The Hindu Business Line : FDI: Pointers for the future

Generally, the prospects for FDI appear to be brighter than in the past mainly because of the growth phase the international economy is currently in. Also, sectorally, there are a number of indicators such as the increase in commodity as well as crude prices which, in the normal course, should lead to higher FDI in the shape of heightened cross-border production activity by transnational corporations.

GOING BY whatever statistics is available, it would appear that foreign direct investments in India during the current year are on a roll. To take the 2004-2005 picture first, preliminary estimates for the year peg the total FDI inflows at $3.75 billion. (The break-up between equity and reinvested earnings is not yet available because they are still being finalised by the Reserve Bank of India.) Going back a year, to 2003-2004, the corresponding overall figure was $4.67 billion of which equity was $2.38 billion.

In 2002-03 the respective figures were $5.03 billion and $2.76 billion. In the current year, the equity FDI inflow alone is expected to be around $5 billion which, given the observed proportion between equity and the total FDI flow, should mean a total FDI inflow into the economy of close to $8 billion.

The Indian FDI scene is, therefore, quite encouraging. But where does Indian FDI stand vis-à-vis foreign direct investment flows in the world economy as a whole? Is the Indian trend a faithful reflection of the international trend or is it an aberration because of specific reasons?

Going by the findings of the latest UNCTAD World Investment Report, the Indian FDI picture mirrors the overall international scene, particularly as far as the developing economies are concerned. At $648 billion, total FDI flows were 2 per cent higher in 2004 than in the previous year, the performance since 2001 till 2003 being declines of 41 per cent, 13 per cent and 12 per cent in the three years, respectively.

However, the more interesting point to note is that while flows to the developed world in 2004 declined for the fourth year in a row (the overall decline was 14 per cent), that to the developing world shot up by around 40 per cent. Not only did the aggregate flow into the latter more than offset the decline in the developed economies, the difference between the two flows was reduced to $147 billion, which, according to the UNCTAD report, represents "a significant narrowing of the gap compared with previous years".

Why this difference between the two groups? But before one goes into this aspect of the movement, the point to note is that the decline in the developed economies as regards FDI has not been uniform. The steepest decline in 2004 was recorded in the EU, inflows declining by 36 per cent "to reach (their) lowest level since 1996". As the UNCTAD report points out, Denmark, Germany, the Netherlands and Sweden accounted for as much as 86 per cent of the total decline spread over 10 EU countries. Among the other European countries, Norway and Switzerland saw a fall of 66 per cent in their FDI inflows. In contrast to this dismal picture, direct investment flows into the US in 2004 rose, for the first time since 2000, to thrice the 2003 level (but still totalling to about a third of the 2000 peak level), while flows into the UK were at nearly four times their 2003 level.

The sharp decline in the EU has been attributed, to some extent, to the large repayments of intra-company loans resulting from tax-changes and repatriation of earnings in a few members. Also held responsible is the change in the system of compilation of balance-of-payments statistics introduced in April 2003 as also low economic growth. On the other hand, the sharp increase in direct investment flows to the developing economies has been traced to a number of factors one of which is the imperative for leading firms to "explore new ways of improving their competitiveness". The UNCTAD report says that firms have sought to expand operations in the fast-growing markets of the emerging economies to increase sales; they have also rationalised production activities "with a view to reaping economies of scale and lowering production costs". In some developed and developing economies, there has been an increase in cross-border merger and acquisition activity; greenfield FDI continues to rise for the third consecutive year in 2004.

Where do such countries as India and China figure in this developing economy FDI scenario? As for India, the UNCTAD report says that the performance of around $5 billion in 2004 was the result of "an improving economic situation and a more open FDI climate". Further, cross-border M&A activity rose during the year as the telecommunications, business process outsourcing and pharmaceutical industries saw an increase in the number of large deals.

Clearly, the surge in FDI already noticed is just a drop in the ocean of the vast Indian economy, the full potential of which is gargantuan if comparisons are made with other national economies China excluded. The UNCTAD report does not spell this out, but the implicit message is clear — that the FDI in India will increase by leaps and bounds if the policy environment is improved further.

As regards China, the wonder boy of international FDI flows, performance has been sizzling with flows reaching the highest level (of around $61 billion) in 2004. What precisely is behind this phenomenal achievement? To quote the report at some length: "Strong economic growth, an improved policy environment and further opening up to FDI in certain industries — such as banking and other financial services — contributed to the increase. In 2004, five Chinese banks attracted $2.7 billion in FDI and total FDI flows to the banking sector reached $3.8 billion. Investments by private equity and venture capital funds, especially from the US, have become important sources of foreign investment in China. The implementation of large-scale FDI projects also led to a significant increase in FDI in the automotive industry and the semi-conductor industry."

Even so, there is something incredible in China's FDI performance, a point of view which has been whetted by the section in the UNCTAD report which focuses on the methods of FDI computation and which, interestingly, cites Chinese data as an example of what different methodologies can lead to. Thus, while China reported FDI worth $868 million from Malaysia in 2002, Malaysia itself recorded a figure of $81 million. The corresponding figures for Japan, the Netherlands, Thailand and the US are $4.1 billion and $2.6 billion, $572 million and $156 million, $188 million and $16 million, and $5.4 billion and $924 million.

What is the outlook for FDI in the year ahead? Generally, prospects appear to be brighter than in the past mainly because of the growth phase the international economy is currently in. This apart, sectorally, there are a number of indicators like the increase in commodity prices as well as the crude price which, in the normal course, should lead to higher FDI in the shape of heightened cross-border production activity by transnational corporations. Take Africa, for instance. It is expected that the lure of higher profits will lead to bigger investments in the Dark Continent's commodity sector, the US itself targeting an increase of its oil imports from Africa from 18 per cent now to 25 per cent by 2015 of its total oil requirements.

Summing up, according to UNCTAD estimates, the outlook is good for the near future although expectations vary from region to region, the brightest prospects being reserved for Asia and Oceania. For the longer term, the FDI trend is poised to continue its upward journey although some time may elapse before the performance level of the late 1990s is attained.

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