Syllabus: GS3/ Economy
Context
- India’s net Foreign Direct Investment (FDI) has witnessed a sharp decline in recent years despite strong gross inflows.
What is Foreign Direct Investment (FDI)?
- It refers to investments made by foreign entities (individuals or companies) in the business interests of another country, typically in the form of ownership or control of enterprises.
- At present, FDI is prohibited in lottery, gambling and betting, chit funds, Nidhi company, real estate business, and manufacturing of cigars, cheroots, cigarillos and cigarettes using tobacco.
- Net FDI: It represents the difference between foreign investment entering the country and capital flowing out through disinvestment and repatriation.
- A decline in net FDI does not necessarily imply a fall in investor interest, as gross inflows may remain strong.
- India’s net FDI fell dramatically from $44 billion in 2020-21 to less than $1 billion in 2024-25, before recovering modestly to $7.6 billion in 2025-26.
- This decline occurred despite a substantial gross FDI inflow of $94.6 billion in 2025-26, indicating that large capital outflows are offsetting fresh inflows.
Evolution of India’s FDI Policy
- The economic reforms of 1991 promoted FDI primarily to acquire advanced technology, enhance exports, and conserve foreign exchange reserves.
- Over time, policy emphasis shifted towards attracting larger volumes of foreign capital and improving India’s investment attractiveness.
- Consequently, concerns relating to the quality of investment, technology transfer, and future external payment obligations received relatively less attention.
Different Types of FDI Investors
- Real FDI (RFDI): Real FDI is undertaken by multinational corporations that establish production facilities and service operations in the host country.
- Such investments generally bring technology, managerial expertise, employment generation, and long-term industrial development.
- Real FDI is considered the most beneficial form of FDI from a developmental perspective.
- It accounted for only 41.9% of effective inflows during 2022-23 to 2025-26.
- Financial Investors: Financial investors include private equity funds, venture capital firms, sovereign wealth funds, and asset management companies.
- Their primary objective is earning capital gains rather than building long-term productive capacity.
- They accounted for 40.5% of effective inflows, nearly matching the share of Real FDI.
- Diaspora investments and special purpose vehicles (SPVs): Diaspora investors and Special Purpose Vehicles (SPVs) contributed 17.6% of effective inflows.
- These investments are often routed through offshore financial centres and may involve round-tripping of domestic capital.
Routes for FDI in India
- Automatic Route: No prior approval is required.
- Investors need to inform the Reserve Bank of India (RBI) after making the investment.
- Most sectors, such as manufacturing and software, fall under this route.
- Government Approval Route: Requires prior approval from the concerned Ministry or Department.
- Sectors such as telecom, media, pharmaceuticals, and insurance fall under this route.
Why Has Net FDI Declined?
- Rising Disinvestment and Capital Repatriation: The principal reason for weak net FDI is the growing scale of investor exits and capital repatriation.
- During calendar year 2025, total recorded divestment reached $52 billion.
- Of this, 45 major private equity and venture capital exits accounted for nearly $29 billion.
- Declining Manufacturing-Oriented FDI: Manufacturing FDI has declined across three consecutive four-year periods.
- Real FDI into manufacturing accounted for only 10.6% of total effective inflows during the latest four-year period.
- Rising Outward Foreign Direct Investment (OFDI): India’s outward FDI has increased significantly in recent years.
- Between 2023-24 and 2025-26, Indian firms invested nearly $65 billion abroad.
- The International Financial Services Centre (IFSC) at GIFT City is emerging as an important conduit for cross-border capital flows.
- OFDI routed through GIFT City increased from $246 million in 2023-24 to $1.18 billion in 2025-26.
What are the Concerns?
- Financialisation of FDI: The growing share of financial investors may reduce technology transfer and long-term industrial benefits.
- Weak Manufacturing FDI: The declining share of manufacturing-oriented FDI could hamper industrialisation, employment generation, and exports.
- Declining Net FDI: Rising disinvestment and capital repatriation have significantly reduced net foreign exchange gains.
- Gross vs Net FDI Gap: Strong gross inflows may mask the underlying weakness in net FDI and investment quality.
- Capital Recycling Risks: The use of SPVs and offshore financial centres can obscure the true nature of investment flows.
Way Ahead
- Prioritise Quality over Quantity: India should focus on attracting technology-intensive, export-oriented, and employment-generating FDI rather than merely maximizing inflow volumes.
- Promote Manufacturing FDI: Policy support should encourage greenfield investments in manufacturing to strengthen industrial capacity and integration with global value chains.
- Enhance Transparency in FDI Reporting: Official data should distinguish between Real FDI, financial investments, and SPV-based flows to enable better policy assessment.
- Strengthen Domestic Competitiveness: Improving infrastructure, logistics, ease of doing business, and innovation ecosystems can attract more productive and sustainable investments.
Source: TH
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