The government’s decision to liberalise the foreign direct investment regime stems directly from its concerns about the deteriorating external account but its impact both in the short and medium term will depend on how the new policy is implemented. At about $85 billion, or 4.5 per cent of GDP, India is running one of the highest current account deficits in the world. With the rupee coming under relentless pressure, not least from speculators and portfolio investment outflows, the government appears to have made a strategic decision to push for stable capital flows in the form of FDI, which stay committed to the host country in times good and bad. At present, our dependence on temporary capital inflows is high — some $25 billion worth of FII money is needed to plug the current account gap. By any yardstick, this is an uncomfortable position to be in. In theory, FDI helps stabilise the external situation in two ways. First, because of its longer investment horizon, and second, because it could help reduce the country’s dependence on imported manufactures. The government’s new policy on FDI in defence, telecom and other sectors will make a difference if it leads to the infusion of critical technology and the augmentation of our productive capacity. For example, the Cabinet Committee on Security can now clear defence FDI proposals beyond 26 per cent; it is essential that this authority be used to reduce India’s dependence on future defence imports in critical technology areas rather than displacing existing capabilities.
The same is true for telecoms and other high-end electronics, where our import dependence is still high. One reason why India’s trade deficit has widened over the years is because of telecom and other technology product imports. Using foreign capital to create a larger domestic manufacturing base is a laudable objective but to achieve this, India must learn how to invite investment and technology on its own terms. Unlike China, we have failed to do this in the past. The West, as also Japan, are increasingly aging societies and should not be allowed to dictate terms to large consuming markets in the same way they did 20 years ago. India must fully leverage this aspect when dealing with the U.S., EU, Japan and even China, which see India as a big market. Preference must also be given to greenfield FDI projects rather than mergers and acquisitions, which unfortunately account for a large percentage of cross-border investment flows. Nor should any corners be cut as far as the process of acquiring land and environmental clearances are concerned. Large projects cannot get off the ground if local communities are sidelined.