Importance of foreign investments in India

Recently crowned as World’s 3^rd largest economy by the Organisation for Economic Cooperation and Development (OECD), is the Indian economy already trembling?

The financial crisis in global markets has made the outlook of Indian economy grim. While the consistently volatile markets and the rupee plunging to an all-time low against the USD are some major concern at this moment, natural calamities and economic scandals seem to be the icing on the cake. Two decades ago, in the early 90’s, India faced a similar crisis. At that time India’s major concerns were the problem in balance of payments and poor foreign exchange reserves.

During the crisis, Dr. Manmohan Singh, the Finance Minister of India at that time, came up with a solution to reform the Indian economy. He liberalized the economy by ending the license raj and gave rise to the phenomena of foreign investments in India. Thus, opening the gates for foreign players to come and invest in India.

*License Raj: A term used to describe the regulation of the private sector in India between 1947 and the early 1990s. In India at that time, one needed the approval of numerous agencies in order to set up a business legally.

Since then, foreign investments have been the backbone of the Indian economy and like the 90’s this time too, it would seem that foreign investments might be holding the magic wand that may be able to pull India out of the current economic slump.

Foreign investments are flows of capital from one nation to another in exchange for significant ownership stakes in domestic companies or other domestic assets. There are two types of foreign investments that play a major role in the growth of Indian economy; Foreign Direct Investments (FDI) and Foreign Institutional Investments (FII).

FDI Inflows into India
*Data from Financial Year 2000-01 to 2012-13 (up to January 2013) Source data: Website of Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India

FDI

Foreign Direct Investments (FDI) is investment of foreign assets into domestic structures, equipment, and organizations. FDI inflows are into the primary market and do not include foreign investments into the stock markets. It is a long-term investment and is used by the developing countries as a source of their economic development, productivity growth, to improve the balance of payments and employment generation. Its aim is to increase the productivity by utilizing the resources to their maximum efficiency. Exit is relatively difficult in this phenomenon.

FII

Foreign Institutional Investments (FII) denotes all those investors or investment companies that are not located within the territory of the country in which they are investing. It is generally a short term investment and invests only in the financial assets. FII inflows are only into the secondary market with an aim to increase the capital inflows. Exit is relatively easier in FII.

While both the type of foreign investments are important for India but for a long term economic growth, Indian government should focus on FDI as compared to FII. As it has been proved that due to low exit barriers in FII, the foreign investors can exit from the Indian market whenever they want resulting in a crash in the Indian stock markets.

This calendar year as of (May - 2013) (source: PTI) India had received an FII inflow of more than $ 15 bn and the FII outflow for the month of June and July had already crossed $ 10 bn, resulting in an uncertainty in the markets. This clearly shows that FII inflows are not sustainable and can be redeemed anytime according to the will of the FIIs and the situations prevalent in their home countries.

So to prevent this uncertainty, it becomes necessary that the foreign money which comes to India should stay here for an adequate time, so that this money could help to promote economic and industrial development. This can only be achieved if the money comes via FDI route.

The Foreign-direct investments were seen sliding about 21% last fiscal. This is despite, the government passing a law in September 2012, allowing big retailers to open stores directly, yet none of the foreign dream-merchants have really taken the bet. Reasons being too many prerequisites, constraints on whom goods can be purchased from, a raft of regulations limiting franchise models and factory construction, and the infuriating need to negotiate separately with each of the states.

However the recent announcements by the government of India on 100% FDI in telecom & defence sector, 100% FDI in single brand retail & 51% FDI in multi brand retail and 49% FDI in Insurance give us some ray of hope for the economic development.

Moreover though this could be temporary slowdown or reversals in FII and FDI inflows based on interest rate cycles, flow of funds, global contagion etc, over the long term, given the nascence of many Indian businesses, the growth potential and 1.2 billion people pining for a taste of globalization, one could expect a kick-start of inflows in near future.