QUESTION : India witnessed the fastest growth in the FDI inflows among all the major economies amid pandemic . Examine the factors behind this positive growth in this direction despite having other issues .
WHAT EXPLAINS THE SURGE IN FDI INFLOWS ?
WHAT ?
- Surge In FDI Inflows
WHY IN NEWS ?
According to the Commerce Ministry the total foreign direct investment (FDI) inflow in 2020-21 is $81.7 billion, up 10% over the previous year.
BACKGROUND :
- The short press release of the ministry highlighted industry and State-specific foreign investment figures without detailed statistical information.
- Measures were taken by the Government on the following fronts, has resulted in increased FDI inflows into the country:
o Foreign Direct Investment (FDI) policy reforms,
o Investment facilitation and
o Ease of doing business.
- The Table and Graph by the RBI above highlight the main headings for 2019-20 and 2020-21 and the percentage growth rate.
WHAT MAKES GROSS INFLOWS :
- “Gross inflows/gross investment” in the RBI report is the same as “total FDI inflow” in the ministry press release.
- The gross inflow consists of:
o Direct investment to India and
o Repatriation/disinvestment.
It means that the FDI inflow increasingly consists of private equity funds, which are usually disinvested after 3-5 years to book profits (per its business model).
In principle, private equity funds do not make long-term greenfield investments.
- The disaggregation shows that direct investment in India has declined by 2.4%.
- An increase of 47% in repatriation/disinvestment entirely accounts for the rise in the gross inflows.
o There is a wide gap between gross FDI inflow and direct investment to India.
- As measured on a net basis (that is, direct investment to India net of “FDI by India” or, outward FDI from India), direct investment to India has barely risen (0.8%) in 2020-21 over the last year.
- It is almost entirely on account of “Net Portfolio Investment”, shooting up from $1.4 billion in 2019-20 to $36.8 billion in the next year.
o That is a whopping 2,526% rise.
- Within the net portfolio investment, foreign institutional investment (FIIs) has boomed by an astounding 6,800% to $38 billion in 2020-21, from a mere half a billion dollars in the previous year.
PORTFOLIO INVESTMENT AND HOW IS IT INCLUDED IN FDI INFLOWS :
- FDI inflow, in theory, is supposed to bring in additional capital to augment potential output (taking managerial control/stake).
- In contrast, foreign portfolio investment is short-term investment in domestic capital (equity and debt) markets to realise better financial returns (that is, higher dividend/interest rate plus capital gains).
- There is a difference in terms of the investment period, the conceptual distinctions have blurred in the ministry official reporting, showing an outsized role of FDI and its growth in India.
IMPACT OF FLOODED FII INFLOWS :
- It added a lot of froth to the stock prices.
- When GDP contracted by 7.3% in 2020-21, the Bombay Stock Exchange (BSE) Sensex nearly doubled.
- BSE’s price-earnings (P-E) multiple (defined as share price relative to earnings per share) is among the world’s highest, close behind S&P 500 in the U.S.
A MODEST DISTRIBUTION FDI INFLOWS :
- The surge in the total FDI inflows is just short term FIIs, it is not adding to fixed investment and employment creation.
- The ratio of net FDI to GDP has remained just over 1% with no discernible rising trend in it.
- The proportion of net FDI to the gross fixed capital formation (fixed investment) is range-bound between 4% and 6%.
- These stagnant trends are evident when the economy’s fixed investment rate (gross fixed capital formation to GDP ratio) has plummeted from 31.3% in 2013-14 to 26.9% in 2019-20.
Greenfield Investment:
- It is a type of foreign direct investment (FDI) in which a parent company creates a subsidiary in a different country, building its operations from the ground up.
- In addition to the construction of new production facilities, these projects can also include the building of new distribution hubs, offices, and living quarters.
- Such investments provide employment opportunities in the investment receiving country which help in boosting the economic growth in terms of both creating capital assets as well as developing human capital.
Foreign Institutional Investor:
- It is an investor or investment fund investing in a country outside of the one in which it is registered or headquartered.
- It provides an important source of capital in developing nations.
- FIIs can include:
o Hedge funds,
o Insurance companies,
o Pension funds,
o Investment banks, and
o Mutual funds.
- India, have placed limits on the total value of assets an FII can purchase and the number of equity shares it can buy, particularly in a single company.
o This helps limit the influence of FIIs on individual companies and the nation’s financial markets, and the potential damage that might occur if FIIs fled en masse during a crisis.
HOW CAN AN INDIAN COMPANY RECEIVE FOREIGN INVESTMENT ?
In India, foreign investment can be made mainly two routes :
- Automatic Route: Under the Automatic Route, the non-resident investor or the Indian company does not require any approval from Government of India for the investment. Reserve Bank of India is in charge of Automatic Route.
- Government Approval Route: Under the Government Approval Route, prior to investment, approval from the Government of India is required. Proposals for foreign direct investment under Government route, are considered by respective Administrative Ministry/ Department.
NOTE : Earlier the Foreign Investment Promotion Board (FIPB) and Secretariat for Industrial Assistance (SIA) was in charge of recommending Foreign Direct Investment (FDI) which does not come under the automatic route. However, FIPB was abolished in 2017, and its power was given to the respective Administrative Ministries/ Departments.
Note: Acquisition of shares and amount remitted through RBI’s NRI Schemes are also considered as FDI.
Examples of FDI in India
- In 2020, BYJU’s (an Indian education technology firm) raised US$ 500 million in a new round of funding led by Silver Lake, a US-based private equity company.
- In 2020, Unacademy, an Edtech platform, raised US$ 150 million from SoftBank Group (a Japanese conglomerate).
SECTORS IN WHICH FDI IS PROHIBITED ARE AS FOLLOWS :
- Lottery Business including Government/private lottery, online lotteries, etc.
- Gambling and Betting including casinos etc.
- Chit funds
- Nidhi company
- Trading in Transferable Development Rights (TDRs)
- Real Estate Business or Construction of Farm Houses
- Manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes.
- Activities/sectors not open to private sector investment e.g.(I) Atomic Energy and (II) Railway operations (other than permitted activities).
CONCLUSION :
Unprecedented short-term foreign portfolio investments are entirely responsible for the surge. The flood of FIIs has boosted stock prices and financial returns. These inflows did little to augment fixed investment and output growth.
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