The net impact of these developments on foreign exchange flows associated with the working of these enterprises is discernible from Chart 8. Net foreign exchange flows, which amounted to an inflow of Rs. 142 crore in 1990-91 and Rs. 529 crore in 1993-94, turned into an outflow of Rs. 186 crore in 1993-94. That outflow had risen to Rs. 340 crore by 1996-97. What is more, even in 1990-91, firms in sectors like Engineering and Chemicals, which were the ones receiving further investments in the subsequent years of liberalisation of FDI regulations, were already registering large outflows. It was only because of the inflows into firms in traditional sectors like Tea, Textiles and Leather, that the aggregate figure turned out to be positive. The evidence is clear that FDI of the kind that India has been receiving in the wake of liberalisation is a factor contributing to a foreign exchange drain rather to an enhancement of India's foreign exchange earning capacity.
Chart 8 >>
 
It would, of course, be argued by the advocates of reform that the drain of foreign exchange on account of the operations of these firms is more than matched by the additional inflow in the form of equity capital. This argument, however, confuses the immediate inflow on account of foreign investment and the long term sustainability of inflows of the kind discussed. It is well known that foreign capital inflows into joint ventures in developing countries are in the nature of large one time flows for establishing or substantially expanding an enterprise accompanied by smaller 'in effect' inflows on account of retention of part of the profits due to the foreign partner, which are not paid out as dividends.
 
Once established much of the expansion of the firm occurs on the basis of borrowing from the domestic market, or issues of additional shares at a premium. Such issues are resorted to in the wake of the capitalisation of reserves through the issue of bonus shares to existing shareholders so that their stake in the company is not substantially diluted. In the case of the FDICs in the RBI sample for example, the share of funds used that were diverted to gross fixed assets formation rose from 33.9 per cent in 1991-92 to 42.2 per cent in 1993-94 and 73.5 per cent in 1996-97. During these years, the share of external sources of funds, consisting dominantly of borrowing from the domestic market, accounted for between 60 and 70 per cent of the total throughout the period (Chart 9). Expansion results in an increase in the fixed assets, sales and profits of the company concerned, which in turn increases outflows on account of imports and non-import foreign exchange expenditures like royalties that are tied to sales volumes.
Chart 9 >>
 
Thus, unless exports increase significantly and bring in additional foreign exchange revenues, net inflows that are positive at the time when equity is flowing in soon turn negative, and within a short period cumulative inflows are negative. It is for this reason that the cumulative foreign exchange impact of foreign investments targeted at domestic markets inevitably tends to be negative. There is no reason to believe that given the nature of FDI flows into India during liberalisation the story would be any different.
 
This conclusion has a larger implication. The theology of liberalisation is based on the presumption that one of the features of globalisation is the emergence of large volumes of footloose capital in search of appropriate locations for world market production. Since every developing country would have some comparative advantage, it is argued, the liberalisation of trade and foreign investment rules would attract some of this capital, which would relocate the relevant capacities to the developing country concerned, to use it as a source for production for the world market. Investment flows would be accompanied by trade flows, including exports, making FDI either benign or virtuous from a balance of payments point of view. This argument regarding capital mobility is not theoretically obvious, since a range of factors can distort this picture of freely flowing capital that redresses production inequalities across the world. If it is to be valid, it must be empirically shown to be true. The available evidence relating to FDI during the liberalisation years suggests that it is not.