C P Chandrasekhar & Jayati Ghosh

The euphoria over foreign investments is misplaced

Easing FDI norms have aided services exports istock   -  istock/alexmillos

Foreign investors in India have focussed on the domestic market and failed to deliver any boom in manufactured exports

Recently, Commerce Minister Suresh Prabhu declared that India is doing well on the foreign direct investment front and that he is confident of raising the annual inflow of FDI from around $40 billion to $100 billion by 2020. This meant that he considers more FDI as necessarily a good thing. But he simultaneously said that he is not happy with the level of India’s exports. He did not seem to think that there could be a contradiction between these two positions.

The neo-liberal reform agenda adopted since 1991 sought to attract foreign direct investment on the grounds that, by modernising Indian manufacturing, linking it to global production chains and raising exports, it would drive much-needed industrial growth. In fact, a much-touted indicator of the success of liberalisation is the flow of foreign investment into the country. Both balance of payments data and firm-based evidence are cited to back that claim.

In the latter category, are the data collected as part of the censuses of foreign assets and liabilities of the corporate sector. The Reserve Bank of India released the results of a dedicated census of India’s foreign assets and liabilities in the year ending March 1997, with comparative figures for 1992, which cover the years immediately after liberalisation began.

Since then, data collection of foreign assets and liabilities has been based on an annual reporting requirement. Initially that was not mandatory, but starting from 2010-11, such reporting has been made mandatory for Indian companies that received foreign direct investment or made direct investments overseas. Data from those annual censuses, which are comprehensive despite some shortfalls in reporting, have been published in RBI publications and on its website for the years starting from 2012-13.

The census relating to 1997 showed the dramatic impact on FDI inflows of liberalisation, which relaxed rules on inward FDI, removed investment ceilings in most sectors, and replaced the regulatory Foreign Exchange Regulation Act with a more accommodative Foreign Exchange Management Act geared to promoting foreign investment.

Not only did the foreign liabilities of the corporate sector in the form of direct investment in equity increase from ₹679 billion in 1992 to ₹1,713 billion in 1997, but portfolio investors’ equity holdings increased from ₹15 billion in 1992 to ₹456 billion in 1997 (Chart 1).


Since then, despite the South-East Asian crisis and the global financial crisis, foreign direct investment in (reporting) Associate Companies and Foreign Subsidiaries (those in which a single investor holds more than 50 per cent of equity) rose to ₹2,528 million in 2012-13 and ₹5,261 million in 2017-18. That, however, was the figure in terms of the face value of the shares.

Since these were the years when liberalisation set off a boom in stock markets, the market value of that equity stood at ₹11,247 billion in 2012-13 and rose to ₹26,851 billion in 2017-18 (Chart 2). These companies were doing well in terms of valuation, even if not always in terms of profitability.


The evidence from the annual censuses suggest that foreign investors were making use of the opportunities provided by liberalisation in one significant way. They were now opting for majority equity control rather than participating in joint ventures in which Indian partners held the majority, as was the case earlier.

In 2012-13, of the 11,232 firms that reported that they had received inward foreign direct investment, already 7,528 (or 67 per cent) were foreign subsidiaries and not associate companies. In 2017-18, of the 18,549 firms reporting, 15,596 (or 84 per cent) were foreign subsidiaries. Thus, foreign investors were clearly exploiting the opportunity provided by the less regulated and liberalised foreign investment environment to reap profits and make capital gains.

Advantage services sector

However, India does not seem to have registered the expected gains from foreign investment. To start with, measured in terms of revenues, the growth driven by foreign investment seems to have been greater in the services sector rather than in manufacturing.

In 2013-14, manufacturing firms accounted for 64 per cent of the value of sales by foreign subsidiaries, and services sector firms for 33 per cent. By 2017-18, manufacturing firms saw a decline in share in sales to 52 per cent, while services firms increased their share to 44 per cent (Chart 3).



It has been argued that this should not be a cause for concern, so long as productivity in services is high and that sector is growing based on exports to the world market.

Evidence from elsewhere does suggest that the revenue per worker in the more rapidly growing services sectors is high. And the RBI censuses indicate that the export intensity of services tends to be high as well.

The ratio of exports to sales of foreign subsidiaries in manufacturing stood at 21.1 per cent in 2012-13, whereas that in services was as high as 52.9 per cent. So, services could be the export-led driver of growth (Chart 4).


However, this was not the principal objective of reform; rather it was claimed would redress the failure to industrialise resulting from misconceived state intervention involving protection and physical controls on capacity creation and production.

Moreover, the export success in the services area has been extremely skewed. The exports to sales ratio in the information and communications sector was 72.5 per cent in 2017-18, way ahead of other sectors in services, many of which delivered non-tradable services.

There is evidence to show that the linkage effect with the rest of the economy of information and communication services is lower than that of many areas of manufacturing. Thus, services exports tend to generate enclaves with limited spillovers to other sectors.

Further, while the services share in the sales of foreign subsidiaries has risen since 2012-13, the export to sales ratio of services firms has fallen from 52.9 per cent in 2012-13 to 47.9 per cent in 2017-18.

So the services export boom is fragile because of dependence mainly on one sector, and its impact on the rest of the economy has been limited — and now there are also some signs that the boom is waning.

In sum, the RBI censuses of foreign assets and liabilities of companies suggest that the euphoria generated by the large inflows of foreign capital, including foreign direct investment, may be somewhat misplaced.

It diverts attention from the fact that the objectives of government’s neo-liberal economic reform programme, within which it chose to woo foreign investors, have not been achieved.

Foreign firms in manufacturing largely cater to the domestic market, partly in keeping with their global strategy. They have done well under liberalisation, as the market value of their equity shows. But they have not delivered the expected boom in manufacturing exports.

Published on March 11, 2019

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