Central Idea

• The Finance Ministry of India emphasized the need to address challenges faced by global investors to facilitate Foreign Direct Investment (FDI) flows.
• In this article, we delve into the factors affecting FDI inflows and propose measures to attract and sustain FDI in India.

What is Foreign Direct Investment (FDI)?

• FDI refers to the investment made by individuals, companies, or governments from one country into business interests located in another country.
• It involves the direct ownership or control of assets in the foreign country, typically in the form of establishing new ventures, acquiring existing businesses, or creating strategic partnerships.

India’s FDI feats

• In terms of investor countries of FDI Equity inflow, Singapore is at the top with 27%, followed by the US with 18% and Mauritius with 16% for the FY 2021-22.
• ‘Computer Software & Hardware’ has emerged as the top recipient sector of FDI Equity inflow during this period with around 25% share followed by Services Sector and Automobile Industry with 12% each.
• With 53 % Karnataka has received the majority share of FDI equity in the `Computer Software & Hardware’ sector.

FDI in India

• Foreign investment was introduced in 1991 under Foreign Exchange Management Act (FEMA), driven by then FM Manmohan Singh.
• Economic liberalisation started in India in the wake of the 1991 crisis and since then, FDI has steadily increased in the country.
• India, today is a part of top 100-club on Ease of Doing Business (EoDB) and globally ranks number 1 in the Greenfield FDI ranking.

There are two routes by which India gets FDI.

1) Automatic route: By this route, FDI is allowed without prior approval by Government or RBI.

2) Government route: Prior approval by the government is needed via this route. The application needs to be made through Foreign Investment Facilitation Portal, which will facilitate the single-window clearance of FDI application under Approval Route.

• India imposes a cap on equity holding by foreign investors in various sectors, current FDI in aviation and insurance sectors is limited to a maximum of 49%.
• In 2015 India overtook China and the US as the top destination for the Foreign Direct Investment.

Sectors that come under the ‘100% Automatic Route’ category are

• Agriculture & Animal Husbandry, Air-Transport Services (non-scheduled and other services under civil aviation sector)
• Airports (Greenfield + Brownfield),
• Asset Reconstruction Companies,
• Auto-components, Automobiles,
• Biotechnology (Greenfield),
• Broadcast Content Services (Up-linking & down-linking of TV channels, Broadcasting Carriage Services,
• Capital Goods, Cash & Carry Wholesale Trading (including sourcing from MSEs), Chemicals, Coal & Lignite, Construction Development,
• Construction of Hospitals,
• E-commerce Activities, Electronic Systems,
• Food Processing, Gems & Jewellery, Healthcare, Industrial Parks, IT & BPM, Leather, Manufacturing, Mining & Exploration of metals & non-metal ores, Other Financial Services,
• Pharmaceuticals, Plantation sector
• Ports & Shipping, Railway Infrastructure, Renewable Energy, Roads & Highways,
• Single Brand Retail Trading, Textiles & Garments,
• Thermal Power,
• Tourism & Hospitality and
• White Label ATM Operations.

Sectors that come under up to 100% Automatic Route’ category are–

• Infrastructure Company in the Securities Market: 49%
• Insurance: up to 49%
• Medical Devices: up to 100%
• Pension: 49%
• Petroleum Refining (By PSUs): 49%
• Power Exchanges: 49%

Sectors that come under the ‘up to 100% Government Route’ category are–

• Banking & Public sector: 20%
• Broadcasting Content Services: 49%
• Core Investment Company: 100%
• Food Products Retail Trading: 100%
• Mining & Minerals separations of titanium bearing minerals and ores: 100%
• Multi-Brand Retail Trading: 51%
• Print Media (publications/ printing of scientific and technical magazines/ specialty journals/ periodicals and facsimile edition of foreign newspapers): 100%
• Print Media (publishing of newspaper, periodicals and Indian editions of foreign magazines dealing with news & current affairs): 26%
• Satellite (Establishment and operations): 100%

Prohibited Sectors

There are a few industries where FDI is strictly prohibited under any route. These industries are

• Atomic Energy Generation
• Any Gambling or Betting businesses
• Lotteries (online, private, government, etc.)
• Investment in Chit Funds
• Nidhi Company
• Agricultural or Plantation Activities (although there are many exceptions like horticulture, fisheries, tea plantations, Pisciculture, animal husbandry, etc.)
• Housing and Real Estate (except townships, commercial projects, etc.)
• Trading in TDR’s
• Cigars, Cigarettes, or any related tobacco industry

Benefits offered by FDI

• Employment generation: FDI boosts the manufacturing and services sector which results in the creation of jobs and helps to reduce unemployment rates in the country.
• Economic growth: Increased employment translates to higher incomes and equips the population with more buying powers, boosting the overall economy of a country.
• Human capital development: Skills that employees gain through training and experience can boost the education and human capital of a specific country. Through a ripple effect, it can train human resources in other sectors and companies.
• Technology boost: The introduction of newer and enhanced technologies results in company’s distribution into the local economy, resulting in enhanced efficiency and effectiveness of the industry.
• Increase in exports: Many goods produced by FDI have global markets, not solely domestic consumption. The creation of 100% export oriented units help to assist FDI investors in boosting exports from other countries.
• Exchange rate stability: The flow of FDI into a country translates into a continuous flow of foreign exchange, helping a country’s Central Bank maintain a prosperous reserve of foreign exchange which results in stable exchange rates.
• Improved Capital Flow: Inflow of capital is particularly beneficial for countries with limited domestic resources, as well as for nations with restricted opportunities to raise funds in global capital markets.
• Creation of a Competitive Market: By facilitating the entry of foreign organizations into the domestic marketplace, FDI helps create a competitive environment, as well as break domestic monopolies.
• Climate mitigation: The United Nations has also promoted the use of FDI around the globe to help combat climate change

Factors Affecting recent FDI inflows

(1) Inflationary Pressures and Tighter Monetary Policies

• The dip in FDI inflows in 2022-23 can be attributed to inflationary pressures and tighter monetary policies.
• Policymakers should address these factors to encourage a favorable investment climate.

(2) Geopolitics vs. Geography

• The Ministry highlights the influence of “political distance more than geographical distance” on FDI flows.
• Geopolitical factors have dominated over traditional geographical considerations.

(3) Global FDI Trends

• Gross FDI flows declined by 16% in 2022, compared to the record high of $84.8 billion in 2021-22.
• Net inflows experienced a sharper decline of 27.4%.
• Similar trends were observed in emerging market economies, where net FDI inflows declined by 36% in 2022.

Challenges for India’s Growth Outlook

(1) External Sector Challenges:

• The review identifies the external sector as a potential challenge for India’s growth in 2023-24.
• Factors such as geopolitical stress, volatility in global financial systems, price corrections in global stock markets, El-Nino impact, and weak global demand could constrain growth.
• Policymakers must closely monitor FDI data and undertake measures to facilitate FDI inflows.

(2) Fragmentation of FDI Flows:

• The Ministry highlights the phenomenon of “friend shoring,” wherein FDI is directed towards geopolitically aligned countries.
• This has led to a fragmentation of FDI flows globally, as per research from the International Monetary Fund (IMF).
• Additionally, inflows from foreign portfolio investors (FPIs) into Indian markets have become less volatile.

Conclusion

• To attract and sustain FDI inflows, India needs to address challenges related to inflation, monetary policies, geopolitical factors, and last-mile infrastructure.
• Additionally, mitigating trade risks and fostering inclusive growth through job creation will contribute to a favorable investment climate.

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