FDI and Economic Growth: Imperatives for India
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FDI and Economic Growth: Imperatives for India

By Kiran Bhatt
 Department of Geopolitics and International Relations, Manipal Academy of Higher Education, India

FDI and Economic Growth: Imperatives for India

The second half of the twentieth century witnessed the growth of Multinational and Transnational Corporations (MNCs and TNCs) based mainly in the developed western world. However, the extensive growth of these corporations led to the emergence of fear in the developing countries, a majority of whom were newly independent of decades of colonial oppression. These MNCs and TNCs carried out economic activities across borders, this raised the fear of losing sovereignty of the host nations. 


One of the popular ways in which foreign firms are allowed to indulge in the economic activities of a nation is through the process of Foreign Direct Investment (FDI). According to Frank (1980), “FDI is the flow of equity capital into a subsidiary where the foreign investor (or TNC/MNC) has a controlling interest.” The FDI as a process is a beneficial mechanism for both the countries, the source/home country as well as the host country. The inflow of capital benefits countries with limited domestic resources. The increased capital inflow when coupled with the introduction of newer technologies can be diffused with the local economy. This could result in the enhanced efficiency of a particular industry. Thus, when a country aims to increase its FDI inflow, it also boosts the manufacturing and service sectors which can employ both skilled and manual labor. This rise in employment translates into income which enhances the economy of a country.  


The Indian Scenario


In the Indian scenario too, the FDI has been attributed a major role in economic development, wherein the volume of FDI inflow and level of economic development are positively related to each other. Coming out of the harsh experience of colonial oppression for nearly two hundred years, the Indian government was reluctant to allow FDI inflow during the initial decades after gaining independence in 1947. But since then, there has been a gradual shift towards liberalizing the economy where 100 percent FDI is allowed in some selected sectors. The FDI as a process is beneficial for a developing country like India as it helps in the transfer of technology from developed economies, brings in more capital investments, enhances the labor market and employment opportunities to name a few. Further, the governments also benefit through the increase in tax revenue generated by the economic activities initiated by the FDI inflow. 


After gaining independence in 1947, India adopted a socialistic pattern of economic development. The policy was known for its methods of centralized planning, government control, permits, and regulations. The economic policy was largely influenced by the Soviet Union, which was the primary factor to follow the five-year planning method. The collapse of the Soviet Union which was India’s largest trading partner and the hike in oil prices due to the Gulf War resulted in the balance of payment crisis. As a result of which India went to the International Monetary Fund seeking a bailout loan, which demanded reforms in return. In 1991, under the prime ministership of P.V. Narasimha Rao, measures of economic liberalization were initiated, moving away from the protectionist policies that were being followed post-independence.


Impact of economic liberalization on the FDI inflow


India had limited FDI inflow prior to the economic reforms. But the reforms due to the 1990-91 crisis bought in the liberalization process. The FDI inflow into India reached historic heights after the reforms. This increase in the inflow also contributed to economic growth significantly. India has successfully emerged as one of the economic superpowers in Asia post the liberalization measures. The substantial increase in FDI inflow in the post-reform period can be claimed as a positive spillover of the economic reforms.


The FDI is seen as one of the important tools to facilitate the growth of an economy. But is there a relationship between the FDI inflow a country receives and the relationship between the source and the host country? There are two possibilities of looking into the matter – one, how do the relationships help to get the FDI; and the other, how does the FDI help in building up the relations. Mechanisms like bilateral investment treaties, bilateral tax treaties, and bilateral political relations can be used to verify the existence of any such relations between the volume of FDI inflow and the kind of relations that the countries share.


Bilateral Investment Treaties (BITs) provide a binding commitment of protection and satisfactory treatment of foreign investors which function as catalysts to reduce the risk perceived by the source country and increases the inflow for the host country. Generally, these BITs signed by the partnering nations provide the source or home country a substitute for improved institutional quality as it might take a longer time to improve the quality of institutions and policies. Even in India’s case, the BITs have played a favorable role and have contributed to the rising level of FDI inflow into India in the post-liberalization period. 


The existence of a conducive business environment is one of the requirements for attracting FDI inflows. The countries which aim to increase their share in the world FDI inflow opt to redesign their tax structure and system which brings global competitiveness. The Bilateral Tax Treaties are one such mechanism whose implementation solves the problem of international double taxation. Under section 90 of the Indian income tax act, India has entered into Double Taxation Avoidance Agreements or bilateral tax treaties with other countries. The major objective of such an initiative is the protection of taxpayers against double taxation. This acts as an incentive to encourage FDI inflow in the economy. The absence of such a treaty could have proven to be a hurdle for the free flow of capital and transfer of technology from various parts of the world.


The relationship between the volume of FDI and political relations is bidirectional. Firstly, when countries are having a cordial political relationship among them, the situation is supportive of trade and FDI exchange. Secondly, some large entrepreneurs and corporations exert pressure on their home country to allow FDI inflow or outflow by enhancing the relations with the desired country. The second case is an example wherein FDI can be claimed as a catalyst to develop relationships with new countries. Further, the signing of the BITs between states are also dependent on the political and diplomatic relationships between the states.


Where does India Stand?


The Asian countries are some of the largest shareholders in world trade. In terms of attracting FDI, India and China are seen as fierce competitors over the years. Though India is consistently performing well in getting its share in the world FDI inflow, several South and Southeast Asian economies have emerged as strong competitors. The lower labor costs and lucrative domestic markets were seen as India’s main competitive advantage. But the aforementioned economies are also developing the advantage. Though the Indian government has taken several measures to improve the FDI inflow, there are a few areas where India needs to focus on in order to stay in the race. 


The impact of COVID-19 has resulted in economic instability, both domestically and globally. It was during the pandemic; the Indian Government came up with certain amendments to the FDI Policy. The 2020 Amendment aims at curbing the opportunistic takeovers or acquisition of Indian Companies suffering due to the COVID-19 pandemic. Although, the changes do not indicate any specific country, the clause which mandates prior approval for investors hailing from countries that share land boundaries is interesting. Of the seven countries that India shares its land borders, China is the largest investor. Hence, this particular amendment appears to be targeting Chinese investment, especially ownership of portfolio investors who typically target to invest in listed securities. Given the Sino-India border skirmishes, the move holds political motive too.


It is amidst the pandemic, India launched its Atmanirbhar Bharat Abhiyan initiative to attain self-reliance. The campaign calls for developing the local manufacturing sector through campaigns such as ‘vocal for local’. Although in the long term, India aims to reduce its dependence on foreign countries for products, in the short term, FDI still plays a crucial role. The aim is not to curb the FDI inflow but rather develop manufacturing capacity at the domestic level. This would help India to cut down its imports while increasing its exports and capture a strong role in the global economy. The government sees FDI as an essential tool for growth, which is evident by the change in FDI cap for several industries including Defence Production. The overall objective should aim at the marketing of Make-in-India Products and promoting larger investments in areas such as infrastructure, skill enhancement, and effective utilization of technologies into small businesses to improve profitability. This could be beneficial for the source country through increased returns on investments as well as the host country due to the overall development of industries. 


India has witnessed enormous growth in the past two decades. But there is an issue with the growth that has been experienced. One can see that the resources in the urban areas are being over-utilized while the rural area is being neglected. The government has to come up with reforms to ensure balanced economic growth, such as incentivizing the foreign companies which are ready to invest in tier two and three cities. Another major issue that might hinder the smooth inflow of FDI into the country is, managing the political class. The countries which are coming from abroad require political support either directly or indirectly. In many cases, foreign investors are required to have good skill of persuasion to please the political class. The common ground between the foreign investors and the government is required to assess the requirements and bring in the necessary reforms which result in an increased inflow of FDI into the economy. 


The Indian government has taken several policy initiatives to encourage FDI inflow into the Indian economy. In the initial years post-independence, the government largely followed a protectionist attitude with limited opportunity for FDI in few selected sectors, but inflow is seen to gradually increase from the 1970s. With the onset of the liberalization era, the FDI inflow grew manifold, with a substantial increase witnessed during the early 2000s. The increase was halted during the Global Financial Crisis but later has started to recover. FDI might be one of the important sources and forces behind the economic development of India but it is not the sole solution for several other issues like poverty, unemployment, and other socio-economic issues.


About the Author:


Kiran Bhatt (ORCID: 0000-0002-0510-797X) is a Masters's Student at the Department of Geopolitics and International Relations, Manipal Academy of Higher Education, India.


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