CHAPTER 4 FOREIGN DIRECT INVESTMENT IN INDIA - OVERVIEW

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1 86 CHAPTER 4 FOREIGN DIRECT INVESTMENT IN INDIA - OVERVIEW Foreign Direct Investment (FDI) is the process whereby residents of one country (the home country) acquire ownership of assets for the purpose of controlling the production, distribution and other activities of a firm in another country (the host country). FDI is a measure of foreign ownership of productive assets, such as factories, mines and land. Increasing foreign investment can be used as one measure of growing economic globalization. According to International Monetary Fund (IMF) definition, FDI has three components, viz., equity capital, reinvested earnings and other direct capital. A large number of countries, including several developing countries report FDI inflows in accordance with the IMF definition, which include reinvested earnings and other direct capital flows, besides equity capital. The aggregate cost of 32 domestic mergers and acquisition (M&A) agreements in India in January 2010 stood at US$ 2,167 million against 8 deals amounting to US$ 1,324 million and 28 deals amounting to US$ 223 million in 2009 and 2008, respectively. In the fiscal year 2009, developing economies gained a massive share of 51.6% FDI, more than what the developed nations gained, as per the survey by Ernst & Young on globalization. This was chiefly because of major decline in FDI into industrial markets, that was 50% less than FDI in With the fiscal structure gaining momentum, endowment proposals in India Inc witnessed an upsurge of around 16% in 2009 to US$ million, as per the report conducted by a premiere sectoral body.

2 87 In 2009, nine tenders contributing total FDI of US$ million was sanctioned by the central administration. Among the sanctioned tenders, Mitsui and Company of Japan is expected to contribute US$ million to set-up a fully governed subsidiary in the warehousing industry. In January 2010, the Indian government gave its consent to 14 FDI tenders which are likely to bring foreign investment amounting to US$ million. These encompass: US$ million worth FDI tender by Asset Reconstruction Company FDI valuing US$ million by Standard Chartered Bank that is likely to elevate to 100% from 74.9% in its portfolio management arm. Tenders by Sahara One, KS Oils and NDTV Imagine, NDTV Lifestyle tender worth US$ million Tender by India Infrastructure Development Fund based in Mauritius that is likely to bring US$ million 4.1 INDIA S FDI ENVIRONMENT In recent years, India has emerged as a desirable location for FDI by investors from the United States and many other countries. Its rapidly growing economy, low wages, and educated work force have attracted FDI in the services and manufacturing sectors to serve both the Indian market and third country markets. Foreign investors enthusiasm for India, however, has been tempered by widespread poverty, rigidity in the labour market, rising salaries and high employee turnover in some industries, an antiquated infrastructure, weaknesses in the overall educational system, and excessive bureaucracy and corruption. India ranked relatively higher in several attributes, including institutions, market efficiency, business sophistication, and innovation, but relatively lower in infrastructure, macro economy, health and primary education, higher education and training, and technological readiness. Actual FDI into India in the past 4 years reflects these mixed perceptions with respect to the business climate in India relative to other countries. Although FDI into India increased irregularly between 2002 and 2005, from $5.6 billion to $6.6 billion, it was orders of magnitude smaller than that into China, Brazil, and Mexico.

3 88 This positive economic environment has attracted FDI by firms anxious to take advantage of higher Indian living standards and increased demand for goods. The Indian economy has grown, an average, more than 7 percent annually since 1994, and is forecast to grow at a comparable rate in The FDI approval process has also been shortened and simplified through the implementation of the automatic route for approval in more and more industries. These incentives, along with the continued liberalization of caps on foreign firms ownership equity in most industries, have contributed to the recent steep increases of FDI in India. The Home Ministry of India has given its approval to London-listed miner Vedanta Resources' buying majority stake in Cairn India for $ 8.7 billion. (Jeyshankar Menon, 2011) 4.2 INDIAN AUTOMOBILE INDUSTRY AND TRENDS AN OVERVIEW The auto industry in India is the ninth largest in the world. After Japan, South Korea and Thailand, in 2009, India emerged as the fourth largest exporter of automobiles. Several Indian automobile manufacturers have spread their operations globally. Indian auto industry, which is currently growing at the pace of around 18 % per annum, has become a hot destination for global auto players like Volvo, General Motors and Ford. The Indian automobile industry is going through a phase of rapid change and high growth. With new projects coming up on a regular basis, the industry is undergoing technological change. The major players are expanding their plants and focusing on mass customization, mass production. (Indian Automobile Industry Apr-Jun 2010) Potential of the Automobile Industry Seeing the growing Indian automobile market, many luxury car makers also made their foray in the country. The turnover of the entire industry in April-February stood at Rs. 1,62, crore as compared to Rs. 1,28, crore in the same period last year. India has manufactured a number of global car makers to establish their manufacturing plants here. Some of the car manufacturers who are making their vehicles here are Audi, BMW, General Motors, Fiat, Honda, Hyundai, Mercedes Benz, Mitsubishi, Volkswagen and Toyota. (Auto Car India 2011).

4 4.3 FDI IN INDIA - POLICY INITIATIVES 89 The Indian government has assured to release an improvised FDI policy in every six months. The offers announced by Union Finance Minister, Pranab Mukherjee, in Union Budget , to enhance investment ambiance in India on February 26, 2010 entail: Measures implemented to un-complicate the FDI system System for computation of indirect foreign investment in Indian firms has been comprehensively classified. Entire liberalization of costing and imbursement of technology transmit charges and trademark, and royalty expenses. Additionally, the Indian government has permitted the Foreign Investment Promotion Board (FIPB), to sanction FDI tenders of up to US$ million. Previously all the tenders that entailed foreign direct investment of more than US$ million were presented in front of Cabinet Committee of Economic Affairs (CCEA) for authorization. Economic policymakers in most countries go out of their way to attract FDI. A high level of FDI inflows is an affirmation of the economic policies that the policymakers have been implementing as well as a stamp of approval of the future economic health of that particular country. There is clearly an intense global competition for FDI. India, for its part, has set up the India Brand Equity Foundation to try and attract that elusive FDI dollar. (Ramkishen et al 2008) India, with its relatively well developed financial sector, strong industrial base and critical mass of well educated workers, appears to be well placed to reap the benefits of FDI In view of this, it is appropriate that Indian policy makers continue to make concerted efforts to make India an attractive destination for FDI. Recognizing the potential benefits of FDI, the government seeks to double the FDI inflow to US$ 30 billion in fiscal 2009 in order to maintain a growth rate of 9 per cent per annum over the next five years.

5 90 Section 2 takes stock of the current state of FDI in India, focusing on the country sources, state-wise destinations and main sectors that have attracted FDI. Section 3 discusses why India has problems in attracting FDI beyond the obvious and major infrastructural constraints. The final section concludes with a selective set of ten policy recommendations relating to Indian FDI policy going forward. (Ramya Ghosh 2008) 4.4 THE INDIAN FOUR WHEELER INDUSTRY The four wheeler industry in India has not been able to match up to the performance of its counterparts in other parts of the world. The main reason for this has been the regulatory atmosphere that prevailed till the deregulation in the mid 1990s. After the Liberalisation the passenger car segment saw a boom and many companies from India as well as foreign entered the market. However, the smooth sailing was suddenly disrupted in the last quarter of FY1996. The automobile industry, which contributed substantially to industrial growth in FY1996, failed to maintain the same momentum between FY1997 and FY1999. The overall slowdown in the economy and the resultant slowdown in industrial production, political uncertainty and inadequate infrastructure development were some of the factors responsible for the slowdown experienced by the automobile industry. In FY2000, the sector experienced a turnaround, posted positive growth rates and witnessed the launch of many new models. But the spectacular growth in FY2000 was followed by a decline in FY2001 and only a marginal growth of 0.5% in FY2002. However, since FY2003, industry sales have increased at a 3- year CAGR (Compound Annual Growth Rate) of 17.4% to 1.14 million in FY2006. Due to the recent natural disaster in Japan and shutdown of several nuclear reactors after the earthquake, auto component manufacturers may send a delegation to explore the possibilities of partnering with Japanese component manufacturers in setting up facilities to India. ACMA (The Automotive Component Manufacturers Association of India) to set up a focused group in this respect at the earliest and also to take the assistance of Japanese manufacturers in India to take forward this activity in the long run. (Shri Ambuj Sharma, 2011)

6 91 Indian auto sales, which grew at a breakneck pace of 30 per cent in fiscal year 2011, are now expected to grow 11 to 13 per cent this fiscal year, slower than the 12 to 15 per cent forecast earlier. Passenger car sales in India are seen growing at 10 to 12 per cent this fiscal year, down from an earlier forecast of 16 to 18 per cent. An increase in vehicle finance rates and fuel prices are the main concerns for the rest of the year, and India has raised diesel and petrol prices by about 9 percent in the past two years day by day. (Goenka 2011) 4.5 DEMAND CHARACTERISTICS (A) Passenger Cars In developed markets, engine capacity and wheel-base are the bases of segmentation of passenger cars: price does play a role but only up to a point. Since affordability is the most important demand driver in India, the domestic car market has until now been segmented on the basis of vehicle price. Price-based competition takes place in a continuum rather than in segments since nearly all the models are launched in multiple versions at different price points. As a result, a higher-end variant may compete with a lower-end variant of a car in a segment above it. (B) Multi Utility Vehicle (MUVs) The MUV segment consists of vehicles that are suited to both rural and urban areas. In rural areas where the roads are usually bad, these vehicles are used as goods carriers and also for public transportation. Northern and Western India account for nearly two-thirds of the demand for MUV. Specifically, in States like Rajasthan, Madhya Pradesh, Uttar Pradesh and Maharashtra, the demand for MUVs is the largest. There are three segments of buyers for MUVs: the private market, Government, and the Defence. Until the 1990s, the Government and Defence segments accounted for the largest share of the market. The reduction in Government and defence spending since the 1990s has substantially reduced sales to these two segments. This has pushed private sector purchases into greater prominence.

7 92 There are three sub-segments of the UV / MUV segment: the hard-top, softtop and pick-up. The hard-top version consists of the higher-end Sports Utility Vehicles (SUVs) that have been present in the Indian markets since FY1999. Following the success of the higher-end SUVs, the share of the hard top segment in total MUV sales has registered an increase. Soft-top MUVs, which are largely dependent on sales in the rural and semi-urban markets where the vehicles serve as modes of mass transportation (maxi taxi); have witnessed a contraction in volumes in recent years. The declining share of the soft-top sub-segment is attributable largely to the increasing acceptance of SUVs as an alternative to soft-tops (and even higher end-cars). That apart, soft-top sale have also been affected by a decline in rural income, increase in sales tax in some states, increase in diesel prices, enforcement of strict emission control norms, and restraints on the issue of licences to use soft-top vehicles as rural taxis.(manisha, et al 2009). 4.6 INDIAN PASSENGER VEHICLE INDUSTRY-NEW POLICY REGULATION Policy on FDI Although Indian business regulation principally falls under the jurisdiction of federal law, state governments are empowered to design and regulate their own FDI policies. Consequently, the regulatory burden on foreign investors tends to be higher at the state level where application and approval procedures can vary widely across states. Ministry of Commerce and Industry, Department of Industrial Policy & Promotion (FC Division), has issued a Circular No. 2 of 2010, updating all instructions and clarifications relating to FDI policy. India has become the centre of attraction for global car makers given the immense opportunity with mid-income masses aspiring to own a car as well as abundance of raw materials and low-cost labour. Favorable Foreign Direct Investment (FDI) policy makes the entry of international players easy into India. India as the hub for small car production which will drive the car exports from our country.

8 93 The Government permitted 100 per cent foreign direct investment (FDI) in the automobile and component sectors under the automatic route, as part of its muchdelayed and watered down Automobile Policy. Until now, 100 per cent FDI in this sector was allowed only on a case-by-case basis, while automatic approval in the sector was granted only for FDI with a maximum equity participation of 51 per cent. The new automobile policy, announced by the Minister for Department of Heavy Industries and Public Enterprises, Mr.Manohar Joshi, does not prescribe any minimum investment norms. Earlier drafts of the policy were planning to impose a minimum investment criterion of $100 million for projects to make four-wheelers and $25 million for projects to make 2-3 wheelers. Analysts are of the opinion that the lack of investment norms may open the door for small Chinese firms to set up shop in India and virtually trade their products rather than resort to local manufacturing. There was no need to impose minimum investment norms in the highly competitive automotive industry in India. The policy will consider fiscal incentives for the sector and change the excise and customs duty levels over a long period of time to encourage domestic production and prevent India from becoming a dumping ground. (Joshi 2010) As part of the policy, the Government has promised to give adequate accommodation to indigenous industry in respect of items such as buses, trucks, tractors, completely built units and auto components, which have bound rates under the World Trade Organization guidelines. In respect of items such as cars, utility vehicles, motorcycles, mopeds, scooters and auto rickshaws (which do not have a bound rate), "the import tariff will be so designed as to give maximum fillip to manufacturing in the country without extending undue protection to the domestic industry." The policy intends to further improve research and development by vehicle manufacturers by "considering" a rebate on the applicable excise duty for every one per cent of the gross turnover of the company spent on research activities. Besides announcing a plan to formulate a comprehensive auto fuel policy, the Auto Policy

9 94 also proposes to give tax breaks for setting up of auto design firms and expand the scope of allocations to automotive chess fund. The structure of India's auto industry is unique when compared to other developed economies. Besides a strong four-wheeler market, India also has sizeable two-wheeler, three-wheeler and commercial truck markets. The country rolled out a total of 8.5 million vehicles in 2004, of which 1.2 million were passenger cars and multi-utility vehicles. By 2010, India will be a two million passenger-car market and will become a three million market by 2015, according to Roland Berger Strategy Consultants. If only India had previously developed an adequate road infrastructure, these volumes could have already been reached. Purchasing power for such volumes exists today, but road development is moving at a far slower pace. Although the foundation for a strong passenger-car industry was laid in the early 1990s, real momentum has been building only since 2000, when the government significantly changed its policies, taking steps to make manufacturing more internationally competitive by creating export promotion zones and expanding infrastructure. India also freed industry from excessive regulations five years ago. Its stance toward foreign direct investment also became less restrictive. In China a joint venture is required for domestic production. India's auto FDI policy, on the other hand, allows global DEMs to have 100% ownership, which has created a healthy industry from the start. India's investment policy has been formulated with a view to invite and encourage FDI in India. The process of regulation and approval has been substantially liberalized. The Reserve Bank of India has prescribed the administrative and compliance aspects of FDI. Two broad categories characterize FDI: investment under automatic route and investment through prior approval of the government.

10 4.6.2 Other policies Fleet Modernization Programme The economic development has also brought with it the unavoidable problems of urbanisation and as people go about their lives at high speeds, air quality in general and emissions from vehicles in particular has become an issue of primary concern. Measures that are essential for reducing the vehicular pollution load are: Mandatory Inspection & Certification (I&C) for all types of vehicles to improve the health and general condition of in-use vehicles, Putting in place an incentive scheme by OEMs for Voluntary Retirement of vehicle and Retirement of vehicles which cannot get the road worthiness certificate. 2. Export Incentives The two schemes recently running to incentivise exports are Focus market Scheme and Target Plus Scheme in their present form does not benefit much the automotive sector. The industry feels that due to high incidence of embedded taxes and duties already faces an uncompetitive cost structure vis-a-vis its competitors (like China) Procedure for FDI under automatic route FDI in sectors/activities to the extent permitted under automatic route does not require any prior approval either by the government or Reserve Bank of India (RBI). The investors are only required to notify the concerned regional office of RBI within 30 days of receipt of inward remittances and file the required documents, that is, the name of the collaborators, details of the allotment, copy of the foreign collaboration agreement, the original foreign inward remittance certificate from the authorised dealer and other specified information with that office within 30 days of issue of shares to foreign investors.

11 4.6.4 Procedure for FDI through government approval 96 FDI in activities not covered under the automatic route, requires prior government approval and are considered by the Foreign Investment Promotion Board (FIPB). Approvals of composite proposals involving foreign investment/foreign technical collaboration are also granted on the recommendations of the FIPB. Application for all FDI cases, except for Non-Resident Indian (NRI) investments and 100% Export Oriented Units (EOUs), should be submitted to the FIPB Unit, Department of Economic Affairs (DEA), Ministry of Finance. Application for NRI and 100% EOU cases should be presented to Secretariat for Industrial Assistance (SIA) in Department of Industrial Policy & Promotion. Applications can also be submitted with the Indian Missions abroad for forwarding onwards to the Department of Economic Affairs for further processing. 4.7 AUTOMOBILE POLICY 2002 The Automobile Policy 2002 seeks to make India an international hub for manufacturing small affordable passenger cars and a key centre for manufacturing tractors and two wheelers for sales worldwide Foreign Direct Investment The Indian auto industry with a turnover of US$12 billion and the auto parts industry with a turnover of US$ 3 billion offer excellent scope for FDI. Automatic approval for foreign equity investment upto 100% of manufacture of automobiles and component is permitted. The automobile industry is deli censed. Import of components is freely allowed Investment Opportunities and Policy Initiatives Foreign direct investment (FDI) flows into India in May more than doubled to about $4.7 billion from the same period a year ago. FDI flows into India during the April-May 2010, period were up an annual 77 percent at about $7.8 billion.

12 97 In 2010/11, India received 25 percent less foreign direct investment than the previous year Future directions in emission standards According to the Automotive Industry Government Report 2011, the Auto Fuel Policy has recommended introduction of Euro IV equivalent emission norms in 2010 in 11 cities and Euro III equivalent in rest of the country. Industry can comply with this roadmap subject to the availability of the required fuel in all retail outlets at least one year ahead of the introduction of emission norms. The industry should gear up for complete alignment with ECE regulations on emission and safety by Other Fiscal Incentives Fiscal incentives in the form of zero taxes/levies on technology transfers (products, features, alternative fuels) would aid industry in its endeavour towards market oriented products. R&D being a highly capital intensive exercise it would be necessary to develop shareable resources for product testing and validation like NATRIP (National Automotive Testing and R&D Infrastructure Project) For promoting Product design and development, which is a highly involved activity, augmentation of weighted deduction under Section 35(2AB) of Income Tax Act to 200%(currently 150%) and extending this up to 10 years may be considered. For Made in India products, it can be thought of providing an Excise Duty concession for vehicles that have 90% or higher local content. This can be a form of incentive for Made in India products vis-à-vis assembled in India products. The development of Indica and Scorpio has instilled a new confidence in local manufacturers, to give it a 22 further fillip and to attract the investment for designing and R & D for product development in India also calls for incentivizing the efforts in that direction. Tax Exemption on R&D Consultancy Services - The process of new product introduction in the automotive industry entails joint work by many specialized institutions and organizations for the development of the new technology, designs and the entire process of commercializing of the product including testing and validation.

13 98 According to Working Group on Automotive Industry Government Report August , Government should exempt the Income Tax on such R&D Consultancy services and consider allocating grants for local R&D Institutions. This would specially benefit institutions like IITs, IISC, BITS, CSIR Labs as well as international institutions specialized in their own field of technology. This shall encourage not only the Indian companies to design and develop new automotive products in India, but would also encourage MNCs to shift their design and development to India, thereby making India as the most preferred destination for global R&D in the automotive industry. These subjects are under study of Mashelkar Committee and the issues pertaining to the industry will be submitted before the Committee.

14 99 CHAPTER INDIAN PASSENGER VEHICLE INDUSTRY-PROFILE India has become the centre of attraction for global car makers given the immense opportunity with mid-income masses aspiring to own a car as well as abundance of raw materials and low- cost labour. Favorable Foreign Direct Investment (FDI) policy makes the entry of international players easy into India. Various manufacturers are envisaging India as the hub for small car production which Care Research believes will drive the car exports from our country. Increasing income levels on the one hand and lower cost of ownership with the launch of Nano by Tata Motors on the other would translate into healthy growth of domestic car sales. (Research & market Report on Indian Passenger Vehicle Industry-p1) 5.2 AUTOMOBILE SECTOR - THE INDIAN SCENARIO During early 60s & 70s, automobiles came largely in twos (two wheelers), 1.Scooters, had a Lambretta or a Vespa., 2. motorcycles, had a Bullet or a Java., cars, had to choose between an Ambassador and a Fiat, In trucks, it was either an Ashok Leyland or a Tata., In tractors, it was between a Swaraj and a Mahindra. This situation reflected the India of yester years. Economic reforms and deregulation have transformed that scene. Automobile industry has written a new inspirational tale. It is a tale of exciting multiplicity, unparalleled growth and amusing consumer experience - all within a few years. India has already become one of the fastest growing automobile markets in the world. This is a tribute to leaders and managers in the industry and, equally to policy planners. The automobile industry has the opportunity to go beyond this remarkable achievement. It is standing on the doorsteps of a quantum leap.