) mentions that the New Industrial Policy (NIP) announced in 1991 led to the abolition of the industry licensing system. However, some industries such as railways, defense, atomic energy harnessing were not opened and government still holds the monopoly.

Growth of three major sectors of Indian Economy (1980 -2010)
Growth of three major sectors of Indian Economy (1980 -2010)

The allowances for foreign investment across various sectors, foreign ownership up to 100% was allowed in most manufacturing sectors, except defense equipment (26%) and items reserved for production by small scale industries (24%). In their paper (Madem, Gudla, & Rao, 2012) have identified the major sectors attracting FDI inflows in India as:

  • Services,
  • Electrical & Electronics amounting to $30,421millions or 32% of total FDI.

Similarly (Saji, 2016) identifies that investor preference in sectors like:

  • Telecommunications,
  • Construction,
  • The real estate and IT & hardware sectors has been very high in the post-reform period.

In the pre-reform period foreign direct investment was allowed only for the export-oriented industries that involved the use of modern technology.

Impact of foreign direct investment in India

Foreign direct investment affected the Indian domestic industries with “market stealing effects” (Nguyen, Simpson, & Saal, 2008). Where enterprises with foreign investment took a large chunk of market share from the domestic players. The loss of market share leads to the inability of domestic enterprises to get the most productive scale size. Therefore, the efficiency of local enterprises was reduced. (Akhtar, 2013) highlighted that the micro and small-scale enterprises were the worst affected by the harsh competition that rose from the opening up of the economy and inflow of foreign direct investment. Further, the agricultural sector faced a negative impact. The majority of agriculture in India is managed by medium and small scale farmers. Due to the pressures from large corporations, farmers were forced to supply at a  predetermined price which led to the decline of the agricultural sector.

Undoubtedly, foreign direct investment is essential for economic growth and development, especially in the case of transforming economics. The foreign investment not only boosted capital formation, but it also enhanced the quality of capital stock in the country (Görg & Greenaway, 2004). India has experienced a tremendous inflow of foreign investment. However, a large portion of the inflow has been in the form of purchasing and leasing existing production units instead of setting up new industries. This does not necessarily imply new capital infusion into a country. But in a country like India with its vast untapped potential, the FDI acts as a driver on the developmental path. Foreign Direct Investment complements the domestic capital, enhances the level of technology, and promotes the skill development in an economy Foreign direct investment promoted entrepreneurship through setting up new industries, boosted the growth of infrastructure, and promoted the overall welfare of the country (UNCTAD, 2005).


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