Foreign Investment: India's Necessary Economic Evolution

Foreign direct investment (FDI) is a major source of economic development in India, with the country witnessing a 20-fold increase in FDI inflows from 2000-01 to 2023-24. FDI in India stands at $1,013.45 billion between April 2000 and June 2024, with the services sector, computer software and hardware, and trading being the major receivers. India's stable democratic regime, vast geography, and skilled workforce make it an attractive destination for foreign investment. The country's economic liberalisation since 1991, along with initiatives like Make in India, have played a significant role in increasing FDI inflows. The availability of two routes for FDI, the automatic route and the government route, provides flexibility for foreign investors. However, certain sectors, such as defence and media, have restrictions on foreign investment, and the government continues to implement measures to attract and restrict FDI in specific sectors.

India's regulatory framework for foreign investment

Foreign Direct Investment (FDI)

Foreign direct investment is allowed in listed and unlisted Indian companies with a minimum equity stake of 10%, subject to sectoral caps. FDI can be made through the automatic route or the government (approval) route, depending on the sector and the amount of investment. The automatic route allows FDI without government or Reserve Bank of India (RBI) approval, while the government route requires prior approval for investments in sectors like mining, defence, broadcasting, civil aviation, and telecommunications.

Foreign Portfolio Investment (FPI)

FPI allows investment in listed securities such as equities, bonds, derivatives, and other securities on public markets. Foreign entities must obtain FPI registration with a sub-custodian bank on behalf of the Indian regulator. FPIs are classified into two categories: Category I FPIs, which include entities with higher regulatory oversight and lower risk profiles, and Category II FPIs, which include entities that do not meet the criteria for Category I.

Foreign Venture Capital Investment (FVCI)

FVCI directs investments towards Indian entities operating in critical sectors, including technology, healthcare, biotechnology, e-commerce, and infrastructure. FVCIs can invest in unlisted securities of Indian companies in these sectors and are exempt from pricing restrictions applicable to FDI investments.

Other Avenues

Foreign investors can also establish alternative investment funds (AIFs) to invest in both listed and unlisted securities, real estate investment trusts (REITs), or infrastructure investment trusts (InvITs). Additionally, they can set up a presence in the International Financial Services Centre (IFSC) in Gujarat, which offers regulatory advantages.

Advantages and disadvantages of FDI in India

Foreign Direct Investment (FDI) is a key catalyst for India's economic growth. FDI inflows have increased by 20 times from 2000-01 to 2023-24. India has become an attractive destination for FDI in recent years, influenced by several factors, including the government's proactive policy framework, a dynamic business environment, improving global competitiveness, and a burgeoning economic influence.

Advantages of FDI in India:

• Economic development stimulation: FDI can stimulate the target country's economic development, creating a more conducive environment for investors and benefits for the local industry.
• Easy international trade: FDI can make international trade easier by simplifying import tariffs and providing access to international markets.
• Employment and economic boost: FDI creates new jobs and opportunities, leading to increased income, buying power, and economic growth.
• Development of human capital resources: FDI can enhance the competence and knowledge of the workforce through training and sharing of expertise, technology, and products.
• Resource transfer: FDI allows for resource transfer and exchanges of knowledge, providing access to new technologies and skills.

Disadvantages of FDI in India:

• Hindrance to domestic investment: FDI can sometimes hinder domestic investment by focusing resources on the target country.
• Risk from political changes: Political issues in the target country can change suddenly, making FDI risky.
• Negative influence on exchange rates: FDI can affect exchange rates, benefiting one country while harming another.
• Higher costs: Investing in foreign countries can be more expensive than exporting goods.
• Economic non-viability: FDI may be economically non-viable or too risky from the investor's perspective.
• Expropriation: Political changes can lead to expropriation, where the government gains control of an investor's property and assets.
• Disappearance of small-scale industries: FDI can lead to the disappearance of small-scale industries that cannot compete with multinational companies.
• Contribution to pollution: Developed countries may shift their pollution-intensive industries to developing countries like India.
• Exchange crisis: Over-dependence on FDI can lead to an exchange crisis, as seen in Southeast Asian countries in 2000.
• Cultural erosion: FDI can cause cultural shock and erosion of domestic culture, values, and social structures.
• Political corruption: FDI companies may influence political setups and engage in corrupt practices to capture foreign markets.
• Inflation: FDI companies may contribute to inflation through high advertising and consumer promotion spending.

Government measures to motivate or restrict FDI

Foreign direct investment (FDI) has been a key catalyst for India's economic growth, providing a substantial non-debt financial reservoir for the nation's developmental endeavours. The Indian government has implemented a range of policies and initiatives to enhance FDI in the country. Here are some measures the government has taken to motivate or restrict FDI:

Measures to Motivate FDI:

• Liberalization of FDI policies: The Indian government has liberalized FDI policies, making it easier for foreign companies to invest in various sectors such as retail, defence, insurance, and single-brand retail trading.
• "Make in India" campaign: This campaign focuses on simplifying procedures and promoting a favourable investment climate across sectors, encouraging foreign companies to manufacture in India.
• Implementation of Goods and Services Tax (GST): The GST has improved transparency and streamlined taxes, making it easier for businesses to comply with tax regulations.
• Special Economic Zones (SEZs): SEZs provide dedicated spaces with tax incentives, making it more attractive for foreign companies to set up operations in India.
• Bilateral Investment Treaty with the United Arab Emirates: The treaty aims to boost investor confidence, attract foreign investments, and create opportunities for overseas direct investment, leading to potential job creation.
• Amendment to the Foreign Direct Investment (FDI) policy: The government has amended the FDI policy to allow 100% FDI in specified sub-sectors/activities, particularly in the space sector, to improve the ease of doing business and attract greater FDI inflows.
• Production Linked Incentive (PLI) scheme: The PLI scheme provides financial incentives to eligible companies on sales of goods manufactured in India, encouraging foreign companies to set up manufacturing operations.
• Corporate tax reduction: The government has reduced the corporate tax rate for foreign companies from 40% to 35% to make India a more attractive investment destination.
• Relaxation of local sourcing norms: The government has relaxed local sourcing norms for up to 3 years for single-brand retail trading, making it easier for foreign retailers to establish operations in India.
• 100% FDI allowed in specific sectors: The government permits 100% FDI in sectors such as manufacturing, construction, IT, and others, providing ample opportunities for foreign investment.
• Foreign Investment Facilitation Portal (FIFP): The government has launched the FIFP, a single-point interface for investors to facilitate and authorize FDI proposals, making the process more efficient and transparent.
• Increase in FDI limit for specific sectors: The government has increased the FDI limit for sectors such as insurance, defence, and telecoms, making these sectors more attractive for foreign investment.

Measures to Restrict FDI:

• Prior government approval required for certain sectors: Some sectors, such as air transport services, satellites, print media, and public sector banks, require prior approval from the government before receiving FDI.
• Sector-specific FDI thresholds: The government imposes FDI thresholds based on the sensitivity of the sector. For example, the FDI limit for air transport services and private sector banking is 49%.
• Scrutiny on FDI from neighbouring countries: The government has implemented restrictions on FDI from countries that share a land border with India, such as China, Pakistan, and Bangladesh, to curb opportunistic takeovers and acquisitions.

The impact of the coronavirus pandemic on FDI in India

The coronavirus pandemic has had a significant impact on foreign direct investment (FDI) in India, with inflows falling steeply in 2020. The United Nations Conference on Trade and Development (UNCTAD) warned that the pandemic, lockdown measures, supply chain disruptions, and economic slowdown could hamper India's ability to attract foreign investment. This is despite India seeing FDI inflows of $51 billion in 2019, a 20% increase from the previous year.

In response to the pandemic, the Indian government introduced new FDI rules to protect Indian companies from "opportunistic takeovers" by foreign entities, particularly those from China. The new rules require certain investments to go through a government approval route, allowing the government to monitor and approve these investments. This move was in line with actions taken by other countries, such as Australia and several European nations, to prevent opportunistic acquisitions during the pandemic.

The pandemic also led to a decline in economic activity and an increase in unemployment in India, with an estimated 140 million people losing their jobs. The Indian economy was expected to lose over ₹32,000 crore ($4.5 billion) every day during the initial 21-day lockdown. The pandemic also disrupted supply chains, particularly affecting those in the informal sector and daily wage groups.

However, the Indian government implemented various measures to mitigate the economic impact of the pandemic. These included food security initiatives, additional funds for healthcare and states, sector-related incentives, and tax deadline extensions. The government also announced economic stimulus packages worth trillions of rupees, which helped the country's economy rebound. By July 2020, economic indicators showed signs of recovery, and by December 2021, India's growth had returned to pre-COVID-19 levels.

Top sectors for FDI in India

Foreign investment has been a key catalyst for India's economic growth, with inflows increasing ~20 times from 2000-01 to 2023-24. The country has received FDI from more than 170 countries across 33 states and union territories, and over 60 sectors.

The top sectors for FDI in India are:

Services Sector

The services sector in India received the highest share of FDI, amounting to over 554 billion Indian rupees in the fiscal year 2020. This includes finance, banking, insurance, and other non-financial sectors like research and development, testing, analysis, and outsourcing.

Computer Software and Hardware

The computer software and hardware sector came second in FDI inflows, amounting to almost 542 billion Indian rupees in 2020.

Trading

Trading was the third-highest sector for FDI inflows, receiving approximately US$43.85 billion between April 2000 and June 2024.

Telecommunications

Telecommunications received the fourth-highest amount of FDI, with inflows of about US$39.78 billion between April 2000 and June 2024.

Automobile Industry

The automobile industry was the fifth-largest recipient of FDI, attracting around US$36.65 billion in investments between April 2000 and June 2024.

Frequently asked questions