Home Truths on Foreign Investment
Pulapre Balakrishnan
The Prime Minister’srecent visit to the US has been highlighted as a sortie to attract foreign direct investment (FDI). But Mr. Modi was in the US for the same purpose in the second half of 2014, and it would be useful to see what has been achieved since.
It has been put about in the media that foreign investment has increased by over 100 percent in the first year of this government. Then came the report of a London- based consultancy, owned by the prestigious Financial Times no less, that in the first half of 2015 Indian had attracted more FDI than China. There was a caveat to it though, and it was that the investment had been counted as “estimated capital expenditure in greenfield projects” i.e., new ventures. While this is encouraging of course, we would be advised to also study FDI data from the RBI, as it is based on actual flows into the country, including capital formation in existing ventures, and not estimates of capital expenditure in new ventures.
Data on FDI released by the RBI is not only rich in itself, but would also serve two purposes. It helps us see what the record of the Modi government is on this aspect but would give us an idea of what may reasonably be expected from a policy of banking on FDI. So, first the claim that there has been a one hundred percent rise in FDI in the first year of the present government and that this represents a thumbs up for its policies from the rest of the world. Such an increase, had it actually taken place, may well be counted as an achievement for the NDA, but has it? What RBI data show is an over 100 percent increase in net FDI in the first half of 2015 by comparison with that for the same period in 2014. Net FDI flows is computed as inflows less ouflows. Inflows in the first half of 2015 increased by over 15 percent while outflows decreased by over 80 percent. This scissor-like movement of its two components resulted in a greater than one hundred percent increase in net FDI. But such an increase cannot be interpreted as the government having attracted an unusually large volume of foreign investment, however the government may choose to spin it.
What about the slowing of outflows one might ask? Of course, this is not to be discounted, as the country can ill afford to lose precious capital. Surely it is to the government’s credit that it manages to keep capital within, and the rate of the slowing of the outflow was very high indeed in 2015. But the slowing of outflows is not some recent development. Outflows have been slowing for some time. In 2012-13 it was less than half of what it was in 2007-08. And why should the slowing of outflow be a surprise in the present context? It need not only be due to the change in policies. The rest of the world has allowed, while India today is currently the world’s fastest growing economy. By now, the opportunities are here. This creates an incentive for domestic capital to stay and for foreign capital to come in to India. So, we can now see that the 100 percent claim is not only exaggerated but is actually misleading. Yes, net FDI inflow has increased substantially in the first half of 2015, but this is due to the slowing of outflows and is in any case not a recent occurrence. Net FDI had increased by over 100 percent in 2006-07 and by close to one hundred percent in 2011-12.
We may now take a longer view of FDI and see where in the economy it has flowed to in terms of geography and sector. But even before that, by looking at where it is coming from we say something about the nature of the beast. The Department of Industrial Promotion and Policy of the Ministry of Commerce has helpfully placed on the net a fact sheet on FDI for fourteen years since 2000. We see that by far the largest part of FDI comes into India via Mauritius, a country with which India has a tax treaty, making it advantageous for firms to take this route. This feature, immediately raises the question as to how much of the inflow adds to the capital stock in India, as leading multinationals are unlikely to be incorporated in the Mauritius. General Electric and Ford are incorporated in the US. Add to this international practice, followed by the GoI, that treats as FDI any investment leading to a greater than 10 percent holding of a firm’s equity. This on grounds that 10 percent is enough to gain control. While the issue of control is relevant for corporate governance it is of no relevance at all from the point of view of growth which depends upon capital expenditure. It is difficult to disentangle from the aggregated data available in the public domain as to how much of the inflow via Mauritius actually creates capital assets in India as opposed to only acquiring equity of Indian firms. This is not of academic interest alone as since April 2000 thirty five percent of the cumulative inflows recorded as FDI has taken this route. Even if not actually a wolf in sheep’s clothing, portfolio investment could just easily flow out.
Now to say something about the flows from the US which the Prime Minister has only recently visited. In the same fourteen-year period we have been considering only six percent of the FDI inflow has been from the US. While inflows from the US may well catapult into first place, this information taken along with the advice given to PM Modi by US corporate chieftains that he should make it easier to do business in India suggests that they plan to hold their horses.
As the future is yet to unfold, we cannot claim that the PM has wasted his time but would be advised to remain cautious. After all, though some policy changes have been affected - notably allowing FDI in insurance, defence production and the railways - India has been open to FDI for over 15 years by now.
Finally, where in India is the FDI going to? Geographically speaking, close to fifty percent of the flows over 2000-14 is shared between Maharashtra and the National Capital Region. Interestingly, the governments of these states have not shown themselves to be overly solicitious of FDI, suggesting that foreign investors pursue profits and not invitations to invest. It does come as a surprise that Gujarat comes in only fifth doing no better than three of the five southern states. During much of these fourteen years Mr. Narendra Modi has been chief Minister of Gujarat. As for the sectors of the economy attracting FDI we find that since 2000 less than 25 percent of the inflows have been into manufacturing. Services including finance, telecommunications and hotels, have gathered most of what has flowed in. Infrastructure has got even less than manufacturing. There is a moral in this story. If ‘Make in India’ is to take off we would have to do much of the heavy-lifting ourselves.
The author teaches economics at Ashoka University. He may be reached at www.pulaprebalakrishnan.in.