Let’s be realistic on FDI

Without changing the overall policy landscape and attitude, India cannot expect to make a success of ‘Make in India’ with the help of Foreign Direct Investment alone

Updated - April 03, 2016 05:04 am IST

Published - November 17, 2015 01:39 am IST

“A vast majority of investment in the construction sector is by private equity investors and Indians bringing back [black] money in some form.” Picture shows a construction site at Manali, an industrial area in Chennai. Photo: S.R. Raghunathan

“A vast majority of investment in the construction sector is by private equity investors and Indians bringing back [black] money in some form.” Picture shows a construction site at Manali, an industrial area in Chennai. Photo: S.R. Raghunathan

In yet another significant move to attract foreign direct investment (FDI), the >government has opened the door wider in several major sectors of the Indian economy, through what it calls “path-breaking” amendments in the extant FDI policy. These amendments can be clubbed into three categories: a “radical change” in the FDI regime in the construction sector; an increase in the threshold of foreign participation (the so-called sectoral caps) in several key sectors, including defence, broadcasting, private sector banks, non-scheduled air transport service, ground-handling services, and credit information companies; and simplification of the procedures for foreign participation in a number of sectors.

K. S. Chalapati Rao, Biswajit Dhar

FDI from developed countries First, globally, FDI flows of all hues have not been growing, especially from the developed countries. The reality is that the developed countries are reaping the benefits of their past investments. Real outflows from them are far less than what the aggregates suggest. Reinvested earnings (profits generated and retained in host countries) are bolstering the reported FDI flows. According to the United Nations Conference on Trade and Development (UNCTAD), the share of reinvested earnings is reported to have accounted for as much as four-fifths of total outflows in 2014 for select developed countries. A mere 10 per cent of total inflows were accounted for by direct equity flows, with loans making up for the rest. Obviously, further opening up by India cannot help attract more FDI that would not have come otherwise. Even if some additional inflows come in, they would soon be more than offset by outflows.

Another important factor is the costs associated with FDI, especially the servicing burden and crowding out of domestic investment. Developing countries like India have reached out to FDI not merely because of the capital they need, but more importantly, for the technologies to make their entities more competitive. However, experience shows that while developing countries have not been able to acquire the technologies they need, they have had to make a variety of payments “for use of intellectual property”. In fact, for India, the servicing burden of FDI in terms of repatriations, dividend payments and payments for use of intellectual property is now showing up prominently. About half of the inflows into India during the past six years were balanced by outflows. What are reported as payments for technology could, in fact, be disguised dividends which deny the exchequer and the public shareholders their due. Foreign companies which did not pay dividends for many years are happily sending remittances abroad on account of royalty payments, including those for the use proprietary brand names.

Why enhance sectoral caps? One of the reasons the government gives for enhancing sectoral caps is that of ‘fragmented ownership issues’. The reality is somewhat different. During the decade 2004-05 to 2013-14, foreign investors in the manufacturing sector have consolidated their position: a majority of the companies which received what may be termed as ‘real FDI’ (as distinct from the funds being brought by NRIs, private equity funds, and so on) are either wholly foreign-owned or have sole control. Further, a majority of such investments is utilised in displacing domestic entrepreneurs/investors instead of adding to production capabilities. India has lost many home-grown industry leaders and potential winners through takeovers by foreign investors. The domination by foreign investors backed by huge financial resources at their disposal is proving to be inimical to the emergence and survival of domestic enterprises. FDI should add to the national productive capacities instead of becoming a threat to existing/emerging alternatives due to their superior financial strength.

There was a special mention in the new policy announcement about the construction sector and the need to build 50 million houses for poor. This once again reveals that not much thought has been given to the nature of foreign investment that the sector has attracted so far. A vast majority of investment in this sector is by private equity investors and Indians bringing back (black) money in one form or the other. The forms of investment that the construction sector has attracted raised several pertinent questions. Will private equity investors, who seek multiple returns, and returning Indians invest in housing for the poor, or in townships for the rich and the upper middle class and commercial complexes? When the private equity investors encash their investments, what would be the net outflow? In this context, it should be pointed out that disinvestments/repatriations were more than a fourth of the total equity inflows during 2009-10 to 2014-15.

Indian subsidiaries of foreign companies in the manufacturing sector run a huge deficit on trade account. The data released by the Reserve Bank of India shows that there is large dependence on imported inputs. Together with other payments and expenditure on other heads, the overall effect on the country’s balance of payments could be substantial. This phenomenon could have significant implications for the ‘Make in India’ programme. Many Indian entrepreneurs have now turned into part-traders of imported consumer durables. Without changing the overall policy landscape and attitude, India cannot expect to make a success of ‘Make in India’ with the help of FDI alone. The new measures in no way address this vital issue. FDI cannot be a substitute for domestic resource mobilisation, and FDI policy cannot be a substitute for prudent domestic policies.

Policymakers need to take cognisance of the fact that it is domestic investment which has provided an overwhelmingly large share of India’s capital formation and has, therefore, been instrumental in pushing up the country’s growth rates. India should be careful not to create two classes of investors wherein the foreign investors, including returning Indians, are given disproportionate advantages. Even UNCTAD had underlined the large amount of losses to the exchequer of developing countries ($100 billion a year) due to the routing of FDI through tax havens. While bringing all related policy measures together, especially the Foreign Exchange Management Act rules, as proposed by the new policy is certainly a welcome step, the Indian government needs to take a realistic view of what foreign investors can do to shape the destiny of an emerging economic powerhouse.

(K.S. Chalapati Rao is professor, Institute for Studies in Industrial Development, New Delhi, and Biswajit Dhar is professor, JNU, New Delhi. This is based on the on-going ICSSR-sponsored study “India’s Inward FDI Experience in the post-liberalisation Period” being conducted at the Institute for Studies in Industrial Development, New Delhi.)

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