What Explains The Surge In FDI Inflows?

Context: Unprecedented short-term foreign portfolio investments are entirely responsible for the capital inflow surge, and its scope in augmenting fixed investment and output growth remains limited.

 

Ministry of Commerce and Industry press release

• Rise in total foreign direct investment (FDI) inflow in 2020-21: At $81.7 billion, up 10% over 2019-20.
• Political claims: “Measures taken by the Government on the fronts of Foreign Direct Investment (FDI) policy reforms, investment facilitation and ease of doing business have resulted in increased FDI inflows into the country.”

Reasons for the rise in the FDI inflows:

• Increase in repatriations: The gross inflow consists of (i) “direct investment to India” and (ii) “repatriation/disinvestment”.
  • While direct investment to India” has declined by 2.4%. Hence, an increase of 47% in “repatriation/disinvestment” entirely accounts for the rise in the gross inflows.
  • On the other hand, direct investment to India has barely risen (0.8%) in 2020-­21 over the last year.
  • FDI inflow increasingly consists of private equity funds. In principle, private equity funds do not make long-­term greenfield investments.
• On account of huge rise in Net Portfolio Investments: Shooting up from $1.4 billion in 2019­20 to $36.8 billion in the next year. That is a whopping 2,526% rise.
  • While FDI inflow, in theory, is supposed to bring in additional capital to augment potential output (taking managerial control/stake), foreign portfolio investment is short-­term investment in domestic capital (equity and debt) markets to realise better financial returns.
  • It added a lot of froth to the stock prices -> The BSE Sensex nearly doubled from about 26,000 points on March 23, 2020, to over 50,000 on March 31, 2021.

Surge in FPI has a modest contribution: FPI does not contribute as such since it does not add to fixed investment and employment creation -

• Between 2013­ 14 and 2019­20, the ratio of net FDI to GDP has remained just over 1%, with no discernible rising trend in it.
• The proportion of net FDI to gross fixed capital formation is range­bound between 4% and 6%.
• Gross fixed capital formation to GDP ratio — has plummeted from 31.3% in 2013-­14 to 26.9% in 2019-­20

Conclusion: The flood of FIIs has boosted stock prices and financial returns. These inflows did little to augment fixed investment and output growth.