The government is desperate to attract foreign direct investment (FDI) to fund its raging CAD. The CAD is also the difference between domestic savings and investment. Therefore, there are two ways to bridge the gap: raising capital through higher domestic savings or foreign capital, and/or reducing the trade deficit.
Of these options, there is no a priori reason to believe that pursuing FDI is the best course of action.
Our CAD may exceed $100 billion in 2013-14, against $88 billion last year (4.8 per cent of GDP) and $78 billion in 2011-12 (4.2 per cent of GDP).
This is because the slowdown in the West is here to stay, impacting exports, while our oil imports (a third of all imports) will remain firm, unless prices drop sharply.
Can a gap of about $100 billion, growing by $10 billion annually, be financed by FDI flows?
The highest net FDI we have received in a year is $22.4 billion in 2011-12; it will take us a decade to get to $100 billion. A three-figure CAD is a tall order even for FII flows, which have never crossed $32 billion. So, FDI and FII cannot solve our CAD problems – more so in the current global climate.
We have to slash our CAD. At present, this cannot be brought down through exports of goods and services. Instead, we should take a hard look at imports. Surely, the oil bill can be trimmed by doing away with inefficient fuel use.
While gold accounts for 12 per cent of total imports, capital goods account for 6 per cent, and chemicals and electronics goods another 5 per cent and 7 per cent, respectively. A dearer rupee may spur indigenisation, but in case prices drop to offset this impact, the government could consider higher tariffs.
Yet, this import profile is taken as a given and FDI (and FII) prioritised over other policy options to control CAD, such as improving domestic savings by curbing inflation.
FDI is not a virtue in itself, unless it is linked to export obligations or technology transfer. But panel after panel, from N.K. Singh in 2001 and the Mayaram panel today, has called for a relaxation of conditions in a desperate effort to attract FDI.
That capital goods and electronics account for 13 per cent of total imports suggests that FDI has not led to technology transfer. FDI (or whatever little has come our way, despite our genuflections) may have contributed to our CAD woes through imports of finished products.
China is the world’s largest recipient of FDI, despite its stern conditions on technology transfer. FDI is attracted by growth — and by a political system that curbs dissent. While the first can be cranked up, the second is problematic.
No matter what the Poscos, Hondas and Enrons might have to say, trying it out is not desirable in a democracy.
Also read: > Will raising FDI caps help fix CAD problems? - YES