The Hindu Business Line : FDI to China and India: The definitional differences

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. But indiscriminate, across-the-board alignment with the IMF definition is not meaningful either, though the Indian FDI statistics looks small compared to China's. India needs to update the FDI definition in certain aspects but not in all, even if that understates inflows, say Nirupam Bajpai and Nandita Dasgupta.

UNDOUBTEDLY, China's track record in attracting foreign direct investment (FDI) is far superior to that of India. In fact, India has been considered an "underachiever" in attracting FDI. However, within this otherwise firm conviction about unmatched Chinese superiority in attracting FDI inflows vis-à-vis India, there has occasionally been some scepticism about what all China includes while compiling its FDI figures and consequently about the actual intensity of the FDI gap between China and India as suggested by the official statistics of the respective countries. On the other hand, it has been pointed out in the FDI literature that Indian FDI is hugely under-reported because of non-conformity of India's method of measuring FDI to the international standards.

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.

On the other hand, India's adoption of a somewhat broader method of FDI computation would raise its net annual FDI inflow figures, as reported in the Reserve Bank of India's official balance of payment statistics, from around $3.2 billion to about $8.1 billion in 2000. While the alignment of the Indian FDI with the international norm narrows down the gap between FDI in China and India, merely accomplishing this is not enough to close the actual difference. Together with the ongoing attempts at the alignment of FDI statistics with the global standards, more importantly, there is an urgent need in India to create a conducive investment climate to attract larger sums of FDI from the multinational companies.

Round-tripping of Chinese capital is common knowledge and a large body of literature has evolved around it. Such round tripping is often referred to as a phenomenon, which contributes to swelling of investment of neighbouring countries (mainly, Taiwan and Macao) as also of Hong Kong into mainland China. According to the `round-tripping' hypothesis, Chinese firms illegally transfer funds to these countries and that in turn gets invested in mainland China as FDI inflows in order to benefit from the preferential treatment given to FDI in terms of fiscal and other incentives. Since round-tripping is essentially clandestine, accurate data are practically impossible to obtain. Nevertheless, estimates suggest that round-tripping FDI accounted for one-fourth of China's total FDI.

There are striking elements of non-conformance between the IMF definition of FDI and that used by the RBI for computational purposes. In fact, compared to the international standard, the Indian FDI statistics appears to be limited because it includes only one component — foreign equity capital reported on the basis of issue/transfer of equity or preference shares to foreign direct investors. Some of the principle components that India excludes from the IMF definition while estimating actual FDI inflows are:

1) Reinvested earnings by foreign companies (which are part of foreign investor profits that are not distributed to shareholders as dividends and are reinvested in the affiliates in the host country).

2) Proceeds of foreign equity listings and foreign subordinated loans to domestic subsidiaries as part of inter-company (short and long-term) debt transactions.

3) Overseas commercial borrowings (financial leasing, trade credits, grants, bonds) by foreign direct investors in foreign invested firms.

4) Non-cash acquisition of equity, investment made by foreign venture capital investors, earnings data of indirectly held FDI enterprises, control premium, non-competition fee etc., as per IMF definition, which are normally included in other country statistics.

All of these account for a massive underestimation of FDI in India and therefore with appropriate adjustment (of course, not including all of the above) consistent with IMF standards, the FDI data in India could be substantially enhanced.

As mentioned above, an especially important component of FDI that is excluded in India constitutes the reinvested earnings, which companies so far have reported on a sporadic and voluntary basis. India has had foreign companies here for decades and many of them have reinvested heavily over the years. If the retained earnings from all these are cumulated, then the current returns on the stock of retained earnings would have to be added to the returns on measured FDI. Added together, these total returns would be high relative to the stock of measured FDI. However, even the flow in recent years can increase since several multinationals have been reinvesting their profits in India and this is not being captured as FDI, a practice China adopts.

Citigroup, for example, has reinvested significant earnings in its Indian business over a sustained period — funds that are not captured in the FDI reporting. Its Citibank unit in India has retained earnings of about $350 million but this was not captured in FDI reporting. The recent reinvestment of more than $ 400 million in India by Citibank alone was also not captured in FDI reporting. Similarly, the purchase of around $300 million in non-equity form of direct investment capital by Fiat to recompense the losses sustained by its Indian subsidiary was also not reflected in Indian FDI figures. Also, Coke and Pepsi have invested $1.3 billion in India.

China, contrary to India, adheres to the IMF standard of FDI computing. China includes all the components of IMF in its definition of FDI. It also classifies imported equipment as FDI, while India captures these as imports in its trade data. China's FDI numbers also include a substantial amount of round tripping. In the process, the actual inflows are vastly underestimated in India's FDI reporting in comparison to such countries as China that adhere to the IMF standard of FDI computing.

The non-conformance of India's FDI statistics to international standards has denied the aggregate FDI data for India direct comparability to those of most of the other countries. Especially, the fact that FDI inflows in India are entirely measured on equity investments while ignoring other components implies that FDI inflows into India have been underestimated.

According to an IFC study, "FDI - India and China — A comparison," China's equity capital of FDI in 2000 composed of $6.24 billion of non-cash, $7.28 billion round- tripping, $16.02 billion of reinvested earnings, $1.53 billion of other capital and $7.28 billion of cash out of a total of $38.35 billion FDI in that year. Considering the fact that India's equity capital (cash only) of FDI was $2.32 billion in 2000, this needs to be compared with China's equity capital cash component of $7.25 billion for that year. Further, in 2001, India's FDI, excluding other factors that normally go into the definition of computing FDI, was running at $3.4 billion. This compares favourably with that of China even if its cash component of FDI has slightly increased in 2001.

There is no doubt that Indian FDI inflow figures are underestimated at present. This is because of the exclusion of certain components of FDI measurement by India that are included in other countries, which maintain conformance with the international standards. It is also a matter of concern that the Indian FDI statistics looks significantly small in relation to that of China. But indiscriminate, across-the-board alignment of FDI definition with the IMF stipulation is not meaningful either. To be more precise, we need to update our FDI definition in certain aspects but not in all, even if that quantitatively understates India's FDI vis-à-vis other countries to some extent.

Areas where modification and/or alignment of FDI data in India is required

Reinvested earnings, which are part of foreign investor profits that are not distributed to shareholders as dividends and are reinvested in the affiliates in the host country, need to be shown as inflow of FDI. Since India has had foreign companies for decades and many of them have reinvested heavily over the years, quantifying this would boost the stock of FDI considerably. However, from a technical point of view, it is well recognised that it is quite difficult to capture `reinvested earnings' through the reporting arrangements for foreign exchange transactions. This is mainly because such transactions do not actually take place and thus have to be imputed in the balance of payments statistics. However, the understatement of the total and reinvested earnings can be prevented by the inclusion of statistics regarding the indirect ownership in subsidiaries, associates and branches, etc.

The reinvested earnings could also be captured through appropriately designed surveys by government authorities. The reporting system must be made legally mandatory for the companies.

Reinvested earnings as an offsetting entry (with opposite sign) could also be notionally shown as dividends paid out under current account flows that are recorded under direct investment income.

FDI flow generated by the direct investor in his subsidiary abroad by borrowing on the subsidiary's local market does not appear in the balance of payments. However this flow could theoretically be accounted for if data collection is based at least in part on a survey system covering direct investors or their affiliates instead of entirely depending on the central banking system.

The non-cash acquisition of equity, which is in the form of tangible and intangible components such as provision of capital equipment, technology and know-how, brand name, etc., should be included in India's FDI inflows. This is because the non-cash flows have the potential to generate direct and spillover benefits similar to those anticipated from FDI in the form of equity flows, and

The investment made by foreign venture capital investors should be made part of India's FDI. It has been pointed out that `hundreds of millions' invested through the Venture Capital route do not form part of the FDI reporting which, if adjusted, could substantially enhance FDI data.

(Dr Nirupam Bajpai is a Senior Development Advisor and Director of the South Asia Program at the Center on Globalization and Sustainable Development (CGSD), Columbia University. Nandita Dasgupta is a Consultant at CGSD.)

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