Syllabus: GS3/Economy
Context
- India is the world’s fastest-growing major economy, with its annual GDP increase averaging 8.2% during 2021 to 2024, yet, it is not attracting commensurate foreign capital inflows.
About
- India is among the world’s fastest-growing major economies (GDP growth 7.4% in Jan–Mar 2025, 7.8% in Apr–Jun 2025).
- Despite this momentum, foreign capital inflows are declining, creating a “foreign capital paradox”.
- Normally, high growth attracts global investors. In India’s case, inflows are not commensurate with its growth performance.
Trends in Capital Flows
- The net capital flows into India includes foreign investment, commercial borrowings, external assistance and non-resident Indian deposits.
- It was just $18.3 billion in 2024-25, the lowest since the $7.8 billion in the global financial crisis year of 2008-09 and well below the all-time-high of $107.9 billion in 2007-08.
- The trend has continued in the current fiscal, with capital inflows during 2025 falling over 40% compared to that for 2024.
- This was despite a stronger-than-expected GDP growth of 7.8% in the latest quarter.
| Net Foreign Direct Investment – Net FDI is gross FDI, which is the total money coming in, minus the money being repatriated out by foreign companies doing business in India and the outward FDI by Indian companies. 1. Net FDI = Gross FDI Inflows − (Repatriation by foreign firms + Outward FDI by Indian firms). – Key Components: 1. Gross FDI Inflows: Total new investments made by foreign entities into the country. It includes setting up factories, acquiring local companies, or expanding operations. 2. Repatriation & Disinvestment: Profits or capital that foreign companies send back to their home countries. Includes sale of assets or shares in domestic firms. 3. Outward FDI: Investments made by domestic companies in foreign countries (e.g., acquisitions, setting up subsidiaries). Why Net FDI Matters? – Positive Net FDI: Indicates more foreign investment is coming in than going out, often seen as a sign of economic attractiveness. – Low or Negative Net FDI: May suggest capital is being withdrawn or domestic firms are investing more abroad than foreigners are investing locally. 1. Not always negative but it may reflect economic maturity or global ambition. |
Why Have Capital Flows Dipped?
- Private Equity/Venture Capital (PE/VC) Exit Cycle: A major share of FDI inflows into India since the mid-2010s — peaking in 2020–21 — came through PE and VC funds across diverse sectors: retail, e-commerce, fintech, green energy, healthcare, and real estate.
- These were largely growth investments intended for medium- to long-term returns.
- Currently, many of these investments have matured, leading investors to exit and realise profits.
- High Market Valuations: It encourages profit-taking and discourages fresh entry.
- Global Factors: Uncertainty due to trade wars, and U.S. tariffs on Indian goods.
- Merchandise Trade Deficit: India’s goods imports far exceed exports.
- Deficit has more than trebled since 2007–08, reaching $287.2 billion in 2024–25.
- Investor Perception: Foreign investors focus less on headline GDP growth and more on:
- Corporate earnings (sustainability, profitability).
- Business climate and reasonable market valuations.
- If earnings don’t justify valuations, investors prefer to exit rather than invest afresh.
Implications
- Economic: Possible stress on external sector financing, and higher current account deficit.
- External sector financing refers to the flow of funds between a country and the rest of the world to finance its economic transactions.
- Currency: Rupee depreciation due to capital flight.
- Investor Confidence: Weak participation in India’s growth story.
- Policy Space: May limit the government’s ability to finance growth through external resources.
Way Forward
- Deepen Structural Reforms: Land, labour, taxation, and regulatory clarity to attract stable FDI.
- Encourage Long-Term Capital: Focus on infrastructure, green energy, and manufacturing investments.
- Strengthen Corporate Earnings: Improve productivity, lower costs, and reduce compliance burden.
- Enhance Export Competitiveness: Diversify markets beyond US/EU, boost Make in India.
- Stabilise Rupee & Macro Fundamentals: Maintain forex reserves, prudent fiscal and monetary policies.
- Investor Confidence Building: Transparent policy regime, predictable taxation, and consistent reforms.
Source: IE
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