1. India’s Integration with the World
Economy: Some Emerging Issues
BHAWANI NANDAN PRASAD
SMP – IIM Calcutta
MBA – Stratford University
B.E. ( Computer Sc. IT )

2. Channels of Integration with the world economy
• Economic
– International Trade in goods and services
– International investment flows
– International financial markets
– Exchange rates
• Integration driven by technology
• Integration due to increased diplomatic and strategic
presence in international forums

3. International Economics-linkages
• Current Account
Transactions
– Trade in goods (merchandise
trade)
– Trade in services
– Other current account
transactions
• Capital Account Transactions
– Inflow and outflow of capital
– Includes foreign direct investment,
foreign portfolio capital flows
– Other debt creating capital flows like
external commercial borrowing
Exchange rates
Foreign Exchange Reserves

4. India’s Current Account
‘Government not included elsewhere (GNIE)’ receipts represent inward remittances towards maintenance of foreign
embassies, diplomatic missions and offices of international/regional institutions in India, while GNIE payments
record the remittances on account of maintenance of Indian embassies and diplomatic missions abroad and
remittances by foreign embassies on their account.

5. Trade Balance to GDP ratio of India (as a % of GDP)
-15
-10
-5
0
5
10
15
20
25
30
1970-71
1971-72
1972-73
1973-74
1974-75
1975-76
1976-77
1977-78
1978-79
1979-80
1980-81
1981-82
1982-83
1983-84
1984-85
1985-86
1986-87
1987-88
1988-89
1989-90
1990-91
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
Export to GDP Import to GDP Trade Balance to GDP

6. Trade to GDP ratio of India (as a % of GDP)
0
5
10
15
20
25
30
35
40
45
1970-71
1971-72
1972-73
1973-74
1974-75
1975-76
1976-77
1977-78
1978-79
1979-80
1980-81
1981-82
1982-83
1983-84
1984-85
1985-86
1986-87
1987-88
1988-89
1989-90
1990-91
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
Export to GDP Import to GDP Trade to GDP

7. Other Terms in Current Account
• Transfers (Official, Private)
– Transfers represent one-sided transactions, i.e., transactions that do not have any quid pro quo, such as grants, gifts, and migrants’
transfers by way of remittances for family maintenance, repatriation of savings and transfer of financial and real resources linked to
change in resident status of migrants.
– Official transfer receipts include grants, donations and other assistance received by the Government from bilateral and multilateral
institutions. Similar transfers by Indian Government to other countries are recorded under official transfer payments.
• Income
– Transactions are in the form of interest, dividend, profit and others for servicing of capital transactions.
– Investment income receipts comprise interest received on loans to nonresidents, dividend/profit received by Indians on foreign
investment, reinvested earnings of Indian FDI companies abroad,
– interest received on debentures, floating rate notes (FRNs), Commercial Papers (CPs), fixed deposits and funds held abroad by ADs
out of foreign currency loans/export proceeds,
– payment of taxes by nonresidents/refunds of taxes by foreign governments, interest/discount earnings on RBI investment etc.
– Investment income payments comprise payment of interest on non-resident deposits, payment of interest on loans from
nonresidents, payment of dividend/profit to nonresident share holders,
– reinvested earnings of the FDI companies, payment of interest on debentures, FRNs, CPs, fixed deposits, Government
securities, charges on Special Drawing Rights (SDRs) etc.
– In accordance with the IMF’s Balance of Payments Manual (5th edition), ‘compensation of employees’ has been shown under
head, “income” with effect from 1997-98; earlier, ‘compensation of employees’ was recorded under the head “Services –
miscellaneous

8. For India, remittances to GDP ratio is about 4%
Top recipient of remittances among developing countries

10. Overall BOP

11. What Are Foreign Exchange Reserves?
• Reserves as external assets that are readily
available to and controlled by monetary
authorities
– for direct financing of external payments
imbalances,
– for indirectly regulating the magnitudes of such
imbalances through intervention in exchange
markets to affect the currency exchange
rate, and/or
– for other purposes

14. Sources of Accretion to Foreign Exchange Reserves since 1991
(US$ billion)
Items 1991-92 to 2010-11
(Upto September 2010)
A Reserves as at end-March 1991 5.8
B.I. Current Account Balance -144.7
B.II. Capital Account (net) (a to e) 415.7
a. Foreign Investment 236.2
Of which
FDI 102.7
FII 103.0
b. Other Deposits 39.1
c. External Assistance 24.3
d. External Commercial Borrowings 76.7
e. Other items in Capital Account* 39.0
B.III. Valuation Change 16.5
Reserves as at end-September 2010 (A+BI+BII+BIII) 292.9
* : Include errors and omissions.

15. Optimum level of Reserve…1
• The optimal level of reserves is neither infinite since reserves
entail costs, nor zero since reserves yield benefits.
• Calculation of optimum or sufficient reserve is important from
the point of view of developing SWFs.
• Nature of the foreign exchange and composition of assets and
liabilities are important to understand when calculating
optimum reserve.

16. Sovereign Wealth Funds
• SWFs generally refer to special purpose investment vehicles created to manage
national savings to generate higher returns.
• The non-commodity SWFs are usually carved out of the official reserves of a
country. Countries having large balance of payments surpluses have been able to
transfer excess foreign exchange reserves to such investment vehicles.
• Typically, countries that have set up SWFs have surplus on the current account due
to “windfall” or sustained current account surpluses, and usually a fiscal surplus as
well.
• The main policy rationale behind setting up a SWF is not to acquire strategic assets
and secure supply of natural resources. Such funds are established to manage
excessive foreign exchange reserves, commodity exports, the proceeds of
privatisations and fiscal surpluses. For instance, China established its SWF, China
Investment Corporation, with a $200 billion corpus to manage its excessive forex
reserves, which reached 2.4 trillion by end-June 2010.

17. Different Modes of Entry in a foreign market
• Through trade: movements of goods and services
• Through establishing a presence in the foreign
territory
– Foreign Direct Investment
– Foreign Portfolio Investment
• Through non-equity modes of International production
(like outsourcing, franchise model, licensing etc.)

18. Foreign Direct Investment
• FDI refers to international capital flows in
which a firm in one country creates or
expands a subsidiary in another
• It involves not only a transfer of resources but
also the acquisition of control
• The subsidiary does not simply have a financial
obligation to the parent company; it is part of the same
organizational structure.

19. Types of FDI: Based on Modes of Entry
• Greenfield investment:
– Greenfield FDI is when a
company builds a new
production facility
abroad.
• Acquisition
• Merger
• Joint venture
Brownfield FDI

20. Types of FDI: Horizontal FDI
• Horizontal FDI is dominated by flows between developed countries.
– Both the multinational parent and the affiliates are usually located in
developed countries.
• The main reason for this type of FDI is to locate production near a
firm’s large customer bases.
– Hence, trade and transport costs play a much more important role than
production cost differences for these FDI decisions.
• With FDI in a large market, it is possible to:
– Avoid transport costs
– Avoid tariffs
– Build/develop more close link with the market through local presence
(better after sales service, consumer interaction, market understanding)

21. Types of FDI: Vertical FDI
• Vertical FDI takes place when the production chain is broken up, and parts of the
production processes are transferred to the affiliate location.
• Vertical FDI, is not primarily or even necessarily aimed at production for sale in the
foreign market, but rather seeks to avail of lower production costs there.
• Vertical FDI is growing fast and is behind the large increase in FDI inflows to
developing countries.
• The vertical FDI decision involves a trade-off between cost savings due to
production relocation and the fixed cost F of setting up an additional production
facility.
– Cost savings related to comparative advantage make some stages of
production cheaper in other countries.

22. Some empirical facts
• Developed countries have been the biggest
recipients of inward FDI.
– much more volatile than FDI going to developing and
transition economies.
• Steady expansion in the share of FDI flowing to
developing and transition countries.
– Accounted for half of worldwide FDI flows in 2009.
• Among developing countries, FDI is concentrated
in a few large developing countries.

24. Potential Benefits of FDI to Host Country
• Increased output
• Increased wages
• Increased employment
• Increased exports
• Increased tax revenues
• Realization of economies of scale
• Import of technical and managerial skills
• Weakening power of domestic monopoly
Different impact of Greenfield vis-à-vis Brownfield Investment?

25. Potential Costs of FDI to Host Country
• Technology transfer vs. appropriateness of technology
• Transfer pricing
• Increased competition for domestic firms
• Decrease in domestic investment (crowding out)
• Instability in the balance of payments through profit
repatriation and transfer payments
• Loss of control over domestic policy

26. FDI Inflows to India (in million US$)

29. What is Foreign Portfolio Investment
• Portfolio investment is defined as cross-border transactions and
positions involving debt or equity securities
• Portfolio investment includes investments by a resident entity in one
country in the equity and debt securities in another country which seek
primarily capital gains and do not necessarily reflect a significant and
lasting interest in the enterprise.
• The category includes investments in bonds, notes, money market
instruments and financial derivatives other than those included under
direct investment, or in other words, investments which are both below
the ten per cent rule and do not involve affiliated enterprises.
• In addition to securities issued by enterprises, foreigners can also
purchase sovereign bonds issued by governments

30. Foreign Portfolio Capital flows and FDI inflows to India
(in US$ millions)

31. Major differences between FDI and FPI
• FDI involves the transfer of other resources than
capital (technology , management, organizational and
marketing skills, etc.) and it is the expected return on
these, rather than on the capital per se, which
prompts enterprises to become MNEs. Thus capital is
simply a conduit for transfer of other resources than
the raisond’être for direct investment.
• Second, in the case of direct investment, resources
are transferred internally within the firm rather than
externally between two independent parties: de jure
control is still retained over their usage.

32. Foreign Institutional Investors
• India does not have convertibility in capital account so foreigners are not free to invest in Indian assets
including Indian securities.
• Only foreign investors who are registered with the Securities and Exchange Board of India (SEBI) are
allowed to invest in Indian security markets. These investors are called the Foreign Institutional
Investors or FIIs.
• FIIs include asset management companies, pension funds, mutual funds, incorporated/institutional
portfolio managers or their power of attorney holders, university funds, endowment foundations,
charitable trusts and charitable societies.
• FIIs need to comply with certain foreign exchange regulations laid down by RBI.
• The initial registration is valid for five years and is renewable for similar five year periods.
• RBI's general permission granted under FERA enables the registered FII to buy, sell and realize capital
gains on investments made through the initial corpus remitted to India, subscribe/renounce rights
offerings of shares, invest on all recognized stock exchanges
• The investments by FIIs enjoy full capital account convertibility.
• Presently, SEBI had more than 1700 registered FIIs.

33. Others who can invest in Indian Capital Markets
• Indian laws also allow Non Resident Indians (NRIs) and PIOs
(People of Indian Origin) to invest in the Indian capital
markets subject to certain restrictions.
• Foreign Venture Capital Firms (FCVIs) are also allowed to
invest subject to certain ceilings.

34. Example of FII Registration detail
from SEBI website:
http://www.sebi.gov.in/FIIIndex.jsp?fiiIndxName=M

36. Policy Change- QFIs!!
• In a major policy decision, the government has decided to allow Qualified
Foreign Investors (QFIs) to directly invest in Indian equity market
• This has been done to widen the class of investors, attract more foreign funds,
and reduce market volatility and to deepen the Indian capital market.
• The QFIs shall include individuals, groups or associations, resident in a foreign
country which is compliant with Financial Action Task Force and that is a
signatory to IOSCO’s multilateral MoU. QFIs do not include FII/sub-accounts.
• The individual and aggregate investment limit for QFIs will be 5% and 10%,
respectively, of the paid up capital of company
• QFIs shall be allowed to invest through SEBI registered Qualified Depository
Participant (DP). A QFI shall open only one demat account and a trading
account with any of the qualified DP. The QFI shall make purchase and sale of
equities through that DP only.

37. Entering Foreign Market:
Equity and Control
Equity and Control
Equity but no Control
No Equity but Control
Foreign Direct Investment, Joint Ventures
Foreign Portfolio Investment
Non Equity Mode of Production

38. Non-Equity Mode (NEM) of TNC Operations
• A cross-border nonequity mode of TNC
operation arises when a TNC externalizes
part of its operations to a host-country-
based partner firm in which it has no
ownership stake, while maintaining a level
of control over the operation by
contractually specifying the way it is to be
conducted.
• Specifications may relate to, for example,
the design and quality of the product or
service to be delivered, the process and
standards of production, or the business
model that the partner firm must adhere
to.
• Thus the defining feature of cross-border
NEMs, as a form of governance of a TNC’s
global value chain, is control over a host-
country business entity by means other
than equity holdings, although each type
of NEM has its own particularities