Source of Long-Term Finance: Foreign Sources, External Borrowings, Foreign Investments and Non-Resident Indians (For CBSE, ICSE, IAS, NET, NRA 2022)

Get unlimited access to the best preparation resource for competitive exams : get questions, notes, tests, video lectures and more- for all subjects of your exam.

Foreign Sources

Foreign Sources also play an important part in meeting the long-term financial needs of the business in India. These usually take the form of

  • External borrowings.
  • Foreign investments and.
  • Deposits from NRIs.

Let us have a brief idea about these sources.

Foreign Source

External Borrowings

These include loans obtained at concessional rates of interest with long maturity period and commercial borrowings. The major sources of concessional loans have been the International Monetary Fund (IMF) , Aid India Consortium (AIC) , Asian Development Bank (ADB) , World Bank (International Bank for Reconstruction and Development) and International Financial Corporation. The World Bank grants loans for specific industrial projects of high priority and given either directly to an industrial concern or through a government agency. The International Finance Corporation, an affiliate of the World Bank, grants loans to industrial units for a period of 8 to 10 years. Such loans do not require government guarantee.

Foreign Investments

  • The foreign investments in our country are generally done in the form of foreign direct investment (FDI) or through foreign collaborations. The foreign direct investment usually refers to the subscription by the foreigners to shares and debentures of the Indian Companies. This is also known as portfolio investment and covers their subscription to ADRs, GDRs and FCCBs (Foreign Currency Convertible Bonds) .
  • The technical collaborations are by way of supply of technical knowledge, patents and machineries. It may be noted that the government has been very successful in attracting more foreign investment in the post liberalisation era. The main advantage of foreign investment is that generally the foreign investor also brings with him the technical expertise and the modern machinery. The disadvantage, however, is that a large part of profits is transferred to the foreign investors.

Non-Resident Indians (NRIs)

You are aware that the persons of Indian origin (PIO) living abroad commonly known as Non-Resident Indians (NRIs) constitute an important source of long-term finance for industries in India. The most common form of their contribution is in the form of deposits under Foreign Currency Non-Resident Account (FCNRA) and Non-Resident (External) Rupee Account (NRERA) . It is worth noting that the share of NRI deposits in the total foreign capital flows (net) was 26.7 % during the year 2001 - 02. It may be noted that they are also permitted to subscribe to the shares and debentures of the companies in India and have the option of selling them and take back the amount. This constitutes an integral part of foreign direct investment.

Retained Earnings

You know that retained earnings refer to the undistributed profits of companies which is usually kept in the form of general reserve. Primarily, it is a hedge against low profits in future and is used for the issue of bonus shares by the company. But, in effect, it acts as an import source of long-term finance for the companies with Zero cost of capital. The retained profits can be used for expansion and modernization programmes by the companies. The amount of retained earnings is determined by the quantum of profits, the dividend pay-out policy followed by the management, the legal provisions for dividend payment, and the rate of corporate taxes.

It is an internal source, which does not involve any cost of floatation and the uncertainties of external financing. In fact, it is regarded as the most dependable source of long-term finance. It also strengthens the firm՚s equity base, which enables to borrow at better terms and conditions. The main drawbacks of this source are

  • it is fully dependent on the accuracy of profits; and
  • possibility of reckless use of funds by the management.

Developed by: