FOREIGN INVESTMENT IN INDIA

Until recently, foreign investment remained closely regulated. Rules and incentives directed the flow of foreign capital mainly toward consumer industries and light engineering, with major capital-intensive projects reserved for the public sector. Under the Foreign Exchange Regulation Act of 1973, which went into effect on 1 January 1974, all branches of foreign companies in which nonresident interest exceeded 40% were required to reapply for permission to carry on business; most companies had reduced their holdings to no more than 40% by 1 January 1976. Certain key export-oriented or technology-intensive industries were permitted to maintain up to 100% nonresident ownership. Tea plantations were also exempted from the 40% requirement. Although the government officially welcomed private foreign investment, collaboration and royalty arrangements were tightly controlled. Due to the restrictiveness of these policies, foreign investment remained remarkably low during the 1980s, ranging between $200 and $400 million a year. Government reform measures in mid-1991 changed this picture significantly. Under the New Industrial Policy, the amount of money invested in the country doubled annually from 1991 to 1995. In 1997 the New Exploration and Licensing Policy (NELP) was announced permitting the participation of foreign oil companies in upstream exploration and development of oil and gas resources. In 2000, the first exploration blocks were awarded in two rounds of bidding, but the major international oil companies (BP, Shell, ExxonMobil) have yet to become involved. Effective 1 April 2001, imports of crude oil and petroleum products were liberalized, with state-run enterprises losing their exclusive right to import certain petroleum products for domestic consumption. Also in 2001, India removed quantitative restrictions (QRs) from 715 items (147 agricultural products, 342 textile items, and 226 manufactured goods, including automobiles) in compliance with WTO standards. Under the New Industrial Policy as amended most sectors have been opened for 100% foreign investment. Sectors such as banking, telecommunications, and print media are still restricted. In some restricted sectors, foreign investment up to 49% or 74% is allowed in the equity of an Indian joint venture company. Recently the requirement prior approval by the Reserve Bank of India was removed from enterprises falling within categories allowing 100% foreign investment. India has eight export processing zones (EPZs) designed to provide internationally competitive infrastructure and duty-free, low-cost facilities for exporters. Foreign investors in some industries can operate in EPZs, export oriented units (EOUs), special economic zones (SEZs) and Software Technology Parks of India (STPIs). Under the Market Access Initiative of 2001, greater access was to SEZs was afforded, although as of 1 April 2003 profits and gains derived from the STPIs and EOUs would only be 90% tax-free. SEZs are regarded as foreign territory for purposes of duties and taxes and sector caps that limit foreign direct investment (FDI) in different industries do not apply in the SEZs. In any case, the corporate tax rate on foreign companies was reduced to 48% to 40%, and the peak customs rate was reduced from 35% to 30%. Other liberalizing steps in the 2002/ 03 budget include the removal of price controls on petroleum products, the removal of price controls from all but 99 drugs, and permission for foreign banks to set up subsidiaries instead of only branches. In November 1999 the government announced its intention to disinvest in 247 state-owned enterprise to the general level of 26% ownership, and established the Ministry of Disinvestment. Although the program has involved the transfer of significant amounts of equity and management control from the government to private sector, it has yet to generate appreciable foreign investment. Despite the trend towards liberalization, India’s foreign investment regime remains complex and relative restricted. Although FDI has increased, average a net $2.64 billion per year 1997/98 to 2001/02, the inflow is still small compared to China, the most relevant comparison, where FDI is running $30 billion to $40 billion a year. The net flow dropped to $1.8 billion in 2000/01, and then recovered to a net $3.4 billion in 2001/02. Net portfolio investment, $1.8 billion in1997/98, turned negative in 1998/99, at net -$100,000. Over the next three years, however, the net portfolio inflow averaged about $3 billion. Statistics on FDI for India show Mauritius as consistently the largest source, averaging about $700 million per year from 1995 to 2000, with the US in second place, averaging about $383 million a year. However, most of the investments credited to Mauritius are actually from American companies seeking to take advantage of its lower withholding taxes or exemptions on payments of royalties, dividends, technical service fees, interest on loans and capital gain by Indian joint venture companies under the terms of the Double Tax Agreement (DTA) between India and Mauritius. From 1991 to 2001 about 10% of FDI has come from the US and 20% from Mauritius. The third-, fourth-, and fifthlargest sources 1995 to 2000 were Japan (annual average $138.3 million), Germany (annual average $115.8 million), and the United Kingdom (annual average 78.2 million). Foreign investment through the stock market is limited to 30% to 40%.