How is India’s inward FDI derived and how can it increase?

CEIC India Data Talk - April 17, 2015 India attracted net inward foreign direct investment (FDI) amounting to USD30.76 billion during the fiscal year ended March 2014, a 14.13% increase compared to the previous fiscal year. However, India’s FDI comprised just 1.48% of its GDP in 2014, comparing poorly with its regional neighbours, notably Singapore (24.6%), but also China at (2.92%) and Malaysia (2.81%). Given that equity direct investments remain one of the most popular sources of India’s FDI (comprising 82.16% of the total FDI inflows as of 2014), a comprehensive evaluation of these types of investments may provide a better understanding of how to improve India’s FDI flows. The government of India has long sought to attract FDI through various incentives. One of the key milestones in India’s foreign investment engagement came with its rationalisation of FDI procedures through the introduction of the “automatic route”. This provides a channel for foreign investors to bypass multiple approval processes for foreign investment activities. The automatic route allows foreign investors access to specified economic sectors without prior approval from the Foreign Investment Promotion Board (FIPB). This route reduces red tape and eases FDI inflows into India once non-residents obtain the requisite industrial licenses. Given the broadness of sectors covered by the automatic route, investments from this channel usually account for over 60% of total equity FDI (excluding a dip during 2007). Outside the automatic route, equity FDI may also come in the form of ordinary shares acquisition (or other instruments such as convertible debt), stock swaps or the FIPB route. The latter, also known as the “government route”, covers foreign investments where prior approvals from the FIPB are required (in addition to other relevant agencies). However, FDI via the automatic route saw two successive year-on-year (YoY) declines during the fiscal year ended March 2013 (-22.78% YoY) and 2014 (-6.88% YoY), in part due to weaknesses in the global economy. Overall equity FDI, however, grew by a modest 8.36% due to sharply improved inflows from the foreign acquisition of shares, which more than doubled during the 2014 fiscal year (rising 133% YoY). In the context of growth in equity FDI overall, amid decline in the automatic route investments (during the fiscal year ended March 2014), there are several possible interpretations. Increased appetite for foreign investments through share acquisitions may suggest a changing preference towards different foreign investment channels. A less benevolent view suggests possible downward trend in foreign direct investments being temporarily offset by a temporary surge in foreign share acquisition, as foreign investors seek to increase their stakes, especially in sectors without caps on foreign investments. Also salient in India’s foreign equity investment statistics is the investment country of origin. India has, effectively, gathered a significant portion of its FDI from Mauritius, accounting for more than 30% of foreign inflows (amounting to USD4.86 billion during the fiscal year ended March 2014) despite the relatively tiny economic size of Mauritius compared to other foreign investors (second is Singapore, followed by the United Kingdom, Japan and the Netherlands). This anomaly is largely due to the favourable taxation status of Mauritius and India. A comprehensive Double Taxation Avoidance Agreement between India and Mauritius, especially on capital gains, allows gains accruing on foreign investment being taxed only in Mauritius and at a favourable 3% rate. As such, a large portion of foreign direct investment originating from Mauritius is channelled through the country by non-Mauritian enterprises, including Oracle Global, Merrill Lynch and Vodafone. Due to the long-standing and unique relationship between India and Mauritius (including the Mauritian generous taxation regime), replicating these arrangements with other countries may not be a feasible means of promoting FDI. While the poor global economic climate has somewhat dented India’s ability to attract FDI, the latest data suggest that returns from its regulatory liberalisation in the 2000s may have peaked and that India must discover new ways to improve its FDI inflows, particularly through structural reforms and improvement in its infrastructure. More importantly, India must extricate itself from a “Catch-22” where it relies on FDI for enhancing its infrastructure and fostering growth yet requires enhanced infrastructure and credible growth prospects to attract these elusive FDIs in the first place. By Ian Lim - CEIC Analyst Discuss this post and many other topics in our LinkedIn Group (you must be a LinkedIn member to participate). Request a Free Trial Subscription. Back to Blog
17th April 2015 How is India’s inward FDI derived and how can it increase?

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