FDI Tide Turns in India’s Favour

Foreign direct investment (FDI) inflows into India are on the rise.

According to the IMF, FDI refers to “an investment made to acquire lasting interest in enterprises operating outside of the economy of the investor.”

FDI is considered one of the most stable forms of non-debt creating capital inflows, with significant positive effects on the economy.

In the case of India, FDI inflows have risen rapidly, from $24 billion in 2012 to $44.2 billion in 2015 — a seven-year high. This increase is also fairly broad-based. It is not just the e-commerce (trading) sector that has received more inflows; other sectors such as computer software and hardware, construction, services, autos and the telecom sectors also account for a large share of the increase.

Interestingly, even though China continues to attract larger FDI inflows than India in absolute terms, India has started to close the gap, when FDI is measured as a share of GDP.

FDI inflows into China have moderated to 2.3% of GDP in 2015, from 2.6% in 2014. During the same period, FDI inflows into India rose to 2.1% from 1.7%.

Additionally, one could also argue that the quality of FDI inflow into India is much better. Over the last decade or more, China has accumulated a large stock of FDI. As a result, almost half of the FDI inflow into China includes retained earnings. In contrast, almost three-quarters of FDI inflows into India are fresh equity infusions.

The resurgence of FDI inflows into India can be traced to both domestic pull factors as well as global push factors. On the domestic front, India has emerged as one of the fastest-growing Asian economies, while China’s growth has stumbled due to large overcapacity and high leverage.

More importantly, ongoing economic reforms in India are likely attracting FDI flows.

FDI limits have been increased in various sectors such as defence, railway infrastructure, insurance and construction (to name a few).

Incremental reforms aimed at improving the ease of doing business and to improve public infrastructure have perhaps also encouraged long-term investors.

What may also have helped are pull factors such as rising labour costs in China. Rising costs in China have partly pushed multinational corporations (MNCs) into shifting production base to South-East Asia, such as Vietnam. India, belatedly, is possibly benefiting from production facilities moving out of China.