India’s Policies towards Foreign Investment!


Most of the LDCs are characterised by shortage of resources required for economic development. Resources may be domestic and foreign. By the shortage of domestic resources we mean scarcity of savings. Economists call such shortage of domestic resources the ‘savings gap’. On the other hand, shortage of foreign resources refer to the scarcity of foreign exchange. We call such scarcity of foreign exchange the ‘trade gap’. Foreign capital can bridge these two gaps.

It permits a country to invest more than it is able to save domestically. In summary, the resource constraint that stands in the way of development of LDCs can be greatly removed if foreign capital is invited. Furthermore, foreign capital also bridges ‘technological gap’ of the developing countries. Technological assistance given by the developed countries to the poor countries has brought more rapid progress to these countries. Hence the necessity of foreign capital in LDCs.

Foreign capital increases competition in markets, brings new technology and faster skill acquisition amongst domestic labour. It serves as a platform for global production chains, which would pave the way for strong exports growth.


In brief, the FDI benefits domestic Indian industries as well as Indian public by providing opportunities for technological up-gradation, access to global managerial skills and practices optimal utilisation of both human natural and physical resources, making Indian industry internationally competitive, opening up export markets in different countries, providing backward and forward linkages and access to international quality goods and services.


Important forms of private foreign investment are: portfolio investment (PI) and foreign direct investment (FDI). Portfolio investment may take the form of equity participation by foreigners’ and creditors’ capital. Participation can either be in the form of an enterprise completely owned by it or purchase of shares of a domestic concern or it can take the form of collaboration.

PI is a form of foreign capital which is used to purchase the shares of companies to claim share of profits and to exercise some sort of control over production. In this sense, PI is a floating capital. It is, thus, volatile in nature and it reflects speculative behaviour of foreign investors.

FDI, on the other, takes the form of equity capital that refers to investment in shares of a company in a foreign country. In India, it comes as direct investments via foreign branches of the parent companies and controlled by Indian companies. This sort of investment is considered as ‘sunk capital’ and, hence, preferred as it directly increases capital formation of the recipient country.


Portfolio investment implies only transfer of resources. As this sort of capital is volatile in nature, its impact on capital formation is ‘one step removed’. Unfortunately, the bulk of foreign capital that is coming to India particularly after the mid-1991 is in the form of PI, rather than FDI. In addition, foreign capital may take the form of inter-governmental loans, loans from international financial institutions, and grants.

Government Policy towards Foreign Capital (1948-1991 June):

At the time of independence, the Government of India’s attitude towards foreign capital was one of fear and suspicion, of course, quite expectedly. Apathy towards foreign capital was even marked in the Government’s Industrial Policy of 1948. In this policy, the Government insisted upon the gradual Indianisation of foreign companies. This scared the foreign firms from investing more in India.

As a result, the Government had to assure the foreign capitalists in 1949 in the following three directions:

i. There shall be no discrimination between Indian and foreign undertakings.


ii. Facilities shall be given to foreign investors for remittance of profit and repatriation of capital.

iii. Due compensation shall be paid in case a foreign undertaking is nationalized.

The attitude towards foreign capital remained unchanged in the 1956 Industrial Policy Resolution. In view of all these announcements and assurances on the part of the Government, private foreign capital entered India rather happily since the beginning (1956) of the Second Plan.

Since then, more and more liberal policies had been announced at different times. For instance, in 1972, the Government permitted entry of wholly-owned subsidiaries of foreign companies provided they undertake to export 100 p.c. or more of their output. In 1977, the Janata Party showed its reservations against foreign collaboration when Coca-Cola and IBM were asked to close their businesses in India.

Policy towards Foreign Capital since 1991:

However, the 1990s saw a U-turn in the policy of the Government towards foreign capital. Earlier, Government regulated its foreign capital investments and collaborations in such a way that these fit into the overall framework of the national economic plans.

It now allows huge concessions and relaxations rather than its selected stand taken earlier when foreign capital was permitted only in certain areas which were of basic and/or strategic importance to this country. The 1991 Industrial Policy announced several concessions and relaxa­tions as far as foreign capital is concerned. It has opened up doors of several industries even of minor importance for foreign investment.

The policies and procedures pertaining to FDI and PI have been progressively liberalised over the years. With increased liberalisation, Government has permitted FDI up to 100 p.c. under automatic route in most sectors, Equity caps on FDI now exist in limited sectors.

These are:

i. Insurance, defence production, petroleum refining in the PSUs, print and electronic media up to 26 p.c.


ii. Air transport services, cable network, etc. up to 49 p.c.

iii. Atomic reactors, private sector banking, telecom services up to 74 p.c.

iv. FDI prohibited in retail trading, except for single brand product retailing, gambling and betting, lottery and atomic energy

v. FDI up to 100 p.c. allowed under automatic route in most sectors activities.


A comprehensive review of the FDI policy was made in 2006 to consolidate the liberalisation already effected and further rationalise the FDI up to 100 p.c. now permitted in tea plantation with some conditions. FDI up to 100 p.c. is permitted under the automatic route in floriculture, horticulture, development of seeds, animal husbandry, pisciculture, aquaculture and services related to agro and allied sector.

At the end of the Tenth Plan period, FDI up to 100 p.c. was permitted in all manufacturing activities except where foreign investor had an existing joint venture.

These measures have so far been taken to make India a most favourable destination for FDI. In 2006-07, electrical equipment including computer software and electronics to attract the largest volume of FDI is channelled into services sector (both financial and non-financial), Telecommunications stand at the third (10.39 p.c.).

Extent of Foreign Investment Inflows:

It is clear that private foreign investment and foreign capital are now entering India in a significant scale as a substitute for declining foreign aid. FDI that stood at a low of$ 97 in 1990-91 rose to $3,358, in 2005. Portfolio investment during the same period rose from $ 6 to $ 2,760. Gross foreign investment inflows thus rose from $ 103 to $ 5099 during 1990-91 and 2000-01. However, these are mere approval figures. The actual or realised foreign investments are considerably low. Roughly 65 p.c. of FDI approved is not realised— and they are on paper.


As a proportion of GDP, foreign investment remained at 0.2 p.c. fell in 1992-93. It picked up with reforms and has remained almost stationary at 2 p.c. since 2003-04. A country-wise FDI inflows during 2000-07 reveal that the largest source of FDI in India is Mauritius (44 p.c.), followed by the USA (9 p.c.). The third position is occupied by UK (8 p.c.). It may be added here that Mauritius-based investments are nothing but US investments since these are routed through Mauritius to avoid the problem of complex tax laws. Many MNCs send their investments to India via Mauritius since here tax rates are rather lowest in the world.


Foreign investments in India pose some serious problems. First, the jump in foreign investment is not so big as is assumed by many. The Government set a target of attracting $ 10 billion of such inflows; the actual figure is just a third of the targeted goal. Between 1991 and 2006, actual inflow of FDI came to Rs. 1,81,566 crore vis-a-vis the approved amount of Rs. 2,84,812 crore. Further, foreign investment inflows into India are less than a tenth of that flowing into China. This indicates that India has failed to exploit the benefits of FDI even in this liberalised era.

Secondly, the gap between approved and actual inflows of investment is widening over time. Approximately 35 p.c of FDI is actually realised and, thus, 65 p.c. remain on paper. This gap may be attributed to the existence of hurdles in the way of implementing foreign investment plans.

Thirdly, so far foreign investors have chosen sectors like power generation and oil extraction. In addition, the most important sectors are telecom, electrical equipment including computer software, energy, and the transportation industry. These four sectors now account for roughly 50 p.c. of FDI inflows. Such preference is due to the wide possibility of profit margin.

By contrast, they are neither going into green-field projects, nor aimed at production for the world as opposed to domestic markets. Foreign firms are showing a great deal of preference for joint ventures in India with the aim of increasing their share in equity held in these companies. So far, FDI, in areas like equipment manufacturing or export-oriented production, has not come to notice.

Actual FDI now concentrates on domestic appliances, finance, .services, food products, etc. There is nothing high-technology about the bulk of FDI inflows and that they are aimed at capturing the market of middle class and upper class. The aspiration of this neo-rich classes is an incentive to foreign investors.


It is said that “300 million strong” Indian middle class’s “appetite for consumption… will not be satiated for the next 50 to 100 years.” “No (other) country could aspire for such a large market, as India, for investment, where an ever-increasing middle class is hungry for quality goods and services.” What is more important is that the balance of payments impacts of such foreign investment inflows are likely to be clearly against long-term interests of the country, without any corresponding gain in productive capacities of the country.

Finally, the strengthening of foreign investment through mergers, acquisitions and takeovers is posing a great threat to Indian monopolists and big businesses as some of them have lost ground to MNCs. A study of the Indian Institute of Management, Calcutta, observed that “not only has there been an accumulation in mergers and acquisitions since liberalisation, but also a dramatic increase, amounting almost to 50 p.c., in the share of such mergers and acquisitions accounted for by TNCs.” The policy has also failed in creating additional job opportu­nities for Indian people.