PHD Chamber calls for a more forward-looking and stable FDI Policy

To build upon the record foreign direct investment (FDI) inflows into India in the last financial year, the PHD Chamber has called for a more forward-looking and transparent FDI Policy with long-term objectives and with minimal mid-course policy changes to boost the foreign investors’ confidence.

According to PHD Chamber, even though the gross domestic savings rate and the gross domestic capital formation rates have increased to 32-33% in the last couple of years, to sustain the desired +9% rate of growth of the gross domestic product (GDP), India will have to continue to rely on foreign savings to bridge the domestic investment-saving gap. With an incremental capital-output ratio (ICOR) of over 4 and a desired rate of growth of the GDP being 9% at the least, an investment rate of over 36% would be required.

The ability to attract non-debt creating inflows of equity investment from abroad to the extent possible will greatly help in relaxing the domestic resource constraint, especially in the infrastructure sector. Therefore, according to PHD Chamber, there there is a need to fast track, and time-bound, clearance of approvals and mechanisms for speedy implementation.

FDI inflows, which stood at $ 4,029 million in 2000-01, reached a record level of $ 19,531 million in 2006-07. In 2006-07, out of the total inflows, equity investment was $ 16,065 million, a growth of 176% over last year. Acquisition of shares of Indian companies by non-residents also jumped by 188% from $ 2,181 million in 2005-06 to $ 6,278 million in 2006-07.

A welcome trend, according to PHD Chamber, is that the low percentage of FDI coming through the automatic route has reversed in the last three years and an increasing share of FDI proposals are now not subject to case-by-case approval of the Foreign Investment Promotion Board (FIPB). 61% of the equity investment in 2000-01 was through the FIPB route and only 19% through the automatic approval route. In 2006-07, 45% was through the automatic route and only 13% through the FIPB route.

According to PHD Chamber, this trend should be further intensified by liberalising the FDI policy and the sectoral caps in a comprehensive manner and providing policy stability thereafter. The government must decide the sectors in which on account of national interest, FDI should be restricted or not allowed at all and allow 100% FDI equity through the automatic route in all others.

In terms of industrial composition of FDI, financing, insurance, real estate & business services have shown a significant jump by attracting $ 4,416 million in 2006-07 as compared to $ 452 million in 2005-06. FDI inflows into the manufacturing sector have risen by 28% by reaching $ 1,610 million in 2006-07. Construction and computer services are the other two sectors which have received significant inflows, $ 968 million and $ 823 million respectively.

The geographical composition of FDI in terms of originating countries, shows that for the first time UK dethroned US as the largest investor in India in 2006-07. Inflows from UK reached a level of $ 1,809 million in 2006-07 as compared to $ 706 million from US. Though, according to the data, Mauritius is the largest investor in India ($ 3,780 million) it is being primarily used as an offshore financial centre. Other major investors in 2006-07 included Singapore ($ 582 million) and Netherlands ($ 559 million).

According to PHD Chamber, FDI is becoming both a major stimulus to globalisation and, at the same time, its growth is a direct result of globalisation and economic liberalisation. The rapid increase in FDI flows is contributing to the acceleration of integration of the global economy and the emergence of an increasingly complex production system.

Major factors behind the accelerating tempo of FDI are soaring levels of cross-border mergers and acquisitions (M&As), rapid moves in most countries towards privatisation of government owned public sector enterprises and strong competitive efforts by countries to attract FDI. Traditional factors, such as the existence of a pro-FDI regime, natural resources, market growth prospects and market size, as well as labour market conditions, such as low labour cost, continue to remain important. Thus, countries can be attractive to potential foreign investors on account of the size and growth of their domestic markets, their geographic proximity and access to key potential markets, including large regional markets and the natural and other resources they host, and of course the extent to which they effectively strive to attract foreign investors.

But increasingly, according to various studies, firms are also seeking investment locations that offer people made advantages, so called ‘created assets’, from technological advantages to particular labour skills. Countries that have developed such assets have become more attractive to foreign investors. It is the rise in the importance of created assets that is the single most important shift among the economic determinants of FDI location in a liberalising and globalising world economy. A high proportion of the cross-border investments is increasingly efficiency seeking and flowing to high value-added services and manufacturing rather than basic manufacturing.