By: Virin Mukherjee; Edited by: Shagun Khetan
The Economic Ashokan has already published an article in February that explores the larger trends for global and domestic FDI trends and their general effect on the macroeconomy. This article will reiterate the complex web of reasons leading to the downturn in FDI into India, and delve deeper into the macroeconomic significance of FDI for India.
India is the fastest-growing economy, growing at 7% p.a. Based on this fact, one may intuitively suggest that FDI inflows will also be increasing for India because we can relate an expanding economy to an attractive one. However, FDI inflows for FY 2023 fell by 16% as compared to the previous year. Moreover, Net FDI fell 45% for the period April 2023-February 2024 as compared to the previous year to $14.5bn.
WHY IS THE FDI ENGINE SLOWING DOWN?
An important thing to note is the general recession in the West, which has brought down global FDI levels. The USA, UK, and the Eurozone will be encouraging domestic investments in response to growing domestic price levels. Thus, from the outset, we mustn’t be too harsh in judging this magnitude of decrease in FDI.
Firstly, let us look at the fall of FDI inflows from the perspective of investors: Singapore and the United States are the two biggest investors in the Indian economy. The real GDP growth rate in both these countries have decreased, which leads to a decrease in disposable income for American and Singaporean investors. The interest rates in the USA are at an all time high, which incentivizes Americans to invest domestically instead of abroad. Since Singapore is strongly integrated into the global financial market whose dominant currency is the dollar, Singapore Overnight Rate Average (SORA) or the Singapore Interbank Offered Rate (SIBOR) move in tandem with the US Federal Reserve. So, the interest rates in Singapore have also increased, resulting negatively for India’s FDI inflows.
Now for the domestic perspective. The termination of 68 out of the total 72 Bilateral Trade Agreements (BITs) in March 2023 revoked the right of international firms investing in India to undertake arbitration and disputes in a neutral country’s court; the foreign firms now had to undertake arbitration in India, which made their confidence in the Indian judicial infrastructure an important factor for investment. According to a study by researchers from The Review of International Organizations, FDI inflows into India decreased by 30% as a response to termination of BITs compared to countries that didn’t terminate BITs. They used quarterly data from 138 investor countries and difference-in-difference(DD) estimates to study investor behavior of rerouting funds in response to the termination of BITs in India over to countries with BITs.
The RBI’s ‘State of the Economy’ report (page 171), however suggested that the drop in net FDI for FY 23-24 ($14.6bn) was “primarily due to an increase in repatriation”. Net accretions to NRI accounts in both foreign currency and rupee amounted to $11.8bn, almost double that compared to $6bn for the previous term. This can definitely be understood as a direct effect of the government's undertaking to streamline the process of repatriation of capital for NRIs.
IS THIS FALL IN FDI A CAUSE FOR CONCERN?
Declining FDI affects macroeconomic balance, reducing investor confidence and access to technology. The previous Economic Ashokan article concluded by raising causes for concern, despite the ‘economy’s resilience.’ For exploring this idea of economic resilience we’ll consider certain metrics for macroeconomic stability in the Indian economy that propose that India doesn’t really need FDI. Firstly, India has had a stable inflation rate ranging from 5-6% since the last year with a 0.2% m.o.m increase in inflation for the ‘food and core’ group and offset by a m-o-m decline in fuel prices by (-) 2.6 per cent. Foreign exchange reserves have increased, which will contribute to stable exchange rates as well as the freedom to implement anti-inflation monetary policy. The central bank is adequately equipped to deal with financial setbacks or crises by injecting liquidity into the economy. This factor definitely works towards providing stability in the backdrop of external shocks like capital outflows - which as mentioned earlier is a primary cause for the FDI downturn. Lastly, the reduced cost of domestic capital will incentivize domestic investments, managing domestic demand and consumption requirements. Specifically, the headline interest rates in India have reduced, which provides a boost to economic activity; Indian exports become cheaper and more competitive, there is more business investment and more consumption expenditure. Reduction in headline rates affects mortgages as well, and coupled with reducing cost in the construction industry (cost of cement), the real estate and construction industry is expected to do well.
However, there are many predictions of recession and downtrends in profits due to declining FDI. Due to a recession in the West, Indian firms can face low investments, evident in the fall of FDI into traditional sectors like automobiles, pharmaceuticals and construction.
Therefore, at this juncture, the need of the hour is to optimize and incentivize FDI inflows according to its potential for instigating growth. There are many opportunities for economic growth and productivity from proper allocation and incentivization of FDI into globally demanded sectors; this article will explore one such big opportunity.
SO WHAT CAN FDI POTENTIALLY DO FOR US?
Our earlier article states weak positive relations between FDI and GDP growth rates, and FDI and market growth. Foreign investments can generally generate employment in labor-intensive sectors, by leading to demand for excess workers and increased productive capacity. It can also increase factor productivity given there is high absorptive capacity. These effects are nuanced by the type of FDI, organization of domestic firms and growth potential for the sector. For example, let’s consider the need for foreign investment into the unsaturated manufacturing sector, and what it can do.
The manufacturing sector employs 27 million workers and contributes to 17% of the nation's GDP. The value of exports for FY 22-23 was almost $500bn, but the sector has the capacity to export $1 trillion by 2030. It has a high Purchasing Managers Interest (PMI) rating, and grew at 9% in the FY 23-24. A McKinsey report demarcates the manufacturing sector as the key to boosting economic growth and job creation, and proposes setting up 11 specialized value chains in this sector which could double contribution to GDP. Thus, FDI into the global manufacturing sector can bring about higher levels of specialization and factor productivity, tapping into huge opportunities - especially as the West looks for alternate import avenues from China for its supply chains. The Chief Economic Advisor of India, V Anantha Nageswaran, suggested Chinese investment into the Indian export manufacturing industry to take advantage of this ‘China-plus-one’ strategy, which will also check the large trade deficit between New Delhi and Beijing. An example is Apple’s increased investments into iPhone manufacturing in India, along with Foxconn as a manufacturing partner - a strategic move to prevent supply chain disruptions amidst geopolitical tensions with China. As mentioned in our earlier article as well, there is high competition to replace China as a manufacturing hub, with other south-east Asian countries like Vietnam, Indonesia and Thailand emerging as other potential hosts for global supply chains. This brings us to the last question for this article: what is India doing to secure this opportunity?
DOMESTIC EFFORTS TO BOOST FDI
Domestic schemes like Production-Linked-Incentive (PLI) of Rs. 1.97 trillion for 14 sectors and Phased Manufacturing Programme brought forward by FM Nirmala Sitharaman are expected to contribute to this vision. The Make In India initiative contributes to the strengthening of supply-chains and self-reliance in manufacturing.
The 2024 budget reduced corporate tax for foreign companies from 40% to 35% and simplified rules for investing in India - aimed at facilitating foreign investment. Amidst a policy of disinclination to Chinese investments due to border disputes, the FM addressed the CEA’s report by stating that the economic advisor’s board is kept at an “arm’s distance” but mentioned that she hasn’t dismissed the suggestion. Additionally, the adoption of 14 new Free Trade Agreements (FTAs), including the UK and the European Free Trade Association (EFTA), is also underway by the government, which brings about reductions in custom duties and trade barriers between the countries participating in the agreement. There is not much consensus on if an FTA directly increases or decreases FDI, as it grants free market access. However, FTAs often include investment commitments and increase demand for Indian services which could construct a more attractive economic environment for foreign investment.
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