India is in need of both FIIs and FDIs, to grow at the targeted 7.5 to 8 per cent growth. They go to countries with high growth potential and laws that are flexible and allow greater investor freedom. India is constrained by certain important considerations related to the rights of the people and protection of the poor.
The recent upheaval in the stock market has been disturbing news. It recovered temporarily and gained nearly 2 per cent on May 7. But again there was a big fall on May 12. There have been massive sell offs by foreign institutional investors (FIIs) that have caused gyration in the Sensex and Nifty ; as a result both the stock indices have fallen drastically.
Withdrawals by FIIs from the Indian stock market have amounted to over Rs 10,000 crore since mid- April. Of course, India is not alone in experiencing stock market volatility because FIIs have been fleeing Emerging Market Economies in the recent past and their stock markets have also experienced sharp falls. The recent stock market fall has led to weakening of the rupee.
In India, the reasons for FIIs leaving are: rising global oil prices, the disappointment about the progress of economic reforms and the sagging bottom lines of the corporate sector. It could also be due to the fact that the US Federal Reserve will most likely raise interest rates on the back of an economic recovery which is attractive to investors.
Another cause is the recent announcement by China to launch around 30 new IPOs (Initial Public Offerings) which is making the FIIs flock to the Chinese stock market and withdrawing from elsewhere. The FII withdrawals are also due to the proposed retrospective imposition of the Minimum Alternate Tax. It is probably one of the most important reasons because as soon as the government announced a reconsideration of the tax policy and the appointment of a high level committee, the stock market bounced back. On May 11, the government further announced that it will be easing up its demands on the payment of MAT, but even so the stock market remained volatile.
The agricultural situation, weak monsoon forecast and the resultant stress in the rural economy with its adverse impact on GDP growth is also one of the factors behind the scepticism shown by the FIIs regarding India's growth prospects.
The rupee's fall as result of the withdrawals may help India's sagging exports but imports will be more expensive which can cause problems since oil and gold prices are inching up. There is much apprehension regarding the two major bills now pending in the Rajya Sabha — the land acquisition bill amended by the Modi government and the GST or the Goods and Services Tax Bill. Both these are important for improving the perception of India as a desirable investment destination and both are important steps towards the big ticket reforms promised by the NDA government.
In any case, FIIs are fickle by nature and tend to park their funds in countries that promise lucrative short term gains. India has had problems with FIIs floating in and out in the past also and that is why Foreign Direct Investment (FDI) has been the more favoured source of investment.FDI also involves transfer of technology and R& D that India needs. Prime Minister Narendra Modi in his trips abroad has targeted potential investors strongly and promises were made to make India an easier place for doing business and setting up manufacturing units.
Fortunately, FDI has been flowing in without much problem. Perhaps it is the perception of a strong and stable government committed to reforms that has increased the flow but the FDI flows after having slowed down in 2012 and 2013, increased quite significantly in 2014. According to 'fDi Markets', a Financial Times data service, India received $23 billion in capital expenditure on inward investment projects in 2014 capturing 9 per cent of market share in Asia-Pacific. Inflows of FDI to China were however much higher at $75 billion witha 30 per cent market share. India saw a 47 per cent increase in the number of projects at 641 in 2014 while China's projects numbered 932, indicating an increase of only 4 per cent.
The interest of foreign investors has been due to the revised GDP forecasts by the IMF at 7.5 per cent. The IMF chief praised the Modi government for its efforts at reducing the budget deficit and planning a huge increase in investment in infrastructure.
Gujarat has been the most successful state in attracting FDI and the most important investors in the past five years have been IBM, Volkswagen, Toyota, Deutsche Post and General Electric. Among the investing countries, the US has been the most important investor and others among the top five are UK, Japan, Germany, and the UAE.The most attractive sectors have been IT and business services and also manufacturing. India is likely to be moreattractive for setting up manufacturing units by foreign investors. India's giant consumer market is an additional attractionespecially if the GST comes into force which will make India a giant territory involving free trade. Some investors are also interested in manufacturing in India and exporting goods abroad. India could gradually replace China as the manufacturing hub of the world because China's economic growth is slowing and production costs are rising.
But the increase in FDI flows should not make us smug because there are many gaps to be filled specially in the social sector and infrastructure. Access to good education and healthcare by the population and skill developmentfor youth, have to be improved to make India's labour force efficient and disciplined. Otherwise instead of increasing job opportunities foreign investors will choose the use of more of robotics and IT resulting in very little increase in employment. The past trend of jobless growth can be reversed only if labour is more productive and skilled.
India is in need of both FIIs and FDIs to grow at the targeted 7.5 to 8 per cent growth. They go to countries with high growth potential and laws that are flexible and allow greater investor freedom. But India is constrained by certain important considerations related to the rights of the people and protection of the poor. As a result, it cannot open up fully to foreign investors. On the other hand, there are very few countries in the world that are growing as fast and have such vast human and material resources.
(The writer is a Senior Fellow at Observer Research Foundation, Delhi)
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David Rusnok Researcher Strengthening National Climate Policy Implementation (SNAPFI) project DIW Germany
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