Explanation on the FDI

Foreign Direct Investment acts as an 'attractive' index for comparing emerging countries. It is important in this scenario to understand the meaning and uses of FDI better.

One of the glaring marketing mistakes that India has been consistently making is the calculation of FDI. It is basic knowledge that if need to compare two numbers we also need to compute them using the same principles; Or else we are comparing apples with oranges. Strange as this may sound that is what is happenning in the FDI calculation between India and China. We have been comparing two different numbers between of FDi with India and China. Apart from this, we also need to remove "noise numbers" like round-tripping to get an accurate picture of the FDI inflows into China.

China has been consistently receiving higher FDI than India as per common knowledge. This is a myth. If we look at the definition of FDI as per IMF and compare the computation of FDI by China and India we find that India is not far behind.

Nirumpam Bajpai and Nandidate Dasguta explained this definitional differences between India and China in this May, 2004 article.

India's FDI figures are underestimated because of the exclusion of certain components that are included by other countries, which go by the IMF's definition.

As a rough approximation, we make the necessary adjustments in China's FDI statistics, that is, by excluding data under several heads that China includes in its FDI, but do not strictly fall under the purview of FDI. These heads include: The round-tripping of funds from Hong Kong, Taiwan, and Macao into mainland China; inter-company debt transactions; short and long-term loans; financial leasing; trade credits; grants; bonds; non-cash acquisition of equity (tangible and intangible components such as technology fee, brand name, etc.); investment made by foreign venture capital investors; earnings data of indirectly-held FDI enterprises; control premium; non-competition fee; and imported equipment. Having excluded data under these heads, net FDI inflows into China reduce from roughly $40.7 billion to $20.3 billion in 2000.

Read the entire article to better understand the difference. The Times of India recently reported on similar lines comparing Indian FDI with China using Chinese FDI computation methods.

India is set to attract record foreign direct investment, narrowly defined, of $15 billion this fiscal, at least thrice the annual flows in post-reform years. Our FII flows are close to $10 billion, and with remittances set to cross $20 billion, our total foreign investment flows in 2004-05, defined in Chinese terms, will end up at about $50 billion. This is pretty close to China's $60 billion inflows, whereas till only the other day our FDI flows seemed a fraction of China's.

Apart from this glaring definitional difference there is the problem of round-tripping and counting reivested earnings from foreign companies.

What is Round Tripping?

Round-tripping FDI refers to the domestic capital that has fled the home country and then flows back in the form of foreign direct investment.

A recent paper, Round-Tripping Foreign Direct Investment in the People’s Republic of China: Scale, Causes and Implications, by Geng Xiao estimates that 40% of the FDI into China is due to round tripping.

Foreign Direct Investment in China, an article on tdctrade.com explains the FDI phenomenon in China.

There have always been doubts about China's economic and financial statistics ranging from GDP growth to FDI inflows. With respect to its FDI inflows of USD52.7bn in 2002, some argue that it overstated China's ability to attract foreign investment. There are two major issues. The first is about reinvested earnings by foreign affiliates in China. Some believe they should not be included in FDI calculation.

UNCTAD statistics show that in 2000-2001, foreign affiliates' reinvested earnings accounted for 1/3 of all China's FDI inflows. Foreign affiliates contribute to 23% of China's industrial production, 18% of tax incomes and 48% of total exports, commanding an important presence in China's economy. Although reinvested earnings originate from China, as long as they are invested instead of flowing out of the country, they should be counted as new FDI inflows based on international practice.