Foreign Direct Investment (FDI) - A declining trend factor in India?

Foreign Direct Investments (FDI) in India seems to be declining over the last couple of financial years. India has witnessed close to 37% y-o-y decline in the net FDI inflow in FY24, owing to highest interest rates in advanced economies and a limited absorptive capacity in various sectors in India. Singapore remained the top investor with US$ 11.77 BN followed by Mauritius, United States, Netherlands and Japan respectively in the same order. Overall global FDI has also seen a negative impact owing to higher borrowing costs, depending on geo – fragmentation, and rising protectionism. Since the pandemic in 2020, there seems to be a structural change in the global investment pattern with FDI flows shifting from the developed countries to the developing ones. FDI in developing Asia fell by 8 per cent to $621 billion, with China — the second-largest FDI recipient in the world — seeing a rare decline in inflows. India has currently slipped seven notches to 15th place in the World Investment ranking due to economic slowdown and rising geopolitical tensions. United States remained at the top with China, Singapore, Hong Kong, Brazil and Canada following in order.

Looking into the trend for the last ten years since FY15, gross FDI inflow in India has increased at a CAGR of 4.62%, however the actual or net FDI inflow in India has seen an overall average decrease of ~3%. This is due to the fact that the rise in reinvested earnings instead of new foreign investments coupled with the increase in the FDI investments going out of India. The drop in actual FDI can lead to the slowdown of the economic growth in India. With more money being taken out than brought in, India’s balance of payments could be negatively affected. This could put pressure on the country’s foreign exchange reserves and affect the stability of the value of rupee.

Top 5 sectors receiving highest FDI equity inflow in India are Services Sector (Finance, Banking, Insurance, Non-Fin/ Business, Outsourcing, R&D, Courier, Tech. Testing and Analysis, Other) (16%), Computer Software & Hardware (15%), Trading (6%), Telecommunications (6%) and Automobile Industry (5%). Inspite of these sectors receiving ample amount of FDI equity inflows, India is witnessing a decline since FY22, with FY23 getting the highest impact. In FY24 the FDI equity inflow has declined by 3.5% to a five year low of US$ 44.4 BN due to lower infusion in the sectors of services, computer hardware and software, telecom, automobiles and pharmaceuticals. The total FDI -- which includes equity inflows, reinvested earnings and other capital -- declined marginally by less than 1% to US$ 70.95 in FY24 from US$ 71.35 BN in FY23.

FDI is crucial for providing capital, creating jobs and promoting innovation. Lower investment levels mean fewer new projects, reduced economic activity and potentially slower growth in GDP. World Bank’s South Asia Economic Focus Report 2020 mentioned that every US$1 BN in FDI can create between 10,000 to 15,000 jobs in the region. A decline in FDI may signal waning confidence among foreign investors in India’s economic prospects. This can be detrimental in the long run, making it harder to attract new investments. Local businesses especially the ones that are dependent on foreign investment for their expansion and operations, will undergo an adverse impact in the coming years. This includes majorly the sectors such as manufacturing, technology and infrastructure. India has witnessed many new jobs that originate from foreign-funded projects and hence a decline in FDI can worsen unemployment.

The government now needs to ensure a stable and predictable economic environment to attract and retain investment. Some of the major steps that they can look into or can act upon are as below.

? The government must look into the upgradation of the infrastructure in the country ensuring smooth transportation of goods and accessing reliable utilities.

? Investing in education and vocational training to build a skilled workforce can make India more attractive to high-tech and high-value industries, ensuring that investments lead to significant economic and employment benefits.

? Regular interaction with foreign investors to understand their concerns and address them proactively can help in retaining existing investments and attract new ones.

? Offering incentives and support for long-term investments can also be beneficial

So, what’s the way ahead and the future of India awaiting with respect to FDI inflow in India?

India is currently aiming to attract at least US$100 BN a year in gross foreign direct investment (FDI) as many investors, multinational companies are looking to diversify away from China. Recently, Apple Inc. and Samsung Electronics Co. have boosted manufacturing in India with the government aid provided. However, the target is way up from the annual average of more than US$70 BN in the last 5 years. Moreover, India has implemented several strategies to attract foreign investments, including measures like reducing corporate tax rates, addressing liquidity issues in non-banking financial companies (NBFCs) and banks, enhancing the ease of doing business, and implementing reforms in the FDI policy. The government has also taken steps to reduce the compliance burden and promote domestic manufacturing through initiatives such as Public Procurement Orders, Phased Manufacturing Programme (PMP), and Production Linked Incentive (PLI) schemes across various ministries.

Annexure: This annexure comprises of the definitions or the details of the terms that are used in the article.

1. The term foreign direct investment (FDI) refers to an ownership stake in a foreign company or project made by an investor, company, or government from another country
2. Gross FDI inflow include equity, reinvested earnings and other capital as published in India's balance of payments statistics.
3. FDI net inflows or actual FDI inflows are the value of inward direct investment made by non-resident investors in the reporting economy
4. FDI actual inflow = Gross FDI inflow - FDI disinvestments
5. FDI Equity inflow refers to an investment through?equity?instruments by a resident outside India, in an unlisted Indian company; or in ten per cent or more of the post issue paid-up equity capital, on a fully diluted basis of a listed Indian company