Introduction Political factors are vital in explaining foreign direct investment (FDI) trends. A considerable number of finance and economic studies have shown that political risk is a critical factor in determining investment or capital flows into or out of the country. Investments in a majority of developing and emerging economies are prone to sizable political risks. For instance, FDI inflows to developing nations dramatically increased in the 1990s representing approximately 46.1 percent of world’s FDI inflows in 2010. Lately, emerging nations, particularly India and China have become the world’s leading FDI destination. In India, FDI has rapidly expanded after the economic reforms that began in the early 1990s. The reforms particularly targeted increased privatization, liberalization and deregulation of the manufacturing sector, integration of India’s economy with global economy by limiting trade barriers and adjusting priority policy structure towards the growth of FDI in the country.
FDI Trends
FDI began to flow into India in a pronounced way particularly following 1991 when the Indian government began neo-liberal economic reforms. The following decade of liberalization saw India become one of the most preferred FDI destinations. India also has a higher level of openness in its FDI targeted policies than most of its Asian competitors like Malaysia, Thailand, China, Singapore and South Korea. Lately, the government of India has also permitted foreign direct investment in multi-brand retailing and raised the sectorial cap of foreign direct investment in different areas like aviation, trading exchanges, single brand retailing, power trading exchanges, mobile TY and teleports. Despite its liberal initiatives, FDI inflows relative to GDP has not considerably increased and was merely at 3.5% of GDP. These recent trends in FDI inflows to India show that regime change is not enough in wooing foreign investors. Instead, FDI flows are determined by a host of many other political factors.
The majority of India’s liberalization commentators argue that 1991 was a time of revolutionary changes in the country’s economic future. The nomination of the Economist Manmohan Singh, regarded as apolitical as finance minister heralded a change in the country’s economic perspective, a radical one for that matter, but didn’t considerably permeate the State or Nation’s economic imagination. However, the introductory section of 1991 report by the ministry of finance economic survey concluded that relative to the domestic investment the impact of FDI was expected to remain insignificant. At the moment the emphasis for long-term planning remained at inwards FDI as efforts were aimed at solving the India’s balance of payment problem, where the country’s resources and ingenuity as “self-reliant” were the only options. Downplaying the imminence of changes at the time, the government of India hangs on to the “self-reliance model” and envisioned to change just as much as was necessary to contain the crisis and then goes back to its status quo.
Irregularity in the implementation of reform policy was caused by protest against economic changes by a number of stakeholders. Due to the probability of reform challenging under-productivity and overmanning, the first main protest came from public sector workers who had previously enjoyed a virtually permanent employment. A major revolt that took a political dimension started in the nature of the Swadeshi Japaran Manch (SJM) formed in November 1991 by the RSS some months following the latest liberal economic policy. The revolt against privatization and globalization discovered multinationals as its prime target. FDI was perceived as the latest kind of western imperialism, which India was to fight through native competencies. The cry targeted the sense of insecurity fawned by economic liberalization and consolidating national identity, synonymously equated with Hindu awareness by raising the threat of foreign dominance.
SJM tactic succeeded in convincing the majority of Indian capitalists acquainted to decades of protectionism. Worried about the outcomes of liberalization on their business interests, the capitalist united to protest that foreign capital would destroy their businesses. Such kind of argument was championed by the director of a business lobby organization called Confederation of Indian Industry (COII). In his April 1996 attack on the impact of multinationals in India, COII director accused the foreign corporations of not being fully dedicated to long-term goal to India, not bringing latest technology and an over dependence on imported parts instead of Indian made ones. Rural Indians were rarely affected by multinationals and only distantly perturbed by FDI, although they formed the biggest group of the Indian Nation and were swept by the anti-FDI campaign. Consequently, for the benefit of political convenience, the Prime Minister P. V. Narasimha Rao rethought the economic reforms. Before pronouncing any changes in contentious issues like financial services, taxation, and the public sector, Rao nominated committee to look into every issue, and table recommendations. Such recommendation, largely similar to proposals made by IMF and World Bank were considered more appropriate.
In the next election political parties, especially the Congress Party pronounced that technology collaboration and foreign direct investment would be allowed to get higher technology, to broaden the production base and to boost exports. The Congress Party acknowledged the significance of reforms in the economic model, although it was aware of domestic revolt against such reforms. The party’s pronouncement for investment was thus accompanied by a reassurance that the foreign investment would not be made at the expense of self-reliance. The alternative reforms of the Congress Party implied that if elected there would be no alienation of the group of population that supported alternative party’s opinion. Although reforms started after Congress Party took power in 1991, there was no formal definition of FDI or its consideration as a process for development. Instead, the ruling party focused on economic stabilization. Thus, although the new policy brought a dramatic rise in investment prospects, there wasn’t a clear appreciation of FDI as a right process for development.
Sweeping agreement on FDI mechanism was only embraced in 1995-96 after the government started to demonstrate gains made from FDI in the defense of the reforms to critics. The recent government emphasis on FDI is evident in 1996-97 reforms that increased resources and understanding towards investment. Such reforms included the establishment of the Foreign Investment Promotion Council (FIPC) together with the streamlining and increased transparency of the Foreign Investment Promotion Board (FIPB). The government also responded to decline in FDI in 1998 by embarking on sweeping technical initiatives in nature of liberalization of investment norms. Likewise, following a plummet in FDI in two successive years, a Foreign Investment Implementation Authority (FIIA) was established for offering a centralized interface between the government machinery like state authorities with foreign investors. FIIA was also given the power to offer comprehensive approvals. By now FDI had attained a reputed position, and its debate was now on a mature level.
The industrial sector was among the first beneficiary of FDI reforms in 1991 as the reforms changed the entire system. Initially, the new policy especially sought to deregulate the industrial sector in order to fast tract growth of an increasingly competitive and efficient industrial economy. In the process, the processes for investment in non-favorable industries were reorganized. The initial FDI reforms did not produce tangible benefits. However, the weakening and decline in investment demand are attributed to the rife of economic uncertainties and social disorders that prevailed at the time. The reform benefits came in 1995-98 when the changes in the industrial sector became the incentive for attracting FDI into the country. Liberalization reforms hence encouraged investment participation under state government FDI reforms.
A typical example of political impacts on foreign direct investment was demonstrated by the Vodafone /Hutchison Tax Case of 2007. The case pitted Vodafone against the Indian government involving a $1.3 billion tax dispute that the government claimed from Vodafone. The court ruled in favor of Vodafone by stating that Indian tax department had no mandate to levy tax on foreign transactions between corporations incorporate outside the country. The case demonstrated the increasing harassment of foreign firms by Indian government, which explains why India no longer attracts more foreign direct investment. Vodafone pointed that Indian tax department claim would have added $600 million to its tax expense, which is quite a disincentive to foreign direct investment.
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- McLain, Sean. “Vodafone Wins Tax Case in India.” WSJ. October 08, 2015. Accessed April 26, 2016. http://www.wsj.com/articles/vodafone-wins-tax-case-in-india-1444315869.
