German Multinational Firms in India

Diplomarbeit von Simon Gerschlauer

Introduction:

Global foreign direct investment (FDI) has risen sharply in the 1990s. At the same time and even more strikingly FDI in emerging market economies has spurred dramatically. Arising at the end of the 20th century and only known from 19th century trading companies as the East India Company, FDI in developing and emerging markets represents today a new phenomenon. Traditionally, literature has mostly focused on FDI between industrialized countries, and publications on FDI in emerging markets remain relatively sparse. Yet, the rise of large emerging market countries such as China and India has attracted interest of an increasing number of multinational firms (MNFs). The combination of high real economic growth and new FDI regulation in these countries creates a specific environment where MNFs have to adjust corporate strategies for successful market penetration. Further, government’s perception of FDI has changed towards increasingly attracting FDI.

The present diploma thesis attempts to contribute to the broad issue of understanding why firms become multinational and why they invest in specific countries. Determinants affecting corporate strategies of MNFs and the influence of FDI related economic policies will be specifically analyzed for the case of German MNFs in India for two reasons:

Firstly, India is of particular interest as its economy has been opened up remarkably for FDI as a consequence of the economic reform process in the early 1990s. FDI in India, one of the Asian emerging market countries, may therefore suitably represent recent FDI trends to developing and emerging market countries. FDI analysis in these countries often concentrates on China. Given that India is most prominently referred to the Chinese case in terms of economic perspective and potential FDI growth, the analysis allows to draw attention on a second large and prospective FDI player in the region.

Secondly, a ‘newly’ available firm-level dataset from the Deutsche Bundesbank provides detailed data on German FDI in India. The dataset allows to jointly analyze determinants of MNF decisions and host country location factors.

The following thesis attempts to provide a (1) profound theoretical background, (2) empirical validation of theoretical predictions using firm-level data and management survey results and (3) implications on corporate strategy and economic policy.

Project Organization:

Section 2 provides the theoretical foundation by outlining an explicit analytical framework to clearly separate determinants. Determinants of MNFs and host countries are specifically discussed and interrelated, before analyzing the effect of MNF determinants on market entry strategies.

Section 3 introduces the Indian case. Based on a brief overview of economic reforms and growth, consequences of the latter on FDI regulation and subsequent FDI growth are presented. Finally, specific host country determinants are discussed from the point of view of MNFs.

Section 4 provides the empirical foundation of the thesis. Based on general analysis of FDI patterns and descriptive firm-level evidence, regressions to test determinants as suggested by theory follow. Further, the same determinants are considered to explain profitability of FDI projects.

In section 5 findings from management surveys with respect to MNF strategies and factors for success are presented, thereby confronting econometric findings from previous sections with survey results.

Section 6, finally, proposes a conclusion, presenting implications of the thesis results on corporate strategies of MNFs in India and on FDI related economic policy issues in India.

Table of Contents:

Text Sample:

Chapter 3.4.1, FDI Rankings:

Referring to international FDI investment climate rankings, India has reported gradual improvements. In general, proposed investment climate rankings represent indices measuring the impact of political, economic and legislative changes. However, exact index compositions change. Data stems from publicly available sources and management opinion surveys. According to the A.T. Kearney FDI Confidence Index , India has improved from rank 11 in 2000 to rank 3 in 2004 and finally to rank 2 in 2007 only left behind by China. This is in line with the FICCI FDI Survey that also registered an increase of its FDI attractiveness index in 2004. According to both surveys, the upturn is in particular explained by the off-shoring boom in recent years, placing China and India in first positions. The 2008/09 Global Competitiveness Report (GCR) confirms an overall score increase in the same period. Even though reporting a slight stagnation (due to weaker macroeconomic outlooks) for India. Yet, all three illustrate substantial challenges and opportunities determining location decisions of MNFs in India.

Challenges:

As indicated in section 2.4.2 political stability and geopolitical risk affect the host country’s investment climate. An important determinant is continuance of reforms which has been ranked most important in the FICCI Survey. This was apparent when India stock markets soared after the reformer Congress party won national elections. Although India’s democratic situation seems stable, external risks likes the Kashmir conflict or terrorism remain important location factors. Macroeconomic stability is a major concern, as India has one of the highest fiscal deficits in the world. Price stability seemed to be improved.However, according to the IMF inflation bounced back to levels near 8 percent for 2008. Surveys, underline the importance of credible ‘Indian commitment to economic growth balanced with fiscal discipline […] to focus investors successfully on long-term market potential’.

Institutional development continues to be problematic as poor indicators for health and education have been reported. Primary educational levels tend to be especially low as well as the share of females in the labor force. Although India’s legal system is fairly developed, it remains inefficient causing long and expensive disputes. Besides political bottlenecks such as resistance to privatization and labor market rigidities, that negatively affect firm expansion, restrain potential FDI. Further, with higher technological sophistication of FDI, protection of intellectual property rights is more seriously conceived as challenge to host country competitiveness.

Additionally, India’s complex tax system differences on state-levels is perceived as critical by MNFs. In general, inconsistencies between central and regional governments hamper the promotion of FDI, requiring ‘efforts to eliminate the divergence between central and regional investment policies’.

In addition, bureaucratic hurdles and corruption hamper investment as procedural delays may be important. Adequate infrastructure represents a major challenge to investors in the areas of electricity, transportation and water. The lack of satisfactory infrastructure affects sectors differently. For instance manufacturing sectors are affected stronger than service sectors, which in turn partly explains the relative surge in FDI in the latter sector.

Referring to host country determinants presented in section 2.4, one can state that mostly long-term policy determinants are perceived as deterrents for FDI in India. Obviously, this may be due to the stage of development of India, where reforms just recently have been introduced. As reactions after national elections proved, continuing reforms and accelerating their implication, with respect to Intellectual Property Rights law, approval of FDI projects and ownership threshold, are key.

Opportunities:

A major attraction of FDI is seen in the size of India’s economy and growth prospects. India is expected to have the highest growth perspective of a set of 34 economies, predicting constant yearly GDP growth rates of 5-6 percent until 2020. Surge in per capita income is expected to infer substantial growth of the middle income segment and change of consumption patterns in the long run, contributing to India’s FDI attractiveness.

Secondly, abundance of low-cost and skilled labor is conceived as an important driver of FDI. Low cost labor aspects refer not only to unskilled but also to skilled labor. India provides the world’s largest Anglophone population combined with a high number of skilled manpower, making India eligible for knowledge intensive FDI. Moreover, the availability of human capital is expected to improve substantially over the next decades. But, improvement depends on governmental implementation of necessary ongoing reforms and development of education and health sectors. In fact, the combination of low-cost and skilled labor qualifies and expands India’s role towards a global hub for R&D. Accordingly, the GCR 2008/09 ranks India third for the availability of scientists and engineers and 27th of 134 countries for the quality of research institutions. Furthermore, India is renowned for strong business expertise and innovation disposing of good business clusters and local suppliers. As a matter of fact, this turns India into an attractive FDI destination for business process outsourcing (BPO) such as low skilled back-office activities and in particular for knowledge process outsourcing (KPO) demanding a higher quality of labor. Specific for both BPO and KPO is that they are closely linked to other production process of MNFs suggesting substantial potential for VFDI. India is assumed to become world leader in KPO by 2010, thereby covering over 70 percent of market demand.

Further investment attraction is based on the profound openness for FDI in many sectors and the strong decline in tariffs. The weighted average tariff had substantially been reduced in the course of economic reforms. The decline continued as average tariffs almost halved from 40 percent in 1998/09 to 22.2 percent for 2004/05. Nevertheless, there remains room for continued openness, as Indian tariffs exceed the average of the ASEAN-5 and in particular China. In contrast to broad evidence on investment incentives, business facilitation seems to attract FDI in specific sectors like public services (power and utilities) and consumer products.

Compared with section 2.4, outstanding location factors attracting FDI in India are foremostly economic determinants. In line with theoretical predictions, low tariffs are perceived as favorable determinants. Clearly, to a minor extent also business facilitation plays a role.