FDI: What's stopping it? - Views on News from Equitymaster

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FDI: What's stopping it?

Jun 21, 2004

In the incessant rise of the stock markets throughout the whole of FY04, Foreign Institutional Investors (FIIs) were in the limelight. In fact, with net inflows of more than US$ 7 bn, these investors almost played a decisive role in the rise of Indian equities. While relatively higher growth prospects of the Indian economy played the pull factor for these inflows, low interest rates in the US (the biggest origin of these flows) acted as the push factor.Now, when there are talks of the US Federal Reserve 'just about' to raise interest rates, Indian investors fear flight of capital from Indian equities to relatively safer US treasury bills and bonds. However, in all this hype and hoopla about foreign capital in the form of FII inflows improving the prospects of the Indian stock markets, nobody seems to be worried about India's continued underperformance on the foreign direct investment (FDI) front.

If one were to give heed to the original policy declaration in 1991, which laid the foundation for foreign investment in India, it gives a clear indication of the then government's expectations from FDI. Some of the benefits of FDI as mentioned in that declaration were - technology transfer, marketing expertise, introduction of modern management techniques, and export promotion.

Now, despite the government's intention of attracting higher amount of FDI into the country, the initiatives so far seem to be lacking pace. As a matter of fact, total foreign investment into India has remained at around 2% of GDP over the past years. This miniscule amount has not been enough to make any significant contribution towards the economy's growth in the past. Now, more importantly, out of this 2% contribution of foreign investment, FDI has been contributing less than 50% of the total. So, its impact has been even lesser.

There have been several factors for India's disappointment with FDI inflows. While the administration tries to portray India as one of the most liberal and transparent FDI regimes amongst emerging nations, there still exists a plethora of 'irritating and confusing' rules and regulations. Some of these are -

  • Caps on equity holdings in several growth industries.

  • Antiquated labour laws that make it almost impossible to downsize in face of downturns.

  • Flawed commercial agreements (like the one with the failed energy major, Enron, which portray India as an unreliable investment destination).

Other factors that deter FDI flows are:

  • Corruption: India ranks high on the corruption ratings and the degree of red-tapism in the Indian bureaucracy (read 'babudom') has added to woes on the FDI front.

  • Adverse ratings by professional agencies (institutions like S&P and Moody's have traditionally rated the Indian currency at a lower level than most of its emerging market peers).

  • Geopolitical factors (like those relating to India-Pakistan tensions and terrorist attacks)

These factors combined with confusing Indian regulations relating to foreign investment deter even the most resolute of foreign investors. Over that, the non-commitment towards dismantling an over-regulated economy plays is own part in discouraging FDI inflows.

As per UNCTAD, FDI levels need to treble (from the current level of around US$ 4-5 bn) if India wishes to achieve an 8% GDP growth as envisaged in the tenth five-year plan of 2002-07. And for that to happen, the government needs to play a more positive, transparent and proactive role. The central message of the above mentioned factors that deter FDI inflows into the Indian economy is that it is important for India to set its own house in order. If we are able to do so, as investors into the long-term Indian growth story, we need not be concerned whether or not FDI would flow in. We believe, it will!

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