The Hindu Business Line : There's more to FDI than financing

India does not need FDI merely to be able to balance the books on capital account. Through FDI, India gains the knowledge and learning acquired elsewhere in the world.

FOREIGN direct investment (FDI) has the ability, like no other issue perhaps, to raise the hackles of ideologues in the country, whatever their directional persuasion or political linkage. The Right see it as impinging on swadeshi and the image of the ideal Indian village republic. And for the Left, it brings an eerie sense of déjà vu, of colonialism emerging all over again. But a simple two-handed economist will argue in favour of it because, if in a globalised world a country runs a massive trade deficit, as India does, FDI helps balance the books.

Though developing at a fast pace, India does not produce all the goods and services necessary for the sustenance of its citizens, and, perforce, there is always a negative trade gap. Exports, at present, are not high enough to bridge this gap. How then is this deficit to be financed? By debt or equity?

In the main, India's external debt has ballooned in the last decade and a half to finance the deficit. Regular interest payments have to be made on this debt, and eventually, the capital repaid as well. India's external debt has been over $100 billion in the past few years. So, how does it matter if foreign exchange reserves have grown substantially? The interest on debt to GDP ratio is over 20 per cent. Will a householder or a corporate financial officer be comfortable with such a high ratio? Are not equity investments a better way to bring money into the country?

Investments, basically, are of two types: Those made largely by foreign institutional investors (FIIs) in the share capital of enterprises that trade on the Indian stock market, and those by foreign firms in domestic enterprises, whether as sole principals or partners in a collaboration. Thus, foreign investments help balance the capital account. India does not need FDI merely for accounting purposes. FDI represents the possession of resources, skills, capabilities and competencies by firms, entities and organisations, which have helped them become rich. These assets and resources are most often intangible, and they embody intellectual property rights.

Through FDI, India is gaining the knowledge and learning that has taken place elsewhere in the world. These are encapsulated in the assets and technologies transferred. Consider, for instance, the impact of FDI on the exports a country. Foreign firms, especially multinationals, possess international marketing capabilities, global operational networks and in-depth knowledge of markets. They also have the ability to manage the international political economy dimension so as to overcome trade barriers. They exploit the relatively cheaper production costs in developing countries for supply to global markets. Thus there appears to be much scope for global production from a country such as India.

Firms making overseas investments possess intangible assets — patented designs/processes, manufacturing/research know-how, and so on. The ownership of these assets enhances the competencies and capabilities these firms. These assets, when deployed in an emerging market economy like India which has relatively low wage levels but an educated workforce, give foreign firms manufacturing and cost advantages. This makes the products subsequently exported out of India competitive in the global markets.

Another major intangible asset is marketing skills such as branding, distribution, merchandising and promotion. Such marketing assets generate a price premium for the product, with buyers willing to pay more than for comparable products.

Even if the financial benefits of FDI are ignored, there are the quality and variety elements. For instance, when buying a car, very few would go in for an Ambassador, now with the Hondas, Hyundais, Mitsubishis et al around. Foreign firms also have a spill-over effect on domestic firms, which can draw on international best practices. In India, especially, MNCs invest with a long-term perspective. The markets here are robust, human capital dynamic and the future prognosis sound. MNCs make commitments with their assets, skills and capabilities, fully realising that their competitors, both local and foreign firms, may utilise these and destroy their competitive advantage.

Thus, there is a clear sunk-cost effect that an MNC immediately creates for itself when it makes a commitment to invest in a foreign country. Also, a country can always take over the assets of MNCs — Esso and Burmah Shell being transformed into Hindustan Petroleum and Bharat Petroleum, respectively, are cases in point.

In spite of such contingencies, if MNCs do want to invest in India, it is because they see the potential benefits outweighing the risks.

Though the FDI coming into India has shot up over the past decade, it is still minuscule compared to what China receives. In every sector, whether it be infrastructure, retail or media, there is a big thirst for investment. And if this cannot be provided through domestic sources, then FDI is obviously the best bet. This has the added advantage of infusion of knowledge inputs into the economy.

Yet, on matters such as FDI, the polity are wont to display a mastery of debate second to none. There are many components that continuously alter the contours of debate on a topic such as FDI. But if a certain amount of reasoning and rationality is applied, it can be seen that the economic consequences of FDI can be substantial.

(The author is Professor of Technology Strategy, University of Texas at Dallas. He can be majumdar@utdallas.edu)

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