The Gist of Yojana: February 2015

The Gist of Yojana: February 2015

Why Do Indian Firms Go Abroad ?

In recent years, India and China have not only liberalised their FDI regimes, but also emerged as investors abroad. Although, the volume of India’s investments is much lower than that of China, the composition of India’s FDI, centered on manufactures and services, its heavy presence in the developed countries, its method of entry into foreign markets based on acquisitions principally the UK and the US, sets it apart from the other emerging economy investors.

Size and Pattern of India’s Investments Abroad

The total stock of India’s FDI increased from a meagre $124 million in the year 1990 to $ 111,257 million in 2011 with a share of 3 per cent in the total Overseas Direct Investment (ODI) stock of the developing countries. India’s ODI is significantly different from that of China in its composition-whereas a large proportion of China’s investments is in oil and raw materials, India’s investments are in manufacturing and services.
Third, more than 50 per cent of India’s ODI is in the developed economies while more than 75 per cent of China’s ODI is in the developing economies.

By the end of the year 2008, India was the second largest investor in the UK, next only to the US.

Fourthly, the growth of India’s ODI is mostly through acquisitions. In the year ending in August 2010, India was second in the list of the ten most acquisitive nations, with a share of 24 per cent of cross-border M&A transactions originating from emerging economies.

The latest tests of the OLI theory relate to ODI from India and China (Pradhan 2011, Buckley, 2007; Kumar, 2007 & Nunnenkamp, 2010). The pioneering studies relating to India are those by Jayaprakash Pradhan who has (2008,2011, 2004). painstakingly put together a set of data from a number of sources including the media and unpublished data from government sources.

Pradhan’s analysis suggests that high labour productivity, R and D expenditures, managerial skills as defined above, exports and the post 1991 liberalisation measures are all factors in the decision of Indian manufacturing firms to go abroad. It is arguable whether or not these results endorse the proposition that Indian firms venturing abroad possess ownership advantages of the sort that the OLI theory emphasizes. High labour productivity of the Indian manufacturing firms flows from the relatively high capital intensity of their production process and their heavy presence in industries that are typically capital intensive.

On top of the list of variables included in Pradhans’ analysis of ODI by Indian firms is managerial skills. Indeed, managerial expertise of Indian firms is an ownership advantage that influences firms to go abroad. But managerial abilities that consist of a variety of attributes are not easily quantifiable. Pradhan quantifies it by regressing profits per unit of assets of firms on age, size, R and D, royalties paid for imported know, how, sales expenditures and a set of dummy variables for type and ownership of industries and sector.

The statistical results referred to earlier suggest that firms with large profits tend to go abroad. But not all firms with large profits may be able to do so. Indeed, it is likely that many of the firms that have invested abroad may have raised funds for investment in international capital markets. Those Indian firms that have ventured abroad enjoy a unique ownership advantage that can be termed entrepreneurship that includes managerial efficiency, risk taking, forecasting and identification of new markets to name ‘only a few of the attributes of entrepreneurship. Indian firms may be unique amongst the firms of the emerging economies in this respect. How and where do these unique attributes of Indian managers come from?

The Unique Attributes of Indian Firms That Go Abroad

It is impossible to generalise on the factors that influence firms to go abroad. The one reason most firms from emerging markets invest abroad is to acquire technological capabilities inherent in existing firms- this is the so called asset seeking motive for ODI. The acquisition of existing firms requires managerial efficiency, but it is not the kind that is referred to in the statistical studies. They are of a different order and include identification of the nature and productivity of the assets that the targeted firms possess, their market potential, risks involved in operating abroad and above, all the ability to manage operations in a foreign locale.

Additionally, the acquired firms may have to be revived, they may possess production oriented advantages but may be ailing because of their inability to explore and develop markets. Indian managers investing abroad seem to possess these sorts of skills, or to use an expression coined by Keynes “animal spirits” of entrepreneurs. It is such entrepreneurial talent that seems to have led several Indian firms, to raise the capital required for their investments abroad in international capital markets.

The entrepreneurial instincts and expertise of Indian firms is to be traced to several unique features of the Indian economy. Foremost of these is the inheritance from history. India has had a long history of business entrepreneurship marked by its caste and community orientation. Foremost amongst these groups are the Banias and the Marwaris, primarily merchants and money lenders with a prominent role in financing India’s foreign trade during the British colonial era. The Parsis who had no religious affiliation with either the Hindus or the Muslims were in a class of their own. They provided a link between the British and the Indian business houses.
The second factor that has contributed to the development of entrepreneurial talent amongst Indian firms is the existence of business groups, mostly of the family orientation. Three quarters of the number of foreign acquisitions estimated at 1347 during the period 2000-2008 are reported to be undertaken by group affiliated firms as opposed to stand alone firms. This reflects the superior advantage enjoyed by business groups over stand alone firms that enable them to efficiently internalize market externalities.

A third factor that has contributed to the entrepreneurial skills of Indian business is the system of education, unique to India, from historic times to the present day. As Tirthankar Roy (2011) notes, the education system in India during the colonial days was caste based and dominated by those who wished to enter the professions. It was thus that the elite caste groups advanced from primary to higher education and the system catered to their needs and primary education for the population in general was ignored. It is the caste based education, primarily oriented towards the civil service and the professions, which laid the base for the growth of the services economy and software in the services group, which is one of India’s major investors abroad.

A fourth factor that has contributed to the growth of managerial expertise of the Indian business houses is the presence of India’s diaspora in the UK and the US. Available data for the later part of the last decade shows that there were 1.6 million Indians in the UK accounting for 1.8 per cent of total population of the country and in the US, there were 2.8 million Indians accounting for 0.9 per cent of US population.There may be two other explanations for this spectacular growth of Indian investments abroad. First, it may be easier to operate in the business environment abroad than that at home.

Second, the attraction of foreign markets in the presence of a fairly lucrative domestic market in India has echoes of Britain’s experience during the second half of the 19th century. During the period 1870-1914, Britain exported substantial volumes of portfolio capital mostly to the colonies, the total stock of British capital abroad in the year 1914 is estimated at $20 billion.

In sum, the sort of skills Indian entrepreneurs possess that serves them well in their quest for investment locales abroad are an inheritance from the country’s history – entrepreneurial and business skills from the colonial days and the engineering and human skills form the more recent past – the post-independence years. These skills were locked up during the days of the license Raj that lasted for more than three decades until the year 1991. The economic liberalisation measures let the genie out of the bottle. They liberated the entrepreneurs from the sort of dull and dreary chores of coping with rules and regulations and provided an environment for risk taking and facing the challenges posed by competitive markets in a globalised world.

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