FDI Flows Into India Hit 5-Year Low In 2023-24: Is The Decline An Economic Dilemma Or A Temporary Blip?

Foreign Direct Investment (FDI) flows into India has hit a five-year low, touching $44.4 billion in the fiscal year 2023-24. This marks a steady decline from the $59.6 billion recorded in 2020-21. According to the Reserve Bank of India (RBI), net FDI flows, which account for outbound investments as well, were $2 billion in the fourth quarter of 2023-24, down from $6.4 billion a year earlier. Despite the decline in FDI, foreign portfolio inflows were notably higher.

The drop in FDI is not an isolated incident. Globally, FDI flows have been affected by rising interest rates in developed countries, particularly in the US, where rates have surged by more than five percentage points. This increase in the cost of capital has reduced the appeal of investing in emerging markets. China, too, has seen a decline in FDI flows. However, dismissing India's FDI reduction as a mere blip would be imprudent.

Interestingly, India registered a current account surplus in the last quarter of 2023-24, a deviation from the usual current account deficit (CAD). The CAD represents the extent to which foreign savings supplement domestic savings to achieve higher investment levels. During 2023-24, India's CAD moderated to $23.2 billion (0.7% of GDP) from $67.0 billion (2.0% of GDP) the previous year, primarily due to a lower merchandise trade deficit. This indicates a reduced ability to absorb external savings, suggesting flagging economic momentum despite a robust initial estimate of 8.2% GDP growth in 2023-24.

A closer look at the sectors attracting FDI reveals that computer software and hardware remain the top draws for global investors, receiving over five times the $1.5 billion that flowed into the automobile sector. This trend indicates that India's manufacturing plans, boosted by subsidies under the production-linked incentive (PLI) scheme, are not attracting as much investment as anticipated.

The preference of foreign capital for portfolio inflows over stable direct investment raises concerns. Portfolio inflows are driven by the allure of India's buoyant asset markets, which are perceived to offer lucrative short-term returns. However, the reluctance to commit to long-horizon direct investments reflects a lack of confidence in India's economic conditions and policy framework. This disparity is less than a ringing endorsement of India's economic climate and requires urgent attention.

To reverse the declining FDI trend, the Indian government needs to address several key hurdles. Firstly, low and convergent import tariffs across all sectors would facilitate the integration of local factories into global supply chains. Simplifying the import tariff structure would provide a stable and predictable tax regime.

India must also dispel the perception that its enforcement and intelligence agencies serve political ends. A neutral and transparent administrative framework would enhance investor confidence. The government should strive to ensure that no industrial group is perceived as having undue advantage.

Joining more free trade agreements could stimulate export-oriented investments, further integrating India into the global economy. Additionally, addressing concerns of social instability, which may arise from uneven economic benefits, is crucial. Ensuring inclusive growth and reducing disparities would create a more stable and attractive investment environment.

In addition to immediate measures, long-term reforms in education, healthcare, and governance are essential for sustainable growth. Improving the quality of education and healthcare services would enhance human capital, making India a more attractive destination for FDI.

The decline in FDI flows into India is a multifaceted issue that cannot be attributed to a single factor. While global economic conditions play a significant role, domestic policies and economic strategies are equally important. By addressing the identified hurdles and implementing comprehensive reforms, India can position itself as a preferred destination for foreign direct investment, driving long-term economic growth and development.

*Inputs from Mint*