Foreign Direct Investment (FDI) flows were subdued in most parts of the world after the first quarter of 2022. According to the United Nations Conference on Trade and Development (UNCTAD), this slack in FDI inflows will continue this year. The most proximate reason for these downward trends was the uncertainty caused by Russia’s invasion of Ukraine. But another significant factor influenced the direction of capital flows, namely, the progressively stronger quantitative tightening pursued by the US Federal Reserve (Fed). With the central banks in several advanced countries opting to follow the Fed, foreign investors’ decisions were influenced by higher interest rates in these countries. Most emerging economies witnessed a slowdown in FDI inflows during this period of uncertainties.
The global trends have been reflected in India as well. During the current financial year, FDI inflows were significantly off the high of $82 billion that the country witnessed in 2020–21, which happened despite the Covid-induced downturn. According to the latest data available from the Reserve Bank of India, for the first ten months of the previous financial year (April–January), gross FDI inflows were $61.5 billion—significantly below the $70.5 billion received in the corresponding period of 2021–22. It may be pointed out that in 2020–21, the year in which FDI inflows reached the record level, inflows during April-January were almost $73 billion. In other words, the inflows during April-January of 2022–23 were almost 17% below the level recorded during the same period in 2020–21.
A better indicator of the investment climate can be gauged from the trends vis-à-vis “direct investment in India”, which excludes repatriation of foreign capital or divestment by foreign companies from the gross FDI inflows. During April-January of 2022–23, direct investment into India was $37.6 billion, or 18.6% lower than the inflows during the corresponding period in 2021–22. These indicate the increased trend of repatriation of foreign capital from India. Since 2021–22, divestments by foreign companies have increased to above $24 billion, a trend that could be maintained in the previous fiscal year. During April-January of 2022–23, divestment of foreign companies as a ratio of gross investments was 39.2%, an increase of nearly 5% from the previous year’s level. In 2022–23, the ratio of divestment to gross investments was almost 20% higher than this figure for 2020–21.
Attracting foreign companies to beef up the country’s manufacturing sector has been one of the major objectives of successive governments since the economic reforms were initiated three decades ago. The present government’s flagship programmes, the Make in India initiative as well as the more recent Production Linked Incentive (PLI) Scheme, were no exceptions.
However, investments in India’s manufacturing sector have not been the priority of foreign investors despite the fact that the country’s investment regime is now among the most liberal among all major economies. In fact, the manufacturing sector has been attracting less than a fourth of the total foreign investment in recent years.
The PLI scheme’s introduction has not changed this pattern. Data for April to December of 2022–23 shows that the manufacturing sector had attracted less than 21.7% of the total FDI inflows. Though the share of the manufacturing sector was relatively less, more than 82% of these inflows were in the high technology sector, with chemicals and pharmaceuticals industries accounting for nearly half of the inflows. The electronics industry, which had attracted large inflows during the past couple of years, saw relatively less inflows during the three quarters of the previous fiscal year.
For several years, foreign investors have found India’s service sector very attractive, investing several times more in this sector compared to the manufacturing sector. During April-December 2022–2023, FDI inflows into the service sector were 74.6% of the total. Information Technology Enabled Services (ITES) was the most popular among foreign investors; 18.6% FDI inflows were routed to this.
Several commentators have argued that FDI inflows to host countries are largely dependent on the motivations of the foreign companies. This implies that the extent of openness of investment regimes in the host countries are necessary but not the sufficient conditions for attracting foreign investment. The decisions of foreign investors, the argument goes, are dependent on the existence of large markets, but more importantly, on the existence of strategic assets in the host countries. The pattern of FDI inflows into India resonates with the above-mentioned arguments. ITES and several other segments in the service sector have witnessed large inflows due to the presence of an efficient workforce that can be regarded as the strategic asset. Since the beginning of the current millennium, India’s ITES has been able to extend its businesses in the global marketplace and it is now evident that foreign investors are utilising this workforce to expand their presence in India’s service sector.
Despite the slowdown in FDI inflows, one of the positives is the change in the top sources. For more than a decade and a half, the two countries that contributed most to FDI inflows were Mauritius and Singapore. With Mauritius, the problem was that of round-tripping, a phenomenon that was fuelled by the fact that investors could get away by avoiding paying any taxes. While India was not taxing outflows of capital from India, Mauritius was offering a tax-free regime, which the investors were taking advantage of. This problem was addressed and FDI inflows from Mauritius have declined. During April-December 2022-23, Singapore remained the largest source, and the US was the second largest.
What are the takeaways for the government from these trends in FDI inflows? The most important of these is to create strategic assets in the manufacturing sector so as to get foreign investors interested in investing in this sector. This is where the government should focus its attention.
Dr Biswajit Dhar
Former Professor, Jawaharlal Nehru University and Vice President, Council for Social Development (bisjit@gmail.com)
K S Chalapati Rao
Senior Research Fellow, Academy of Business Studies, Delhi (kschalapatirao@gmail.com)