The fact that
FDI inflows do not always reflect investments in greenfield projects
is not without significance. Both foreign firms set up during the
years when FERA limited foreign shareholding to 40 per cent and Indian
companies established during the import substitution phase of Indian
industrialisation were created with the domestic market as their primary
targets. In the case of foreign firms, quantitative restrictions and
high tariffs forced those that could earlier service the Indian market
with exports from the parent or third-country subsidiaries to jump
tariff barriers and set up capacity within the domestic tariff area
in defence of existing markets. On the other hand, the large market
'opened up' to domestic entrepreneurs by protection, which
was expanding as a result of state investment and expenditure, provided
a major stimulus for the creation of new indigenous firms by Indian
industrialists to cater to the local market. Such protection also
ensured that profit margins on domestic sales exceeded that on exports,
encouraging firms to focus on production for the home market. The
government itself did little to counter this tendency generated in
part by its own actions.
of such firms was not merely because protection made the domestic
market the target for these investors. Foreign firms which either
invested in domestic capacity or licenced their technologies to domestic
firms, were not keen on encouraging competition from capacity created
in India in international markets being serviced by the parent firm
or its third-country subsidiaries. Firms in India were virtually straitjacketed
into servicing the large Indian market. The net result was that even
when the world market for manufactures was expanding quite rapidly
in the 1950s and 1960s, both foreign and domestic firms from India
were conspicuous by their absence in international markets.
Given the evolution
of these firms, it should be expected that any increase in the equity
stake of the foreign investors in existing joint ventures or purchase
of a share of equity by them in domestic firms does not automatically
change the orientation of the firm. This implies that if FDI inflows
in the wake of liberalisation are directed at enhancing foreign equity
in 'rupee companies' registered in India but controlled
by foreigners or into the acquisition of Indian companies occupying
a prominent place in the Indian market, the aim of the investor is
to benefit from the profits being earned by such firms in the Indian
market. As a result, in such cases FDI inflows need not be accompanied
by any substantial increase in exports, whether such investment leads
to the modernisation of domestic capacity or not. This fact counters
the presumption of many advocates of reform who argue that, in the
context of globalisation, FDI flows reflect the need of large international
firms to seek out the best locations for world market production,
resulting in a virtuous nexus between foreign direct investment and
This is not to
say that there is no change in the nature and operations of foreign
firms in a more liberalised context. Rather, since the relaxation
of controls on FDI inflows under reform is accompanied by the liberalisation
of the rules governing the operation of foreign firms and is accompanied
by substantial trade liberalisation, we can expect two tendencies.
First, there could be greater expenditure of foreign exchange by these
firms on imported inputs. Second, there could be greater expenditure
of foreign exchange because of the larger payments on account of royalties
and technical fees and larger repatriation of profits as dividends
encouraged by the more liberalised environment.
The first of
these is most likely. To start with, foreign firms would seek to use
trade liberalisation and the liberalisation of regulations with regard
to use of international brand names, to cash in on the pent up demand
among the more well-to-do for a range of product innovations available
in the international market place, access to which was restricted
in the protectionist phase. Even if the market for this range of 'new'
products is small, they can be 'manufactured' and sold in
the domestic market with relatively small investments at the penultimate
stages of production, based on imported intermediates and components.
restrictions on imports can encourage the practice of 'transfer
pricing' or imports from the parent or a third country subsidiary
located in a tax-haven at inflated prices, so that profits are 'transferred'
to firms in low tax locations. This obviously implies that the foreign
exchange cost of domestic production is inflated further.
the tendency to extract larger payments in the form of more 'open'
transfers such as royalties and technical fees, the operations of
foreign firms can for these reasons result in a significant drain
of foreign exchange. To the extent that these tendencies are associated
with investments focused on exploiting the domestic market, where
the market shares of domestic producers are either bought out or eroded
by competition from internationally known brands, there would be little
by way of enhanced foreign exchange earnings to neutralise their adverse
balance of payments consequences. In the even, the net balance of
payments impact of FDI inflows can be negative.