Manual fifth edition
The dissertation is aimed at exploring the factors responsible for a gap that exists between the real FDI inflows as compared with approved FDI in India moreover the dissertation is also intended to find out weather or not there is a link between corporate taxes, import duties and the FDI gap in country. Both qualitative and quantitative approaches are utilized to explore different aspects of the issue. Secondary analysis of data is done to portray the picture of current scenario of FDI, GDP Growth, corporate taxed, import duties and MNCs activities.
In addition 20 interviews are conducted from the representatives of multinational companies operating in India that have secured approval for Foreign Investment from the Indian Government; from the representatives of the Reserve Bank of India and from Foreign Investment promotion Board. These interviews are conducted with a view to find evidence about the impact of corporate taxes and duties on FDI and to find out that up to what extent these factors are determining the gap between approved and actual FDI inflows coming to the country. 1. Introduction
Foreign direct investment is a modern phenomenon that is gaining importance in today’s advanced world. IMF’s Balance of Payments Manual fifth edition (BPM5) defines the foreign direct investment “as a category of international investment that reflects the objective of a resident in one economy (the direct investor) obtaining a lasting interest in an enterprise resident in another economy (the direct investment enterprise). For the establishment of foreign direct investment relation ship it is very necessary that the investor must acquire about 10 % ordinary shares or voting power of an enterprise (IMF Report, p6, 2003)
The growing volume of international trade and capital flows across the borders has characterized the economy of the modern world in the recent era of globalization. Foreign Direct Investment has become a vital tool for the countries to attain sustainable economic growth especially the developing countries have recognized the importance of FDI as a channel through which they can get access to the resources essential for the economic growth however a major share in the global FDI is contributed by the developed countries and the developing countries are still not getting big share in the global FDI inflows (Thomas L.
Brewer, 1991, p1). There are several factors behind this low share of developing countries like inadequate infrastructure of the developing countries, lack of investment incentives, high import duties and tax rates and overall illiberal investment regimes of most of the developing countries. Over the last couple of decade a spectacular change has been observed in the attitude of the developing countries towards FDI and these countries have made their trade policies relatively open and liberal so that they can attract more foreign direct investment (Thomas L.
Brewer, 1991, p1). The developing countries are facilitating the multinational companies by lowering down the tax barriers and raising the investment incentives so that the MNCs could be encouraged to invest in the country and along with the rise in the FDI flow, several other advantages could also be enjoyed by the host country like improvement in employment conditions, tax revenues and technology transfer etc (Dr. Amar KJR Nayak, p3, 2006). Like many other developing countries India is also deliberate to grab a substantial share in the global FDI flow.
The history of Foreign Direct Investment can be traced over the last hundred years but it has gain attention since the last 15 to 20 years. From the year 1999 the government has adopted the policy of attracting foreign direct investment and there are several steps taken by the government to facilitate the foreign investors for example foreign equity participation up to 100 percent was allowed for initiating projects in many of the sectors including for electricity generation, transmission and distribution.
An attempt was done in 1999 to liberalize the investment regime by introducing GRD/ADR guidelines that allowed the unlisted companies to float Euro issues under certain conditions. Despite all these measures a gap exists between approved and actual FDI inflows of the country. Some of the experts believe that high rates of corporate taxes and import duties are important factors behind this gap. It is measures that as compared with other rival economies like China, Germany, Spain and Singapore, India has a high rate of corporate taxes imposed on investment. The corporate taxes on the domestic companies are varied from 33.
6 per cent whereas for the foreign firms it is even more then 42 percent. In other countries the corporate taxes on the foreign firms are relatively low like in Hong Kong the foreign firms face corporate 17. 5 per cent tax whereas it is 20 percent in Singapore and 27 percent in Malaysia. This dissertation is based on a research study that is conducted through a mixed approach of qualitative and quantitative method and along with studying the current scenario of FDI inflows in the country, the paper also highlights the factors that play a part in creating this gap.
The study is based on a hypothesis that there is a positive relationship between FDI gap and rate of taxes and duties; when the duties and tax rates goes high the FDI gap is also widened and vice versa. This hypothesis is going to be tested in the dissertation so that based on the result of the study, some recommendations could be presented that can work to narrow down the gap between the actual and approved FDI and that the economy of the country can get maximum advantages of the FDI inflows.
1. 1 Need for the Study Most of the literature on FDI world wide and related to India is concerned with the variation in the FDI inflows and its impact on the economy however little researched have been done on the gap existing between the approved FDI by a host country against the actual utilised flow of FDI and to sort out the factors that are responsible for creating such gap between actual and approved FDI in India.
Therefore there is a gap in current research reflecting the relationship between the unrealised FDI and levels of tax, import duties as well as transaction costs, which if correlates to each other and addressed will result in benefits to the policy makers of India as well as MNCs willing to invest. Hence there is great need of understanding the reasons behind it so that it becomes possible to put forward some recommendations for improving the situation and to narrow down the gap.
It is also important to find evidence about the link between taxes, duties and FDI gap so that to control on the situation could be get through change in rates of corporate taxes and duties. This dissertation is an attempt to fill the gap that is found in the literature regarding the gap in real and approved FDI flows and the factors behind it. 1. 2 Rationale of the Study The study is based on finding out the reasons behind the gap created in the actual and approved flow of FDI in India and to witness the relationship between high rates of taxes, duties with FDI.
Therefore the rationale of the study is to witness the gap in actual and approved FDI flow in India and the role of taxes and duties in creating this gap. The objective to study the role and relation between taxes and FDI Gap is to come at a point that declining the tax rates and duties can result in minimizing the FDI Gap and the related government agencies and departments can concentrate on this point to achieve sustainable economic growth by increasing the FDI inflows. 1. 3 Significance of the Study
The study unfolds various important factors associated with the gap in actual and approved FDI flow in India. The link between taxes, duties and FDI gap is also attempted to explain through different sources. The study revolves around an important subject and the outcomes of the study will be useful as well as important because unfortunately in past there are not much work done on the same lines and this study will be among the few researches that are emphasised on the gap between actual and real flow of FDI and to explore the governing factors for this gap.
The study is significant from the investment point of view and the people interested in the investment regime of India can find in this study some very useful information about the current situation of investment in the country and can get a better understanding of different issues related with the investment opportunities and problems in India. Moreover the study possessed great significance because it is aimed at identifying the factors responsible for a problem so that the solution of the problem could be proposed.
1. 4 Investment Regime of India – Background Information Located in the Southern Asia region, India consists of population of 1,129. 9 million, as on 1st July 2007 (CIA Fact Book, 2007). Foreign Direct Investment is allowed in India in form of “financial collaborations, joint ventures and technical collaborations, thought capital markets and Euro Issues and through private placement or preferential allotments”.
However the foreign investors can not make these investments in some of the forbidden territories including “Arms and ammunition, Atomic Energy, Railway Transport, Coal and lignite and mining of iron, manganese, chrome, gypsum, sulphur, gold, diamonds, copper, zinc. ” The top three industries that catch the attention of foreign investors in India are “IT and Software, Business services and Consumer Electronics” however the real estate industry of the country is also emerging as an important and attention catching destination for the foreign investors.
India offers a return of 20 – 25 percent on real estate investment that is higher then other property markets like China and Thailand etc. that’s why the foreign investors are more encouraged to invest in the real estate industry of India and as a result there was increase of 16 percent in FDI in the real estate industry in 2006 whereas it is expected that in 2007 the foreign direct investment in the sector will rise up to 25 percent. (Indian Reality News, n. p. , 2007) 1. 5 Foreign Direct Investment in India – Trends and Statistics
As a result of the government policies to attract the foreign investors in the country there is a considerable rise in the FDI flows in the country and the growing interest of foreign investors in the investment opportunities of India is making the country an important destination for the FDI inflows. India is also considered as second most favourite centre for foreign direct investors after China. In the year 2004 there were total 986 projects were initiated by the foreign investments in the country and the market share of these project in the region was 92. 2 percent. There were 16.
5 percent projects that were related to the GDP growth of the country. The main source countries for FDI inflow in India are US, UK and Germany. Along with these countries Mauritius, The Netherlands, Japan, Germany and Singapore are also important source countries of FDI inflows in India. “LG, General Electrics and Intel” are the top most foreign investors that have brought considerable inflows of FDI in India. There is rise in the FDI inflow in the country that can be observed in the following table The trends in the FDI inflows in India are also explained by UNCTAD AS FOLLOWED
FDI Trends in India, 1987-2004 (Source UNCTAD website) 2. Theoretical Framework 2. 1 Foreign Direct Investment – Significance and Importance United Nations’ World Investment Report declared that foreign investment is continuously growing and in 2005 also there was considerable transaction and foreign direct investment flow was recorded. The report point out that foreign direct investment has become a global phenomenon in today’s world. The figures further support this impression that FDI has increases in 2005. Foreign direct investment rose by 29% – to reach $916 billion – having already increased by 27% in 2004.
Inward FDI grew in all the main sub regions, in some to unprecedented levels, and in 126 out of the 200 economies covered by UNCTAD. (World Investment Report, p1, 2006) UNCTAD (2007) declared that the foreign direct investment has a great potential for boosting economic growth of a country because due to increased foreign investment in the country, more jobs are created and the situation of employment becomes better. At the same time foreign direct investment also raises productivity because the manufactures have greater scope of trading.
Through foreign direct investment management skills and technologies are also exchanged between the host and investor country. In this way foreign direct investment accounts for economic development and most of the developing countries are well supported by foreign direct investment in their development process. UNCTAD also observe that almost all the countries are paying attention to the foreign trade investment and taking such steps that can attract the investors from all around the world to invest in their country and initiate different developmental projects.
(UNCTAD. org, 2007) Bijit Bora (2002) revealed that countries all over the world are interested and willing to increase the production and trade of good and services at international level through the multinational enterprises because these firms have identified the importance of foreign direct investment for the economic growth of the country that’s why “the annual growth rate of FDI during the last decade exceeded the growth of both the international trade in goods and services and output”. (Bijit Bora, p1, 2002).
Nagesh Kumar (1996) disclosed that the per capita income and the growth rate of a country are the main factors that can enhance the flow of foreign direct investment in the country. Foreign direct investment also has great impact on the income, balance of payment, private savings and government savings. More over the important feature of foreign direct investment is the generation of new employment opportunities because when any new project is started the companies need skilled labour to carry on the work (Nagesh Kumar, p9-11, 1996)
Jeffrey P. Graham and R. Barry Spaulding (2005) discovered that the role of foreign direct investment FDI in international trade is escalating day by day. According to their study foreign direct investment facilitates enterprises in so many ways and provide them “new markets and marketing channels, cheaper production facilities, access to new technology, products, capital, processes, products, organizational technologies, management skills and financing”.
In this way foreign direct investment accelerates the economy of the country. Raj Kumar (2003) draws light on the importance of FDI for an economy and defines foreign direct investment as “one of the key drivers of globalization”. He argues that foreign direct investment is a great challenge in front of the developing countries that they have to design such strategies that could result in rise of foreign direct investment in the country.
In this regard the governments of the countries play a very crucial role and their policies matter a lot in bringing foreign direct investment in to the country. If the government succeeds to raise the flow of FDI in the country then the country also enjoys positive enhancement in the human skills. (Raj Kumar, p1, 2003) 2. 2 Foreign Direct Investment in India
Lall (1999) studies the trends of Foreign Direct Investment in India and revealed that there were several restriction in the investment regime of India in term of restrictive investment policies on a freer inwards FDI however the changed attitude of the government towards the investment policies has resulted in increase of FDI inflows as the government has taken many steps to encourage the foreign investors by relaxing the investment policies and tight controls over the investment procedures.
Moreover the government has also done the reformation of the entry and registration procedures for the foreign investors that are bringing positive impacts on the economy of India (Lall S. , p27, 1999). Bajpai, Sachs (2000) revealed that there are many obstacles that are responsible for restricting the FDI inflows in the country. These factors were identified as “limited scale of export processing zones, no liberalization in exit barriers, high corporate tax rates, and high tariff rates by international standards, stringent labor laws, and financial sector reforms”.
Kumar (2005) noticed that these barriers have been minimized by the government but still the country need more liberal system so that it can be among the biggest receivers of FDI in world (Kumar, p459, 2005) Jha (2003) conducted a study on the investment regime of India and pointed out that there are six main constraints that are acting as a barrier for FDI inflows. He pointed out these major constraints as “Image and Attitude, Domestic Policy, Procedures, Quality of Infrastructure, State Government Level Obstacles and Delays in Legal Process (Jha, n. p. , 2003).
Jha further explained that the overall image of the country sometimes discourage the foreign investors to come and invest in the country because some of the investors think that in India the foreign investors will not receive a favorable response. Moreover the domestic policies of the country also create problems for the foreign investors. Though as a result of the government steps, the FDI policy has become relatively liberal but after initiating business in India the foreign investors also have to face the excessive domestic regulation that often discourage them.
The foreign investors often get problems in securing the approvals and permission from different government departments and agencies. The infrastructure of the country including the inadequate system of electricity and transport also act as a negative point and the foreign investors complain about the inadequate infrastructure of the country. The foreign investors face a major problem in form of completing legal requirements.
The process is marked with a highly structured legal system and the investors have to go through a time consuming process in case of any dispute. All these factors act as barrier and slow down the pace of FDI inflows in India (Jha, n. p. , 2003). Nicolas Forsans (2005) revealed that the foreign direct investment in India is much affected by the government policies and trade barriers in form of taxes, duties and legal procedure and as a result the foreign investors are more attracted towards China where the investment regime is more liberal then that of India.
The study of Nicolas Forsans revealed that all over the world there is improvement observed in the FDI inflows on the country as a result of the trade liberalization reforms and likewise India is also required to make its investment regime liberal by lowering down the tax rates and duties (Nicolas Forsans, n. p. , 2005) The Times of India (2005) revealed with reference to the AT Kearney study that most of the multinational companies prefer China over India because of the liberal investment regime of China.
It is disclosed that when a survey was conducted among the Multinational companies, it came out that there are 75 percent MNCs that view India unfavourable for investment as compared with China because of the liberal trade system though there were 70 percent MNCs that believe that in India MNCs have now great opportunities to grow and expand business but the high taxes and duties hinder them to go and start business there (The Times of India, n. p, 2005)
Nirupam Bajpai, Nandita Dasgupta (2004) revealed that the Indian methods of measuring and recording FDI are not of international standards and as a result FDI inflows in India are often under reported. As compared with China India is considered as a underachiever to attract FDI and the track record of China is much better then that of India but the methods of measuring FDI make difference here and there is a possibility that while using the international methods of measuring FDI, China compiles its FDI statistics and that makes a difference in the rates of FDI flows of both the countries.
Manikandan A. D (2005) noticed that India is moving forward to get a major share in the global inflows of foreign direct investment but there is great need to further liberalize the investment policies of the country so that the gap between the actual and approved FDI inflows could be minimized. Manikandan A. D revealed that with the help of open investment regime, there is great need to narrow down the FDI gap that could be clearly observed in the following table (Manikandan A. D, p1, 2005)
3. Research Methodology In order to find out the answer of the research question and to test the hypothesis, a mixed methodological approach is used and the data for the study is gathered both from the secondary as well as primary sources. The study is conducted in two phases. In the first phases the qualitative method is used and “secondary analysis of data” is conducted to support the research topic with the review of relevant literature, figures and statistical data.
The qualitative approach is used to establish a theoretical framework of the topic as well as to understand the issue with the help of authentic facts and figures moreover the qualitative approach will be predominant to establish clear factors and discreet dependencies of taxation and duties, as well as transaction costs which affect the existing gap between the approval and actual inflow of FDI in India.
In the second phase quantitative approach is utilized to ascertain that up to what extent taxation and duties, with other factors, influences the FDI gap. Hence the interviews are conducted from 20 representatives of multinational, Reserve Bank of India and Foreign Investment promotion Board.
The face to face interviews are conducted by using a structured questionnaire and the data obtained from these interviews in used to make generalizations about the role of taxes and duties in building up the FDI gap and to understand the issue from the perspective of the concerned organizations. Hence the study is conducted through utilizing a mixture of qualitative and quantitative approaches and the outcomes of both these methods are analysed to get the answer of the research question as well as to test the hypothesis.Sample Essay of BuyEssay.org