The impact of FDI inflow on local companies efficiency: evidence from the Indian case

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1 The impact of FDI inflow on local companies efficiency: evidence from the Indian case Yogesh Ingle ICSSR Research Fellow. Student of Sinhgad Institute of Management, Pune & Dr Sanjay Patankar Director, AISSM, Pune. PhD Guide Abstract: This research paper aims to investigate the impact of foreign direct investment (FDI) inflow occurring through merger and acquisition upon the local target company performance, as measured by efficiency. It relies upon the idea that multinational enterprises (MNEs) act as a device to transfer firm specific proprietary assets, thus causing their subsidiaries to exhibit better performance than their host country rivals. To prove this authors has used efficiency ratios to help in assessing the adequacy of efficiency earned by the company and also to know whether efficiency is increasing or declining. The efficiency of the firm is the net results of a large number of policies and decisions. These ratios are also called assets management ratios or activity ratios. These ratios measure how effectively the firm employees its resources. These ratios involve comparison between level of sales and investment in various accounts such as inventories, assets, debtors etc. This shows the combined effect of liquidity, assets management and debt management on the operating results. Efficiency ratios in this research paper are measured with reference to Stock Turnover Ratio, Inventory Ratio, and Assets turnover ratio. This is Descriptive research where objective is to find out relationship between FDI and efficiency on the basis of data which is collected from Secondary sources like Circulars, Bulletins and reports of WIR, DIPP, RBI & Planning commission, and various websites like CMIE Prowess, RBI etc., At the end with the help of Durbin- Watson, ANOVA and Karl Pearson Coefficient of Correlation method on SPSS version-20, study will find impact of FDI on efficiency in last decade, Keywords: FDI, Industrial sector, Stock Turnover Ratio, Assets turnover ratio, Indian Economy. Introduction: FDI is usually defined as a transfer of package of resources across the countries of the globe, which includes capital, technology, management and marketing expertise.1fdi is one of the three components of international capital flows, besides the portfolio investment and other flows like bank loans. Significant degree of influence and long term relationship are the key terms to distinguish FDI from portfolio investments, which are short term activities undertaken by institutional investors through the equity market. A lasting interest in foreign entity emphasises the difference to other forms of capital flows and occurs in form of know-how or management-skills transfer. Since a firm becomes multinational by setting up foreign affiliates, the term multinational enterprise can be used as synonym for foreign direct investment. In a globalized economy, for home economies, FDI provides opportunities for MNCs to earn profits on economic activities conducted outside the MNC s home economy. For host economies, FDI income represents the return on direct investment positions that accrues to MNCs acting as direct investors. Part of this income may be used by MNCs as additional sources for their capital expenditures in host economies, and the rest is repatriated to home or other countries. In some cases, these returns from host countries constitute a significant share of the total return to MNC capital. Because of the growth of FDI, FDI income has become an increasingly important component of the balance of payments, contributing significantly to FDI itself, and can play an important role in the overall economy as a source of domestic income or as an income outflow. Global markets are characterized by an uneven geographical distribution of reserves, production and consumption. Some developing and transition economies are among the main producers and net RJSSM: Volume: 05, Number: 11, March 2016 Page 133

2 exporters of various minerals, while developed countries and fast-growing emerging economies are the major consumers and importers. These imbalances sometimes create concerns among importing countries over the security of supply, and concerns among exporting countries over market access. The supply of minerals is essential for economic development: no modern economy can function without adequate, affordable and secure access to these raw materials. Trade can be important for both host and home countries in this context. For countries that lack the necessary indigenous capabilities for transforming their natural resources into commercial goods, foreign companies can bring the needed capital, knowledge and access to markets; for home countries, they can serve as vehicles for securing access to foreign supplies. 2 Intense competitive pressures in many industries are leading firms to explore new ways of improving their competitiveness. Some of these ways are by expanding operations in the fast-growing markets of emerging economies to boost sales, and by rationalizing production activities with a view to reaping economies of scale and lowering production costs. Higher prices for many commodities have further stimulated FDI to countries that are rich in natural resources. One of the main features of the globalisation at the end of the 20th century was the rapid increase of foreign direct investment (FDI). Multinational enterprises conducted FDI to serve foreign markets or to exploit differences in production costs among countries. This research paper has analysed the impact of FDI on Industrial growth through the efficiency of companies of India in the last decade, To prove this authors has used efficiency ratios to help in assessing the adequacy of efficiency earned by the company and also to know whether efficiency is increasing or declining. The efficiency of the firm is the net results of a large number of policies and decisions. These ratios are also called assets management ratios or activity ratios. These ratios measure how effectively the firm employees its resources. These ratios involve comparison between level of sales and investment in various accounts such as inventories, assets, debtors etc. This shows the combined effect of liquidity, assets management and debt management on the operating results. Efficiency ratios in this research paper are measured with reference to Stock Turnover Ratio, Inventory Ratio, and Assets turnover ratio. This is Descriptive research where objective is to find out relationship between FDI and efficiency of selected companies in India on the basis of data which is collected from Secondary sources like Circulars, Bulletins and reports of WIR, DIPP, RBI & Planning commission, and various websites like CMIE Prowess, RBI etc., are referred. At the end with the help of Durbin- Watson, ANOVA and Karl Pearson Coefficient of Correlation method on SPSS version-20, study found positive impact of FDI on companies efficiency in Last Decade, Objectives of the Study: 1. To make a comparative analysis of the financial performance of FDI-sourced companies. 2. To assess the impact of FDI inflows on the growth of companies efficiency in India. Hypothesis of the Study: 1. H 01 : There is no significant impact of FDI on the Stock Turnover Ratio of selected companies in India. 2. H 02 : There is no significant impact of FDI on the Inventory Ratio of selected companies in India. 3. H 03 : There is no significant impact of FDI on the Assets turnover ratio of selected companies in India. Research Methodology: I. Explorative Analysis: A detailed literature survey was carried in the relevant areas like: International Trade, Theories of FDI, FDI, FDI s impact at Global level, Impact of FDI on Indian Economy. This enables the authors to form a basis for sourcing and preparing the base for carrying out the analysis. II. Analytical Analysis: This section of the study measured efficiency ratios with reference to Stock Turnover Ratio, Inventory Ratio, and Assets turnover ratio Of 12 FDI sourced companies which are listed on NSE index i.e. RJSSM: Volume: 05, Number: 11, March 2016 Page 134

3 Nifty, has been considered for analysis for the period of ten years from 2002 to In this case, FDI (as percentage of foreign promoter in the share holding pattern of the company) is considered as independent variable and financial ratios measured as dependent variables. 12 FDI based companies have been considered for the purpose of analysis. For each company FDI (% of foreign promoter) is considered as independent variable and selected 12 financial ratios are considered as dependent variables. Sampling Framework: Data Sources: Data on Foreign Direct Investment inflows of India was sourced from websites and reports of RBI and Department of Industrial Policy and Promotion (DIPP) and financial data of FDI companies taken from the website of Centre for Monitoring Indian Economy (CMIE Prowess) and respective company s website. Analytical Framework of the Study: Based on the literature deliberated and on conceptual understanding and the said objectives, analysis of the current study has been carried out at Micro level where financial variables are studied. Statistical Tools Applied: Karl Person s Correlation has been applied to analyze the correlation between the FDI inflows and Economic variables at Macro level and at Micro level, Regression Correlation has been applied to analyze the correlation between FDI inflows and financial performance of FDI sourced companies. Similarly, ANOVA, Durbin Watson [D-W] statistic, paired t test were performed to measure the internal consistency or deviation in the sample mean values for FDI inflows. Scope of the Study: This empirical study aims to fulfil this core need and is an indispensable reference guide for multi-national material suppliers, product manufacturers, foreign investors, executives, distributors, academicians, research scholars and many more, who are dealing with these composite markets. Limitations of the Study: The present research work has focused only on secondary data and the required data available from reputed sources were not uniform and hence interpreting results based on the statistical analysis may not be accurate Financial ratios on profitability and liquidity would have provided some more insight into assessing the impact of FDI on the growth companies efficiency of the specific sector. Literature Review: 1. Odozi V A (1995) 3 FDI is usually defined as a transfer of package of resources across the countries of the globe, which includes capital, technology, management and marketing expertise. 2. Subrahmanya M H B (2004) 4. In this paper, researcher in conclusion said that development that has been taking place since the early 1990s in the free movement of capital, commonly through FDI, particularly from the developed to developing countries. 3. Loots E (2002) 5 Author of this paper concluded that Globalization is a process in which an economy gets integrated with the rest of the world through trade, investment, and financial flows. 4. The theory of industrial organization proposed by Hymer (1976) and later developed by Kindleberger ( ), Caves (1971,1974), and Johnson (1970) emerged with Hymer s celebrated doctoral thesis of 1960 (published in 1976). 6 The theory is based on the general idea that foreign investors must possess some 'compensating or 'firm specific advantage, such as superior technology, differentiated product, a popular brand name or lower costs due to economies of scale, if they are to risk investing abroad. RJSSM: Volume: 05, Number: 11, March 2016 Page 135

4 5. The eclectic theory of FDI was proposed by Dunning (1981). 7 It has widely come to be known as the 'O L I (Ownership, Location, and Internalization) framework. Its attraction lies in the fact that it brings together various explanations of FDI. 6. The theory of FDI based on differences in international capital market is attributed to the work of Aliber (1970, 1971). 8 Author suggested that FDI is better explained in terms of capital advantages enjoyed by the source-country firm that should be enable it to capitalize the same stream of expected earnings at a rate higher than the host-country firms 7. Jamie D. Collins Dan Li and Purva Kansal As per the researchers, the stronger the institutional environment in a given home country, the more likely inbound FDI transactions are to originate from that country. Home country institutional munificence contributes to the deal screening, due diligence, deal structuring and transaction execution capabilities required to complete FDI transactions. Home country s institutional environment influences Indian FDI inflows. Strong home country regulative institutions and cognitive institutions are predictive of FDI inflows to India. 8. Dr. Arjun Singh Sirari, and Mr. Narendra Singh Bohra, As per Authors, FDI has helped to raise the output, productivity and employment in some sectors especially in service sector. Indian service sector is generating the proper employment options for skilled worker with high perks. 9. Nilanjana kumari Author concluded that India should accept FDI for the development and asked to have patience to get the benefit. Even researcher suggested to safe guard the interest of small companies and retailers due to increasing trend of FDI. 10. Zafar Ahmad Sultan In this research paper Author found out that most the MNC s comes to India to take advantage of growing market size determined by large population and economic growth (horizontal FDI). And there is one co integration relation between the variables implying that FDI and export has long run relationship. The VECM result shows that there is unidirectional causal relation from export to FDI direction and not from FDI to export direction. This implies that inflow of FDI in India is mostly not for efficiency seeking (vertical FDI). 11. Ms Poonam Dharyan, Dr.Geeta Shiromani and Ms tanushree Gulati, In this paper authors have suggested to government to focus on industries where FDI is required and even authors have suggested government to have watch and guard against the MNC s entering soft areas, transforming outdated technology and exploiting domestic market instead of helping to boost the county s foreign exchange earnings As per the literature review, scarcity of resources made every country to depend on each other for one or other reason. Now it is up to country s need, how much and in which sectors FDI should be allowed? Foreign companies enter into other country s market with the strategy of profit and wealth maximisation, and not for charity. So Host country where trade is going to happen should be well aware about its policies through which it can protect its resources from exploitation and take maximum advantages of Home country s resources. At the time of independence India was basically an agrarian economy, suffering from heavy population pressure with low labour productivity. During that time, the government of India spelt out its approach to the development of the industrial sector in successive five-year plans through different Industrial Policy. In India, it was only after 1985 that a shift towards liberalization started. But the active liberalization and globalization efforts were initiated with the economic reforms of the early 1990s. 14 As per data available from various studies it was over 8% of the GDP from to mainly due to expenditures on subsidies, interest payments, salaries and defence. The gap was managed by external borrowing. The condition became adverse and in 1991, foreign exchange reserves came down to $1 billion barely sufficient for two weeks imports at that time. The inflation rate peaked to 17% by August After pursuing a restrictive policy towards FDI over four decades of planning with varying degrees of selectivity, India changed track in the 1990s and initiated various changes such as devaluation of rupee, dismantling of import license system, full convertibility on trade account, fiscal retrenchment and credit squeeze, abolition of export subsidies, introduction of RJSSM: Volume: 05, Number: 11, March 2016 Page 136

5 import entitlement scheme for exporters, unification of the exchange rates, removal of the quantitative restrictions, massive reduction in the tariff rates and protection rates, and easing the restrictions on foreign investments. 16 These reforms paved way for FDI and facilitated the development of industrial sector. The Indian market was competitive, and it had been seen that not all entrants succeed. Foreign firms were therefore weighing the risk and the likely rewards, and adopting different strategies. In some cases, they were opting for mere technology alliances, without infusion of equity. In others, they were adopting a minority holding posture, joining hands with a local joint-venture partner. In others, they seek dominant control. A combination of factors plays a role in determining the nature of foreign participation. 17 Increase in export-oriented FDI inflows into India, which has helped to improve the Balance of Payments (BOP) of the Indian economy. It implies that FDI inflow has played a vital role in the Indian economy and it really matters in the growth process of the economy. In this context, it can be suggested that India should encourage the FDI inflows for the overall growth of the economy. There is a need to cautiously step towards FDI policy in order to further opening up of the economy as part of the Indian reform process. 18 The increasing inflow of FDI into India is partly attributed to rising inflow of FDI at global level and partly to liberalization policies proclaimed in the late 1980s and early 1990s. Further, the MNCs expanded their activities in other developing countries with the objective of reducing their cost of production on the one hand, and to search for new markets on the other. 19 As per World Investment Report 2013, 20 India continued to be the dominant recipient of FDI inflows to South Asia in However, the Indian economy experienced its slowest growth in a decade, and a high inflation rate increased risks for both domestic and foreign investors. As a result, investor confidence has been affected and FDI inflows to India declined significantly. A number of other factors, however, positively influenced FDI prospects in the country. Inflows to services are likely to grow, thanks to ongoing efforts to further open up key economic sectors. FDI helped the country to boost the economic development in terms of Capital, Employment, Machinery, Management skills etc. It helped domestic market to expand. In last decade i.e. from 2002 to 2012, average growth rate of FDI was 34.96%. During 2004 to 2009, FDI increased by 63%, pleasant thing was 159% growth of FDI in the year The gap formed between intended investment and the actual savings of the country was lifted up by portfolio investments by Foreign Institutional Investors, loans by foreign banks and other places, and foreign direct investments. Among these three forms of financial assistance, India prefers as well as possesses the maximum amount of Foreign Direct Investment which is non debt fund. Anitha (2012). 14 Authors have used efficiency ratio these ratios are also called assets management ratios or activity ratios. These ratios measure how effectively the firm employees its resources. These ratios involve comparison between level of sales and investment in various accounts such as inventories, assets, debtors etc. The turnover ratios used in this study are: I. Stock Turnover Ratio: This is also called Inventory turnover ratio. This ratio calculated as Stock Turnover Ratio = Net sales / Closing inventory: The stock turnover ratio measures how many times a company s inventory has been sold during the year. If this ratio has decreased, it means that either inventory is growing or sales is dropping. II. Inventory Ratio: This ratio is calculated as Inventory Ratio = Closing Inventory/ Current assets This ratio is helpful in assessing the level of inventories held up in current assets. III Assets turnover ratio : This is calculated as Assets Turnover ratio = Sales/ Total assets This ratio indicates the number of times assets are being turned over in a year. Higher ratio indicates over trading of total assets while a lower ratio indicates idle capacity. Impact of FDI on select economic variables: An Analysis based on aggregate parameters: The regression analysis run to assess the impact of FDI on Stock turnover ratio (STR), Inventory Ratio (IR) and Assets turnover ratio (ATR) of FDI based companies reveal that FDI significantly influences the STR and IR in the selected companies(see table 1 to 5) STR with R square value of and beta(t) value of with significance value of RJSSM: Volume: 05, Number: 11, March 2016 Page 137

6 IR with R square value of 0.647and beta(t) value of with significance value of ATR with R square value of 0.04 and beta(t) value of with significance value of FDI and Financial variables: Table No.1 Variable s Sales Inventori es Current assets Total assets FDI Inflow (Rs) FDI % Source: Compiled from various reports, circulars and bulletins of RBI, DIPP and Planning Commission and compiled from CMIE Prowess website. Financial Ratios: Table No.2 Year Stock turnover ratio Inventory ratio Asset turnover ratio Source: Compiled from CMIE Prowess website. FDI and Financial variables Summary: Table No.3 Mode l STO ITR R R Square Adjusted R Square Std. Error of the Estimate Sig. F Change Durbin- Watson.821 a a a ATO Source: Compiled by using SPSS version 20. FDI and Sales ANOVA: Table No.4 Model Sum of Squares df Mean Square F Sig. STO Regression b Residual Total ITR Regression b RJSSM: Volume: 05, Number: 11, March 2016 Page 138

7 Residual Total ATO Regression b Residual Total Source: Compiled by using SPSS version 20. FDI and Financial Variable Coefficient: Table No.5 Model STO ITR Unstandardized Coefficients B Std. Error Standardized Coefficients Beta t Sig. (Constant) FDI in % (Constant) FDI in % (Constant) FDI in % ATO Source: Compiled by using SPSS version 20. ANOVA, Durbin Watson [D-W] statistiopc and paired t test results were significant which were performed to measure the internal consistency in the sample mean values for FDI inflows. Test of Hypotheses: Based upon the analysis carried out, the following hypotheses are accepted/ rejected. The explanation for which is given below: No. Hypotheses Result Explanation 1 H 01 : There is no significant impact of FDI on the Stock Turnover Ratio of selected companies in India. Rejected Refer Table No.4 & 5 2 H 02 : There is no significant impact of FDI on the Inventory Ratio of selected companies in India. 3 H 03 : There is no significant impact of FDI on the Assets turnover ratio of selected companies in India.. Rejected Refer Table No.4 & 5 Accepted Refer Table No.4 & 5 Conclusion: In this study, authors has found positive impact of FDI on Stock turnover ratio and Inventory turnover ratio of select FDI companies. In case of Asset turnover ratio, authors has found no significant impact of FDI. Due to uneven growth in FDI, Sales, Inventory, Current assets and Total assets, ratios are also grown unevenly. Till 2009 there was steady growth in ratios but after that there was steep decline in these ratios due global financial slowdown. In future, growth in Sales, Total Asset and FDI in local companies may be enhanced by properly examining the challenges and opportunities available in the global markets and meeting the current market requirements. The Indian Corporate Sector also needs to take advantage of the recent advances in information technology and determine its future market and how well it can market its products to several regions and distributes risks, its forward and backward integration capabilities, its R&D, its consolidation through mergers and acquisitions, comarketing and licensing agreements. Bibliography: 1. Odozi V A (1995), An Overview of Foreign Investment in Nigeria: , CBN Research Department Occasional Paper Series No. 11, Central Bank of Nigeria, Nigeria 2. Stiglitz J (2002), Globalization and Its Discontents, Penguin Press, London. 3. Odozi V A (1995), An Overview of Foreign Investment in Nigeria: , CBN Research Department Occasional Paper Series No. 11, Central Bank of Nigeria, Nigeria. RJSSM: Volume: 05, Number: 11, March 2016 Page 139

8 4. Subrahmanya M H B (2004), Small Industry and Globalization: Implications, Performance and Prospects, Economic and Political Weekly, Vol. 59, No. 18, pp Loots E (2002), Globalization, Emerging Markets and the South African Economy, South African Journal of Economics, Vol. 70, No. 2, pp Nayyar D (2002), Governing Globalisation: Issues and Institutions, Oxford University Press, New Delhi. 6. Hymer, S.H. (1976). The International Operation of National Firms: A Study of Direct Foreign Investment. MIT Press, Cambridge, MA, United States. 7. Dunning J H (1994),, in Kogut B (Ed.), Country Competitiveness, Oxford University Press, Oxford. 8. Aliber, R.Z. (1970). A theory of direct foreign investment, in C. P. Kindleberger (ed.), The International Corporation. MIT Press, Cambridge, MA, United States 9. Jamie D. Collins Dan Li and Purva Kansal Home Country Institutions As Predictors Of FDI In India. Journal of Asia Business Studies FALL Dr. Arjun Singh Sirari and Mr. Narendra Singh Bohra. (2011). Foreign direct investment in India service sector (A study of post liberalisation). Int. J. Eco. Res., 2011, 2(2), Nilanjana kumari A study of fdi in india 2013.Journal of Economics and Sustainable Development. ISSN (Paper) ISSN (Online) Vol.4, No.3, Zafar Ahmad Sultan 2013 A Causal Relationship between FDI Inflows and Export: The Case of India Journal of Economics and Sustainable Development, ISSN (Paper) ISSN (Online) Vol.4, No.2, Ms Poonam Dharyan, Dr.Geeta Shiromani and Ms tanushree Gulati, 2013 Changing foreign investment policy and its impact on Indian economy. 14. R. ANITHA (2012).Foreign Direct Investment & Economic Growth in India. RJSSM: Volume: 05, Number: 11, March 2016 Page 140