Improving climate for foreign investments

 

The silver lining for those who have been waiting for some quick progress on the economic reforms front arrived on Tuesday. The department of industrial policy and promotion (DIPP) announced a review of foreign direct investment (FDI) policy in as many as 15 sectors. These reforms were long overdue and their final realization should considerably bolster India’s attractiveness to foreign capital and technology.

With an aim “to further ease, rationalize and simplify the process of foreign investments in the country”, the announced measures involve sectors as diverse as defence, mining, construction and plantation. A whole range of FDI proposals have been, in one stroke, shifted from the route of government approval, where, as the DIPP notes, time and energy of investors is wasted, to the automatic route. For instance, in the defence sector, the proposals for FDI up to 49% will now come under the automatic route instead of the government route as under extant rules. For investments above 49%, the proposal will be considered by the Foreign Investment Promotion Board (FIPB) instead of the current scrutiny by the Cabinet Committee on Security.

The liberalization of the FDI regime in the construction sector has the potential for yielding a considerable windfall as this sector has been the second highest beneficiary of foreign investment—accounting for 9.34% of the total FDI inflows from April 2000 to June 2015. In other measures, sectoral caps have been increased and new avenues have been opened up for foreign investments. The wholesale, retail and e-commerce spaces have been opened up for manufacturing industries. To cap it all, the threshold up to which FIPB can consider foreign equity proposals has been raised from Rs.3,000 crore to Rs.5,000 crore. Beyond this limit is the realm of the Cabinet Committee on Economic Affairs.

In order to make it easier for foreign investors, DIPP has also been advised to consolidate all FDI-related instructions from countless government notifications and press notes into a single booklet. The recovery of the Indian economy, fragile and slow though it may be, has definitely been helped by an increase in foreign investment. The foreign equity inflows for the first six months of the calendar year 2015 saw a 34% increase from the corresponding figure last year. According to a Financial Times report in September, India has emerged as the world’s most favourite destination for FDI in 2015.

It is true that India has traditionally been far more reliant on domestic investments than on foreign inflows for economic growth. According to World Bank data, at its peak in 2008, FDI in India stood at 3.5% of GDP. The level of gross capital formation as a percentage of GDP, however, has consistently hovered above 30% since 2004, achieving a peak of 39% in 2011. There are, however, three reasons why the government’s push for greater FDI inflows is not at all misplaced.

One, the FDI inflows tapered off from a peak of 3.5% of GDP in 2008 to 1.3% in 2012 before marginally reviving to 1.7% in 2014. It is clear that India has adequate capacity and need to further absorb foreign capital. Two, domestic investment has not picked up because the Indian corporate sector has been battling over-leveraged balance sheets. With large numbers of stressed and non-performing assets on their books, banks, too, have been unwilling to lend further. World Bank data reflect the same, as gross capital formation plummeted from 39% of GDP in 2011 to 31% of GDP in 2014—the lowest in over a decade. In the light of such a decline, the 2014-15 Economic Survey was unequivocal on the imperative of augmenting public investment “to recreate an environment to crowd-in private sector investment”. A spurt in FDI will undoubtedly support the increasing public investment in spurring consumer demand and create positive conditions for private domestic investments.

Three, an increase in the level of FDI is not just a transient indicator of the health of the economy or a measure of success for initiatives such as “Make in India”. FDI brings with itself world’s best practices and access to technology. It induces greater competition in the markets of the recipient country and helps the latter integrate with global supply chain. In short, more and more FDI is welcome and so are the measures to facilitate the same.