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  • Oct 03, 2023
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The Investment Reality Check

Relevance

  • GS 3: Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.
  • Tags: #IndianEconomy #FDIinIndia #UPSC #IndianExpressEditorialAnalysis #IE #IndianExpress #Editorials #CurrentAffairs.

Why in News?

India is positioned as a Potential economic contender by its strong GDP growth and shifting geopolitical environment. However, the decline in foreign direct investment (FDI) raises concerns about the root causes and potential obstacles to this narrative.

India’s Impressive Economic Growth

The Indian economy surged by 7.8% in the first quarter of the current fiscal year, exceeding expectations.

  • Analysts, including the Reserve Bank, forecast annual growth of 6-6.5%, reinforcing India’s economic resilience.
  • IMF estimates suggest sustained growth of around 6% between 2023 and 2028, highlighting India’s consistent economic potential.
  • India’s rising prominence as an investment hub attracts multinational corporations seeking alternatives to China, aided by favorable geopolitical dynamics.
  • India’s growth trajectory positions it to potentially rival China’s contribution to global growth in the coming years.
  • India emerges as one of the world’s most compelling growth stories, fueled by robust economic performance and strategic advantages.

Declining Foreign Direct Investment (FDI)

Foreign Direct Investment (FDI) in India has witnessed a concerning decline in recent years.

  • FDI inflows, including reinvested earnings and other capital, reached $71.3 billion in 2022-23, marking a 16% drop from the previous fiscal year’s $84.8
  • FDI levels for 2022-23 were even lower than those observed in 2019-20.
  • The decline has persisted into the current fiscal year, with gross FDI inflows for April-July totaling $29 billion, a 25% decrease from the same period in the previous year.
  • The declining FDI raises concerns about India’s attractiveness as an investment destination.

Equity Investment Decline

  • The decline in foreign direct investment (FDI) is particularly evident in fresh equity flows, which decreased significantly from approximately $59.6 billion in 2021-22 to around $47.6 billion in 2022-23.
  • In the first four months of the current fiscal year, equity investments further decreased to $13.9 billion from the previous year’s $22 billion.
  • In contrast, investments through the reinvested earnings route have remained relatively stable during this period.
  • Uncommitted Investors: The data suggests that the reluctance to invest in India is more pronounced among potential investors who have not yet committed substantial capital.
  • Established investors, who are more familiar with the system, may still have reservations about further investments.

Broad-Based FDI Decline

FDI decline is not limited to the technology sector, as evident in the computer software and hardware industry.

  • The drop in FDI is observed in various sectors, including the automobile industry, construction (infrastructure activities), and metallurgical industries.
  • The decline in foreign investment is broad-based, affecting several key industries beyond just technology.

Interest Rate Trends

While interest rates have significantly risen in developed economies, India has witnessed a sharp decline in interest rates.

FDI Performance of Competing Countries

  • Vietnam’s Steady FDI: Vietnam, a competitor in the “China plus one” strategy, experienced steady FDI inflows during January-August, reaching approximately $18 billion, marking an 8% increase compared to the same period last year.
  • Indonesia’s Consistent Flows: Indonesia maintained FDI levels around $10 billion during January-June this year, similar to the previous year.

India’s Prospects

Companies like Foxconn within the Apple ecosystem are significantly increasing their investments in India, signaling confidence in the country’s prospects.

  • Foreign Portfolio Investments (FPIs) have shown renewed interest in India, with approximately $15 billion invested in Indian markets since January, following a withdrawal of $16.5 billion in 2022.

Investor Dilemma

India is considered an alternative for diversifying companies moving away from China and a part of the “China plus one” strategy.

  • The government’s Production-Linked Incentive (PLI) scheme is designed to attract investments.
  • However, the decline in foreign direct investment (FDI) raises questions. If India is such an attractive destination, why aren’t all types of investors rushing in?
  • In spite of India’s potential for growth, is this fall a sign of more serious problems undermining investor confidence?

 Reasons for Decline in FDI

 Indirect Investments

  • Some foreign investors might prefer investing indirectly through established Indian companies that can navigate the system better.
  • For certain industries like electronics and textiles, investors might find other countries more appealing for diversification, despite India’s potential.

Investor Hesitations

  • In addition to traditional obstacles Foreign and domestic investors are hesitant due to Policy uncertainty, fearing that the rules may change arbitrarily.
  • Uncertain Business Environment: An unpredictable business environment and an uneven playing field discourage investments.

Trading Block Absence

India’s absence from major trading blocks like the European Union and RCEP puts it at a disadvantage.

  • As economic integration deepens within these countries, India’s exclusion from these agreements and supply chains hinders its position in the global manufacturing ecosystem.
  • Supply Chain Dependency: RCEP member countries are central to manufacturing supply chains, making India’s exclusion more significant.

FDI flows tend to favor countries with comprehensive trade agreements, such as lower tariffs. India’s exclusion from such agreements may explain the decline in FDI. India’s decline in FDI suggests it’s not the sole attractive investment destination. A realistic evaluation of India’s prospects is needed.

Foreign Direct Investment (FDI)

· FDI is when a foreign entity directly invests in or acquires assets in another country with a significant ownership stake, usually at least 10%.

· Long-term Investment: FDI involves establishing business operations or acquiring assets in a foreign country with a long-term perspective. It often includes management control.

· Example: A foreign car manufacturer building a factory in India and owning a majority stake in the venture.

Foreign Portfolio Investment (FPI)

· FPI is when investors buy financial assets in a foreign country, such as stocks and bonds, without direct control or management influence.

· Short-term Investment: FPI is typically short-term and doesn’t involve a significant ownership stake in the invested company.

· Example: A foreign investor buying shares of an Indian company listed on a stock exchange without taking managerial control.

Equity Investment

· Equity investment refers to the purchase of shares or ownership stakes in a company, entitling the investor to a portion of the company’s profits and assets.

· Risk and Reward: Equity investors bear both the risks and rewards of a company’s performance.

· Example: Buying stocks in a tech company, where you become a partial owner and benefit from its growth or suffer losses if the stock price declines.

 

Source: Indian Express

Mains Question

The Indian economy has shown promising growth prospects, yet foreign direct investment (FDI) has been declining. Analyze the factors contributing to the decline in FDI and its implications for India’s economic growth and global competitiveness?