The Reality Behind Falling Net FDI

UPSC Syllabus: Gs Paper 3- Indian economy

Introduction

India’s net Foreign Direct Investment (FDI) has declined sharply despite strong gross inflows. The debate often focuses on headline numbers, but this overlooks the composition of FDI and the Balance of Payments (BoP) framework governing inflows and outflows. Different investor types, capital repatriation, outward investment and associated payment obligations provide a more complete picture of the real impact of FDI on India’s economy.

Trends in India’s Net and Gross FDI

1. Sharp decline in net FDI: Net FDI fell from $44 billion in 2020-21 to less than $1 billion in 2024-25. It recovered to $7.6 billion in 2025-26, while gross inflows reached $94.6 billion.
2. BoP-based calculation of net FDI: Net FDI is measured by adjusting inflows against outflows and capital repatriation. Therefore, high gross inflows do not automatically translate into high net FDI.
3. Shift in policy priorities: The 1991 FDI policy focused on technology acquisition, export promotion and foreign exchange conservation. Over time, greater emphasis was placed on attracting larger inflows.
4. Neglect of investment quality concerns: As inflow targets gained importance, concerns regarding future payment obligations and the quality of investments received less attention.

Understanding the Nature and Composition of FDI

1. Three distinct categories of FDI: FDI is not a uniform form of investment. It consists of Real FDI (RFDI), Financial Investor FDI, and Diaspora/SPV investments, each having different objectives, capabilities and exit timelines.
2. Real FDI (RFDI): This category consists of multinational enterprises that bring technology, brands and production capabilities. These investments generally represent long-term commitments to production and services.
3. Financial Investor FDI: Private equity funds, venture capital firms, sovereign wealth funds and asset managers mainly seek capital appreciation. Their investments are usually linked to planned exits and future capital repatriation.
4. Diaspora and SPV investments: These investments involve capital raised abroad and routed through offshore financial centres. They may also include the round-tripping of Indian funds.
5. Changing composition of inflows: Between 2022-23 and 2025-26, RFDI accounted for 41.9% of effective inflows, while financial investors contributed 40.5% and diaspora/SPV investments 17.6%.
6. Declining manufacturing-oriented FDI: Manufacturing FDI has declined across three consecutive four-year periods. RFDI in manufacturing accounted for only 10.6% of total effective inflows during the latest period.

Why Gross FDI Figures Can Be Misleading

1. Mixing fresh capital with accounting changes: Gross FDI figures include ownership restructuring, mergers, share swaps and debt-to-equity conversions. These transactions change ownership structures without bringing fresh capital into India.
2. Impact of non-equity instrument conversions: Earlier instruments such as External Commercial Borrowings (ECBs) and convertible debentures can be converted into equity. Such conversions increase recorded FDI without generating new inflows.
3. Overstatement of actual inflows: About $40 billion out of $560 billion in recorded equity inflows between 2014-15 and 2025-26 resulted from ownership restructuring, mergers, share swaps and debt conversions. These transactions increased recorded FDI without bringing new foreign capital into the country.
4. Distortion of annual trends: Large corporate transactions can significantly affect yearly FDI statistics. Such transactions may create a misleading impression about sectoral performance and investment trends.

The Real Causes Behind Weak Net FDI

1. Disinvestment is the main driver: Weak net FDI is primarily linked to disinvestment and capital repatriation. These transactions are recorded in the financial account and directly reduce net FDI.
2. Profit repatriation affects CAD, not net FDI: Dividend payments are recorded as investment income in the current account. They increase the Current Account Deficit (CAD) but do not reduce reported net FDI.
3. Capital repatriation through investor exits: Financial investors often exit after earning returns, leading to large outflows. For example, Temasek earned $6.4 billion from an investment of $637 million in Schneider Electric India after exiting in 2025.
4. Rising divestment activity: Total recorded divestment reached $52 billion in 2025. This has become an important factor behind declining net FDI figures.

Rising Outward FDI and Expanding Capital Outflows

1. Growth in Outward Foreign Direct Investment (OFDI): Between 2023-24 and 2025-26, India’s outbound investment reached $65 billion. Nearly 45%went to the financial, insurance and business services sector.
2. Routing through financial centres: Singapore received 27% and the UAE 11% of India’s outbound investment. Much of this money went to holding companies and Special Purpose Vehicles (SPVs).
3. Nature of outbound investment: A significant share of OFDI was directed towards financial entities rather than operational businesses. This requires closer examination of its ultimate use.
4. Possibility of capital recycling: Outward investment may reflect genuine global expansion and technology acquisition, but some flows may also represent capital moving through different jurisdictions.
5. Growing current account payments: Dividend remittances reached $118.9 billion, while Intellectual Property Rights (IPR) payments (patents, trademarks and technology usage) totalled $46.6 billion. These royalty payments can sometimes substitute dividends.
6. Rising outflow burden: Even excluding OFDI and technical service payments, total outflows reached $344.4 billion. For every dollar of fresh inflow, nearly $1.50 flowed out.

Conclusion

Net FDI cannot be assessed solely through headline inflow figures. The type of investor, nature of investment, exit strategy and associated outflows influence technology transfer, industrial growth and external sustainability. A more informed assessment requires examining FDI composition, capital repatriation and external payment obligations alongside gross inflow data.

Question for practice:

Discuss the reasons behind the decline in India’s net Foreign Direct Investment (FDI) despite strong gross inflows, and explain why headline FDI figures may not reflect the true impact of foreign investment on the economy.

Source: The Hindu