i. Automatic route
FDI up to 100 per cent is allowed under the automatic route in all activities/sectors except where the provisions of the consolidated FDI Policy, paragraph on ‘Entry routes for Investment’ issued by the Government of India from time to time, are attracted. FDI in sectors /activities to the extent permitted under the automatic route does not require any prior approval either of the Government or the Reserve Bank of India. ii. Government route
FDI in activities not covered under the automatic route requires prior approval of the Government which are considered by the Foreign Investment Promotion Board (FIPB), Department of Economic Affairs, Ministry of Finance.
Indian companies having foreign investment approval through FIPB route do not require any further clearance from the Reserve Bank of India for receiving inward remittance and for the issue of shares to the non-resident investors.
As can be seen that since 2005-06 there has been a significant difference in the amount of FDI inflows through the two routes a possible explanation for which could be that with the investment climate in India improving and healthy competition among states to 3
http://www.rbi.org.in/scripts/FAQView.aspx?Id=26India’s Experience with FDI: Role of a Game Changer 8
attract FDI, the government eased foreign investment regulations leading to a spurt in FDI coming through the RBI route, which is a positive sign. As per the data available there is an increase in share of inflows through the RBI’s automatic route, a decrease in the shares of inflows through the SIA/FIPB. (Chart 3)
Why does the government differentiate between various forms of foreign investment?
FDI is preferred over FII investments since it is considered to be the most beneficial form of foreign investment for the economy as a whole. Direct investment targets a specific enterprise, with the aim of increasing its capacity/productivity or changing its management control. Direct investment to create or augment capacity ensures that the capital inflow translates into additional production. In the case of FII investment that flows into the secondary market, the effect is to increase capital availability in general, rather than availability of capital to a particular enterprise. Translating an FII inflow into additional production depends on production decisions by someone other than the foreign investor — some local investor has to draw upon the additional capital made available via FII inflows to augment production. In the case of FDI that flows in for the purpose of acquiring an existing asset, no addition to production capacity takes place as a direct result of the FDI inflow. Just like in the case of FII inflows, in this case too, addition to production capacity does not result from the action of the foreign investor – the domestic seller has to invest the proceeds of the sale in a manner that augments capacity or productivity for the foreign capital inflow to boost domestic production. There is a widespread notion that FII inflows are hot money — that it comes and goes, creating volatility in the stock market and exchange rates. While this might be true of individual funds, cumulatively, FII inflows have only provided net inflows of capital.
FDI tends to be much more stable than FII inflows. Moreover, FDI brings not just capital but also better management and governance practices and, often, technology transfer. The know-how thus transferred along with FDI is often more crucial than the capital per se. No such benefit accrues in the case of FII inflows, although the search by FIIs for credible investment options has tended to improve accounting and governance practices among listed Indian companies.
According to the Prime Minister’s Economic Advisory Committee, net FDI inflows amounted to $8.5 billion in 2006-07 and is estimated to have gone up to $15.5 billion in 07-08. The panel feels FDI inflows would increase to...
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