Why is FDI important for India’s economic growth and development process?

Before Xi Jinping’s rise to power in 2013, China’s economy was flourishing. As a global manufacturing hub, China benefited from a strong supply chain, skilled workforce, increasing wages, and excellent infrastructure. Foreign Direct Investment (FDI) was flowing steadily into the country, and its export-driven model was driving remarkable GDP growth. This period of prosperity saw rising per capita income, positioning China as a leading force in global trade. However, significant shifts occurred following Xi Jinping’s assumption of power.

Changes in China’s Economic and Political Landscape Under Xi Jinping

• Increasing political power: Xi consolidated his control over the Communist Party, and in 2018, he abolished presidential term limits, previously restricted to two terms, allowing him to potentially remain in power indefinitely. This political consolidation created uncertainty among foreign investors, who became increasingly concerned about the unpredictability of Chinese policies under Xi’s increasingly authoritarian rule.  
• Centralization of Power and Crackdown on Dissent: One of the defining changes introduced by Xi Jinping has been the arbitrary centralization of state power. Xi emphasised state control and nationalism, and those who opposed him faced severe crackdowns.
  • Example: The 2015 crackdown on private tech firms, such as Alibaba, led to Jack Ma’s sudden disappearance from the public eye, signalling the tightening grip of the state over private enterprises.  
• Disruption of the “China Model” for Progress: China’s previous export-driven economic model, which had attracted substantial foreign investment, began to shift under Xi’s leadership. The focus moved from global trade to a more nationalist, inward-looking approach.
• COVID-19 pandemic: These concerns were magnified during the COVID-19 pandemic, as China’s aggressive stance, especially towards countries like Australia, highlighted its willingness to use trade as a political weapon.
  • Example: China threatened to halt trade with Australia, creating a sense of insecurity among businesses reliant on the Chinese market. As a result, many companies began to perceive China as an unreliable partner, prompting them to diversify their operations and seek alternative markets.

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The Impact of Xi’s Policies on Foreign Investment

• Unpredictability: Xi Jinping’s policy changes, particularly the centralization of power and unpredictable state interventions, have caused growing unease among foreign companies and investors.
• Decadal Decline in Foreign Direct Investment (FDI): The consequences of these changes are evident in the sharp decline in FDI over the past decade. In 2013, China attracted $291 billion in FDI. However, by 2023, this figure had dropped to just $43 billion.
  • Example: Companies like Apple have started moving their operations to countries such as Vietnam, seeking a more stable and predictable business environment.
• Decline in Venture Capital-Funded Company Creation: China’s once-thriving startup ecosystem has also seen a drastic decline in venture capital-funded company creation. At its peak in 2018, 51,032 companies were funded by venture capital. By 2023, that number had dropped to just 1,202 companies — a staggering 97.6% decline.

The megatrend of the shift away from China (2018-2028) highlights a global realignment of supply chains and manufacturing, driven by rising labour costs, trade tensions, and geopolitical concerns. Companies and countries are increasingly diversifying production, seeking alternatives in Southeast Asia, particularly in countries like Vietnam, India, and Thailand. This trend accelerated during the COVID-19 pandemic, as nations prioritized supply chain resilience and reduced dependence on China, fostering new opportunities for emerging economies in the region.

India’s Efforts to Attract Shifting Companies

India saw the global shift of production from China as a major opportunity to attract multinational companies. Tech giants like Samsung shifted significant parts of their production to India and Vietnam, highlighting India’s potential as a manufacturing hub. However, despite this opportunity, India faced stiff competition from countries like Vietnam and Thailand, which were also positioning themselves as the next global manufacturing hubs.

• Limited Success in Attracting FDI: Although India aimed to benefit from this global shift, it has not witnessed the significant foreign direct investment (FDI) inflows it expected. The Indian government set ambitious goals, such as increasing FDI from $26 billion to $260 billion, but the actual FDI growth from 2013 to 2024 has been disappointing. During this period, the net FDI growth rate was negative 1.5% compound annual growth, reflecting capital outflows from India alongside new investments.
• Boost in the service sector: India’s merchandise export growth has been modest, with a compound annual growth rate (CAGR) of just 3.3% from 2013 to 2024. This figure is relatively low, considering India’s potential as a global manufacturing hub. However, India has experienced stronger growth in service exports, with a CAGR of 8.45% during the same period. This reflects India’s strength in sectors such as IT and business process outsourcing (BPO).
  • Example: Companies like Microsoft and Amazon have established global capacity centres in India, providing financial, legal, and technical support services due to the country’s lower labour costs. These centres represent the export of services, as they cater to clients outside India. Similarly, Indian IT giants like TCS and Infosys have capitalised on this trend, expanding their global service offerings and contributing to the country’s service export growth.

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Importance of FDI for National Development

• Transfer of Advanced Knowledge and Techniques: FDI brings advanced knowledge and techniques that can modernise local industries.
  • Example: BMW’s investment in India introduced cutting-edge automobile manufacturing practices, improving local production capabilities.
• Improvement in Productivity: Foreign companies bring efficient management practices for labour, capital, and resources, which can enhance local productivity.  
  • Example: In Vietnam, FDI in the textile sector significantly boosted local production standards, making the industry more competitive globally.  
• Knowledge Diffusion: FDI facilitates the transfer of valuable knowledge to the local workforce. As foreign companies hire local employees, these workers acquire skills that they later bring to other firms.
  • Example: Employees trained by Amazon India have moved on to local startups, spreading technical knowledge and contributing to the improvement of the startup ecosystem.
• Key to Firm Internationalisation: FDI helps domestic firms expand internationally.
  • Example: Infosys expanded globally after collaborating with multinational firms through FDI, enabling the company to develop a strong global presence and improve its productivity.
• Increase in Competitiveness of Local Companies: When foreign companies enter a market, they introduce global standards that push local companies to become more competitive. Local firms learn from the practices and technologies of their foreign counterparts, improving efficiency and output.

Challenges in Attracting FDI to India

• Poor Performance in Manufacturing/Infrastructure FDI: India has struggled to attract significant FDI in the manufacturing and infrastructure sectors due to weak infrastructure and high operational costs. Although the government implemented strategies like the Production-Linked Incentive (PLI) scheme, global firms have hesitated to invest in India’s underdeveloped infrastructure.
• Limitations of Conventional Policy Strategies: Traditional policy approaches, such as focusing on improving infrastructure or offering production-linked incentives, have not been fully successful in attracting FDI. For example, the PLI scheme, intended to boost FDI in the electronics sector, has not resulted in the expected surge in foreign investments.
• Infeasibility of Using Taxpayer Money for Significant FDI Subsidies: India faces fiscal constraints, with high deficits and a low tax base, limiting the government’s ability to offer large incentives to foreign investors. The use of taxpayer money for such incentives must be carefully balanced, as it raises questions about the effectiveness and sustainability of these strategies in boosting FDI inflows.

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Barriers to FDI Growth in India

• Work Visa Issues: Nationals from other countries often face difficulties in obtaining work visas in India. Delays in work visa approvals affected companies like Amazon, hampering their ability to expand teams in India.
• Capital Controls: Government restrictions on capital repatriation create challenges for foreign investors. India’s restrictions on capital repatriation have discouraged foreign investments, limiting the inflow of foreign capital.   
• Protectionism: Support for domestic firms and high tariffs on imports create barriers for foreign companies. High tariffs on imported goods have made it harder for foreign manufacturers to enter and compete in the Indian market.   
  • Economic Nationalism: Policies promoting self-reliance, such as “Atmanirbhar Bharat,” can discourage foreign firms from entering certain sectors.
• Tax Policy and Administrative Challenges: India’s tax policies are often unpredictable and subject to sudden changes, creating uncertainty for foreign investors. Vodafone’s tax dispute with the Indian government raised concerns about the unpredictability of India’s tax regime.
• Regulatory Issues: Overlapping regulatory bodies and arbitrary government powers create uncertainty for investors. The telecom sector has faced regulatory hurdles due to overlapping jurisdictions between different regulatory bodies.
• Centralised Planning: Centralised control over most sectors, with limited delegation to state and local governments, leads to delays and inefficiencies. Foreign firms have experienced delays due to India’s complex and centralised planning processes, where even small decisions require approval from the central government.
• Lack of Rule of Law: The judicial process in India can be slow, especially in cases of contract enforcement, which deters foreign investment. Long litigation processes in property disputes have discouraged long-term FDI, as investors face potential financial losses due to delayed legal resolutions.
• Technical Standards and Monopolies: In some sectors, monopolies persist, and India’s unique technical standards create difficulties for foreign firms. The telecom sector’s unique technical standards have made it challenging for global companies to comply, creating barriers to entry.
• Intellectual Property Theft: Foreign companies have expressed concerns that intellectual property rights are not adequately protected in India, though on a smaller scale than in China. Weak enforcement of intellectual property rights in India’s pharmaceutical sector has raised concerns among foreign investors about the security of their innovations.

Solutions for Improving FDI in India

• Better Economic Reform Processes: Simplifying processes like land acquisition laws would make it easier for foreign firms to set up operations in India.
  • Example: A streamlined land acquisition process would encourage more manufacturing-based FDI.
• Investment in Research Organisations: Building capable research institutions would support more effective policy-making.
  • Example: Establishing think tanks similar to RAND Corporation would enable better-informed economic decisions and strategies.
• Infusion of Ideas into Government Implementation Teams: India faces competition from countries like Vietnam that are actively courting FDI, while the Indian bureaucracy tends to be slow in adapting to global trends.
  • Example: Consulting global experts in project management and economic reform could help improve infrastructure development and fast-track investment processes.
• Addressing Political Economy Chokepoints: Reducing bureaucratic red tape and simplifying procedures would make India a more attractive destination for foreign investment.
  • Example: Streamlining the process for obtaining a GST number, which is currently delayed and sometimes marred by corruption, would help speed up business operations.   
• Respectful Approach Towards Foreign Technology and Knowledge: Encouraging collaboration with foreign firms would facilitate the transfer of technology and best practices.
  • Example: Promoting partnerships between Indian and foreign firms would help India leverage global expertise and foster knowledge transfer across industries.

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Conclusion

FDI is crucial for India’s economic growth, bringing advanced technology, enhancing productivity, and creating jobs. However, to fully capitalise on global shifts, India must address challenges like regulatory bottlenecks, infrastructure deficits, and policy inconsistencies. By improving the investment climate, India can position itself as a leading global manufacturing hub.

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