Multinational corporations are usually large firms incorporated in one country which produce or sell goods or services in various countries. The two main characteristics of multinationals are their large size and the fact that their worldwide activities are centrally controlled by the parent companies. In an ideal world, most multinational companies, and especially American-owned ones, would prefer to retain 100% control over their subsidiaries throughout the world. Full ownership enables them to plan and manage operations on an integrated basis, to maximise economies of scale, and to move components across national borders without having to be sensitive to the special needs of local shareholders.

Some countries, especially in the developing world, have taken measures to compel multinationals to enter into partnership with local investors. In Nigeria, for example, the government’s “Indigenization” decree forced many foreign companies to accept increasing Nigerian participation in the ownership of their companies. In India, a similar policy towards foreign investment was followed, and the “Indianization” of their industry was achieved by means of the Foreign Exchange Regulation Act of 1973, almost half a Century ago.

The Foreign Exchange Regulation Act (FERA) was legislation passed in 1973 that imposed strict regulations on certain kinds of payments, the dealings in foreign Exchange (forex) and securities, and the transactions which had an indirect impact on the foreign exchange and the import and export of currency. The FERA therefore proceeded on the presumption that all foreign exchange earned by Indian residents rightfully belonged to the Government of India and had to be collected and surrendered to the Reserve Bank of India (RBI). The FERA primarily prohibited all transactions not permitted by the RBI.

It was this act which, in 1977, led to a dramatic confrontation between the Indian government, on the one hand, and the two multinationals Coca Cola and IBM, on the other. After tough negotiations, the trial of strength resulted in both companies pulling out of India. The act required foreign companies to dilute their foreign equity shareholdings to 40%, this process being carried out in stages. The foreign company, therefore, has to reorganise its Indian operations to allow majority local ownership.

In the case of Coca Cola, the dispute arose because of the company’s refusal to fall into line with the Foreign Exchange Regulation Act (FERA). Coca-Cola was India's leading soft drink until 1977 when it left India after a new government ordered the company to dilute its stake. The main point at issue concerned the formula for making the product. For 130 years, (the company was established in 1885) this has been a closely guarded secret. Besides, the Coca Cola company had had a long-standing policy of supervising the manufacture of the concentrate from which the drink was made, and this had applied to plants in the US and overseas. If the Coca Cola company had complied

with the act in 1977, it would have had to divulge the secret formula of its concentrate. At that time, the Indian bottling plants imported the concentrate through a Delhi-based company which received supplies from the parent company.

Under the act, the Coca Cola company would have had to set up an Indian company in which the foreign equity would not exceed 40%. This new firm would have taken over all Coca Cola’s operations in India, including the supply of the concentrate. During the protracted negotiations, Coca Cola offered to increase its exports of other commodities from India to make up for the foreign exchange that it spent on the concentrate. Nevertheless, the government insisted that Coca Cola transferred to the proposed Indian company all its activities, including the technical know-how and blending operations of the concentrate.

The closure of the Coca Cola plant left 22 Indian-owned bottling factories idle and thousands of workers unemployed. To remedy this situation, the government planned to manufacture a Coca Cola substitute which was being developed by its food research laboratories. This would be supplied to manufacturers. One idea was to call it “77” to mark the year that Coca Cola fell from grace! While the Indian government was optimistic about the potential of the new soft drink, most experts took the view that it was impossible to duplicate exactly the ingredients of the product, since minute quantities of these affect its taste. It was not until 1993 when the company (along with PepsiCo) returned to the country, after the introduction of India's Liberalization policy.

IBM fell out with the Indian government for different reasons. This company has a global policy that all its subsidiaries in other countries must be fully US owned; also, it does not establish factories in countries where it is not allowed to market its products. To get round the provisions of the Foreign Exchange Regulation Act, IBM tried to bargain with the Indian government. IBM wanted to retain 100% ownership of a plant which would export all the computers which it manufactured in India. It also agreed to set up another Indian majority-owned company to service existing IBM machines. It continued, however, to demand the right to import modern IBM machines for its Indian customers. This turned out to be the major stumbling block to agreement with the Indian government.

An important opponent to IBM in India was India’s department of electronics. It argued that no special concessions should be allowed to IBM. It calculated that if IBM was required to sell in India computers manufactured in the country itself, rather than import them, there would be a 40% saving in foreign exchange costs on this item. Another argument used was that other computer companies, including Britain’s ICL, had already toed the line regarding dilution of ownership.

IBM, like Coca Cola, found that it could not budge the Indian government which probably took a hard line because it feared that, once it started making concessions to powerful multinationals, its whole policy towards foreign investment would be undermined. For its part, by pulling out of India, IBM upheld its principle of operating independently.

The exit from India of these two companies was dramatic and caused a stir internationally, but they were not the only ones to pull out as a result of FERA. About 670 foreign companies were asked to dilute their holdings, and at least 52 companies wound up their operations rather than comply with the act. Some companies were allowed, under the act, to keep a majority share providing that they diversified into agreed fields coming under the category of “sophisticated technology” or “export”. They really had to propose an acceptable package combining these categories. Some firms managed to do just this. Union Carbide, for example, set up a deep-sea fishing unit aimed solely at export markets. Most companies fell into line either by diversifying their activities or by “Indianizing”. They probably reasoned, “Half a loaf is better than none”. After all, India was probably the most important third world market in which many of them had a stake.

Was IBM wise to stick to its principles? Should it perhaps have taken a pragmatic position like most other companies who had obviously been swayed by the importance of India as a market? If IBM continues this policy, it might be squeezed out of large areas of the world, leaving markets free for more flexible competitors.

On the other hand, would India’s tough approach create anxiety in other foreign investors, and thereby reduce the flow of investment funds? The Minister of Industry stated quite clearly after the showdown with IBM that India welcomed foreign investment in areas of sophisticated technology, production designed to boost exports, and in high priority sectors, but, he added, such foreign expertise and foreign investment must be “on our terms”.