'Waiting for foreign investment', The Hindu, 5 May, 2002.

On his recent visit to South East Asia upon the heels of the gruesome events in Gujarat, the Prime Minister is reported to have stated that while the news were grievous they were unlikely to affect foreign direct investment (FDI) flows into India. Even to the most hard-nosed economist the PM had employed a most callous trade-off. But one thing is certain, foreign investment is on the mind of the Indian politician today. From Laloo Prasad Yadav in his time in Bihar to governments of every stripe in New Delhi, foreign investment appears to be an irresistible honey pot to be sought out relentlessly. Even a relative latecomer to this scene, the government of Kerala is jockeying for position. In November in Kochi is planned a show to attract overseas capitalists to invest in the state as its Industries Minister Mr. P.K. Kunhalikutty has given advance notice. But how reasonable it is to expect substantial FDI flows into India?

            An indication of the expectations in Delhi is evident from the recent budgetary measures extending capital account convertibility. What was intended is to facilitate the repatriation of income earned on investments in India, particularly by NRIs. Not quite linked to capital account convertibility is the revocation of limits on foreign direct investment (FDI) except in specified sectors. While a savvy reading of their provenance would suggest that these measures reflect the gathering clout of NRIs with respect to Indian economic policy, a more academic reading may be that all these measures with respect to capital flows are based on the sound principle that there is unlikely to be entry into a field from which no exit is assured, hence the increasingly generous provision for repatriation of earnings. However, be that as it may, the best reflection on the promise of a more liberal policy towards external capital flows must start from experience rather than economic theory. First, India’s experience with FDI, as opposed to portfolio flows, has been very poor since 1991 so that we may be led to enquire whether the changes in the Budget are so significant as to turn the tide. Second, the experience of China is of the essence in assessing India’s prospects of attracting foreign capital.

The persistent reference to the much higher level of capital inflow into China as a predictor of higher inflow into India consequent upon more liberal policy misses the cause of the Chinese experience. There are two aspects to the Chinese experience that are germane to India. First, FDI in China is high because domestic investment is high there, over a third higher as a share of GDP than in India. Indeed all the East Asian economies are high-investment economies, it being part of their character as much as their, at least by-now, open trade regimes. Essentially, FDI is high in these economies because domestic investment is high, and not vice versa. Secondly, as in the other East Asian economies, domestic investment is high in China because public investment is high. Here, it bears emphasising that private investment in East Asia, far from having allowed itself to be `crowded out’, appears to have responded favourably to what is clearly a buoyant investment climate due at least in part to high public investment. Finally, an aspect many appear to be unaware of is that the share of FDI in aggregate investment in China is not very high. As this is of the essence I provide some numbers from a back-of-the-envelope calculation. In 2000-1 China saved 40 percent of her GDP of 1, 120 billion US. Assuming that savings is exactly equal to investment, this implies investment of 448 billion US. Now, FDI of 46.8 billion US in China the same year may be incomparably higher than India’s meagre 2.3 billion, but amounts to only 10.4 percent of gross investment. All this under the assumption that saving equals investment, which it does not necessarily in an open economy. In fact, in China saving may reasonably be expected to be greater, for it has a current account surplus. This suggests that FDI is very likely less than ten percent of investment in China. Surely, not a prepossessing statistic?

            Most of the argument thus far has been almost exclusively macroeconomic. Macroeconomics is of course a crucial part of the picture, but cannot be considered all of it. There is the extremely important and autonomous microeconomic issue of composition, which is whether the supply of FDI is likely to match the nature of the demand for it component wise? This may be an idea difficult to conceptualise, but is easy to understand when we try to compare the areas in which we need investment with those in which overseas capitalists may find an interest. The one area in which we truly need investment is infrastructure. There is a tendency to see infrastructure in terms of mega projects – highways, airports, or even the Three Gorges Dam if you wish to venture into China once again. But this is a case of getting blinding by a big picture, as it were. I would have thought that what India’s needs most is infrastructure in terms of schools, primary health facilities and plain municipal services such as water supply and sidewalks. To refuse to see this is myopia of the bleakest kind, something that has characterised much of our economic policy during the past fifty or so years. As they are mostly relegated to ‘social’ infrastructure, we underestimate the necessary resource flows that would be required to take us to an acceptable level of the services I have mentioned. The prospect of foreign direct investment in these areas is remote indeed. Historically - in the last fifty years in any case - FDI has seldom flowed there. Many argue that this is so because the rate of return is low. More to the point, much of these services have been provided by the state, and no market has existed for them even in the highly developed economies of Europe. These societies have chosen to make these investments themselves rather than leave them to foreigners. The last major FDI-led investment in infrastructure internationally is perhaps English capital flooding the Americas to build the railways in the late 1800s. Presently, as far as the developing countries are concerned, it is not really a question of FDI in crucial social infrastructure as much as FDI at all. For, over ninety percent of global FDI are flows among the rich countries of the North.

            We are best advised to believe that massive foreign investment flows into India today are unlikely, barring a radical change in the domestic scenario. Under the circumstances, it is particularly worrying that promise of FDI inflow has encouraged our governments to act as if they are excused from taking even the minimal steps needed to improve the quality of our lives. Crucially, the public finances of nearly all our states are in a shambles. Unwilling to begin work on strengthening the resource base, these governments scour the world for evidently shy foreign capitalists. FDI is the newest god on the block it seems. But even the proverbial god only helps those who first help themselves.

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