Foreign Capital

Foreign capital or investment has become significant part of sources of funding for various projects in every country. This source of funding has received the attention of both the government as well as the corporate sector that there has been increasing reliance on this source for planning and execution of projects by the government as well as the corporate sector. Foreign capital can come into a country in different forms. Let us first understand these forms of foreign capital before discussing the need for foreign capital.

Forms of Foreign Capital

  1. Direct Entrepreneurial Investment: In this form of foreign capital, the foreign investors can start a company abroad mainly for the purpose of establishing its branches and subsidiaries in other countries. For instance an American business group may invest in a new project in India directly and start its own affiliate or branch or even a subsidiary. Sometimes, the investors abroad may participate in the stocks or share capital of Indian companies. Whenever the Indian companies go for public issue of shares or debentures, the foreign investors may respond by participating in such public issue. This is also called foreign capital. In the past external business group used to invest in new companies and that form of foreign capital used to flow much, but now-a-days participation in the equity or debenture of companies by foreign investors and non-resident Indians is becoming more predominant.
  2. Foreign Collaboration: Foreign collaboration is another form of foreign capital. Under this a domestic company may join with the foreign company, mostly the reputed one in the industry, and start with the joint operation in India. Usually this type of effort is undertaken to get the state of the art or the latest technology available abroad in the Indian companies. Foreign collaboration may be only for technology or for funding or both. Accordingly we may have technical collaboration, financial collaboration or mixed collaboration. The collaboration may be between private parties or companies in the two countries, or the foreign company with domestic Government or between the foreign Government and the domestic Government.
  3. Inter-government Loans: This type of foreign capital refers to the loans granted by the government of one country to that of the other for a specific purpose or for general economic reconstruction. For example under the Marshall plan, USA gave loans to various European governments to help them in the reconstruction of their war-shattered economies. The developed countries also grant loans and grants to the under developed countries to help them in economic development programme.
  4. Loans from International Institutions: This source of foreign capital has emerged as a very important source in the recent years. Most of the developing countries get sizeable quantum of funds from this source. International institutions like International Monetary Fund (IMF), International Bank for Reconstruction and Development (IBRD) or World Bank, Asian Development Bank (ADB) and others have all become very important providers of funds for developing countries. The role of IMF and IBRD in tiding over the balance of payment difficulties and execution of power and irrigation projects.
  5. External Commercial Borrowing: Another source of foreign capital is the borrowing in the capital market of other countries. This can be done either directly or indirectly by the government. In both ways, the inter-government understanding and political relationship apart from the domestic investment climate are all important. Such capital is normally used for international trade purposes and specifically for export credits. Read More: External Commercial Borrowing

Need for Foreign Capital

No country can be self-sufficient today. Even developed countries have to depend on the developing countries for certain purposes and also for marketing their products. Further the specialization in finance has become world wide, that every investor wants to maximize return on his investments and minimize the risk. This is applicable both to government investment as well as corporate and private investments. These are days of multinational corporations and giants that closed economic system can no longer be realistic. In this situation, flow of capital from one country to another in different forms takes place for several reasons. From the view point of a country, there is a need to execute their plans for economic development. This could be explained in terms of the points given below:

  • The availability of funds for execution of plans and achieve rapid economic development. Domestic availability of funds, especially in the developing countries is becoming difficult with the government in these countries undertaking increasing responsibility for the welfare activities. Hence, these countries have to tap the source lying outside to get the funds required for their development purposes. In this respect the foreign capital should be attracted at any cost and in any form.
  • Domestic investors and managers of funds available, may not have the required expertise or entrepreneurship in identifying the right and profitable avenues for investment. This may be due to lack of experience or inability to identify opportunities. When foreign capital is allowed to flow, the benefits of the experience of the foreign technicians, finance specialists, production specialists, marketing wizards, etc., are made available to the domestic ventures. This will improve the efficiency of the domestic projects which is directly benefiting the country. On this count foreign capital should be welcomed.
  • One of the basic requirements for achieving rapid economic development is mobilizing savings. Savings depend upon income and income depends on the level of economic activity. Hence, any attempt to increase savings should start with attempts for increasing income which necessitates increasing investment If the domestic rate of savings and the purpose for which savings is used is unproductive, then efforts should be made to obtain the necessary investment from abroad. This would accelerate economic development leading to income generation and increased savings. Hence, in the process of economic development, foreign capital becomes an essential ingredient.
  • Foreign capital is necessary for one more reason. In every developing country, the economic development requires investment in certain projects relating to infrastructural development, basic industries, etc., which are long gestation projects, low income yielding, but accelerating economic development. No private investment or corporate investment in these projects will come about in the early stage of development either because the investors have no inclination or because the capital market in such a situation is not developed. But the government has to initiate development activities, for which foreign capital becomes essential. Once the ‘economic engine’ is activated, in due course, the economic development will start taking place. Until then foreign capital is needed.
  • Foreign capital can be in different forms as has been already explained. Countries like India having high rate of savings, but low investment in productive projects, with large human force but with less employment opportunities, have to seek technical know-how and technology available abroad. These can be slightly modified to suit the domestic conditions so that the production can take place in large scale, cost can be minimized and employment opportunities can be generated in large scale. Further there are areas like atomic energy, automobile industry, management, marketing and others where we do not have the best of experts or expertise. The best available talent or technology available abroad can be imported so that we can improve our strength in these areas and become a force to reckon with. This will also help us to achieve higher level of economic development.
  • One of the methods of achieving higher levels of development is through mutual co-operation with other countries through bi-lateral or multi-lateral agreements which provide excellent scope for transfer of technology, etc., between countries. Political wisdom warrants use of such agreements for mutual benefits which leads to flow of foreign capital from one country to another.

Problems of Foreign Capital

So far we have discussed the need for and role of foreign capital in economic development. Let us now study the problems that are associated with the foreign capital.

  1. The foreign investors are choosy in extending their funds to projects floated in our country. It is found that foreign capital flows easily towards the private sector projects but with a lot of hesitation to the projects of public sector. While there is justification for hesitant flow towards public sector, our government has been giving pride of place only to pubic sector in achieving rapid economic development. Hence, it is clear that there is no lack of investment opportunities, but there is difference in ideology. Therefore, flow of foreign capital is not uniform to all sectors. This trend has to be observed so that corrective measures can be taken to attract more foreign capital to public sector projects.
  2. Another serious problem of foreign capital is the domestic technology is simply duplicated due to over indulgence and dependence on external assistance. Such duplication is in no way beneficial to the country. This has to be corrected.
  3. One more experience is that under the pretext cf transferring technology, foreign countries simply dump their obsolete technology in the domestic country. Apart from importing inappropriate technology, there are also situations when the technology not required is imported. Further, there are tie-up agreements with such imported technology which are unfavorable to the domestic country. But such agreements have been approved much against the interest of our domestic manufacturers and technologists.
  4. Often me complaint about foreign capital is the restrictive conditions imposed by the exporting country. It may be relate to spares or technicians or repatriation of profits, etc. An increasing number of such agreements would only be against our own interest.
  5. Heavy remittance of profits, dividends, etc., is yet another problem under foreign capital. Such remittances cause severe strain on our already strained balance of payments and foreign exchange reserve position. Even if the agreement provides for such remittances, the country cannot afford to lose the hard earned foreign exchange resources under this type of remittances.
  6. One more consequence of foreign capital is that it causes serious balance of payments problem. When foreign capital in different forms is permitted, with the preference of the foreign investors, the private sector is able to attract more than the public sector. As a result the private sector indulges in importing heavily their requirements which results in heavy outflow of earned exchange reserves on the one hand and leads to balance of payments deficits on the other. Even if the government has to ultimately approve of such imports, yet the private sector is able to appease the officials through liaison officers and get the necessary approvals.

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