Perking the economy with FDI

Dr Vanita Mahajan

Foreign direct investment is often seen as an economic blessing for developing nations. FDI plays a crucial role in financing development, both directly, as an external source of capital, and indirectly through its impact on domestic capital formation. Foreign investments are often welcome in developing countries as they bring fresh capital together with a number of intangible assets that are usually scarce in those economies, namely, technological capabilities, management skills, brand names, channels for marketing products internationally, product design that help in boosting growth of Indian economy.
There have been a number of mechanisms through which FDI can increase the profitability of domestic investment. First, FDI can act as a catalyst for domestic investment because multinationals usually have greater access to information and financial resources than most private investors do in developing countries. Hence, they are able to both directly identify and take advantage of profitable opportunities more quickly than domestic investors, so that the entry of foreign firms in a developing country signals the existence of unexploited profitable business opportunities that domestic investors might not be capable of identifying or willing to seize by themselves. Moreover, foreign firms entering a developing country often bring about the need for more efficient infrastructure facilities (roads, telecommunications, ports, railways etc), which they can also contribute to finance. As poor or insufficient infrastructure is often a binding constraint to business development in developing countries, improved infrastructure can open up new business opportunities that would not have been profitable otherwise, thus increasing the profitability of overall domestic investment.
A further mechanism through which foreign firms can contribute to capital formation is through the supply of scarce inputs, which they can vehicle by importing human and physical assets, technology and other intangible assets. In particular, positive externalities are the increased availability of training services, managerial skills, technological capabilities, and access to overseas markets, market information, all of which benefit domestic firms.
The entry of foreign firms may also create new demand for inputs that can be supplied by local firms through backward linkages as complements to those imported from their home countries.
But, there have also been the existence of potential negative effects on the profitability of domestic investment due to presence of foreign firms. Different mechanisms may be at work. Foreign owned firms can acquire domestic market shares to the detriment of domestic firms. Foreign firms can crowd out domestic investment if they increase the host country’s interest rate by borrowing on the domestic market. Foreign firms entering a developing country in sectors with relatively underdeveloped productive capacity may sensibly increase the cost of locally supplied inputs, especially wages. Moreover, FDI have uncertain effects on the degree of competition in host economies, as foreign firms, usually more efficient and productive than domestic firms, can boost competition among the latter, but at the same time could acquire market power, with a potentially negative effect on domestic investment. FDI can have negative effects on overall capital formation in developing countries, when the entry of foreign-owned firms pushes the less efficient domestic firms out of the market and therefore reduces domestic production capacity. Finally, foreign firms could also have a negative impact on the demand for local inputs, if they rely less on domestic inputs than domestic firms.There is generally a positive effect of FDI on GFCF (gross fixed capital formation) but also that this effect is statistically significant only when new investment projects are directed to productive activities.
The Foreign Direct Investment (FDI) has displayed increase in absolute numbers from $ 45.15 billion in FY 15 to $ 60.97 in FY 18 but the rate of growth in FDI inflows is falling consecutively since the last two years recording a growth of just 1.24 percent in FY 18.
The main sectors which benefitted from the FDI inflows in the last fiscal were services ($6.7 billion), computer software and hardware ($ 6.15 billion), telecommunications ($ 6.21 billion), trading ($4.34 billion), construction ($2.73 billion), automobile ($ 2 billion) and power ($1.62 billion).
Singapore continued to be the largest source of FDI in India during the first half of the financial year 2018-19 with USD 8 billion investments. It was followed by Mauritius (USD 6.36 billion), the US (USD 2.15 billion), the Netherlands (USD 2.32 billion) and Japan (USD 1.78 billion).
However, on 17 April 2020, India changed its foreign direct investment (FDI) policy to protect Indian companies from “opportunistic takeovers / acquisitions of Indian companies due to the current 2019-20 corona virus pandemic, according to the Department for Promotion of Industry and Internal Trade. While the new FDI policy does not restrict markets, the policy ensures that all FDI will now be under scrutiny of the Ministry of Commerce and Industry.
According to the revised guidelines, foreign direct investment cap is 100 %. Foreign direct investment upto 49 % is allowed through automatic route and above 49 % under government route.
Prime Minister Narendra Modi had launched the ‘Make in India’ initiative in September 2014 to drive foreign investment in the country and turn India into a global manufacturing hub. FDI is important as the country requires major investments to overhaul its infrastructure sector to boost growth. Department for Promotion of Industry and Internal Trade (DPIIT) secretary Guruprasad Mohapatra has said that despite a slowdown in the global economy, inflows of foreign investment into the country have not been impacted. Modiji has also made attracting investments his personal mission. A big part of his overseas tours has been a deliberate effort to integrate foreign policy with economic and corporate policies. He meets with CEOs of global business giants to attract foreign direct investment, as well as seeking to engage the 20 million strong Indian diaspora around the world.
His pitch was clever, as he said early in his term, “FDI should be understood as ‘First develop India” alongwith ‘Foreign direct investment.” The aim was twofold, not only to attract foreign investors but also spur domestic players into investing in industry with his promise to layout the “red carpet” instead of “red tape” to boost investor confidence. Among the countries that Modiji visited, Japan committed to invest about $ 35 billion in five years and South Korea about $ 10 billion, China assured $ 20 billion in the next five years, while France had announced $ 2.26 billion and the UAE pledged to contribute to India’s $ 75 billion infrastructure fund.
The whole exercise is aimed at providing investor friendly climate to foreign players and in turn attract more FDI to boost economic growth and create jobs. Foreign investments are considered crucial for India which needs around US $ 1 trillion to overhaul its infrastructure such as ports, airports and highways. FDI also helps improve the country’s balance of payments situation and strengthen the rupee against other global currencies especially the US dollar.
Confidence is up. In a marked turn-around from 2013 when Morgan Stanley labeled the country one of the “Fragile Five” emerging market economies, the United Nations Conference on Trade and Development now calls India one of the most favoured investment destinations globally. In a move to further attract investments in manufacturing of defence equipment, the government today approved foreign investment (FDI) upto 100 % in Defence sector. FDI norms have also been eased in other sectors that include civil aviation, pharmaceutical, single brand retail, animal husbandry and private security agencies.
It took us nearly 60 years after Independence to achieve USD 1 trillion mark. It took 12 years to achieve our second trillion (dollar economy). And it has taken only five years, 2014 to 2019, to achieve the third trillion economy. The Prime Minister envisions an India that becomes a USD 5 trillion economy, meaning jumping by another USD 2 trillion in the next five years to come, U S Harsh Vardhan Shringla said. In 2014, when Prime Minister Narendra Modi took off office, India was the 11th largest economy in the world. Five years down the line, India is either the fifth or sixth largest economy of the world.
But to reach the $ 5 trillion mark by 2024, the economy would have to grow at over 12 % a year. India is currently a $ 2.8 trillion economy; to reach the $ 5 trillion mark by 2024, the economy would require nominal growth in dollar terms of over 12 % a year. In the last quarter for which data is available, India grew at slower than 6 % in real terms.
To succeed in this endeavour, it is essential to first build a strong financial base. Sustained internal reforms combined with healthy growth rate will help India Achieve the dream of becoming a five trillion economy. But substantial progress cannot be the end in liberalizing foreign investment policy settings. If India is to attract the capital required to boost productivity, create employment opportunities and deliver real improvements to living standards, more needs to be done to offer greater certainty to investors.
(The author is Lecturer in Education Department GGHSS Camp Shastri Nagar Jammu)
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