Foreign direct investment has been a cornerstone of India’s strategy to bolster economic growth, create jobs, and facilitate technology transfer. However, recent data indicate a worrying decline in FDI inflows. According to a report by UNCTAD, FDI flows to India plummeted by 43% in 2023 to $28 billion, dropping India from 8th to 15th in global rankings. This decline, coupled with a broader global trend, raises the question – should India rework its FDI policy?
The global FDI slump, influenced by heightened financial scrutiny and geopolitical tensions, has inevitably impacted India. Developed countries such as France, Australia, China, and the US witnessed substantial drops in FDI inflows, exacerbated by efforts to implement a global minimum tax rate. This has had a ripple effect, leading to reduced investments in developing nations, including India.
READ | Remittance revolution: UPI, CBDCs can bring down transfer costs
The fall in FDI inflows into India is not an isolated event. The UNCTAD report highlights that developing Asia saw an 8% decline, with significant drops in China and Central Asia. Despite these challenges, India remains in the top five for greenfield projects and international project finance deals, indicating resilience in certain sectors.
A comparative analysis with global trends reveals that while India’s FDI decline is significant, it is part of a broader global trend of shrinking FDI flows. FDI inflows as a percentage of global GDP have declined to 1.3% in 2023, the lowest since 1996. This broader context highlights the systemic nature of the issue and underscores the need for India to adopt innovative strategies to remain competitive. Understanding these global patterns can help India craft policies that address both domestic and international investment dynamics.
Sectoral and source country dynamics
The Reserve Bank of India (RBI) data from April 2024 offers a fresh perspective. Despite a general decline, net FDI improved to $4 billion from $2.82 billion a year ago, driven by a reduction in capital repatriation. Major source countries like Singapore, Mauritius, Cyprus, the US, and the Netherlands contributed over 80% of the flows, focusing on sectors such as manufacturing, financial services, business services, and energy.
Moreover, India’s efforts towards sustainable finance have been notable. The country has rolled out national strategies and frameworks on sustainable finance, integrating sustainable development considerations into banking operations. These initiatives include sustainable deposits, loans, and green credits. Such policies reflect India’s growing commitment to sustainability and could attract FDI from investors prioritising Environmental, Social, and Governance (ESG) criteria. Leveraging these policies to attract green investments could help diversify FDI inflows while aligning with global sustainability trends.
The need for policy reworking
One of the critical issues identified is the high level of capital repatriation. In FY24, foreign companies repatriated or disinvested 63% of the gross investment inflow. This trend underscores a broader issue: the intent of multinational corporations (MNCs) to prioritise profit repatriation over reinvestment. Additionally, FDI inflows have become increasingly concentrated in fewer sectors, mainly IT and non-conventional energy, limiting broader economic benefits.
Recent liberalisation efforts such as allowing foreign lawyers and firms to practice foreign law within India demonstrate the country’s openness to global integration. Evaluating the impact of these measures can provide insights into further liberalisation opportunities. Ensuring that such initiatives translate into tangible FDI inflows requires continuous monitoring and adjustment based on investor feedback and global best practices. This iterative approach can help fine-tune policies to better meet the needs of foreign investors.
India’s aggressive shift towards FTAs aimed at attracting FDI has had mixed results. While these agreements have opened markets, they have also led to increased trade deficits with partner countries. For instance, India’s trade deficit with ASEAN countries grew by 300%, with South Korea by 161%, and with Japan by 138% from 2007-09 to 2020-22. These statistics suggest that while FTAs have reduced import duties, they have not significantly boosted India’s export-oriented FDIs.
Strategic recommendations
India needs a more strategic approach to FTAs. This involves negotiating sharper agreements that consider relative sectoral advantages and establishing a common exclusion list to protect sensitive industries. Such calibrated FTAs could better balance market access, ensuring mutual benefits.
To counter the trend of high repatriation, India should implement policies that incentivise reinvestment. This could include tax incentives for profits reinvested into domestic projects, particularly in manufacturing and export-oriented sectors. Encouraging diversification of FDI beyond the IT and non-conventional energy sectors is crucial. Expanding incentives to sectors like electronics, general machinery, auto parts, and apparel could enhance the China+1 strategy, positioning India as a viable alternative investment destination.
The digital economy represents a burgeoning opportunity for attracting FDI. With India’s rapidly growing tech ecosystem, investments in digital infrastructure, e-commerce, and fintech have the potential to drive significant FDI inflows. Encouraging foreign investments in these areas through targeted incentives and regulatory support can help tap into the global digital transformation wave. Additionally, fostering innovation hubs and strengthening intellectual property rights can position India as a global tech investment destination.
Long-term improvement in FDI inflows requires a robust domestic economic environment. This includes fostering a high savings rate, stimulating private capital expenditure, and enhancing export competitiveness. Policies aimed at reducing public and household debt, improving infrastructure, and ensuring political and economic stability will create a more attractive environment for foreign investors.
The recent decline in FDI inflows to India is a wake-up call for policymakers. While global trends and geopolitical factors play a significant role, India must rework its FDI policy to address internal challenges and leverage its strengths. By recalibrating FTAs, diversifying investment sectors, and strengthening domestic economic fundamentals, India can attract sustainable and growth-oriented FDI, ensuring long-term economic resilience and prosperity.