A Research Paper submitted

On

FOREIGN DIRECT INVESTMENT AND IT’S IMPACT ON

INDIA

IN COMPLIANCE TO THE PARTIAL FULFILLMENT OF THE MARKING SCHEME FOR

SEMESTER VIII OF 2018-2019, IN THE SUBJECT OF

INTERNATIONAL TRADE LAW.

SUBMITTED TO: SUBMITTED BY:

Prof. JHARNA SAHIJWANI Varun Dwivedi (A016)

BA.LLB (Hons.)

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 TABLE OF CONTENTS

S. NO. PARTICULARS PAGE NO.

1. INTRODUCTION 3

2. ISSUES 5

3. INDIAN PERSPECTIVE : IMPACT OF FDI ON INDIA 8

4. CASE LAWS (ARBITRATION RULINGS FROM ICSID) 10

5. CONCLUSION 13

6. SUGGESTIONS 14

7. BIBLIOGRAPHY 15

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 INTRODUCTION

The World Trade Organization is a living and growing organism. The functioning of WTO
affects the economic life of all countries around the globe. It is not concerned only with
international trade law-meaning exports and imports of goods and services in the traditional
sense-but with “international business” in general, and that includes foreign direct investment
(FDI). Foreign direct investment (FDI) is a direct investment into production or business in a
country by an individual or company of another country, either by buying a company in the
target country or by expanding operations of an existing business in that country. The
provisions on FDI in the WTO framework are contained in two agreements: the General
Agreement on Trade in Services (GATS) and the Agreement on Trade-Related Investment
Measures (TRIMs) in relation to trade in goods. All forms of FDI come under the jurisdiction
of WTO. The infamous Foreign Exchange Regulation Act (FERA) came into existence in
1973. This was replaced by the Foreign Exchange Management Act 1999 later which made
foreign exchange more liberal. Policies were eased in the 1980s. In the wake of the oil price
shocks it was probably realized that the country needed to increase its exports considerably
and for various reasons, domestic firm alone would not be up to the task FERA restrictions
were relaxed for 100 percent export-oriented units. In 1986, the tax rate on royalty payments
was brought down from 40 percent to 30 percent. FDI regulations continued to fall at a
gradual rate throughout the 1980s.

An FDI proposal requires approval. There are two approval bodies: the Reserve Bank of
India and the Secretariat for Industrial Assistance and Foreign Investment Promotion Board.
The RBI gives automatic approval to proposals in high-priority sectors where foreign equity
does not exceed 51 percent and in the mining sector as long as it does not exceed 50 percent.
SIA/FIPB deals with other proposals, such as where foreign equity exceed 51 percent the
industry is not on the list of high-priority sectors, or foreign equity does not cover the import
of capital goods. Unlike the RBI, SIA/FIPB can initiate and carry on detailed negotiations
with foreign firms.

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KEYWORDS

FDI- FOREIGN DIRECT INVESTMENT

GATS- General Agreement on Trade in Services

ARBITRATION

WTO

RESEARCH PLAN

The research conducted was of secondary nature. All materials are taken from various books,
reports, articles and the internet.

The system of foreign direct investment is a smooth mechanism of investment for investors
who want to invest internationally; this not only helps the investors but benefits the nation as
well. But this investment comes with a price and this price is paid by the developing
countries and that is a tougher completion for the local market. As far as Indian consumers
are concerned we have a mentality of assuming foreign products to be superior to local
products which makes the competition unfair as well. The research project‟s objective is to
find out the following:-

1. Relation between FDI and growth of India.

2. Impact of FDI policies on India.

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 ISSUES

Every nation‟s economy in these days work somewhat to the principle of Quid Pro Quo, there
is no nation which is not dependent on other nation states for resources or technology. Some
nations try their best to be independent of other nations but that is not possible. Not only in
resources but in investments all the countries also are dependent on each other for their
overall economic growth.

Development economists state that effects of FDI are significant on economic growth. The
gains from FDI inflows are unquestionable because it contributes to economic growth
through an increase in productivity by providing new investment, better technologies and
managerial skills to the host countries. However, the effect of FDI on domestic investment is
an issue of concern because there is a possibility of displacement of domestic capital due to
competition from foreign investors with their superior technologies and skills. Thus, the
ultimate impact of FDI on economic growth depends on the degree of capacity of the host
country to use FDI as efficiently as possible. Similarly, trade liberalisation may facilitate
economic growth through efficiency in production by utilising the abundant factors of
production more effectively and absorbing better technologies from advanced countries. The
main concern of the government accepting FDI is they have to choose between development
and damaging the local market as these investments may become competitors for the local
market.1

Foreign direct investment (FDI) is an investment made by a firm or individual in one country
into business interests located in another country. Generally, FDI takes place when an
investor establishes foreign business operations or acquires foreign business assets, including
establishing ownership or controlling interest in a foreign company. Foreign direct
investments are distinguished from portfolio investments in which an investor merely
purchases equities of foreign-based companies.2

Foreign direct investments are commonly categorized as being horizontal, vertical or

conglomerate. A horizontal direct investment refers to the investor establishing the same type
of business operation in a foreign country as it operates in its home country, for example, a
cell phone provider based in the United States opening up stores in China. A vertical
investment is one in which different but related business activities from the investor's main
1
Robert M. Stern, India and the WTO, World bank Publication.
2
https://www.investopedia.com/terms/f/fdi.asp

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business are established or acquired in a foreign country, such as when a manufacturing
company acquires an interest in a foreign company that supplies parts or raw materials
required for the manufacturing company to make its products.

A conglomerate type of foreign direct investment is one where a company or individual

makes a foreign investment in a business that is unrelated to its existing business in its home
country. Since this type of investment involves entering an industry the investor has no
previous experience in, it often takes the form of a joint venture with a foreign company
already operating in the industry.

If we see from the investor‟s perspective, they usually look for countries that have had recent
economic success, hoping that the trend will carry on in the long-run. Investors will have
more confidence in that nation that has done well in the past will also do well in the future. In
addition to macroeconomic stability, the consistency of exchange rates is also important. The
foreign investment of an MNC many times is used to supplement the firm in the host country.
As a result consistent exchange rates are necessary for an MNC to repatriate fractions of its
FDI profit to the home country. Lastly, the human capital of a country is an important factor
for an MNC when considering for investment. When investing for the long term in another
country, an MNC will most likely have to utilize the labour in the host country.3

THE WTO AGREEMENTS

The General Agreement on Trade in Services (GATS) is a treaty of the World Trade
Organization (WTO) that entered into force in January 1995 as a result of the Uruguay Round
negotiations. The treaty was created to extend the multilateral trading system to service
sector, in the same way the General Agreement on Tariffs and Trade (GATT) provides such a
system for merchandise trade. While the overall goal of GATS is to remove barriers to trade,
members are free to choose which sectors are to be progressively "liberalised", i.e.
marketised and privatised, which mode of supply would apply to a particular sector, and to
what extent liberalisation will occur over a given period of time. Members' commitments are
governed by a "ratchet effect", meaning that commitments are one-way and are not to be
wound back once entered into. The reason for this rule is to create a stable trading climate.
However, Article XXI does allow Members to withdraw commitments. For countries that like
to attract trade and investment, GATS adds a measure of transparency and legal

3
Michael Gestrin, Alan Rugman, Rules for Foreign Direct Investment at the WTO: Building on Regional Trade
Agreements, http://link.springer.com/chapter/10.1007%2F0-387-22688-5_50

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predictability. Legal obstacles to services trade can have legitimate policy reasons, but can
also be an effective tool for large scale corruption.

The Agreement on Trade Related Investment Measures (TRIMs) are rules that apply to the
domestic regulations a country applies to foreign investors, often as part of an industrial
policy. In the late 1980s, there was a significant increase in foreign direct investment
throughout the world. However, some of the countries receiving foreign investment imposed
numerous restrictions on that investment designed to protect and foster domestic industries,
and to prevent the outflow of foreign exchange reserves. Examples of these restrictions
include local content requirements (which require that locally-produced goods be purchased
or used), manufacturing requirements (which require the domestic manufacturing of certain
components), trade balancing requirements, domestic sales requirements, technology transfer
requirements, export performance requirements (which require the export of a specified
percentage of production volume), local equity restrictions, foreign exchange restrictions,
remittance restrictions, licensing requirements, and employment restrictions. These measures
can also be used in connection with fiscal incentives as opposed to requirement. There are
eight types of TRIMs:

1. Local content requirements

2. Trade balancing requirements

3. Foreign exchange restrictions

4. Export performance requirements

5. Local production requirements

6. Mandatory technology transfers

7. Production mandates

8. Limits on foreign equity and remittances

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 INDIAN PERSPECTIVE : IMPACT OF FDI ON INDIA

India as we know is a developing nation and is dependent on other countries for resources,
technology and investment as well, before 1991 economic crisis in India there was no
economic liberalisation but after the policies have been changed the FDI has increased since
then. As discussed above a nation accepting FDI has to face only one dilemma that is
development versus damaging the local market which is the case with India as well. Indian
economy was also concerned with issues pertaining to foreign private capital inflows and
trade liberalisation initially. However, it later moved to liberalize its trade and investment
policies to include various investment incentives, particularly for foreign investors. Along
with this it had maintained high and steady economic growth, single-digit inflation rate; it has
a growing domestic market, a large number of skilled personnel and a more favourable
investment market. FDI inflows into India had grown since 2000. The Government of India
has amended FDI policy to increase FDI inflow. In 2014, the government increased foreign
investment upper limit from 26% to 49% in insurance sector.4 It also launched Make in India
initiative in September 2014 under which FDI policy for 25 sectors was liberalised further.5
As of April 2015, FDI inflow in India increased by 48% since the launch of "Make in India"
initiative.6 India was ranking 15th in the world in 2013 in terms of FDI inflow; it rose up to
9th position in 2014 while in 2015 India became top destination for foreign direct investment.

India is not a country which is only dependent on other nations for resources, technology and
investment, India is a country with great exports and with the help of WTO India has
successfully increased its exports. Growth in merchandise exports: The establishment of the
WTO has increased the exports of developing countries because of reduction in tariff and
non-tariff trade barriers. Growth in service exports: The WTO introduced the GATS (general
Agreement on Trade in Services) that proved beneficial for countries like India. Agricultural
exports: Reduction of trade barriers and domestic subsidies raise the price of agricultural
products in international market, India hopes to benefit from this in the form of higher export
earnings from agriculture. Foreign Direct Investment: As per the TRIMs agreement,
restrictions on foreign investment have been withdrawn by the member nations of the WTO.

4
"FDI up 48% since 'Make in India' campaign launch". The Economic Times. 14 July 2015
5
"Eyeing big-billions in 2015, government rolls out FDI red carpet". The Economic Times. 28 December 2014.
6
"Govt initiatives help revive FDI inflow after 3-year slump, up 54% in FY15". The Indian Express. 31 August
2015.

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This has benefited developing countries by way of foreign direct investment, euro equities
and portfolio investment.

There are some negative impacts of these policies as well which are as follows:-

1. TRIPs: Protection of intellectual property rights has been one of the major concerns of the
WTO. As a member of the WTO, India has to comply with the TRIPs standards. However,
the agreement on TRIPs goes against the Indian patent act, 1970, in the following ways:

Pharmaceutical sector: Under the Indian Patent act, 1970, only process patents are granted to
chemicals, drugs and medicines. Thus, a company can legally manufacture once it had the
product patent. So Indian pharmaceutical companies could sell good quality products
(medicines) at low prices. However under TRIPs agreement, product patents will also be
granted that will raise the prices of medicines, thus keeping those out of reach of the poor
people, fortunately, most of drugs manufactured in India are off –patents and so will be less
affected.

Agriculture: Since the agreement on TRIPs extends to agriculture as well, it will have
considerable implications on Indian agriculture. The MNG, with their huge financial
resources, may also take over seed production and will eventually control food production.
Since a large majority of Indian population depends on agriculture for their livelihood, these
developments will have serious consequences.

Micro-organisms: Under TRIPs Agreement, patenting has been extended to micro-organisms

as well. This will largely benefit MNCs and not developing countries like India.

2. GATS: The Agreement on GATS will also favour the developed nations more. Thus, the
rapidly growing service sector in India will now have to compete with giant foreign firms.
Moreover, since foreign firms are allowed to remit their profits, dividends and royalties to
their parent company, it will cause foreign exchange burden for India.

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 CASE LAWS (ARBITRATION RULINGS FROM ICSID)

The International Centre for Settlement of Investment Disputes (ICSID) is an international

arbitration institution established in 1966 for legal dispute resolution and conciliation
between international investors.7 The ICSID is part of and funded by the World Bank Group,
headquartered in Washington, D.C., in the United States. It is an autonomous, multilateral
specialized institution to encourage international flow of investment and mitigate non-
commercial risks by a treaty drafted by the International Bank for Reconstruction and
Development's executive directors and signed by member countries.8

1. ABN AMRO VS. INDIA

The home state of the investor in this case was Netherlands and this dispute was settled in
2005.The investment done was creditor of loans associated with the financing of the Dabhol
energy project in Maharashtra, India. There is a bilateral investment treaty (BIT) between
India and Netherlands which the investors argued was breached. The investors had claimed
$42.80 million.

The banks/investors had argued that the “Indian government had failed to comply with its
international obligations under the investment treaties between these countries and India.
India, if the arbitral claims are upheld by the arbitration tribunal, would have to pay
compensation equal to the outstanding loans plus interest, default interest and expenses, a
release issued by Dua Associates on behalf of the offshore lenders said here today.”9

The investors were not awarded any pecuniary relief but it was settled that Dabhol will have a
new owner. Newage Power Company Private Ltd with an 85.5 per cent stake. Newage will
then transfer assets worth Rs 10,036 crore to financial institutions the creditors of Dabhol.
(The claimants in this case.)

The joint memorandum submitted as an „out-of-court settlement‟ said the Dabhol board
would be re-constituted. It will now comprise “two directors nominated by the petitioner, the
Maharashtra Power Development Corporation Ltd (MPDCL), two nominated by the Newage
Power Company and two by the Indian financial institutions”. This arrangement will continue

7
International Centre for Settlement of Investment Disputes. "About ICSID". World Bank Group.
8
International Centre for Settlement of Investment Disputes. "Organizational Structure of ICSID". World Bank
Group.
9
https://www.financialexpress.com/archive/offshorebankslauncharbitrationforrecoveryofclaimsindabhol/1224
38/

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“until all the shares are transferred to and in favour of Newage”, according to the settlement
memo filed before a division bench comprising Justices S.N. Variava and A.R.
Lakshmanan.10

2. WHITE INDUSTRIES V. INDIA

India had a bilateral treaty with Australia (BIT) which was terminated in 2017. During the
1970's and 1980's, India decided that it needed to develop its coal resources. At that time,
Coal India was a Public Sector Undertaking incorporated under Sections 6/7 of the Indian
Companies Act, 1956, which was engaged in coal mining and responsible for the coal mining
sector in India.

However, with respect to projects proposed to be undertaken whose capital requirements

exceeded those which its board of directors was entitled to approve; approval was required
from the Government of India ("GOI").11 Subsequently, meetings were held between high
level officials of the Australian and Indian governments to determine whether the
governments could co-operate in any ventures, particularly in the mining industry. The
Australian government indicated that it might be prepared to assist India with the financing
for particular developments. Shortly afterwards, a delegation from India's Ministry of Coal
and Coal India visited Australia to inspect Australian mining technology. Various Australian
companies, including White, were involved in the "marketing" to the Indian representatives.
Thus there was a contract between Coal India and White Industries. The Contract provided
that White was to be entitled to a bonus where production was in excess of the target figure
and, conversely, White was also liable to a penalty where production was below the target
figure.
Disputes subsequently arose between Coal India and White as to whether White was entitled
to the bonuses and/or Coal India was entitled to penalty payments. A number of other related
technical disputes also arose, primarily concerning the quality of the washed and processed
coal and the sampling process by which quality would be measured.12

The case was decided in the investor‟s favour it was of the opinion of the board that “The
Republic of India has breached its obligation to provide "effective means of asserting claims
and enforcing rights" with respect to White Industries Australia Limited's investment
10
https://www.telegraphindia.com/business/sc-clears-dabhol-settlement/cid/867613
11
In 2008-2009, Coal India was awarded "Navratna" status which enabled it, thereafter, to take decisions on
new projects and the use of funds without formal approval from the GOL
12
https://www.italaw.com/sites/default/files/case-documents/ita0906.pdf

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pursuant to Articles 4(2) of the BIT.” The Republic of India was asked to pay almost $5.5
million to White Industries.

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 CONCLUSION

The positive things about FDI are first, there appears to be a wide consensus that FDI is an
important, perhaps even the most important, channel through which advanced technology is
transferred to developing countries. Second, there also seems to be a consensus that FDI leads
to higher productivity in locally owned firms, particularly in the manufacturing sector. Third,
there is evidence that the amount of technology transferred through FDI is influenced by
various host industry and host country characteristics.

However the FDI guidelines usually are in favour of the developed nations and the
development of developing nations become more and more difficult due to a tough
competition in the market. It is a difficult task for a country like India to maintain the balance
of FDI and the local market.

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 SUGGESTIONS

India is a developing nation and the government needs to have a balance between easing
FDI‟s and not damaging the local market. Another motive should be to avoid matters to reach
ICSID as we have seen it not only is wastage of money (as seen in case study India had to
pay compensation to the foreign investors) it also hampers India‟s reputation worldwide. The
make in India is a good initiative to ensure this balance remains. The following measures can
be taken to ensure India becomes a developed state in near future:-

1. Not to accept any FDI in the agriculture sector and not to make any treaties related to the
agriculture sector. The reason for this is the agriculture sector is a flourishing sector in India
and as a very high percentage of the population is involved in this, this sector if organised
internally can be fruitful for the economy and for the upliftment of the farmers.

2. This is a very difficult thing to achieve and is a bit utopian but if there is no corruption a
major portion of India‟s investment will be used for the purpose it is intended to be used and
the need and desperation of FDI will decrease.

3. This step is being used by the Indian government and can be increased that is incentivise
exporters to increase exports as much as possible.

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 BIBLIOGRAPHY

BOOKS REFERRED

Robert M. Sem, India and the WTO, World bank Publication.

WEBSITES REFERRED

https://www.telegraphindia.com/business/sc-clears-dabhol-settlement/cid/867613

https://www.italaw.com

https://www.financialexpress.com

https://www.investopedia.com

http://wto.org.

http://link.springer.com

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