The Hindu Business Line : Stronger rupee — What it means for FDI growth

With GDP poised to grow annually at 10 per cent in the next five years, FDI will play a key role in sustaining this growth. And given the rise in rupee value, telecommunications, electronics, automobile and banking are the front-runners in the race to attract FDI flows, says S. MAJUMDER.

Foreign direct investment (FDI) in India has trebled from a mere $6 billion in 2004-05 (actual flow) to $17.7 billion in 2006-07. It is expected to jump to $25 billion in 2007-08, according to the Commerce Ministry. So far, the factors attracting FDI were the surge in manufacturing growth, boom in domestic consumption, a buoyant stock market, skilled manpower and unabated growth in the IT sector. Added to these favourable factors now is the strong rupee.

The Indian rupee has appreciated more than 10 per cent since late 2006 — for the first time in eight years. It appreciated from Rs 45-46 against the dollar in October 2006 to Rs 44 in March 2007, and thereafter to Rs 40.5 in the first week of August.

Had the RBI not intervened and ECB norms not been tightened, the rupee might have shot up to Rs 38-39. The surge in rupee value was driven by the gushing flow of FII investment and strong macro-economic parameters. Between April 2006 and March 2007, India added $46.8 billion to its foreign exchange reserves. Of these, almost half — $24.7 billion — was added in January-March.

What does this foretell for FDI growth in the country? With GDP poised for annual growth of 10 per cent in the next five years and the manufacturing and service sectors being its principal drivers, FDI will play a key role in sustaining this growth. Today, the manufacturing sector attracts 75 per cent of FDI. Vast potential lies ahead, with the opening up of the service sectors, which contribute 45 per cent to GDP.

Impact of strong rupee

The return on FDI is in rupee denomination. Thus, rupee appreciation fetches more profits to foreign investors in India. This may leverage India’s strengths vis-À-vis China.

In China, any surge in the yuan will hit the profitability of foreign investors. This is because the latter’s earnings are closely related to exports. A large part of the output of FDI enterprises in China is exported. Any increase in yuan value will hit the cheaper production in China by foreign enterprises, which are mainly meant for exports. In contrast, in India, growth is driven by domestic consumption. Nearly 79 per cent of GDP growth is driven by domestic consumption (compared to China’s 57 per cent). Export is not the main attraction in India for foreign investors.

A strong rupee will make import-based foreign investment more attractive. These include mainly electronic, electrical and automobile industries. There is constant technological innovation in these sectors and, consequently, new models are regularly introduced in the market. When new models are introduced, the import ratio of input increases in the initial stages — particularly in a country like India, where expenditure on R&D is incurred by foreign investors. The main part of R&D expense is borne by the parent companies. As a result, whenever a new model is introduced, import ratio of input is high till it gets indigenised.

A strong rupee liberalises the FDI cap stipulated for selected industries and service sectors. With the rupee value getting stronger, the cap swells, resulting in greater scope for investment in depreciated currencies, such as the dollar or other currencies, without changing the ceiling of investment. In other words, the scope of foreign investment increases in the banking, telecommunication, insurance, retail and air transport services, where such ceilings were stipulated.

A strong rupee offsets the impact of high import tariffs. Indian tariffs are higher than in Asean countries and China. High import tariffs tend to put off FDI. A strong rupee will thus have a cascading impact on input costs, resulting in a higher margin of profits for foreign investors.

Telecommunication, electronics and electrical industry, automobile and banking are the front-runners in the race to draw FDI flows with the rise in rupee value.

ATTRACTIVE SECTORS

The telecom industry is the third largest FDI recipient, accounting for 8 per cent of the total inflows. And the industry holds greater potential for foreign investment. Between May 2006 and May 2007, India added 71 million telecom subscribers, or over five million subscribers a month. The country is geared up to meet the target of 250 million in 2007. By 2008, India is expected to overtake the US in the number of telecom subscribers. By 2010, the subscribers’ list is expected to stretch to 500 million. Studies estimate that the corresponding investment required to meet this growth would be $25-30 billion. FDI is thus imperative to fund such a huge investment.

Growth in the electronics and electrical sector is increasing with the consumer boom in the country. It is a high import-intensity industry. From the present level of manufacturing worth $14 billion of electronic and electrical goods, the industry is poised for manufacturing worth $32 billion in 2011, according to a Gartner study. Consumer electronics will account for biggest share with 39 per cent, followed by communication and data processing with 38 per cent and 12 per cent shares respectively. Semiconductor consumption will double from $2.6 billion in 2006 to $7.2 billion in 2011. The electronics and electrical sector is the largest recipient of FDI. With the rise in rupee value, and its cascading impact on input costs for these high import-intensive industries, the industry could attract greater FDI flow.

The automobile industry is riding the crest of the growth boom. India is the world’s second largest producer of two-wheelers, the fourth largest manufacturer of commercial vehicles and the eleventh largest passenger car maker. It is expected to become the third largest automobile market by 2030, according to US-based consultancy firm Keystone.

The auto component industry saw galloping growth in the last seven years. From a $8-billion market in 2002-03, the industry grew to become a $18-billion market in 2006-07. The industry expects the market to be worth $40-50 billion by 2030.

Correspondingly, investment surged in the auto component industry. It grew from $2.6 billion in 2002-03 to $5.4 billion in 2006-07. The investment commission has set a target of $5-billion investment in the auto component industry over the next five years. The upswing in the rupee value is unabated. The government is perhaps hesitant to intervene strongly against the rise in the rupee from the long-term perspective. The Finance Minister has advised exporters to live with a strong rupee. Strong rupee yields more windfalls than impediments.

The surging growth in the economy is investment-driven. Public sector investment is shrinking in the wake of fiscal responsibility obligation, while domestic private investment is cautious in the wake of growing competition. Under these circumstances, FDI is a key source for economic development.

(The author is Adviser, Japan External Trade Organisation, New Delhi.)

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