The answer to this question is a qualified, rather than a thumping, ‘yes’. There is obviously a close linkage between a burgeoning current account deficit (CAD) and the Government’s move to increase caps on FDI on the basis of the Mayaram Committee’s views.
We need to understand the reasons for the fall in the rupee and the rise in CAD in the recent period. External factors, such as the proposed withdrawal of quantitative easing in the US, and the expected increase in interest rates prompted a large pullback by US investors across the world to the US. This had an impact on India. India has a poor FDI record, compared with China and other countries. In the past five years, China has attracted nearly a $1 trillion of FDI whereas all India could manage is $168 billion, or about 17 per cent of China’s FDI. Most investors find India very attractive from a market perspective, but are deterred by the regulatory maze, operational bottlenecks, corruption, tax challenges and the legal system.
In today’s global economy, there is pressure on large global corporations to invest in countries with good growth potential, since the advanced Western economies have slowed down. However, investment will not flow in, unless the constraints alluded to above are addressed. Hence, the difference between the FDI flows into India and China.
Liberalisation of FDI norms is welcome, but that needs to be accompanied by other measures as well. That includes an overall environment where industry is allowed to invest and operate with minimal pain, without having to do a lot of “environment” management.
However, FDI is not like FII or portfolio investment, given its sticky nature. Liberalisation will not result in significant FDI flows in the short-term — which is what is required to address the CAD. If, along with FDI-friendly moves, other reform measures are implemented, FII money would return, and quickly. This could be followed by an improvement in FDI flows.
It is also telling that while we are hoping for FDI investment to pour in, ‘Indian direct investment’, or investment by Indian industry, is slowing down. A number of Indian corporates are looking to invest in other countries (FDI outflows), despite the growth potential of Indian markets. While it is a matter of pride that Indian companies have reached the size, scale and confidence to buy global companies, the other view is that they could have invested in India, rather than in the slowing Western markets.
In sum, FDI liberalisation measures are important. But they need to be accompanied by industry-friendly measures to ensure that FII flows come back in the short term, and in the longer term the country attracts a lot more FDI.
(The author is Partner, India Leadership Team, Grant Thornton India LLP)
Also read: > Will raising FDI caps help fix CAD problems? - NO