Why FDI bypasses India
Shankar Acharya
SINCE almost everyone is talking and writing about the consequences of September 11, let me discuss something else for a change - foreign direct investment FDI) into India. Successive governments since 1991 have sought to increase FDI. How have we fared and why?
Here are some basic facts. FDI averaged a pitiful $250 million a year in 1985-90. After the liberalisation of 1991, FDI increased substantially to a peak of $3.6 billion in 1997 and then declined thereafter to only $2.3 billion in 2000.
Even in the peak year of 1997 the table shows that FDI into India accounted for just two per cent of all FDI inflows to developing countries. By 2000 India's share had fallen to less than one per cent. And if we include developed countries, India's share in 2000 was a miserable 0.2 per cent of all FDI inflows!
Our record also compares badly with other developing countries. As against a total of $13 billion received by India in the last five years, China (mainland) received $209 billion, Brazil $123 billion and even little Malaysia got almost $26 billion, or double what we got. So much for the "flood" of FDI raising swadeshi hackles.
What explains this anaemic performance? There are many reasons, but let me highlight a few. First, in many developing countries (including China and other East Asian countries), a lot of FDI has gone into export-oriented manufacturing industries which supply global markets.
India has failed to attract this type of FDI despite our huge pool of low-cost unskilled and semi-skilled labour. The reasons include the anti-export bias of our foreign trade policies, the unusual rigidity of our labour laws, the peculiar policy of SSI reservations, the weakness of our infrastructure (especially power, ports, roads and railways) and slow and cumbersome administrative procedures.
Just to elaborate briefly on the first point, our trade policies are anti-export because high protective import duties and import licensing restrictions (until March 2001) encouraged production for the home market rather than exports.
Indeed, a recently published Planning Commission report shows that, after declining for five years, the weighted average import duty has increased from 25 per cent in 1996/97 to 35 per cent in 2000/01.
Infrastructure (including energy) has been a major sectoral destination for FDI in countries that have successfully attracted large inflows of FDI. Here too we have had only limited success.
For a start, our weak regulatory-cum-policy framework, especially for pricing and investment decisions in infrastructure sectors, has discouraged FDI - and indeed private domestic investment. Our electric power sector provides the classic example: who dares to invest when a large proportion of the users don't pay?
And, as the Enron/Dabhol case has shown painfully, a network of government guarantees is no substitute for payment by the users of electricity. Furthermore, unlike many developing countries, we have faltered in privatising our infrastructure utilities through strategic sales to foreign companies.
Just compare our record in airlines and telecom to little Sri Lanka's - they successfully sold management control of their national airline and telecom utility to foreign transnational companies several years ago. In contrast, we have made little progress with our government-owned airlines (A-I and IA) and telecom companies (BSNL, MTNL and VSNL).
Actually, in telecom we have made significant headway in attracting FDI in new ventures after a somewhat tortuous process of evolving a workable regulatory-cum-policy framework.
Third, in some sectors, our policies actively discourage FDI by setting caps on foreign equity holding. This is true for telecom, airlines, banking and insurance sectors amongst others.
Fourth, FDI flows have been discouraged by the apparent lack of governmental commitment and credibility in a number of high profile cases which misfired, including the Tata-Singapore Airlines venture, the Bangalore international airport and, of course, Dabhol.
Fifth, according to many reports, the high "transactions costs" of doing business in India deter many foreign investors. It doesn't help to be ranked low by Transparency International.
Sixth, the ambivalence to FDI in the form of acquisitions (of shares and management control) in existing companies also hurts FDI flows at a time when this form of FDI has become important globally.
Finally, there are all the other reasons which have damped growth of domestic investment, including the slowdown in the pace of economic reforms, rising fiscal deficits, uncertainties of coalition politics, weak infrastructure and the global slowdown since late 2000. These also affect FDI negatively.
So what's to be done to revive FDI into India? Logically, prescription has to follow diagnosis. If the above listing of negative factors is correct, then removing (or diluting) them should certainly boost FDI.
In particular, FDI (and domestic investment) will be encouraged by reform of labour laws, the removal of SSI reservations, systematic reductions in customs duties, sustained success in privatisations (especially of public utilities), decisive reforms in the power sector, removal of sectoral caps on FDI, reductions of fiscal deficits and a results-based commitment of government's political and administrative resources to solving the problems encountered by FDI in India.
It is encouraging that much of this is on the government's policy agenda. The sooner the agenda is successfully implemented, the sooner we can expect positive results. The converse is also true!
Finally, despite my best intentions, I have to now follow the herd of newspaper commentators and mention September 11. Although it is too early to tell, it is quite possible that those tragic events (and the chain of violence they may have triggered) will exercise a baneful influence on the scale of FDI world-wide, and especially to South Asia. Time alone will tell.
(The author is a professor at ICRIER on leave from his previous assignment as chief economic adviser, ministry of finance. The views expressed are strictly personal) -
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