China and India are the giants of the developing world. Both enjoy healthy rates of economic growth. But there are significant differences in their FDI performance. FDI flows to China grew from $3.5 billion in 1990 to $52.7

billion in 2002; if round-tripping is taken into account, China’s FDI inflows could fall to, say, $40 billion.a Those to India rose from $0.4 billion to $5.5 billion during the same time period (box table II.4.1).b

Even with these adjustments, China attracted seven times more FDI than India in 2002, 3.2% of its GDP compared with 1.1% for India.c In UNCTAD’s FDI Performance Index, China ranked 54th and India 122nd in 1999—2001. FDI has contributed to the rapid growth of China’s merchandise exports, at an annual rate of 15% between 1989 and 2001. In 1989 foreign affiliates accounted for less than 9% of total Chinese exports; by 2002 they provided half. In some high-tech industries in 2000 the share of foreign affiliates in total exports was as high as

91% in electronics circuits and 96% in mobile phones (WIR02, pp. 162-163).

About two-thirds of FDI flows to China in 2000—2001 went to manufacturing. In India, by contrast, FDI has been much less important in driving India’s export growth, except in information technology. FDI in Indian manufacturing has been and remains domestic market-seeking. FDI accounted for only 3% of India’s exports in the early 1990s (WIR02, pp. 154)

Even today, FDI is estimated to account for less than 10% of India’s manufacturing exports (UNCTAD forthcoming a). For China the lion’s share of FDI inflows in 2000—2001 went to a broad range of manufacturing industries. For India most went to services, electronics and electrical equipment and engineering and computer industries. What explains the differences? Basic determinants, development strategies and policies and overseas networks.

On the basic economic determinants of inward FDI, China does better than India. China’s total and per capita GDP are higher (box table II.4.1), making it more attractive for marketseeking FDI. Its higher literacy and education rates suggest that its labour is more skilled, making it more attractive to efficiency-seeking investors (World Bank 2003c, p. 234; UNDP 2002). China also has large natural resource endowments. In addition, China’s physical infrastructure is more competitive, particularly in the coastal areas (CUTS 2003, Marubeni Corporation Economic Research Institute 2002). But, India may have an advantage in technical manpower, particularly in information technology. It also has better English language skills.

Some of the differences in competitive advantages of the two countries are illustrated by the composition of their inward FDI flows. In information and communication technology, China has become a key centre for hardware design and manufacturing by such companies as Acer, Ericsson, General Electric, Hitachi Semiconductors, Hyundai Electronics, Intel, LG Electronics, Microsoft, Mitac International Corporation, Motorola, NEC, Nokia, Philips, Samsung Electronics, Sony, Taiwan Semiconductor Manufacturing, Toshiba and other major electronics TNCs. India specializes in IT services, call centers, business back-office operations and R&D.

Rapid growth in China has increased the local demand for consumer durables and nondurables, such as home appliances, electronics equipment, automobiles, housing and leisure. This rapid growth in local demand, as well as competitive business environment and infrastructure, have attracted many market-seeking investors. It has also encouraged the growth of many local indigenous firms that support manufacturing.

Other determinants related to FDI attitudes, policies and procedures also explain why China does better in attracting FDI.

• China has "more business-oriented" and more FDI-friendly policies than India (AT Kearney 2001).

• China’s FDI procedures are easier, and decisions can be taken rapidly.

• China has more flexible labour laws, a better labour climate and better entry and exit procedures for business (CUTS 2003).

A recent business environment survey indicated that China is more attractive than India in the macroeconomic environment, market opportunities and policy towards FDI. India scored better on the political environment, taxes and financing (EIU 2003a). A confidence tracking survey in 2002 indicated that China was the top FDI destination, displacing the United States for the first time in the investment plans of the TNCs surveyed; India came 15th (AT Kearney 2002). A Federation of Indian Chambers of Commerce and Industry (FICCI) survey suggests that China has a better FDI policy framework, market growth, consumer

purchasing power, rate of return, labour laws and tax regime than India (FICCI 2003).

The different FDI performance of the two countries is also related to the timing, progress and content of FDI liberalization in the two countries and the development strategies pursued by them.

• China opened its doors to FDI in 1979 and has been progressively liberalizing its investment regime. India allowed FDI long before that but did not take comprehensive steps towards liberalization until 1991 (Nagaraj 2003).

• The two countries focused on different types of FDI and pursued different strategies for industrial development. India long followed an import-substitution policy and relied on domestic resource mobilization and domestic firms (Bhalla 2002; Sarma 2002), encouraging FDI only in higher-technology activities.

Despite the progressive liberalization, imposition of joint venture requirements and restrictions on FDI in certain sectors, China has, since its opening, favoured FDI, especially export-oriented FDI, rather than domestic firms (Buckley forthcoming; IMF 2002). Such policies not only attracted FDI but led to round-tripping through funds channelled by domestic Chinese firms into Hong Kong (China), reinvested in China to avoid regulatory restrictions or obtain privileges given to foreign investors. In India, round-tripping, mainly through Mauritius, is much smaller and for tax reasons. It has been suggested that domestic market imperfections associated with problems of outsourcing, regulations and local inputs have led to "excessive internalization" of production activities by TNCs in China. So part of the FDI, occurring because of the imperfections of the domestic market, is undertaken as a second best response by manufacturing TNCs to the Chinese environment (Buckley forthcoming).

For India the situation is somewhat different. A tradition of entrepreneurship has spawned a broad based domestic enterprise sector (Huang and Khanna 2003). This combines with the necessary legal and institutional infrastructure and a restrictive FDI policies followed until the 1990s. As a result, TNC participation in production has often taken externalized forms (such as licensing and other

contractual arrangements). Even after a significant liberalization of FDI policies, internalization is not necessarily dominant. Consider information technology, industries where outsourcing to private Indian firms is efficient and there are quality domestic subcontractors.

China’s accession to the WTO in 2001 has led to the introduction of more favourable FDI measures. With further liberalization in the services sector, China’s investment environment may be further enhanced. For instance, China will allow 100% foreign equity ownership in such industries as leasing, storage and warehousing and wholesale and retail trade by 2004, advertising and multimodal transport services by 2005, insurance brokerage by 2006 and transportation of goods (railroad) by 2007. In retail trade, China has already opened and attracted FDI from nearly all the big-name department stores and supermarkets such as Auchan, Carrefour, Diary Farm, Ito Yokado, Jusco, Makro,

Metro, Pricesmart, 7-Eleven and Wal-Mart (PricewaterhouseCoopers 2002).

In India the Government is planning to open some more industries for FDI and further relax the foreign equity ownership ceiling (EIU 2003a). To identify approaches to increase FDI flows, the Planning Commission established a steering committee on FDI in August 2001. Following the Chinese model, India recently took steps to establish special economic zones. China’s special economic zones have been more successful than Indian export processing zones in promoting trade and attracting FDI (Bhalla 2002).

In addition to economic and policy-related factors, an important explanation for China’s larger FDI flows lies in its position as the destination of choice for FDI by Chinese businesses and individuals overseas, especially in Asia. The role of the Chinese business networks abroad and their significant investment in mainland China contrasts with the much smaller Indian overseas networks and investment in India (Bhalla 2002). Why? Overseas Chinese are more in number, tend to be more entrepreneurial, enjoy family connections (guanxi) in China and have the interest and financial capability to invest in China–and when they do, they receive red-carpet treatment. Overseas Indians are fewer, more of a professional group and, unlike the Chinese, often lack the family network connections and financial resources to invest in India

Both China and India are good candidates for the relocation of labour-intensive activities by TNCs, a major factor in the growth of Chinese exports. In India, however, this has been primarily in services, notably information and communication technology. Indeed, almost all major United States and European information technology firms are in India, mostly in Bangalore. Companies such as American Express, British Airways, Conseco, Dell Computer and GE Capital have their back-office operations in India. Other companies–such as Amazon.com and Citigroup–outsource services to local or foreign companies already established in the country (AT Kearney 2003). Foreign companies

dominate India’s call centre industry, with a 60% share of the annual $1.5 billion turnover.

Investor sentiment on China as a location for investment is improving (MIGA 2002; AT Kearney 2002; American Chamber of Commerce in China 2002). Nearly 80% of all Fortune 500 companies are in China (WIR01, p. 26), while 37% of the Fortune 500 outsource to India (NASSCOM 2001). Despite the improvement in India’s policy environment, TNC investment interest remains

lukewarm, with some exceptions, such as in information and communication technology (AT Kearney 2001).

The prospects for FDI flows to China and India are promising, assuming that both countries want to accord FDI a role in their development process – a sovereign decision. The large market size and potential, the skilled labour force and the

low wage cost will remain key attractions. China will continue to be a magnet of FDI flows and India’s biggest competitor. But, FDI flows to India are set to rise – helped by a vibrant domestic enterprise sector and if policy reforms continue and the Government is committed to the objective of attracting FDI flows to the country.

Source: UNCTAD.