Foreign Trade, FDI/FPI & International Bodies
Foreign trade and foreign investment connect the Indian economy with the rest of the world, and they are shaped by a dense network of international institutions and agreements. India is a major importer of crude oil and a growing exporter of goods and services, and it attracts foreign capital both as direct investment and as portfolio investment. This topic brings together trade policy, the rules governing foreign investment, and the global bodies such as the World Trade Organization, the International Monetary Fund and the World Bank. These notes explain the structure of these institutions, the difference between types of foreign investment, the routes for approving investment, and the trade agreements that govern India's external economic relations.
The World Trade Organization and GATT
The General Agreement on Tariffs and Trade was signed in 1947 and served for decades as the framework for reducing tariffs and expanding world trade. The World Trade Organization was established in 1995 as its successor through the Marrakesh Agreement, and its headquarters is in Geneva, Switzerland. India was a founding member of the organization when it came into effect on 1 January 1995. The core principle of the organization is non-discrimination, expressed in the most favoured nation principle, under which a member must grant the same trade advantages to all other members, and in the national treatment principle, under which imported goods must be treated no less favourably than domestic goods. Trade disputes between members are adjudicated by the Dispute Settlement Body.
The Bretton Woods institutions
The International Monetary Fund and the World Bank were established by forty-four allied nations at the Bretton Woods Conference in July 1944. The International Monetary Fund provides temporary financial assistance to member countries facing balance of payments problems and works to promote monetary cooperation and exchange rate stability. The World Bank Group is a family of institutions. The International Bank for Reconstruction and Development lends to middle-income countries, the International Development Association provides concessional loans and grants to the poorest countries, the International Finance Corporation provides loans and equity to the private sector, the Multilateral Investment Guarantee Agency offers political risk insurance, and the International Centre for Settlement of Investment Disputes settles investment disputes. The Asian Development Bank was established in 1966 with its headquarters in Manila, and the New Development Bank was set up by the BRICS countries in 2014 with its headquarters in Shanghai. The South Asian Association for Regional Cooperation was founded in 1985.
Foreign direct investment and foreign portfolio investment
Foreign direct investment, or FDI, is investment in physical assets that brings with it a lasting interest and management control in a business. Foreign portfolio investment, or FPI, is investment in financial assets such as shares and bonds without any management control. FDI is considered more stable because it is committed for the long term, whereas FPI can leave quickly and is therefore more volatile. FDI can enter India through two routes. Under the automatic route, investment is allowed without prior approval from the government or the Reserve Bank. Under the approval route, prior approval is required, usually through the concerned ministry. The nodal agency for FDI policy is the Department for Promotion of Industry and Internal Trade, which functions under the Ministry of Commerce and Industry. Foreign portfolio investment is regulated by the Securities and Exchange Board of India.
Sectoral limits and policy initiatives
India allows foreign investment in most sectors, with limits that differ from sector to sector and routes that determine whether approval is needed. The defence sector allows FDI of up to seventy-four per cent through the automatic route, and the insurance sector also allows seventy-four per cent. Many sectors, including most manufacturing, single-brand retail and renewable energy, allow one hundred per cent foreign direct investment through the automatic route. The Make in India initiative was launched on 25 September 2014 to promote manufacturing and to make India a global hub for design and production, and it is closely linked to the liberalisation of investment rules. The Foreign Trade Policy 2023 is valid for the period from 1 April 2023 to 31 March 2028 and provides the framework for export promotion and trade facilitation.
Trade agreements and trade patterns
A free trade agreement is an arrangement between countries to reduce or eliminate tariffs on a wide range of goods and services, while a preferential trade agreement covers a limited set of goods and offers only partial tariff cuts. India has entered into several such agreements to expand its markets. In recent years the United States has been India's largest export destination, and Singapore, followed by Mauritius and the United States, has been a major source of foreign direct investment inflows. Crude petroleum is India's largest import item by value, which explains the importance of the balance of payments, while basmati rice and marine products are among India's largest agricultural exports. The BRICS group consists of Brazil, Russia, India, China and South Africa, and it established the New Development Bank to finance infrastructure and sustainable development in emerging economies.
Key facts at a glance
- GATT was signed in 1947; the WTO was established in 1995.
- The WTO headquarters is in Geneva, Switzerland.
- The most favoured nation principle ensures equal treatment for all trading partners.
- The WTO's Dispute Settlement Body adjudicates trade disputes.
- The IMF and World Bank were set up at Bretton Woods in July 1944.
- The IMF gives temporary help to countries with balance of payments problems.
- The IFC lends to the private sector; the IDA gives concessional loans to the poorest countries.
- The ADB was established in 1966 with headquarters in Manila.
- The New Development Bank, set up by BRICS in 2014, is headquartered in Shanghai.
- SAARC was founded in 1985.
- FDI brings management control; FPI does not.
- The automatic route requires no prior approval; the approval route does.
- DPIIT, under the Ministry of Commerce and Industry, is the nodal agency for FDI policy.
- Make in India was launched on 25 September 2014.
- The Foreign Trade Policy 2023 runs from 1 April 2023 to 31 March 2028.
- FDI limits: defence 74 per cent and insurance 74 per cent.
- India was a founding member of the WTO, effective 1 January 1995.
- Crude petroleum is India's largest import item by value.
Quick revision points
- The WTO is the successor to GATT and is based on non-discrimination.
- The World Bank Group has five institutions with distinct roles.
- FDI is long term and stable; FPI is short term and volatile.
- Automatic and approval are the two routes for foreign investment.
- FTA offers deeper liberalisation than a PTA.
- Crude oil dominates imports, so the trade deficit is closely tied to oil prices.
How to prepare this topic
- Memorise the years of GATT, the WTO, Bretton Woods, the ADB, the NDB and SAARC.
- Learn the five institutions of the World Bank Group and their target groups.
- Practise the difference between FDI and FPI and between the two approval routes.
- Remember the sectoral limits for defence and insurance.
- Note the nodal agency and ministry for FDI policy.
- Revise India's main export and import items and its largest trade partners.
Common exam traps
- Confusing the year GATT was signed with the year the WTO was created.
- Mixing up the IFC and the IDA; one serves the private sector and the other the poorest countries.
- Treating FDI and FPI as the same; management control is the key difference.
- Placing DPIIT under the Finance Ministry instead of Commerce and Industry.
- Say the FTA and PTA are identical; their coverage differs.
- Forgetting that India was a founding member of the WTO.
Frequently Asked Questions
What is the World Trade Organization and how did it replace GATT?
The World Trade Organization was established in 1995 through the Marrakesh Agreement as the successor to the General Agreement on Tariffs and Trade, which had been signed in 1947. It provides a rules-based framework for international trade based on non-discrimination, and it has a Dispute Settlement Body to settle trade disputes. Its headquarters is in Geneva, and India was a founding member.
What is the difference between FDI and FPI?
Foreign direct investment is investment in physical assets that brings a lasting interest and management control in a business, and it is considered stable because it is committed for the long term. Foreign portfolio investment is investment in financial assets such as shares and bonds without management control, and it is more volatile because it can be withdrawn quickly. FDI is regulated through DPIIT policy, while FPI is regulated by SEBI.
What are the automatic route and the approval route for FDI?
Under the automatic route, foreign direct investment is allowed without prior approval from the government or the Reserve Bank of India, and many sectors including most manufacturing allow up to one hundred per cent through this route. Under the approval route, prior approval is required, usually obtained through the concerned administrative ministry. The route and the sectoral limit together determine how much investment is permitted and how it may enter.
What is the difference between an FTA and a PTA?
A free trade agreement is an arrangement between countries to reduce or eliminate tariffs on a wide range of goods and services. A preferential trade agreement covers a limited set of goods and provides only partial tariff concessions. An FTA therefore offers deeper and broader liberalisation than a PTA. India has signed several such agreements to expand market access for its exporters.
What are the main institutions of the World Bank Group?
The World Bank Group includes the International Bank for Reconstruction and Development, which lends to middle-income countries; the International Development Association, which gives concessional loans and grants to the poorest countries; the International Finance Corporation, which lends to the private sector; the Multilateral Investment Guarantee Agency, which provides political risk insurance; and the International Centre for Settlement of Investment Disputes, which settles investment disputes.