Don’t be Afraid of FDI, We Need it More Than Ever
It’s clear what India’s next step should be to achieve growth: make foreign direct Investment (FDI) a top priority. However, India offers only a hesitant welcome to FDI. It seeks investment in several industries, including manufacturing, construction, telecommunications and FINANCIAL services, but not in others like multi-brand retail.
Often, regulation allows only a minority investment for fear of losing domestic management control. For example, FDI in insurance companies is permitted up to 49% with restrictions on voting rights to ensure that management control of an insurance firm doesn’t shift to a foreign entity.
Concern of loss of management control is of much less importance compared to sacrifice of economic growth. Considering the potential of FDI to spur growth, India’s ambivalence toward FDI is completely misplaced. If India wants to accelerate growth, it is imperative that the country attracts FDI in large, really large amounts.
Growth results from domestic investment from savings, from productivity improvements and from foreign Investment . Countries like China that have grown rapidly in recent decades have taken advantage of all three sources of economic growth. India, on the other hand, has tried to achieve growth without much FDI.
However, India’s approach to growth is like bringing a knife to a gunfight: it’s destined to fail relative to other countries’ growth strategies, which take advantage of FDI. To transcend from 5-7% growth to 10-12% growth, FDI is essential.
To put India’s track record in attracting FDI in an international context, it’s been at best a trickle compared to FDI into countries like Mexico and China. In the last 10 years, Mexico has attracted $247 billion of FDI net inflows and China $2 trillion, compared to India’s $229 billion.
From the standpoint of an average citizen, the comparison is worse because Mexico is far less populous than India or China. What matters to an average citizen is per-capita Investment . On a per-capita basis, FDI net inflows for Mexico, China and India are $2,017, $1,531 and $183, respectively. No wonder the per-capita GDP of Mexico is $10,300, China $6,800 and India $1,500.
So how much FDI would be needed to make a meaningful difference in India’s economic growth rate? What is the effect of FDI on growth? Based on analysis of data from the last 20 years for about 100 countries, I have compared FDI as a percentage of GDP for each country against its annual growth in GDP. Each 1% increase in FDI adds about 0.4% to a country’s GDP growth. So, to boost GDP growth by about 2%, India will need FDI of about 5% of GDP. Put another way, at the current level of GDP of almost $2 trillion in India, about $100 billion of FDI is required to boost GDP growth by 2%.
For a massive increase in the growth rate by 4% to GDP, $200 billion of FDI would be needed — this is about eight times the level of GDP India currently attracts in FDI. Also, as the economy expands, the dollar amount of FDI will have to grow proportionately. Obviously, this becomes a challenge. For China, it’s already a challenge to attract ever-growing sums of FDI that would enable China to sustain a high rate of growth. China’s growth rate should continue to taper off and become modest — a life-cycle phenomenon.
In the case of India, if the government’s goal is to grow the economy faster, then it’s important to recognise the necessity of FDI. There is no point in being cagey in its efforts to attract FDI. The naysayers should recognise that FDI hasn’t harmed other countries that have attracted FDI, including Japan, South Korea, Mexico and China. For the last 10 years, global FDI net inflows have totaled nearly $15 trillion, and even countries with populations that are fractions of India’s are making noticeable contributions to that figure. Brazil, with a population less than a fifth of India’s, has seen $461 billion in FDI net inflows in the last decade, while Turkey, nearly one-20th India’s size, has seen $135 billion in FDI.
Proclamations of a simplified or streamlined process for FDI into India are not enough to attract Investment . Real changes and commitment, as well as incentives to states and bureaucrats for actually receiving FDI, are needed. The mindset has to change to judging the success of FDI policies on the basis of amount of investment attracted.