A more important issue for the Indian growth story is that FDI cannot entirely meet the country’s capital needs and that it needs to rustle up its own capital.
Prime Minister Narendra Modi recently held a meeting to review the foreign direct investment (FDI) policy with commerce and industry minister Nirmala Sitharaman and other officials. It was a closed door affair and no announcements were made.
The government is quite happy with the FDI inflows in the last three years – $31 billion in 2014-15, $55.5 billion in 2015-16 and $60.8 billion in 2016-17. There is a sense of exultation that record FDI inflows are taking place and there was speculation that there would be further relaxation in the FDI policy in order to provide an investor friendly climate to foreign players.
But there is a need to ask the obvious question: How is FDI faring in the Indian economy? This is a crucial question that should be of keen interest to many India watchers. One of the key premises has been that the liberalisation of FDI rules will help boost growth and that it will make up for the paucity of domestic capital.
When Manmohan Singh visited the US after taking over as prime minister in 2004, he told American investors that India was in need of $150 billion in investments, especially in infrastructure. That figure had jumped, naturally so, by the time Modi went to the US in 2014 and talked of the potential for investment in India to be of $1 trillion, again mostly in infrastructure.
There was convergence in perception of the two prime ministers from different ends of the political spectrum that India needed FDI to get into the fast lane of economic development. Perhaps there is need to debate and challenge the premise. If a country can garner enough investment from internal sources, can it hope to do well? Is it also the case that it is not so much the investment as much as a country’s share of global trade through exports that will better explain the growth of an economy? The experience of China, Japan and other East and Southeast Asian economies shows that exports alone cannot drive an economy, and that you need healthy domestic consumption too.
FDI-funded vs non-FDI funded companies
One of the two issues – the other is about the international banking statistics of India in 2016 – that the RBI’s July bulletin focuses on is the performance of FDI-funded companies in the country compared to others that had no FDI in 2015-16. Both the groups have not done too well in terms of growth and their contribution to gross value added, though according to the central bank, the FDI companies’ performance is “relatively better” than the non-FDI ones at the aggregate level.
In terms of economic growth, 2015-16 has not been a happy year, though it seems to be better when compared to 2016-17. Therefore, no verdict can be passed on the performance of either of the two groups of companies.
What is of greater interest, however, is the FDI footprint in the Indian economy. Economists have already noted that FDI contributed no more than 7-8% of total investments in the last 20 years and more, which coincides with the era of economic liberalisation. But as the saying goes, the devil is in the details indeed, and it is the details of FDI that are quite revealing.
FDI footprint in the Indian economy
The number of FDI companies on March 31, 2016, stood at 6,433. When this number is broken down further, FDI in manufacturing is 1,820, while it is 4,070 in the services sector, of which computer companies and those related to computer activities accounted for 1,202. The comparable figures for non-FDI companies are startling.
The aggregate figure of non-FDI companies stands at 3,04,978, of which manufacturing has 78,337 companies, services account for 1,75,926 and computers and related activities firms are represented by 18,040. The few big ones and the many small will always be the case in a market economy. It can even be argued that you can do without the big ones, but you cannot do without the army of the small companies.
It would be a gross distortion if one were to judge the usefulness of FDI by these figures. It is common sense that it is a small number of big companies which earn huge profits and contribute to the overall impressive growth rate, and that a large number of companies stay on the margins of performance and profits. But the larger number with smaller profits is of great importance because it forms the sheet-anchor of the economy as such.
Domestic savings and capital formation
In terms of investment, the FDI companies had 40% of the paid-up capital, which is not surprising. But the corollary needs to be asked – Is there adequate capital provision for the no-FDI companies? It can be seen that 60% of the capital needs of the company are met through local resources. It is the figures for domestic savings and domestic capital formation that give a hint as to capital adequacy. In 2014-15, gross domestic savings stood at 33% and gross domestic capital formation at 34.20%. The corresponding figure for net domestic savings is 25% and for net domestic capital formation 26.4%. Domestic savings and domestic capital formation are clearly below the benchmark. The general assumption that a fast-growing economy needs a 40% savings rate holds good.
International power politics
It would be churlish to either dismiss the crucial role played by FDI in buoying up an economy or to pretend that there is no politics involved in it. When American political and business leaders push for relaxation of FDI rules in India, they are not only helping American businesses but they are also looking at political influence. There should be no illusions on this latter count.
Remember American pressures on India with regard to sanctions against Iran? India did find it difficult to manage but it did succeed in keeping its economic deals with Tehran intact. International power politics follow capital flows from the affluent Western countries into relatively capital-starved economies of the East. But you do not shy away from allowing FDI in because you fear the political muscle of the foreign investors and their governments. You learn to take the pressure and play ball with the apparently big guys on terms of near equality.
The more important issue for the Indian growth story is that it needs to rustle up its own capital as one goes along. There is as yet not much thinking or debate on the issue. Post-liberalisation, the thinking has been that India should attract as much FDI as it can. As a matter of fact, the boast of BJP-led NDA government of Prime Minister Modi and finance minister Arun Jaitley has been that India is now attracting greater FDI, and that the liberalisation of FDI caps for a larger number of sectors and the dismantling of the Foreign Investment Promotion Board are touted as achievements on the path of economic reforms. But the RBI figures for FDI companies show that there is a problem, and that FDI cannot entirely meet India’s capital needs. And that it would be a mistake to measure the success of the Indian economy by FDI.
Parsa Venkateshwar Rao Jr is a senior economic commentator.