The Hindu Business Line : Why FDI eludes India

India has all the right ingredients to attract large FDI flows, but if such investment is still slow to come in, it is because of the shortcomings on the infrastructure, labour law and procedural fronts.

The importance of Foreign Direct Investments has been well spelt out in India in different forums and at all levels over the last decade. Recently an international consultancy firm rated India second, ahead of the US, in the FDI Confidence Index, while Unctad put India as the third most attractive destination in the world for FDI. However, a hard look at the FDI flows into India reveals a different picture. Though the fourth largest economy, India gets only 0.8 per cent of total global FDI flows and less than 3 per cent of the total FDI flows to developing countries.

FDI inflow criteria

China gets more than 25 per cent of total FDI flows to developing countries and around 10 per cent of total global FDI flows. Other developing countries such as Brazil, Singapore and South Korea receive far higher levels of FDI than India.

Theoretically, all the macro fundamentals determining FDI flows, except fiscal deficit, are going good for India. For instance, India has a huge market, excellent economic prospects, good balance of payments situation, low external vulnerabilities, stable price levels, a progressive tax regime, a high degree of openness, and a large English-speaking population.

Also, the right host-country policies, such as promotion of private ownership and financial market regulation, have been pursued. Yet, FDI flows to India have lagged those into China, Brazil or Singapore.

Where is India failing?

This indicates that India lacks in some of the crucial factors determining FDI flows, mainly infrastructure, labour reforms, and quality of governance.

Over the years, infrastructure issues have not been properly addressed and outlays have been inadequate. For instance, the use of energy per capita in India (379 kWh in 2002) is far less than China (987 kWh), Korea (6,171 kWh), Singapore (7,038 kWh), and Malaysia (2831 kWh).

Though rail and road infrastructure indicators are comparable with other countries, the quality of service is inferior. Despite the telecommunication revolution, India still lags behind developing Asian countries. Telephone subscribers (per 1000 population) in China are six times, and in Korea 15 times, higher than India.

Overall infrastructure facilities in India are far below international standards and one of the major problems in attracting FDI inflow.

Flexible labour laws needed

China gets maximum FDI in the manufacturing sector, which has helped the country become the manufacturing hub of the world and export more than $400 billion per annum.

The manufacturing sector can grow in India provided infrastructure facilities are improved, and labour reforms take off. The country needs to gradually move towards more flexible labour laws. .

Relook at sectoral caps

Though the Government has hiked the sectoral cap for FDI over the years, it is time to revisit issues pertaining to limits in such sectors as coal mining, insurance, real estate, and retail trade, apart from the small-scale sector . Government should gradually put more sectors under automatic route for FDI. Bringing more sectors under the automatic route, increasing the FDI cap and simplifying procedural delays need to be addressed with more vigour.

Various sops are provided to foreign investors setting up export oriented units (EOUs), Special Economic Zones (SEZs), or industrial and electronics hardware parks. Though the SEZs in India are not as successful as in China, their performance has improved in recent years. However, there is an urgent need to improve these SEZs in terms of their size, road and port connectivity, assured power supply, flexible labour laws and decentralised decision-making.

It is well known that China has been able to attract FDI due its trade promotion, particularly exports. In turn, FDI also helps exports and more than half of China's exports originate from `FDI-owned' firms. The nexus between exports and FDI is well-documented. In fact, most developing countries such as China, Singapore, Korea and Malaysia boast export-GDP ratios almost double that of India.

Govt Must keep promises

The Government needs to act on the promises made in the Trade Policy to reduce procedural hassles and make all export procedures online. This would certainly improve the FDI flow into the export-oriented industries.

On the fiscal sops to investment, it is time to think about redesigning the incentives given on the basis of differential development of the places. Though the idea of developing backward areas by extending fiscal incentives to investors is good, investors are hardly likely to be interested in the backward areas. Much of the Chinese FDI comes to the developed coastal areas. Thus, giving fiscal incentives for investing in the backward areas has not been very successful, and the Government needs to change tack.

Given that most of the emerging markets have been competing to attract investors, multinational corporations are becoming increasingly choosy aboutinvestment climate, institutions and governance in the host country. Most recent surveys and studies on FDI in India point to procedural hassles and poor governance as the major deterrents to investment.

Good governance

Improving governance and overall accountability in public office will not only help attract more FDI but also increase domestic investment. Given the economy's performance in the recent past and the recognition that India is one of the major emerging markets, the Government should try to improve the investment climate.

Improved infrastructure, flexible labour laws and easy procedures are crucial to drawing more FDI . The recent literature on FDI also suggests that the quality of governance is a major positive for higher investment and growth. Therefore, a smart government, not big or small, is the key.

(The author is on the Faculty of the Institute of Economic Growth, New Delhi. He can be contacted at pravakar@iegindia.org)

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