Is FDI the new engine of growth?: 

Is FDI the new engine of growth?: 

Context

FDI from private equity funds have mainly financed e-commerce firms. These have drove import-led consumption boom.

Discussion paper on Industrial Policy – 2017

• The official discussion paper (DP), Industrial Policy 2017 sets down a list of known constraints, but it ignores serious analyses of poor industrial performance.
• Discussing competitiveness, the policy paper makes very little reference to trends in global trade, or inadequate domestic industrial demand, falling capacity utilization or negative credit growth.
• Exception: Flagging the boom in foreign direct investment (FDI) inflows, the paper claims it as a badge of success for official policy. India is now ranked amongst top 3 FDI destinations (World Investment Report 2016) and ninth in the FDI Confidence Index in 2016.
• The official paper also pins hope on outward FDI to strengthen domestic industrial and services capabilities.

What does FDI inflow do for the economy?

• FDI (as against foreign portfolio investment, which flows into the secondary capital market) brings in long-term fixed investments, technology and managerial expertise, together with foreign firms’ managerial control.
• FDI in green field investment is for fresh capital formation, and in brown field investment for acquiring existing enterprises with the expectation of improving the firm’s productivity and profits.
• Despite rising FDI inflows, domestic capital formation rate, or industrial capacity utilization, have declined.
• Drawback: FDI does not come from leading global producers of goods and services, but from shadow banking entities such as private equity (PE) funds.

About Private Equity (PE) funds

• These funds are used to finance retail trade of mostly imported consumer goods to expand their market shares, in order to boost the firm’s market valuations.
• Since PE investments are highly leveraged (high debt-equity ratios), rising markets valuations help them reap disproportionate gains when they make their exit.
• PE firms do not commit to fresh capital formation or invest in technology, as expected of FDI.

Where is the outflow going?

• India is being used as a conduit for routing international capital for tax arbitrage.
• Inward and outward FDI flows across emerging market economies are highly correlated, responding to the US policy rate.
• Inward and outward FDI flows apparently represent channeling of global capital via India to take advantage of tax concessions.
• Hence, such short-term foreign capital movements in and out of the country may contribute little to augment domestic capability.

Contribution of FDI in question

• If the foregoing arguments and evidence are valid, then recent FDI flows have contributed little by augmenting domestic capabilities, output and employment growth.
• Inward FDI, increasingly from PE funds, has largely financed e-commerce firms, driving import-led consumption boom.
• Outward FDI, instead of enabling domestic enterprises to access external markets and technology, has instead helped international capital to take advantage of India’s tax treaties to optimize tax burden of global firms.

Conclusion

The proposed industrial policy needs to look elsewhere, other than FDI to realize the vision of Make In India.