By Akhil Raj Gupta

Introduction

At the outset, it is important to distinguish between Foreign Direct Investment (FDI) and Foreign Institutional Investment (FII) / Foreign Portfolio Investment in context of the potential beneficial impact that it could have on Indian financial space. The heuristic to distinguish between these two slightly blurry terms is duration. FDIs are considered to be long-term and steady investments that involve more than financial capital. Foreign companies investing in India are likely to finance import of superior technology, globally renowned management practices, and exploit hitherto untapped business opportunities thereby generating employment opportunities. FIIs on the other hand are considered to be ‘good weather friends’, looking to exit the country at the first sign of distress or better arbitrage opportunities elsewhere. This volatility has been displayed in the net outflow of portfolio investment to the tune of $14 billion in the aftermath of the global financial crisis. FDI on the other hand dipped slightly but remained within a respectable bound of  $28-30 billion in the post-crisis years. Portfolio investments generally tend to be proportionally higher in India than its competitors like China due to a restrictive policy framework and volatile environment that has discouraged many companies from investing. However, the general consensus currently is that FDI is not only a sufficient but also a necessary condition for stimulating economic growth in India.

Policy Framework

Currently an Indian company may receive Foreign Direct Investment under the two routes as given under:

  1. Automatic Route

FDI is allowed under the automatic route without prior approval either of the Government or the Reserve Bank of India in all activities/sectors as specified in the consolidated FDI Policy, issued by the Government of India from time to time.

  1. Government Route

 FDI in activities not covered under the automatic route requires prior approval of the Government which are considered by the Foreign Investment Promotion Board (FIPB), Department of Economic Affairs, Ministry of Finance

Scope for improvement

FDI in India is still concentrated in a few sectors and states. Factors that hinder FDI inflows include infrastructure bottlenecks, rigid and complicated labor laws, lack of coordination between the states and the central government, lack of reforms at the state level, FDI equity caps in many potential sectors, and delays in getting multiple clearances and approvals.

Future reforms and policies need to address these issues and set up appropriate institutions. Some necessary reforms include:

1.Creating a better environment for infrastructure development with an appropriate institutional framework such as a dispute-resolution mechanism, independent regulatory authority, and special investment law

2.Establishing a uniform labor code after an independent review and proper consultation with stakeholders; ensuring proper design and planning of special economic zones (SEZ), including local-level solutions for land acquisition and sector-specific policies with incentives to attract FDI into SEZs

3. Revisiting outdated laws, controls, regulatory systems, and government monopolies affecting the investment environment; and last, encouraging nongovernmental facilitation services for foreign investors.

Sector-wise distribution

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Source – Department of Industrial Policy & Promotion (DIPP)

Examples of industry-specific benefits of Foreign Direct Investment (FDI)

  1. Telecom sector

–       In 2013, the Indian government raised the FDI cap from 74% to 100% for the telecommunications sector in India. This was perceived as a cause for celebration for the debt-laden industry that has only attracted 12% of FDI inflows over the past nine years.

–       It is widely hoped that MNC giants like Vodafone, Telenor, and Sistema will benefit from this and implement technological advancement to match local players Airtel and Reliance.

–       Economists argue that the pace of technology transfer is a function of the ‘technology gap’ i.e. the difference in level of technology between domestic companies and international firms.

  1. Aviation sector

–       In September 2012, the Indian government permitted FDI upto 49 percent in aviation sector, which acted as a catalyst for many mergers and acquisitions like Jet Airways – Etihad, Tata-Singapore Airlines, and SpiceJet-Tiger Airways.

–       This influx of investment is supposed to promote efficiency and alleviate the problems of high leverage and poor interest coverage ratio that currently plague the industry.

In sum, we can conclude that Foreign Direct Investment has largely proved beneficial for the Indian economy. It was a key factor in Gross Domestic Capital Formation peaking at 38.11 % of GDP in 2007-08 and is generally considered less volatile than other external finance instruments. Given the right policy framework and atmosphere conducive to all stakeholders, it can act as a valuable support to Indian economic growth prospects. It further permits capital outlays in spite of decelerating/ constant domestic household savings by providing adequate finance for the savings-investment gap as measured by the current account deficit.

 Akhil is currently in his second year at college, pursuing a Bachelor of Arts degree in Economics (Hons) at Sri Ram College of Commerce, University of Delhi. He has been passionate about writing since an early age and is currently involved with the official College magazine and Economics Department magazine at SRCC. His areas of interest include behavioural economics / finance, econometric analysis, macroeconomic policy, and political theory. He spends his free time reading extensively, watching interesting videos on YouTube, and trying to convince everybody around him that he really does know a thing or two about economics in the midst of all the pontification!

Posted by The Indian Economist | For the Curious Mind