By: Harnoor Kaur | Edited by: Lavanya Goswami
Post the liberalisation of developing economies in the 1990s, Foreign Direct Investment (FDI) has served an important factor in improving efficiency, expansion of employment opportunities, increasing capital formation and development of new technologies. It also acts as a key indicator of a nation's economic health and attractiveness to international investors. This blog delves into an analysis of the role of FDI in India’s economy and trends over years. How has the recent decline in FDI in India potentially impacted the nation’s economic sectors? By exploring the causes and subsequent consequences, the blog aims to understand the challenges and opportunities that lie ahead for India’s economic resurgence.
Role of Foreign Direct Investment
In the literature, the foreign direct investment inflows’ impact on the Indian Economy has been studied by various scholars. The FDI inflows have played an important role in transfer of technology across countries. This has been emphasised by Borensztein E, Gregario J.D. and Lee J.W. (1995) who highlighted that the effect of FDI inflows is contingent on the level of human capital in the host country. Following this, similar conclusions have been drawn in the Indian context where a positive relationship has been found between Gross Domestic Product (GDP) and FDI, projecting a growth of 23.6% with a 1% increase in FDI inflows. On the other hand, there hasn’t been a significant relationship between FDI and employment. These results have been corroborated by Dutta (2021) who finds a positive significant relationship between GDP and FDI in both short and long runs with insignificant impact of FDI on employment generation in the short run. On the other hand, looking at sector-specific Das G. and Chaudhary B.R. (2018) conducted a study on the Indian IT sector from 2002 to 2016, finding a statistically positive impact of capital intensity and labour quality on the productivity of domestic IT firms.
Contrary to Mehra’s findings, Agrawal and Khan take a more cautious stance suggesting that 1% increase in FDI would result in 0.02% increase in India’s GDP. Similarly, Jacob T. and Jiji N. (2021) conducted a regression analysis which indicated that FDI has no significant effect on the Indian economy, pointing towards a low positive correlation between the inflow of FDI and the market growth rate in India. Thus, implying that the influx of foreign investment might not be the powerhouse that some envision for India’s economic growth. Thus, there are divergent perspectives in literature on the impact of FDI on GDP.
Trends in Foreign Direct Investment in India
There have been positive indicators in Foreign direct investment inflows in India since the 2000s. India emerged as a dominant choice for International corporations, overtaking China, as Western multinationals adopted a diversification strategy known as ‘China plus one’. As indicated by the United Nations Conference on Trade and Development (UNCTAD), India recorded an increase in its FDI share from 2.4% in 2017 to 3.8% in 2022. According to UNCTAD Report 2021, Indian gained the fifth largest position, primarily due to increased demand for the information and communication technology during the pandemic period, particularly the large investments in Reliance’s Jio platform by investors such as Google, Catterton, Face.
However, there was a sharp decline in FDI into India in FY2023, which includes gross inflows which fell by 16% from $84.83 billion to $70.97 billion. The country wise FDI inflows dropped in FY 23-24 as shown in the table 1,
In USD Million
The below table 2 shows the sector-wise trends in Foreign Direct Investment into India. There is a sharp decline in all the sectors, particularly Computer Software and Hardware which boosted in FY 2021-22.
In USD Million
This sharp decline can be attributed to the geo-political factors, specifically the increased inflation rates in the United States and other western nations leading to increased interest rates globally. Furthermore, the Indian startups are grappling with an extended funding winter, the reduction in FDI can be traced back to investors exercising caution and refraining from injecting fresh funds, influenced by the economic slowdown experienced in developed regions like the US and Europe. Also, as far as the West’s China plus one strategy is concerned, Vietnam is emerging as a potential host country giving a strong competition to India.
Additionally, the economic landscape for FDI is shifting towards emerging sectors like artificial intelligence, data centres, electric vehicles with a decline in investment interests in traditional physical sectors such as automobiles, pharmaceuticals and construction, according to HSBC bank whose net investment inflows dropped by $25 billion in the FY 2023-24.
Challenges faced by Indian Economy
The Indian government has introduced policies to attract investor interest in India, particularly the Production-Linked incentives of Rs. 1.97 trillion for 14 sectors. The other initiatives include the Make in India program which drove self-reliance and aids in manufacturing by strengthening the logistics supply chain, a Special Economic Zones Act facilitating states to become partners in development of enterprise and service hubs, and liberal FDI norms with several sectors opening to 100% FDI under automatic route and 13 FTAs and six preferential trade agreements are signed with several countries.
Despite these efforts, FDI inflows faced significant decline. With decline in FDI, the recession warnings are on rise due to the discord between fiscal and monetary policies. Despite the economy’s resilience, economists predict a significant risk of recession, a mild downturn in profits, and a rise in corporate results. The decline in FDI has also impacted the potential investor confidence loss in the country’s economy, affecting economic growth. This can also impact technological advancements with limited access to advanced technologies and expertise. In sum, FDI decline affects the macroeconomic balance.