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The anticipation of a possible reform of India’s FDI policy has been watered down, with DPIIT’s focus shifting to tweaking of rules and procedural aspects. Since FDI inflows are likely to fall given global economic uncertainty and geopolitical tensions, the government must undertake a major reform of FDI policies.
The 2024 World Investment Report indicates that global FDI flows dipped by 2 per cent to $1.3 trillion in 2023.
Further, the flows to developing economies declined by 7 per cent on a year-on-year basis. Flows to India declined by 43 per cent year-on-year to $28 billion. The slowdown in FDI inflows is not a recent phenomenon.
The 10-year CAGR until 2022-23 was around 7 per cent, substantially lower than the growth witnessed before 2010. So it is time to have a relook at India’s FDI and trade policy.
Though India has permitted 100 per cent FDI through the automatic route in most sectors, except certain sensitive sectors, there lies ample scope for policy reforms. India’s position in the OECD FDI Regulatory Restrictiveness Index reflects this as it lags some of its peers like Brazil and Vietnam. The recent FDI reforms is largely focused on tweaking rules and other procedural aspects.
To improve the investment climate, the government must address the issues of rationalising tax and inverted duty structure, particularly in sectors like electronics.The higher corporate tax rate compared to its peers, particularly the South-East Asian countries, further dampens the investment climate. FDI policy reforms that do not simplify the existing tax regime may not deliver the desired results.
An associated issue is the existence of high levels of profit repatriation, with estimates suggesting that more than 60 per cent of gross investment inflow was repatriated or disinvested in FY24.
The present FDI policy does not incentivise foreign entities to remain invested in India for the long term. Formulating policies that encourage profit reinvestment is critical in ensuring sustainable long-term economic growth. Some important pathways through which reinvestment can be incentivized include tax reforms and incorporating specific provisions in the FTAs and CEPAs that India plans to sign in the future.
The BIT issue
The decision to terminate numerous Bilateral Investment Treaties (BIT) in 2016 in the context of increased arbitration claims has significantly impacted the FDI inflows into the country.
Studies confirm that FDI inflows from countries with which India terminated the BIT witnessed a significant decline. The new model of BITs makes it difficult for investors to undertake international arbitrations, which is a dampener for foreign investors.
Another critical aspect that requires attention is the sectoral concentration of FDI. Between 2018-23, computer software and hardware, services sector (financial, banking, insurance, outsourcing etc.), trading, and construction sectors have attracted the lion’s share of inflows.
Policymakers must turn attention to other sectors with huge untapped potential, such as pharma, food processing, textiles, petroleum, and natural gas, to name a few. The policy reforms must be brought about in coordination with the ministries handling these sectors. Another critical issue that policymakers have often failed to address over the years is the concentration of FDI in few States such as Gujarat and Maharashtra.
States’ play
A flexible approach with a greater say for the States may yield better results than the present top-down approach.
Future policy reforms must kick-start the efforts to correct the skewness in the distribution of foreign investments. Furthermore, there is a significant divergence in India’s FDI and trade policies. The government must correct the lack of congruence between the two.
Global trade is now dominated by global value chains. A restrictive trade policy with high import tariffs can hinder the flow of export-oriented FDI and can have implications for sectors such as electronics. This can throw a spanner in India’s efforts to project itself as an alternative to China.
Policies such as Make-in-India can achieve their full potential only if these anomalies are corrected.
Krishnan is Assistant Professor at Christ University, Bengaluru; Gopalakrishnan is Fellow, NITI Aayog; and Padmaja is Assistant Professor at NIT Trichy. Views are personal
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