According to a recent report of the global credit rating agency Moody’s, foreign direct investment (FDI) inflows have increased significantly in India in the current fiscal. This, according to Moody’s, is due to India’s current pro-growth policies. Net FDI inflows totalled USD 14.1 billion in the first five months of 2014-15, representing a 33.5 per cent increase from the same period in 2013-14.
FDI is a direct investment in production or business in a country by an individual or company from another country with the objective of establishing a lasting interest in the investee economy. Mostly, the investment is in production by either buying a company in the target country or by expanding operations of an existing business in that country. It includes mergers and acquisitions, building new capacities and reinvesting profits from overseas investments.
In addition to being an important driver of economic growth, FDI is the major source of non-debt financial resource for economic development. FDI is attracted to a country for various reasons such as taking advantage of cheaper wages, special investment privileges like tax exemptions, etc. offered by the country. Besides, it is a means of achieving technical know-how and generation of employment. FDI usually involves participation in management, joint venture, transfer of technology and expertise. It is different from foreign institutional investment (FII) or portfolio investment, which is a passive investment in the securities of another country such as stocks and bonds.
But India’s performance as an FDI destination is far from satisfactory. A recent United Nations Conference on Trade and Development report shows India’s FDI inflow is merely 4.3 per cent of its gross fixed capital formation as compared to the global average of 8.3 per cent. Also, FDI stocks as a percentage of GDP stand at 12.2 per cent in contrast to the ratio for developing economies at 30.4 per cent. Throughout 2013, inward FDI in India almost halved. China still led Asia-Pacific in 2013 with an FDI total value of $64.14 billion and a dominant 34.73 per cent market share for FDI. India’s FDI market share was only 8.57 per cent.
When it comes to the supply of transport, energy and ICT (Information and Communications Technology), India is 84th on the list. This insufficient infrastructure is the single biggest obstacle turning away foreign investors. In the World Bank’s ranking of countries on Ease of Doing Business, India ranks 132nd; and 173rd for the ease of starting a new business. The multiplicity of licences, approvals, administrative procedures, labour regulations, legal system, etc. act as hindrances to doing business in India.
The spate of scams the country witnessed also hasn’t helped the way India is viewed abroad. There are enough evidences to show that corruption impedes trade. India stood at 94th position in Transparency International’s 2012 Corruption Perception Index. Following corruption and policy flip-flops many foreign companies are reviewing their India exposure. They feel that they cannot do business in India, without paying someone, somewhere for something. And even after they pay there is uncertainty about the outcome. In China, they pay but the job gets done.
It is also important to maintain investor confidence by stability in policy framework. Recent amendments to policies and tax structures, some of them retrospective, detracted investor confidence and were partly responsible for the slowdown in FDI inflows. A highly stable and predictable policy regime is essential for continuous FDI inflow. Policy flip-flops, sometimes within the space of a few weeks or months, perplex many a foreign investor. India’s complex M&A (Mergers and Acquisition) rules effectively rule out leverage finance, which makes deals less profitable for foreign firms by discouraging them from borrowing money to make acquisitions.
The depreciating rupee has taken a heavy toll on investor sentiment. Deals done before 2007 when a dollar equalled `45 are now under water. Successive spirals of recessions in the economy lead to deceleration in FDI as well.
Revival of business optimism is necessary for making FDI a significant contributor to our national economy. If we are capable of revising our economic growth projections and exhibiting strong economic fundamentals there will be a rebound of inward FDI in India. FDI is primarily market-seeking and only those countries that foster a high-growth economy attract FDI. Recent trends in India suggest any rebound in FDI will depend on a high-tech communication sector and large job-creating construction sectors.
Since India’s growth is mainly services-led, it is important to attract FDI in this sector. The service sector currently contributes about 60 per cent of India’s GDP, 25 per cent of employment and 1/3rd of all exports. India has limited FDI exposure in many niche areas like financial, legal, education and health services. Currently, FDI in education is less than 1 per cent. Considering the importance of this sector in influencing India’s future economic strength and its global competitiveness, FDI should be encouraged in education. Software, telecom, tourism, shipping, logistics, etc. offer gold mines of opportunities. As the India Attractiveness Survey 2014 says, “To realise its FDI potential, India needs to improve its operating environment and develop infrastructure. Other priorities should include boosting production, improving the taxation system, easing FDI regulations and increasing awareness about emerging cities. India’s solid domestic market, educated workforce and competitive labour are going to be the major drivers of the future rebound in FDI.”
Despite a strong democracy, large domestic market, rule of law and relatively low labour costs, India does not attract much FDI. The major factors are the high import tariffs and exit barriers for firms, stringent labour laws, inferior infrastructure, centralised decision-making, and a limited number of export-processing zones. Even after opening up multi-brand retail a year ago, not a single super store has started India operations. Most MNCs interested in setting up shop in India still seek clarifications on clauses like sourcing from Indian SMEs and infrastructure investments by them in India.
India’s poor ranking in its foreign trade promotion policies explains our showing in inward FDI. In the World Economic Forum’s 2012 Global Enabling Trade Index, India figures in the bottom tier. On market access parameters in particular, it figures third from last on a list of 132 countries.
The writer is professor of economics at Christ University, Bangalore, and can be reached at email@example.com