Definition of Direct Foreign Investment (DFI)

Direct Foreign Investment (DFI)

Balance of payment accountants define direct foreign investment “as any flow of lending to, or purchase of ownership in a foreign enterprise that is largely owned by the residents of the investing company.” The proportions of ownership that define “largely “ vary from country to country.

The most distinguishing feature of DFI is the exercise of control over decision- making in an enterprise located in one country by investors located in another country. Although individuals or partnerships may make such investment, most of them are made by enterprise, a large part by MNCs. We may here note the difference portfolio investment and direct investment. In direct investment the investor retains control over the invested capital. Direct Investment and management go together. With portfolio investment, no such control is exercised. Here the investor lends the capital in order to get a return on it. But has no control over the use of capital.

Direct investment is much more than just a capital movement. It is accompanied by inputs of managerial skill, trade secrets, technology, right5 to use brand names and instructions about which markets to pursue and which to avoid. The classical examples of FDI is a multinational enterprise starting a foreign subsidy with 100% equity ownership or acquire more than 50% equity in a domestic company so that it will have control over managerial decisions. Obviously a MNC could not come into existence without having direct investment. These enterprises essentially own or control production facilities in more than one country. At times, the strategy of a multinational is to enter into joint ventures with domestic firms as well as MNC. By such arrangements, divergent resources and skill can be merged. Domestic companies can establish themselves in new markets and gain access to technology. That might not otherwise be available. But one difficulty with joint venture is fogging a consensus with representatives of both companies sitting on the board of directors. We may cite the case of Maruti Udyog a joint venture of Government of India and Suzuki of Japan having differences over the appoint of Managing Director

Guide Lines for Specific Sectors

The preceding paragraphs have listed the general policies and rules that govern the FDI. However, special packages of policies and incentives have been evolved for some key sectors of the economy.

Some of the areas where indicative guidelines have been laid down for maximum FDI contributions are: Power (100 percent), telecommunication services such as basic telephony and cellular mobile and paging services (49 %), petroleum sector (100%), roads and highways (100%) and tourism (100%).

Enhancement of Foreign Equity in Existing Companies

An existing company engaged in manufacture of items included in the priority, which have foreign holding less than 74%/51%/50%, may also increase its foreign holding to the allowed level as part of its expansion programme, which should relate to the priority sector items. The additional equity should be part of the financing of the expansion programme and the money to be remitted should be in foreign exchange.

It is not necessary that the company should be exclusively engaged in the priority sector activities specified, only the proposed expansion must relate exclusively in high priority industries may increase its foreign equity to the maximum allowed level without any expansion programme. The increase in the equity level must result from expansion of the equity base of the existing company and the additional equity must be form remittance of foreign exchange

The proposals meeting the above conditions can be submitted to the RBI for automatic approval. Other proposals for inducting or raising foreign equity in an existing company, will be subject to prior approval of the Government and should be addressed to the SIA.

An application for raising foreign equity in an existing Indian company has to be accompanied by a board resolution and approval by the shareholders of the company through a special resolution for preferential share allocation to foreign investors. Every preferential allotment of shares by companies other than allotment of shares on a right basis, by listed companies to foreign investors will be the market price of the shares according to SEBI guidelines

Foreign investment in EPZs/EOUs

In the case of export processing zones (EPZ) units/100% oriented units foreign participation may be up to 100% of equity. In the case of units set up in EPZs, the respective Development Commissioner Grants approvals, while for 100% EOUs approvals are granted by the SIA.

Majority foreign equity holding up to 51% Equity is allowed by the RBI for trading companies primarily engaged in export activities. Such trading companies will be treated on a par with domestic trading and export housed in accordance with the extent Export/ Import policy and the company will have to register itself with the Ministry of commerce as registered exporter/importer.

In case of existing companies, already registered as an export house, a trading house or a star trading house, the RBI will give automatic approval for foreign Investment up to 51 per cent equity, subject to the provision that the company passed a special resolution for preferential allocation of fresh equity to the foreign investors.

Foreign investment in SSI sector

To provide access to the capital market and to encourage modernization and technological up gradation in the small scale sector, foreign equity p[participation to the extent of 24 percent of the total share holding has been allowed.

The policy on the opening of branches by foreign companies has been liberalized. Foreign companies engaged in manufacturing and trading activities abroad are permitted by the RBI to open branch offices India for the purposes of carrying on the following activities:

To represent the parent company/other foreign companies in various matters in India, For example, acting as buying/selling agents in India;

To conduct the research work in which the parent company is engaged provided the result of the research work are made available to the Indian companies;

To undertake export and import trading activities;

To promote technical and/or financial collaboration between Indian companies and overseas companies.

Short-Term Capital Flows

Besides the long-term capital flows in the forms of direct and portfolio investments abroad, there is a flow of capital among nations for a short period as well. These flows take the forms of export credit and loans, Imports debts, banks deposits, and commercial papers held abroad, foreign currency holdings and obligations, etc., Incidentally, you may note that the difference between long term and short term capital flow is one the basis of instruments rather than the intentions of the investor

The short- term capital flows across nations take place due to a variety of factors. Further, the determinant of these flows depends on the type of the flow. In order to explain their determinants, it is convenient to divide the short-term flow into three categories, viz, trade capital, arbitrage and speculative. The motives behind each of these flows and their determinants are explained below.

Trade Capital

Exports and imports are negotiated both on down payments as well as on credits. When down payments are made, bank deposits in exporting country’s currency increase while those in importing countries currency decrease. In the case of transactions on credits, accounts a receivable /payables increase. Since these accounts are usually payable within one year they are included in short term capital flows. The volume of trade capital obviously varies directly with the magnitude of merchandise trade, and the credit relationships between trading partners.

Arbitrage

Under arbitrage, individuals and institutions buy one currency and sell other currency with the sole objective of making profits without taking any risk. The opportunities for such profits arise due to two factors. One, spot exchange rates are not quite consistent in all the worldwide markets. Two, the difference between spot rates and forward rates is not always consistent with the interest rate differentials in different markets. To see the gains from arbitrage under these two conditions; we take one example for each case.

Suppose spot rates in three markets were as follows:

Frankfurt L/DM: 0. 20 New York $/DM: 0.40 London $/L: 1.90

The arbitrageur (trader) sells US dollars, say, in amounts of $ 1.9 million and buys British pound in the of L 1million in London. He then sells his L 1million and buys Deutsche mark (DM) in the amount of DM 5million in Frankfurt. Finally he sells his DM 5million for $2million in New York. Through this process, he makes a profit of $0.1 million, gross of transaction cast, without taking any foreign exchange risk. Needless to say, such an opportunity arises because the exchange rate in the three markets is not quite consistent. If the exchange rate in London were $2=L1, there would be no scope for such an arbitrage.

Relationship between the spot and forward rates and the interest rates in the two countries whose currencies are involved in these exchange rates.

I$-iL=F-S/S

Where I$ = interest rate in USA

 Where iL= interest rate in UK

 Where F= forward rate ($/L)

Where S=sport rate ($/L)

If the interest and exchange rates are not consistent to this theorem, there is a scope for arbitrage. For example, if

I$=15%, IL= 10%, and S: $2= L1.

Then F must be given by 0.15-0.10=F-2/2 or F=2.10

However, if actual F is such that $2.15= L1. Then the arbitrageur could make profit by borrowing pound at 10% SELLING THEM FOR DOLLAR AS s: $2=L1 depositing the dollar proceeds at 15% and eventually selling dollars in the forward market at F=2.15. Through this process, the trade would make a profit at the rate of $0.05 per pound minus his transactions cost, if any.

Opportunities of the above two types do sometimes exist and thus there are international financial flows through arbitrage as well. The magnitude of such an arbitrage depends inversely on the level of efficiency of international markets. As the information system become more perfect and prompt through the international computer network round the clock the scope for arbitrage will become small and short-lived. However to the extent government intervene in the determination of the exchange and interest rates, arbitrage could continue at least upto a certain extent.

Speculative Flows

Speculative flows of capital take place across countries with the sole objective of making money through deliberate understanding of foreign exchange risk. Since the breakdown of the Britton Woods system in 1971, exchange rates have been fluctuating widely and this had given rise to significant speculative flows of capital. Speculators buy currencies, which they expect to appreciate and sell those, which they expect to depreciate. These transactions are of course, subject to government regulations.

The magnitude of speculative flows depends directly on the variability of exchange rates, and the ability and attitudes of speculator towards risks. When the exchange rates were relatively stable until 1971, speculative flows were very much limited.

With the increased variability of exchange rates and the enormous profits that the speculators in foreign exchange have made the scope for such transactions has increased manifold and the trend is expected to continue ion future, nevertheless, it must be noted that these speculations are perhaps the most difficult and this profession has attracted the best brains

Before we close this section, it must be noted that there are multilateral institutions like the World Bank, International monetary fund and Asian development bank, which advance loans, and regulate foreign exchange rates and international liquidity among other activities. Transactions between these organizations and nations are also components of the above-mentioned international financial flows

Special Features of Service Marketing

Services are intangibles and cannot be standardized or reproduced in the same for. They are customer need based and unique.

Both supplier of services and consumers should have a rapport, willingly understand each other and cooperate through meaningful dialogue and effective communications.

Services are dominated by human element and quality counts. But quality cannot be homogenized, “It will vary with time, Place and customer to customer.”

Inventories cannot be created. Services are immediately consumed and marketing and operation are closely interlinked.

Vendors of services should have a track record of integrity, reputation for quality and timeliness of delivery. More than media advertisement, the best advertisement for them is the mouth to mouth word of satisfied customers, and building of corporate image of the vendors, rather than their presentations, oral assurances to the vendors. The first best market strategy is thus a satisfied customer. The second strategy is to maintain quality, human approach, appearances and courtesies of the personnel and the available infrastructural facilities for them. Thirdly service a\counts in terms of how it is priced and how it is cost effective for the customer and for the vendor each.

Integration of Markets

Business houses no longer restrict themselves to domestic sources of financing. The search for capital does not stop is water edge, with the pursuit of policies for liberalization and globalization; the distinction between domestic and foreign financial markets is becoming increasingly blurred. With the lifting for regulatory systems in 1980s that inhibit competition and protect domestic markets the world had become one vast connected market.

In international finance centers or markets, the type of transactions occurring is:

between foreign lenders and domestic borrowers; (ii) between domestic lenders and foreign borrowers; (iii) between foreign lenders and foreign borrowers. The third types of transaction are called entrepot or offshore transitions. In this case the financial centers merely provide facilitation services for foreign lending and borrowing.

Until the development of the euro marked in late 1950s internationals financial centers were principal supplier of capital to foreign borrowers. In the post 1960-euro market, entreport type and offshore financial transactions became increasingly predominant. Hence the traditional nature to financial centers was altered radically. With the internationalization of credit transactions, it was no longer necessary for an international center to be a net supplier of capital. Thus small and relatively unknown parts of the world became important banking centers- Nassau, Singapore, Luxembourg etc., The world’s financial centers as a group provide three types of international services

Traditional capital exports,

Entrepot financial services, and

Offshore banking.

The traditional financial centers were net exporters of domestic capital. This function has been performed through foreign lending by commercial banks, the underwriting and placement of marketable securities for foreign issuers for foreign issuers and the purchase of notes and obligations of non-resident entities of domestic investors in the secondary markets

Offshore banking is a special kind of business of entrepot financial center. It is financial intermediation performed primarily for non- resident borrowers and depositors. It refers to international banking business involving non-resident foreign currency- denominated assets and liabilities. Its confines to the banking operations of non-residents and does not mix with domestic banking. But the domestic financial market is well insulated from offshore banking activity by an array of capital and exchange controls. Offshore banking is carried in about 20 centers through tout the world. It offers benefits like exemption from minimum cash reserve requirements, freedom from control on interest rates, low or non-existence taxes and levies, low license fee etc., Offshore banking units are branches of international banks. They provide project-financing syndicated loans, issue of short-term and medium term instrument Etc.,