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India's FDI Inflows: Trends and Concepts

K, S Chalapati Rao and Dhar, Biswajit (2011): India's FDI Inflows: Trends and Concepts.

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Abstract

India’s inward investment regime went through a series of changes since economic reforms were ushered in two decades back. The expectation of the policy makers was that an “investor friendly” regime will help India establish itself as a preferred destination of foreign investors. These expectations remained largely unfulfilled despite the consistent attempts by the policy makers to increase the attractiveness of India by further changes in policies that included opening up of individual sectors, raising the hitherto existing caps on foreign holding and improving investment procedures. But after 2005‐06, official statistics started reporting steep increases in FDI inflows. This paper is an attempt to explain this divergence from the earlier trend. At the outset, the paper dwells on the ambiguities surrounding the definition and the non‐adherence of international norms in measuring the FDI inflows. The study finds that portfolio investors and round-tripping investments have been important contributors to India’s reported FDI inflows thus blurring the distinction between direct and portfolio investors on one hand and foreign and domestic investors on the other. These investors were also the ones which have exploited the tax haven route most. These observations acquire added significance in the context of the substantial fall in the inflows seen during 2010‐11. In most countries, particularly those that have faced chronic current account deficits, obtaining stable long term FDI flows was preferred over volatile portfolio investments. This distinction between long term FDI and the volatile portfolio investments has now been removed in the accepted official definition of FDI. From an analytical point of view, the blurring of the lines between long term FDI and the volatile portfolio investments has meant that the essential characteristics of FDI, especially the positive spill‐overs that the long term FDI was seen to result in, are being overlooked. FDI that is dominated by financial investments, though a little more stable than the portfolio investments through the stock market, cannot deliver the perceived advantages of FDI. The net result is that while much of the FDI cannot enhance India’s ability to earn foreign exchange through exports of goods and services and thus cover the current account gap on its own strength, large inflows of portfolio capital causes currency appreciation and erodes the competitiveness of domestic players. The falling share of manufacturing and even of IT and ITES means that there is less likelihood of FDI directly contributing to export earnings. India seems to have been caught in a trap wherein large inflows are regularly required in order to finance the current account deficit. To keep FDI flowing in, the investment regime has to be liberalised further and M&As are allowed freely.

Even at the global level, the developmental impact of FDI is being given lesser importance notwithstanding the repeated assertions to the contrary in some fora. International data on FDI and its impact has never been unambiguous. If FDI has to deliver, it has to be defined precisely and chosen with care instead of treating it as generic capital flow. India should strengthen its information base that will allow a proper assessment of the impact that FDI can make on its development aspirations.

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