Role of foreign capital

Foreign Capital

1. Unit- Vb (iii) Foreign Capital Prof. Mahendra Kumar Ghadoliya

2. Contents Introduction Forms of Foreign capital Advantages of foreign Capital Disadvantages of Foreign Capital Government Policy

3. Introduction Relationship between capital and development To raise rate of growth through rapid industrialization Low saving, low rate of capital formation Lack of skills and technical know-how Shortage of resources for development Foreign capital is an important source of finance in the development. Overcome BoP crisis Foreign capital is needed for competition and break domestic monopolies, to raise investment and employment

4. Components of Foreign Capital in India Foreign Capital Investments Foreign Aid External Commercial Borrowings 1. Foreign Capital Investments:-  Foreign capital investments refer to investments made by an entity which is not the resident of the country. In India there are two components of foreign capital Investments: ( i )   Foreign Direct Investments (FDI) (ii)   Foreign Portfolio Investments (FPI)

5. ( i ) Foreign Direct Investments (FDI): FDI refers to the physical investments made by foreign investors in the domestic country. The physical investments refer to the direct investments into building, machinery and equipment. The direct investor can be an individual, public or private enterprises (referred to multinational corporations or MNCs) or Government. The   important forms of FDI  are investments through: ( i )               Financial Collaboration (ii)           Joint Ventures and Technical Collaboration (iii)          Capital Markets (iv)           Private Placements .

6. (ii)  Foreign Portfolio Investments (FPI):  FPI refers to the short-term investments by foreign entity in the financial markets. These are indirect investments and include investment in tradable securities, such as shares, bonds, debenture of the companies. Foreign Portfolio investors don’t exert management control on the enterprise in which they invest. There are three kinds of FPI in India:   a )   Foreign Institutional Investment:  These are the investments made by foreign institutions like pension funds, foreign mutual funds etc. in the financial markets. b) Funds raised through Global Depository Receipts or American Depository Receipts (GDRs/ADRs):     GDRs and ADRs are instruments which signify the purchase of share of Indian companies by foreign investors or American investors respectively. c) Off-shore funds:  The schemes of mutual funds that are launched in the foreign country .

7. 2.External Aid External aid refers to the concessional foreign finance with flexible terms and conditions. It may be in the form of  long term concessional debt or grants (doesn’t involves any repayment obligations). The tenure of the aid is generally very long.  The important  sources  of foreign aid in India are: ( i ) Official Aid: It is given by foreign governments or international official bodies such World Bank, International Monetary Fund (IMF), Asian Development Bank (ADB) etc. It can be: Bilateral Aid- It is between government to government basis. Multilateral Aid – It is Foreign Assistance through International Institutional Agencies- World Bank, IMF.

8. 2.External Aid-2 Further, official aid (Bilateral or Multilateral) can be  Government Aid  (i.e. aid that passes through government) or Non-Government Aid  (i.e. aid received by non-government bodies directly from bilateral or multilateral agencies).  (ii)   Private Aid:  It is the fund which is received from private individuals, firms or institutions.

9. External aid may also be distinguished as:   Tied aid Untied aid. The tied aid is given with conditions in terms of its use e.g for the purchase of goods for specific purpose or to be spent on specific country. The untied aid can be used freely by the recipient country. Foreign aid allows an access to foreign funds without putting pressures of their repayment.

10. Problems with Foreign Aid- Political Pressures:  Uncertainty of Aid:  Restrictive Use:  Low Utilization Rate:  Complacent domestic initiatives: Despite the problems associated with foreign aid, factors, such as lower cost, long-term nature of aid, have encouraged the dependence on foreign aid in comparison to commercial funds. In the recent years however, there is a significant decline in foreign aid as a percentage of GDP.

11. 3. External Commercial Borrowings Any money that has been borrowed from foreign sources for financing the commercial activities in India are called External Commercial Borrowings. The Government of India permits ECBs as a source of finance for Indian Corporates for expansion of existing capacity as well as for fresh investment.

12. Foreign Sources The ECBs are defined as money borrowed from foreign resources including the following: Commercial bank loans Buyers’ credit and suppliers’ credit Securitised instruments such as Floating Rate Notes and Fixed Rate Bonds etc. Credit from official export credit agencies and Commercial borrowings from the private sector window of Multilateral Financial Institutions such as International Finance Corporation (Washington), ADB, AFIC, CDC, etc.

13. How ECB is different from FDI? External Commercial Borrowings is not meant for Equity participation. If the foreign capital is used to finance the Equity Capital, it would be termed as Foreign Direct Investment . The ECB should satisfy the RBI regulations in this regard. The Bonds, Credit notes, Asset Backed Securities, Mortgage Backed Securities or anything of that nature are included in ECB. The following are not included in the ECBs: Any Investment made towards core capital of an organization such as equity shares, convertible preference shares or convertible debentures. The convertible instruments are covered under the FDI Policy.

14. Advantages of foreign Capital Technical and Managerial Improvement Supplement domestic resources Human Capital improvement Ease balance of payment position Infrastructure development Create competitive and efficient Business Environment Augmentation of employment opportunities Better corporate practice Improvement in financial System Contribution to national exchequer

15. Disadvantages of foreign Capital Can Aggravate Monopolistic Tendencies Old technology Income Inequalities Profit goes out of the country Luxury consumption pattern Reduce foreign exchange Volatility in the market Regional disparities Crowds out local entrepreneur and Growth