Introduction Economic development needs investment. For an emerging market economy like India, domestic savings need to be augmented by foreign savings to support the order of investment that is required to accelerate the economy's income growth. The incoming foreign capital may be classified, at the first instance, into two broad types–official and private. In recent years, official flows are becoming less important as compared to private flows, which are again of two types; equity and debt. An alternative classification of these flows is based on the nature of economic interest that underlies them – portfolio investment and direct investment. Foreign direct investment generally comes embodied in modern technology and processes that a developing country badly needs and, therefore, more enduring and desirable from a developing country's perspective. The importance of this form of capital flow has increased manifold in the wake of bitter lessons that the emerging economies have learnt during some of the most recent economic crises. During these crises, the policy makers could realize that the footloose nature of portfolio capital, which is perennially looking for higher risk adjusted return, can destabilize an economy in a damaging way. Although some critics has called for a reappraisal of positive features of Foreign Direct Investment (FDI), the general consensus is that, subject to availability of some enabling conditions, like absence of infrastructure bottleneck and lack of required complementary domestic capital, on the balance, a developing economy benefits significantly from flow of FDI. Given this perception about FDI, there is a clamour for attracting FDI to their respective countries by policy makers. In fact, many a times, the success of reform and stabilization program of a developing country is evaluated in terms of the economy's ability to attract a larger share of global FDI flows. It is customary in India to compare India's performance in this regard with that of China. For example, according to World Investment Report of UNCTAD, the FDI flows to China have grown by leaps and bounds in the 1990s while India could attract only modest amount of such flows. The FDI to GDP ratio of China has been hovering around 4 to 5 per cent, as compared to less than 1 per cent in case of India. A doubt has been raised by many researchers and international agencies that China's FDI figures are inflated due to the practice of “round tripping” while FDI flows to India is underestimated due to non-adherence to international methodology in compilation of India's FDI figures. It has been claimed that if needed adjustment are made to both Chinese and Indian FDI estimates, the yawning gap between two estimates would be pared down by almost a factor of three [Bajpai & Dasgupta (2004), Pfeffermann (2002)]. In view of this perception, DIPP constituted a committee to look into the methodology of FDI compilation in India and suggest ways to make India's FDI data comparable and compatible to international FDI statistics. Section 2 in this paper discusses the conceptual framework aspect of the FDI while Section 3 presents the current reporting system of foreign investment data in India. Recent developments made in FDI compilation are presented in Section 4 while Section 5 discusses the issues. Some measures to resolve the issues have been suggested in Section 6 while Section 7 concludes. |
Top FDI: Conceptual Framework Definition The accounting and conceptual framework of the balance of payments statistics encompasses FDI statistics also. Currently, most of the countries including India, compile and present BoP figures as per the guidelines given in IMF Balance of Payments Manual, Fifth Edition, 1993 (BPM5). The Benchmark definition of FDI of Organization for Economic Cooperation and Development (OECD) is also based on and compatible with IMF definition. The United Nations Council for Trade and Development (UNCTAD) also has adopted IMF definition for reporting FDI data in its annual publication entitled ‘World Investment Report’. According to the IMF BPM5 (1993), FDI is the category of international capital flow that creates a relationship of ‘lasting interest’ and control of decision making process between a resident entity in one economy (“direct investor” or parent enterprise) and an enterprise resident in another economy (“direct investment enterprise"). The main differentiator between a portfolio investment and FDI is the presence of this “lasting interest”, a concept not precisely defined in BPM5. A “lasting relationship” is said to prevail when the relationship is of enduring nature and the foreign investor exercises some degree of management control over the direct investment enterprise. It appears that, an investment by a non-resident entity is considered as FDI, only when such investment is not motivated by pursuit of short-term speculative profit or capital gain. However, FDI need not always lead to creation of real asset and add to the productive capacity of the economy. For example when FDI is used to purchase existing enterprises, or undistributed profit of FDI enterprise is used for portfolio investment in the host country, no addition to productive capacity of the recipient country takes place. No timeframe is, however, specified to define what constitutes “long-term relationship”. The “effective control” aspect is translated in terms of holding of ordinary share or voting power. IMF indicates a threshold of ten per cent. The OECD also adopts the ten per cent numerical threshold for determining direct investment relationship. However, if a foreign entity initially makes a small investment less than ten per cent of equity in the invested enterprise but with the ultimate goal of acquiring a greater degree of control, then also, to go by the spirit of the BPM5 definition, such investment should qualify for being considered as FDI. But given the fuzziness of the concept of control and measurement difficulties, most countries adopt an objective numerical parameter like ten per cent of equity capital to determine FDI. Based on this criterion, ‘direct investment enterprises’ are further divided into subsidiaries (in which the non-resident investor owns more than 50 per cent), associates (in which the non-resident investor owns between 10 and 50 per cent), and branches (unincorporated enterprises, wholly or jointly owned by the non-resident). The FDI relationship of ‘direct investor’ also extends to the direct investment enterpise's subsidiaries, sub-subsidiaries and associates (unless the direct investment enterprise itself is an associate). If an enterprise (direct investor) have ‘longterm interest in more than one economy’, then related ‘direct investment enterprises’ of those different economies are also considered to be in direct investment relationship with each other. Components of FDI Capital Direct investment capital is capital provided by a direct investor–either directly or through other enterprises related to that investor–to a direct investment enterprises. The FDI capital includes equity, reinvested earning and other capital comprising various inter-company debt transactions. Also, direct investment is recorded on a directional basis-capital invested by a direct investment enterprise in its direct investor (reverse investment) is regarded as a ‘disinvestment’ by direct investor rather than an asset of the direct investment enterprises. Equity capital Equity capital includes subscription to equity capital by direct investor but also allotment of equity in lieu of supply of technology, brand name and other tangible and intangibles. The concept of Direct Investment includes not only the initial capital funds provided by the direct investor to a direct investment enterprise but also all subsequent transactions in the nature of infusion of fund through equity or debt route. Even if these transactions are made between affiliates and other enterprises connected to the direct investor and FDI enterprise this should qualify as direct investment. Reinvested earning The undistributed profit of an existing FDI enterprise engenders proportionate liabilities to the direct investor to the extent of its share in total equity. This is called reinvested earning. As per IMF guidelines, these reinvested earnings should be considered as a part of FDI inflows, and these inflows should appear on the financial account of host country's balance of payments (bop). Other capital All inter-company debt transactions including supplier's credit between direct investors as well as its associates, branches and subsidiaries and direct investment enterprise is covered under this category of FDI component. In case of banking, other depository institutions and other financial intermediaries, all debt transactions between direct investor and direct investment financial enterprise should not be treated as direct investment flow. For such enterprises only those loan capital which are in the nature of permanent debt only should be recorded as direct investment. Deposits, loans and other liabilities which arise in the course of normal banking transactions should not be classified as direct investment. Valuation of FDI components The BPM5 stipulates that FDI transactions should be evaluated for the BoP purpose at the accrued value, i.e. “transactions are recorded when economic value is created, transformed, exchanged, transferred, or extinguished”. Since it is almost impossible to determine empirically correct accrued value, BoP compilation is generally based on valuation as reported by transactors. Moreover, the recommended use of market price as the basis for valuation of flows and stocks is difficult to implement in respect of stock items for non-availability of relevant data. For example, market values of debt securities is not easy to obtain in many situations. However, some countries (in particular, Australia) encourage companies to report market values and instruct companies to use (a) current share price or a recent relevant transactions value, or (b) net worth/net assets (valuation of assets & liabilities at current values with adjustments for intangibles). Top Current reporting system of foreign investment data in India The compilation of FDI statistics has been substantially revamped recently to bring it in line with international standards. Before we touch upon the compilation issues we first have a look at the current procedure in India for monitoring of FDI flows and reporting system built around it. |
Foreign direct investments in India can be made either with the specific prior approval of the Secretariat for Industrial Assistance/Foreign Investment Promotion Board (SIA/FIPB) under the auspices of Ministry of Industry, Government of India, or under the Automatic route. However, there are certain areas where foreign investments are prohibited by any of the routes. Foreign Institutional Investors (FIIs) registered with SEBI and Non-resident Indians are eligible to purchase the shares and convertible debentures under the Portfolio Investment Scheme. The FII should apply to the designated AD who may then grant permission to FII for opening a foreign currency account and/or a Non Resident Rupee Account. NRIs should apply to the concerned AD designated bank for permission to open a NRE/NRO account with its designated branch. Detail guidelines on Foreign Investments in India are available in master circular issued by the RBI to ADs. Master Circular No./6/2004–05 issued by RBI on July 1, 2004 (to be updated in 2005) is the latest master circular in that regard. Annexure-1 reproduces a few important instructions on Foreign Investments in India from that circular. |
Present Reporting System In order to enforce the regulatory framework described above and monitor its implementation, respective authorities have prescribed different sets of returns which also form the basis of compilation of FDI statistics in India. Some of these are described below. FDI An Indian company issuing shares or convertible debentures under bonus, rights, amalgamation and stock option in accordance with these Regulations should submit to Reserve Bank the details of advance remittance, not later than 30 days from the date of receipt of the amount of consideration, giving necessary details regarding (i) Name and address of the foreign investors, date of receipt of funds and their rupee equivalent, Name and address of the authorised dealer through whom the funds have been received, and details of the Government approval, if any. After the issue of shares the company should file a report in Form FC-GPR not later than 30 days from the date of issue of shares with the Regional Office of RBI where the registered office of the company is situated. Portfolio Investment (PI) The link office of the designated branch of an AD shall furnish to the CGM, RBI, Foreign Exchange Department (FED), Central Office, Mumbai a report on a daily basis on Portfolio Investment Scheme (PIS) transactions undertaken by it; such report is to be furnished on-line or on a floppy in a format supplied by RBI. With effect from November 29, 2001, Overseas Corporate Bodies (OCBs) are not permitted to invest under the PIS in India. Further, the OCBs that have already made investments under the Portfolio Investment Scheme, may continue to hold such shares/convertible debentures till such time these are sold on the stock exchange. OCBs have been de-recognised as a class of investor entity in India with effect from September 16 2003. However, requests from such entities that are incorporated and not under the adverse notice of RBI/SEBI will be considered for undertaking fresh investments under FDI scheme with prior approval of Government if the investment is under Govt. route and with the prior approval of RBI if the investment is under automatic route. It is obvious that serious data gaps would ensue if FDI statistics are compiled based on controlled returns as described above. First of all, the focus of controlled returns is to regulate and monitor all cross border transactions, in this case those related to capital account transactions. But the FDI concept as defined by BPM5 is much broader and encompasses all transactions including within border ones that might increase or extinguish liabilities/assets of resident economic entities vis-à-vis their non-resident counterparts. Inclusion of reinvested earnings of FDI enterprises in FDI statistics is a glaring example. Moreover, the controlled returns capture only the identities of immediate transactors. FDI statistics should trace the entire chain of controls. Further more, as per BPM5 direct investment is to be recorded on a directorial basis. To compile FDI statistics on directorial basis one has to necessarily collect enterprise centric data rather than transaction centric data as it is done in India. On these considerations, most of the countries having significant FDI, resort to enterprise surveys for compilation of FDI statistics. Annexure-2 reproduced from the IMF's BoP Compilation guide [BoP_CG (1995)] gives the comparative picture of advantages and disadvantages of various data sources viz. in international transactions reporting system (ITRS), enterprise survey and controlled returns that are used for compilation of FDI statistics. Top Recent development in compilation of FDI in India According to BPM5 (1993), FDI has three components, viz., equity capital, reinvested earnings and other direct capital. Until recently, FDI data released by RBI did not include reinvested earnings and other capital. Due to the same FDI data compiled by RBI remained underestimated and was also incomparable with FDI data released by many other countries of the world. To bring the current FDI reporting system of RBI in alignment with the international reporting system, Government of India (GoI), in consultation with RBI, had constituted a Committee viz. ‘The Committee on Compilation of Foreign Direct Investment of India [CCFDI (2002)]’ comprising officials from RBI and the Department of Industrial Policy and Promotion (DIPP), GoI in May 2002 to study the conceptual and methodological issues, including data gaps involved and make necessary recommendations to strengthen the collection, compilation and reporting of FDI data. The committee in its Report submitted in October 2002 recommended, among others, to include Reinvested earnings and other capital while compiling FDI for the country. As a follow up of the submission of the Report, GoI constituted a Technical Monitoring Group [TMG (2003)] to expedite the implementation of the recommendations made by the above Committee. The TMG was constituted by DIPP with the representatives from RBI, DIPP, Department of Economic Affairs (DEA), Department of Company Affaires (DCA) and National Informatics Centre (NIC). The TMG submitted its Report in June 2003. Resolving various operational issues associated with the compilation of the FDI statistics as per international best practice was the main concern of the TMG. It mainly focused on compilation process of the identified components such as (a) reinvested earnings by FDI entities, (b) “other capital” in the form of inter-corporate debt transactions, and (c) equity capital of branches of foreign banks operating in India. TMG identified the 14 items (see Annexure-3) for inclusion in FDI statistics in order to make the data internationally comparable. Based on the data availability in respect of the newly identified items, TMG revised the FDI data for the years 2000–01 and 2001–02 as shown below: |
The revised data on FDI include all items indicated under equity capital (except non-cash acquisitions) and reinvested earnings (except reinvested earnings of indirectly held direct investment enterprises). Data under ‘other capital’ relate to short-term and long-term borrowing, trade credit (more than 180 days, suppliers' credit (more than 180 days), and financial leasing only. Data on short-term trade credit (up to 180 days) have not been included, as these data are not captured separately through the present reporting system. Attempts are being made to capture these data through revised FC-GPR form. RBI has already revised its FET-ERS to collect data on suppliers' credit up to 180 days. TMG concluded its report stating that the figures on FDI (see Table 1 above) as revised by them were provisional. It was mentioned that finer data on FDI would be disseminated when reporting system is stabilized to capture data on trade credit, venture capital, financial derivatives etc. TMG in its Report also mentioned that RBI would make appropriate changes in the current account as well as capital account transactions of BoP and the BoP statistics would be modified accordingly.
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Top Issues Compilation of Re-invested earning As may be observed from Table 1 that re-invested earning has been revised by incorporating the relevant data in respect of foreign bank branches. However, it is also contemplating to further revise the statistics by incorporating data on other unincorporated sector. It may be mentioned that FDI is also allowed in private sector banks (49% in terms of the Press Note no. 4 dated May 21, 2001; cap raised to 74% subsequently) and also in public sector banks [overall statutory limits of 20% as provided in Banking Companies Acts, 1970/80 (FDIM (2004))]. Valuation of FDI At present FDI stock released by the RBI annually as on March end through its International Investment Position (InIP) are compiled based on perpetual inventory method by adding the flow to the stock as at the end of the previous year. Although the compilation procedure accounts for changes in valuation due to exchange rate and transaction changes, no adjustment is done for price and other changes. Although, RBI is fully aware of the fact, due to non-availability of any acceptable methodology to compile the adjustment factor in connection with price change, the data are being released at present without adjusting for price and other changes. Proper classification In an economy (in India, for example) where portfolio investment by non-residents are freely allowed, enforcement of 10 per cent rule requires strict monitoring of the equity holdings by non-residents in a domestic enterprise. For example, when the initial equity holding of a nonresident is less than 10 per cent and when subsequent purchases takes the non-resident's holding beyond 10 per cent threshold, these additional purchases should be treated as direct investment in BoP and the same would be true of all subsequent purchase transactions [BoP_TB (1996)]. The previous holdings, however, do not get reclassified as direct investment in the BoP statement. But in the InIP statement the total holding is reclassified as direct investment. This issue is yet to be addressed by the RBI. Top Suggested Measures Data on ‘Foreign Investment’ for InIP are collected by most of the countries through surveys only; many of them have sound legal system to ensure response to the surveys. In India too, foreign investment data for statistical purposes are collected through a survey viz. ‘Foreign Liabilities & Assets Survey (FLAS)’. This survey is conducted every year by the RBI on corporate sectors to collect position data on FDI, PI and Other investment (loan, trade credits etc.). The main purpose of the survey is to compile foreign investment in/by corporate sector in India. Information received through the survey is also used for the compilation of re-invested earning for BoP. Sub-sequent to the submission of the TMG (2003), the survey form was accordingly revised. The revised FLAS schedule incorporates the necessary reporting for direct investment through other enterprises related to ‘direct investors’ to a direct investment enterprises. |
However, due to poor quality of response and poor quality of the responded data, the survey has not become very successful to serve its objectives. The main reasons for the same are absence of legal backing to the FLA survey, non-response from many of the big companies, inadequate/no publicity while the FLA survey is launched, non-involvement of any regulatory agency in direct control of the companies with the survey exercise, etc. At present, compilation of stock of foreign investment data by RBI is done using the BoP data that are based on regulatory reporting of flow data. However, use of regulatory data can not resolve the issues pertaining to valuation and classification. However, looking into the big number of companies with foreign investment in India, it may not be easy, as already experienced, to collect data from all companies in the absence of legal provision. At the same time, it may not also be essential, to collect all details from every companies. The entire survey methodology needs to be re-designed to resolve the problem on non-response as mentioned below: |
A three yearly comprehensive survey on all entities including corporate, banks and other unincorporated entities; |
A representative survey every year on the top few entities accounting for around 80 per cent as per the comprehensive survey; |
The annual foreign investment statistics should be compiled by bloating up the representing survey data using the share of the entities (covered in the representing survey) in the comprehensive survey data. A small sample (size and procedure to draw the sample to be decided by the RBI) to be selected from rest of the exporters under the same Comprehensive Survey should also be included in the final sample for the Representative Surveys to make the sample more representative. |
Top Conclusion In this paper, we have looked into the definitional aspects of the FDI as given in BPM5 (1993) which is also the internationally accepted standards by most of the countries. Till recently, FDI statistics compiled and disseminated by India did not conform to these international standards. In fact, according to many, FDI to India was grossly underestimated due to this problem. To address this problem, GoI/RBI formed a committee and then a group (based on the recommendation of the committee) to look into the definitional issues involved. Subsequently, FDI statistics were revised by the RBI for two years viz. 2000–01 and 2001–02 only. Data for the earlier years are yet to be revised. However, the basic deficiency of FDI statistics of India arising out of non-availability of required data still remains unresolved. In this paper, we have pointed out how a transaction centric control return based information system can never be adequate to compile FDI statistics as per international standards & concepts. The paper strongly suggests adoption of enterprise based surveys with proper legal backing to compile FDI statistics. |
Top Table | Table 1: FDI data in India: Pre-revised & Revised Data
(Figures in US$ Million)
| | | Pre-revised | Adjustment factor | Revised1 | |
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| | 2000–01 | 2001–02 | 2000–01 | 2001–02 | 2000–01 | 2001–02 | | (i) | (ii) | (iii) | (iv) | (i) + (iii) | (ii) + (iv) |
| | I. | Equity Capital | 2342 | 3905 | 58 | 190 | 2400 | 4095 | Banking Capital of the Branches of Foreign Banks included | | II. | Reinvested | 0 | 0 | 1350 | 1646 | 1350 | 1646 | Reinvested Earnings of Earnings corporate sector & in Branches of foreign banks | | III. | Other Capital | 0 | 0 | 279 | 390 | 279 | 390 | Other Capital (Inter-company Debt Transactions) | | IV. | Total | 2342 | 3905 | 1687 | 2226 | 4029 | 6131 |
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