From UPSC perspective, the following things are important :
Prelims level : Not much
Mains level : Paper 3- What explained increased total FDI in Indian?
The article analyses the factors contributing to the claim of 10% rise in total Foreign Direct Investment in 2020-21 and its impact on economy.
Making sense of increased FDI
- Total foreign direct investment (FDI) inflow in 2020-21 is $81.7 billion, up 10% over the previous year, reported a recent Ministry of Commerce and Industry press release.
- The short press release highlighted industry and State-specific foreign investment figures without detailed statistical information.
- The Reserve Bank of India (RBI) bulletin, which was released a week earlier, has the details.
What explains increased gross inflows
- The gross inflow consists of (i) direct investment to India and (ii) repatriation/disinvestment.
- The disaggregation shows that direct investment to India has declined by 2.4%.
- Hence, an increase of 47% in “repatriation/disinvestment” entirely accounts for the rise in the gross inflows.
- In other words, there is a wide gap between gross FDI inflow and direct investment to India.
- Similarly, measured on a net basis (that is, “direct investment to India” net of “FDI by India” or, outward FDI from India), direct investment to India has barely risen (0.8%) in 2020-21 over the last year.
- What then accounts for the impressive headline number of 10% rise in gross inflow?
- It is almost entirely on account of “Net Portfolio Investment”, shooting up from $1.4 billion in 2019-20 to $36.8 billion in the next year.
- That is a whopping 2,526% rise.
- Further, within the net portfolio investment, foreign institutional investment (FIIs) has boomed by an astounding 6,800% to $38 billion in 2020-21, from a mere half a billion dollars in the previous year.
- This explains the surge in gross FDI inflows which is entirely on account of net foreign portfolio investment.
How FDI is different from FII
- FDI inflow, in theory, is supposed to bring in additional capital to augment potential output (taking managerial control/stake).
- In contrast, foreign portfolio investment, as the name suggests, is short-term investment in domestic capital (equity and debt) markets to realise better financial returns.
- But the conceptual distinctions have blurred in official reporting, showing an outsized role of FDI and its growth in India.
How FPI distorted equity markets?
- The deluge of FII inflow did little to augment the economy’s potential output.
- It added a lot of froth to the stock prices.
- When GDP has contracted by 7.3% in 2020-21 on account of the pandemic and the economic lockdown, the BSE Sensex nearly doubled from about 26,000 points on March 23, 2020 to over 50,000 on March 31, 2021.
- BSE’s price-earnings (P-E) multiple — defined as share price relative to earnings per share — is among the world’s highest, close behind S&P 500 in the U.S.
FDI inflow’s contribution to domestic output
- As Figure below shows, between 2013-14 and 2019-20, the ratio of net FDI to GDP has remained just over 1% (left-hand scale), with no discernible rising trend in it.
- The proportion of net FDI to gross fixed capital formation (fixed investment) is range-bound between 4% and 6%.
- These stagnant trends are evident when the economy’s fixed investment rate — gross fixed capital formation to GDP ratio — has plummeted from 31.3% in 2013-14 to 26.9% in 2019-20 (right-hand scale).
- Thus, FDI inflow’s contribution to domestic output and investment remains modest.
The flood of FIIs has boosted stock prices and financial returns. These inflows did little to augment fixed investment and output growth.