A Complex Turn in India’s FDI Story

Syllabus: GS3/Economy

Context

• India continues to attract significant foreign direct investment (FDI), but rising profit repatriations, disinvestments, and outward Indian FDI have diluted the long-term growth impact. 
• The Reserve Bank of India has flagged this dual trend as a risk to India’s external resilience.

About Foreign Direct Investment (FDI)

• Definition: Investment made by a foreign entity directly into the business or productive capacity of another country.
• Modes: Equity participation, joint ventures, setting up subsidiaries, or greenfield projects.
• Distinction: Unlike portfolio investment, FDI is expected to provide long-term capital, technology transfer, and management expertise.

Trend in India’s FDI

• India attracted $81 billion in FY 2024-25, marking nearly 14% increase from the previous year.
  • Inflows nearly doubled between 2011 and 2021, reflecting India’s attractiveness. However, since the peak of FY 2021-22, net FDI inflows have sharply declined.
  • Gross inflows (post-pandemic): $308.5 billion;
  • Withdrawals/repatriations: $153.9 billion;
  • Net retained capital (FY 2024-25): $0.4 billion;
• Key Sectoral Trends:
  • The manufacturing sector has seen its share fall to just 12% of total FDI.
  • Service sectors such as finance, hospitality, and energy distribution dominate inflows, however, they lack the multiplier effects of manufacturing or infrastructure.
  • It suggests investors are prioritising quick financial gains, often routed through tax havens such as Singapore and Mauritius, rather than strategic, technology-driven commitments.
• Rising Indian Outward FDI:
  • A parallel development is the growth of Indian outward investment, which climbed from $13 billion in FY 2011-12 to $29.2 billion in FY 2024-25.
  • Firms increasingly look abroad, citing regulatory inefficiencies, infrastructure gaps, and policy unpredictability at home.
    • It weakens domestic capital formation, job creation, and industrial competitiveness.

Other Key Concerns Surrounding India’s FDI

• Structural Barriers to Sustainable FDI: India faces persistent hurdles, despite reforms and improved rankings, regulatory opacity; inconsistent legal and policy frameworks; and governance challenges.
  • These issues undermine investor confidence, contributing to both foreign disinvestments and rising Indian capital flight.
• Macroeconomic Implications: FDI inflows are crucial for India’s balance of payments, currency stability, and monetary policy flexibility.
  • A decline in net FDI inflows heightens risks to external account management.
  • The Reserve Bank of India has acknowledged this dual trend of high inflows and high outflows, noting its long-term implications for economic resilience.
• Geopolitical and Global Headwinds: FDI inflows from key countries like the US, UK, UAE, and Germany have declined amid global uncertainty.
  • Policy shifts in the U.S. and economic stimulus in China are also expected to divert capital away from emerging markets like India.
• Overdependence on Tax Haven Routes: A significant portion of FDI continues to flow through Mauritius (25%) and Singapore (24%), raising concerns about the transparency and sustainability of these investments.
  • These routes are often used for tax optimization rather than long-term industrial investment.
• Policy Execution Gaps: Despite ambitious reforms like the National Single Window System and Jan Vishwas Act, investors still cite:
  • Unpredictable tax enforcement;
  • Weak contract enforcement;
  • Slow regulatory approvals;
  • These issues undermine India’s image as a reliable investment destination.

Efforts To Boost India’s FDI

• Liberalization of Sectoral Caps: 100% FDI under automatic route in major sectors like telecom, insurance intermediaries, coal mining, and contract manufacturing.
  • Defense sector cap raised to 74% under automatic route for new industrial licenses;
• Make in India & National Manufacturing Mission: To boost domestic manufacturing and attract foreign capital;
  • Focus on 27 strategic sectors under Make in India 2.0, including electronics, pharmaceuticals, and textiles;
• Ease of Doing Business (EoDB): India jumped from 142nd to 63rd in the World Bank’s Doing Business Report between 2014 and 2019;
• Initiatives like Jan Vishwas Act and Jan Vishwas 2.0 aim to decriminalize business laws and simplify compliance;
• Digital Transformation & Single Window Clearance: Implementation of the National Single Window System (NSWS) for faster approvals;
  • Digitization of FDI approval processes and investor grievance redressal;
• Production-Linked Incentive (PLI) Schemes: Targeted incentives across 14 sectors, including semiconductors, medical devices, and technical textiles;
  • Designed to enhance India’s global competitiveness and reduce import dependence;

Way Forward

• To transform into a sustainable global investment hub, India needs to:
  • Prioritise long-term capital over short-term speculative flows.
  • Simplify regulations and ensure policy consistency.
  • Invest in infrastructure and institutions to strengthen investor trust.
  • Focus on human capital to attract advanced manufacturing, clean energy, and technology.
  • Align FDI with national goals to ensure developmental impact.

Source: TH